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19 March 2018

EY Tax Alert
SC upholds the principle of
mutuality in case of
transactions between
members and co-operative
societies

Tax Alerts cover significant tax Executive summary


news, developments and changes
This Tax Alert summarizes a recent ruling of the Supreme Court (SC), in a batch of cases
in legislation that affect Indian with the lead case being that of Venkatesh Premises Cooperative Society Ltd. [1]
businesses. They act as technical (Taxpayer or Society), wherein the issue before the SC was whether the receipt of
summaries to keep you on top of transfer charges, non-occupancy charges and premium received, for allotment of
occupancy rights in additional construction of the Society’s property, from the members
the latest tax issues. For more of the Society can be regarded as not taxable on the principle of mutuality.
information, please contact your The principle of mutuality rests on the proposition that no one can derive any income
EY advisor. from themselves, as income generally comes from an outsider. According to this
principle, no income accrues when a common group of persons contributes to and
participates in a common fund with an expectation that the amount would be spent for a
common good or on objectives that will benefit all the contributors.
[1] [TS-111-SC-2018-SC]
In the present case, the Taxpayer had received (a) part of
• The amount received by the Taxpayer was not offered
transfer charges from incoming members (transferee) on
to tax on the principle of mutuality. However, the Tax
transfer of premises/flat by outgoing members (b) non-
Authority contended that non-occupancy and part of
occupancy charges from members for premises that are
the transfer charges received from transferee
not self-occupied but let out on rent and (c) premium on
constituted as business income, generating profits and
sale of additional construction rights to members of the
surplus and having an element of commerciality and,
Society’s property.
therefore, taxable.
The SC held that all receipts are covered by the principle of
mutuality and, hence, the same are not taxable. On transfer
charges, it was ruled that the moment a transferee is
inducted as a member, the principle of mutuality is applicable
Tax Authority’s contentions:
as the amount can be appropriated only after transferee has
• In relation to transfer fees received from an
become a member and in the event of non-admission, the
incoming member, receipt was from transferee who
amount is returned. On non-occupancy charges and
was not a member at the time of payment and,
premium received by the Society from its members on
hence, the principle of mutuality failed. The
allotment of occupancy rights, it was ruled that these
economic participation is to be restricted to
receipts have been used for the mutual benefit toward
members and had no application to transferee, who
maintenance of the premises and provision of common
was not a member.
amenities which ultimately enures to the enjoyment, benefit
and safety of the members and, accordingly, the principle of
• As regards the non-occupancy charges, relying on
mutuality was applicable.
the Notification, validity of which was upheld by the
Bombay High Court in case of New India Co-
operative society[3], it was contended that the receipt
Background and facts beyond a specified limit is illegal and attracts an
element of commerciality and is taxable.
• Mutual association is one where persons come together
for a common good, with an intent to contribute to • The principle of mutuality cannot be invoked to
making and running of the association without a profit prevent taxability of high value receipts by a society
motive. The common desire is for enjoyment of facilities selling properties and then inducting such
or benefits through a medium of association or society. purchasers as members.
According to this principle, no income accrues when a
common group of persons contribute to and participate
in a common fund with an expectation that contribution
would be spent for common good or on objectives that
Taxpayer’s contentions:
will benefit all the contributors. This is on the principle
that no one can derive any income from themselves, as • The transfer fee can be appropriated by the Society
income comes from an outsider. only after the member was admitted and in case
membership was not allotted, the same was required
• In order to restrict the commerciality in co-operative to be returned to that person. Once a person is
housing societies, the Maharashtra State Government admitted to the membership, the principle of
mutuality automatically gets attracted. Further the
issued a notification[2] on 9 August 2001 (Notification)
transfer fee was essentially from an outgoing
under Maharashtra Co-operative Societies Act, which
member and it was only from a convenience
provides that any premium charged for transfer of
perspective the same was collected from the
flat/premises shall be determined at the general meeting
transferee.
of the societies. Further, it also provides for a cap on the
maximum amount which can be charged from a member
• The Notification was applicable only to “housing co-
as transfer charges and non-occupancy charges.
operative society” and same is not applicable to
“premises co-operative society” and, accordingly,
• The Taxpayer, a premises co-operative society, received
the excess amount recovered towards non-
from its members transfer charges, non-occupancy
occupancy charges cannot be regarded as taxable.
charges and premium on sale of additional construction
rights of the Society’s property. Non-occupancy charges
• Non-occupancy charges were levied for the purpose
were levied by the Society and was payable by a member
of general maintenance and the fact that higher
who does not occupy the premises but lets it out on rent
amount was levied was irrelevant as long as the
and, transfer charges were collected on transfer of
funds are utilized for the benefit of the members as a
flat/premised by an outgoing member part of which was
class.
also paid by incoming member (transferee).

[2] This is basis our understanding from the decision and we have not been [3]
[2013 (2) MHLJ 666]
able to source the Notification.
• On the receipt of premium for additional construction,
reliance was placed on Bombay HC decision in the case SC’s ruling
of CIT v Jai Hind Cooperative House Construction
Society[4] to contend that premium receipts payable by • The SC, on an analysis of various judicial precedents[7]
certain members, for allowing a member to construct on the matter, reiterated following principles on the
additional area using extra FSI[5] of societies was not principle of mutuality :
taxable on the principle of mutuality.
• The principle of mutuality is based on common law
• Once the test of determining mutuality and principles. It rests on the theory that a person cannot
commonality of interest are met, receipt is not taxable make a profit from himself/herself. An amount
under the general understanding of the principle of received from oneself cannot be regarded as income
mutuality that a person cannot make profits from so as to be liable to tax.
himself/herself[6]. • The distinctive feature of the principle of mutuality
lies in the commonness between the persons
contributing to and also participating in surplus of a
mutual organization which does not have any profit
• The First Appellate Authority upheld the Tax Authority’s
motive from the transactions with its members.
contentions. However, the Second Appellate Authority
• There should be complete identity between the
upheld the Taxpayer’s contention that Notification was
contributors and the participants as a class, in the
applicable only to housing co-operative society and not
sense, what is returned to members is contributed
to premises co-operative society. With respect to
by a member. Any surplus in the common fund shall
transfer charges it held that the transfer fee paid by
therefore not constitute income but will only be an
transferee member was taxable as he/she did not have
increase in the common fund meant to meet sudden
the status of member at the time of payment.
eventualities.
• A common feature of mutual organizations, in
• On further appeal, the High Court set aside the findings
general, can be stated to be that the participants
of Second Appellate Authority that transfer fee paid by
usually do not have the property rights to their share
transferee member was taxable, while upholding the
in the common fund, nor can they sell their share.
taxability of non- occupancy receipt beyond the specified
Cessation from the membership would result in the
limit as specified in the Notification.
loss of right to participate without receiving financial
benefit from the cessation of the membership.
• Aggrieved, the matter was appealed before the SC on
the issue whether the transfer charges, non-occupancy
• Basis the above principles and for the following
charges and premium on sale of additional construction
reasoning, the SC ruled that various receipts were not
rights of the Society’s property are exempt from income
taxable in the hands of the Taxpayer as the principle of
tax based on the principle of mutuality.
mutuality was applicable.

On transfer fee

• The transfer charges are payable by an outgoing


member and if for convenience, part of it is paid by
transferee, it would not partake the nature of profit
or commerciality as the amount is appropriated only
after the transferee is inducted as a member. In the
event of non-admission, the amount is returned.
Therefore, the moment transferee is inducted as a
member, the principle of mutuality applies.

• It is the membership which forms a class which is


relevant; the identity of an individual member is
irrelevant. Hence, induction into the membership
automatically attracts the principle of mutuality.

[4]
[349 ITR 541]
[5]
Floor Space index [7]
[6] Commissioner of Income Tax, Bihar v. Bankipur Club Ltd., [(1997)
Reliance was placed on Commissioner of Income Tax, Mumbai v.
226 ITR 97 (SC )]; Bangalore Club v. Commissioner of Income Tax and
D.P.Sandhu Bros. Chembur (P) Ltd.,(2005) [273 ITR 1 (SC)]; CIT v. Royal Another, [(2013) 350 ITR 509 (SC)]; The Commissioner of Income Tax
Western India Turf Club Ltd., [AIR 1954 SC 85]; Commissioner of Income v. Common Effluent Treatment Plant, (Thane Belapur) Association,
Tax, Bihar v. Bankipur Club Ltd., [(1997) 226 ITR 97 (SC)];Bangalore Club v. [(2010) 328 ITR 362 (Bom)]; Styles v. New York Life Insurance
Commissioner of Income Tax and Another,[(2013) 350 ITR 509 (SC)]. Company, [(1889) 2 T.C. 460] by Lord Watson in the House of Lords.
On non-occupancy charges

• Like in case of transfer fees, the non-occupancy


charges collected from member are also utilized for Comments
the common benefit of facilities and amenities to the The doctrine of mutuality is a well-
members and, hence, are indisputably used for mutual
settled principle. However, litigation
benefit.
often arises on its application to facts
of cases. There has been a controversy
in the context of co-operative housing
Premium on sale of additional construction society as also other societies on
rights applicability of the principle of
mutuality to the amount collected by
• If a society inducts a new member who is required to the society from its existing or
contribute extra charges to the common funds for incoming member towards transfer
availing common facilities, and then occupancy rights fees or in respect of levy of non-
in respect of additional construction are granted by occupancy charges or on sale of
draw of lots while society retaining ownership of
additional construction rights to
property, receipt is protected by the principle of
members against recovery of premium
mutuality. It would be incorrect to classify it as income
of the society with commerciality. by society.

• Any contribution to the common amenity funds which


is utilized for the maintenance of the properties of Present ruling set at rest the
societies which ultimately enures to the enjoyment, controversy. The SC upheld the
benefit and safety of the members would satisfy applicability of mutuality to each of the
mutual benefit test. collections received by society from its
members. The SC ruled that so long as
• The SC upheld the order of the High Court stating that
the funds received from the members
the Notification is applicable only to housing co-operative
society and not to premises co-operative society which are utilized for the common benefit of
consists of non-residential premises. the members the principle of mutuality
should be regarded as satisfied. The SC
also held that mutuality is attached to
membership which represents as class.
Neither the identity of an individual
member nor the disproportionality of
the contribution of the member is
relevant.
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