Edited version of private advice

Authorisation Number: 1052082687394

Date of advice: 8 February 2023

Ruling

Subject: Mutuality principle

Question

Does the principle of mutuality apply so as to exclude 'shareholder rate contributions' received by the Company from its assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following periods:

Income year ending 30 June 20XX

Income year ending 30 June 20XX

Income year ending 30 June 20XX

Income year ending 30 June 20XX

Income year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

1.      The Company is a company limited by shares.

2.      The Memorandum of Association (MoA) of the Company is dated September 19XX and is current in 20XX.

3.      The primary aim of the Company as stated in its MoA is to establish a common fund for a common purpose for the sole use and benefit of the members of the Company without attempting to make any profits or other gains for the Company, it being understood that all expenses for maintenance of the property owned by the Company shall be paid by the members of the Company in proportion to their shareholdings.

4.      The objects of the Company are stated in the MoA.

5.      Paragraph XX of the MoA outlines how transfer of shares operates. Further to this, before a transfer of shares occurs, a deposit is paid to the existing shareholder by the proposed new shareholder, and a meeting of all the shareholders takes place. Once all the shareholders are happy with the transfer of the shares from the existing shareholder to the new shareholder, the shares are then transferred via either the Company's Director or third party legal representatives. Once this is completed, the shareholder information is then updated with the Australian Securities and Investments Commission (ASIC). Therefore despite paragraph XX of the MoA there will not be a situation where a shareholder will be required to make 'shareholder rate contributions' and not have access to the full entitlements owed to shareholders.

6.      The Company receives amounts from shareholders, these amounts are listed in its financial records as 'Shareholder rates' and 'motor vehicle fees'.

7.      'Shareholder rates' are applied to transactions listed as expenses in the financial records of the Company.

8.      Voting of members occurs at annual AGM once a year. Each shareholder has a single vote. If there are two names on the share certificate, then this is considered as one vote.

Relevant legislative provisions

Section 6-5 of the Income Tax Assessment Act 1997

Section 6-10 of the Income Tax Assessment Act 1997

Reasons for decision

Summary

All the elements of mutuality are present and the principal of mutuality applies to the 'shareholder rate contributions' received by the Company.

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 principles 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 is 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 the 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.

The application of the principle of mutuality is determined in respect of receipts. For the purposes of this ruling 'shareholder rate contributions' are receipts received by the Company from shareholders to contribute towards the following expenses:

•         ASIC Fees

•         Council Rates

•         Diesel - used for vehicle

•         Insurance (public liability - $XX million)

•         Local Land Services

•         Postage/Courier

•         Printing/Stationery

•         Rep/Maint

•         Safety Deposit Box

•         Motor vehicle Registration

•         Motor vehicle fees on a user pays basis.

It is necessary to consider whether the elements of mutuality are present in relation to these receipts 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.

The Company was established for a common purpose, for the sole use and benefit of the members, without attempting to make any profits or other gains. A fund was created to meet its objectives. Members (shareholders) contribute annual rates to the fund to meet the objectives. Shareholder rate income includes both annual contributions to the fund and motor vehicle fees from member hire of the motor vehicles.

Voting of the members occurs at Annual General Meeting once a year. Each shareholder has a single vote. If there are two names on the share certificate, then this is considered as one vote.

The 'shareholder rate contributions' form a common fund which is controlled by the shareholders of the Company for the common purpose of maintaining property owned by the Company. All members benefit from the common fund.

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.

Only the shareholders of the Company are the shareholders of the common Company property and only the shareholders contribute to the common fund through annual shareholder contributions. On winding up, only the shareholders are entitled to receive a 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 the common fund, or 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 into for commercial purposes are not mutual receipts (Revesby Credit Union).

'Shareholder rate contributions' are not profit, rather member's own contributions for the benefit of the shareholders. 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 TV 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). The Company is the vehicle used to hold and control the common fund for the common purpose of its members. The use of the Company as a vehicle of convenience will not affect the operation of the mutuality principle.

Conclusion

Therefore, the 'shareholder rate contributions' are controlled by the Company's members for the 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 the Company.

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