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Ruling

Subject: Principle of Mutuality

Question 1

Does the principle of mutuality apply to the subscription fees described below and received by the Rulee for providing services to its member funds?

Question 2:

Does the principle of mutuality apply to amounts received by the Rulee for services provided to its non-members, being services identical to those provided to its members?

Question 3:

Is interest received on bank deposits held by the Rulee, non-mutual receipts and therefore assessable income for income tax purposes?

Answer 1:

Yes

Answer 2:

No

Answer 3:

Yes

This ruling applies for the following periods:

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

The scheme commences on:

1 July 2011

Relevant facts and circumstances

Membership to the Rulee is restricted to registered private health funds.

The Rulee constitution contains the following clauses

Non-profit

6 No profits for Members

Transfer of income or property

6.1 No income or property of the Company may be paid or transferred, directly or indirectly to any Member.

Winding up

17 Surplus assets on winding up or dissolution

17.1 Upon the winding up or dissolution of the Company, any remaining property after satisfaction of all debts and liabilities, will be distributed among the Members in such manner as determined by the Members at or before the time of dissolution. In the event that the Members cannot agree on the distribution of any property, the property will be distributed among the Members in proportion to their annual subscriptions paid during the 12 months prior to the winding up or dissolution.

Member Services

The Rulee provides a mix of services to its members including negotiating business partnerships and collection, analysis, dissemination of medical and hospital data.

Non-Members

The Rulee provides member services to one Non-member fund.

The Non-member fund is prohibited from becoming a member of the Rulee

The Rulee and Non-member fund sign an Agency Agreement, which gives the Rulee the authority to act on behalf of the Non-member fund.

The Rulee provides the same services to the Non-member fund as it does to its members.

The Non-member fund does not participate in any surplus upon the winding up or dissolution of the Rulee.

Relevant legislative provisions

Section 6-5 of the Income Tax Assessment Act 1997

Section 59-35 of the Income Tax Assessment Act 1997

Reasons for decision

Question 1

Summary of decision

The subscription fees received by the Rulee for providing services to its member funds are not ordinary income by virtue of the principle of mutuality.

Detailed reasoning

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that assessable income includes income according to ordinary concepts, which is called ordinary income.

The principles and tests for ascertaining whether a receipt is income according to ordinary concepts have been laid down by the courts over the years. One of these principles is the principle of mutuality.

The principle of mutuality is based on the proposition that a taxpayer cannot derive income from itself. Under that principle receipts derived by a taxpayer from mutual dealings with its members are not assessable income. Such receipts are called mutual receipts. Mutual receipts may include member subscriptions.

The principle was established in New York Life Insurance Company v. Styles (1889) 14 App. Cas. 381. There the sole 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 (at p. 394):

``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.''

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.

However not all member contributions are mutual dealings; see FC of T v. Australian Music Traders Association per Davies J at ATC 4538:

It is not in dispute that the taxpayer, Australian Music Traders Association, is a mutual association for the purposes of that principle or that many of its receipts are of a mutual character. But, as was pointed out in Sydney Water Board and in R.A.C.V., the fact that an organisation is a mutual organisation does not mean that all of its receipts, even receipts from members, are within the principle. An activity may or may not be undertaken on a mutual basis.

Thus, in a social club, one finds a number of persons associated together, not to trade with each other or for profit, but to acquire and maintain a social facility benefiting all members. In mutual insurance, one finds a common fund in which all contributors are entitled to participate more or less equally having regard to their contributions and contractual rights. Their mutual dealings do not give rise to profit. Though the concept of mutuality has not been definitively delineated, its crux is an association of persons who have joined together not for trade or profit but to achieve through their mutual contributions a common end or benefit in which all members participate or are entitled to do so.

Apart from R.A.C.V., to which the learned presidential member constituting the Administrative Appeals Tribunal does not appear to have been referred, particular mention should be made of Sydney Water Board and English and Scottish Joint Co-operative Wholesale Society Ltd. v. Commr of Agricultural Income-Tax, Assam (1948) A.C. 405. In Sydney Water Board, it was held that the interest paid by individual members on borrowings from their credit union were not contributions by those members to a common fund but simply the cost of obtaining their individual loans. In the Assam Tea case, whilst it was not in dispute that there were mutual elements in the association, it was held that the sale of tea to members of the association, who then on-sold, was a trading, not a mutual activity.

The activities with which we are concerned in this appeal centre around the holding of a music traders' trade fair. In years prior to the subject year of income, the Association itself organised the trade fairs and leased stalls to music traders. Although the rental received by the Association from such stall-holders as were members of the Association was accepted by the Commissioner of Taxation to be mutual, nevertheless, as the individual traders displayed and sold their wares to members of the public, it may be doubted whether the fairs had a mutual character. Each trader, many of whom were not members of the Association, carried on his individual business. The rental paid was calculated according to the space occupied and was the charge made for the space leased by the stall-holder for the purposes of his own business activity. Even in respect of those years, it is difficult to distinguish the facts from those which were the subject of the decisions in the Assam Tea case and Sydney Water Board.

The Rulee is carried on for the benefit of its members by way of the services it provides. The member funds also share a common purpose.

In addition, all members contribute an entrance fee upon admission to membership and an annual subscription based on the number of policies in the fund.

The constitution of the Rulee specifies that it is to receive funds and best distribute these to achieve its overall objectives and therefore the contributions are applied for the collective benefit of the members.

There is one class of membership of the Rulee and the members have ownership and control of the common fund.

Whilst the constitution prohibits the members from receiving any income or property of the Rulee, the constitution allows the members to share in any surplus after the satisfaction of all debts upon winding up.

The subscription fees received by the Rulee for providing services to its member funds are not ordinary income by virtue of the principle of mutuality.

Question 2

Summary

Contributions received by the Rulee from a Non-member fund are not subject to the principle of mutuality and therefore assessable income for tax purposes.

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 Non-member fund paid an entrance fee and continues to pay an annual fee in the same manner as the members of the Rulee. However the Non-member fund has not applied for membership and is not bound by the Rulee's constitution.

In addition, the agreement signed by the Non-member fund does not afford it any voting rights as described in the Rulee's constitution or other rights provided for in the constitution.

Accordingly any contribution received by the Rulee from the Non-member fund is not subject to the principle of mutuality and therefore assessable income for tax purposes.

Question 3

Summary

Interest from bank deposits is income from non-mutual sources and therefore assessable income for tax purposes

Detailed reasoning

The principle of mutuality does not extend to include income that is derived from sources outside the group as discussed in Taxation Ruling IT 2505, where interest and dividends from invested funds was held to be from non-mutual sources and therefore assessable income for tax purposes.

Therefore interest received on bank deposits held by the Rulee, is non-mutual receipts and therefore assessable income for tax purposes.