Andhra Pradesh H.C : Whether, on the facts and in the circumstances of the case, the Tribunal is correct in law in holding that the principle of mutuality is satisfied in the case of the assessee-firm and consequently the income of Rs. 48,310 is not taxable for the asst. yr. 1977-78 ?

Section 4

Asst. Year 1977-78

Counsel Appeared

Murthy & A.V. Krishna Kaundinya, for the Revenue : K.Raghavendra Rao, for the Assessee

V. ANJANEYULU, J.:

This is a reference under s. 256(1) of the IT Act, 1961 (hereinafter referred to as ” the Act “), by the Tribunal in connection with the asst. yr. 1977-78. The following question of law is referred for the consideration of this Court :

” Whether, on the facts and in the circumstances of the case, the Tribunal is correct in law in holding that the principle of mutuality is satisfied in the case of the assessee-firm and consequently the income of Rs. 48,310 is not taxable for the asst. yr. 1977-78 ? “

2.The assessee describes itself as a firm registered for income- tax purposes. It carries on business in lending money, somewhat unusually, to its partners. Although it is not clear from the record, it is clear that this firm has been carrying on this so called business for quite some time, because there is an indication that the firm was assessed to tax upto and including the asst. yr. 1976-77 and tax was paid by the former partners. In the previous year relevant to the asst. yr. 1977-78, some changes occurred in the constitution of the firm, with the result that a deed of partnership was executed on April 15, 1976, among 19 partners. This firm filed a return declaring an income of Rs. 48,310.It is said to represent interest received on loans advanced by the firm to its partners. It would also appear that this amount included interest received on outstandings due from a former partner and also on moneys deposited in a savings account with the Canara Bank. The record does not indicate that the interest of Rs. 48,310 included interest from any person other than the above. In connection with its income-tax assessment for the asst. yr. 1977-78, the assessee set up a claim that it is a mutual benefit association or society and its income is derived wholly from members and, consequently, the principle of mutuality is applicable and the income cannot be taxed. The ITO rejected this contention on the short ground that in cl. 1(b) of the partnership deed there is a provision to carry on the business in advancing loans to outsiders also and this provision militated against the assessee’s claim of mutuality. The assessee’s contention was accordingly rejected and the income returned was subjected to tax. An appeal was filed before the AAC , who upheld the claim of the assessee and allowed the appeal. The Revenue filed an appeal before the Tribunal against the order of the AAC. The Tribunal upheld the order of the AAC and rejected the Revenue’s contention that the income derived by the assessee in this case is liable to tax. In other words, the claim regarding mutuality has been accepted by the appellate authorities. The CIT applied for and obtained this reference under s. 256(1) of the Act to consider the question referred to in para. (1).

3.We have heard learned counsel for the Revenue and also learned counsel for the assessee. From the facts on record it is clear that although the assessee has been carrying on the business activity of lending moneys to its members, it described itself as a partnership firm. Looking into the provisions of the partnership deed, which are extracted by the Tribunal in its order, we are satisfied that the description by the assessee of itself as a ” partnership ” is a mis-description. It looks as if the deed of partnership is a memorandum of association in truth and reality. The mere fact that the firm is described as a partnership firm need not necessarily be considered as decisive for determining the character of the assessee before us.

4.The provisions of the deed of partnership extracted by the Tribunal in its order show that each partner contributes Rs. 25 per month to the partnership firm. The contributions so made by the partners are accumulated and lent to such partners as may be in need of the same. The provisions relating to the grant of loans to members, etc., in the deed would indicate that in reality the deed of partnership is only a memorandum of association containing the terms and conditions governing the conduct of the business of the assessee consisting of 19 members. It would be more appropriate to consider the assessee as an association of persons as, admittedly, no business is being carried on by the assessee. Unless a business is carried on, the question of a partnership being formed under the Indian Partnership Act does not arise. On the facts and circumstances, it seems to us that the more appropriate description of the assessee would be an ” association of persons ” rather than a firm. Even so, the question still remains whether the association satisfies its mutuality in the sense that all the participators to the common fund are also contributors and their identity is established. It is this basic principle that satisfies the test of mutuality.

5.We have already referred to the relevant facts. There is nothing on record to show that the assessee has been carrying on the business activity of lending moneys to any persons other than its 19 members. The two other persons referred to, from whom interest was received, are not really persons to whom moneys were advanced. One person is a former partner who is paying interest on the moneys owed by him at the time of his retirement and the other person is the Canara Bank with which moneys are kept in safe deposit. It is not possible to say that any business transactions are carried on by the assessee with the former partner or the Canara Bank. There is also no indication from the record to the effect that in the past years, the assessee had carried on the activities of lending moneys to any person other than the members constituting the association. We, therefore, proceed on the assumption that the assessee’s claim that it confines its moneylending activity only to its members and to no outsiders, has to be accepted. If that be so, it follows automatically that the interest received by the assessee is distributed among the members forming the association and thus the principle of mutuality governs.

6.Learned counsel for the Revenue, however, says that this is not adequate. According to learned counsel, there must be complete identity between the contributors to the common fund and the participators in the same. It is urged that moneys had not been advanced to each and every member and interest also has not been paid by each and every member. It is pointed out that interest was paid only by such of the members to whom moneys were lent and all the persons who had not taken loans were also sharing the income. This, according to learned counsel for the Revenue, militated against the principle of mutuality as, according to him, the identity between thecontributors to the common fund and the participators in the same is not established. We are unable to accept this contention. It is not necessary to refer to the various authorities which repelled this proposition very often advanced by the Revenue. It is enough to refer to a decision of this Court in CIT vs. Merchant Navy Club (1974) 96 ITR 261(AP). Dealing with an identical question, this Court, at observed : ” The contributors to the common fund and the participators in the surplus must be an identical body. That does not mean that each member should contribute to the common fund or that each member should participate in the surplus or get back from the surplus precisely what he has paid. What is required is that the members as a class should contribute to the common fund and participators as a class must be able to participate in the surplus. It is immaterial whether the surplus is paid back to the members in cash or is put to reserve with the club for its development and for providing better amenities to its members. ” The aforesaid observations answer the criticism of learned counsel for the Revenue that the identity between contributors and participators is not established in this case.

7.Learned counsel for the Revenue relied upon the decision of the Supreme Court in CIT vs. Kumbakonam Mutual Benefit Fund Ltd. (1964) 53 ITR 241(SC). According to learned counsel for the Revenue, the facts of this case are identical with the facts obtaining in the present case and, therefore, the decision of the Supreme Court should govern the present case also in the sense that the principle of mutuality is not satisfied. Learned counsel also relied upon the decision of this Court in CIT vs. Dharmavaram Mutual Benefit Permanent Fund Ltd. (1968) 67 ITR 673(AP). The decision of the Supreme Court was referred to by this Court in Merchant Navy Club’s case (supra), above referred to and was explained. It should be borne in mind that the decisions of the Supreme Court as well as this Court, relied upon by learned counsel for the Revenue, refer to corporate bodies having a legal status. The question which fell for consideration in those cases was whether the companies could be considered to be carrying on business with the member- shareholders in order that the income derived by them qualified for consideration as income derived by a mutual benefit society. Considering the fact that the assessees in those cases were corporate bodies having legal existence, the Court held that the principle of mutuality does not apply in relation to transactions with shareholders. The aforesaid distinction has been clearly brought out by this Court in Merchant Navy Club’s case (supra) . We have seen in the present case that the members of the association constituting the assessee carry on the activity among themselves. Unless it is possible to state that a person derives income by trading with himself, it is not possible to consider that the income derived from transactions between members inter se possessed the character of income of a non- mutual benefit concern. It is difficult to subscribe to the view canvassed by learned counsel for the Revenue that the 19 members in the case of the assessee should be held to be carrying on business with themselves in order to derive income of Rs. 48,000 odd. On the facts and circumstances above stated, we are equally of the view that the appellate authorities below were justified in coming to the conclusion that the assessee is a mutual benefit association and its income is not liable to be taxed.

8.We are supported in the above view taken by the decision of this Court in Addl. CIT vs. Secunderabad Club (1984) 150 ITR 401.

9.We, accordingly, answer the question in the affirmative, i.e., in favour of the assessee and against the Revenue. There shall be no order as to costs.

[Citation : 169 ITR 732]