YUM! restaurants is not liable for Income tax exemption, absence of mutuality & non-adherence to terms of SIA approval: SC

The SC on April 24, 2020 {Yum! Restaurants (Marketing) Private Limited v Commissioner of Income Tax, Delhi} held that  there are 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.

It was further observed by the SC Bench, comprising of Justice A.M. Khanwilkar  &  Justice Dinesh Maheshwari, that the principle of common identity prohibits any one­-dimensional alteration in the nature of participation in the mutual fund as the transaction fructifies. It was held that any such alteration would lead to the non-­uniform participation of an external element or entity in the transaction, thereby opening the scope for a manifest or latent profit­-based 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.

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 non-profit basis on the principles   of   mutuality.

It was held by the SC that 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 was held that it must manifest uniformity in the class of participants in the transaction. It was held that the moment such a transaction opens itself to non-­members, either in the contribution or the surplus,   the   uniformity   of   identity   is   impaired   and   the transaction assumes the taint of a commercial transaction.

It was held by the SC that in the present case, it is indisputable that Pepsi Foods Ltd. is a contributor to the common pool of funds. It was observed, 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. It was further held by the SC that 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.

The moot   question involved in   the present appeal before the SC 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.

This   appeal before the SC assailed   the   final judgment passed by the High Court of Delhi at New Delhi 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 2001-­02, was settled in favour   of   the   Revenue   and   against   the   assessee,   thereby confirming the orders of the Income Tax Appellate Tribunal, Commissioner of Income Tax (Appeals)  and   the   Assessing   Officer.   The   preceding forums, without any exception, have returned consistent verdicts refusing   to   acknowledge   the   assessee   company   as   a   mutual concern and denying any exemption from taxability.

That the following questions of law arose for consideration in the present case before the SC:

(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?

It was held by the SC that  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. It was held that this would be nothing short of derivation of gains/profits out of inputs supplied by others.  It was observed that cannot be countenanced as being violative of the basic   essence   of   mutuality.  It was held that the   doctrine   of   mutuality,   in principle, entails that there should not be any profit earning motive, either directly or indirectly. It was further held that the third test of mutuality,   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.

It was further held by the SC that 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. It was observed that the clause provides that the assessee company may refund the surplus subject to the approval   of   its   Board   of   Directors.   It was held that it  implies   that   the franchisees/contributors   cannot   claim   a   refund   of   their remaining amount as a matter of right. It was observed 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.  It was held thus, the fulfilment of this condition becomes essential. In the present   case, it was held that 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 non-­negotiable, irrespective of whether any funds are surplus in the previous year. It was held that 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.

It was held that the doctrine of mutuality bestows a special status to qualify for exemption from tax liability. It was held that it is a settled proposition of law that   exemptions   are   to   be   put   to   strict   interpretation. It was held that 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. It was held that taking any other view would entail in stretching the limits of construction.

It was held that 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.

It was held by the SC that the questions posed for consideration   stand   answered   against   the   appellant   (assessee company) and in favour of the Revenue and the appeal stands disposed of upholding the impugned judgment.