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Commr. Of Income Tax v. Cochin Oil Merchants Association

Kerala High Court

Jun 17, 1987

Judgment

Subsequent
References

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Factual and Procedural Background

This opinion arises from five referred cases submitted to this Court by the Income-tax Appellate Tribunal at the instance of the Revenue. The respondent in all five matters is the same assessee, a trade association of oil merchants formed to promote and protect persons engaged in coconut oil generally.

The relevant assessments were: re-assessments for the years 1974-75 to 1976-77 (under S. 143(3) read with S. 147(b) of the Income-tax Act, 1961) and regular assessments for 1977-78 and 1978-79. For these years the respondent/assessee received subscriptions from its members in the amounts of Rs. 6,850; Rs. 5,800; Rs. 5,700; Rs. 5,500; and Rs. 5,150 respectively.

The central factual and procedural dispute was whether these subscriptions paid by members to the association were assessable income. The assessee asserted that the subscriptions were not taxable because the association is a mutual association. The Income-tax Officer rejected that claim. The Appellate Assistant Commissioner and thereafter the Income-tax Appellate Tribunal held that the association was a mutual benefit association and that subscriptions received from members could not be considered income in the hands of the association, relying on the decision in C.I.T. v. Madras Race Club (105 I.T.R. 433). The Revenue, dissatisfied, invoked S. 256(1) of the Income-tax Act to have questions of law referred to this Court.

The Tribunal referred five specific questions of law arising from its common appellate order. The Court heard counsel for the Revenue (Mr. N.R.K. Nair) and for the respondent/assessee (Mr. Chacko George). Following argument, the Court addressed whether, as a matter of law, the assessee could be considered a mutual association and whether the Tribunal's conclusions were legally correct.

Legal Issues Presented

Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the subscriptions received by the assessee from its members cannot be considered to be income in the hands of the assessee?
Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the assessee was a “mutual association”?
Whether, on the facts and in the circumstances of the case and on an interpretation of S.44A of the Income-tax Act, 1961, the Tribunal was correct in law in holding that S.44 of the Income-tax Act, 1961 recognizes the position that the receipts from the members by way of subscription or otherwise would not be income in the hands of the association?
Whether, on the facts and in the circumstances of the case, the Tribunal was correct in law in holding that the receipts of a trade association from its members by way of subscription or otherwise are receipts that partake the character of mutual receipts and that treating them as "otherwise" (i.e., non-mutual receipts) would be unwarranted and wrong?
Whether, on the facts and in the circumstances of the case, the Tribunal was correct in law and on facts in holding that neither the incorporation under S.26 of the Companies Act nor Clause V of the memorandum of association of the assessee has destroyed the mutual character of the assessee?

Arguments of the Parties

Revenue's Arguments

The Revenue stressed two principal aspects to show that the assessee could not be a mutual association in law:
- The assessee is incorporated as a company under S.26 of the Companies Act, and that incorporation is said to be inconsistent with mutuality.
- The Memorandum of Association contains a provision that on winding up or dissolution the surplus would be transferred to another institution with similar objects or to a charitable body or bodies to be determined by the members and not be distributed among the members. The Revenue contended this provision negates the members' participatory claim to surplus and thus destroys mutuality.

Assessee's Arguments

The assessee (respondent) contended that incorporation as a company does not destroy its mutual character.
Regarding the clause dealing with disposal of surplus on winding up, the assessee submitted that this clause is only a fetter on the mode of disposal and does not mean members are not participators in the surplus; the members continue to have disposal over the surplus.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
C.I.T. v. Madras Race Club (105 I.T.R. 433)	Establishes that incorporation of a limited company does not necessarily destroy a claim for exemption based on mutuality; a company may be eligible for exemption of surplus derived from dealings of the members either on the principle of mutuality (no one can make a profit out of himself) or because there is no trading or profit motive in transactions between a club and its members.	The Court relied on and expressly concurred with the reasoning and conclusion of the Madras High Court. It applied the principle that incorporation and a memorandum clause about disposal on winding up do not, by themselves, negate mutuality.
C.I.T. v. Madras Stock Exchange Ltd. (105 I.T.R. 546) (Madras)	This decision dealt with entitlement to exemption under S.11 on the basis that the trust was for a charitable purpose (different legal question and context).	The Court accepted the Appellate Tribunal's distinction of this case as not applicable to the mutuality question before it.
Addl. C.I.T. v. Ahmedabad Millowners' Association (106 I.T.R. 725) (Gujarat)	That case concerned exemption from income-tax under S.11 based on charitable purpose (distinguishable facts and legal basis).	The Court concurred with the Tribunal's view that this authority is distinguishable and does not defeat the mutuality claim in the present case.
C.I.T. v. Shree Jari Merchants Association (106 I.T.R. 542) (Gujarat)	Concerned an association registered under S.27 of the Trade Unions Act where, at dissolution, surplus assets were to be used as per a resolution and need not be returned to members; in that circumstance identity between contributors and recipients could be lost.	The Court accepted the Tribunal's distinction: because in that case surplus need not be returned to members, it differed materially and thus did not govern the present mutuality issue.

Court's Reasoning and Analysis

The Court framed the sole legal question for decision as whether, in law, the assessee could be considered a mutual association. It proceeded through the following analytical steps, based on the opinion's text:

The Court noted the two primary contentions of the Revenue (incorporation under S.26 and the memorandum clause regarding surplus on winding up) and the corresponding responses by the assessee (incorporation does not destroy mutual character; the surplus clause is merely a fetter on disposal).
The Court determined that the matter was governed by the Madras High Court decision in C.I.T. v. Madras Race Club (105 I.T.R. 433). That decision, after reviewing authorities (including the Supreme Court, Privy Council and House of Lords as referenced by the Madras Court), held that incorporation of a limited company does not by itself extinguish a claim to exemption founded on mutuality, and that a company may qualify for exemption where dealings are between members without trading or profit motive.
The Court extracted from the Madras decision the specific holding that a clause in the memorandum or articles restricting distribution of surplus on winding up does not necessarily mean members are not participators: the memorandum and articles represent the contract between company and members, and because members have ownership and control over surplus assets (including the right to decide disposal), a clause specifying a mode of disposal is merely a fetter and does not negate participation in the surplus.
Applying these principles to the facts, the Court held that incorporation under S.26 and the memorandum clause about disposal on dissolution did not nullify the principle of mutuality in the present case. The members retained a right of disposal over surplus sufficient to demonstrate participation.
The Court considered and accepted the Appellate Tribunal's distinctions of cited contrary authority (cases turning on S.11 charitable trusts or different registration and dissolution rules under S.27 Trade Unions Act) as factually and legally distinguishable from the present situation.
The Tribunal's invocation of S.44A of the Income-tax Act was noted and accepted as reinforcing the conclusion that receipts from members by way of subscription are of a mutual character and not assessable as business income: S.44A, in the Tribunal's view, recognizes that certain expenditures related to member receipts are to be treated so as not to convert receipts into assessable business receipts. The Court found no error in that reasoning or conclusion.
The Court treated the finding that the assessee is a trade association rendering services to its members (and sometimes to non-members for a fee) as a pure finding of fact by the Tribunal, which supported the mutuality conclusion.

Holding and Implications

The Court answered each of the five questions referred by the Tribunal in the affirmative, against the Revenue and in favour of the assessee. Concretely:

Question No.1: Answered in the affirmative — the subscriptions received by the assessee from its members cannot be considered income in the hands of the assessee.
Question No.2: Answered in the affirmative — the assessee is a mutual association.
Question No.3: Answered in the affirmative — the Tribunal's interpretation of S.44A (and reference to S.44) is correct as recognizing that member receipts are not taxable income of the association.
Question No.4: Answered in the affirmative — receipts from members by way of subscription or otherwise partake of the character of mutual receipts; the Tribunal was right to emphasise the word "otherwise".
Question No.5: Answered in the affirmative — neither incorporation under S.26 of the Companies Act nor the memorandum clause regarding surplus on winding up destroyed the mutual character of the assessee.

The opinion concludes: THE ABOVE INCOME TAX REFERRED CASES ARE DISPOSED OF AS ABOVE. A copy of the judgment will be forwarded to the Tribunal under the seal of the Court and signature of the Registrar, as required by law.

Implications: The direct effect of the decision is that, on the facts before the Tribunal and Court, the subscription receipts from members are not treated as taxable income of the association and the assessee's mutuality claim succeeds. The opinion relies on and concurs with existing authority (C.I.T. v. Madras Race Club) and, as presented in the text, does not purport to establish a new broader rule beyond the application to these referred cases.

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The Judgment of the Court was delivered by

Paripoornan, J.:— Common questions of law have been referred for the decision of this Court by the Income-tax Appellate Tribunal, in these five referred cases, at the instance of the Revenue. The respondent in these five cases is the same assessee. The assessee is a trade association of oil merchants. Its objects are the promotion and protection of those persons engaged in coconut oil generally. The assessment for the three years, 1974-75 to 1976-77, are re-assessments effected under S. 143(3) read with S. 147(b) of the Income Tax Act, 1961. The assessments for the years 1977-78 and 1978-79 are regular assessments. The respondert/assessee received subscriptions of Rs. 6,850/-, Rs. 5,800/-, Rs. 5,700/-, Rs. 5,500/- and Rs. 5,150/- for these years from its members. The question that was considered by the Appellate Tribunal and again raised for our consideration is regarding the assessability of the subscription paid by the members of the assessee-association to the assessee for the various years. The assessee claimed that the above subscriptions are not taxable since it is a mutual association. The Income Tex Officer negatived the said plea. In the appeals, the Appellate Assistant Commissioner held that the respondent-assessee is a mutual benefit assessee is a mutual benefit association. He took the view that the mere fact that the assessee is incorporated under S. 26 of the Companies Act, will not destory the principle of mutuality. Reliance was placed on the decision reported in C.I.T v. Madras Race Club (105 I.T.R 433). The Appellate Tribunal concurred with the said decision, and held that the subscriptions received by the assessee from its members cannot be considered to be income in the hands of the assessee. The Revenue filed petitions under S. 256(1) of the Income Tax Act for referring certain questions of law which arose out of the common appellate order of the Tribunal, for first 4 years dated 26-12-1980. Accordingly, the Appellate Tribunal has referred the following five questions of law for the decision of this Court:

“(1) Whether, on the facts and in the circumstances of the case, the Tribunal was tight in law in holding that the subscriptions received by the assessee from Ha members cannot be considered to be income in the hands of the assessee?

(2) Whether, on the facts and in the circumstances of the case, the Tribunal has right in law in holding that the assessee was a “mutual association”?

(3) Whether, on the facts and in the circumstances of the case and on an interpretation of S. 44A of the Income-tax Act. 1961 the Tribunal was correct in law in holding that “S. 44 of Incometax Act, 1961 recognise the position that the receipts from the members by way of subscription or otherwise, would not be income in the hands of the association”?

(4) Whether, on the facts and in the circumstances of the case, the Tribunal was correct in law in holding that the receipts of a trade association from its members by way of subscription or otherwise are receipts that partake the character of mutual receipts and is not consideration of receipts “otherwise” unwarranted and wrong?

(5) Whether, on the facts and in the circumstances of the case, the Tribunal was correct in law and on facts in holding that neither the incorporation under S. 26 of the Companies Act nor Clause V of the memorandum of association of the assessee has destroyed the mutual character of the assessee?

2. For the assessment year 1978-79, the Appellate Tribunal followed its earlier decision dated 26-12-1980. Thereafter, on motion by the Revenue, the Appellate Tribunal referred question Nos. 1, 3, 4 and 5, out of the above mentioned questions, for the decision of this Court in I.T.R No. 126 of 1983, relating to the assessmeat year 1978-79.

3. We heard counsel for the Revenue, Mr. N.R.K Nair, as also counsel for the respondent/assessee, Mr. Chacko George.

4. The sole question raised before us was whether in law, the asaassea cauld be ooasidered to be a mutual association. Two aspects were stressed to show that the assessee cannot be a mutual association in law as claimed. They are: (1) The assessee is incorporated as a company under S. 26 of the Companies Act. (2) There is a provision in the Memorandum of Association of the company that on winding up or dissolution of the club, the surplus left over was to be transferred to some other institution having objects similar to the objects of the club or to a charitable body of bodies to be determined by the members of the club at or before the time of dissolution end not to be distributed among the members of the association. Counsel for the Revenue contended that these two salient aspects would show that the respondent/assessee is not a mutual association, as claimed. Counsel for the respondent/assessee submitted that the fact that the club is incorporated will not destroy its mutual character. It was further submitted that the provision in the articles of association that on winding up or dissolution of the club, the surplus left was to be transferred to same other institution having similar objects cannot mean that they were not participators in the surplus. It was only & fetter in the manner of disposal. They continue to have the disposal over the surplus.

5. On hearing the rivel contentions of the parties, we ere of opinion that the plea raised by the Revenue should fail. The matter is fully governed by the decision of the Madras High Court in C.I.T v. Madras Race Club (105 I.T.R 433). The two aspects stressed before us were also highlighted in the Madras decision. Placing reliance on the decisions of the Supreme Court, the Judicial Committee of the Privy Council and the House of Lords, the learned Judges, at page 446 of the Reports, concluded as follows:

“Thus, incorporation of a limited company would not take away the claim for exemption.

The result of the above discussion is that a company may be eligible for exemption of any surplus derived from the dealings of the members either on the principle of mutuality based on the doctrine that no one can make profit out of himself or on the basis that there is no trading or profit motive in the transactions between a club and its members.”

6. The above observations clearly show that the incorporation of the respondeat/assessee as a company to carry on the activities of the club does not result in the deprivation of the admissibility of the claim for exemption based on the concept of mutuality. Regarding the provision in the articles of association as whet should be done on winding up or dissolution of the club about the surplus left over, the learned Judges, in the same decision, at page 443, observed as follows:

“It is well settled that the memorandum and articles of a company represent the contract between the company and the members. It is only by virtue of their ownership of the surplus assets, if any, that the members bad agreed to the clause that they would not take back the surplus, but allow it to be transferred to any similar entity. As they themselves are to deal with the surplus, if any, at the time of winding up, it cannot be said that they are not participators in the surplus. The clause is only a fetter In the manner of disposal. The participation envisaged in the principle of mutuality is not that the members should willy-nilly take the surplus to themselves. It is enough if they had a right of disposal over the surplus to show that they were the participators.”

7. It is evident therefrom that the members of the respondent/assessee have a right of disposal cver the surplus to show that they are participators and it cannot be said that the provision dealing with the surplus left over, in the instant case, will nullify the principle of mutuality. The two aspects, highlighted by the Revenue, have been expressly dealt with by the Madras High Court is its decision reported in C.I.T v. Madras Race Club (105 I.T.R 433) and they were held to be insufficient to negative the principle of mutuality, and to deny exemption. We respectfully concur with the reasoning and conclusion of the Madras High Court in its decision in C.I.T v. Madras Race Club (105 ITR 433). The Appellate Tribunal has rightly distinguished other decisions brought to its notice—C.I.T v. Madras Stock Exchange Ltd., (105 ITR 546) (Madras) and Addl. C.I.T v. Ahmedabad Millowner's Association (106 ITR 725) (Gujarat). Those cases dealt with the question as to whether the assesses therein were entitled to exemption from Income-tax (under S. 11 of the Acs) on the basis that the trust was for a charitable purpose. Similarly, the decision reported in 106 ITR 542 (C.I.T v. Shree Jari Merchants Association—Gujarat) is clearly distinguishable. There, the association was registered under S. 27 of the Trade Unions Act. At the time of dissolution, the surplus assets should be used in the manner proposed in the resolution passed by the association and it is clear that the resolution need not necessarily provide for the distribution of the surplus assets only amongst the members of the association. If they are not liable to be returned to the members, the identity between the contributors and the recipients would be lost. So, the decisions reported in 105 I.T.R 546, 106 ITR 725 and 106 ITR 542 are distinguishable, as held by the Appellate Tribunal in para 7 of its appellate order. The decision of the Appellate Tribunal holding that the respondeat/assessee is a mutual association and the subscriptions received from the members cannot be considered to be income in the hands of the assessee, is clearly justified in law.

8. The Appellate Tribunal also referred to S. 44A of the Income Tax Act to re-inforce its conclusion. It was held that the said provision would recognise the position that but for S. 44A of the Act, the excess of the expenditure of the nature contemplated which were to have been met out of she subscriptions from the members over the receipts from the members could not be claimed as a deduction from she receipts which would be assessable, as business receipts. This will show that the receipts from the members by way of subscription would not be income in the hands of the assesses. It was held that the receipts of a trade association from its members by way of subscriptions or otherwise are receipts that partake the character of mutual receipts. We are of the view that there is ao error either in the reasoning or in the conclusion of the Appellate Tribunal, contained in para 9 of its appellate order.

9. No serious argument was advanced to the effect that the respondent/assessee is not in fact a mutual association. The Appellate Tribunal found that the assesses is a trade association being an association of the oil merchants carrying on a particular trade. Its objects are generally for the promotion and protection of those engaged in coconut oil generally. It renders specific service to its members and non-members for a fee. The assesses/respondent was held to be a mutual association. The said finding is a pure finding of fact.

10. We answer the questions, referred to us, in the following manner:

1. We answer question No. 1 —in the affirmative, agaisst the Revenue and in favour of the assessee. 2. We answer question No. 2 —in the affirmative, against the Revenue and in favour of the assessee. 3. We answer question No. 3 —in the affirmative, against the Revenue and in favour of the assessee. 4. We answer question No. 4 —in the affirmative, against the Revenue and in favour of the assessee. We further hold that the Appellate Tribunal rightly stressed the word “otherwise”. 5. We answer question No. 5 —in the affirmative, against the Revenue and in favour of the assessee.

The above Income Tax Referred Cases are disposed of as above.

A copy of this Judgment, under the seal of this Court and the signature ef the Registrar, will be forwarded to the Tribunal, as required by law.