Edited version of private ruling

Authorisation Number: 1011838458528

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Ruling

Subject: Income tax Exemption

Question 1

Is the total ordinary income and statutory income of the Company exempt from income tax, in accordance with section 50-1 and pursuant to item 6.3 of section 50-30 of the Income tax Assessment Act 1997 (ITAA1997)?

Answer

No

Question 2

Is the total ordinary income and statutory income of the Company exempt from income tax, in accordance with section 50-1 and pursuant to item 8.2(c) or item 8.3 of section 50-40 of the ITAA1997?

Answer

No

Relevant facts

The Company owns information technology, which it develops and improves

The intellectual property in the information technology is owned by the members of the company

The surplus assets and income of the Company are distributed to members on winding up.

Members have to pay fees to use the information technology

Not all fees are payable by all members

Reasons for decision

Issue 1 Question 1

To be an exempt entity under item 6.3 of section 50-30 of the ITAA 1997, an entity must be a private health insurer within the meaning of the Private Health Insurance Act 2007.

The Private Health Insurance Act 2007 (the Act) provides that a private health insurer is a person registered under Part 4-3 of the Act. The Commonwealth Private health Insurance Ombudsman provides a list of private health insurers registered under the Act (see www.privatehealth.gov.au). The Company is not on the list.

The Company is not considered to be a health insurance provider within the meaning of the Private Health Insurance Act 2007.

Further, to be exempt from income tax as a private health insurer within the meaning of the Private Health Insurance Act 2007, an entity must not be carried on for the profit or gain of its individual members (non-profit). The prohibition against distribution of profits and assets among members applies while the entity is operating and when it winds up.

The ATO accepts an entity as non-profit where its constituent or governing documents prevent it from distributing profits or assets for the benefit of particular people, both while it is operating and when it winds up.

The Company's constitution prevents distribution of income and property to members while the Company operates, but allows for the surplus property of the Company to be distributed among its members on winding up or dissolution.

In the relevant years, the Company is not considered to be a private health insurer within the meaning of the Private Health Insurance Act 2007.

We note that we previously accepted that the Company was exempt. The following paragraphs from Taxation Ruling TR 2005/22 Income tax: companies controlled by exempt entities state the current ATO view on the income tax exemption under Division 50 of the ITAA 1997 relating to companies which are controlled by exempt entities:

14. For the ordinary income and statutory income of a non-profit company to be exempt from income tax under Division 50 of the ITAA 1997, the company itself must be covered by the tables in that Division.

15. To be covered, the company itself must meet the description and requirements of an item in those tables. If the company, in its own right, does not fall within the description and meet the requirements of any item, it will not be covered by the tables, and so its ordinary and statutory income will not be exempt from income tax under the Division.

16. It is not possible to merely attribute the characteristics and purposes of an exempt entity to a different company, or to simply 'look through' the company to the exempt entity, ignoring the characteristics and purposes of the company itself.

17. Deciding whether an entity is covered by a category of exempt entity in the tables in Division 50 involves matters of fact and degree. In this regard the degree and type of integration of a company with an organisation that happens to be an exempt entity can be relevant. Nonetheless, it is the purposes and character of the company itself - as shown by all relevant features including its constituent documents and activities - that will be determinative.

…

72. The mere providing of services to an exempt entity would not, however, demonstrate exemption (see also the discussion from paragraph 54).

Example 3

73. A college and its seven related entities, which are all charities, set up and control a non-profit corporation to provide business support services, such as labour hire, office services and publicity. The corporation actively seeks clients in the business and non-profit sectors, and provides its services to them at commercial rates and on a commercial basis. It also provides at-cost services to the eight charities.

74. The corporation is not a charitable institution in terms of item 1.1 in section 50-5. While it provides at-cost services to the charities and is controlled by them, its purposes are not limited to charitable purposes only.

75. The fact that a company only operates in a way that is integrated with the operations of its exempt parent does not necessarily mean it will qualify for exemption under Division 50. In each situation the particular requirements of the items in the tables in Division 50 must be satisfied.

Example 4

76. A non-profit hospital, which is not a charitable institution is exempt from income tax in terms of item 6.2 in section 50-30 of the ITAA 1997. It sets up and controls a company to provide laundry and food services to the hospital. The company's sole function is to provide those services to the hospital.

77. The company is not exempt from income tax in terms of item 6.2 in section 50-30. The item requires that the entity be a 'hospital'. Even though the company's purposes are solely for the sake of the operation of the hospital, and are fully integrated with it, it is not itself a hospital. Accordingly, it cannot qualify under that item.

The Company does not satisfy the requirements of item 6.3 of section 50-30 of the ITAA 1997 (it is not a registered private health insurer).

Issue 1 Question 2

Detailed reasoning

To be an exempt entity under item 8.2(c) or 8.3 of section 50-40 of the ITAA 1997, an entity must be a society or association established for the purpose of promoting the development of industry resources or information and communications technology resources, and not be carried on for the profit or gain of its individual members.

Society or Association

The terms 'society' and 'association' are not defined in the ITAA 1997 and have their ordinary meaning.

In Pro-Campo Ltd v Commr. of Land Tax (NSW) 81 ATC 4270 Lee J said the following on the meaning of society and association:

In Theosophical Foundation Pty Ltd v Commr. of Land Tax (1966-1967) 67 SR 70 … Sugerman JA stated at p.82

"A society, in the relevant sense, is 'a number of persons associated together by some common interest or purpose, united by a common vow, holding the same belief or opinion, following the same trade or profession, etc: an association.' (Oxford English Dictionary,…) A society as thus described, in which the common element pertains to areas concerned with religion, may aptly be described as a religious society."

…

The meaning of "society" as the Oxford English Dictionary shows can be the equivalent of "association" and I do not think that any relevant distinction in nature exists between the two. It merely seems to have happened that some organisations are called "associations", others are called "societies" but no meaningful difference can be detected between the two… (at 4279)

The Company is an incorporated body comprised by a number of members who have a common purpose.

The Company is considered to be an association.

Not carried on for the profit or gain of its individual members

As previously discussed, the Company's constitution allows for the surplus property of the Company to be distributed among its members on winding up or dissolution.

The Company is carried on for the profit or gain of its members.

Established for the purpose of promoting the development of Australian industrial resources- Item 8.2(c)

The Company contends that it is promoting the development of Australian insurance industry resources.

In Australian Insurance Agency v Federal Commissioner of Taxation 79 ATC 4569 Sheppard J determined that insurance is a business resource and stated:

There is a degree of specificity in the words used in the section. It refers to aviation, then to four resources of primary industry, then to manufacturing and finally to industrial resources. The use of theses various expressions does not suggest that the draftsman intended to give to the word "industrial" any wide meaning intended to embrace business or commercial resources (at 4574).

Promoting the development of an insurance industry resource does not come within item 8.2(c)

In the relevant years, the Company is not considered to be established for the purpose of promoting the development of industrial resources.

Established for the purpose of promoting the development of Australian information and communications technology resources - item 8.3

The constitution, annual reports and activities of the Company show that they provide information technology services to members of the insurance industry.

The Company is considered to be promoting Australian information and communications technology resources. However, section 50-40 requires more than promoting a resource, it requires an entity to promote the development of the resource.

Taxation ruling IT 2415 Income tax: Associations promoting the development of Australian resources states the following on the meaning of development:

The term "development" must be taken to be used in a commercial or business sense, i.e. it comprehends all elements which must be taken into account to ensure that the specified resources are used in the best interests of Australia.

The Company owns information technology resources. The Company develops the information technology resources. The Company also provides support to its users, hosts and annual conference for members, and participated in developing a system.

The above shows that the Company does promote the development of Australian information and communications technology resources.

The Company will only be exempt if it was established for that purpose.

In Australian Insurance Agency v Federal Commissioner of Taxation (supra) Sheppard J stated that purpose means:

… the principal or dominant purpose for which the society or association was established (at 4576).

In Case W49 89 ATC 469 Senior Member Roach stated the following on the meaning of 'established for the purpose…':

… I am satisfied that the term "established" is not to be used in the narrow sense of considering only the motives and objectives which led to the incorporation… In my opinion it is sufficient that the question be considered as to whether during the period under review the organisation was in existence and was operated and maintained in an established and stable condition as an organisation having as its principal or dominant purpose provided for in the subsection (at 474).

The constitution and activities of the Company indicate that in addition to the purpose of promoting the development of Australian information and communications technology resources, the Company exists for the benefit of its members.

Where an association operates primarily to confer benefits on its members jointly or as a group, it is unlikely to have the main purpose of promoting the development of Australian resources. However, where benefits flow to members as a consequence of activities that promote the development of Australian resources the benefits will be incidental and not affect entitlement to income tax exemption

The Company was formed to hold the intellectual property and other assets in the information technology for the benefit of its members. Since its incorporation this has been the raison d'etre of the Company.

The constitution provides that control of the Intellectual property and other assets of the Company is with the members; and the intellectual property and other assets of the Company are beneficially owned by members.

The activities undertaken by the Company to improve and develop the information technology are to ensure that the software is suitable for use by its members. The benefit to members is not considered incidental or ancillary to any purpose concerned with the development of Australian information and communications technology resources.

In the relevant years, the Company is not considered to be established for the purpose of promoting the development of information and communications technology resources.

Issue 2 Question 1

Detailed reasoning

Receipts derived by an entity through dealings with members will not be assessable income where the principle of mutuality applies to the receipt and it is considered a mutual dealing.

The principle was established in New York Life Insurance Company v. Styles (1889) 14 App. Cas. 381. There the members of a life insurance company were participating policy holders each of whom was entitled to a share of the assets and liable to all losses. The surplus on premiums paid by policy holders were returned annually to them as bonuses or by way of reduction of future premiums. Any balance was carried forward and held for the benefit of the general body of members. The ratio of the decision was expressed in the following passage taken from the speech of Lord Watson:

When a number of individuals agree to contribute funds for a common purpose, such as the payment of annuities, or of capital sums, to some or all of them, on the occurrence of events certain or uncertain, and stipulate that their contributions, so far as not required for that purpose, shall be repaid to them, I cannot conceive... why contributions returned to them should be regarded as profits.... a member of the appellant company, when he pays a premium, makes a rateable contribution to a common fund, in which he and his co-partners are jointly interested, and which is divisible among them.... He pays according to an estimate of the amount which will be required for the common benefit; if his contribution proves to be insufficient he must make good the deficiency; if it exceeds what is ultimately found to be requisite, the excess is returned to him (at 394).

In Revesby Credit Union Co-Operative Ltd v Federal Commissioner of Taxation (1964-1965) 112 CLR 566 McTiernan J explained the principle of mutuality as follows:

The principle of mutuality seems to me to be settled. Where a number of people contribute to a fund created and controlled by them for a common purpose any surplus paid to the contributors after the use of the fund for the common purpose is not income but is to be regarded as a mere repayment of the contributor's own money (at 574).

A number of authorities have established the application of the mutuality principle in Australia. They include The Bohemians Club v. Acting Federal Commissioner of Taxation (1918) 24 CLR 334, Revesby Credit Union Co-operative Ltd v. FC of T (Supra), The Social Credit Savings & Loan Society Ltd v. FC of T (1971) 125 CLR 560; (1971) 2 ATR 612; 71 ATC 4232, Sydney Water Board Employees Credit Union Ltd v. FC of T (1973) 129 CLR 446; (1973) 4 ATR 157; 73 ATC 4129, R.A.C.V. v. FC of T (1973) 4 ATR 567; 73 ATC 4153, and FC of T v. Australian Music Traders Association (1990) 21 ATR 471; 90 ATC 4536.

A mutual association has all of the following characteristics:

· a voluntary association of persons (contributors) who make contributions out of their own moneys to a common fund (which they create, own, control and all have an interest in) for a common purpose (which may also be for their personal benefit as participators) and that purpose is not undertaken for profit;

· contributions are based on an estimate of expected expenses of the common purpose (mutual liabilities), and are made on the stipulation that any surplus (the unused or unexpected amount) will be, sooner or later, returned/repaid to the contributors (in their capacity as contributors) in some form or other (however under section 59-35 of the Income Tax Assessment Act 1997 (ITAA 1997) an amount of ordinary income is non-assessable non-exempt income where the only thing preventing it from being a mutual receipt is a prohibition on actual distribution to the members);

· complete identity as a class between the contributors and the participators; and

· a reasonable relationship between what a member contributes and what the member may be expected or entitled to receive in respect of the common fund.

The Company generally has the characteristics of a mutual association: the Company was incorporated to purchase information technology using contributions from members; the information technology is used to by members; members make regular contributions to ensure that the information technology is current; member contributions are calculated with a view to ensuring that the Company has adequate financial resources to carry out its activities and to ensure that funds are available if needed; the assets of the Company are beneficially owned by the members; and members are entitled to a portion of the assets on winding up in such manner as shall be determined by the members at or before the time of dissolution, and in default thereof, equally among such members.

However, the Company has more than one fee payable by members and it is necessary to consider whether each fee is a mutual dealing. In North Ryde RSL Community Club Ltd v FC of T 2002 ATC 4293 the court stated

… not all receipts by a club from members or from a third party on account of services or facilities made available to members are necessarily mutual receipts… They may be no more than trading receipts. It is the nature of the actual transactions in question, and not the fact that a benefit was received or a service used by members that will determine whether receipts derived are liable to, or immune from, tax (at 4306).

Members are required to pay fees to use the information technology

The applicant has described the fees as calculated on a cost recovery basis or as a pre-estimate of expenses apportioned on a mutual basis. Given the history of the development of the company it is accepted therefore that a reasonable relationship between what each member contributes and what they are entitled to receive continues; members contribute as a class, they are entitled to use the information technology while the Company operates, and they are entitled to a portion of the Company's assets on winding-up. These fees are considered as mutual dealings and are not assessable income.

In Sydney Water Board Employees Credit Union Ltd v. FC of T (supra), Mason J held that payments made in discharge of a legal obligation do not come within the mutuality principle (at 458). Whilst the Company has some transaction based charges these are stated to be on a cost recovery basis. It is also accepted that the variable component of the information technology fee remains mutual, however it is noted that this is not always the case; see Fletcher v. Income Tax Commissioner [1971] 3 All ER 1185.

The entrance fee paid by joining members is paid in recognition of the contributions made by existing members to the acquisition and development of the information technology. The fee exceeds any reasonable administrative charge for entrance and the new member gains their rights as a member through payment of the information technology fees. The contributor's or new member's right to a surplus in proportion to the contribution is diluted to the existing members upon payment; see Municipal Mutual Insurance Ltd. v. Hills (1931) 16 T.C. 430; The Social Credit Savings & Loan Society Ltd v. FC of T (supra); Sydney Water Board Employees Credit Union Ltd v. FC of T (supra). It is considered that this fee is not a contribution to the common fund in the relevant sense and forms assessable income of the Company.

Issue 2 Question 2

Detailed reasoning

The principle of mutuality only applies to the dealings of contributors to a common fund. The common law is well developed in this regard; see Carlisle and Silloth Golf Club v. Smith - [1912] 2 KB 177; Coleambally Irrigation Mutual Co-Operative Ltd v Commissioner of Taxation [2004] FCAFC 250 (7 September 2004).

The receipts derived by the Company from dealings with non-members are not mutual dealings and are assessable income.

Whilst the rulee did not request a ruling in relation to the matter, the rulee has stated in relation to the annual conference, that the costs are subsidised by sponsorship payments. Taxation determination TD 1999/38 Income tax: does the principle of mutuality apply to income derived by a registered/licensed club under an arrangement entered into with an external party to conduct gaming or other activities on the club's premises? provides the view that such payments are assessable income.

Whilst the conference may be considered a "mutual activity" it is considered that the sponsorships are not mutual receipts. In Royal Automobile Club of Victoria (RACV) v. FC of T (supra), Anderson J at ATC 4160 noted the following in relation to advertising income from the club's journal 'Royal Auto':

It seems to me, so far as the commercial advertisements are concerned, that the appellant was in business for the purpose of selling space to the advertisers. No doubt it did so for a number of reasons, two of which probably were (1) to provide for its members information about motor accessories and other articles which were available to be purchased, and (2) to enable it to produce for its members a larger and more imposing journal than it would have been without the advertisements. This did not, however, to my mind alter the nature of the transaction so far as the advertisers were concerned. No figures were given in evidence as to the cost to the appellant of printing of the advertisements but it is most unlikely that the appellant would have obliged advertisers by printing their advertisements at a loss, and the strong probability is, I think, that the revenue from advertisements exceeded the cost of their printing. The concession which the Commissioner is prepared to make removes any basis on which tax may be assessed in relation to the journal, and the loss sustained in printing the journal is, in my opinion, a loss sustained in providing a service for members on a mutual basis.

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