Edited version of your written advice

Authorisation Number: 1012928784932

Date of advice: 19 January 2016

Ruling

Subject: Principle of Mutuality

Question

Does the mutuality principle apply to receipts in the form of fees received from its Shareholding Members so that they do not constitute assessable income of the entity for Australian income tax purposes?

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

1. The entity is a proprietary company limited by shares.

2. There are currently XX shareholders, referred to as 'Shareholding Members'.

3. Each Shareholding Member holds one ordinary share (except for one shareholder which owns two ordinary shares as a result of a merger).

4. The entity holds a brand name and licences that name to its Shareholding Members.

5. Each Shareholding Member owns or operates a business and use the brand name in their business name.

6. The use of the brand name is governed by the Shareholding Entities' Agreement.

7. The entity has X 'Non-Shareholding' members.

8. Non-Shareholding members are sub-entities of some of the Shareholding Members.

9. Non-Shareholding Members are not eligible to vote at a general meeting of the entity and nor are they able to participate in a distribution of the assets of the entity (both capital and surplus) in a winding up.

10. The entity only provides services to Shareholding Members and Non-Shareholding Members.

11. The entity provides the following services:

• growth of the national brand by co-ordinating and enabling uniform standards of service,

• co-ordination of purchasing advantages,

• development and adoption of common operating systems

• development of risk management procedures,

• hosting centralised databases maintained by the entity, Shareholder Members and Non-Shareholder Members, and

• Additional Projects.

12. Additional Projects refer to activities such as:

• strategic direction and planning,

• marketing,

• tender management,

• risk and compliance,

• IT software development, and

• policy development.

13. Fees charged by the entity for their services are based on a percentage of the revenue of Shareholder Members and Non-Shareholder Members, which decreases marginally as turnover increases.

14. There are four categories of fees charged by the entity:

• IT - membership fees are based on a set rate per user per month

• Cost recovery - relates to costs such as advertising, incurred in respect of specific members such as advertising (no mark-up applied)

• Administration - turnover of sub-entity or parent-entity Shareholding members and Non-Shareholding members is grouped together for the purposes of calculation. Turnover thresholds start from every dollar from $1 to $500,000 and increases by 0.1% at $ 500,000 intervals rising to several million dollars.

• Other projects - these fees are levied for additional projects undertaken by the entity on behalf of members that run for a limited time

15. Costs incurred by the entity relating to specific Shareholder Members or Non-Shareholder Members are recovered from those entities.

16. The entity treats receipts from Non-Shareholding members as income.

17. Constitution

The constitution contains the following:

Objects of company

1.2 The Company has been formed and must operate for the primary objects of:

1.2.1 providing services to the members of the Company; and

1.2.2 owning and licensing certain names, brands and intellectual property to the members of the company.

Shares with special rights

2.2 Subject to clause 2.1, the directors may issue classes of shares with preferred, deferred or other special rights or restrictions, and with such rights to dividend, voting, return of capital or otherwise and at such price as the directors think fit.

7 Transfer of shares

Restriction

7.1 A shareholder must not dispose of any shares in the Company other than in accordance with the relevant provisions of the Shareholders' Agreement.

10 Voting Rights

Right to vote

10.1 All shareholders are entitled to vote at a general meeting, except in respect of the following shares:

10.1.1. Shares in a class of shares that do not carry the right to vote; and

10.1.2 Shares on which a call or other amount immediately payable by the relevant shareholder has not been paid.

12 Appointment and removal of directors

Number of directors

12.1 The number of directors shall be a minimum of 3

12.2 The shareholders, by resolution in general meeting, may increase or reduce the number of directors, or increase or reduce the maximum number

12.3 A director must be an individual

Election of directors

12.4 Each director shall be elected at an annual general meeting of the Company by the shareholders and shall serve for a 2 year term of office, expiring at the annual general meeting 2 years later, but shall be eligible for re-election at the expiry of each such term of office, subject to the provisions of clause 12.5 of this constitution

12.5 The conduct of elections of directors and the rules relating to eligibility for election to the board shall be determined from time to time by resolution of the board of directors of the Company.

12.6 A person who is to be appointed as a director must consent in writing before being appointed.

14 Powers of directors

14.1 The business of the Company is managed by or under the direction of its directors.

14.2 The directors may exercise all those powers of the Company as are not, by the Corporations Act or by this document, required to be exercised by the shareholders in general meeting or otherwise.

14.3 Without limiting clause 14.2, the directors may not do any of the following things except with the prior agreement of the members by Shareholders' Special Resolution:

14.3.1 Alter, change or waive the rights, preferences, or privileges of the Shares (by amendment of the Constitution, merger, reorganisation or otherwise).

14.3.2 Issue any securities in the Company.

14.3.3 Redeem, buy back, cancel or undertake a capital reduction of any share capital or other securities of the Company.

14.3.4 Sell all or substantially all of the Company's assets

14.3.5 Merge the Company with another entity or other Change in Control transaction.

14.3.6 Issue any equity securities by a subsidiary to any person other than the Company.

Voting

15.10 A question which arises at a meeting of directors must be decided by a majority vote. The chairperson does not have a casting vote. If a vote is tied, the motion is not passed. A decision reached by vote is treated as the decision of all the directors.

21 Profits and dividends

Source of Dividends

21.1 Dividends are to be paid solely out of the Company's profits or otherwise as allowed by the Corporation Act. The Company does not pay interest on them.

Declaring a dividend

21.2 The directors alone may declare a dividend to be paid to shareholders. The dividend is payable as soon as it is declared unless the directors specify a later time for payment.

Reserved Profits

21.3 Before declaring a dividend the directors may set aside out of the Company's profit any amount that they consider appropriate. This amount may be used in any way that profits can be used and can be invested or used in the Company's business in the interim.

Interim dividends

21.4 The directors may declare interim dividends if they consider that the Company's profits justify it. However, they may also choose to carry any profits forward,

Payment of dividends

21.5 Declared dividends must be paid to shareholders in proportion to their shares except in relation to shares that have special rights relating to dividends attached to them.

Distribution of assets

21.7 The directors may choose to pay a dividend or bonus by distributing Company assets to shareholders - such as paid up shares, debentures stock of another body corporate. The directors may settle a difficulty arising in relation to such a distribution in any way that they consider appropriate, - for example, making cash payments to some shareholders in respect of the value of the assets, or vesting some assets in trustees.

Capitalisation of profits

21.9 The directors may resolve to capitalise any part of the Company's profit that is available for distribution. If they do that, they must not pay the amount in cash, but must use it to benefit those shareholders who are entitled to dividends in the proportions that would apply if it were a dividend. The benefit must be given in either of the following ways:

21.9.1 Paying up the amounts unpaid on the shareholder's shares; or

21.9.2 Issuing fully paid shares or debentures of the Company to the shareholder

Applying an amount for the benefit of shareholders

21.10 The amount of profit capitalised must be applied for the benefit of shareholders in the proportions in which the shareholders would have been entitled to dividends if the amount capitalised had been distributed as a dividend.

Shareholder Entities Agreement

Parties

Background:

A. The Shareholding Entities each carry on their own businesses under a name and associated brands and have agreed to certain operating and performance standards for the protection and enhancement of the Name and associated Brands.

B. The Shareholding Entities subscribed for shared in the entity with the understanding that its primary purpose was and is providing services to the Shareholding Entities, owning and licensing the Names, Brands (as defined in the Agreement) and other intellectual property.

C. The Shareholding Entities subscribed for shares in a consolidated entity with the understanding that its primary purpose was and is contracting with clients that may require particular services and advisory services on a national or multi-state or multi-entity basis and subcontracts the performance of those services to Shareholding Entities.

D. At the date of this Agreement, the parties listed in Schedule 1 are all the current Shareholding Entities that are legally entitled to the shares in the entity and the consolidated entity.

E. This Agreement is the paramount agreement setting out the rights and obligations of the Shareholding Entities as shareholders of each of the entity and the consolidated entity.

Operative Provisions

1. FORMATION OF RELATIONSHIPS

1.2 While this Agreement is on foot:

1.2.3 the entity and the consolidated entity must provide the Services to the Shareholding Entities in accordance with this Agreement; and

1.2.4 Each Shareholding Entity must carry out its business in accordance with the requirements of this Agreement and the Associated Agreements.

1.3 A Shareholding Entity is entitled to use the Services for so long as:

1.3.1 the Shareholding Entity holds shares in the entity and the consolidated entity and …

1.4 Subject to all requirements of law, each Shareholding Entity must, in relation to the conduct of the Shareholding Entity's business under the Names and the Brands, conform with:

1.4.1 all lawful rules policies and directions issued by the entity or the consolidated entity; and

1.4.2 all applicable laws relating to the operation of the Shareholding Entity's business

4. FUNDING OPERATIONS

General levies

4.1 The ordinary operations of the entity and the consolidated entity shall be funded by way of general levies that are:

4.1.1 determined by an ordinary resolution of all Shareholding Entities; and

4.1.2 issued by the entity or the consolidated entity (as the case requires) at such frequency as the board of directors of the entity or the consolidated entity determines from time to time

Supplementary levies

4.2 If the board of directors of the entity or the consolidated entity determines the monies raised by general levy under clause 4.1 will be insufficient to fund the ordinary operations of the entity or the consolidated entity for a given period, the board of directors of the entity or the consolidated entity may resolve:

4.2.1 To impose a supplementary levy not exceeding in total $100,000 (of which each Shareholding Entity is to pay a part) to provide for the shortfall, or anticipated shortfall; and

4.2.2 whether such levy is payable by the Shareholding Entities as a lump sum or by instalments.

Special Levies

4.3 The board of directors of the entity or the consolidated entity may resolve to impose a levy not referred to in clause 4.1 or 4.2 on all Shareholding Entities subject to approval or ratification of a resolution passed by 75% of the Shareholding Entities entitled to vote at a meeting of Shareholding Entities

5. TRANSFER OF SHARES

Restriction

5.1 Any Shareholding Entity who wishes to dispose of any of their shares in the entity or the consolidated entity must do so strictly in accordance with the provisions of this clause 5, unless the board of directors of the entity and the consolidated entity resolve otherwise.

Notice and Consent

5.2 A Shareholding Entity must not dispose of any of their shares in the entity or the consolidated entity unless the Shareholding Entity first:

5.2.1 provides a notice of intention to dispose of their shares in entity and consolidated entity to the entity and the consolidated entity; and

5.2.2 obtains the written consent of the entity and the consolidated entity to that disposal which consent may only be refused in accordance with the provisions of clause 5.3.

5.3 The entity and the consolidated entity may refuse consent to a disposal of shares by a Shareholding Entity.

Consolidated

22. A separate company (Consolidated) Pty Ltd is used by Shareholding Members as a single vehicle to tender for national clients.

23. The shareholders of the consolidated entity are the same as the shareholders of the entity.

24. The consolidated entity does not directly utilise any of the property or services of the entity other than using the brand in its name (for which no payment is made to the entity).

25. The consolidated entity subcontracts its work to Shareholding Members and Non-Shareholding Members.

26. The consolidated entity state that they operate on a break even basis with the relevant Shareholding Member or Non-Shareholding Member making the profits attributable to the work undertaken.

Relevant legislative provisions

Income Tax Assessment Act 1997, section 6-5

Anti-avoidance rules

Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part IVA general' in the search box on the top right of the page, then select: 'Part IVA: the general anti-avoidance rule for income tax'.

Reasons for decision

Summary

The entity is a service company which provides services to Shareholding and Non-Shareholding members as customers in the nature of trade. The entity's dealings with Shareholder Members are not considered to be mutual dealings because:

• The transactions are in the nature of trade;

• Membership alone is not determinative of the existence of a mutual relationship; rather it is the nature of the transactions which determine mutuality. In this instance Shareholder Members and Non-Shareholder Members alike are dealing with the entity as customers to advance their individual business interests. Membership of the entity is not determinative in establishing a mutual relationship;

• There is no common fund controlled by the contributors for a common purpose because the class of contributors (being the Shareholder Members and Non-Shareholder Members as customers) is not the same as the class of those who might participate in any surplus (being the Shareholder Members as owners);

• In circumstances where Shareholder Members and Non-Shareholder Members are trading with the entity as customers it is not appropriate to look through the corporate veil of the entity and consider it as a mere entity of convenience for its members.

Principle of Mutuality

Section 6-5 of the ITAA97 provides that assessable income includes income according to ordinary concepts, which is called ordinary income. Whether a receipt is income depends upon its quality in the hands of the recipient.

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 profit.

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.

Mutual receipts versus receipts in the nature of trade

The courts recognised that a company can trade with its members and the dealings can still be mutual. However where the dealings undertaken between members and the company are in the nature of trading producing profit membership or non-membership is of no significance.

In Fletcher v. Income Tax Commissioner [1971] 3 All ER 1185 (Fletcher) The Privy Council considered whether the mutuality principle applied to receipts from hotel members of a bathing club who joined the bathing club in order to provide access for their hotel guests to an attractive bathing beach. Lord Wilberforce in Fletcher at 1189 stated that:

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 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?

In concluding that the fees from the hotel members were not mutual receipts the court in Fletcher stated at 1191:

What is, and always has been, of significance is not the fact of membership or non-membership but the nature of the transactions: if these were trading transactions, the addition of membership makes no difference.

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 whether they 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 court was required to determine if the resulting sum payable to the Association was it to be characterised as income, or whether it was 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 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?'. 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.

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.

The entity is established as a private company limited by shares. The background section of the Shareholders Agreement makes it clear that:

• the shareholding entities carry on their own business,

• the primary purpose of the entity is to provide services to shareholding entities and to own and licence Names, Brands and other intellectual property,

• the consolidated entity has the primary purpose of contracting with clients requiring services on a national scale.

• Clause 4 of the entity's Shareholders Agreement requires all shareholding entities to pay fees to the entity for the provision of specified services.

The entity provides the following services to its Shareholding Members and Non-Shareholding members:

• access to the brand name,

• coordinating of purchasing advantages, adoption of a common operating system, development of risk management procedures, hosts centralised data bases.

Members pay the entity based either on a fee for service basis or on their level of turnover, which demonstrates a relationship between services provided by the entity and the rate of payment for these services. In essence members are paying the entity for services rendered. Just as with Music Traders, Shareholding Members and Non-Shareholding Members alike each contribute to the entity in order to gain access to services to advance their individual business interests. The services provided by the entity are by their very nature inherently linked to the business activities of members.

Based on the facts, Shareholding members are in business as professional businesses and are paying the entity as a service company for services rendered. There is no distinction between shareholding members and non-shareholding members in the provision of services by the entity. It is accepted by the entity that receipts from Non-Shareholding Members are not mutual receipts.

Because the Shareholding Members are in business there would be strong commercial reasons for operating a service company to provide common services for shareholders. The independent pursuit of business objectives is a private activity of each shareholder which is unrelated to any common purpose or mutual activity they may have as a group. In circumstances such as these as explained in Fletcher, and Assam Tea membership or non-membership is of no significance, rather it is the nature of the transactions which matters.

In this instance the entity is trading with professional firms to provide services to assist its members (who also happen to be predominately the entity shareholders) to advance their individual business interests. This represents dealings in the nature of trade and is inconsistent with the principle of mutuality applying to the entity.

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 Liverpool Corn Trade Association Limited v. Monks (HM Inspector of taxes) (1926) 2 KB 110 (Liverpool Corn Trade), the King's Bench where tasked with considering the nature of the dealings between the Liverpool Corn Trade Association and their members in relation to mutuality. The association in Liverpool Corn Trade provided common infrastructure and provided services to members and other persons using market facilities on an equal footing. Of relevance in Liverpool Corn Trade, the members were also shareholders of the association which was incorporated as a company. Rowlatt J at 121 and 122 of Liverpool Corn Trade states:

The question here is whether the profit which the company makes out of what the members pay to it is taxable income of the business which the company undoubtedly carries on.

….

I do not see why that amount is not a profit. The company has a capital upon which dividends may be earned, and the company has assets which can be used for the purpose of obtaining payments from its members for the advantages of such use, and one is tempted to ask why a profit is not so made exactly on the same footing as a profit is made by a railway company who issues a travelling ticket at a price to one of its own shareholders, or at any rate as much a profit as a profit made by a company from dealing with its own shareholders in a line of business which is restricted to shareholders. If there were a railway company which only carried its own shareholders, one would say that when it afforded the advantage to a shareholder of performing an act of transit for him, being paid by the shareholder therefor, that the profit thereby made was a profit of the company just as much as if the shareholder was a stranger.

While going on to acknowledge the principle in New York Life Insurance Co v. Styles 14 App. Cas. 381 of an incorporated entity being a mere entity of convenience for its members, Rowlatt J went on to say at 123 that:

…. in a case of this kind where there is a company with share capital, and shareholders with a right to dividends, if declared, upon the share capital, coupled with a dealing by the company with the persons who happen to be the owners of the share capital, affording benefits to those persons individually for which they pay money by way of subscriptions and by way of entrance fees as a sort of overriding subscription, if I may use that word, which opens the door to subscriptions, there is no reason at all for disregarding the fact that the company is incorporated, or for regarding otherwise than as profits the difference which is obtained by dealings between that corporation and the persons who happen to be members.

Liverpool Corn Trade illustrates the principle that in circumstances where members are dealing with a corporation in which they also happen to be shareholders there will be a lack of identity between what the members, as customers contribute, and what they may stand to receive as shareholders or owners of the company.

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. In circumstances where the owners of a company are dealing with a company as customers, it is unlikely that identity will be present.

The entity exists as a service company which provides services to shareholders (referred to as Shareholder Members) and non-members alike. The payment for the services provided to the entity are based on the level of turnover of the Shareholder Member entities or based on the type of service provided. This relationship is in the nature of a customer using the services of a service provider.

The entity constitution provides for the declaration of dividends at the discretion of its directors, this relationship is based on the ownership of the company and is not inconsistent with any other profit making company with owners. While it is possible to look through the corporate veil to view an incorporated entity as an entity of convenience for the members, in circumstances where shareholders are trading with a corporate entity as customers, to advance their individual business interests it is not appropriate to do so.

Based on this it is not accepted that there is identity between what the Shareholder Members contribute to the entity as customers and what they stand to receive from the entity as shareholders or owners.

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 apply.

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.

The existence of a common fund is premised on the existence of identity between what a member of the fund contributes to the fund and the benefit they stand to receive from the fund. Sydney Water Board illustrates the principle that where a member deals with an association as a customer they are not contributing to a common fund, rather they are contracting on an individual basis with the provider of a service on their own account.

The entity provides services to its Shareholding and Non-Shareholding members as customers. The entity's Shareholding Members, as owners of the entity, have the right to dividends and distributions of capital from the entity as shareholders. The customers of the entity as a class, being their Shareholding Members and Non-Shareholding, who contribute in order to receive services and benefits from the entity are not the same as the Shareholding Members of the entity as shareholders who as a class stand to receive dividends and capital distributions as owners. While it is acknowledged that the entity states that they do not pay dividends and intend to distribute capital upon dissolution based on their contributions; this does not diminish from the fact that Shareholding Members are owners of the entity with all the rights of ordinary shareholders to control the entity and receive dividends and capital distributions as owners.

Applying the principle in Sydney Water Board it is not possible to accept that the Shareholder Members, as customers of the entity are contributing to a common fund for their common purpose.

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.

Applying the principles in RACV, Shareholder Members and Non-Shareholder Members alike are dealing with the entity as customers to advance their individual business interests, these dealings are business dealings in the nature of trade and do not exhibit the characteristics of a mutual relationship.

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.

This should be contrasted with the position taken in Liverpool Corn Trade, where it was not considered appropriate to look through the corporate veil in circumstances where the shareholders of a corporate entity were trading with that entity as customers, in this instance the corporate entity was more than a mere entity of convenience.

The entity is an incorporated entity which provides services to Shareholder Member and Non-Shareholder Members as customers. As with Liverpool Corn Trade, there is little to distinguish the services provided by the entity to its members and non-members, compared to the role of Shareholder Members as shareholders who have all the normal rights of the owners of a company. In circumstances such as these it is not appropriate to look behind the corporate veil and view the entity as a mere entity of convenience for its members.

Conclusion

The entity is a service company which provides services to Shareholding and Non-Shareholding members as customers in the nature of trade. The entity's dealings with Shareholder Members are not considered to be mutual dealings because:

• The transactions are in the nature of trade.

• Membership alone is not determinative of the existence of a mutual relationship; rather it is the nature of the transactions which determine mutuality. In this instance Shareholder Members and Non-Shareholder Members alike are dealing with the entity as customers to advance their individual business interests. Membership of the entity is not determinative in establishing a mutual relationship.

• There is no common fund controlled by the contributors for a common purpose because the class of contributors (being the Shareholder Members and Non-Shareholder Members as customers) is not the same as the class of those who might participate in any surplus (being the Shareholder Members as owners).

• In circumstances where Shareholder Member and Non-Shareholder Members are trading with the entity as customers it is not appropriate to look through the corporate veil of the entity and consider it as a mere entity of convenience for its members.