Edited version of private advice

Authorisation Number: 1051949960097

Date of advice: 15 February 2022

Ruling

Subject: Principle of mutuality

Question 1

Are entrance fees and annual subscription fees received by the entity from its members, excluded from the assessable income of the entity by application of the principle of mutuality?

Answer

Yes.

Question 2

Does the principle of mutuality apply to fees for services to non-members or income from investments from non-member sources, so that these amounts do not constitute assessable income of the entity?

Answer

No.

Question 3

Does the receipt of income from non-members preclude the entity from applying the principle of mutuality to receipts from members?

Answer

No.

This ruling applies for the following periods:

1 July 20XX to 30 June 20XX

1 July 20XX to 30 June 20XX

1 July 20XX to 30 June 20XX

1 July 20XX to 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Entity was incorporated as a public company limited by guarantee.

The Entity membership is restricted to entities with a particular characteristic

There is only one class of membership interest in the Entity.

The objects of the Entity, as stated in the Constitution are as follows:

•         To provide Members with services.

•         To raise money to further the aims and to secure sufficient funds for the purposes of the Entity;

•         To receive any funds and to distribute these funds in a manner that best attains the objects of the Entity and

•         To do all such things as are incidental or conducive to the attainment of all or any of the objects.

Membership is defined in the Constitution, in the following way:

•         The Members are those entities who are Members at the date of adoption of this Constitution and such other persons as the Board admits to membership in accordance with this document.

Clause X of the Constitution provides the following non-profit clause:

No income or property of the Company may be paid or transferred, directly or indirectly to any member.

Clauses in the Constitution set out the voting rights for Members at General meetings and for ballots.

Clause X of the Constitution provides the following dissolution clause:

Upon winding up or dissolution of the Company, any remaining property after satisfaction of all debts and liabilities, will be distributed among the Members in such manner as determined by the Members at or before the time of dissolution. In the event that the Members cannot agree on the distribution of any property, the property will be distributed among the Members in proportion to their annual subscriptions paid during the 12 months prior to the winding up or dissolution.

The Entity provides general service to all members.

The Entity prices general services to Members as set out in the Constitution in the following way:

•         receives entrance fees and annual subscription fees from its Members.

•         the subscription fee is calculated by a formula prescribed by the Board.

•         the Board may reduce annual subscription fees of Members after taking into account any net income derived from services provided to persons or entities which is in surplus to the needs of the Entity.

•         Whilst the calculation mechanism for member subscription fees is not specifically provided for in the Constitution, the subscription fee is worked out based on a resolution of the company adopted at an Annual General Meeting:

­   The Entity forecast the amount of expected expenditure for the income year and increase the forecast by a notional amount to provide a buffer;

­   The Entity reduce the total forecasted expenditure by:

o   Expected bank interest income; and

o   Expected non-member income.

­   The Entity divide the remaining balance by the number of members based on their membership.

Most of the revenue received by the Entity is from its Members.

In addition to providing services to Members, The Entity provides services to Non-Members, who for various reasons, (beyond the control of The Entity or the Non-Member) are not able to be Members of the Entity.

The services provided to Non-Members by the Entity are similar to and compliment the services provided to Members, which serves to improve the services provided by the Entity to its Members.

The services provided to Non-Members are marked up and the Entity includes these amounts in its assessable income.

The level of income received by the Entity by Non-Members is a materially small amount compared with receipts from Members.

Non-Members do not have any rights of Membership, including voting rights or the right to participate in the distribution of a surplus upon dissolution of the Entity.

The Entity receives bank interest which comprises a materially small amount when compared to receipts from Members.

Bank interest is included in the assessable income of the Entity.

Relevant legislative provisions

Income Tax Assessment Act 1997, section 6-5

Reasons for decision

Issue 1

Question 1

Summary

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. Mutuality will apply even in circumstances where members do not avail themselves of all the facilities afforded by membership, provided all members have access to all of the services provided by the association.

Mutuality applies to entrance fees, annual subscription fees and fees for specific services from Members as these receipts amount to a contribution from Members to a common fund for a common purpose.

Detailed reasoning

Principle of Mutuality

Section 6-5 of the ITAA97 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[1].

The term income is not defined in the Income Tax Assessment Act 1936 (ITAA36) or ITAA97. 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 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.

A number of authorities have established the application of the mutuality principle in Australia. They include Bohemians Club, Revesby Credit Union, Social Credit Savings & Loan Society Ltd v. FC of T 125 CLR 560 (Social Credit Savings & Loan Society), Sydney Water Board Employees Credit Union Ltd v. FC of T (1973) 73 ATC 4129 (Sydney Water Board), Royal Automobile Club of Victoria (RACV) v. Federal Commissioner of Taxation 73 ATC 4153 (RACV), and FC of T v. Australian Music Traders Association (1990) 90 ATC 4536 (Music Traders).

A mutual association has all of the following characteristics:

§  a voluntary association of persons (contributors) who make contributions out of their own moneys to a common fund (which they create, own, control and all have an interest in) for a common purpose (which may also be for their personal benefit as participators) and that purpose is not undertaken for profit,

§  contributions are based on an estimate of expected expenses of the common purpose (mutual liabilities), and are made on the stipulation that any surplus (the unused or unexpected amount) will be, sooner or later, returned/repaid to the contributors (in their capacity as contributors) in some form or other,

§  complete identity as a class between the contributors and the participators, and

§  a reasonable relationship between what a member contributes and what the member may be expected or entitled to receive in respect of the common fund.

Anderson J in RACV at 4157 (citing the view of Lord Wilberforce in Fletcher v. Income Tax Commissioner [1971] 3 All ER 1185 (Fletcher), at 1190), states:

Many criteria have been considered in the numerous cases where one or another criterion has been regarded as determining the issue [of mutuality]. Lord Wilberforce expressed the opinion that, except in the simplest cases, no single criterion was likely to be decisive.

Case law demonstrates that no single criterion is likely to be decisive in determining if mutuality applies and not all factors will be present in all cases.

General services provided to Members

The Entity is carried on for the benefit of its Members by way of the services it provides. Members also share a common purpose as described in the Constitution a purpose for which the Entity was established.

Members contribute an entrance fee upon admission to membership and an annual subscription based on their membership. It is accepted that a reasonable relationship exists between what the Members contributes and the services provided.

The constitution specifies that the Entity is to receive funds and best distribute these to achieve the overall objectives and therefore the contributions are applied for the collective benefit of the Members in line with the Entities objectives.

There is one class of membership of the Entity and the Members have ownership and control of the common fund as demonstrated by the voting rights and ability to participate in a distribution of surpluses on dissolution in accordance with the Constitution.

Whilst the Constitution prohibits the Members from receiving any income or property of the Entity during operation, the Constitution allows the Members to share in any surplus after the satisfaction of all debts upon dissolution of The Association.

It is accepted that the nature of receipts for general services provided by the Entity to Members is mutual meaning receipts from Members for general services will not constitute ordinary income of the Entity. As such, receipts for general service provided by the Entity to Members will not be included in the assessable income of the Entity by section 6-5 of the ITAA 1997 because mutuality applies.

Question 2

Summary

Mutuality can only apply to contributions from members to a common fund. Income from an external source, such as income from services provided to non-members or bank interest from investments, is not from a member source so mutuality does not apply. As such income from non-members or income from investments such as bank interest will be ordinary income and by virtue of section 6-5 of the ITAA 1997, form part of the assessable income of The Association.

Detailed reasoning

The principle of mutuality only applies to the dealings of contributors to a common fund; see Carlisle and Silloth Golf Club v. Smith [1912] 2 KB 177 (Carlisle) and Coleambally Irrigation Mutual Co-Operative Ltd v Commissioner of Taxation [2004] FCAFC 250 (Coleambally). Referencing Carlisle the court held in RACV that, despite dealings with members being considered mutual, income from the same activity with non-members was not mutual; Anderson J explained it at 4157as follows:

...outside the social aspect of a club, as in the Carlisle and Silloth Golf case, there is the provision of facilities of which members and non-members may avail themselves, the particular dealing with a member in relation to the use of the facility, even at a charge, may well be a mutual dealing, whereas the particular dealing with a non-member would not be a mutual dealing.

Application to income from Non-Members

The Entity provides services to Non-Members which are similar to the services it provides to Members and which complement the services provided to Members.

Non-Members do not have any voting rights, or any other rights of membership, particularly the right to a share in the distribution of any surplus after satisfaction of all debts, upon winding up or dissolution of the Entity.

Applying the principles in RACV, Carlisle and Coleambally, because Non-Members are not contributing to the common fund of the Members, as they lack the ability to control the common fund or benefit from any surpluses of the common fund. As such the principle of mutuality does not apply to fees for services from Non-Members and therefore these fees from Non-Members would not be excluded from the assessable income of the Enitity by the mutuality principle.

Application to investment income such as bank interest

Mutuality can only apply to contributions from members to a common fund for a common purpose. Income from investments, such as bank interest (Investment Income), is derived from sources outside the group, consisting of the Members who are the contributors to the common fund administered by the Entity. As such, Investment Income which is derived from sources outside the Entity is not from a member source and will be assessable income.

Question 3

Summary

At their present level, dealings with Non-Members and the receipt of bank interest does not preclude the entity from applying mutuality to receipts from Members. Should trade for profit with Non-Members increase to such an extent that it could no longer be said that trading with non-members is merely an incident of providing services to Members, mutuality will be displaced and mutuality will no longer apply to receipts from Member Funds.

Detailed reasoning

The courts have long recognised that a company can trade with its members and the dealings can still be mutual. On the other hand where dealings are in the nature of trading transactions resulting in pecuniary gain for members, membership or non-membership is of no significance.

In Fletcher the Privy Council considered whether mutuality applied to receipts from hotel members of a bathing club who joined the bathing club in order to provide access for their hotel guests to an attractive bathing beach. Lord Wilberforce in Fletcher at 1189 stated that:

Cases in which groups of persons making contributions towards a common purpose have been held not liable for tax on any surplus over expenditure fall under a number of heads. The expression 'the mutuality principle' has been devised to express the basis for exemption of these groups from taxation. It is a convenient expression, but the situations it covers are not in all respects alike In some cases the essence of the matter is that the group of persons in question is not in any sense trading, so the starting point for an assessment for income tax in respect of trading profits does not exist. In other cases, there may be in some sense trading activity, but the objective or the outcome, is not profits, it is merely to cover expenditure and to return any surplus, directly or indirectly, sooner or later, to the members of the group. These two criteria often, perhaps generally, overlap; since one of the criteria of a trade is the intention to make profits, and a surplus comes to be called a profit if it derives from a trade. So the issue is better framed as one question, rather than two: is the activity, on the one hand, a trade, or an adventure in the nature of trade, producing a profit, or is it, on the other, a mutual arrangement which, at most, gives rise to a surplus?

In concluding that the fees from the hotel members were not mutual receipts the court in Fletcher stated at 1191:

What is, and always has been, of significance is not the fact of membership or non-membership but the nature of the transactions: if these were trading transactions, the addition of membership makes no difference.

In reaching this conclusion Lord Wilberforce made reference to Carlisle (at 1189-1190):

The classic case as to members' clubs is Carlisle and Silloth Golf Club v. Smith which brings out the distinction between members, contributing on a mutual basis in order to secure an amenity, and outsiders admitted to participate in amenities on payment, with whom the club is trading. The central passage from the judgment of Hamilton J is apposite to the present case:

'I think, therefore, that at the outset the club has, for considerations sufficient in its own view, annexed to its ordinary enterprise of a golf club the rendering of services systematically to strangers for the purpose of obtaining, among other advantages to itself, the revenue that those strangers provide. It is not a case where, thanks to the relations of membership or family bonds, people club together and reduce the common expenditure on some common object by contributions which they fix roughly with some reference to the cost. It seems to me that it is not a case in which the members as an aggregate (for they are not incorporated) dispose of their surplus because they have no necessity to consume it; it is a case it seems to me at the outset in which this aggregate of gentlemen, who may for practical purposes be treated as one person, annexed to their club for the purposes of recreation an enterprise which is separate from it and which results in pecuniary receipts to themselves.'

In Sydney Water Board it was unsuccessfully argued that interest paid by borrowing members of the credit union constituted a common fund paid for the common purpose of enabling the credit union to meet its administrative and operating expenses, with any surplus refundable to borrower members. Interest paid was not maintained as a common fund in which the borrowing members as a class had any rights. Interest was paid by borrowers in discharge of their legal obligations and became part of the general funds of the credit union. It was not paid as a contribution to the mutual liabilities on behalf of the borrowers. Mason J. noted at 4136 that the borrowing members did not have any right to a refund of part of the interest which they have paid; on the contrary:

...the interest so paid forms part of the funds of the taxpayer... the borrowing members are entitled to participate in a distribution of the surplus which results from the taxpayer's use of the general funds.

Sydney Water Board illustrates the principle that where an association receives revenue from trading activity with customers, whether they are members or not, the customers are not contributing to a common fund, rather they are contributing to the general funds of the association. In these circumstances it is not possible to differentiate between the general funds of the association derived from trading and amounts contributed to a common fund by members. This principle is supported by Liverpool Corn Trade Association Limited v. Monks (HM Inspector of taxes) (1926) 2 KB 110 (Liverpool Corn Trade), English and Scottish Joint Co-operative Wholesale Society Ltd v. Assam Commissioner of Agriculture Income Tax [1948] 2 ALL ER 395 (Assam Tea) and Music Traders, in circumstances where the members of an association actively seek profit making trading activity with customers (whether they are members or not), mutuality is displaced. It can no longer be said that members are merely contributing to a common fund for a common purpose; rather they are trading for pecuniary gain. By trading with outsiders, the members are increasing the funds available to their association from an external source, reducing the amount needed for their contributions to the common fund. In these circumstances it can no longer be said that the funds of the association amount to a mutual fund, rather mutuality is displaced and the funds become the general funds of the association.

It is acknowledged that in RACV, trading activity with non-members was considered compatible with mutuality, however this trading activity particularly relating to the driving school which ran at a loss, could not be said to have been conducted for the pecuniary gain of the members. It is also acknowledged that some dealings by a mutual association with outsiders, such as interest on bank deposits, does not displace mutuality, this type of activity is merely an incident of managing the common funds of members.

The Entity receives most of its revenue from Members and the contributions of members is based on an estimate of what the board of the Entity consider will be necessary to meet shared expenditure. There is also provision in the Constitution of the Entity for the return of surpluses to Members. In isolation these characteristics support a conclusion that dealing between the Entity and Members is mutual activity.

On the other hand, the Entity has arrangements to provide services to Non-Members generating profits which are used to reduce the subscription fees for Members. This activity (as was the case in Carlisle, Liverpool Corn Trade, Assam Tea, Fletcher, Sydney Water Board and Music Traders), amounts to trading activity and pecuniary gain for Members in the form of reduced subscription fees. While it is acknowledged that the Entity includes amounts from Non-Members in its assessable income, there is a point at which mutuality breaks down and trading for profit begins, such that it can no longer be said that the Entity is merely an entity of convenience for the management of the common funds of members. Rather, as was the case in Sydney Water Board, Members and Non-Members alike are contributing as customers, to the general funds of the Entity, the intermingling of funds means a common fund can no longer be identified and mutuality is displaced.

At present revenue from Non-Members is materially small when compared to receipts from Members. The Entity has explained that providing services to Non-Members reduces the subscription fees for Members as well as complementing and improving the quality of services provided to Members. Additionally, the Entity has explained that Non-Member involvement is as a result of factors beyond the control of Non-Members which excludes them from becoming Members of The Association.

On balance it is considered that the current level of non-mutual activity can be explained in non-commercial terms and is not sufficient to displace mutuality. As with RACV, the services provided by the Entity to Non-Members compliment the services provided to Members. Income received from Non-Members, at present does not contribute in a substantial way to the funds of Members and is included in the assessable income of the Entity. It is accepted that based on their current level, the services provided to Non-Members is incidental to the management of member funds by the Entity and as such does not preclude the Entity from applying the principle of mutuality to receipts from Members.

Similarly, it is considered that the receipt of bank interest from investing the money of the Entity, which at present is a materially small amount, is merely incidental to the management of Member funds. Bank interest is included in the assessable income of the Entity and as such it is accepted that the receipt of bank interest is not sufficient to preclude the Entity from applying the principle of mutuality to receipts from Members.

[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