Supreme Court while Rejecting Exemption of Tax Liability Reiterates Doctrine of Mutuality

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The doctrine of mutuality in the context of the law of taxation traces its origin in the common law principle that a person cannot engage in business with oneself and thus any amount received from oneself cannot be regarded as income and thereby taxable.

The Supreme Court in the present case (Yum! Restaurants (Marketing) Pvt. Ltd. v. Commissioner of Income Tax, Delhi) tests the complex facts on the tripartite test of doctrine of mutuality to determine the taxable liability of the assessee, that is, Yum! Restaurants (Marketing) Pvt. Ltd.

Brief Facts

The Assessee is a wholly-owned subsidiary of Yum! Restaurants (India) Pvt. Ltd. (“Parent Company”) incorporated after having obtained approval from the Secretariat for Industrial Assistance (“SIA”) for advertising and promotion on behalf of the Parent Company and its franchisees. The appeal arises from the order of the High Court of Delhi dismissing the appeal of the Assessee in favour of the Revenue on the question of taxability of Rs. 44,44,002/-.

The Assessing Officer had rejected the returns filed by the Assessee for the Assessment Year in consideration on the ground that the Parent Company was not under any obligation to contribute to the common fund being utilized by the Assess for Advertising, Marketing and Promotion. This discretion was reflected in the Tripartite Agreement between the Parent Company, the Assessee and the Franchisers. The C.I.T (A) upheld the imposition of liability on the ground that the activity undertaken by the Assessee was tainted by the aspect of commerciality because Pepsi Foods Ltd. joined the common pool of funds, in violation of the sanction of Government Approval as confirmed further by the Tribunal.

Arguments

The Appellant argued that since the Parent Company earned fixed percentages from the franchises by way of royalties, as a consequence benefits directly from enhanced sales resulting in increased royalties, the activities earmarked strictly for the benefit of the contributors. In the context of the doctrine of mutuality, Assessee argued that the doctrine merely required a common identity between the contributors and beneficiaries, and it does not contemplate each member should contribute to the common fund.

To the contrary, the Respondent submitted that the moment a nonmember (in this case, Pepsi Foods Pvt. Ltd.) joins the common pool of funds created for the benefit of the contributors, it taints the transaction with commerciality and the principle of mutuality ceases to exist. Moreover, it was contended that the transaction violated the SIA approval.

Court’s View

The Court examined the doctrine of mutuality tracing the origin to the principle that a man cannot engage in business with himself. Therefore, for the doctrine to succeed it is necessary to show that there existed no profit motive to regard the ‘surplus’ as ‘income’ under Sec. 2(24) of the Income Tax Act, 1961. For any transaction to be taxed under the Income Tax Act, 1961, an income, profit or gain must arise or accrue to a person, this has been observed in a catena of cases. Moreover, while considering the question of mutuality, this Hon’ble Court quoted the case of Bangalore Club v. Commissioner of Income Tax & Anr., (2013) 5 SCC 509 (“Bangalore Club”), wherein it was held that,

… it is settled law that if the persons carrying on a trade do so in such a way that they and the customers are the same persons, no profits or gains are yielded by the trade for tax purposes and therefore no assessment in respect of the trade can be made

To established mutuality for exempting oneself from tax liability, the Court followed the test laid down in the English and Scottish Joint Co-operative Wholesale Society Ltd. v. Commissioner of Agricultural Tax, Assam, AIR 1948 PC 142, which was quoted with approval in the Bangalore Club case. The three conditions that are to be fulfilled are:

  1. Common Identity of the contributors and the recipients from the fund;
  2. Non-profiteering;
  3. Obedience to mandate.

As per the first condition no person ought to contribute to the fund without being entitled to benefit from the fund, conversely, no person shall be entitled to the funds without first having contributed to the funds, that is, the person should be both a contributor to the funds and recipient from the funds. There must exist the status quo of the class of members as the transaction progresses and must manifest uniformity. As soon as the transaction opens itself to a non-member, the common identity is impaired. As expressed by the Court,

 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.

In the instant case, Pepsi Foods Pvt Ltd. is a contributor to the common pool however does not participate in the surplus as a beneficiary for two reasons – first, it is not a mutual concern as per the Tripartite Agreement which as per the approval of SIA permits only ‘franchises’. Secondly, it is neither entitled to participate in the surplus nor has the right to receive back the surplus. The surplus being the excess of amount remaining post the expenditure incurred in the advertising, marketing and promotion of Parent Company. Accordingly, the Pepsi Foods Pvt. Ltd., which stands on exclusive contracts with the franchises and thus stands on an independent footing. Moreover, the Assessee Company is not responsible for the implementation of the contract. Resultantly, the first test is nullified.

Furthermore, concerning non-profiteering and obedience of mandate, the Court observed that the inclusion of Pepsi Foods Pvt. Ltd., tainted the operations of the Assessee company with commerciality and thus contravened the conditions of mutuality. Moreover, the discretion granted to the Parent Company under the Tripartite Agreement concerning contribution as against a fixed percentage of contribution to be made by the franchises was under violation of the approval granted by the SIA. In this regard,

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 an antithesis to the mutual character in the eyes of law.”

Lastly, the Court emphasized the importance of strict interpretation of exemption granted by the statutes.

Court’s Decision

The Court found that the three conditions of the mutuality were not successively established by the Assessee and accordingly there was no exemption to be granted. In the view of the aforementioned reason, the Court dismissed the appeal filed by the Assessee Company.


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