Supreme Court Denies Mutuality Claim for Advertising Subsidiary: Yum! Restaurants vs. Commissioner of Income Tax (24 April 2020)

Date of the Judgment: 24 April 2020
Citation: (2020) INSC 288
Judges: A.M. Khanwilkar, J. and Dinesh Maheshwari, J.

Can a company, created as a subsidiary for advertising and marketing, claim tax exemption under the doctrine of mutuality? The Supreme Court of India addressed this question in a case involving Yum! Restaurants (Marketing) Private Limited. The court examined whether the company, formed to handle advertising for its parent company and franchisees, truly operated on the principles of mutuality, which would exempt it from tax liability. The bench comprised Justices A.M. Khanwilkar and Dinesh Maheshwari, who delivered a unanimous judgment.

Case Background

Yum! Restaurants (India) Pvt. Ltd. (YRIPL) established Yum! Restaurants (Marketing) Private Limited (YRMPL) as a wholly-owned subsidiary. This was done after receiving approval from the Secretariat for Industrial Assistance (SIA) to manage advertising, marketing, and promotion (AMP) activities for YRIPL and its franchisees. The SIA approval mandated that YRMPL operate on a non-profit basis, adhering to the principles of mutuality, with contributions from both YRIPL and its franchisees. YRMPL entered into a Tripartite Operating Agreement with YRIPL and its franchisees, where it received 5% of gross sales as contributions for AMP activities. However, a dispute arose when the tax authorities questioned YRMPL’s claim of being a mutual concern, leading to the present case.

Timeline:

Course of Proceedings

The Assessing Officer rejected YRMPL’s claim of being a mutual concern and imposed tax liability for the Assessment Year 2001-02. The Commissioner of Income Tax (Appeals) [CIT(A)] upheld this decision, citing commerciality in YRMPL’s activities. The Income Tax Appellate Tribunal (Tribunal) also confirmed the tax liability, stating that the essential ingredients of mutuality were missing. The High Court of Delhi upheld the Tribunal’s decision, leading YRMPL to appeal to the Supreme Court.

Legal Framework

The core legal principle in this case is the doctrine of mutuality. This doctrine, as explained by the Supreme Court, stems from the idea that a person cannot do business with themselves. If a group of people contribute to a common fund for a common purpose, and any surplus is returned to them, it is not considered a profit. The Income Tax Act, 1961, taxes income, profits, or gains that accrue to a person in dealings with another entity. The court referred to several cases and texts to define the conditions for mutuality.

The court referred to the following authorities:

• Commissioner of Income Tax, Bihar v. Bankipur Club Ltd. (1997) 5 SCC 394
• Bangalore Club v. Commissioner of Income Tax & Anr. (2013) 5 SCC 509
• New York Life Insurance Co. v. Styles (Surveyor of Taxes) (1889) 2 TC 460
• Simon’s Taxes, Volume B, 3rd Edition, Pgs. 159, 167
• The English and Scottish Joint Co-operative Wholesale Society Ltd. v. Commissioner of Agricultural Income-Tax, Assam AIR 1948 PC 142
• Commissioner of Income Tax, Bombay City v. Royal Western India Turf Club Ltd. AIR 1954 SC 85
• British Tax Encyclopaedia (I), 1962 Edition, Pgs. 1200 and 1201
• Dalmia Cement Ltd., Rajasthan v. Commissioner of Income Tax, New Delhi (1999) 4 SCC 124
• The Commissioner of Income Tax, Bombay City II v. Sitaldas Tirathdas AIR 1961 SC 728
• Associated Power Co. Ltd. v. Commissioner of Income Tax (1996) 7 SCC 221
• The Commissioner of Income Tax, Kerala, Ernakulam v. The Travancore Sugars & Chemical Ltd. (1973) 3 SCC 274
• Thomas M. Cooley, The Law of Taxation, 4th Edition, Volume 2, Pg. 671

The court outlined three tests for mutuality:

1. Identity of the contributors to the fund and the recipients from the fund.
2. Treatment of the company as a mere entity for the convenience of the members.
3. Impossibility that contributors should derive profits from contributions made by themselves.

Arguments

Appellant (YRMPL) Arguments:

• YRMPL was created solely to carry out earmarked activities on a non-profit basis for the benefit of contributors.
• YRMPL does not charge franchisees for its operations.
• YRIPL, the parent company, benefits from increased sales, which results in higher royalties, and Pepsi Foods Ltd. benefits from increased sales of its drinks at the outlets.
• The doctrine of mutuality requires only an identity between contributors and beneficiaries, not that each member contributes or benefits equally.
• The functioning of YRMPL is similar to that of clubs, where mutuality is recognized.

Respondent (Commissioner of Income Tax) Arguments:

• The moment a non-member contributes to a common fund, the taint of commerciality arises, and mutuality ceases.
• YRMPL violated the SIA approval by receiving contributions from Pepsi, which is not a member of the brand fund.
• The basic purpose of benefiting actual contributors is lost when non-members contribute.

Issues Framed by the Supreme Court

1. Whether the assessee company would qualify as a mutual concern, thereby exempting subject transactions from tax liability?
2. Whether the excess of income over expenditure in the hands of the assessee company is not taxable?

Treatment of the Issue by the Court

Authorities

Judgment

How each authority was viewed by the Court?

• The Supreme Court relied on Commissioner of Income Tax, Bihar v. Bankipur Club Ltd. [(1997) 5 SCC 394]* to establish the basic principle that a man cannot do business with himself.
• The Supreme Court used Bangalore Club v. Commissioner of Income Tax & Anr. [(2013) 5 SCC 509]* to reiterate the conditions for mutuality and quoted New York Life Insurance Co. v. Styles [(1889) 2 TC 460]* to define the concept of mutuality.
• The Court referred to Simon’s Taxes* to explain the principle that if the persons carrying on a trade and the customers are the same, no profits are yielded for tax purposes.
• The Supreme Court used The English and Scottish Joint Co-operative Wholesale Society Ltd. v. Commissioner of Agricultural Income-Tax, Assam [AIR 1948 PC 142]* to outline the three tests for mutuality.
• The Supreme Court cited Commissioner of Income Tax, Bombay City v. Royal Western India Turf Club Ltd. [AIR 1954 SC 85]* to support the proposition that operations involving members and non-members are antithetical to mutuality.
• The Court referred to British Tax Encyclopaedia* to explain that for mutuality to apply, all contributors must be entitled to participate in the surplus.
• The Supreme Court used Dalmia Cement Ltd., Rajasthan v. Commissioner of Income Tax, New Delhi [(1999) 4 SCC 124]*, The Commissioner of Income Tax, Bombay City II v. Sitaldas Tirathdas [AIR 1961 SC 728]*, Associated Power Co. Ltd. v. Commissioner of Income Tax [(1996) 7 SCC 221]*, and The Commissioner of Income Tax, Kerala, Ernakulam v. The Travancore Sugars & Chemical Ltd. [(1973) 3 SCC 274]* to explain the difference between diversion of income before accrual and application of income after accrual.
• The Supreme Court cited Thomas M. Cooley, The Law of Taxation* to emphasize the rule of strict interpretation for tax exemptions.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily driven by the failure of YRMPL to meet the essential conditions for mutuality. The court emphasized that the doctrine of mutuality requires a complete identity between contributors and beneficiaries, which was absent in this case due to the involvement of Pepsi Foods Ltd. as a contributor without being a member. Additionally, the court noted that YRIPL, the parent company, had an overriding discretion over the contributions, which contradicted the principle of mutual control. The court also highlighted that the franchisees did not have an entitlement to the surplus and that the company’s operations were tainted with commerciality. The court found that the conditions for claiming exemption were not fulfilled. The court was also swayed by the fact that the SIA approval was not followed in the agreement between the parties.

Fact:Law Ratio

The court’s reasoning was a blend of factual analysis and legal interpretation. While the factual aspects of the case, such as the involvement of Pepsi and the terms of the Tripartite Agreement, played a significant role, the court’s decision was ultimately grounded in the legal principles of mutuality and the interpretation of tax laws.

Logical Reasoning

The court considered arguments that YRMPL was acting as a trustee and had an overriding obligation to spend the funds. However, the court did not accept this argument, stating that the amounts received by YRMPL were not diverted before accrual, but were rather an application of income after it had accrued. The court also noted that the Tripartite Agreement did not create any trust or obligation to spend the amounts for the specific benefit of the franchisees.

The court observed that the terms of the Tripartite Agreement allowed YRIPL to not contribute to the common pool, while still deriving profits in the form of royalties. This was considered a violation of the basic essence of mutuality. The court also found that the franchisees did not have a right to claim a refund of the surplus, which further undermined the claim of mutuality.

The court quoted from the judgment: “…if the object of the assessee company claiming to be a “mutual concern” or “club”, is to carry on a particular business and the money is realised both from the members and from non-members, for the same consideration by giving the same or similar facilities to all alike in respect of the one and the same business carried on by it, the dealings as a whole disclose the same profit-earning motive and are alike tainted with commerciality… and the resultant surplus is profit-income liable to tax…”

The court also stated, “The doctrine of mutuality, in principle, entails that there should not be any profit earning motive, either directly or indirectly.”

The court further noted, “The mutuality and non-profiteering character of a concern are to be determined in light of its actual working structure and the factum of corporation or incorporation or the form in which it is clothed is immaterial.”

Key Takeaways

• The doctrine of mutuality requires a complete identity between contributors and beneficiaries.
• Contributions from non-members can invalidate a claim of mutuality.
• A parent company’s overriding discretion over a subsidiary’s operations can negate the principle of mutuality.
• Tax exemptions are to be strictly interpreted, and the burden of proof lies with the claimant.
• The actual working structure of a concern is more important than its form.

Directions

The Supreme Court allowed the appellant to pursue the remedy of rectification before the Tribunal regarding the argument that the contributions received by the appellant cannot be said to be its income, but did not express any opinion on the tenability of the said application.

Development of Law

The ratio decidendi of this case is that for a company to claim tax exemption under the doctrine of mutuality, it must strictly adhere to the principles of mutuality. This includes having a complete identity between contributors and beneficiaries, operating on a non-profit basis, and not having any overriding discretion by one member over others. The court reaffirmed the existing legal position on mutuality and did not introduce any new legal principles.

Conclusion

The Supreme Court dismissed the appeal by Yum! Restaurants (Marketing) Private Limited, holding that the company did not qualify as a mutual concern and was therefore liable to pay taxes on its income. The court emphasized that the doctrine of mutuality requires a complete identity between contributors and beneficiaries, and that the company’s operations were tainted with commerciality due to the involvement of non-members and the overriding discretion of the parent company. This judgment reinforces the strict interpretation of tax exemptions and the importance of adhering to the principles of mutuality.

Category

Parent Category: Income Tax Act, 1961

Child Categories:

• Doctrine of Mutuality
• Tax Exemption
• Section 2(24), Income Tax Act, 1961
• Commercial Activity

Parent Category: Doctrine of Mutuality

Child Categories:

• Conditions for Mutuality
• Mutual Concern
• Non-Profit Organization

Parent Category: Income Tax Act, 1961

Child Categories:

• Section 2(24), Income Tax Act, 1961

FAQ

Q: What is the doctrine of mutuality?
A: The doctrine of mutuality is a legal principle that states that if a group of people contribute to a common fund for a common purpose, and any surplus is returned to them, it is not considered a profit and is therefore not taxable. This is based on the idea that a person cannot do business with themselves.

Q: Why did the Supreme Court deny the mutuality claim in this case?
A: The Supreme Court denied the claim because the company received contributions from a non-member (Pepsi Foods Ltd.), and the parent company (YRIPL) had an overriding discretion over the contributions. This violated the principle of complete identity between contributors and beneficiaries.

Q: What are the key conditions for a company to be considered a mutual concern?
A: The key conditions are: (1) a complete identity between contributors and beneficiaries, (2) the company must be a mere entity for the convenience of the members, and (3) there must be an impossibility that contributors should derive profits from contributions made by themselves.

Q: What does this judgment mean for other companies operating under similar structures?
A: This judgment means that companies claiming tax exemption under the doctrine of mutuality must strictly adhere to the principles of mutuality. They must ensure that all contributors are also beneficiaries, operate on a non-profit basis, and do not have any overriding discretion by one member over others.

Q: What is the significance of the SIA approval in this case?
A: The SIA approval was a conditional document that mandated the company to operate on a non-profit basis and adhere to the principles of mutuality. The court found that the company’s operations were in contravention of the terms of the SIA approval.