Edited version of your written advice

Authorisation Number: 1051456879383

Date of advice: 20 November 2018

Ruling

Subject: CGT Small business concessions and mutuality

Question 1

Will a receipt which constitutes a ‘mutual receipt’ at common law be excluded from the calculation of ordinary income under section 6-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

If an amount fails the common law test due to the decision in Coleambally, though a non-assessable non-exempt receipt under section 59-35 of the ITAA 1997, is it nonetheless included in calculating turnover under subsection 358-120(1), as ordinary income under subsection 6-5(1)?

Answer

Yes

This ruling applies for the following period:

Year of income ended 30 June 20XX

Year of income ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Club, a not-for-profit club, is a company limited by guarantee.

The Club is a compliant club under the relevant state legislation.

The Club is not an exempt entity under Division 50 of the ITAA 1997.

The Club’s constitution has a not-for-profit clause that prevents any distributions to members on winding-up.

The Club’s total combined member and non-member receipts in any year is more than $2 million.

The Club’s total non-member receipts in any year is less than $2 million.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Subsection 6-15(3)

Income Tax Assessment Act 1997 Section 17-5

Income Tax Assessment Act 1997 Section 59-35

Income Tax Assessment Act 1997 Subsection 152-10(1AA)

Income Tax Assessment Act 1997 Division 328

Income Tax Assessment Act 1997 Section 328-120

Income Tax Assessment Act 1997 Subsection 328-120(2)

Income Tax Assessment Act 1997 Subsection 328-120(3)

Reasons for decision

Summary

A receipt that is a ‘mutual receipt’ at common law is excluded from the calculation of ordinary income under section 6-5(1) of the ITAA 1997. However, an amount that fails the common law test due to the decision in Coleambally, although a non-assessable non-exempt receipt under section 59-35 of the ITAA 1997, is included in calculating turnover under subsection 358-120(1).

Detailed reasoning

Section 6-5 of the ITAA 1997 provides that ‘assessable income’ includes income according to ordinary concepts. Whether a receipt is income depends upon its quality in the hands of the recipient: Scott v Federal Commissioner of Taxation (1966) 117 CLR 514 at p. 526. However, any receipts that are mutual receipts are not ordinary income (Taxation Ruling TR 2015/3), and therefore not included in assessable income under section 6-5.

The mutuality principle provides that where a number of people come together 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 purposes that is then distributed to the contributors, is a return of funds and not income or profit (Social Credit Savings and Loans Society Ltd v Federal Commissioner of Taxation (1971) 125 CLR 560). That is, income is not derived from dealings with oneself.

In Coleambally Irrigation Mutual Co-operative Ltd v FC of T 2004 ATC 4126 (Coleambally), the court found that where a constitution prohibits distribution to members on winding up, the connection between those who contribute to the common fund and those who participate in the common fund is broken so as to prevent the principle of mutuality from applying. As a result of the decision in Coleambally, section 59-35 was enacted to provide that an amount, that would be a mutual receipt but for an entity’s constituent document prohibiting distributions to members, will be non-assessable and non-exempt income. Subsection 6-15(3) specifically excludes from assessable income any amounts that are non-assessable and non-exempt.

The Club’s constitution prohibits any distribution to members on winding up. As a result, the decision in Coleambally will preclude member receipts from being ‘mutual receipts’ at common law, and member receipts will be ordinary income. However, pursuant to section 59-35 member receipts will be non-assessable non-exempt income and excluded from assessable income by subsection 6-15(3).

Small Business Concessions

Taxation legislation provides for various taxation concessions for entities that qualify as a small business entity under Division 328 of the ITAA 1997. An entity that carries on a business will be a small business entity if it satisfies the $10m aggregated turnover test (section 328-120 of the ITAA 1997). However, for the purposes of the CGT small business concessions, the aggregated turnover threshold is $2m (subsection 152-10(1AA) of the ITAA 1997).

For the purposes of the small business aggregated turnover test, annual turnover is defined in section 328-120 of the ITAA 1997 to be the total ordinary income that the entity derives in the income year in the ordinary course of carrying on a business. However, some amounts are specifically excluded from the calculation of turnover:

● amounts that are non-assessable non-exempt income under section 17-5 (certain amounts of GST) – subsection 328-120(2) and

● amounts of ordinary income derived from the sales of retail fuel – subsection 328-120(3).

Therefore, for the purposes of Division 328 of the ITAA 1997, the Club will be a small business entity if its aggregated turnover is less than $10 million. However, to access the small business CGT concessions, the Club’s aggregated turnover calculated in accordance with section 328-120 must be less than $2 million (subsection 152-10(1AA)). As already noted above, the decision in Coleambally means that member receipts of the Club are ordinary income of the Club because they are not mutual receipts, although they are not included in the Club’s assessable income because of the operation of section 59-35. Therefore, member receipts will be included in the calculation of the Club’s aggregated turnover.

You have mentioned that section 59-35 was introduced following the decision in Coleambally with the intention of excluding member receipts from assessable income. You make reference to the comments at 2.14 of the Explanatory Memorandum for the Tax Laws Amendment (2005 Measures No. 6) Bill 2005:

These amendments are retrospective to 1 July 2000 as they are designed to ensure the taxation status of not-for-profit entities is not adversely affected by the Federal Court decision in Coleambally, and will cover the ATO’s four year time limit for the amendment of assessments.

You have argued that as a result of the decision in Coleambally the Club’s member receipts are not mutual income, which means that they are ordinary income amounts, and therefore form part of the Club’s aggregated turnover under section 328-120. Therefore, contrary to the stated intention of section 59-35, the Club is worse off because, if member receipts were mutual income, they would not be included in the calculation of the Club’s small business aggregate turnover threshold in section 328-120.

However, the concept of a small business entity post-dates the introduction of section 59-35 (which was introduced in 2005), being introduced in 2007 as part of the Tax Laws Amendment (Small Business) Act 2007. It provides a single definition of a ‘small business entity’ for the purpose of accessing any of the small business tax concessions (paragraph 1.1 of the Explanatory Memorandum to the Tax Laws Amendment (Small Business) Act 2007). As mentioned above, specific items of non-assessable non-exempt income were excluded from small business aggregate turnover test, however mutual receipts were not specifically excluded. Further, prior to 2007, small businesses were able to access certain concessions under the Simplified Tax System (STS), provided they met a turnover test that was based on the value of supplies made in the ordinary course of carrying on a business. This concept was broadly based on an entity’s annual GST turnover, excluding input taxed and certain other supplies, in connection with an enterprise the entity carried on. Therefore under the STS, the Club’s member receipts would have been included in the STS turnover threshold test.

In conclusion, the Club will be a small business entity under section 328-120 if its total aggregated turnover (including both member and non-member receipts) is less than $10 million, or $2 million in relation to the small business CGT concessions. Neither Division 328 nor Division 152 provides for any discretion for the Commissioner to exclude specific amounts of ordinary income from the calculation of the aggregate turnover amount.