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Ruling

Subject: Income tax exemption and mutuality principle

Question 1

Is the company exempt from income tax pursuant to the provisions of section 50-1 of the Income Tax Assessment Act 1997 on the basis that it is a society, association or club established for community services purposes (except political or lobbying purposes) under item 2.1 of the table in section 50-10 of the Income Tax Assessment Act 1997?

Answer

No.

Question 2

Are the membership fees paid by members of the company subject to the principles of mutuality?

Answers

No.

This ruling applies for the following periods:

April 2009 to 30 June 2009

Year ended 30 June 2010

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

The scheme commences on:

On or after 1 April 2009

Relevant facts and circumstances

The company has applied for a private ruling seeking income tax exemption pursuant to item 2.1 of the table in section 50-10 of the Income Tax Assessment Act 1997 (ITAA 1997).

If the company is not exempt from income tax it seeks to know if the mutuality principle applies to receipts from members in respect of:

· dealings for membership; and

· goods or services provided by an entity in mutual dealings in pursuance of one of its purposes.

The company has an ABN.

It is an Australian Public Company limited by guarantee, pursuing its activities wholly within Australia. It is the holding company of another company (the child company), which is itself exempt from income tax pursuant to item 2.1 of the table in section 50-10 of the ITAA 1997.

The company was established in 2009. In 2011, the objects clause of the company was amended to ensure that its primary object was clearly identified. The revised clause is identical to those of the child company.

The company's Constitution provides appropriate non-profit and winding-up clauses.

The company was established to build and improve a community sector characterised by financial inclusion and capability, by supporting the activities of its 100% owned subsidiary (the child company).

The company states that its principal activity is to support and promote the activities of the child company by providing funding as well as promoting the activities of the child company in its charitable endeavours. Consequently the company argues that its activities ultimately benefit the community, since the child company has been determined to be a community services organisation by the ATO.

The company has no employees, with its only representatives being its honorary Board members. Both the company and the child company have common membership of the Board.

The day to day activities of the company are undertaken by the child company staff. The majority of its events also involve the child company. Funds raised through these events and memberships are intended for use by the child company in delivery of its services to the public. For instance, the company promotes the research of the child company so as to connect its members, which will ultimately distribute the research, to the peer groups, individuals, social purpose businesses, government and community sector organisations.

The company's main source of income is from membership fees. The members of the company have a common purpose and interest of helping to promote an support the activities of the child company. Some members also provide goods and services in pursuance of these purposes.

Relevant legislative provisions

Section 50-1 of the Income Tax Assessment Act 1997

Section 50-10 of the Income Tax Assessment Act 1997

Section 50-70 of the Income Tax Assessment Act 1997

Section 59-35 of the Income Tax Assessment Act 1997

Reasons for decision

Question 1

Item 2.1 of the table in section 50-10 of the ITAA 1997 in conjunction with section 50-1 of the ITAA 1997, provides that the total ordinary income and statutory income of a society, association or club established for community service purposes (except political or lobbying purposes) is exempt from income tax, subject to the special conditions detailed in section 50-70 of the ITAA 1997.

Accordingly to be an entity described in item 2.1, the entity must:

· Be a society, association or club;

· Be established for community service purposes (except political or lobbying purposes); and

· Satisfy the special conditions in section 50-70 of the ITAA 1997.

Society, Association or Club

The words 'society', 'association' or 'club' are not defined in the ITAA 1997 and have their ordinary meaning.

The Shorter Oxford English Dictionary defines 'association' to be 'a body of persons associated for a common purpose; the organisation formed to effect their purpose'. The Macquarie Dictionary defines it as 'an organisation of people with a common purpose and having a formal structure'. 'Society' has an equivalent meaning (Pro-campo Ltd v. Commr of Land Tax (NSW) 81 ATC 4270 at 4279; (1981) 12 ATR 90 at 35).

This approach is also confirmed in Taxation Determination TD 95/56, which refers to the decision by Olsson J, in Quinton v. South Australian Psychological Board (1985) 38 SASR 523, who also stated that the term 'association' has come to be regarded as attaching to a body of persons associated for a common purpose.

The Macquarie Dictionary defines 'club' as a 'group of persons organised for a social, literary, sporting, political, or other purpose, regulated by rules agreed by its members'.

The interpretations of 'society', 'association' or 'club' as described above, emphasise on a 'body of persons' and 'an organisation of people' with a 'common purpose'.

The company is registered as a public company limited by guarantee and is an organised body of members instituted for the objects as per its constitution

It is accepted that the company is an association, society or club.

Political or Lobbying Purposes

The Explanatory Memorandum to Taxation Laws Amendment Bill (No. 2) 1990 confirms the words 'political or lobbying purposes' to mean:

Political or lobbying purposes include standing candidates for election, campaigning for changes to the law or to government policy, and the like. Community service organisations may engage in political or lobbying activities, provided these are no more than merely incidental to other purposes beneficial to the community. But a body will be unable to claim exemption from income tax under this subparagraph if its only undertakings for the benefit of the community are political or lobbying ones.

From the information provided, the company appears to have a minor role in advocating to government. However, from the information provided these activities are relatively minor and considered to be incidental to the company carrying out its objects.

The company has not been established for political or lobbying purposes.

Established for Community Service Purposes

For an organisation to exist for community service purposes its purposes must be altruistic as per Taxation Determination 93/190 -'Income tax: what is the scope of the exemption from income tax provided by subparagraph 23(g)(v) of the Income Tax Assessment Act 1936?' (TD 93/190) which states:

3. The Explanatory Memorandum to section 23(g)(v) of the Act confirms that the words 'community service purposes' are to be given a wide interpretation. Those words extend to a range of altruistic purposes which are not otherwise charitable, such as promoting, providing or carrying out activities, facilities or projects for the benefit or welfare of the community or any members of the community who have a particular need by reason of youth, age, infirmity or disablement, poverty, or social or economic circumstances.

4. However, the provision does not give exemption from income tax to a broad range of organisations that are established within the community, but whose purposes are not of an altruistic nature. Altruistic purposes are an essential element of even the widest interpretation of 'community service purposes.'

5. It is not accepted that common association as such is altruistic. Neither the purposes of members, nor the purposes of their organisation, are altruistic merely because the members form a non-profit association to advance their common interests. Members who seek to advance their common interests are not therefore motivated by an unselfish regard for others, and neither is their organisation. It follows that an organisation established for the purposes of its members is not therefore established for community service purposes. Only when the purposes of the organisation are altruistic can they be community service purposes.

Therefore, to be considered an organisation established for community service purposes, the organisation's activities must be directed to altruistic purposes. Altruistic purposes are directed for the benefit or welfare of the community or any members of the community who have a particular need by reason of youth, age, infirmity or disablement, poverty, or social or economic circumstances. That is, a community services organisation is expected to serve at least a particular group in need such as those expressed in paragraph 3 of TD 93/190.

In the company's case it was established to support and promote the activities of its 100% owned subsidiary company (the child company). The child company has previously been determined to be a community services organisation pursuant to item 2.1 of the table in section 50-10 of the ITAA 1997. Consequently the company has argued that it ultimately benefits the community, via its support of the child company.

However, the fact that an entity is exempt from income tax does not mean that exemption flows to related entities. Taxation Ruling TR 2005/22 Income tax: companies controlled by exempt entities, concerns the income tax exemption under Division 50 of the ITAA 1997 of companies and the exemption status of companies controlled by them.

Although in the company's case it is the controlling entity of an income tax exempt company (rather than the other way around), the principles of TR 2005/22 nonetheless apply. Paragraph 16 of TR 2005/22 explains that the characteristics and purposes of an exempt entity cannot be attributed to another company because it is related or connected in some way.

Paragraph 18 of TR 2005/22 states that the following features on their own are insufficient to determine whether a company is covered by the tables in Division 50:

· control of the company by an exempt entity or entities;

· common membership of the board of both the company and the exempt entity;

· use of the company's surplus funds for exempt entities or their purposes;

· the commitments of members of the company being related to those of an exempt entity or entities;

· common motives inspiring the company and associated exempt entities;

· the providing of free services to associated exempt entities; and

· the holding of property by the company on trust for exempt entities.

Paragraph 30 of TR 2005/22 further explains:

To focus on the character of the relevant entity itself, means that a 'look through' approach is not appropriate. A 'look through' approach would ignore the character of the relevant entity. That is, it would focus only on the controlling body and not on the relevant entity itself. Such an ignoring of the features and circumstances of the relevant entity is not consistent with the legislative requirements of Division 50. The items require that the entity itself meet the conditions. The court cases on Division 50 and its predecessor provisions have not ignored the relevant entity. Rather, they demonstrate the relevance of the entity's own features.

In essence therefore, all the relevant circumstances of a company are to be taken into account in determining whether it satisfies the particular legislative requirements for exemption. It is not sufficient for an entity with which the company has a connection or relationship to be exempt from income tax.

This view is reinforced in Glebe Administration Board v. Commissioner of Pay-roll Tax (NSW) ²⁰ (see paragraphs 28 and 29 of TR 2005/22) where the relationship between the Board and a religious institution was described in this way:

... a religious institution, the Church of England Diocese of Sydney, had been given power by statute to confer by its own ordinance management powers of a commercial kind upon the Board as a corporate body. Thus the religious institution was enabled to, and did, create an entity controlled by, but distinct from, the religious institution, namely a non-religious Board whose duty was to raise money in a commercial way, for the purposes of the religious institution.

29. The character of the Church of England Diocese of Sydney was not attributed to the Board it had established and controlled. Rather, the Board was held to not be a religious institution. This was because, on a consideration of the Board itself, it did not have this character. The character of the body that formed and controlled it was not determinative. The Board did not have a constitution or charter giving it any religious purposes. It was the Church of England that had the religious purposes and the power to require the Board to remit funds from time to time to carry out those purposes.

In short, it cannot be said that the income of the company is exempt merely based on the fact that it controls the child company. The company must satisfy the meaning of a community services organisation in its own right, independent of its connection with the child company.

It is the company's purposes, characteristics and activities that must be examined. That is, the company's activities must be directed to altruistic purposes for the benefit or welfare of the community or any members of the community who have a particular need by reason of youth, age, infirmity or disablement, poverty, or social or economic circumstances. It is expected to serve at least a particular group in need such as those expressed in paragraph 3 of TD 93/190.

The company states that its principal activity is to support and promote the activities of the child company by providing funding as well as promoting the activities of the child company in its charitable endeavours. As such it does not direct its activities towards altruistic purposes for the benefit or welfare of the community. It directs them at the child company.

That is, the company does not serve a particular group in need such as those expressed in paragraph 3 of TD 93/190, but rather exists to advance the interests of the child company. While there are ultimately flow-on benefits for the broader community, as per the principles of TR 2005/22 this does not entitle the company to income tax exemption as a community services organisation.

Special conditions

Section 50-70 of the ITAA 1997 states that an entity covered by item 2.1 is not exempt unless it is not carried on for the purposes or gain of its individual members, and:

· It has a physical presence in Australia, and to that extent it pursues its objectives and incurs its expenditure principally in Australia; or

· It is a deductible gift recipient; or

· It is prescribed by law in the income tax regulations and it is located outside Australia and is exempt from income tax in its country of residence.

The company amended its constitution in 2011 to include acceptable non-profit and dissolution clauses. It is considered that the company was a non-profit association from this time.

The company is an organisation which is physically present in Australia and which pursues its objectives and incurs its expenditure principally in Australia.

The company therefore meets the special conditions of section 50-70 of the ITAA 1997.

Conclusion

The company is a non-profit association which satisfies the special conditions of section 50-70 of the ITAA 1997. However it is not a community services organisation, since it is not altruistic in nature. It was established primarily for the purpose of advancing the interests of the child company.

Accordingly the company is not a community services organisation and is not exempt from income tax pursuant to section 50-1 of the ITAA 1997.

Question 2

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. This is because it merely represents, in substance, the contributors' own unexpended money.

Whether a mutual association exists between persons depends upon the nature of their relationship, and whether amounts are accretions to a common fund depends on the nature of their transactions and dealings.

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).

A mutual association has all of the following essential 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 (merely to cover expenses);

· 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 s59-35 of the 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.

In the company's case it is accepted that members have a common purpose, without profit-making intent, being to promote and support the activities of the child company.

As stated by the company however, funds raised through memberships are intended for use by the child company in delivery of its services to the public. The fees therefore become part of the pool of funds to be used for the company's primary activity - to promote and support the activities of the child company.

The company members can not be said to collectively benefit from their membership fee contribution (nor goods or services provided by any member in pursuance of one of the company's purposes). That is, any surplus created by the fees (or provision of goods or services) would at no time belong to the contributors since in effect their fees are paid to benefit the child company. There is no identity as a class between the contributors and the participators. That is, the contributors are the members of the company whereas the participator is the child company. There is therefore no reasonable relationship between what a member contributes and what the member may be expected or entitled to receive in respect of the common fund.

Conclusion

Under the principle of mutuality, all or essentially all, of the contributors to a common fund must be entitled to participate in any surplus of the common fund. In the case of the company none of the contributors, being the members, will be entitled to participate in any surplus created by their membership fees, since these are directed to the ultimate benefit of the child company. Accordingly the membership fees received by the company from its members will not be entitled to the benefits of mutuality.