Understanding the Principle of Mutuality in Tax Law: Key Implications

No man can trade with himself; he cannot make, in what is its true sense or meaning, taxable profit by dealing with himself Or No man can make a profit out of himself.

In the realm of tax law, the principle of mutuality presents a unique perspective on transactions conducted within mutual associations or cooperative societies. This principle, rooted in the idea that one cannot generate taxable profit from themselves, holds significant implications for both individuals and associations alike. Through this piece, we aim to elucidate the meaning of this principle, its bearing on the Income Tax Act of 1961, and its real-world application in the context of mutual concerns like cooperative societies or members’ clubs.

A money collected from the closed one or from family cannot be treated as money earned. In same way, in legal terms, the principle of mutuality refers to a concept where a group of individuals enter into transactions or dealings among themselves as part of a mutual association. This principle offers a potential tax advantage as long as the mutual nature of the association is maintained.

Mutual concerns like members’ clubs, cooperative societies, mutual benefit funds or chit funds, etc., where the persons form the concern or the association for the benefit or advancement of certain mutual activities uses the concept of mutuality or the principle of mutuality.

With reference to income tax act, 1961, Section 2(24) states “income” which includes profit, dividend, allowances and subsides but does not include the contribution received from the members of society, club, association.

In simple term, we say that contribution received by the Association of person from the members then the principal  of mutuality applies. Here the society/ AOP merely acts as an agent who collects charges in different forms on behalf of members & spends the same to meet the various joint expenses of the society/ clubs. The excess contribution cannot be said as profit of association or society, it is the amount which will be utilised in next year or retain as surplus in association.

Here, we need to know that the cardinal requirement in the case of mutual association is that all the contributors to the common fund must be entitled to participate in the surplus & all the participators to the surplus must be contributors to the common funds i.e. there should be complete identity between the contributors and the participators. Like society maintenance charges paid by all since the utility in building used by all. Here, the society is not earning any income but rather giving/ working to give the benefit to contributor to the common fund like maintenance of common area, lift facility, common trade platform, etc.

Any contribution received from the members of AOP cannot be taxed. Since the same is treated as a member’s contribution and the society/ association is eligible to avail the benefit of the Mutuality Concept.

So what is taxable under the Income Tax Act in such AOP / Society ?

“income” or “profits” or “gains” as they accrue to AOP/ Society in his dealings with other party or parties that do not share the same identity with the assessee. For example the Interest income from bank, Income earned from outside party i.e. other then members, Free space given to companies for hoarding, property given for film shooting, etc. Therefore,  for income, there is an underlying exchange of a commercial nature between two different entities. Taxes on income are taxes on moneys or profits generated by a person in their transactions with others. No assessee can generate real income out of himself, which can be taxed.

In specific term, we can say that the concept of profit in a co-operative housing society is slightly different from that of a for-profit business. Cooperative housing societies are typically established to provide affordable housing and promote the welfare of their members, rather than generating profits for members.

The financial operations of a cooperative housing society involve the collection of maintenance charges or fees from its members to cover the costs of managing and maintaining the housing society’s infrastructure, common areas, and services.

These charges are generally aimed at achieving a break-even point, where the income from members covers the expenses incurred by the society.However, if the total income from maintenance charges exceeds the total expenses incurred by the cooperative housing society, a surplus or excess amount may be generated. This surplus is typically utilized for:

Reserve Fund – This fund acts as a financial buffer to meet future contingencies, repairs, or planned improvements to the society’s infrastructure and facilities.

Common Area Maintenance – The surplus may be utilized to enhance and maintain the common areas, amenities, and services provided by the cooperative housing society, benefiting all the members.

Subsidies or Benefits – This can include initiatives such as reducing maintenance charges, offering discounts on specific services, or providing welfare programs for the benefit of the members.

Let take a example of commercial society Income from members and non members, to understand the concept in better way:

As we can see from the above tables that majority of the income earned by the Society is nothing but reimbursement of the expenses from its members which is required to collect in order to maintain the society. Such contribution to the common amenity fund taken from a member disposing property is similarly utilised for meeting sudden and regular heavy repairs to ensure continuous and proper hazard free maintenance of the properties of the society which ultimately ensures to the enjoyment, benefit and safety of the members and other income earned from bank, free space rent is offered to taxes.

In the following cases where it was held that any income in form of contribution received from members of society or club is come under the concept of Mutuality and same is exempt under the provision of Income Tax Act.

The first judgement is in the case of CIT Vs. Bankipur Club Ltd., 226 ITR p.97 (SC). It was held in this case that excess of receipts over expenditure received by club from facilities extended to its members as part of advantage attached to such membership, is not taxable as income.

The second judgement is in the case of Chelmsford Club Vs. CIT, 243 ITR p.89 (SC). It was held in this case that

(i) Income of a mutual concern is not assessable to tax,

(ii) the charge of tax is on income from property and not on the property itself, and

(iii) the income from property of a mutual concern is not assessable to tax.

In the case of CIT Vs. National Sports Club of India (No.1), 230 ITR p.777 (Delhi), it was held that the rent receipt from members to whom rooms were let out by the assessee-club, which was a mutual concern, along with other facilities, was not taxable as income. The aforesaid view has been affirmed by the Apex Court in the case of Chelmsford Club Vs. CIT, 243 ITR p.89 (SC).

The Kerala High Court in the case of CIT v. Bus Operators Association [2013] 33 taxmann.com 568/[2012] 344 ITR 268 (Ker.), following the decision of the Supreme Court in the case of Chelmsford Ltd.(supra), held that where the assessee, an association of bus operators, was engaged in purchase and distribution of tyres, automobile spares, etc., to its own members and profit, if any, arising in such transactions went to its members, principle of mutuality applied to that case.

To Conclude, one can say that a family cannot earn from family member, the same cannot be offered as income for taxation purpose. The concept of mutuality in the Income Tax Act 1961 serves as a crucial instrument in promoting cooperation and shared benefits within societies and associations. By recognizing that certain income streams arising from mutual contributions are exempt from taxation.

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This article is a synthesis of various sources available on the internet, with special credit to CA. Vaishali S More for her insightful research on the subject.

Written by: CA. Tushar Nagori nagoritushar@gmail.com