Commissioner of Income-Tax, Madras v. Kumbakonam Mutual Benefit Fund Ltd.

Judgment

Civil Appellate Jurisdiction: Civil Appeals Nos. 637-- 644 Of 1963. Appeals from the judgment and order dated October 20. 1960, of the Madras High Court in Case Referred No. 78 of 1956. K. N. Rajagopa/ Sastri and R. N. Sachthey, for th~ appellant. P. Kesava Iyengar, M. S. K. Iyengar and Krishna Pillai, for the respondent. May 7. 1964. The Judgment of the (ourt was delivered by StKRI J.-The respondent. the Kumbakonam Mutual Benefit Fund Ltd., hereinafter referred to as the assessee, is a company incorporated under the Indian Companies Act. 1882, limited by shares. Since 1938. the nominal capital of the assessee is Rs. 33,00,000 divided into sh.ares of Re. I each. It carries on banking business restricted ti' its shareholders. i.e .. the shareholders are entitled to participate in the various recurring deposit schemes of the assessee or to obtain loans on security. The statement of the case describes the working of the assesscc thus:

"Recurring deposits are obtained from members for fixed - amounts to be contributed monthly by them for a fixed number of months as stipulated. i at the end of which a fixed mnount is returned to them according to published tables. 'The amount so returned will cover the compound interest of the period. These recurring deposits constitute the main source of funds of the assessee for advancing loans. Such loans are restricted only to members who have. however. to offer substantial security, therefor, by way of either the paid up value of their recurring deposits. if any, or immovable properties within the Tanjore district.

Out of the interest realised by the assessee on the loans which constitute its main income. interest on the recurring deposits aforesaid are paid as also all the other outgoings and expenses of managemer.t and the balance is divided among the members pro rata according to their shareholdings after making provision for reserves, etc .. as required by the Memorandum of Articles aforesaid. The shareholders who are thus entitled to participate in the profits need not have either taken loans or have made recurring deposits." The Income-Tax Officer assessed the entire profits for eight years from 1946-47 to 1953-54. In a detailed and closely reasoned order, dated February 29, 1952, which is part of the statement. of the case, passed in respect of the assessment year 1947-48, the Incm>1e Tax Officer held that New York Life A.n11ra11ce Cnmpany v. Styles(') did not apply to the facts of this case. He distinguished Style's<') case thus:

"Whereas the New York Life Assurance Company paid to its members what it had saved, the assessee fund pays to its members what it has earned. A share-holder in the New York Life Assurance Company did not get back anything more than what he contributed. a share-holder of the Kumbakonam Mutual Benefit Fund does (IJ 2 T.C. 46o C.l.T. K. M. Be"41 Fund Ltd. Slkri CJ.T. ltl. Bctw(ii Fwtd Ltd. on the other hand get more than wh.1t he contributes. A fixed depositor gets back on maturity of the deposit not only the amount he deposited but also th.e interest thereon. A r~­ curring depositor who pays, say a rupee eacil month for eighty-six months does not get back Rs. 86 only, or something less, but Rs. 100, the balance of Rs. 14 representing the interest on his deposit.

What is returned to him is not a mere refund and there is no question here, as in the case of the New York Life Assurance Company, of his contributing m1mcy for .a .common purpose and getting back that much of his contribution as is not required for the common purpose. From the point of view of the individual member, an investment in the assessee fund is just like any other lucrative investment and his primary object in inv~sting his money with the fund is the income. which comes to him in the guise of interest or dividend." Sikri Relying on Rowlatt, .l.'s, observations in Thomas v. Richard Evans Co. Ltd., ( 1) that 'it does not come back to them as purchasers or customers; it comes back to them as share-holders upon their shares', the Jncome Tax Officer held that "the profits made by the fund belong to them as share-holders and not as borrowers from the fund or in the capacity of individuals who have in any way utilised the facilities afforded by the fund."

He further held that "there · should firstly be a common fund and then it must be proved that the contributors to this common fund and the participators in the surplus are one and the same. As far as I can see, there is no common fund in this case. The income of the assessee is derived from interest on loans le~t to its members, interest on Government securities, rents from property, etc., and it is distributed to the members either in the shape of guaranteed interest or dividends or both. As far as the .allegedly "mutual" transactions of the assessee are concerned, the contributors to the income of the company (I) II T.C. 790 SUPREME COURT REPOI~TS are those members who have borrowed from t_he assessee and paid interest on their borrowings. If the requirement of the complete identity between contributors and participators were to be satisfied, then the above contributors should also be entitled to participate in the profits."

He further pointed out that a shareholder may not hold any deposit with the fund and may not utilise the borrowing facilities afforded by the fund but may be content to receive such dividend as is declared. The Appe!late Assistant Commissioner, on appeal, upheld the order of the Income Tax Officer. It was urged before him, inter alia, that the decision in the case of Roard of Revenue Madras v. The Mylapore Hindu Permanent Fund Ltd.,(1 ) applied to the facts because the capital was also fluctuating in this case. He, however, held that it was not a case of fluc.tuating capital but only a steady increase of capital. He further held that a shareholder need not be a subscriber to the fixed or recurring deposits, and· a shareholder may not participate in the interest earnings if 110 dividend is declared. On further appeal, the Income Tax Appellate Tribunal held as follows: "The fund's claim that it is in reality a mutual benefit society is untenable.

The cardinal requirement is th.at all the contributors to the common fund must be able to participat~ in the surplus and that all the participators in the surplus must be contributors to the common fund. In other words, complete identity between the contri· butors and the participators is essential. Firstly, there is no common fund. Secondly, the shareholders may or may not receive a dividend. But those sh.1reholders who contribute to the recurring deposits of various duration receive guaranteed interest. The persons who contnbute to the income of the company are those shareholders who borrow from the appellant and pay interest on their borrowings. (1) [1924] I.L.R. •7 Mad. 1 51 S.C.-14 C.1.T. K. M. Benefit Fund Ltd. Sikri C.1.T. re. M. B•M(il Fund Lid. Sikri J. SUPREME COURT REPOR1~ [1964)

Out of the income so derived, the guaranteed interest to the shareholders who make monthly deposits, receive guaranteed interest but the shareholders who do not contribute monthly deposits may or may not receive any dividend. Thus, the complete identity between co11tributors and participators does not exist. The nature of the business of the appellant is that of ordinary banking though the business is restricted to its members or shareholders only. This restriction does not in the least take the income of the appellant out of the purview of the charging sections of the Act. In our opinion, the Income-tax authorities were right in treating the appellant as a banking concern." The Appellate Tribunal, however, stated a consolidated case in respect of the assessment years, 1946-47 to 1953-54, and referred the following questions to the High Court: " ( 1)

Whether there were materials for the Tribunal to hold that the assessee is a banking concern assessable under Section 10 for all the assessment years and not exempt. (2) If the answer to the above question is in the affirmative and against the assessee, whether the payments to the non-recognised provident fund by the assessee for the six years of assessment 1946-47 and 1948-49 to 1952-53 are allowable deductions under any provisions of the Act." We are here only concerned with question No. 1. The High Court, for reasons which will be shortly stated, answered the question in the negative, and awarded costs Rs. 250. It further ordered the refund to the assessee of the institution fee of Rs. 100 for each of the references "as part of the costs to which as successful assessee it will be entitled to." The High Court, after a review of the cases cited before it, came to the conclusion that the assessee satisfied the con· ditions necessary for the applicability of Style's case(').

According to it, the facts that the benefits of the association (1) T.C. 460 S S.C.R. are available only to members thereof and no non-member can particip(lte in the benefits, and that the profits that arise from this mutu1l trading are the result of the interest collected from members who take advantage of the loans offered by the fund and also of the default interest paid by members who delay payment of recurring deposits, and that the 'profit' after payment of interest to depositors and after meeting the other expenses of administration of the fund are availal>le for distribution among the entire body of the members, showed that there was complete mutuality. It had that "what is accordingly required is that both the right to contribute and the right to participate must be available to an identical body and it is not necessary that every member should contribute before he can be allowed to participate. That this test is also satisfied in the present case is beyond question."

It is this test which is attacked as unsound by the learned counsel for the appellant. The High Court certified the cases as being fit for appeal to this Co mt, under s. 66 (A) ( 2) of the Indian Income Tax Act, and the appeals are now before us for disposal. The question that arises in this case is whether the Style's(') case covers the facts of this case. In other words. to use the language of Lord Macmillan in Municipal Mutual Insurance Limited v. Hills(') has the cardinal requirement, namely, 'that all the contributors to the common fund must be entitled to particip.ate in the surplus and that all the participators in the surplus must be contributors to .the common fund; in other words, there must be complete identity between the contributors and the participators', been satisfied? Most of the cases, both English and Indian. bearing on the point under discussion, were reviewed by this Court in Commissioner of Income Tax v. Royal Western Indian Turf Club Ltd. (3), and this relieves us of the task of reviewing al! of them again.

We will, however, shortly deal with those in which companies limited by sh.ares were concerned for they stand on a slightly different footing from companies limited by guarantee. (r) 2 T.C. 460 (2) 16 T.C. 430 (3) [1954] S.C.R. 289 C.l.T. K. M. Benefit Fund Ltd. Sikri C.I.T. K. M, Benefit Fund Ltd. Sikri [1964] Although the f.acts in the Ruyal Western Turf Club case were different, this Court laid down the following: "The principle that no one can make a profit out of himself is true enough but may in its application easily lead to confusion. There is nothing per se to prevent a comp.any from making a profit out of its own members.

Thus a railway company which earns profits by carrying passengers may also make a profit by carrying its shareholders or a trading company may make a profit out of its trading with its members besides the profit it makes from the general pwblic which deals with it but that profit belongs to the members as shareholders and does not come back to them as persons who had contributed them. Where a company collects money from the members and applies it for their benefit not as shareholders but as persons who put up the fund the company makes no profit. In such cases where there is identity in the character of those who contribute and of those who participate in the surplus. the fact of incorporation may be immaterial and the incorporated company may well be regarded as a mere instrument, a convenient agent for carrying out what the members might more laboriously do for themselves.

But it c1nnot be said that incorporation which brings into being a legal entity separate from its constituent members is to be disregarded always and that the legal entity can never make a profit out of its own members." In the Dibrugarh District Club Lid. v. The Commissioner of Income Tax, Assam(1 ), which was noticed by this Court, the Calcutta High Court distinguishing Style's(') case held that the fact of incorporation could be neglected on the facts of the case. In that club, out of the members of the club only 69 were shareholders and 220 were non· {I) 2 I.T.C. 521 (2)T.C. 460 S S.C.R. Cl.T. shareholders, while 7 4 out of 445 of the shares were held by non-members of the club, and the profits of the club were being distributed every year as dividend to shareholders. K. M. B•~ Rowlatt J., in our opinion, correctly points out that if profits are distributed to sh.1reholders as shareholders, the principle of mutuality is not satisfied. In Thomas v. Richard Evans and Co.('), at pp. 822-823, he observes thus:

"Bur a company can make a profit out of its members as customers, although its range of customers is limited to its shareholders. If a railway company makes a profit by earring its bareho_lders, or if a trading company, by trad- .1g with the shareholders-even if it is limitea to tradi11g with them-makes a profit, that profit belopgs to the shareholders, in a sense, but it belongs to them qua shareholders. It does not come back to -them as purchasers or customers. It comes back to thein as shareholders, upon th.eir shares. Where all that a company does is to collect money from a certain mun- 1>er of poeple--it does not matter whether they are called members of the company, or participating policy holders-and apply it for the benefit of those same people, not as shareholders in the company, but as the people who subscribed it, then, as I understand the New Yark c.ase, th~re is no profit.

If the people were to do the . thing for themselves, there would be no profit, and the fact that they mcorporate a legal entity to do it for them makes no difference. there is still no profit. This is not because the entity of the company is to be disregarded, it is because there is no profit, the money being simply collected from those people and handed back to them, not in the character of shareholders, but in the character of those who have paid it. That, as I understand it, is the effect of the decision in the New York case." )Ii T.C. 790 Fund Ltd. Silr•i CJ.T. [1964) K. M. Benefit Fund Ltd. It seems to us that the test applied by the High Court is not sound. It is not consistent with the true decision in Style's case, as understood by this Court and in other subsequent cases. It wat be noticed that Lord Macmillan clearlv said that all participators must be contributors to the com~ mon fund and not that all participators must be entitled to contribute.

The essence of mutuality lies in the return of what one has contributed to a common fund. Sikri Das, J., as he then was, in the passage quoted above, in Commissioner of Income Tax v. Royal Western Indian Turf Club Ltd. ( 1) reiterated the same idea. The learned counsel for the assessee, relying on The National Association of Local Government Officers v. Watkins('), urged that it is not necessary that all must contribute to the common fund. But in that case it was an unincorporated association, and Finlay, J., regarded that as a matter of fundamental importance, for it followed from it, as held by Finlay, J., "that the property belongs to the members and it is a fallacy, as had been pointed out in several cases, one at least of which was cited to me, to say in the case of such a club that, where a member orders a dinner and consumes it, there is any sale to him. There is not a sale. The fundamental thing is that the whole property is vested in the members."

He emphasized this again when he says that "it may be that where you have a separate entity, where you have a company, in a great many cases the test is that you have to look at the subscribers, look at the participants, and see if they are the same. Here it seems to me to lie at the root of the thing that the property was not the property of the Association; it was the property of the members themselves ..... " It is this feature of the case which Chagla, C.J ., failed to notice in Ismailia Grain Merchants Association v. Commissioner of Income Tax("). We may now deal with the cases decided by the Madra~: High Court, and relied on by the learned coupsel for the assessee. In Board of Revenue v. The Mylapore Hindu (1) [1954] S.C.R. 289 (2) 18 T.C. 49' (3) A.I.R. 1'58 Born. 32 f; S.C.R. 2I5 Permanent Fund Ltd.,(') the Fund was registered under the Indian Companies Act of 1866. A shareholder subscribed one rupee per share per mensem and at the end of 7 years drew Rs. 102-8-0, and then he ceased to be shareholder (qua the share).

A shareholder had to pay interest on the subscription, if not paid within the time prescribed by the rules. Apart from the interest on the subscription, the Fund derived income from interest on loans . given exclusively to its members, every one of them being entitled under the rules to take loan, and occasionally from interest from outside investments with bank. The High Court held the Style's(') case applied and ~!so held that the income earned by the Fund by way of interest from its own members was not taxable under the Income Tax Act, 1918, in spite of the fact that such profits were devided among directors and distributed among the shareholders with reference to the number of shares and the number of months during which they hau held them. But the point urged by Mr. Rajagopal Sastri was not raised before the High Court and the High Court was' content to apply the test 'whether the income comes in from outside and not from within'.

But as held by the Full Bench in The Madura Hindu Permanent Fund Ltd. v. The Commissioner of Income Tax( 3 ), this case could not have been rightly based on Style's case. In The Sivaganga Shri Meenakshi Swadeshi Saswatha Nidhi Ltd. v. The Commissioner of Income Tax (4) the High Court, without adverting to doubts expressed in the decision in Madura Hindu Permanent Fund Ltd.,(') regarding the applicability of Stvle's case, which was referred to in the statement of the case, and without giving any reasons, held that the Mylapore Hindu Permanent Trust(') case applied. In Tanjore Permanent Fund v. Commissioner of Income Tax(") the High Court held that there was no conflict between the decision in Mylapore Hindu Permanent Fund(') case and the Madura Hindu Permanent Fund(') case. As (I) [19241 I.L.R. 47 Mod. I (3) 6 l.T.r.. 326 (5) 11.T.R. 160 (2) 2 T.C. 460 (4)81.TC 83 CJ.T. K. M. B•n• Fund Ltd. Sikri /. 19114 C.1.T. M. B<n•fit Fund Ltd. Sikri I. the facts in the case were similar to that in Mylapore Hindu Permanent Fund (1) case, the High Court refused to reopen the question and disturb the practice, but however added that '"though the term 'shareholder' has been here used, we do not wish to be understood as deciding that these subscribers are shareholders properly so called within the meaning of the Companies Act."

As already pointed out, in none of these cases the point was debated as to what is the position when shareholders participate in profits as shareholders and not as contributors. It seems to us that it is difficult to hold that Style's(') case applies to the facts of the case. A shareholder in the assessee company is entitled to participate in the profits without contributing to the funds of the company by taking loans. He is entitled to receive his dividend as long as he holds .a share. He has not to fulfil any other condition. His position is in no way different from a shareholder in a banking company, limited by shares. Indeed, the position <>f the assessee is no different from an ordinary bank except that it lends money to and receives deposits from its shareholders. This does not by itself make its income any the less income from business within s. 10 of the Indian Income Tax Act. In our opinion, the answer to the question referred to the High Court should be in the affirmative.

The appeals are accordingly accepted, but in view of the fact that the Mylapore Fund(') case has held .the field in Madras since 1923, we do not wish to burden the assessee with costs. Accordingly, the parties will bear their own costs through- <>Ut. A subsidiary point was raised by Mr. Sastri that the High Court had no jurisdiction to order the refund of the reference fees deposited by the .assessee. This is true. Isut the High Courts can, if they so deem fit in a particular case. 11Ssess the costs in such a way as to include the sum of rts. I 00 deposited as reference fee. (1) [1924] I.L.R. 47 Mad. 1 Appeal allowed. (2) 2 T.C. 460