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Ruling

Subject: Principle of Mutuality

Mutuality principle

Question 1

Are the fees received by the Entity assessable income under section 6-5 or section 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 2011

Year ended 30 June 2012

The scheme commences on:

1 July 2010

Relevant facts and circumstances

Corporation

1.1. The Entity is a company incorporated in Australia

Description of the Organisation

2.1. The Entity is an open, membership-based, not-for-profit organisation (noting that the term "not- for-profit" is used in a purely everyday sense, and in no way indicates that the organisation considers itself as non-profit for tax purposes).

2.2. The Entity provides shared public resources

2.3. The Entity does not sell, or offer for sale, any resources. It registers the right to use those resources according to policies set by the community who use them.

Membership of the Entity

3.1. Membership of the Entity is allowed to organisations who have applied under the the Entity's Membership Agreement ("Members"), and Members consist of a range of bodies interested in the resources.

All members have equal access to all of the membership benefits, regardless of their membership tier.

3.2. The Entity recognises that some organisations wish to be allocated resources without becoming full Members. As such, these organisations are entitled to apply for allocations as 'Non-Member Account Holders'.

Fee structure

4.1. An organisation must pay a membership fee to become a new Member.

4.2. To be initially allocated resources, an organisation must pay a one-off allocation fee, the amount of which depends on the type of resources being allocated. Fees are not charged for subsequent resource allocations.

4.3. Annual fees are payable by Members on the member's anniversary. The annual fee is assessed based on the number and type of resources allocated to the Member on the anniversary date. If a Member fails to remain financial, the resources allocated to the Member will be revoked.

4.4. The amount of the application fee Non-Member Account Holders pay to be allocated resources is generally slightly greater than the corresponding member application fee. Likewise, the annual membership fee is assessed differently.

4.5. The Entity's Articles of Association states that upon dissolution or liquidation, any surplus funds attributable to contributions of members are to be returned to those members in proportion to the amounts contributed by each member.

4.6. Non-Member Account Holders are neither eligible to vote on the governing body of the Entity nor entitled to participate in a distribution of the assets of the Company (both capital and surplus) in a winding up.

Relevant legislative provisions

Section 6-5 of the Income Tax Assessment Act 1997

Section 6-10 of the Income Tax Assessment Act 1997

Reasons for decision

Section 6-5 and section 6-10 of the ITAA 1997 provides that assessable income of a taxpayer includes income according to ordinary concepts (ordinary income) and statutory income.

However, income derived that is a 'mutual receipt' will not be assessable under section 6-5 or section 6-10 of the ITAA 1997.

Mutuality Principle

The principle of mutuality is a legal principle established by case law. It is based on the proposition that a taxpayer cannot derive income from itself. The principle provides that where a number of persons contribute to a 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 ordinary income.

In Bohemian Club v The Acting Federal Commissioner of Taxation (1918)

24 CLR 3374 it was held that unexpended contributions were not income of the club, merely contributions of capital for a common purpose intended to defray expenses. Any unexpended amount was not income or profits but savings which the members may claim to be returned.

For the principle of mutuality to apply there must be a common fund and the fund must be owned or controlled wholly by the contributors (Revesby Credit Union Co-operative Ltd v FC of T (1965) 13 ATD 449). A mutual relationship must exist between the contributors and the benefactors of the common fund such that all contributions to the fund are applied for their collective benefit, in line with the common 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 (Municipal Mutual Insurance Ltd v Hills (1932) 16 T.C. 430). It is essential 'that at any given moment of time the persons who are contributing must be identical with the persons who are entitled to participate' (Faulconbridge v National Employers' Mutual General Insurance Association Ltd (1952) 33 T.C. 103, at 125).

Accordingly, the following concepts are essential elements of the principle of mutuality to apply:

(a) there is a common purpose;

(b) contributions to a common fund to give effect to that purpose;

(c) ownership and control of the fund must vest in the contributors; and

(d) contributors to the common fund must be entitled to participate in any surplus and all participators in the surplus must be contributors to the common fund.

The legal structure of the entity (incorporated or otherwise) is not a decisive factor in determining whether the principle of mutuality applies. The mutuality principle may still apply notwithstanding that the entity is a corporation. This is because a corporation is merely an entity that is used for the benefit of the members (Royal Automobile Club of Victoria v. FC of T 4 ATR 567; 73 ATC 4153). This is supported by Gibbs J in Social Credit Savings & Loans Society Ltd v FC of T 71 ATC 4232 at 4238, who stated that the mutuality principle may apply notwithstanding that the people thus associated have been incorporated, for the corporation is treated as a "mere entity for the convenience of the members..., as an instrument obedient to their mandate".

The relevance of membership to the principle of mutuality was considered in Inland Revenue Commissioners v Ayrshire Employers Mutual Insurance Association Ltd (1946) 1 ALL ER 637 where it was held that it is not membership or non-membership which determines immunity from liability to tax; it is the nature of the transactions. If the transactions are of the nature of (in this case) mutual insurance, the resultant surplus is not taxable whether the transactions are with members or non-members.

This approach was adopted in Royal Automobile Club of Victoria v FC of T 4 ATR 567; 73 ATC 4153) where the taxpayer was a company limited by guarantee that provided certain services and facilities in relation to motor vehicles. They received payments from a number of sources including both members and non-members in relation their services and facilities, together with commissions, interest on investments and rent from property. The Court looked at each activity to determine if it had the quality of mutuality. It was held that mutual dealings and business dealings had to be distinguished and apportionment applied. Activities relating to business dealings were considered in the nature of trade and assessable, while activities that were mutual in nature, were mutual receipts even if only some members took advantage of the facility.

Therefore, an entity to which the principle of mutuality applies may also receive nonmember income without jeopardising the application of the principle. It may be necessary for an entity to separate the funds which consist of mutual receipts from other receipts.

Application to the Entity

If the elements of a 'mutual arrangement' are present, then principle of mutuality will apply to those activities that are of a mutual nature.

(d) there is a common purpose;

The By-laws of the members of the Entity have associated in order to access resources. They also seek to develop public policies and public positions in the best interest of the Members and to seek legislative and regulatory consideration of issues of general benefit to the members.

(e) contributions to a common fund to give effect to that purpose

Pursuant to the membership agreement:

§ All members are required to pay all fees and charges due to the Entity.

§ The membership fees are contributions to a common fund and in return members have access to the resources and services provided by the Entity. There is no restriction on the level of resources or services provided regardless of the level of membership.

(f) ownership and control of the fund must vest in the contributors

The members determine the general policies for fulfilling the objects of the Entity. The members of the Special Committee have control of the common fund into which they contribute.

Pursuant to the Entity's Membership Agreement, all members are entitled to utilise the resources and services provided. There is no restriction on the level of resources or services provided regardless of the level of membership. All levels of members are treated as a single class, as distinct from classes with different entitlements.

(e) contributors to the common fund must be entitled to participate in any surplus and all participators in the surplus must be contributors to the common fund;

The contributing Entity's members are also the beneficiaries of the common fund. Pursuant to the Articles of Association, any surplus in the fund would in the event of dissolution be distributed among the members in proportion to the amounts contributed by each member. As such the contributors to the common fund and the beneficiaries of it are identical as a class. Non-Member Account Holders are not entitled to participate in the return of surplus funds.

Conclusion

The fees payable by members are contributions to a common fund for a common purpose and ownership and control is vested in members. Upon dissolution of the Entity, the members are entitled to the distribution of surplus funds in proportion to their actual contribution.

In view of the above, it is accepted that principle of mutuality applies to the Entity, such that the receipts from members are treated as mutual receipts and is not assessable under section 6-5 as ordinary income and 6-10 of the ITAA 1997 as statutory income.

Additional comments

Non Member receipts

Non member revenue derived by the Entity are assessable income and reduced by deductible expenses apportioned on the basis of member and non-member receipts.