Doctrine of Mutuality

In CIT v. Common Effluent Treatment Plant Association the Bombay High Court has reiterated that if an association satisfies the norm of mutuality in respect of some receipts contributed by its members it does not necessarily lead to the conclusion that all the activities of the association satisfies the test of mutuality. I say reiterated because the same principle of law had been enunciated by the Gujrat High Court in Sports Club of Gujrat v. CIT ((1988) 171 ITR 504) .


Before discussing the facts and ruling of the Bombay High Court, it is necessary to briefly elucidate on the Doctrine of Mutuality. The doctrine of mutuality revolves around the hypothesis that “No man can trade with himself’. For e.g., a mutual society, say a club generates a surplus after providing certain privileges such as accommodation, refreshments etc. to its members. This surplus of receipts over expenditure cannot be deemed to be income on the ground of doctrine of mutuality as the club receives the funds from its members and uses it to provide certain privileges to the same members (CIT v. Bankipur Club Limited [ (1972) 82 ITR 831]). In Chelmsford Club v. CIT, the Supreme Court propounded the following tests which would establish mutuality:

(i) The contributors to the fund are the same persons who are also the recipients from the fund.

(ii) The entity is incorporated only for the convenience of the members i.e. the object should not be to earn profit.

(iii) 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.

In Common Effluent the assesse was an association formed for the purpose of setting up an effluent treatment plant for the members of the assesse who ran industrial units. The income of the assesse consisted of the contribution made by the members for setting up of the effluent plant. The assesse had surplus of receipts over expenditure i.e. the assesse collected more funds than what was needed. The main purpose for maintaining such a surplus as contended by the assesse was to meet any unforeseen circumstances. The assesse further invested the surplus funds in a bank as fixed deposits. In light of this background two issues had arisen before the court, (i) whether the surplus of receipts over expenditure for the purpose of setting up and maintaining the effluent treatment plant is exempt from income tax on the principle of mutuality and (ii) whether the income generated from bank fixed deposits is exempt from tax on the principle of mutuality.

The first question was answered in favour of the assesse. The court relying on Chelmsford held that the surplus income held by the assesse was solely for the purposes of providing common effluent facility to its members and hence was exempt from tax on the principle of mutuality. However, the court answered the second question in favour of the revenue. On this question the court concluded that the interest that is generated on investment of the surplus funds in fixed deposits is not income from the contribution of the members instead it is an income derived from a third party (in this case a bank). The assesse had put forth an interesting submission pursuant to the second issue. The assesse contended that as per S. 35(1) of the Bombay Trust Act, 1950 it was legally mandated to invest the surplus money as deposits in a bank. In essence the contention of the assesse was that the investment made as fixed deposits was a statutory obligation and was not tainted with commerciality i.e. the purpose was not to derive profits. In contrast the court correctly held that the Bombay Trust Act only mandated deposits and not “fixed deposits”. The court further opined that the purpose for investing in “fixed deposits” was to earn interests which would not be available on moneys maintained in ordinary, current or savings account; hence the investment was a prudent commercial decision. In arguendo, the court while relying on the Supreme Court judgment Totgars Cooperative Sale Society Limited v. ITO held that even if their was a statutory obligation to deposit the surplus as fixed deposits, the interests derived from the same would be chargeable to tax under the head income from other sources. However, as the court correctly noticed the question in Totgars was in relation to deduction u/s 80P of the IT Act, 1961 and not on the principle of mutuality.