Edited version of private advice

Authorisation Number: 1052179133229

Date of advice: 12 October 2023

Ruling

Subject: Principle of mutuality

Question1

Will the receipts received by the Company from its Member, on transfer of the Assets be mutual receipts and therefore non-assessable non-exempt income under section 6-23 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Will the Service Fees paid by the Member to the Company for the provision of Services be mutual receipts and therefore non-assessable non-exempt income under section 6-23 of the ITAA 1997?

Answer

No

This ruling applies for the following periods:

Year ending 30 June 2024

Year ending 30 June 2025

Year ending 30 June 2026

Year ending 30 June 2027

Year ending 30 June 2028

The scheme commenced on:

1 July 2023

Relevant facts and circumstances

1.      The Company is a not-for-profit company limited by guarantee.

2.      The Company is a taxable not-for-profit that calculates its taxable income in accordance with the principle of mutuality.

3.      The purposes of the Company are concerned with promoting a profession.

4.      Members of the Company are required to pay a membership fee and are entitled to the same membership rights.

5.      The Member is a member of the Company.

6.      The Member and the Company will enter an Agreement A and Agreement B.

7.      Pursuant to Agreement A, the Member will transfer Assets to the Company for consideration.

8.      The Assets transferred under Agreement A will be provided to the Company to enable the Company to provide the Services under Agreement B.

9.      The Assets transferred under Agreement A must be used by the Company to provide the Services under Agreement B.

10.   Pursuant to the Agreement B, the Company will provide Services to the Member for a Service Fee.

11.   The Service Fee will be paid monthly and will relate to the Services provided by the Company in the previous month.

12.   At the expiry or termination of Agreement B, the Company must transfer certain Assets back to the Member.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-23

Income Tax Assessment Act 1997 section 59-35

Reasons for decision

Question 1

Detailed reasoning

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that 'your assessable income includes income according to ordinary concepts, which is called ordinary income'.

Section 6-23 of the ITAA 1997 states that 'an amount of ordinary income or statutory income is non-assessable none-exempt income if a provision of this Act or another Commonwealth law states that it is not assessable income and is not exempt income'.

Section 59-35 of the ITAA 1997 relevantly 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 ...;and

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

Therefore for section 59-35 of the ITAA 1997 to apply to a receipt, it must be one that would be ordinary income but for the application of the principle of mutuality (adjusted to exclude the requirement to distribute money or property to its members).

Whether a receipt is income depends upon its quality in the hands of the recipient (Scott v Federal Commissioner of Taxation (1966) 117 CLR 514 at 526).

In G. P. International Pipecoaters Pty Ltd v FCT (1989-90) 170 CLR 124 at 138 the High Court said the following, in relation to whether an amount is income or capital:

"To determine whether a receipt is of an income or of a capital nature, various factors may be relevant. Sometimes, the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes, by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business."

Pursuant to Agreement B, the Member will appoint the Company to provide certain Services. Agreement A provides that the Member will transfer certain Assets to the Company which are to be used by the Company to provide the Services under Agreement B. At the expiry or termination of Agreement B, the Company must transfer certain Assets back to the Member.

The Assets will be transferred to the Company to enable it to provide the Services under Agreement B for the term of that Agreement. The transfer under Agreement A is a 'one-off' transaction between the parties that will enable the Company to provide the Services. The Assets received by the Company are considered capital in nature and will not be income according to ordinary concepts in the hands of the Company.

As these receipts are considered capital in nature and not income, section 59-35 of the ITAA 1997 will not operate to treat the Assets as non-assessable and non-exempt income; the section only applies to amounts that would be ordinary income but for the application of the principle of mutuality.

Further, the Assets transferred under Agreement A are not mutual receipts.

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, including Bohemians Club v The Acting Federal Commissioner of Taxation [1918] 24 CLR 334, 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 receipt has the following characteristics:

•                     the receipt (contribution) must be to a common fund (created by contributors which they own, control and all have an interest in) for a common purpose, which is not undertaken for profit,

•                     contributions are based on an estimate of expected expenses of the common purpose, 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,

•                     identity as a class between the contributors and the participators, and

•                     a reasonable relationship between what is contributed and what the contributor may be expected or entitled to receive in respect of the common fund.

The Company was incorporated by its members for a specified purpose. The members contribute membership fees and have the same membership rights. Members are not entitled to any surplus assets while the Company operates and when it winds up.

The Company and Member have negotiated Agreement A and Agreement B which results in additional Services being provided to the Member. Under the terms of Agreement A, the Member will transfer certain Assets to the Company. The Assets transferred will be used by the Company to provide Services to the Member under Agreement B. At the expiry or termination of Agreement B, the Company must transfer certain Assets back to the Member.

The above analysis shows that the Assets transferred under Agreement A will not be received by the Company to be used for its purposes and for the benefit of all its members. Instead, the Company will receive the Assets to provide Services to the Member, and at the termination or expiry of Agreement B, certain Assets will be transferred back to the Member. The Assets transferred to the Company under Agreement A are not contributions to the Company for the common purpose of the Company and are not held by the Company for the benefit of its members (contributors). Rather the Assets are transferred for the specific purpose of enabling the Company to provide additional Services to the Member under Agreement B, and are held by the Company for the benefit of the Member.

As the Assets transferred by the Member to the Company under Agreement A are not contributions to the Company for the common purpose of the Company and for the benefit of its members, the principle of mutuality will not apply to those Assets received by the Company.

Section 59-35 of the ITAA 1997 will not operate to treat the Assets transferred to the Company under the Asset Agreement as non-assessable and non-exempt income; the section only applies to amounts of ordinary income that would be mutual receipts. Therefore section 6-23 of the ITAA 1997 will not apply to treat the transferred Assets as not assessable and not exempt income.

Question 2

Detailed reasoning

Refer to question 1 for a discussion of the relevant law.

As discussed in question 1, for section 59-35 of the ITAA 1997 to apply to a receipt (and be treated as non-assessable and non-exempt income under section 6-23 of the ITAA 1997), it must be one that would be ordinary income but for the application of the principle of mutuality (adjusted to exclude the requirement to distribute money or property to its members).

Under Agreement B, the Member will pay to the Company a monthly Service Fee in consideration for the Company providing the Services. The Service Fee is for Services provided in the previous calendar month. The Service Fee is a periodical payment made by the Member for the Services rendered by the Company, and has the nature of ordinary income in the hands of the Company.

As mentioned to in question 1, a mutual receipt has the following characteristics:

•                     the receipt (contribution) must be to a common fund (created by contributors which they own, control and all have an interest in) for a common purpose, which is not undertaken for profit,

•                     contributions are based on an estimate of expected expenses of the common purpose, 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,

•                     identity as a class between the contributors and the participators, and

•                     a reasonable relationship between what is contributed and what the contributor may be expected or entitled to receive in respect of the common fund.

The terms of Agreement B show that the Service Fee is a monthly payment by the Member for Services provided by the Company in the previous month (the Service Fee relates to Services already provided).

The Service Fees will be paid by the Member for additional Services provided by the Company for the benefit of the Member. The Service Fees will not be received by the Company for its purposes and for the benefit of its members (contributors). As such, the payment of the Service Fees by the Member to the Company will not be a contribution to the Company for the common purpose of the Company and for the benefit of its members.

As the Service Fees paid under Agreement B are not contributions by the Member to the Company for the common purpose of the Company and for the benefit of the members of the Company, the principle of mutuality will not apply to those receipts received by the Company.

Section 59-35 of the ITAA 1997 will not operate to treat the Service Fees as non-assessable and non-exempt income; the section only applies to amounts of ordinary income that would be mutual receipts. Therefore section 6-23 of the ITAA 1997 will not apply to treat the Service Fees as not assessable and not exempt income.