Before the Calcutta High Court
AIR 1963 Cal 598, 1963 47 ITR 247 Cal
Petitioner
Calcutta Hospital & Nursing Home Benefits Association Ltd., Calcutta
Respondent
Commissioner of Income Tax, W. B. Calcutta
Date of Judgement
26 December 1961
Bench
B.Mukharji, J.; Niyogi, J.
Background
The case dwells upon the Income tax law to determine whether the profit earned by a mutual insurance society will be taxable or would it be exempted from tax liability on the account of being in the nature of a surplus. The reference made to numerous decisions of the House of Lords deduces that the surplus of a mutual insurance company is not in the nature of profits but a return of contribution made by self and such an amount cannot be taxed, based on the principle that one cannot earn profits by dealing with oneself. Further, it will be unbusinesslike for a mutual insurance society to not keep reserves for risks and the surplus in these reserves would not amount to be taxable profits as well.
Facts
The assessee is a mutual concern carrying on miscellaneous insurance business. It has no share capital and no shareholder. Its objective is to provide insurance for accommodation and treatment in hospitals and nursing homes. The balance of either profit or loss was earned by transferring reserves to the balance sheet and making deductions in the revenue account. The balance of the revenue account was transferred to the profit and loss account which was further transferred to the profit in one year appropriation account. The issue came out to be whether this profit was ‘surplus’ and if it is covered in the ambit of taxable profit.
Five applications 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.
STATUE AND PROVISIONS DISCUSSED
1. Section 2(6C) (vii) of the Income-tax Act, 1961
2. Section 10 (7)of the Income-tax Act, 1961
3. Section 27of the Companies Act prior to the present Act of 1956
4. Rule 6 of Schedule of Income Tax Act, 1961
5. Section 21of the Insurance Act, 1938
Issues
1. Whether the profit arising to the assessee company from miscellaneous insurance transactions of mutual character was assessable under the Indian Income-tax Act (the Act)?
2. If the answer to question No. 1 is in the affirmative, whether on the facts and in the circumstances of the case the balance of the profits as disclosed in the assessee company’s profit and loss account after deducting the various reserves should be taxable profits within the meaning of Section 2(6C)read with Rule 6 of the Schedule of the Indian Income-tax Act?
Tribunal’s decision
The Tribunal dismissed the assessee’s appeal. It 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. The Tribunal, to answer the question whether S. 2(6C) of the Act has included such surplus within the meaning of taxable profits, ordered that under Section 2(6C) of the Income-tax Act read with Rules 6 and 9 of the Schedule to the Act, the profit of such a mutual concern as the assessee was income and liable to income-tax. The Tribunal relied on the decision of the Bombay High Court in Bombay Mutual Life Assurance Society Ltd. v. Commissioner of Income-tax, Bombay City,[1] where it was concluded that the surplus accruing to a life insurance company from insurance transactions of a mutual character was assessable to tax under the Income-tax Act.
Further, the Tribunal held the view that the profit in all cases was a profit before the provision of reserve was made. That in a general insurance company, the company reserves generally fifty per cent of the premium to cover the unexpired risks 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. The Tribunal holds that there is no legal sanction behind the executive instructions issued by the Central Board of Revenue to the Income-tax Officers to allow such reserve for computation of the profits. 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. The Tribunal argued 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 and this provision for the reserve is an expense to be deducted from the profit disclosed by the assessee to arrive at the profits within the meaning of Rule 6.
Arguments Raised
Arguments from Petitioner:
The assessee contended that the profit as disclosed in the assessee’s account was not taxable under the Indian Income-tax Act as it was a mutual insurance company and that technically such a fund in the mutual insurance jurisprudence was ‘surplus’ and not taxable profit as the members are merely participating in the surplus funds subscribed and provided by themselves. It was rather in the nature of a refund of one’s own money either in cash or in benefits and that no one could make a profit by dealing with himself. The assesses further objected to the Rule 6 of the Schedule of the Income-tax Act that the Income-tax Officer must accept the balance of profit disclosed by the annual account after deducting the reserves as the taxable profits instead of adding back the reserved for computing taxable profits like it had been doing.
Arguments from Respondent:
The Respondents urged and contended that the assessee was an ordinary trading concern and as such was earning profits that would be charged with tax. They relied on the observation of Lord Dunedin[2] and tried to invoke the objects in the Articles of Association (AoA) of the present assessee company to establish that the profit here goes to the insured which is the company, which is described as a separate legal entity making such profit taxable. The objects of AoA indicate that these profits do not go back to the insurer that is the members themselves.
The reliance was placed on four landmark judgments of the House of Lords to establish the inclusivity of surplus in profits to make it chargeable however because of wrong assumptions and distinctive character of matters, their rationale became inapplicable to the current facts and circumstances.
Further arguments were submitted to contest that a mutual insurance association or company need not build any reserve at all because its purpose is not to make a profit or a surplus for which attention was drawn to the balance-sheets of 1949 and 1950 to suggest that profits and reserves were being built, accumulated and multiplied by the assessee.
Articles 17, 18 and 19 and Article 72 (3) of the Articles of Association of the assessee were also brought to notice to show that
(1) That the assessee intends to, make profits,
(2) That reserve fund and depreciation fund can only arise out of profits, and
(3) That the profits can be used in any manner or even as working capital as the Committee of the Association may decide.
However, the Court rejected this contention for it did not make the assessee an ordinary trading and profit making concern.
Judgment
The Court held that the surplus, miscalled profit, arising to the assessee company from the miscellaneous insurance transactions of mutual character was not assessable under the Indian Income-tax Act and that, in any event, the assessee was entitled to deduct the reserves within the meaning of Section 2 (6C) read with Rule 6 of the Schedule of the Indian Income-tax Act. The first issue was thus answered in the negative leading the second to be in favor of the assessee by justifying the deduction of reserve.
Ratio decidendi:
Issue I
The net result of Section 2 (6C) (vii) and Section 10(7) of the Income-tax Act is that they make profits and gains of any business of insurance taxable in accordance with the rules contained in the Schedule to the Act, the former making special and particular reference to mutual insurance and the latter making reference to any business of insurance. There are nine relevant rules in the Schedule titled “Rules for the computation of the profits and gains of insurance business” which are based on four broad classifications inclusive of mutual insurance society. The essential characteristics of a mutual insurance company, expressly provided in Section 95(1) (a) of the Insurance Act, are (1) that it has no share capital and (2) of which by its constitution only all policy-holders are members. These two tests are satisfied by the present assessee and is hence a mutual insurance company.
The assessee is a company limited by guarantee and has no share capital. Its only source of revenue and income is the subscriptions of the members. S. 27 of the Companies Act (prior to 1956) appears to underline the principle that ordinary profit making is not permissible in such a company and the only kind of divisible profits available are such that the member qua member could receive. Indeed, any attempt or device to override that limitation was avoided by law and the express statutory provision.
The reliance made by the Tribunal on the Bombay HC[3] is erroneous as it is distinguishable from the facts of the present case as in that matter, it was a life insurance company where different rules are applicable and the clauses in the Memorandum of Objects and the Articles of Association of the assessee in both cases are also distinctive.
That the contention of counsel for the assessee is based on the Report of the Income-tax Investigation Commission and the legislative history relating to attempted taxation of mutual insurance societies in India which made observations in this regard after referring to numerous judicial pronouncements. It remarked that that Rule 9 of the Schedule is not a charging provision and merely prescribes the method of computation. The charge must be derived by implication from the definition of ‘income’ but that definition only brings in ‘profits’ of the mutual insurance business. The definition is based on the assumption that the surplus can be regarded as profits in such a case which is criticised by the House of Lords in its latest decision, simply because surplus and profit are distinct[4].
It was submitted by the assessee’s counsel that the past and the future Indian law in the last ten years serves to indicate that it was not intended to include surplus of mutual insurance companies as coming within the charge of income-tax. It is paramount to note that the real nature of the so called profit is not so much profit but a return of their own money contributed but not required ultimately. That the company is an entirely separate legal entity and that the members are distinct and apart from such legal entity but in a mutual insurance society with no share capital and with no members other than the policy-holders, the situation is different and the legal notion of the separate juristic entity of a company is not enough to override the complete identity between the Corporation and the corporators.
The Court further stated that in this case, there is no distinction between the insurer and the insured because the company and its members are one and the same from the point of view of taxing purposes invalidating the contention based on the assumption that the profits do not go back to the insurer, that is the members in this case.
Moreover, the Court acknowledged the applicability and similarities between the Style’s case[5] and present case as Clause 4 of AoA co-exists with the object of granting benefit back to the members by way of rebate or return of subscriptions in accordance with the regulations of the Association. It clearly shows that the benefit is and can be returnable.
The reliance on articles of association by the tax authorities do not hold ground as the nature of profit mentioned in Articles 17, 18, 19 and 72(3) is nothing more than surplus. The reserve fund and depreciation fund are always made from such profits which, in this case, are really of the nature of surplus. The records show that this so-called profits are not the trading profits but is entirely the excess of the subscriptions paid by the members and not utilized or eaten up by expenses.
Moreover, the question of nature of assessee as a mutual insurance society cannot be reopened as it has been an undisputed fact in the Tribunal’s order. That the principles of mutual insurance rest on certain basic assumptions[6] and the court was satisfied that the assessee meets the tests in the present Reference which makes them entitled to claim the exemption from tax liability on the ground of mutual insurance.
The law that mutual insurance companies do not make profit but have surplus which are not taxable profits within the meaning of the Income-tax Act is based on the fundamental principle of more general application that one cannot earn profit by trading with oneself and therefore the transaction relied upon by the department is not a transaction which was capable of resulting in any profits. The mutual insurance society is a closed society which by the combined operation of statutory provisions of, Section 95(1) (a) of the Insurance Act and Section 27 of the Companies Act, is confined only to policy-holder-members with no share capital and with bar against profit-making as such members of the mutual insurance society.
From the above observations, it is held that the so-called profit of the assessee in this reference is really surplus from miscellaneous mutual insurance business and such surplus cannot be brought in as taxable profits within the meaning of the Indian Income-tax Act in spite of Section 2 (6C) read with Section 10 (7) of the Income-tax Act.
Issue II
According to the Court, Section 2 (6C) of the Income-tax Act means by the use of the word ‘profits’ only trading profits and not the technical ‘surplus’ of a mutual insurance association. In the present case, Rule 6 of the Schedule is the governing rule as it applies to business of insurance ‘other than life insurance’ and it significantly omits the use of word ‘surplus’.
The Appellate Assistant Commissioner had disallowed the reserves by pointing out the claims made for reserve for un-expired risks are not formally within the form of reserves allowable in the schedule. However, the words ‘Additional reserve if any’ are unqualified and may not be confined only to reserve for unexpired risks and both contingency reserves and general reserves may reasonably come under the ordinary meaning of the word ‘additional reserve, if any’ as used in Form F of the third schedule of Insurance Act. Besides, a part of the reserve may be also for the unexpired 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.
The Court observed that it is usual for a mutual insurance society to keep a reserve and keeping the ‘surplus’ in reserve does not convert ‘surplus’ into taxable profits. It was not the intention of the company to make a profit but to afford the maximum benefits at minimum cost to members and to prepare a modest reserve so that benefits can be, maintained even in the event of an adverse claim experienced in later years’.
A clear reading of Rule 6 points out those reserves are not mentioned and hence not specifically excluded under Section 10 of the Income-tax Act. For adjusting the balance, only deductions permissible under Section are excluded. For the same reasons, reserve is not expenditure within the meaning of Rule 6 and thus, the reserves could not be disallowed by the Income-tax Officer.
Principles discussed
- In a mutual concern the so called profits payable to or receivable by the members were really “Surplus” and not taxable and they mean that the members are merely participating in the surplus funds subscribed and provided by them.
- No one can trade with oneself and earn profit.
Edited by Parul Soni
Approved & Published – Sakshi Raje
Reference
[1] Bombay Mutual Life Assurance Society Ltd. v. Commissioner of Income-tax, Bombay City, (1951) 20 ITR 189.
[2]Municipal Mutual Insurance Ltd. v. Hill, (1932) 16 Tax Cas 430
[3]Supra note 1.
[4]New York Life Insurance Co, v. Styles, (1889) 14 A. C. 381
[5]Id.
[6]English and Scottish Joint Co-operative Wholesale Society Ltd. v. Commissioner of Agricultural I. T., (1948) 16 ITR 270 (PC) (Lord Normand)
