Recently, the Apex Court in the case of Yum Restaurants (Marketing) Pvt. Ltd. v. CIT bearing Civil Appeal no. 2847 of 2010 (SC), order dated 24th April, 2020 held that the doctrine of mutuality bestows a special status to qualify for exemption from tax liability and exemptions are to be put to strict interpretation. The apex court has reiterated certain tests which have to be strictly applied before it can be said that the assessee is operating on the principle of mutuality. We have analysed the said decision in the light of past precedence and culled out certain key principles which must be kept in mind before making a claim that the surplus is not taxable as it is governed by the principle of mutuality.
Facts of the case :
The assessee company is a wholly owned step down subsidiary of YRIPL for undertaking the activities relating to Advertising, Marketing and Promotion (“AMP activities”). As per the Secretariat for Industrial Assistance (“SIA”), the assessee company was obligated to operate on a “non-profit” basis. The assessee company entered into Tripartite Agreement with YRIPL and its franchisees as per which the assessee company was to receive fixed contributions to the extent of 5% of “gross sales” achieved by the Franchisee. The said amount was to be utilised for the proper conduct of the AMP activities for the mutual benefit of the parent company and the franchisees only. During the year under consideration, the assessee company has also provided services relating to AMP activities to M/s. Pepsi Food Ltd. (“Pepsi”) on contribution made by it even though Pepsi is not a franchisee and no such tripartite agreement with Pepsi exists as with franchisee.
The assessee filed its return of income for the year under consideration declaring “nil” income. The claim of the assessee was based on the understanding that the surplus generated due to receipt and expenditure is the contributor’s own money and cannot be used for any other purpose. The assessee further claimed that there is complete identity between the contributors and beneficiary which is the main test to be applied for determining the mutuality. It was also submitted that merely because new contributors are added and some leave does not mean that the doctrine will get defeated till the funds are being used for the mutual benefit of the contributors.
The AO and subsequent authorities rejected the claim on the following grounds :
a) Activity had taint of commerciality since non-member Pepsi joined as contributor and the said contribution was not used for the purpose of marketing of Pepsi but for marketing of Yum brand for the benefit of franchisee.
b) YRIPL was not under any obligation to contribute as per terms of Tripartite Agreement. The agreement gave an option to YRIPL whether to contribute or not. However, the benefit of marketing was available to YRIPL. Hence the test of complete identity between contributor and the beneficiary was totally lost.
c) Contributions was also received from Pepsi which is neither a “franchisee” nor a “beneficiary”. This transaction with Pepsi was a purely commercial transaction and hence it could not be said that the franchisee operated on the basis of mutuality.
The consistent line of opinion recorded by the aforementioned three forums was further approved in appeal by the High Court. The matter travelled to Apex court at the behest of assessee company. The Apex Court opted to decide whether the activity of assessee company would qualify under the “Doctrine of Mutuality” so as to exempt the surplus of appellant as non-taxable?
Rule applied by Supreme Court : Doctrine of Mutuality :
The Apex Court ruled that the exemption from tax is a heavy burden on exchequer and hence has to be strictly construed. Under the Income Tax Act, 1961 “income” or “profits” or “gains” is taxable when they accrue to a person in his dealings with other party or parties that do not share the same identity with the assessee. Reliance was placed on the decision of CIT v. Bankipur Club Ltd.. In the said decision the apex court relied upon the decision of a very early decision in the case of The English and Scottish Joint Cooperative Wholesale Society Ltd. v. CIT where the Privy Council has observed that there are three important tests / conditions to prove the existence of mutuality. These tests are :
(i) Oneness of the contributors to the fund and the recipients from the fund ;
(ii) Entity constituted only for the convenience and common benefit of the members.
(iii) Impossibility that contributors derive profit from the contributions made by them to a fund which could only be expended or returned to themselves.
The said test are described as under :
(i) Oneness of the contributors to the fund and the recipients from the fund :No person ought to contribute to the common fund without having the entitlement to participate as a beneficiary in the surplus thereof. The moment such a transaction opens itself to non member, either in the contribution or the surplus, the uniformity of identity is impaired and the transaction assumes the taint of a commercial transaction.
(ii) Entity constituted merely for the convenience and common benefit of the members :presupposes the contributors and participators to be two separate classes, but there is oneness or equality in the matter of sharing of surplus/profits. There is no interference of any alien commercial entity in the transaction (British Tax Encyclopaedia (I), 1962 Edition, Pgs. 1200 and 1201).
(iii) Impossibility that contributors derive profit from the contributions made by them to a fund which could only be expended or returned to themselves :The third test of mutuality requires that the purported mutual operations must be marked by an impossibility of profits. The excess fund remaining after meeting the expenses, shall be distributed amongst the members or the same must be adjusted in the cost of next year. Thus, the company should operate on non profit mechanism.
The Apex Court, rejected the claim of doctrine of mutuality advanced by the Appellant. It held that the appellant had violated the principle of mutuality as laid down in the case of The English and Scottish Joint Cooperative Wholesale Society Ltd. v. CIT (supra) and CIT v. Bankipur Club Ltd. (supra).
The Apex Court observed that the management and control and decision making was vested with the holding company YRIPL and not with the contributors. This is because YRIPL had an option not to contribute to the appellant company. This choice or option with YRIPL totally violated the basic condition of contributors and beneficiaries being the same. The Apex Court held that the possibility that YRIPL does not contribute but benefit from the assessee company itself creates a possibility that the assessee company is not operating on the principle of mutuality.
The other adverse finding by Apex Court was the decision making being vested with YRIPL. The decision to use the surplus in the manner was to be decided by YRIPL and such decision making was vested only with YRIPL. Therefore, the contributors could not participate in the management and its decision making. Such concentration of the management with one entity cannot be equated with mutuality.
Finally, the fact that the assessee company actually had a commercial transaction with Pepsi did not go down well with the apex court. The said transaction was in the domain of commerciality which violated any mutuality. The contribution was made by Pepsi but such fund was used only for advancing and promoting the brand of YRIPL. Hence, the apex court was of the view that this had an element of “income” and applying the strict provisions of doctrine of mutuality.
Acelegal Analysis :
The doctrine of mutuality is premised on the theory that a person cannot make a profit from himself. An amount received from oneself, therefore, cannot be regarded as income and taxable.
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.”
Mutuality involve that the contributors to the common fund are entitled to participate in the surplus thereby creating an identity between the participators and the contributors. Once such identity is established the surplus income would not be eligible to the tax on the principle that no man can make a profit out of himself.
In the case of Commissioner of Customs (Import) v. M/S. Dilip Kumar And Company bearing Civil Appeal no. 3327 OF 2007, order dt. 30 July, 2018 the apex court has held that the rule of strict interpretation should be provided to the eligibility conditions while conferring the benefits to such exemption. Therefore, the tests / conditions as laid down for mutuality have to be applied strictly and literally.
The said doctrine of mutuality is applicable in the case of the resident housing welfare society which is an incorporated bodies formed of the members, for the members, by the members. The contributors are the members themselves wherein the members contribute in the form of society maintenance as reimbursement of common expenses. Thus, there is no “facility” or benefit” provided to members by the society. The Society by the same principle of mutuality should not be liable to charge GST on the maintenance received from members of the society. The Apex Court in the case of State of West Bengal v. Calcutta Club Limited bearing no. Civil Appeal no. 4184 of 2009 (SC), order dt. 03/10/2019 held that contribution made by the members to their association shall not be liable for sales / service tax. The Court while holding the same observed as under :
“3. It was contended before the Tribunal that there could be no sale by the respondent club to its own permanent members, for doctrine of mutuality would come into play. To elaborate, the respondent club treated itself as the agent of the permanent members in entirety and advanced the stand that no consideration passed for supplies of food, drink or beverages, etc. and there was only reimbursement of the amount by the members and therefore, no sales tax could be levied.”
In the decision of M/s. Vaishnavi Splendor Homeowners Welfare Association bearing order no. KAR/AAAR-10/2019-20 and dated 21/10/2020 the AAAR held that service supplied by Association to its member is a taxable service under GST Law and therefore, contribution received from members is liable for GST is required to be reconsidered by AAAR. This decision of Apex Court in the case of Yum! Restaurants (Marketing) Pvt. Ltd. (supra) is now going to help the societies to claim mutuality as all tests as laid down stand satisfied.
1 (1997) 5 SCC 394 / (1997) 92 Taxman 278 (SC)
2 AIR 1948 PC 142
Adv. Bharat Agarwal (Managing Partner) | CA Sneha Sarbhushan (Associate) | Acelegal