* THE HON’BLE SRI JUSTICE V.V.S.RAO AND THE HON’BLE SRI JUSTICE RAMESH RANGANATHAN I.T.T.A.Nos.422, 443, 529, 530, 531, 532 and 533 of 2006, 78 and 81 of 2007 and 244 of 2010 % .08.2011 # Commissioner of Income Tax-V Hyderabad. ...Appellant VERSUS $ M/s.Secunderabad Club, Picket, Secunderabad. ...Respondent < GIST: > HEAD NOTE: ! Counsel for Appellant: Sri B.Narasimha Sarma ^Counsel for Respondent: Sri Y.Ratnakar ? Cases referred 1. (1997) 5 SCC 394 : (1997) 226 ITR 97 (SC) 2. (1988) 169 ITR 732 (AP) 3. (1974) 96 ITR 261 (AP) 4. (1995) 211 ITR 379 (Guj) 5. (1988) 171 ITR 504 (Guj) 6. (2010) 328 ITR 348 (Mad) 7. (2000) 3 SCC 214 : (2000) 243 ITR 89 (SC) 8. (2006) 287 ITR 263 (Kar) 9. (2004) 140 Taxman 378 (SC) 10. [2010] 328 ITR 362 (2010) (Bom) 11. (1984) 150 ITR 394 (AP) 12. (1985) 153 ITR 676 (Cal) 13. (1990) 184 CTR 274 (Del) 14. (2009) 308 ITR 202 (Kar) 15. (2009) 319 ITR 179 (Del) 16. (2011) 10 Taxmann 114 : (2011) 53 DTR 330 (Del) 17. (2010) 44 DTR 58 (Del) 18. (2002) 258 ITR 761 (SC) 19. (1973) 89 ITR 236 (SC) 20. (1973) 89 ITR 251 SC) 21. (1973) 88 ITR 192 (SC) 22. (1889) 2 TC 460 : (1889) 14 AC 381 23. 1948 AC 405 : (1948) 2 All ER 395 (PC) 24. (1885) 10 AC 438 25. (1932) 16 T.C. 430 26. (1972) AC 414 27. AIR 1954 SC 85 : (1953) 24 ITR 551 (SC) 28. AIR 1965 SC 96 29. AIR 1955 SC 74 30. AIR 1965 SC 40 THE HON’BLE SRI JUSTICE V.V.S.RAO AND THE HON’BLE SRI JUSTICE RAMESH RANGANATHAN I.T.T.A.Nos.422, 443, 529, 530, 531, 532 and 533 of 2006, 78 and 81 of 2007 and 244 of 2010 .08.2011 Between: Commissioner of Income Tax-V Hyderabad. …. Appellant AND M/s.Secunderabad Club, Picket, Secunderabad. … Respondent THE HON'BLE SRI JUSTICE V.V.S.RAO AND THE HON'BLE SRI JUSTICE RAMESH RANGANATHAN I.T.T.A.Nos.422, 443, 529, 530, 531, 532 and 533 of 2006, 78 and 81 of 2007, and 244 of 2010 COMMON JUDGMENT: (Per Hon’ble Sri Justice V.V.S.Rao) These appeals by the revenue are against the orders of the Income Tax Appellate Tribunal (ITAT), Hyderabad Bench, holding that the interest accrued to the assessee club from its deposits with banks and financial institutions, which are its corporate members, are not tainted with commerciality; and that such interest income is not taxable on the principle of mutuality. The question of law raised in these appeals by the revenue is whether interest accrued on the fixed deposits, parked with commercial banks, is liable to tax. I.T.T.A.Nos.422, 529, 530, 531, 532 and 533 of 2006 are filed against the Secunderabad Club, and the other three appeals, being I.T.T.A.Nos.443 of 2006, 78 and 81 of 2007, are filed against the Armed Forces Officers Cooperative Housing Society. The following factual matrix is with reference to I.T.T.A.No.422 of 2006. The respondent – Secunderabad Club (hereafter, the assessee) is a social and recreational club. It is not registered either as an association or a society. It is a mutual association, statedly, not a profit making concern. All their activities are allegedly not tainted with commerciality or business modalities. The assessee receives monthly subscriptions, admission/entrance fee and payments made by its members for use of club facilities. During the assessment year 1996-97, the assessee earned interest on the fixed deposits kept by it with Andhra Bank, Lloyds Finance Limited, ITC Agrotech Limited, VST Industries Limited, Nagarjuna Finance Limited and Apple Credit Corporation Limited. In their return for 1996-97, the assessee sought exemption, of the interest received, from tax citing the principle of mutuality. The banks/financial institutions, with whom the fixed deposits were made, are corporate members of the club. The return for the year 1996-97, admitting Rs.1,22,700/-, was accepted under Section 143(1) of the Income Tax Act, 1961 (the Act, for brevity). However, the assessing officer issued notice under Section 148 of the Act on the ground that the exemption claimed with regard to the interest on fixed deposits from banks/companies is not a valid claim. During the enquiry, the assessee furnished information. They stated that the assessee started admitting corporate bodies/banks as members about twenty years ago, the members of all categories are governed by the rules/bye-laws of the club, the entrance fee payable by corporate members is Rs.3.5 lakhs for the first two nominees, and Rs.1 lakh for each subsequent nominee, who are whole time directors or senior executives, resident in Hyderabad. There could be upto 5 nominees if the paid up capital of the corporate member is Rs.5 crores, and upto 10 nominees if the paid up capital exceeds Rs.5 crores. Any company incorporated under the Companies Act or a statute of the State or Central Government or International Renowned Association including a cooperative society having its office or place of business in Hyderabad and Secunderabad and its suburbs is eligible for membership as a corporate member. The club also benefits by the accrual of additional income by way of entrance fee; and nominees of the corporate members of the club enjoy the same facilities and privileges as other members. There were as many as 31 corporate members, but the assessee deposited their funds with the above named six banks/financial institutions. The contention was that the interest earned by the assessee from these corporate members is interest earned from its members and, consequently, the principle of mutuality applies. The assessee relied on the decision of the Supreme Court in Civil Appeal Nos.4777-4778 of 1998 dated 05.02.1998 (unreported Judgment in CIT, Cawnpore v M/s.Cawnpore Club Limited) and CIT v Bankipur Club Limited[1]. The assessing officer came to the conclusion that the assessee did not deposit the amounts with the Banks treating them as corporate members; and the banks had not accepted the deposits from the assessee in their capacity as a member of the club. They accepted the deposits from the assessee as any other depositor, and paid the same rate of interest as is payable to general public and, therefore, corporate membership in the club had no nexus whatever with their capacity of accepting deposits from the assessee. The assessing officer relied on the order of the Tribunal in I.T.A.No.819 and 820/Hyderabad/1994, dated 05.02.2002 wherein it was held that advancing loans or making fixed deposits is not one of the objects of the assessee club; the members of the assessee had a double role one as a member and the other as a member of the general public; the banks, while accepting deposits from the assessee, did not act in their capacity as members of the club but as members of the general public; and therefore, the principle of mutuality cannot be applied. The assessing officer also came to the conclusion that the unreported Judgment of the Supreme Court in Cawnpore Club did not lay down or enunciate a general proposition or applicability of the principle of mutuality to the interest income earned by a club on the deposits made. Further, after analyzing the decision of the Supreme Court, the assessing officer came to the conclusion that Bankipur Club nowhere dealt with the question of taxability of interest income on fixed deposits etc. The assessee also relied on CIT v Natraj Finance Corporation[2]. The assessing officer opined that the said decision is of no avail to him as the High Court did not discuss whether the principle of mutuality applied to any interest income derived from money lying in deposit with any bank. Accordingly, the assessing officer added interest on deposits, and assessed them to tax. Being aggrieved by the assessment order dated 26.03.2004, the assessee went in appeal. This was heard along with four other appeals pertaining to the assessment years 1998-99, 1999-00, 2000-01 and 2001-02. The main ground for appeal was non-taxability of interest income derived from corporate deposits. Reliance was placed on the order of the Tribunal dated 13.08.2003 in the case of Fateh Maidan Club v Additional Commissioner of Income Tax (ITA Nos.937 to 939 and 947 to 952/Hyd/1995 and 716 to 720/Hyd/2000) and Natraj Finance Corporation. The Appellate Commissioner relied on the decision of the Tribunal dated 05.03.2002 for the assessment year 1990-91 and 1991-92, and held that the principle of mutuality cannot be applied to the interest income derived from investments. He came to the conclusion that the decision of the jurisdictional Tribunal on the specific issue in the appellant’s own case for earlier years is binding. He also discussed Natraj Corporation, Cawnpore Club and came to the conclusion that they do not lay down any ratio applicable to the case, and followed the decision of the Tribunal dated 13.08.2003 in the case of assessee itself. The appeal was, therefore, dismissed. The learned Tribunal, Hyderabad Bench, reversed the orders of the Commissioner of IT. Having come to the conclusion that the interest income earned by the assessee on the deposits made by its corporate members is not liable to be taxed, the learned Tribunal deleted the additions made by the assessing officer as confirmed by the CIT (A). The Tribunal referred to various precedents and held that the assessee did not engage in any business by parking their surplus money in the banks and that, ‘even if it is held as a trade with members as no outsiders are involved, the income is not exigible to tax’. The Senior Standing Counsel for revenue raised the following contentions. The income derived by providing facilities, services and amenities to the members is alone non-exigible on the principle of mutuality, but the income derived from third parties is taxable under the Act; for invoking the principle of mutuality the purpose should be referable to the object of the society; and parking of the funds for earning interest is not one of the objects of the assessee and, therefore, the income is exigible to tax. He relied on CIT v Merchant Navy Club[3], Rajpath Club Limited v CIT[4], Sports Club of Gujarat v CIT[5], M/s.Madras Gymkhana Club v the Deputy Commissioner of Income Tax[6], Chelmsford Club v CIT[7], CIT v Bangalore Club[8], Bankipur Club, CIT v Cawnpore Club[9] and CIT v Common Effluent Treatment Plant[10] (Common ETP). A corporate member, being a juridical person, does not satisfy the criteria of being a contributor to the funds as well as the recipient to the funds. In the case of a corporate member, the contributory is a juridical person, and the recipient of the services is a natural person/persons nominated by the corporate member. In view of this, when the assessee deposited their surplus finds with the banks, who incidentally happened to be corporate members, such income is not immune from taxability. Learned Counsel for the Secunderabad Club would submit that when his client deposited the surplus funds with banks, who are corporate members of the assessee club, the interest income cannot be treated as income. According to him, even if the surplus amount is deposited with the third parties, the interest thereon is not exigible to tax. According to him, the principle of mutuality applies to interest on deposits with third parties or corporate members. The corporate members also contribute and, at the time of winding up, they also get a share of the surplus from the liquidation funds. There is nexus between the contributions made and the benefits derived by corporate members as in the case of ordinary members. The assessee club can never be said to have derived profits from contributions made by the members to the fund which could only be spent for the benefit or returned to the members. Learned counsel referred to Merchant Navy Club, CIT v West Godavari Rice Millers Association[11], CIT v Darjeeling Club Limited[12], Natraj Finance Corporation, Director of IT (Exemption) v All India Oriental Bank of Commerce Welfare Society[13], Canara Bank Golden Jubilee Staff Welfare Fund v Deputy CIT[14], CIT v Standing Committee of Public Enterprises[15], CIT v Delhi Gymkhana Club Limited[16], CIT v Talangang Cooperative Group Housing Society Limited[17], Cawnpore Club Limited, Bankipur Club Limited, Chelmsford Club, Union of India v Onkar S.Kanwar[18], CIT v Naga Hills Tea & Company Limited[19], Controller of Estate Duty v R.Kanakasa Bai[20] and CIT v Vegetable Products Limited[21]. Point for consideration The point that arises for consideration in these appeals is whether the principle of mutuality pleaded by the assessee is attracted, and whether interest income earned from various deposits kept with the banks/financial institutions is a non-taxable receipt? Principles and Precedents The business law maxim that no one can make profit out of himself over a period of time, has evolved into the principle of mutuality in income tax law. In plain terms, the principle postulates that, “when persons contribute to a common fund in pursuance of a scheme for their mutual benefit, having no dealings or relations with any outside body, they cannot be said to have made a profit when they find they have overcharged themselves and that some portion of their contributions may be safely refunded”. If complete identity, between the contributors and the participants or recipients, is established, the surplus generated and returned to the contributors is not regarded as profit for the purpose of charging income tax. If the persons carry on an activity, which is also trade, in such a way that they and the customers are the same persons, no profits are yielded by such trade for tax purposes and, therefore, no assessment in respect of the trade can be made. The surplus, resulting from trading, represents such contributions of the participants which is in excess of the requirements. Access to profits or services is a condition precedent to satisfy the element of mutuality. Even when the aggregate of the members are incorporated, the effect of principle is not lost (British Tax Encyclopaedia, Simon’s Taxes and Halsbury’s Laws of England as quoted in Bankipur Club). In New York Life Insurance Company v Styles[22], life insurance policies were issued to participating and non-participating members of the company. The holder of a participating policy became a member of the company, and was entitled to a share in the assets and liabilities and share in the losses. After working out annuities, the premium to be paid by each member was determined which was paid. Every year, the surplus of premia over the expenditure referable to policies was returned to the holders of the participating policies, and the balance was carried forward as a fund in hand to the credit of the general body members. The Surveyor of Tax treated the surplus as taxable profit. Ultimately the Privy Council negatived the contention. It was held that, when the members had associated themselves together for the purpose of insuring each other’s life on the principle of mutuality assurance and had contributed to a common fund from out of which payments were made in the event of death, they were alone the owners of the common fund, and they were entitled to participate in the surplus. The incorporation of the company did not alter the identity of the contributors and those who received the surplus; and, accordingly, the company did not carry on any business at all. Thus Styles case established the principle of mutuality and was followed not only in England but in many other common law jurisdictions. English & Scottish Joint Co-operative Wholesale Society Limited v Commissioner of Agricultural Income Tax[23] (hereafter, Scottish Joint Society) dealt with the question whether the profit distributed to two member cooperative wholesale societies, from out of the surplus earned by the joint wholesale society, was exempt from Assam Agricultural Income Tax Act, 1939. The member societies advanced monies to the Joint Society. As and when tea was supplied to them, the price was debited against the advances; and the surplus over the costs was dealt with as payment of interest on the share capital. The surplus was distributed to two members proportionate to their purchase of tea. The surplus distributed to the societies was held as profit, and as taxable under the relevant Act. The unanimous judicial committee, quoting with approval from Last v London Assurance Corporation[24], opined that, “when a number of individuals agree to contribute funds for a common purpose, … stipulate that their contributions, so far as not required for that purpose, shall be repaid to them, I cannot conceive why they should be regarded as traders, or why contributions returned to them should be regarded as profits”. It was further held that, “the members contribute for a common object to a fund which is their common property; it turns out that they have contributed more than is needed, and therefore more than ought to have been contributed by them, for this object, and accordingly their next contribution is reduced by an amount equal to their proportion of this excess. I am at a loss to see how this can be considered as a ‘profit’ arising or accruing to them from a trade or vocation which they carry on. From these quotations it appears that the exemption was based on (1) the identity of the contributors to the fund and the recipients from the fund, (2) the treatment of the company, though incorporated, as a mere entity for the convenience of the members and policy holders, 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 only be expended or returned to themselves”. Further, the statement of law in Municipal Mutual Insurance Limited v Hills (Inspector of Taxes)[25] by Lord McMillan to the effect that, “the cardinal requirement is that all the contributors to the common fund must be entitled to participate in the surplus and that all the participators in the surplus must be contributors to the common fund; in other words there must be complete identity between the contributors and the participators” was quoted and relied on. In Walter Fletcher v Income Tax Commissioner[26], Doctor’s Cave Bathing Club which owned bathing beach provided various amenities. Ordinary members of the club paid subscription, and they enjoyed the right to a bath. In addition, they also allowed others who were, however, required to buy a ticket for bathing. This facility was extended to the hotel guests. The hotels purchased a block of tickets, and re-sold it to the hotel guests. In 1963, a question arose as to the club’s liability for income tax in respect of receipts from the hotels. The Income Tax Appeal Board affirmed the liability rejecting the mutuality principle. The fact that the hotels had no right to vote weighed with the Appeal Board. Therefore, the rules were amended giving one vote to each hotel member who were required to pay annual subscription as in the case of ordinary members. Nonetheless, the Commissioner proposed to tax the profit element in the proportion of the hotel membership subscription. The Court of Appeal of Jamaica held against the club, but allowed an appeal to the Privy Council. The judicial committee considered the question whether the club was assessable to income on the profit element contained in the receipts from hotels whose guests had the right to use the club. Lord Wilberforce noticed three main fields in which mutuality principles had been applied, namely, insurance companies, rating groups and clubs. In so far as the applicability of mutuality principle to clubs was concerned, it was observed that, “even in a club governed by the relationship of mutuality, the surplus income is not exempt from the charge if the relationship of mutuality ends and trading begin”. While discussing the difference between insurance associations, rating groups and clubs, it was held that when a trading company is a member, “the inquiry is open whether the relationship of the aggregate of the ordinary bathing members with the hotels is truly one of mutuality or is rather of a trading character”. It was further observed that the nature of the transaction is significant than the fact of membership or non-membership and, if there were trading transactions, the addition of membership made no difference. The relevant observations are as follows. “ ... ... mutuality is not necessarily excluded by the fact that some “members” are corporate bodies, or even corporate bodies engaged in trade. But the relevance of facts such as these must vary with the nature of the activity. In the case of insurance, they are of little or no weight, since companies, and trading companies, can just as naturally and appropriately engage in a mutual insurance scheme as individuals. And in the field of rating the same is true; a rate payer can just as well be a trading corporation as an individual. In social relationships or where recreation is involved the position may be different; the presence among “members” of trading companies at least suggests the necessity of inquiry as to the reason for and nature of their participation. In the present case, it may be agreed that the fact that hotels are not themselves potential bathers may be immaterial; but yet the inquiry is open whether the relationship of the aggregate of the ordinary bathing members with the hotels is truly one of mutuality, or is rather of a trading character. It is necessary therefore to seek other indications pointing in one direction or the other.” (emphasis supplied) In CIT v Royal Western India Turf Club Limited[27], after a review of Styles, Hills, Scottish Joint Society and other cases, the Supreme Court observed that, “the principle that no one can make a profit out of himself is true enough but may in its application easily lead to confusion. There is nothing per se to prevent a company from making a profit out of its own members. Thus a railway company which earns profits by carrying passengers may also make a profit by carrying its shareholders or a trading company may make a profit out of its trading with its members besides the profit it makes from the general public which deals with it but that profit belongs to the members as shareholders and does not come back to them as persons who had contributed them. Where a company collects from its members and applies it for their benefit not as shareholders but as persons who put up the fund the company makes no profit. In such cases, where there is identity in the character all those who contribute and of those who participate in the surplus, the fact of incorporation may be immaterial and the incorporated company may well be regarded as a mere instrument, a convenient agent for carrying out what the members might more laboriously do for themselves. But it cannot be said that incorporation which brings into being a legal entity separate from its constituent members is to be disregarded always and that the legal entity can never make a profit out of its own members”. In CIT v Kumbakonam Mutual Benefit Fund Limited[28], the respondent which was carrying on banking business and extending loan facilities only to shareholders, claimed exemption from tax on the interest income realized from members. The assessing officer, the appellate Commissioner and the Income Tax Appellate Tribunal came to the conclusion that the respondent was a banking concern; whether or not a member/shareholder availed loan facility he was entitled for distribution of profits; and, therefore, the principle of mutuality as evolved in Styles did not apply. The High Court of Madras held in favour of the assessee. The Supreme Court reversed the High Court and observed that, “the essence of mutuality lies in the return of what one has contributed to the common fund, and that in the case of Kumbakonam Mutual Benefit Fund, the interest from the loans was divided among the members pro rata according to their shareholding after making provision for reserves and deducting expenditure, and therefore, the essence of mutuality is not satisfied. The income distributed was the income from business and therefore, not exempt from taxation”.