TaxTMI 
TaxTMI 
2011 (8) TMI 752
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....e following factual matrix is with reference to I. T. T. A. No. 422 of 2006. The respondent-Secunderabad Club (hereafter, "the assessee") is a social and recreational club. It is not registered either as an association or a society. It is a mutual association, statedly, not a profit making concern. All their activities are allegedly not tainted with commerciality or business modalities. The assessee receives monthly subscriptions, admission/entrance fee and payments made by its members for use of club facilities. During the assessment year 1996-97, the assessee earned interest on the fixed deposits kept by it with Andhra Bank, Lloyds Finance Ltd., ITC Agro-tech Ltd., VST Industries Ltd., Nagarjuna Finance Ltd. and Apple Credit Corporation Ltd. In their return for 1996-97, the assessee sought exemption of the interest received from tax citing the principle of mutuality. The banks/financial institutions, with whom the fixed deposits were made, are corporate members of the club. The return for the year 1996-97, admitting Rs. 1,22,700, was accepted under section 143(1) of the Income-tax Act, 1961 ("the Act", for brevity). However, the Assessing Officer issued notice under section 148 o....
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....on the order of the Tribunal in I. T.A. Nos. 819 and 820/Hyderabad/1994, dated February 5, 2002, wherein it was held that advancing loans or making fixed deposits is not one of the objects of the assessee-club ; the members of the assessee had a double role one as a member and the other as a member of the general public ; the banks, while accepting deposits from the assessee, did not act in their capacity as members of the club but as members of the general public and, therefore, the principle of mutuality cannot be applied. The Assessing Officer also came to the conclusion that the unreported judgment of the Supreme Court in Cawnpore Club Ltd. [2004] 140 Taxman 378 (SC) did not lay down or enunciate a general proposition or applicability of the principle of mutuality to the interest income earned by a club on the deposits made. Further, after analysing the decision of the Supreme Court, the Assessing Officer came to the conclusion that Bankipur Club Ltd. [1997] 226 ITR 97 (SC) nowhere dealt with the question of taxability of interest income on fixed deposits, etc. The assessee also relied on CIT v. Natraj Finance Corporation [1988] 169 ITR 732 (AP). The Assessing Officer opined th....
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....lone non-exigible on the principle of mutuality, but the income derived from third parties is taxable under the Act for invoking the principle of mutuality the purpose should be referable to the object of the society and parking of the funds for earning interest is not one of the objects of the assessee and, therefore, the income is exigible to tax. He relied on CIT v. Merchant Navy Club [1974] 96 ITR 261 (AP), Rajpath Club Limited v. CIT [1995] 211 ITR 379 (Guj), Sports Club of Gujarat v. CIT [1988] 171 ITR 504 (Guj), Madras Gymkhana Club v. Deputy CIT [2010] 328 ITR 348 (Mad), Chelmsford Club v. CIT [2000] 243 ITR 89 (SC) ; [2000] 3 SCC 214, CIT v. Bangalore Club [2006] 287 ITR 263 (Karn), Bankipur Club Ltd. [1997] 226 ITR 97 (SC), CIT v. Cawnpore Club [2004] 140 Taxman 378 (SC) and CIT v. Common Effluent Treatment Plant (Thane-Belapur) Association [2010] 328 ITR 362 (Bom) (Common Effluent Treatment Plant). A corporate member, being a juridical person, does not satisfy the criteria of being a contributor to the funds as well as the recipient to the funds. In the case of a corporate member, the contributory is a juridical person and the recipient of the services is a natural perso....
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.... and whether interest income earned from various deposits kept with the banks/financial institutions is a non-taxable receipt ? Principles and precedents 9. The business law maxim that no one can make profit out of himself over a period of time, has evolved into the principle of mutuality in income-tax law. In plain terms, the principle postulates that, "when persons contribute to a common fund in pursuance of a scheme for their mutual benefit, having no dealings or relations with any outside body, they cannot be said to have made a profit when they find they have overcharged themselves and that some portion of their contributions may be safely refunded". If complete identity, between the contributors and the participants or recipients, is established, the surplus generated and returned to the contributors is not regarded as profit for the purpose of charging income-tax. If the persons carry on an activity, which is also trade, in such a way that they and the customers are the same persons, no profits are yielded by such trade for tax purposes and, therefore, no assessment in respect of the trade can be made. The surplus, resulting from trading, represents such cont....
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....e price was debited against the advances and the surplus over the costs was dealt with as payment of interest on the share capital. The surplus was distributed to two members proportionate to their purchase of tea. The surplus distributed to the societies was held as profit and as taxable under the relevant Act. The unanimous judicial committee, quoting with the approval from William Harrison (Surveyor of Taxes) v. London Assurance Corporation [1885] 10 AC 438 (HL), opined that, "when a number of individuals agree to contribute funds for a common purpose, . . . stipulate that their contributions, so far as not required for that purpose, shall be repaid to them, I cannot conceive why they should be regarded as traders, or why contributions returned to them should be regarded as profits". It was further held that, "the members contribute for a common object to a fund which is their common property ; it turns out that they have contributed more than is needed and, therefore, more than ought to have been contributed by them, for this object, and accordingly their next contribution is reduced by an amount equal to their proportion of this excess. I am at a loss to see how this can be co....
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....lberforce noticed three main fields in which mutuality principles had been applied, namely, insurance companies, rating groups and clubs. In so far as the applicability of mutuality principle to clubs was concerned, it was observed that, "even in a club governed by the relationship of mutuality, the surplus income is not exempt from the charge if the relationship of mutuality ends and trading begin". While discussing the difference between insurance associations, rating groups and clubs, it was held that when a trading company is a member, "the inquiry is open whether the relationship of the aggregate of the ordinary bathing members with the hotels is truly one of mutuality or is rather of a trading character". It was further observed that the nature of the transaction is significant than the fact of membership or non-membership and, if there were trading transactions, the addition of membership made no difference. The relevant observations are as follows : ". . . mutuality is not necessarily excluded by the fact that some 'members' are corporate bodies, or even corporate bodies engaged in trade. But the relevance of facts such as these must vary with the nature of the acti....
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..... But it cannot be said that incorporation which brings into being a legal entity separate from its constituent members is to be disregarded always and that the legal entity can never make a profit out of its own members". 15. In CIT v. Kumbakonam Mutual Benefit Fund Ltd. [1964] 53 ITR 241 (SC) ; [1965] AIR 1965 SC 96, the respondent which was carrying on banking business and extending loan facilities only to shareholders, claimed exemption from tax on the interest income realised from members. The Assessing Officer, the Appellate Commissioner and the Income-tax Appellate Tribunal came to the conclusion that the respondent was a banking concern ; whether or not a member/shareholder availed of loan facility he was entitled for distribution of profits ; and, therefore, the principle of mutuality as evolved in Styles [1889] 2 TC 460 did not apply. The High Court of Madras held in favour of the assessee. The Supreme Court reversed the High Court and observed that the essence of mutuality lies in the return of what one has contributed to the common fund, and that in the case of Kumbakonam Mutual Benefit Fund the interest from the loans was divided among the members pro rata acco....
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....curities was exempt from tax on the principle of mutuality has been considered by various High Courts. The view, however, is not one and the same. In All India Oriental Bank of Commerce Welfare Society [2003] 184 CTR 274 (Delhi), Delhi Gymkhana Club Ltd. [2011] 339 ITR 525 (Delhi) and Talangang Co-operative Group Housing Society Ltd. [2011] 339 ITR 518 (Delhi) the Delhi High Court held that the interest income on deposits with third parties or members was not liable to tax. The Karnataka High Court in Canara Bank Golden Jubilee Staff Welfare Fund [2009] 308 ITR 202 (Karn) and the Allahabad High Court in Cawnpore Club Ltd. took a similar view. In contrast, the Karnataka High Court in Bangalore Club [2006] 287 ITR 263 (Karn) the Madras High Court in Madras Gymkhana Club [2010] 328 ITR 348 (Mad) and the Bombay High Court in Common Effluent Treatment Plant [2010] 328 ITR 362 (Bom) have held that interest received on deposits with corporate members, like banks, is not exempt on the principle of mutuality. The counsel for the assessee strongly relies on Natraj Finance Corporation [1988] 169 ITR 732 (AP). We would refer to some of these decisions at an appropriate place infra. &nb....
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....ess in Hyderabad or Secunderabad or its suburbs on its being wound up following its liquidation or pursuant to any amalgamation of the said corporate member with any other company and on non-payment of any amount due to the club either by it or by its nominees. In the case of no other category of member, is there a time stipulation for automatic termination of membership. 20. As per rule XXII, the annual general meeting of the general body shall elect a club committee consisting of a president, a vice-president and six other permanent members. Out of these, the president or vice-president and three other members shall retire at the end of the first year, the remaining members shall retire at the end of the second year of election, and each vacancy so caused shall be filled up for two years by election at the next annual general meeting. It is the club committee which is entrusted with the entire management of the club duly exercising the powers vested under the club rules. The winding up procedure is stipulated in rule XXVII of the club rules. The power to initiate winding up of the club is also vested with the club committee. When it is proposed to wind up the club, notice....
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....of the Companies Act, 1956. The directors, secretaries, treasurers, managers are treated as officers of the company. They may act on behalf of the juridical person, but they would not don the juridical personality. 23. A shareholder acquires a right to profits of the company but does not acquire any interest in the assets of the company. A shareholder has no right in the property of the company which is a juristic entity entirely distinct from the shareholders. A shareholder as an investor is entitled to participate in the profits of the company subject to the articles of association. A shareholder would be entitled to participate in the assets only in the event of winding up (Mrs. Bacha F. Guzdar v. CIT [1955] 27 ITR 1 (SC); AIR 1955 SC 74). The corporation is separate from its shareholders. It bears its own name and has a seal of its own ; its assets are separate and distinct from those of its members ; it can sue and be sued exclusively for its own purpose ; and the liability of the members or shareholders is limited to the capital invested by them and further the creditors or the members have no right to the assets of the corporation (Tata Engineering and Locomotive Co.....
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....the club for their mutual benefit. As noticed in Walter Fletcher [1972] AC 414, this disparity in the voting strength is relevant when the court considers a question of non-taxability of the income of a club claiming the benefit of the principle of mutuality because "the ordinary members as a group have an overwhelmingly greater interest in the regularly earned surplus". Further, even in the event of winding up, it is the permanent members who would have a dominant role. 26. An important facet of the principle of mutuality is not only the identity of the contributors of, and the recipients from, the fund, but also the right to be returned the contribution in the event of the aggregate of members getting dissolved. If the continuance of the original contributors till the end, or till the achievement of the objects for forming the association or society/club is uncertain, the principle of mutuality, to our mind, ceases to apply. Rule XII deals with termination of membership. In so far as natural persons are concerned, the membership and all rights and privileges relating thereto shall be deemed to have ceased if the member resigns or dies, or is dismissed from service, if any....
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....anks for reasons of safety, an assured return of the principal, and a reasonable return in the form of interest thereon. It may be a prudent business decision not to keep the surplus funds idle and park them in interest-earning deposits. The principle of mutuality ends the moment the club deposits the amount with the sole aim of earning interest on the deposits. Further, by depositing its funds with its corporate member banks, the Secunderabad Club would certainly help increase the business of the bank. In that view of the matter, the corporate member bank is being shown a favour, and is not being provided a facility. Even the bank has not applied any special rules to govern the clubs' deposits. It accepts deposits from any person because borrowing money and accepting deposits are age old forms of banking business. If the club, being a party to such a banking business, earns interest, the principle of mutuality ends. The social relationship and social activities of the club have nothing to do with its deposits with corporate members. Therefore, it is difficult to accept the assessee's contention that interest income is non-taxable. 28. If the assessee, claiming to be a "mut....
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....at the deposit of such funds would enure to the benefit of that member alone, who would be in a position to utilise the said deposit in any manner it likes and thereby depriving of such benefit for the other members to enjoy which would under no circumstances satisfy the test of identity of the contributors and the participants." 31. In Common Effluent Treatment Plant [2010] 328 ITR 362 (Bom), the Bombay High Court, after referring to various decisions, held as under (page 375) : "In order to fulfil the requirement of mutuality, a mutual association has to establish, as an essential requirement, the identity between participators and contributors to the fund. However, the fact that an association satisfies the norm of mutuality in respect of the receipts of contributions from its members does not necessarily lead to the conclusion that every activity of the association satisfies the test of mutuality. An association may engage in activities which can be described as mutual and in other activities which are not mutual. The Gujarat High Court recognised this in its decision in Sports Club of Gujarat [1988] 171 ITR 504 (Guj). Adverting to the decision in CIT v. Madras Race Clu....
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....bunal that the income from FDRs in banks would also attract the doctrine of mutuality and, therefore, no tax was payable thereon. We have perused the judgments relied on in Delhi Gymkhana Club [2011] 339 ITR 525 (Delhi), and are not able to persuade ourselves to agree with the view. We, for various reasons discussed supra, very humbly differ from the Delhi High Court's view. 33. In Natraj Finance Corporation [1988] 169 ITR 732 (AP), an association of persons consisting of 19 members claimed to be a mutual benefit association. For the assessment year 1977-78, they declared Rs. 48,310 as income, and raised the plea of non-taxability on the principle of mutuality. The Assessing Officer rejected the claim, but the appellate authority upheld the contention. The Revenue's appeal failed before the Tribunal. The Division Bench of this court opined that monthly contributions of the members, advance of loans only to the members and receipt of interest thereon was sufficient enough to establish complete identity between the contributors to the common fund and the participators for attracting the principle of mutuality rendering the income non-taxable. The Revenue relied on Kumbakonam ....
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.... to add that, if an association of persons receives contributions from its own members and earns interest income by lending the money to them from out of the contribution, the principle of mutuality may apply rendering such income non-taxable. An unregistered association, like the Secunderabad club, parking their surplus funds with corporate member banks to earn interest is altogether different from an association of persons lending money only to its members. Further, as held by the Supreme Court in Bankipur Club Ltd. [1997] 226 ITR 97 (SC), "a host of factors need to be considered to arrive at a conclusion as to at what point does the relationship of mutuality end and that of trading begin". Furthermore, the nature of the transaction between the assessee and the bank/banks would disqualify application of the principle of mutuality. We are, therefore, of the considered opinion that the impugned orders of the Income-tax Appellate Tribunal are liable to be set aside. 36. The assessee in I. T. T. A. Nos. 443 of 2006 and 78 and 81 of 2007 is a cooperative society. Statedly its object is buying, acquiring, selling, hiring, letting and developing lands, and construction o....