Case Law Details
DECIDED BY: HIGH COURT OF KARNATAKA, IN THE CASE OF: Prabhashankar Plaza Vs. ITO, APPEAL NO: ITA No. 2612/2005, DECIDED ON February 16, 2010
______JUDGMENT_______
In this appeal, the assessee has challenged the order dated 4.2.2005 passed in 1TA 222, 223, 1057 and 1058 / Bang/2002 passed by the Income Tax Appellate Tribunal, Bangalore Bench and has sought for the benefit of the doctrine of mutuality in the instant case.
The facts of the case are that the appellant assessee is a partnership firm carrying on the business as property developers, traders in general merchandise and as commission agents. The partnership firm pools the resources of all the partners and carries on its business. According to the
assessee. The firm owns a building and the same has been rented out to two of its partners on a monthly rent of Rs.2.50,000/- Apart from the rental income, the firm also sets interest income from the other partners. The partnership deed and we supplementary partnership deed are annexed as annexures B and B1 to the memorandum of the appeal.
The assessee furnished the return of the income for the assessment year 1996-97 up to 1999-2000 respectively. The Assessing Officer scrutinised the assessment and disallowed the claim of exemption of payment of income under S.4 of the Income Tax Act by not accepting the plea of mutuality of receipt.
The Assessing Officer, after examining the ease of the assessee, held that the firm and the partners being two distinct taxable entities under the Income Tax Act, the income arising to each is taxable in the hands of the recipient unless specifically exempted under the Act and the question of mutuaility of receipt does not arise with regard to the partnership firm’s activities as the same has done with a profit motive. Accordingly, for that years 1996-97 and 1997-98. The Assessing Officer assessed the rental income under the head of income from house property and for the years 1991$-1999 and 1999-2000. The Assessing Officer passed the orders following the “order passed by the Commissioner of Appeals to the assessment year 1996-97 and 1997-98 rejecting the claim of mutuality and assessed the mutual income of the firm and rental received from twin in the hands of the firm.
Being aggrieved with he orders of assessment, the appellant assessee filed appeals before the Commissioner of Appeals for the assessment year 1996-97 and 1997-98 one- again urging the plea of mutuality by relying upon certain decisions of various High Courts as well as of the Apex Court. The Commissioner of Appeals, however, dismissed the appeals of the assessee by order dated 2J.5.2002. As against the said order, the assessee preferred appeals before the Income Tax Appellate Tribunal. The Tribunal, by following the decision in the case of Govindaraj Ganash Enterprises Vs Income Tax Officer 91- ITD 174 dismissed the appeals for the assessment year 1996-97 up to 1999-2000. Against the said common order, this, appeal has been preferred raising the following substantial question is of law:
1 , Whether the rental income derived by the firm from leasing “but to its partners where no outsiders-are outsiders is exempted from taxation on the principles of mutuality;
2 :, Whether the facts that the firm is treated as different entity from its partners would deprive the exemption of income received from taxation on the principles of mutuality;
3. Whether the tribunal was justified in deviating from its own order on the principles of mutuality which was decided by it with regard to the case of Smt. Meera Govind v. ITO one of the partners of M/s Govindaraj Ganesh Enterprises while deciding the issue of taxability of income in the hands of one of it partners, which decision has become final having been accepted by the revenue.
We have heard Sri Parthasarathi, learned counsel for the appellant and Sri Seshachata, learned counsel for the Revenue.
It is submitted on behalf of the appellant that in the instant case, the partnership deed which is annexed as annexure B as well as the supplementary deed, clearly indicate the nature of business which is undertaken by the firm; that the partners are all related to one another: that the partners have contributed to the business of the firm and the profits arising out of such business are divided in the respective shares amongst the partners; truth they do not deal with any outsiders; there is no third party which is connected in the business of the firm and therefore, this is a fit case where the principle of mutuality would apply and therefore, the Tribunal ought to have granted the benefit of the said principle under S.4 of the Income Tax Act and exempt the income of the firm from taxation.
Per contra, counsel for the Revenue has stated that, a perusal of the various terms and conditions of the partnership firm would clearly indicate that this is net a case where the doctrine of mutuality would apply: that in similar matter.-:, this Court has rejected the said principle and has brought the income of such firms to tax and, has relied upon the decision of this court in M/s Anupam Enterprises v. Income Tax Officer in ITA 600/2004 decided on 28,7,2008 which judgment is delivered by this Bench, in support of his submission.
Having heard the counsel on both sides and on perusal of (he matter, we note that the nature of business of the partnership firm is as given in clause (3) of the instrument of partnership dated 1.8.1986 which reads as follows:
The business of the firm shall be that of property developers, traders in genera! merchandise, commission and real estate agents and also the activity of pooling their resources and making them available to the partners inter-se on mutual fund and association basis so that the income from such activity ensures to the benefit of the partners for the time being to the firm who shall be the contributors and participants of the funds. The funds of the partnership firm and the properties of the partnership firm to the extent not immediately required and applied to the business of the partnership firm shall be made available to any one or more of the partners or the minors admitted to the benefits of partnership either on interest or otherwise and the interest, rent or any other compensation for the user of the funds or properly of the firm for the purposes of division and distribution among the partners and the minors admitted to the benefit of partnership and the shares of the partners as well as minors in the resultant surplus among such mutual activity shall be shared in the same ratio in which the income of the firm is being shared and for purpose of determining share of income, the same shall be treated as income of the firm. However, the firm may carry on any other business or businesses as the parties may from time to time mutually agree upon.
The supplementary agreement entered into on 1.11.1995 specifically suites as follows:
A Whereas the parties referred to above have been carrying on the business of property developers and pursuing certain activities of mutual fund for mutual benefit by admitting KG Varsha. K G Rohit, K G Shankar, K G Akash and K G Amulya, minors to the benefits of partnership duly evidenced and constituted by the latest by the Instrument of partnership deed dated 1.4.1991: and
Dl The parties hereto have agreed that Party No. l and Party No.3 shall be entitled to make use of the property described in the schedule for their own business purposes and each of the party No.1 and No. l shall be liable to pay to the partnership account a sun’, of Rs. 1.25,000/- each totalling to Rs.2.50.000/-p.m. during the subsistence of this partnership as consideration for the use of the property of the firm. They shall be entitled in their own discretion to let out the property to any person of their choice and shall be entitled to any income, rent received therefrom and retain them as their own. They shall be liable to keep the properly in a good state of repair and deliver the same back to the firm in a good condition subject to normal wear and tear.
D3 Subject to the above two amendments, all the terms and conditions of the partnership dated 1.4.1992 to the extent not in conflict with the terms incorporated in this supplementary Instrument of partnership shall mutatis mutandis apply to govern the relationship among the partners.
On a reading of the various clauses of the aforesaid agreements, it is clear that the nature of business activities of the assessec firm is not restricted to the partners only. The assessee is engaged in the business of property development, commission agency and other allied activities which implies dealing with third parties. It also has the intention of pooling resources of the partners and the funds of the partnership firm not immediately required by the firm, can be made use of by the partners. In the supplementary agreement, only with regard to the schedule building put up at King Street, Civil Station, Bangalore, two of the partners are entitled to make use of it and pay rents to the firm. This is only a device to pool in resources for the firm to utilise the same in its other activities. The other clauses of the initial partnership agreement are to be read as pan and parcel of the supplementary agreement. So long as there is no conflict, the clauses in no way indicate that the business of the assessee firm is restricted to only the partners. Therefore, the doctrine of mutuality does not apply in the instant case.
Further, the supplementary agreement which has been executed on l.l1.1095 is by way of amendment to the earlier partnership deed and though the various terms of the supplementary agreement are in order to give the colour of mutuality in the business of the partnership firm, we find that taking into consideration the nature of the business as stated in the partnership firm in the original partnership deed, the contents of the supplementary agreement. No way supports the contention of the learned counsel for the appellant that, it is in the nature of mutuality.
Under the general law relating to mutual concerns, the surplus accruing to a mutual concern cannot be regarded as income, profits or gain for the purpose of the Act (Section 4) as, where the contributors are to receive back a part of their own contributions, the complete identity between the contributors and recipients negatives the idea of any profit, for no man can make profit out of himself. Therefore, a mutual concern can carry on an activity with its members, though the surplus arising from such activity is not taxable income or profit. The principle of mutuality has also been accepted in the case of a voluntary organization, which receives contributions from its members.
Thus, the ‘crucial lest of mutuality is that all the contributors to the common fund must be entitled to participate in the surplus und 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 und the participators. If this requirement is satisfied the particular form which the association takes is immaterial. Conversely, where there is no such identity between the class of contributors to the common fund and the class of participators in the surplus, the profits of the association would be assessable to tax.
The Supreme Court in CIT Vs Royal Western India Turf Club Ltd -24 ITR 551 reviewed the case law related to mutual concerns and laid down that an incorporated company which carries on business and realize money both from members and from non-members for the same consideration. namely, the giving of same or similar facilities lo all alike in the course of one and the same business cameo on by it, cannot be regarded as a mutual concern.
On the other hand, in the case of CIT Vs Bankipur Club- 226 ITR 97 followed in Chelmsford Club – 243 ITR 89. The Hon’hle Supreme Court summed up that where a number of persons combined together and contribute to the common fund for the financing of some venture or object and in this respect have to dealings or relations with any outside body, then any surplus returned to those persons cannot be regarded in any sense as profit.
Hence, where an Association or Company trades with its member only and the surplus out of the common fund is distributable among the members, there is mutuality and the surplus is not assessable to tax as profit, line reason being that there is complete identity between the contributors and the participators for only those members would be entitled to participate in the surplus who have contributed to it as customers.
The question whether the Doctrine of Mutuality applies to a particular activity is largely a question of fact.
Therefore, under Doctrine of Mutuality, the following three conditions should exist before an activity could be brought under the concept of mutuality: {I) Thai no person tan earn from himself:
That there is no profit motivation and (3) That there is no sharing of profits.
With regard to the first condition i.e., no person can earn from himself means that there should, be a complete identity between the contributors and participators.
In CIT vs ITI Employees Death & Superannuation Relief Fund -(1998) 234 ITH 308, this Court while examining the Trust Deed and its various clauses and after referring to several decisions on the concept of mutuality held that the ingredients of mutuality were missing in the said case as apart from the contribution made by the members, there were other sources of funding of the trust fund, the trust fund could be augmented by contribution made by the ITI Management, donations, interest or other income accrued or earned from the said fund or any investments thereof and investments made from out of the funds. This court further held as follows:
The object of the trust is to invest .the funds of the trusts in banks and securities for earning interest to discharge the liabilities and obligations created under the trust. The /fund is a welfare fund established for providing benefit to the employees on retirement/termination of service/death, etc., of such employees. It is not a case of surplus from the contributions made by the members. It is also not a case where the assessee had advanced its funds to its members and had earned interest of those loans. As already observed the income was earned by making deposit.:- by way of investments in the bank. It is a case where the assessee had invested its surplus funds in various banks and earned interest on W. deposits. As was held in CIT Vs Ranehi Club Limited (1992) 1% ITR 137 (Patna) (FB) by the Patna High Court. The principle of mutuality could be Lont’inet1 in respect of surplus accrued to the club out of the contributions received by the club from its members. But this principle would have no application in respect of surplus received from non-members. In the case on hand, the lax sought to be levied is not on the surplus from out of the contributions made by the members or from the interest earned on the money advanced to its members. The deposits in the banks were made for earning interest by way of income. The principle that no person can trade with himself does not arise in this case as the monies had been invested by the assessee with the bank to earn income to enable the assessee to discharge its obligations created under the trust. It is clear that income earned from outside agency on interest or securities from the bank would not be covered on the principles of mutuality for claiming exemption from lax and therefore, it could not be excluded from the arena of taxation.
For the reasons stated, it is held that the assessee was hot entitled to exemption from lax on the principle of mutuality. (Underlining Dy us)
In the case of Nufaraj Finance Corporation – 169 ITR 733. The question arose as to whether the assessee which was described as a partnership firm and had been carrying out the business activities of lending out money to its members was not liable for tax on the principle of mutuality. In the said case, after looking into the memorandum of association, the High Court of Andhra Pradesh, held that it was an Association of persons and that there was mailing on record to show that the assessee had been carrying out the business activity of lending money to any person other than its 19 members and there was no indication from the records to the effect that in the past years the assessce had been carrying out the activities of lending money to any person other than the members constituting an association. The assessee’s claim that it confined its money lending activity only to its members and not to outsides was accepted. The court further held as follows:
We have seen in the present case that the members of the association of constituting the assessee carry on the activity among themselves Unless it is possible to state that a person derives income by trading with himself, it is not possible to consider that the income derived from transactions between members inter se possessed character of income of a non-mutual benefit concern. lit is difficult to subscribe to the view canvassed by learned counsel for the Revenue that the 19 members in the case of the assessee should be held to be carrying on business with themselves in order to derive income of Rs.48,000/- odd. On the fact and circumstances above slated, we are equally of the view that the appellate authorities below were justified in coming to the conclusion that the assessee is a mutual benefit association and its income is not liable to be taxed.
We observe that in the case of 777 Employees Death & Superannuation Relief Fund, this court has referred to the case of Nataraj Finance Corporation but has not applied the latter decision as the facts and circumstances of the two cases are different.
In the case of Chelmsford Club – 243 ITR 89, the meanings of ‘mutual concern’ and ‘principle of mulualily’ were explained by stating that S.2(24) of the Act shows that the Act recognized the principles of mutuality and has excluded all business involving such principle from the purview of the Act. except those mentioned at clause (vii) of the Section. After referring to its earlier decision in CIT Vs Royal Western India Turf Club Ud – 1953 24 ITR SSI (SC), the Supreme Court stated that –
It is crystal clear that the law recognises the principle of mutuality excluding the levy of income tax from the income of such business to which the above principle is applicable. In the above case, this Court quoted with approval the three conditions stipulated by the Judicial Committee in the case of English and Scottish Joint Co-operative Wholesale Society Ltd Vs Commissioner of Agricultural 1 T (1948) 16 ITR 270 (PC); existence of which establishes the doctrine of mutuality. They are as follows (page 559)
(1) The identity of the contributors lo the fund and the recipients from the fund (2) the treatment of the company though incorporated as a mere entity for the convenience of the members and policy holders, in other words, as an instrument obedient to their mandate and (3) the impossibility that contributors should derive profits from contributions made by themselves to a fund which could only be expended or returned to themselves.
A comparison of the facts and circumstances of the above noted three decisions has enabled us to conclude that the facts and circumstances of the instant case is not covered by the decision of the And bra Pradesh High Court in Nataraj Finance Corporation case we are supported in our view by the principles laid down by the Hon’ble Supreme Court and this court referred to supra. Taking into consideration the objections of the asscssee, its source of funds during the relevant years and the applicability of said funds for the benefit of its members and keeping in mind the interest on investments, the decision of this Court in IT! Employees Death & Superannuation Relief Fund is applicable to the fact.: and circumstances of the instant case.
In this context, it would be of relevance to refer to the decision of this Court rendered by us m the case of M/s Anupatn Enterprises. In the said case also, the assessee was a registered partnership firm consisting of four brothers and their respective spouses. The nature of the business as indicated in the said partnership deed was to carry on the business of money lending and trade in fabrics and garments. In the said case also the contention regarding exemption on the principles of mutuality was raised by the said partnership firm, placing reliance on the decision rendered in the case of Commissioner of Income Tax Vs Bankipttr Club Ltd and Commissioner of Income Tax Vs Nataraj Finance Corporation, on which judgment learned counsel for the appellant has also sought to place reliance in the instant case. The question of law which was re-framed in the said case is as under:
“Whether the authorities below were justified in not considering the income derived by the assessee as the income from its partners only and 10 apply the doctrine of mutuality?”
It was held, while answering the said question, that the fact situation in the case of Nataraj Finance Corporation was entirely different as opposed to the fact situation in the said case, which facts are similar to the case at hand. While making a distinction with the decision in Nataraj Finance Corporation case, it was held that the partnership dztti clearly revealed that the firm was constituted not with the object of dealing with third parties but only with the partners of the firm. However, in the case of M/s Anupam Enterprises as well as in the instant ease, we find that the nature of business is such that the-partnership firm us enabled to enter into business transaction with third parties and not only amongst the various partners as such. Therefore, as held in the aid case, even in the present case, we are of the view that the decision in Nataraj Finance Corporation case is not applicable, so also the decision in the case of Bankipur Club Ltd.
Accordingly, following our decision in M/s Anupam Enterprises, we confirm the order passed by the Tribunal and dismiss the appeal by answering the question against the appellant assessee.
