I've raised this issue before. However, new facts have emerged now. The Society has been filing its return as AOP have claimed exemption of interest income on Fixed Deposits with banks. Our CA has advised the Society to deposit tax around Rs.6 lacs after adjusting TDS deposit of Rs. 2 lacs to avoid penalties and interest.
The Society has been advised that while their income i.e excess of income over expenditure is exempt from Income Tax as long as the same is spent for the welfare of residents of the Society. Whilst the interest earned on savings deposits maintained with all Banks are exempt from Income tax. However, the interest earned on Fixed Deposits with Private Sector Banks are fully taxable. The Society is now trying to switch over to Fixed Deposits with a Co-operative Bank or Tax Free Bonds.
Several High Courts have considered the question whether interest earned on surplus funds originating in the members’ contribution of a mutual association is eligible to income tax, some of them are given below:
IN FAVOUR OF ASSESSEE:
Ø CIT Vs Delhi Gymkhana Club Ltd. 198 Taxman 207 (Del.)
Ø CIT Vs Standing Conference of Public Enterprises 319 ITR 179 (Del.)
Ø DIT Vs All India Oriental Bank of Commerce Welfare Society 130 Taxman 575 (Del.)
Ø Canara Bank Golden Jubilee Staff Welfare Fund v. Dy. CIT, 308 ITR 202 (Kar.)
IN FAVOUR OF REVENUE
Ø Madras Gymkhana Club Vs DCIT 183 Taxman 333 (Mad.)
Ø CIT Vs Bangalore Club (2006) 156 Taxman 323 (Kar.)
Ø Sports Club of Gujarat Ltd. Vs CIT [1988] 171 ITR 504 (Guj.)
Ø Devi Ahilya New Cloth Market Co. Ltd. Vs CIT [2009] 222 CTR 583 (MP)
Ø CIT Vs I.T.I.Employees Death & Superannuation Relief Fund (1998) 234 ITR 308 (Kar.)
Decisions favouring assessee and revenue shows that the issue had not attained finality.However, a Landmark Judgement passed by Hon’ble Supreme Court in the case of M/s Bangalore Club vs. Commissioner of Income Tax (CIT)M/s Bangalore Club vs. Commissioner of Income Tax (CIT) [2013] 212 Taxman 566 (SC) on 14-January-2013, gives great clarity on “Principles of Mutuality”, under which the Tax Exemption of Societies is considered.
Brief Gist of the aforesaid case is given below:
The Bangalore Club (an Association of People, AOP) created Fixed Deposits with Banks which are also Members of the Club. It claimed that the Interest earned on these Fixed Deposits should be exempt from Income Tax, as the Income is subject to the Principle of Mutuality. Commissioner of Income Tax claimed to the contrary.
The Verdict
“In our opinion, unlike the surplus amount itself, which is exempt from tax under the doctrine of mutuality, the amount of interest earned by the assessee (Bangalore Club) from the member banks will not fall within the ambit of the mutuality principle and will therefore, be exigible to Income-Tax in the hands of the assessee-club.
The surplus funds in the hands of the assessee (Bangalore Club) were placed at the disposal of the corporate members viz. the banks, with the sole motive to earn interest, which brings in the commerciality element and thus, the interest so earned by the assessee has to be treated as a revenue receipt, exigible to tax. It was pleaded that transaction between the assessee and the member banks concerned was in the nature of parking of funds by the assessee with a corporate member and was nothing but what could have been done by a customer of a bank and therefore, the principle that “no man could trade with himself” is not applicable.” – D.K. JAIN AND JAGDISH SINGH KHEHAR, JJ
The Reasons given by their Lordships of the Hon’ble Supreme Court, in the case, are:
There should be THREE conditions which must be satisfied, for an Income to be Exempt on the Principle of Mutuality:
- There must be a complete identity between the contributors and participators.
- The actions of the participators and contributors must be in furtherance of the mandate of the association.
- There must be no scope of profiteering by the contributors from a fund made by them which could only be expended or returned to themselves.
In the instant case, their Lordships noted non-compliance of all three Conditions:
Ø The arrangement lacks a complete identity between the contributors and participators. Till the stage of generation of surplus funds, the setup resembled that of a mutuality; the flow of money, to and fro, was maintained within the closed circuit formed by the banks and the club, and to that extent, nobody who was not privy to this mutuality, benefited from the arrangement. However, as soon as these funds were placed in fixed deposits with banks, the closed flow of funds between the banks and the club suffered from deflections due to exposure to commercial banking operations. During the course of their banking business, the member banks used such deposits to advance loans to their clients. Hence, in the present case, with the funds of the mutuality, member banks engaged in commercial operations with third parties outside of the mutuality, rupturing the ‘privity of mutuality’, and consequently, violating the one to one identity between the contributors and participators as mandated by the first condition. Thus, in the case before us the first condition for a claim of mutuality is not satisfied.
Ø Once parked as FD, the surplus funds were not used for any specific service, infrastructure, maintenance or for any other direct benefit for the member of the club. These were taken out of mutuality when the member banks placed the same at the disposal of third parties, thus, initiating an independent contract between the bank and the clients of the bank, a third party, not privy to the mutuality. This contract lacked the degree of proximity between the club and its member, which may in a distant and indirect way benefit the club, nonetheless, it cannot be categorized as an activity of the club in pursuit of its objectives. It needs little emphasis that the second condition postulates a direct step with direct benefits to the functioning of the club. For the sake of argument, one may draw remote connections with the most brazen commercial activities to a club’s functioning. However, such is not the design of the second condition. Therefore, it stands violated.
Ø The facts at hand also fail to satisfy the third condition of the mutuality principle i.e. the impossibility that contributors should derive profits from contributions made by themselves to a fund which could only be expended or returned to themselves. This principle requires that the funds must be returned to the contributors as well as expended solely on the contributors. True, that in the present case, the funds do return to the club. However, before that, they are expended on non- members i.e. the clients of the bank. Banks generate revenue by paying a lower rate of interest to club-assessee, that makes deposits with them, and then loan out the deposited amounts at a higher rate of interest to third parties. This loaning out of funds of the club by banks to outsiders for commercial reasons, in our opinion, snaps the link of mutuality and thus, breaches the third condition.
In view of the above judgement of Hon’ble Apex Court, you would agree that bank interest income would be chargeable to tax, thereby judgement reference of which you have given, is not relevant.
I am of the opinion that the judgement relates to a CLUB not to a Housing Society. It is quite absurd to assume that interest earning on Fixed Deposit varying between 8.5% to 9.25% are taxable but the interest earned on Savings Deposits which is varying between 4 to 7% p.a is fully exempt.
Please share your opinion without using any technical jargon in simple language.
CAclubindia
