Edited version of your written advice

Authorisation Number: 1012790516462

Ruling

Subject: Application of mutuality

Question 1

Are receipts of an additional fee for a specified service to members assessable income to Company A under s.6-5 and s.6-10 of the Income Tax Assessment Act 1997?

Answer

No

This ruling applies for the following periods:

1 July 2015 to 30 June 2016

1 July 2016 to 30 June 2017

1 July 2017 to 30 June 2018

1 July 2018 to 30 June 2019

1 July 2019 to 30 June 2020

The scheme commences on:

1 July 2015

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Company A's purpose is to administer a system.

By law, an entity is unable to undertake a specific retail activity in X unless it becomes a member of Company A.

Company A's primary aim and main activities are related to administration of a system.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5 and section 6-10

Reasons for decision

Mutuality is a common law principle developed in the United Kingdom and first considered in connection with insurance companies. The mutuality principle is not specifically mentioned in the Income Tax Assessment Act 1997 (ITAA 1997), however, it has been accepted and applied narrowly in relation to Australian taxation law.

The principle is based on the proposition that a taxpayer cannot derive income from itself. In the case of corporate entities, the principle recognises that contributions by proprietors are not in the nature of income because 'income consists of monies derived from sources outside of the taxpayer' (Bohemians Club v. Acting Federal Commissioner of Taxation (1918) 24 CLR 334 at 337).

Page 6 of the Tax Office publication Mutuality and taxable income (NAT 73436-07.2010) states:

Not all amounts of money or property your organisation receives will be assessable income. Receipts derived from mutual dealings with members of your organisation are not assessable income. This is due to the principle of mutuality.

The principle is summarised in Revesby Credit Union Co-operative Ltd v. Federal Commissioner of Taxation (1955) 112 CLR 564 at 574 where McTiernan J said:

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 is not income but is to be regarded as a mere repayment of the contributor's own money… Incorporation of the fund is not relevant… What is required is that the fund must have been created for the common purpose and owned or controlled by the contributors.

The contributors to the fund must also be identifiable with those to benefit from any surplus. Lord Macmillan in Municipal Mutual Insurance Ltd v Hills (1932) 16 TC 430 at 448 states:

The cardinal requirement is that all the contributors to the common fund must be entitled to participate in the surplus and that all the participators in the surplus must be contributors to the common fund; in other words, there must be complete identity between the contributors and the participators. If this requirement is satisfied, the particular form which the association takes is immaterial.

Lord Wilberforce in Fletcher v. Income Tax Commr (1971) 3 All ER 1185 drew the distinction between a mutual activity which does not give rise to profits and a trading activity which does at 1189:

Cases in which groups of persons making contributions towards a common purpose have been held not liable for tax on any surplus over expenditure fall under a number of heads. The expression 'the mutuality principle' has been devised to express the basis for exemption of these groups from taxation. It is a convenient expression, but the situations it covers are not in all respects alike. In some cases the essence of the matter is that the group of persons in question is not in any sense trading, so the starting point for an assessment for income tax in respect of trading profits does not exist. In other cases, there may be in some sense a trading activity, but the objective, or the outcome, is not profits, it is merely to cover expenditure and to return any surplus, directly or indirectly, sooner or later, to the members of the group. These two criteria often, perhaps generally, overlap; since one of the criteria of a trade is the intention to make profits, and a surplus comes to be called a profit if it derives from a trade. So the issue is better framed as one question, rather than two: is the activity, on the one hand, a trade, or an adventure in the nature of trade, producing a profit, or is it on the other, a mutual arrangement which, at most, gives rise to a surplus?

The mutuality principle will apply to activities with the following criteria:

1. A fund must have been created for common purpose.

2. The fund must have been owned or controlled by contributors.

3. Contributors must be identical with participants.

4. The fund cannot be carrying on a trading operation for profits purposes.

Common purpose

Company A's purpose is to administer a system.

By law, an entity is unable to undertake a specific retail activity in a specified locality unless it becomes a member of Company A.

Company A's primary aim and main activities are related to administration of a system.

Owned or controlled by contributors

Section 350 of the Income Tax Assessment Act 1936 (ITAA 1936) provides that an entity holds a direct control interest in a company at a particular time, which is equal to the percentage that the entity holds, or is entitled to acquire, at that time of:

(a) the total paid-up share capital of the company; or

(b) the total rights of shareholders to vote, or participate in any decision-making, concerning any of the following:

(i) the making of distributions of capital or profits of the company to its shareholders;

(ii) the constituent document of the company;

(iii) any variation of the share capital of the company; or

(c) the total rights to distributions of capital or profits of the company to its shareholders on winding-up; or

(d) the total rights to distributions of capital or profits of the company to its shareholders, otherwise than on winding-up;

or, if different percentages are applicable under the preceding paragraphs, the greater or greatest of those percentages.

A member of a guarantee company does not hold or have any right to acquire 'paid up share capital' as defined in subsection 6(1) of the ITAA 1936 and is not within the first test in paragraph 350(1)(a) of the ITAA 1936. However, whether the remaining tests contained in paragraphs 350(1)(b) to (d) of the ITAA 1936 apply will depend on whether the taxpayer holds, or is entitled to acquire, specified rights as a 'shareholder' (as defined in subsection 6(1) of the ITAA 1936).

Subsection 6(1) of the ITAA 1936 provides that a 'shareholder' of a company 'includes a member or stockholder' of the company. A person who has undertaken to contribute a limited amount to the company upon its winding up is a member of that company and is, accordingly, a 'shareholder' as defined. Under section 9 of the Corporations Act 2001, a 'company limited by guarantee' is defined as a 'company formed on the principle of having the liability of its members limited to the respective amounts that the members undertake to contribute to the property of the company if it is wound up'.

A member of a guarantee company may acquire certain rights against the company, such as the rights to a dividend. These specific rights will generally be set out in the constitution of the company. If a member of a guarantee company has the right to vote or participate in any decision-making concerning the distribution of capital or profits or its constituent documents, then that member will have a direct control interest in the foreign company in accordance with paragraph 350(1)(b) of the ITAA 1936.

In addition, if a member of a guarantee company has a right to any distributions from the company, whether on the winding up of the company or otherwise, then that member will have a direct control interest in the company in accordance with either paragraph 350(1)(c) or paragraph 350(1)(d) of the ITAA 1936 respectively.

All Company A members have a right to the surplus on winding-up of the company. Company A's members have voting rights at general meetings and a right to nominate a director.

Further the ATO guide Mutuality and taxable income (NAT 73436, 2014-06-05) states at page 8:

Members need not have voting rights, but those who do not must be eligible to other rights and privileges of membership.

Members are considered to hold ownership and control of Company A and the common fund.

Complete identity between the contributors and the participants

There must also be complete identity between the people who are contributing and the people who are entitled to participate in the surplus. Each class must be identical (Taxation Ruling IT 2505, paragraph 14).

All Company A members contribute to the fund by paying membership and other fees. Although they are not entitled to any distribution of income and property, they are entitled to participate in any surplus of the common fund on a winding up proportionally to their contributions as provided by its Constitution.

Accordingly, it is accepted that there is a common identity between Company A's contributors and participants.

Activities in the nature of trade

There are exceptions to the mutuality principle and some receipts from members may constitute income for the purpose of the ITAA 1997. The principle will not apply to activities that are considered to be in the nature of trade.

This exception was best explained by Lord MacMillan in Inland Revenue Commissioners v. Ayrshire Employers Mutual Insurance Association Ltd (1946) 1 All ER 637 at 640 when he said:

It is not membership or non-membership which determines immunity from or liability to tax; it is the nature of the transactions.

Royal Automobile Club of Victoria v. FC of T 73 ATC 4153 distinguishes between mutual and non-mutual dealings. Anderson J stated at 4157:

Where the activity is mutual, the fact that some members only take advantage of the facilities available does not affect the element of mutuality (National Association of Local Government Officers v. Watkins (1934) 18 T.C. 499).

In Federal Commissioner of Taxation v Australian Music Traders 90 ATC 4536 mutual dealing that do not give rise to profits were considered. Davies J stated at 4538:

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.

While the additional service is only provided to Member B it could in theory be provided to other members of Company A. Further the additional service fee charged by Company A to Member B is only to recovery costs and the provision of this service to Member B provides benefits to all Company A's members. For these reasons the provision of this service would not be considered as activities in the nature of trade, and the receipt of the charge by Company A would be a mutual receipt.

Conclusion:

The receipt of the additional charge to recover the cost of the service to Member B is not assessable as income to Company A.