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Taxable income and mutuality

Last updated 3 December 2018

The taxable income of a club, society or association is calculated in the same way as a company for tax purposes.

One particular aspect that affects many clubs, societies and associations is mutual dealings with members.

We explain how to identify whether a person is a member of an organisation.

As a result of the mutuality principle, revenue and expenditure of an organisation falls within one of three categories for income tax purposes.

We explain how the categories are used in calculating taxable income.

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Taxable income

Taxable income is calculated as the difference between an organisation's assessable income and deductions.

Taxable income = assessable income – allowable deductions

See also:

Assessable income

Assessable income is, broadly speaking, the income derived by your organisation. It can also include some capital gains made on the disposal of assets.

Many amounts received by a NFP organisation are assessable income. Examples are bank interest and the proceeds from fundraising drives to the public.

Not all amounts of money or property your organisation receives will be assessable income. Receipts derived from mutual dealings with members of your organisation are not assessable income. This is due to the principle of mutuality, which we discuss in Mutuality principle.

Deductions

Deductions are, broadly speaking, operating expenses that are incurred in earning assessable income. Examples of expenses incurred in deriving an organisation's assessable income are fees for earning bank interest and costs of fundraising drives to the public.

Your organisation may incur expenses in earning both assessable income and non-assessable income. The deduction your organisation will be able to claim will be limited to the extent the expenditure was incurred in deriving the assessable income. Therefore, your organisation may need to apportion its expenses.

For example, if only 30% of an organisation's bar sales are assessable, only 30% of expenses for running its bar will be deductible. Examples of other expenses that could be deductible but could require apportionment are printing, rent and insurance.

There are some deductions, however, that do not have to be incurred in deriving assessable income. They include tax-deductible gifts and superannuation contributions for employees.

Goods and services tax

The effect of goods and services tax (GST) on the calculation of taxable income differs depending on whether your organisation is registered for GST, or is required to be registered.

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Mutuality principle

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.

Mutual dealings

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.

See also:

  • 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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Meaning of member

For the purposes of mutuality, we accept that a person is a member of an organisation where the person has done all of the following:

  • applied for membership (which may entail being nominated and paying the appropriate nomination fee)
  • been accepted by the organisation (for example, by the board of directors)
  • paid the appropriate membership subscription.

Once a person has applied for membership and has been accepted by the organisation as a member, they are bound by the organisation's constitution and any rules or by–laws of the organisation.

Members need not have voting rights, but those who do not must be eligible to the other rights and privileges of membership. This would include knowing that they are a member, receiving the appropriate membership identification (for example, a card or badge) and receiving the organisation's newsletters and publications.

Various terms are used to describe members – for example, temporary, honorary, social and reciprocal members. As the meanings of these terms can differ between organisations, the use of a particular term does not determine whether a person is a member or non-member for tax purposes.

The general principle is that temporary, honorary or social members who have not been through the above membership process are visitors for tax purposes. This also applies to reciprocal members – that is, members of another organisation sharing reciprocal arrangements.

Non-members

A non-member is someone who is not a member of the organisation. Non-members include:

  • temporary, honorary, social and reciprocal members who have not been through the above membership process and are treated as visitors
  • members' guests – those visitors who accompany a member and are signed in by the member
  • other visitors.

A visitor to the organisation includes anyone who is not:

  • a member
  • a child
  • an employee of the organisation*
  • engaged to work or provide services to the organisation.*

* This only applies while the person is on the organisation's premises in their capacity as an employee or contractor.

Example: Status of employee

An employee is not counted as a visitor when they are at the organisation performing their duties.

However, if the employee visits the organisation on a day off (and is not a member), they are counted as a visitor on that day.

End of example

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Categories of revenue and expenses

As a result of the mutuality principle, revenue and expenses fall within one of three categories for tax purposes.

Category

Revenue

Expenses

1

Non-assessable

  • Revenue from mutual dealings with members (for example, membership subscriptions).
  • Revenue that the tax law classifies as not assessable (for example, donations received).
 

Non-deductible

  • Expenses relating to members (for example, the cost of membership badges).
  • Expenses that the tax law specifies as non-deductible (for example, fines and penalties imposed by an Australian law).
 

2

Assessable

  • Revenue from trading activities relating to non-members (for example, fees from hiring function rooms to the public).
  • Revenue from sources outside the organisation (for example, bank interest received).
  • Revenue that the tax law specifies as assessable (for example, payments received to fulfil a lease obligation to repair).
 

Deductible

  • Expenses relating to non-members (for example, the cost of running a function solely for non-members).
  • Expenses relating to fully assessable income (for example, fees for earning bank interest).
  • Expenses that the tax law allows without apportionment (for example, contributions to staff superannuation).

 

3

Apportionable

Revenue from trading activities relating to members and non-members (for example, bar sales).

Apportionable

Expenses of trading activities relating to members and non-members (for example, bar expenses).

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Steps for calculating taxable income

This flowchart shows how the three categories of revenue and expenses are used in calculating taxable income.

Step 1: Classify revenue

Classify the organisation's revenue into one of the following categories:

  • non-assessable
  • assessable
  • apportionable

We explain how to do this in Classifying revenue.

Step 2: Classify expenses

Classify the organisation's expenses into one of the following categories:

  • non-deductible
  • deductible
  • apportionable

We explain how to do this in Classifying expenses.

Step 3: Separate the apportionable items

Separate the apportionable revenue and expenses into:

  • non-assessable and assessable
  • non-deductible and deductible

We explain how to do this in Separating apportionable items.

Step 4: Calculate the taxable income

Total the assessable income (from steps 1 and 3) and the deductible expenses (from steps 2 and 3). Once you have done this, you can calculate the taxable income.

Taxable income = assessable income – deductions

We provide worked examples of how to calculate taxable income in Calculating taxable income.

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