General Anti-Avoidance Rule (GAAR) and Tax Treaties

GAAR (General Anti-Avoidance Rule) is a set of rules that allows a tax authority to deny tax benefits from arrangements that are technically legal but are primarily designed to obtain an impermissible tax advantage. GAAR can also be relevant where an arrangement involves a tax treaty.

For example, a taxpayer may attempt to structure an arrangement through a particular jurisdiction mainly to obtain treaty benefits.

However, treaty benefits are not automatically denied merely because a treaty route is used. The relevant GAAR conditions and applicable provisions have to be examined.

In India, Chapter XI of the Income Tax Act, 2025 contains GAAR provisions. Broadly, an arrangement can be treated as an impermissible avoidance arrangement (IAA) where its main purpose is obtaining a tax benefit and it also satisfies specified conditions, such as creating rights or obligations that are not ordinarily created between independent parties, lacking commercial substance, or being carried out in an improper or abusive manner.

Indian law expressly provides that GAAR can apply to an arrangement even if the arrangement is permissible under a tax treaty, subject to the statutory framework and applicable safeguards.

EXAMPLE

Suppose :

Indian Company → Shell Company in Country B → Investment in Country C

Country B has a favourable treaty with India, so the intermediary company claims a reduced withholding-tax rate. If the Country B company :

§  has no meaningful employees or operations,

§  exists primarily to obtain the treaty rate,

§  immediately passes the income to another jurisdiction, and

§  has little or no commercial justification,

Indian tax authorities may examine whether the structure is an impermissible avoidance arrangement and potentially deny the treaty benefit under GAAR.

 GAAR and treaty benefits

 GAAR becomes particularly important in international taxation. Consider :

India → Foreign subsidiary → Treaty jurisdiction → Investor

Suppose an investor routes an investment through a treaty jurisdiction primarily to obtain a treaty benefit, despite having no meaningful commercial connection with that jurisdiction. The question becomes whether the treaty structure is genuine or merely an artificial arrangement. GAAR therefore interacts with :

§  Double Taxation Avoidance Agreements (DTAAs);

§  treaty-shopping concerns;

§  Limitation of Benefits (LoB) provisions;

§  beneficial ownership concepts;

§  Specific Anti-Avoidance Rules.

Core Concept 

§  TAX TREATIES : Bilateral or multilateral agreements designed to prevent double taxation, promote cross-border trade, and allocate taxing rights between Contracting States.

§  GAAR : A broad, principle-based statutory framework empowering tax authorities to look past the legal form of a transaction, identify lack of commercial substance or artificiality, and recharacterize or deny tax benefits.

GAAR can override tax treaties (DTAA)

The General Anti-Avoidance Rule (GAAR) contains non-obstante provisions that allow tax authorities to override beneficial treaty provisions {Double Taxation Avoidance Agreement (DTAA)} if an arrangement is classified as an impermissible avoidance agreement designed primarily to exploit treaty shopping

Statutory Subordination

Section 159(6) of the Income Tax Act, 2025, explicitly states that the provisions of Chapter XI (containing GAAR : Treaty Override Rider) apply even if they are inconsistent with or less beneficial than a DTAA.

Section 159(6) of the Income Tax Act, 12025 states, “Irrespective of  anything contained in sub-section (4), the provisions of Chapter XI of the Act shall apply to the assessee even if such provisions are not beneficial to him.”

In other words, this sub-section (6) in section 159, suggests that in case of an inconsistency between the DTAA and the provisions of Chapter XI, containing GAAR provisions, the statute shall override the treaty. Consequently, the assessee may be denied tax benefits of the DTAA.

NOTE

Section 159(4) preserves the beneficial treaty rule, while section 159(6) provides that the provisions of Chapter XI shall apply notwithstanding section 159(4). Thus, Parliament has expressly recognised the overriding operation of GAAR where the substantive requirements of Chapter XI are satisfied.

However, section 159(6) does not provide that every treaty anti-avoidance provision, including an LOB clause, shall stand displaced whenever a taxpayer derives a tax benefit under a DTAA. It establishes the relationship between the treaty-benefit rule in section 159(4) and Chapter XI; it does not dispense with the substantive statutory conditions prescribed for an “impermissible avoidance arrangement”.

Supreme Court Precedent : The Tiger Global International Holdings Ruling :

The Supreme Court in the case of Authority for Advance Rulings (Income-tax) v. Tiger Global International II Holdings (2026) 485 ITR 214 : 182 taxmann.com 375 (SC) affirmed that GAAR and domestic anti-abuse provisions take precedence over treaty protections and Tax Residency Certificate (TRC) reliance when structures are used primarily for tax avoidance. The key principles emerging from the Supreme Court’s detailed ruling are as below:

§  AAR EMPOWERED TO REJECT APPLICATIONS ON PRIMA FACIE TAX AVOIDANCE GROUNDS : Where an initial examination of the documents indicates that an arrangement is structured for tax avoidance, the AAR is empowered to dismiss the application on grounds of maintainability without adjudicating the matter on its merits.

 

§  TRC IS NECESSARY BUT NOT SUFFICIENT; AUTHORITIES CAN ‘LOOK BEHIND IT’: A TRC is an eligibility document under the Act for claiming DTAA benefits. However, pursuant to the amendments to Section 90 and the introduction of GAAR, a TRC, by itself, does not establish residency or beneficial entitlement. In cases involving potential abuse, including treaty abuse through conduit structures, the IRA may deny DTAA benefits. The same principle would apply even to shares that are grandfathered. Circulars issued by the CBDT prior to the introduction of GAAR would not hold good in the post-GAAR environment. 

§  GAAR OVERRIDES DTAA – FOCUSES ON TAX BENEFITS, NOT INVESTMENT TIMING: GAAR applies to any arrangement that yields a tax benefit on or after April 1, 2017, even if the underlying investment predates that date. Grandfathering under the DTAA safeguards genuine investments but does not protect abusive structures. Rule 10U of the Income-tax Rules, 1962, ensures that the scrutiny focuses on the arrangement producing the tax benefit rather than on the timing of the investment.

§  DOMESTIC SOURCE RULE CONTROLS INDIRECT TRANSFERS IN ABUSE CASES: The indirect transfer provisions under Section 9 of the Act, which seek to tax transactions where the underlying value is derived from Indian assets, would have primacy over DTAA relief where anti-abuse provisions apply.

§  EFFECTIVE MANAGEMENT DETERMINES COMPANY’S RESIDENCY: If the real control and decision-making of a company occur outside the country in which it claims to be resident, entitlement to treaty benefits may fail. The Supreme Court has emphasised that mere incorporation or formal compliance cannot substitute for genuine residence.

 

§  BURDEN OF PROOF ON THE TAXPAYER TO NEGATE AN IMPERMISSIBLE AVOIDANCE ARRANGEMENT : The Supreme Court reiterated that, under the GAAR provisions, an Impermissible Avoidance Arrangement may be presumed where the facts indicate that the arrangement was designed to obtain a tax benefit. The taxpayer must rebut such presumption with strong evidence demonstrating a bona fide commercial purpose.

§  GRANDFATHERING AND LIMITATION OF BENEFITS LIMITED TO DIRECT TRANSFERS: The Supreme Court clarified that Article 13(3A) of the India-Mauritius Double Taxation Avoidance Agreement (DTAA), {Article 13(3A) deals with capital gains from the sale/transfer of shares}, which provides for grandfathering and the related LoB clause, applies only to direct transfers of Indian shares. Indirect transfers fall under the residuary Article 13(4) of the India-Mauritius Double Taxation Avoidance Agreement (DTAA) and, therefore, do not enjoy the protection of the LoB clause or grandfathering provisions.

§  JUDICIAL ANTI-AVOIDANCE RULES (JAAR) EXPOSURE, DESPITE GAAR NON-APPLICABILITY: The Supreme Court clarified that, in respect of certain arrangements, even where it may technically be argued that GAAR does not apply, the provisions relating to JAAR could nevertheless apply.

Revenue may invoke GAAR where there is an independent abuse irrespective of Limitation of Benefits (LoB clause)

The assessee does not submit that satisfaction of LoB immunises an arrangement from all forms of GAAR.

FOR EXAMPLE

If the Revenue establishes that :

(a) the arrangement is a sham or colourable device;

(b) the interposed entity lacks commercial substance;

(c) accommodating parties have been inserted;

(d) artificial steps have been introduced solely to obtain a tax benefit;

(e) the arrangement misuses or abuses the provisions of the Act; or

(f) another statutory condition of an impermissible avoidance arrangement is independently satisfied,

GAAR may remain available notwithstanding satisfaction of the LoB.

Treaty-Level GAAR : The Principal Purpose Test (PPT)

Following BEPS Action 6 and the Multilateral Instrument (MLI), anti-avoidance mechanisms were integrated directly into bilateral tax treaties themselves:

§  Article 29(9) of the OECD Model / MLI Article 7 : Introduces the Principal Purpose Test (PPT).

§  The Standard : Treaty benefits are denied if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of the arrangement or transaction.

§  Exception : Benefits are still granted if establishing that granting the benefit accords with the object and purpose of the relevant provisions of the treaty.

Comparing Domestic GAAR and Treaty-Level PPT 

Attribute	Domestic GAAR	Treaty Principal Purpose Test (PPT)
Source	Domestic income tax legislation.	Bilateral tax treaty / MLI.
Threshold	Often requires “main purpose” plus additional statutory “tainted elements” (e.g., misuse/abuse of law, non-arm's length terms, lack of commercial substance).	“One of the principal purposes” test; lower threshold than pure main purpose.
Consequences	Recharacterization of income, disregard of entities, adjustment of tax liability.	Specific denial of the treaty benefit claimed.
Safeguards	Usually governed by internal administrative panels and threshold limits (e.g., monetary limits).	Subject to Mutual Agreement Procedure (MAP) and international treaty interpretation.

Treaty benefits are not unconditional

A taxpayer may technically qualify for a treaty benefit while using an arrangement that has been deliberately structured to obtain a tax advantage without genuine commercial substance.

Therefore, a treaty must be interpreted and applied in accordance with its object and purpose, and not as an instrument for facilitating artificial arrangements designed solely to escape taxation.

GAAR should be invoked where the facts demonstrate artificiality, abuse, lack of commercial substance, or deliberate manipulation of the treaty framework.

For instance :

Genuine investment structure	Potentially abusive structure
Substantial employees	No employees
Genuine office	Mere registered address
Independent management	Nominee directors
Genuine commercial risks	Risks borne elsewhere
Substantial business activity	Conduit activity
Investment rationale	Treaty benefit as principal motivation
Income retained/reinvested commercially	Immediate pass-through
Long-term commercial presence	Entity created immediately before transaction

 Treaty shopping is a legitimate target of anti-avoidance principles

Suppose an investor from Country A wants to invest in India. Instead of investing directly, it establishes a shell entity in Country B because India has a favourable DTAA with Country B.

The structure becomes : Country A investor → Shell entity in Country B → India

If the Country B entity has no substantial commercial purpose other than accessing the India - Country B treaty, the Revenue can argue that the treaty benefit is being obtained by an entity that was not the genuine economic investor contemplated by the treaty framework. From the Revenue's perspective, allowing such arrangements would:

§  erode India’s tax base;

§  permit non-residents to obtain benefits never intended for them;

§  encourage artificial corporate structures;

§  discriminate against genuine taxpayers who conduct business directly; and

§  undermine the object and effectiveness of domestic tax legislation.

Treaty interpretation should not encourage abuse

Tax treaties should not be interpreted in a manner that facilitates abuse of treaty provisions. A treaty allocates taxing rights between sovereign states. It is not ordinarily intended to enable a person with no genuine economic connection to a treaty jurisdiction to manufacture entitlement to treaty benefits.

Treaty must be interpreted in light of its object, purpose and the need to prevent abusive exploitation of its provisions

This is particularly persuasive in cases involving:

§  treaty shopping;

§  conduit companies;

§  circular transactions;

§  artificial holding structures;

§  round-tripping;

§  shell entities;

§  arrangements lacking commercial substance.

It reflects the balance established under Article 31(1) of the Vienna Convention on the Law of Treaties (VCLT), which dictates that a treaty must be interpreted in good faith, in accordance with the ordinary meaning of its terms in their context, and in the light of its object and purpose.

A DTAA grants treaty benefits; it does not grant immunity from GAAR

A taxpayer cannot claim an unrestricted entitlement to treaty benefits merely by satisfying the formal conditions of a DTAA. Where an arrangement has been deliberately structured to obtain a tax benefit and falls within the statutory definition of an impermissible avoidance arrangement, Chapter XI permits the Revenue to disregard or recharacterise the arrangement in accordance with law. Section 159(4) cannot be invoked as an absolute shield against GAAR, particularly in view of Section 159(6). The availability of treaty protection must therefore be examined in conjunction with the domestic anti-avoidance provisions.

Taxability of Income derived by a trade, professional or similar association from specific services performed for its members [Section 26(2)(d) – Erstwhile Section 28(iii) of the Income Tax Act, 1961]

Income derived by a trade, professional or similar association from specific services performed for its members is taxable as Profits and Gains of Business or Profession under Section 26(2)(d) of the Income-tax Act, 2025, corresponding to Section 28(iii) of the Income-tax Act, 1961.

Section 26(2)(d) of the Income-tax Act, 2025 (formerly Section 28(iii) of the Income-tax Act, 1961) is an anti-avoidance provision that specifically taxes income earned by trade, professional, or similar associations from identifiable services rendered to their members. While the doctrine of mutuality may protect general member contributions in appropriate cases, fees received for specific services are expressly chargeable to tax as business income, with the benefit of deduction for related business expenditure.

Text of Section 26(2)(d) of the Income Tax Act, 2025

The following income shall be chargeable to income-tax under the head “Profits and gains of business or profession”:

(d) income derived by a trade, professional or similar association from specific services performed for its members.

Meaning

This provision taxes income earned by an association from rendering identifiable and specific services exclusively to its members.

Normally, under the principle of mutuality, surplus arising from contributions by members for common purposes is not taxable. However, Section 26(2)(d) creates a statutory exception by specifically taxing receipts from specific services rendered to members. Thus, even if the association is based on mutuality, income from such services becomes taxable.

Purpose of Section 26(2)(d)

The Legislature intended to prevent trade and professional associations from avoiding tax by claiming mutuality when they charge members separately for commercial or professional services.

Examples of such associations include:

§  Chambers of Commerce

§  Trade Associations

§  Bar Associations

§  Medical Associations

§  Chartered Accountants' Associations

§  Builders’ Associations

§  Export Promotion Councils

§  Industry Associations

 Statutory Objective & Principle of Mutuality

The primary purpose of this provision is to create a statutory exception to the Principle of Mutuality:

• General Rule (Mutuality): Under general tax law, mutual organizations (such as clubs or associations) are not taxable on contributions or surpluses derived from members, based on the legal principle that "no one can make a profit out of oneself."
• Statutory Exception: Section 26(2)(d) (Erstwhile Section 28(iii) of the Income Tax Act, 1961) cuts through the doctrine of mutuality. When an association acts in a commercial/business-like manner by offering specialized, targeted services to members for a specific fee or remuneration, that income loses mutual immunity and is brought under the Profits and gains of business or profession tax net.

What are “Specific Services” performed for its members?

These are services rendered individually or specifically for the benefit of particular members and not for the common benefit of all members.

Examples include:

• Certification services
• Arbitration facilities
• Market surveys
• Technical consultancy
• Testing laboratories
• Legal advice
• Publication supplied on payment
• Training programmes conducted for a fee
• Advertisement services
• Exhibition stalls allotted on payment
• Export documentation
• Secretarial assistance
• Data processing services

Income Covered

The following receipts generally fall within Section 26(2)(d):

Receipt	Taxability
Consultancy fees from members	Taxable
Laboratory testing charges	Taxable
Certificate fees	Taxable
Arbitration charges	Taxable
Training programme fees	Taxable
Technical advisory charges	Taxable
Paid publications supplied to members	Taxable
Exhibition stall rent	Taxable

Income Not Covered under Section 26(2)(d)

The following generally do not fall under Section 26(2)(d):

§  Annual membership subscription

§  Entrance fees

§  General contributions

§  Corpus donations

§  Mutual contributions for common purposes

§  Amounts collected for welfare activities

Such receipts may still be governed by the principle of mutuality, subject to judicial principles and the facts of the case.

Essential Conditions for taxation under Section 26(2)(d)

For taxation under Section 26(2)(d), the following conditions should ordinarily exist:

For an income item to fall within the scope of this provision, the following conditions must be satisfied:

1.      Eligible Entity: The entity must be a trade, professional, or similar association (e.g., Chambers of Commerce, Industry Associations, Bar Councils, or Professional Institutes).

2.      Specific Services Rendered and not merely general activities for all members : The service provided must be identifiable, distinct, and specific to particular members requesting it, rather than general administrative or statutory benefits shared equally by the entire membership body.

3.      Quid Pro Quo (Remuneration): The fee, charge, or consideration paid by the member must be directly linked to the specific service performed by the association.

4.      Such income is chargeable under the head Profits and Gains of Business or Profession.

 Examples 1 – Chamber of Commerce

A Chamber of Commerce charges:

• Membership fee – ₹ 10,00,000
• Certificate of Origin fees – ₹ 7,50,000

Tax Treatment:

• Membership fee – Governed by mutuality (subject to facts).
• Certificate fees – Taxable under Section 26(2)(d).

Example 2 – Medical Association

A Medical Association charges doctors:

• Annual subscription – ₹ 15,00,000
• CME programme fee – ₹ 6,00,000
• Laboratory testing fee – ₹ 2,00,000

TAXABILITY:

Receipt	Taxability
Subscription	Generally covered by mutuality (subject to facts)
CME programme fee	Taxable
Laboratory testing fee	Taxable

Example 3 – Builders’ Association

The association receives:

• Membership subscription – ₹ 20,00,000
• Market research reports sold to members – ₹ 5,00,000
• Arbitration charges – ₹ 3,00,000

TAXABILITY:

Only the ₹ 8,00,000 from market research reports and arbitration services is taxable under Section 26(2)(d), subject to allowable business deductions under section 50.

Allowable Deductions

Since the income is assessed under Profits and Gains of Business or Profession, the association may claim expenditure incurred wholly and exclusively for earning such income, subject to the applicable provisions of the Act. Examples include:

§  Salary of technical staff

§  Office expenses

§  Printing costs

§  Depreciation

§  Professional fees

§  Administrative expenses attributable to the taxable activity

The taxable income is the net profit, not the gross receipts.

 

Distinguished between General mutual contributions & Income from specific services rendered to members

Courts have consistently distinguished between:

§  General mutual contributions, which may enjoy the benefit of mutuality if all conditions are satisfied; and

§  Income from specific services rendered to members, which the statute expressly brings to tax under this provision.

The emphasis is on the nature of the receipt. A receipt linked to a distinct, fee-based service rendered to a member is ordinarily taxable under Section 26(2)(d).

 

Practical Illustration

Suppose a Chamber of Commerce has:

(i)        Membership subscriptions (Mutual) : ₹ 80,00,000

(ii)      Common-interest expenditure :  ₹ 95,00,000

(iii)       Fees for issuing certificates and other member-specific services : ₹ 30,00,000

(iv)       Interest from Bank : ₹ 10,00,000

 

Tax treatment:

(i)     service fees) is taxable under Section 26(2)(d)            =  ₹ 30,00,000

(ii)   Interest from Bank is taxable under Section 26(2)(d)   = ₹ 10,00,000

(iii)  Deficit (₹ 95,00,000 - ₹ 80,00,000)                            = ₹ 15,00,000.

NOTE :

o   Subject to Section 50 conditions and the 50% ceiling, this deficit is allowable as a deduction.

o   Membership subscriptions of ₹ 80,00,000 are compared with common-interest expenditure of ₹ 95,00,000.

Solution :

(i)               Mutual subscriptions → not taxable.

(ii)             Taxable income [under Section 26(2)(d)] = ₹ 30 lakh + ₹ 10 lakh = ₹ 40 lakh

(iii)           Deficiency : ₹ 95,00,000 − ₹ 80,00,000 = ₹ 15,00,000

(iv)            Section 50 deduction  = lower of

§  ₹ 15,00,000

§  50% of ₹ 40,00,000 = ₹ 20,00,000

Therefore deduction under section 50 = ₹ 15,00,000.

Taxable income:

• Total income before deduction   = ₹ 40,00,000
• Less: Section 50 deduction                    = ₹ 15,00,000
• Taxable income                                   = ₹ 25,00,000

Assessing Officer’s Verification Checklist

An Assessing Officer should examine:

§  Whether the assessee is a trade, professional, or similar association.

§  Nature of receipts from members.

§  Whether separate consideration has been charged for specific services.

§  Agreements, invoices, fee schedules, and supporting documents.

§  Segregation of taxable service receipts from mutual receipts.

§  Allocation of expenses relating to taxable services.

§  Whether any receipts from non-members have been correctly offered to tax under the appropriate provisions.

§  Whether the claim of mutuality is sustainable for receipts other than those covered by Section 26(2)(d).

Interplay with Charitable Exemption [Section 336 of the Income Tax Act, 2025 - Erstwhile Section 11 of the Income Tax Act, 1961 & Section 346 – Erstwhile proviso to section 2(15) of the Income Tax Act, 1961]

Even though receipts from specific services are classified as business income under Section 26(2)(d) [Erstwhile Section 28(iii) of the Income Tax Act, 1961], a trade or professional association registered as a charitable institution (under the object of “advancement of any other object of general public utility”) may still claim exemption under Section 336 of the Income Tax Act, 2025 (Erstwhile Section 11 of the Income Tax Act, 1961), provided the activity does not violate the commercial activity thresholds specified under Section 346 of the Income Tax Act, 2025 [Erstwhile proviso to section 2(15) of the Income Tax Act, 1961].

Deduction of Deficit [Section 50 of the Income Tax Act, 2025]

Section 50 of the Income Tax Act, 2025 (Erstwhile Section 44A of the Income Tax Act, 1961) provides a mechanism for trade or professional associations whose receipts from non-members fall short of their expenditure. Under specified conditions, the excess expenditure can be set off against the association’s taxable business income derived from specific services performed for members.

Frequently Asked Questions

Query : If an association has only mutual receipts and no taxable income, can any deduction under Section 50 practically be allowed ?

Answer : Since Section 50 is a deduction provision, it presupposes the existence of taxable income against which the deduction can operate. If there is no taxable total income (because all receipts are excluded by mutuality), the statutory 50% ceiling would effectively result in no allowable deduction, notwithstanding the existence of a deficiency.

Supreme Court granted Special Leave against order of High Court where it was held that income derived by a chamber of commerce from specific services rendered to its members may be assessable as business income under section 28(iii), but such characterization does not by itself deny exemption under section 11. If the dominant purpose is charitable, there is no profit motive, and the statutory conditions of section 11 are satisfied, the exemption is available

Brief facts of the case

The assessee was PHD Chamber of Commerce & Industry, a chamber of commerce registered as a charitable institution under section 12A of the Income-tax Act, 1961. Its principal object was to promote trade, commerce and industry, an object claimed to be one of general public utility. During the relevant assessment years, the assessee collected fees from its members for rendering specific services such as:

§  Issuance of certificates and attestations,

§  Conducting seminars, conferences and training programmes,

§  Arbitration and consultancy services,

§  Publication and sale of journals and reports,

§  Other trade promotion and member-support services.

The Assessing Officer held that these receipts constituted business income under section 28(iii) (income derived by a trade, professional or similar association from specific services performed for its members). According to the Revenue, the activities were commercial in nature, and the exemption under section 11 was not available.

 Assessee’s Arguments

The assessee (PHD Chamber of Commerce & Industry) advanced the following principal arguments:

1. Charitable Institution

The assessee was registered under section 12A of the Income-tax Act, 1961. Its dominant object was the promotion of trade, commerce and industry, which constituted an object of general public utility.

2. No Profit Motive

The Chamber did not exist for earning profits. Fees charged from members were only to recover the cost of rendering services and carrying out its objects. Any surplus generated was incidental and was applied solely towards its charitable purposes.

3. Section 28(iii) Merely Classifies the Income

Section 28(iii) merely provides that receipts from specific services rendered to members are assessable under the head “Profits and gains of business or profession.” It does not create a bar against exemption under section 11.

4. Section 11 Overrides the Charge to Tax

Once the institution satisfies the conditions of section 11, its income, irrespective of the head under which it is computed, is exempt to the extent permitted by law. Therefore, the characterization of receipts as business income does not automatically make them taxable.

5. Activities Were Incidental to Charitable Objects

Services such as issuing certificates, organizing seminars, conducting training programmes, publishing journals and providing trade-related assistance were directly connected with the Chamber's principal charitable object. These activities were not carried on as an independent commercial venture.

6. Compliance with Section 11(4A)

Even if the activities constituted a business, they were incidental to the attainment of the charitable objects. Separate books of account were maintained as required under section 11(4A), and therefore the exemption could not be denied.

7. Application of Income

The entire income and surplus were utilized for the promotion of trade, commerce and industry and not distributed to members. No member derived any personal profit from the activities of the Chamber.

8. Mutual Benefit was not the Dominant Purpose

Although services were rendered to members, the Chamber's activities ultimately benefited trade and industry at large. Hence, the institution continued to pursue an object of general public utility rather than a commercial or mutual-profit objective.

Essence of the Assessee’s Case

The assessee’s central submission was :

The fact that receipts are taxable under section 28(iii) only determines the head of income. It does not deprive a registered charitable institution of exemption under section 11, provided the institution has no profit motive, the activities are incidental to its charitable objects, and the statutory conditions for exemption are fulfilled.

Revenue’s Arguments

The Revenue advanced the following principal arguments:

1. Receipts are Business Income under Section 28(iii)

• The assessee was a trade association/chamber of commerce rendering specific services exclusively to its members. The fees received for such services were expressly covered by section 28(iii) of the Income-tax Act, 1961. Therefore, the receipts constituted business income.

2. Activities Were Commercial in Nature

The Chamber was charging fees for services such as:

o  issue of certificates,

o  seminars,

o  training programmes,

o  arbitration,

o  publications,

o  consultancy and other member services.

Ø These activities were carried on in an organized and systematic manner and generated substantial receipts, indicating a commercial activity.

3. Section 11 cannot automatically Override Section 28(iii)

• Merely because the assessee was registered under section 12A did not entitle it to exemption.
• Once Parliament specifically treated receipts from specific services to members as business income under section 28(iii), the assessee had to satisfy the strict requirements of section 11 and section 11(4A).

4. Business was not merely Incidental

The Revenue contended that the service activities constituted an independent business rather than being merely incidental to the charitable objects. Consequently, the assessee was not entitled to exemption under section 11.

5. Presence of Profit Element

The fees collected were not merely reimbursement of costs but resulted in substantial surpluses. The generation of recurring surplus indicated a profit-making activity, even if the profits were subsequently applied for charitable purposes.

6. Benefit Was Primarily to Members

The services were rendered mainly to the Chamber's own members. Therefore, the activities were directed towards the benefit of a specific class of persons rather than the public at large, which was inconsistent with the concept of a charitable institution engaged in an object of general public utility.

7. Legislative Intent of Section 28(iii)

Parliament intentionally enacted section 28(iii) to tax income earned by trade, professional and similar associations from specific services rendered to members. Accepting the assessee's interpretation would render section 28(iii) largely ineffective, as every registered chamber could claim exemption under section 11 despite carrying on business activities.

Core Submission of the Revenue

The Revenue's essential contention was:

Since the assessee was carrying on business by rendering specific services to its members and earning income expressly covered by section 28(iii), such receipts should not qualify for exemption under section 11 unless the assessee strictly established that the business was merely incidental to its charitable objects and complied with all the conditions prescribed under section 11(4A).

Decision of the High Court

The Delhi High Court decided the issue in favour of the assessee and held that:

1. Receipts from specific services are business income

The income earned by a chamber of commerce from rendering specific services to its members is assessable as business income under section 28(iii) of the Income-tax Act, 1961.

2. Section 28(iii) only determines the head of income

The fact that such receipts are assessed under the head “Profits and gains of business or profession” does not automatically disentitle the assessee from claiming exemption under section 11.

3. Section 11 operates independently

If the institution is registered under section 12A and exists for charitable purposes, the exemption under section 11 cannot be denied merely because a part of its income is characterized as business income.

4. Profit motive is the decisive test

The Court observed that the dominant object of the chamber was the promotion of trade and commerce and not the earning of profits. Fees charged from members were incidental to achieving its charitable objects. Any surplus generated was applied towards the charitable purposes of the institution.

5. Incidental business does not defeat charity

Merely because the assessee earned income while carrying out its charitable objects did not convert it into a profit-making commercial organization. Where there is no independent profit motive, exemption under section 11 remains available, subject to fulfillment of the statutory conditions.

Thus, the High Court accepted the assessee’s contention and held that although the receipts were taxable as business income under section 28(iii), they would still qualify for exemption under section 11, provided there was no profit motive and the statutory conditions for exemption were satisfied. Aggrieved by the High Court's decision, the Revenue filed a Special Leave Petition (SLP) before the Supreme Court.

Core Legal Issue before the Supreme Court

Whether receipts derived by a chamber of commerce from specific services rendered to its members, though assessable as business income under section 28(iii), can still be exempt under section 11 if the institution exists for charitable purposes and there is no profit motive ?

Decision of the Supreme Court

Supreme Court : Granted Special Leave Petition (SLP) against the High Court’s judgment. No final judgment on merits was delivered in the reported order. Therefore, the Supreme Court order is not a binding precedent on the substantive legal issue. Special Leave Petition filed against impugned order was to be granted. It merely means that the Court considered the question sufficiently important to hear the appeal. [In favour of revenue] (Related Assessment years : 2006-07 and 2007-08) – [Director of Income-tax v. PHD Chamber of Commerce & Industry (2014) 51 taxmann.com 380 (SC)]

Assessee was not a “similar association” contemplated by sections 28(iii) and 44A; Expression ‘similar association’ used in section 44A is in pari materia with expression ‘similar association’ used in section 28(iii) and, thus, in view of facts stated under head ‘Mutual concern’ assessee was not entitled to benefit under section 44A

Brief facts of the case

The assessee was a company incorporated with the principal object of promoting cricket and other sports. It collected income from : Membership fees, Subscriptions, Grants, Other receipts. Its Memorandum and Articles of Association authorised it: to invest surplus funds not immediately required, and on winding up, any surplus was distributable among members. The assessee claimed exemption under the then section 10(23). The Assessing Officer rejected the claim.

The Tribunal held that receipts governed by mutuality were not taxable under section 28(iii); however, interest earned on bank fixed deposits was taxable because it arose from dealings with third parties.

Issues before the High Court

The Court considered two principal questions:

1. Whether the assessee was a “similar association” eligible for deduction under the erstwhile section 44A.
2. Whether interest earned on bank fixed deposits was exempt on the principle of mutuality.

Assessee’s Arguments

The assessee contended that it was an association established for promotion of sports; it functioned on the principle of mutuality; contributors and participators were substantially identical; therefore, its income should not be taxed; alternatively, it was a “similar association” entitled to deduction under section 44A.

Revenue’s Arguments

The Revenue argued that the expression “similar association” in section 44A has the same meaning as in section 28(iii); section 44A was never intended to enlarge the class of eligible associations; the assessee was not a trade, professional or similar association contemplated by section 28(iii); interest from bank deposits arose from transactions with outsiders and therefore lacked mutuality.

Decision of the High Court

The Gujarat High Court held against the assessee on both issues.

A. Meaning of “Similar Association” under Sections 28(iii) and 44A

The Court observed that Section 44A was enacted to provide relief to certain professional associations. The expression “similar association” occurring in section 44A is in pari materia with the same expression used in section 28(iii). The reference in section 44A to associations other than those covered by section 10(23A) merely restricts the class of eligible associations. It does not enlarge the meaning of “similar association.” Accordingly, an assessee not falling within “similar association” under section 28(iii) cannot claim deduction under section 44A. Thus, the Sports Club was not entitled to the benefit of section 44A.

B. Mutuality and Interest Income

The Court reiterated the essential principle of mutuality. Contributors and participators must be identical. No person can make profit out of himself. However, interest on bank deposits: was earned from banks, banks were third parties, such income did not arise from members' mutual dealings.

The Court also noted that the Articles authorised investment of surplus funds in any form; returns from such investments (interest, dividend, rent, etc.) originated from outsiders; therefore, these receipts constituted non-mutual income. Hence, an association which received such income could be said to be indulging in both mutual activity as well as non-mutual activity. In view of the decided cases on this point, the income received by the assessee in the instant case, by way of interest was exigible to tax. [In favour of revenue] – [Sports Club of Gujarat Ltd. v. CIT (1988) 171 ITR 504 : 67 CTR 233 : 37 TAXMAN 38 (Guj.)]

Receipts of a trade association from registration fees, service charges, and discounts retained for specific services rendered to its members are taxable under section 28(iii) (now section 26(2)(d)), even if the association’s primary object is to regulate members' activities rather than carry on trade

Brief Facts of the Case

All the truck owners of Hoshiarpur district, who had permits to ply their trucks on the hill routes, formed a union in order to cut down the competition amongst themselves and set up a device to regularise the working of the trucks for the maximum benefit of its members. Any truck owner could get himself registered with the union on payment of Rs. 4. Whenever a truck was allotted a load, the member paid Re. 1 to the union. The union procured transport work from customers and allocated the loads to members on a rotation basis. Customers were allowed a 30% rebate. Out of this : 15% was passed on to the customer, 5% was retained by the union as its income.

During Assessment year 1973-74, the union earned a surplus of Rs. 37,450. The assessee claimed that the surplus was exempt because: it was not carrying on any trade or business; and the surplus was subsequently refunded to members. The Income-tax Officer and the Appellate Assistant Commissioner rejected the claim and assessed the surplus under section 28(iii) of the Income-tax Act, 1961.

The AAC held (i) that the members did not make any voluntary contributions which were only a recompense for the services rendered by the union; and (ii) that it would not make any difference whether the commission had been paid by the truck owners or by the customers whose load has been transported and the receipt could directly correlate with the union’s services. On further appeal, the Tribunal, however, held that such an activity did not constitute a trading activity and the resultant surplus was not chargeable to income-tax. Observing that the union’s main object was not to carry on business itself but to regulate working of various members in such a way as to avoid unhealthy competition amongst themselves. On reference:

Assessee’s Arguments

The assessee contended that the union was formed merely to regulate the work of truck owners and prevent unhealthy competition. It was not carrying on any trade or business. The registration fee and loading charges were not business receipts but merely contributions from members. The surplus was ultimately refunded to members and therefore did not constitute taxable income. Since there was no trading activity, section 28(iii) could not apply.

Revenue’s Arguments

The Revenue argued that the union rendered specific services to its members by: procuring transport contracts, allocating loads, maintaining the turn system, regulating transport operations. The registration fee and loading charges were consideration for these services. The union also earned income by retaining 5% of the discount allowed by customers. Such receipts squarely fell within section 28(iii) because they arose from specific services rendered to members. The section does not require that the association itself should carry on trade.

Decision of the High Court

The High Court reversed the Tribunal and decided the case in favour of the Revenue. Findings :

1. The union was a trade association

The Court held that the assessee was clearly a trade association within the meaning of section 28(iii).

 2. Trading activity by the association is not essential

The Court observed that section 28(iii) taxes income derived by a trade, professional or similar association from specific services rendered to its members. The provision does not require that the association itself must carry on any trade or business.

3. Payments were for specific services

The Court held that Rs. 4 registration fee, Re. 1 loading fee, were not voluntary contributions. These payments were made only because the union rendered specific services, namely : arranging transport work, allocating loads, providing business opportunities to members. Without paying these charges, a truck owner could not obtain work through the union. Hence, these were receipts from specific services.

4. The union itself was carrying on commercial activities

The Court further observed that the union itself procured transport contracts, dealt directly with customers, allocated transport work, retained part of the rebate allowed to customers. Thus, the union was engaged in commercial activities in addition to rendering services.

5. Refund of surplus was irrelevant

The subsequent refund of surplus to members did not alter the character of the receipts at the time they were earned.

The surplus was taxable under section 28(iii). The Tribunal erred in treating the receipts as non-taxable merely because the association’s principal object was regulation rather than trade. The reference was answered in favour of the Revenue. [In favour of revenue] (Related Assessment year 1973-74) - [CIT v. Hill Goods Truck Owners Union (1980) 124 ITR 224 : 4 Taxman 20 (P&H)]