M/s. Bangalore Club Vs Commissioner of Income Tax

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REPORTABLE IN THE SUPREME COURT OF INDIA

CIVIL APPELLATE JURISDICTION

CIVIL APPEAL NO. 124 OF 2007

M/S. BANGALORE CLUB — APPELLANT

VERSUS

COMMISSIONER OF INCOME TAX & ANR.

— RESPONDENTS

WITH

CIVIL APPEAL NO. 125 OF 2007, CIVIL APPEAL NO. 272 OF 2013

(Arising out of S.L.P.(Civil) No. 16863 of 2010),

CIVIL APPEAL NO.273 OF 2013 (Arising out of S.L.P.(Civil) No. 16880 of 2010),

CIVIL APPEAL NO.274 OF 2013 (Arising out of S.L.P.(Civil) No. 16881 of 2010),

CIVIL APPEAL NO.275 OF 2013 (Arising out of S.L.P.(Civil) No. 16882 of 2010)

CIVIL APPEAL NOS.276-277 OF 2013 (Arising out of S.L.P.(Civil) Nos. 16883-16884 of 2010)

AND

CIVIL APPEAL NO.278 OF 2013 (Arising out of S.L.P.(Civil) No. 16879 of 2010)

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J U D G M E N T

D.K. JAIN, J.

1. Leave granted in Special Leave Petitions.

2. This batch of appeals arises from a common judgment and

order pronounced by the High Court of Karnataka, in

Income Tax Appeals No. 115 of 1999 along with 70 of

2000, 3095 of 2005, 1547 of 2005, 1548 of 2005, 3091 of

2005, 3089 of 2005 along with 3093 of 2005, and 3088 of

2005. Since these appeals entail the same issue, they are

being disposed of by this common judgment.

3. The facts necessary for the purpose of appreciating the

controversy involved in the appeal are as follows:

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The Bangalore Club (hereinafter referred to as the

“assessee”), the appellant herein, is an unincorporated

Association of Persons, (AOP). In relation to the assessment

years 1989-90, 1990-91, 1993-94, 1994-95, 1995-96, 1996-

97, 1997-98, 1998-99 and 1999-2000, the assessee sought

an exemption from payment of income tax on the interest

earned on the fixed deposits kept with certain banks, which

were corporate members of the assessee, on the basis of

doctrine of mutuality. However, tax was paid on the interest

earned on fixed deposits kept with non-member banks.

The assessing officer rejected the assessee’s claim,

holding that there was a lack of identity between the

contributors and the participators to the fund, and hence

treated the amount received by it as interest as taxable

business income. On appeal by the assessee, the

Commissioner of Income Tax (Appeals)-II, Bangalore (“CIT

(A)” for short) reversed the view taken by the assessing

officer, and held that the doctrine of mutuality clearly applied

to the assessee’s case. On appeal by the revenue the

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Income-Tax Appellate Tribunal (for short “the Tribunal”),

affirmed the view taken by the CIT (A), observing thus (ITA

No. 2440/Ban/1991):

“7. In the instant case, the funds of the club are given in the form of deposits for earning income from the corporate members, namely, the banks here and, therefore, the earning of interest is clearly had risen out of the concept of mutuality only. The decisions relied upon by the DR have nowhere touch (sic) upon the fact as to whether it was with corporate members or not. Apparently, they had dealt with the situation where the transactions of interest are from persons who are not the members of the club. During the argument, the DR had admitted that the assessee had shown interest from certain other banks as its income which also goes to show that wherever the concept of mutuality was absent, the assessee had offered the same as income.”

On an application by the Commissioner of Income Tax,

Bangalore under Section 260A of the Income Tax Act, 1961

(for short “the Act”), the High Court entertained the appeal

and framed the following two substantial questions of law for

its adjudication :-

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“(1) Whether, a sum of Rs. 7,87,648/- received by the assessee as interest from fixed deposit made by the assessee in four banks who are members in the assessee club amounted to its income and constituted a revenue receipt as per the provision of Income Tax Act.

(2) Whether, the principle of mutuality can be made applicable to the fund deposited in the four banks who are also members of assessee club, especially when the fund is raised from contribution of several members including the four banks and the interest derived from it is utilized by several members of the assessee club?”

Answering both the questions in favour of the revenue, the High Court held :-

“12. On the facts of this case and in the light of the legal principles it is clear to us that what has been done by the club is nothing but what could have been done by a customer of a Bank . The principle of ‘no man can trade with himself’ is not available in respect of a nationalised bank holding a fixed deposit on behalf of its customer. The relationship is one of a banker and a customer.”

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Consequently, the High Court reversed the decision of the

Tribunal and restored the order of the assessing officer.

Hence, this appeal by the assessee.

4. Thus, the short question for determination is whether or

not the interest earned by the assessee on the surplus

funds invested in fixed deposits with the corporate

member banks is exempt from levy of Income Tax, based

on the doctrine of mutuality?

5. Mr. Joseph Vellapally, learned senior counsel appearing for

the assessee strenuously urged that the assessee meets

all the requirements, as laid down in The English &

Scottish Joint Co-operative Wholesale Society Ltd.

Vs. The Commissioner of Agricultural Income Tax,

Assam1, as affirmed by this Court in Chelmsford Club

Vs. Commissioner of Income Tax, Delhi2 in order to

fall within the ambit of the principle of mutuality.

According to the learned counsel, there is a complete 1 AIR 1948 PC 142 (E) 2 (2000) 3 SCC 214

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identity between the contributors to the fund and the

assessee and the recipients from the funds, in as much

as the interest earned by the assessee from the surplus

fund invested in fixed deposits with member banks are

always available and are used for the benefit of members

alike. It was asserted that there is no commercial motive

involved in the dealings of the assessee with its members,

including the banks concerned. It was also argued that the

interest earned on such deposits with the member banks

was always available for use and benefit of the members

of the assessee, in as much as the said interest merged

with the common fund of the club.

6. Mr. A.S. Chandhiok, learned Additional Solicitor General of

India, on the other hand, contended that the fundamental

principle for applicability of the doctrine of mutuality is a

complete identity between the contributors and the

participators, which is missing in this case. It was

submitted that in the present case, the surplus funds in

the hands of the assessee were placed at the disposal of

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the corporate members viz. the banks, with the sole

motive to earn interest, which brings in the commerciality

element and thus, the interest so earned by the assessee

has to be treated as a revenue receipt, exigible to tax. It

was pleaded that transaction between the assessee and

the member banks concerned was in the nature of parking

of funds by the assessee with a corporate member and

was nothing but what could have been done by a

customer of a bank and therefore, the principle that “no

man could trade with himself” is not applicable.

7. Before we evaluate the rival stands, it would be necessary

to appreciate the general understanding of doctrine of

mutuality. The principle relates to the notion that a person

cannot make a profit from himself. An amount received

from oneself is not regarded as income and is therefore

not subject to tax; only the income which comes within the

definition of Section 2(24) of the Act is subject to tax

(income from business involving the doctrine of mutuality

is denied exemption only in special cases covered under

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clause (vii) of Section 2 (24) of the Act). The concept of

mutuality has been extended to defined groups of people

who contribute to a common fund, controlled by the group,

for a common benefit. Any amount surplus to that needed

to pursue the common purpose is said to be simply an

increase of the common fund and as such neither

considered income nor taxable. Over time, groups which

have been considered to have mutual income have

included corporate bodies, clubs, friendly societies, credit

unions, automobile associations, insurance companies and

finance organizations. Mutuality is not a form of

organization, even if the participants are often called

members. Any organization can have mutual activities. A

common feature of mutual organizations in general and of

licensed clubs in particular, is that participants usually do

not have property rights to their share in the common

fund, nor can they sell their share. And when they cease to

be members, they lose their right to participate without

receiving a financial benefit from the surrender of their

membership. A further feature of licensed clubs is that

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there are both membership fees and, where prices

charged for club services are greater than their cost,

additional contributions. It is these kinds of prices and/or

additional contributions which constitute mutual income.

8. The doctrine of mutuality finds its origin in common law.

One of the earliest modern judicial statements of the

mutuality principle is by Lord Watson in the House of

Lords, in 1889, in Styles (Surveyor of Taxes) Vs. New

York Life Insurance Co.3 (hereinafter referred to as the

“Styles case”). The appellant in that case was an

incorporated company. The company issued life policies of

two kinds, namely, participating and non-participating. The

members of the mutual life insurance company were

confined to the holders of the participating policies, and

each year, the surplus of receipts over expenses and

estimated liabilities was divided among them, either in the

form of a reduction of future premiums or of a

reversionary addition to the policies. There were no shares

3 [1889] 2 TC 460 10

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or shareholders in the ordinary sense of the term but each

and every holder of a participating policy became ipso

facto a member of the company and as such became

entitled to a share in the assets and liable for a share in

the losses. The company conducted a calculation of the

probable death rate amongst the members and the

probable expenses and liabilities; calls in the shape of

premiums were made on the members accordingly. An

account used to be taken annually and the greater part of

the surplus of such premiums, over the expenditure

referable to such policies, was returned to the members

i.e. (holders of participating policies) and the balance was

carried forward as a fund in hand to the credit of the

general body of members. The question was whether the

surplus returned to the members was liable to be assessed

to income tax as profits or gains. The majority of the Law

Lords answered the question in the negative. It may be

noticed that in that case the members had associated

themselves together for the purpose of insuring each

other’s life on the principle of mutual assurance, that is to

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say, they contributed annually to a common fund out of

which payments were to be made, in the event of death,

to the representatives of the deceased members. Those

persons were alone the owners of the common fund and

they alone were entitled to participate in the surplus. This

surplus was obtained partly from the profits arising from

non-participating policies and other business. It was held

that that portion of the surplus which arose from the

excess contributions of the holders of participating policies

was not an assessable profit. It was therefore, held to be a

case of mutual assurance. The individuals insured and

those associated for the purpose of receiving their

dividends and meeting other stipulated requisites under

the policies were identical. It was held that that identity

was not destroyed by the incorporation of the company.

Lord Watson even went to the extent of saying that the

company in that case did not carry on any business at all,

which perhaps was stating the position a little too widely

as pointed out by Viscount Cave in a later case; but, be

that as it may, all the Noble Lords, who formed the

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majority, were of the view that what the members

received were not profits but their respective shares of the

excess amount contributed by themselves. They held 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.”

9. Lord Watson’s statement was explained by the House of

Lords in The Commissioners Of Inland Revenue Vs.

The Cornish Mutual Assurance Co. Ltd.4 wherein it

was held that a mutual concern may be held to carry on a

business or trade with its members, though the surplus

arising from such trade is not taxable income or profit.

10. The High Court of Australia first considered the

mutuality principle in The Bohemians Club Vs. The

Acting Federal Commissioner of Taxation5 in 1918:

4 [1926] 12 T.C. 841 (H.L.) 5 (1918) 24 CLR 334

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“A man is not the source of his own income ... A man’s income consists of moneys derived from sources outside of himself. Contributions made by a person for expenditure in his business or otherwise for his own benefit cannot be regarded as his income ... The contributions are, in substance, advances of capital for a common purpose, which are expected to be exhausted during the year for which they are paid. They are not income of the collective body of members any more than the calls paid by members of a company upon their shares are income of the company. If anything is left unexpended it is not income or profits, but savings, which the members may claim to have returned to them.”

(Emphasis

added)

11. One of the first Indian cases that dealt with the

principle was Commissioner of Income-Tax, Bombay

City Vs. Royal Western India Turf Club Ltd.6. It

quoted with approval three conditions stipulated in The

English & Scottish Joint Co-operative Wholesale

Society Ltd. (supra), which were propounded after

referring to various passages from the speeches of the

different Law Lords in Styles case (supra). Lord Normand,

6 AIR 1954 SC 85 14

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who delivered the judgment of the Board summarized the

grounds of the decision in Styles case (supra) as follows:

“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.”

12. We will consider each of these conditions in detail

before proceeding to the facts of the case. The first

condition requires that there must be a complete identity

between the contributors and participators. This was first

laid down by Lord Macmillan in Municipal Mutual

Insurance Ltd. Vs. Hills7 wherein he observed:

“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

7 (1932) 16 TC 430, 448 (HL); CIT v. Firozepur Ice Manufacturers’ Association 84 ITR 607

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contributors to the common fund; in other words, there must be complete identity between the contributors and the participators.”

13. On this aspect of the doctrine, especially with regard

to the non-members, Halsbury’s Laws of England, 4th

Edition, Reissue, Vol. 23, paras 161 and 162 (pp. 130 and

132) states:

“Where the trade or activity is mutual, the fact that, as regards certain activities, certain members only of the association take advantage of the facilities which it offers does not affect the mutuality of the enterprise.

* * * Members' clubs are an example of a mutual undertaking; but, where a club extends facilities to non-members, to that extent the element of mutuality is wanting....”

14. Simon’s Taxes, Vol. B, 3rd Edn., paras B1.218 and B1.

222 (pp. 159 and 167) formulate the law on the point,

thus:

“..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 therefore no assessment in respect of the trade can be made. Any surplus resulting from

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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....

* * * It has been held that a company conducting a members' (and not a proprietary) club, the members of the company and of the club being identical, was not carrying on a trade or business or undertaking of a similar character for purposes of the former corporation profits tax.

* * * A members' club is assessable, however, in respect of profits derived from affording its facilities to non-members. Thus, in Carlisle and Silloth Golf Club v. Smith, (1913) 3 K.B. 75, where a members' golf club admitted non- members to play on payment of green fees it was held that it was carrying on a business which could be isolated and defined, and the profit of which was assessable to income tax. But there is no liability in respect of profits made from members who avail themselves of the facilities provided for members.”

(Emphasis supplied)

15. In short, there has to be a complete identity between

the class of participators and class of contributors; the

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particular label or form by which the mutual association is

known is of no consequence. Kanga & Palkhivala explain

this concept in “The Law and Practice of Income Tax” (8th

Edn. Vol. I, 1990) at p. 113 as follows:

“...The contributors to the common fund and the participators in the surplus must be an identical body. That does not mean that each member should contribute to the common fund or that each member should participate in the surplus or get back from the surplus precisely what he has paid." The Madras, Andhra Pradesh and Kerala High Courts have held that the test of mutuality does not require that the contributors to the common fund should willy-nilly distribute the surplus amongst themselves : it is enough if they have a right of disposal over the surplus, and in exercise of that right they may agree that on winding up the surplus will be transferred to a similar association or used for some charitable objects....” (Emphasis supplied)

16. British Tax Encyclopedia (I), 1962 Edn. (edited by

G.S.A. Wheatcroft) at pp. 1201, dealing with “mutual

trading operations”, the law is stated as under:

“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

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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....”

(Emphasis supplied)

17. In Jones Vs. South-West Lancashire Coal Owners’

Association Ltd.8, Viscount Cave LC held that “sooner or

later, in meal or in malt, the whole of the associations”

receipts must go back to the policy holders as a class,

though not precisely in the proportions in which they have

contributed to them and the association does not in any

true sense make any profit out of their contributions.

18. Therefore, in the case of Royal Western India Turf

Club Ltd. (supra), since the club realized money from

both members and non- members, in lieu of the same

81927 AC 827 19

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services rendered in the course of the same business, the

exemption of mutuality could not be granted. This Court

held thus:

“As already stated, in the instant case there is no mutual dealing between the members inter se and no putting up of a common fund for discharging the common obligations to each other undertaken by the contributors for their mutual benefit. On the contrary, we have here an incorporated company authorised to carry on an ordinary business of a race course company and that of licensed victuallers and refreshment purveyors and in fact carrying on such a business. There is no dispute that the dealings of the company with non-members take place in the ordinary course of business carried on with a view to earning profits as in any other commercial concern.”

(Emphasis supplied)

19. The second feature demands that the actions of the

participators and contributors must be in furtherance of

the mandate of the association. In the case of a club, it

would be necessary to show that steps are taken in

furtherance of activities that benefit the club, and in turn

its members. Therefore, in Chelmsford Club (supra),

since the appellant provided recreational facilities 20

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exclusively to its members and their guests on “no-profit-

no-loss” basis and surplus, if any, was used solely for

maintenance and development of the club, the Court

allowed the exception of mutuality.

20. The mandate of the club is a question of fact and can

be determined from the memorandum or articles of

association, rules of membership, rules of the

organization, etc. However, the mandate must not be

construed myopically. While in some situations, the

benefits may be evident directly in the short-run, in others,

they may be accruable to an organization indirectly, in the

long-run. Space must be made for both such forms of

interactions between the organization and its members.

Therefore, as Finlay J. observed in National Association

of Local Government Officers Vs. Watkins9, where

member of a club orders dinner and consumes it, there is

no sale to him. At the same time, as in case of

Commissioner of Income Tax, Bihar Vs. Bankipur

9 (1934) 18 TC 499; 503, 506 21

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Club Ltd.10, where a club makes ‘surplus receipts’ from

the subscriptions and charges for the various

conveniences paid by members, even though there is no

direct benefit of the receipts to the customers, the fact

that they will eventually be used in furtherance of the

services of the club must be considered as a furtherance

of the mandate of the club.

21. Thirdly, there must be no scope of profiteering by the

contributors from a fund made by them which could only

be expended or returned to themselves. The locus

classicus pronouncement comes from Rowlatt, J’s

observations in Thomas Vs. Richard Evans & Co. Ltd.11

wherein, while interpreting Styles case (supra), he held

that if profits are distributed to shareholders as

shareholders, the principle of mutuality is not satisfied. He

observed thus:

"But a company can make a profit out of its members as customers, although its range of customers is limited to its shareholders. If a

10 (1997) 5 SCC 394 11 (1927) 11 TC 790

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railway company makes a profit by carrying its shareholders, or if a trading company, by trading with the shareholders - even if it limited to trading with them - makes a profit, that profit belongs to the shareholders, in a sense, but it belongs to them qua shareholders. It does not come back to them as purchasers or customers. It comes back to them as shareholders, upon their shares. Where all that a company does is to collect money from a certain number of people - it does not matter whether they are called members of the company, or participating policy holders - and apply it for the benefit of those same people, not as shareholders in the company, but as the people who subscribed it, then, as I understand the New York case, there is no profit. If the people were to do the thing for themselves, there would be no profit, and the fact that they incorporate a legal entity to do it for them makes no difference, there is still no profit. This is not because the entity of the company is to be disregarded, it is because there is no profit, the money being simply collected from those people and handed back to them, not in the character of shareholders, but in the character of those who have paid it. That, as I understand it, is the effect of the decision in the New York case." (Emphasis supplied)

22. In Commissioner of Income Tax, Madras Vs.

Kumbakonam Mutual Benefit Fund Ltd.12, this Court

12 AIR 1965 SC 96 23

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differentiated the facts of the case before it from those of

Styles case (supra) and denied the exemption of

mutuality because of the taint of commerciality. It was

observed thus:

“It seems to us that it is difficult to hold that Style's case applies to the facts of the case. A shareholder in the assessee company is entitled to participate in the profits without contributing to the funds of the company by taking loans. He is entitled to receive his dividend as long as he holds a share. He has not to fulfil any other condition. His position is in no way different from a shareholder in a banking company, limited by shares. Indeed, the position of the assessee is no different from an ordinary bank except that it lends money to and receives deposits from its shareholders. This does not by itself make its income any the less income from business within S. 10 of the Indian Income Tax Act.”

23. However, at what point mutuality ends and

commerciality begins is a difficult question of fact. It is

best summarized in Bankipur Club (supra) wherein this

Court echoed the following views:

“…if the object of the assessee company claiming to be a "mutual concern" or "club", is to carry on a particular business and money is realised both from the members and from non- members, for the same consideration by giving

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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. In other words, the activity carried on by the assessee in such cases, claiming to be a "mutual concern" or “members' club" is a trade or an adventure in the nature of trade and the transactions entered into with the members or non-members alike is a trade/business/transaction and the resultant surplus is certainly profit - income liable to tax. We should also state, that "at what point, does the relationship of mutuality end and that of trading begin" is a difficult and vexed question. A host of factors may have to be considered to arrive at a conclusion. "Whether or not the persons dealing with each other, is a ‘mutual club’ or carrying on a trading activity or an adventure in the nature of trade", is largely a question of fact [Wilcock's case - 9 Tax Cases 111, (p.132); C.A. (1925) (1) KB 30 at p. 44 and 45].”

24. In Royal Western India Turf Club Ltd. (supra), this

Court made similar observations, holding that it is not

always the case that a legal entity cannot make profits out

of its members. It held as follows :

“14…The principle that no one can make a profit out of himself is true enough but may in its application easily lead to confusion.

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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 money 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 of 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…”

(Emphasis

supplied)

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25. This brings us to the facts of the present case. As

aforesaid, the assessee is an AOP. The concerned banks

are all corporate members of the club. The interest earned

from fixed deposits kept with non- member banks was

offered for taxation and the tax due was paid. Therefore,

we are required to examine the case of the assessee, in

relation to the interest earned on fixed deposits with the

member banks, on the touchstone of the three cumulative

conditions, enumerated above.

26. Firstly, the arrangement lacks a complete identity

between the contributors and participators. Till the stage

of generation of surplus funds, the setup resembled that of

a mutuality; the flow of money, to and fro, was maintained

within the closed circuit formed by the banks and the club,

and to that extent, nobody who was not privy to this

mutuality, benefited from the arrangement. However, as

soon as these funds were placed in fixed deposits with

banks, the closed flow of funds between the banks and the

club suffered from deflections due to exposure to

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commercial banking operations. During the course of their

banking business, the member banks used such deposits

to advance loans to their clients. Hence, in the present

case, with the funds of the mutuality, member banks

engaged in commercial operations with third parties

outside of the mutuality, rupturing the ‘privity of

mutuality’, and consequently, violating the one to one

identity between the contributors and participators as

mandated by the first condition. Thus, in the case before

us the first condition for a claim of mutuality is not

satisfied.

27. As aforesaid, the second condition demands that to

claim an exemption from tax on the principle of mutuality,

treatment of the excess funds must be in furtherance of

the object of the club, which is not the case here. In the

instant case, the surplus funds were not used for any

specific service, infrastructure, maintenance or for any

other direct benefit for the member of the club. These

were taken out of mutuality when the member banks

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placed the same at the disposal of third parties, thus,

initiating an independent contract between the bank and

the clients of the bank, a third party, not privy to the

mutuality. This contract lacked the degree of proximity

between the club and its member, which may in a distant

and indirect way benefit the club, nonetheless, it cannot

be categorized as an activity of the club in pursuit of its

objectives. It needs little emphasis that the second

condition postulates a direct step with direct benefits to

the functioning of the club. For the sake of argument, one

may draw remote connections with the most brazen

commercial activities to a club’s functioning. However,

such is not the design of the second condition. Therefore,

it stands violated.

28. The facts at hand also fail to satisfy the third condition

of the mutuality principle i.e. the impossibility that

contributors should derive profits from contributions made

by themselves to a fund which could only be expended or

returned to themselves. This principle requires that the

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funds must be returned to the contributors as well as

expended solely on the contributors. True, that in the

present case, the funds do return to the club. However,

before that, they are expended on non- members i.e. the

clients of the bank. Banks generate revenue by paying a

lower rate of interest to club-assessee, that makes

deposits with them, and then loan out the deposited

amounts at a higher rate of interest to third parties. This

loaning out of funds of the club by banks to outsiders for

commercial reasons, in our opinion, snaps the link of

mutuality and thus, breaches the third condition.

29. There is nothing on record which shows that the banks

made separate and special provisions for the funds that

came from the club, or that they did not loan them out.

Therefore, clearly, the club did not give, or get, the

treatment a club gets from its members; the interaction

between them clearly reflected one between a bank and

its client. This directly contravenes the third condition as

elucidated in Styles and Kumbakonam Mutual Benefit

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Fund Ltd. cases (supra). Rowlatt J., in our opinion,

correctly points out that if profits are distributed to

shareholders as shareholders, the principle of mutuality is

not satisfied. In Thomas Vs. Richard Evans & Co.

(supra), at pp. 822-823, he observed thus :

"But a company can make a profit out of its members as customers, although its range of customers is limited to its shareholders. If a railway company makes a profit by carrying its shareholders, or if a trading company, by trading with the shareholders - even if it limited to trading with them - makes a profit, that profit belongs to the shareholders, in a sense, but it belongs to them qua shareholders. It does not come back to them as purchasers or customers. It comes back to them as shareholders, upon their shares. Where all that a company does is to collect money from a certain number of people - it does not matter whether they are called members of the company, or participating policy holders - and apply it for the benefit of those same people, not as shareholders in the company, but as the people who subscribed it, then, as I understand the New York case, there is no profit. If the people were to do the thing for themselves, there would be no profit, and the fact that they incorporate a legal entity to do it for them makes no difference, there is still no profit. This is not because the entity of the company is to be disregarded, it is because there is no profit, the money being simply collected from those people and handed back to them, not in the

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character of shareholders, but in the character of those who have paid it. That, as I understand it, is the effect of the decision in the New York case."

(Emphasis supplied)

In the present case, the interest accrues on the surplus

deposited by the club like in the case of any other deposit

made by an account holder with the bank.

30. An almost similar issue arose in Kumbakonam

Mutual Benefit Fund Ltd. case (supra). The facts in

that case were that the assessee, namely, Kumbakonam

Mutual Benefit Fund Ltd., was an incorporated company

limited by shares. Since 1938, the nominal capital of the

assessee was Rs.33,00,000/- divided into shares of

Rs.1/- each. It carried on banking business restricted to its

shareholders, i.e., the shareholders were entitled to

participate in its various recurring deposit schemes or

obtain loans on security. Recurring deposits were

obtained from members for fixed amounts to be

contributed monthly by them for a fixed number of months

as stipulated at the end of which a fixed amount was

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returned to them according to published tables. The

amount so returned, covered the compound interest of the

period. These recurring deposits constituted the main

source of funds of the assessee for advancing loans. Such

loans were restricted only to members who had, however,

to offer substantial security therefor, by way of either the

paid up value of their recurring deposits, if any, or

immovable properties within a particular district. Out of

the interest realised by the assessee on the loans which

constituted its main income, interest on the recurring

deposits aforesaid was paid as also all the other outgoings

and expenses of management and the balance amount

was divided among the members pro rata according to

their share-holdings after making provision for reserves,

etc., as required by the Memorandum or Articles aforesaid.

It was not necessary for the shareholders, who were

entitled to participate in the profits to either take loans or

make recurring deposits.

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31. On these facts, as already noted, the Court

distinguished Styles case (supra) and opined that the

position of the assessee was no different from an ordinary

bank except that it lent money and received deposits from

its shareholders. This did not by itself make its income

any less income from business. In our opinion, the ratio of

the said decision is on all fours to the facts at hand. The

interest earned by the assessee even from the member

banks on the surplus funds deposited with them had the

taint of commerciality, fatal to the principle of mutuality.

32. We may add that the assessee is already availing the

benefit of the doctrine of mutuality in respect of the

surplus amount received as contributions or price for some

of the facilities availed by its members, before it is

deposited with the bank. This surplus amount was not

treated as income; since it was the residue of the

collections left behind with the club. A façade of a club

cannot be constructed over commercial transactions to

avoid liability to tax. Such setups cannot be permitted to 34

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claim double benefit of mutuality. We feel that the present

case is a clear instance of what this Court had cautioned

against in Bankipur Club (supra), when it said:

“… if the object of the assessee company claiming to be a "mutual concern" or "club", is to carry on a particular business and 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. In other words, the activity carried on by the assessee in such cases, claiming to be a "mutual concern" or Members' club" is a trade or an adventure in the nature of trade and the transactions entered into with the members or non-members alike is a trade/business/transaction and the resultant surplus is certainly profit - income liable to tax. We should also state, that "at what point, does the relationship of mutuality end and that of trading begin" is a difficult and vexed question. A host of factors may have to be considered to arrive at a conclusion. "Whether or not the persons dealing with each other, is a "mutual club" or carrying on a trading activity or an adventure in the nature of trade" is largely a question of fact [Wilcock's case - 9 Tax Cases 111, (132) C.A. (1925) (1) KB 30 at 44 and 45].” (Emphasis supplied)

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33. In our opinion, unlike the aforesaid surplus amount

itself, which is exempt from tax under the doctrine of

mutuality, the amount of interest earned by the assessee

from the afore-noted four banks will not fall within the

ambit of the mutuality principle and will therefore, be

exigible to Income-Tax in the hands of the assessee-club.

34. In light of the afore-going discussion, these appeals

are bereft of any merit and are thus, liable to be

dismissed. Accordingly, we dismiss all the appeals with

costs.

……..…………………………………. (D.K. JAIN, J.)

……..…………………………………. (JAGDISH SINGH KHEHAR, J.)

NEW DELHI, JANUARY 14, 2013.

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RS

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M/S. BANGALORE CLUB Vs COMMISSIONER OF INCOME TAX

M/S. BANGALORE CLUB Vs COMMISSIONER OF INCOME TAX