2010 (6) TMI 52 - HC - Income Tax

Surplus from member contributions exempt under doctrine of mutuality, but interest from bank FDs taxable as income

HC upheld that surplus arising from contributions retained and expended for members falls within the doctrine of mutuality and is not taxable, agreeing ... Concept of mutuality - taxability of excess of income over expenditure - taxability of interest on bank fixed deposits - Held that:- The principle of mutuality postulates that all the contributors to the common fund must be entitled to participate in the surplus and that all the participators in the surplus are contributors to the common fund. It is in this sense that the law postulates that there must be a complete identity between the contributors and the participators. The essence of the doctrine of mutuality lies in the principle that what is returned is what is contributed by a member. A person cannot trade with himself. It is on this hypothesis that the income which falls within the purview of the doctrine of mutuality is exempt from taxation. The income is not generated out of dealings with any third party. The entire contribution originates in its members and is expended only in furtherance of the objects of the Association, for the benefit of the members. On these facts, both the Commissioner (Appeals) and the Tribunal were justified in coming to the conclusion that the surplus so generated falls within the purview of the doctrine of mutuality and was not exigible to tax. Exigibility to tax of interest earned on fixed deposits placed with a bank on the surplus funds - The assessee in the present case utilizes its surplus funds for investment in fixed deposits with Banks. The interest that is generated on the investment of such funds is not income which is received from the members of the assessee but from third parties such as the banks with whom the funds are invested. Section 35(1) of the Bombay Public Trust Act, 1950 provides that where the trust property consists of money and which cannot be applied immediately or at an early date to the purposes of the public trust, the trustees shall be bound to deposit the money, notwithstanding anything contained in the instrument of the trust in a Scheduled Bank, in a Postal Savings Bank or in a Cooperative Bank approved by the State Government or to invest in public securities. The principle of mutuality applies to surplus funds generated from the contribution of members for the reason that the funds are contributed by the members of the Society and there is an identity between the contributors and the participators in the fund. The decision to invest the funds of the Association in Bank fixed deposits is a prudent commercial decision motivated by the desire to earn interest that would not be available on moneys maintained in ordinary, current or savings accounts. Such interest does not fulfill the requirement of mutuality. The fact that the funds which are invested have their source in the contribution by the members of the assessee cannot be dispositive of the nature of the receipt obtained by the assessee on account of the interest payments on the deposits made. In determining the exigibility to tax of receipts on account of interest, it is the character of the receipt as interest that must play a determinative role. A payment on account of interest by the bank or a party with whom the deposit is placed is an arms length transaction with a third party. The recompense which is received by the assessee by and as a result of the transaction does not fulfill the condition of mutuality to which the contributions received from the members of the assessee are subject. The second question of law as formulated would have to be answered in favour of the Revenue and against the assessee. Issues Involved:1. Whether the excess of income over expenditure in respect of the effluent treatment receipts is exempt from income-tax on the principle of mutuality.2. Whether interest on bank fixed deposits, other deposits, and income-tax refunds is chargeable to tax on the principle of mutuality.Issue-Wise Detailed Analysis:RE: QUESTION AThe first issue concerns whether the excess of income over expenditure in respect of effluent treatment receipts is exempt from income-tax on the principle of mutuality. The assessee, an Association incorporated under Section 25 of the Companies Act, 1956, was formed to provide a centralized treatment facility for industrial effluents. The income of the assessee consists of contributions by its members for setting up the effluent treatment facility. The principle of mutuality postulates that all contributors to the common fund must be entitled to participate in the surplus and that all participators in the surplus are contributors to the common fund. This principle was reiterated by the Supreme Court in Commissioner of Income Tax V/s. Bankipur Club Limited and Chelmsford Club V/s. Commissioner of Income Tax.The Tribunal noted that the assessee is a nonprofit company formed by units engaged in industrial activity with the object of setting up a common effluent treatment facility. Both the Commissioner (Appeals) and the Tribunal found that there is a complete identity between contributors and participators, applying the principle of mutuality to the excess of income over expenditure. The Court concluded that the surplus generated by the assessee, representing the excess of its income over expenditure, falls within the purview of the doctrine of mutuality and is not exigible to tax. The first question of law was answered in favor of the assessee and against the Revenue.RE: QUESTION BThe second issue pertains to the taxability of interest on bank deposits, other deposits, and income-tax refunds amounting to Rs. 45.46 lakhs. The Revenue argued that the interest income does not satisfy the test of mutuality since it is generated from third parties such as banks. Several High Courts, including those of Madras, Karnataka, Gujarat, and Jammu & Kashmir, have held that interest earned on surplus funds parked with a bank does not satisfy the test of mutuality.The Gujarat High Court in Sports Club of Gujarat Limited V/s. Commissioner of Income Tax held that income derived from investment, whether by way of interest, dividend, or rent, is derived from a third party and not from contributions from the members of the club. The Karnataka High Court in Commissioner of Income Tax V/s. I.T.I. Employees Death & Superannuation Relief Fund and Commissioner of Income Tax V/s. Bangalore Club held that interest earned on surplus funds invested in banks does not fulfill the requirement of mutuality.The Madras High Court in Madras Gymkhana Club V/s. Deputy Commissioner of Income-tax also held that interest earned on surplus income derived in the course of the activities of the club and invested in fixed deposits does not satisfy the test of mutuality. The Jammu & Kashmir High Court in Amar Singh Club v/s. Union of India held that interest received on fixed deposits and bank deposits would not be covered by the principle of mutuality.The Court concluded that the interest generated on the investment of surplus funds is not income received from the members of the assessee but from third parties such as banks. The decision to invest the funds in bank fixed deposits is a prudent commercial decision motivated by the desire to earn interest, which does not fulfill the requirement of mutuality. The second question of law was answered in favor of the Revenue and against the assessee.Regarding the taxability of other deposits and interest on income-tax refunds, the Tribunal had not specifically dealt with or considered this issue. Therefore, the Court restored the question of the taxability of other deposits and income-tax refunds for decision by the Tribunal afresh.Conclusion:The appeal was disposed of with no order as to costs. The first question of law was answered in favor of the assessee, while the second question of law was answered in favor of the Revenue. The issue of the taxability of other deposits and income-tax refunds was remanded to the Tribunal for fresh consideration.