Edited version of private advice

Authorisation Number: 1051790419581

Date of advice: 16 December 2020

Ruling

Subject: Mutuality principle

Question 1

Does the principle of mutuality apply so as to exclude shareholder rate contributions received by X from its assessable income under section 6-5 of the ITAA1997?

Summary

Yes.

This ruling applies for the following period:

1 July 20XX to 20 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Objects

X is a company limited by shares that operates for the benefit of its members.

The objects of X are set out in its Memorandum of Association.

Since incorporation in 19XX, the object of X has been to X, for the sole use and benefit of the members of the Company, without attempting to make any profits or other gains.

Each X acquires shares in the Company which grants the member the right to X. A X agreement is also entered.

There are no benefits afforded to members other than those outlined in the memorandum of association and X.

The Company does not deal with or extend its facilities to non-members.

Income

The quantum of shareholder rate contributions paid per year is the same for all shareholders. This entitles them to the same privileges and facilities X.

All income and property derived or held by X must be applied solely towards the objects of the Company.

The Company does not derive income from sources other than the contributors' payments (other than interest income). For instance, no income from a business activity or transactions in the nature of trade, or for a profit, conducted by the members or non-members have been received.

Where surplus funds remain, in practice the Company leaves it in its interest-bearing account. It does however have the power to declare dividends from profits (if any) in proportion to the shareholders interest.

Expenses

The members rates' each year are budgeted to cover cost of X for the next 12 months. Expenses typically include X.

No portion of the members' contribution is used to purchase insurance policies from third-party insurance entities.

Other

No strata title body or body corporate is involved in the X.

No funds are loaned by the Company to members or non-members.

If the Company is wound up, assets of the Company are divided amongst members.

The business of the Company is managed by the Directors.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Reasons for Decision

These reasons for decision accompany the Notice of private ruling for X.

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Question 1

Does the principle of mutuality apply so as to exclude shareholder rate contributions received by X from its assessable income under section 6-5 of the ITAA1997?

Summary

Yes.

Detailed reasoning

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) 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. Section 6-10 of the ITAA 1997 provides that assessable income also includes statutory income, which are amounts that are included in assessable income as stipulated by specific legislative provisions.

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 is not income or profit.

In The Bohemians Club v The Acting Federal Commissioner of Taxation [1918] 24 CLR 334 (Bohemians Club) 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 comments of Griffith CJ have formed the basis of the principle of mutuality as it applies in Australia. As such, a receipt by a taxpayer will not have the quality of ordinary income if the mutuality principle applies to it. The principle of mutuality is a feature of common law. It is not defined in the ITAA 1997.

The mutuality principle was described by Mc Tiernan 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.

Revesby Credit Union establishes that a mutual association has all of the following characteristics:

•         existence of a common fund controlled by the contributors for a common purpose;

•         identity between the contributors and the participants;

•         dealings are not in the nature of trade; and

•         an incorporated entity must be an entity for the convenience of its members.

It is necessary to consider whether the elements of mutuality are present in relation to their receipt of shareholder rate contributions.

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.

X was established for the purpose of X, for the sole use and benefit of the members of the Company, without attempting to make any profits or other gains. A fund was created to meet its objectives. Members contribute annual rates to the fund to meet the objectives. The activities of the Association support their objectives and there is a common fund controlled by the contributors for a common purpose. All members have equal access to the benefits of the Company. The benefits of such a system are shared in common by the members.

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 Irrigation Mutual Co-Operative Ltd v FC of T 2004 ATC 4835 (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.

The Company shareholders are the X. The shareholders are the only contributors to the fund, each contributing annual rates. There are no shareholders which are not X, and there are no non-members who participate in the fund. Only shareholders (who are therefore X) are entitled to participate in the distribution of surplus (if any), in proportion to their interest in the Company.

Accordingly, the element of identity between the contributors and those entitled to participate in any surplus is satisfied.

Not in the nature of trade

The courts have long recognised that a company can trade with its members. However, transactions entered in to for commercial purposes are not mutual receipts (Revesby Credit Union).

Shareholder rate contributions are not profit, rather members own contributions for the benefit of the fund. Consideration of the constituent document indicates that the Company is not trading for profit and members are not engaging in any commercial transactions.

Incorporation

Incorporation will not affect the operation of the mutuality principle (New York Life Insurance Co v Styles 2 TC 460) provided the incorporated body can properly be treated as an entity for the convenience of the contributors (Coleambally Irrigation Mutual Co-operative Ltd v Federal Commissioner of Taxation 2004 ATC 4835 at 4842). X is the vehicle used to pursue the common purpose of its members. The use of the company a vehicle of convenience will not affect the operation of the mutuality principle.

Conclusion

Therefore, shareholder rate contributions are controlled by X members for their common purpose, there is identity between the contributors of the rates and the participators in the fund, and the members are not engaging in activities in the nature of trade.

The elements of mutuality are present, and the principal of mutuality applies to the shareholder rate contributions received by X.

For completeness, we note that interest income is not a mutual receipt and is assessable to X under section 6-5 of the ITAA 1997.