Edited version of your written advice

Authorisation Number: 1012925896580

Date of advice: 9 December 2015

Ruling

Subject: Not for profit and mutual organisations

Question 1

Does the mutuality principle apply to membership fees received by the entity so that they do not constitute assessable income under section 6-5 or 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following periods:

1 July 2014 to 30 June 2015

1 July 2015 to 30 June 2016

1 July 2016 to 30 June 2017

The scheme commences on:

1 July 2014

Relevant facts and circumstances

1. The Entity is a member based organisation incorporated as a company.

2. The Entity operates on a cost recovery basis not intending to generate a profit for members. The Entity is prohibited in its Governing document from declaring or paying a dividend to its members.

3. The Entity administers a shared public resource based on the demonstrated need of the user.

4. 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.

5. Membership of the Entity is allowed to organisations who have applied under the Entity's Membership Agreement and Members consist of a range of bodies interested in the shared resources.

6. Membership is divided into tiers based on the level of usage of the shared resource by the Member.

7. All Members have equal access to all of the membership benefit, regardless of their membership tier.

8. The Entity allocates resources to some bodies who are not members (Non-Members).

9. Non-Members pay to use the shared resource at a higher rate than Members.

10. A body must pay membership fees to become and remain a Member.

11. The amount of Membership fees paid is based on the level of usage of the shared resource by the body.

12. Members elect an Executive body who represent the Members in the decision making of the Entity.

13. In accordance with the governing document of the Entity, Members are entitled to a distribution of surpluses upon dissolution of the Entity in proportion to their contributions.

14. Non-Members are not entitled to vote and have no rights to a distribution or surpluses upon dissolution of the Entity.

15. The Entity derives income from external sources such as interest from investments.

Relevant legislative provisions

Income Tax Assessment Act 1997, section 6-5

Income Tax Assessment Act 1997, section 6-10

Reasons for decision

Summary

The principle of mutuality is based on the premise that a person cannot derive income from themself. If the principle of mutuality applies to membership fees received from Members of the Entity then the fees will not be income and will not be included in its assessable income under either section 6-5 or section 6-10 of the ITAA 1997.

For mutuality to apply, membership fees must be properly characterised as contributions to a fund, created and controlled by the contributors, for a common purpose. It is concluded that the principle of mutuality does apply to membership fees received from members, because:

• based on the available evidence the members of the Entity share a common purpose,

• membership fees are paid to a common fund to give effect to a common purpose,

• the members of the Entity control the common fund,

• on balance, there is identity between the contributors and participants, and

• receipts from members are not in the nature of trade.

As membership fees received from Members are mutual in nature they do not constitute assessable income under either section 6-5 or section 6-10 of the ITAA 1997.

Detailed reasoning

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.

Principle of Mutuality

Whether a receipt is income depends upon its quality in the hands of the recipient¹.

The term income is not defined in the Income Tax Assessment Act 1936 (ITAA36) or ITAA97. In The Bohemians Club v The Acting Federal Commissioner of Taxation [1918] 24 CLR 334, Griffith CJ stated at 337-338:

A man is not the source of his own income, though in another sense his exertions may be so described. A man's income consists of moneys derived from sources outside himself. Contributions made by a person for expenditure in his business or otherwise for his own benefit cannot be regarded as his income unless the Legislature expressly so declares.

The exposition by Griffith CJ has formed the basis of the principle of mutuality as it applies to Australia. As such, a receipt by a taxpayer will not have the quality of ordinary income if the mutuality principle applies to it.

The essence of the mutuality principle is that you cannot derive any gain, and therefore income, from dealings with yourself. The mutuality principle provides that where a number of people associate for a common purpose and contribute to a common fund in which they are all interested, any surplus of those contributions remaining after the fund has been applied to the common purpose that is then distributed to the contributors, is a return of funds and not income or profit².

The mutuality principle was described succinctly by McTiernan J in Revesby Credit Union Cooperative Ltd v Federal Commissioner of Taxation (1965) 112 CLR 564 (Revesby Credit Union) at 574-575:

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…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 wholly by the contributors. If it is owned or controlled by anyone else the principle cannot apply…Furthermore any contributions to the fund derived from sources other than the contributors' payments, such as interest from the investment of part of the fund, or income from a business activity conducted by the members, cannot be taken into account in computing the surplus…Also the cases establish that the principle cannot apply unless at any given point in time the contributors to the fund are identical with the beneficiaries of the distribution of the surplus.

The principle of mutuality is not limited in its application to situations where a refund of surplus contributions is distributed to the contributors. In Coleambally Irrigation Mutual Co-Operative Ltd v FC of T 2004 ATC 4835 (Coleambally) the Full Federal Court was not concerned with a refund of overpaid contributions to the contributors. The question was whether the contributions made by members to CIMCL was income in the hands of CIMCL. Beaumont, Merkel and Hely JJ held at 4842:

The authorities establish that the mutuality principle is not confined in its operation to the situation in which the surplus contributions made by a contributor to a common fund are returned to the contributor. In The Bohemians Club v Acting Federal Commissioner of Taxation (1918) 24 CLR 334 the receipt by a social club of annual subscriptions from its members was held not to be income of the club even though, for tax purposes, the club was a separate entity from its members. Griffith CJ held (at 337) that the contributions were, in substance, advances of capital for a common purpose which were expected to be exhausted in the year in which they were paid. They were not income of the club any more than calls made by members of the company upon their shares are income of the company.

Existence of a common fund controlled by the contributors for a common purpose

For the principle of mutuality to apply there must be a common fund. It can be described as a fund established by contributors for a common purpose in which contributing members as a class have rights. The fund must be owned or controlled wholly by the contributors. If it is owned and controlled by anyone else the principle cannot apply³.

In Sydney Water Board Employees' Credit Union v FCT 73 ATC 4129 (Sydney Water Board) the taxpayer unsuccessfully argued that interest paid by borrowing members of the credit union constituted a common fund paid for the common purpose of enabling the credit union to meet its administrative and operating expenses, with any surplus refundable to borrower members. Interest paid was not maintained as a common fund in which the borrowing members as a class had any rights. Interest was paid by borrowers in discharge of their legal obligations and became part of the general funds of the credit union. It was not paid as a contribution to the mutual liabilities on behalf of the borrowers. Mason J. noted at 4136 that the borrowing members did not have any right to a refund of part of the interest which they have paid; on the contrary:

…the interest so paid forms part of the funds of the taxpayer… the borrowing members are entitled to participate in a distribution of the surplus which results from the taxpayer's use of the general funds.

Identity between the contributors and the participants

The principle of mutuality is dependent upon the existence of an 'identity' between contributors to the fund and those who are entitled to participate in it. The mutuality principle may be displaced where there is a difference of identity between those who contribute and those who can receive a distribution of surplus, or where the distribution of surplus is disproportionate to the amount contributed.

In Coleambally, Beaumont, Merkel and Hely JJ said at 4842:

The identity required is not an identity between individuals, but an identity between classes, and all that is required is a reasonable relationship between what a member contributes, and the member's expected participation in the common fund: Sydney Water Board Employees Credit Union (supra) at ATC 4135; CLR 457; Social Credit Savings & Loans Society Ltd (supra) at ATC 4238-4239; CLR 571-572. For the mutuality principle to apply, in one way or another ("in meal or in malt") the contributing members must be entitled to recoupment or refund of any surplus so that in the result the body corporate does not make a profit from them: Jones v South-West Lancashire Coal Owners Association Ltd [1927] AC 827 at 832. In Social Credit Savings & Loans Society Ltd (supra) at ATC 4240-4241; CLR 576, Gibbs J held that a power in the Society to apply the surplus in a fund in favour of employees of the Society was sufficient to negate the proposition that the fund "belonged" to the contributors.

Furthermore, Beaumont, Merkel and Hely JJ said at 4844:

…if the amounts standing to the credit of the sinking fund truly 'belonged' to the contributors, with CIMCL no more than a convenient vehicle, the members would have a choice as to whether any surplus would come back to the members in the event of a winding up. The denial of that choice by CIMCL's constitution demonstrates that the amounts contributed to the sinking fund do not truly belong to the member contributors. When the members make, and CIMCL receives, a contribution, the contributing members have no right to participate in any surplus of the members' contributions over what may be expended in carrying out the common purpose.

In order for mutuality to exist there must be a reasonable relationship between contributions made by members and what they can expect to benefit from the fund. The return of surplus to contributors need not occur on an annual or other scheduled basis, nor must the surplus be returned in any particular form. Even the application of contributions to build up reserves need not displace the presence of mutuality⁴. What is required is that the collective entitlement must be returned sooner or later, in 'meal or in malt'⁵.

Mutual receipts versus receipts in the nature of trade

The courts have long recognised that a company can trade with its members. The Privy Council considered whether a company could derive a profit from its members in English and Scottish Joint Co-operative Wholesale Society Ltd v Assam Commissioner of Agricultural Income Tax [1948] 2 All ER 395 (Assam Tea). The following facts as described in the High Court judgment, from which the taxpayer appealed to the Privy Council, were accepted by Lord Normand at 397-398:

…the society is incorporated in the United Kingdom under the Industrial and Provident Societies Act, 1893. It has an unlimited capital divided into shares of £5 each… Its objects, as set out in its rules, inter alia, are: 'To carry on the business of planters, growers, producers, merchants and manufacturers and brokers of tea.' The society consists of two members, viz., the Co-operative Wholesale Society, Ltd. and the Scottish Co-operative Wholesale Society, Ltd. The society owns the Deckiajuli estate where it grows and manufactures tea. Except a small portion of produce, which is unfit for export and which is sold locally, the whole of the society's output of tea is sold to its two members at market rates and is exported to England and Scotland. Each year the members of the society pay, by way of advances to the society, sums of money to meet the cost of tea supplied by the society to the members. The market prices of the tea, with which the members are supplied, are debited against these payments. The supplies are recorded as sales to the members. Out of the proceeds from the sales, the expenses of production and management and the interest on loans are paid or provided. By the rules of the society its net profits are applied (a) in depreciation of land… (b) payment of interest not exceeding 6 per cent. per annum on the share capital; (c) appropriation to a reserve fund; (d) appropriation to a special fund for making grants as determined in general meeting; (e) payment of a dividend to members rateable in proportion to the amount of purchases made by them from the society; and (f) the remainder, if any, carried forward to the next account.

In considering whether or not the principle of mutuality applied in this case, the Privy Council concluded that profits were not only likely to arise from the sales of tea to members, but that the generation of profits was in fact contemplated by the rules that provided for their application (at 398). The court went on to say that it was difficult to distinguish the company, in its dealings with members, from an ordinary trading company (at 398):

The application of net profits… is, in essentials, not different from the application of net profits which might be made by any trading company, and it need not result in the distribution of all profits among the members of the society. Thus, any net profits applied under heads (a), (c), (d) and (f) would be retained by the appellant society. When the constitution, rules and business practice of the appellant society so closely conform to the pattern of an ordinary profit-making concern, how can it plausibly be maintained that no profits can result?

This case highlights three points of relevance to mutuality. Firstly, the company's constituent documents in contemplating that profits will be derived are an indication that the company is trading. Secondly, when the business operations of the company conform so closely to an ordinary profit-making business, it would also indicate that the company is trading with its members. Thirdly, this case supports the proposition that just because an association's dealings are with its members, it does not necessarily mean that the association's receipts arising from those dealings have a mutual character.

In FC of T v Australian Music Traders Association (1990) 90 ATC 4536 (Music Traders), the Full Federal Court considered whether fees paid by members of an association to a third party in return for exhibition space at a trade fair, which were then on-paid to the association constituted contributions to a common fund by the members and thus subject to the principle of mutuality, or were in the nature of profit derived in the course of trading. The Australian Music Traders Association was established for the promotion of the interests of people engaged in dealing in musical instruments, records and associated equipment; and the conduct of music trade fairs for the exhibition of goods dealt in by members and others. In the relevant income year, the Association engaged a third party company to organise a trade fair on its behalf. The company sold exhibition space to traders, some of whom were members of the association. Each trader that took exhibition space entered into a written agreement which set out the cost and size of the floor space to be taken. The agreement between the Association and the trade fair organiser entitled the Association to receive out of monies paid by member traders, an amount determined in accordance with a formula relating to floor space occupied. The resulting sum payable to the Association was the amount at issue; was it to be characterised as income, or was it subject to the principle of mutuality, and thus not income.

The majority found that the receipts were not subject to the mutuality principle. Davies J, who was a member of the majority, quoted from the judgment of Lord Wilberforce in Fletcher v Income Tax Commissioner [1971] 3 All ER 1185 at 1189 in posing the question to be answered: '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?'⁶. Davies J concluded that the activity and the fee received in connection with the activity were not mutual in nature. He said at 4538-39:

The fee paid by the organisers of the fair to the Association was not a fee payable by members of the Association into a common fund. And the fair, though it benefited members of the association, was not a mutual, non-profit activity. Its essence was that of trading for profit by individual traders, though through the medium of a common activity, the fair.

Davies J in the course of characterising the fee paid by the organisers, sought to determine whether the payment was a contribution into a common fund by the members by reference to what purpose the individual traders had in participating in the fair. Put another way, Davies J addressed the question of whether members were making a contribution to a fund for a common purpose or were participating in the fair and making the payments for another purpose. He concluded that the members were participating to generate profits for their own businesses.

Wilcox J, the other member of the majority, in concluding that the members were not making contributions to a common fund said at 4546:

The point, of course, is that the decisions made by individual members as to the extent of their payments depended not upon any wish or need to make members' contributions to the Association but rather upon the display space which they wished to take.

Membership

The relevance of membership to the principle of mutuality was considered by Lord MacMillian in the case Inland Revenue Commissioners v Ayrshire Employers Mutual Insurance Association Ltd (1946) 1 ALL ER 637 at 640 where he indicated:

It is not membership or non-membership which determines immunity from or 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…There is nothing to prevent a mutual insurance company entering a contract of mutual insurance with a person who is not a member of the company.

This approach was adopted in Royal Automobile Club of Victoria (RACV) v Federal Commissioner of Taxation 73 ATC 4153 (RACV), 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.

If the dealing is mutual, then it is immaterial whether that transaction is with a member or not. Where there is a mutual transaction between an association and a non-member, 'the non-member may be regarded pro tempore as in effect a member of a somewhat wider organisation involving himself and the association'⁷. However, for this to occur, the necessary element of mutuality must be present, which is the contribution to and if a surplus, entitlement from the common fund.

An incorporated entity must be an entity for the convenience of its members

The incorporation of an organisation will not of itself affect the operation of the mutuality principle so far as the company has been incorporated as a mere convenient agent or instrument of the common purpose of its members. In Coleambally, Beaumont, Merkel and Hely JJ said at 4842:

In North Ryde RSL Community Club Ltd v FC of T 2002 ATC 4293; (2002) 121 FCR 1, the Full Court (Spender, Finn and Merkel JJ) said that it is (at ATC 4302; FCR 13) 'well enough established' that the mutuality principle, in addition to applying to refunds of contributions made to a common fund, may also apply to contributions made and distributions received where the persons who associate for a common purpose and contribute to a common fund have incorporated to effectuate their common purpose, provided the company can properly be treated as an entity for their convenience. In such cases, the fact of incorporation is irrelevant: Revesby Credit Union Co-operative Ltd v FC of T (1965) 13 ATD 449 at 453; (1964-1965) 112 CLR 564 at 574.

Application to the Entity

In order for the mutuality principle to apply to the fees paid to the Entity must be properly characterised as contributions to a fund, created and controlled by the contributors, for a common purpose. If, upon analysis, the fees paid by members are properly characterised as mutual receipts, then the fees will not be income in the hands of the Entity.

The first matter to consider is whether the dealing is for a common purpose. The Entity is established to ensure the fair administration of a public resource. Members of the Entity obtain the right to request access to the shares resource based on demonstrated need. Membership also entitles members to voting rights and representation in policy development. All members have equal access to all membership benefits, regardless of membership tier.

There are benefits to all members in a fair and responsible administration of the public resource. The benefits of such a system are shared in common by members. The fact that fees are paid in proportion to the member's allocated resources is consistent with the concept of contributions to a common fund for this common purpose.

On the other hand, for certain organisations there are powerful commercial reasons for membership. Failure to take out membership would result either in exclusion from accessing resources or having to pay more for access through being a non-member. For some entities that cannot carry on their business without access to the shared resource, they may be compelled to take up membership in the Entity whether or not they actively support the promotion of fair and responsible administration of the shared resources. Such considerations point to the existence of strong commercial reasons for membership which are private and unrelated to any common purpose. The payment of member fees could be viewed as members individually contracting with the Entity to access resources to further their business interests.

The decision in Music Traders emphasised the importance of determining the purpose of the members making the payments in ascertaining whether those payments are to be properly characterised as contributions to a common fund. The question to be asked here is whether each member's purpose in paying the membership fees is to contribute to the common fund, or whether, as in Music Traders, there is no common purpose but rather each member makes the payment for their own purpose.

Although it cannot be concluded with certainty that the prevailing purpose of members in making contributions to the Entity is for a common purpose, on the balance of the factual evidence, it is considered that the existence of a common purpose whereby members of the Entity have associated to access shared resources is the better view.

The second matter for consideration is whether the contributions of members are made to a common fund to give effect to the common purpose. Members are required to pay all fees and charges to the Entity. The membership fees paid by members are contributions to a common fund.

The third matter for consideration is whether control of the common fund is held by the contributors. For the principle of mutuality to apply there must be a common fund that must be a common fund that must be owned and controlled wholly by the contributors. If it is owned and controlled by anyone else the principle cannot apply (Revesby Credit Union).

The members of the Entity vote for the Executive body which carries out the operations of the Entity. The Executive body manages the funds of the Entity. The members of the Entity have control of the common fund into which they contribute.

The fourth matter for consideration is whether there is 'identity' between the contributors and participants. In Coleambally it was said that if the amounts standing to the credit of the sinking fund truly 'belonged' to the contributors, with CIMCL no more than a convenient vehicle, the members would have a choice as to whether any surplus would come back to the members in the event of a winding up.

Pursuant to the governing document of the Entity, upon dissolution any surplus funds attributable to the contributions of Members shall redistributed among the Members in proportion to their contributions. Non-Members are not entitled to participate in the return of surplus funds.

As such the common fund 'belongs' to the contributors as a class with the Entity merely a convenient vehicle. These considerations indicate that there is the required 'identity' between contributors and participants for the purposes of mutuality. There is a reasonable relationship between contributions made by members and what they can expect to benefit from the fund.

It was held in Revesby Credit Union that any contributions to the fund derived from sources other than the contributors' payments, such as interest from the investment of part of the fund, or income from a business activity conducted by the members, cannot be taken into account in computing the surplus. The Entity receives income from sources outside the membership, including from Non-Members and interest from investments. Providing income from external sources is kept separate from mutual receipts from members, the receipt of income from external sources is not inconsistent with the application of mutuality.

The final matter for consideration is whether the receipts from members are mutual in nature or received in the nature of trade. As stated in Assam Tea, reference to a profit making purpose in the constituent documents of the company is relevant for determining whether the receipts from members are in the nature of trade. Furthermore, when the business operations of the company conform so closely to an ordinary profit-making business, it would also indicate that the company is trading with its members.

The Governing Document of the Entity prohibits the declaration or payment of dividends and the Entity operates on a cost recovery basis. These considerations indicate that the Entity is not trading for profit. In this regard the present case can be distinguished from Assam Tea and Music Traders where the dealings with members were trading activities in the nature of trade.

Conclusion

On balance, the fees paid by Members to the Entity are contributions to a common fund for a common purpose where ownership and control of the fund is vested in Members. Upon dissolution Members are entitled to the distribution of surplus funds in proportion to their actual contribution.

It is accepted that the mutuality principle applies to the fees received by the Entity from Members. The fees are not assessable as ordinary income under section 6-5 or section 6-10 of the ITAA97.

¹ Scott v Federal Commissioner of Taxation (1966) 117 CLR 514

² Social Credit Savings and Loans Society Ltd v Federal Commissioner of Taxation (1971) 125 CLR 560

³ Revesby Credit Union Cooperative Ltd v Federal Commissioner of Taxation (1965) 112 CLR 564 at 574-575

⁴ Faulconbridge v. National Employers' Mutual General Insurance Association Ltd [1952] 33 TC 103

⁵ Jones v South-West Lancashire Coal Owners Association Ltd [1927] AC 827 at 832)

⁶ (1990) 21 ATR 471 at 472; 90 ATC 4536 at 4537-8

⁷ 73 ATC 4153 at 4157