Edited version of private advice

Authorisation Number: 1051996739102

Date of advice: 4 July 2022

Ruling

Subject: Principle of mutuality and deductions

Question 1

Are expenses incurred for Events deductible for income tax purposes when fully funded by member subscriptions?

Answer

No

Question 2

Are expenses incurred for Events deductible for income tax purposes if attendees of the event are charged a fee and the intention is for the Chapter to break even?

Answer

No

Question 3

Are expenses incurred for Events deductible for income tax purposes if attendees of the event are charged a fee to partially contribute toward the cost of the event (balance of cost funded by member subscriptions)?

Answer

No

This ruling applies for the following period:

Income year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

1.      The Company is an incorporated association.

2.      The Company is not-for-profit.

3.      The Company supports leaders.

4.      The Company holds Events for members. Members family can attend most Events.

5.      The Company believes family is important to being a good leader.

6.      Members pay membership fees.

7.      Payment of membership fees entitles members to attend Events and other benefits of membership.

8.      The costs of the Events were covered by membership fees with no additional cost for members.

Relevant legislative provisions

Section 6-5 of the Income Tax Assessment Act 1997

Section 6-10 of the Income Tax Assessment Act 1997

Section 8-1 of the Income Tax Assessment Act 1997

Section 59-35 of the Income Tax Assessment Act 1997

Reasons for decision

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature, relate to the earning of exempt income or are excluded by another provision of the taxation legislation.

Section 6-5 of the 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[1]. Section 6-10 of the ITAA 1997 provides that assessable income also includes statutory income (amounts included by provisions about assessable income).

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 (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 above 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.

In RACV v Federal Commissioner of Taxation 73 ATC 4153 (RACV) Anderson J made the following comments on whether the costs of conducting a mutual activity are deductible:

To the extent that any particular activity of the appellant is a mutual activity, the authorities make it clear that the surplus of receipts in any year beyond the costs of conducting the activity is not income. The corollary to that proposition is, of course, that the cost of conducting a mutual activity is not an allowable deduction within the meaning of sec. 51. If a mutual activity is run at a loss, the deficiency may be made up by the appellant from other funds available to it, but no part of that deficiency is a deduction either in respect of the mutual activity or the particular activity or activities, the profit from which have been used to meet the deficiency of the mutual activity. (at 4163)

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.

The mutuality principle was described 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.

The principal of mutuality has the following characteristics:

•         contributors who make contributions out of their own moneys to a common fund for a common purpose that is not undertaken for profit,

•         contributions 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.

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.

Anderson J in RACV (supra) stated (at 4157):

Many criteria have been considered in the numerous cases where one or another criterion has been regarded as determining or not determining the issue [of mutuality]. Lord Wilberforce expressed the opinion that, except in the simplest cases, no single criterion was likely to be decisive.

Where the contributors set up an incorporated body to undertake the mutual activity the principal of mutuality will still apply provided the incorporated body is a mere entity for the convenience of the members that is obedient to their mandate (Social Credit Savings and Loan Society Ltd v Federal Commissioner of Taxation (1971) 125 CLR 560 at 571).

The object of the Company is to support leaders. To achieve the purpose the Company holds Events for members. Each member is entitled to attend the events and can take family to most Events. The Company believes that family is important to being a good leader.

Each member contributes to the funds of the Company by payment of an annual subscription. Payment of these fees entitles members to attend Events, and other membership rights. All funds of the Company must be applied for the object of the Company.

In the 2022 income year, all of the Events of the Company were covered by membership subscriptions with no additional cost for members and their family to attend.

The Company considers family to be important to being a good leader and having family involved in the Events is a benefit provided to members within the purpose of the Company.

Based on the facts outlined regarding the establishment and operation of the Company, there is a common fund established and controlled by members, the fund has a common purpose, only members make contributions to the fund for the common purpose, and there is identity between the people that contribute to the common fund and the people who participate. Although members cannot share in a surplus of the common fund, a reasonable relationship exists between the amounts paid by members and the rights and entitlements they have to benefit from the common fund. The contributions made by members for the Events are contributions to the common fund.

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 contributed to the common fund and those who participated in the common fund is broken so as to prevent the principle of mutuality from applying (at 4842-4843):

For the mutuality principle to apply, in one way or another ("in meal or malt") the contributing members must be entitled to recoupment or refund of any surplus so that in the result the body corporate does not make a profit from them....

CIMCL's constitution is such that once the contributions are made, the monies contributed can no longer be said to "belong" to the members, either in a formal or a substantive sense. The contributions may only be applied in the manner specified ... whilst CIMCL is a going concern, and may not be distributed amongst CIMCL's members on winding up. The mutuality principle requires there to be a pooling of funds which can only be expended in pursuit of the common purpose, or returned to the contributors... Rules 71 and 75 of CIMCL's constitution are such that the sinking fund does not satisfy this description.

In response to the decision in Coleambally, section 59-35 of the ITAA 1997 was enacted to ensure that contributions from members to an entity (common fund) would not be subject to taxation, where the constituent document of the entity prevents the distribution of money or property to its members.

Section 59-35 of the ITAA 1997 operates to treat the contributions from members in such cases, as non-assessable, non-exempt income (NANE income). This has the effect that no provision in the ITAA 1936 or ITAA 1997 operates to treat the member contributions as assessable income.

All contributions of members related to the Events are contributions for the common purpose and are NANE income of the Company. As the contributions are NANE income, all costs incurred to hold the Events are not deductible under section 8-1 of the ITAA 1997; they are not incurred in producing assessable income.

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