ATO Interpretative Decision

ATO ID 2014/24 (Withdrawn)

Income Tax

• This ATO ID is withdrawn as the interpretative issue is considered in Draft Taxation Ruling TR 2015/D1 Income tax: income tax matters relating to bodies corporate constituted under strata title legislation.
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Issue

Does the principle of mutuality apply to a penalty amount received by a strata corporation such that the amount is not ordinary income for the purposes of section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision

No. The principle of mutuality does not apply to a penalty amount received by a strata corporation. Therefore, the amount is ordinary income for the purposes of section 6-5 of the ITAA 1997.

Facts

A strata corporation has by-laws governing the behaviour of residents and the use of common property.

A member of the strata corporation breaches one of these by-laws (for example by keeping a pet without permission, parking in the wrong spot, etc.).

The breach of the by-law cannot be resolved by the strata corporation.

An application is made to an independent Tribunal to decide the matter.

The Tribunal makes a determination, imposing a pecuniary penalty on the member and orders that it be paid to the strata corporation.

The strata corporation receives the penalty amount from the member.

Reasons for Decision

Section 6-5 of the ITAA 1997 provides that the assessable income of a taxpayer includes income according to ordinary concepts (ordinary income). In these circumstances, the payment of a pecuniary penalty is a normal incident of the taxpayer's income earning activities - the amount is received by the taxpayer in the ordinary course of carrying on their income earning activities - and as such is income according to ordinary concepts.

However, the amount of the pecuniary penalty will not be included as assessable income under section 6-5 of the ITAA 1997 where the principle of mutuality applies.

The principle of mutuality is based on the premise that you cannot derive income from yourself. The principle provides that where a number of people contribute to a common fund created and controlled by them for a common purpose, any surplus arising from the use of that fund for the common purpose is not income (The Bohemians Club v. Acting Commissioner of Taxation (1918) 24 CLR 334; [1918] HCA 16).

Mutuality is limited in its application. It does not include '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...'(Revesby Credit Union Co-operative Ltd v. Federal Commissioner of Taxation (1965) 112 CLR 564 at 574).

While the Commissioner has accepted that the principle of mutuality applies to certain contributions and levies paid by members to bodies corporate under strata corporation legislation (Taxation Ruling IT 2505: Income tax: bodies corporate constituted under strata title legislation), each transaction needs to be examined to determine whether a "particular dealing" is mutual (Royal Automobile Club of Victoria RACV v. Federal Commissioner of Taxation 73 ATC 4153; (1974) 4 ATR 567; [1975] VR 1).

In this case, the principle of mutuality does not apply to the penalty amount received by the strata corporation for the following reasons:

(1)

The by-laws of a strata corporation that govern the behaviour of residents and the use of common property apply irrespective of membership of the strata corporation. Their application is beyond matters that govern the mutual relationship between members and therefore any penalty imposed for a breach of the by-laws does not have the requisite link to the common fund.

(2)

It is the Tribunal, who is a third party, that makes a determination on whether the penalty applies, the amount of the penalty and who receives it. In situations involving external party arrangements the Commissioner has taken the view that mutuality does not apply (Mutuality and Taxable Income Guide).

(3)

The payment of the pecuniary penalty by a member, to the strata corporation is undertaken in discharge of their individual legal obligation. The penalty is a deterrent and is in no sense a pre-estimate of the amount required to meet the member's proportion of the mutual liabilities (Sydney Water Board Employees Credit Union Ltd v. Federal Commissioner of Taxation (1973) 129 CLR 446; 73 ATC 4129; (1973) 4 ATR 157; and Federal Commissioner of Taxation v. Australian Music Traders Association 90 ATC 4536; 21 ATR 471).

(4)

Ultimately, the member is dealing with the strata corporation as a 'stranger'. The payment of a pecuniary penalty by the member is done outside their capacity as a member and therefore puts them in the same position as a non-member (e.g. a tenant) (Liverpool Corn Trade Association Limited v. Monks (HM Inspector of taxes) (1926) 2 KB 110; Municipal Mutual Insurance Ltd v. Hills (HM Inspector of Taxes) 16 TC 430).

Consequently, the penalty amount received by the strata corporation will form part of its assessable income under section 6-5 of the ITAA 1997.

Legislative References:
Income Tax Assessment Act 1997
   section 6-5

Case References:
Federal Commissioner of Taxation v Australian Music Traders Association
   90 ATC 4536
   21 ATR 471

Related Public Rulings (including Determinations)
IT 2505
TD 96/22

Other References:
Mutuality and Taxable Income Guide (Nat 73436)

Keywords
income
non exempt income of exempt entities
association income
mutuality principle

Business Line:  Private Groups and High Wealth Individuals

Date of publication:  18 July 2014

ISSN: 1445-2782