SEPTEMBER 03, 2024

By CA Lukose Joseph & CA Jobby George

Introduction:

WE have received a query from a Flat Owners' Association regarding the taxability of income under the concept of mutuality and the applicability of the Maximum Marginal Rate (MMR). In response to this query, we are trying to analyze these tax aspects in brief, particularly focusing on the distinction between income derived from mutual activities and income from external sources like bank interest read with tax rate applicable as per Finance Act with basic exemption subject to Section 167B of Income Tax Act, 1961 in the case of Association of Person (AOP)/Body of Individuals (BOI).

Taxation and Formation of AOP/BOI

The income of an Association of Persons (AOP) in which a member can be any person as defined in section 2(31) of the Income Tax Act, 1961 and Body of Individuals (BOI) (only individuals can be members) is generally taxed according to the income slab as per Finance Act of respective years.

Tax Treatment of AOP/BOI

Under Indian tax law, Associations of Persons (AOPs) are treated differently from individuals and corporate entities. It is important to note that an AOP is deemed to be a "person" under the Income Tax Act, regardless of whether it was formed with the objective of deriving income, profits, or gains.

The income of an AOP is generally taxed as per the rates in force as per the Finance Act for the relevant assessment year as per applicable slab subject to Section 167B of the Income Tax Act, 1961 which provides charging tax at maximum marginal rate where shares of members in association of persons or body of individuals indeterminate or unknown or exceeds the maximum amount which is not chargeable to tax.

Taxability of AOP/BOI in Different Situations

The taxability of an AOP or BOI varies depending on the determinability of members' share and the tax rates applicable to the members. The situations are summarized in the table below:

Where the shares of members are determinate:

Where the shares of members are indeterminate: - Section 167B of the Income tax Act, 1961

The Doctrine of Mutuality

The Supreme Court, in the case of Secunderabad Club v. CIT [2023] 153, delivered a comprehensive judgment ruling that the interest income earned on fixed deposits (FDs) made by clubs must be treated as income from other sources within the meaning of Section 2(24) of the Income-tax Act, 1961.

The Supreme Court, in the above case, considered the matter of mutuality based on three key points:

1. The identity of the contributors to the fund and the recipients of the fund.

2. The treatment of the entity (e.g., a company or club), though incorporated, as a mere instrument for the convenience of members and policyholders, obedient to their mandate.

3. The impossibility that contributors should derive profits from contributions made by themselves to a fund that could be expended or returned to themselves

Further, the doctrine of mutuality postulates that all contributors to a common fund must be entitled to participate in the surplus, and all participants in the surplus must be contributors to the common fund. In other words, there is a complete identity between the contributors and the participators [CIT v. Indian Paper Mills Association [1994] 74 Taxman 188/209 ITR 28 (Cal.)].

Again, the Supreme Court in ITO v. Venkatesh Premises Co-operative Society Ltd. - 2018-TIOL-82-SC-IT ruled that receipts by a cooperative society from its members - such as non-occupancy charges, transfer charges, common amenity fund charges, and other charges are exempt from income tax based on the principle of mutuality.

Taxability of Societies as AOPs

For societies registered under the Societies Registration Act, which are often treated as AOPs for tax assessment purposes, there are various judicial rulings that provide clarity on the applicability of the maximum marginal rate.

Some relevant case laws include:(1) CIT vs. Andhra Pradesh State Road Transport Corporation - 2002-TIOL-742-SC-IT, (2) CIT vs. Calcutta Stock Exchange Association - 2002-TIOL-1210-SC-IT-LB, (3) CIT vs. Tamil Nadu State Consumer Protection Council (2002) 254 ITR 449 (Mad) and (4) CIT vs. Indian Institute of Technology (2013) 356 ITR 537 (Del)

These case laws affirm that a society registered under the Societies Registration Act in India is considered as a separate legal entity from its members and, therefore, is not liable to pay tax at the maximum marginal rate, regardless of the income levels of its individual members.

This principle is particularly relevant for societies formed for the benefit of members in apartment complexes or residential associations. In the case of an AOP or BOI, where members come together for their mutual benefit and pool resources for their own use, the principle of mutuality applies. Under this principle, no tax is levied on amounts collected and spent for services rendered to members. However, income earned from interest or investments by such AOPs/BOIs is taxable under the Income Tax Act. The taxability of such income depends on the specific situations outlined earlier.

Conclusion:

Based on the above discussion, it is clear that in the case of AOP and BOI,

1. Surplus from Mutual Activities:

The surplus generated from mutual activities, such as collections from members for common expenses (E.g: Collection from members by organization like Flat Owners' Association), is not taxable. This is because the principle of mutuality applies, meaning that the income is derived from contributions made by members and is used solely for their benefit, with no element of profit.

2. Applicability of Maximum Marginal Rate (MMR):

For Association of Persons (AOP) and Body of Individuals (BOI), the applicable tax rate is that of an individual under 60 years of age. However, the Maximum Marginal Rate (MMR) is applicable in cases falling under Section 167B. Notably, a society registered under the Societies Registration Act or similar laws is considered a separate legal entity from its members and, therefore, is not subject to tax at the maximum marginal rate, regardless of the income levels of its individual members.

[The views expressed are strictly personal.]