Doctrine Of Mutuality – The Never-Ending Saga

Background and Evolution of the Doctrine of Mutuality Controversy:

The controversy surrounding the taxability of transactions between clubs or associations and their members is long-standing. It has engaged courts for over half a century and remains ongoing.

In the case of The Joint Commercial Tax Officer vs Young Men's Indian Association, Madras and Others¹ in the context of sales tax under the Madras General Sales Tax Act, 1959, it was held that sales tax is not leviable on refreshments, beverages and other preparations by the club to its members. It was held that:

• There is no transfer of property from one to another.
• If the club, even though a distinct legal entity, is only acting as an agent for its members in the matter of supply of various preparations to them no sale would be involved as the element of transfer would be completely absent.

In other words, sale by an unincorporated club or association of persons to its members is not taxable as such the club or association, in law, has no separate existence from that of the members. This reasoning crystallised into what is now known as the doctrine of mutuality, founded on the principle that one cannot transact with oneself and, therefore, no sale can arise between a club and its members.

In order to curb the tax leakage, by way of The Constitution (Forty-Sixth Amendment) Act, 1982, Article 366 of the Constitution of India was amended to incorporate Clause 29-A "tax on the sale or purchase of goods" to include a tax on the supply of goods by any unincorporated association or body of persons to a member thereof for cash, deferred payment or other valuable consideration.

The matter again travelled up to the Supreme Court in the case of State of West Bengal & Ors. vs Calcutta Club Limited² wherein the judgment covered two aspects:

1. leviability of sales tax on supply of food and drinks by a member club to its members; and
2. leviability of service tax on the services provided by a member club to its members.

Regarding the leviability of sales tax, the Supreme Court held that there cannot be a sale transaction between an incorporated and unincorporated members club and its members. The Court further observed that the Young Men's Indian Association judgment which applied the doctrine of mutuality continues to hold even after the 46th Amendment adding Article 366(29-A) to the Constitution of India.

Regarding the leviability of service tax, the Court restricted its ruling stating that from 2005 onwards, service tax is not leviable on services provided by incorporated member clubs to their members.

GST law and the Amendment

Considering the aforesaid rulings, the Government made a retrospective amendment to the scope of levy by inserting sub-clause (aa) to Section 7(1) of the Central Goods and Services Tax Act, 2017 ('the GST Act') vide Section 108 of the Finance Act, 2021, specifying that:

The objective behind inserting this provision was to levy GST on supplies by an association or body of persons (whether incorporated or not) to its members by statutorily overcoming the doctrine of mutuality and the judicial precedents on the subject matter.

As per the amendment, the following are the attributes that are required to be fulfilled to qualify as a supply under Section 7(1)(aa) of the GST Act:

• There must be an activity or a transaction.
• It must be between a person (other than individual) to its members or constituents or vice versa.
• It must be for a consideration.

The terms 'member' and 'constituents' are not defined. In common parlance, a 'member' denotes a person belonging to a group, while 'constituents' refers to elements or components forming part of a group or entity.

Probable Unintended Consequences of the Amendment

At first glance, the language employed is strikingly wide. Firstly, the provision does not expressly require an underlying supply of goods or services. Secondly, the fundamental requirement that the activity must be undertaken 'in the course or furtherance of business' is entirely absent. Read literally, it appears capable of covering virtually all activities and transactions between an entity and its members, including transactions that may not otherwise qualify as goods or services under the GST framework, such as a company paying dividends to shareholders, contribution of capital or additional capital by a partner to a partnership firm or LLP, share of profits by a partnership or an LLP to its partners, and so on.

The language appears problematic and likely unintended, as it marks a significant departure from the foundational architecture of GST, which is premised on taxing supplies of goods and services made in the course or furtherance of business, and is ultra vires the Constitutional mandate. An overzealous interpretation by authorities could lead to unnecessary disputes. For instance, if Section 7(1)(aa) is read together with Section 7(2)(a) of the GST Act, which provides that activities in Schedule III are neither a supply of goods nor services, one might allege that transactions listed in Schedule III, though excluded under Section 7(1), could still be brought under the ambit of Section 7(1)(aa). Such a strained interpretation could create avoidable complications.

Should a tax authority adopt such a theoretically aggressive interpretation, it would be highly susceptible to constitutional scrutiny on inter alia the following grounds:

• Article 366(12A) of the Constitution of India defines GST as a tax on the 'supply of goods or services or both'.
• Article 246A of the Constitution of India empowers Parliament and State Legislatures to legislate on GST only in respect of goods and services.
• The Statement of Objects and Reasons to the Constitution (One Hundred and First Amendment) Act, 2016, makes it clear that GST is fundamentally a tax on the supply of goods and services.

Accordingly, transactions that do not involve the supply of goods or services, or which are not undertaken in the course or furtherance of business, cannot be brought within the GST net merely by invoking the deeming fiction under Section 7(1)(aa).

It is noteworthy that the draft provision proposed before the GST Council was:

However, for reasons that remain unclear, the language eventually enacted departed materially from the draft and resulted in the present formulation.

Recent Judicial Development:

The Division Bench of the Kerala High Court³ declared Section 7(1)(aa), and the Explanation thereto, unconstitutional and void, being ultra vires Articles 246A, 366(12A), and 265 of the Constitution of India. The decision proceeds on the basis that GST, by constitutional design, is a tax on goods and services, and that the deeming fiction in Section 7(1)(aa) impermissibly travels beyond this constitutional contour. The judgment has been appealed and the matter is presently pending before the Supreme Court⁴. The constitutional validity of Section 7(1)(aa) has also been challenged before the Punjab & Haryana High Court5..

Way Forward:

From a practical perspective, this raises several important considerations for taxpayers. In respect of past periods where GST has already been discharged on transactions involving members, taxpayers will need to assess whether refund claims should be pursued, keeping in mind the applicable limitation periods and the doctrine of unjust enrichment. Where the tax burden has been passed on to members, refund claims may encounter significant legal and procedural challenges, and one could evaluate whether an undertaking to refund the GST to members could overcome the doctrine of unjust enrichment.

For ongoing and future transactions, a conservative approach may justify the continued payment of GST until the Supreme Court conclusively settles the issue, particularly considering that it may be difficult to recover tax with interest from members in the future. However, this approach presents a strategic dilemma. If the levy is ultimately declared unconstitutional, recovery of GST from members at present may subsequently operate as a bar to refunds on account of unjust enrichment. However, the members can consider claiming refund of GST paid if the quantum is significant. One also needs to consider that at present, since GST is being discharged, credits are also available. If a view on non-applicability of GST is taken, credits cannot be availed, and therefore, the better view is to discharge GST, albeit under protest, reserving the right to claim refund.

The ramifications are not confined to traditional clubs and societies. Other association of person arrangements, such as cost-sharing mechanisms within corporate groups where multiple entities contribute towards joint advertisements or common facilities, will also need to be examined against the established tests of mutuality. One could evaluate an AOP structure based on the principles of mutuality within a group for sharing common costs, specifically, where GST credit is not available.

The final word on the scope and constitutional validity of Section 7(1)(aa) will ultimately rest with the Supreme Court. If the Supreme Court finally decides against the levy of GST based on the principle of mutuality, the Government may have limited discretion to introduce any further amendments to make the transaction taxable. Hence, any proposed structure or discontinuation of GST payments may have to wait till the Hon'ble Supreme Court gives a final verdict on the subject matter. In the meantime, GST should be paid under protest, reserving the right to claim a refund, and refund claims should be filed promptly.

Footnotes

1. W. P. No. 129, 130, & 181 of 1960

2. Civil Appeal No. 7497 of 2012

3. Indian Medical Association, Kerala vs UOI & Others [No.- W. A. No. 1659 of 2024]

4. UOI and Ors. vs Indian Medical Association and Anr. [SLP(C) Nos. 18349-18350/2025]

5. Huda Urban Estate and Town and Country Planning Employees Welfare Organization vs UOI & Others [No.- CWP-8065-2024]

Originally published by Taxsutra.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.