If surplus fund not applied for common purpose, club loses its control over it and identity between contributors & participators ends

While refusing to reconsider the coordinate bench decision in Commissioner of Income Tax vs. M/s Cawnpore Club Ltd., Kanpur [(2004) 140 Taxman 378 (SC)], since there is no ratio decidendi on the issue of taxability of interest, and hence, does not have any precedential value, the Supreme Court held that the ruling in Cawnpore Club cannot be a binding precedent.

The Apex Court clarified that the only thing in a judge’s decision binding a party is the principle upon which the case is decided and for this reason it is important to analyse a decision and isolate from it the ratio decidendi.

The Apex Court went on to observe that banks utilizing the funds of the clubs for their banking business would completely rupture the principle of mutuality and as a result, the element of complete identity between the contributors and participators stands lost.

Highlighting that the class of members should stay intact as the transaction proceeds from the stage of contributions to that of surplus, the Apex Court observes that the moment such a transaction opens itself to non-members, either in the contribution or the surplus, the uniformity of identity got impaired and the transaction assumes the tint of a commercial transaction.

Elucidating that the principle of mutuality applies till the stage deposit of funds and would lose its application, once the funds are deposited in banks as they are exposed to commercial banking operations for lending to third parties and earning a higher interest thereon and by paying a lower rate of interest on the fixed deposits to the clubs, the Two Judge Bench comprising of Justice B.V Nagarathna and Justice Prashant Kumar Mishra clarified that once the funds from the contributions stands deposited with the bank, the interest income on same becomes taxable.

Senior Advocates D. Abhinav Rao and Radha Rangaswamy appeared for the Petitioner, whereas the Department was represented by ASG Balbir Singh and Senior Advocate Raj Bahadur Yadav.

Briefly put, the present appeals had arisen from the orders of the High Courts of Andhra Pradesh pertaining to Secunderabad Club and the Madras High Court pertaining to Madras Gymkhana Club, Madras Cricket Club, The Coimbatore Cosmopolitan Club, Madras Club, M/s Wellington Gymkhana Club and M/s the Coonoor Club, whereby it was uniformly held that the interest earned on the bank deposits made by the clubs is liable to be taxed in the hands of the clubs and that the principle of mutuality would not apply.

The assessee therefore sought clarification as to whether the deposit of surplus funds by the appellant Clubs by way of bank deposits in various banks is liable to be taxed in the hands of the Clubs or, whether, the principle of mutuality would apply and the interest earned from the deposits would not be subject to tax under the provisions of the Income Tax Act.

After considering the submission, the Division Bench of the Apex Court observed that the essence of the principle lies in the commonality of the contributors and therefore, 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.

Thus, the Bench opined that there is no dispute on the taxability of the clubs on interest earned from banks irrespective of the fact that that the banks are corporate members of the Club.

The Apex Court highlights that element of mutuality subsists only till the club extends facilities to non-members, but when the fixed deposits were made by the clubs in the banks, they were exposed to transactions with third parties, i.e., between the banks and its customers and this ceases the principle of mutuality.

The Apex Court also illustrated that once a third party starts dealing with the contributions of or funds of the club and return the same with interest, then, the relationship of the parties is not based on the privity of mutuality.

Therefore, when surplus fund is not applied for the common purpose of the club or of the members of the club directly but is invested with a third party i.e., bank with the right to utilize the said funds, subject to payment of interest on it, the Apex Court concluded that in case of such event, the essential condition of mutuality ends.

Cause Title: Secundrabad Club vs. Commissioner of Income Tax [CIVL APPEAL NO(S). 5195-5201 OF 2012 / 2023-Enterslice-1-SC-IT]

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