YUM! RESTAURANTS (MARKETING) PRIVATE LIMITED versus COMMISSIONER OF INCOME TAX, DELHI
[2020] 11 S.C.R. 136, Supreme Court of India, 2020
Outcome: Disposed off
Segment: Ratio
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YUM! RESTAURANTS (MARKETING) PRIVATE LIMITED
v.
COMMISSIONER OF INCOME TAX, DELHI
(Civil Appeal No. 2847 of 2010)
APRIL 24, 2020
[A. M. KHANWILKAR AND DINESH MAHESHWARI, JJ.]
Doctrines / Principles – Doctrine of mutuality – Applicability
of, qua assessee-appellant company (YRMPL), a fully owned
subsidiary of YRIPL, incorporated for undertaking activities relating
to Advertising, Marketing and Promotion (AMP activities) for and
on behalf of YRIPL and its franchisees – Assessee was incorporated
by YRIPL as its fully owned subsidiary after approval from the
Secretariat for Industrial Assistance (SIA) – Such approval was
granted subject to conditions, inter alia, to operate on non-profit
basis on principles of mutuality – After SIA approval, assessee
entered into a Tripartite Operating Agreement with YRIPL and its
franchisees, wherein assessee received fixed contributions to the
extent of 5% of gross sales for proper conduct of advertising,
marketing and promotional activities for mutual benefit of the parent
company and the franchisees – For the Assessment Year under
consideration, assessee filed its returns stating the income to be
“Nil” on ground of mutual character of the company – Whether
assessee-company qualified as a mutual concern in the eyes of law,
thereby exempting subject transactions from tax liability – Held:
There are three conditions/tests to prove the existence of mutuality
– First test involves the
test of common entity, and coterminous with
it, the requirement of commonality of identity – The moment a
transaction opens itself to non-members, either in the contribution
or the surplus, the uniformity of identity is impaired and the
transaction assumes the taint of a commercial transaction – On facts,
the purported mutual concern undertook a commercial venture
wherein contributions were accepted both from the members as well
as non-members – With the interference of an alien entity, the idea
of conducting business with oneself was defeated and any profits
or gains accruing therefrom became subject to tax liability – Thus,
doctrine of mutuality stood debunked with the failure of the first
test – Nonetheless, the second test of obedience to mandate and the
[2020] 11 S.C.R. 136
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third test of impossibility of profits were also contravened in the
factual scenario – The mandate of the assessee company was laid
down in the SIA approval wherein the twin conditions of mutuality
and non-profiteering were envisioned as the sine qua non for
functioning of assessee company – Contributions made by Pepsi
Foods Ltd. tainted the operations of assessee company with
commerciality and concomitantly contravened pre-requisites of
mutuality and non-profiteering – Third test of mutuality, which
requires the purported mutual operations to be marked by
impossibility of profits, also not fulfilled in the present case – One
member was vested with a myriad set of powers to control the
functioning and interests of other members (franchisees), even to
their detriment – The only entity that could derive any benefit from
the surplus funds was YRIPL, i.e. the parent company – This is
antithetical to the third test of mutuality – Appellant accordingly
failed to fulfil the stipulations and to prove the existence of mutuality
– It did not operate as a mutual concern – Taxation – Exemption.
Doctrines – Doctrine of mutuality – Doctrine of mutuality
traces its origin from the basic principle that a man cannot engage
into a business with himself.
Words and Phrases – Word “mutual” – Meaning of – Held:
The word “mutual” points towards reciprocity.
Taxation – “Mutual concern” – Quintessence for the existence
of a mutual concern – Discussed – Words and Phrases.
Interpretation of Statutes – Exemptions – Strict construction
– Exemptions are to be put to strict interpretation.
Disposing the appeal, the Court
HELD: 1.1. 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 cannot
be regarded as “income” taxable under the Income Tax Act, 1961.
[Para 14][154-G-H; 155-A]
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1.2. The stream of judicial pronouncements expound three
conditions/tests to prove the existence of mutuality: (i) Identity
of the contributors to the fund and the recipients from the fund;
(ii) 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;
(iii) Impossibility that contributors should derive profits from
contributions made by themselves to a fund which could only be
expended or returned to themselves. [Para 16][156-C-E]
Common Identity
2. The first element involves the test of commonality of
identity between the members or participators in the mutual
concern and the beneficiaries thereof. Succinctly put, this limb of
the three-pronged test requires that no person ought to
contribute to the common fund without having the entitlement to
participate as a beneficiary in the surplus thereof. Conversely,
no person ought to participate as a beneficiary without first having
been a contributor or a member of the class of contributors to
the common fund. Common identity, as it occurs in the present
context, signifies that the class of members should stay intact as
the transaction progresses from the stage of contributions to that
of returns/surplus. It must manifest uniformity in the class of
participants in the transaction. The moment such a transaction
opens itself to non-members, either in
the contribution or the
surplus, the uniformity of identity is impaired and the transaction
assumes the taint of a commercial transaction. The emphasis on
the words member and non-member is of import because the
doctrine of mutuality does not prohibit the inclusion or exclusion
of new members. What is prohibited is the infusion of a participant
in the transaction who does not become a ‘member’ of the
common fund, at par with other members, and yet participates
either in the contribution or surplus without subjecting itself to
mutual rights and obligations. The principle of common identity
prohibits any one-dimensional alteration in the nature of
participation in the mutual fund as the transaction fructifies. Any
such alteration would lead to the non-uniform participation of an
external element or entity in the transaction, thereby opening
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the scope for a manifest or latent profit-based dealing in the
transaction with parties outside the closed circuit of members. It
would be amenable to income tax as per Section 2(24) of the
Income Tax Act, 1961. [Para 17][156-G; 157-A-E]
Completeness of Identity
3.1. Coterminous with the requirement of common identity,
the law also contemplates a completeness of identity between
the contributors and participators. The theory of completeness
of identity presupposes the contributors and participators to be
two separate classes, but there is oneness or equality in the
matter of sharing of surplus/profits. This is to ensure that there
is no interference of any alien commercial entity in the transaction.
With the interference of any alien entity, the idea of conducting
business with oneself is defeated and any profits or gains accruing
therefrom become subject to tax liability. [Para 18][157-F-G]
3.2. 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. [Para 18][158-C]
3.3. In the present case, it is indisputable that Pepsi Foods
Ltd. is a contributor to the common pool of funds. However, it
does not participate in the surplus as a beneficiary for at least
two reasons- first, Pepsi is not a member of the purported mutual
concern as the Tripartite Agreement as well as the terms of SIA
approval permit only ‘franchisees’ to become members of the
mutual concern. Notably, Pepsi Foods Ltd. is not a franchisee
and thus, it cannot participate in the surplus. Second, Pepsi does
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. [Para 19][158-D-E]
3.4. Further, the Tripartite Agreement requires the
assessee company to constitute a separate Brand Fund for each
franchisee as stated in clause 2.2 of the said agreement.  Since
no Brand Fund, as contemplated, has been constituted for Pepsi
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Foods Ltd., it does not become a part of the purported Tripartite
mutual arrangement so as to qualify as a beneficiary of the mutual
operations. The definition clause of the Tripartite Agreement adds
weight to this finding. From the definition of “Advertising
Contribution”, and “Franchise Agreements”, in the definition
clause, what follows is that for any amount received by the
assessee company to be treated as an advertising contribution,
it must be paid by a franchisee, that too in the aftermath of a prior
franchisee agreement to that effect. In the light of the prevailing
relationship, there is no such franchisee agreement between
Tricon or TRIM and Pepsi Foods Ltd. and therefore, the amounts
received from Pepsi Foods Ltd. cannot be viewed as advertising
contributions “from a member of the mutual undertaking” as such.
[Para 20][158-F; 159-A, C-D]
3.5. In the present case, therefore, the assessee company
is realising money both from the members as well as non-members
in the course of the same activity carried on by it. Such operations
are antithetical to mutuality. [Para 21][159-E]
3.6. The contention of the assessee company that Pepsi
Foods Ltd., in fact, does benefit from the mutual operations by
virtue of its exclusive contracts with the franchisees is tenuous,
as the very basis of mutuality is missing as far as Pepsi Foods
Ltd. is concerned. Even if any remote or indirect benefit is being
reaped by Pepsi Foods
Ltd., the same cannot be said to be in lieu
of it being a member of the purported mutual concern and
therefore, cannot be used to fill the missing links in the chain of
mutuality. Concededly, the surplus of a mutual operation is meant
to be utilised by the members of the mutual concern as members
enjoy a proximate connection with the mutual operation. Non-
members, including Pepsi Foods Ltd., stand on a different footing
and have no proximate connection with the affairs of the mutual
concern. The exclusive contract between the franchisees and
Pepsi Foods Ltd. stands on an independent footing and YRIPL
as well as the assessee company are not responsible for
implementation of this contract. Resultantly, the first limb of the
three-pronged test stands severed. [Para 22][159-G-H;
160-A-C]
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Test of Non-profiteering and Obedience to Mandate
4. The receipt of money from an outside entity without
affording it the right to have a share in the surplus does not only
subjugate the first test of common identity, but also contravenes
the other two conditions for the existence of mutuality i.e.
impossibility of profits and obedience to the mandate. The mandate
of the assessee company was laid down in the SIA approval
wherein the twin conditions of mutuality and non-profiteering
were envisioned as the sine qua non for the functioning of the
assessee company. The contributions made by Pepsi Foods Ltd.
tainted the operations of the assessee company with
commerciality and concomitantly contravened the pre-requisites
of mutuality and non-profiteering. [Para 23][160-D-E]
5. 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. It is, therefore,
imperative to examine the actual functional framework of the
assessee company in light of the status of YRIPL (parent company)
vis-a-vis other members/franchisees. As per the terms of the SIA
approval, YRIPL and franchisees were equally obligated to make
contribution of a fixed percentage to the assessee company. This
requirement was incorporated as a pre-condition for the grant of
permission to operate as a mutual concern. However, drifting
from this
mandate, the Tripartite Agreement made it discretionary
upon YRIPL to contribute to the common pool, thereby putting it
at a higher pedestal than the franchisees. Furthermore, the
management of the assessee company was under full and absolute
control of its parent company YRIPL. Also, the participation of
the franchisees in the management of the assessee company was
again subject to approval by YRIPL, which falls within its sole
discretion. [Para 24][160-F-G; 161-B, D-E]
6. The net effect of the clauses 4.1 and 7.1 of the Tripartite
Agreement is to render the pre-conditions for the grant of
approval, as otiose. It also becomes amply clear that YRIPL and
the franchisees stand on two substantially different footings. For,
the franchisees are obligated to contribute a fixed percentage
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for the conduct of AMP activities whereas YRIPL is under no
such obligation in utter violation of the terms of SIA approval.
Moreover, even upon request for the grant of funds by the
assessee company, YRIPL is not bound to accede to the request
and enjoys a “sole and absolute” discretion to decide against
such request. That members of a financial concern exercise mutual
control over its management without the scope of prejudicial
exercise of power by one class of members over the others is
the quintessence for the existence of a mutual concern. The word
“mutual” offers guidance to this effect. Literally understood, the
word “mutual” points towards reciprocity and a mutual
arrangement is one in which the members/parties have reciprocal
rights or understanding or arrangement. An arrangement wherein
one member is subjected to the absolute discretion of another,
in such a manner that the entire liability may fall upon one whereas
benefits are reaped by all, is antithesis to the mutual character in
the eyes of law. [Para 25][162-B-E]
7. The contention advanced by the appellant that it is not
mandatory for every member of the mutual concern to contribute
to the common pool fails to advance the case of the appellant. It
is no doubt true that every member of the mutual concern might
not be required to contribute to the common pool at all times.
However, it does not mean that one member cannot be made to
contribute under any
pretext whatsoever. For, that would amount
to the grant of an overriding position to a member in the mutual
agreement, extending upto even overruling the requests for
contribution from other members for mutual necessity. It is this
all-pervasive overriding position of one member over the others
that negates the effect of mutuality. There is a fine line of distinction
between absence of obligation and presence of overriding
discretion. In the present case, YRIPL enjoys the latter at the
detriment of the franchisees of the purported undertaking, both
in matters of contribution and management. In a mutual concern,
it is no doubt true that an obligation to pay may or may not be
there, but in the same breath, it is equally true that an overriding
discretion of one member over others cannot be sustained, in
order to preserve the real essence of mutuality wherein members
contribute for the mutual benefit of all and not of one at the cost
of others. [Para 26][162-F-H; 163-A]
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8. More importantly, in order to qualify as a mutual concern,
the contributors to the common fund either acquire a right to
participate in the surplus or an entitlement to get back the
remaining proportion of their respective contributions. Contrary
to the abovestated legal position, clause 8.4 of the Tripartite
Agreement makes it clear that the franchisees do not enjoy any
“entitlement” or “right” on the surplus remaining after the
operations have been carried out for a given assessment year.
The clause provides that the assessee company may refund the
surplus subject to the approval of its Board of Directors. It implies
that the franchisees/contributors cannot claim a refund of their
remaining amount as a matter of right. The raison d’etre behind
the refund of surplus to the contributors or mandatory utilisation
of the same in the subsequent assessment year is to reduce their
burden of contribution in the next year proportionate to the
surplus remaining from the previous year. Thus, the fulfilment of
this condition becomes essential. In the present case, even if
any surplus is remaining in a given assessment year, it is unlikely
to reduce the liability of the franchisees in the following year as
their liability to the extent of 5 percent is fixed and non-negotiable,
irrespective of whether any funds are surplus in the previous
year. The only entity that could derive any benefit from the surplus
funds is YRIPL, i.e. the parent company. This is
antithetical to
the third test of mutuality. [Paras 27, 28][163-B, E-H]
9. Be that as it may, the dispensation predicated in the
Tripartite Agreement may entail in a situation where YRIPL would
not contribute even a single penny to the common pool and yet
be able to derive profits in the form of royalties out of the
purported mutual operations, created from the fixed 5 per cent
contribution made by the franchisees. This would be nothing short
of derivation of gains/profits out of inputs supplied by others.
That cannot be countenanced as being violative of the basic
essence of mutuality. The doctrine of mutuality, in principle,
entails that there should not be any profit earning motive, either
directly or indirectly. The third test of mutuality requires that the
purported mutual operations must be marked by an impossibility
of profits and this crucial test is also not fulfilled in the present
case. [Para 29][164-A-C]
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10. Furthermore, the exemption granted to a mutual concern
is premised on the assumption that the concern is being run for
the mutual benefit of the contributors and the contributions made
by the members ought to be directed in that direction. Contrary
to this fundamental tenet, clause 8.1 of the Tripartite Agreement
relieves the assessee company from any specific obligation of
spending the amounts received by way of contributions for the
benefit of the contributors. It explicates that the assessee
company does not hold such amount under any implied trust for
the franchisees. [Para 30][164-D]
11. A priori, it must follow that the assessee company had
acted in contravention of the terms of approval. Notably, the SIA
approval or Government approval was not only a binding
document but also a conditional document with a defined set of
preconditions for the functioning of the assessee company as a
mutual concern. The SIA approval categorically reads that the
grant of approval is subject to the terms and conditions specified
therein and any contravention thereof would be infraction of the
mandate of the government approval. [Para 31][164-G]
12. The appellant had urged that no fixed percentage of
contribution could be imputed upon YRIPL as it does not operate
any restaurant directly and thus, the actual volume of sales cannot
be determined. At the very outset, this argument holds no water
as YRIPL receives fixed percentage
of royalty from the
franchisees on the sales. This is so because if the franchisees
could be obligated with a fixed percentage of contribution, 5
percent in the present case, it is unfathomable as to why the same
obligation ought not to apply to YRIPL. [Para 32][164-H;
165-A-B]
13. The text of the Tripartite Agreement points towards
the true intent of the formation of the assessee company as a
step down subsidiary. In the absence of any ambiguity, the terms
of a contract are to be understood in their ordinary and natural
sense, thus revealing the true intent of the contracting parties.
Clause C clearly points towards the fact that the assessee company
was formed to manage business on behalf of the holding company.
In its true form, it was not contemplated as a non-business
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concern because operations integral to the functioning of a
business were entrusted to it. [Para 33][165-B, D-E]
14. 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. Taking any other view would entail in
stretching the limits of construction. [Para 34][165-F]
15. The assessee company has tried to establish a parallel
between the operations carried out by itself and clubs. However,
there are structural differences between the operations carried
out by the purported mutual concern (assessee company) and
clubs. In the case of clubs, the operations are exempted from
taxability because of the underlying notion that they operate for
the common benefit of the members wishing to enter into a social
exchange with no commercial intent. Further, all the members of
the club not only have a common identity in the concern but also
stand on an equal footing in terms of their rights and liabilities
towards the club or the mutual undertaking. Such clubs are a
means of social intercourse, and are not formed for the facilitation
of any commercial activity. On the contrary, the purported mutual
concern in the present
case undertakes a commercial venture
wherein contributions are accepted both from the members as
well as non-members. Moreover, one member is vested with a
myriad set of powers to control the functioning and interests of
other members (franchisees), even to their detriment. Such an
assimilation cannot be termed as a case of ordinary social
intercourse devoid of commerciality. [Para 35][166-D-G]
16. 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. Be that as
it may, to support an alternative claim for exemption, the assessee
company took a plea in the written submissions that it was acting
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under a Trust for the contributors, and was under an overriding
obligation to spend the amounts received for advertising,
marketing and promotional activities. It was urged that once the
incoming amount is earmarked for an obligation, it does not
become “income” in the hands of the assessee as no occasion
for the application of such income arises. [Para 36]167-A-C]
17. Considering the fact that the question of diversion by
overriding title was neither framed nor agitated in the appeal
memo before the High Court or before this Court (except a brief
mention in the written submissions), coupled with the fact that
neither the Tribunal nor the High Court has dealt with that plea
and that the rectification application raising that ground is still
undecided and stated to be pending before the Tribunal, it is left
open to the appellant to pursue the rectification application, if so
advised. [Paras 38, 41][169-C-D]
Commissioner of Income Tax, Bihar v. Bankipur Club
Ltd. (1997) 5 SCC 394 : [1997] 1 Suppl. SCR 263;
Bangalore Club v. Commissioner of Income Tax & Anr.
(2013) 5 SCC 509 : [2013] 1 SCR 267; Commissioner
of Income Tax, Bombay City v. Royal Western India Turf
Club Ltd, AIR 1954 SC 85 : [1954] SCR 289 – relied
on.
Dalmia Cement Ltd., Rajasthan v. Commissioner of
Income Tax, New Delhi (1999) 4 SCC 124 : [1999] 2
SCR 735; The Commissioner of Income Tax, Bombay
City II v. Sitaldas Tirathdas AIR 1961 SC 728 : [1961]
SCR
634; Associated Power Co. Ltd. v. Commissioner
of Income Tax (1996) 7 SCC 221 : [1995] 5 Suppl.
SCR 721; The Commissioner of Income Tax, Kerala,
Ernakulam v. The Travancore Sugars & Chemical Ltd.
(1973) 3 SCC 274 : [1973] 2 SCR 738- referred to.
The English and Scottish Joint Co-operative Wholesale
Society Ltd. v. Commissioner of Agricultural Income-
Tax, Assam AIR 1948 PC 142 –referred to.
New York Life Insurance Co. v. Styles (Surveyor of
Taxes) (1889) 2 TC 460 – referred to.
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Simon’s Taxes, Volume B, 3rd Edition, Pgs. 159, 167;
British Tax Encyclopedia (I), 1962 Edition, Pgs. 1200
and 1201 and Thomas M. Cooley, The Law of Taxation,
4th Edition, Volume 2, Pg. 671 – referred to.
Case Law Reference
[1997] 1 Suppl. SCR 263
relied on
Para 14
[2013] 1 SCR 267
relied on
Para 15
[1954] SCR 289
relied on
Para 16
[1999] 2 SCR 735
referred to
Para 38
[1961] SCR 634
referred to
Para 38
[1995] 5 Suppl. SCR 721
referred to
Para 13
[1973] 2 SCR 738
referred to
Para 22
CIVIL APPELLATE JURISDICTION: Civil Appeal No. 2847
of 2010.
From the Judgment and Order dated 01.04.2009 of the High Court
of Delhi at New Delhi in I. T. Appeal No. 1433 of 2008.
Balbir Singh, Sr. Adv., Ms. Anuradha Dutt, Ms. Fereshte D. Sethna,
Tushar Jarwal, Rahul Sateeja, Ms. B. Vijayalakshmi Menon and Deepak
Thakur, Adv. for the Appellant.
V. Shekhar, Sr. Adv., Ms. Praveen Gautam, Shashank Shekhar
and Ms. Sheetal Rajput, Advs. for the Respondent.
The Judgment of the Court was delivered by
A. M. KHANWILKAR, J.
1. The moot question involved in the present appeal bears upon
the applicability of the doctrine of mutuality qua the assessee company,
a fully owned subsidiary of Yum! Restaurants (India) Pvt. Ltd. (for short,
“YRIPL”), formerly known as Tricon Restaurants India Pvt. Ltd.,
incorporated for undertaking the activities relating to Advertising,
Marketing and Promotion (for short, “AMP activities”) for and on behalf
of YRIPL and its franchisees.
2. This appeal assails the
final judgment and order dated 1.4.2009
passed by the High Court of Delhi at New Delhi (for short, “the High
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Court”) in I.T.A. No. 1433 of 2008 wherein the question of taxability of
Rs. 44,44,002/- (Rupees forty four lakhs forty four thousand two only),
being the excess of income over expenditure for the Assessment Year
2001-02, was settled in favour of the Revenue and against the assessee,
thereby confirming the orders of the Income Tax Appellate Tribunal (for
short, “the Tribunal”), Commissioner of Income Tax (Appeals) [for short,
the “CIT(A)”] and the Assessing Officer. The preceding forums, without
any exception, have returned consistent verdicts refusing to acknowledge
the assessee company as a mutual concern and denying any exemption
from taxability.
3. The appellant company Yum! Restaurants (Marketing) Private
Limited (for short, “YRMPL” or “assessee company” or “assessee”)
was incorporated by YRIPL as its fully owned subsidiary after having
obtained approval from the Secretariat for Industrial Assistance (for
short “SIA”) for the purpose of economisation of the cost of advertising
and promotion of the franchisees as per their needs. 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. The relevant clauses of the approval granted
by the SIA for the aforementioned operations read thus:
“3. It is noted that the broad framework within which such
subsidiary shall be managed and operated in
India is as follows:
- The franchises and Tricon India will both make contribution
of a fixed percentage of their respective revenues (net of taxes)
to the proposed New Company on regular basis;
- The proposed New Company would be a non-profit enterprise
governed by the principles of mutuality. No part of the
contributions or other income shall enure to the benefit of any
individual contributor;
- The contributors will be optimally used by the proposed new
Company to economise the cost of advertising and promotion
cater to the specific needs of franchisees to concentrate on
restaurant operations and management;
- The management of the proposed New Company shall vest
with Tricon India and application of contributions will be decided
by Tricon India in consultation with the franchisee;
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-The approval is subject to the condition that the step down
subsidiary would be a non-profit enterprise and would not be
allowed to repatriate dividends.”
4. In furtherance of the approval, the assessee entered into a
Tripartite Operating Agreement (for short, the “Tripartite Agreement”)
with YRIPL and its franchisees, wherein the assessee company 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. The
terms of the Tripartite Agreement, to the extent relevant for the
consideration of the present case, are produced thus:
“2.2 TRIM will establish and operate Brand Funds in respect of
each Brand for the purpose of allocating and using the Advertising
Contribution received from franchisee and other franchisee of
Tricon operating Restaurants under the Brands. TRIM will allocate
the advertising contribution received from the Franchisees including
Franchisee for each Restaurant to the respective Brand funds
established for that brand. It is agreed between the Parties that
the advertising contribution paid into a brand fund will be used for
the AMP Activities relating to that brand.
3. FRANCHISEE ADVERTISING CONTRIBUTIONS
3.1 As and from the Effect Date, Franchisee will pay the
Advertising Contribution of 5% of Revenues for a particular month
into the Bank account of the Brand Fund established by
TRIM by
the 10th day of the following month. Details of the bank account,
of each Brand Fund set up by TRIM will notified to Franchisee
by TRIM from time to time. Notwithstanding the aforesaid, the
executive committee of any Brand (constituted under Article 7 of
this Agreement) may, by a three fourth majority, which shall be
binding on all franchisees of Tricon including the Franchisee,
require the franchisee to pay the advertising Contribution in
advance. For the avoidance of doubt it is clarified and agreed that
while recommending advance payment of Advertising Contribution
the chairman will not have a casting vote.
Franchise will spend an additional 1% of Revenues, in the manner
directed by Tricon and/or TRIM in writing from time to time, on
such local store marketing, advertising, promotional and research
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expenditure proposed by Franchisee and approved in advance by
Tricon and/or TRIM during the relevant Accounting Period, in
accordance with the requirements and guidelines set out in the
Manuals, provided that if Franchisee fails to spend the full amount
as directed by Tricon and/or TRIM franchisee will pay the unspent
amount to TRIM within the period specified in a written demand
from TRIM. Upon receipt of the unspent amount TRIM will spend
the amount on regional and/or national advertising, promotions or
research expenditure conducted by TRIM in its discretion.......”
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4.1 Tricon may at the request of TRIM, but subject to
Tricon’s sole and absolute discretion pay to TRIM any such
amount(s) as it may deem appropriate to support the AMP
[sic]activities during any Accounting Period for the
avoidance of doubt, it is clarified and agreed between the
Parties that Tricon shall have no obligation to pay any such
amounts if it chooses not to do so.
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8.4 In the event there is any surplus left over in any of the Brand
Funds at the end of an accounting period, TRIM shall be entitled
to retain the surplus to be spent on AMP activities during the
following accounting period. Alternatively, TRIM may, subject to
the approval of its Board of Directors refund the surplus amounts
to the franchisees including Franchisee in the same proportion as
the actual advertising contribution made by each franchisee
including
franchisee in that accounting period.
On the other hand, if there is a deficit in any of the brand funds at
the end of an accounting period, the deficit will be carried forward
to the next accounting period and be met out of the advertising
contribution paid by the franchisees including franchisee for that
accounting period. For the avoidance of doubt, it is agreed between
the parties that Tricon and/or TRIM shall not be obliged to fund
the deficit.
8.5 It is clearly understood and agreed between the parties that
the only objective of TRIM is to coordinate the marketing activities
of the brands including the mutual benefit of the franchisees
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including the Franchisee. It is envisaged that no profits will be
earned and no dividends will be declared by TRIM.”
(emphasis supplied)
5. For the Assessment Year under consideration, 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
Assessing Officer, who observed thus:
“VI.7.3 As per the SIA letter dated 05.10.1998 Assessee Company
along with the franchisees were to contribute a fix percentage of
its revenue to YRMPL. However as per clause 4.1 of Tripartite
operating agreement submitted by YRMPL, the assessee company
had its sole absolute discretion to pay to YRMPL any amount as
it may deem appropriate and that YRIPL shall have no obligation
to pay any such amounts if it chooses not to do so. This clearly
shows that YRIPL was under no legal obligation to pay any amount
of contribution as per its own version reflected from tripartite
agreement.”
6. The imposition of liability by the Assessing Officer was upheld
by the C.I.T. (A) on the ground of taint of commerciality in the activities
undertaken by the assessee company, wherein it was observed thus:
“1.14 ....The AMP activity is quite a critical component of running
a successful business venture, it is intrinsically linked to sales and
profit of the franchisees the contributors. Accordingly it cannot
be said that such activity is immune from the taint of commerciality.
Unlike in the cases of a club,
the appellant Co. is not existing for
any social inter course nor is it for cultural activities where the
idea of profit or trade does not exist. What is essential is that
there should not be any dealing with outside body which results in
a benefit which promotes some commercial/business venture.
There should not be any profit earning motive in any transaction
directly or indirectly. In fact in the appellant’s case the essence of
mutuality also appears to be missing in that there is no instance or
scope of say trading between persons associating together. Thus
though the form taken up to conduct its revenue activity
undoubtedly resemble a mutual concern but the contributions made
on the other hand are undeniably for business considerations. In
my opinion, taking an overall view of the intent and motive of the
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appellant company to form a ‘mutual concern’ it can be concluded
that the underlying purpose was solely for commercial
consideration. Therefore in view of the above as demonstrated
by the appellant Co. the excess of receipts over the expenditure
i.e. the surplus in my opinion would be income liable to tax….”
7. The liability was further confirmed by the Tribunal, wherein the
essential ingredients of the doctrine of mutuality were found to be missing.
It observed thus:
“11. .... Firstly the Government order sanctioning setting up of the
wholly owned subsidiary prescribes that the approval is subject to
the condition that such subsidiary would be a non-profit enterprise
and is also not entitled to repatriate dividends. The main object of
the assessee company reveals that it is to carry out advertising,
marketing and promotion for brands owned by its parent company.
The main plank of the assessee’s arguments is that the principles
of mutuality will apply and hence the income cannot be taxed.
Time and again various courts have held that where there is
complete identity between the contributors and the participators
or the beneficiaries, only then such principles can be applied.
However, in the present case it is seen that apart from
contributions is also received from M/s Pepsi Foods Ltd.
and YRIPL. Pepsi Foods Ltd. is neither a franchisee nor a
beneficiary. Similarly some contribution is also received
from YRIPL which
YRIPL is not under any obligation to
pay. Thus it can be said that essential requirement that of
the contributors to the common fund are either to participate
in the surplus or they are beneficiaries of the contribution
is missing. Through the common AMP activities no benefit
accrues to Pepsi Food Ltd. or YRIPL. Accordingly the
principles of mutuality cannot be applied. It is a different
facts that the assessee was established with the object not to
make profit but it is also a fact that there is a surplus in the hands
of the assessee which arose due to contribution from certain
persons who were neither the benficiaries nor have right to receive
the surplus....”
(emphasis supplied)
8. The consistent line of opinion recorded by the aforementioned
three forums was further approved in appeal by the High Court vide
impugned judgment, by observing thus:
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“8. ....The principle of mutuality as enunciated by the Courts in
various cases is applicable to a situation where the income of the
mutual concern is the contributions received from its contributors.
The expenses incurred by the mutual concerns are incurred from
such contributions and hence on the principle that no man can do
business with himself, the excess of income over expenditure is
not amenable to tax. However, in the present case the authorities
below have returned a finding of fact that the fund as contributors
such as Pepsi Food Ltd which do not benefit from the APM
Activities. Moreover, the principle of mutuality is applicable to
those entities whose activities are not tinged with commercial
purpose. As a matter of fact in the instant case the parent company
i.e., YRIPL which has also contributed to the brand fund is under
the agreement under no obligation to do so. The contributions of
YRIPL are at its own discretion. Thus, looking at the facts obtaining
in the present case, it is quite clear that the principle of mutuality
would not be applicable to the instant case....”
9. On cogitating over the rival submissions, we reckon that the
following questions of law would arise for our consideration in the present
case:
(i) Whether the assessee company would qualify as a mutual
concern in the eyes of law, thereby exempting subject transactions
from tax liability?
(ii) Whether the excess of income over expenditure in the hands
of the assessee
company is not taxable?
10. The appellant/assessee has contended that the sole objective
of the assessee company was to carry on the earmarked activities on a
no-profit basis and to operate strictly for the benefit of the contributors
to the mutual concern. It has further been contended that the assessee
company levies no charge on the franchisees for carrying out the
operations. While assailing the observations made in the impugned
judgment, holding that Pepsi Foods Ltd. and YRIPL are not beneficiaries
of the concern, the assessee company has urged that YRIPL is the
parent company of the assessee and earns fixed percentage from the
franchisees by way of royalty. Therefore, it benefits directly from
enhanced sales as increased sales would translate into increased royalties.
A similar argument has been advanced as regards Pepsi Foods Ltd. It is
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stated that under a marketing agreement, the franchisees are bound to
serve Pepsi drinks at their outlets and thus, an increase in the sales at
KFC and Pizza Hut outlets as a result of AMP activities would lead to a
corresponding increase in the sales of Pepsi. To add weight to this
argument, it has been brought to our notice that Pepsi was also advertised
by the franchisees in their advertising and promotional material, along
with Pizza Hut and KFC, and copy of the said material has been placed
on record.
11. As regards the doctrine of mutuality, it is urged by the assessee
company 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.
Reliance has been placed by the appellant upon reported decisions to
draw a parallel between the functioning of the assessee company and
clubs to support the presence of mutuality.
12. The Revenue/respondent has countered the submissions made
by the assessee company by submitting that the moment a non-member
joins the common pool of funds created for the benefit of the contributors,
the taint of commerciality begins and mutuality ceases to exist in the
eyes of law. It has been submitted that the assessee company operated
in contravention of the SIA approval as
contributions were received
from Pepsi, despite it not being a member of the brand fund. To buttress
this submission, it is urged that once the basic purpose of benefiting the
actual contributors is lost, mutuality stands wiped out.
13. We have heard Mr. Balbir Singh, learned senior counsel for
the appellant and Mr. V. Shekhar, learned senior counsel for the
respondent.
Re: Question (i):
14. 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
cannot be regarded as “income” taxable under the Income Tax Act,
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1961 (for short, “the 1961 Act”). What is taxable under the 1961 Act is
“income” or “profits” or “gains” as they accrue to a person in his dealings
with other party or parties that do not share the same identity with the
assessee. For income, there is an underlying exchange of a commercial
nature between two different entities. In Commissioner of Income Tax,
Bihar v. Bankipur Club Ltd.1, this court observed on the nature of
liability under the 1961 Act thus:
“6. Under the Income Tax Act (hereinafter referred to as “the
Act”) what is taxed is, the “income, profits or gains earned or
“arising”, “accruing” to a person”. The question is whether in the
case of members’ clubs - a species of mutual undertaking - in
rendering various services to its members which result in a surplus,
the club can be said to “have earned income or profits” In order
to answer the question, it is necessary to have a background of
the law relating to “mutual trading” or “mutual undertaking” and
a “members club”.”
15. 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. In Bangalore Club v.
Commissioner of Income Tax& Anr.2, this Court authoritatively quoted
one of the earliest judicial pronouncements in New York Life Insurance
Co. v. Styles (Surveyor of Taxes)3 thus:
“When a number of individuals agree to contribute funds for a
common purpose. . . and 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.”
The proposition of law is restated in Bankipur Club (supra) and
Bangalore Club (supra) by placing reliance upon the following extract
from Simon’s Taxes4:
“…it is settled law that if the persons carrying on a trade do so in
such a way that they and the customers are the same persons,
no profits or gains are yielded by the trade for tax purposes and
1 (1997) 5 SCC 394
2 (2013) 5 SCC 509
3 (1889) 2 TC 460
4 Simon’s Taxes, Volume B, 3rd Edition, Pgs. 159, 167
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therefore no assessment in respect of the trade can be made.
Any surplus resulting from this form of trading represents only
the extent to which the contributions of the participators have
proved to be in excess of requirements. Such a surplus is regarded
as their own money and returnable to them. In order that this
exempting element of mutuality should exist it is essential that the
profits should be capable of coming back at some time and in
some form to the persons to whom the goods were sold or the
services rendered...”
16. In order to undertake the examination of mutuality, we gainfully
advert to The English and Scottish Joint Co-operative Wholesale
Society Ltd. v. Commissioner of Agricultural Income-Tax, Assam5,
which has been quoted with approval by this Court in Commissioner of
Income Tax, Bombay City v. Royal Western India Turf Club Ltd.6
and Bangalore Club (supra). The aforestated stream of judicial
pronouncements expound three conditions/tests to prove the existence
of mutuality:
(i) Identity of the contributors to the fund and the recipients from
the fund;
(ii) 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;
(iii) 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.
Common Identity
17. The first element involves the test of commonality of identity
between the members or participators in the mutual concern and the
beneficiaries thereof. Succinctly put, this limb of the three-pronged test
5 AIR 1948 PC 142
6 AIR 1954 SC 85
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requires that no person ought to contribute to the common fund without
having the entitlement to participate as a beneficiary in the surplus
thereof. Conversely, no person ought to participate as a beneficiary without
first having been a contributor or a member of the class of contributors
to the common fund. Common identity, as it occurs in the present context,
signifies that the class of members should stay intact as the transaction
progresses from the stage of contributions to that of returns/surplus. It
must manifest uniformity in the class of participants in the transaction.
The moment such a transaction opens itself to non-members, either in
the contribution or the surplus, the uniformity of identity is impaired and
the transaction assumes the taint of a commercial transaction. The
emphasis on the words member and non-member is of import because
the doctrine of mutuality does not prohibit the inclusion or exclusion of
new members. What is prohibited is the infusion of a participant in the
transaction who does not become a ‘member’ of the common fund, at
par with other members, and yet participates either in the contribution or
surplus without subjecting itself to mutual rights and obligations. The
principle of common identity prohibits any one-dimensional alteration in
the nature of participation in the mutual fund as the transaction fructifies.
Any such alteration would lead to the non-uniform participation of an
external element or entity in the
transaction, thereby opening the scope
for a manifest or latent profit-based dealing in the transaction with parties
outside the closed circuit of members. It would be amenable to income
tax as per Section 2(24) of the 1961 Act.
Completeness of Identity
18. Coterminous with the requirement of common identity, as
discussed above, the law also contemplates a completeness of identity
between the contributors and participators. The theory of completeness
of identity presupposes the contributors and participators to be two
separate classes, but there is oneness or equality in the matter of sharing
of surplus/profits. This is to ensure that there is no interference of any
alien commercial entity in the transaction. With the interference of any
alien entity, the idea of conducting business with oneself is defeated and
any profits or gains accruing therefrom become subject to tax liability.
This proposition of law is succinctly predicated in British Tax
Encyclopaedia7, which reads thus:
7 British Tax Encyclopedia (I), 1962 Edition, Pgs. 1200 and 1201
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“…For this doctrine to apply it is essential that all the contributors
to the common fund are entitled to participate in the surplus and
that all the participators in the surplus are contributors, so that
there is complete identity between contributors and
participators. This means identity as a class, so that at any given
moment of time the persons who are contributing are identical
with the persons entitled to participate; it does not matter that the
class may be diminished by persons going out of the scheme or
increased by others coming in”
It is pertinent to note that 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.
19. In the present case, it is indisputable that Pepsi Foods Ltd. is
a contributor to the common pool of funds. However, it does not
participate in the surplus as a beneficiary for at least two reasons- first,
Pepsi is not a member of the purported mutual concern as the Tripartite
Agreement as well as the terms of SIA approval permit only ‘franchisees’
to become members of the mutual concern. Notably, Pepsi Foods Ltd. is
not a franchisee and thus, it cannot participate in the surplus. Second,
Pepsi does 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.
20. We find it noteworthy that the Tripartite Agreement requires
the assessee company to constitute a separate Brand Fund for each
franchisee as stated in clause 2.2 of the said agreement, which reads
thus:
“2.2 TRIM will establish and operate Brand Funds in respect of
each Brand, for the purpose of allocating and using the Advertising
Contribution received from franchisee and other franchisee of
Tricon operating Restaurants under the Brands TRIM will allocate
the advertising contribution received from the franchisees including
Franchisee for each Restaurant to the Parties that the Advertising
Contribution paid into a Brand Fund will be used for the AMP
Activities relating to that Brand.”
(emphasis supplied)
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Since no Brand Fund, as contemplated above, has been constituted
for Pepsi Foods Ltd., it does not become a part of the purported Tripartite
mutual arrangement so as to qualify as a beneficiary of the mutual
operations. The definition clause of the Tripartite Agreement adds weight
to this finding. “Advertising Contribution”, as defined in the definition
clause means,
“the advertising contributions which Franchisee has agreed to pay
to Tricon pursuant to [sic] the Franchisee Agreements.”
Furthermore, “Franchise Agreements”, as defined in the definition
clause, means agreements executed between Tricon and Franchisee.
As a corollary, what follows is that for any amount received by the
assessee company to be treated as an advertising contribution, it must
be paid by a franchisee, that too in the aftermath of a prior franchisee
agreement to that effect. In the light of the prevailing relationship, there
is no such franchisee agreement between Tricon or TRIM and Pepsi
Foods Ltd. and therefore, the amounts received from Pepsi Foods Ltd.
cannot be viewed as advertising contributions “from a member of the
mutual undertaking” as such.
21. In the present case, therefore, the assessee company is realising
money both from the members as well as non-members in the course of
the same activity carried on by it. This court, in Royal Western India
Turf Club Ltd. (supra) has categorically held such operations to be
antithetical to mutuality. We deem it apposite to take note
of the dictum
in Bankipur Club (supra), wherein this principle has been restated thus:
“22. ...if the object of the assessee company claiming to be a
“mutual concern” or “club”, is to carry on a particular business
and the money is realised both from the members and from non-
members, for the same consideration by giving the same or similar
facilities to all alike in respect of the one and the same business
carried on by it, the dealings as a whole disclose the same profit-
earning motive and are alike tainted with commerciality...and the
resultant surplus is profit-income liable to tax…”
22. The contention of the assessee company that Pepsi Foods
Ltd., in fact, does benefit from the mutual operations by virtue of its
exclusive contracts with the franchisees is tenuous, as the very basis of
mutuality is missing as far as Pepsi Foods Ltd. is concerned, as discussed
hitherto. Even if any remote or indirect benefit is being reaped by Pepsi
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Foods Ltd., the same cannot be said to be in lieu of it being a member of
the purported mutual concern and therefore, cannot be used to fill the
missing links in the chain of mutuality. Concededly, the surplus of a mutual
operation is meant to be utilised by the members of the mutual concern
as members enjoy a proximate connection with the mutual operation.
Non-members, including Pepsi Foods Ltd., stand on a different footing
and have no proximate connection with the affairs of the mutual concern.
The exclusive contract between the franchisees and Pepsi Foods Ltd.
stands on an independent footing and YRIPL as well as the assessee
company are not responsible for implementation of this contract.
Resultantly, the first limb of the three-pronged test stands severed.
Non-profiteering and Obedience to Mandate
23. Whereas the doctrine of mutuality stands debunked with the
failure of the first test, let us, nonetheless, examine the other two tests in
the present factual scenario. Indubitably, the receipt of money from an
outside entity without affording it the right to have a share in the surplus
does not only subjugate the first test of common identity, but also
contravenes the other two conditions for the existence of mutuality i.e.
impossibility of profits and obedience to the mandate. The mandate of
the assessee company was laid down in the SIA approval wherein the
twin conditions of mutuality and non-profiteering were
envisioned as the
sine qua non for the functioning of the assessee company. The
contributions made by Pepsi Foods Ltd. tainted the operations of the
assessee company with commerciality and concomitantly contravened
the pre-requisites of mutuality and non-profiteering.
24. 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. It is, therefore, imperative to examine the actual functional
framework of the assessee company in light of the status of YRIPL
(parent company) vis-a-vis other members/franchisees. As per the terms
of the SIA approval, YRIPL and franchisees were equally obligated to
make contribution of a fixed percentage to the assessee company. This
requirement was incorporated as a pre-condition for the grant of
permission to operate as a mutual concern. Clause 3 of the approval
letter reads thus:
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“The franchises and Tricon Indian will both make contribution of
a fixed percentage of their respective revenues (net of taxes) to
the proposed New Company on regular basis:”
However, drifting from this mandate, the Tripartite Agreement
made it discretionary upon YRIPL to contribute to the common pool,
thereby putting it at a higher pedestal than the franchisees. Clause 4.1 of
the Tripartite Agreement reads thus:
“4.1 Tricon may at the request of TRIM, but subject to Tricon
sole and absolute discretion pay to TRIM any such
amount(s) as it may deem appropriate to support the VVIP
activities during the Accounting Period for the avoidance of doubt,
it is clarified and agreed between the Parties that Tricon shall
have no obligation to pay any such amounts if it chooses
not to do so.”
(emphasis supplied)
Thus, clause 4.1 is not in confirmity with the terms of approval.
Furthermore, it is noteworthy that the management of the assessee
company was under full and absolute control of its parent company
YRIPL. Be it also noted that the participation of the franchisees in the
management of the assessee company was again subject to approval by
YRIPL, which falls within its sole discretion. Clause 7.1 of the Tripartite
Agreement reads thus:
“7.1 The management and operations of TRIM will be carried
out by its Board of Directors in accordance with the Articles of
Association of TRIM, the terms of which shall be read as a part
of this Agreement. The Board of Directors
of TRIM will be
nominated by Tricon from time to time in accordance with the
Articles of Association of TRIM. The Board of Directors of TRIM
shall consist of a minimum number of five directors. Out of the
five directors Tricon may, in its absolute and sole discretion,
nominate one representative each of two franchisees (to
be selected by Tricon on a rational basis) to be appointed
as directors on the Board of Directors of TRIM such
nominees to hold office for a period of one year from the date of
their appointment. In the event the representative of the Franchisee
is nominated to the Board of Directors of TRIM. Franchisee agrees
and undertakes to cause such representative to (i) accept such
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appointment as and when the same is made; and (ii) to resign
from the post of Director on the expiry of one year from the date
of appointment or earlier, if so requested by Tricon.”
(emphasis supplied)
25. The net effect of the aforequoted clauses is to render the pre-
conditions for the grant of approval, as otiose. It also becomes amply
clear that YRIPL and the franchisees stand on two substantially different
footings. For, the franchisees are obligated to contribute a fixed percentage
for the conduct of AMP activities whereas YRIPL is under no such
obligation in utter violation of the terms of SIA approval. Moreover, even
upon request for the grant of funds by the assessee company, YRIPL is
not bound to accede to the request and enjoys a “sole and absolute”
discretion to decide against such request. That members of a financial
concern exercise mutual control over its management without the scope
of prejudicial exercise of power by one class of members over the others
is the quintessence for the existence of a mutual concern. The word
“mutual” offers guidance to this effect. Literally understood, the word
“mutual” points towards reciprocity and a mutual arrangement is one in
which the members/parties have reciprocal rights or understanding or
arrangement. An arrangement wherein one member is subjected to the
absolute discretion of another, in such a manner that the entire liability
may fall upon one whereas
benefits are reaped by all, is antithesis to the
mutual character in the eyes of law.
26. The contention advanced by the appellant that it is not
mandatory for every member of the mutual concern to contribute to the
common pool fails to advance the case of the appellant. It is no doubt
true that every member of the mutual concern might not be required to
contribute to the common pool at all times. However, it does not mean
that one member cannot be made to contribute under any pretext
whatsoever. For, that would amount to the grant of an overriding position
to a member in the mutual agreement, extending upto even overruling
the requests for contribution from other members for mutual necessity.
It is this all-pervasive overriding position of one member over the others
that negates the effect of mutuality. There is a fine line of distinction
between absence of obligation and presence of overriding discretion. In
the present case, YRIPL enjoys the latter at the detriment of the
franchisees of the purported undertaking, both in matters of contribution
and management. In a mutual concern, it is no doubt true that an obligation
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to pay may or may not be there, but in the same breath, it is equally true
that an overriding discretion of one member over others cannot be
sustained, in order to preserve the real essence of mutuality wherein
members contribute for the mutual benefit of all and not of one at the
cost of others.
27. More importantly, an examination of the judicial decisions relied
upon by the parties brings out the settled legal position that in order to
qualify as a mutual concern, the contributors to the common fund either
acquire a right to participate in the surplus or an entitlement to get back
the remaining proportion of their respective contributions. In the present
scheme of things, clause 8.4 provides that,
“8.4 In the event there is any surplus left over in any of the Brand
Funds at the end of an Accounting Period. TRIM shall be entitled
to retain the surplus to be spent on AMP activities during the
following Accounting Period. Alternatively, TRIM may, subject
to the approval of its Board of Directors, refund the surplus
amounts to the franchisees including Franchisee in the same
proportion as the actual Advertising Contribution made by each
franchisee including Franchisee in that Accounting Period.”
(emphasis supplied)
28. Contrary to the abovestated legal position, clause 8.4 makes it
clear that the franchisees do not enjoy any “entitlement” or “right” on
the surplus remaining after the operations have been carried out for a
given assessment year. The clause
provides that the assessee company
may refund the surplus subject to the approval of its Board of Directors.
It implies that the franchisees/contributors cannot claim a refund of their
remaining amount as a matter of right. Be it noted that the raison d’etre
behind the refund of surplus to the contributors or mandatory utilisation
of the same in the subsequent assessment year is to reduce their burden
of contribution in the next year proportionate to the surplus remaining
from the previous year. Thus, the fulfilment of this condition becomes
essential. In the present case, even if any surplus is remaining in a given
assessment year, it is unlikely to reduce the liability of the franchisees in
the following year as their liability to the extent of 5 percent is fixed and
non-negotiable, irrespective of whether any funds are surplus in the
previous year. The only entity that could derive any benefit from the
surplus funds is YRIPL, i.e. the parent company. This is antithetical to
the third test of mutuality.
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29. ‘Be that as it may, the dispensation predicated in the Tripartite
Agreement may entail in a situation where YRIPL would not contribute
even a single penny to the common pool and yet be able to derive profits
in the form of royalties out of the purported mutual operations, created
from the fixed 5 per cent contribution made by the franchisees. This
would be nothing short of derivation of gains/profits out of inputs supplied
by others. That cannot be countenanced as being violative of the basic
essence of mutuality. The doctrine of mutuality, in principle, entails that
there should not be any profit earning motive, either directly or indirectly.
The third test of mutuality, quoted above, requires that the purported
mutual operations must be marked by an impossibility of profits and this
crucial test is also not fulfilled in the present case.
30. Furthermore, the exemption granted to a mutual concern is
premised on the assumption that the concern is being run for the mutual
benefit of the contributors and the contributions made by the members
ought to be directed in that direction. Contrary to this fundamental tenet,
clause 8.1 of the Tripartite Agreement relieves the assessee company
from any specific obligation of spending the amounts received by way
of contributions for the benefit of the contributors. It explicates that the
assessee company does not hold such amount under any implied trust
for the franchisees,
and reads thus:
“8.1 .... Notwithstanding the foregoing, any amount paid by
Franchisee to TRIM will not be required to be spent for the specific
benefit, either direct or indirect, of Franchisee or the Business
and no express or implied trust will be created in respect of such
amount. Additionally, Franchisee will not have any claim or action
against Tricon and/or TRIM in connection with the level of success
of any such advertising, marketing, promotion, research or test.”
31. A priori, it must follow that the assessee company had acted
in contravention of the terms of approval. Notably, the SIA approval or
Government approval was not only a binding document but also a
conditional document with a defined set of preconditions for the
functioning of the assessee company as a mutual concern. The SIA
approval categorically reads that the grant of approval is subject to the
terms and conditions specified therein and any contravention thereof
would be infraction of the mandate of the government approval.
32. The appellant had urged that no fixed percentage of
contribution could be imputed upon YRIPL as it does not operate any
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restaurant directly and thus, the actual volume of sales cannot be
determined. At the very outset, this argument holds no water as YRIPL
receives fixed percentage of royalty from the franchisees on the sales.
We say so because if the franchisees could be obligated with a fixed
percentage of contribution, 5 percent in the present case, it is
unfathomable as to why the same obligation ought not to apply to YRIPL.
33. Be it noted that the text of the Tripartite Agreement points
towards the true intent of the formation of the assessee company as a
step down subsidiary. For, clause C predicates thus:
“C. TRIM has been established as a wholly owned step down
subsidiary Tricon to manage of the retail restaurant business, the
advertising medial and promotion at regional level and national
level of KFC. Pizza Hut and other brands currently owned or
acquired in future by Tricon and on its parents and of its associate
company.”
In the absence of any ambiguity, the terms of a contract are to be
understood in their ordinary and natural sense, thus revealing the true
intent of the contracting parties. The aforequoted clause clearly points
towards the fact that the assessee company was formed to manage
business on behalf of the holding company. In its true form, it was not
contemplated as a non-business concern because operations integral to
the functioning of a business were entrusted to it.
34. 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. Taking any other
view would entail in stretching the limits of construction. In The Law of
Taxation by Thomas M. Cooley8, the rule regarding strict construction
of exemptions is succinctly summarised thus:
“672. Strict construction-Rule stated.An intention on the part
of the legislature to grant an exemption from the taxing power of
the state will never be implied from language which will admit of
any other reasonable construction. Such an intention must be
expressed in clear and unmistakable terms, or must appear by
8 Thomas M. Cooley, The Law of Taxation, 4th Edition, Volume 2, Pg. 671
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necessary implication from the language used, for it is a well-
settled principle that, when a special privilege or exemption is
claimed under a statute, charter or act of incorporation, it is to be
construed strictly against the property owner and in favour of the
public. This principle applies with peculiar force to a claim of
exemption from taxation. Exemptions are never presumed, the
burden is on a claimant to establish clearly his right to exemption,
and an alleged grant of exemption will be strictly construed and
cannot be made out by inference or implication but must be beyond
reasonable doubt. ....... Moreover, if an exemption is found to
exist, it must not be enlarged by construction, since the reasonable
presumption is that the state has granted in express terms all it
intended to grant at all, and that unless the privilege is limited to
the very terms of the statute the favour would be extended beyond
what was meant…”
35. The assessee company has relied upon reported decisions to
establish a parallel between the operations carried out by itself and clubs.
Upon closer scrutiny, however, we find that the authorities cited by the
appellant do not advance its case because of the structural differences
between the operations carried out by the purported mutual concern
(assessee company) and clubs. In the case of clubs, the operations are
exempted from taxability because of the underlying notion that they
operate for the common benefit of the members wishing to enter into a
social exchange with no commercial intent. Further, all the members of
the club not only have a common identity in the concern but also stand
on an equal footing in terms of their rights and liabilities towards the club
or the mutual undertaking. Such clubs are a means of social intercourse,
as rightly observed by CIT (A) in the present case, and are not formed
for the facilitation of any commercial activity. On the contrary, the
purported mutual concern in the present case undertakes a commercial
venture wherein contributions are accepted both from the members as
well as non-members, as discussed earlier. Moreover, one member is
vested with a myriad set of powers to control the functioning and interests
of other members (franchisees), even to their detriment. Such an
assimilation cannot be termed as a case of ordinary social intercourse
devoid of commerciality.
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Re: question No. (ii):
36. 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. Be that as it may, to support an
alternative claim for exemption, the assessee company took a plea in the
written submissions that it was acting under a Trust for the contributors,
and was under an overriding obligation to spend the amounts received
for advertising, marketing and promotional activities. It is urged that once
the incoming amount is earmarked for an obligation, it does not become
“income” in the hands of the assessee as no occasion for the application
of such income arises.
37. In the written submissions, the assessee company has
contended thus:
“The Hon’ble High Court further erred in not adjudicating the
specific ground raised by the Appellant that the contributions
received by the Appellant cannot be said to be its income because
the Appellant merely holds them as a trustee and also under an
overriding obligation to spend such contributions received for AMP
activities.”
38. The law on what amounts to a case of diversion before accrual
and what amounts to application post accrual is well settled and can be
summarised by making reference to Dalmia Cement Ltd., Rajasthanv.
Commissioner of Income Tax, New Delhi9, wherein the following
extract of TheCommissioner of Income Tax, Bombay City II v.
Sitaldas Tirathdas10 was quoted with approval:
“16…  In
our opinion, the true test is whether the amount sought
to be deducted, in truth, never reached the assessee as his income.
Obligations, no doubt, there are in every case, but it is the nature
of the obligation which is the decisive fact. There is a difference
between an amount which a person is obliged to apply out of his
income and an amount which by the nature of the obligation cannot
be said to be a part of the income of the assessee. Whereby the
obligation income is diverted before it reaches the assessee, it is
deductible; but where the income is required to be applied to
discharge an obligation after such income reaches the assessee,
9 (1999) 4 SCC 124
10 AIR 1961 SC 728
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the same consequence, in law, does not follow. It is the first kind
of payment which can truly be excused and not the second. The
second payment is merely an obligation to pay another portion of
one’s own income, which has been received and is since applied.
The first is a case in which the income never reaches the assessee,
who even if he were to collect it, does so, not as part of his income,
but for and on behalf of the person to whom it is payable...”
Furthermore, in Associated Power Co. Ltd. v. Commissioner of
Income Tax11, this Court again observed thus:
“13. The application of the doctrine of diversion of income by
reason of an over-riding title is quite inapposite. The doctrine applies
when, by reason of an over-riding title or obligation, income is
diverted and never reaches the person in whose hands it is sought
to be assessed...”
Similarly, in The Commissioner of Income Tax, Kerala,
Ernakulam v. The Travancore Sugars & Chemical Ltd.12, this
Courtrestated thus:
“22…  It is thus clear that where by the obligation income is
diverted before it reaches the assessee, it is deductible. But, where
the income is required to be applied to discharge an obligation
after such income reaches the assessee it is merely a case of
application of income to satisfy an obligation of payment and is
therefore not deductible.”
39. The CIT (A), while rejecting this ground, relied upon Sitaldas
Tirathdas (supra), and observed thus:
“... Where an assessee applies an income to discharge an obligation
after the income reaches the hands of the assessee, it would be
an application of income and this would resulting taxation of such
income in the hands of the appellant.”
40. We note that the same ground was also pressed in appeal
before the Tribunal which finds mention in the Tribunal’s order dated
31.01.2008 in the following words:
“(b) In failing to consider and appreciate that the amount received
by the appellant from the franchisees towards advertising
11 (1996) 7 SCC 221
12 (1973) 3 SCC 274
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contributions are diverted at source by overriding title for being
spent on advertisement ..”
However, the Tribunal did not record any observation addressing
this ground in the abovesaid order. It has been brought to our notice that
the assessee company has made an application under section 254(2) of
the 1961 Act for rectification of the Tribunal’s order citing an error
apparent on the face of the record. The said application is stated to be
pending.
41. Considering the fact that the question of diversion by overriding
title was neither framed nor agitated in the appeal memo before the
High Court or before this Court (except a brief mention in the written
submissions), coupled with the fact that neither the Tribunal nor the High
Court has dealt with that plea and that the rectification application raising
that ground is still undecided and stated to be pending before the Tribunal,
we deem it appropriate to leave it open to the appellant to pursue the
rectification application, if so advised. We may not be understood to
have expressed any opinion either way as regards the tenability of the
said application or otherwise.
42. In view of the aforestated terms, the questions posed for our
consideration stand answered against the appellant (assessee company)
and in favour of the Revenue and the appeal stands disposed of upholding
the impugned judgment with liberty to the appellant to pursue remedy of
rectification, as per law. There shall be no order as to
costs. Pending
interlocutory applications, if any, shall also stand disposed of.
Bibhuti Bhushan Bose
Appeal disposed of.
YUM! RESTAURANTS (MKTG.) PVT. LTD. v. COMMISSIONER OF
INCOME TAX, DELHI [A. M. KHANWILKAR, J.]