MUTUAL CONCERN |
Mutual Concern ID – 04 (JBC-075) |
Under the Income-tax Act what is taxed is, the “income, profits or gains earned or “arising”, “accruing” to a “person”. The question is whether in the case of a members’ club a species of mutual undertaking in rendering various services to its members which result in a surplus, the club can be said to “have earned income or profits”. In order to answer the question, it is necessary to have a background of the law relating to “mutual trading” or “mutual undertaking” and a “members’ club”.
In Halsbury’s Laws of England, Fourth edition, Reissue Volume 23, paragraphs 161 and 162 (pages 130 and 132), the relevant law is stated thus: “Where a number of persons combine together and contribute to a common fund for the financing of some venture or object and will in this respect have no dealings or relations with any outside body, then any surplus returned to those persons cannot be regarded in any sense as profit. There must be complete identity between the contributors and the participators. If these requirements are fulfilled, it is immaterial what particular form the association takes. Trading between persons associating together in this way does not give rise to profits which are chargeable to tax. Where the trade or activity is mutual, the fact that, as regards certain activities, certain members only of the association take advantage of the facilities which it offers does not affect the mutuality of the enterprise. Members’ clubs are an example of a mutual undertaking; but, where a club extends facilities to non-members, to that extent the element of mutuality is wanting. . . .’’.
Simon’s Taxes, Volume B, Third edition, paragraphs B1.218 and B1.222 (pages 159 and 167), formulate the law on the point, thus: “. . . . it is settled law that if the persons carrying 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. . . .”
The said principle which has been laid down in the leading decisions and emphasised in the leading English text books mentioned above, has been explained with reference to Indian decisions in “The Law and Practice of Income-tax” (Eighth edition, Volume I, 1990) by Kanga and Palkhivala at page 113, thus: “. . . . ‘The contributors to the common fund and the participators in the surplus must be an identical body. That does not mean that each member should contribute to the common fund or that each member should participate in the surplus or get back from the surplus precisely what he has paid. The Madras, Andhra Pradesh and the Kerala High Courts have held that the test of mutuality does not require that the contributors to the common fund should willy-nilly distribute the surplus amongst themselves: it is enough if they have a right of disposal over the surplus, and in exercise of that right they may agree that on winding up the surplus will be transferred to a similar association or used for some charitable objects. . . .”
No man can make a profit out of himself. Indian courts, in various cases has said "no man, in my opinion, can trade with himself, he cannot in my opinion make taxable profit by dealing with himself". This proposition which is obvious in respect of an individual is now applied for bodies of individuals, whether it is members club, co-operative institution, mutual benefit fund, a thrift fund or a pool.
Principle of mutuality is available even for companies In the case of CIT v. Royal Western India Turf Club the principle was applied to a race club in respect of moneys received from its members on the ground that incorporation is no bar to the principle of mutuality. Though in this particular case it was held that the company could be denied the benefit of mutuality, it was not because it was incorporated but it was only because it was largely dealing with non-members with the result that its dealings with members could not be isolated and made the subject matter of any separate deduction.
In CWT Rama Varma Club the club owned properties and afforded facilities to members for playing games like badminton, etc. No member had any right or interest in the property. The income was being applied for promoting the objects of the club. On dissolution, surplus if any was to be transferred to a club with similar objects. It was held that the club was not to be assessed as an individual. The implication is that the members do not derive any income and the club's income is exempt under mutuality. The fact that the guests were allowed to be entertained was not similarly considered to be a disqualification.
Such associations have surplus funds which they may invest with banks. Since the bank may not be a member of the association, could it be said that there is violation of the principle of mutuality ? The mere fact that surplus money was kept with third parties, and not with members and banks, cannot vitiate mutuality, especially where commercial character is lacking in such investments. Short term investments pending some long term legitimate use for the association or granting of staff loans cannot be treated as coming in the way of exemption. It may, however, be pointed out that if the amount involved is substantial, the decision could have been otherwise. There should be identity of the contributors and the beneficiaries or participants as they are called. Where the class of persons who have contributed are different from those who benefit from them, there could be no such identity. It is also possible that, some of the items like subscriptions and entrance fees may qualify for exemption on principle of mutuality, while others being service charges may not so qualify, where there are others from whom such charges are levied or where disparity between the contributors and the participants is marked. But it is equally established that there need be no identity in the sense of complete quid pro quo as between the contributors and participants as long as there is a broad indication with no different classes of persons. In other words, there is no stipulation that every contributor must also be a participant.
Bankipur club ltd. (supreme court of india)
The decision of the Supreme Court in CIT v. Bankipur Club Ltd. [1997] 226 ITR 97 has reiterated the general principles which have governed taxation of clubs, associations and other mutual concerns. The principle that no one can make a profit out of himself has long since been found to be applicable to a combination of persons with transactions confined as between themselves, so that there is complete identity between the contributors and the participators. Hence, one would not expect any fresh cases disputing the principle of mutuality and its applicability for tax purposes. But then in Bankipur Club's case [1997] 226 ITR 97 the Revenue sought to make an exception in respect of sale of drinks at the bar on the ground that it was tainted with commerciality having profit motive. The argument of the Revenue was that in cases of clubs and such associations, admission fee, subscriptions, etc., may be non-taxable but not commercial transactions and that it is not every receipt of such mutual association, which can have the character of mutuality. The Supreme Court found that the activities undertaken by these clubs by and large partake of the nature of the "usual privileges, advantages, convenience and accommodation". It would, therefore, not have the character of income.
chelmsford club vs. Commissioner of income-tax (sc)
In this case, though it was accepted that the club is a mutual association with benefits restricted to members, the Delhi High Court drawing support from observations made by it in an earlier judgement in CIT v. Delhi Gymkhana Club Ltd. [1985] 155 ITR 373 had inferred that in view of the statutory provision requiring assessment of property income on notional basis, such income if assessable under the head "Property" may well be taxable. The Supreme Court held that if the club were not a mutual association, it may well be liable on notional income, but since it is a mutual association, there can be no liability. It was pointed out that the decision in CIT v. Bankipur Club Ltd. [1997] 226 ITR 97 (SC) amply supported this view. The principle of mutuality cannot be diluted with reference to the head of income under which it may fall to be assessed. Property income of such club, even if it is only deemed income, is governed by the principle of mutuality.
The assessee, a members’ club, provided recreational and refreshment facilities exclusively to its members and their guests. Its facilities were not available to non-members. The club was run on “no profit no loss” basis in that the members paid for all their expenses and were not entitled to any share in the profits. Surplus, if any, was used for maintenance and development of the club. The club house was owned by the assessee. The assessee claimed that it was a mutual concern and so the annual letting value of the club house was not assessable. Held that the assessee’s business was governed by the doctrine of mutuality. It was an admitted fact that the business of the assessee did not come within the scope of business. It was not only the surplus from the activities of the business of the club that was excluded from the levy of income-tax, even the annual value of the club house, as contemplated in section 22 of the Act, would be outside the purview of the levy of income-tax.
delhi stock exchange association ltd. Vs. Cit (supreme court of india)
Company was doing stock exchange business. Admission fees received from members and their authorised assistants and profits were distributed to shareholders. Mutuality was lacking and the fees were assessable to tax. Since as the body of trading members who paid the entrance fees and the shareholders among whom the profits of the company were distributed were not identical and the element of mutuality was lacking, the company carried on a business whose profits were taxable and, therefore, the admission fees received from members were taxable in its hands.
Trivandrum Club (Kerala High Court)
The real contributors of income by availing of the facilities of the marriage hall were not the members but non-members. In order to enable them to avail of the facilities of the club, non-members were to be given temporary membership only for the purpose of availing of this benefit. The Trivandrum Club’s case [1989] 177 ITR 550 (Ker) was decided on the basis of the admitted factual position that no non-member was enjoying the facilities of the club. The facts in this case were different. The marriage hall was admittedly being rented out to non-members making them temporary members only for the purpose of letting out the marriage hall from non-members. The principle of mutuality would not apply. Rental income received from non-members was taxable.
A club may be exempt on its receipts from members on the mutuality principle. As decided in CIT v. Bankipur Club Ltd. [1997] 226 ITR 97 (SC), there could be some latitude in respect of some miscellaneous income from transactions with outsiders, if such income arises from transactions without a “taint of commerciality”. Income from interest on fixed deposits could be exempt on the same reasoning as was found in CIT v. Cawnpore Club Ltd. [2004] 140 Taxman 378 (SC). But then, an activity, which is tainted with commerciality, cannot qualify for exemption on the grounds of mutuality under the rule in Bankipur Club’s case. It is what was decided in CIT v. Trivandrum Club [2006] 282 ITR 505 (Ker) in respect of income from letting out a marriage hall, because such letting out constituted a trade or a business and the income was from transactions with outsiders.
Contributory and participatory must be the same
Company was doing stock exchange business. Admission fees received from members and their authorised assistants and profits were distributed to shareholders. Mutuality was lacking and the fees were assessable to tax. Since as the body of trading members who paid the entrance fees and the shareholders among whom the profits of the company were distributed were not identical and the element of mutuality was lacking, the company carried on a business whose profits were taxable and, therefore, the admission fees received from members were taxable in its hands. [1961] 041 ITR 0495- Delhi Stock Exchange Association Ltd. vs. CIT (Supreme Court of India)
Mutual concern v/s co.op. Society
In the case of a housing society, the Calcutta High Court in CIT v. Apsara Co-operative Housing Society Ltd. [1993] 204 ITR 662 had found that the transfer fees charged by the members, who formed themselves as a co-operative society without any profit element for the society itself is eligible for treatment as a mutual concern. However, a similar claim failed in Haryana State Co-operative Labour and Construction Federation Ltd. v. CIT [2001] 252 ITR 265 (P&H), since the High Court found that the contributors to the federation had no control over the funds, so collected and that there was no obligation on the part of the Federation to return the funds to the contributors, so that no exemption was available on the principle of mutuality.
267 ITR (A.T.) 0086- WALKESHWAR TRIVENI CO-OPERATIVE HOUSING SOCIETY LTD. VS. INCOME-TAX OFFICER (BOM) No one can make a profit out of himself. In short, this is the principle of mutuality. The cardinal requirement is that all the contributors to the common fund must be entitled to participate in the surplus and that all the participators in the surplus must be contributors to the common fund. There must be complete identity between the contributors and the participators. If all the participators to the common fund are also contributors and their identity is established, then the test of mutuality is satisfied. A co-operative society can be registered only if it is in accordance with the co-operative principles and is a voluntary association. The assessee had been granted registration and it could be presumed that the Registrar of Co-operative Societies in Mumbai found this to be a voluntary association. It is mandatory for the promoter to form a society as soon as there is a minimum number of persons required to form a co-operative housing society. The members join the society out of their free choice. There is no compulsion to join the society. There is no compulsion to continue having joined once.
The society could raise funds only for achieving the objects of the society and not for any other purpose. So long as the society was charging the amount of premium, within the framework of law, no profit motive could be attributed to the society. With the common consent, the transferor and the transferee divided equally the premium and paid it to the society. The society issued separate receipts to the transferor and the transferee. The transferor satisfied the test of mutuality. When the premium was paid, he was a member of the society. He received the consideration for alienating his right in favour of the transferee. Legally speaking, the transferee stepped into the shoes of the transferor and became eligible for all the benefits which were till then available to the transferor. But at the time of effecting the transfer, the transferee was not a member. As such, the amount received from the transferee would not satisfy the test of mutuality. The amount received from the transferor was not exigible to tax, whereas the amount received from the transferee was exigible to tax.
A co-operative housing society, once it is conceded to be a mutual association, the premium which is paid by the transferor as a member at the time of payment is exempt and not the premium received from the transferee, who was not the member at the relevant time. It was so decided by the Tribunal in Walkeshwar Triveni Co-operative Housing Society Ltd. v. ITO [2004] 267 ITR (AT) 86 following the principles laid down under co-operative laws and the principle of mutuality. The garb of a co-operative society does not rule out application of the principle of mutuality as was found in CIT v. Apsara Co-operative Housing Society Ltd. [1993] 204 ITR 662 (Cal).
Mutual concern v/s insurance business
A company which carries on a form of insurance business under which the policy money payable on the happening of the contingency insured against is not fixed but depends either partly or wholly on the results of the division of any portion of the premium income or funds among the policies which have become due for payment in proportion to the premiums received under each class in the specified period. Where the shareholders and the policy holders are not the same, a company carrying on such business is not a mutual society and its income is not exempt from tax on that account. The fact that the subscribed capital is very small compared with the premium income does not make any difference. [1939] 007 ITR 0333- Commissioner of Income-tax vs. Sind Central Provident Fund Society Ltd. (Sind High Court)
Chit fund treatment as mutual concern.
Under the system a chit company organises various groups of subscribers, all making monthly contributions with such monthly collections being offered either on lot or auction basis to one of them. Where the lot system is followed, the lucky winner gets the amount subject to deduction for the services of the foreman the organiser. Where it is an auction, chit, the amount which the highest bidder agrees to forego is the amount which is distributed to the other members, subject again to deduction of foreman's commission. In an auction chit, therefore, the early bidder is a loser as the gross amount, which he gets on the total contribution, is less and would in essence represent the interest for the funds borrowed by him . For an investor, who is prepared to wait, he gets a larger amount by way of dividend than what he has contributed with the result that his gain, that is the difference between what he has contributed and what he has received, represents the surplus. Even where the chit is organised by a chit company, its role is only as that of a foreman. But the difference between the amount contributed and the amount received has given rise to controversies which is very much alive and is pending litigation in a number of cases.
Conclusion
Under the Income-tax Act, what is taxed is, the "income, profits or gains" earned or "arising", "accruing" to a "person". Where a number of persons combine together and contribute to a common fund for the financing of some venture or object and in this respect have no dealings or relations with any outside body, then any surplus returned to those persons cannot be regarded in any sense as profit. There must be complete identity between the contributors and the participators. If these requirements are fulfilled, it is immaterial what particular form the association takes. Trading between persons associating together in this way does not give rise to profits which are chargeable to tax. Where the trade or activity is mutual, the fact that, as regards certain activities, certain members only of the association take advantage of the facilities which it offers does not affect the mutuality of the enterprise.
Points to be noted for mutual concern
The transfer fee is not liable to tax provided the co-operative society does not carry on any business, and the transfer fee is meant for the benefit of the members of the co-operative society.
The participators in the profit are members; but the contributors to such profit are non-members who are the buyers of the books. There is no identity between the contributors and the participants. Therefore, the profits derived from the sales to the members is not exempt but taxable.
The principle may not apply where the residential accommodation is not confined to members. In such cases, the rent is taxable under the head Income from house property. Even if the income is treated as business income, it would not be exempt, because only some of the members occupy the accommodation, and there is no identity between the contributors and the participants. Supreme Court in CIT v. Bankipur Club Ltd it has been held that the income from the guest houses received from the members of the club for their use and the use of their guests is entitled to exemption from tax on the principle of mutuality.
There is no reason why a mutual organisation formed as a company should not be treated as a mutual association.
If the object is charitable, a mutual association like a trade association can claim exemption under section 11 where the surplus was to use only for public benefit and not to be distributed to its members. If the surplus is to be shared between members, it could claim exemption on grounds of mutuality, if other conditions like participants and contributors are both members with no dealings with outsiders.
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