TMI Blog1961 (9) TMI 97X X X X Extracts X X X X X X X X Extracts X X X X ..... ad with rule 6 of the Schedule of the Indian Income-tax Act ? There were five applications which have been consolidated into one statement of case covering the different assessment years. The Tribunal disposed of these applications by the consolidated order of the Tribunal dated 4th September, 1956. The essential facts may be briefly stated at the outset: The assessee is a mutual concern carrying on miscellaneous insurance business. It has no share capital and no shareholder. To quote some of the major clauses like 3(1) and (iv) of the memorandum of association the objects of the society, inter alia, are: (1)To provide, or help towards providing, anywhere in the world for the expense of accommodation and treatment in hospitals and nursing homes and of private nursing for members and their dependants by means of insurance on the mutual principle . (2) To organise insurance on the mutual principle under regulations to be framed for the purpose with the object of providing such hospital, medical, surgical, nursing and allied services and of relieving members and their dependants in whole or in part from payment of hospital and other charges. The members are require ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aling with himself. It was, therefore, contended by the assessee that technically such a fund, in the mutual insurance jurisprudence, was surplus and not taxable profit. The Tribunal proceeded on the basis that it was a mutual insurance concern and that the company was only open to policy holder members and not outsiders. Mr. Mitter, learned standing counsel, tried to urge and contend that the assessee was an ordinary trading concern and as such was earning profits. But that ground obviously is not open to him on the facts and on the case as made out throughout before the proceedings before the income-tax authorities ending with the Tribunals The statement of case proceeds on this basis that it was a mutual insurance company; the question raised proceeds on the facts pleaded in paragraph 2 of such enclosure, namely: Since it was a mutual association doing miscellaneous insurance in a mutual business, it had no profits in the eye of the income-tax law and, therefore, was exempt from taxation in respect of any surplus arising from any such activity . To that the taxing authority had occasion to reply and in its reply it did not at all contest that ground of fact by controve ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... urance, etc., the company reserves generally fifty per cent, of the premium to cover the unexpired risks. It proceeds to explain this by saying that this is done because the company is liable to certain risks for the unexpired premium and, unless such a reserve was made, the profits could not be taken to be a correct one according to the commercial usage of such general insurance companies. Then the Tribunal notices the executive instructions issued by the Central Board of Revenue to the Income-tax Officers to allow such reserve for computation of the profits but holds that there is no legal sanction behind such executive instructions. The Tribunal proceeds further to say that in the present case the risk covered is generally for a month and on the expiry of the calendar year there was little liability for unexpired risks. In fact, the Tribunal argues that the company thought it prudent to reserve a portion to meet the contingencies, etc., and the reserves are provided out of the balance of profit. The Tribunal then says that this provision for the reserve is an expense to be deducted from the profit disclosed by the assessee in order to arrive at the profits within the meaning o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nce carried on by a mutual insurance association or by a cooperative society. The rules appear, therefore, to be based on four broad classifications of insurance society, namely, (1) the life insurance society, (2) insurance other than life insurance, (3) dividing society and (4) insurance carried on by mutual insurance society. In this reference we are concerned with mutual insurance society. The nature and character of a mutual insurance society must be carefully borne in mind with a view to come to a proper decision. The essential characteristics of a mutual insurance company are (1) that it has no share capital, and (2) of which by its constitution only all policy-holders are members. That is expressly provided in section 95(1)(a) of the Insurance Act. These two tests, of having no share capital and only policyholders being members, are satisfied by the present assessee. Therefore, it is a mutual insurance company within the meaning of section 95(1)(a) of the Insurance Act. One other statutory provision requires to be noticed on the nature and character of a mutual insurance company. That is provided by section 27 of the Companies Act, prior to the present Act of 1956, an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... has failed to express its intention in sufficiently clear language which would compel us to hold that the surplus to which the participating members are entitled is not subject to tax . In that view of the matter Chagla C.J. distinguished the leading authority of the House of Lords decision in Inland Revenue Commissioners v. Ayrshire Employers Mutual Insurance Association Ltd. [1948] 16 ITR (Suppl.) 80, by observing that Lord Macmillan's observation against the English legislature that it had plainly missed fire and therefore failed to include such surplus within the taxable profits was inapplicable and that the Indian legislature was a better marksman and had hit the bull's eye. The Bombay decision also was of the view that the amounts paid to or reserved for or expended on behalf of the policyholders of a mutual life insurance company within the meaning of rule 3(a) of the Schedule to the Income-tax Act did not include the expenses incurred by the company for payment of income-tax or provision for income-tax. If the Bombay decision in Bombay Mutual Life Assurance Society Ltd. v. Commissioner of Income-tax [1951] 20 ITR 189 applied to the facts of this case, as the T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h 'if those transactions were transactions with non-members'. This lead was followed by the Indian legislature in the legislation of 1939. The new definition of 'income' (section 2(6C)) was made to include 'the profits of any business of insurance carried on by a mutual insurance association computed in accordance with rule 9 in the Schedule' and rule 9 provided that the preceding rules (1 to 8) apply to the assessment of the profits of any business of insurance carried on by a mutual insurance association. This rule reproduces in effect the concluding words of section 31(1) of the English Finance Act, 1933 . The operation of the above provision in the English Finance Act has practically been nullified, so far as mutual insurance companies are concerned, by the decision of the House of Lords in Inland Revenue Commissioners v. Ayrshire Employers Mutual Insurance Association [1948] 16 ITR (Suppl.) 80. Relying on the exposition given in Municipal Mutual Insurance Ltd. v. Hills [1932] 16 Tax Cas. 430, as to the basis and effect of the decision in Styles' case (supra), the House of Lords emphasised the distinction between 'surplus' and 'profits ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iticism may not probably apply to the taxation of the investment income of the company as interest and not as profits . But for these weighty observations coming from so eminent a judge and jurist as Sir Varadachariar we might have been content to follow the view that the Bombay decision took. But these observations and expression of opinion on the construction against the wealth of legal decisions, coupled with the legislative history in the last ten years, make us hesitate to adopt the Bombay decision specially in the case of mutual non-life insurance and compel us to examine more closely the arguments of Mr. Iyengar for the assessee. Clearly Sir Varadachariar was expressing a view different from that expressed by Chagla C.J. On section 2(6C) of the Income-tax Act. Mr. Mitter for the Income-tax Commissioner realised the difficulty in the light of these observations. He, however, tried to nullify the rigour of those observations by himself relying on paragraph 101 at page 44 of the same Income-tax Investigation Commission Report on mutual associations. But they do not make the position more favourable to the taxing authorities. Those observations are as follows: The law ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t from the history of the decisions which Sir Varadachariar has noticed as above. On an examination of the legislative history it appears that after the report of the Income-tax Investigation Commission suggesting express mention of surplus in the case of mutual insurance, if that was intended to be taxed, a comprehensive Bill in 1951 was brought which, inter alia, attempted to re-define income to include the surplus, if any, in any business of insurance carried on by a mutual insurance association computed in accordance with rule 9 of the Schedule . It has been urged that this attempt in the Bill to bring in surplus for taxation shows that the surplus of the mutual insurance association was not within the tax. The Bill of 1951, however, lapsed and did not become an Act. The result was that the Act remained with the word profit and without the word surplus so far as the mutual insurance associations were concerned. An Indian Income-tax (Amendment) Bill was again introduced in 1952 suggesting various amendments some of which became law, but then this Bill of 1952 did not introduce surplus expressly as taxable, so far as mutual insurance associations were concerned. F ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... profits arising from non-participating policies, the sale of life and wage and other business conducted by the society with non-members. No such complication arises in the present reference before us, as there is no business with non-members at all. The majority members of the House of Lords consisting of Lords Watson, Bramwell, Herschell and Macnaghten, held that so much of the surplus that arose from the excess contributions of the participating policyholders was not profit assessable to income-tax. Lord Halsbury L.C. and Lord Fitzgerald dissented and were in the minority. Lord Watson at page 470 of the report in New York Life Insurance Co.'s case (supra) noticed: ........the excess, if any, of premiums received from these members over expenditure for which they are responsible is, after carrying part to a reserved fund, returned or repaid to them, either in the shape of bonus additions to their insurances, or by a deduction of the future premiums required from them . Lord Watson further pointed out at the same page that the question before the House for determination was: ...........the question which we have to decide is whether that surplus represents 'a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mbers are required to pay being in excess of what is necessary to provide for the requisite payments to be made upon the deaths of members, and not being, as the case states they were intended to be, commensurate therewith. This may result either from the contributions having, owing to an erroneous estimate or over-caution, been originally fixed at a higher rate than was necessary, or from the death-rate being lower than was anticipated. Can it be properly said that, under these circumstances, the association of mutual insurers has earned a profit? The members contribute for a common object to a fund which is their common property; it turns out that they have contributed more than is needed, and therefore more than ought to have been contributed by them for this object, and accordingly their next contribution is reduced by an amount equal to their proportion of this excess. I am at a loss to see how this can be considered as a 'profit' arising or accruing to them from a trade or vocation which they carry on. It is true the alternative is allowed them of leaving the excess in the common fund, and so increasing their representative's claim upon it in case of death but I c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , 1933, in England. The ratio of this decision is that section 31 which sought to render the surplus of such mutual insurance companies assessable failed because it was based on the wrong assumption that surplus from dealings with non-members would be assessable and sought to put the two kinds of surplus on the same footing and that it was not membership or non-membership which determined the immunity from or liability to tax but the nature of the transaction. It was definitely held by the House of Lords in that decision that, if the transactions were of the nature of mutual insurance, the resultant surplus was not taxable whether the transactions were with members or with non-members. Again, the present reference before us is not complicated with any question of transaction with non-members. At page 347 of the report, Lord Macmillan observed: The structure of section 31(1) is quite simple. It assumes that a surplus arising from the transactions of an incorporated company with its members is not taxable as profits or gains. To render such a surplus taxable it enacts that the surplus, although in fact arising from transactions of the company with its members, shall be deemed to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ment of Mr. Mitter and I think that the observations of Lord Dunedin far from helping the taxing authorities are against their contention. The first answer is that there is no dividing rigid line between a mutual insurance company and its members such as Mr. Mitter thought. That part of the argument is already answered by Lord Watson's observations quoted above in Styles' case (supra) and is especially so in India where such a mutual insurance company can have no share capital and can have no member other than the policyholders. Therefore, there is no distinction between the insurer and the insured in this case because the company and its members are really one and the same from the point of view of taxing purposes. The second answer is that Mr. Mitter's assumption that the profits do not go back to the insured, that is, the members in this case, is entirely wrong. Clause 4 opens with the words the income and property of the association when so ever derived shall be applied solely towards the promotion of the objects of the association as set forth in this memorandum of association . The object was and is mutual insurance. The next portion of clause 4 on which Mr. Mitt ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... privileges and benefits set out in these rules. A copy of the rules and regulations of the association effective from 1st July, 1950, which has not been brought on the paper-book is directed to be kept on the records of this reference. The rules and regulations, therefore, make it abundantly and expressly clear that the whole of the subscriptions has to be returned in the form of benefits to the members. It is essential to emphasise here that, on the decision, the settled law is that this return may be either in cash or in kind and it does not matter whether it is not in cash but in kind so long as the benefit is returned in some shape or other. The attempted distinction, therefore, by which Mr. Mitter tried to distinguish the Styles' case (supra) from the present reference cannot succeed. The next House of Lords decision is Jones v. South-West Lancashire Coal Owners' Association Ltd. [1927] AC 827. This was a case of mutual insurance. It was a case of a company limited by guarantee which had for its sole effective purpose the indemnity of its members who were all coal owners against liability for compensation in respect of fatal accidents to workmen in their emplo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... attempt to show from the objects in the articles of association that the assessee is making a trading profit in this case cannot stand. Clause 5 of the objects, in fact, penalises any payment or receipt of any dividend, bonus or profit by a member in contravention of clause 4. Clause 7 of the objects of the memorandum shows that even on winding up or dissolution, any property which remains unpaid or undistributed among the members of the association, such residue shall be given or transferred to some other organisation or institution or organisations or institutions having objects similar to the objects of the association to be determined by the members of the association at or before the time of dissolution or in default thereof by the High Court of Judicature in Calcutta . Clause 7, far from making possible any profit, rather provides to the contrary, that residue, if any, shall not be distributable but will be distributed cypres to other organisations. Then Mr. Mitter contends that articles 17, 18 and 19 and article 72(3) of the articles of association of the assessee show (1) that the assessee intends to make profits, (2) that reserve fund and depreciation fund can only ari ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e receipts from the trade or business exceed the expenditure necessary for the purpose of earning those receipts . That observation is irrelevant for the purpose of this reference, because that was made in the case of a bank and a trading at that and it was not a case either of a mutual insurance company confined only to. policyholder members and no outsiders. In fact, such profit-making is illegal by statute under section 27 of the Companies Act as indicated above. The technical objection to Mr. Mitter's argument that this is not a mutual insurance society at all but an ordinary profit-making trading company has already been given by saying that this is not a fact which is permissible for Mr. Mitter to reopen. It was not put in issue at any stage before the taxing authorities and does not arise from the Tribunal's order within the meaning of section 66 of the Income-tax Act. It will do grave injustice to the assessee to reopen that question, because if it was not a mutual insurance company, then other avenues for exemption from taxation on the ground of charity could be open to the assessee as in Commissioners of Inland Revenue v. Peeblesshire Nursing Association [1926] ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... x when there is a sale by a vendor to himself. A vendor cannot make profit out of himself, and therefore the transaction relied upon by the department is not a transaction which was capable of resulting in any profits . Chagla C.J. called in support of that view the decision of the Privy Council in Doughty v. Commissioner of Taxes [1927] AC 327 and expressed himself at page 940 in Sir Homi Mehta's Executors' s case (supra) by saying: Although the vendor was a different entity from the vendee, the first being a partnership and the second being a limited company, even so, the Privy Council looked upon the transaction as a mere readjustment of the business position of the partners. At page 332 the Privy Council points out that as the vendors were the takers of the shares they would gain nothing, because in one sense the vendors were selling to themselves and in place of the partnership assets they were getting the shares of the limited company which represented those very partnership assets . It will be appropriate at this stage to refer to the four decisions on which Mr. Mitter relied. The first was Municipal Mutual Insurance Ltd.' s case (supra), which has alre ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , there must be complete identity between the contributors and the participators. If this requirement is satisfied, the particular form which the association takes is immaterial . Now this cardinal requirement is fully and completely satisfied in the present reference before us and, therefore, the so-called profits of the assessee as a mutual insurance company can only be regarded as surplus, not taxable. Again, the case of Liverpool Corn Trade Association Limited v. Monks [1926] 10 Tax Cas. 442 , relied on by Mr. Mitter has no application to this reference. It was held there that the profit arising, from the association's transactions with members was assessable to income-tax as part of the profits of the business and that the entrance fees and subscriptions received from members must be included in the computation of such profits. The distinguishing features in that case are incorporation, independent share capital and facilities to non-members, with the object of protecting the interests of the corn trade, of providing a clearing house, a market, an exchange and arbitration and other facilities for the persons engaged in that trade. But, although the membership was ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ciety in the present reference. No question of any profit and of any sale of any product in excess of the cost of production only to members or non-members arises in this case. Subsequently, Lord Normand makes it clear at page 279 that the principles of mutual insurance really rested on certain basic assumptions and according to his Lordship, after noticing the decided authorities, they were: From these quotations it appears that the exemption was based on (1) the identity of the contributors to the fund and the recipients from the fund, (2) the treatment of the company, though incorporated, as a mere entity for the convenience of the members and policyholders, in other words as an instrument obedient to their mandate, and (3) the impossibility that contributors should derive profits from contributions made by themselves to a fund which, could only be expended or returned to themselves . We are satisfied that all these tests are met in the present reference to make the assessee entitled to claim the exemption on the ground of mutual insurance. The next case on which Mr. Mitter relied is Commissioner of Income-tax v. Royal Western India Turf Club Limited [1953] 24 ITR 551 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... carried on by a mutual insurance association must include any business of insurance carried on by a mutual insurance association , but the word profits retains its connotation as trading profits which the surplus is not as being the member's own money in a mutual insurance association which is repaid or refunded to him either in cash or in kind. This view does not mean that a mutual insurance association cannot indulge in some kind of business of insurance which produces trading profits. It can, for instance, when it invests its so-called surplus and earns profit or interest thereupon, then such profit or interest will be profits of business of insurance carried on by the mutual insurance association, and as such, liable to tax. Indeed in this case, the interest earned on investment is stated and accepted to be taxable. Again for instance, even in the case of any business of insurance carried on by a mutual insurance association some property may be sold at a profit; then such sale proceeds will be taxable. That is also what the Privy Council said in English and Scottish Co-operative Society Ltd. v. Commissioner of Agricultural Income-tax [1948] 16 ITR 270. That is also imp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... applies. The Bombay decision can be justified by reason of the fact that the word surplus is used in rule 2(b) and, therefore, it can be reasonably said that even surplus was brought within the meaning of profit in the particular case of a mutual life insurance society, with which the Bombay decision was dealing. That argument is not avail able in rule 6 which significantly omits to use the word surplus . We shall now make a closer and more detailed analysis of rule 6 and its provisions. The rule prominently declares that the profit shall be taken to be a particular balance. No other profit other than balance Can therefore be contemplated. The word profit in rule 6 has the same meaning as the word profit in section 2(6C) and section 10(7) of the Income-tax Act and does not include technical surplus of mutual insurance societies except, if the Bombay decision is taken to be right, the case of a mutual life insurance society where this surplus is expressly brought in by the clear language of rules 2 and 3 to that effect, but which rules 2 and 3 are inapplicable in the case governed by rule 6. The scheme of the rules in the Schedule follows a particular pattern of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... expired risks even though the liability for unexpired risks is limited here as the Tribunal indicates in the case of the present assessee having regard to the period of monthly subscription and the three months' grace available. Mr. Mitter advanced his arguments still further on this point by submitting that a mutual insurance association or a company need not build any reserve at all because its purpose is not to make a profit or make a surplus. In aid of his argument, he drew our attention to the balance-sheets of 1949 and 1950 to suggest that profits and reserves were being built, accumulated and multiplied by the assessee. It is difficult to accept Mr. Mitter's argument as sound on this particular point. It is difficult to see why a mutual insurance society should not have a reserve or even a larger reserve if that is necessary for the purpose of mutual insurance business and how the existence of that reserve will convert into profit the legal nature and character of a surplus, which is one's own money in surplus and refundable in cash or in kind. It would be very unbusiness like indeed if a mutual insurance company were to live from hand to mouth without keep ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the executive committee dated 23rd May, 1950, shows that new members were continuing to join the association in each month and that the membership was increasing. It also expressly declares: The committee will continue to bear in mind that it is not the intention to make a profit but as far as possible to afford the maximum benefits at minimum cost to members. At the same time, your committee feel that members will appreciate the necessity for building up a modest reserve so that benefits can be maintained even in the event of an adverse claim experienced in later years . I should have thought that in the case of a mutual insurance, which by law in India is prohibited from having any share capital or shareholding, it is all the more necessary to have reserves and it is unthinkable that such an association or a company should live from hand to mouth. A few more observations of Upjohn J. we shall quote from the different portions in Faulconbridge v. National Employers' Mutual General Insurance Association Ltd. [1952] 33 Tax Cas. 103 in order to show that those observations fully meet pointedly some of the very arguments advanced by Mr. Mitter before us. They are: (1) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . Nor in my judgment can the rate of change of contributors affect the principle. Over the years there must in New York Life Insurance Company v. Styles [1889] 2 Tax Cas. 460 have been a complete change of contributors, though the tempo may have been slowed due to the inherent difference between life policies and indemnity policies; but the principle is plainly not confined to the former class of policy . But the most formidable answer to Mr. Mitter against the applicability of rule 6 in the Schedule arises from the third feature of that rule which we shall presently explain. Recalling the words of rule 6 quoted .above it will be remembered that the rule permits adjustment of the balance by certain specified and stated exclusions. The material words on this point are: ...adjusting such balance so as to exclude from it any expenditure... which may under the provisions of section 10 of this Act be allowed for in computing the profits and gains of a business . It will be clear from this part of the rule that reserves as such are not mentioned and, therefore, as they are not specifically excluded under section 10 of the Act, they must be taken as included in rule 6. On an exa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d in the accounts, must be allowed in full . Remembering that the present reference before us is not a life insurance case and remembering that rules 2 and 3 are not applicable to rule 6, it is still possible to find from this judgment the indication of the scheme of the rules and to find support for the view which we are taking that the Income-tax Officer cannot disallow the reserves on the ground that it is not a permissible expenditure within the meaning of rule 6. Indeed the present reference is stronger than the Calcutta Insurance case (supra), for the simple reason that this reserve is not expenditure at all and is not connected with any depreciation either. This view will be supported by the observations of the Supreme Court made by Hidayatullah J. in Indian Molasses Co. (Private) Ltd. v. Commissioner of Income-tax. [1959] 37 ITR 66 (SC). The Supreme Court in that case, dealing with section 10(2)(xv), considered the word expenditure to mean what is paid out or away and is something which is gone irretrievably . Again, the Supreme Court makes it clear in the case at page 80 that expenditure which if deductible for income-tax purposes is one which is towards a liability ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sioner of Excess Profits Tax v. Ruby General Insurance Co. Lid. [1957] 32 ITR 82 (SC). This decision, in our opinion, is irrelevant to the point that we have to decide in this reference. This was a case of a contingent liability arising out of the contract of insurance from business other than life insurance for unexpired risks and the actual construction related to rule 2 of Schedule 2 to the Excess Profits Tax Act, 1940. There is a reference to rule 6 of the Schedule at page 845 of that report but it was not on the point that is presented to us in this reference. Incidentally, it was not a case of mutual insurance association at all, but the case of a company carrying on life, fire, marine and general insurance business. It is unnecessary for us to discuss the minor question about the power of the Controller of Insurance to accept or reject the returns submitted to it. The provisions are clearly made under section 21 of the Insurance Act and under sub-clause (d) thereof the Controller can decline to accept any such return. But, in the present case, the fact whether he actually declined to accept such return is not established. For the reasons stated above, we hold that the ..... X X X X Extracts X X X X X X X X Extracts X X X X
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