Yum! Restaurants' subsidiary denied tax exemption for failing to meet mutuality principles, Supreme Court upholds tax liability.

Case Name:

Yum! Restaurants (Marketing) Private Limited vs. Commissioner of Income Tax

Civil Appeal No. 2847 of 2010

Key Takeaways:

- The court outlined three conditions to establish mutuality: identity of contributors and recipients, treatment of the company as an instrument obedient to members, and impossibility for contributors to derive profits from their contributions.

- The inclusion of non-member Pepsi Foods Ltd. as a contributor violated the principle of common identity between contributors and beneficiaries.

- The overriding control of the parent company (Yum! Restaurants (India) Pvt. Ltd.) over the subsidiary and the lack of entitlement for franchisees to the surplus contravened the principles of mutuality.

- Exemptions from tax liability are subject to strict interpretation, and the burden is on the claimant to clearly establish their right to exemption.

Issue:

Whether the assessee company, Yum! Restaurants (Marketing) Private Limited, would qualify as a mutual concern in the eyes of law, thereby exempting it from tax liability on the excess of income over expenditure.

Facts:

Yum! Restaurants (Marketing) Private Limited (the assessee company) was incorporated as a fully-owned subsidiary of Yum! Restaurants (India) Pvt. Ltd. (YRIPL) to undertake advertising, marketing, and promotional activities for YRIPL and its franchisees. The company received fixed contributions from franchisees and Pepsi Foods Ltd. for these activities.

The Secretariat for Industrial Assistance (SIA) approved the subsidiary's formation on the condition that it would operate as a non-profit enterprise based on the principles of mutuality. However, the assessee company entered into a Tripartite Operating Agreement with YRIPL and its franchisees, which deviated from the SIA approval terms.

Arguments:

- The assessee company argued that it operated as a mutual concern, with an identity between contributors and beneficiaries. It claimed that YRIPL, as the parent company, was a beneficiary by earning a fixed percentage from franchisees as royalty.

- The Revenue contended that the inclusion of Pepsi Foods Ltd., a non-member, in the common pool of funds tainted the operations with commerciality and violated the principles of mutuality and non-profiteering.

Key Legal Precedents:

- The court referred to the cases of Bangalore Club v. Commissioner of Income Tax & Anr., New York Life Insurance Co. v. Styles (Surveyor of Taxes), Bankipur Club, and The English and Scottish Joint Co-operative Wholesale Society Ltd. v. Commissioner of Agricultural Income-Tax, Assam to outline the three conditions for establishing mutuality.

- The court cited The Law of Taxation by Thomas M. Cooley, which states that exemptions are never presumed, and the burden is on the claimant to establish their right to exemption clearly.

Judgement:

The Supreme Court ruled against the assessee company and in favor of the Revenue, upholding the tax liability imposed by the lower authorities.

The court found that the inclusion of Pepsi Foods Ltd. as a contributor, without it being a beneficiary, violated the principle of common identity between contributors and participators. Additionally, the overriding control of YRIPL over the management and operations of the assessee company, coupled with the lack of entitlement for franchisees to the surplus, contravened the principles of mutuality.

The court concluded that the assessee company did not operate as a mutual concern and was not eligible for exemption from tax liability. The appellant failed to fulfill the stipulations and prove the existence of mutuality, which is subject to strict interpretation for tax exemptions.

FAQs:

Q1: What is the significance of the court's decision?

A1: The decision reinforces the strict interpretation of the principles of mutuality for claiming tax exemption. It clarifies that the inclusion of non-members as contributors and the lack of entitlement for members to the surplus violate the principles of mutuality, leading to tax liability.

Q2: What are the implications for companies seeking tax exemption as mutual concerns?

A2: Companies seeking tax exemption as mutual concerns must strictly adhere to the principles of mutuality, ensuring common identity between contributors and beneficiaries, obedience to the mandate, and the impossibility of contributors deriving profits from their contributions.

Q3: Can the assessee company pursue any further legal remedies?

A3: The court left it open for the assessee company to pursue a pending rectification application regarding the issue of diversion by overriding title, without expressing an opinion on its tenability.

Q4: What is the significance of the legal precedents cited by the court?

A4: The court relied on established precedents such as Bangalore Club v. Commissioner of Income Tax & Anr., New York Life Insurance Co. v. Styles (Surveyor of Taxes), and The English and Scottish Joint Co-operative Wholesale Society Ltd. v. Commissioner of Agricultural Income-Tax, Assam to outline the principles of mutuality and the conditions for establishing it.

Q5: What is the court's stance on the strict interpretation of tax exemptions?

A5: The court emphasized that exemptions from tax liability are subject to strict interpretation, and the burden is on the claimant to clearly establish their right to exemption. The court cited The Law of Taxation by Thomas M. Cooley, which states that exemptions are never presumed and must be expressed in clear and unmistakable terms.

1. The moot question involved in the present appeal bears upon the applicability of the doctrine of mutuality qua the assessee company, a fully owned subsidiary of Yum! Restaurants (India) Pvt. Ltd. (for short, “YRIPL”), formerly known as Tricon Restaurants India Pvt. Ltd., incorporated for undertaking the activities relating to Advertising, Marketing and Promotion (for short, “AMP activities”) for and on behalf of YRIPL and its franchisees.

2. This appeal assails the final judgment and order dated 1.4.2009 passed by the High Court of Delhi at New Delhi (for short, “the High Court”) in I.T.A. No. 1433 of 2008 wherein the question of taxability of Rs. 44,44,002/­ (Rupees forty four lakhs forty four thousand two only), being the excess of income over expenditure for the Assessment Year 2001­02, was settled in

favour of the Revenue and against the assessee, thereby confirming the orders of the Income Tax Appellate Tribunal (for short, “the Tribunal”), Commissioner of Income Tax (Appeals) [for short, the “CIT(A)”] and the Assessing Officer. The preceding forums, without any exception, have returned consistent verdict refusing to acknowledge the assessee company as a mutual concern and denying any exemption from taxability.

3. The appellant company Yum! Restaurants (Marketing) Private Limited (for short, “YRMPL” or “assessee company” or “assessee”) was incorporated by YRIPL as its fully owned subsidiary after having obtained approval from the Secretariat for Industrial Assistance (for short “SIA”) for the purpose of

economisation of the cost of advertising and promotion of the franchisees as per their needs. The approval was granted subject to certain conditions as regards the functioning of assessee, whereby it was obligated to operate on a non­profit basis on the principles of mutuality. The relevant clauses of the approval granted by the SIA for the aforementioned operations read thus:

“3.It is noted that the broad framework within which such subsidiary shall be managed and operated in India is as follows:

­The franchises and Tricon India will both make contribution of a fixed percentage of their respective revenues (net of taxes) to the proposed New Company on regular basis;

­The proposed New Company would be a non­profit enterprise governed by the principles of mutuality. No part of the contributions or other income shall enure to the benefit of any individual contributor;

­The contributors will be optimally used by the proposed new Company to economise the cost of advertising and promotion cater to the specific needs

of franchisees to concentrate on restaurant operations and management;

­The management of the proposed New Company shall vest with Tricon India and application of contributions will be decided by Tricon India in consultation with the franchisee;

­The approval is subject to the condition that the step down subsidiary would be a non-­profit enterprise and would not be allowed to repatriate dividends.”

4. In furtherance of the approval, the assessee entered into a

Tripartite Operating Agreement (for short, the “Tripartite

Agreement”) with YRIPL and its franchisees, wherein the assessee

company received fixed contributions to the extent of 5 per cent

of gross sales for the proper conduct of the advertising,

marketing and promotional activities for the mutual benefit of the

parent company and the franchisees. The terms of the Tripartite

Agreement, to the extent relevant for the consideration of the

present case, are produced thus:

“2.2 TRIM will establish and operate Brand Funds in

respect of each Brand for the purpose of allocating and

using the Advertising Contribution received from

franchisee and other franchisee of Tricon operating

Restaurants under the Brands. TRIM will allocate the

advertising contribution received from the Franchisees

including Franchisee for each Restaurant to the

respective Brand funds established for that brand. It is

agreed between the Parties that the advertising

contribution paid into a brand fund will be used for the

AMP Activities relating to that brand.

3. FRANCHISEE ADVERTISING CONTRIBUTIONS

3.1 As and from the Effect Date, Franchisee will pay

the Advertising Contribution of 5% of Revenues for a

particular month into the Bank account of the Brand

Fund established by TRIM by the 10th day of the

following month. Details of the bank account, of each

Brand Fund set up by TRIM will notified to Franchisee by

TRIM from time to time. Notwithstanding the aforesaid,

the executive committee of any Brand (constituted under

Article 7 of this Agreement) may, by a three fourth

majority, which shall be binding on all franchisees of

Tricon including the Franchisee, require the franchisee to

pay the advertising Contribution in advance. For the

avoidance of doubt it is clarified and agreed that while

recommending advance payment of Advertising

Contribution the chairman will not have a casting vote.

Franchise will spend an additional 1% of Revenues, in the

manner directed by Tricon and/or TRIM in writing from

time to time, on such local store marketing, advertising,

promotional and research expenditure proposed by

Franchisee and approved in advance by Tricon and/or

TRIM during the relevant Accounting Period, in

accordance with the requirements and guidelines set out

in the Manuals, provided that if Franchisee fails to spend

the full amount as directed by Tricon and/or TRIM

franchisee will pay the unspent amount to TRIM within

the period specified in a written demand from TRIM. Upon

receipt of the unspent amount TRIM will spend the

amount on regional and/or national advertising,

promotions or research expenditure conducted by TRIM

in its discretion.......”

4.1 Tricon may at the request of TRIM, but

subject to Tricon’s sole and absolute discretion pay to

TRIM any such amount(s) as it may deem appropriate

to support the AMP [sic] activities during any

Accounting Period for the avoidance of doubt, it is

clarified and agreed between the Parties that Tricon

shall have no obligation to pay any such amounts if it

chooses not to do so.

8.4 In the event there is any surplus left over in any

of the Brand Funds at the end of an accounting period,

TRIM shall be entitled to retain the surplus to be spent on

AMP activities during the following accounting period.

Alternatively, TRIM may, subject to the approval of its

Board of Directors refund the surplus amounts to the

franchisees including Franchisee in the same proportion

as the actual advertising contribution made by each

franchisee including franchisee in that accounting period.

On the other hand, if there is a deficit in any of the brand

funds at the end of an accounting period, the deficit will

be carried forward to the next accounting period and be

met out of the advertising contribution paid by the

franchisees including franchisee for that accounting

period. For the avoidance of doubt, it is agreed between

the parties that Tricon and/or TRIM shall not be obliged

to fund the deficit.

8.5 It is clearly understood and agreed between the

parties that the only objective of TRIM is to coordinate the

marketing activities of the brands including the mutual

benefit of the franchisees including the Franchisee. It is

envisaged that no profits will be earned and no dividends

will be declared by TRIM.”

(emphasis supplied)

5. For the Assessment Year under consideration, the assessee

filed its returns stating the income to be “Nil” under the pretext of

the mutual character of the company. The same was not

accepted by the Assessing Officer, who observed thus:

“VI.7.3 As per the SIA letter dated 05.10.1998 Assessee

Company along with the franchisees were to contribute a

fix percentage of its revenue to YRMPL. However as per

clause 4.1 of Tripartite operating agreement submitted by

YRMPL, the assessee company had its sole absolute

discretion to pay to YRMPL any amount as it may deem

appropriate and that YRIPL shall have no obligation to

pay any such amounts if it chooses not to do so. This

clearly shows that YRIPL was under no legal obligation to

pay any amount of contribution as per its own version

reflected from tripartite agreement.”

6. The imposition of liability by the Assessing Officer was

upheld by the C.I.T. (A) on the ground of taint of commerciality in

the activities undertaken by the assessee company, wherein it

was observed thus:

“1.14 ....The AMP activity is quite a critical component of

running a successful business venture, it is intrinsically

linked to sales and profit of the franchisees the

contributors. Accordingly it cannot be said that such

activity is immune from the taint of commerciality. Unlike

in the cases of a club, the appellant Co. is not existing for

any social inter course nor is it for cultural activities

where the idea of profit or trade does not exist. What is

essential is that there should not be any dealing with

outside body which results in a benefit which promotes

some commercial/business venture. There should not be

any profit earning motive in any transaction directly or

indirectly. In fact in the appellant’s case the essence of

mutuality also appears to be missing in that there is no

instance or scope of say trading between persons

associating together. Thus though the form taken up to

conduct its revenue activity undoubtedly resemble a

mutual concern but the contributions made on the other

hand are undeniably for business considerations. In my

opinion, taking an overall view of the intent and motive of

the appellant company to form a ‘mutual concern’ it can

be concluded that the underlying purpose was solely for

commercial consideration. Therefore in view of the above

as demonstrated by the appellant Co. the excess of

receipts over the expenditure i.e. the surplus in my

opinion would be income liable to tax....”

7. The liability was further confirmed by the Tribunal, wherein

the essential ingredients of the doctrine of mutuality were found

to be missing. It observed thus:

“11. .... Firstly the Government order sanctioning setting

up of the wholly owned subsidiary prescribes that the

approval is subject to the condition that such subsidiary

would be a non­profit enterprise and is also not entitled

to repatriate dividends. The main object of the assessee

company reveals that it is to carry out advertising,

marketing and promotion for brands owned by its parent

company. The main plank of the assessee’s arguments is

that the principles of mutuality will apply and hence the

income cannot be taxed. Time and again various courts

have held that where there is complete identity between

the contributors and the participators or the

beneficiaries, only then such principles can be applied.

However, in the present case it is seen that apart

from contributions is also received from M/s Pepsi

Foods Ltd. and YRIPL. Pepsi Foods Ltd. is neither a

franchisee nor a beneficiary. Similarly some

contribution is also received from YRIPL which YRIPL

is not under any obligation to pay. Thus it can be said

that essential requirement that of the contributors to

the common fund are either to participate in the

surplus or they are beneficiaries of the contribution is

missing. Through the common AMP activities no

benefit accrues to Pepsi Food Ltd. or YRIPL.

Accordingly the principles of mutuality cannot be

applied. It is a different facts that the assessee was

established with the object not to make profit but it is

also a fact that there is a surplus in the hands of the

assessee which arose due to contribution from certain

persons who were neither the benficiaries nor have right

to receive the surplus....”

(emphasis supplied)

8. The consistent line of opinion recorded by the

aforementioned three forums was further approved in appeal by

the High Court vide impugned judgment, by observing thus:

“8. ....The principle of mutuality as enunciated by the

Courts in various cases is applicable to a situation where

the income of the mutual concern is the contributions

received from its contributors. The expenses incurred by

the mutual concerns are incurred from such

contributions and hence on the principle that no man can

do business with himself, the excess of income over

expenditure is not amenable to tax. However, in the

present case the authorities below have returned a

finding of fact that the fund as contributors such as Pepsi

Food Ltd which do not benefit from the APM Activities.

Moreover, the principle of mutuality is applicable to those

entities whose activities are not tinged with commercial

purpose. As a matter of fact in the instant case the parent

company i.e., YRIPL which has also contributed to the

brand fund is under the agreement under no obligation to

do so. The contributions of YRIPL are at its own

discretion. Thus, looking at the facts obtaining in the

present case, it is quite clear that the principle of

mutuality would not be applicable to the instant case....”

9. On cogitating over the rival submissions, we reckon that the

following questions of law would arise for our consideration in the

present case:

(i) Whether the assessee company would qualify as a

mutual concern in the eyes of law, thereby exempting

subject transactions from tax liability?

(ii) Whether the excess of income over expenditure in the

hands of the assessee company is not taxable?

10. The appellant/assessee has contended that the sole

objective of the assessee company was to carry on the earmarked

activities on a no­profit basis and to operate strictly for the

benefit of the contributors to the mutual concern. It has further

been contended that the assessee company levies no charge on

the franchisees for carrying out the operations. While assailing

the observations made in the impugned judgment, holding that

Pepsi Foods Ltd. and YRIPL are not beneficiaries of the concern,

the assessee company has urged that YRIPL is the parent

company of the assessee and earns fixed percentage from the

franchisees by way of royalty. Therefore, it benefits directly from

enhanced sales as increased sales would translate into increased

royalties. A similar argument has been advanced as regards Pepsi

Foods Ltd. It is stated that under a marketing agreement, the

franchisees are bound to serve Pepsi drinks at their outlets and

thus, an increase in the sales at KFC and Pizza Hut outlets as a

result of AMP activities would lead to a corresponding increase in

the sales of Pepsi. To add weight to this argument, it has been

brought to our notice that Pepsi was also advertised by the

franchisees in their advertising and promotional material, along

with Pizza Hut and KFC, and copy of the said material has been

placed on record.

11. As regards the doctrine of mutuality, it is urged by the

assessee company that the doctrine merely requires an identity

between the contributors and beneficiaries and it does not

contemplate that each member should contribute to the common

fund or that the benefits must be derived by the beneficiaries in

the same manner or to the same extent. Reliance has been placed

by the appellant upon reported decisions to draw a parallel

between the functioning of the assessee company and clubs to

support the presence of mutuality.

12. The Revenue/respondent has countered the submissions

made by the assessee company by submitting that the moment a

non­member joins the common pool of funds created for the

benefit of the contributors, the taint of commerciality begins and

mutuality ceases to exist in the eyes of law. It has been

submitted that the assessee company operated in contravention

of the SIA approval as contributions were received from Pepsi,

despite it not being a member of the brand fund. To buttress this

submission, it is urged that once the basic purpose of benefiting

the actual contributors is lost, mutuality stands wiped out.

13. We have heard Mr. Balbir Singh, learned senior counsel for

the appellant and Mr. V. Shekhar, learned senior counsel for the

respondent.

Re: Question (i):

14. The doctrine of mutuality traces its origin from the basic

principle that a man cannot engage into a business with himself.

For that reason, it is deemed in law that if the identity of the

seller and the buyer; or the vendor and the consumer; or the

contributor and the participator is marked by oneness, then a

profit motive cannot be attached to such a venture. Thus, for the

lack of a profit motive, the excess of income over the expenditure

or the “surplus” remaining in the hands of such a venture cannot

be regarded as “income” taxable under the Income Tax Act, 1961

(for short, “the 1961 Act”). What is taxable under the 1961 Act is

“income” or “profits” or “gains” as they accrue to a person in his

dealings with other party or parties that do not share the same

identity with the assessee. For income, there is an underlying

exchange of a commercial nature between two different entities.

In Commissioner of Income Tax, Bihar v. Bankipur Club

Ltd., this court observed on the nature of liability under the

1961 Act thus:

“6. Under the Income Tax Act (hereinafter referred to

as “the Act”) what is taxed is, the "income, profits or gains

earned or "arising", "accruing" to a person". The question

is whether in the case of members’ clubs ­ a species of

mutual undertaking ­ in rendering various services to its

members which result in a surplus, the club can be said

to "have earned income or profits" In order to answer the

question, it is necessary to have a background of the law

relating to "mutual trading" or "mutual undertaking" and

a "members club".”

15. The law regarding the tenets of mutuality is no more res

integra. It has been settled in a catena of judicial

pronouncements and academic works across multiple

jurisdictions. In Bangalore Club v. Commissioner of Income

Tax & Anr., this Court authoritatively quoted one of the earliest

judicial pronouncements in New York Life Insurance Co. v.

Styles (Surveyor of Taxes) thus:

“When a number of individuals agree to contribute funds

for a common purpose. . . and stipulate that their

contributions, so far as not required for that purpose,

shall be repaid to them. I cannot conceive why they

should be regarded as traders, or why contributions

returned to them should be regarded as profits.”

The proposition of law is restated in Bankipur Club (supra) and

Bangalore Club (supra) by placing reliance upon the following

extract from Simon’s Taxes :

“... it is settled law that if the persons carrying on a trade

do so in such a way that they and the customers are the

same persons, no profits or gains are yielded by the trade

for tax purposes and therefore no assessment in respect

of the trade can be made. Any surplus resulting from this

form of trading represents only the extent to which the

contributions of the participators have proved to be in

excess of requirements. Such a surplus is regarded as

their own money and returnable to them. In order that

this exempting element of mutuality should exist it is

essential that the profits should be capable of coming

back at some time and in some form to the persons to

whom the goods were sold or the services rendered..."

16. In order to undertake the examination of mutuality, we

gainfully advert to The English and Scottish Joint Co-

operative Wholesale Society Ltd. v. Commissioner of

Agricultural Income­Tax, Assam, which has been quoted with

approval by this Court in Commissioner of Income Tax,

Bombay City v. Royal Western India Turf Club Ltd.6

and Bangalore Club (supra). The aforestated stream of judicial

pronouncements expound three conditions/tests to prove the

existence of mutuality:

(i) Identity of the contributors to the fund and the

recipients from the fund;

(ii) Treatment of the company, though incorporated as a

mere entity for the convenience of the members and policy

holders, in other words, as an instrument obedient to their

mandate, and;

(iii) Impossibility that contributors should derive profits

from contributions made by themselves to a fund which

could only be expended or returned to themselves.

Whereas the legal position on what amounts to a mutual concern

stands fairly settled, the factual determination of the same on a

case to case basis poses a complex issue that requires deeper

examination. Such examination ought to be conducted in the

light of the tests enunciated above.

Common Identity

17. The first element involves the test of commonality of identity

between the members or participators in the mutual concern and

the beneficiaries thereof. Succinctly put, this limb of the three-

pronged test requires that no person ought to contribute to the

common fund without having the entitlement to participate as a

beneficiary in the surplus thereof. Conversely, no person ought

to participate as a beneficiary without first having been a

contributor or a member of the class of contributors to the

common fund. Common identity, as it occurs in the present

context, signifies that the class of members should stay intact as

the transaction progresses from the stage of contributions to that

of returns/surplus. It must manifest uniformity in the class of

participants in the transaction. The moment such a transaction

opens itself to non­members, either in the contribution or the

surplus, the uniformity of identity is impaired and the

transaction assumes the taint of a commercial transaction. The

emphasis on the words member and non­member is of import

because the doctrine of mutuality does not prohibit the inclusion

or exclusion of new members. What is prohibited is the infusion

of a participant in the transaction who does not become a

‘member’ of the common fund, at par with other members, and

yet participates either in the contribution or surplus without

subjecting itself to mutual rights and obligations. The principle of

common identity prohibits any one­dimensional alteration in the

nature of participation in the mutual fund as the transaction

fructifies. Any such alteration would lead to the non­uniform

participation of an external element or entity in the transaction,

thereby opening the scope for a manifest or latent profit­based

dealing in the transaction with parties outside the closed circuit

of members. It would be amenable to income tax as per Section

2(24) of the 1961 Act.

Completeness of Identity

18. Coterminous with the requirement of common identity, as

discussed above, the law also contemplates a completeness of

identity between the contributors and participators. The theory of

completeness of identity presupposes the contributors and

participators to be two separate classes, but there is oneness or

equality in the matter of sharing of surplus/profits. This is to

ensure that there is no interference of any alien commercial

entity in the transaction. With the interference of any alien entity,

the idea of conducting business with oneself is defeated and any

profits or gains accruing therefrom become subject to tax

liability. This proposition of law is succinctly predicated in

British Tax Encyclopaedia, which reads thus:

“...For this doctrine to apply it is essential that all the

contributors to the common fund are entitled to

participate in the surplus and that all the participators in

the surplus are contributors, so that there is complete

identity between contributors and participators. This

means identity as a class, so that at any given moment of

time the persons who are contributing are identical with

the persons entitled to participate; it does not matter that

the class may be diminished by persons going out of the

scheme or increased by others coming in”

It is pertinent to note that in order to determine the breach in

mutuality, the court is well within its powers to go beyond the

periphery of the concern and undertake an examination akin to

the lifting of the veil in order to discern the real nature thereof.

19. In the present case, it is indisputable that Pepsi Foods Ltd.

is a contributor to the common pool of funds. However, it does

not participate in the surplus as a beneficiary for at least two

reasons­ first, Pepsi is not a member of the purported mutual

concern as the Tripartite Agreement as well as the terms of SIA

approval permit only ‘franchisees’ to become members of the

mutual concern. Notably, Pepsi Foods Ltd. is not a franchisee

and thus, it cannot participate in the surplus. Second, Pepsi does

not enjoy any right of participation in the surplus or any right to

receive back the surplus which are mandatory ingredients to

sustain the principle of mutuality.

20. We find it noteworthy that the Tripartite Agreement requires

the assessee company to constitute a separate Brand Fund for

each franchisee as stated in clause 2.2 of the said agreement,

which reads thus:

“2.2 TRIM will establish and operate Brand Funds in

respect of each Brand, for the purpose of allocating and

using the Advertising Contribution received from

franchisee and other franchisee of Tricon operating

Restaurants under the Brands TRIM will allocate the

advertising contribution received from the franchisees

including Franchisee for each Restaurant to the Parties

that the Advertising Contribution paid into a Brand Fund

will be used for the AMP Activities relating to that Brand.”

(emphasis supplied)

Since no Brand Fund, as contemplated above, has been

constituted for Pepsi Foods Ltd., it does not become a part of the

purported Tripartite mutual arrangement so as to qualify as a

beneficiary of the mutual operations. The definition clause of the

Tripartite Agreement adds weight to this finding. “Advertising

Contribution”, as defined in the definition clause means,

“the advertising contributions which Franchisee has

agreed to pay to Tricon pursuant to [sic] the Franchisee

Agreements.”

Furthermore, “Franchise Agreements”, as defined in the

definition clause, means agreements executed between Tricon

and Franchisee. As a corollary, what follows is that for any

amount received by the assessee company to be treated as an

advertising contribution, it must be paid by a franchisee, that too

in the aftermath of a prior franchisee agreement to that effect. In

the light of the prevailing relationship, there is no such

franchisee agreement between Tricon or TRIM and Pepsi Foods

Ltd. and therefore, the amounts received from Pepsi Foods Ltd.

cannot be viewed as advertising contributions “from a member of

the mutual undertaking” as such.

21. In the present case, therefore, the assessee company is

realising money both from the members as well as non­members

in the course of the same activity carried on by it. This court, in

Royal Western India Turf Club Ltd. (supra) has categorically

held such operations to be antithetical to mutuality. We deem it

apposite to take note of the dictum in Bankipur Club (supra),

wherein this principle has been restated thus:

“22. ...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 non­members, 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 profit­income liable to tax...”

22. The contention of the assessee company that Pepsi Foods

Ltd., in fact, does benefit from the mutual operations by virtue of

its exclusive contracts with the franchisees is tenuous, as the

very basis of mutuality is missing as far as Pepsi Foods Ltd. is

concerned, as discussed hitherto. Even if any remote or indirect

benefit is being reaped by Pepsi Foods Ltd., the same cannot be

said to be in lieu of it being a member of the purported mutual

concern and therefore, cannot be used to fill the missing links in

the chain of mutuality. Concededly, the surplus of a mutual

operation is meant to be utilised by the members of the mutual

concern as members enjoy a proximate connection with the

mutual operation. Non­members, including Pepsi Foods Ltd.,

stand on a different footing and have no proximate connection

with the affairs of the mutual concern. The exclusive contract

between the franchisees and Pepsi Foods Ltd. stands on an

independent footing and YRIPL as well as the assessee company

are not responsible for implementation of this contract.

Resultantly, the first limb of the three­pronged test stands

severed.

Non­ profiteering and Obedience to Mandate

23. Whereas the doctrine of mutuality stands debunked with

the failure of the first test, let us, nonetheless, examine the other

two tests in the present factual scenario. Indubitably, the receipt

of money from an outside entity without affording it the right to

have a share in the surplus does not only subjugate the first test

of common identity, but also contravenes the other two

conditions for the existence of mutuality i.e. impossibility of

profits and obedience to the mandate. The mandate of the

assessee company was laid down in the SIA approval wherein the

twin conditions of mutuality and non­profiteering were

envisioned as the sine qua non for the functioning of the assessee

company. The contributions made by Pepsi Foods Ltd. tainted the

operations of the assessee company with commerciality and

concomitantly contravened the pre­requisites of mutuality and

non­profiteering.

24. The mutuality and non­profiteering 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. It is, therefore, imperative to examine

the actual functional framework of the assessee company in light

of the status of YRIPL (parent company) vis­a­vis other

members/franchisees. As per the terms of the SIA approval,

YRIPL and franchisees were equally obligated to make

contribution of a fixed percentage to the assessee company. This

requirement was incorporated as a pre­condition for the grant of

permission to operate as a mutual concern. Clause 3 of the

approval letter reads thus:

“The franchises and Tricon Indian will both make

contribution of a fixed percentage of their respective

revenues (net of taxes) to the proposed New Company on

regular basis:”

However, drifting from this mandate, the Tripartite Agreement

made it discretionary upon YRIPL to contribute to the common

pool, thereby putting it at a higher pedestal than the franchisees.

Clause 4.1 of the Tripartite Agreement reads thus:

“4.1 Tricon may at the request of TRIM, but subject

to Tricon sole and absolute discretion pay to TRIM

any such amount(s) as it may deem appropriate to

support the VVIP activities during the Accounting Period

for the avoidance of doubt, it is clarified and agreed

between the Parties that Tricon shall have no obligation

to pay any such amounts if it chooses not to do so.”

(emphasis supplied)

Thus, clause 4.1 is not in confirmity with the terms of approval.

Furthermore, it is noteworthy that the management of the

assessee company was under full and absolute control of its

parent company YRIPL. Be it also noted that the participation of

the franchisees in the management of the assessee company was

again subject to approval by YRIPL, which falls within its sole

discretion. Clause 7.1 of the Tripartite Agreement reads thus:

“7.1 The management and operations of TRIM will be

carried out by its Board of Directors in accordance with

the Articles of Association of TRIM, the terms of which

shall be read as a part of this Agreement. The Board of

Directors of TRIM will be nominated by Tricon from time

to time in accordance with the Articles of Association of

TRIM. The Board of Directors of TRIM shall consist of a

minimum number of five directors. Out of the five

directors Tricon may, in its absolute and sole

discretion, nominate one representative each of two

franchisees (to be selected by Tricon on a rational

basis) to be appointed as directors on the Board of

Directors of TRIM such nominees to hold office for a

period of one year from the date of their appointment. In

the event the representative of the Franchisee is

nominated to the Board of Directors of TRIM. Franchisee

agrees and undertakes to cause such representative to (i)

accept such appointment as and when the same is made;

and (ii) to resign from the post of Director on the expiry of

one year from the date of appointment or earlier, if so

requested by Tricon.”

(emphasis supplied)

25. The net effect of the aforequoted clauses is to render the

pre­conditions for the grant of approval, as otiose. It also

becomes amply clear that YRIPL and the franchisees stand on

two substantially different footings. For, the franchisees are

obligated to contribute a fixed percentage for the conduct of AMP

activities whereas YRIPL is under no such obligation in utter

violation of the terms of SIA approval. Moreover, even upon

request for the grant of funds by the assessee company, YRIPL is

not bound to accede to the request and enjoys a “sole and

absolute” discretion to decide against such request. That

members of a financial concern exercise mutual control over its

management without the scope of prejudicial exercise of power by

one class of members over the others is the quintessence for the

existence of a mutual concern. The word “mutual” offers guidance

to this effect. Literally understood, the word “mutual” points

towards reciprocity and a mutual arrangement is one in which

the members/parties have reciprocal rights or understanding or

arrangement. An arrangement wherein one member is subjected

to the absolute discretion of another, in such a manner that the

entire liability may fall upon one whereas benefits are reaped by

all, is antithesis to the mutual character in the eyes of law.

26. The contention advanced by the appellant that it is not

mandatory for every member of the mutual concern to contribute

to the common pool fails to advance the case of the appellant. It

is no doubt true that every member of the mutual concern might

not be required to contribute to the common pool at all times.

However, it does not mean that one member cannot be made to

contribute under any pretext whatsoever. For, that would

amount to the grant of an overriding position to a member in the

mutual agreement, extending upto even overruling the requests

for contribution from other members for mutual necessity. It is

this all­pervasive overriding position of one member over the

others that negates the effect of mutuality. There is a fine line of

distinction between absence of obligation and presence of

overriding discretion. In the present case, YRIPL enjoys the latter

at the detriment of the franchisees of the purported undertaking,

both in matters of contribution and management. In a mutual

concern, it is no doubt true that an obligation to pay may or may

not be there, but in the same breath, it is equally true that an

overriding discretion of one member over others cannot be

sustained, in order to preserve the real essence of mutuality

wherein members contribute for the mutual benefit of all and not

of one at the cost of others.

27. More importantly, an examination of the judicial decisions

relied upon by the parties brings out the settled legal position

that in order to qualify as a mutual concern, the contributors to

the common fund either acquire a right to participate in the

surplus or an entitlement to get back the remaining proportion of

their respective contributions. In the present scheme of things,

clause 8.4 provides that,

“8.4 In the event there is any surplus left over in any of

the Brand Funds at the end of an Accounting Period.

TRIM shall be entitled to retain the surplus to be spent on

AMP activities during the following Accounting Period.

Alternatively, TRIM may, subject to the approval of

its Board of Directors, refund the surplus amounts to

the franchisees including Franchisee in the same

proportion as the actual Advertising Contribution made

by each franchisee including Franchisee in that

Accounting Period.”

(emphasis supplied)

28. Contrary to the abovestated legal position, clause 8.4 makes

it clear that the franchisees do not enjoy any “entitlement” or

“right” on the surplus remaining after the operations have been

carried out for a given assessment year. The clause provides that

the assessee company may refund the surplus subject to the

approval of its Board of Directors. It implies that the

franchisees/contributors cannot claim a refund of their

remaining amount as a matter of right. Be it noted that the

raison d’etre behind the refund of surplus to the contributors or

mandatory utilisation of the same in the subsequent assessment

year is to reduce their burden of contribution in the next year

proportionate to the surplus remaining from the previous year.

Thus, the fulfilment of this condition becomes essential. In the

present case, even if any surplus is remaining in a given

assessment year, it is unlikely to reduce the liability of the

franchisees in the following year as their liability to the extent of

5 per cent is fixed and non­negotiable, irrespective of whether

any funds are surplus in the previous year. The only entity that

could derive any benefit from the surplus funds is YRIPL, i.e. the

parent company. This is antithetical to the third test of

mutuality.

29. `Be that as it may, the dispensation predicated in the

Tripartite Agreement may entail in a situation where YRIPL would

not contribute even a single penny to the common pool and yet

be able to derive profits in the form of royalties out of the

purported mutual operations, created from the fixed 5 per cent

contribution made by the franchisees. This would be nothing

short of derivation of gains/profits out of inputs supplied by

others. That cannot be countenanced as being violative of the

basic essence of mutuality. The doctrine of mutuality, in

principle, entails that there should not be any profit earning

motive, either directly or indirectly. The third test of mutuality,

quoted above, requires that the purported mutual operations

must be marked by an impossibility of profits and this crucial

test is also not fulfilled in the present case.

30. Furthermore, the exemption granted to a mutual concern is

premised on the assumption that the concern is being run for the

mutual benefit of the contributors and the contributions made by

the members ought to be directed in that direction. Contrary to

this fundamental tenet, clause 8.1 of the Tripartite Agreement

relieves the assessee company from any specific obligation of

spending the amounts received by way of contributions for the

benefit of the contributors. It explicates that the assessee

company does not hold such amount under any implied trust for

the franchisees, and reads thus:

“8.1 .... Notwithstanding the foregoing, any amount paid

by Franchisee to TRIM will not be required to be spent for

the specific benefit, either direct or indirect, of Franchisee

or the Business and no express or implied trust will be

created in respect of such amount. Additionally,

Franchisee will not have any claim or action against

Tricon and/or TRIM in connection with the level of

success of any such advertising, marketing, promotion,

research or test.”

31. A priori, it must follow that the assessee company had acted

in contravention of the terms of approval. Notably, the SIA

approval or Government approval was not only a binding

document but also a conditional document with a defined set of

preconditions for the functioning of the assessee company as a

mutual concern. The SIA approval categorically reads that the

grant of approval is subject to the terms and conditions specified

therein and any contravention thereof would be infraction of the

mandate of the government approval.

32. The appellant had urged that no fixed percentage of

contribution could be imputed upon YRIPL as it does not operate

any restaurant directly and thus, the actual volume of sales

cannot be determined. At the very outset, this argument holds no

water as YRIPL receives fixed percentage of royalty from the

franchisees on the sales. We say so because if the franchisees

could be obligated with a fixed percentage of contribution, 5 per

cent in the present case, it is unfathomable as to why the same

obligation ought not to apply to YRIPL.

33. Be it noted that the text of the Tripartite Agreement points

towards the true intent of the formation of the assessee company

as a step down subsidiary. For, clause C predicates thus:

“C. TRIM has been established as a wholly owned

step down subsidiary Tricon to manage of the retail

restaurant business, the advertising medial and

promotion at regional level and national level of KFC.

Pizza Hut and other brands currently owned or

acquired in future by Tricon and on its parents and of

its associate company.”

In the absence of any ambiguity, the terms of a contract are to be

understood in their ordinary and natural sense, thus revealing

the true intent of the contracting parties. The aforequoted clause

clearly points towards the fact that the assessee company was

formed to manage business on behalf of the holding company. In

its true form, it was not contemplated as a non­business concern

because operations integral to the functioning of a business were

entrusted to it.

34. The doctrine of mutuality bestows a special status to qualify

for exemption from tax liability. It is a settled proposition of law

that exemptions are to be put to strict interpretation. The

appellant having failed to fulfil the stipulations and to prove the

existence of mutuality, the question of extending exemption from

tax liability to the appellant, that too at the cost of public

exchequer, does not arise. Taking any other view would entail in

stretching the limits of construction. In The Law of Taxation by

Thomas M. Cooley, the rule regarding strict construction of

exemptions is succinctly summarised thus:

“672. Strict construction­Rule stated. An intention

on the part of the legislature to grant an exemption from

the taxing power of the state will never be implied from

language which will admit of any other reasonable

construction. Such an intention must be expressed in

clear and unmistakable terms, or must appear by

necessary implication from the language used, for it is a

well­settled principle that, when a special privilege or

exemption is claimed under a statute, charter or act of

incorporation, it is to be construed strictly against the

property owner and in favour of the public. This principle

applies with peculiar force to a claim of exemption from

taxation. Exemptions are never presumed, the burden is

on a claimant to establish clearly his right to exemption,

and an alleged grant of exemption will be strictly

construed and cannot be made out by inference or

implication but must be beyond reasonable doubt. .......

Moreover, if an exemption is found to exist, it must not be

enlarged by construction, since the reasonable

presumption is that the state has granted in express

terms all it intended to grant at all, and that unless the

privilege is limited to the very terms of the statute the

favour would be extended beyond what was meant...”

35. The assessee company has relied upon reported decisions to

establish a parallel between the operations carried out by itself

and clubs. Upon closer scrutiny, however, we find that the

authorities cited by the appellant do not advance its case because

of the structural differences between the operations carried out

by the purported mutual concern (assessee company) and clubs.

In the case of clubs, the operations are exempted from taxability

because of the underlying notion that they operate for the

common benefit of the members wishing to enter into a social

exchange with no commercial intent. Further, all the members of

the club not only have a common identity in the concern but also

stand on an equal footing in terms of their rights and liabilities

towards the club or the mutual undertaking. Such clubs are a

means of social intercourse, as rightly observed by CIT (A) in the

present case, and are not formed for the facilitation of any

commercial activity. On the contrary, the purported mutual

concern in the present case undertakes a commercial venture

wherein contributions are accepted both from the members as

well as non­members, as discussed earlier. Moreover, one

member is vested with a myriad set of powers to control the

functioning and interests of other members (franchisees), even to

their detriment. Such an assimilation cannot be termed as a case

of ordinary social intercourse devoid of commerciality.

Re: question No. (ii):

36. Once it is conclusively determined that the assessee

company had not operated as a mutual concern, there would be

no question of extending exemption from tax liability. Be that as

it may, to support an alternative claim for exemption, the

assessee company took a plea in the written submissions that it

was acting under a Trust for the contributors, and was under an

overriding obligation to spend the amounts received for

advertising, marketing and promotional activities. It is urged that

once the incoming amount is earmarked for an obligation, it does

not become “income” in the hands of the assessee as no occasion

for the application of such income arises.

37. In the written submissions, the assessee company has

contended thus:

“The Hon’ble High Court further erred in not adjudicating

the specific ground raised by the Appellant that the

contributions received by the Appellant cannot be said to

be its income because the Appellant merely holds them as

a trustee and also under an overriding obligation to spend

such contributions received for AMP activities.”

38. The law on what amounts to a case of diversion before

accrual and what amounts to application post accrual is well

settled and can be summarised by making reference to Dalmia

Cement Ltd., Rajasthan v. Commissioner of Income Tax, New

Delhi, wherein the following extract of The Commissioner of

Income Tax, Bombay City II v. Sitaldas Tirathdas10 was

quoted with approval:

“16... In our opinion, the true test is whether the amount

sought to be deducted, in truth, never reached the

assessee as his income. Obligations, no doubt, there are

in every case, but it is the nature of the obligation which

is the decisive fact. There is a difference between an

amount which a person is obliged to apply out of his

income and an amount which by the nature of the

obligation cannot be said to be a part of the income of the

assessee. Whereby the obligation income is diverted

before it reaches the assessee, it is deductible; but where

the income is required to be applied to discharge an

obligation after such income reaches the assessee, the

same consequence, in law, does not follow. It is the first

kind of payment which can truly be excused and not the

second. The second payment is merely an obligation to

pay another portion of one's own income, which has been

received and is since applied. The first is a case in which

the income never reaches the assessee, who even if he

were to collect it, does so, not as part of his income, but

for and on behalf of the person to whom it is payable...”

Furthermore, in Associated Power Co. Ltd. v. Commissioner of

Income Tax11, this Court again observed thus:

“13. The application of the doctrine of diversion of income

by reason of an over­riding title is quite inapposite. The

doctrine applies when, by reason of an over­riding title or

obligation, income is diverted and never reaches the

person in whose hands it is sought to be assessed...”

Similarly, in The Commissioner of Income Tax, Kerala,

Ernakulam v. The Travancore Sugars & Chemical Ltd.12, this

Court restated thus:

“22... It is thus clear that where by the obligation income

is diverted before it reaches the assessee, it is deductible.

But, where the income is required to be applied to

discharge an obligation after such income reaches the

assessee it is merely a case of application of income to

satisfy an obligation of payment and is therefore not

deductible.”

39. The CIT (A), while rejecting this ground, relied upon

Sitaldas Tirathdas (supra), and observed thus:

“... Where an assessee applies an income to discharge an

obligation after the income reaches the hands of the

assessee, it would be an application of income and this

would resulting taxation of such income in the hands of

the appellant.”

40. We note that the same ground was also pressed in appeal

before the Tribunal which finds mention in the Tribunal’s order

dated 31.01.2008 in the following words:

“(b) In failing to consider and appreciate that the amount

received by the appellant from the franchisees towards

advertising contributions are diverted at source by

overriding title for being spent on advertisement ..”

However, the Tribunal did not record any observation addressing

this ground in the abovesaid order. It has been brought to our

notice that the assessee company has made an application under

section 254(2) of the 1961 Act for rectification of the Tribunal’s

order citing an error apparent on the face of the record. The said

application is stated to be pending.

41. Considering the fact that the question of diversion by

overriding title was neither framed nor agitated in the appeal

memo before the High Court or before this Court (except a brief

mention in the written submissions), coupled with the fact that

neither the Tribunal nor the High Court has dealt with that plea

and that the rectification application raising that ground is still

undecided and stated to be pending before the Tribunal, we deem

it appropriate to leave it open to the appellant to pursue the

rectification application, if so advised. We may not be understood

to have expressed any opinion either way as regards the

tenability of the said application or otherwise.

42. In view of the aforestated terms, the questions posed for our

consideration stand answered against the appellant (assessee

company) and in favour of the Revenue and the appeal stands

disposed of upholding the impugned judgment with liberty to the

appellant to pursue remedy of rectification, as per law. There

shall be no order as to costs. Pending interlocutory applications,

if any, shall also stand disposed of.

(A.M. Khanwilkar)

(Dinesh Maheshwari)

New Delhi;

April 24, 2020.