Principle of mutuality cannot be denied simply because there are two categories of members as per bye-laws of society

M/s. Sri Sai Datta Mutual Aided Co-operative Credit Society Vs Asst. (ITAT Hyderabad)

The AO and CIT(A) have considered the ordinary members and nominal members are different class of members. AO accepts that ordinary members are having mutuality but he denies the same with reference to nominal members. The principle of mutuality cannot be denied simply because there are two categories of members as per the bye-laws of the society. What is important to decide is the class of contributors and the class of participators, rather than classification of members. In this case, the class of contributors and class of participators are identical. Even though the bye-laws characterizes two types of members, the ‘original members’ being the founder members, others are called ‘nominal members’ but as seen from the order of the AO itself and the clause-9 extracted in the assessment order, it indicates that membership is given to any individual who is competent to contact and who expresses his willingness to practice the co-operative principles and function in accordance with by-laws. Both the ordinary members and nominal members do come under the definition as per the clase-4(iv) and the negative restrictions are not applicable either to the ordinary member or to the nominal member. Even under clause-4(iv), member means a person who has been a member of the society at the time of application for registration (or) person duly admitted to the membership of the society under the APMACS Act, 1995 after registration. The nominal members are also admitted under the by-laws. These are people admitted after the society was registered. Therefore, there may be a separate classification / nomenclature but they have all the rights and duties of any other member. It may be true that the by-laws restrict the voting rights and participation in the general body meetings, but in practice, there is no such difference being followed under the Co-operative Law. Unless a person become a member, he cannot transact with the society or its members. The society transactions are restricted to the Members and no general public is involved with it. Consequently, it cannot be stated that assessee is dealing with third parties, who are not members.

There is no distinction between ordinary members and nominal members and just because categorized as nominal members, they cannot be treated as ‘non-members’. If assessee’s transactions are with non-members, who are not members of the society, principles of mutuality do not apply. But in this case, even a nominal member is also admitted to the membership as per clause-9 and he has all the rights of any other member. The ordinary members are those members who are available at the time of registration and that cannot be considered as a restriction because at the time of formation of any society or an organization, only few members join at the time of incorporation whereas the by-laws permit admission of further members in the course of its activity, be it a business or not business. Thus, we are of the opinion that there is no definition between the transaction of members and nominal members and only when the transactions are with non-members, the principles of mutuality can be invoked or denied. A nominal member cannot be treated as a non-member and so the transactions of nominal members cannot be treated as transactions of non-members.

For the reasons stated above, we are of the opinion that the distinction sought to be made by the AO and CIT(A) is arbitrary and artificial. Therefore, we agree that assessee is covered by the principle of mutuality and its income will be exempt on that concept.

FULL TEXT OF THE ITAT ORDER IS AS FOLLOWS:-

This is an appeal by assessee against the order of the Commissioner of Income Tax (Appeals)-Kurnool, dated 24-03-2016. The issue in this appeal is whether assessee is entitled for benefit of mutuality.

2. This appeal was filed with a delay of 11 days. The reason given for the delay was that the appeals were sought to be filed by way of post but unfortunately, they were sent to the old address of the Tribunal at Shapur House, Adarsh Nagar, Hyderabad and the appeal papers were duly returned due to wrong address. Subsequently, correct address was ascertained and it was duly sent to the correct address. Considering the delay of 11 days which should be condoned as there is sufficient cause. After discussing with DR, we are of the opinion that there is a sufficient cause for non-filing of the appeal in time. Accordingly, the delay in filing the appeal is condoned and appeal memo is admitted to be heard on merits.

3. Briefly stated, assessee is a mutually aided co-operative society, having registered with the District Registrar of Cooperatives, Anantapur. Assessee filed total income at NIL, claiming deduction U/s. 80P of the Act of Rs. 40,03,672/-. In the course of scrutiny assessment, it was the contention of assessee that it is a mutually aided co-operative society and the activities of the society are confined to Members only who are making deposits and availing loans and surplus if any is distributed among the Members only. In the course of assessment proceedings, AO asked the clarifications, examined the by-laws and noticed that there are two categories of Members – Ordinary Members and Nominal Members and the transactions with non-Members being third parties is not entitled for deduction either U/s. 80P or under the concept of mutuality. Accordingly, he denied the benefit and restricted it to an amount of Rs. 40,300/- U/s. 80P(2) of the Act. In addition to the above issue, AO noticed that assessee has paid honorarium to its directors to an extent of Rs. 20,76,200/- and since TDS was not deducted, the said amount was also disallowed U/s. 40(a)(ia) of the Act. Third issue raised by the AO is with reference to interest earned on deposits to an extent of Rs. 17,01,964/-. Relying on the principles laid down by the Hon’ble Supreme Court in the case of M/s. Totgars Co-operative Sale Society Limited [322 ITR 283] (SC) he brought the above amount to tax under the head ‘income from other sources’.

4. Before the Ld.CIT(A), assessee submitted the following facts :

i. The assessee is a Mutually Aided Co-operative Credit Society registered under the APMACC Societies Act, 1995 in the year 2001;

ii. The assessee is formed initially by 15 members and admitted hundred of members into the society;

iii. The main object of the society is under the ‘Concept of Mutuality’ where the members can deposit amounts into the society and avail loans from the society. In other words, a single member can deposit his amount and if required he can avail loan from the society. In other words, a single member can deposit his amount and if required he can avail loan from the society subject to terms and conditions of the society;

iv. It is a mandatory provision in the bye-laws of the society for the intending borrowers from the society become members of the society by contributing admission fees and share capital;

v. In the process of deposits made by the members for which interest is paid by the society and the loans extended by the society to its members and the receipt of interest on such loans constitute the main heads of expenses and income of the society;

vi. After meeting all the administration expenses including sitting fees and honorarium paid to the members, the resulting surplus is distributed among all the members of the society as dividends in the ratio of the capital contributed by the members;

vii. Like other members the working members who are known as directors who have contributed their capital initially and periodically have also availed loans from the society;

viii. The society is distributing the surplus amount among all the members irrespective of depositors or borrowers depending upon the amount of share capital contributed by the members;

ix. The learned assessing officer has not given the cognizance for the concept of mutuality and made the following additions which are completely unjustified.

a) Honorarium paid to members for the services rendered by them throughout the year in collecting deposits from members, extending loans to members and primarily to recover the loans effectively without losing any principal amount of the trusted members of the society. As the society has complied with the following three mutual principles of mutuality, the Learned Assessing Officer should have given the benefit of mutuality to the Society. The three conditions, the existence of which establishes the doctrine of mutuality are:

a) The identity of the contributors to the fund and the recipients from the fund.

b) The treatment of the company, though incorporated as a mere entity for the convenience of the members, in other words, as an instrument obedient to their mandate, and

c) The impossibility that contributors should derive profits from contributions made by themselves to a fund which could only be expended or returned to themselves.

4.1. With reference to the treatment of income on bank deposits, it was submitted that these interests were earned in the course of its activities with the members and following the principles laid down by various decision including the jurisdictional High Court, the income is business income and cannot be brought to tax under the head ‘other sources’.

4.2. Coming to the disallowance U/s. 40(a)(ia) of the Act on the honorarium paid, it was submitted that honorarium was paid to 15 directors for all the 12 months and this amount is not covered by the provisions of Section 194J as it is not a professional fees and they are not directors of a ‘company’ but of a society.

5. Ld.CIT(A) rejected the contentions stating as under:

“5.1. The AR of the appellant filed written submissions which are part of the appellate record and are listed as under:

i) Written submissions dated 19-2-2016

ii) Written submissions dated 25-2-2016

iii) Written submissions dated 2-3-2016

iv) Written submissions dated 18-3-2016

An examination of the above details called for in order to make a detailed examination of the activities of the Society and analysis of the concept of mutuality revealed that :

a) The classification of Membership was not uniform but arbitrary.

b) Huge cash deposits are noticed to be collected and the veracity of such contributions coming from the specified members seemed highly suspicious.

c) The large deposits predominantly were in the names of the special category members and many of such deposits were noticed to be cash deposits beyond the minimum threshold limits.

d) The loans were disbursed in cheque/cash and some of the loans were big ticket loans.

e) The bank account maintained by the appellant society had tell tale signs of huge cash transactions ostensibly owned up in the names of several members.

5.2. The very manner in which the mobilization of deposits by the appellant society needs mention as a result of the examination of the accounts produced during the course of appellate proceedings. The cash book maintained by the society revealed that huge cash deposits are collected directly from the so called category members and they are stated to be credited to the savings account maintained with the society and from thee the book entries are made to show that the said amounts are transferred to various bank accounts. But in reality these are huge cash infusions into the society and totally take a different gamut from the concept of mutuality.

5.3. In the above backdrop of detailed facts brought on record, I now proceed to give my findings on the germane issue which are as follows:

Issue of Applicability of Sec 80P(2)(a)(i) of the Income Tax Act 1961:

The AO analysed the status of the Society in detail as brought out in his assessment order (para 6). I am in agreement with the findings of the AO on the following fundamental principles of mutuality:-

1. The varied nature and identity of the contributors to the fund and the recipients from the fund 

2. The treatment of the society as a mere entity for the convenience of the members and in other words as a instrument obedient to their mandate

3. The impossibility that the contributors of the fund should derive profits from contributions made by themselves to the society to be selectively utilized by themselves thereby creating a colourable devise to circumvent the mandatory provisions of Law from the best advantage

5.4. In my considered view, the Society is not being run on the lines of the objects for which it is constituted and the action of the AO in recomputing the benefits of the Sec 80P needs to be upheld. Accordingly, this ground raised by the appellant is dismissed.

5.5. Ground No. 4 relate to the addition made U/s. 40(a)(ia) and since it is not a case of assessee filing the ROI during the relevant previous year. Therefore for the detailed reasons brought out by the AO in para 7.3 of the Assessment Order, I am in conformity with the view that the appellant is not eligible for any deducation during this year. Accordingly, the sum of Rs. 20,76,000/- disallowed by the AO is upheld.

5.6. Ground No. 5 relates to the Treatment of income on interest from bank deposits and since the AO has detailed the same in para 8.1 of the Assessment order, I am in agreement with the AO on the taxability of the deposits parked with banks as ‘Income from other sources’. Accordingly, the ground of the assessee is dismissed.

5.7. Ground No. 7 relates to the citations made by the appellant which have no relevance to the facts of the case and the observations of the AO in Para 10.4 of the Assessment order on this count are accordingly upheld”.

6. Referring to the issues, it was the submission of the Ld. Counsel that there is no distinction between ordinary members and nominal members and all the members are having equal rights. He referred to the definition of ‘Membership’ to submit that the nominal members were admitted to the membership of the society. Therefore, the concept of Mutuality cannot be denied only, because some members are categorised as nominal members. It was further submitted that the nominal members also participated in general body meeting and got dividends from the society along with other members as per the objects of the society. Therefore, the distinction drawn by the AO on members and non-members is not maintainable.

6.1. Coming to the disallowance made U/s. 40(a)(ia) for non- deduction of tax, it was the submission that the provisions of Section 194J as contended by the AO does not apply as the honorarium is not on professional fee and further, they are not the directors of a company as defined in the Companies Act/Income Tax Act. They are termed as directors, to manage affairs of the society, which is not a company. Therefore, disallowance U/s. 40(a)(ia) per se does not arise. Without prejudice, it was submitted that all those members have filed their returns of income and as per the second proviso to Section 40(a)(ia), the amounts are allowable as under:

It was the submission that the entire disallowance does not warrant on the facts of the case.

7. Ld.DR, however, relied on the orders of AO and CIT(A) to submit that assessee has two different types of members and hence the transactions with non-members are to be brought to tax and principles of mutuality does not apply. Ld.DR, supported all other disallowances also.

8. We have considered the rival contentions and perused the order of the AO and CIT(A).

Principles of Mutuality

The AO and CIT(A) have considered the ordinary members and nominal members are different class of members. AO accepts that ordinary members are having mutuality but he denies the same with reference to nominal members. The principle of mutuality cannot be denied simply because there are two categories of members as per the bye-laws of the society. What is important to decide is the class of contributors and the class of participators, rather than classification of members. In this case, the class of contributors and class of participators are identical. Even though the bye-laws characterizes two types of members, the ‘original members’ being the founder members, others are called ‘nominal members’ but as seen from the order of the AO itself and the clause-9 extracted in the assessment order, it indicates that membership is given to any individual who is competent to contact and who expresses his willingness to practice the co-operative principles and function in accordance with by-laws. Both the ordinary members and nominal members do come under the definition as per the clase-4(iv) and the negative restrictions are not applicable either to the ordinary member or to the nominal member. Even under clause-4(iv), member means a person who has been a member of the society at the time of application for registration (or) person duly admitted to the membership of the society under the APMACS Act, 1995 after registration. The nominal members are also admitted under the by-laws. These are people admitted after the society was registered. Therefore, there may be a separate classification / nomenclature but they have all the rights and duties of any other member. It may be true that the by-laws restrict the voting rights and participation in the general body meetings, but in practice, there is no such difference being followed under the Co-operative Law. Unless a person become a member, he cannot transact with the society or its members. The society transactions are restricted to the Members and no general public is involved with it. Consequently, it cannot be stated that assessee is dealing with third parties, who are not members.

9. The principle of mutuality is ably defined by the jurisdictional High Court in the case of CIT Vs. Merchant Navy Club [96 ITR 261] wherein it was held as follows:

“The contributors to the common fund and the participators in the surplus must be an identical body. That does not mean that each member should contribute to the common fund or that each member should participate in the surplus or get back from the surplus precisely what he has paid. What is required is that the members as a class should contribute to the common fund and participators as a class must be able to participate in the surplus. It is immaterial whether the surplus is paid back to the members in cash or is put to reserve with the club for its development and for providing better amenities to its members”.

10. The same view was also reiterated in the later case of CIT Vs. Nataraj Finance Corporation [169 ITR 732]. The Hon’ble Supreme Court in the case of CIT Vs. Bankipur Club [226 ITR 97] held as under:

“13. There must be a complete identity between the contributors and the participators. If these requirements are fulfilled, it is immaterial what particular from the association takes. Trading between persons associated together in this way does not give rise to profits which are chargeable to tax. Where the trades 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”.

11. Since all the parameters with regard to principles of mutuality are complied, we are of the opinion that the AO’s distinction or findings that society is transacting with non-members is not correct. There is no distinction between ordinary members and nominal members and just because categorized as nominal members, they cannot be treated as ‘non-members’. If assessee’s transactions are with non-members, who are not members of the society, principles of mutuality do not apply. But in this case, even a nominal member is also admitted to the membership as per clause-9 and he has all the rights of any other member. The ordinary members are those members who are available at the time of registration and that cannot be considered as a restriction because at the time of formation of any society or an organization, only few members join at the time of incorporation whereas the by-laws permit admission of further members in the course of its activity, be it a business or not business. Thus, we are of the opinion that there is no definition between the transaction of members and nominal members and only when the transactions are with non-members, the principles of mutuality can be invoked or denied. A nominal member cannot be treated as a non-member and so the transactions of nominal members cannot be treated as transactions of non-members.

12. For the reasons stated above, we are of the opinion that the distinction sought to be made by the AO and CIT(A) is arbitrary and artificial. Therefore, we agree that assessee is covered by the principle of mutuality and its income will be exempt on that concept. Grounds are allowed accordingly.

Disallowance of honorarium:

13. Even though this ground and later grounds will become academic, consequent to granting of principle of mutuality in the above ground, however, we reiterate that the disallowance is not warranted. First of all, the honorarium paid is not a ‘professional fee’ to be covered under the provisions of Section 194J. Even if it is to be considered as a payment to director, the provisions of section 194J(1)(ba) specifies that any remuneration or fees or commission by whatever name called other than those on which tax is deductible U/s. 192 to a director of the ‘company’ are covered by the definition of fees for professional or technical services. The director referred to therein is not equivalent to the ‘director’ of the assessee-society. The director, manager or managing agent in relation to a company have the meaning respectively assigned to them in the Companies Act, 1956. A company is different from a co-operative society as they are defined U/s. 2(17) and 2(19) separately. Just because the person administering the society is also referred to as director, provisions of Section 194J cannot be attracted to the payment of honorarium made to the director of assessee-society. In view of that, we are of the opinion that there is no violation U/s. 194J so as to attract disallowance U/s. 40(a)(ia).

13.1. Be that as it may, since assessee has adduced the evidence to the respective person have paid/filing returns of income and AO has not initiated any proceedings U/s. 201 for violation of TDS provisions under any other provisions of the Act, the disallowance U/s. 40(a)(ia) cannot be sustained. Grounds are allowed.

Interest on bank deposits:

14. AO treated the interest earned on bank deposits amounting to Rs. 17,01,963/- as income from other sources. AO relied on the principles laid down by the Hon’ble Supreme Court in the case of M/s. Totgars Co-operative Sale Society Limited (supra) rendered U/s. 80P of the Act. Even though the Hon’ble Supreme Court has upheld the treatment given to the income from bank deposits as from other sources, there is no finding that these funds are ‘surplus funds’ not used in the business of assessee. It was the submission that assessee in the course of business activity itself maintain the deposits as per the principles governing by the co-operative society and the source of funds are the borrowals or deposits from the members and they are not ‘surplus funds’ as considered by the Hon’ble Supreme Court in the case of M/s. Totgars Co-operative Sale Society Limited (supra). There is no finding whether by the AO that these funds are surplus funds kept in deposits in a longer period and the funds are not being utilized in the course of business. Since these findings are not available, it is not possible to apply the principle of law unless the facts are identical or similar. The Hon’ble High Court of A.P. in the case of CIT Vs. Andhra Pradesh State Co-operative Bank Ltd., [336 ITR 516] held that interest on deposits out of non-SLR funds which are required to be maintained by a scheduled bank or the co-operative bank under the provisions of RBI Act or the BR Act are all the activities which are part of business of banking. The decision of the Hon’ble Supreme Court was also distinguished in the above said case. Therefore, the nature of interest is to be examined before coming to a conclusion. Only in the event of interest earned on deposits is from the ‘surplus funds’ not used regularly in the business, the amounts can be assessed under the head ‘other sources’. Just because assessee the earned interest on deposits, it cannot be straight away categorized as income from other sources. These aspects are not examined by the AO, however, since assessee itself is getting exemption on the principle of mutuality, this issue becomes academic. We are not giving any clear direction or finding on the issue. However, AO is advised to examine this aspect, if at all at any point of time, principle of mutuality is not allowed to assessee by any of the orders of the higher judicial forum.

15. Since the principles of mutuality are applicable to the society, we consider that income cannot be brought to tax on the activities of the Society. Grounds are considered allowed.

16. In the result, the appeal of assessee is allowed. Order pronounced in the open court on 18th May, 2018