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Edited version of your written advice
Authorisation Number: 1013052067303
Date of advice: 13 July 2016
Ruling
Subject: Income from deposits
Question 1
Is interest received from financial investments taxable? If so, does the receipt of taxable income change the entity's NFP status?
Answer
Yes, interest is considered assessable income
This ruling applies for the following periods:
1 July 2011 - 30 June 2017
The scheme commences on:
July 20YY
Relevant facts and circumstances
• The Club was established in the early 19XX
• The Club has numerous branches throughout Australia
• The Club is not listed by the Australian Securities and Investments Commission
• The Club is a not-for-profit organisation
• The Club ABN became active on the Australian Business Register in 19XY
• The objects and aims of the Club are listed in their constitution. The objectives and aims of the club are to provide:
• An association for members who have the common bond of XX vehicle ownership.
• A means whereby its members can meet for companionship, social engagement, enjoyment, education, safety, recreation and the common interest in driving the vehicle.
• Full membership is open to a person who holds a current vehicle licence (licence) and owns a XX vehicle or a person who holds a licence, owns or drives a vehicle other than a XX and who demonstrates a willingness to promote the aims and objectives of the association
• The Club's funds are derived from entrance fees and annual member subscriptions, donations and any other source as determined by the National Committee
• Part 5 clause 44 (1) states that the Club's funds are to be used in pursuance of the objects of the association in such manner as the determined by the National Committee
• Clause 53 states:
• the income and property of the association is to be applied solely towards its aims and objectives. Further, no portion of it is to be distributed to members, or to any person or bodies claiming through them.
• on winding up or dissolution of the association the Club's property will be auctioned off to members. The funds from any auction in addition to remaining funds (after satisfaction of debts and liabilities) will be transferred to the YY.
• The Club wishes to derive income from an investment in a fixed term deposit account
Information is also available on the Club's website
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 6-5
Income Tax Assessment Act 1997 Section 6-20
Reasons for decision
Issue 1 Income Tax ~ not for profit and mutual organisations
Question 1
Is interest received from financial investments taxable? If so, does the receipt of taxable income change the entity's NFP status?
Summary
Income from investments is considered to be income according to ordinary concepts under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) and therefore is not a mutual receipt but, rather, assessable income of the Club. The receipt of assessable income does not preclude the Club from having a not for profit status.
Detailed reasoning
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 was described succinctly by McTiernan J in Revesby Credit Union Co-operative Ltd v FCT (1965) 112 CLR 564 at 574-575, who said:
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…Incorporation of the fund is not relevant…What is required is that the fund must have been created for the common purpose and owned or controlled wholly by the contributors. If it is owned or controlled by anyone else the principle cannot apply…Furthermore any contributions to the fund derived from sources other than the contributors' payments, such as interest from the investment of part of the fund, or income from a business activity conducted by the members, cannot be taken into account in computing the surplus…Also the cases establish that the principle cannot apply unless at any given point in time the contributors to the fund are identical with the beneficiaries of the distribution of the surplus.
An organisation can apply mutuality to receipts where:
• 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 the mutuality principle applies:
• 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.
Essentially, for the mutuality principle to apply, there must be contributions to a common fund for a common purpose, the fund must be controlled by the contributors and there must be complete identity between the contributors of the fund and those entitled to the surplus of the common fund.
In circumstances where it can be established that the principle of mutuality applies, mutual receipts from associated entities sharing a common purpose, contributing to a common fund have been found not to constitute ordinary income and as such are not subject to income tax under section 6-5 of the ITAA 1997.
The principle does not extend to include income that is derived from sources outside that group.
Interest
Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year.
Interest from investments is considered to be income from outside of the group as it is derived from the investments rather than the individual members. Therefore, interest income is regarded as ordinary income and consequently is assessable under subsection 6-5(2) of the ITAA 1997.
Subsection 6-5(4) of the ITAA 1997 provides that:
in working out whether you have derived an amount of ordinary income and (if so), when you derived it, you are taken to have received the amount as soon as it is applied or dealt with in any way on your behalf or as you direct.
Not for profit requirement
The basic premise of a not for profit organisation is that it is not operating for the profit or gain of its individual members, whether these gains would have been direct or indirect. This applies both while the organisation is operating and when it winds up. Any profit made by the organisation goes back into the operation of the organisation to carry out its purposes and is not distributed to any of its members. We accept an organisation as non-profit where its constituent or governing documents prevent it from distributing profits or assets for the benefit of particular people - both operating and on winding up.
The constitution (clause 53) of the Club prevents distribution to members, regardless of income source, and it is not carried on for the profit or gain of its individual members. The Club has a presence in Australia. Further, the Club carries on its activities, pursues its objectives and incurs its expenditure in Australia.
The Club satisfies the requirement to have a not for profit status.
Conclusion
In summary the principle of mutuality does not apply to receipt of investment interest because income received as a result of investing is regarded as ordinary income and is therefore assessable under subsection 6-5(2) of the ITAA 1997.
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