Edited version of your written advice

Authorisation Number: 1051479394421

Date of advice: 5 February 2019

Ruling

Subject: Assessable income, franking credits and frankable distributions

Question 1

Will distributions by Co-operative Limited from its non-mutual surplus result in Co-operative Limited’s mutual receipts being assessable income under section 6-5 or section 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Will a franking credit arise under section 205-15 of the ITAA 1997 as and when Co-operative Limited makes a payment of income tax?

Answer

Yes.

Question 3

Will a distribution by Co-operative Limited from its mutual surplus be a frankable distribution under section 202-40 of the ITAA 1997, and be taken to be a dividend paid by Co-operative Limited to the Members under Division 7A of Part III of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

Question 4

Will a distribution by Co-operative Limited from its non-mutual surplus be a frankable distribution under section 202-40 of the ITAA 1997, and the distribution franked under section 202-5 of the ITAA 1997?

Answer

Yes.

Question 5

Will a distribution from Co-operative Limited its Bad Debts Fund result in the mutual receipts of Co-operative Limited being assessable income under section 6-5 or section 6-10 of the ITAA 1997?

Answer

No.

This ruling applies for the following periods:

A number of income years

The scheme commenced on:

1 July of an income year

Relevant facts and circumstances

Background

1. Co-operative Limited is an Australian resident company at all times.

2. Co-operative Limited is a co-operative registered under the relevant state legislation.

3. Co-operative Limited is a distributing co-operative, and is not a private company, a friendly society dispensary, a mutual insurance company, or a trustee of a trust.

4. The shares of Co-operative Limited are not quoted for sale or purchase at any stock exchange or in any other public manner.

5. According to The Rules of Co-operative a ‘Member’ is a shareholder of Co-operative Limited.

6. The object of Co-operative Limited is the provision of credit management services Members.

Credit management services

7. Members are required to prepare and deliver a weekly statement of their credit sales to Co-operative Limited made in the previous week. Co-operative Limited processes this information and sends a statement to buyers of goods on a regular basis.

8. Co-operative Limited charges Members and Members pay service fees on a regular basis.

9. Members can be buyers of goods; however, some buyers are also non-members.

10. Each buyer statement issued shows the respective amounts due to the various Members and the fees due to Co-operative Limited.

11. When Co-operative Limited receives payments from buyers, it holds the payments for the relevant Members in an interest-bearing bank account in the name of Co-operative Limited, on which Co-operative Limited derives interest, until such a time the funds are remitted to the relevant Members.

12. Given the delay between the time at which the buyers pay their debts and the time the funds are remitted to the relevant Members, there will be money on deposit in Co-operative Limited’ bank account, for a period of time.

Bad Debt Fund

13. Co-operative Limited operates a Bad Debt Fund.

14. Each year, Co-operative Limited may set aside funds from Member contributions in a Bad Debt Fund governed by the Fund Policy.

^15. A distribution of an amount from the Bad Debt Fund by Co-operative Limited to a Member is governed by the Fund Policy.

16. The Fund Policy states that only Members may participate in distributions from the Bad Debt Fund.

17. The operation of the Bad Debt Fund is largely at the discretion of Co-operative Limited’s Directors.

18. The Bad Debt Fund is to be built up with Member’s contributions over a specified period, at the end of which any Bad Debt Fund surplus is returned to Members.

Receipts

19. Co-operative Limited receives receipts for the activities it undertakes that Co-operative Limited determines to be either mutual receipts or non-mutual receipts.

20. Co-operative Limited’s mutual receipts mostly comprise of Member management fees. These fees are calculated as a fixed percentage of the Member’s credit sales processed by Co-operative Limited.

21. Co-operative Limited’s non-mutual receipts (non-membership contributions) mainly comprise of interest.

22. Co-operative Limited:

● apportions outgoings between mutual receipts and non-mutual receipts

● calculates its taxable income (non-mutual surplus) on the basis of non-mutual receipts less apportioned outgoings referable to non-mutual receipts

● pays income tax on its non-mutual surplus at the appropriate corporate rate (whether as instalments or as a payment of the final balance for a relevant income year).

Rebate

23. The Rules of Co-operative Limited provides that the board of Co-operative Limited may resolve to retain all or part of the surplus arising in a financial year from the business of Co-operative Limited to be applied for the benefit of Co-operative Limited.

24. The board of Co-operative Limited may apply part of the surplus arising in a year from its business or any part of the reserves to:

● be paid to a Member by way of bonus or rebate based on the business done by the Member with Co-operative Limited; or

● be paid to a Member by way of a limited dividend for the shares held.

25. Any part of the surplus arising in any financial year from the business of the Co-operative Limited may be credited to any person who is not a Member, but is qualified to be a Member, by way of bonus or rebate in proportion to the business done between the person and Co-operative Limited, if the person was a Member at the time the business was done and the membership has since lapsed.

26. Co-operative Limited has made distributions from its non-mutual surplus (which includes non-mutual surplus accumulated from prior income years). In accordance with the Rules of Co-operative Limited, a distribution (by way of rebate) from the non-mutual surplus is also based on the business turnover undertaken by the relevant Member with Co-operative Limited. A current Member and a former Member are eligible to participate in any distributions from non-mutual surplus.

Assumption

27. Co-operative Limited’s mutual receipts will remain below 90% of the total value of its receipts from the rendering of services for the purposes of section 118 of the Income Tax Assessment Act 1936 for each relevant income year.

Relevant legislative provisions

Income Tax Assessment Act 1936 Subsection 6(1)

Income Tax Assessment Act 1936 Division 7A of Part III

Income Tax Assessment Act 1936 Division 9 of Part III

Income Tax Assessment Act 1936 Section 117

Income Tax Assessment Act 1936 Section 118

Income Tax Assessment Act 1936 Section 119

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Section 10-5

Income Tax Assessment Act 1997 Section 202-5

Income Tax Assessment Act 1997 Paragraph 202-5(a)

Income Tax Assessment Act 1997 Paragraph 202-5(b)

Income Tax Assessment Act 1997 Paragraph 202-5(c)

Income Tax Assessment Act 1997 Section 202-40

Income Tax Assessment Act 1997 Subsection 202-40(1)

Income Tax Assessment Act 1997 Section 202-45

Income Tax Assessment Act 1997 Paragraph 202-45(c)

Income Tax Assessment Act 1997 Paragraph 202-45(d)

Income Tax Assessment Act 1997 Paragraph 202-45(e)

Income Tax Assessment Act 1997 Paragraph 202-45(f)

Income Tax Assessment Act 1997 Subparagraph 202-45(g)(i)

Income Tax Assessment Act 1997 Subparagraph 202-45(g)(iii)

Income Tax Assessment Act 1997 Subparagraph 202-45(g)(iv)

Income Tax Assessment Act 1997 Subparagraph 202-45(h)(i)

Income Tax Assessment Act 1997 Subparagraph 202-45(h)(ii)

Income Tax Assessment Act 1997 Paragraph 202-45(i)

Income Tax Assessment Act 1997 Paragraph 202-45(j)

Income Tax Assessment Act 1997 Section 205-15

Income Tax Assessment Act 1997 Subsection 205-15(1)

Income Tax Assessment Act 1997 Subsection 205-20(3)

Income Tax Assessment Act 1997 Section 960-120

Income Tax Assessment Act 1997 Subsection 960-120(1)

Income Tax Assessment Act 1997 Subsection 995-1(1)

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 unless otherwise specified.

Question 1

Summary

Distributions by Co-operative Limited (by way of rebate) from its non-mutual surplus will not result in receipts Co-operative Limited has characterised as mutual receipts (as per the Facts) being assessable income under section 6-5 or section 6-10.

Detailed reasoning

Section 6-5 provides that your assessable income includes income according to ordinary concepts, which is called ordinary income.

Section 6-10 provides that your assessable income also includes amounts that are not ordinary income, which are called statutory income.

Section 10-5 provides a table of provisions that will include in your assessable income amounts that are not ordinary income, and vary or replace the rules that would otherwise apply for certain kinds of ordinary income.

Relevantly, section 10-5 refers to section 119 of the Income Tax Assessment Act 1936 (ITAA 1936) in respect to receipts of a co-operative company.

Co-operative companies

Section 119 of the ITAA 1936, contained within Division 9 of Part III, provides what is included as assessable income for a co-operative company.

Section 117 of the ITAA 1936 defines a ‘co-operative company’ for the purposes of Division 9 of Part III.

Co-operative Limited satisfies the definition of a co-operative under section 117 of the ITAA 1936.

However, section 118 of the ITAA 1936 provides that if, in the ordinary course of business of a company in the year of income, the amount of its receipts from the rendering of services to shareholders is less than 90% of the receipts from the rendering of services, that company shall in respect of that year be deemed not to be a co-operative company.

As stated in the Facts, the value of Co-operative Limited’s receipts from rendering services to its Members is less than 90% of the total value of its receipts from the rendering of services in each of the relevant income years.

As such, Co-operative Limited is deemed not to be a co-operative company for the purposes of Division 9 of Part III of the ITAA 1936.

Accordingly, Co-operative Limited’s assessable income under section 6-5 and 6-10 is not affected by section 119 of the ITAA 1936.

Effect of distributions on mutual receipts

The principle of mutuality is a common law doctrine based on the premise that an organisation cannot derive income from itself. The principle provides that where a number of people 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.

Each transaction needs to be examined to determine whether a particular dealing is mutual.

As stated in the Facts:

● Co-operative Limited receives receipts for the activities it undertakes

● Co-operative Limited has determined that it receives mutual receipts (Member contributions) that mostly comprise of Members management fees

● Co-operative Limited has determined that it receives non-mutual (non-membership contributions) that mainly comprise of interest.

Distributions by Co-operative Limited (by way of rebate) from its non-mutual surplus will not affect the nature of Co-operative Limited’s dealings, nor will they affect Co-operative Limited’s characterisation of receipts under the principle of mutuality.

Conclusion

On this analysis, distributions by Co-operative Limited (by way of rebate) from its non-mutual surplus will not result in receipts Co-operative Limited has characterised as mutual receipts (as per the Facts) being assessable income under section 6-5 or section 6-10.

Question 2

Summary

A franking credit will arise under section 205-15 as and when Co-operative Limited makes a payment of income tax.

Detailed reasoning

Subsection 205-15(1) sets out when a credit arises in the franking account of an entity and the amount of the credit. The credit is called a ‘franking credit’.

Item 2 of the table contained within subsection 205-15(1) provides that a credit arises in the franking account of an entity if the entity:

● pays income tax

● satisfies the residency requirement for the income year for which the tax is paid

● is a franking entity for the whole or part of that income year.

Pays income tax

Subsection 205-20(3) provides that an entity pays income tax, only if it has a liability to pay the income tax (excluding voluntary payments), and that entity makes a payment (in whole or part) or a credit or a running balance account is applied to discharge or reduce that liability.

Co-operative Limited receives non-mutual receipts (non-membership contributions) that mainly comprise of interest.

Co-operative Limited pays income tax (whether as instalments or as a payment of the final balance for a relevant income year) on the non-mutual surplus (non-mutual receipts less apportioned outgoings referrable to non-mutual receipts) at the appropriate corporate rate.

Therefore, Co-operative Limited is an entity that pays income tax for the purposes of Item 2 of the table contained within subsection 205-15(1).

Residency requirement

Co-operative Limited is a resident Australian company at all times.

As such, Co-operative Limited satisfies the residency requirement for the purposes of Item 2 of the table contained within subsection 205-15(1).

A franking entity

Co-operative Limited is a corporate tax entity as it is a company, and is not a life insurance company that is a mutual insurance company nor is it a trustee of a trust at the relevant time.

As such, Co-operative Limited is a ‘franking entity’ for the purposes of Item 2 of the table contained within subsection 205-15(1).

Conclusion

Based on the above analysis, Co-operative Limited satisfies all the conditions set out in Item 2 of the table contained within subsection 205-15(1).

As such, a franking credit will arise under section 205-15 as and when Co-operative Limited makes a payment of income tax.

Question 3

Summary

A distribution (by way of rebate) by Co-operative Limited from its mutual surplus will not be a ‘frankable distribution’ under section 202-40, and will not be taken to be a dividend paid by SMCS to its Members pursuant to Division 7A of Part III of the ITAA 1936.

Detailed reasoning

Frankable distribution

Subsection 202-40(1) provides that a distribution is a ‘frankable distribution’, to the extent that it is not unfrankable under section 202-45.

Subsection 995-1(1) states a ‘distribution’, by a corporate tax entity, has the meaning given by section 960-120.

Section 960-120 sets out what constitutes a distribution by various corporate tax entities.

Co-operative Limited is a corporate tax entity as it is a company.

Item 1 of the table within subsection 960-120(1) provides that when the corporate tax entity is a company, a dividend, or something that is taken to be a dividend, under the Act will constitute a distribution.

Subsection 995-1(1) relevantly provides that ‘dividend’ has the meaning given by subsection 6(1) of the ITAA 1936.

Dividend for the purposes of subsection 6(1) of the ITAA 1936 includes any distribution made by a company to any of its shareholders, whether in money or other property and any amount credited by a company to any of its shareholder as shareholders.

Subsection 6(1) of the ITAA 1936 also defines ‘distribution’ as, ‘when used in the franking context, has the same meaning as in the ITAA 1997’ [which is given by section 960-120].

Further, subsection 6(1) of the ITAA 1936 also defines a ‘shareholder’ to include a member or stockholder. As such, a distribution to members would also be considered to be a dividend for the purposes of subsection 6(1).

In this case, Co-operative Limited makes a distribution (by way of rebate) from its mutual surplus to its Members.

Relevantly, paragraph 32 of Taxation Ruling TR 2015/3 Income tax: matters relating to strata title bodies under strata title legislation provides:

As the principle of mutuality applies to proprietors’ contributions, any distributions to proprietors that are a return of surplus contributions are not assessable income.

On this basis, a distribution of mutual surplus to members represents a return of members’ contributions and is not a dividend as the distribution does not represent a distribution of profits.

In this case, a distribution (by way of rebate) by Co-operative Limited from its mutual surplus to its Members is based on the business done by the Member with Co-operative Limited. That is, the distribution (by way of rebate) by Co-operative Limited to its Members represents a return of Members’ contributions.

Therefore the return to Members of their own contributions does not represent a distribution of profits by Co-operative Limited under subsection 6(1) of the ITAA 1936, and is not considered to be a dividend or something taken to be a dividend, for the purposes of subsection 960-120(1).

As such, a distribution (by way of rebate) by Co-operative Limited from its mutual surplus to its Members is not a frankable distribution under section 202-40.

Division 7A of Part III of the ITAA 1936

Division 7A of Part III of the ITAA 1936 (Division 7A) relates to distributions to entities connected with a private company.

Co-operative Limited is not a private company. As such, Division 7A does not apply.

Conclusion

A distribution (by way of rebate) by Co-operative Limited from its mutual surplus will not be a frankable distribution under section 202-40 and will not be taken to be a dividend paid by Co-operative Limited to its Members pursuant to Division 7A.

Question 4

Summary

A distribution by Co-operative Limited (by way of rebate) from its non-mutual surplus will be a ‘frankable distribution’ under section 202-40, and the distribution would be franked in accordance with section 202-5.

Detailed Reasoning

Frankable distribution

Subsection 202-40(1) provides that a distribution is a ‘frankable distribution’, to the extent that it is not unfrankable under section 202-45.

Distributions

As explained in the detailed reasoning at Question 3, when a corporate tax entity is a company, a dividend, or something that is taken to be a dividend, under the Act, will constitute a distribution for the purposes of section 202-45.

In this case, Co-operative Limited, a corporate tax entity that is a company, makes a distribution (by way of rebate) from its non-mutual surplus to its current and former Members.

Paragraph 33 of TR 2015/3 relevantly provides:

Any distributions to proprietors out of profits derived by the strata title body constitute dividends which are assessable income of the proprietors and are able to be franked.

On this basis, a distribution of non-mutual surplus to members represents a distribution of profits and would therefore be a dividend for the purposes of subsection 960-120(1).

In this case, Co-operative Limited makes a distribution (by way of rebate) from Co-operative Limited non-mutual surplus which represents a distribution of profit to Co-operative Limited’s current Members.

Accordingly, the distribution is considered to be a dividend or something taken to be a dividend, for the purposes of subsection 960-120(1).

As such, a distribution (by way of rebate) by Co-operative Limited from its non-mutual surplus to its current Members is a frankable distribution under section 202-40, to the extent that it is not unfrankable under section 202-45.

Distributions to former Members

The Rules of Co-operative Limited provide that former Members are entitled to receive distributions of the non-mutual surplus that has arisen during the time they were Members. Their participation as Members and consequently the value of their credit sales affected the total receipts from buyers and in turn the bank interest derived by, Co-operative Limited.

While the definition of ‘dividend’ in subsection 6(1) of the ITAA 1936 refers to the distributions and amounts credited by a company to any of its shareholders, the word ‘shareholder’ is defined to include members and stockholders. While former Members are not current Members, the former Members would be entitled to any part of the surplus arising at the time they were a qualified Member.

Accordingly, a distribution by Co-operative Limited from the non-mutual surplus to the former Members will be in the nature of a dividend paid out of profits and as such it is a frankable distribution under section 202-40, to the extent that it is not unfrankable under section 202-45.

Unfrankable distribution

Section 202-45 lists the types of distributions that are classified as unfrankable distributions.

In accordance with the Facts that apply to Co-operative Limited, a distribution to current and former Members from Co-operative Limited’s non-mutual surplus will not satisfy any of the definitions of an unfrankable distribution in section 202-45.

On this basis, a distribution (by way of rebate) from Co-operative Limited’s non-mutual surplus to Co-operative Limited’s current and former Members will not be unfrankable.

Therefore, a distribution (by way of rebate) from the non-mutual surplus of Co-operative Limited to its Members represents a dividend and the distribution will be a frankable distribution.

Franking a frankable distribution

Section 202-5 provides that an entity franks a distribution if it satisfies the residency requirement when the distribution is made, the distribution is a frankable distribution and the entity allocates a franking credit to the distribution.

As determined in Question 2, Co-operative Limited is a franking entity that satisfies the residency requirement when the distribution is made, therefore paragraph 202-5(a) is satisfied.

Further, as determined above, a distribution by Co-operative Limited to both current and former Members from its non-mutual surplus will be a frankable distribution. Therefore, paragraph 202-5(b) is satisfied.

Accordingly, Co-operative Limited may allocate a franking credit to the distribution under paragraph 202-5(c) allowing it to frank a distribution of its non-mutual surplus to both its current and former Members who are entitled to receive the distribution.

Conclusion

A distribution by Co-operative Limited (by way of rebate) from its non-mutual surplus will be a frankable distribution under section 202-40, and the distribution would be franked in accordance with section 202-5.

Question 5

Summary

A distribution from Co-operative Limited’s Bad Debt Fund will not result in receipts Co-operative Limited has characterised as mutual receipts (as per the Facts) being assessable income under section 6-5 or section 6-10.

Detailed reasoning

As explained in the detailed reasoning at Question 1, in respect to the principle of mutuality, each transaction needs to be examined to determine whether a particular dealing is mutual.

As stated in the Facts:

● Co-operative Limited has determined that it receives mutual receipts (Member contributions) that mostly comprise of Members management fees

● Co-operative Limited operates a Bad Debt Fund

● only Members may participate in distributions from Co-operative Limited’s Bad Debt Fund

● any Bad Debt Fund surplus is returned to Members.

A distribution from Co-operative Limited’s Bad Debt Fund will not affect the nature of Co-operative Limited’s dealings, nor will it affect Co-operative Limited’s characterisation of receipts under the principle of mutuality.

Conclusion

On this analysis, a distribution from Co-operative Limited’s Bad Debt Fund will not result in receipts Co-operative Limited has characterised as mutual receipts (as per the Facts) being assessable income under section 6-5 or section 6-10.

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