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TMI Blog2013 (1) TMI 343X X X X Extracts X X X X X X X X Extracts X X X X ..... g operations. During the course of their banking business, the member banks used such deposits to advance loans to their clients. Hence, in the present case, with the funds of the mutuality, member banks engaged in commercial operations with third parties outside of the mutuality, rupturing the privity of mutuality , and consequently, violating the one to one identity between the contributors and participators as mandated by the first condition. Thus, in the case before us the first condition for a claim of mutuality is not satisfied. As the second condition demands that to claim an exemption from tax on the principle of mutuality, treatment of the excess funds must be in furtherance of the object of the club, which is not the case here. The surplus funds were not used for any specific service, infrastructure, maintenance or for any other direct benefit for the member of the club. The facts at hand also fail to satisfy the third condition of the mutuality principle i.e. the impossibility that contributors should derive profits from contributions made by themselves to a fund which could only be expended or returned to themselves. As in the present case, the funds do return to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that there was a lack of identity between the contributors and the participators to the fund, and hence treated the amount received by it as interest as taxable business income. On appeal by the assessee, the Commissioner of Income Tax (Appeals)-II, Bangalore ( CIT (A) for short) reversed the view taken by the assessing officer, and held that the doctrine of mutuality clearly applied to the assessee s case. On appeal by the revenue the Income- Tax Appellate Tribunal (for short the Tribunal ), affirmed the view taken by the CIT (A), observing thus (ITA No. 2440/Ban/1991): 7. In the instant case, the funds of the club are given in the form of deposits for earning income from the corporate members, namely, the banks here and, therefore, the earning of interest is clearly had risen out of the concept of mutuality only. The decisions relied upon by the DR have nowhere touch (sic) upon the fact as to whether it was with corporate members or not. Apparently, they had dealt with the situation where the transactions of interest are from persons who are not the members of the club. During the argument, the DR had admitted that the assessee had shown interest from certain other banks ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... complete identity between the contributors to the fund and the assessee and the recipients from the funds, in as much as the interest earned by the assessee from the surplus fund invested in fixed deposits with member banks are always available and are used for the benefit of members alike. It was asserted that there is no commercial motive involved in the dealings of the assessee with its members, including the banks concerned. It was also argued that the interest earned on such deposits with the member banks was always available for use and benefit of the members of the assessee, in as much as the said interest merged with the common fund of the club. 6. Mr. A.S. Chandhiok, learned Additional Solicitor General of India, on the other hand, contended that the fundamental principle for applicability of the doctrine of mutuality is a complete identity between the contributors and the participators, which is missing in this case. It was submitted that in the present case, the surplus funds in the hands of the assessee were placed at the disposal of the corporate members viz. the banks, with the sole motive to earn interest, which brings in the commerciality element and thus, the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y principle is by Lord Watson in the House of Lords, in 1889, in Styles (Surveyor of Taxes) Vs. New York Life Insurance Co.[[1889] 2 TC 460 ] (hereinafter referred to as the Styles case ). The appellant in that case was an incorporated company. The company issued life policies of two kinds, namely, participating and non- participating. The members of the mutual life insurance company were confined to the holders of the participating policies, and each year, the surplus of receipts over expenses and estimated liabilities was divided among them, either in the form of a reduction of future premiums or of a reversionary addition to the policies. There were no shares or shareholders in the ordinary sense of the term but each and every holder of a participating policy became ipso facto a member of the company and as such became entitled to a share in the assets and liable for a share in the losses. The company conducted a calculation of the probable death rate amongst the members and the probable expenses and liabilities; calls in the shape of premiums were made on the members accordingly. An account used to be taken annually and the greater part of the surplus of such premiums, over th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a mutual concern may be held to carry on a business or trade with its members, though the surplus arising from such trade is not taxable income or profit. 10. The High Court of Australia first considered the mutuality principle in The Bohemians Club Vs. The Acting Federal Commissioner of Taxation[(1918) 24 CLR 334] in 1918: A man is not the source of his own income ... A man s income consists of moneys derived from sources outside of himself. Contributions made by a person for expenditure in his business or otherwise for his own benefit cannot be regarded as his income ... The contributions are, in substance, advances of capital for a common purpose, which are expected to be exhausted during the year for which they are paid. They are not income of the collective body of members any more than the calls paid by members of a company upon their shares are income of the company. If anything is left unexpended it is not income or profits, but savings, which the members may claim to have returned to them. (Emphasis added) 11. One of the first Indian cases that dealt with the principle was Commissioner of Income-Tax, Bombay City Vs. Royal Western India Turf Club Ltd.[A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on a trade do so in such a way that they and the customers are the same persons, no profits or gains are yielded by the trade for tax purposes and therefore no assessment in respect of the trade can be made. Any surplus resulting from this form of trading represents only the extent to which the contributions of the participators have proved to be in excess of requirements. Such a surplus is regarded as their own money and returnable to them. In order that this exempting element of mutuality should exist it is essential that the profits should be capable of coming back at some time and in some form to the persons to whom the goods were sold or the services rendered.... * * * It has been held that a company conducting a members' (and not a proprietary) club, the members of the company and of the club being identical, was not carrying on a trade or business or undertaking of a similar character for purposes of the former corporation profits tax. * * * A members' club is assessable, however, in respect of profits derived from affording its facilities to non-members. Thus, in Carlisle and Silloth Golf Club v. Smith, (1913) 3 K.B. 75, where a members' golf club admitted non-memb ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t precisely in the proportions in which they have contributed to them and the association does not in any true sense make any profit out of their contributions. 18. Therefore, in the case of Royal Western India Turf Club Ltd. (supra), since the club realized money from both members and non- members, in lieu of the same services rendered in the course of the same business, the exemption of mutuality could not be granted. This Court held thus: As already stated, in the instant case there is no mutual dealing between the members inter se and no putting up of a common fund for discharging the common obligations to each other undertaken by the contributors for their mutual benefit. On the contrary, we have here an incorporated company authorised to carry on an ordinary business of a race course company and that of licensed victuallers and refreshment purveyors and in fact carrying on such a business. There is no dispute that the dealings of the company with non- members take place in the ordinary course of business carried on with a view to earning profits as in any other commercial concern. (Emphasis supplied) 19. The second feature demands that the actions of the p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... areholders - even if it limited to trading with them - makes a profit, that profit belongs to the shareholders, in a sense, but it belongs to them qua shareholders. It does not come back to them as purchasers or customers. It comes back to them as shareholders, upon their shares. Where all that a company does is to collect money from a certain number of people - it does not matter whether they are called members of the company, or participating policy holders - and apply it for the benefit of those same people, not as shareholders in the company, but as the people who subscribed it, then, as I understand the New York case, there is no profit. If the people were to do the thing for themselves, there would be no profit, and the fact that they incorporate a legal entity to do it for them makes no difference, there is still no profit. This is not because the entity of the company is to be disregarded, it is because there is no profit, the money being simply collected from those people and handed back to them, not in the character of shareholders, but in the character of those who have paid it. That, as I understand it, is the effect of the decision in the New York case." (Emphasis ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... act [Wilcock's case - 9 Tax Cases 111, (p.132); C.A. (1925) (1) KB 30 at p. 44 and 45]. 24. In Royal Western India Turf Club Ltd. (supra), this Court made similar observations, holding that it is not always the case that a legal entity cannot make profits out of its members. It held as follows : 14 The principle that no one can make a profit out of himself is true enough but may in its application easily lead to confusion. There is nothing per se to prevent a company from making a profit out of its own members. Thus a railway company which earns profits by carrying passengers may also make a profit by carrying its shareholders or a trading company may make a profit out of its trading with its members besides the profit it makes from the general public which deals with it but that profit belongs to the members as shareholders and does not come back to them as persons who had contributed them. Where a company collects money from its members and applies it for their benefit not as shareholders but as persons who put up the fund the company makes no profit. In such cases where there is identity in the character of those who contribute and of those who participate in the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aintenance or for any other direct benefit for the member of the club. These were taken out of mutuality when the member banks placed the same at the disposal of third parties, thus, initiating an independent contract between the bank and the clients of the bank, a third party, not privy to the mutuality. This contract lacked the degree of proximity between the club and its member, which may in a distant and indirect way benefit the club, nonetheless, it cannot be categorized as an activity of the club in pursuit of its objectives. It needs little emphasis that the second condition postulates a direct step with direct benefits to the functioning of the club. For the sake of argument, one may draw remote connections with the most brazen commercial activities to a club s functioning. However, such is not the design of the second condition. Therefore, it stands violated. 28. The facts at hand also fail to satisfy the third condition of the mutuality principle i.e. the impossibility that contributors should derive profits from contributions made by themselves to a fund which could only be expended or returned to themselves. This principle requires that the funds must be returned to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e the entity of the company is to be disregarded, it is because there is no profit, the money being simply collected from those people and handed back to them, not in the character of shareholders, but in the character of those who have paid it. That, as I understand it, is the effect of the decision in the New York case." (Emphasis supplied) In the present case, the interest accrues on the surplus deposited by the club like in the case of any other deposit made by an account holder with the bank. 30. An almost similar issue arose in Kumbakonam Mutual Benefit Fund Ltd. case (supra). The facts in that case were that the assessee, namely, Kumbakonam Mutual Benefit Fund Ltd., was an incorporated company limited by shares. Since 1938, the nominal capital of the assessee was Rs.33,00,000/- divided into shares of Rs.1/- each. It carried on banking business restricted to its shareholders, i.e., the shareholders were entitled to participate in its various recurring deposit schemes or obtain loans on security. Recurring deposits were obtained from members for fixed amounts to be contributed monthly by them for a fixed number of months as stipulated at the end of which a fixed amou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd from non- members, for the same consideration by giving the same or similar facilities to all alike in respect of the one and the same business carried on by it, the dealings as a whole disclose the same profit earning motive and are alike tainted with commerciality. In other words, the activity carried on by the assessee in such cases, claiming to be a "mutual concern" or Members' club" is a trade or an adventure in the nature of trade and the transactions entered into with the members or non- members alike is a trade/business/transaction and the resultant surplus is certainly profit - income liable to tax. We should also state, that "at what point, does the relationship of mutuality end and that of trading begin" is a difficult and vexed question. A host of factors may have to be considered to arrive at a conclusion. "Whether or not the persons dealing with each other, is a "mutual club" or carrying on a trading activity or an adventure in the nature of trade" is largely a question of fact [Wilcock's case - 9 Tax Cases 111, (132) C.A. (1925) (1) KB 30 at 44 and 45]. (Emphasis supplied) 33. In our opinion, unlike the aforesaid surplus amount itself, which is exempt fro ..... X X X X Extracts X X X X X X X X Extracts X X X X
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