Introduction
No man can make a profit out of himself; this principle is named as the principle of mutuality, which is extended to a group of persons in respect of dealings among themselves. This principle basically offers a tax shelter to certain entities, as far as they form a mutual association with their income that is not tainted by commerciality.
Under the Income Tax Act, 1961 “income” or “profits” or “gains” are subject to be taxed when they accrue to a person while dealing with other party/ parties, not sharing the same identity with the assesse. When we discuss the topic ‘income tax’ then the most important concern that comes to our mind at first instance is income from house property that is the most important heads of income under the Income Tax Act. Another concern for tax payers is the exemptions and deductions that are available under the Act based on repayment of interest and principal of the loan obtained to purchase the house property, if that house property is let out or self-occupied.
Under Section 22 of the Income Tax Act, tax imposed on house property is based on Principle of Mutuality. We must understand that under this Section tax is imposed on the income from the house property and the tax is not imposed on the house owner based on house property. ‘Principle of mutuality’ is based on the concept that, no one can derive any income from themselves, as income comes from an outside source.
Principle of mutuality
The Halsbury Laws of England reads “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.”
This principle is based on the underlying concept i.e. ‘no one can make profit out of himself’. Principle of mutuality is applicable on income/ surplus etc. and hence they are not liable to be taxed under the Income Tax Act. We may also say that, any surplus based on mutual concerns is exempted from the ambit of Income Tax Act and the same is not considered to be a part of the gross total income. The aim and motive of contributing to a common fund is done for a common good with an objective for benefitting all the contributors.
It is applicable to all non-commercial activities. If we talk about the income from various commercial pursuits such as a club or society that is of a commercial nature then in such a case these entities would not be considered as a mutual association for non-profitable goals and hence it cannot lay any claim for exemption.
In the case of Commissioner of Income-tax v. Bankipur Club Ltd, [1997] 092 TAXMAN 278 (SC)- The Apex Court held that selling of the drinks is not done with a motive to earn profit. As the members of the society pay the monthly subscription and they also enjoy the benefit of this privilege of supply of drinks to them on additional payment hence there is no profit-earning motive of the society hence the principle of mutuality can be applied here.
Mutual organization and mutual concern
Another question that will come to our mind while discussing about ‘principle of mutuality’ is that what are mutual organizations and mutual concerns?
Thus the essential elements of a mutual organization are:
- ‘Mutual organization’ is an association of people who are called as members;
- These members have a common cause
- Each member forming mutual organization makes his contribution; and
- Most importantly, their aim is not to earn profits or gains out of those contributions that they make.
We may define a mutual concern as, “An association of persons who agree to contribute funds for some common purpose mutually beneficial and receive back the surplus left out in the same capacity in which they have made the contributions.”
An entity governed by the principle of mutuality is called a mutual concern. The capacity as contributors and participators remains the same. A mutual association is one where persons come together for a common good, with intent to contribute to making and running of the association without a profit motive.
Examples to mutual concerns are social clubs and co-operative societies. These entities have various sources of income, and some of these sources of mutual concerns are administered by the principle of mutuality. Those incomes are not liable to be taxed under the Income Tax Act, but the incomes that are not governed by principle of mutuality are liable to be taxed under the Act.
In the case of CIT v. Royal Western India Turf Club Ltd., 24 ITR p.551 (SC)– It was held that, “No one can enter into a trade or business with himself. The essence of mutuality is complete identity between contributors and participators.”
In another case of CIT v. West Godavari District Rice Millers Association, 150 ITR p.394 (AP)- The Court held that under mutual concerns investment or contributions by members are not done with an idea to start a trade or a business but it is done with a motive to render mutual help. The essence of mutuality lies in the return of what one has contributed to a common fund, and if profits are distributed as shareholders, the principle of mutuality is not satisfied.
There are mutual benefit funds or societies in respect of the income of which the principle of mutuality is normally claimed to be applicable. Members who associate together have a mutual concern i.e. to render help or have some motive that is not to gain profit or start a trade.
Principle of mutuality and co-operative societies/ housing societies
The principle on which this doctrine is based is, “One cannot earn profits from himself.” Hence based on this principle the income of a housing society is contested to be tax-free as a society.
ITO v. Venkatesh Premises Co-op Society Ltd, Civil Appeal No. 2706 of 2018
In this case, recently the Supreme Court of India, dealt with the issue, “Whether certain receipts by co-operative societies from its members (non-occupancy charges, transfer charges, common amenity fund charges) are exempt based on the doctrine of mutuality?”
The Supreme Court made observations related to ‘the doctrine of mutuality’ and stated that the income of a co-operative society from business is taxable under Section 2(24)(vii) and will stand excluded based on the principle of mutuality. While elaborating the essence of the principle of mutuality, the Apex Court further stated that this principle lies in the commonality of the contributors and the participants who are also the beneficiaries. The contributors to the common fund must be entitled to participate in the surplus and the participators in the surplus are contributors to the common fund. The Court further clarified that any surplus in the common fund would not constitute income but it shall only be taken into account as an increase in the common fund that shall be used to meet sudden eventualities.
Observations of the Supreme Court
- Taxation of Transfer charge
If the transferee pays the part of the transfer charges, they would not partake the nature of profit and in this case the amount paid by the transferee shall be appropriated only after the transferee was inducted as a member. If there is a situation that the transferee does not become a member then the amount would be returned. Here, we must note that the moment a transferee becomes a member the principles of mutuality applies.
- Non-occupancy charges
Such charges are payable by a member of a society who does not occupy the premises but he lets out the premises to a third party. The charges paid by the member to the society shall be utilized only for common benefit of facilities and amenities to the members.
- Contribution to the common amenity fund
When a member of a society pays some charge for disposal of property, the society shall utilize those funds for meeting heavy repairs and to ensure hazard-free maintenance of the properties that shall be done for the benefits of the members of society. Membership in a society automatically attracts the doctrine of mutuality.
Decision of the Court
The doctrine of mutuality is based on the common law principle that a person cannot make a profit from himself. The Court held that clubs are not entitled to charge, collect and pay service tax on any services made to members. Hence, we can say that receipts of non-occupancy charges, transfer charges, common amenity fund charges received by cooperative societies, from its members are exempted from being taxed.
Principle of mutuality and Clubs/ Associations
Supreme Court’s Recent Verdict on Calcutta Club Limited Case
Very recently a three-member Bench of the Apex Court has taking into account the concerns related to ‘mutuality in tax’. This decision has made a great impact on goods and services tax regime [GST]. In this case the primary issue before the Hon’ble Court was-
Whether the ratio of Young Men’s Indian Association would continue to operate even after the 46th Amendment of the Constitution of India?
While answering the above-mentioned issue, the Apex Court placed its reliance on the English judgments- Graff v Evans and Trebanog Working Men’s Club and Institute Limited v. Macdonald.
Under the 46th Amendment Act to the Constitution of India, a new definition was introduced to define the expression ‘tax on sale or purchase of goods’. Article 366(29-A) was inserted to the Constitution whereby certain acts which were not otherwise covered under ‘sale’ were included under the scope and ambit of sale. For example- Tax on supply of goods by unincorporated associations/ body of persons for money or for some valuable considerations.
The Court held that this doctrine shall be continued to be applicable on incorporated and unincorporated member’s club even after 46th Amendment Act. The member clubs act as an agent of their members and when we talk about supply of goods then one cannot supply goods to himself. If an incorporated members clubs supplies its property to its members at a fixed tariff, the transaction would be sale even though the transaction is on no-profit basis. Court took reference of Section 2(d) of the Indian Contract Act, where it stated that under Contract Act consideration flows from one person to another for entering into a valid contract.
While concluding the Court stated that the final test in each case would be, ‘whether or not the club is transferring its property for a price or the club is acting as an agent for making its available property belonging to its members’? In the present case the Association has not transferred its property to the members but acting merely as an agent for the members. Hence, they would not be taxed.
Important tests of existence of mutuality
In the case of Chelmsford Club v. Commissioner of Income-tax, [2000] 109 TAXMAN 215 (SC) – The Court mentioned three important tests to prove the existence of mutuality, which are discussed below-
- 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. In simple words, we may say that the contributors of the fund must be the beneficiaries of the surplus. If the transaction opens for a non-member, the said transaction assumes the flaw of a commercial transaction.
- Common benefit of the members
Contributors and participators are considered to be separate classes; however there is equality with regard to sharing of surplus and profits.
- Impossibility that contributors derive profit from the contributions made by them to a fund which could only be expended or returned to themselves
There shall be no derivation of profit from the contributions made by the contributors, it means that the excess fund shall be distributed amongst the members and hence the company shall be operating as a non-profit mechanism.
What is not included under the Principle?
Section 2(24) of the Income Tax Act defines taxable income, under this Section the income of a cooperative society from business is taxable in nature and hence it shall be excluded from the principle of mutuality. If the activities are carried out commercially by the housing society, then it shall not be covered under the scope of ‘principle of mutuality’.
Illustration
If a society lets out the community hall for marriage purposes of outsiders who are not the members of the society and earns huge profit out of it then in such a scenario the principle of mutuality won’t be applicable. As the contributors and the participants are the different set of people and hence such business activities of housing society shall be taxable.
Trade or Profession Associations
Section 28(iii) of the Income Tax Act, provides that the income that is derived from trade, professions or such similar association whereby a specific services are performed by the members of such entities then such activities shall not be included under the doctrine of mutuality.
Mutual Insurance Association
Section 44 of the Income Tax Act, deals with the profit of the insurance business, that is carried by a company or co-operative society, it cannot be considered as mutual associations and hence it is not covered under the shelter provided by the ‘principle of mutuality’.
Conclusion
The essence of the ‘principle of mutuality’ is that it acts as a tax shelter where the income of ‘mutual associations’ are not tainted by commerciality. The principle is applicable on non-commercial activities and if the income is earned from different commercial pursuits by a club, society or any other entity of an adventure that is commercial in nature then it shall not be considered as a mutual concern and hence shall be taxed.
When an activity is mutual then the fact that certain activities or certain members of the association take advantage of those offered facilities would not affect the mutuality of the enterprise. Supreme Court in a recent judgment, as discussed above stated that the doctrine of mutuality exempts- receipts of non-occupancy charges, transfer charges, common amenity fund charges received by cooperative societies (from its members) from being taxed.