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Principle of Mutuality and Incomes Exempt from Tax

The Point where Mutuality ends and Trading begins, determines non-exemption or taxability of income

The Point where Mutuality ends and Trading begins, determines non-exemption or taxability of income

Secundrabad Club Etc. v. CIT – V. Etc., [Civil Appeal Nos. 5195-5201 of 2012] decided on 17 August 2023

In a very recent judgement in Secundrabad Club Etc. v. CIT – V. Etc., [Civil Appeal Nos. 5195-5201 of 2012] decided on 17 August 2023, the Hon’ble Supreme Court [B. V. Nagarathna and Prashant Kumar Mishra, JJ] has dealt with at length on the Principle of Mutuality and Exempt Income under the Income Tax Act.

The question of law decided in these batch of appeals was – 

“whether the deposit of surplus funds by the appellant Clubs by way of bank deposits in various banks is liable to be taxed in the hands of the Clubs or, whether, the principle of mutuality would apply and the interest earned from the deposits would not be subject to tax under the provisions of the Income Tax Act, 1961”

[Para 2]

The controversy that gave rise to the question of law for determination was whether an earlier judgement of the Apex Court in Bangalore Club vs. Commissioner of Income Tax [(2013) 5 SCC 509] ignored an even earlier precedent laid down by the Apex Court in Commissioner of Income Tax v. M/s Cawnpore Club Ltd., Kanpur [(2004) 140 Taxman 378 (SC)] and whether for this, the judgement in Bangalore Club requires reconsideration.

While holding that the decision in Bangalore Club does not require reconsideration, the Supreme Court disposed of the Appeals in terms of the judgement in Bangalore Club.  The issues in Bangalore Club can be understood from para 32 of the judgement which is as follows:

“32. Applying the aforesaid principles to the facts of the case, it was observed in Bangalore Club, that in relation to transactions, namely, deposit of surplus funds earned by the clubs, in banks which are members of the club, the principle of mutuality applies till the stage of deposit of funds and would lose its application, once the funds are deposited as fixed deposit in the banks. This is because the funds would be exposed to commercial banking operations which means that the deposits could be used for lending to third parties and earning a higher interest thereon and by paying a lower rate of interest on the fixed deposits to the clubs. That the bank’s utilizing the funds of the clubs deposited in fixed deposit receipts, for their banking business would completely rupture the “privity of mutuality” and as a result, the element of complete identity between the contributors and participators would be lost. Consequently, the first condition for the claim of mutuality is not satisfied.”

[Emphasis supplied]

The Hon’ble Supreme Court, while referring to the judgement in Bangalore Club which observes that in order to understand the doctrine of mutuality, 

  • there should be a complete identity between the participators and contributors of the mutual association.  
  • the actions of the participators and contributors must be in furtherance of the mandate of the association; mandate is a question of fact and can be determined from the Memorandum or Articles of Association, rules of membership or the rules of the organisation.
  • there must be no scope of profiteering by the contributors; the fund to which contribution is made can only be expended on or returned to the contributors.

The judgement discusses the principle of mutuality in the context of income tax law in para 8.1 as follows:

“8.1 The principle of mutuality is rooted in common sense. A person cannot make a profit from herself. This implies that a person cannot earn profit from an association that he shares a common identity with. The essence of the principle lies in the commonality of the contributors and the participants who are also beneficiaries. There has to be a complete identity between the contributors and the participants. Therefore, it follows, that any surplus in the common fund shall not constitute income but will only be an increase in the common fund meant to meet sudden eventualities.”

The Hon’ble Supreme Court has observed that Indian jurisprudence has a rich engagement with the principle of mutuality, especially in the context of taxation.  It goes on to refer to a catena of decisions, of which a few decisions are culled out for the benefit of the reader: 

  • In CIT v. Royal Western India Turf Club Ltd. [AIR 1954 SC 85], needs mention.  The Supreme Court held that an exemption founded on the doctrine of mutuality cannot be granted when there is no mutual dealing between the members inter se and no putting of a common fund for discharging the common obligations to each other undertaken by the contributors for their mutual benefit.
  • In Yum! Restaurants (Marketing) Pvt. Ltd. Vs. Commissioner of Income Tax, Delhi [(2021) 7 SCC 678], the Supreme Court, while discussing the element which involves the test of commonality of identity between the members or participators in the mutual concern and the beneficiaries has observed that common identity signifies that the class of members should stay intact as the transaction progresses from the stage of contributions to the stage of returns / surplus.  A uniformity in the class of participants is necessary.

While holding that the judgement in Bangalore Club is not per incuriam and does not require reconsideration, the Supreme Court, in the Appeals before it has held in Para 43 that:

  • the interest income earned on fixed deposits made in the banks by the appellant Clubs has to be treated like any other income from other sources within the meaning of Section 2(24) of Income Tax Act, 1961.
  • Conversely, if any income is earned by the Clubs through its assets and resources, from persons who are not members of the Clubs, such income would also not be covered under the principle of mutuality and would be liable to be taxed under the provisions of the Income Tax Act.

Before concluding this article, it would be injustice if an important ratio is not presented to the reader. 

The important ratio that gets lost in the entire judgement was – 

that whether an earlier judgement, which would necessarily attract the doctrine of merger inasmuch as the decision of the Supreme Court gave its imprimatur to the judgement of the impugned judgement of a High Court, could be treated as a binding precedent under Article 141.  The Supreme Court held that when an order is brief and sans reasoning and dehors any ratio, it cannot be considered to be a binding precedent for subsequent cases.

The judgement also explains the importance of Article 141 in para 14 by laying out the well-settled theory of precedents and the three ingredients which a decision must fulfil to be of precedential value.  The three ingredients are extracted from the dissenting judgement of A. P. Sen, J., in Dalbir Singh vs. State of Punjab, (1979) 3 SCC 745 which are as follows:

(i) findings of material facts, direct and inferential. An inferential finding of fact is the inference which the Judge draws from the direct or perceptible facts;

(ii) statements of the principles of law applicable to the legal problems disclosed by the facts; and

(iii) judgment based on the combined effect of (i) and (ii) above.

On the issue of ratio decidendi and obiter dictum the Hon’ble Court’s observation in para 20 deserves reproduction:

“20. As against the ratio decidendi of a judgment, an obiter dictum is an observation by a court on a legal question which may not be necessary for the decision pronounced by the court. However, the obiter dictum of the Supreme Court is binding under Article 141 to the extent of the observations on points raised and decided by the Court in a case.  Although the obiter dictum of the Supreme Court is binding on all courts, it has only persuasive authority as far as the Supreme Court itself is concerned.”

[Emphasis supplied]

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