It’s a well-known fact that the income earned by a person or an entity comes into the purview of the Income Tax Act, 1961. Section 2(24) of the said act says that any kind of receipt, by whatever name attributable, qualifies to be an income, unless proved contrary. Such income is taxable.
However, money pooled through contributions from individuals or entities to form not-for-profit recreational or societal organizations, can be immune to taxation, if it falls within the ambit of Doctrine of Mutuality.
Doctrine of Mutuality is based on the principle of natural justice, which enumerates that no one can make profit from himself or trade with himself.
The Doctrine of Mutuality is invoked when the surplus money that is left after all the intended activities are completed using the common pool of funds, is distributed back to the contributors/participants in the ratio of contributions or utilised for their benefit only.
Establishing Doctrine of Mutuality
The principle of doctrine of mutuality is established when the common identity, oneness of identity, non-profiteering, and obedience to mandate is established between the contributors and the entity. All these four conditions must be adhered jointly.
Applicability of doctrine of mutuality in three scenarios each case along with precedents laid by the Supreme Court of India:
- Interest earned from FDs of surplus from common pool fund
- Deemed letting out value on club house maintained through the common pool fund
- Surplus of a common pool fund, wherein non-members also contribute.
Scenario 1: Interest Earned from Fixed Deposits of Surplus from Common Pool Fund
Surplus arising out of income over expenditure, the sole source of income being contributions from registered members only, is exempted when doctrine of mutuality is applied. However, interest earned from such Fixed deposits made from the surplus funds are taxable.
Supreme Court Ruling –
The Hon’ble Supreme Court’s held that interest earned by a club on FDs made from Common Funds.
In the case of Banglore Club Vs. Commissioner of Income Tax & Another (2013) 3 SCC 509, it was observed by the Hon’ble Supreme Court that the concept of mutuality was extendable to the defined group of people who contributed to a common fund, controlled by the group, for a common benefit. Hence, any small increase in the common pool fund couldn’t be treated as income.
However, their Lordships observed that the ‘privity of mutuality’ was violated when the funds were placed by the club in the fixed deposits of a member’s bank. The member’s bank used the deposits in their ordinary course of banking business, thus violated the common pool as well as common identity principle. As a result, interest earned by the Assessee-club from the fixed deposits made through the surplus funds were pronounced as taxable under the head “Income from other Sources”.
Scenario 2: Deemed Letting Out Value of Club House Maintained through the common pool fund
The purpose of club house is to provide recreational and refreshment facilities exclusively to its members and their guests. It runs on no-profit-no-loss basis. Members pay for all their expenses and they aren’t entitled to share any surplus accrued. Surplus is utilised only in maintenance and developmental activities, to provide better facilities to its members.
Supreme Court Ruling
The Hon’ble Supreme Court’s observed that on deemed letting out value of club house maintained through the common pool fund.
In the case of Chelmsford Club Vs. Commissioner of Income Tax (2000) 3 SCC 214 it was held by the Hon’ble Supreme Court that even the deemed income from the property owned and maintained by the Club in the form of ‘Club House’ is governed by the principle of mutuality and the Annual Letting Value is not assessable as per the provisions of section 22 of Income Tax Act, 1961.
Delhi High Court Ruling
In the case of Commissioner of Income Tax, Delhi-II Vs. Delhi Gymkhana Club Ltd., (1985) 155 ITR 373 it was held by the Hon’ble Delhi High Court that letting out of the premises is merely a provision of a facility for members. The principle of mutuality clearly applied to the surplus earned as a result of such activities. The receipts of the club were not for the mere use of the rooms by way of rent. The receipts of the club were in the nature of payments made to the club for various kinds of facilities and services provided by it. The levy of a composite charge for such provision of facilities of residence and other incidentals shouldn’t be equated to the charging of a house rent or a rent for occupation of a residential building. Hence, the amounts received as a composite charge were not assessable as per the provisions of section 22 of Income Tax Act, 1961.
As a result, the notional value of rent also termed as Annual Letting Value that aroused based on ownership of the ‘Club House’ by the Assessee-club is not taxable under the head “Income from House Property”.
Scenario 3: Surplus of a common pool fund, wherein non-members also contribute
An entity incorporated exclusively for economisation of cost receives contributes for a common pool fund/Brand Fund from the franchisees/members qualifies under Doctrine of Mutuality, but when it receives contributions from non-members, though the said contributions are utilised for the only for the benefit the members of the common pool fund/Brand Fund, it will get independent status and thereby becomes taxable.
Supreme Court Ruling
The Hon’ble Supreme Court’s rulings on surplus of a common pool fund, wherein non-members also contribute.
In the case of YUM! Restaurants (Marketing) Private Limited Vs. Commissioner of Income Tax, Delhi [Civil Appeal No. 2847 of 2020], the Supreme Court has observed that any entity that receives contributions, the contributors must be the sole beneficiary, whereby the concept of mutuality is applicable, YUM! Restaurants (Marketing) Private Limited(YRMPL) is a wholly owned subsidiary of YRIPL exclusively for the purpose of economisation of the cost of advertising and promotion of the franchisees. As per the Tripartite Operating Agreement all the franchisees of YRIPL would contribute 5% of their gross sales for the proper conduct of the advertising, marketing and promotional activities for the mutual benefit of the parent company, Tricon India or TRIM and the franchisees. Since the entity and the said arrangement of cost management was made for no profit basis the concept of mutuality was invoked for, however based on the following specific conditions in the agreement:
- Funds are contributed by franchisees only, Tricon India/TRIM does not make any contribution
- The executive committee of Tricon India/TRIM rather than the contributing franchisees allocate the Advertising contribution, which possess sole and absolute discretion.
- Surplus or unspent amount is refundable to the contributing franchisees subject to the approval of the board.
- Pepsi Food Ltd, Pizza Hut as well as KFC made contributions for the Fund, fact being they were not franchisee of YRIPL or Tricon India or TRIM.
The impact of the above conditions, results in identification of each entity separately and violates the concept of mutuality, since contributors and the entity must have common identity and non-member cannot be a contributor, third party entity cannot have voting rights.
In result, the concept of mutuality is not applicable and the surplus is brought to tax under the head “Profits and Gains from Business or Profession”.
The burden of proof for adherence to concept of mutuality rests on the Assessee, who is under an obligation to produce cogent documentary evidence that establishes Doctrine of Mutuality beyond any reasonable doubt. The Assessee must also ensure zero contribution as well as executive powers from non-members.
The article titled “Doctrine of Mutuality – The Burden of Proof under Income Tax Act” is published in Andhra Chamber of Commerce – Information Bulletin – May 2020 Volume No. LXXV Page No. 19 to 21