TAXABILITY OF TRANSFER FEE RECEIVED BY A CO-OPERATIVE HOUSING SOCIETY1

INTRODUCTION

In this article
would be discussed the taxability of transfer fee received by a
co-operative
housing society under the principles and provisions of the Income-tax
Act, 1961
(‘the Act’). A co-operative housing society (hereinafter also referred
to as ‘Society’) here would include all Societies – residential,
commercial and industrial. Apart from transfer fee simpliciter, the
taxability of its many variants such as voluntary contribution on transfer,
premium on transfer, etc. would also be examined.

NATURE OF TRANSFER FEE

At the outset, it
is most pertinent to understand the nature of a co-operative housing society
and the nature and purpose of the transfer fee collected by a Society. A
Society is generally formed and registered with the following objects in its
bye-laws:

(a) To obtain conveyance from the owner / promoter
builder, in accordance with the provisions of the Ownership Flats Act and the Rules
made thereunder, of the right, title and interest, in the land with building /
buildings thereon, the details of which are as hereunder:

The building /
buildings known / numbered as…….. constructed on the plot / plot Nos. …… /
Survey No……… / CTS No…….. of ……….. (village / taluka) admeasuring……. sq.
metres, more particularly described in the application for the registration of
the Society;

(b) To manage, maintain and administer the property
of the Society;

(c) To raise funds for achieving the objects of the
Society;

(d) To undertake and provide for, on its own
account or jointly with a co-operative or other institution social, cultural or
recreative activities;

(e) To provide
co-operative education and training to develop co-operative skills to….. …..its………
Members, Committee Members, officers and employees of the Society; and

(f) To do all
things, necessary or expedient for the attainment of the objects of the
Society, specified in these Bye-laws.

(Refer clause 5 of
the Model Bye-laws as approved by the Commissioner for Co-operation and
Registrar, C.S., M.S., Pune, which are generally adopted by the Societies in
Maharashtra.)

From the above, one
can decipher that a Society is nothing but a pool of people residing in /
occupying a building, and having as its common object managing and maintaining
the building / property for the common benefit of all in a spirit of camaraderie.
Thus, there is no taint of commerciality, nor any intention of carrying on any
trade or any activity for the purpose of profits in the objects of a Society.

For this management
and maintenance of the building / property for the common benefit of all the
members, the Society has to pay various outgoings like property tax to the local
authorities, water charges, common electricity charges, salaries to security
and other staff members, repair, maintenance and proper upkeep of the building,
lift, etc. To defray all these common expenses, the Society collects from all
the members contribution by way of monthly maintenance charges, specific
collection against the outgoings mentioned above, transfer fee,
donation, etc. The authority for the collection for and payment of the common
expenses is embodied in the bye-laws of the Society to which every member is a
party. So, the modus operandi of the entire scheme is such that the
Society is the convenient instrument or medium or conduit through which the
building / property is maintained and managed by the members, for the common
benefit of all the members, from the contributions received from all the
members in different ways and on different occasions.

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1 An article on this subject was written by
the same author in the July 1990 issue of The BCA Journal. After over 30 years, at the suggestion of The BCA Journal, the author discusses in this article the
current position on this evergreen or ever-grey subject of great importance. – Editor.

Transfer fee is one
such mode of collecting contribution towards common expenses by a Society on
the occasion or the event of the transfer of a flat / office / unit by the
member of the Society, credited to a separate account called ‘Reserve Fund’ by
the Society. (See clause 12 of the Model Bye-laws.) The ‘Reserve Fund’ is
utilised by the Society for the ‘expenditure on repairs, maintenance and
renewals of the Society’s property’. [See clause 14(a) of the Model Bye-laws.]

Thus, by nature,
character or quality, transfer fee is only a form of collection or contribution
from the members which is utilised for the common benefit of all the members
only.

DOCTRINE OF MUTUALITY

Another concept
which has a material bearing while analysing the taxability of transfer fee is
the concept or doctrine of mutuality. The doctrine of mutuality is the
foundation on which the entire edifice of the non-taxability of transfer fee is
built. It is submitted that this is a simple but often misunderstood concept,
especially by the tax authorities.

The concept of
mutuality is extensively discussed and relied upon in a large number of
judicial cases which are commonly called ‘club cases’², and which
concern the taxation of sports or other creative clubs, because the
non-taxability of the income of the clubs is also based on the doctrine of
mutuality.

Let us try to
understand this doctrine by turning to some decided cases. In CIT vs.
Madras Race Club [1976] 105 ITR 433, 443 (Mad), this doctrine was
elucidated thus: ‘To take a common instance, supposing a dozen persons gather
together and agree to purchase certain commodities in bulk and distribute them
among themselves in accordance with their individual requirements, they may
collect a certain amount provisionally based on the anticipated price of the
commodities to be purchased. If it ultimately happens that the commodities are
available at a cheaper price so that at the end of the distribution of the
commodities among themselves, a part of the original amount provisionally
collected is repaid, then what is repaid cannot by any test be classified as
income. This would represent savings and not income. The Income-tax Act seeks
to tax income and not savings….’

The fundamental
test of mutuality was explained succinctly by Lord Macmillan in Municipal
Mutual Insurance Ltd. vs. Hills [1932] 16 TC 430, 448 (HL): ‘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; in other words, there must
be complete identity between the contributors and the participators. If
this requirement is satisfied the particular form which the association takes
is immaterial.’ (Emphasis supplied)

In the often-quoted
case of Styles vs. New York Life Insurance Company [1889] 2 TC 460 (HL)
the doctrine of mutuality was discussed as follows by Lord Watson: ‘When a
number of individuals agree to contribute funds for a common purpose, such as
the payment of annuities or of capital sums, to some or all of them, on the
occurrence of events certain or uncertain, 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.’

The Supreme Court
in a recent decision in ITO vs. Venkatesh Premises Co-operative Society
Ltd. [2018] 402 ITR 670 (SC), after referring to numerous weighty
authorities – both Indian and English – narrated the concept of mutuality in
the following crystal clear words (see head notes):

‘The doctrine of mutuality, based on common law principles, is
premised on the theory that a person cannot make a profit from himself. An
amount received from oneself, therefore, cannot be regarded as income and
taxable. The essence of the principle of mutuality lies in the commonality of
the contributors and the participants who are also the beneficiaries. The
contributors to the common fund must be entitled to participate in the surplus
and the participators in the surplus are contributors to the common fund. The
law envisages a complete identity between the contributors and the participants
in this sense. The principle postulates that what is returned is
contributed by a member. Any surplus in the common fund shall therefore not
constitute income but will only be an increase in the common fund meant to meet
sudden eventualities.’ (Emphasis supplied)

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2 For instance, see CIT vs. Royal Western India Turf
Club Ltd. [1953] 24 ITR 551 (SC); CIT vs. Bankipur Club [1997] 226 ITR 97 (SC);
Chelmsford Club vs. CIT [2000] 243 ITR 89 (SC); Bangalore Club vs. CIT [2013]
350 ITR 509 (SC); IRC vs. Eccentric Club Ltd. [1925] 12 TC 657 (HL); CIT vs.
Merchant Navy Club [1974] 96 ITR 261 (AP); The Presidency Club Ltd. vs. CIT
[1981] 127 ITR 264 (Mad); CIT vs. Cawnpore Club Ltd. [1984] 146 ITR 181 (All); CIT
vs. Darjeeling Club Ltd. [1985] 153 ITR 676 (Cal) and CIT vs. Willingdon Sports
Club [2008] 302 ITR 279 (Bom). The principle of mutuality is also explained in CIT vs. Common Effluent Treatment
Plant (Thane Belapur) Association [2010] 328 ITR 362 (Bom); CIT vs. Kumbakonam
Mutual Benefit Fund Ltd. [1964] 53 ITR 241 (SC) and CIT vs. Shree Jari Merchants Association
[1977] 106 ITR 542 (Guj).

The concept of
mutuality is based on the principle that no man can make profit out of himself.
So, when more than one person combine themselves for some common purpose or
mutual benefit and contribute for the common purpose or benefit and if afterwards
some surplus is left over and is returned to those contributors in their
capacity as contributors, the same does not amount to income in the hands of
the contributor-recipient, nor does the contribution as such amount to income
in the hands of the mutual benefit association of such persons.

BASIC PROPOSITION: TRANSFER FEE IS GOVERNED BY THE DOCTRINE OF MUTUALITY

Based on the nature
of the transfer fee received by a Society, discussed hereinabove, and based on
the principle of mutuality, discussed above, it is submitted that the transfer
fee received by a Society on the transfer of a flat / office / shop / unit by a
member of the Society is completely governed by the principle of mutuality and
hence not liable to any tax under the Act. Transfer fee is nothing but a
contribution to the common fund of a mutual benefit association, i.e., the
Society, by its member on the occasion of the transfer of a flat, etc. which is
going to be utilised, either immediately or at a later date, for the common
benefit of all the members of the Society.

There is no express
statutory provision in the Act contrary to the above proposition. Whenever the
legislature intends to tax an item, it specifically provides for the same. For
example, section 2(24)(vii) of the Act specifically includes within the
definition of the term ‘Income’, ‘the profits and gains of any business of
insurance carried on by a mutual insurance company or by a co-operative
society, computed in accordance with section 44 or any surplus taken to be such
profits and gains by virtue of provisions contained in the First Schedule’.
Such income is, obviously, excluded from the principle of mutuality.³

Another example of
an express statutory provision creating an exception to the principle of
mutuality is section 2(24)(viia) which includes within the definition of
‘Income’, ‘the profits and gains of any business of banking (including
providing credit facilities) carried on by a co-operative society with its
members’.

3 See the observations at p. 679 in ITO vs. Venkatesh Premises
Co-operative Society Ltd. [2019] 402 ITR 670 (SC). See also the observations at pp. 40-41 in State of West Bengal vs. Calcutta
Club Ltd. 2019-VIL-34-SC-ST.

JUMPING SOME HURDLES

As stated above,
the transfer fee received by a Society is non-taxable on the principle of
mutuality. But there are some hurdles in the way of this theory, which are
jumped over in the succeeding paragraphs.

Hurdle 1:
Incorporation

The principle of mutuality requires that there must be complete identity
between the contributors to the common fund and the participators in the
surplus, but a Society is always formed and registered under the Societies
Registration Act, 1860 or under the relevant State law concerning the
incorporation and registration of a Society, e.g., The Maharashtra Co-operative
Societies Act, 1960 (hereinafter also referred to as ‘the Societies Act’), which is a legal entity, separate and distinct from its members.
Then, how does the principle of mutuality apply to a Society?

It is well settled
now that once the identity between the contributors to the common fund and the
participators in the benefits and surplus is established completely, the fact
of incorporation of the mutual benefit association does not damage the
applicability of the principle of mutuality to it. As Lord Macmillan observed
in a passage reproduced above from Municipal Mutual Insurance Ltd. vs.
Hills [1932] 16 TC 430, 448 (HL): ‘… in other words, there must be
complete identity between the contributors and the participators. If this
requirement is satisfied the particular form which the association takes is
immaterial.’ (Emphasis supplied)

Likewise, the House
of Lords held in Styles vs. New York Life Insurance Co. [1889] 2 TC 460
(HL): ‘…. Incorporation does not destroy or even impair the complete
identity between the contributors and the participators.’ (Emphasis
supplied)

The Supreme Court in an early case in CIT vs. Royal Western India
Turf Club Ltd. [1953] 24 ITR 551, 560 (SC) explained convincingly: ‘In such cases where there is
identity in the character of those who contribute and of those who participate
in the surplus, the fact of incorporation may be immaterial and the
incorporated company may well be regarded as a mere instrument, a convenient
agent for carrying out what the members might more laboriously do for
themselves.’ (Emphasis supplied)

Later, in yet
another decision in CIT vs. Chelmsford Club [2000] 243 ITR 89 (SC),
it was observed (see head notes at p. 90): ‘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.’ (Emphasis supplied)

When one surveys
all the club cases, one notices that in most of the cases, the club was an
incorporated company, still, the Courts have upheld the applicability of the
principle of mutuality to the club. The incorporation of the club as a company
did not pose a hurdle in the way of applying the principle of mutuality to the
club.

In view of the
above, one can safely conclude that it is settled law that incorporation of
members into a registered society under the Societies Act would not adversely
impact the applicability of the principle of mutuality to the transfer fee
received by a Society.

Hurdle 2:
Members as a class

As discussed above,
the cardinal requirement of mutuality is that all the contributors to the
common fund must be participators in the surplus and that all the participators
in the surplus must be contributors to the common fund. In the case of transfer
fee received by a Society, the beneficiaries are all the members of the
Society, but the contributors are only those members who have transferred their
flat / shop / office / unit and not all the members. Then, how does it
satisfy the requirement of mutuality?

In terms of the
bye-laws of every Society, every member who transfers the flat / office,
etc. is liable to pay to the Society transfer fee. So, the basic or primary
liability to contribute to the Society in the form of transfer fee is on every
member, meaning thereby that all the members are liable to pay the transfer
fee and not a particular member or a particular section of the members is
liable to pay the transfer fee – only the occasion to pay, i.e., transfer of
the flat / office, should arise. The person paying the transfer fee is paying
in his capacity or character as ‘a member’ of the Society and not in any
other capacity. Further, the participators in or beneficiaries of the transfer
fee received by the Society are also enjoying the same in their capacity or character as ‘members’. Thus, the identity between the
contributors and the participators is perfectly established.

While comparing the
contributors and the participators, they should be compared as ‘a class’ and no
individual contributor or participator is to be compared. For the purpose of
applicability of the principle of mutuality to the transfer fee received by a
Society it is not necessary that all the members should contribute or pay the
transfer fee at the same time which is an impossible event. It is sufficient if
all the members are liable by terms of the agreement to the bye-laws to
pay the transfer fee at the time of ‘transfer’.

The above reasoning
of comparing the members as ‘a class’ is well settled by numerous judicial
precedents. In CIT vs. Merchant Navy Club [1974] 96 ITR 261, 273 (AP) the
Court articulated with precision: ‘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. What is required is that the members as a class should
contribute to the common fund and participators as a class must be able
to participate in the surplus….’ (Emphasis supplied)

On this topic, a
learned author, Wheatcroft enlightens in his authoritative treatise ‘The Law
of Income-tax, Sur-tax and Profits Tax’ in paragraph 1-417 at pp. 1200-01:
‘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) This paragraph was noted and followed
by the Andhra Pradesh High Court in CIT vs. Merchant Navy Club (Supra)
while making the above observations.

Likewise, in CIT
vs. Shree Jari Merchants Association [1977] 106 ITR 542, 550-551 (Guj)
it was commented: ‘…. the main test of mutuality is complete identity of the
contributors with the recipients. This identity need not necessarily be of
individuals, because it is the identity of status or capacity which matters
more. Thus, individual members of an association may be different at different
times; but so long as the contributors and recipients are both holding the
membership status in the association, their identity would be clearly
established, and the principle of mutuality would be available to them.’
(Emphasis supplied)

Thus, if the
character or capacity of the persons paying the transfer fee, i.e., members, is
compared with the character or capacity of the persons enjoying the benefits or
participating in the surplus, i.e., members, the identity between the two is
established beyond the slightest shadow of doubt.

As rightly observed
in many cases⁴, in a Society the members are a class and that class
may be diminished by the members going out or increased by the members coming
in – but the class remains the same.

The Department
often argues that the member contributing the transfer fee is an outgoing
member, whereas the members enjoying the benefits of the transfer fee are the
existing members and the incoming members and therefore the contributors and
the participators are not identical. This argument stands answered by the class
theory discussed above.

Practically
speaking, it should be ensured that when the transfer fee is received by the
Society, the contributor is technically a ‘member’ registered in the records of
the Society. The occasion to take care arises more when the transfer fee or a
part thereof is received from an incoming member (‘transferee’) and on the date
when he pays the transfer fee he is not yet technically admitted as a member in
the records of the Society. The Department, in such a situation, often contends
that the transfer fee is paid by a person who is not a member and hence the
identity between the contributors and the participators is not established and the transfer fee is therefore taxable.⁵
Fortunately, however, the Supreme Court has adopted a very liberal and
pragmatic view even in such situations by granting the exemption even though
the admission of the transferee was pending when he paid the transfer fee. The
Supreme Court⁶ has unequivocally held that the transfer fee received
by a Society from a transferee member would not partake of the nature of profit
or commerciality as the amount is appropriated by the Society only after the
transferee is inducted as a member and the moment the transferee is inducted as
member the principle of mutuality applies, and in the event of non-admission,
the amount is refunded.⁷

Hurdle 3:
Participation in the surplus

In order to satisfy
the test of mutuality it is not necessary that the transfer fee received by a
Society should be utilised for the repairs and renewals of the Society’s
property in the year of receipt of the transfer fee. It may happen that the
transfer fee received may remain unutilised in the year of receipt and may have
to be carried forward to the future years under ‘Reserve Fund’ to be utilised
for ‘expenditure on repairs, maintenance and renewals of the Society’s
property’. Practically, one day or the other the amount is going to be utilised
for the repairs, renewals, etc. of the Society’s property, and there would be
no damage to the applicability of the principle of mutuality to the transfer
fee received by the Society. But, theoretically, technically or legally, what
happens if the surplus remains unutilised and the Society is to be wound up?

As per section 110
of the Maharashtra Co-operative Societies Act, 1960, in the event of winding up
of the Society, the following are the options available for the disposal of the
surplus:

(a) The same may be divided by the Registrar, with
the previous sanction of the State Government, amongst its members in such
manner as may be prescribed; or

(b) The same may be devoted to any object or
objects provided in the bye-laws of the Society; or

(c) If the same is not divided amongst the members
and the Society has no such bye-laws for its utilisation for its objects, the
surplus shall vest in the Registrar, who shall hold it in trust and shall
transfer the same to the reserve fund of any other Society having similar
objects and serving more or less an area which the Society, to which the
surplus belonged, was serving. It is further provided that if no such Society
is available, the Registrar may use it for some public purpose or charitable
purpose.

If the surplus is
utilised as per (a) and (b) above, there is certainly no damage to the
applicability of the principle of mutuality to the transfer fee since, in those
cases, it is the members who are the ultimate beneficiaries of or the
participators in the surplus and that would be perfectly in keeping with the
requirement of the principle of mutuality. But, in the event the surplus vests
in the Registrar in terms of (c) above, and is not utilised by or for the
members, would it militate against the applicability of the principle of
mutuality to the transfer fee received by the Society, because the
participators in the surplus would not be the members who have contributed to
it?

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4 See, for example, Sind Co-operative Housing Society
vs. ITO [2009] 317 ITR 47, 60-61 (Bom).

5 This was the view expressed in Walkeshwar Triveni Co-operative
Housing Society Ltd. vs. ITO [2004] 267 ITR (AT) 86 (Mum)(SB).

6 ITO vs. Venkatesh Premises Co-operative
Society Ltd. [2018] 402 ITR 670, 681 (SC).

7 See the similar views expressed in Sind Co-operative Housing Society
vs. ITO [2009] 317 ITR 47, 60 (Bom) [after considering the decision in Walkeshwar Triveni Co-operative
Housing Society Ltd. vs. ITO [2004] 267 ITR (AT) 86  (Mumbai) (SB)], followed in Mittal Court Premises Co-operative
Society Ltd. vs. ITO [2010] 320 ITR 414, 419 (Bom) (later affirmed by the Supreme

First of all,
looking at the provisions of the Model Bye-laws adopted by all the Societies,
the possibility of a situation arising under (c) is practically almost none.
But theoretically, technically or legally, what happens if the situation in (c)
arises and there is a possibility of the surplus falling into the hands of
persons other than members? Would it militate against the applicability of the
principle of mutuality? Let us go through some decided cases in search of
judicial guidance.

In IRC vs.
Eccentric Club [1925] 12 TC 657 (HL), there was a club incorporated as
a company with the object to promote social relations amongst gentlemen connected
with literature, art, music, drama, etc., which conducted a club of
non-political character. Clause 6 of its memorandum of association prohibited
distribution of dividend and also provided that on winding up of the club, the
surplus, if any, was not to be distributed amongst the members, but was to be
given or transferred as the committee of management may determine. In spite of
these features, it was held by the House of Lords that the principle of
mutuality was applicable to the club and the income of the club was
non-taxable.

This decision was
followed in India by the Madras High Court in CIT vs. Madras Race Club
[1976] 105 ITR 433 (Mad). In this case the memorandum of association of
the club provided that in the event of winding up, the surplus was not
divisible amongst the members, but had to be made over to the entities having
similar objects. Despite this feature, the Madras High Court held that the
principle of mutuality was applicable, following the above referred decision in
IRC vs. Eccentric Club (Supra). The Court made very interesting
observations (p. 443): ‘It is well settled that the memorandum and
articles of a company represent the contract between the company and the
members. It is only by virtue of their ownership of the surplus assets, if any,
that the members had agreed to the clause that they would not take back the
surplus, but allow it to be transferred to any similar entity. As they
themselves are to deal with the surplus, if any, at the time of winding up, it
cannot be said that they are not participators in the surplus. The clause
is only a fetter in the manner of disposal. The participation envisaged in
the principle of mutuality is not that the members should willy-nilly take the
surplus to themselves. It is enough if they held a right of disposal over the
surplus to show that they were the participators.’ (Emphasis supplied)

However, the
Gujarat High Court adopted a contrary view in CIT vs. Shree Jari
Merchants Association [1977] 106 ITR 542 (Guj). In this case a rule of
the constitution of the association provided that at the time of its
dissolution the surplus assets of the association shall be used in the manner
proposed in the resolution passed by the association. The Court observed (p.
551-552): ‘It is apparent that any resolution which may come up for
consideration in future would not necessarily provide for the distribution of
the surplus assets only amongst the members of the association. If, therefore,
the assets of the association are not liable to be returned to the members, the
identity between the contributors and recipients would be lost. This would
militate against the very basic principle of mutuality.’ The Court
concluded (p. 553): ‘In the result, we conclude that the assessee is not
a mutual concern and cannot claim exemption on that ground.’

Thus, in this case,
it is the fear or possibility of distribution of surplus amongst non-members
which influenced the decision of the Court against the assessee.

But, in a
subsequent case, the Andhra Pradesh High Court in CIT vs. West Godavari
Dist. Rice Millers Association [1984] 150 ITR 394 (AP) held the
principle of mutuality applicable to the association despite the provision that
the surplus remaining with the association should not, at the time of
dissolution, go to the members but it should be made over to an
association with similar objects. The Court followed the
above decisions in IRC vs. Eccentric Club (Supra) and CIT
vs. Madras Race Club (Supra) and dissented from the above
decision in CIT vs. Shree Jari Merchants Association (Supra).⁸

It would be
worthwhile to note that every Society is subject to rigid discipline of the
Maharashtra Co-operative Societies Act, 1960 or any other relevant law under
which it is registered and therefore the apprehension expressed by the Gujarat
High Court in CIT vs. Shree Jari Merchants Association (Supra) of
the possibility of the surplus being distributed among non-members is not
present in the case of a Society.

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8 For identical views, see CIT vs. Cochin Oil Merchants’
Association [1987] 168 ITR 240 (Ker); CIT vs. Northern India Motion Pictures
Association [1989] 180 ITR 160 (P & H) and CIT vs. Indian Paper Mills
Association [1994] 209 ITR 28 (Cal).

Later, in CIT vs. Adarsh Co-operative
Housing Society Ltd.
[1995] 213 ITR 677 (Guj), the Gujarat High Court has taken a
favourable view by distinguishing the earlier adverse decision in
CIT vs. Shree Jari Merchants Association (Supra). This case was concerned with
determining the taxability of the premium amounts received by a Society on the
transfer of lease of plots by its members. Despite the fact that the bye-laws
of the Society provided that the surplus could be dealt with in accordance with
the resolution of the committee of the Society, the Court held that the premium
amounts were exempt on the principle of mutuality. The Court raised a pertinent
question (p. 692): ‘… the question which arises is: what is meant by ‘‘return’’
of what has been contributed to a common fund? Does it mean the return of the
corpus of the fund or does it include retention of control over the
corpus to be used in consonance with the statute regulating the association,
company or society, as the case may be?’ (Emphasis supplied)

Dispelling the fear of the surplus going into the
hands of non-members,
the Court, taking into consideration the scheme and provisions of the
Gujarat
Co-operative Societies Act, observed that it is only on the failure of
the
members to exercise such power that the surplus vests in the Registrar
and not
otherwise. The Court observed that the phrase ‘return of the surplus to
contributors’ in the context of regulatory provisions as opposed to
voluntary act of parties, cannot be construed in the narrow sense of
division
of the corpus, where the body of the members as a whole retains the
power and
control over utilisation of surplus left at the time of dissolution or
winding
up, though division of the corpus is prohibited; it is return of the
corpus to
the members for their use. The Court elaborated the concept by stating
that it
is not the requirement that return of the corpus to the members must be
only
for the purpose of division; the fact that the members may in future
abandon
their power and may allow the surplus to be vested in the Registrar
cannot be a
decisive factor in determining the present status of mutuality. The
Court made
very significant comments (p. 693):

‘What is of the
essence is: what are the ordinary consequences envisaged by members within the
framework of the statute to deal with the surplus? The right of the members to
deal with the surplus is not destroyed but is only restricted to the extent
that instead of dividing the corpus pro rata, it has been confined to
utilisation or expending of the surplus for the objectives as per their own
decision. This does not detract from the concept of return of the surplus to
members which they have contributed in making that fund.’

After referring to
the facts of the adverse decision in Shree Jari Merchants Association
(Supra), strongly relied upon by the Department, the Court observed
that in that case the question as to what is the meaning of ‘return of surplus’
was neither raised nor decided by the Court, but it proceeded on the assumption
that ‘return of surplus’ relates to ‘return of corpus’ to be shared by the
members pro rata. The Court finally stated: ‘We find that the facts of the present case do not attract the ratio
of the decision in the case of Shree Jari Merchants Association [1977]
106 ITR 542 (Guj).’

On this point, in Kanga
& Palkhivala’s The Law & Practice of Income Tax, ninth edition (pp.
193-194), after referring to several judicial pronouncements discussed
hereinabove, the principle is summarised with precision: ‘….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
each member should participate in the surplus or get back from the surplus
precisely what he has paid.…..the test of mutuality does not require that
the contributors to the common fund should 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.’⁹ (Emphasis supplied)

In view of the
foregoing discussion, it is submitted that the applicability of the principle
of mutuality to the transfer fee received by a Society is not impaired on the
ground that the surplus might be distributed amongst non-members and
consequently the identity between the contributors and the participators may be
lost.

Hurdle 4:
Presence of other income

The fourth hurdle
could be the presence of some incidental receipts by the Society which may not
be governed by the principle of mutuality and hence may be taxable, e.g.,
interest received by a Society on excess funds deposited with a co-operative
bank. But would the presence of such taxable items jeopardise the applicability
of the principle of mutuality to the Society as a whole and qua the
transfer fee?

__________________________________________________________________________________________________

It is submitted
that mere presence of certain incidental items of taxable income should not
adversely affect the claim of the Society to the principle of mutuality in
respect of its main activities and in respect of the transfer fee.

In CIT vs.
Madras Race Club [1976] 105 ITR 433 (Mad), where there were
transactions of the same nature with members as well as non-members resulting
in surplus, the Court applied the principle of mutuality to the transactions
with members, and observed (p. 442): ‘….
the application of the principle of mutuality is not destroyed by the
presence of transactions with or profits derived from non-members. The said
principle could apply to transactions with members.’¹⁰ (Emphasis
supplied)

SOME DIRECT JUDICIAL PRECEDENTS ANALYSED

In a plethora of
judicial decisions on the subject rendered by the Tribunal as well as several
High Courts over the last three decades, the issue of taxability of transfer
fee received by a Society came to be examined. Some decisions earlier had gone
against the assessee and the transfer fee was held taxable. But the recent
trend of the judicial decisions has been of upholding the applicability of the
principle of mutuality to the transfer fee received by a Society from its
members and treat it as non-taxable. To avoid overcrowding of citations, only a
few selected recent decisions and that, too, of the High Courts are discussed
here.

In CIT vs.
Apsara Co-operative Housing Society  Ltd.
[1993] 204 ITR 662 (Cal) the assessee was a  co-operative housing society which provided residential premises to its members
and received transfer fee for transfer of flats. The question arose about the
taxability of the transfer fee received by the assessee-society. Applying the
principle of mutuality the Court held that the transfer fee was not taxable.

In Sind
Co-operative Housing Society vs. ITO [2009] 317 ITR 47 (Bom)¹¹,
the Court categorically held (at p. 63) that the principle of mutuality will
apply to a co-operative housing society which has as its predominant activity,
the maintenance of the property of the Society which includes its building or
buildings and as long as there is no taint of commerciality, trade or business.
This decision was followed in Mittal Court Premises Co-operative Society
Ltd. vs. ITO [2010] 320 ITR 414 (Bom).¹²

Earlier there were
several Tribunal and High Court¹³ decisions where the taxability or
otherwise of the transfer fee was examined with reference to whether the
transfer fee is a capital receipt or revenue receipt, and not on the principle
of mutuality. Those decisions are not discussed here, since now they have no
relevance, especially when there are umpteen judicial rulings upholding the
applicability of the principle of mutuality to the transfer fee received by a
Society.

SUPREME COURT’S VIEW

In a recent
decision, several issues concerning the taxability of transfer fees,
non-occupancy charges, contribution to common amenities fund, etc. came up for
the consideration of the Apex Court in ITO vs. Venkatesh Premises
Co-operative Society Ltd. [2018] 402 ITR 670 (SC).¹⁴ Based
on a careful reading of this decision, it is submitted that the Supreme Court
is of the clear-cut view that the transfer fee received by a co-operative
housing society gets the shelter of the principle of mutuality and is not taxable.
Fortunately, after a long battle, the issue has been finally set at rest by
this decision of the Supreme Court in favour of the assessee.

PREMIUM COLLECTED BY SOCIETIES

Some Societies have
a provision in their bye-laws, or in their lease agreements in case of plot
holder Societies, providing that at the time of transfer of the plot, the
transferor will pay to the Society a certain amount of premium calculated
either as a percentage of the sale price realised by the transferor or at a
rate per square foot of the plot. The question has arisen many times whether
such premium received by such Society is taxable or it gets the shelter of the
principle of mutuality.

It is submitted
that such premium collected by the Society from members is ultimately going to
be utilised for the common benefit of all the members only and hence such
premium is also governed by the principle of mutuality and is non-taxable. No
doubt, earlier there were some adverse Tribunal decisions, but now most of the
judicial decisions are in favour of the view that such premium is not taxable
being covered by the principle of mutuality.

___________________________________________________________________________________________________

10 For reaching this conclusion, the Court
relied upon Carlisle
& Silloth Golf Club vs. Smith [1912] 6 TC 48, 54, 55 (KB).

11 This decision has been consistently
followed in countless judicial decisions (of the Tribunal and of the High
Courts) in favour of the assessee (which are not discussed here for brevity’s
sake).

12 Later affirmed in ITO vs. Venkatesh Premises
Co-operative Society Ltd. [2018] 402 ITR 670 (SC).

13 For example, see CIT vs. Presidency Co-operative
Housing Society Ltd. [1995] 216 ITR 321 (Bom). See the comments on this decision in Sind Cooperative Housing Society
vs. ITO [2009] 317 ITR 47 (Bom) at p. 57.

14 By the way, the Supreme Court considered
several judicial pronouncements in this case and affirmed Mittal Court Premises Co-operative
Society Ltd. vs.
ITO
[2010] 320 ITR 414 (Bom) and CIT vs. Shree Parleshwar Co-operative Housing Society Ltd. [2017] 10
ITR-OL 202 (Bom).

In CIT vs.
Adarsh Co-operative Housing Society Ltd. [1995] 213 ITR 677 (Guj) the
assessee was a co-operative society registered under the Bombay Societies Act,
1925. The Society acquired land and leased out the same to its members for a
period of 998 years. The Society permitted disposition or devolution of the
lease of any plot with any building thereon from an existing member to another
who registered himself as a member of the Society. On such transfer of lease
the existing member to whom the plot was leased had to pay to the Society half
of the premium amount received by him from the purchaser. The Court held that
the amounts contributed by the outgoing members were utilised by the Society
for extending common amenities to the members and hence the premium so
collected was non-taxable on the principle of mutuality.

In CIT vs.
Jai Hind Co-operative Housing Society Ltd. [2012] 349 ITR 541 (Bom)¹⁵
the assessee was a co-operative housing society formed of plot owners, who had
obtained land on lease from the Maharashtra Housing Board. The assessee in turn
entered into sub-lease agreements with its members. The assessee looked after
the maintenance and infrastructure. In terms of a resolution passed by the
assessee-society a member who desired to avail of the benefit of transferable
development rights and carry out construction or additional construction on his
plot, had to pay a premium of Rs. 250 per square foot to the assessee-society.
The assessee collected a premium of Rs. 18.75 lakhs in the previous year
relevant to the assessment year 2005-06. The A.O. was of the view that by
allowing the member to commercially exploit the plot and charging the premium
for that, the assessee-society was sharing the profit which was of commercial
nature. When the dispute regarding its taxability reached the High Court, it
held that such premium received by the Society is non-taxable on the principle
of mutuality as the premium flowed from a member.¹⁶

VOLUNTARY CONTRIBUTION OVER AND ABOVE TRANSFER FEE

As per the
notification¹⁷ issued, in the State of Maharashtra, the maximum
transfer fee which a Society can collect is Rs. 25,000. With increasing costs
of repairs and maintenance of buildings, the Societies are finding it difficult
to garner resources to maintain their buildings. As a result, many Societies,
especially in South Mumbai, are, in terms of resolutions passed in their
general body meetings, collecting voluntary contributions on transfer of flats
/ offices over and above the transfer fee of Rs. 25,000 as per the Government
notification. This voluntary contribution is fixed either at a particular rate
per square foot of the flat / office or sometimes even as a percentage of the
sale price of the flat / office. The Department has been contending that
collecting from the members any amount over and above the limit fixed by the
Government notification is illegal and amounts to profiteering and therefore
taxable.

But, fortunately,
even this controversy is now settled in favour of the assessee by the Supreme
Court decision in ITO vs. Venkatesh Premises Co-operative Society Ltd.
[2018] 402 ITR 670 (SC). The Department relied upon (at p. 677) the
decision in New India Co-operative Housing Society vs. State of
Maharashtra [2013] 2 MHLJ 666 (Bom) and contended that any receipt by the
Society beyond the permissible limit was not only illegal but also amounted to
rendering of services for profit attracting an element of commerciality and
thus was taxable. In response, the Supreme Court held (at p. 683) that in New
India Co-operative Housing Society (Supra), the challenge by the
aggrieved was to the transfer fee levied by the Society in excess of that
specified in the notification, which is a completely different cause of action
having no relevance to the present controversy; that it is not the case of the
Revenue that such receipts have not been utilised for the common benefit of
those who have contributed to the funds. From these observations of the Supreme
Court it is clear that the Supreme Court is of the unequivocal view that so long
as the amount contributed over and above the limit specified in the Government
notification is utilised for the common benefit of all the members, it
satisfies the test of mutuality and is non-taxable. There is another pointer to
support this in the Supreme Court decision. At p. 676, the Supreme Court notes:
‘The assessee in Civil Appeal No. 1180 of 2015 assails the finding that such
receipts, to the extent they were beyond the limits specified in the Government
notification dated August 9, 2001 issued under section 79A of the Maharashtra
Co-operative Societies Act, 1960…was exigible to tax falling beyond the
mutuality doctrine.’ In this regard, the Supreme Court held (p. 684): ‘Civil
Appeal No. 1180 of 2015 preferred by the assessee-society is allowed.’

__________________________________________________________________________________________________

15 On identical facts, earlier same view was
expressed by the Mumbai Bench of the Tribunal in The Friends Co-operative Housing
Society Ltd. vs. ITO (ITA No. 962/Mum/2010)(Order dated October 22, 2010). For identical views, see ITO vs. Presidency Co-operative
Housing Society Ltd. (ITA No. 6076/M/2017) (Order dated December 5, 2017). See also Hatkesh Co-operative Housing Society Ltd. vs. Asst. CIT [2017]
10 ITR-OL 263 (Bom).

16 The Court followed Mittal Court Premises Co-operative
Society Ltd. vs. ITO [2010] 320 ITR 414 (Bom) (later affirmed by the Supreme Court).

17 Circular No. CHS-2001/M. No. 188/14-C
dated August 9, 2001 issued under section 79A of the Maharashtra Co-operative
Societies Act, 1960, by the Cooperation & Textile Department, Government of
Maharashtra. The validity of this circular was upheld in New India Co-operative Housing
Society vs. State
of
Maharashtra [2013] 2 MHLJ 666 (Bom).

Earlier, in CIT
vs. Darbhanga Mansion Co-operative Housing Society Ltd. (ITXA No. 1474 of 2012)
(Order dated December 18, 2014)¹⁸ the Bombay High Court held
that even if the amount of transfer fee collected exceeds the limit of Rs.
25,000 it is non-taxable on the principle of mutuality, because the
applicability of the principle of mutuality is not dependent upon the amount.

In view of the
above, it is submitted that the voluntary contribution collected by a Society
over and above the limit specified in the Government notification gets the
shelter of the doctrine of mutuality and hence is non-taxable. It is noteworthy
that this will not be affected even if it is found that the contribution is not
voluntary but involuntary.¹⁹

SECTION 56(2)(x): APPLICABLE TO TRANSFER FEE?

Section 56(2)(x)²⁰
of the Act contains a legal fiction to the effect that where any person
receives any benefit in terms of money or money’s worth, without consideration
or for inadequate consideration, such benefit is taxable as income in his hands
under the head ‘Income from other sources’. In effect, a gift or deemed gift is
subjected to tax as income in the hands of the recipient.²¹ This
provision encompasses within its fold three types of gifts: (i) sum of money
(b) immovable property and (iii) property²² other than an immovable
property. There is a threshold exemption of Rs. 50,000 of such gift from this
tax. There are of course some exemptions from this charge, contained in the proviso
to section 56(2)(x), such as gift received from any relative, gift received on
the occasion of marriage, etc.

Can the Department
contend that the Society has ‘received’ the transfer fee from a member without
consideration and therefore is taxable as income under section 56(2)(x)?

As discussed above,
a Society is a mutual benefit association governed by the doctrine of
mutuality, and the principle of mutuality is premised on the theory that a
person cannot make a profit from himself and an amount received from
oneself, therefore, cannot be regarded as income and taxable.²³
Thus, the Society and the members constitute ‘one person’ and not two persons.
Incorporation as a Society is only a convenient mode. It is held that the word
‘received’  implies two persons, namely,
the person who receives and the person from whom he receives; a person cannot
receive a thing from himself. [Rai Bahadur Sundar Das vs. The Collector
of Gujarat (1922) ITC 189, 192 (Lahore).] Since the Society and the
members constitute one person, the Society cannot be said to have ‘received’
the sum of money from another person (member) and hence the transaction does
not fall within the purview of section 56(2)(x) at all.²⁴ Thus,
section 56(2)(x) does not override, or carve an exception to, the principle of mutuality. It is pertinent to note that
even in the contexts of sales tax²⁵ and service tax²⁶, it
is settled that in the case of a mutual concern, there is only one person and
there are no two persons involved and therefore there cannot be any ‘sale’ by
one person to another to be subjected to sales tax and that there is no
‘service provided’ by one person to another and therefore there is no question
of charging service tax.

It can be argued
alternatively that the transfer fee is paid by a member to the Society for
discharging the obligation cast upon him by the bye-laws of the Society and
hence it is not ‘without consideration’ and hence it does not fall within the
purview of section 56(2)(x).

It can also be further contended that the member paying the transfer
fee to the Society receives the consideration  in the form of all amenities and facilities of
the Society, including particularly good maintenance of the building in which
such member lives; and, therefore, there is a consideration for payment of
transfer fee. As such, the Society does not receive it ‘without
consideration’ and hence it does not fall
within the purview of section 56(2)(x).

____________________________________________________________________________________________________________

18 For identical views, see The Friends Co-operative Housing
Society Ltd. vs. ITO (ITA No. 962/Mum/2010)(Order dated October 22, 2010); ITO
vs. Damodar Bhuvan Co-operative Housing Society Ltd. (ITA No. 1610/ Mum/2010)
(Order dated September 16, 2011); ITO vs. The Presidency Co-operative Housing
Society Ltd. (ITA No. 6076/M/2017) (Order dated December 5, 2017) and ITO vs. The Casa Grande
Co-operative Housing Society Ltd. (ITA No. 4598/Mum/2014) (Order dated January
29, 2016). 19 See
Sind
Co-operative Housing Society vs. ITO [2009] 317 ITR 47, 61 (Bom).

20 Read with section 2(24)(xviia).

21 As is known, gift-tax, hitherto levied
under the Gift-tax Act, 1958, has been abolished from October 1, 1998.

22 The term ‘property’ is defined to mean
nine specific items enumerated therein (which includes an immovable property).
See the Explanation
below
clause (x) of sub-section (2) of section 56 with clause (d) of the Explanation to clause (vii) of sub-section (2) of section
56.

23 See ITO vs. Venkatesh Premises
Co-operative Society Ltd. [2018] 402 ITR 670, 679 (SC).

24 Whenever the legislature intended to tax a
transaction with self, it has provided so by an express statutory provision.
For example, see section 45(2) (conversion of a capital asset into
stock-in-trade) and section 28(via) (conversion of stockin- trade into a
capital assert). (See the observations at p. 41 in State of West Bengal vs. Calcutta Club Ltd.
2019-VIL-34-SC-ST.) Section
56(2)(x) is not a provision which would encompass transfer fee within its fold.

25 See CTO vs. Young Men’s Indian
Association (1970) 1 SCC 462.

26 See State of West Bengal vs. Calcutta
Club Ltd. 2019-VIL-34-SC-ST.

It is further
arguable that section 56(2)(x) contains a legal fiction. As is settled, a legal
fiction is created for a specific purpose and it has to be construed strictly²⁷,
and its application has to be confined to the purpose for which it is
created and should not be extended beyond its legitimate field. Section
56(2)(x) (as well as its predecessors) was enacted to
fill the void created by the abolition of the Gift-tax Act, 1958 and to
tax
gifts by one person to another. Going by this principle, it is submitted
that
the transfer fee received by a Society (which is non-taxable on the
principle
of mutuality) cannot be accommodated within the scope and ambit of the
legal
fiction of section 56(2)(x).

GST IMPACT

As stated above, in
the contexts of sales tax and service tax, it is settled by the Supreme Court
that in the case of a mutual concern, where the doctrine of mutuality is
applicable, there cannot be sales tax and service tax. A view is maintained
that this judicial position holds good even for the purpose of tax under the
Goods and Services Tax Laws (‘GST Laws’), but there are a few recent rulings to
the contrary. Be that as it may, the position of income-tax on transfer fee
stands concluded in favour of the assessee as discussed above and it will
remain intact and unaffected by some adverse rulings under the GST Laws.

TO SUM UP

In conclusion, it
is submitted that all the following amounts received by a Society –
residential, commercial and industrial – on the transfer of a flat / office /
shop / unit are non-taxable on the principle of mutuality:

(i)  the normal transfer fee up to Rs. 25,000;

(ii)  the voluntary contribution / donation by a
member, over and above the normal transfer fee of Rs. 25,000; and

(iii) the premium on transfer
of plots or leasehold rights in plots.