CONCEPT OF MUTUALITY

Though
the concept of ‘mutuality’ has been a subject-matter of extensive
judicial considerations under the Income tax Act and Sales tax laws, it
has been tested judicially to a very limited extent under Service tax.

However,
it assumed significance in the context of Club or Association Service,
the category introduced w.e.f. June 16, 2005, more particularly in the
context of co-operative societies, trade associations and clubs.

The
following Explanation was inserted at the end of section 65(105) of the
Finance Act, 1994 (Act) w.e.f. May 01, 2006: “For the purpose of this
section, taxable service includes any taxable service provided or to be
provided by any unincorporated association or body of persons to a
member thereof, for cash, deferred payment or any other valuable
consideration.” Attention is particularly invited to the following
Explanation inserted to newly introduced section 65B(44) of the Act
which now defines ‘service’ effective from July 01, 2012: “
…………………….

Explanation 2 — For the purpose of
this Chapter, — (a) An unincorporated association or a body of persons,
as the case may be, and a member thereof shall be treated as distinct
persons. ……………”

General concept

It is
widely known that no person can make a profit out of himself. The old
adage that a penny saved is a penny earned may be a lesson in household
economics, but not for tax purposes, since money saved cannot be treated
as taxable income. It is this principle, which is extended to a group
of persons in respect of dealings among themselves. This was set out by
the House of Lords in Styles v. New York Life Insurance Co., (1889) 2 TC
460 (HL). It was clarified by the Privy Council in English and Scottish
Joint Co-operative Wholesale Society Ltd. v. Commissioner of
Agricultural Income-tax, (1948) 16 ITR 270 (PC), that mutuality
principle will have application only if there is identity of interest as
between contributors and beneficiaries. It was the lack of such a
substantial identity between the participants, with depositor
shareholders forming a class distinct from the borrowing beneficiaries,
that the principle of mutuality was not accepted for tax purposes for a
Nidhi Company (a mutual benefit society recognised u/s.620A of the
Companies Act, 1956) in CIT v. Kumbakonam Mutual Benefit Fund Ltd.,
(1964) 53 ITR 241 (SC).

Distinction between Members’ Club/Association and Proprietary Club/Association

(i)
The concept of mutuality and distinction between ‘Members’ Clubs’ and
‘Proprietary Clubs’ has been discussed in detail in a 6-Member Supreme
Court Ruling viz. Joint CTO v. Young Men’s Indian Association, (1970) 26
STC 241 (SC). (‘YMIA’) The relevant extract of discussion is set out
hereafter for reference.

If a members’ club, even though a
distinct legal entity, acts only as an agent for its members in the
matter of supply of various preparations and articles to them, no sale
would be involved as the element of transfer would be completely absent.
Members are joint owners of all the club properties. Proprietary clubs
stand on a different footing. The members are not owners of or
interested in the property of the club. To show the difference of
characteristics between Members’ Club and Proprietary Club, the Supreme
Court held that where every member is a shareholder and every
shareholder is a member, then the same would be called a Members’ Club.

In
a Members’ Club what is essential is that the holding of the property
by the agent or trustee must be holding for and on behalf of and not a
holding antagonistic to the members of the club. (ii) In CIT v. Bankipur
Club Ltd., (1997) 226 ITR 97 (SC), it was held by the Supreme Court
that there must be complete identity between contributors and
participators. If this requirement is fulfilled, it is immaterial, what
particular form the association takes. Trading between persons
associating together in this way does not give rise to profits which are
chargeable to tax. Facilities were offered only as a matter of
convenience for the use of the members. (iii) It was further held in
Chelmsford Club v. CIT, (2000) 243 ITR 89 (SC) that the surplus from the
activities of a club is excluded from the levy of the income-tax.

Applicability to a co-operative society

Where
a co-operative society deals solely with its members, right to
recognition for exemption on grounds of mutuality has been recognised
under income-tax in the following High Court rulings:

• CIT v. Apsara Co-operative Housing Society Ltd., (1993) 204 ITR 662 (Cal.);
•  CIT v. Adarsh Co-operative Housing Society Ltd., (1995) 213 ITR 677 (Guj.) and;
• Director of Income-Tax v. All India Oriental Bank of Commerce and Welfare Society, (2003) 130 Taxman 575 (Del.).

 Judicial considerations under Service tax

The
Service tax authorities had issued show-cause notices to various clubs
demanding Service tax under the service category ‘Mandap Keeper’ on the
ground that the clubs have allowed the members to hold parties for
social functions. Two of such clubs disputed the levy before the
Calcutta High Court viz.:

• Dalhousie Institute v. AC, (2005) 180 ELT 18 (Cal.).
•  Saturday
  Club Ltd. v. AC, (2005) 180 ELT 437 (Cal.). In Saturday Club’s case, a
  members’ club permitted occupation of club space by any member or his
  family members or his guest for a function by constructing a mandap.

On the principle of mutuality, there cannot be

(a) any sale to oneself,
(b) any service to oneself or
(c) any profit out of oneself.

Therefore,
the Calcutta High Court held that the same principle of mutuality would
apply to income-tax, Sales tax and Service tax in the following words:
“Income tax is applicable if there is an income. Sales tax is applicable
if there is a sale. Service tax is applicable if there is a service.
All three will be applicable in a case of transaction between two
parties.

Therefore, principally there should be existence of two
sides/entities for having transaction as against consideration. In a
members’ club there is no question of two sides. ‘members’ and ‘club’
both are the same entity. One may be called as principal while the other
may be called as agent, therefore, such transaction in between
themselves cannot be recorded as income, sale or service as per
applicability of the revenue tax of the country. Hence, I do not find it
is prudent to say that members’ club is liable to pay service tax in
allowing its members to use its space as ‘mandap’.”

While
quashing the proceedings, the High Court referred to the decisions in
the case of Chelmsford Club v. CIT, (2000) 243 ITR 89 (SC) & CIT v.
Bankipur Club Ltd., (1997) 226 ITR 97 (SC)

Principles laid down by the Calcutta High Court under Service tax

(a)
The principles laid down by the Calcutta High Court in Saturday Club
& Dalhousie Institute discussed above have been followed in a large
number of subsequently decided cases. Some of these are:

• Sports Club of Gujarat Ltd. v. UOI, (2010) 20 STR 17 (Guj.)
• Karnavati Club Ltd. v. UOI, (2010) 20 STR 169 (Guj.)
•  CST v. Delhi Gymkhana Club Ltd., (2009) 18 STT 227 (CESTAT-New Delhi)
•  Ahmedabad Management Association v. CST, (2009) 14 STR 171 (Tri.-Ahd.) and
•  India International Centre v. CST, (2007) 7 STR 235 (Tri.-Delhi)

“using of facilities of club, cannot be said to be acting as its clients and hence, in respect of services provided to its members, a club would not be liable to pay Service tax in the category of club or association service.”

The Revenue’s appeal against the above ruling was dismissed by the Delhi High Court on technical grounds. It needs to be noted that, Explanation inserted at the end of section 65(105) of the Act w.e.f. May 01, 2006, has not been discussed in the aforesaid ruling.

Recent judgment in Ranchi Club Ltd. v. CCE & ST, (2012) 26 STR 401 (JHAR)

Background

A writ petition was preferred by Ranchi Club Limited for declaration that the Club was not covered under the Act and, therefore, was not liable to pay Service tax under ‘Mandap Keeper Service’ or under the ‘Club or Association Service’ categories and prayed for order of prohibition against Central Excise Division, Ranchi from enforcing any of the provisions of the Act.

Contention of the petitioner

Petitioner is a club which is a registered company under the Companies Act, 1956 and is giving service to its members but the club is formed on the principle of mutuality and, therefore, any transaction by the club with its member is not a transaction between two parties. When the club is dealing with its member, it is not a separate and distinct individual. It was submitted that in identical facts and circumstances, however, in the matter of imposition of sales tax, when the club was expressly included in the statutory definition of ‘dealer’ under the Madras General Sales Tax Act, 1959, so as to bring the club within the purview of taxing statute of the Madras Sales Tax, the Supreme Court, in YMIA case, considered the definition of the ‘dealer’ by which the club was declared as a ‘dealer’. The Court considered the definition of ‘sale’ as given in the Act of 1959 and Explanation-I appended to section 2(n), specifically declaring ‘sale’ or ‘supply or distribution of goods by a club’ to its members whether or not in the course of business to be a ‘deemed sale’ for the purpose of the said Act. In that situation, the Supreme Court considered the issue that when the club is rendering service or selling any commodity to its members for a consideration, whether that amounts to sale or not. The Supreme Court held that it is a mutuality which constitutes the club and, therefore, sale by a club to its members and its services rendered to the members, is not a sale by the club to its members. In sum and substance, the ratio is that for a transaction of sale, there must be two persons in view of this judgment as well as in view of the Full Bench judgment of this Court delivered in the petitioner’s own case i.e., Tax v. Ranchi Club Limited, (1992) 1 PLJR 252 (PAT) (FB) (‘Ranchi Club’). The Full Bench considering the identical issue in the matter of imposition of income-tax observed that no one can earn profit out of himself on the basis of principle of mutuality and held that income-tax cannot be imposed on the transaction of the club with its members.

With the help of these two judgments, it was submitted that the petitioner was a club and was rendering services to its members and the same principle of mutuality applied to the facts of the case in view of the reason that the language in the provisions of the Madras General Sales Tax Act, 1959 and the provisions under the Income-tax Act are pari materia with the provisions which are sought to be applied against the writ petitioner for levy of Service tax.

Contentions of the Department

The Department submitted that the sale has its own meaning and the service is entirely different transaction which cannot be equated with the sale in any manner. They relied upon the book ‘Principles of Statutory Interpretation’ by G. P. Singh, the then Chief Justice, M.P. High Court (3rd edition), wherein there is reference to a case wherein Bhagwati J observed that, for construction of fiscal statute and determination of liability of the subject to tax, one must refer to the strict letters of law. It was submitted that the statutory provisions are very clear which are sections 65(25a), 65(105)(zzze) as well as Explanation appended to section 65. It was also submitted that when the language of section is absolutely clear, then the meaning of the statute in fiscal matter should be given according to the language and words used in the section and cannot be interpreted on the basis of some ideology or some impressions or with the help of some other enactments. Each of the taxing statute may have its own definition and meaning and they are required to be given effect to, irrespective of the fact that meaning of the same word in different statute has been given differently. It was further submitted that the Supreme Court in the situation of imposition of Sales tax may have held that there cannot be sale by oneself to oneself and himself to himself, but the club can certainly render the service to its members and tax is on the service and the members are paying for the service to the club and, therefore, it is a service for consideration rendered by the club and is liable for tax.

Observations of the High Court

The question which was considered by the Supreme Court in YMIA case was that whether the supply of various preparations by each club to its members involves a transaction of sale within the meaning of the Sale of Goods Act, 1930. In para 15 of the judgement, the High Court quoted the Supreme Court as under:

“Thus in spite of the definition contained in section 2(n) read with Explanation 1 of the Act, if there is no transfer of property from one to another there is no sale which would be exigible to tax. If the club even though a distinct legal entity is only acting as an agent for its members in matter of supply of various preparations to them, no sale would be involved as the element of transfer would be completely absent. This position has been rightly accepted even in the previous decision of this Court”.

The Supreme Court held so after considering the English Law also and observed that the law in England has always been that members’ clubs to which category the clubs in the present case belong cannot be made subject to the provisions of the Licensing Acts concerning sale because the members are joint owners of all the club property including the excisable liquor. The supply of liquor to a member at a fixed price by the club cannot be regarded to be a sale. With regard to incorporated clubs a distinction has been drawn. Where such a club has all the characteristics of a members’ club consistent with its incorporation, that is to say, where every member is a shareholder and every shareholder is a member, no licence need to be taken if liquor is supplied only to the members. If some of the shareholders are not members or some of the members are not shareholders that would be the case of a Proprietary Club and would involve sale. Proprietary clubs stand on a different footing. The members are not owners of or interested in the property of the club. The Supreme Court observed that the above view was accepted by various High Courts in India. The Supreme Court, relying upon other judgments held that members’ club is only structurally a company and it did not carry on trade or business so as to attract the corporation profit tax. Therefore, in spite of specific inclusion of the club in the definition of the dealer in the Madras General Sales Tax Act, 1959, the Supreme Court categorically held that , there cannot be transaction of transfer of property.

The Full Bench of the Patna High Court in the case of the petitioner itself (Ranchi Club case) after finding that the club was a limited company incorporated under the Indian Companies Act, considered various clauses of the main objects of the club and relying upon various judgments, observed as under:

    Therefore, by applying the principle of mutuality, members’ clubs always claim exemption in respect of surplus accruing to them out of the contributions received by the clubs from their members. But this principle cannot have any application in respect of surplus received from non-members. It is not difficult to conceive in case where one and the same concern may indulge in activities which are partly mutual and non-mutual. True, keeping in view the principle of mutuality, the surplus accruing to a members’ Club from the subscription charges received from its members cannot be said to be income within the meaning of the Act. But, if such receipts are from sources other than the members, then can it still be said that such receipts are not taxable in the hands of the club? The answer is obvious. No exemption can be claimed in respect of such receipts on the plea of mutuality. To illustrate, a members’ club may have income by way of interest, security, house property, capital gains and income from other sources. But such income cannot be said to be arising out of the surplus of the receipts from the members of the club. “

Conclusion by the High Court

Taxability of mutual concerns (up to 30-6-2012)

    a) According to one school of thought, the scheme of Service tax envisages a contractual relationship between the service provider and service receiver. Under a service contract, money flows from the service receiver and service is rendered by the service provider. The Courts have held that relationship between a mutual association and its members is governed by the principle of mutuality and is not one between two different entities. When a facility or amenity is provided to the members, it is so done by the members to themselves through the medium of their agent, the association. There cannot be an independent commercial transaction between a principal and his agent. Therefore, the very scheme of service tax is not applicable to the relationship between the members’ association and its members. Hence, the club or association service category (introduced w.e.f. June 16, 2005) would not apply to mutual concerns.

The ruling of the Jharkhand High Court in Ranchi Club discussed above strongly supports this view and more importantly it has considered the Explanation inserted at the end of section 65(105) of the Act w.e.f. May 01, 2006 to nullify the Calcutta High Court rulings of Saturday Club (supra) and Dalhousie Institute (supra).

    b) According to another school of thought, the Calcutta High Court ruling in Saturday Club & Dalhousie Institute case discussed earlier was in the context of Mandap Keeper Services wherein the relevant taxable service definition u/s. 65(105) of the Act, the service recipient was specified as ‘Client’. However, under the club or association service category, the relevant taxable service definition u/s.65(105)(zzze) of the Act, the service recipient is specified as ‘members’.

The distinction made by the Government is reinforced, if one closely examines, the taxable services definitions of all the newly introduced taxable services through the Finance Act, 2005 which clearly demonstrates that in the context of club or association services ‘members’ have been specified as service recipients liable to tax. Hence the ratio of Saturday Club’s case would not apply in the context of mutual concerns like club, associations, etc. The aforesaid view is reinforced by the insertion of Explanation at the end of section 65 of the Act w.e.f. May 01, 2006.

    c) Though principle of mutuality is relevant, it would appear that taxability of mutual concerns under Service tax remains a highly contentious and litigative issue.

Taxability of mutual concerns under the ‘negative list’ based taxation of services (w.e.f. July 01, 2012)

The terminology employed in Explanation 2 inserted in section 65B(44) of the Act which defines ‘Service’ is identical to that employed in Explanation to section 65(105) of the Act (up to June 30, 2012). Hence, it would appear that, principles of mutuality upheld by the Calcutta High Court in Saturday Club and Dalhousie Institute and the Jharkhand High Court in Ranchi Club, would continue to be relevant.

Further, under Sales tax a constitutional amendment was carried out, to enable States to levy sales tax on sale of goods by a club or association to its members. The same has not been carried out for Service tax.

However, it needs to be expressly noted that the is-sue is likely to be subject of extensive litigations.