Edited version of private advice

Authorisation Number: 1052071526237

Date of advice: 16 December 2022

Ruling

Subject: Mutuality

Question 1

Are membership fees received by the entity, mutual receipts, and not income for the purposes of sections 6-5 and 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997) or treated as non-assessable non-exempt income under section 59-35 of the ITAA 1997?

Answer

Yes.

Question 2

Are fees received by the entity from its members for various services, mutual receipts, and not income for the purposes of sections 6-5 and 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997) or treated as non-assessable non-exempt income under section 59-35 of the ITAA 1997?

Answer

Yes.

Question 3

If the entity was to raise finance through the issue of Mutual Capital Instruments (MCI) in the future, would this impact the treatment of member receipts as either mutual receipts or non-assessable non-exempt income under section 59-35 of the ITAA 1997?

Answer

No.

This ruling applies for the following periods:

Income year ending 31 December 20XX

Income year ending 31 December 20XX

Income year ending 31 December 20XX

Income year ending 31 December 20XX

Income year ending 31 December 20XX

The scheme commences on:

1 January 20XX

Relevant facts and circumstances

The entity is a company limited by guarantee.

It is not a registered entity within the meaning of the Australian Charities and Not-for-Profits Commission Act 2012.

The entity is a non-profit organisation.

The entity provides a range of services to members. In the constitution MCI Holders are not classified as 'Members' of the entity.

Currently, the entity has not issued any MCIs.

The entity amended its constitution to allow for the issue of MCI's as a way of raising financing.

The constitution includes anintention to be an MCI mutual entity and has appropriate income and property and winding up clauses.

Clauses in the constitution align with the Corporations Act 2001 requirements for MCIs.

Relevant legislative provisions

Section 6-5 of the Income Tax Assessment Act 1997

Section 6-10 of the Income Tax Assessment Act 1997

Section 59-35 of the Income Tax Assessment Act 1997

Corporations Act 2001

Reasons for decision

Questions 1 and 2

Summary

Fees from members (for various services) will not be included in the assessable income of the entity under section 6-5 or 6-10 of the ITAA 1997.

If the entity was to raise finance through the issue of Mutual Capital Instruments (MCIs) in the future this would not impact the treatment of membership receipts as non-assessable and non-exempt income (NANE).

Detailed reasoning

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.

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.

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.

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 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.

Fees from members

The receipts paid by members can be characterised as contributions to a fund, created and controlled by the contributors, for a common purpose which is not undertaken for profit.

A reasonable relationship exists between the fees contributed by a member and the rights and entitlements they have 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 continue to be treated as mutual, 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 what would be a mutual receipt, as non-assessable, non-exempt income. No provision in the ITAA 1936 or ITAA 1997 operates to treat mutual receipts as assessable income.

The Constitution provides that on dissolution any surplus property must be given to a company with similar objects. Section 59-35 of the ITAA 1997 will operate to prevent the member receipts as being treated as assessable income and will cause the member receipts to be treated as NANE.

As such, member receipts will not be included in the assessable income of the entity under sections 6-5 or 6-10 of the ITAA 1997.

Mutual Capital Instruments (MCIs)

MCI Holders are not classified as members under the constitution. Therefore, membership for the purposes of the CA would not impact the mutuality treatment of member receipts.

Section 59-35 of ITAA 1997 provides that an amount of ordinary income of an entity is not assessable income and not 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; or

(ii) the entity ' s constituent document providing for the entity to issue MCIs (within the meaning of the Corporations Act 2001) or to pay ^* dividends in respect of MCIs; or

(iii) the entity having issued one or more MCIs (within the meaning of the Corporations Act 2001) or having paid dividends in respect of one or more MCIs; and

(b) apart from this section, the amount would be assessable income only because it is ordinary income.

In 2019, the Corporations Act 2001 (CA) was amended to allow mutual entities that are companies limited by shares, companies limited by guarantee and companies limited by shares and guarantee, to issue MCIs without losing their mutual status (provided that the mutual entity is a public company, does not have voting shares (other than MCIs) quoted on a prescribed financial market and is not a registered entity within the meaning of the Australian Charities and Not-for-profits Commission Act 2012), the entity's constitution states that the entity is intended to be an MCI mutual entity and the entity has issued one or more MCIs.

An MCI is a type of share for the mutual sector and is subject to the CA regulatory regime that ordinarily applies to the issuance of shares. In order to be issued as an MCI, the share must confer the right to no more than one vote irrespective of the number of MCIs that the Holder owns. In addition, the rights attaching to an MCI can only be varied or cancelled by a special resolution of the company and either a special resolution of all members holding the same class of MCI or obtaining written consent of 75% of the Holders of the class of MCI.

Furthermore, a mutual entity's constitution must provide, in relation to the MCIs, that the shares may only be issued as a fully paid shares and that dividends in respect of MCIs are non-cumulative and set out the rights attached to MCIs with respect to participation in surplus assets and profits.

The entity is a public company limited by guarantee and is not a registered entity within the meaning of the ACNC Act. The Constitution states the intention to be an MCI mutual entity. The 2019 amendments to the CA allow the entity to raise additional funds through the issue of MCIs without raising debt or compromising its mutual status.

The Constitution was amended in accordance with the new requirements in the CA to authorise the entity to issue MCIs. Currently, the entity has not issued any MCIs. The Constitution provides voting rights, conferring a single voting right to each Holder (regardless of how many MCIs they hold). The Constitution provides a winding up clause and states the rights of Holders with respect to participation in surplus assets and profits.

The constitution requires that MCIs are fully paid, and that dividends are non-cumulative and the special resolution requirements are met.

Therefore, the terms in the Constitution align with the requirements of the CA and section 59-35 will continue to apply to treat membership receipts as NANE were the entity to raise finance through the issue of MCIs in the future.

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