The principle of mutuality in the context of income tax law is hereby discussed.

1 The principle of mutuality is rooted in common sense. A person cannot make a profit from herself. This implies that a person cannot earn profit from an association that he shares a common identity with. The essence of the principle lies in the commonality of the contributors and the participants who are also beneficiaries. There has to be a complete identity between the contributors and the participants. Therefore, it follows, that any surplus in the common fund shall not constitute income but will only be an increase in the common fund meant to meet sudden eventualities.

2 The landmark House of Lords precedent on the application of the doctrine of mutuality to the taxability of the surplus made by mutual benefit associations is the Styles case. The members of New York Life Insurance Company comprised its policyholders. The Company calculated insurance premium based on the estimated death rate in its membership. The surplus of premium collected after deducting the expenditure incurred towards insurance claims was returned to the members in the form of credit to their account. The question was whether the surplus returned to the members – being earned from and by holders of the participating policies – was liable to be assessed to income tax as profits or gains. The insurance company sought to distinguish its case from Last vs. London Assurance Corporation, 10 App. Cas. 438 (“London Assurance Corporation”), wherein surplus premiums credited to members of the insurance company were held to be exigible to tax. The Company argued that its premium income was not profit, and hence not amenable to income tax. The Queen’s Bench Division being of the opinion that the case could not be distinguished from London Assurance Corporation, held that the premium income of the Company received under participating policies was liable to be assessed to income tax and reversed the determination of the Commissioners. This decision was affirmed by the Court of Appeal.

3 Against these decisions, the company brought an appeal before the House of Lords. The House of Lords was divided in the ratio 4:2 in the matter, with the majority holding that that no part of the premium income received under participating policies was liable to be assessed to income tax as profits or gains. That London Assurance Corporation was distinguishable, the income in that case being derived from transactions with persons who were not members and not from mutual insurances between members only.

4 The majority concluded that for income to be taxable, its source must be external to the Assessee. The fact that the Fund is a legal entity (for certain purposes) does not matter for, in the language of Lord Watson, it represented “the aggregate of its members and the members are the participators of its profits.” Lord Halsbury and Lord Fitzgerald dissented. Lord Halsbury reasoned that the nature of business would be more relevant than the relationship between the parties. Lord Fitzgerald, in his dissenting opinion, concluded that the premiums earned by the insurance company, so transferred to its headquarters in New York, ‘for the purpose of investment there by the corporation, formed part of the profit of the concern, and became liable here to income tax.’ He adjudicated the dispute independently, without placing any reliance on London Assurance Corporation, which was sought to be distinguished by the Assessee. While acknowledging the difference between the facts of both cases, to the extent that policyholders were members of the New York Life Insurance Company, but outsiders as regards London Assurance Corporation, it was concluded that ‘distinction creates no real difference.’

The principle of mutuality in India:

5 The Calcutta High Court also made a notable contribution to the evolution of the common law on mutuality. In Royal Calcutta Turf Club vs. Secretary of State, (1921) ILR 48 Cal 844 : AIR (1921) Cal 633 : (1921) 1 ITC 108, the Calcutta High Court considered the case of an unincorporated club that carried on business within the meaning of the Excess Profits Duty Act (10 of 1919). The Calcutta High Court reasoned that the proceeds generated by way of entrance fees charged from the public and the license fees credited by the book makers, would be assessable to income tax.

6 The Privy Council’s decision in an appeal emerging from the Madras High Court, in English and Scottish Joint Co-Operative Wholesale Society, Ltd. vs. Commissioner of Agricultural Income-Tax, 1948 SCC OnLine PC 41, crystallized the triple test for applying the principle of mutuality: (1) the identity of the contributors with and recipients of the common fund; (2) the status of the association or company, as an instrument obedient to the mandate of its members; and (3) the absence of possibility for contributors of the fund to derive profits from contributions made by them.

7 Substantial emphasis was placed on the pricing of the services offered and the profit motive behind the same. It was noted that the English and Scottish Joint Co-operative Wholesale Society, Ltd. is not bound by its rules to sell its tea only to its members, but it could make no difference if it were. The pertinent observations in this regard, are extracted as under: “No matter who the purchasers may be, if the society sells the tea grown and manufactured by it at a price which exceeds the cost of producing it and rendering it fit for sale, it has earned profits which are, subject to the provisions of the taxing Act, taxable profits.” Given the deep-rooted common law tradition, Indian jurisprudence has had a rich engagement with the principle of mutuality, especially in the context of taxation.

8 A Constitution Bench of the Supreme Court in CIT vs. Royal Western India Turf Club Ltd., AIR 1954 SC 85 rendered a significant judgment on this subject. Royal Western India Turf Club realised money from both members and non-members, in lieu of the same services rendered in the course of the same business. The Supreme Court held, as extracted below, that an exemption founded on the doctrine of mutuality could not be granted:

“23. 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.”

The Supreme Court further reasoned that the principles of Styles case had no application to the case before it. This Court noted that ‘there is no mutual dealing between the members inter se in the nature of mutual insurance, no contribution to a common fund put up for payment of liabilities undertaken by each contributor to the other contributors and no refund of surplus to the contributors.

9 Important English and American cases on the aspect of mutuality

9.1 In Walter Fletcher on his own behalf and on behalf of Trustees and Committee of Doctor’s Cave Bathing Club vs. the Commissioner of Income Tax (“Walter Fletcher”) reported in (1971) UKPC 30, the Privy Council considered the question whether, the Doctor’s Cave Bathing Club at Montego Bay, Jamaica (appellant therein) was assessable to income tax on the profit element contained in receipts from certain hotels, whose guests had the right to use the said Club. It was observed therein that the expression “the mutuality principle” has been devised to express the basis for exemption of groups of persons making contribution towards the common purpose or any surplus over expenditure. That it is a convenient expression, but the situations it covers are not in all respects alike. In some cases, the essence of the matter is that the group of persons in question is not in any sense trading, so the starting point for an assessment for income tax in respect of trading profits does not exist. In other cases, there may be in some sense a trading activity, but the objective or the outcome, is not profits, it is merely to cover expenditure and to return any surplus, directly or indirectly, sooner or later, to the members of the group. These two criteria often, perhaps generally, overlap since one of the criteria of a trade is the intention to make profits and a surplus comes to be called a profit if it derives from a trade. So, the issue is better framed as one question, rather than two: is the activity, on the one hand, a trade, or an adventure in the nature of trade, producing a profit, or is it on the other, a mutual arrangement which, at most, gives rise to a surplus.

9.2 On the facts of the said case, it was observed that the disparity between the member of the club and the guest of the hotel (hotel members) was substantial. In other words, the members of the club were trading, earning profits from the hotel which used to send their guests for using the club facilities, commensurate with their subscription. Therefore, any surplus income derived by the said Club from the hotel members was in the nature of profits and therefore the nature of the transaction being a trading transaction, the income thus generated was liable for tax.

9.3 Reference was made to the case of The Carlisle & Silloth Golf Club vs. Smith, (1912) 6 TC 48, which brings out the distinction between members, contributing on a mutual basis in order to secure an amenity, and outsiders admitted to participate in amenities on payment, with whom the club is trading. At what point, does the relationship of mutuality end and that of trading begin? That is the critical and difficult question and the relevance of facts is to ascertain the nature of the activity. It was observed that it is not an essential condition of mutuality that contributions to the fund and rights in it should be equal; but if mutuality is to have any meaning, there must be a reasonable relationship, contemplated or in result, between what a member contributes and what with due allowance for interim benefits of enjoyment, he may expect or be entitled to draw from the fund i.e., there ought to be a relationship between his liabilities and his rights.

9.4 In Revesby Credit Union Cooperative Ltd. vs. Federal Commissioner of Taxation, (1965) 112 CLR 564, the High Court of Australia considered the question, whether, principle of mutuality applies to deprive the dividend of the character of income. It was observed that the principle of mutuality seems to be settled in cases where a number of people contribute to a fund created and controlled by them for a common purpose. In such cases, any surplus paid to the contributors after the use of the fund for the common purpose is not income but is to be regarded as a mere repayment of the contributor’s own money vide Bohemians Club vs. Acting Federal Commissioner of Taxation, (1918) 24 CLR 334. Incorporation of the fund is not relevant vide Styles. What is required is that the fund must have been created for the common purpose and owned or controlled wholly by the contributors. If it is owned or controlled by anyone else the principle cannot apply vide Equitable Life Assurance Society of the United States vs. Bishop, (1900) 1 QB 177. Furthermore, any contributions to the fund derived from sources other than the contributors’ payments, such as interest from the investment of part of the fund, or income from a business activity conducted by the members, cannot be taken into account in computing the surplus vide Carlisle and Silloth Golf Club vs. Smith (supra). Also, the cases establish that the principle cannot apply unless at any given point in time the contributors to the fund are identical with the beneficiaries of the distribution of the surplus vide Styles (supra).

9.5 While applying the aforesaid dicta to the facts of the said case, it was held that the principle of mutuality cannot apply to deprive the dividend of the character of income. The dividend in question therein was the surplus of revenue over expenditure. The greater part of the revenue was drawn from two sources namely, interest on loans to members and interest on investments in associated credit societies. The contributors to the revenue are those members who had current loans and the societies in which money was invested. However, the beneficiaries of the payment of the dividend were all the members. It was observed that the revenue earned was by virtue of the society’s business dealings with a number of its members and should be classed as income.

9.6 In Re: Commissioner of Taxation And: Australian Music Traders Association, (1990) FCA 261, the case pertained to the Australian Music Traders Association, a mutual association. The controversy was whether such a mutual association or organization which received income from an activity would fall within the mutuality principle. In the said case, reference was made to Walter Fletcher (supra) and the test enunciated therein by Lord Wilberforce with regard to the nature of an activity undertaken by a mutual association or a club namely, whether, the activity is a trade or an adventure in the nature of trade, producing a profit, or is it, a mutual arrangement which, wholly gives rise to a surplus. In the said case, the activity in question was the holding of a music traders’ trade fair. In the years prior to the subject year of income, the Association itself had organised the trade fairs and let out stalls to music traders. Although the rental income received by the Association from such stall holders who were members of the Association was accepted to be mutual, nevertheless, as the individual traders displayed and sold their wares to members of the public, it was doubted whether the fairs had a mutual character. Traders, many of whom were not members of the Association, carried on their individual businesses. The rental paid was calculated according to the space occupied or leased by the stall holder for the purposes of his own business activity. In the year of income in question, the Association had arranged for a separate organisation, namely, Exhibition and Trade Fair Pvt. Ltd., to organise the fair. The fee which the Association received from the organiser was fixed by their agreement, though referrable in part to the total space sublet by the organiser to members of the Association and non-members alike. It was observed that no strand of mutuality remained as no contribution was made by any member of the Association to the Association in respect of the fair. That the amount paid by the organiser of the fair to the Association was not a fee payable by the members of the Association into a common fund and the fair, though it benefitted members of the Association, was not a mutual, non-profit activity. Its essence was that of trading for profit by individual traders, though through the medium of a common activity, the fair. Therefore, it was observed that the Association’s receipts from the organiser of the fair were not receipts which had a mutual character. The receipts were income assessable to tax.

9.7 Discussing the early formulations of the mutuality principle which was generally associated with insurance, reference was also made to Styles (supra) which was followed in Jones vs. South-West Lancashire Coal Owners’ Association Limited, (1927) AC 827 (Jones). Five years later, in Municipal Mutual Insurance Limited vs. Hills, (1932) 16 TC 430, the House of Lords distinguished Styles and Jones. The facts in the latter case were that the appellant therein was formed by various local authorities primarily for the purpose of enabling them to insure against fire, on favourable terms. The effective control of the said Company was held by fire policy holders, who alone were entitled to the surplus assets of the Company on winding up of the Company. However, in the course of time, the Company also undertook an extensive business in employers’ liability and other insurances, both with existing fire policy holders and others. The revenue conceded that the fire insurance business is a business of mutual insurance which did not attract liability to income tax. The appellant company therein agreed that it was liable for tax on its profits from employers’ liability and other insurances undertaken on behalf of persons who were not fire policy holders. However, there was an issue between the parties as to whether the appellant company was liable to pay tax on the profits which it earned on such other insurances, with fire policy holders. At first instance, Justice Rowlatt dealt with the critical question and analysed that in the said case there was no distinction between what is made out of a member in respect of non-fire business and what is made out of a stranger in respect of non-fire business; the member is a stranger. He is not, as a miscellaneous policy holder, getting any share in the miscellaneous policy business. The miscellaneous policy business is done for the benefit of the body of fire policy holders. Therefore, revenue earned out of fire insurance business of the company by the members who were all fire policy holders was a business of mutual insurance which did not attract liability to income tax but the revenue earned from miscellaneous policy business was taxable. The position was compared to a shareholder of a railway company who buys a ticket to travel by train; for this purpose, he is merely an outsider.

9.8 The aforesaid analysis of Rowlatt J. was affirmed by the Court of Appeal as well as by the House of Lords. The House of Lords clarified that insofar as surplus income arising from a fire policy, they are really entitled to the money as being those who contributed it and, accordingly, it has been admitted that any profit made on the fire policies is governed by the Styles case (supra). But as regards employers’ liability business and miscellaneous business the surplus it did not go to the contributors for, as fire policy holders in a body, they had not contributed and therefore this business was in the same position as business with complete outsiders, the surpluses in which are admitted to be profit.

9.9 Reference was also made to another Australian decision in the case of Social Credit Savings and Loans Society Limited vs. Commissioner of Taxation, (1971) 125 CLR 560, wherein the necessity for identicality between the contributors to the common fund and the participators in it, was emphasised.

9.10 Reference was also made to Sydney Water Board Employees’ Credit Union Limited vs. Commissioner of Taxation, (1973) 129 CLR 446 which is a decision of the Full High Court of Australia. In the said case, the facts are interesting. The taxpayer was a credit union which borrowed money from its members. It also borrowed money, to a smaller amount, from non-members, on fixed deposit. The money borrowed was re-lent by it to members, but the class of borrowing members was not identical with the class of lending members; some borrowing members did not lend money to the taxpayer, and some lending members did not borrow. The taxpayer received interest on the money lent by it, and obtained surpluses over its expenditure. The issue was whether the interest received by the credit union from its members was taxable under the Australian Income Tax Act. The Court unanimously held that the interest was taxable.

9.11 While considering the application of the mutuality principle in the said case, it was held that there were two impediments: that precise identicality between the individuals contributing to a fund and the participants in that fund was no longer required. However, there ought be a “reasonable relationship” between contributions and benefits and that no such relationship existed, as all members of the Association had not taken space at the 1984 Australian Music Exhibition. Secondly, it was observed that the money received by the Association in respect of the exhibition was not the money held on behalf of individual members. The money became part of the general funds of the Association, to be dealt with as the members of the Association might see fit from time to time, but without any obligation to those members who had taken space at the 1984 exhibition. Till 1984, the Association used to organise the fair itself using voluntary members’ labour but in 1985, the fair was organised by a professional organiser i.e., through the Company (Exhibition and Trade Fairs Pty Limited). There were fortyeight exhibitors out of which only twenty-nine were members of the Association. The claim was initially rejected by the Commissioner of Income Tax on the basis that the receipt must be treated as an ordinary trading receipt received in the course of the Association’s business. It was held that the principle of mutuality did not apply. Ultimately, the High Court of Australia by a majority of 2:1 held that the Commissioner was right and affirmed his decision and set aside the decision of the Tribunal