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 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]
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 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 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. Nonmembers, 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]
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 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 tow ards 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]
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]
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 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 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 IncomeTax, Assam AIR 1948 PC 142 –referred to. New York Life Insurance Co. v. Styles (Surveyor of Taxes) (1889) 2 TC 460 – referred to.
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.
As published in the Supreme Court Reports, Supreme Court of India. Text from the Indian Supreme Court Judgments open data set (Dattam Labs), CC BY 4.0.
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