Introduction:

The doctrine of mutuality is a doctrine derived from the theory that a person cannot make a profit from himself. This doctrine is generally applicable in the case wherein a group of people form an association and pool in their surplus income in the common fund of the association. The fund that is collected in this pool is used in furtherance of the benefit of the members, depending on the nature of the association.

The Halsbury Laws of England, Fourth Edn., Reissue, Vol. 23, paras 161 and 162 (pages 130 and 132), which also reads 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, certain members-only of the association take advantage of the facilities which it offers does not affect the mutuality of the enterprise.”[1]

The association so described can be of any type and any form, that is, it can be a tea club wherein the members would pool in money and pay for the snacks out of it or a club which would seek membership fees and entail membership benefits.

Thus, an important question arises, which is, whether such money which is pooled from the members be taxed or not? The answer is no, because of the principle that no person can make a profit himself, any amount received from the person himself is not an income and so should not be taxed. This happens due to the fact that there is no commercial transaction that has taken place,

For a better understanding of the doctrine one such case that can be referred is M/s Bangalore Club vs. CIT, wherein the facts of the case were that the assesses was an unincorporated Association of Persons, they sought exemption from payment of income tax on interest earned on fixed deposits, with certain banks, the banks were the corporate members of the assesses, they pleaded doctrine of mutuality.[2]

Facts:

The Bangalore Club (assessee) was an unincorporated Association of Persons (AOP). The main issue of dispute was in relation to assessment years 1989-90….to 1999-2000.  The assessee-club had kept fixed deposits with certain banks who were the corporate members and claimed tax exemption on the interest earned on fixed deposits kept with certain banks, by relying on the Doctrine of mutuality.

The claim was rejected by the AO as it held there was a lack of identity between the contributors and the participators in the fund of the Club.

In the first appeal, the CIT (A) reversed the AO’s Order holding that the Doctrine of mutuality was applicable.

The CIT (Admn.) took up the dispute to the HC under Section 260A[3].

Answering the questions in favour of the Revenue, the HC held Doctrine of mutuality not applicable.

Issue:

Whether the principle of mutuality pleaded by the assessee is applicable and whether interest income earned from various deposits kept with the banks/financial institutions is a non-taxable receipt?

The question of law was whether the principle of mutuality was applicable to funds deposited by the said club in four nationalised banks who were also members of the club, especially when the fund was raised from the contribution of several members, including the four banks, and the interest derived from it is visualised by several members of the assesses club.

Analysis of the Principles Involved:

The court in this case laid three essential conditions which facilitated that help determines whether the mutual activity is being carried out or not. They are:

  • There must be a complete identity between the contributors and participators.

The court in this condition meant that there shall be a complete and a wholesome identity between the contributors and the participators and that there must be privity between the two, there was a complete identity between the contributors and participators until they created the fixed deposits with the member banks, and thus the first condition for the doctrine of mutuality is not satisfied.

  • The actions of the participators and contributors must be in the furtherance of the mandate of the association.

The court in this condition meant that the demand to claim an exemption from tax through the principle of mutuality, the utilization of the surplus funds with the association must be in the furtherance of the object of the club. It is essential that such utilisation should be for the purpose of providing services, infrastructure, maintenance or an act which should lead to the direct benefit of the members. However, in this case, they were taken out of the mutuality and were placed for the disposal of a third party.

Thus, the court found that there was no proximity of any direct benefit to the member and so it was not held to be an action in furtherance of the mandate of the association. Therefore, the second condition for the doctrine of mutuality was not satisfied.

  • There must be no scope of profiteering by the contributors from a fun made by them which could only be expended or returned to themselves.

The Banks in this case generated revenue by paying a lower rate of interest to the club and loaning the funds at a higher rate to third parties. The nature of the transaction is thus, commercial in nature. The interest accrued on the surplus deposited by the club like in the case of any other deposit made by an account holder with the bank. The court also referred to the  Sports Club of Gujarat [1988] 171 ITR 504 (Guj) and also Kumbakonam Mutual Benefit Fund [1964] 53 ITR 241 (SC)  case where the Karnataka High Court held that the principle of “no man can trade with himself” is not available in respect of a nationalized bank holding a fixed deposit on behalf of its customer and that, “the relationship is one of a banker and a customer”.[4]

Analysis:

According to me, the logic of the Supreme Court is faulty for taking a view that when interest is earned by the club because of fixed deposits in member banks, the mutuality is broken.

In my opinion, it’s the banks who are doing a commercial transaction and not the club because the club has only deposited a certain amount. In my opinion, an interest paid by banks lieu of fixed deposits it holds is simply compensation and not a part of commercial transaction. It is only in the nature of transaction the bank carries out that it becomes a commercial transaction as they have the profit motive.

The court also inferred the interest received as a ‘contribution’ which is not the case, it cannot be called to have a character of a contribution. In the perspective of the banks, it is simply an outgoing interest for the fixed deposits received and not a contribution per se.

The court should have emphasised on the need to differentiate interest and contribution in this case.

Thus, due to the aforementioned reasons, this is a bad precedent in law.

Conclusion:

Thus, the court, in this case, laid down three conditions to determine whether the mutual activity is there or not and because all three conditions were not satisfied the court held that the interest accrued was not by way of mutual activity but commercial activity and hence, the interest earned on the fixed deposits was not exempt.

The court came to this conclusion by saying that interest paid back by the bank was in the nature of the contribution and thus profiteering motive was established, it also held that the banks and the club didn’t form a complete identity, and this complete was initially there but broken when the club placed a fixed deposit in the member banks, lastly the court held that the actions by the club weren’t directly in the benefit or furtherance of the club and its member. And thus, the court taking into consideration all these considerations and reasoning came to the conclusion that the activity between the club and the member banks was not in the nature of the mutual activity.

[1] 23 Halsbury Laws of England 130-132 (4th ed.)

[2] M/s Bangalore Club v CIT, (2013) 5 S.C.C. 509 (India).

[3] Sec.260A, Income Tax Act, 1961 (India).

[4] The Sports Club of Gujarat (1988) 171 ITR 504 (Guj); Kumbakonam Mutual Benefit Fund (1964) 53 ITR 241 (India).

Author Bio

Qualification: Student- Others
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Location: Ahmedabad, Gujarat, IN
Member Since: 06 Oct 2020 | Total Posts: 1
Milind is a penultimate year law student at Institute of Law, Nirma University, Ahmedabad. View Full Profile

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