TaxTMI 
TaxTMI 
2013 (1) TMI 343
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....Bangalore Club (hereinafter referred to as the "assessee"), the appellant herein, is an unincorporated Association of Persons, (AOP). In relation to the assessment years 1989-90, 1990-91, 1993-94, 1994-95, 1995- 96, 1996-97, 1997-98, 1998-99 and 1999-2000, the assessee sought an exemption from payment of income tax on the interest earned on the fixed deposits kept with certain banks, which were corporate members of the assessee, on the basis of doctrine of mutuality. However, tax was paid on the interest earned on fixed deposits kept with non-member banks. The assessing officer rejected the assessee's claim, holding 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. 24....
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....the interest earned by the assessee on the surplus funds invested in fixed deposits with the corporate member banks is exempt from levy of Income Tax, based on the doctrine of mutuality? 5. Mr. Joseph Vellapally, learned senior counsel appearing for the assessee strenuously urged that the assessee meets all the requirements, as laid down in The English & Scottish Joint Co-operative Wholesale Society Ltd. Vs. The Commissioner of Agricultural Income Tax, Assam [AIR 1948 PC 142 (E)], as affirmed by this Court in Chelmsford Club Vs. Commissioner of Income Tax, Delhi [(2000) 3 SCC 214] in order to fall within the ambit of the principle of mutuality. According to the learned counsel, there is a 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 deposit....
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....ns in general and of licensed clubs in particular, is that participants usually do not have property rights to their share in the common fund, nor can they sell their share. And when they cease to be members, they lose their right to participate without receiving a financial benefit from the surrender of their membership. A further feature of licensed clubs is that there are both membership fees and, where prices charged for club services are greater than their cost, additional contributions. It is these kinds of prices and/or additional contributions which constitute mutual income. 8. The doctrine of mutuality finds its origin in common law. One of the earliest modern judicial statements of the mutuality 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....
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....l the Noble Lords, who formed the majority, were of the view that what the members received were not profits but their respective shares of the excess amount contributed by themselves. They held thus: "... when a number of individuals agree to contribute funds for a common purpose ... and 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." 9. Lord Watson's statement was explained by the House of Lords in The Commissioners Of Inland Revenue Vs. The Cornish Mutual Assurance Co. Ltd. [[1926] 12 T.C. 841 (H.L.)] wherein it was held that 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 o....
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....tors and the participators." 13. On this aspect of the doctrine, especially with regard to the non- members, Halsbury's Laws of England, 4th Edition, Reissue, Vol. 23, paras 161 and 162 (pp. 130 and 132) states: "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...." 14. Simon's Taxes, Vol. B, 3rd Edn., paras B1.218 and B1. 222 (pp. 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....
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.... Wheatcroft) at pp. 1201, dealing with "mutual trading operations", the law is stated as under: "For this doctrine to apply it is essential that all the contributors to the common fund are entitled to participate in the surplus and that all the participators in the surplus are contributors, so that there is complete identity between contributors and participators. This means identity as a class, so that at any given moment of time the persons who are contributing are identical with the persons entitled to participate; it does not matter that the class may be diminished by persons going out of the scheme or increased by others coming in...." (Emphasis supplied) 17. In Jones Vs. South-West Lancashire Coal Owners' Association Ltd. [1927 AC 827], Viscount Cave LC held that "sooner or later, in meal or in malt, the whole of the associations" receipts must go back to the policy holders as a class, though not 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....
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....the various conveniences paid by members, even though there is no direct benefit of the receipts to the customers, the fact that they will eventually be used in furtherance of the services of the club must be considered as a furtherance of the mandate of the club. 21. Thirdly, there must be no scope of profiteering by the contributors from a fund made by them which could only be expended or returned to themselves. The locus classicus pronouncement comes from Rowlatt, J's observations in Thomas Vs. Richard Evans & Co. Ltd.[(1927) 11 TC 790] wherein, while interpreting Styles case (supra), he held that if profits are distributed to shareholders as shareholders, the principle of mutuality is not satisfied. He observed thus: "But a company can make a profit out of its members as customers, although its range of customers is limited to its shareholders. If a railway company makes a profit by carrying its shareholders, or if a trading company, by trading with the shareholders - 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 pu....
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.... money is realised both from the members and 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, (p.132); C.A. (1925) (1) KB 30 at p. 44 and 45]." 24. In Royal Western India Turf Club Ltd. (su....
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.... to this mutuality, benefited from the arrangement. However, as soon as these funds were placed in fixed deposits with banks, the closed flow of funds between the banks and the club suffered from deflections due to exposure to commercial banking 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. 27. As aforesaid, 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. In the instant case, the surplus funds were not used for any specific service, infrastructure, maintenance or for any other direct benefit for the member of the club. These were take....
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....e observed thus : "But a company can make a profit out of its members as customers, although its range of customers is limited to its shareholders. If a railway company makes a profit by carrying its shareholders, or if a trading company, by trading with the shareholders - 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 becaus....
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....y itself make its income any less income from business. In our opinion, the ratio of the said decision is on all fours to the facts at hand. The interest earned by the assessee even from the member banks on the surplus funds deposited with them had the taint of commerciality, fatal to the principle of mutuality. 32. We may add that the assessee is already availing the benefit of the doctrine of mutuality in respect of the surplus amount received as contributions or price for some of the facilities availed by its members, before it is deposited with the bank. This surplus amount was not treated as income; since it was the residue of the collections left behind with the club. A façade of a club cannot be constructed over commercial transactions to avoid liability to tax. Such setups cannot be permitted to claim double benefit of mutuality. We feel that the present case is a clear instance of what this Court had cautioned against in Bankipur Club (supra), when it said: "... if the object of the assessee company claiming to be a "mutual concern" or "club", is to carry on a particular business and money is realised both from the members and from non- mem....