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Date of advice: 27 October 2017

Ruling

Subject: Co-operative company – distribution of rebates

Question 1:

Did the Co-Operative (Co-op) meet the conditions contained in section 118 of the Income Tax Assessment Act 1936 during the 2014-15, 2015-16 and 2016-17 income years?

Answer:

No.

Question 2:

Can the Co-op claim a deduction for rebates distributed to its members?

Answer:

No.

This ruling applies for the following periods

Income year ending 30 June 2015

Income year ending 30 June 2016

Income year ending 30 June 2017

The scheme commences on

1 July 2014.

Relevant facts and circumstances

The Co-op was incorporated prior to 20 September 1985, and was registered under the Co-operatives National Law in the state in which it is located on the same day.

The Rules of the Co-op contains the following:

● the objects of the co-operative is to provide a specified type of services in the area in which the Co-op is located;

● no member of the Co-op will hold shares exceeding $XXX,XXX, or more than XX% of the nominal value of issued share capital of the Co-op;

● Shares in the Co-op shall not be quoted for sale or purchase at any stock exchange or other public manner

● every member of the Co-op shall hold at least X,XXX shares on admission to the membership of the Co-op;

● the Board may resolve to retain all or part of the surplus arising in a year from the business of the Co-op to be applied for the benefit of the Co-op;

● the Board may apply any part of the surplus arising in a year from the business of the Co-op or any part of the reserves to pay a rebate to members based on the business done by the member with the Co-op, or issue bonus shares to members, or pay a limited dividend for shares held;

● “surplus” means the excess of income over expenditure after making appropriate allowance for taxation expense, deduction in value of the property of the Co-op and for future contingencies; and

● a dividend or rebate will be declared at any general meeting of the Co-op but shall not exceed the amount recommended by the Board, nor exceed the percentage permitted by the Co-operatives Act 1992.

● The Co-op undertakes the following activities:

The Co-op currently has X directors and XX members.

All members of the Co-op receive an equal rebate which is not based on the member’s contributions as set out in the Rules and which is generally paid around the middle of each year.

Rebates are paid from any profits made by the Co-op before tax which are sourced from:

● income streams from the Service B and Service C amounts and members contributions; or

● the Co-op does not charge its members for their subscriptions for a number of months in the last part of the financial year.

The rebates are calculated to reduce the tax liability of the Co-op and are based on how much tax the Co-op has to pay and how much they can reduce the tax in accordance with income streams.

The Co-op paid the following rebates to its members:

	2017	2016	2015
Total amount of rebates paid	$XXX,XXX	$XX,XXX	$X

The Co-op does not distribute any dividends.

The following amounts were included in the Co-op’s income statements for the 2014-15 and 2015-16 income years:

The Co-op’s operations have not materially changed during the 2015-16 to 2016-17 income years.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 9

Income Tax Assessment Act 1936 Subsection 6(1)

Income Tax Assessment Act 1936 Section 44

Income Tax Assessment Act 1936 Section 117

Income Tax Assessment Act 1936 Section 118

Income Tax Assessment Act 1936 Section 120

Income Tax Assessment Act 1997 Section 218-5

Reasons for decision

Question 1

Co-operative status under Division 9 of the ITAA 1936 is established by a two-step process. First, it is necessary to determine whether the company satisfies section 117 of the ITAA 1936. If it does, then section 118 of the ITAA 1936 must not apply to preclude it from obtaining co-operative status.

Determining the co-operative status of a company for the purposes of subsection 117(1) of the ITAA 1936

Subsection 117(1) of the ITAA 1997 defines the term “co-operative company” for the purposes of Division 9 of the ITAA 1936 and requires that:

● the company is not a friendly society dispensary;

● the rules of the company limit the number of shares which may be held by, or on behalf of, any one shareholder;

● the rules of the company prohibit the quotation of the shares for sale or purchase at any stock exchange or in any other public manner whatever; and

● the company has been established for the purpose of carrying on any business having as its primary object or objects one or more of the following as outlined in subsection 117(1) of the ITAA 1936:

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

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

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

(d) the rendering of services to its shareholders;

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

Taxation Ruling TR 1999/14 Income tax: determining the co-operative status of a company which makes loans to its shareholders (TR 1999/14) states that when considering subsection 117(1) of the ITAA 1936, two questions need to be asked, as expressed by Gibbs CJ in Brookton Co-operative v.FCT (1977) 7 ATR 587 (Brookton Co-operative):

● What business or businesses is the company carrying on?

● What is/are the primary object/objects of each business?

In discussing the first question, Mason J said in Brookton Co-operative at 886:

As a matter of common experience, companies are usually established for the purpose of carrying on a business. Consequently, to the question “For what purpose is the X company established?” We expect to hear the response “For the purpose of carrying on the business of…

The purpose for which a company is established must be determined at the time when the company’s status as a co-operative is under examination, rather than at the time of the company’s inception.

Whether the company satisfies the requirement of subsection 117(1) of the ITAA 1936 depends on its activities during the income year. A company may engage in several distinct businesses, which may have one or more primary object or objects. If any of the businesses have a primary object which does not come within the scope of the objects listed in paragraphs (a) to (e) of subsection 117(1) of the ITAA 1936, the company will not qualify as a co-operative company.

The second question addressed in determining the co-operative status of a company is “What is/are the primary object/objects of each business that is being carried on?” The question of which activities of a business represent its 'primary objects' is one of degree. The Macquarie Dictionary defines the word 'primary' as including:

1. first or highest in rank or importance; chief; principal.

2. first in order in any series, sequence, etc...'

Each business carried on by a company may have several primary objects. Section 117 of the ITAA 1936 contemplates that there may be several primary objects of a business carried on by the company and that there may be one or more secondary or subsidiary objects.

If a company is kept in operation in a particular year for the purpose of carrying on a business having as its primary object one of the permitted activities and also for the purpose of carrying on some other activity or for the purpose of carrying on some other business, it will not qualify as a co-operative company unless that other business has as its primary object one of the permitted activities as outlined in subsection 117(1) of the ITAA 1936.

It is recognised that a business may have secondary objects in conjunction with its primary objects. Secondary objects are those activities that do not impact on the overriding character of the business. They should be no more than occasional or incidental.

A company is not a co-operative company if less than 90% of its business is with its members

Although a company may be a co-operative company within the meaning of the definition contained in section 117 of the ITAA 1936, it may be deemed not to be a co-operative company for a particular income year if it does not comply with the requirements of section 118 of the ITAA 1936 in respect of that year.

Section 118 of the ITAA 1936 states that if, in the ordinary course of business of a company in the year of income, the value of commodities and animals disposed of to, or acquired from, its shareholders by the company, or the amount of its receipts from the storage, marketing, packing and processing of commodities of its shareholders, or from the rendering of services to them, or the amount lent by it to them, is less respectively than 90% of the total value of commodities and animals disposed of or acquired by the company, or of its receipts from the storage, marketing, packing and processing of commodities, or from the rendering of services, or of the total amount lent by it, that company shall in respect of that year be deemed not to be a co-operative company.

Therefore in general terms, while 90% of the value of the company’s total activity is with it shareholders, then the company can still be a co-operative company. There is no prohibition on activity being conducted with third parties while the value of that activity is less than 10% of the company’s total activity.

Application of the legislation to your situation

Based on the information and documentation provided, it is viewed that the Co-op operates the business of providing services and undertakes the following activities:

● providing services to members through Service A;

● operating Service B; and

● providing services for the Commonwealth Entity through Service C.

The Co-op meets the following conditions contained in section 117 of the ITAA 1936:

● the Co-op is not a friendly society dispensary;

● the Co-op’s rules restrict the number of shares which may be held by its members; and

● the Co-op’s rules prohibits the shares being quoted for sale or purchase on any stock exchange, or any other public manner.

From the information provided it is unclear whether the services provided to the Co-op’s members will meet the object contained in paragraph 117(1)(d) of the ITAA 1936. However, even if it did, the activities undertaken in relation to Service B and Service C will not meet any of the paragraphs contained in subsection 117(1) of the ITAA 1997 as they are not services provided to the Co-op’s members.

It has been stated that the Service B activities accounts for less than 10% of the total amount of the Co-ops work based on annual job figures. However, as outlined above when considering whether the Co-op will meet the conditions contained in section 118 of the ITAA 1936 in relation to the rendering of services to its members, it is the total amount received by the Co-op and whether the amounts relating to services provided to the Co-op’s members is 90% of the Co-op’s total receipts.

Based on the information provided for the 2014-15 and 2015-16 income years, the percentage of the total income received by the Co-op from all of its activities are as follows:

● Service A – XX%;

● Service B – XX%; and

● Service C – XX%.

The Service B activities operate independently from the Co-op’s members and also do not meet any of the objects outlined in subsection 117(1) of the ITAA 1936. The percentage of the amounts received by the Co-op in each income year from its Service B activities as outlined above are more than 10% of the Co-op’s total amounts received in each income year. This activity is also not viewed as being occasional or incidental.

It is viewed that the activities the Co-op undertakes in relation to Service C are not provided to its members, but is a service provided to the Commonwealth Entity. Therefore, these activities do not meet any of objects contained in subsection 117(1) of the ITAA 1936. Additionally the percent of the amounts received by the Co-op in relation to its Service C activities are more than 10% in each income year and cannot be viewed as being occasional or incidental in relation to the Co-op’s total activities.

After reviewing the facts of this case it is viewed that the Co-op does not meet the conditions contained in section 117 of the ITAA 1936, or alternatively does not meet the section 118 of the ITAA 1936. Therefore, as the Co-op has not met those conditions it is not viewed as being a co-operative company for income tax purposes during the 2014-15, 2015-16 and 2016-17 income years and is viewed as a company.

Question 2

Co-operatives are taxed like other companies, in most respects, including treatment of depreciation and other deductions. However, co-operative companies, unlike other companies are specifically allowed deductions for amounts distributed from assessable income to members as rebates or bonuses on business done, or as interest or dividends under subsection 120(1) of the ITAA 1936.

Alternatively, co-operative companies have the option of franking distributions paid to members from assessable income under subsection 218-5 of the Income Tax Assessment Act 1997.

Companies can distribute either franked or unfranked dividends to its shareholders.

For taxation purposes, the expression “dividend” is defined in section 6(1) of the ITAA 1936 to include any distribution made by a company to its shareholders, whether in money or other property, and any amount credited by a company.

Dividends paid to Australian resident shareholders out of any profits of the company are assessable under section 44 of the ITAA 1936.

Application of the legislation to your situation

As outlined above, the Co-op is not viewed as a co-operative for income tax purposes. Therefore, where the Co-op distributes rebates to its members, it cannot claim a deduction for those distributed rebates. Also, the surplus that had been previously distributed by the Co-op as rebates would be viewed as being a profit of the Co-op, and therefore payment of it will be a dividend.

Note: Further information about companies paying dividends and other distributions can be viewed on our website, www.ato.gov.au by conducting a search for quick code QC 47301.