1. Issue for consideration :
1.1 Income of certain associations of persons is exempt on the doctrine of mutuality. The common examples of these associations are clubs, societies, trade professional and mutual benefit associations, where the contributors to the fund and the recipients or beneficiaries of the fund are the same persons or class of persons. In other words, such persons are contributing to the common fund for their common good.
1.2 Receipt of subscription from members to the common fund is exempt on the grounds of mutuality, as in such cases, the contributors and the beneficiaries are the same persons or the same class of persons, and on the same principles, the receipt by the members on distribution is exempt from tax. The difficulty however arises often in cases where the funds are invested for earning interest income; whether such income also qualifies for exemption, on the grounds of mutuality in the hands of the association. The issue gets further complicated if the interest income is earned from investments made with members.
1.3 For quite some time it was believed that the issue has been settled in favour of non-taxation, as was discussed in the BCAJ in the past. The issue however has reemerged and it appears that the courts presently are divided on this issue under consideration, which fact has made us take note of the same and examine the aspect afresh to ascertain whether the view canvassed in the past requires a reconsideration. While the Andhra Pradesh, Karnataka and Delhi High Courts have taken the view in a few cases that such interest income is exempt on the grounds of mutuality, the Karnataka, Madras and Gujarat High Courts seem to have taken a contrary view in other cases.
2. Canara Bank Golden Jubilee Staff Welfare Fund’s case :
2.1 The issue recently came up before the Karnataka High Court in the case of Canara Bank Golden Jubilee Staff Welfare Fund v. Dy. CIT, 308 ITR 202 (Kar.).
2.2 In this case, the assessee was a society consisting of employees of Canara Bank, established with the object of promoting welfare amongst members who contributed towards the corpus fund. The welfare fund was utilised for advancing loans to members, on which it received interest, which constituted the major portion of its revenue. Surplus funds were kept with the bank, on which interest also was earned. The assessee also earned dividend income on shares.
2.3 The assessee filed the return of income claiming exemption on the principle of mutuality. The assessment was completed u/s.143(1)(a). Subsequently the income was reassessed, bringing to tax the interest income on investments and dividend income on shares. The Commissioner (Appeals) dismissed the appeals of the assessee. The Tribunal also dismissed the assessee’s appeals.
2.4 Before the High Court, on behalf of the assessee it was argued that the Society was established for mutual benefit of its members, and funds of the Society, consisting of contribution from the members, were used for advancing loans to members and collecting interest from the members. As such, it was claimed that the income was exempt from tax on the principle of mutuality. It was further claimed that the funds collected by the appellant were used to provide monetary assistance to members, and, as a matter of precaution, the surplus funds were kept in the bank, not with the primary object of earning interest, but to keep such funds in safe custody. Further, such interest earned had been used only for the ultimate benefit of members. It was claimed that while applying the principle of mutuality, it was the source of the deposit that had to be taken into consideration and not the manner in which the funds were applied. Reliance was placed by the assessee on the Supreme Court decision in the case of Chelmsford Club v. CIT, 243 ITR 89 and the Andhra Pradesh High Court decision in the case of CIT v. Natraj Finance Corporation, 169 ITR 732.
2.5 On behalf of the Department, reliance was placed on the earlier Karnataka High Court decision in the case of CIT v. ITI Employees Death and Superannuation Relief Fund, 234 ITR 308, in which case the High Court had taken the view that such interest income was taxable, to contend that the income in question was taxable.
2.6 The Karnataka High Court, while discussing the principle of mutuality, observed that the following three conditions should exist before an activity could be brought under the concept of mutuality; that no person can earn from himself, that there is no profit motivation, and that there is no sharing of profits. It noted that the source of funds in the case before it was only from the members of the assessee and that the assessee had not received any donations or other monetary grants from any outside source, apart from the members during the relevant years. It was therefore the member’s contribution which had become the corpus fund which was utilised to advance loans to members and invested, from which the interest and dividend has arisen.
2.7 The Karnataka High Court noted that the funds of the assessee had been invested in the term deposit with the bank which was not a member of the assessee’s welfare fund, and interest had been earned on such investment. Though the bank formed a third-party vis-à-vis the assessee, it could not be said that the identity between the contributors and the recipients was lost in such a case. The High Court observed that in ITI Employees Death and Superannuation Relief Fund’s case (supra), the ingredients of mutuality were missing as, apart from contributions made by members, there were other sources of funding of the trust fund, including contributions made by the ITI management and donations. Further, in that case, the object of the trust was to invest the funds of the trust in banks and securities for earning interest to discharge the liabilities and obligations created under the trust.
2.8 Taking into consideration the objects of the assessee, the source of funds during the relevant years and the applicability of the funds for the benefit of its members, and keeping in mind the interest on investments and dividend earned on shares was only a small portion of the total earned by investment of the surplus funds wholly contributed by the members of the assessee, the Karnataka High Court held that the interest earned on investment and dividend received on shares was deemed income from the property of the assessee contributed by its members, and was governed by the principle of mutuality and was therefore exempt.
2.9 The Court noted with approval a similar view which had been taken earlier by the Andhra Pradesh High Court in the case of CIT v. Natraj Finance Corporation, 169 ITR 733. In that case, the assessee was a firm which lent money to its partners, and during the relevant years, received income on out-standing dues from a former partner and on amounts deposited in a savings account with a bank. The Court held that such interest, considering the quantum of such interest in relation to the total income, was also exempt on the grounds of mutuality, as it could not be said that the assessee was carrying on business in order to derive such a small amount of income.
2.10 The Court also noted that the Delhi High Court also, in the case of DIT(E) v. All India Oriental Bank of Commerce Welfare Society, 130 Taxman 575, has held that the principle of mutuality applies to interest income derived by a co-operative society from deposits made out of contributions made by members of the society. In taking this view, the Delhi High Court took a cue from the decision of the Supreme Court in Chelmsford Club v. CIT, 243 ITR 89, where the Supreme Court had laid down the principle that where a number of persons combine together to a common fund for financing of some venture or object and in this respect have no dealings or relations with any outside body, then any surplus generated cannot in any sense be regarded as profits chargeable to tax.
3. Madras Gymkhana Club’s case:
3.1 The issue again recently came up before the Madras High Court in the case of Madras Gymkhana Club v. Dy. CIT, 183 Taxman 333.
3.2 The assessee in this case was a sports club providing various facilities to its members, such as restaurant, gymnasium, library, bar, coffee shop and swimming pool. Apart from the surplus funds derived from such activities, it also received interest income from its corporate members on the investment of surplus funds as fixed deposits with them. It claimed that such interest income was covered by the concept of mutuality and was therefore exempt from tax.
3.3 In the course of reassessment proceedings, the income from investment was subjected to tax along with certain other interest income. Both the Commissioner (Appeals) and the Income Tax Appellate Tribunal rejected the appeals of the assessee.
3.4 Before the Madras High Court, it was argued on behalf of the assessee that the interest earned by the club out of fixed deposits and other investments made with its own institutional members was covered by the principle of mutuality. On behalf of the Revenue, it was argued that the interest on such investments could not be brought within the concept of mutuality as such investments were in the regular course of business of such club and had no nexus with either membership or regular activities of the club.
3.5 The Madras High Court noted that it had held in an earlier case in Wankaner fain Social Welfare Society v. CIT, 260 ITR 241, that to satisfy the concept of mutuality, the identity was required to be established in relation to the relevant income as regards those contributing to the income and those participating in the distribution of that income. According to the Madras High Court, surplus funds deposited with a member bank enured to the benefit of that member alone, who was in a position to utilise the deposit in any manner it liked, thereby depriving other members of enjoyment of such benefit, which did not satisfy the test of identity of the contributors and the participants. Though the distribution of interest was to all members, there was no identity between the contributors and the participants, inasmuch as the distribution of interest was made both to members with whom funds were deposited and to those with whom funds were not deposited, while the interest was earned only from members with whom funds were deposited.
3.6 The Madras High Court also noted that the club had received donations and gifts as well as sponsorship for programmes and activities, and advertisements. According to the Madras High Court, on a reading of the objects of the club and the provisions for making the investments, the position which emerged was that the investment of surplus funds had nothing to do with the objects of the club. It also noted that substantial amounts had been earned by way of interest from such investment of surplus funds, and that there were no plans for immediate utilisation of such funds.
3.7 The Madras High Court, following the decision of the Karnataka High Court in the case of CIT v. Bangalore Club, 287 ITR 263, held that the interest earned on investment of surplus funds, being substantial, could not be held to satisfy the mutuality concept and was therefore taxable.
3.8 A similar view had been taken earlier by the Karnataka High Court in the case of Bangalore Club (supra), where the Karnataka High Court had held that interest on surplus funds placed by the club in fixed deposits with member banks was not exempt on the ground of mutuality. The Court noted that the Karnataka High Court had also earlier in the case of ITI Employees Death and Superannuation Relief Fund (supra) held that interest on investments earned by the fund was not exempt on the grounds of mutuality and so also the Gujarat High Court, in the case of Sports Club of Gujarat Ltd. v. CIT, 171 ITR 504, has held that in the case of a club whose object was to promote the game of cricket and other games and sports, which derived income from investments of surplus funds, the income from interest was not from mutual activity and was therefore liable to tax.
4. Observations:
4.1 When one analyses the decisions on the subject, one notices that the difference of opinion between the Courts hinges on the answers to the following questions:
Firstly, for application of the doctrine of mutuality, in order to claim exemption on the ground of mutuality, is it sufficient that an income arise out of an investment of surplus generated from members, or is it necessary that such income should also arise from members only?
Secondly, does the activity of investment with non-members amount to a separate activity, distinct from the main activity of the entity and therefore not covered by mutuality? Is it not sufficient that the funds invested are out of the surplus of the members and the income received on investment is also for the benefit of the members?
Thirdly, is the object for which funds are invested relevant, is it necessary that the investment income should arise out of the main activity in order for the income to qualify for mutuality?
4.2 The Supreme Court in CIT v. Bankipur Club Ltd., 226 ITR 97, held that a host of factors, not one single factor, have to be considered to arrive at a conclusion as to whether the principle of mutuality applies in a given case or not, and further observed that whether or not the persons dealing with each other are a mutual club or not and whether such persons are carrying on a trading activity or an adventure in the nature of trade is largely a question of fact.
4.3 In the case of Chelmsford Club (supra), the issue before the Supreme Court was whether the annual letting value. of the clubhouse of the Chelmsford Club, which provided recreational and refreshment facilities exclusively to its members and their guests, was liable to income-tax. In that case, certain observations of the Supreme Court indicate that the principle of mutuality has to be considered qua the business or the object thereof. However, one must keep in mind the facts of the case before the Supreme Court, where there was no actual income arising other than out of the activity of the club, and therefore the Supreme Court did not have occasion to consider whether the principle of mutuality should be applied to certain incomes separately.
4.4 In the case of Bankipur Club (supra), the Su-preme Court cited from the Halsbury’s Laws of England as under:
“Where a number of persons combine together and contribute to a common fund for the financing of some venture or object and will in this respect have no dealings or relations with any outside body, then any surplus returned to those persons cannot be regarded in any sense as profit. 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. Trading between persons associating together in this way does not give rise to profits which are chargeable to tax.
Where the trade or activity is mutual, the fact that, as regards certain activities, only certain members of the association take advantage of the facilities which it offers does not affect the mutuality of the enterprise.
Members’ clubs are an example of a mutual undertaking; but, where a club extends facilities to non-members, to that extent the element of mutuality is wanting …. “.
The Supreme Court in that case also cited from Simon’s Taxes as under:
…. it is settled law that if the persons carrying on a trade do so in such a way that they and the customers are the same persons, no profits or gains are yielded by the trade for tax purposes and therefore, no assessment in respect of the trade can be made. Any surplus resulting from this form of trading represents only the extent to
which the contributions of the participators have proved to be in excess of requirements. Such a surplus is regarded as their own money and returnable to them. In order that this exempting element of mutuality should exist, it is essential that the profits should be capable of coming back at some time and in some form to the persons to whom the goods were sold or the services rendered …. “
4.5 In the above referred Bankipur Club’s case, the Court was concerned with the clubs’ entitlement to exemption for (i) the receipts or surplus arising from the sales of drinks, refreshments, etc., (ii) amounts received by way of rent for letting out the buildings, and (iii) amounts received by way of admission fees, periodical subscriptions and receipts of similar nature, from its members and guests. The Supreme Court noted that the amounts received by the clubs for supply of drinks, refreshments or other goods as also the letting out of building for rent or the amounts received by way of admission fees, periodical subscription, etc. from the members of the clubs were only for/towards charges for the privileges, conveniences and amenities provided to the members, which they were entitled to as per the rules and regulations of the respective clubs. It also noted that different clubs realised various sums on the above counts only to afford to their members the usual privileges, advantages, conveniences and accommodation. In other words, the services offered on the above counts were not with any profit motive, and were not tainted with commerciality. The facilities were offered only as a matter of convenience for the use of members (and their friends, if any, availing of the facilities occasionally). On that reasoning, the Supreme Court held that the excess-surplus arising from the mutual arrangement, including amounts received from guests (though third parties), was exempt on the grounds of mutuality. Incidentally, one of the assessees in this case was Cawnpore Club, where the income that was sought to be assessed was derived from property let out and also interest received from ED.R., N.s.C., etc. The Supreme Court delinked that case and did not decide it, directing it to be put up for a separate hearing.
4.6 In the case of Chelmsford Club (supra), the Supreme Court observed :
“It is clear that it is not only the surplus from the activities of the business of the club that is excluded from the levy of income-tax, even the annual value of the club-house, as contemplated in S. 22 of the Act, will be outside the purview of the levy of income-tax.”
” …. we are of the view that the business of the appellant is governed by the principle of mutuality – even the deemed income from its property is governed by the said principle of mutuality.”
4.7 From the foregoing, relying on the views of the the Courts and the commentaries on taxation, the emerging view is that the surplus from the activity of mutual benefit association of any form is exempt from taxation and such exemption is not restricted to some specific incomes.
4.8 An incidental question that may as well be addressed is whether the activity of investment is an integral part of the object of the mutual benefit association or is an independent activity which aspect would depend upon the facts of each case. Various factors as follows may be helpful in examining this aspect: (i) Whether the investment is a mere temporary deployment of surplus funds, or of a long-term nature? (ii) Whether the intention behind making the investment is merely to see that the funds are not kept idle, but deployed till such time as required? (iii) Is the quantum of investment income small as compared to members’ contributions ? (iv) Whether the surplus has been built up only out of member contributions? Generally, if the investment income is small in relation to member contributions and the investment is primarily with a view to deploy unutilised funds, the investment activity cannot be regarded as an activity independent of the object of the association, and would be part of the surplus qualifying for exemption.
4.9 The rigours surely will be easy when investment is made with the members of the association. However here also, difference might be carved out between an investment made as an investor and the one made in the normal course.
4.10 The rigours will also be eased in cases where an investment of the association’s funds has been made pending the use of surplus funds on activi-ties of the association.
4.11 With utmost respect for the Madras High Court, the insistence on commonality between the contributors and the beneficiaries in case of investments, seems to be misplaced. The test of commonality is required to be satisfied w.r.t. the members’ contributions, and not w.r.t. the interest income arisng out of deployment of such members’ contributions. It is also helpful that the interest income that arises out of the deployment of surplus funds of members is earned for the members’ benefit, who surely are the participants on distribution of such an income.
4.12 An important principle of mutuality is that the members receive back that which was their own. The fact that in the meanwhile the funds belonging to them were deployed would not materially alter the applicability of the principle where the income remains, in reality, the income of the members.
4.13 The issue however continues to be contentious as is evident from the conflicting decisions of the Courts including the decision in the case of Rajpath Club Ltd., 211 ITR 379 (Guj.), Gulmarg Association & Anr., 90 TTJ 184 (Ahd.) and Sagar Sanjog CHS Ltd. ITA No. 1972, 1973 and 1974/Mum./2005.
4.14 The better view in the meanwhile seems to be that interest income of a mutual benefit association earned on its investments is exempt from tax under the doctrine of mutuality and the case for its exemption is stronger where the deployment of funds is merely a part of and incidental to the object of the association.
