Commissioner Of Income-Tax, Madras vs Kumbakonam Mutual Benefit Fund Ltd

Rewritten Version Notice: This is a rewritten version of the original judgment.

Court: Supreme Court of India

Case Number: Civil Appeals Nos. 637644 of 1963

Decision Date: 7 May 1964

Coram: S.M. Sikri, J.C. Shah

In the matter titled Commissioner of Income‑Tax, Madras versus Kumbakonam Mutual Benefit Fund Ltd., the Supreme Court of India delivered its judgment on 7 May 1964. The opinion was authored by Justice S. M. Sikri, who was joined by Justices K. Shah and J. C. Shah on the bench. The citation for the decision is recorded as 1965 AIR 96 and 1964 SCR (8) 204. The case concerned the application of section 10(2)(iii) of the Income‑Tax Act, 1922, to a company that operated as a mutual benefit society engaged in banking activities that were limited to its members. The fund collected recurring monthly deposits from its members for a predetermined period, after which it repaid the principal together with interest. Using the accumulated deposits, the fund extended loans to its members, and the interest earned on these loans represented the principal source of income for the fund. After meeting the obligations of interest on the deposits and covering all other expenses related to management and operations, the remaining balance was distributed among the members in proportion to their shareholdings. It was noted that shareholders who were entitled to share in the profits were not required either to have made deposits or to have obtained loans from the fund. The assessee, Kumbakonam Mutual Benefit Fund Ltd., argued that it should be exempt from tax on the basis that it qualified as a mutual benefit society under section 10 of the Income‑Tax Act, relying on the principle articulated in New York Life Assurance Co. v. Styles, 2 T.C. 460, which had been applied in Board of Revenue v. Mylapore Hindu Permanent Fund Ltd., (1924) I.L.R. 47 Mad. 1. The Income‑Tax Officer, however, assessed the full amount of the fund’s profits, holding that the profits belonged to the members in their capacity as shareholders rather than as borrowers or as individuals who had utilized the fund’s facilities. The officer further concluded that the necessary identity between contributors and participators, as required by the Styles precedent, was not satisfied. Both the Appellate Assistant Commissioner and the Income‑Tax Appellate Tribunal affirmed the officer’s assessment on appeal. The Tribunal, while referring the matter to the High Court, raised the question of whether material existed for the Tribunal to consider the assessee as a banking concern assessable under section 10, thereby potentially exempting it. The High Court answered this question negatively and applied a test requiring that the right to contribute and the right to participate be held by the same group, though it was not required that every member must have contributed before being allowed to participate. The High Court’s reasoning was subsequently examined by this Court.

The Court held that the test applied by the High Court was not sound. It observed a clear distinction between a situation in which a company earned profit from its shareholders acting as customers – even if the company dealt only with those shareholders – and then distributed that profit to them as shareholders, and a situation in which a company merely collected money from its members and applied that money for the benefit of those same persons, not as shareholders but as subscribers to the fund. For the principle laid down in Style’s case to be applicable, the Court explained that it was essential that every contributor to a common fund must be entitled to share in any surplus, and that every participant in the surplus must also be a contributor to the fund; it was not sufficient that participants merely had the right to contribute. The Court referred to the authorities Municipal Mutual Insurance Ltd. v. Hills, 16 T.C. 430; C.I.T. v. Royal Western Indian Turf Club Ltd., 1954 1 S.C.R. 289; Dibrugarh District Chit Ltd. v. C.I.T., Assam, 2 I.T.C. 521; Thomas v. Richard Evans & Co., 11 T.C. 790; The National Association of Local Government Officers v. Watkins, 18 T.C. 499; and Ismailia Grain Merchants Association v. C.I.T., A.I.R. 1958 Bom. 32. The Court further stated that the decision in Board of Revenue v. The Mylapore Hindu Permanent Fund Ltd. (1924) I.L.R. 47 Mad. 1 could not have been correctly based on Style’s case. It also noted the case of Madura Hindu Permanent Fund Ltd. v. C.I.T., 6 I.T.C. 326. The decisions in Sivaganga Sri Meenakshi Swadeshi Saswatha Nidhi Ltd. v. C.I.T., 8 I.T.C. 83 and Tanjore Permanent Fund v. C.I.T., 5 I.T.R. 160, were founded on the Mylapore Hindu Permanent Fund case, but in none of those cases was the question examined of what the position would be when shareholders participated in profits solely as shareholders and not as contributors. The judgment proceeded under the civil appellate jurisdiction for Civil Appeals Nos. 637‑644 of 1963, arising from the judgment and order dated 20 October 1960 of the Madras High Court in Case Referred No. 78 of 1956. Counsel for the appellant were identified as senior advocates, while counsel for the respondent were also named. The judgment was delivered on 7 May 1964 by Justice Sikri. The respondent, Kumbakonam Mutual Benefit Fund Ltd., hereinafter referred to as the assessee, was a company incorporated under the Indian Companies Act, 1882, and limited by shares. Since 1938 the nominal capital of the assessee had been Rs. 33,00,000 divided into shares of Re. 1 each. The fund carried on a banking business that was restricted to its shareholders; the shareholders were entitled to participate in various recurring‑deposit schemes of the fund or to obtain loans on security. The statement of the case described the operation of the fund as follows: recurring deposits were obtained from members for fixed amounts to be contributed monthly for a fixed number of months as stipulated, and at the end of the period a fixed amount was returned to the members according to published tables. The amount returned covered the compound interest of the deposits.

The assesse, Kumbakonam Mutual Benefit Fund Ltd., operated a banking scheme that was limited to its shareholders. The fund obtained recurring deposits from its members, each member committing to a fixed monthly contribution for a predetermined number of months as specified in the fund’s published tables. At the end of the agreed period the fund returned to each depositor a fixed sum that included the original contributions together with the compound interest earned on those contributions. These recurring deposits represented the principal source of capital that the fund used to advance loans. The loans were granted exclusively to members, and each borrowing member was required to provide substantial security, which could consist either of the paid‑up value of his own recurring deposits, if any, or of immovable property situated within the Tanjore district. The fund earned its main income from the interest charged on these member loans. From this income the fund paid interest on the recurring deposits, covered all other outgoings and management expenses, and, after setting aside the reserves required by its memorandum and articles of association, distributed the remaining balance among the shareholders in proportion to the number of shares each held. The shareholders were therefore entitled to participate in the profits irrespective of whether they had taken any loan from the fund or had made any recurring deposit.

On the basis of this arrangement the Income‑Tax Officer assessed the total profits of the fund for the eight assessment years spanning 1946‑47 to 1953‑54. In a detailed order dated 29 February 1952, which formed part of the statement of the case for the assessment year 1947‑48, the officer concluded that the precedent set in New York Life Assurance Company v. Styles(1) was not applicable to the present facts. He distinguished the Styles case by observing that, whereas the New York Life Assurance Company merely returned to its members the amount they had saved, the Kumbakonam Mutual Benefit Fund returned to its members what it had earned. He noted that a shareholder in the New York Life Assurance Company received back no more than his contribution, while a shareholder in the Kumbakonam Mutual Benefit Fund received more than his contribution. He explained that a fixed‑term depositor receives on maturity both the principal and the interest, and that a recurring depositor who pays, for example, one rupee each month for eighty‑six months receives not merely Rs 86 but Rs 100, the excess representing interest. The officer emphasized that this return was not a simple refund and that, unlike the New York case, the member’s contribution was not made for a common purpose from which he later reclaimed a proportionate share. From the individual member’s viewpoint, an investment in the fund was akin to any other lucrative investment, and the member’s primary aim was to obtain the income that appeared as interest or dividend. Relying on the observations of Rowlatt, J. in Thomas v. Richard Evans Co. Ltd.(1), which stated that the returns come back to them not as purchasers or customers but as shareholders upon their shares, the officer held that the profits of the fund belonged to the shareholders in their capacity as shareholders and not as borrowers or individuals who had utilised the fund’s facilities.

The Court observed that the Income Tax Officer had concluded that the members of the fund had “utilised the facilities afforded by the fund.” The Officer further stated that, in order to qualify as a mutual benefit society, there must first exist a common fund and it must be shown that the contributors to that fund and the participants in any surplus are one and the same. The Officer then expressed his view that, in the present case, no such common fund existed. He explained that the assessee’s income was derived from interest on loans advanced to its members, interest on Government securities, rents from property and similar sources, and that this income was distributed to members either as guaranteed interest, as dividends, or as a combination of both.

Regarding the transactions that the assessee described as “mutual,” the Officer noted that the contributors to the company’s income, as reported in the case citation (II T.C. 790), were those members who had borrowed from the assessee and had paid interest on those borrowings. He added that, if the requirement of complete identity between contributors and participants were satisfied, those contributors would also have to be entitled to share in the profits. The Officer further pointed out that a shareholder could be someone who neither held any deposit with the fund nor used the borrowing facilities, and who might simply be content to receive any dividend that the fund declared.

The Appellate Assistant Commissioner, on appeal, affirmed the Income Tax Officer’s order. Counsel for the assessee argued, among other points, that the decision in Board of Revenue Madras v. The Mylapore Hindu Permanent Fund Ltd. should apply because the capital of the assessee also fluctuated. The Commissioner rejected that argument, holding that the capital in the present case did not fluctuate but increased steadily. He also held that a shareholder need not be a subscriber to either fixed or recurring deposits, and that a shareholder might not participate in interest earnings if no dividend was declared.

On a further appeal, the Income Tax Appellate Tribunal made a detailed finding. The Tribunal stated that the fund’s claim to be a genuine mutual benefit society was untenable. It emphasized that the essential requirement of a mutual benefit society is that all contributors to the common fund must be able to participate in the surplus, and conversely, all participants in the surplus must be contributors to the common fund; in other words, complete identity between contributors and participants is indispensable. The Tribunal observed first that no common fund existed. Second, it noted that shareholders might or might not receive a dividend, while those shareholders who made recurring deposits of varying durations were entitled to guaranteed interest. It identified the persons who actually contributed to the company’s income as the shareholders who borrowed from the appellant and paid interest on those borrowings. From the income thus derived, the Tribunal explained, shareholders who made monthly deposits received guaranteed interest, whereas shareholders who did not make such deposits might receive a dividend but were not assured any payment. Consequently, the Tribunal concluded that the required identity between contributors and participants was absent. The Tribunal then described the nature of the appellant’s business as being that of

In this matter, the business of the appellant was described as ordinary banking, although it was limited to members or shareholders only, and that limitation did not remove the appellant’s income from the reach of the charging provisions of the Act. The Court observed that the Income‑tax authorities were correct in treating the appellant as a banking concern. The Appellate Tribunal, however, framed a consolidated case covering the assessment years 1946‑47 through 1953‑54 and referred two questions to the High Court. The first question asked whether there were material facts enabling the Tribunal to hold that the assessee was a banking concern assessable under Section 10 for all the assessment years and therefore not exempt. The second question, contingent on an affirmative answer to the first, sought to determine whether the payments made by the assessee to a non‑recognised provident fund for the assessment years 1946‑47 and 1948‑49 to 1952‑53 could be allowed as deductions under any provision of the Act. The present discussion is limited to the first question. The High Court, after briefly stating its reasons, answered the first question in the negative, awarded costs of Rs 250, and ordered that the institution fee of Rs 100 payable in each reference be refunded to the assessee as part of the costs to which the successful assessee was entitled. After reviewing the authorities cited before it, the High Court concluded that the assessee satisfied the conditions required for the application of the precedent set in Style’s case. It highlighted that the benefits of the association were available only to members, that no non‑member could partake in those benefits, and that the profits of this mutual trading arose from interest collected on loans granted to members and from default interest charged to members who delayed recurring deposits. The Court further noted that after paying interest to depositors and covering administrative expenses, the remaining profit was distributed among the entire membership, thereby demonstrating complete mutuality. The Court explained that the essential requirement is that the right to contribute and the right to participate must be possessed by the same group, and it is not necessary for every member to contribute before being allowed to participate; this test, the Court held, was unquestionably satisfied in the present case. This test, however, was challenged by the appellant’s counsel. The High Court certified that the matters were suitable for appeal to this Court under section 66A(2) of the Indian Income‑Tax Act, and the appeals are now before the Supreme Court for disposal. The principal issue now before the Court is whether the principle laid down in Style’s case applies to the facts of the present case, that is, whether the language used by Lord Macmillan in Municipal Mutual Insurance Limited is applicable here.

In this case, the Court examined whether the rule articulated in Hills required that every person who contributed to a common fund also had the right to share in any surplus, and that every person who shared in the surplus had necessarily been a contributor to that fund, meaning there had to be complete identity between contributors and surplus participants. The Court asked whether this essential condition had been satisfied. The Court noted that most of the English and Indian cases dealing with this issue had already been examined by the Court in Commissioner of Income Tax v. Royal Western Indian Turf Club Ltd., and therefore it was not required to revisit each of those authorities again. However, the Court said it would briefly consider the decisions that involved companies limited by shares, because those entities occupy a slightly different position from companies limited by guarantee. The Court cited the authorities 2 T.C. 460, 16 T.C. 430 and [1954] S.C.R. 289. Although the factual situation in the Royal Western Turf Club case differed from the present matter, the Court reproduced the principle it had articulated: that the proposition that no person may profit from himself is generally true, yet applying it rigidly can create confusion. The Court explained that there is nothing in law that absolutely prevents a company from earning a profit from its own members. For example, a railway company may earn profits by transporting passengers and may also earn a profit by transporting its shareholders; similarly, a trading company may earn profit by trading with its members in addition to profit earned from the general public. In such circumstances the profit earned from members belongs to them in their capacity as shareholders and does not revert to them as the individuals who made the contributions. The Court further observed that when a company collects money from its members and uses it for their benefit, not as shareholders but as the persons who actually contributed to the fund, the company itself does not make a profit. In situations where the contributors and the participants in the surplus are the same persons, the fact that the entity is incorporated may be irrelevant, and the incorporated company may be treated merely as a convenient instrument through which the members could have acted themselves. Nevertheless, the Court warned that incorporation creates a separate legal entity and this fact cannot be ignored altogether; the separate legal entity may, in some cases, make a profit from its own members.

The Court then turned to the decision in Dibrugarh District Club Ltd. v. Commissioner of Income Tax, Assam, which it had previously noticed. The Court recalled that the Calcutta High Court, while distinguishing the earlier Style case, held that the question of incorporation could be set aside based on the facts of that case. In the Dibrugarh club, out of the total membership only sixty‑nine persons were shareholders, while two hundred and twenty members were non‑shareholders; additionally, seventy‑four of the four hundred and forty‑five shares were held by persons who were not members of the club. The club distributed its profits each year as dividends to its shareholders. The Court agreed with the observation of Justice Rowlatt that if profits are

In the situation where profits are handed out to shareholders in their capacity as shareholders, the Court observed that the principle of mutuality is not fulfilled. The Court then referred to the decision in Thomas v. Richard Evans and Co., citing pages 822‑823, where the learned judge explained that a company may generate profit from its members when those members act as customers, even though the pool of customers is limited to the shareholders themselves. The judge illustrated that if a railway company gains profit by carrying its shareholders, or if a trading company earns profit by dealing only with its shareholders, the profit, although it belongs to the shareholders in a sense, belongs to them in the role of shareholders and not in the role of purchasers or customers. Consequently, the profit returns to them on the basis of their shareholdings and not as a reimbursement for a purchase.

The judge further explained that when a company merely collects money from a defined group of people and then uses that money for the benefit of the same people, the label attached to those people—whether they are called members of the company or participating policy‑holders—does not alter the analysis. In such a circumstance, as the judge understood from the New York case, there is no profit at all. He noted that if the individuals performed the same activity themselves, there would be no profit, and the mere fact that they create a corporate entity to perform the activity on their behalf does not create a profit. The absence of profit arises not because the corporate entity should be ignored, but because the money is simply collected from the individuals and subsequently returned to them, not as shareholders but as the persons who originally paid the money. The judge stated that this reasoning reflects the effect of the decision in the New York case, as reported in the Income Tax Cases, volume 790.

The Court then expressed the view that the test applied by the Madras High Court in the earlier proceeding was unsound and failed to accord with the true meaning of the decision in Style’s case, a meaning that this Court and later authorities have embraced. The Court highlighted Lord Macmillan’s clear statement that every participant must be a contributor to the common fund, rather than merely being entitled to contribute. The essence of mutuality, according to the Court, lies in the return of each participant’s contribution to the common fund. The Court also referred to the observations of Das, J., then sitting as a judge, in Commissioner of Income Tax v. Royal Western Indian Turf Club Ltd., where the same principle was reiterated.

For the assessee, counsel relied on the decision in The National Association of Local Government Officers v. Watkins, arguing that it is not essential for every participant to contribute to the common fund. The Court, however, distinguished that case on the ground that it involved an unincorporated association. In that case, Finlay, J. treated the contribution requirement as a matter of fundamental importance, observing that the property of such an association belongs to its members. Finlay, J. warned against the fallacy—cited in several authorities—that in a club the property is separate from the members, emphasizing instead that the property is vested directly in the members themselves.

The Court explained that when a member orders a dinner and consumes it, no sale takes place because the property in question is held by the members as a whole. The essential point, according to the judgment, is that the entire property belongs to the members themselves. The Court further emphasized that where a separate legal entity such as a company exists, the relevant test is to examine whether the subscribers or participants are the same persons who own the property. It was observed that in the present case the property was not owned by the Association but by the individual members. The Court noted that this particular aspect was overlooked by Chief Justice Chagla in the decision of Ismailia Grain Merchants Association v. Commissioner of Income Tax.

Turning to the authorities cited by the counsel for the assessee, the Court set out the facts of several decisions of the Madras High Court. In Board of Revenue v. The Mylapore Hindu Permanent Fund Ltd. (1) [1954] S.C.R. 289 (2) 18 T.C. 499 (3) A.I.R. 1958 Bom. 32, the Fund had been registered under the Indian Companies Act of 1866. Each shareholder subscribed one rupee per share per month and, after seven years, withdrew Rs. 102‑8‑0, at which point his shareholding ceased. The rules required shareholders to pay interest on any subscription that was not paid within the prescribed time. In addition to interest on subscriptions, the Fund earned income from interest on loans made exclusively to its members—each member being entitled by the rules to obtain a loan—and occasionally from interest earned on external bank investments. The High Court applied the principle laid down in Style’s case and held that interest income derived from the Fund’s own members was not taxable under the Income‑Tax Act, 1918, even though the profits were divided among directors and distributed to shareholders in proportion to the number of shares held and the duration of those holdings. The Court pointed out that the argument raised by Mr. Rajagopal Sastri was not put before the High Court, which had simply applied the test of whether the income originated from outside the Fund rather than from within it.

Subsequent appellate decisions were then examined. The Full Bench in The Madura Hindu Permanent Fund Ltd. v. Commissioner of Income Tax (3) held that the earlier decision could not be correctly based on Style’s case. In The Sivaganga Shri Meenakshi Swadeshi Saswatha Nidhi Ltd. v. Commissioner of Income Tax (4), the High Court, without addressing the doubts expressed in the Madura Hindu Permanent Fund judgment concerning the applicability of Style’s case, and without providing reasons, applied the reasoning of the Mylapore Hindu Permanent Trust case. Finally, the Court referenced the decision in Tanjore Permanent Fund v. Commissioner of Income Tax (5), indicating that the discussion would continue on that line of authority.

The High Court held that there was no conflict between the decision in the Mylapore Hindu Permanent Fund(1) case and the decision in the Madura Hindu Permanent Fund(1) case. The citations for those decisions were recorded as follows: (1) [1924] I.L.R. 47 Mad. 1, (2) 2 T.C. 460, (3) A.I.T.C. 326, (4) 8 I.T.C. 83, (5) 5 I.T.R. 160. The Court observed that the facts in the present matter were similar to those in the Mylapore Hindu Permanent Fund(1) case; consequently, it declined to reopen the question or to disturb the established practice. Nevertheless, the Court added that although the term “shareholder” had been used, it did not intend to be understood as holding that the subscribers were shareholders in the proper sense within the meaning of the Companies Act. It was further noted that none of the earlier cases had debated the position of shareholders who participated in profits as shareholders rather than as contributors. The Court expressed the view that it would be difficult to apply the principle laid down in Style’s case to the facts before it. It explained that a shareholder in the assessee company was entitled to partake in profits without having to contribute to the company’s funds by way of loans, and that a shareholder was entitled to receive dividends so long as the share was held, without any additional conditions. The Court observed that such a shareholder’s position was no different from that of a shareholder in a banking company limited by shares. Moreover, the Court stated that the assessee’s situation resembled that of an ordinary bank, the only distinction being that the bank lent money to and received deposits from its own shareholders. This circumstance, the Court held, did not render the income any less income from business within section 10 of the Indian Income Tax Act. Accordingly, the Court concluded that the answer to the question referred to the High Court should be affirmative, and it allowed the appeals. However, because the Mylapore Fund(1) case had settled the issue in Madras since 1923, the Court declined to impose costs on the assessee and ordered that each party bear its own costs. A subsidiary point raised by counsel for the appellant concerned the High Court’s jurisdiction to order a refund of the reference fee deposited by the assessee. The Court accepted that the High Court lacked such jurisdiction, but noted that a High Court could, if it deemed appropriate in a particular case, assess costs in a manner that included the sum of Rs. 100 deposited as a reference fee. The appeal was therefore allowed. (1) [1924] I.L.R. 47 Mad. 1 (2) 2 T.C. 460