Edited version of private advice

Authorisation Number: 1051853551746

Date of advice: 18 June 2021

Ruling

Subject: Not-for-profit entity ex-gratia receipt

Question

Should the ex-gratia payment received by the Club be treated as mutual receipts for the member's portion and ordinary income for the non-member's portion?

Answer

Yes

This ruling applies for the following period:

Year ending 30 June 20xx

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

The Club is a company limited by guarantee and a not-for-profit (NFP) entity.

The Club has a number of principal activities.

The Club is prohibited from making income and/or capital distribution to its members.

The Club is not income tax exempt and is taxable at the company tax rate.

The Club has been claiming the member's proportion of its receipts as mutual receipts and non-member's proportion as ordinary income.

The Club has assessed that this equates to X% of receipts being classified as mutual receipts and Y% as ordinary income for the income year ending 30 June 20xx (20xx income year).

The Project commenced construction in 20xx near the Club's business premises, which resulted in the Club losing access to its main car park.

The construction of the Project exceeded the anticipated completion timeframe of 12 months due to various factors.

Throughout the duration of the Project, the Club experienced a decline in revenue due to the disruption from the construction. There was a decline in patron's foot traffic, which impacted the financial performance of the Club.

The Club received an ex-gratia financial assistance payment related to the time of disruption and overstay of the Project.

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 59-35

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 (ITAA 1997), unless otherwise indicated.

Summary

The ex-gratia payment received by the Club can be treated as mutual receipts for the member's portion and ordinary income for the non-member's portion.

Detailed reasoning

Non-profit companies

For your organisation to be a non-profit company it must meet the 'non-profit requirement'. This means that:

•         it must be a company that is not carried on for the purposes of profit or gain to its individual members, and

•         its constituent documents must prohibit it from making any distribution, whether in money, property or otherwise, to its members.

Mutuality principle

Whether a receipt is income depends upon its quality in the hands of the recipient[1].

The term income is not defined in the Income Tax Assessment Act 1936 (ITAA 1936) or ITAA 1997. 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[2].

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.

Under the mutuality principle 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. This does not extend to include income that is derived from sources outside that group.

Receipts derived from mutual dealings with members of your organisation are called mutual receipts, which include:

•         member subscriptions and levies

•         fees from members using the organisation's facilities (for example, gyms, pools and squash courts)

•         drinks and food sold by the organisation to members

•         amounts members pay to attend dinners, parties, dances or social functions arranged by the organisation

•         amounts members pay to attend a talk, workshop or presentation arranged by the organisation

•         the sale of items, such as souvenirs, to members.

Assessable income

Section 6-5 provides that assessable income includes income according to ordinary concepts, which is called 'ordinary income'.

Ordinary income is not clearly defined in the legislation and therefore the courts have identified a number of factors that indicate whether an amount has the character of income according to ordinary concepts.

It has been determined that a frequent characteristic of income receipts is an element of periodicity, recurrence or regularity[3]. Other characteristics of income that have evolved from case law also include receipts that:

•         are earned,

•         are expected, and

•         are relied upon.

Assessable income includes receipts from trading with non-members and income from sources outside the organisation

Subsection 6-15(3) provides that if an amount is non-assessable non-exempt income, it is not assessable income.

Under section 59-35, ordinary income of an entity is non-assessable and non-exempt income if:

(a) the amount would be a mutual receipt, but for:

(i) the entity's constituent document preventing the entity from making any distribution, whether in money, property or otherwise, to its members;

... and

(b) apart from this section, the amount would be assessable income only because of section 6-5.

Apportionable revenue

Apportionable revenue is revenue that comprises both assessable and non-assessable income. This revenue needs to be separated using a practical and suitable method.

Guidance on how an organisation can calculate their net profit arising from receipts from non-members is provided in Taxation Determination TD 93/194 Income tax: how should a licensed club apportion expenses when calculating its taxable income? Other apportionment methods are acceptable, provided they are reasonable and give a correct reflection of the income earned.

Ex-gratia payment

There is no statutory definition of the term 'ex-gratia', reference must therefore be made to the ordinary meaning of the word shaped by the context in which it is found.

The Macquarie Dictionary, 2020 8th edition defines 'ex-gratia' to mean something granted as a favour and not because of a legal obligation.

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts considers the capital gains tax (CGT) consequences for the recipient of a compensation amount, and whether the amount should be included in assessable income. Paragraph 3 of TR 95/35 which states the following:

A compensation receipt, or compensation, includes any amount (whether money or other property) received by a taxpayer in respect of a right to seek compensation or a cause of action, or any proceeding instituted by the taxpayer in respect of that right or cause of action, whether or not:

-        in relation to any underlying asset;

-        arising out of Court proceedings; or

-        made up of dissected amounts.

Paragraphs 188 and 189 respectively of TR 95/35 states:

188. Whether a receipt constitutes income or capital in the hands of the taxpayer depends on the circumstances of the receipt and the reasons why it was paid to the taxpayer (FC of T v. Slaven 84 ATC 4077; (1984) 15 ATR 242). In that case, the Federal Court was required to consider the nature of an amount of compensation received by the taxpayer following a motor vehicle accident. The Court (Bowen CJ, Lockhart and Sheppard JJ), in concluding that the amount was paid as compensation for loss or impairment of the taxpayer's earning capacity, stated (84 ATC at 4085; 15 ATR at 252):

'It is the character of the receipt in the hands of the taxpayer as recipient that must be determined'.

189. The Courts have also emphasised that there is a clear distinction between the character of a payment and how it is calculated or quantified (for example,Tinkler v. FC of T 79 ATC 4641; (1979) 10 ATR 411) and that the method used:

'may provide a quite misleading guide to the character of the payment' (Deane and Fisher JJ, in the Tinkler case, 79 ATC at 4648; 10 ATR at 418).

Taxation Determination TD 93/58 Income tax: under what circumstances is the receipt of a lump sum compensation/settlement payment assessable? outlines the circumstances under which the receipt of a lump sum payment is assessable as ordinary income. Paragraph 1 states that it is assessable income:

(a)    if the payment is compensation for loss of income only e.g. past year profits, and/or interest (even when the basis of the calculation of the lump sum cannot be determined); or

(b)    to the extent that a portion of the lump sum payment is identifiable and quantifiable as income. This will be possible where the parties either expressly or impliedly agree that a certain portion of the payment relates to a loss of an income nature [cf. Mc Laurin v. FC of T (1961) 104 CLR 381; (1961) 8 AITR 180 and Allsop v. FC of T (1965) 113 CLR 341; (1965) 9 AITR 724].

Taxation Determination TD 93/3 Income tax: is a payment, being a partial commutation of weekly compensation payments, assessable income? considers that were a lump sum payment is made in lieu of weekly compensation for loss of income, the amount is assessable income. Paragraph 4 of TD 93/3 states:

The weekly payments are assessable income because they are paid as compensation for loss of income or salary, or because of their regular receipt and their nature as a supplement to income, etc (FC of T v. Inkster 89 ATC 5142; 20 ATR 1516). We consider that a lump sum payment, which is a partial commutation of weekly payments, does not change its character of compensation for loss of income. Effectively, the payment is an advance of future weekly payments. Consequently, it continues to be assessable ...

Application to your circumstances

The Club is an NFP entity as it is prohibited from making any distribution to its members, its profits are instead used to carry out its purpose. The Club has dealings with both members and non-members. Receipts derived from the Club's mutual dealings with members are mutual receipts and are not considered assessable income. Whereas, the Club's receipts from non-members exhibit the characteristics of income and are ordinary income.

The ex-gratia payment was not sourced from the Club's members, as such the principle of mutuality does not apply to the payment itself. This means that if the payment qualifies as either ordinary or statutory income, it will be assessable income of the Club.

The Club was granted the ex-gratia financial assistance payment as the Club suffered financially due to the overstay of the Project. The payment was made as a gesture of goodwill and on the basis that it was not an admission of liability. Nevertheless, it is characteristic of a compensation payment. This is because the payment was received by the Club in respect to seeking compensation for the loss of income/revenue it experienced due to the decline in foot traffic from the disruptions prompted by the Project.

The character of the receipt in the hands of the Club must be determined. As the compensation payment takes on the character of that which it is substituted, the payment is substituting the Club's income. The lump sum payment, which is a partial commutation of weekly payments, does not change its character of compensation for loss of income.

However, as the Club has dealings with both members and non-members, the Club's income is mutual receipts and ordinary income. The Club has assessed that in the 20xx income year, X% of receipts were receipts from members and Y% were receipts from non-members. As such the ex-gratia payment should be apportioned appropriately between assessable and non-assessable income. Where, X% will be classified as mutual receipts and non-assessable non-exempt income under section 59-35 and Y% as ordinary income under section 6-5.

[1] Scott v Federal Commissioner of Taxation (1966) 117 CLR 514

[2] Social Credit Savings and Loans Society Ltd v Federal Commissioner of Taxation (1971) 125 CLR 560

[3] Federal Commissioner of Taxation v. Dixon (1952) CLR 540; (1952) 10 ATD 82