Edited version of private advice

Authorisation Number: 1052163149128

Date of advice: 7 September 2023

Ruling

Subject: Occupation specific matters

Question

Are fee type A received by the Company excluded from its assessable income under section 6-5 of the ITAA 1997 by the application of the principle of mutuality?

Answer

Yes

Question

Are fee type B received by the Company excluded from its assessable income under section 6-5 of the ITAA 1997 by the application of the principle of mutuality?

Answer

Yes

Question

Are sales received by the Company excluded from its assessable income under section 6-5 of the ITAA 1997 by the application of the principle of mutuality?

Answer

No

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

The scheme commenced on:

30 June 20XX

Relevant facts and circumstances

The Company is an Australian public company limited by shares.

The Company operates on a not-for-profit (NFP) basis. The Company is not a charity, nor an entity currently registered under the Australian Charities and Not-for-profits Commission Act 2012 (Cth).

While members do not need to be shareholders, all shareholders must be members, and members may elect to become shareholders at any time. Shares in the Company carry no application fee or entitlement to additional distributions or assets.

The Company manages, sells and distributes a particular asset to, and on behalf of, its members.

The Company's members hold land within a designated zone, and enter into a contract with the Company dependant on what services they require and what zone their land falls within.

Members pay two kinds of membership fees to the company, depending on required services and the size of their personal entitlement to the Company's distribution of assets.

Members can elect to pay a one-off fee to purchase an additional allocation of assets when the Company has a surplus.

The Company operates on a cost recovery basis.

Upon winding up or dissolution of the Company, any surplus assets remaining may not be paid or distributed to shareholders, and must instead be given or transferred, for no consideration, to a body which has similar or consistent objects with the Company and also prohibits the distribution of assets upon winding up.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 59-35

Reasons for decision

Question 1

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that assessable income of an Australian resident includes income derived directly or indirectly from all sources according to ordinary concepts, which is called ordinary income. Whether a receipt is income depends upon its quality in the hands of the recipient (Scott v FC of T (1966) 117 CLR 514 per Windeyer J at 526 and see MIM Holdings Ltd v FC of T (1997) 36 ATR 108; 97 ATC 4420).

The term 'income' is not defined in the ITAA 1936 or ITAA 1997. Principles and tests for ascertaining whether a receipt has the character of income according to ordinary concepts have been identified in the Courts over the years. These factors include:

•                     Whether the amount has the characteristics of periodicity, recurrence or regularity;

•                     Whether it is convertible into money or money's worth;

•                     Whether it is associated with business activities or services rendered as distinct from the mere sale of property, and

•                     Whether it is solicited, as distinct from a windfall.

The presence of these factors will assist in a conclusion that the amount is more likely to be ordinary income. Whether a receipt is ordinary income depends upon its quality in the hands of the recipient as noted in Scott v. Federal Commissioner of Taxation (1966) 117 CLR 514; and GP International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413. Generally, payments or other benefits received for, in respect of, or in connection with services provided are assessable as ordinary income.

Members of the Company pay annual fees, fixed and variable, in return for assets and services provided by the Company. Members who hold rights to larger quantities of assets pay a proportionally larger fee than those who hold rights to a smaller quantity. Members who require the services of the company pay an additional fee for those services, which is not paid by members who do not require the services. Fees are paid regularly each year and are solicited by the Company by issue of an invoice payable in advance of the relevant period.

The fee paid by members for the provision of assets is therefore considered to be assessable as ordinary income under section 6-5 of the ITAA 1997.

However, if the mutuality principle applies, its effect would be to deny an income quality to an item which would, in other respects, have that quality: Social Credit Savings & Loans Society Ltd v FC of T 71 ATC 4232 at 4238; (1971) 125 CLR 560 at 571; RW Parsons, Income Taxation in Australia, LBC, Sydney 1985 at [2.51].

Principle of Mutuality

The essence of the mutuality principle is that a taxpayer cannot derive any gain, and therefore income, from dealings with itself. 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.

In The Bohemians Club v the Acting Federal Commissioner of Taxation [1918] 24 CLR 334 (Bohemians Club) Griffith CJ stated at 337-338:

The contributions were, in substance, advances of capital for a common purpose which were expected to be exhausted in the year in which they were paid. They were not income of the club any more than calls made by members of the company upon their shares are income of the company. If anything is left unexpended it is not income or profits, but savings, which the members may claim to have returned to them.

...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 Income Tax Assessment Act 1936 (ITAA 1936) or ITAA 1997.

The term 'income' is not defined in the ITAA 1936 or ITAA 1997. Subsection 995-1(1) of the ITAA 1997 defines 'assessable income' to have the meaning given by sections 6-5, 6-10, 6-15, 17-10 and 17-30 of the ITAA 1997.

Section 6-15 of the ITAA 1997 provides that an amount is not assessable income if it is not ordinary income and is not statutory income. As iterated above, 'ordinary income' is defined in section 6-5 of the ITAA 1997 to mean income according to ordinary concepts. Mutual receipts, by their nature, do not constitute income according to ordinary concepts. As ordinary income is not derived for income tax purposes unless it is received from an external source, a payment to oneself cannot be income.

Section 6-10 of the ITAA 1997 provides that assessable income includes some amounts that are not ordinary income (which are called 'statutory income'), as per provisions listed in section 10-5 of the ITAA 1997. Mutual receipts are not listed in section 10-5 of the ITAA 1997 and as such do not constitute statutory income.

Therefore, as mutual receipts do not constitute ordinary income or statutory income as defined in sections 6-5 and 6-10 of the ITAA 1997 respectively, mutual receipts are not assessable income pursuant to section 6-15 of the ITAA 1997.

Section 6-20 of the ITAA 1997, which defines 'exempt income', is referred to in section 6-10 of the ITAA 1997. As mutual receipts have not been made exempt from income tax pursuant to section 6-20 of the ITAA 1997, mutual receipts are not exempt income.

The mutuality principle was described by McTiernan J in Revesby Credit Union Co-Operative Ltd v. Federal Commissioner of Taxation (1965) 112 CLR 566 (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 established that the principle cannot apply unless at any given point in the time the contributors to the fund are identical with the beneficiaries of the distribution of the surplus.

The principle of mutuality is not limited in its application to situations where a refund of surplus contributions is distributed to the contributors. In Coleambally Irrigation Mutual Co-operative Ltd v. FC of T 2004 ATC 4835 (Coleambally Irrigation) the Full Federal Court was not concerned with a refund of overpaid contributions to the contributors. The question was whether the contributions made by members to Coleambally Irrigation Mutual Co-Operative Ltd (CIMCL) were income in the hands of CIMCL. Beaumont, Merkel and Hely JJ held at 4842:

The authorities establish that the mutuality principle is not confined in its operation to the situation in which the surplus contributions made by a contributor to a common fund are returned to the contributor. In The Bohemians Club v Acting Federal Commissioner of Taxation (1918) 24 CLR 334 the receipt by a social club of annual subscriptions from its members was held not to be income of the club even though, for tax purposes, the club was a separate entity from its members. Griffith CJ held (at 337) that the contributions were, in substance, advances of capital for a common purpose which were expected to be exhausted in the year in which they were paid. They were not income of the club any more than calls made by members of the company upon their shares are income of the company.

No particular criterion is decisive

Whether a mutual association exists between persons depends upon the nature of their relationship, transactions and dealings. 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 Royal Automobile Club of Victoria (RACV) v. Federal Commissioner of Taxation 73 ATC 4153 (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.

By way of summary of the various legal principles established by case law surrounding the mutuality principle, as discussed above, the ATO's publication entitled 'Mutuality and taxable income for not-for-profits' on the ATO's website provides a summary of the typical characteristics of organisations that can access mutuality. These elements of a mutual arrangement include:

•                     The organisation is carried on for the benefit of its members collectively, not individually.

•                     The members of the organisation share a common purpose in which they all participate or are entitled to do so.

•                     The main purpose for which the organisation was established, and is operated, is the common purpose of the members.

•                     There is a common fund that gives effect to the common purpose and all the members contribute to it.

•                     All the contributions to the common fund are applied for the collective benefit of all the members, in line with the common purpose.

•                     Different classes of memberships may exist with varying subscription rates, rights and entitlements to facilities.

•                     The members have ownership and control of the common fund.

•                     The contributors to the common fund must be entitled to participate in any surplus of the common fund. Where an organisation's constituent document prevents it from making any distribution to its members, and this is the only thing that prevents an amount of its income from being a mutual receipt, the organisation is not prevented from accessing mutuality for income purposes.

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 established by contributors for a common purpose in which contributing members as a class have rights. The fund must be owned or controlled by the contributors. If it is owned and controlled by anyone else, the principle cannot apply.

In FC of T v Australian Music Traders Association (1990) 90 ATC 4536 (Music Traders), Davies J (at 4538) described the requirement of a common purpose as follows:

...in a social club, one finds a number of persons associated together not to trade with each other or for profit, but to acquire and maintain a social facility benefiting all members. In mutual insurance, one finds a common fund in which all contributors are entitled to participate more or less equally having regard to their contributions and contractual rights. Their mutual dealings do not give rise to a profit. Although the concept has not been definitely delineated, its crux is an association of persons who have joined together not for trade or profit but to achieve a common end or benefit in which all members participate or are entitled to do so.

In Sydney Water Board Employees' Credit Union v FCT 73 ATC 4129(Sydney Water Board) the taxpayer 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. Mason J, at 4136, found that interest paid was not maintained as a common fund in which the borrowing members as a class had any rights. Rather, 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.

In Coleambally Irrigation, Beaumont, Merkel and Hely JJ referred to the primary judge in Coleambally Irrigation at 4132 to 4133 on the relevant concepts of the mutuality principle, in particular, the meaning of contributors.

18. In Sydney Water Board Employees Credit Union v. FC of T 73 ATC 4129; (1973) 129 CLR 446 Barwick CJ said (at ATC 4131; CLR 450) that the description "mutuality principle" is used, unfortunately in his Honour's opinion, to express the reason for the conclusion that the return to a taxpayer of a share of the surplus of a fund to which the taxpayer has contributed with others, after the fund has been used for a purpose agreed between the contributors, is not income. What distinguishes the amount refunded in such circumstances from profit or income is that the payment is made out of monies which are in substance the monies of the contributors. Similarly, Mason J (with whose judgment Menzies, Walsh and Stephen JJ agreed) said (at ATC 4133; CLR 454) that according to the mutuality principle, when a group of persons subscribe to a common fund for a common purpose, a return to the contributors of surplus contributions, that is, money in excess of what is required for the common purpose, does not constitute assessable income in their hands. A refund to contributors of part of their own money which they had overpaid is not 'income' in the hands of the recipients in the ordinary sense of that word.

[...]

32. It seems to be essential to the application of mutuality that the monies contributed are and remain 'in substance' the monies of the contributors. Cf per Mason J, with whom Barwick CJ, Menzies, Walsh and Stephen JJ agreed in Sydney Water Board Employees Credit Union v. FC of T ATC 4129 at 4134-4135; (1973) 129 CLR 446 at 456. In the simple case of the members' unincorporated club the monies belong to the members in the normal sense of that expression. If the monies are not expended the members will have the right to have them returned to them. It is clear, however, that the word 'belong' as used in the above proposition is not used in its normal sense. In the case of an incorporated club the monies of the incorporated club will belong in law to the incorporated club itself, yet that will not deny mutuality for in substance the assets of the incorporated club can be seen to belong to its members.

[...]

34. In the Social Credit Savings and Loans Society case it was held that a lending body which made loans to members at a rate of interest and was entitled to apply its surplus in paying benefits to employees, to provide interest rebates to borrowing members and subject thereto for distribution to all members, whether or not they borrowed, was not entitled to be regarded as subject to the doctrine of mutuality this was because there was lacking the requirement of identicality between the contributors to the common fund and the participators in it. The common fund there was the payments of interest and the borrowers, therefore, the contributors. Many members were not borrowers, however. Further, the surplus (even after an amendment was made to the rules in an attempt to have the taxpayer comply with the mutuality principle by ensuring that any surplus could not be paid to members who did not borrow) could be paid to employees or the whole of the members. Gibbs J was of the view that the fact that the whole surplus could be paid to employees meant that there was not identity between the contributors and the possible participators. In other words, the surplus did not belong to the contributors. See too Revesby Credit Union Co-operative Ltd v. FC of T (1965) 112 CLR 564.

The existence of a common fund is premised on the existence of identity between what a member of the fund contributes to the fund and the benefit they stand to receive from the fund. Sydney Water Board illustrates the principle that where a member deals with an association as a customer that is discharging a legal obligation they are not contributing to a common fund, rather they are contracting on an individual basis with the provider of a service on their own account.

Whether a common fund exists depends on the identity between the contributors and the participants. It is not a question of whether a separate bank account is maintained for the contributions of contributors as was explained in Federal Commissioner of Taxation v Australian Music Traders Association 90 ATC 4536 at 4550 to 4551:

... Although the $19,000 was paid by the organiser to the Association, it was clearly regarded by both the payer and the payee as being paid from funds received by the payer from the Association's own members. The maintenance of a separate account by the organiser for moneys received from the Association's members might have made this more obvious but was not, in my view, in any way necessary. It was a perfectly simple matter to determine what amounts were received from the Association's own members for the hire of floor space, to total these amounts and to pay them over, as was done, to the Association. ...

... the difficulty of determining what is a common fund for the purpose of the application of the doctrine is demonstrable as is the difficulty of ascertaining what members can be properly described as common participants in the benefits of the fund.

... Once it be accepted that the amount of $19,000 can be regarded as, in fact, merely a total of payments made to the Association by a number of its members for a service provided to them by the Association within its constitution, then those payments can properly be seen merely to form part of the general funds of the Association available to be applied for the benefit of the members.

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.

It is a principal requirement of mutuality that contributors to the common fund can be identified with those participants who receive a benefit from the fund. There must therefore be complete identity between the contributors and the participators in surplus mutual receipts, at least as a class. This was established in Municipal Mutual Insurance Ltd v. Hills (1932) 16 TC 430 where Lord Macmillan stated at 448:

The cardinal requirement is that all the contributors to the common fund must be entitled to participate in the surplus and that all the participators in the surplus must be contributors to the common fund; in other words, there must be complete identity between the contributors and the participators. If this requirement is satisfied, the particular form which the association takes is immaterial.

In order for mutuality to exist there must be a reasonable relationship between contributions made by members and what they can expect to benefit from the fund. As noted by the Privy Council in Fletcher v. Income Tax Commissioner [1972] AC 414:

It may not be an essential condition of mutuality that contributions to the fund and rights in it should be equal; but if mutuality is to have any meaning there must be a reasonable relationship, contemplated or in result, between what a member contributes and what, with due allowance for interim benefits of enjoyment, he may expect or be entitled to draw from the fund: between his liabilities and his rights.

Likewise in Music Traders, Mason J commented at 4135 and 4136:

... Conformably with the original concept that the return of surplus funds is a refund to the contributors of their own money, it has been said that there must exist an 'identity' between the contributors and the participators. In Municipal Mutual Insurance Ltd v. Hills...at p. 448, Lord Macmillan said there must be a 'complete identity'. On other occasions, it has been pointed out that the identity required is not an identity between individuals but an identity between classes... Again, with the same end in view, although it has not been insisted that the refund to contributors should be in precisely the same proportions in which they have contributed to the fund, it has been said that there must be 'a reasonable relationship' between what a member contributes and what he may be expected or entitled to receive from the fund...

...the "so-called 'contributors', the borrowing members", were a proportion only of the total class of members.

In Social Credit Savings & Loan Society Ltd v. FCT (1971) 125 CLR 560; 2 ATR 612 (Social Credit Savings), the Court took the view that the identity required is not an identity between individuals, but an identity between classes of individuals. In Faulconbridge (Inspector of Taxes) v. National Employers' Mutual General Association Ltd (1952) 33 TC 103 at 125, it was stated that:

....at any given moment of time the persons who are contributing must be identical with the persons who are entitled to participate; whereas it follows, in my judgement, that it matters not that the class has been diminished by persons going out of the scheme or that others may come in their place in the future.

In Coleambally Irrigation, 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 and Loans Society Ltd (supra) at ATC 4238-4239; CLR 571-572. For the mutuality principle to apply, in one way or another ("in meal or in 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: Jones v South-West Lancashire Coal Owners Association Ltd [1927] AC 827 at 832. In Social Credit Savings and Loans Society Ltd (supra) at ATC 4240-4241; CLR 576, Gibbs J held that a power in the Society to apply the surplus in a fund in favour of employees of the Society was sufficient to negate the proposition that the fund "belonged" to the contributors.

Furthermore, Beaumont, Merkel and Hely JJ said at 4844:

...if the amounts standing to the credit of the sinking fund truly 'belonged' to the contributors, with CIMCL no more than a convenient vehicle, the members would have a choice as to whether any surplus would come back to the members in the event of a winding up. The denial of that choice by CIMCL's constitution demonstrates that the amounts contributed to the sinking fund do not truly belong to the member contributors. When the members make, and CIMCL receives, a contribution, the contributing members have no right to participate in any surplus of the members' contributions over what may be expended in carrying out the common purpose.

The Full Federal Court held that the mutuality principle cannot apply where an organisation is precluded from distributing to members on winding up (Coleambally Irrigation). To ensure not-for-profit organisations were not disadvantaged by the Coleambally Irrigation decision, section 59-35 of the ITAA 1997 was enacted. Section 59-35 of the ITAA 1997 states:

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 form making any *distribution, whether in money, property or otherwise, to its members; or

...

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

Under section 59-35 of the ITAA 1997, what would be a mutual receipt of an entity but for a provision in its constituent document preventing the distribution of surplus to members is deemed to be not assessable income and not exempt income.

Section 59-35 of the ITAA 1997 thus effectively preserves the mutual treatment of such receipts where it would otherwise be excluded by a constitutional bar on distributions.

Mutual receipts versus receipts in the nature of trade

An entity's dealings with its members are not always mutual. There is a point at which the relationship of mutuality ends and that of trading begins. The principle of mutuality does not apply to dealings between an organisation and member that go beyond a mutual arrangement and are in the nature of trade. In this situation, the fact an organisation is dealing with a member is not relevant. Lord Wilberforce in Fletcher v Income Tax Commissioner 1972 A.C.414 at page 421 stated -

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.

It is accepted that a corporation can make a taxable profit from its members even if it is limited to dealing with them. In English and Scottish Joint Co-operative Wholesale Society Ltd. v. Commissioner of Agriculture Income-Tax, Assam (1948) 2 All ER 395 (Assam Tea) an incorporated society which produced tea and sold it predominantly to its members at a market value was taxable on those profits there being no common fund to which members contributed and participated. The following facts as described in the High Court judgment, from which the taxpayer appealed to the Privy Council, were accepted by Lord Normand at 397-398:

...the society is incorporated in the United Kingdom under the Industrial and Provident Societies Act, 1893. It has an unlimited capital divided into shares of £pound;5 each... Its objects, as set out in its rules, inter alia, are: 'To carry on the business of planters, growers, producers, merchants and manufacturers and brokers of tea.' The society consists of two members, viz., the Co-operative Wholesale Society, Ltd. and the Scottish Co-operative Wholesale Society, Ltd. The society owns the Deckiajuli estate where it grows and manufactures tea. Except a small portion of produce, which is unfit for export and which is sold locally, the whole of the society's output of tea is sold to its two members at market rates and is exported to England and Scotland. Each year the members of the society pay, by way of advances to the society, sums of money to meet the cost of tea supplied by the society to the members. The market prices of the tea, with which the members are supplied, are debited against these payments. The supplies are recorded as sales to the members. Out of the proceeds from the sales, the expenses of production and management and the interest on loans are paid or provided. By the rules of the society its net profits are applied (a) in depreciation of land... (b) payment of interest not exceeding 6 per cent. per annum on the share capital; (c) appropriation to a reserve fund; (d) appropriation to a special fund for making grants as determined in general meeting; (e) payment of a dividend to members rateable in proportion to the amount of purchases made by them from the society; and (f) the remainder, if any, carried forward to the next account.

Lord Normand said (at 399) that the mutuality principle could not apply to an association, society or company which grew produce on its own land or manufactured goods in its own factories, using either its own capital or capital borrowed whether from its members or from others, and sells its produce or goods to its members exclusively. In coming to this conclusion, the court described the difficulty of distinguishing the company, in its dealings with members, from an ordinary trading company (at 398):

The application of net profits... is, in essentials, not different from the application of net profits which might be made by any trading company, and it need not result in the distribution of all profits among the members of the society. Thus, any net profits applied under heads (a), (c), (d) and (f) would be retained by the appellant society. When the constitution, rules and business practice of the appellant society so closely conform to the pattern of an ordinary profit-making concern, how can it plausibly be maintained that no profits can result?

This case highlights three points of relevance to mutuality. Firstly, a company's constituent documents contemplating that profit will be derived is an indication that the company is trading. Secondly, when the business operations of a company conform so closely to an ordinary profit-making business, it would also indicate that the company is trading with its members. Thirdly, this case supports the proposition that just because an association's dealings are with its members, it does not necessarily mean that the association's receipts arising from those dealings have a mutual character.

In Federal Commissioner of Taxation v. Australian Music Traders Association (Music Traders) 90 ATC 4536, Davies J at 4528:

The activities with which we are concerned in this appeal centre around the holding of a music traders' trade fair. In years prior to the subject year of income, the Association itself organised the trade fairs and leased stalls to music traders. Although the rental received by the Association from such stall-holders as were members of the Association was accepted by the Commissioner of Taxation to be mutual, nevertheless, as the individual traders displayed and sold their wares to members of the public, it may be doubted whether the fairs had a mutual character. Each trader, many of whom were not members of the Association, carried on his individual business. The rental paid was calculated according to the space occupied and was the charge made for the space leased by the stall-holder for the purposes of his own business activity. Even in respect of those years, it is difficult to distinguish the facts from those which were the subject of the decisions in the Assam Tea case and Sydney Water Board.

In coming to the conclusion that the activity and the fee received in connection with the activity were not mutual, Davis J (at 4538 to 4539) sought to determine whether the payment was a contribution into a common fund by the members by reference to what purpose the individual traders had in participating in the fair and concluded that the members were participating to generate profits for their own businesses:

The fee paid by the organisers of the fair to the Association was not a fee payable by members of the Association into a common fund. And the fair, though it benefited members of the association, was not a mutual, non-profit activity. Its essence was that of trading for profit by individual traders, though through the medium of a common activity, the fair.

In Sydney Water Board, Mason J when determining that the principle had no application to a credit union with borrowing and depositing members looked at the nature of the payments made by contributing members. He determined that the payment was made out of a legal obligation and not to meet a mutual liability. At page 4136 he stated -

payment by a borrower is not in any sense a pre-estimate of the amount which will be required to meet his proportion of mutual liabilities incurred on behalf of all borrowers.

Similarly in RACV in relation to the comprehensive and third party insurance each member entered into an individual commercial contract with Club Motor. It was a business transaction and the individual made payments under a legal obligation to do so. Anderson J concluded at 4162:

In my opinion this was a trading activity, both as to the comprehensive insurance and the third party insurance. Both commissions were being paid by Club Motor, an insurance company, for services rendered to it by the appellant. Whether the members paid their premiums direct to Club Motor or to Club Motor via the appellant, there was no payment by members into a common fund in the relevant sense. Nor were members paying for mutual service to be rendered by the appellant. What they were paying for was insurance by Club Motor; each member entering into an individual commercial contract with an insurance company, albeit on advantageous terms. The fact that the channel of the premiums may have been through the appellant and that insurance at a preferential rate was available from Club Motor are irrelevant considerations. Moreover, the payments by Club Motor to the appellant were not payments by a member to a common fund. There is no element of mutuality present in the arrangement with Club Motor. It is a business transaction, pure and simple...

In Re Ku-Ring-Gai Co operative Building Society (No 12) Ltd. (1978) 36 FLR 134 the court determined that the mutuality principle applied notwithstanding that the lending of money, receipt of payments and the like have a regularity that is the hallmark of a trade. It was stated at 142 that:

The presence of that mutuality may be derived from a whole complex of factors, not solely the absence of profit. It excludes the commercial element which is a necessary part of - trade or commerce.

A person trading with a body of which they are a member has two distinct relationships with that body:

•                     there is the buyer-seller (or similar) relationship as regards their trading transactions with the body, and

•                     a member-society (or similar) relationship as regards their right to a division of the society's distributable surplus.

There is a clear distinction between a body that acts on behalf of its members as their agent and a body that acts as principal. Any surplus arising to the body from transactions where it acts as principal are profits earned by the body itself - they do not represent the surplus of members' funds not required for the realisation of the joint purpose. This follows from Lord Normand's remarks in the English & Scottish Joint Co-operative Wholesale Societies Ltd v The Commissioners of Agricultural Income Tax, Assam 1948 19 AC 405 at 7 that:

...there was a dual relationship between the appellant and its members...a mutual creditor debtor relationship and...a buyer/seller relationship...

Rather than there being a common fund to which the members contributed and in which they participated. Lord Normand went on to say at 12 that:

The principles of the Styles case cannot apply to a body which grows produce on its land or manufactures goods in its own factories...and sells its goods to its members exclusively.

In TPC v. Legion Cabs (trading) Co-Operative Society Ltd (1978) 35 FLR 372 the Court had to determine whether the society was a trading corporation within the meaning of the Trade Practices Act (1974). The society had a number of members the majority of whom were owner members who were licensed to operate a taxi in Sydney. The main activity of the society was to provide radio services for 650 taxis owned by members so that communication can be maintained with the driver taxi. It also operated a service station that dealt with members and the public. Fannki J stated -

but in deciding whether a corporation is a trading corporation it is important to look at a number of matters and in particular, at least according to Menzies J (1974) 130 CLR, at pp 550-552 and Gibbs J ( 1974) 130 CLR, at pp 556, 562, 564-565, the purpose for which the corporation was incorporated.....If this be not the most relevant test and one applies the test used by Barwick C. J (1974) 130 CLR, at p 539, that of the activities of the corporation at the relevant time...- At page 380 he went on to state - and in my opinion, although it appears that the respondent probably conducted more than ninety per cent of its activities with its members, I consider that it was and is a trading corporation. There is no question of any sporting activity in the public interest, or any other similar activity being the purpose for which the respondent was incorporated as was the case in Sydney Turf Club v. Carr (1975) TPRS 30383. The respondent is not an unincorporated club for members where the principle of mutuality may have greater significance, see for example John v Matthews (1970) 2 WLR 1246. (at p 380).- and at page 383 - Were transactions between the respondent and its members in trade or commerce? The respondent submitted that the transactions between it and its members were not in trade or commerce. This was put, as it was said as a 'simple proposition unsupported by authority'. It was also conceded that it had been held that trade or commerce was not to be given any narrow or restricted interpretation. Whilst this submission at first seemed somewhat attractive I have decided against it. The respondent is a corporation distinct from its members and I consider that even in relation to its members it engaged in trade or commerce in the supply to them of the radio service.

The nature of trade is defined within the ATO's mutuality guide, Mutuality and Taxable Income for Non-for-Profits, at page 15, as follows:

The definition of 'business' under tax law includes 'a trade'. The terms 'business' and 'trade' are commonly used to refer to activities that are commercial in nature and intended to produce a profit. These activities are usually for a taxable purpose.

A mutual organisation may be carrying on a business (or trade) if various indicators are present.

The capacity to earn and distribute profits need not be present before an activity of a not-for-profit entity has the form of a business.

A mutual organisation's business can either be for a taxable purpose (producing assessable income) or non-taxable purposes (producing mutual receipts), or a combination of both.

The indicators of business are outlined in TR 97/11 Income tax: am I carrying on a business of primary production? These indicators include:

•                     whether the activity has a significant commercial purpose or character;

•                     whether the taxpayer has more than just an intention to engage in business;

•                     whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity;

•                     whether there is repetition and regularity of the activity;

•                     whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business;

•                     whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit;

•                     the size, scale and permanency of the activity; and

•                     whether the activity is better described as a hobby, a form of recreation or a sporting activity

The ATO's mutuality guide further notes:

When an organisation transacts with its members it must ask itself if the activity is either:

-        A trade or something in the nature of trade producing a profit (a taxable purpose); or

-        A mutual arrangement which, at most, gives rise to a surplus of funds to the organisation (a non-taxable purpose).

In a mutual arrangement, there must be complete identity between contributors and participants as a class, not individually, in the surplus of common funds. The members collectively contribute and collectively benefit from the common fund. Where an organisation transacts with members collectively to produce a surplus of common funds, the activity is for a non-taxable purpose and is a mutual arrangement.

...

Mutuality ceases to apply when a member individually 'contributes' - say by paying rent - to secure a right over the use of a collectively owned asset (where that right is not available to members as a class), and the member benefits from the use of that asset for their own purposes. This breaks the complete identity between contributors and participants as a class in the common fund.

Where the organisation transacts with a member in this way, the activity is in the nature of trade and is for a taxable purpose. For example, leasing a club facility to a member for their individual benefit in earning their assessable income is in the nature of trade and so the lease income is assessable to the club.

Example: Business nature

A NFP club owns two factory units. One is used for club activities and the other is rented to a club member. The member uses the unit to carry on a business.

The club's activity involving the leasing of a factory unit to one club member is considered to be of a business nature rather than a mutual arrangement. Income from this activity is assessable to the club.

Page 23 of the ATO's mutuality guide describes circumstances of ordinary income generated from non-mutual dealings with members:

Not all dealings involving members are mutual dealings.

Although receipts may be received from a member, if they are from activities that go beyond a mutual arrangement and are in the nature of trade, the receipts are assessable income.

Example: Assessable - lease payments from member

A NFP club leases part of its premises to a member so the member can operate a gym business.

This activity is of a business nature rather than a mutual arrangement. As such, the lease payments from the member to the club will form part of the club's assessable income.

For mutuality to apply the members of an organisation must share a common purpose in which they all participate or are entitled to participate. The main purpose for which the organisation was established and is operated must be this common purpose of the members, and a common fund contributed to by all of the members must give effect to that common purpose. The fund must be owned or controlled wholly by the contributors. If it is owned and controlled by anyone else the principle cannot apply.

Membership

Under the principle of mutuality, receipts derived by a taxpayer from mutual dealings with its members are not assessable income. As set out on page 17 of the ATO's Mutuality Guide, for the purposes of mutuality a person is a member of an organisation where the person has done all of the following:

•                     Applied for membership (which may entail being nominated and paying the appropriate nomination fee)

•                     Been accepted by the organisation (for example, by the board of directors), and

•                     Paid the appropriate membership subscription.

Once a person has applied for Membership and has been accepted by the organisation as a member, they are bound by the organisation's constitution and any rules or by-laws of the organisation. Generally, a person who has not been through the above membership process are considered visitors for tax purposes.

The relevance of membership to the principle of mutuality was considered by Lord MacMillian in the case Inland Revenue Commissioners v Ayrshire Employers Mutual Insurance Association Ltd (1946) 1 ALL ER 637 at 640 where he indicated:

It is not membership or non-membership which determines immunity from or liability to tax; it is the nature of the transactions'. If the transactions are of the nature of (in this case) mutual insurance, the resultant surplus is not taxable whether the transactions are with members or non-members...There is nothing to prevent a mutual insurance company entering a contract of mutual insurance with a person who is not a member of the company.

This approach was adopted in Royal Automobile Club of Victoria (RACV) v Federal Commissioner of Taxation 73 ATC 4153 (RACV), where the taxpayer was a company limited by guarantee that provided certain services and facilities in relation to motor vehicles. They received payments from a number of sources including both members and non-members in relation their services and facilities, together with commissions, interest on investments and rent from property. The court looked at each activity to determine if it had the quality of mutuality. It was held that mutual dealings and business dealings had to be distinguished and apportionment applied. Activities relating to business dealings were considered in the nature of trade and assessable, while activities that were mutual in nature, were mutual receipts even if only some members took advantage of the facility.

If the dealing is mutual, then it is immaterial whether that transaction is with a member or not. Where there is a mutual transaction between an association and a non-member, 'the non-member may be regarded pro tempore as in effect a member of a somewhat wider organisation involving himself and the association' (per Anderson J in RACV at 4157). However, for this to occur, the necessary element of mutuality must be present, which is the contribution to and if a surplus, entitlement from the common fund.

An incorporated entity must be an entity for the convenience of its members

The incorporation of an organisation will not of itself affect the operation of the mutuality principle so far as the company has been incorporated as a mere convenient agent or instrument of the common purpose of its members. In Coleambally Irrigation, Beaumont, Merkel and Hely JJ said at 4842:

In North Ryde RSL Community Club Ltd v FC of T 2002 ATC 4293; (2002) 121 FCR 1, the Full Court (Spender, Finn and Merkel JJ) said that it is (at ATC 4302; FCR 13) 'well enough established' that the mutuality principle, in addition to applying to refunds of contributions made to a common fund, may also apply to contributions made and distributions received where the persons who associate for a common purpose and contribute to a common fund have incorporated to effectuate their common purpose, provided the company can properly be treated as an entity for their convenience. In such cases, the fact of incorporation is irrelevant: Revesby Credit Union Co-operative Ltd v FC of T (1965) 13 ATD 449 at 453; (1964-1965) 112 CLR 564 at 574.

Application of the mutuality principle to the Company's fee for assets

The principal of mutuality will apply to the fees the Company receives from members for the provision of assets where they can be properly characterised as follows:

•                     contributions to a common fund, created and controlled by the contributors, for a common purpose,

•                     there is identity, as a class, between the contributors and the participants to the fund, and

•                     the receipts are not in the nature of trade

It is accepted that the incorporation of the Company does not itself affect the operation of the mutuality principal so far as the Company has been incorporated as a mere convenient agent or instrument of the common purpose of its members (North Ryde RSL; Revesby Credit Union).

It is also accepted that although the Company's Constitution does not explicitly refer to customers as 'Members', the general characteristics of membership are met by the customers who pay a fee for the provision of assets, in that these customers:

•                     Submit a contract to receive the assets from the Company,

•                     Are accepted by the Company on the basis that the customer satisfies the eligibility criteria, and

•                     Pay the appropriate fee.

Once a customer pays their fee and enters into the contract, they are bound by the Company's rules or by-laws. The process of membership in the Company is similar to that of members in the Coleambally Irrigation case.

Common Purpose

The main purpose for the establishment and operation of the Company is the management, sale and distribution of particular assets to entitled individuals and entities.

On consideration of the facts, it is confirmed that the Company's members who pay a fee for the maintenance and delivery of assets have a common purpose.

Common Fund

The Company's standard contract sets out conditions which includes the customer's requirement to pay a fee. The fees contribute to the collective costs involved in the Company storing, maintaining and delivering the assets to the members.

On consideration of the facts, it is confirmed that the Company's members who pay a fee for the maintenance and delivery of assets do so to support a common fund.

Controlled by contributors

The Company's common fund consisting of fees paid by members in return for the ongoing maintenance and delivery of assets, is controlled by the contributors to the fund.

Ownership of common fund

The Company is a not-for-profit, with its income and property used solely in promotion of its objectives. The Company is prohibited from distributing any surplus upon winding up or dissolving to its shareholders. While the ownership of the common fund requirement may not be met, this will not prevent the fee receipts from being mutual in nature as section 59-35 of the ITAA 1997 will operate to prevent the fees from being treated as Assessable Income if that is the only factor on which the company fails to satisfy the mutuality requirements.

Identity between contributors and 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, 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.

Justices Beaumont, Merkel and Hely went on to say, in the context of the Coleambally irrigators at 4843:

Some irrigators may cease to be members of CIMCL over the life of the project, and others may become members in their place. But it is sufficient if there is an identity between contributors and participants as a class: Faulconbridge (Inspector of Taxes v National Employers' Mutuals General Association Ltd (1952) 33 TC 103 at 125.

... If all that occurs is a pooling of the contributors' funds with a complete identity between the contributors to the common fund and those entitled to participate in it, then CIMCL's receipt of the contributions will not be income of CIMCL according to ordinary concepts.

Justice Hill noted at 4131, in quoting Fletcher v Income Tax Commissioner [1972] AC 414 (PC) at 423 that:

If subscriptions are unequal then there is a necessity that there be a:

"Reasonable relationship, contemplated or in result between what a member contributes and what, with due allowance for interim benefits of enjoyment, he may expect or be entitled to draw from the fund; between his liability and his rights."

It is a principal requirement of mutuality that contributors to the common fund can be identified with those participants who receive a benefit from the fund. There must therefore be complete identity between the contributors and the participators in surplus mutual receipts, at least as a class. This was established in Municipal Mutual Insurance Ltd v. Hills (1932) 16 TC 430 where Lord Macmillan stated at 448:

The cardinal requirement is that all the contributors to the common fund must be entitled to participate in the surplus and that all the participators in the surplus must be contributors to the common fund; in other words, there must be complete identity between the contributors and the participators. If this requirement is satisfied, the particular form which the association takes is immaterial.

Pursuant to the facts, there is an identity between what the members paying the fee collectively contribute and what they collectively benefit from the common fund.

Not in the nature of trade

The relevant question, as stated by Lord Wilberforce in Fletcher (at 421) is whether the activity is, 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.

On the facts of the case, the Company does not operate in the nature of trade.

Conclusion

It can be concluded that the elements of mutuality have been met in regard to the fees paid by Members relating to the maintenance and provision of assets by the Company. As such, these fees will be excluded from the Company's annual income under section 6-5 of the ITAA 1997 by the application of the principal of mutuality.

Question 2

Assessable Income

As discussed in the reasoning of Question 1, the fee for services provided by the Company from its customers are considered to be assessable as ordinary income under section 6-5 of the ITAA 1997.

Membership and Incorporation of the Company

It is accepted that while the Company's Constitution does not explicitly refer to its customers as 'members', the general characteristics of membership are met by the customers who pay a fee for services provided by the Company, in that these customers:

•                     Submit a contract to receive the services from the Company,

•                     Are accepted by the Company on the basis that the customer satisfies the eligibility criteria to receive services, and

•                     Pay the appropriate fee for services.

One a customer pays their fee for services and enters into the contract, they are bound by the Company's rules or by-laws.

It is also accepted that the incorporation of the Company does not of itself affect the operation of the mutuality principle so far as the Company has been incorporated as a mere convenient agent or instrument of the common purpose of its members (North Ryde RSL; Revesby Credit Union).

Common Purpose

Per the facts, customers of the Company who pay the fee for services have not associated together to trade with each other, or to profit, but to acquire and maintain the services which benefit all members of the Company. As a class, customers who pay the fee for services have the right to receive those services, and the management of the Company required to meet their collective right. The customers therefore have a common purpose.

Common Fund

As with in Question 1, all revenue from fees for services are spent by the Company in operating and maintaining the provision of services in the future. Customers therefore contribute to the collective costs of owning, managing and maintaining the Company.

On the facts, the customers who pay for services are not contracting on an individual basis with the Company on their own account, but rather are contributing to a common fund for the provision of services.

Controlled by contributors

The common fund consisting of the service fees is controlled by the contributors.

Identity between the contributors and the participants

It is a principal requirement of mutuality that contributors to the common fund can be identified with those participants who receive a benefit from the fund. There must therefore be complete identity between the contributors and the participators in surplus mutual receipts, at least as a class. This was established in Municipal Mutual Insurance Ltd v. Hills (1932) 16 TC 430 where Lord Macmillan stated at 448:

The cardinal requirement is that all the contributors to the common fund must be entitled to participate in the surplus and that all the participators in the surplus must be contributors to the common fund; in other words, there must be complete identity between the contributors and the participators. If this requirement is satisfied, the particular form which the association takes is immaterial.

Pursuant to the facts, there is an identity between what the members paying the service fee collectively contribute and what they collectively benefit from the common fund.

Receipts from members are mutual in nature and not in nature of trade

Per the facts of the case, it can be concluded that the receipts form members, being service fees from eligible customers, are mutual in nature and are not in the nature of trade.

Conclusion

It can be concluded that the elements of mutuality have been met in regard to the service fees paid by Members. As such, these fees will be excluded from the Company's annual income under section 6-5 of the ITAA 1997 by the application of the principal of mutuality.

Question 3

Assessable Income

As discussed in the reasoning of Question 1, the payment for the sale of surplus assets from customers of the Company are considered to be assessable as ordinary income under section 6-5 of the ITAA 1997.

Membership and Incorporation

Customers of the Company who are members for the purpose of Question 1 are members for the purpose of Question 3.

As stated above, the incorporation of the Company does not of itself affect the operation of the mutuality principle so far as the Company has been incorporated as a mere convenient agent or instrument of the common purpose of its members (North Ryde RSL; Revesby Credit Union).

Common purpose

Customers who purchase additional assets from the surplus held by the Company each year do so for their own gain. The purchase is therefore an act of individual benefit rather than one to achieve a common purpose.

Contributions of members are made to a common fund to give effect to the common purpose

Contributions made by members for the purchase of surplus assets are an individual, optional payment made for the purpose of private gain. These contributions are used to benefit all customers of the Company, not just customers who purchase surplus assets, and as such there is no common fund giving effect to a common purpose.

Control of common fund is held by the contributors

As there is no common fund, control of the common fund cannot be satisfied.

Identity between contributors and 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 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..

Those customers who buy surplus assets do so on a transactional basis, providing the Company with an additional revenue stream for commercial purposes to generate profit, rather than as a contribution to a common fund. It cannot be said that there is any identity between a class of contributors and participants.

Receipts from members are mutual in nature and not in the nature of trade

The character of customers purchasing surplus assets from the Company is that of a buyer/seller rather than a member/society. Customers elect to purchase additional assets to meet their individual needs and business purposes, rather than providing funds to a common fund to further common interest with other customers of the Company. As such, these receipts are received in the nature of trade, being a sale of assets, rather than being mutual in nature.

Conclusion

The sale of surplus assets is not a contribution to a common fund, there is no identity between contributors and participants, and receipts are more in line with the nature of trade than a mutual dealing. As such, the principal of mutuality foes not apply to the sale of surplus assets.