Case Law Details
HIGH COURT OF ANDHRA PRADESH
Commissioner of Income-tax
V/s.
Secunderabad Club Picket
ITTA NOS. 422, 443, 529-533 OF 2006, 78 & 81 OF 2007 AND 244 OF 2010
AUGUST 27, 2011
JUDGMENT
V. V. S. Rao J.
These appeals by the Revenue are against the orders of the Income-tax Appellate Tribunal (ITAT), Hyderabad Bench, holding that the interest accrued to the assessee club from its deposits with banks and financial institutions, which are its corporate members, are not tainted with commerciality ; and that such interest income is not taxable on the principle of mutuality. The question of law raised in these appeals by the Revenue is whether interest accrued on the fixed deposits, parked with commercial banks, is liable to tax. I. T. T. A. Nos. 422, 529, 530, 531, 532 and 533 of 2006 are filed against the Secunderabad Club and the other three appeals, being I. T. T. A. Nos. 443 of 2006, 78 and 81 of 2007, are filed against the Armed Forces Officers’ Co-operative Housing Society.
2. The following factual matrix is with reference to I. T. T. A. No. 422 of 2006. The respondent-Secunderabad Club (hereafter, “the assessee”) is a social and recreational club. It is not registered either as an association or a society. It is a mutual association, statedly, not a profit making concern. All their activities are allegedly not tainted with commerciality or business modalities. The assessee receives monthly subscriptions, admission/ entrance fee and payments made by its members for use of club facilities. During the assessment year 1996-97, the assessee earned interest on the fixed deposits kept by it with Andhra Bank, Lloyds Finance Ltd., ITC Agrotech Ltd., VST Industries Ltd., Nagarjuna Finance Ltd. and Apple Credit Corporation Ltd. In their return for 1996-97, the assessee sought exemption of the interest received from tax citing the principle of mutuality. The banks/financial institutions, with whom the fixed deposits were made, are corporate members of the club. The return for the year 1996-97, admitting Rs. 1,22,700, was accepted under section 143(1) of the Income-tax Act, 1961 (“the Act”, for brevity). However, the Assessing Officer issued notice under section 148 of the Act on the ground that the exemption claimed with regard to the interest on fixed deposits from banks/companies is not a valid claim. During the enquiry, the assessee furnished information. They stated that the assessee started admitting corporate bodies/banks as members about twenty years ago, the members of all categories are governed by the rules/bye-laws of the club, the entrance fee payable by corporate members is Rs. 3.5 lakhs for the first two nominees, and Rs. 1 lakh for each subsequent nominee, who are whole time directors or senior executives, resident in Hyderabad. There could be up to five nominees if the paid-up capital of the corporate member is Rs. 5 crores, and up to ten nominees if the paid-up capital exceeds Rs. 5 crores. Any company incorporated under the Companies Act or a statute of the State or Central Government or International Renowned Association including a co-operative society having its office or place of business in Hyderabad and Secunderabad and its suburbs is eligible for membership as a corporate member. The club also benefits by the accrual of additional income by way of entrance fee ; and nominees of the corporate members of the club enjoy the same facilities and privileges as other members. There were as many as 31 corporate members but the assessee deposited their funds with the above named six banks/financial institutions. The contention was that the interest earned by the assessee from these corporate members is interest earned from its members and, consequently, the principle of mutuality applies. The assessee relied on the decision of the Supreme Court in Civil Appeals Nos. 4777 and 4778 of 1998, dated February 5, 1998 (unreported judgment in CIT v. Cawnpore Club Ltd. [2004] 140 Taxman 378 (SC) and CIT v. Bankipur Club Ltd. [1997] 226 ITR 97 (SC) ; [1997] 5 SCC 394.
3. The Assessing Officer came to the conclusion that the assessee did not deposit the amounts with the banks treating them as corporate members ; and the banks had not accepted the deposits from the assessee in their capacity as a member of the club. They accepted the deposits from the assessee as any other depositor and paid the same rate of interest as is payable to general public and, therefore, corporate membership in the club had no nexus whatever with their capacity of accepting deposits from the assessee. The Assessing Officer relied on the order of the Tribunal in I. T.A. Nos. 819 and 820/Hyderabad/1994, dated February 5, 2002, wherein it was held that advancing loans or making fixed deposits is not one of the objects of the assessee-club ; the members of the assessee had a double role one as a member and the other as a member of the general public ; the banks, while accepting deposits from the assessee, did not act in their capacity as members of the club but as members of the general public and, therefore, the principle of mutuality cannot be applied. The Assessing Officer also came to the conclusion that the unreported judgment of the Supreme Court in Cawnpore Club Ltd. [2004] 140 Taxman 378 (SC) did not lay down or enunciate a general proposition or applicability of the principle of mutuality to the interest income earned by a club on the deposits made. Further, after analysing the decision of the Supreme Court, the Assessing Officer came to the conclusion that Bankipur Club Ltd. [1997] 226 ITR 97 (SC) nowhere dealt with the question of taxability of interest income on fixed deposits, etc. The assessee also relied on CIT v. Natraj Finance Corporation [1988] 169 ITR 732 (AP). The Assessing Officer opined that the said decision is of no avail to him as the High Court did not discuss whether the principle of mutuality applied to any interest income derived from money lying in deposit with any bank. Accordingly, the Assessing Officer added interest on deposits and assessed them to tax.
4. Being aggrieved by the assessment order dated March 26, 2004, the assessee went in appeal. This was heard along with four other appeals pertaining to the assessment years 1998-99, 1999-00, 2000-01 and 2001-02. The main ground for appeal was non-taxability of interest income derived from corporate deposits. Reliance was placed on the order of the Tribunal dated August 13, 2003, in the case of Fateh Maidan Club v. Addl. CIT (I.T. A. Nos. 937 to 939 and 947 to 952/Hyd/1995 and 716 to 720/Hyd/2000) and Natraj Finance Corporation [1988] 169 ITR 732 (AP). The Appellate Commissioner relied on the decision of the Tribunal dated March 5, 2002, for the assessment years 1990-91 and 1991-92 and held that the principle of mutuality cannot be applied to the interest income derived from investments. He came to the conclusion that the decision of the jurisdictional Tribunal on the specific issue in the appellant’s own case for earlier years is binding. He also discussed Natraj Finance Corporation [1988] 169 ITR 732 (AP), Cawnpore Club [2004] 140 Taxman 378 (SC) and came to the conclusion that they do not lay down any ratio applicable to the case and followed the decision of the Tribunal dated August 13, 2003, in the case of the assessee itself. The appeal was, therefore, dismissed.
5. The learned Tribunal, Hyderabad Bench, reversed the orders of the Commissioner of Income-tax. Having come to the conclusion that the interest income earned by the assessee on the deposits made by its corporate members is not liable to be taxed, the learned Tribunal deleted the additions made by the Assessing Officer as confirmed by the Commissioner of Income-tax (Appeals). The Tribunal referred to various precedents and held that the assessee did not engage in any business by parking their surplus money in the banks and that, “even if it is held as a trade with members as no outsiders are involved, the income is not exigible to tax”.
6. The senior standing counsel for the Revenue raised the following contentions. The income derived by providing facilities, services and amenities to the members is alone non-exigible on the principle of mutuality, but the income derived from third parties is taxable under the Act for invoking the principle of mutuality the purpose should be referable to the object of the society and parking of the funds for earning interest is not one of the objects of the assessee and, therefore, the income is exigible to tax. He relied on CIT v. Merchant Navy Club [1974] 96 ITR 261 (AP), Rajpath Club Limited v. CIT [1995] 211 ITR 379 (Guj), Sports Club of Gujarat v. CIT [1988] 171 ITR 504 (Guj), Madras Gymkhana Club v. Deputy CIT [2010] 328 ITR 348 (Mad), Chelmsford Club v. CIT [2000] 243 ITR 89 (SC) ; [2000] 3 SCC 214, CIT v. Bangalore Club [2006] 287 ITR 263 (Karn), Bankipur Club Ltd. [1997] 226 ITR 97 (SC), CIT v. Cawnpore Club [2004] 140 Taxman 378 (SC) and CIT v. Common Effluent Treatment Plant (Thane-Belapur) Association [2010] 328 ITR 362 (Bom) (Common Effluent Treatment Plant). A corporate member, being a juridical person, does not satisfy the criteria of being a contributor to the funds as well as the recipient to the funds. In the case of a corporate member, the contributory is a juridical person and the recipient of the services is a natural person/persons nominated by the corporate member. In view of this, when the assessee deposited their surplus funds with the banks, who incidentally happened to be corporate members, such income is not immune from taxability.
7. Learned counsel for the Secunderabad Club would submit that when his client deposited the surplus funds with banks, who are corporate members of the assessee-club, the interest income cannot be treated as income. According to him, even if the surplus amount is deposited with the third parties, the interest thereon is not exigible to tax. According to him, the principle of mutuality applies to interest on deposits with third parties or corporate members. The corporate members also contribute and, at the time of winding up, they also get a share of the surplus from the liquidation funds. There is nexus between the contributions made and the benefits derived by corporate members as in the case of ordinary members. The assessee-club can never be said to have derived profits from contributions made by the members to the fund which could only be spent for the benefit or returned to the members. Learned counsel referred to Merchant Navy Club [1974] 96 ITR 261 (AP), CIT v. West Godavari Rice Millers Association [1984] 150 ITR 394 (AP), CIT v. Darjeeling Club Ltd. [1985] 153 ITR 676 (Cal), Natraj Finance Corporation [1988] 169 ITR 732 (AP), Director of I. T. (Exemption) v. All India Oriental Bank of Commerce Welfare Society [2003] 184 CTR 274 (Delhi), Canara Bank Golden Jubilee Staff Welfare Fund v. Deputy CIT [2009] 308 ITR 202 (Karn), CIT v. Standing Conference of Public Enterprises [2009] 319 ITR 179 (Delhi), CIT v. Delhi Gymkhana Club Ltd. [2011] 339 ITR 525 (Delhi) ; [2011] 10 Taxman 114 ; [2011] 53 DTR 330 (Delhi) CIT v. Talangang Co-operative Group Housing Society Ltd. [2011] 339 ITR 518 (Delhi) ; [2010] 44 DTR 58 (Delhi), Cawnpore Club Ltd. [2004] 140 Taxman 378 (SC) ; Bankipur Club Ltd. [1997] 226 ITR 97 (SC), Chelmsford Club [2000} 243 ITR 89 (SC), Union of India v. Onkar S. Kanwar [2002] 258 ITR 761 (SC), CIT v. Naga Hills Tea and Co. Ltd. [1973] 89 ITR 236 (SC), CED v. R. Kanakasabai [1973] 89 ITR 251 (SC) and CIT v. Vegetable Products Ltd. [1973] 88 ITR 192 (SC).
Point for consideration
8. The point that arises for consideration in these appeals is whether the principle of mutuality pleaded by the assessee is attracted and whether interest income earned from various deposits kept with the banks/financial institutions is a non-taxable receipt ?
Principles and precedents
9. The business law maxim that no one can make profit out of himself over a period of time, has evolved into the principle of mutuality in income-tax law. In plain terms, the principle postulates that, “when persons contribute to a common fund in pursuance of a scheme for their mutual benefit, having no dealings or relations with any outside body, they cannot be said to have made a profit when they find they have overcharged themselves and that some portion of their contributions may be safely refunded”. If complete identity, between the contributors and the participants or recipients, is established, the surplus generated and returned to the contributors is not regarded as profit for the purpose of charging income-tax. If the persons carry on an activity, which is also trade, in such a way that they and the customers are the same persons, no profits are yielded by such trade for tax purposes and, therefore, no assessment in respect of the trade can be made. The surplus, resulting from trading, represents such contributions of the participants which is in excess of the requirements. Access to profits or services is a condition precedent to satisfy the element of mutuality. Even when the aggregate of the members are incorporated, the effect of principle is not lost (British Tax Encyclopaedia, Simon’s Taxes and Halsbury’s Laws of England as quoted in Bankipur Club Ltd. [1997] 226 ITR 97 (SC)).
10. In New York Life Insurance Co. v. Styles [1889] 2 TC 460 ; [1889] 14 AC 381, life insurance policies were issued to participating and non-participating members of the company. The holder of a participating policy became a member of the company and was entitled to a share in the assets and liabilities and share in the losses. After working out annuities, the premium to be paid by each member was determined which was paid. Every year, the surplus of premia over the expenditure referable to policies was returned to the holders of the participating policies and the balance was carried forward as a fund in hand to the credit of the general body members. The Surveyor of Tax treated the surplus as taxable profit. Ultimately the Privy Council negatived the contention. It was held that, when the members had associated themselves together for the purpose of insuring each other’s life on the principle of mutuality assurance and had contributed to a common fund from out of which payments were made in the event of death, they were alone the owners of the common fund, and they were entitled to participate in the surplus. The incorporation of the company did not alter the identity of the contributors and those who received the surplus and, accordingly, the company did not carry on any business at all. Thus, Styles’ case [1889] 2 TC 460 established the principle of mutuality and was followed not only in England but in many other common law jurisdictions.
11. English and Scottish Joint Co-operative Wholesale Society Ltd. v. Commissioner of Agricultural I. T. [1948] 16 ITR 270 (PC) ; [1948] AC 405 ; [1948] 2 All ER 395 (PC) (hereafter Scottish Joint Society) dealt with the question whether the profit distributed to two member co-operative wholesale societies, from out of the surplus earned by the joint wholesale society, was exempt from the Assam Agricultural Income-tax Act, 1939. The member societies advanced monies to the Joint Society. As and when tea was supplied to them, the price was debited against the advances and the surplus over the costs was dealt with as payment of interest on the share capital. The surplus was distributed to two members proportionate to their purchase of tea. The surplus distributed to the societies was held as profit and as taxable under the relevant Act. The unanimous judicial committee, quoting with the approval from William Harrison (Surveyor of Taxes) v. London Assurance Corporation [1885] 10 AC 438 (HL), opined that, “when a number of individuals agree to contribute funds for a common purpose, . . . stipulate that their contributions, so far as not required for that purpose, shall be repaid to them, I cannot conceive why they should be regarded as traders, or why contributions returned to them should be regarded as profits”. It was further held that, “the members contribute for a common object to a fund which is their common property ; it turns out that they have contributed more than is needed and, therefore, more than ought to have been contributed by them, for this object, and accordingly their next contribution is reduced by an amount equal to their proportion of this excess. I am at a loss to see how this can be considered as a ‘profit’ arising or accruing to them from a trade or vocation which they carry on. From these quotations it appears that the exemption was based on (1) the identity of the contributors to 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”. Further, the statement of law in Municipal Mutual Insurance Ltd. v. Hills (Inspector of Taxes) [1932] 16 TC 430 by Lord Macmillan to the effect that, “the cardinal requirement is that all the contributors to the common fund must be entitled to participate in the surplus and 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 and the participators” was quoted and relied on.
12. In Walter Fletcher v. Income Tax Commissioner [1972] AC 414, Doctor’s Cave Bathing Club which owned bathing beach provided various amenities. Ordinary members of the club paid subscription and they enjoyed the right to a bath. In addition, they also allowed others who were, however, required to buy a ticket for bathing. This facility was extended to the hotel guests. The hotels purchased a block of tickets, and re-sold it to the hotel guests. In 1963, a question arose as to the club’s liability for income-tax in respect of receipts from the hotels. The Income-tax Appeal Board affirmed the liability rejecting the mutuality principle. The fact that the hotels had no right to vote weighed with the Appeal Board. Therefore, the rules were amended giving one vote to each hotel member who were required to pay annual subscription as in the case of ordinary members. None the less, the Commissioner proposed to tax the profit element in the proportion of the hotel membership subscription. The Court of Appeal of Jamaica held against the club, but allowed an appeal to the Privy Council. The Judicial Committee considered the question whether the club was assessable to income on the profit element contained in the receipts from hotels whose guests had the right to use the club.
13. Lord Wilberforce noticed three main fields in which mutuality principles had been applied, namely, insurance companies, rating groups and clubs. In so far as the applicability of mutuality principle to clubs was concerned, it was observed that, “even in a club governed by the relationship of mutuality, the surplus income is not exempt from the charge if the relationship of mutuality ends and trading begin”. While discussing the difference between insurance associations, rating groups and clubs, it was held that when a trading company is a member, “the inquiry is open whether the relationship of the aggregate of the ordinary bathing members with the hotels is truly one of mutuality or is rather of a trading character”. It was further observed that the nature of the transaction is significant than the fact of membership or non-membership and, if there were trading transactions, the addition of membership made no difference. The relevant observations are as follows :
“. . . mutuality is not necessarily excluded by the fact that some ‘members’ are corporate bodies, or even corporate bodies engaged in trade. But the relevance of facts such as these must vary with the nature of the activity. In the case of insurance, they are of little or no weight, since companies, and trading companies, can just as naturally and appropriately engage in a mutual insurance scheme as individuals. And in the field of rating the same is true ; a rate payer can just as well be a trading corporation as an individual. In social relationships or where recreation is involved the position may be different ; the presence among ‘members’ of trading companies at least suggests the necessity of inquiry as to the reason for and nature of their participation. In the present case, it may be agreed that the fact that hotels are not themselves potential bathers may be immaterial ; but yet the inquiry is open whether the relationship of the aggregate of the ordinary bathing members with the hotels is truly one of mutuality, or is rather of a trading character. It is necessary, therefore, to seek other indications pointing in one direction or the other.” (emphasis supplied)
14. In CIT v. Royal Western India Turf Club Ltd. [1953] 24 ITR 551 (SC) ; [1954] AIR 1954 SC 85, after a review of Styles [1889] 2 TC 460, Hills[1932] 16 TC 430 (HL), English and Scottish Joint Co-operative Wholesale Society Ltd. [1948] 16 ITR 270 (PC) and other cases, the Supreme Court observed that (page 560) : “the principle that no one can make a profit out of himself is true enough but may in its application easily lead to confusion. There is nothing per se to prevent a company from making a profit out of its own members. Thus, a railway company which earns profits by carrying passengers may also make a profit by carrying its shareholders or a trading company may make a profit out of its trading with its members besides the profit it makes from the general public which deals with it but that profit belongs to the members as shareholders and does not come back to them as persons who had contributed them. Where a company collects money from its members and applies it for their benefit not as shareholders but as persons who put up the fund the company makes no profit. In such cases, where there is identity in the character of those who contribute and of those who participate in the surplus, the fact of incorporation may be immaterial and the incorporated company may well be regarded as a mere instrument, a convenient agent for carrying out what the members might more laboriously do for themselves. But it cannot be said that incorporation which brings into being a legal entity separate from its constituent members is to be disregarded always and that the legal entity can never make a profit out of its own members”.
15. In CIT v. Kumbakonam Mutual Benefit Fund Ltd. [1964] 53 ITR 241 (SC) ; [1965] AIR 1965 SC 96, the respondent which was carrying on banking business and extending loan facilities only to shareholders, claimed exemption from tax on the interest income realised from members. The Assessing Officer, the Appellate Commissioner and the Income-tax Appellate Tribunal came to the conclusion that the respondent was a banking concern ; whether or not a member/shareholder availed of loan facility he was entitled for distribution of profits ; and, therefore, the principle of mutuality as evolved in Styles [1889] 2 TC 460 did not apply. The High Court of Madras held in favour of the assessee. The Supreme Court reversed the High Court and observed that the essence of mutuality lies in the return of what one has contributed to the common fund, and that in the case of Kumbakonam Mutual Benefit Fund the interest from the loans was divided among the members pro rata according to their shareholding after making provision for reserves and deducting expenditure, and, therefore, the essence of mutuality is not satisfied. The income distributed was the income from business and, therefore, not exempt from taxation.
16. In Bankipur Club Ltd. [1997] 226 ITR 97 (SC), the Supreme Court reiterated the principle as follows (page 110) :
“. . . if the object of the assessee-company claiming to be a ‘mutual concern’ or ‘club’, is to carry on a particular business and money is realised both from the members and from non-members, for the same consideration by giving the same or similar facilities to all alike in respect of the one and the same business carried on by it, the dealings as a whole disclose the same profit-earning motive and are alike tainted with commerciality. In other words, the activity carried on by the assessee in such cases, claiming to be a ‘mutual concern’ or ‘members’ club’ is a trade or an adventure in the nature of trade and the transactions entered into with the members or non-members alike is a trade/ business/ transaction and the resultant surplus is certainly profit income liable to tax. We should also state, that ‘at what point, does the relationship of mutuality end and that of trading begin’ is a difficult and vexed question. A host of factors may have to be considered to arrive at a conclusion.”
17. Chelmsford Club [2000] 243 ITR 89 (SC) was an appeal against the judgment of the Delhi High Court taking the view that the annual letting value of the Chelmsford Club was assessable to income-tax under the head ‘income from property’. In appeal, referring to Styles [1889] 2 TC 460 English and Scottish Joint Co-operative Wholesale Society Ltd. [1948] 16 ITR 270 (PC) and Bankipur Club Ltd. [1997] 226 ITR 97 (SC), the Supreme Court held that, “it is not only the surplus from the activities of the business of the club that is excluded from the levy of income-tax, even the annual value of the club house, as contemplated in section 22 of the Act will be outside the purview of levy of income-tax”, and that, “the law recognises the principle of mutuality excluding the levy of income-tax from the income of such business to which the principle is applicable”.
18. The question whether the club’s interest income from fixed deposits in nationalised banks/scheduled banks or from Government securities was exempt from tax on the principle of mutuality has been considered by various High Courts. The view, however, is not one and the same. In All India Oriental Bank of Commerce Welfare Society [2003] 184 CTR 274 (Delhi), Delhi Gymkhana Club Ltd. [2011] 339 ITR 525 (Delhi) and Talangang Co-operative Group Housing Society Ltd. [2011] 339 ITR 518 (Delhi) the Delhi High Court held that the interest income on deposits with third parties or members was not liable to tax. The Karnataka High Court in Canara Bank Golden Jubilee Staff Welfare Fund [2009] 308 ITR 202 (Karn) and the Allahabad High Court in Cawnpore Club Ltd. took a similar view. In contrast, the Karnataka High Court in Bangalore Club [2006] 287 ITR 263 (Karn) the Madras High Court in Madras Gymkhana Club [2010] 328 ITR 348 (Mad) and the Bombay High Court in Common Effluent Treatment Plant [2010] 328 ITR 362 (Bom) have held that interest received on deposits with corporate members, like banks, is not exempt on the principle of mutuality. The counsel for the assessee strongly relies on Natraj Finance Corporation [1988] 169 ITR 732 (AP). We would refer to some of these decisions at an appropriate place infra.
Interest income of the assessee
19. Indisputably, Secunderabad Club is an unregistered body. It was established with the object of conducting social activities including sports and provide recreation facilities. There are eight classes of members. They are honorary members, permanent members, mess members, lady members, temporary members (long-term and short-term), corporate members, associate members (lady) and affiliated members. Except honorary members and permanent members, all other members compulsorily pay the entrance fee depending on the class/classes of membership. Corporate members are incorporated concerns or internationally renowned industries or associations, with their place of business in Hyderabad, Secunderabad and its suburbs (famously referred to as “twin cities”). As per the rules of the club, the total number of corporate members shall not exceed 250. Unless the paid-up capital is rupees one crore, no company can be admitted as a corporate member. A corporate member, (a juridical person), shall be entitled to nominate up to 5 (five) nominees who shall be its whole time directors or senior executives residing in twin cities. These nominees are entitled to use and enjoy all the facilities offered by the club to its members, subject to payment of admission fee under the rules. Every corporate member shall pay admission fee of Rs. 10 lakhs and shall be entitled for nomination to two memberships and for every additional nominee, to which a corporate member is entitled to nominate, admission fee shall be Rs. 5 lakhs. This is subject to the relevant rule dealing with the right of the corporate member to nominate. It provides that, where the paid up capital is Rs. 5 crores and above, the corporate entity can apply for additional memberships not exceeding five. As per the declaration to be given by the corporate member, while seeking membership, the nominees shall be their employees, and the nominees shall be withdrawn as soon as they cease to be the employees of such a corporate member. Another important rule, which is peculiar to corporate membership, is rule XII(A). It deals with termination of the corporate membership, and provides that a corporate member shall automatically cease to be a member after expiry of a period of 10 years from the date of its election as corporate member on its ceasing to have an office or place of business in Hyderabad or Secunderabad or its suburbs on its being wound up following its liquidation or pursuant to any amalgamation of the said corporate member with any other company and on non-payment of any amount due to the club either by it or by its nominees. In the case of no other category of member, is there a time stipulation for automatic termination of membership.
20. As per rule XXII, the annual general meeting of the general body shall elect a club committee consisting of a president, a vice-president and six other permanent members. Out of these, the president or vice-president and three other members shall retire at the end of the first year, the remaining members shall retire at the end of the second year of election, and each vacancy so caused shall be filled up for two years by election at the next annual general meeting. It is the club committee which is entrusted with the entire management of the club duly exercising the powers vested under the club rules. The winding up procedure is stipulated in rule XXVII of the club rules. The power to initiate winding up of the club is also vested with the club committee. When it is proposed to wind up the club, notice in writing shall be given of the meeting to all the subscribing permanent members. Half of the subscribing members shall form the quorum, and no proposal shall be deemed to have been passed unless three-fourths of the permanent members present in the meeting vote in favour of winding up. In the event of the general body deciding to wind up, liquidation shall be conducted, as nearly as practicable, in accordance with the Indian Companies Act and “any surplus assets remaining after all the liabilities have been discharged shall be shared equally by the members of the club”.
21. The counsel for the assessee vehemently contends that, under the rules, the members and corporate members are not treated differently either for the purpose of contribution or participation ; the members and corporate members are equal recipients, and there is complete identity between them. He would urge that interest income on deposits with the corporate members has to be treated as contribution by the corporate members, and it cannot be treated as income. The counsel would strongly commend to this court application of the principle of mutuality to the interest income on deposits with corporate members. He would also submit that, in the event of winding up, even the corporate members also have a share in the surplus after meeting the liabilities and, therefore, the interest on deposits cannot be treated as income. We find it difficult to countenance these submissions.
22. Jurisprudentially an incorporated company is different from its promoters, members and/or shareholders. The directors or senior executives themselves cannot be treated as juridical persons. It is a vintage principle that an incorporated juridical person is different from the persons who represent the juridical person. Under the Indian Companies Act, the subscribers to memorandum of a company, and every person holding equity share capital, are treated as members, but such members do not have the right to interfere in the management of the affairs of the company, except to the limited extent as provided in the memorandum and articles of association of the company. Not all the directors participate in the management unless they are specifically assigned such duty, although as members of the board of directors they decide the policy and are liable as per the memorandum of association and other provisions of the Companies Act, 1956. The directors, secretaries, treasurers, managers are treated as officers of the company. They may act on behalf of the juridical person, but they would not don the juridical personality.
23. A shareholder acquires a right to profits of the company but does not acquire any interest in the assets of the company. A shareholder has no right in the property of the company which is a juristic entity entirely distinct from the shareholders. A shareholder as an investor is entitled to participate in the profits of the company subject to the articles of association. A shareholder would be entitled to participate in the assets only in the event of winding up (Mrs. Bacha F. Guzdar v. CIT [1955] 27 ITR 1 (SC); AIR 1955 SC 74). The corporation is separate from its shareholders. It bears its own name and has a seal of its own ; its assets are separate and distinct from those of its members ; it can sue and be sued exclusively for its own purpose ; and the liability of the members or shareholders is limited to the capital invested by them and further the creditors or the members have no right to the assets of the corporation (Tata Engineering and Locomotive Co. Ltd. v. State of Bihar [1965] AIR 1965 SC 40).
24. Indisputably, as per the club rules, a corporate member like a nationalised/scheduled bank as in these cases-is entitled to nominate their whole time directors, or full time senior executives, as members. It would, therefore, be relevant to determine whether the nominees of a corporate member, who avail of the facilities of the club, can be equated with the juridical personality of the company. When a company itself becomes a member of a club to the extent of making contribution it is responsible, but when it comes to participation and availment of facilities and privileges it is not the juridical person but it is only the nominated officers of the company who do so. There is thus a discernible factor which takes away the nexus between contribution and participation. There is also a dichotomy between the juridical personality who contributes to the club and the nominees (who can be changed) who actually avail of facilities and receive benefits from the club activities.
25. As we shall presently point out, there is an unignorable difference between the ordinary/permanent members of the club on the one hand, and the corporate members on the other. An ordinary/permanent member who contributes to the club avails of the facilities of the club and it is he or she who receives the surplus contribution, if any, paid or participates and enjoys the fruits of the surplus funds generated by the activities of the club. It is only a member who would be entitled to a proportionate amount in the event of liquidation, and it is the member who has the right to be elected to the committee of the club, and a right to vote. In the case of a corporate member, the amount of membership/subscription is contributed by the juridical person whereas participation in the club activities is by a natural person nominated to participate and avail of the facilities of the club. A corporate member, as per the rules, has no right to be elected to the committee of the club, nor entitled to as many votes as the number of its nominees. Further, there is a ceiling of 250 corporate members and they are negligible (it was 31 at the relevant time) in comparison with other ordinary/permanent members. Corporate members represent an insignificant minority and it is the ordinary/permanent members who control and manage the activities of the club for their mutual benefit. As noticed in Walter Fletcher [1972] AC 414, this disparity in the voting strength is relevant when the court considers a question of non-taxability of the income of a club claiming the benefit of the principle of mutuality because “the ordinary members as a group have an overwhelmingly greater interest in the regularly earned surplus”. Further, even in the event of winding up, it is the permanent members who would have a dominant role.
26. An important facet of the principle of mutuality is not only the identity of the contributors of, and the recipients from, the fund, but also the right to be returned the contribution in the event of the aggregate of members getting dissolved. If the continuance of the original contributors till the end, or till the achievement of the objects for forming the association or society/club is uncertain, the principle of mutuality, to our mind, ceases to apply. Rule XII deals with termination of membership. In so far as natural persons are concerned, the membership and all rights and privileges relating thereto shall be deemed to have ceased if the member resigns or dies, or is dismissed from service, if any, to which he belongs, declared as an insolvent, or of unsound mind or sentenced to imprisonment for any offence involving moral turpitude. In the case of a corporate member, termination of membership is automatic, or if the corporate member closes its office or place of business in Hyderabad or is wound up following liquidation proceedings and on non-payment of any amount due to the club either from itself or from its nominees. The distinction in the method and the manner of cessation of membership cannot also be ignored. All these are relevant while considering the applicability of the principle of mutuality to the interest earned from deposits of the club with banks/ financial institutions who also happen to be corporate members.
Relationship of mutuality and business
27. The object of the Secunderabad Club is to take up social activities including sports and recreation. The rules nowhere require the club to deposit its surplus with banks. The principle of mutuality as invoked in Styles [1889] 2 TC 460 requires repayment to the members the amount in excess than what is needed. In case surplus funds are accumulated, even though there are no plans for augmenting the club facilities, why should it not be treated as trade or business when the surplus is used for earning profit by way of interest income. There is no dispute that the Secunderabad Club has parked its funds with financial institutions who are in the business of accepting deposits and lending money. The surplus was also deposited in nationalised banks who carry on banking business as described in section 6 of the Banking Regulation Act, 1949. Money was also deposited with financial institutions who had necessary permissions to accept deposits. When a person deposits money in a bank, the relationship is that of a creditor and a debtor, and they would be bound by the contract that regulates the deposit and payment of interest thereon. When the club deposits its funds with a bank, the latter does not treat the club any differently from its other depositors, nor is any higher rate of interest offered. Similarly when the club deposits its surplus with banks, the latter might have been treated as the preferred bank for obvious reasons. If that is the case, the club could as well have lent the money to all its members and collected interest. The Secunderabad Club chose to deposit its surplus in banks for reasons of safety, an assured return of the principal, and a reasonable return in the form of interest thereon. It may be a prudent business decision not to keep the surplus funds idle and park them in interestearning deposits. The principle of mutuality ends the moment the club deposits the amount with the sole aim of earning interest on the deposits. Further, by depositing its funds with its corporate member banks, the Secunderabad Club would certainly help increase the business of the bank. In that view of the matter, the corporate member bank is being shown a favour, and is not being provided a facility. Even the bank has not applied any special rules to govern the clubs’ deposits. It accepts deposits from any person because borrowing money and accepting deposits are age old forms of banking business. If the club, being a party to such a banking business, earns interest, the principle of mutuality ends. The social relationship and social activities of the club have nothing to do with its deposits with corporate members. Therefore, it is difficult to accept the assessee’s contention that interest income is non-taxable.
28. If the assessee, claiming to be a “mutual concern” or a “club”, is to carry on a particular business, and money is realised both from members and from non-members for the same consideration by giving the same or similar facilities to all alike in respect of one and the same business carried on by it, the dealings as a whole disclose the same profit-earning motive and are tainted with commerciality. The resultant surplus is income liable to tax (Bankipur Club Ltd. [1997] 226 ITR 97 (SC)). Of course, if the income is derived by providing amenities, facilities and services to the members without any profit motive, the principle of mutuality would apply and the income derived would not be chargeable to tax.
29. In Bangalore Club [2006] 287 ITR 263 (Karn), the question was whether the principle of mutuality could be made applicable to funds deposited by the said club in four banks who are 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 assessee’s club. Following Sports Club of Gujarat [1988] 171 ITR 504 (Guj) and Kumbakonam Mutual Benefit Fund [1964] 53 ITR 241 (SC) the Karnataka High Court held that the principle of “no man can trade with himself” is not available in respect of a nationalised bank holding a fixed deposit on behalf of its customer and that, “the relationship is one of a banker and a customer”.
30. In Madras Gymkhana Club [2010] 328 ITR 348 (Mad), a similar question was considered by a Division Bench of the Madras High Court and, after referring to several judgments, it was held that the investment of surplus funds had nothing to do with the objects of the club ; investment of surplus in the bank, and earning of interest, had absolutely no nexus to the objects enumerated under the rules of the club ; investments with the corporate members could not be equated or brought within the concept of mutuality ; the principle was applicable in respect of the income earned by the club out of the contributions received from its members and it had no application in respect of interest earned on the deposit of surplus funds in banks. The relevant observations are as follows (page 357) :
“With the above principles in mind, when the deposit of surplus funds even with a member bank, is considered, one can easily visualise that the deposit of such funds would enure to the benefit of that member alone, who would be in a position to utilise the said deposit in any manner it likes and thereby depriving of such benefit for the other members to enjoy which would under no circumstances satisfy the test of identity of the contributors and the participants.”
31. In Common Effluent Treatment Plant [2010] 328 ITR 362 (Bom), the Bombay High Court, after referring to various decisions, held as under (page 375) :
“In order to fulfil the requirement of mutuality, a mutual association has to establish, as an essential requirement, the identity between participators and contributors to the fund. However, the fact that an association satisfies the norm of mutuality in respect of the receipts of contributions from its members does not necessarily lead to the conclusion that every activity of the association satisfies the test of mutuality. An association may engage in activities which can be described as mutual and in other activities which are not mutual. The Gujarat High Court recognised this in its decision in Sports Club of Gujarat [1988] 171 ITR 504 (Guj). Adverting to the decision in CIT v. Madras Race Club [1976] 105 ITR 433 (Mad), the court noted that the application of the principle of mutuality is not destroyed by the presence of transactions which are non-mutual in character. However, in such a case, the principle of mutuality has to be confined to transactions with members possessing the essential character of mutuality. The two activities can in appropriate cases be separated and the profits derived from transactions which do not fulfil the requirements of mutuality can be brought to tax.
Yet again it was held (page 376).
The assessee in the present case utilises its surplus funds for investment in fixed deposits with banks. The interest that is generated on the investment of such funds is not income which is received from the members of the assessee but from third parties such as the banks with whom the funds are invested . . . The decision to invest the funds of the association in bank fixed deposits is a prudent commercial decision motivated by the desire to earn interest that would not be available on moneys maintained in ordinary, current or savings accounts. Such interest does not fulfil the requirement of mutuality. While investing the funds with a bank or a financial institution, the assessee assumes the character of a customer of the bank or institution and the relationship that is engendered is that between a banker and its customer. The fact that the funds which are invested have their source in the contribution by the members of the assessee cannot be dispositive of the nature of the receipt obtained by the assessee on account of the interest payments on the deposits made. In determining the exigibility to tax of receipts on account of interest, it is the character of the receipt as interest that must play a determinative role. A payment on account of interest by the bank or a party with whom the deposit is placed is an arm’s length transaction with a third party. The recompense which is received by the assessee by and as a result of the transaction does not fulfil the condition of mutuality to which the contributions received from the members of the assessee are subject.” (emphasis supplied)
32. As noticed supra, the Delhi High Court has taken a contra view. In Delhi Gymkhana Club [2011] 339 ITR 525 (Delhi), the court referred to three of its earlier decisions, and affirmed the view of the Income-tax Appellate Tribunal that the income from FDRs in banks would also attract the doctrine of mutuality and, therefore, no tax was payable thereon. We have perused the judgments relied on in Delhi Gymkhana Club [2011] 339 ITR 525 (Delhi), and are not able to persuade ourselves to agree with the view. We, for various reasons discussed supra, very humbly differ from the Delhi High Court’s view.
33. In Natraj Finance Corporation [1988] 169 ITR 732 (AP), an association of persons consisting of 19 members claimed to be a mutual benefit association. For the assessment year 1977-78, they declared Rs. 48,310 as income, and raised the plea of non-taxability on the principle of mutuality. The Assessing Officer rejected the claim, but the appellate authority upheld the contention. The Revenue’s appeal failed before the Tribunal. The Division Bench of this court opined that monthly contributions of the members, advance of loans only to the members and receipt of interest thereon was sufficient enough to establish complete identity between the contributors to the common fund and the participators for attracting the principle of mutuality rendering the income non-taxable. The Revenue relied on Kumbakonam Mutual Benefit Fund Ltd. [1964] 53 ITR 241 (SC) ; [1965] AIR 1965 SC 96. Distinguishing the same this court observed as follows (page 736 of 169 ITR) :
“The decision of the Supreme Court was referred to by this court in Merchant Navy Club [1974] 96 ITR 261 (AP) above referred to and was explained. It should be borne in mind that the decisions of the Supreme Court as well as this court, relied upon by learned counsel for the Revenue, refer to corporate bodies having a legal status. The question which fell for consideration in those cases was whether the companies could be considered to be carrying on business with the member-shareholders in order that the income derived by them qualified for consideration as income derived by a mutual benefit society. Considering the fact that the assessees in those cases were corporate bodies having legal existence, the court held that the principle of mutuality does not apply in relation to transactions with shareholders. The aforesaid distinction has been clearly brought out by this court in Merchant Navy Club [1974] 96 ITR 261 (AP). We have seen in the present case that the members of the association 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 the character of income of a non-mutual benefit concern.”
34. Reading the above observations, it is not possible to accept the contention of the counsel for the assessee that interest earned even from third parties would be exempt from the charge of income-tax, in all types of transactions. The ratio therein is that, if an incorporated entity is engaged in trade, the profit from it, even if they are transactions with members, would be taxable and the principle of mutuality would have no application.
35. The decision of this court was long prior to Bankipur Club Ltd. [1997] 226 ITR 97 (SC) and Chelmsford Club [2000] 243 ITR 89 (SC), and no reference was made therein to Royal Western India Turf Club Ltd. [1953] 24 ITR 551 (SC). As we have considered these cases in the light of the law laid down by the Supreme Court in these three judgments, we do not feel compelled to apply the ratio in Natraj Finance Corporation [1988] 169 ITR 732 (AP). We, however, hasten to add that, if an association of persons receives contributions from its own members and earns interest income by lending the money to them from out of the contribution, the principle of mutuality may apply rendering such income non-taxable. An unregistered association, like the Secunderabad club, parking their surplus funds with corporate member banks to earn interest is altogether different from an association of persons lending money only to its members. Further, as held by the Supreme Court in Bankipur Club Ltd. [1997] 226 ITR 97 (SC), “a host of factors need to be considered to arrive at a conclusion as to at what point does the relationship of mutuality end and that of trading begin”. Furthermore, the nature of the transaction between the assessee and the bank/banks would disqualify application of the principle of mutuality. We are, therefore, of the considered opinion that the impugned orders of the Income-tax Appellate Tribunal are liable to be set aside.
36. The assessee in I. T. T. A. Nos. 443 of 2006 and 78 and 81 of 2007 is a cooperative society. Statedly its object is buying, acquiring, selling, hiring, letting and developing lands, and construction of buildings for its members. It also runs a dispensary, CST canteen and vocational/welfare centres. It has a dedicated water supply system. The society itself operates and maintains it with a ground level sump, overhead tanks-cum-houses, and water distribution lines for supplying water. It levies and collects charges. It receives amounts not only from members but also from outsiders towards water charges and rents as interest. They filed their income-tax returns showing loss. During the assessment proceedings under section 148 the Assessing Officer, however, added interest on FDRs, savings bank account and the commission of one per cent. on the sale of immovable property, holding that all the receipts were outside the purview of the principle of mutuality. The Commissioner, however, held that the surplus of receipts from members, over the expenditure incurred on providing services, did not constitute income ; but the income from rent and bank interest were taxable. The assessee further successfully appealed before the Income-tax Appellate Tribunal. Aggrieved by which, the Revenue filed the three appeals. The learned counsel for Armed Forces Club adopts the arguments of the Secunderabad Club. In view of our finding therein, the Revenue appeals must succeed.
37. In the result, for the above reasons, these appeals are allowed. We decline to make any order as to costs.
