Edited version of your written advice

Authorisation Number: 1012783547668

Ruling

Subject: Principle of Mutuality.

Question 1

Does the mutuality principle apply to the member income of the Co-operative, such that these receipts of member income do not form part of the assessable income of the Federation pursuant to section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2013

Year ended 30 June 2014

Year ending 30 June 2015

Year ending 30 June 2016

The scheme commences on:

1 July 2012

Relevant facts and circumstances

The Co-operative is a co-operative registered under the relevant state Co-operatives legislation.

The Co-operative has no share capital.

The Co-operative is controlled by way of voting interests issued to members as outlined in the rules. A copy of the Rules of the Co-operative was attached to the application for private ruling. They contain an appropriate non-profit and dissolution clause.

The Co-operative has a website which explains its purpose and activities.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 117(1),

Income Tax Assessment Act 1936 subsection 119(1) and

Income Tax Assessment Act 1997 section 6-5.

Reasons for decision

Subsection 119(1) of the Income Tax Assessment Act 1936 (ITAA 1936) states:

The assessable income of a co-operative shall include all sums received by it, whether from shareholders or from other persons, for the storage, marketing, packing or processing of commodities, or for the rendering of services, or in payment for commodities or animals or land sold, whether on account of the company or on account of its shareholders.

Therefore, where an entity meets the criteria of being a co-operative for taxation purposes pursuant to subsection 117(1) of the ITAA 1936, the principle of mutuality will not apply to remove member contributions from the assessable income of the co-operative company.

It is therefore important to firstly consider whether the Co-operative qualifies as a co-operative for taxation purposes before we can make a decision of the applicability of the principle of mutuality to the member income of the Co-operative.

Whether a Co-operative pursuant to subsection 117(1) of the ITAA 1936

Subsection 117(1) of the ITAA 1936 states:

In this Division, ``co-operative company'' means a company, not being a friendly society dispensary, the rules of which limit the number of shares which may be held by, or by and on behalf of, any one shareholder, and prohibit the quotation of the shares for sale or purchase at any stock exchange or in any other public manner whatever, and includes a company, not being a friendly society dispensary, which has no share capital, and which in either case is established for the purpose of carrying on any business having as its primary object or objects one or more of the following:

(a) the acquisition of commodities or animals for disposal or distribution among its shareholders;

(b) the acquisition of commodities or animals from its shareholders for disposal or distribution;

(c) the storage, marketing, packing or processing of commodities of its shareholders;

(d) the rendering of services to its shareholders;

(e) the obtaining of funds from its shareholders for the purpose of making loans to its shareholders to enable them to acquire land or buildings to be used for the purpose of residence or of residence and business.

It is not considered that the Co-operative meets the above criteria to be considered to be a co-operative company for the purposes of subsection 117(1) of the ITAA 1936. The Co-operative was not established to carry on a business with its primary objects as per (a) to (e) as listed above. As a non-profit entity, the Federation is not permitted by virtue of its non-profit clause within its Constitution at clause 64 to make distributions to its members. The Co-operative is a
non-distributing co-operative and has no share capital. Accordingly, as the Co-operative does not satisfy subsection 117(1) of the ITAA 1936 to be a co-operative for taxation purposes, section 119 of the ITAA 1936 will not apply to the entity.

Principle of Mutuality

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 principle of mutuality recognises that a person's income consists only of moneys derived from external sources, that is, from sources other than the person. 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 from 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 been held to have 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 Co-operative is carried on for the benefit of its members by way of the objects and activities of the Co-operative are directed to represent the interest of their member entities. The member funds also share a common purpose as described in their Rules and funds are utilised solely to meet that common purpose in which the Co-operative was established.

In addition, all members contribute an annual subscription fee upon admission to membership as per the Co-operative's Rules. It is accepted that in all likelihood that there exists a reasonable relationship between what the member contributes and the services provided. For example, the payment of an annual subscription fee recognises the cost to the Co-operative of servicing matters dealing with that particular member.

The relevant clause of the Co-operative's rules specifies that the Co-operative is to receive funds and best distribute these to achieve the overall objectives and therefore the contributions are applied for the collective benefit of the members in line with the Co-operative's objectives.

There is one class of membership of the Co-operative and the members have ownership and control of the common fund as demonstrated by clause 64.

Conclusion

The mutuality principle applies to the member income of the Co-operative, such that receipts of member income do not form part of the assessable income of the Co-operative pursuant to section 6-5 of the ITAA 1997.