[Opinion] Supreme Court Sets at Rest Controversy Surrounding the Phrase “Mutuality”

S. Krishnan – [2023] 153 taxmann.com 518 (Article)

1. Introductory Remarks

The Supreme Court in the case of Secundrabad Club v. CIT [2023] 153 taxmann.com 441 through a detailed and illuminating judgment has ruled that the interest income earned on fixed deposits (FDs) made by Clubs in the banks which are members of those Clubs has to be treated like any other income from other sources within the meaning of Section 2(24) of the Income-tax Act,1961 (the Act). In other words, it was held that

“Mutuality does not exempt from tax, interest income earned by clubs from FDs in banks, irrespective of whether the banks are corporate members of the club or not.”

The Supreme Court also ruled that its earlier decision in the case of CIT v. Cawnpore Club Ltd. [2004] 140 Taxman 378 (SC)” cannot be treated as a precedent within the meaning of Article 141 of the Constitution of India as the said order does not declare any law and the appeals filed by the revenue as against Cawnpore Club were disposed of without going into the larger question as to whether Cawnpore Club could be taxed on the interest income earned on fixed deposits made by it in the banks, or whether the principle of mutuality would apply to the said income.

At this juncture it is to be noted that the issue before the Supreme Court in Secundrabad Club’s case (supra) was whether principles of mutuality would be applicable in case of income earned by the clubs through its assets and resources from persons who are not members of the club.

Let us understand the term “mutuality” before analysing few decisions rendered by the Supreme Court and High Courts.

2. Doctrine of Mutuality

Where a number of persons combine together and contribute to common fund for financing of some venture or subject and in this respect have no dealing or relation 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 participants. Trading between persons associating together in this way does not give rise to profits which are chargeable to tax. The trade or activity is mutual [CIT v. Bankipur Club Ltd. [1997] 92 Taxman 278 (SC)].

The concept of mutuality has been succinctly stated by the Judicial Committee of the privy council in Fletcher v. ITC [1971] 3 A11 ER 1185, thus:

“is the activity on the one hand, a trade, or an adventure in the nature of trade, producing a profit, or it is, on the other, a natural arrangement which, at most, gives rise to a surplus…”

The doctrine of mutuality postulates that all contributors to the common fund must be entitled to participate in the surplus and that all the participants in the surplus must be contributors to the common fund; in other words, there is complete identify between the contributors and the participators [CIT v. Indian Paper Mills Association [1994] 74 Taxman 188/209 ITR 28 (Cal.)]. In the case of English Scottish Joint Co-operative Wholesale Society Ltd. v. CAIT [1948] AC 405, three conditions have been stipulated the existence of which would establish the doctrine of mutuality.

These are:

1. The identity of the contributors to the fund and the recipient of the fund;
2. The treatment of the company, though incorporated as a mere entity for the convenience of member and policy holder: 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 be expended or returned to themselves.

The law recognises the principle of mutuality and has excluded all businesses involving such principle from the purview of the income tax Act, 1961, except those mentioned in clause (vii) of section 2(24) of the Act. [Chelmsford Club v. CIT [2000] 109 Taxman 215 (SC)]

The principle of mutuality is satisfied even when it is shown that the members had a right to contribute, and that the members had, as participators, the right to receive the benefit accruing to the common fund. [CIT v. Cement Allocation & Coordinating Organization [1999] 103 Taxman 403/236 ITR 553 (Bom.)]

The identity between the contributors and the participators need not necessarily be of individuals, because it is an identity of status or capacity that matters. The individual members of an association may be different at different times, but so long as the contributors and participators are both holding the membership status in the association, their identity would be clearly established and the principle of mutuality would be available to them. The contributors to the common fund and the participators in the surplus must be an identical body; but that does not mean that each member should participate in the surplus and get back the surplus over what he had paid [Indian paper Mills Association’s case (supra)]

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