Supreme Court clarifies Wealth Tax on Clubs: Bangalore Club vs. Commissioner of Wealth Tax (2020)

Date of the Judgment: September 8, 2020

Citation: 2020 INSC 672

Judges: R.F. Nariman, J., Navin Sinha, J., Indira Banerjee, J.

Can a social club be taxed as an “association of persons” under the Wealth Tax Act, 1957? The Supreme Court of India addressed this question in a case involving the Bangalore Club. The core issue was whether the club’s assets could be taxed under the Wealth Tax Act, specifically when the shares of the members were not indeterminate. The judgment was delivered by a three-judge bench composed of Justices R.F. Nariman, Navin Sinha, and Indira Banerjee, with Justice Nariman authoring the opinion.

Case Background

The Bangalore Club, established in 1868, was assessed for wealth tax for the assessment years 1981-82 and 1984-85 up to 1990-91. The Wealth Tax Officer concluded that the club’s assets belonged to its members, and since the membership was variable, the shares were indeterminate, making the club liable for wealth tax. The Commissioner of Income Tax (Appeals) upheld this order. However, the Income Tax Appellate Tribunal reversed the decision, stating that the club was a social club and not an association of persons formed to earn income. The High Court, however, sided with the revenue relying on a previous decision.

The Bangalore Club appealed to the Supreme Court, arguing that it was a social club, not an association of persons formed for profit, and that the members’ shares were determinate because they were entitled to equal shares upon winding up. The tax authorities argued that the fluctuating membership made the shares indeterminate, and that the club should be treated as an association of persons.

Timeline:

Course of Proceedings

The Wealth Tax Officer assessed the Bangalore Club for wealth tax, a decision upheld by the Commissioner of Income Tax (Appeals). The Income Tax Appellate Tribunal reversed this decision, stating the club was a social club, not an association of persons for profit. The High Court, however, sided with the revenue, relying on a previous decision. The Supreme Court then heard the appeal.

Legal Framework

The core legal provisions discussed in this case are:

• Section 3(1) of the Wealth Tax Act, 1957: This section specifies who is liable to pay wealth tax, namely, individuals, Hindu undivided families, and companies. It states:

  “3. Charge of wealth -tax — (1) Subject to the other provisions contained in this Act, there shall be charged for every assessment year commencing on and from the first day of April, 1957 but before the first day of April, 1993, a tax (hereinafter referred to as wealth -tax) in respect of the net wealth on the corresponding valuation date of every individual, Hindu undivided family and company at the rate or rates specified in Schedule I.”

• Section 21AA of the Wealth Tax Act, 1957: This section was introduced to tax associations of persons where the individual shares of the members are indeterminate or unknown. It states:

  “21AA. Assessment when assets are held by certain associations of persons — (1) Where assets chargeable to tax under this Act are held by an association of persons, other than a company or cooperative society or society registered under the Societies Registration Act, 1860 (21 of 1860) or under any law corresponding to that Act in force in any part of India, and the individual shares of the members of the said association in the income or assets or both of the said association on the date of its formation or at any time thereafter are indeterminate or unknown, the wealth -tax shall be levied upon and recovered from such association in the like manner and to the same extent as it would be leviable upon and recoverable from an individual who is a citizen of India and resident in India for the purposes of this Act.”

  “(2) Where any business or profession carried on by an association of persons referred to in subsection (1) has been discontinued or where such association of persons is dissolved, the Assessing Officer shall make an assessment of the net wealth of the association of persons as if no such discontinuance or dissolution had taken place and all the provisions of this Act, including the provisions relating to the levy of penalty or any other sum chargeable under any provisions of this Act, so far as may be, shall apply to such assessment.”

• Section 2(31) of the Income Tax Act, 1961: This section defines “person” and includes an association of persons or a body of individuals. An explanation was added to this section effective from April 1, 2002, which states:

  “Explanation. —For the purposes of this clause, an association of persons or a body of individuals or a local authority or an artificial juridical person shall be deemed to be a person, whether or not such person or body or authority or juridical person was formed or established or incorporated with the object of deriving income, profits or gains;”

The Supreme Court also considered the interpretation of the term “association of persons” in the context of tax laws, as established in previous judgments.

Arguments

Appellant’s Arguments (Bangalore Club):

• The Bangalore Club is a social club, not an association of persons formed for the purpose of earning income or profits.
• The term “association of persons” in a taxing statute refers to entities formed with the common goal of generating income or profits.
• The individual shares of the members are not indeterminate because upon winding up, the members are entitled to equal shares of the remaining assets after all debts and liabilities are paid.
• The explanation added to Section 2(31) of the Income Tax Act, which broadens the definition of “person” to include entities not formed for profit, does not apply to the Wealth Tax Act.
• The club’s activities are for the benefit of its members and are not commercial in nature.

Respondent’s Arguments (Tax Authorities):

• Section 21AA(2) of the Wealth Tax Act applies to the Bangalore Club because it deals with the dissolution of an association of persons.
• Rule 35 of the Club Rules, which provides for the distribution of assets upon winding up, triggers the application of Section 21AA.
• The Bangalore Club was assessed as an association of persons under the Income Tax Act, and therefore, should be treated similarly under the Wealth Tax Act.
• The fluctuating membership of the club leads to indeterminate shares of the members in the assets.
• The High Court’s judgment in CWT v. Chikmagalur Club correctly applied the law, which relied on the Supreme Court’s decision in CWT v. Ellis Bridge Gymkhana.

Issues Framed by the Supreme Court

The Supreme Court considered the following issue:

1. Whether the Bangalore Club is liable to pay wealth tax under the Wealth Tax Act as an association of persons, particularly when the individual shares of its members in the income or assets are not indeterminate or unknown?

Treatment of the Issue by the Court

The following table demonstrates how the Court decided the issue:

Authorities

The Supreme Court considered the following authorities:

Judgment

How each authority was viewed by the Court?

• The Supreme Court followed the principle laid down in CIT v. Indira Balkrishna (1960) 39 ITR 546* that an association of persons must have a common purpose to earn profits.
• The Court distinguished CWT v. Ellis Bridge Gymkhana (1998) 1 SCC 384*, stating that Section 21AA was introduced to prevent tax evasion, not to tax all associations of persons.
• The Court overruled CWT v. Chikmagalur Club 197 ITR Karnataka 609*, stating that it did not correctly apply the principles of Ellis Bridge Gymkhana.
• The Court relied on CWT v. Trustees of H.E.H. Nizam’s Family 108 ITR 555 (1977)* to state that the determination of members must be made on the relevant valuation date.

What weighed in the mind of the Court?

The Supreme Court emphasized the following points in its reasoning:

• The definition of “association of persons” in tax law requires a common business or commercial objective to earn income or profits.
• Section 21AA of the Wealth Tax Act was introduced to prevent tax evasion by those creating multiple associations of persons without defining members’ shares, not to tax all associations of persons.
• The shares of the members of the Bangalore Club are determinate because they are entitled to equal shares upon winding up, as per Rule 35.
• The fluctuating nature of membership does not make the shares indeterminate if the members are identifiable on the date of liquidation.
• The interpretation of tax laws must consider the object of the law and not just the literal meaning of the words.

Logical Reasoning:

The Court reasoned that since the Bangalore Club was not formed for the purpose of making profits, and the members’ shares were determinate, it could not be taxed as an association of persons under Section 21AA of the Wealth Tax Act.

The Court rejected the argument that the fluctuating membership made the shares indeterminate, stating that the relevant date for determining the shares was the date of liquidation when the members would be fixed and their shares would be equal.

The Court also rejected the argument that because the club was assessed as an association of persons under the Income Tax Act, it should be treated similarly under the Wealth Tax Act. The Court stated that the definition of “person” under the Income Tax Act is wider and that Section 21AA is a tax evasion provision, not a charging provision.

The Court emphasized that the object of Section 21AA was to prevent tax evasion by those creating multiple associations of persons without defining members’ shares. It was not meant to bring all associations of persons into the tax net.

The Court quoted from the judgment:

“This being the case, it is clear that in order to be an association of persons attracting Section 21AA of the Wealth Tax Act, it is necessary that persons band together with some business or commercial object in view in order to make income or profits.”

“The object was to rope in certain assessees who have resorted to the creation of a large number of association of persons without specifically defining the shares of the members of such association s of persons so as to evade tax. In construing Section 21AA, it is important to have regard to this object.”

“Given that as on that particular date, there would be a fixed list of members belonging to the various classes mentioned in the rules, it is clear that, applying the ratio of Trustees of H.E.H. Nizam’s Family (supra) , such list of members not being a fluctuating body, but a fixed body as on the date of liquidation would again make the members ‘determinate’ as a result of which , Sec. 21AA would have no application.”

The Court also clarified that the term “association of persons” in a taxing statute must be interpreted as persons banding together for a business purpose to earn income or profits, and not just any group of persons.

Key Takeaways

• Social clubs are generally not considered “associations of persons” for the purpose of wealth tax under Section 21AA of the Wealth Tax Act, 1957, unless they are formed with a business or commercial objective to earn income or profits.
• The shares of members in a club are considered determinate if they are entitled to equal shares upon winding up, even if the membership is fluctuating.
• Section 21AA of the Wealth Tax Act is a tax evasion provision and not a charging provision, and it applies only when the shares of members are indeterminate or unknown.
• The interpretation of tax laws must be guided by the object of the law and not just the literal meaning of the words.
• The definition of “person” under the Income Tax Act is wider than the concept of “association of persons” under the Wealth Tax Act.

Directions

The Supreme Court set aside the impugned judgment and the review judgment of the High Court. The appeals of the Bangalore Club were allowed with no order as to costs.

Development of Law

The ratio decidendi of this case is that a social club is not an “association of persons” for the purpose of Section 21AA of the Wealth Tax Act, 1957, unless it is formed with a business or commercial objective to earn income or profits, and the members’ shares are indeterminate. This judgment clarifies the scope of Section 21AA and overrules the High Court’s decision in CWT v. Chikmagalur Club, which had incorrectly applied the law. This decision reinforces the principle that tax laws must be interpreted in light of their object and purpose, rather than a strict literal interpretation.

Conclusion

The Supreme Court’s judgment in the Bangalore Club case clarifies that social clubs are not automatically considered “associations of persons” for wealth tax purposes. The key factors are whether the club is formed for profit and whether the members’ shares are indeterminate. This decision provides important guidance for the taxation of clubs and other similar entities.

Category

• Tax Law
  • Wealth Tax Act, 1957
  • Section 21AA, Wealth Tax Act, 1957
  • Association of Persons
  • Income Tax Act, 1961
  • Section 2(31), Income Tax Act, 1961
• Wealth Tax Act, 1957
  • Section 21AA, Wealth Tax Act, 1957
• Income Tax Act, 1961
  • Section 2(31), Income Tax Act, 1961

FAQ

Q: What is an “association of persons” in the context of tax law?

A: In tax law, an “association of persons” generally refers to a group of individuals who come together with a common business or commercial objective to earn income or profits.

Q: What is Section 21AA of the Wealth Tax Act, 1957?

A: Section 21AA was introduced to tax associations of persons where the individual shares of the members in the income or assets are indeterminate or unknown. It was primarily intended to prevent tax evasion.

Q: Why was the Bangalore Club not considered an “association of persons” for wealth tax purposes?

A: The Bangalore Club was not considered an “association of persons” because it is a social club, not formed for the purpose of earning income or profits. Also, the members’ shares were not indeterminate because they were entitled to equal shares upon winding up.

Q: What does it mean for members’ shares to be “determinate”?

A: Members’ shares are considered “determinate” when they are clearly defined and known. In the case of the Bangalore Club, the members’ shares were determinate because they were entitled to equal shares of the remaining assets upon winding up.

Q: How does this ruling affect other clubs?

A: This ruling clarifies that social clubs are generally not subject to wealth tax as “associations of persons” unless they are formed with a business objective and have indeterminate member shares. This provides clarity for similar clubs regarding their tax liabilities.