Edited version of your written advice

Authorisation Number: 1012938937050

Date of advice: 19 January 2016

Ruling

Subject: Application of the Mutuality principle

Question 1

Are receipts of Management Pty Ltd subject to the principle of Mutuality and therefore not assessable?

Answer

No

This ruling applies for the following periods:

1 July 2010 - 30 June 2011

1 July 2011 - 30 June 2012

1 July 2012 - 30 June 2013

1 July 2013 - 30 June 2014

1 July 2014 - 30 June 2015

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

• The Village was a development undertaken by Development Pty Ltd. Development Pty Ltd held sufficient voting rights to control all matters in relation to the Village development

• Development Pty Ltd was placed in receivership, at this time the controlling voting rights passed to the receivers. The receivers did not wish carry on the management of the Village

• The Village comprised X residential lots. Prior to Development Pty Ltd being placed in receivership, Y of the X Village lots had been developed and sold and a single lot comprised the community land - open space, road and infrastructure

• The homeowners of the Village created a Trust to manage their interests in the Village. Any person who is a homeowner and any company appointed as manager of the Village are beneficiaries of the Trust

• The trustees of the Trust are A, B, and C (jointly referred to as the Trustee)

• The purpose of the trust is to provide financial assistance and contribution to facilities for the maintenance and benefit of the Village

• The Trustee has the absolute discretion to pay, apply or set aside income to or for the benefit of beneficiaries in such shares as the trustee may determine

• Until winding up, the capital of the trust is held on trust in shares or proportions as determined by the Trustee

• On winding up the income and capital is applied in the manner expressed in the deed and any remainder of the Trust is held for the default beneficiaries, being such people who are the homeowners of the Village at the time of termination of the Trust

• The Trustee has taken no active role in running of the Village and has not received income

• Management Pty Ltd is a proprietary company limited by shares. Management Pty Ltd was registered in 20XX after the developer of the Village was placed in receivership and operates as the operational arm of the Trust

• Management Pty Ltd is not a body corporate constituted under strata title legislation

• Management Pty Ltd has X shares held by one joint member - A, B and C. B and C are Village homeowners. The joint member believes it acts as an agent for the Village homeowners, however no Agent Agreement or other documents are in place

• Further residential lots within the Village, unsold when Development Pty Ltd entered receivership, were sold by the receivers. The number of beneficiaries of the Trust, therefore, increased

• Management Pty Ltd receives income from the homeowners of the Village via payment of a monthly management fee. These fees are used to meet the Village expenses and to accumulate a pool of funds to cover infrastructure repairs

• The Management Pty Ltd constitution states that members are to receive a distribution, on winding up, in proportion to the shares held by them

• Management Pty Ltd also receives interest and donations from the Y Shed (occupying community land but paying no fees)

• The receivers contributed X% of the cost of upkeep of the common areas of the Village. This amount was close to their proportional interest in the development. The receivers reimbursed X% of actual bills paid by Management Pty Ltd for services provided by tradespeople and gardeners. They did not contribute to the pool of funds held by Management Pty Ltd. The receivers did not contribute to Management Pty Ltd's administrative expenses or other fees or surcharges

• Two lots were not maintained by Management Pty Ltd as they were outside the main residential area and have since been removed from the community title subdivision. The Council approved the purchase of these lots in 20ZZ.

• Management Pty Ltd is responsible for a single utliity account for the Village; the homeowners receive an account from Management Pty Ltd according to their individual metered usage. No fees or charges are levied by Management Pty Ltd

• On 31 July 20ZZ the remaining vacant lots within the Village were sold by the receiver to a property developer. The receivers no longer have an interest in the Village

• Management Pty Ltd's constitution allows distributions to members, however distributions have never been made

• Management Pty Ltd and the Trust are to be wound up

• Action has commenced to place the Village under the management of a community association

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 6

Reasons for decision

Issue 1

Application of the Mutuality principle

Question 1

Are receipts of Management Pty Ltd subject to the principle of Mutuality and therefore not assessable?

Summary

The receipts of fees paid by homeowners of the Village to Management Pty Ltd are not subject to the principle of mutuality. All the elements for mutuality to apply have not been met. It is accepted that homeowners (the Contributors) have contributed to a common fund (the Fund) for a common purpose. However the Fund is managed and controlled by Management Pty Ltd, and for mutuality to apply the Fund must be owned and controlled by the Contributors. Further all the Contributors must be entitled to distribution of the surplus from the Fund. Only two Contributors are members of Management Pty Ltd and therefore only two of the Contributors own and manage the Fund and are entitled to receive the surplus of the Fund when Management Pty Ltd is wound up.

Detailed reasoning

The mutuality principle

The mutuality principle is a legal principle established by case law. It is based on the proposition that an organisation cannot derive income from itself.

The principle provides that where a number of persons contribute to a common fund created and controlled by them for a common purpose, any surplus arising from the use of that fund for the common purpose is not income.

The principle was described succinctly by McTiernan J in Revesby Credit Union Co-operative Ltd v FCT (1965) 112 CLR 564 at 574-575, who 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 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 does not extend to include income that is derived from sources outside that group.

An organisation can apply mutuality to receipts where:

• The organisation is carried on for the benefit of its members collectively, not individually

• The members of the organisation share a common purpose in which they all participate or are entitled to do so

• The main purpose for which the organisation was established, and is operated, is the common purpose of the members

• There is a common fund that gives effect to the common purpose and all the members contribute to it

• All the contributions to the common fund are applied for the collective benefit of all the members, in line with the common purpose

• Different classes of memberships may exist with varying subscription rates, rights and entitlements to facilities

• The members have ownership and control of the common fund

• The contributors to the common fund must be entitled to participate in any surplus of the common fund.

If the mutuality principle applies:

• receipts derived from mutual dealings with members are not assessable income (these are called mutual receipts)

• expenses incurred to get mutual receipts are not deductible.

Essentially, for the mutuality principle to apply, there must be contributions to a common fund for a common purpose, the fund must be controlled by the contributors and there must be complete identity between the contributors of the fund and those entitled to the surplus of the common fund.

Are there contributions to a fund for a common purpose?

Management Pty Ltd receives income from the homeowners of the Village via payment of a monthly management fee. All homeowners of the Village contribute management fees to Management Pty Ltd. These fees are used to meet the Village expenses and to accumulate a pool of funds to cover infrastructure repairs and maintenance. Management Pty Ltd also received reimbursements from the receivers of the Village development.

The contributions made by the homeowners to Management Pty Ltd are for a common purpose - to cover the costs of the Village infrastructure repairs and maintenance. Therefore the homeowners make contributions to a common fund for a common purpose.

Is the fund owned or controlled by the contributors to the fund?

The Trust and Management Pty Ltd were established to secure residential assets when the Village developers entered receivership.

The beneficiaries of the Trust are any homeowner and any company appointed as manager of the Village. The trustees of the Trust are A, B, and C. The Trust has taken no active role in running of the village and has not received income.

Management Pty Ltd is a proprietary company limited by shares and is the operational arm of the Village. Management Pty Ltd has X shares held by one joint member - A, B and C. Although the joint member believes it acts as an agent for the homeowners of the Village no agent agreement or other documents to support this are in place.

The homeowners, as contributors, do not own or control the fund as it is owned and controlled by the joint member.

Is there complete identity between the contributors to the fund and those entitled to the surplus to the common fund?

In a mutual arrangement, there must be complete identity between contributors and those entitled to participate in the surplus of common fund. The members must collectively contribute and collectively benefit from the common fund.

On winding up, the net capital of Management Pty Ltd will be distributed in accordance with Management Pty Ltd's constitution. It states that members are to receive a distribution, on winding up, in proportion to the shares held by them. Management Pty Ltd has 1 joint member, therefore funds will be distributed to the individuals who comprise the joint membership - A, B and C. While other homeowners contribute to the fund under the Constitution of Management Pty Ltd, only two homeowners are entitled to the surplus of the common fund when it is distributed. Therefore there is not complete identity between the contributors to the fund and those entitled to receive the surplus of the fund on winding up.

Conclusion

Although the homeowners of the Village contribute to a common fund for a common purpose they do not own or control the fund nor do they are they entitled to participate in a surplus of the common fund. Therefore, the receipts of Management Pty Ltd are not subject to the principle of Mutuality and the receipts are assessable.