Doctrine of mutuality was vitiated by absence of right to participate in surplus. Supreme Court explains three basic tests to be followed
ABCAUS Case Law Citation:
ABCAUS 3301 (2020) (04) SC
Important case law relied upon by the parties:
Commissioner of Income Tax, Bihar vs. Bankipur Club Ltd.
Bangalore Club v. Commissioner of Income Tax & Anr
The moot question involved in this appeal was the applicability of the doctrine of mutuality.
The appellant assessee company was a fully owned subsidiary of a Pvt. Ltd. Company. The assessee had assailed the judgment passed by the High Court wherein the question of taxability was settled in favour of the the Revenue by confirming the orders of the Income Tax Appellate Tribunal (“the Tribunal”), CIT(A) and the Assessing Officer (AO). The assessee was held to be a mutual concern and denied any exemption from taxability.
The assessee had obtained approval from the Secretariat for Industrial Assistance (“SIA”). The approval was granted subject to certain conditions as regards the functioning of assessee, whereby it was obligated to operate on a non-profit basis on the principles of mutuality.
In furtherance of the SIA approval, the assessee entered into a Tripartite Operating Agreement with its holding company and its franchisees wherein the assessee company had received fixed contributions to the extent of 5 per cent of gross sales for the proper conduct of the advertising, marketing and promotional activities for the mutual benefit of the parent company and the franchisees
For the relevant Assessment Year, the assessee filed its returns stating the income to be “Nil” under the pretext of the mutual character of the company. The same was not accepted by the AO, who observed.
CIT(A) upheld the liability and it was further confirmed by the Tribunal on the ground the essential ingredients of the doctrine of mutuality were found to be missing.
The Hon’ble High Court approved the findings of the lowe authorities.
As regards the doctrine of mutuality, before the Hon’ble Supreme Court it was urged by the assessee that the doctrine merely requires an identity between the contributors and beneficiaries and it does not contemplate that each member should contribute to the common fund or that the benefits must be derived by the beneficiaries in the same manner or to the same extent.
The Hon’ble Supreme Court stated that the doctrine of mutuality traces its origin from the basic principle that a man cannot engage into a business with himself. For that reason, it is deemed in law that if the identity of the seller and the buyer; or the vendor and the consumer; or the contributor and the participator is marked by oneness, then a profit motive cannot be attached to such a venture. Thus, for the lack of a profit motive, the excess of income over the expenditure or the “surplus” remaining in the hands of such a venture can not be regarded as “income” taxable under the Income Tax Act,1961 (the Act).
The Hon’ble Supreme Court observed that the law regarding the tenets of mutuality is no more res integra. It has been settled in a catena of judicial pronouncements and academic works across multiple jurisdictions which expound three conditions/tests to prove the existence of mutuality:
(i) Common Identity
Identity of the contributors to the fund and the recipients from the fund;
(ii) Completeness of Identity
Treatment of the company, though incorporated as a mere entity for the convenience of the members and policyholders, in other words, as an instrument obedient to their mandate, and;
(iii) Non profiteering and Obedience to Mandate
Impossibility that contributors should derive profits from contributions made by themselves to a fund which could only be expended or returned to themselves. Whereas the legal position on what amounts to a mutual concern stands fairly settled, the factual determination of the same on a case to case basis poses a complex issue that requires deeper examination. Such examination ought to be conducted in the light of the tests enunciated above.
In order to determine the breach in mutuality, the court is well within its powers to go beyond the periphery of the concern and undertake an examination akin to the lifting of the veil in order to discern the real nature thereof.
Doctrine of mutuality was vitiated by absence of right to participate in surplus
The Court observed that in the instant case, the company has received contribution from the holding company and one other company. However, they did not participate in the surplus as a beneficiary as they were not a member of the purported mutual concern as the Tripartite Agreement as well as the terms of SIA approval permitted only ‘franchisees’ to become members of the mutual concern. Since, the said other company did not enjoy any right of participation in the surplus or any right to receive back the surplus which are mandatory ingredients to sustain the principle of mutuality.
Thus, the assessee company was realising money both from the members as well as non members in the course of the same activity carried on by it.
The Hon’ble Supreme Court opined that the contributions made by other company tainted the operations of the assessee company with commerciality and concomitantly contravened the prerequisites of mutuality and non profiteering. The mutuality and non profiteering character of a concern are to be determined in light of its actual working structure and the factum of corporation or incorporation or the form in which it is clothed is immaterial.
Further, the Tripartite Agreement made it discretionary upon holding company to contribute to the common pool, thereby putting it at a higher pedestal than the franchisees.
Again, it was noticed that the franchisees did not enjoy any “entitlement” or “right” on the surplus remaining after the operations have been carried out for a given assessment year. The clause provided that the assessee company may refund the surplus subject to the approval of its Board of Directors. This implied that the franchisees/contributors could not claim a refund of their remaining amount as a matter of right.
The Hon’ble Supreme Court stated that once it is conclusively determined that the assessee company had not operated as a mutual concern, there would be no question of extending exemption from tax liability
The Hon’ble Supreme Court stated that the doctrine of mutuality bestows a special status to qualify for exemption from tax liability. It is a settled proposition of law that exemptions are to be put to strict interpretation. The appellant having failed to fulfil the stipulations and to prove the existence of mutuality, the question of extending exemption from tax liability to the appellant, that too at the cost of public exchequer, does not arise.
The Hon’ble Supreme Court answered the questions posed for the consideration against the appellant and in favour of the Revenue and the appeal was disposed of upholding the impugned judgment.
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