Edited version of private advice

Authorisation Number: 1052348882682

Date of advice: 09 January 2025

Ruling

Subject: Mutuality

Question 1

Will the payment of Entity A's Special Fund to Entity B impact any previous treatment of contributions by Entity A's members to that fund as 'not assessable and not exempt' income in accordance with section 59-35 of the Income Tax Assessment Act 1997?

Answer 1

No

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20YY

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

Entity A is a member-owned co-operative which forms part of the business, operating under a dual co-operative structure with Entity B.

Before 19XX, the business was owned and managed by a government entity. As part of the move to privatisation and local ownership, in 19XX the business and assets of the business were transferred to a dual co-operative structure, consisting of two separate co-operatives: Entity A and Entity B. Entity A and Entity B were established with local members and shares initially held in these entities based on the member allocation held prior to privatisation.

Currently, the business still operates under the dual co-operative structure.

Entity A has responsibility for, and its charges are specifically directed at providing for, the maintenance and renewal of some of the infrastructure. Entity A is responsible for collecting access charges and levies (Levies) from members for the infrastructure that it owns as contributions to its Special Fund. Currently, this fund is comprised of investments valued at approximately $XX. Entity A's other assets and property are valued at approximately $XX. The Levies are charged based on the number of shares held by each member. The following activities are the primary activities of Entity A:

•                the provision, management, maintenance and renewal of Entity A assets;

•                the replacement and refurbishment of Entity A's assets and the construction of new assets;

•                the establishment, determination and management of reserves, including the Special Fund; and

•                preparing and providing an annual report on the Special Fund to members.

Entity A does not employ staff because Entity B is responsible for undertaking Entity A's activities (under the Memorandum of Understanding referred to below). The boards of directors of Entity A and Entity B are comprised of different member directors and there is one independent director who sits on both boards.

Entity B is the trading entity for the business. It deals directly with customers, employs staff, holds the statutory licences issued by the government necessary to operate the business and manages the day-to-day operations of the business. Entity B also owns some of the infrastructure.

Entity C provides project design and construct services and management services and does not access the network. Entity D customers' use of the network contributes to approximately 0.XX% of usage in the network.

The business has a regulatory requirement to support community members which includes By-law customers and XXX Entity D customers. Entity D holds shares in both cooperatives.

Like all members, Entity D pays access charges and levies to Entity A as contributions to Entity A's Special Fund. There is a Memorandum of Understanding (MOU) between Entity B and Entity D.

Relevant rules

Entity A's Rules, as the constituent document of Entity A and the document creating a contractual and binding relationship between each Entity A member, Entity A and its board of directors, sets out the "common purpose" on which contributions to the fund were made and for which the fund must be used.

The Special Fund is defined in the Rules as the common fund established by Entity A consisting only of Member funds.

A member is defined in the Rules as a member of Entity A in accordance with Part X of the Act, and who is either an initial subscriber to Entity A or who qualifies for membership of Entity A in accordance with Rule X.

The rights of a member are described in Division X of the Rules.

Entity A is restricted in the activities it may carry out, including the use of the Special Fund, by its objects. These are contained in Entity A's existing Rules at rule X.

Two funds have been established by Entity A, as dictated by the Rules. This is contained in Entity A's existing Rules at Rule XX.

The treatment of surplus of Entity A is detailed in the Rules. This is contained in Entity A's existing Rules at Rule XX.

Structure

The rules of Entity B and Entity A make membership of the one entity conditional on membership of the other. Membership of the two co-operatives is identical, other than that Entity B is deemed to be a member of Entity A and Entity A is deemed to be a member of Entity B. All members are members of both Entity B and Entity A. Should a member sell, normally the vendor would simultaneously transfer their shares in Entity B and Entity A, and their entitlements issued by Entity B, to the purchaser. The vendor's membership of Entity B and Entity A would then be terminated, and the purchaser would be admitted as a new member of both Entity A and Entity B.

Entity A is financed by the Levies and returns on its investments. All infrastructure owned by Entity A, including any future infrastructure constructed using the Special Fund, is leased to Entity B with an annual fee payable by Entity B to Entity A (under the Memorandum of Understanding referred to below).

There is a Memorandum of Understanding between Entity B and Entity A under which:

•                Levies payable to Entity A are collected by Entity B from members on behalf of Entity A and remitted to Entity A;

•                Entity B provides asset maintenance and refurbishment services to Entity A, including developing an asset maintenance and refurbishment program and reporting on the progress of asset maintenance and refurbishment to the Entity A board of directors;

•                all maintenance and refurbishment costs incurred in relation to Entity A's assets under the Memorandum of Understanding are funded by Entity A;

•                Entity B provides secretarial and administrative services to Entity A, including accounting services, storage of documents and corporate secretarial services. In exchange for these services, Entity A pays Entity B a management fee; and

•                Entity A leases its infrastructure and office premises to Entity B.

At present, both Entity A and Entity B own some of the infrastructure. This is because in or around 20XX up to 20XX, Entity B undertook projects. This infrastructure is held by Entity B, which applies accelerated depreciation under income tax laws that Entity A cannot apply. These projects have broadly resulted in the Entity A assets they replaced to become redundant. As Entity B now holds some infrastructure, the dual co-operative structure has become 'contaminated' and less meaningful.

Furthermore, having two co-operatives operating under the dual structure results in a duplication of some operational costs (such as directors' fees).

Restructure

Stakeholders relevant to the business have proposed a restructure to remedy some of the issues with the current structure discussed above. This restructure will involve:

•                Entity A will cease collecting Levies and Entity B will begin collecting levies for a new special fund in place of the current Special Fund;

•                Entity A will transfer its assets (comprised primarily of its infrastructure and the Special Fund) to Entity B under a deed entered into between the two entities (Transfer Deed). The Transfer Deed would, among other things:

°                treat the transfer of the Special Fund as a prepayment for future expenses to be incurred in relation to the maintenance, replacement and refurbishment of the infrastructure;

°                require the use of the Special Fund by Entity B to be consistent with any private binding ruling that Entity A obtains from the ATO and for the purpose for which the Special Fund was collected (that is, in a manner consistent with Entity A's objects); and

°                require Entity A to pay to Entity B all future contributions to the Special Fund collected by Entity A;

•                Entity B would maintain and use the Special Fund to maintain, replace and refurbish the infrastructure in a manner consistent with Entity A's Rules and the Transfer Deed; and

•                Entity A will be wound up.

Both Entity A and Entity B are now regulated by the Co-operatives Act. Under subsection 12(2) of that act, a co-operative may be either:

•                a distributing co-operative - which Entity B currently is; or

•                a non-distributing co-operative - which Entity A is.

A distributing co-operative is a co-operative that must have share capital and is not prohibited from giving returns or distributions on surplus or share capital. A non-distributing cooperative is generally prohibited from giving returns or distributions on surplus or share capital to members other than the nominal paid-up value of shares (if any) at winding up. However, the rules of a non-distributing co-operative that has operated as a mutual may provide that:

•                surplus funds are payable only to members who have paid contributions to the cooperative and have a credit balance in their member's ledger; and

•                the payment of surplus funds is limited to the return of the contributions paid by the member to the co-operative and the nominal paid-up value of the member's shares.

Current taxation status

Entity A is a tax-paying entity with its main source of income derived from returns from the investment of the Special Fund. Income tax returns lodged by Entity A in the past have not included the levies paid to Entity A by its members as income. Entity A has treated these levies as subject to the "mutuality principle" and therefore not included them in assessable income.

The Commissioner of Taxation provided Entity B with a private binding ruling on DD MM YYYY confirming the mutual status of contributions received by Entity A from its members. Entity A has continued to operate on that basis. This includes the management fees paid by Entity B to Entity A being regarded as mutual income to Entity A as they are fees paid to Entity B and passed on to Entity A for services provided by Entity A on behalf of the members, even though they are paid to Entity A indirectly. The income can be readily identified as coming from the members.

Entity B is also a tax-paying entity, and its income is comprised primarily of charges levied on members for services, including fixed access, storage charges, variable usage fees and temporary and permanent transfer fees.

The other members of the corporate group to which Entity A and Entity B belong are Entity C and Entity D, both wholly owned subsidiaries of Entity B.

None of the entities are members of any tax consolidated group.

Relevant legislative provisions

The Income Tax Assessment Act 1997 section 6-5

The Income Tax Assessment Act 1997 section 6-23

The Income Tax Assessment Act 1997 section 59-35