V Swaminathan

1. The matter focused on in the discussion vide the previous Article @ https://taxguru.in/income-tax/mutuality-doctrine-critical-study.html is with regard to a mutual concern’s claim for tax exemption, by invoking what is known as the common law principle / the doctrine, of mutuality (DoM). The attempted analytical study has been with particular reference to, in comparison, a recent Judgment of the Apex Court in re. Bangalore Club.

2. To recapitulate:

Housing Association (HA) as mandated by the special property law, governing ‘UNITS’ (i.e. Flats or Apartments) – namely, the special legislative enactment by state (s) – is an Association (of Persons). It is formed and constituted exclusively by purchasers /owners of the Units for all purposes. Such legal ownership in a building project, unlike in an independent and exclusively owned house property, is of a composite nature, being both several and joint. For, the interiors of each Unit are exclusively owned, for use by its purchaser; and the rest of the property (the land, and the wedded / appended undivided portions of “common areas and facilities” (UDI)) are owned jointly for use and enjoyment in common.

2.1. The special law – for instance in Karnataka, called Karnataka Apartment Ownership Act (KAOA) (rtw the Rules framed there under -herein after compendiously referred to as the state law) contains detailed provisions and procedural rules for compliance. Those call for compliance in two stages. The first stage is while the building is under construction, and until its completion and readiness for conveyance by the promoter. The second stage is after the formability of sales made and final conveyance effected to HA with an absolute possession given to and collectively taken by the purchasers, as a body – the entity being an AOP for taxation.

2.2. The dire need for forming and constituting such an entity has been considered inevitable and accordingly mandated by the law; hence could not, for any reason, be wished away, or not opted for. For, without such an entity, administration and management of the common affairs, including day- to- day upkeep and maintenance of the housing complex will be unimaginable; rather be rendered a well nigh impossible task. Because of its inherent complicity, entailing unavoidable conflicting rights and interests of individuals (members), the common affairs, as mandated by the state law, are required to be entrusted to a representative body of those as elected by and among the members themselves, known as ‘Management Committee’ (MC). It is, accordingly, expected of the MC doing or refraining from doing anything, having wholly and exclusively, only the common welfare of the member-owners. That is an aspect requiring to be ensured by having a consensus, – mostly and necessarily going by what is decided in formal meetings of the members, and by a decision of the ‘majority’.

In such of the matters of intricacies, especially with legal impediments or consequences, the MC is obligated to act in consultation with, and on the strength of a proper /competent ‘legal advice’, dependable and weighty enough to hang the coat later on, if and when impeached / questioned. That explains why in a decided court case, the person designated and acting as the secretary, in discharge of his duties and responsibilities to the general body of the members, by virtue of/emanating from his fiduciary relationship, has been held to be a ‘public servant’(vide. the Judgment of Madras HC –https://taxguru.in/corporate-law/secretary-society-public-servant-booked-corruption-hc.html)

To know MORE, suggest a search through, – HOUSING Association & Its Governing Body

3. In most cases in which the points of related issue have been taken up to courts and adjudicated upon, taxpayer has invariably cited and heavily relied upon the leading, land mark Judgment of the Apex court in the earliest of case law; that is, in the case of Chelmsford Club Vs. CIT, 243 ITR p.89(SC)–Report@ https://indiankanoon.org/doc/993328/

3.1. The relevant observations explaining the underlying criteria may be found reproduced in the previous Article.

To narrate (with suitable changes in own words, in order to bring out the essence thereof):

A number of persons must combine together and contribute to a common fund.

There must be complete identity between the contributors to, and the participators in, such common fund.

If these requirements are once fulfilled, it is immaterial what particular ‘FORM ‘the mutual concern takes.

Trading between persons associating together in this way- that is on a mutual basis, does not give rise to taxable income / profits.

The fact that, as regards certain activities, only some not all members of the association take advantage of the facilities, which it offers, does not affect the mutuality of the enterprise.

3.2. The court’s observation that deserves a conscious noting reads, –

“A perusal of S. 2(24) of the Income-tax Act, 1961, shows that the Act recognizes the principle of mutuality and has excluded all businesses involving such principle from the purview of the Act, except those mentioned in clause (vii) of that section.”

The obvious reference is to the only exception carved out of the several types of mutual concern in which the principle of mutuality has been invoked and judiciary has been called upon to deliver its opinion. That is an entity which is engaged in the business of mutual insurance; and the scheme of things are specially covered in the IT Act, under the provisions of section 44A rtw sec 2 (24) (vii).

Premised so, it might be urged, with success, that the legislative intent therefore is quite clear, albeit by necessary inference; that is to the effect, that applicability of the said principle to all the other types of mutual concern is no longer disputable ; having been left out of the realm of income-tax law.

4.1. For ensuring a proper and firm grip of the issue(s) as dealt with in the Bangalore Club case, it may be restated but simply to be rightly rejected, as under:

It is not the common law requirement that a mutual concern, to be precise a HA, in order to qualify for tax exemption, must not invest its surplus funds with a bank or like institution, with a view to earning interest, thereby to augmenting its funds, again only for the common benefit of its members. More so, should the funds and application thereof by HA be in accordance with the governing law.

Aside: The stance taken by the Revenue in several cases of HA placing reliance on the Judgment in Bangalore Club case, -it needs to be sufficiently stressed,- suffers from a faulty logic; and certainly, is not reconcilable with, or in any manner falls short of, the well established criteria for satisfying the principle of mutuality. For a dilation of the said point of view, refer the renowned Experts’ opinion as set out in the previous Article.

Be that as it may, the prevailing ‘hung-certainty’, surrounding the applicability of the principle of mutuality to HA could have been easily avoided or been unequivocally made clear, provided the related issues have been duly addressed and forcefully dealt with, with a pointed focus on what the said principle conceptually means; and, with due regard to the related property law provisions.

4.2. In reference to certain observations In the cited court cases, more specifically in the SC Judgment in re. Bangalore Club, the following angles call for a special focus.

Distinguishing features of social, sports and other clubs, or other types of mutual- concern on one hand, and of HA on the other- in respect of which courts have been called upon to, and adjudicated, may be set out as under:

HA has distinct characteristics and functionalities, in comparison to a social club dealt with in Bangalore Club case.

To elaborate:

Unlike all the others, HA is not a voluntary concern.

Unlike Bangalore Club, etc., as briefly set out herein before, – which right from the conceptual stage and formation, is mostly formed and already in place, for anyone to join as members, – HA is a creature of the state law. And, it is formed and constituted by co-purchasers of Units in a building; so done by them only at a stage when they have already purchased and become owners of the developed and constructed immovable property. As such, it is a AOP of which the member-owners’ identity is unimpeachable. Again, it is they alone who are exclusive contributors to, and also the sole participants in, the Funds.

The Funds of HA, including all later accretions thereto, of any kind, the benefit of application whereof endures only to the common benefit of all its members, with no discrimination whatsoever.

Its objects and functions are, in comparison, totally different.

Club is an entity, if and when registered, has, according to the empowered authorities, to be registered under the Societies Registration Act in force in any state. But, for HA there is no such formal registration required under any law.

HA is a close-knit combination of individuals, Those are eligible to, and accordingly, admitted as its members soon after having purchased from the promoter- seller, or in case of a second sale, after having purchased from its previous owner. And, in any other instance,- such as inheritance or succession under a will or otherwise as per the law- the inheritor or successor steps into the shoes of the erstwhile owner; and is similarly admitted as a member of HA. In short, no gainsaying that, HA is a AOP exclusively of member–owners (of Apartments); and only owners (of Apartments) are members of the HA- the AOP.

5. For the purposes herein, the legal position as applicable to/obtaining in the States of Maharashtra and Karnataka may be selectively looked through.

For a HA , the Byelaws  (see the published Model @ Sample Bye-Laws),  and the Maharashtra State legislative enactment   (see  The Maharashtra Cooperative Housing Society Model Bye-Laws  ) provide as per extracts below:

A) FUNDS MAY BE RAISED BY THE ASSOCIATION IN ALL OR ANY OF THE FOLLOWING WAYS:

a) Membership Fees and Transfer Fees

b) CONTRIBUTION and DONATION from the Apartment Owners.

c) SURPLUS OF INCOME OVER EXPENDITURE WHICH SHALL FORM THE NUCLEUS OF THE RESERVE FUND.

d) BY RAISING LOANS, if necessary, subject to such terms and conditions of the Association with the approval of the General Body.

B) THE ASSOCIATION MAY INVEST, OR DEPOSIT ITS FUNDS IN ANYONE OR MORE OF THE FOLLOWING:

a) In any of the securities specified in Section 20 of the Indian Trust Act, 1882;

b) IN ANY PUBLIC SECTOR BANK, OR GOVERNMENT FINANCIAL INSTITUTION; OR

c) IN ANY BANKING COMPANY, OR INSTITUTION, APPROVED FOR THIS PURPOSE BY THE ASSOCIATION.

It is to be noted from the portions as highlighted above, that the permissible contributions by the members to its Funds and the types of investments open are quite wide; and, is left to the General Body and its MC to pick and choose, and decide.

Notably, these include among others ‘monies borrowed’, so as to constituting the ‘FUNDS’. And, Investments made out of the FUNDS is an ‘application’. So applied funds, such as for investment made- say, in fixed deposits with bank, – is the source of income by way of interest received from the bank. In the eyes of law, the relationship between the AOP and the bank is that of creditor and debtor, in its legal as well as commercial sense. Investee is the bank and the HA is the investor.

(To Be Concluded)

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