Principle Of

Mutuality – A Study
Taxation (Hons.)

Abhirup Ghosh
3RD Year Law Student
abhirup0911@gmail.com

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Introduction
“No man can trade with himself; he cannot make, in what is its true sense or meaning, taxable
profit by dealing with himself”1

No man can make a profit out of himself. The old adage that a penny saved is a penny earned
may be a lesson in household economics, but not for tax purposes, since money saved cannot be
treated as taxable income. It is this principle, named as the principle of mutuality, which is
extended to a group of persons in respect of dealings among themselves. Mutuality principle
offers a tax shelter, as long as its character of a mutual association is retained, with its income
not tainted by commerciality. A formal organization indicating mutuality as between members
with bye-laws spelling out mutuality may, however, be necessary as proof of claim to mutuality
either as a society or a company registered under Section 25 of the Companies Act, 1956, or
even as managed by a public trust, with such activities primarily intended to be confined to its
members.

The Principle of Mutuality is beneficially utilized by mutual concerns like members' clubs, co-
operative societies, mutual benefit funds or chit funds, etc., where the persons form the concern
or the association for the benefit or advancement of certain mutual activities. Such organizations
where the objectives are not of `General Public Utility’ and therefore their incomes are not
eligible for exemption u/s 11 of the Income Tax Act, 1961 as the benefits are available to only a
`Class of Public’ instead of `General Public’ take the shelter of Principle of Mutuality. Thus, in
case the receipts of such a mutual association exceed the expenses, then, on the footing of the
principle of mutuality, such surplus is to be regarded as devoid of revenue quality, hence, not
taxable under the Act.

The Principle of Mutuality, a concept, borrowed from the `English Decisions’ has been refined
over the years with the various decisions pronounced by the Supreme Court and High Courts and
Income Tax Appellate Tribunals. Still the application of this principle in a fact-situation should
be very cautious and as per the ratios emanating from the various decision.

Now, as far as the recognition of the Principle of Mutuality under the Income Tax Act, 1961
goes, the `Act’ has the following indirect references to this principle:

a) Section 2(24)(vii) states:“income” includes “the profits and gains of any business of
insurance carried on by a mutual insurance company”.

1
Dublin Corpn. v. M. Adam 2 T.C. 387

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b) Section 28(iii) states: The following incomes shall be chargeable to income-tax under the
head: `Profits and gains of business or profession’: “income derived by a trade, professional or
similar association from specific services performed for its members”.

c) Circular no. 11/2008, dated 19-12-2008 states: “Therefore, where industry or trade
associations claim both to be charitable institutions as well as mutual organizations and their
activities are restricted to contributions from and participation of only their members, these
would not fall under the purview of the proviso to section 2(15) owing to the principle of
mutuality.”

The whole structure of the Principle of Mutuality rests upon three pillars, which have been
discussed in the light of judicial interpretation from time to time:

1. Is there any commerciality involved?

2. What would constitute complete identity between the contributor and the participator?
3. Whether the benefit is available to the non-mutual income?

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Case References and Analysis
The principle of mutuality derives from the concept that income earned by a person from
external sources is taxable. Thus, income derived from oneself cannot be treated as income thus
cannot be taxed. This concept has evolved over a period be it through legal precedents and or
through assessments. Concept of mutuality was developed in late 1800’s. Mutuality
organizations have been in existence since the period unknown and have played vital role in the
development of the society. Presently we can see such organizations existing in the shape of
insurance companies, societies, clubs, associations etc. Initially mutual organizations were
created with the sole purpose of compensating members by providing insurance without any
motive to earn profits or gains. The concept of mutuality was legally argued in a court of law in
the Glasgow Corporation Waterworks Acts v. IRC2. The courts held that the concept of mutuality
in based on the fact the there is existence of an association of persons joined together to achieve
a common objective by mutually contributing to the same with absolute and clear mind not to
earn any profits or gains. Thus the essential elements of a mutual organization are:

i. It is an association of people called members

ii. There is a common cause
iii. Every member makes his contribution; and
iv. The aim of the activity is not to earn profits or gains.

The Principle of Mutuality has been derive from the English laws and it was mainly a Common
Law concept before it was inculcated in the Income Tax Act, 1961. And the principle of
mutuality was set out by the House of Lords in Styles v. New York Life Insurance Co. 3. It was
clarified by the Privy Council in English and Scottish Joint Co-operative Wholesale Society Ltd.
v. Commissioner of Agricultural Income-tax4, that mutuality principle will have application only
if there is identity of interest as between contributors and beneficiaries.

Now, there are a few questions that need to be answered like:

 Can a Co-operative Society qualify?
- It has been said that, where a co-operative society deals solely with its members,
right to recognition for exemption on grounds of mutuality was recognized in CIT
v. Apsara Co-operative Housing Society Ltd.5 and Director of Income-tax
(Exemptions) v. Indo Oriental Bank and Commerce Welfare6.

2
(1875) ITC 28
3
(1889) 2 TC 460 (HL)
4
(1948) 16 ITR 270 (PC)
5
(1993) 204 ITR 662 (Cal)
6
Society (2003) 130 Taxman 575 (Del)

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  Can a Partnership be a Mutual Association?
- Mutuality principle was applied even in respect of a partnership firm, when its
activities were confined to its partners in the case of CIT v. Natraj Finance
Corporation7, but was dissented in Wankaner Jain Social Welfare Society v. CIT8,
not because a partnership could not be a mutual association, but because it was
found that there was no identity of interest as between partners, who were
depositors and partners, who were borrowers following the rationale of the
decision in CIT v. Kumbakonam Mutual Benefit Fund Ltd. 9
 Can a Mutual Society also be a Charity?
- In any mutual organization, there is an element of altruism, since the benefit
availed by a member may not always be commensurate with his contribution. It
was for these reasons that even where there is no return on the contribution, as in
the case of an association formed for the purpose of general public utility,
mutuality may not be lost. Such association may also be entitled to tax
concessions as a charitable institution as was found in Addl. CIT v. Surat Silk
Cloth Manufacturer’s Association10 and CIT v. Andhra Chamber of Commerce 11.
In such cases, income from entrance fee, subscription and donations from
members may be governed by the principle of mutuality and any other income
governed by the exemption for charitable institution. It is likely that both the
shelters, whether mutuality principle and concessions meant for charities subject
to conditions, may be available for the same entity.

The principle of mutuality postulates that all the contributors to the common fund must be
entitled to participate in the surplus and that all the participators in the surplus are contributors to
the common fund. It is in this sense that the law postulates that there must be a complete
identity between the contributors and the participators. The essence of the doctrine of mutuality
lies in the principle that what is returned is what a member contributes. A person cannot trade
with himself. It is on the hypothesis that the income, which falls within the purview of the
doctrine of mutuality, is exempt from taxation.

Commissioner of Income-tax v. Royal Western India Turf Club Ltd.12: In the earliest case of
Royal Western India Turf Club, the Supreme Court adopted a very strict approach in applying
the principle of mutuality. In that case, the assessee, which was an incorporated company, carried
on the business of racecourse and dealt with non-members as well in the ordinary course of
business carried on with a view to earning profit as in any other concern. It gave to its members

7
(1988) 169 ITR 732 (AP)
8
(2003) 260 ITR 241 (Mad)
9
(1964) 53 ITR 241 (SC)
10
(1980) 121 ITR 1 (SC)
11
(1965) 55 ITR 722 (SC)
12
[1953] 24 ITR 551 (SC)

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the same or similar amenities as it gave to non-members. On these facts, the Supreme Court held
that the facilities were given to members and non-members alike for a price and therefore items
of receipts from the members also, were to be taken into account in computing the total income
of the company.

Commissioner of Income-tax v. Bankipur Club Ltd.13: The assessment years involved are
1960-61 to 1964-65. The assessee club filed "nil" returns. The assessee had income from house
property and also from business or profession. The receipt under the head "sale of drinks at the
Bar" was alone disputed in all the aforesaid five years. The Income Tax Officer held that the
profit on the sale proceeds of the drinks by the club is income and so, liable to be taxed. The
High Court held that the bar in question only sold drinks to the club members. Outsiders were
not allowed. The High Court took the view that while selling drinks to its members; it is not done
with motive of profit earning which can be said to be tainted with "commerciality". The
members pay the monthly subscription and in addition, they enjoy the benefit of this privilege of
supply of drinks to them on additional payment and so, there is no profit-earning motive. And
principle of mutuality can be applied here. Supreme Court upheld the judgments in Royal
Western14 and Kumbakonam15 further elaborated the Principle of Mutuality in more clear words.

Chelmsford Club v. Commissioner of Income-tax16: The appellant provides recreational and

refreshment facilities exclusively to its members and their guests. Its facilities are not available
to non-members. The Club is run on 'no profit no loss' basis in that the members pay for all their
expenses and are not entitled to any share in the profits. Surplus, if any, is used for maintenance
and development of the Club. The Clubhouse which is the subject matter of these appeals is
owned by the appellant and is used for providing facilities to its members for which the members
paid fees. The Court held that letting out of the premises is merely a provision of a facility for
members. The principle of mutuality clearly applies to the surplus earned as a result of such
activities. In this case, the Supreme Court propounded the following tests which would establish
mutuality:

1. The contributors to the fund are the same persons who are also the recipients from the
fund.
2. The entity is incorporated only for the convenience of the members i.e. the object should
not be to earn profit.
3. There is an impossibility that the contributors would derive profit from an activity where
they are the contributors as well as the recipients of the funds.

13
[1997] 092 TAXMAN 278 (SC)
14
Supra note 12
15
Supra note 9
16
[2000] 109 TAXMAN 215 (SC)

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Commissioner of Income-tax v. J.K. Organisation17: Here, in this case, while applying the
principle laid down by the Apex Court in the case of Royal Western India Turf Club Ltd. (supra)
and followed in the case of Chelmsford Club (supra) to the facts of the present case, we find that
the Organisation has been formed to promote and protect the interest of its members and it also
provided that upon dissolution the surplus shall be distributed amongst the members of the
organisation on the basis of their contribution. There is no finding that the respondent-
organisation was catering to the need of any outsider. The principle laid down by the Apex Court
in the aforementioned cases are fully applicable in the present case.

Yum! Restaurants (Marketing) (P.) Ltd. v. Commissioner of Income-tax18 : In this case, the
assessee-company was a wholly owned subsidiary company of YRIPL, which was engaged in
developing and managing franchisees for running restaurants. It was set up to carry out and
economize cost of advertising and promotion by catering to specific needs of franchisees of
YRIPL in order to enable them to concentrate on restaurant operations and management.
Assessee-company filed its return declaring nil income on ground that it was a non-profit
organization governed by principles of mutuality. HC upheld decision of Tribunal and
Commissioner (Appeals) noting the fact that assessee-company had not only received
contributions from various franchisees but also from `P’ Ltd. and YRIPL who were neither
franchisees nor beneficiaries, and, therefore, essential requirements of a mutual concern were
missing.

Commissioner of Income-tax v. J.K. Organisation19: Applying the principle laid down by the
Apex Court in the case of Royal Western India Turf Club Ltd. (supra) and followed in the case
of Chelmsford Club (supra) to the facts of the present case, we find that the Organisation has
been formed to promote and protect the interest of its members and it also provided that upon
dissolution the surplus shall be distributed amongst the members of the organisation on the basis
of their contribution. There is no finding that the respondent-organisation was catering to the
need of any outsider. The principle laid down by the Apex Court in the aforementioned cases are
fully applicable in the present case.

Madras Gymkhana Club v. Deputy Commissioner of Income-tax20: The question which arose
for the decision of the court was: “Whether the interest income of the assessee received from its
corporate members on the investments of surplus funds as Fixed Deposits or Debentures etc., is
exempted from tax on the concept of Mutuality”?

It was held that investment of surplus fund with some of the member banks and other
institutions in the form of Fixed Deposits and securities which in turn result in earning of huge
surplus amounts by way of interest cannot be held to satisfy the mutuality concept. As held in the

17
[2005] 144 TAXMAN 560 (ALL.)
18
[2009] 180 TAXMAN 27 (DELHI)
19
[2005] 144 TAXMAN 560 (ALL.)
20
[2009] 183 TAXMAN 333 (MAD.)

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decision of the Karnataka High Court reported in CIT Vs. I.T.I. Employees Death and
Superannuation Relief Fund21 the principle of mutuality could be confined in respect of the
income earned by the club out of the contributions received by the club from its members but it
will have no application in respect of the interest earned from the deposits of surplus funds in the
banks by way of income.

Canara Bank Golden Jubilee Staff Welfare Fund v. Deputy Commissioner of Income-tax22
:The Court held that the Tribunal was not right in stating that the principle of mutuality did not
apply to income of the appellants derived from interest on investments and dividend on shares
and is, therefore, non-taxable income and that the decision in I. T. I. Employees Death and
Superannuation Relief Fund 23 is not applicable to the facts and circumstances of this case as far
as the two relevant assessment years are concerned. The judgment, however, makes it clear that
the conclusion is based on the source of funds of the assessee during the two relevant assessment
years. The Karnatka High Court while delivering the Canara Bank Golden Jubilee Staff Welfare
Fund judgment elaborately distinguished the judgment of I.T.I. Employees delivered by the same
court. The principal reason of two diametrically opposite judgments was `Source of Funds’.
While in the case of I.T.I. Employees, the management contributed funds which were invested
in bank deposits and therefore lost the benefit of mutuality, however the in the case of `Canara
Bank’, sources of funds were from members only in last two relevant assessment years and
therefore were granted the benefit of Principle of Mutuality.

21
(1998) 234 ITR 308
22
[2009] 308 ITR 202 (Kar)
23
[1998] 234 ITR 308 (Karn)

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Conclusion
Mutuality principle offers a tax shelter, as long as its character of a mutual association is
retained, with its income not tainted by commerciality. A formal organization indicating
mutuality as between members with bye-laws spelling out mutuality may, however, be necessary
as proof of claim to mutuality either as a society or a company registered under Section 25 of the
Companies Act, 1956, or even as managed by a public trust, with such activities primarily
intended to be confined to its members.

Bibliography
For this project, the following books and websites have been referred to:

Books referred:

1. The Income Tax Act, 1961, 2010-’11, Universal Law Publishing Co. Pvt. Ltd.
2. Dr. Vinod K. Singhania & Dr. Monica Singhania, “Students’ Guide To Income Tax”,
44Th Edition 2011-12, Taxmann Publications.
3. Dr. Girish Ahuja & Dr. Ravi Gupta, “Systematic Approach to Income Tax”, 25 Th Edition
2011-12, Bharat Law House Pvt. Ltd.

Websites accessed:

1. http://taxguru.in/income-tax-case-laws/principle-of-mutuality-where-the-income-of-the-
mutual-concern-is-the-contributions-received-from-its-contributors.html
2. http://indianlegalspace.blogspot.com/2010/07/doctrine-of-mutuality.html
3. http://www.taxmanagementindia.com/visitor/detail_article.asp?ArticleID=1054
4. http://www.thefreedictionary.com/mutuality
5. http://www.yourdictionary.com/mutuality

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