Tax Liability in a Mutual Concern

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Tax Liability in a Mutual Concern TABLE OF CONTENTS TABLE OF CASES RESEARCH QUESTION INTRODUCTION BASIS FOR EXCEPTION FOR THE INCOME APPLICABILITY OF THE PRINCIPLE OF MUTUALITY BIBLIOGRAPHY   TABLE OF CASES Chemsford Club v CIT (2000) 243 ITR 89 (SC)................................7 CIT v Apsara Co-op Housing Society Ltd. (1993) 204 ITR 662 (Cal)...................9 CIT v Bankipur Club Ltd. (1997) 226 ITR 97 (SC)..............................6 CIT v Darjeeling Club Ltd. (1985) 153 ITR 676................................7 CIT v Delhi Gymkhana Club Ltd. (1985) 155 ITR 373 (Del)........................7 CIT v Delhi Gymkhana Club Lts. (2011) 53 DTR 330 (Del)........................7 CIT v Escorts Dealer Development Association Ltd. (2002) 253 ITR 305 (P&H)...........5 CIT v Madras Race Club (1976) 105 ITR 433 (Mad)............................4 CIT v Royal Western India Turf Club Ltd (1953) 24 ITR 551 (SC)....................5 CIT v Shree Jari Merchants Association (1977) 106 ITR 542 (Guj...................5 CIT v West Godavari District Rice Millers’ Association (1984) 150 ITR 394 (AP)..........9 Director of Income-tax v All India Oriental Bank of Commerce Welfare Society (2003) 130 Taxman 573 (Del) 9 General Family Pension Fund v CIT (1946) 14 ITR 488 (Cal)......................3 ITO v Mumbai Hindi Shikshak Sayahak Nidhi (1985) 22 TTJ (Bom) 133...............9 Ludhiana Aggarwal Co-operative House Building Society Ltd v ITO (1995) 55 ITD 423 (Chd).9 Madras Gymkhana Club v DCIT (2009) 183 Taxman 333 (Mad).....................7 Mittal Court Premises Co-operative Society Ltd. v ITO (2009) 184 Taxmman 292 (Bom).....9 Mittal Court Premises Co-operative Society Ltd. v ITO (2010) 320 ITR 414 (Bom).........9 Rajpath Club Ltd. v CIT (1995) 211 ITR 379 (Guj).............................7 SIND Co-op Housing Society v ITO Pune (2009) 182 Taxman 346 (Bom)...............9 RESEARCH QUESTION
  1. Is there any commerciality involved?
  2. What would constitute complete identity between the contributor and the participator?
  3. Whether the benefit is available to the non-mutual income?

INTRODUCTION

A person cannot trade or earn income from himself. Even though, people can carry on trade or business with themselves but the resulting surpus from these operations is not a profit from a trade for the purpose of income-tax. Conversely, the true proposition is not that a man cannot make a profit out of himself, but that he cannot trade with himself. Whichever way the matter is looked at, the ultimate result is that where persons engage themselves in mutual activities and there remains an excess of receipts over expenses, such excess is not taxable and is to be regarded as merely a surpus having no revenue quality. The surpus arising from an ordinary mutual activity would not lead to a resultant profit profit, because each pays originally according to an estimate of the amount which would be required for the common purposes. If his contribution proves to be insufficient, he makes good the deficiency. If on the other hand, it is found that it exceeds what is ultimately required, the excess will have to be returned in the shape of dividends, or creation of a reserve against depreciation or a reserve for a building fund, etc. such excess can from no point of view be regarded as profits or gains. Mutual dealings arise out of a mutual association. To constitute a mutual association, a number of persons associate together to subscribe money for a fund for the purpose of its being spent upon a particular object, and the balance, if any, being returned to the subscribers and proportionately distributed among them. This balance is that part of the fund which is not absorbed by the particular object of the subscriptions. Those transactions are mutual dealings and the unrequited balance is the surpus. This surpus is not assessable to income-tax since it arises out of the mutual dealings.[1] No person can trade with himself and make an assessable profit. If, instead of one person, more than one combines themselves into a distinct and separate legal entity for rendering services to themselves by only charging themselves, the resulting surpus is not assessable to tax.[2]

BASIS FOR EXCEPTION FOR THE INCOME

The following are the basis for exemption of the income:
  1. Common identity of contributors and participators,
  2. The treatment of the assessee, though incorporated, as a mere entity for the convenience of the members, and
  3. The impossibility of the contributors deriving profit from the contribution made by themselves to a fund which could only be expended or returned to themselves.
  1. Common identity of contributors and participators
The essential condition, for considering an assessee to be a mutual concern, is that there should be an identity between the contributors and the participants. Income taxable if there is no complete identity between the contributors and participators in the common fund: the essence of mutuality lies in the return of what one has contributed to a common fund, and, unless there is complete identity between the contributors and the participators in a common fund, the principle of mutuality would not be attracted. If some of the contributors to the common funds are not participators in the surpus or if some of the participators in the surpus are not contributors to the common fund, the profits of the association would be assessable to tax. However, the criterion that the contributors to the common fund and participators in the surpus must be an identical body does not mean that each member should participate in the surpus or get back from the surpus precisely what he has paid. What is required is that the members as a class should contribute to the common fund and as a class they must be able to participate in the surpus.[3] 2. The treatment of the assessee, though incorporated, as a mere entity for the convenience of the members If there is a common identity of contributors and participators, the particular form which the association takes is immaterial. Incorporation as a company or as a registered society is a convenient medium for enabling the members to conduct a mutual concern. The property of the incorporated company or registered society, for all practical purposes, in the case of a mutual enterprise, is considered as the property of the members. The incorporation of any company to carry on the activities of a club does not result in the deprivation of the admissibility of the claim for exemption based on the concept of mutuality.[4] A company does not rule out inference of mutuality, but the benefit of mutuality could be denied not because of an incorporated company, but because of the dealings of the company with non-members, if the dealing with members could be isolated and made the subject separate deduction.[5] Even a company assessee can claim exemption on the basis of mutuality principle where is memorandum and articles of association provided that the funds of the company should be utilized solely for the promotion of its objects and that no portion of the income or property shall be paid or transferred directly or indirectly, by way of dividends, bonus to any member or former member.[6]
  1. The impossibility of the contributors deriving profit from the contribution made by themselves to the fund which could only be expended or returned to themselves.
A mutual association is an association of persons who agree to contribute funds for some common purpose mutually beneficial and receive back the surpus left out of these funds in the same capacity in which they have made the contributions. This capacity as contributors and recipients remains the same. They contribute not with an idea to trade but with an idea of rendering mutual help. They receive back the surpus, which is left after meeting the expenditure which they have incurred for this common purpose, in the same capacity in which they have contributed. Thus, they receive back what was already their own. The receipt which thus comes in their hands, in their hands, is not profit, because no man can make profit out of himself, just as he cannot trade with himself.[7] The participation in the surpus need not be immediate as soon as the surpus is discerned, but may be on the winding up or dissolution, the surpus for the time being carried to a reserve. The surpus may be handed back, it may be kept for some future contingency; the test is whether it is the members’ money. APPLICABILITY OF THE PRINCIPLE OF MUTUALITY The principle of mutuality which is true in the case of an individual is equally true in respect of bodies of individuals, such as (A) a members’ club (B) a co-operative society (C) a mutual benefit fund (D) a thrift fund or (F) a pooling association.
  1. Members’ Club – Members’ club are without doubt, percent mutual associations. They are co-operative bodies whereby the members raise funds by way entrance fees and periodical subscriptions in order to provide themselves with social sporting or similar other amenities.
One among the popular activities of such a club is the providing of refreshment to the members for a charge to cover the cost of preparation, overheads and service. If such refreshments be served to non-members, it would only be on the basis of such non-members being guests of the member who pays for himself and hiss guest. Another popular activity of a club is the providing of residential rooms to non-resident members and mofussil members and supply them with board for a charge to cover the rent of the rooms and the cost of the food and overhead. Amenities are also provided for sports, such as billiards, tennis, golf or cards, at a charge to compensate the maintenance of the tennis-court, or golf-course, or the cost of the playing of cards or the wear and tear of the billiard table. The above are all activities of any social club and there is no element of buying and selling in the providing of these amenities for a certain fee. It is a fallacy to say that where a member of a club orders for dinner and consumes it, there is any sale of them. The Supreme Court in the case of CIT v Bankipur Club Ltd.[8] has held that the receipt for various facilities extended by the club to members as part of the usual privileges, advantages and convenience, attached to the membership of the club, could not be said to be a trading activity. The surpus of excess of receipts over the expenditure as a result of mutual arrangement could not be said to be “Income” for the purpose of Income-tax Act. The fact that the members are also allowed to entertain their guest hall not be considered to be a disqualification.[9] The fact that there is some diversion to non-members as it happened when some of the rooms were let out to non-members need not vitiate the principle of mutuality as long as there is substantial compliance with the principle.[10] It may be pointed out that if the amount involved is substantial, the decision could have been otherwise. Where the business of the assesses was governed by doctrine of mutuality, not only the srplus from the activity of the club but even the annual value of the club house would be outside the purview of the levy of income-tax.[11] Interest income of a sports club derived from deposits with the bank is not exempt on the ground of mutuality.[12] Investment of surpus fund with some of member banks and other institutions in form of fixed deposit and securities which, in turn resulted in earning of huge interest could not be held to satisfy mutuality concept and, therefore, such interest income was liable to be taxed.[13] Assessee company is running a recreation club for its members the income earned from the members is exempt on the principle of mutuality. Income of the club from FDR’s in banks and Government securities, dividend income and profit on sale of investment is also covered by the doctrine of mutuality and is not taxable.[14]
  1. Co-operative Societies – A co-operative society is defined in section 2(19)[15] as ‘a co-operative society registered under the CO-operative Societies Act, 1912 or under any other law for the time being n force in any state for the registration of co-operative societies’. Turning to the Co-operative Societies Act, 1912, some of its important provisions may be noticed:
  1. Section 4 of the said Act provides that a ‘ society which has its object the promotion of the economic interest of its member in accordance with co-operative principles (emphasis supplied), or a society established with the object of facilitating the operations of such a society, may be registered under this Act’.
  2. Section 29(1) further provides that” ‘a registered society’ shall not make a loan to any person other than a member provided that with the general or special sanction of the Registrar, a registered society may make loans to another registered society”.
  3. Section 30 restricts the powers of the society in respect of its receiving any deposits or loans from persons who are not members of the society.
  4. Section 31 restricts the transactions of the societies with non-members
  5. Finally, section 33 provides that “no part of the funds of a registered society shall be divided by way of bonus or dividend or otherwise among its members; provided that after at least one-fourth of the net profits in any year have been carried to a reserve fund, payments from the remainder of such profits and from any profits of past years available for distribution may be made among the members of such extent and under such conditions as may be prescribed by rules.”
Section 34 further enacts that out of the balance left under section 33, an amount not exceeding ten percent thereof may be contributed to a charitable purpose with the sanction of the Registrar. The above provisions show that a co-operative society is a mutual society and, on mutual principles, would not be earning any income in the eye of law. Transfer fee received by a co-operative housing society is not assessable since the co-operative housing society is a mutual concern and the persons became members of the society before they were entitled to get the flat transferred in their names or were liable to pay the transfer fees. There is an element of mutuality in respect of the transfer fees and therefore the same are not taxable.[16] Transfer fee received by a co-operative housing society whether from outgoing or from incoming members is not liable to tax on the ground of principle of mutuality where predominant activity of such co-operative society is maintenance of property of society.[17] Transfer fee and non-occupancy charges received by assessee are not taxable in the hands of the asssessee as being governed by principle of mutuality.[18] Where a co-operative housing society collects contributions from members for an amenity fund for repairs, besides collecting contributions for a welfare fund from new members in pursuance of bye-laws framed under the Maharashtra Co-operative Societies Act, there was no violation of the mutuality principle because of these collections. Further the collection of non-occupation charges would also have similar character.[19]
  1. Polling Associations – Pooling associations are formed to maintain prices, to open up markets for goods, or to demarcate areas for trade operations. The activities of such associations cannot be said to bring any profit which can be taxed under the Income-tax Act. An association of traders collecting subscriptions or donations from its members for construction of a building will be mutual concern although its memorandum may enable its assets to be given to association with allied objects in the event of its dissolution.[20]
Exceptions to the above rule: The aforesaid general observation that mutual activities of a mutual concern do not return taxable income is, however, subject to the following four exceptions expressly provided in the Act:
  1. Income accruing to a life and non-life mutual insurance concern from the business of such insurance is liable to tax.[21]
  2. Income derived by a trade, professional or similar association from specific services performed for its members is chareable to tax.[22]
  3. Income of insurance business carried on by a co-operative society is taxable in all cases (even if it is a mutual concern) and is to be computed in accordance with the rules in the First Schedule.[23]
  4. The profits and gains of any business of banking (including providing credit facilities) carried on by a co-operative society with its members.[24]
BIBLIOGRAPHY BOOKS
  1. Dr Girish Ahuja &Dr. Ravi Gupta, Direct Taxes, (29th ed., 2014)
  2. M K Pithisaria & Mukesh Pithisaria, Chaturvedi & Pithisaria Landmark Judgments on income Tax, 1st ed, 2014,
3. Arvind P Datar, Kanga & Palkhivala The law and practice of Income Tax, 10th ed 2014 4. A. N Aiyers, Indian Tax laws, 49th ed, 2012. 5. Vinod k. Singhania & kapil singhania, Direct Taxes and Law Practices, 52th ed, 2014
[1] General Family Pension Fund v CIT (1946) 14 ITR 488 (Cal). [2] CIT v Merchant Navy Club (1974) 96 ITR 261 (AP). [3] CIT v Merchant Navy Club (1974) 96 ITR 261 (AP). [4] CIT v Madras Race Club (1976) 105 ITR 433 (Mad). [5] CIT v Royal Western India Turf Club Ltd (1953) 24 ITR 551 (SC). [6] CIT v Escorts Dealer Development Association Ltd. (2002) 253 ITR 305 (P&H). [7] CIT v Shree Jari Merchants Association (1977) 106 ITR 542 (Guj). [8] CIT v Bankipur Club Ltd. (1997) 226 ITR 97 (SC). [9] CIT v Darjeeling Club Ltd. (1985) 153 ITR 676. [10] CIT v Delhi Gymkhana Club Ltd. (1985) 155 ITR 373 (Del). [11] Chemsford Club v CIT (2000) 243 ITR 89 (SC). [12] Rajpath Club Ltd. v CIT (1995) 211 ITR 379 (Guj). [13] Madras Gymkhana Club v DCIT (2009) 183 Taxman 333 (Mad). [14] CIT v Delhi Gymkhana Club Lts. (2011) 53 DTR 330 (Del). [15] Income-tax Act, 1961, section 2(19). [16] CIT v Apsara Co-op Housing Society Ltd. (1993) 204 ITR 662 (Cal). See also Director of Income-tax v All India Oriental Bank of Commerce Welfare Society (2003) 130 Taxman 573 (Del); Ludhiana Aggarwal Co-operative House Building Society Ltd v ITO (1995) 55 ITD 423 (Chd); ITO v Mumbai Hindi Shikshak Sayahak Nidhi (1985) 22 TTJ (Bom) 133. [17] SIND Co-op Housing Society v ITO Pune (2009) 182 Taxman 346 (Bom). [18] Mittal Court Premises Co-operative Society Ltd. v ITO (2009) 184 Taxmman 292 (Bom). [19] Mittal Court Premises Co-operative Society Ltd. v ITO (2010) 320 ITR 414 (Bom). [20] CIT v West Godavari District Rice Millers’ Association (1984) 150 ITR 394 (AP). [21] Income-tax Act, 1961, section 2(24)(vii). [22] Income-tax Act, 1961, section 2(24)(v) and section 28(iii). [23] Income-tax Act, 1961, section 2(24) (vii). [24] Income-tax Act, 1961, section 2(24)(viia).
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