Transactions Between Clubs and Their Members: An Analysis Through the Lens of the Principle of Mutuality

Introduction

The taxation of transactions between clubs and their members has long been a contentious issue, repeatedly surfacing in litigation. This controversy has not abated under the goods and services tax (GST) regime, where similar complexities continue to arise. To fully grasp the treatment of clubs under GST, it is essential to revisit the foundational principles rooted in the earlier service tax and sales tax frameworks. Historically, Revenue Authorities motivated by the need to broaden the tax base and curb evasion have sought to impose tax even on those transactions not traditionally considered “sales”. One such area is the supply of goods or services by clubs, whether incorporated or not, to their own members for a consideration. Such attempts to tax intra-club transactions have often been met with legal resistance, with clubs asserting the principle of mutuality as a defence.

This proposition that a club and its members form a single entity, has been central to numerous judicial interpretations and has significantly influenced the legal outcomes surrounding club taxation. This article explores the evolution of this principle through key judicial decisions, examines the legislative response to those rulings, analyses the current legal position in light of amendments under the GST law and the Kerala High Court judgment invalidating the same.

Principle of mutuality and its judicial recognition

At its core, the principle of mutuality posits that no individual or entity can trade with oneself, where the supplier and recipient are the same, no taxable transaction arises. Clubs have argued that due to the complete identity between members and the club itself, there is no existence of two distinct persons, a fundamental requirement for the levy of tax. In simpler terms, as per the principle of mutuality, no one can make a profit out of himself. Since the existence of two distinct persons is a necessary condition for the imposition of tax, clubs have consistently maintained that they fall outside the scope of taxation.

One of the landmark judgments that clearly distinguished on this principle and its application on transactions involving clubs or association or societies and their members was CTO v. Young Men’s Indian Assn.¹ The central legal issue was whether the supply of refreshments, food, and beverages by these members — only clubs and associations to their own members — constituted a “sale” within the meaning of Section 2(n), Madras General Sales Tax Act, 1959, and whether these institutions could be treated as “dealers” under Section 2(g), Madras General Sales Tax Act, 1959 (the Act), thereby making them liable to pay sales tax on such supplies. The Court while dismissing the appeal and upholding the principle of mutuality held that that for a transaction to be a sale, there must be a transfer of property in goods from one distinct person to another. In the case of members’ clubs, this essential requirement was lacking because the club and its members were not two separate legal entities in the context of the supplies. The club merely acted as an agent or mandatory of its members in procuring and supplying goods. The money paid by the members was a reimbursement of expenses and not a consideration in a commercial sale. Therefore, there was no “sale” in the legal sense, and as a result, no sales tax could be levied.

The principle of mutuality was also explained and dealt in great detail by the Supreme Court in Bangalore Club v. CWT², wherein the Court held that the doctrine of mutuality has been broadened to encompass groups of individuals who pool resources into a collective fund, managed by the group itself, to serve a shared purpose. Any excess funds remaining after fulfilling the common objective are regarded merely as an augmentation of the shared pool and, therefore, are not treated as income or subject to tax.

The amendment of Article 366

Now as per this mutuality principle, clubs or association or societies would not be under the ambit of taxation when they transact with their members. Under Chapter 1-D of the 61st Law Commission Report the issue of sale by associations to its members was discussed. The chapter considers a question as to whether taxability of such transaction should be provided by expanding the concept of “sale” under the Indian Constitution. The commission notes that it would not be appropriate to do so as there is no serious question of evasion and a member takes his own good. However, the legislature with the intention to include such similar transactions as taxable event went on to make amendments in the law to implement the same. A new article in the form of Article 366(29-A) has been introduced under the 46th Constitutional Amendment Act, 1982, to lay down the meaning of the expression ”tax on sale or purchase of goods”, wherein six instances of sale which are not normally understood as sale are brought in. One of the such entries, deals with, a tax on supply of goods by an unincorporated association or body of persons to a member thereof for cash, deferred payment or other valuable consideration. The relevant portion of Article 366(29-A) read as follows:

(29-A) “tax on the sale or purchase of goods” includes—

(e) 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 Calcutta Club judgment

Post this amendment, the question came back again to the Supreme Court in State of W.B. v. Calcutta Club Ltd.³, that whether a club, acting as an agent to its members, supplying foods and beverages would be liable to pay sales tax in light of the 46th Amendment or not. Basic facts of the case are that the Assistant Commissioner of Commercial Taxes issued a notice to the respondent Club for non-payment of sales tax on food and drink supplied to its permanent members. The Club contended before the Tribunal that it was not a “dealer” under the Act, as there was no sale involved, invoking the principle of mutuality. The Tribunal ruled in its favour, and the High Court upheld the decision. The matter was then appealed to the Supreme Court and the primary three questions were referred to a larger Bench.

The larger Bench, after analysing several authorities including Graff v. Evans⁴, Trebanog Working Men’s Club and Institute Ltd. v. Macdonald⁵, the 61st Law Commission Report, the 46th Constitutional Amendment, Young Men’s Indian Assn.⁶, and Enfield India Ltd. Coop. Canteen Ltd.⁷, concluded that the 46th Amendment aimed to cover sales by unincorporated clubs to their members not those by incorporated entities. This conclusion is grounded in the language of Article 366(29-A)(e), which refers specifically to supplies by “unincorporated associations or bodies of persons”, thereby excluding incorporated clubs.

Additionally, the Bench pointed out that the 46th Amendment failed to fully address the legal principles established in the case of Young Men’s Indian Assn.⁸ It opined that the amendment was based on a limited interpretation and that the framers were incorrect in assuming that sales by incorporated clubs to their members could be taxed. As a result, such clubs fall outside the purview of Article 366(29-A)(e). Reaffirming the earlier legal position regarding unincorporated clubs, the Bench noted that the definition of “consideration” under the Contract Act, 1872 implies a transaction between two distinct parties. Since Young Men’s Indian Assn. case established that, due to the doctrine of mutuality, a club and its members are not separate entities, there can be no sale from the club to itself. Consequently, the limited legal fiction introduced by Article 366(29-A)(e) does not nullify the principle laid down in the case of Young Men’s Indian Assn.

The larger Bench in the case of Calcutta Club⁹ was also tasked with deciding the applicability of service tax in case of provision of services by Clubs to its members. The Supreme Court in its detailed analysis reaffirmed the applicability of the doctrine of mutuality to both incorporated and unincorporated members’ clubs in the context of service tax. It held that for service tax to be attracted under the Finance Act, 1994, there must be a provision of service by one person to another for consideration. However, in the case of members’ clubs, the club and its members are not distinct legal persons; instead, they form a single entity acting collectively for mutual benefit. The incorporation of a club does not alter this fundamental nature, especially where such clubs operate on a non-profit basis, do not declare dividends, and any surplus generated is retained within the organisation to further its objects. The Court rejected the contention that incorporation alone is sufficient to establish the distinct identity necessary for a taxable service transaction.

The Court also examined the statutory framework and concluded that until 2012, the Finance Act did not define “person” to include members’ clubs. The term “club or association” was also not wide enough to cover incorporated clubs providing services to their own members. Even after the introduction of the negative list regime in 2012, services by clubs to their members remained excluded under Section 66-D, Entry 28, until the entry was removed in 2016. Hence, both under the pre-2012 regime and the negative list regime post-2012, members’ clubs could not be subjected to service tax for services rendered to their own members. The Court emphasised that there is no supply of services in such cases, as there is no legal distinction between the supplier and the recipient. It rejected the argument that such clubs could be brought within the tax net by construing them as agents or trustees of their members.

The judgment clarified that departmental circulars and contrary interpretations cannot override the constitutional doctrine of mutuality or the express provisions of the Finance Act. The Court further observed that the extended definition of “sale” under Article 366(29-A) of the Constitution, which deems certain supplies by unincorporated bodies to their members as sales, does not apply to incorporated clubs and does not affect the principle of mutuality. Consequently, the Court upheld the decision in Ranchi Club Ltd. v. CCE & ST¹⁰ where it was established that a fundamental element common to both sale and service transactions is the presence of two distinct parties. Given that the Supreme Court had already examined and ruled on whether a members’ club constitutes two separate legal entities in the Young Men’s Indian Assn. case¹¹, it was concluded that, due to the principle of mutuality and the nature of the club’s functions, any service rendered by the club to its members could not be treated as a service between two separate parties. This is because the essential requirement of there being two distinct legal entities was absent in such a scenario.

The issue under the GST

Section 7, Central Goods and Services Tax Act, 2017 (CGST Act) outlines the definition of “supply” under GST. According to this section, supply encompasses various transactions involving goods or services or both such as sale, transfer, barter, exchange, licence, rental, lease, or disposal provided these are carried out for consideration by a person during the course or in furtherance of business. Under Section 7 CGST Act, imported services for consideration are considered supply, even for personal use. Schedule I includes supplies without consideration, while Section 7(2) and Schedule III list activities excluded from GST.

An amendment was made in Section 7 via the Finance Act, 2021, through which Section 7(1)(aa) was inserted and was given retrospective operation from 1-7-2017. This provision states that any activity or transaction conducted by a person (other than an individual) to its members or constituents, or vice versa, in exchange for cash, deferred payment, or any other valuable consideration, shall be treated as a supply. The explanation to the clause further provides that, irrespective of any contrary provision in any prevailing law or judicial pronouncement, the person and its members or constituents shall be treated as distinct and separate persons. Consequently, any transaction or activity between them shall be deemed a supply from one person to another, thereby attracting GST liability. Therefore, in accordance with this amendment any club/association/societies would be liable to pay GST on any transaction that takes place between them and their members. This stance of the law is quite the contrary of the principle of mutuality that has been upheld by Indian courts in abovementioned several judgments

View of Kerala High Court

The constitutionality of Section 7(1)(aa) CGST Act was under test in the recent judgment of the Kerala High Court in Indian Medical Assn. v. Union of India¹² wherein, the petitioner operates multiple mutual assistance schemes intended to benefit the participating members or their close family members, for example, Social Security Schemes or SSS (I, II and III), Professional Disability Support Scheme (PDSS), Professional Protection Scheme, Kerala Health Scheme, etc. Members contribute through various fees, and in the event of death or disability, a pooled fund is disbursed to the member or their dependents. These schemes maintain individual bank accounts, and their financial records are prepared and audited separately. The petitioner did not charge GST on member contributions, relying on the principle of mutuality. On the other hand, the Directorate General of GST Intelligence took actions to recover GST on the said schemes.

While examining the framework of GST, the Court in the Ranchi Club Ltd. judgment¹³ emphasised that a valid supply transaction necessitates the presence of two distinct parties, a service provider and a service recipient. It further noted that the constitutional scheme of GST presupposes the existence of at least two separate persons before a transaction can be classified as a “supply” or “service” liable to tax. In essence, the Constitution does not recognise the concept of self-supply or self-service for the purpose of taxation under GST.

The Court furthermore observed that the term “supply” used in Article 246-A has not been accorded any artificial or expanded definition that would encompass even a “deemed supply”. Historically, when the Constitution was amended by the 46th Amendment Act in 1982 to bring within the ambit of sales tax certain transactions that did not align with the traditional notion of a sale, it explicitly introduced a deeming fiction. Through Article 366(29-A), specific transactions such as the supply of goods by an incorporated association or body of persons to its members for consideration were constitutionally deemed to be a “sale” or “purchase” of goods. In contrast, the recent amendment to the CGST/SGST Acts merely broadens the definition of “supply” to include activities or transactions between a person (other than an individual) and its members or constituents for consideration. Crucially, this change does not deem such transactions to be a “service”, nor has the statutory definition of “service” itself been altered to incorporate such exchanges.

The Court held that when a term or concept used in the Constitution has been interpreted by the Supreme Court in a specific manner, a legislative body whose authority to enact laws stems from the Constitution, cannot assign a contradictory meaning to that term or concept within a statute. This principle is particularly significant because the interpretation given in the constitutional context governs the very scope of the legislature’s competence to legislate on matters related to that term or concept. Therefore, although the recent amendments to the CGST/SGST Acts introduce a deemed “supply” in cases involving transactions between a club or association and its members, it is important to note that there is no corresponding deeming provision treating such transactions as a “service”, as the definition of “service” under the law remains unchanged.

Since the notions of “supply” and “service” have been judicially construed to require the existence of two distinct persons, i.e. a provider and a recipient and the Supreme Court, in the case of Calcutta Club¹⁴, affirmed that the principle of mutuality remains intact even after the 46th Constitutional Amendment, any legislative attempt to override this understanding must align with constitutional mandates. Therefore, as long as this judgment remains authoritative and the Constitution is not expressly amended to eliminate the concept of mutuality from the definitions of supply and service, the contested amendment to the CGST/SGST Acts is likely to fail the test of constitutionality. In conclusion, the provisions of Sections 2(17)(e) and 7(1)(aa) and the explanation thereto of the CGST Act, 2017 and the provisions of Sections 2(17)(e) and 7(1)(aa) and the explanation thereto of the Kerala Goods and Services Tax Act, (KGST Act) are declared as unconstitutional and void being ultra vires the provisions of Article 246-A read with Articles 366(12-A) and 265 of the Constitution of India.

Conclusion

The principle of mutuality has increasingly become a contentious issue, reflecting a growing conflict between judicial interpretation and legislative intent. On one hand, the judiciary, most notably through the Calcutta Club¹⁵ case decision, has reinforced the application of mutuality and has effectively protected transactions between clubs and their members from tax liability. On the other hand, the legislature has taken deliberate measures to bring such transactions within the scope of taxation by introducing specific amendments intended to override the mutuality principle.

Prior to the implementation of the GST regime, disputes primarily centered around whether sales tax and service tax could apply to such transactions. In response, the legislature even attempted to amend Article 366 of the Constitution to include transactions by clubs or associations within the definition of a taxable supply. However, the Supreme Court in the case of Calcutta Club¹⁶ upheld that the principle of mutuality excludes the possibility of treating such transactions as taxable, as there is no involvement of two distinct legal entities.

In the context of GST, the Finance Act of 2021 introduced an amendment that altered the definition of ”supply” to include activities between clubs and their members. This legislative action was later held unconstitutional by the Kerala High Court, which reaffirmed the judiciary’s consistent support for the doctrine of mutuality. Therefore, if the legislature intends to lawfully include such transactions under the GST framework, it must first amend the Constitution, followed by appropriate modifications to the GST law, in order to resolve the existing legal ambiguity.