The mutuality principle is a legal principle established by case law. It is based on the proposition that an organisation cannot derive income from itself.
The principle provides that where a number of persons contribute to a common fund created and controlled by them for a common purpose, any surplus arising from the use of that fund for the common purpose is not income.
The principle does not extend to include income that is derived from sources outside that group.
Organisations that can access mutuality
The characteristics of organisations that can access mutuality typically include:
- The organisation is carried on for the benefit of its members collectively, not individually.
- The members of the organisation share a common purpose in which they all participate or are entitled to do so.
- The main purpose for which the organisation was established, and is operated, is the common purpose of the members.
- There is a common fund that gives effect to the common purpose and all the members contribute to it.
- All the contributions to the common fund are applied for the collective benefit of all the members, in line with the common purpose.
- Different classes of memberships may exist with varying subscription rates, rights and entitlements to facilities.
- The members have ownership and control of the common fund.
- The contributors to the common fund must be entitled to participate in any surplus of the common fund.*
* If an organisation's constituent document prevents it from making any distribution to its members, and this is the only thing that prevents an amount of its income from being a mutual receipt, the organisation is not prevented from accessing mutuality for income tax purposes.
As a result of the mutuality principle:
- receipts derived from mutual dealings with members are not assessable income (these are called mutual receipts)
- expenses incurred to get mutual receipts are not deductible.
Not all dealings involving members are mutual dealings.
The principle of mutuality does not apply to dealings between an organisation and member that go beyond a mutual arrangement and are in the nature of trade. In this situation, the fact the organisation is dealing with a member is not relevant.
Nature of trade
The definition of 'business' under tax law includes 'a trade'. The terms 'business' and 'trade' are commonly used to refer to activities that are commercial in nature and intended to produce a profit. These activities are usually for a taxable purpose.
However, the courts and tax law confirm that a mutual organisation may be carrying on a business (or trade) if various indicators are present. The indicators of business are outlined in TR 97/11 Income tax: am I carrying on a business of primary production? We also accept that the capacity to earn and distribute profits need not be present before an activity of a NFP entity has the form of a business.
A mutual organisation's business can either be for a taxable purpose (producing assessable income) or non-taxable purpose (producing mutual receipts), or a combination of both.
If a mutual organisation is carrying on a business, it may, in certain circumstances, be eligible for concessions available to small business entities (for example, capital gains tax concessions and immediate deductions for prepaid expenses).
To work out if your organisation is a small business entity, see Small business entity.
- TR 97/11 Income tax: am I carrying on a business of primary production?
Dealings with members
When an organisation transacts with its members, it must ask itself if the activity is either:
- a trade or something in the nature of trade producing a profit (a taxable purpose)
- a mutual arrangement which, at most, gives rise to a surplus of funds to the organisation (a non-taxable purpose)?
In a mutual arrangement, there must be complete identity between contributors and participants as a class, not individually, in the surplus of common funds. The members collectively contribute and collectively benefit from the common fund.
Where an organisation transacts with members collectively to produce a surplus of common funds, the activity is for a non-taxable purpose and is a mutual arrangement. For example, a bar is provided for the benefit of all members so the sales from members contribute to a surplus of common funds.
Mutuality ceases to apply when a member individually 'contributes' - say by paying rent - to secure a right over the use of a collectively owned asset (where that right is not available to members as a class), and the member benefits from the use of that asset for their own purposes. This breaks the complete identity between contributors and participants as a class in the common fund.
Where the organisation transacts with a member in this way, the activity is in the nature of a trade and is for a taxable purpose. For example, leasing a club facility to a member for their individual benefit in earning their assessable income is in the nature of trade and so the lease income is assessable to the club.
Example: Business nature
A NFP club owns two factory units. One is used for club activities and the other is rented to a club member. The member uses the unit to carry on a business.
The club's activity involving the leasing of a factory unit to one club member is considered to be of a business nature rather than a mutual arrangement. Income from this activity is assessable to the club.
End of example
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