Edited version of your private ruling

Authorisation Number: 1012604293178

Ruling

Subject: Mutuality principle

This ruling applies to

ABCD Co-operative Limited (ABCD)

Question 1

Will a distribution by ABCD from its non-mutual surplus result in the company's mutual receipts being assessable income of ABCD under section 6-5 or 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Will a franking credit arise pursuant to section 205-15 of the ITAA 1997 as and when ABCD makes a payment of income tax?

Answer

Yes.

Question 3

Will a distribution by ABCD from its mutual surplus be a "frankable distribution" pursuant to section 202-40 of the ITAA 1997, and will it be taken to be a dividend paid by ABCD to its members pursuant to Division 7A of Part III of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

Question 4

Will a distribution by ABCD from its non-mutual surplus be a "frankable distribution" pursuant to section 202-40 of the ITAA 1997 and may it be franked in accordance with section 202-5 of the ITAA 1997?

Answer

Yes.

Question 5

Will a distribution by ABCD from its Bad Debt Fund result in the mutual receipts of ABCD being assessable income under section 6-5 or 6-10 of the ITAA 1997?

Answer

No.

This ruling applies for the following periods

The income years ended

30 June 2009

30 June 2010

30 June 2011

30 June 2012

30 June 2013

The income years ending

30 June 2014

30 June 2015

30 June 2016

The scheme commenced on

The scheme has commenced

Relevant facts

Background

It is stated that ABCD is an Australian resident company at all relevant times for Australian income tax purposes. It is also stated that ABCD is a company incorporated in Australia.

Further, it is acknowledged that ABCD is not a co-operative company within the meaning of section 117 of the Income Tax Assessment Act 1936 (ITAA 1936) by virtue of the operation of section 118 of the ITAA 1936.

Section 118 of the ITAA 1936, amongst other things, prescribes that if in the ordinary course of the business of a co-operative company in the year of income, the value of its receipts from the rendering of services to its shareholders is less than 90% of the total value of its receipts from the rendering of services the company will be deemed not to be a co-operative company.

It is stated that ABCD is not a co-operative company because it has constantly failed the 90% test.

Activities undertaken

ABCD operates a trading co-operative. ABCD provides credit management services for its members.

Members are required to prepare and deliver to ABCD a periodic statement of credit sales which is a record of credit sales made in the previous period. ABCD processes this information and sends a statement to buyers of goods on a periodic basis. Each statement is issued showing the respective amounts due to the various members.

When ABCD receives payment from buyers, ABCD holds the payment for the relevant members. This payment is deposited into an interest bearing bank account in the name of ABCD (on which ABCD derives interest), until such time as the funds are remitted to the relevant members. Given the delay between the time at which the buyers pay their debts and the time at which the funds are remitted to the relevant members, there will be money on deposit in the ABCD bank account, for a period.

Bad Debt Fund

From year to year ABCD may set aside in the accounts some funds from member contributions in a Bad Debt Fund to pay to members where a debtor fails to pay a member's invoice. The payment of amounts from the Bad Debt Fund by ABCD to members is governed by Regulations of the Bad Debt Fund and only members of ABCD may participate in payments from the Bad Debt Fund.

It is stated that any part of the Bad Debt Fund created in a year and not distributed to members in the following year in accordance with the Regulations of the Bad Debt Fund will form part of the ABCD mutual surplus for distribution to members. That is, the Bad Debt Fund will be reduced to nil at the end of the year and re-created from member contributions in the next year, as necessary.

Receipts

It is stated that members' management fees make up the majority of the mutual receipts of ABCD. These fees are calculated as a fixed percentage of the member's credit sales processed by ABCD.

The non-mutual receipts, that is, the non-member contributions mainly comprise interest.

Rebate

In accordance with the Rules of ABCD the amount of rebate paid to members from the ABCD mutual surplus, is based on the business turnover undertaken by the member with ABCD.

ABCD has also made distributions from its non-mutual surplus (which includes the non-mutual surplus accumulated from prior income years). In accordance with the Rules of ABCD, a distribution from the non-mutual surplus is also based on the business turnover undertaken by the relevant member with ABCD. Current members and former members (i.e. those persons who were members during one or more of the income years in which ABCD derived the non-mutual surplus that is the subject of the distribution) are eligible to participate in any distribution from the non-mutual surplus.

Assumptions

None made.

Relevant legislative provisions

Income Tax Assessment Act 1936

Subsection 6(1)

Division 7A

Paragraph 24J(2)(a)

Section 45

Section 45C

Section 47A

Section 103A

Subsection 103A(5)

Section 109

Section 117

Paragraph 117(1)(d)

Section 118

Section 159GZZZP

Income Tax Assessment Act 1997

Section 6-5

Section 6-10

Section 202-5

Section 202-15

Section 202-40

Section 202-45

Paragraph 202-45(b)

Paragraph 202-45(c)

Paragraph 202-45(d)

Paragraph 202-45(e)

Paragraph 202-45(f)

Subparagraph 202-45(g)(i)

Subparagraph 202-45(g)(iii)

Subparagraph 202-45(g)(iv)

Subparagraph 202-45(h)(i)

Subparagraph 202-45(h)(ii)

Paragraph 202-45(i)

Paragraph 202-45(j)

Subsection 205-15(1)

Section 205-25

Paragraph 205-25(1)(a)

Section 960-115

Section 960-120

Subsection 960-120(1)

Subsection 995-1(1)

Reasons for decision

Note: Legislative references are to provisions of the Income Tax Assessment Act 1997 unless otherwise stated.

Question 1

Summary

ABCD is deemed not to be a co-operative company by virtue of the operation of section 118 of the ITAA 1936. Thus the assessable income of ABCD is determined by reference to section 6-5 and section 6-10. However the principle of mutuality is to be considered with respect to the receipts of ABCD.

In order for the principle of mutuality to apply it is necessary that the element of identity and the element of proportion be met so ABCD is examined with respect to these features. As they are found to be present the principle of mutuality applies to the receipts of ABCD from its members.

Yet ABCD also has non-mutual receipts and this question relates to a distribution by ABCD from the non-mutual surplus to the members.

A distribution by ABCD from the non-mutual surplus will not cause the mutual receipts of ABCD to be reclassified as non-mutual receipts. The mutual receipts of ABCD will not be assessable income in terms of section 6-5 or section 6-10.

Detailed reasoning

In terms of paragraph 117(1)(d) of the ITAA 1936 ABCD is a co-operative company.

However, it is stated in the Facts above that the value of receipts from the rendering of services to members of ABCD is less than 90% of the total value of receipts from the rendering of services in each of the relevant years. Further it is likely that the same situation will prevail in each of the subsequent years.

Accordingly in terms of section 118 of the ITAA 1936 ABCD shall be deemed not to be a co-operative company in respect of all income years for which this ruling is sought.

As ABCD is not a co-operative company for the purposes of Division 9 in Part III of the ITAA 1936, the assessable income of ABCD is determined by reference to section 6-5 and section 6-10.

However, it is necessary to consider the application of the principle of mutuality.

The element of identity is required between the contributors to a fund and the participants in the surplus. The Rules of ABCD contains rules which achieve this. These rules permit a distribution of the surplus to both current and past members.

On the other hand the second element being the element of proportion requires that there be a "reasonable relationship" between the contribution of a member to an association and the amount of any actual payment by the association to the member.

The Rules of ABCD has a rule which deals with surplus funds and that rule provides for payment to a member based on the business done by the member with ABCD. Given that members shall pay service fees at the rate of $X per $Y (or part thereof) of the total value of sales processed in each period this component of the mutual receipts is likewise based upon the business done by the member with ABCD. Thus there is a "reasonable relationship" between member contribution and the actual payment by ABCD to the member. Therefore the element of proportion is satisfied.

Taxation Ruling No. IT 2505 titled "Income Tax: Bodies corporate constituted under strata title legislation" contains a discussion of the mutuality principle and at paragraph 19 it states:

19. Under the principle of mutuality, where proprietors have contributed to any administration, reserve or special purpose fund to meet common expenses, and any surplus contributions are returned to those proprietors in their capacity as contributors, such surpluses are not assessable income. However, any distributions to proprietors out of profits derived by the body corporate constitute dividends which are assessable income of the proprietors under subsection 44(1).

The basic conclusion drawn from these statements is that the nature of a mutual surplus is different from a non-mutual surplus. Likewise the law applying to a distribution from a mutual surplus to members is different from the law that applies to a distribution to members from a non-mutual surplus. The distribution from the mutual surplus is not assessable income while the distribution from the non-mutual surplus is assessable income.

These differences are such that a distribution of a non-mutual surplus to members has no bearing upon the treatment of the mutual surplus. A distribution of the non-mutual surplus does not affect the nature of the mutual surplus.

Therefore having regard to the above the mutuality principle applies to the receipts of ABCD from members. To date these receipts have been classified as mutual receipts and the mutuality principle will continue to apply to such receipts subject to there being no material change in the facts upon which this ruling is given.

However ABCD also has non-mutual receipts and this question relates to a distribution by ABCD from the non-mutual surplus to the members.

A distribution by ABCD from the non-mutual surplus will not cause the mutual receipts of ABCD to be reclassified as non-mutual receipts. The mutual receipts will not be assessable income in terms of section 6-5 or section 6-10.

Question 2

Summary

This question examines the requirements contained in interlocking provisions of the ITAA 1997 in order for a franking credit to arise. The outcome of that examination is that a credit will arise in the franking account of ABCD upon the payment of income tax by ABCD.

Detailed reasoning

Subsection 205-15(1) contains a table in which it is set out when a credit arises in the franking account of an entity and the amount of the credit.

In terms of item 2 of the table a credit arises in the franking account of the entity if the entity pays income tax and the entity satisfies the *residency requirement for the income year for which the tax is paid; and the entity is a *franking entity for the whole or part of that income year. A credit of that part of the payment that is attributable to the period during which the entity was a *franking entity arises on the day on which the payment was made.

The asterisked terms *residency requirement and *franking entity are defined in subsection 995-1(1).

The term *residency requirement has the meaning given by section 205-25.

In terms of paragraph 205-25(1)(a) an entity satisfies the residency requirement for an income year in which an event specified in a relevant table occurs, if the entity is a company, the company is an Australian resident for more than half of the 12 months immediately preceding the event if the event occurs before the end of the income year.

With respect to the credit in the franking account upon the payment of income tax, ABCD meets the residency requirement as it is a company which is incorporated in Australia and "is an Australian resident company at all relevant times, for Australian income tax purposes". That is to say it was a resident in all years from the relevant years and that it will be a resident in all subsequent years.

Section 202-15 reads:

An entity is a franking entity at a particular time if:

(a) it is a *corporate tax entity at that time: and

(b) it is not a *life insurance company that is a *mutual insurance company at that time; and

(c) in a case where the entity is a company that is a trustee of a trust - it is not acting in its capacity as trustee of the trust at that time.

A *corporate tax entity is defined in subsection 995-1(1) as having the meaning given by section 960-115.

ABCD is a corporate tax entity because one of the meanings of the term corporate tax entity is that "the entity is a company at that time".

Further ABCD is neither a life insurance company nor a mutual insurance company at that time and ABCD is not the trustee of a trust.

Accordingly, the conditions set out in item 2 in the table in subsection 205-15 are met so that a credit will arise in the franking account of ABCD upon the payment of income tax by ABCD.

Question 3

Summary

This question about the treatment of a distribution from the mutual surplus of ABCD requires that it first be ascertained whether such a distribution is a frankable distribution. It is found that it is not a frankable distribution because a distribution from the mutual surplus is not a dividend.

The application of Division 7A of the ITAA 1936 is then examined and the views put as to why Division 7A does not apply are considered. The assertion that Division 7A should not apply to the distribution by ABCD from the mutual surplus because the Commissioner should treat ABCD as a public company was not supported by argument to persuade the Commissioner to this view and hence it is rejected.

The second argument is that the distribution from the mutual surplus is analogous to a return of share capital and consequently Division 7A should not apply. This is on the basis that a return of capital is specifically excluded from the definition of a dividend in the legislation. This argument is not accepted. The nature of a discretionary distribution of an amount which is excess to needs is different from a return of share capital contributed to establish an entity. Further the character of a mutual surplus and share capital are distinctly different as indicated by the legal formalities necessary to make a return of share capital.

However, the argument that it is not the policy objective that Division 7A apply to a distribution of a mutual surplus is accepted. You cite and rely upon the Explanatory Memorandum to the Bill which introduced Division 7A into the legislation in support of your view.

Accordingly it is concluded that a distribution from the mutual surplus is not a frankable distribution in terms of section 202-40 nor is it taken to be a dividend pursuant to Division 7A of the ITAA 1936.

Detailed reasoning

This question about a distribution from the mutual surplus of ABCD to members of ABCD falls for consideration under section 202-40 with respect to a frankable distribution.

The term *distribution is defined in subsection 995-1(1) to have the meaning given by section 960-120.

As ABCD is a company it is a corporate tax entity in terms of item 1 of the table in subsection 960-120(1).

Further in terms of item 1 of that table a distribution is "a dividend or something that is taken to be a dividend under this Act".

A distribution by ABCD from the mutual surplus is a return to members of their own contributions and does not represent a distribution of profits by ABCD so that it is not "a dividend or something that is taken to be a dividend under this Act".

This interpretation is also in accordance with Taxation Ruling No. IT 2505 where in respect of a body corporate under Strata Titles legislation, which has mutual income receipts and non-mutual income receipts, it was said:

19. Under the principle of mutuality, where proprietors have contributed to any administration, reserve or special purpose fund to meet common expenses, and any surplus contributions are returned to those proprietors in their capacity as contributors, such surpluses are not assessable income. However, any distributions to proprietors out of profits derived by the body corporate constitute dividends which are assessable income of the proprietors under subsection 44(1).

It is accepted that the mutuality principle applies as described and thus the surplus is not assessable income and specifically a distribution from the mutual surplus is not a dividend.

Therefore the distribution to members from the mutual surplus of ABCD is not a frankable distribution in terms of section 202-40.

Division 7A

Turning to a consideration of Division 7A of Part III of the ITAA 1936, it is noted that Division 7A relates to distributions by private companies and that Division 7A will apply unless specifically excluded.

In your application for a private ruling you assert that:

• Division 7A does not apply because ABCD should be considered a "public company" pursuant to section 103A of the ITAA 1936. This is said to be in terms of subsection 103A(5) which gives the Commissioner the power to treat a company as a public company where subject to certain factual conditions being met it is reasonable to do so. However, no explanation is provided as to how the conditions set down in subsection 103A(5) are met and accordingly your assertion is rejected.

• Division 7A does not apply to a distribution where another provision of the ITAA 1936 or ITAA 1997 excludes the distribution from the assessable income of the member. Here you go back to your view which was put earlier that a distribution from the mutual surplus of ABCD is analogous to a return of share capital. Furthermore you state that there is a specific exemption of the return of share capital from the definition of a "dividend" in subsection 6(1) of the ITAA 1936. However, it is not accepted that a distribution from the mutual surplus is equivalent to the return of share capital. First and foremost this is because of the nature of share capital as the foundation of the entity. The nature of a surplus as a sum in excess of needs is different in character from the share capital of a company. Your view is also not accepted because the legal formalities necessary for the return of share capital to be made are lacking and different from the situation in which a discretionary decision to make a distribution from the mutual surplus occurs. The mutual surplus is not equivalent to the share capital of an entity.

• If Division 7A were to apply to distributions sourced from a mutual surplus, it would defeat the operation of the mutuality principle. In support of this argument you rely upon the Explanatory Memorandum to Taxation Laws Amendment Bill (No.7) 1997. That Bill was delayed and it was later enacted as Taxation Laws Amendment Act (No.3) 1998 which introduced Division 7A into the ITAA 1936. In the Explanatory Memorandum to Taxation Laws Amendment Act (No.3) 1998 is "Chapter 9 - Distributions from private companies" from which is drawn a quote to demonstrate what you state to be the policy objective of Division 7A.

Paragraph 9.119 reads:

"The purpose of this tax measure is to reduce the scope for tax avoidance by ensuring that tax is payable on distributions from private companies which take the form of loans which are not on commercial terms. Currently, private companies are in certain circumstances, able to make distributions of realised or unrealised profits that are effectively tax free by structuring them as payments or loans to shareholders rather than as taxable distributions."

Thus, you contend that it was never the policy intention that Division 7A would apply to a distribution sourced from a mutual surplus where such receipts were subject to the mutuality principle as is the case with ABCD, and were not generally included in a member's assessable income at common law.

Your contention that Division 7A of the ITAA 1936 should not apply to the distribution by ABCD from the mutual surplus on the basis of the policy intention of Division 7A is accepted.

It is therefore concluded that for the reasons given earlier in answer to this question, a distribution by ABCD from the mutual surplus is not a frankable distribution in terms of section 202-40. Further, in accordance with the statement cited from the Explanatory Memorandum it is acknowledged that it was not the policy intention that Division 7A is directed to capture distributions from a mutual surplus and hence Division 7A does not apply here to treat the distribution by ABCD from the mutual surplus as a dividend.

Question 4

Summary

The reasoning you provide in support of your view is separated into a discussion of a distribution to current members and a distribution to former members. We have followed that approach in the structure of our reasoning.

In both instances the guidelines on the interpretation of the mutuality principle in Taxation Ruling No. IT 2505 are relied upon in reaching the view that the distribution comes within the definition of a dividend in subsection 6(1) of the ITAA 1936.

Accordingly the distribution will be a frankable distribution unless it falls within the terms of section 202-245 as an unfrankable distribution. You address all of those provisions within section 202-45 to demonstrate how none applies and your analysis is accepted.

The Rules of ABCD with respect to a distribution from the non-mutual surplus to former members is a special situation which is examined in detail.

The outcome of that examination is that there is no difference between a distribution to current and former members.

Therefore a distribution to members by ABCD from its non-mutual surplus is a frankable distribution pursuant to section 202-40 and it may be franked in accordance with section 202-5.

Detailed reasoning

This question about a distribution from the non-mutual surplus of ABCD falls for consideration under section 202-40 with respect to a frankable distribution.

You distinguish in your reasoning between current members and former members. Accordingly that distinction is followed here.

Frankable distribution - current members

Subsection 202-40(1) provides that

A *distribution is a frankable distribution, to the extent that it is not unfrankable under section 202-45

The term *distribution is defined in subsection 995-1(1) to have the meaning given by section 960-120.

Subsection 960-120(1) contains a table setting out the meaning of *distribution according to the nature of the corporate tax entity. At item 1 of the table the corporate tax entity is a company and as ABCD is a company that item applies here.

Therefore in terms of item 1 of that table a distribution is "a dividend or something that is taken to be a dividend under this Act".

Subsection 995-1(1) defines a dividend, amongst other things, to have the meaning given by subsection 6(1) of the ITAA 1936.

In subsection 6(1) the definition of dividend reads:

dividend includes

(a) any distribution made to any of its shareholders, whether in money or other property; and

(b) any amount credited by a company to any of its shareholders as shareholders

The excluded distributions, which are not dividends are set out in paragraphs 6(1)(d), (e) and (f), however none of those distributions occur here and therefore those paragraphs do not apply.

Further in subsection 6(1)

shareholder includes member or stockholder

A distribution from the non-mutual surplus is a payment to its shareholders out of the profits of ABCD and is therefore a dividend.

This is also in accordance with Taxation Ruling No. IT 2505 where in respect of a body corporate under Strata Titles legislation, which has mutual receipts and non-mutual receipts, it was said:

19. Under the principle of mutuality, where proprietors have contributed to any administration, reserve or special purpose fund to meet common expenses, and any surplus contributions are returned to those proprietors in their capacity as contributors, such surpluses are not assessable income. However, any distributions to proprietors out of profits derived by the body corporate constitute dividends which are assessable income of the proprietors under subsection 44(1).

Further, section 202-45 which gives the meaning of unfrankable distributions is to be considered.

Section 202-45 lists each type of distribution that is classified as an unfrankable distribution. As paragraph 202-45 (a) has been repealed only paragraphs 202-45 (b) to (j) are relevant.

In your application you addressed each of those provisions and the information you supplied is reproduced below.

• Paragraph 202-45(b) will not apply as ABCD is not a "Territory company" for the purposes of paragraph 24J(2)(a) of the ITAA 1936;

• Paragraph 202-45(c) will not apply as a distribution from the non-mutual surplus is not part of the purchase price on the buyback of a share from one of its members so that it will not be taken to be a dividend under section 159GZZZP of the ITAA 1936;

• Paragraph 202-45(d) will not apply as the interest held by members of ABCD are not non-equity shares for the purposes of subsection 6(1) of the ITAA 1936 and subsection 995-1(1);

• Paragraph 202-45(e) will not apply because the distribution is not sourced from a share capital account of ABCD;

• Paragraph 202-45(f) will not apply because ABCD is not an ADI (authorised deposit-taking institution) as required by section 215-10 and the amount of the available frankable profits have exceeded and will exceed nil for the purposes of subsection 215-15(1);

• Subparagraph 202-45(g)(i) will not apply because Division 7A of Part III of the ITAA 1936 will not apply to the distribution from the non-mutual surplus by ABCD;

• Subparagraph 202-45(g)(ii) has been repealed;

• Subparagraph 202-45(g)(iii) will not apply because any distribution from the non-mutual surplus will not be an excessive payment to the members of ABCD for the purpose of section 109 of the ITAA 1936;

• Subparagraph 202-45(g)(iv) will not apply because ABCD will not be a CFC (controlled foreign company) for the purposes of section 47A of the ITAA 1936;

• Subparagraphs 202-45(h)(i) and (h)(ii) will not apply because any distribution from the non-mutual surplus will not be a "streaming bonus share" for the purposes of section 45 of the ITAA 1936 and a determination under sections 45A and 45B of the ITAA 1936 will not be made by the Commissioner and thus section 45C of the ITAA 1936 will not apply;

• Paragraph 202-45(i) will not apply because any distribution from the non-mutual surplus will not be a demerger dividend in terms of subsection 6(1) of the ITAA 1936;

• Paragraph 202-45(j) will not apply because the distribution from the non-mutual surplus is not a payment to CGT concession stakeholders in terms of section 152-125 and as ABCD is not an overseas franking company section 220-105 does not apply.

In answer to the questions which appear above it has been found that ABCD is a *franking entity that satisfies the *residency requirement. Further It has been found in this question that the distribution is a *frankable distribution. Thereby the conditions set out in paragraphs 202-5 (a) and (b) are met. Accordingly it remains for ABCD to allocate a *franking credit to the distribution in terms of paragraph 202-5(c).

Therefore it is concluded that a distribution by ABCD from the non-mutual surplus to current members will be a frankable distribution in terms of section 202-40 such that ABCD may frank the distribution in terms of section 202-5.

Frankable distribution - former members

The legislative provisions discussed above regarding ABCD being a franking entity and satisfying the residency requirement apply equally to a distribution from the non-mutual surplus to former members and will not be repeated here. Similarly the extract quoted from Taxation Ruling No. IT 2505 applies equally here.

Briefly the distribution from the non-mutual profits is a dividend in terms of subsection 6(1) of the ITAA 1936 and thereby constitutes a frankable distribution in terms of section 202-40. Following the analysis above none of the provisions which would render the distribution an unfrankable distribution applies.

However consideration of the application of the law in the case of a distribution to former members necessitates an analysis of the Rules of ABCD.

The Rules of ABCD recognise the rights of former members to participate in a distribution from the non-mutual surplus.

By virtue of a rule former members are entitled to receive part of the non-mutual surplus that has arisen during the time they were members.

Accordingly you contend that in view of this rule and given that any distribution from the non-mutual surplus will be paid by ABCD to a former member in their capacity as a bona fide former member any such distribution is a "dividend".

Consequently as it is accepted that the distribution by ABCD from the non-mutual surplus to the former members will be in the nature of a dividend and as such it is a frankable distribution.

Thus it remains that in order for the franking of the distribution in terms of section 202-5 to be completed it is necessary for ABCD to fulfil the requirement of paragraph 202-5(c) by allocating a franking credit to the distribution.

Question 5

Summary

The application of the mutuality principle to the Bad Debt Fund follows the same method as in question 1 above regarding the element of identity and the element of proportion and how each element is met.

It was necessary to consider the operation of the Bad Debt Fund Regulations and the Rules of ABCD in arriving at a decision.

It was found that the mutuality principle applies to the Bad Debt Fund such that payments from the Bad Debt Fund will not cause the mutual receipts of ABCD to be reclassified as non-mutual receipts. The mutual receipts of ABCD will not be assessable in terms of section 6-5 or section 6-10.

Detailed reasoning

In Coleambally Irrigation Mutual Co-operative Ltd v FC of T [2004] FCA 2; 2004 ATC 4126 at p 4132 Hill J said:

32. It seems to be essential to the application of mutuality that the monies contributed are and remain ``in substance'' the monies of the contributors: cf per Mason J, with whom Barwick CJ, Menzies, Walsh and Stephen JJ agreed in Sydney Water Board Employees Credit Union Ltd v FC of T 73 ATC 4129 at 4134-4135; (1973) 129 CLR 446 at 456. In the simple case of the members' unincorporated club the monies belong to the members in the normal sense of that expression. If the monies are not expended the members will have the right to have them returned to them. It is clear, however, that the word 'belong' as used in the above proposition is not used in its normal sense. In the case of an incorporated club the monies of the incorporated club will belong in law to the incorporated club itself, yet that will not deny mutuality for in substance the assets of the incorporated club can be seen to belong to its members.

33. It is said also to be essential to mutuality that there be a complete identity between the contributors and the participators, at least as a class. So, as was said by Upjohn J in Faulconbridge (Inspector of Taxes) v National Employers' Mutual General Association Ltd (1952) 33 TC 103 at 125:

``... at any given moment of time the persons who are contributing must be identical with the persons who are entitled to participate; whereas it follows, in my judgment, that it matters not that the class has been diminished by persons going out of the scheme or that others may come in their place in the future.'' (Emphasis added).

The above extract from the judgement will be considered in respect of the application of the mutuality principle to the operation of the Bad Debt Fund.

It is understood that only the contributions from current members in each particular year will be assigned to the fund.

Given these facts the question posed raises the same issues as in question 1. Although those issues have been addressed comprehensively in that earlier question they will be examined again here.

The mutuality principle requires that both the element of identity and the element of proportion are satisfied.

The element of identity requires the contributors to a fund and the participants in distributions from that fund are of the same class; it is not necessary that there be an exact matching of individual identity. See the extract from Coleambally Irrigation Mutual Co-operative Ltd v FC of T above.

The element of identity is satisfied with respect to the Bad Debt Fund by virtue of the terms of various Bad Debt Fund Regulations.

Therefore only a member of ABCD can participate in the Bad Debt Fund and receive a payment from the Bad Debt Fund.

With respect to the mutuality principle each member of ABCD has rights equal to every other member to receive a payment from the Bad Debt Fund where a buyer defaults.

Therefore the existence of the Bad Debt Fund is to the mutual benefit of every member of ABCD. This is because every member faces the uncertainty of a buyer defaulting.

However, not every member of ABCD may suffer a buyer defaulting on the payment of a debt to the member such that they seek redress from and receive a payment from the Bad Debt Fund. Put another way only those members of ABCD who suffer a default by a buyer in respect of the payment of their invoice will receive a payment from the Bad Debt Fund.

Even though the Bad Debt Fund was established with mutual receipts contributed by all members a payment from the Bad Debt Fund will not be made to all members.

Yet this outcome will not deny the application of the mutuality principle to the Bad Debt Fund. This is because every member, as a class, has the right to participate in the Bad Debt Fund. Consequently every member has a right to receive a payment from the Bad Debt Fund in circumstances that meet the requirements as set down in the Bad Debt Fund Regulations for such a payment to be made.

In terms of the above extract from the decision in Coleambally Irrigation Mutual Co-operative Ltd v FC of T the mutuality principle will apply because the necessary identity exists between the contributors to the Bad Debt Fund and the potential recipients of a payment from the Bad Debt Fund as a class.

The element of proportion is considered to be met because every member has the potential to benefit from the Bad Debt Fund in the same manner as every other member who may suffer a defaulting buyer.

For these reasons the mutuality principle will apply to the Bad Debt Fund so that the character of the mutual receipts of ABCD remains unchanged. Payments from the Bad Debt Fund will not cause the mutual receipts of ABCD to be reclassified as non-mutual receipts. The mutual receipts of ABCD will not be assessable in terms of section 6-5 or section 6-10.