Private ruling: Principle of mutuality
Date of advice: 6 May 2019
Published: July 2019
Ruling period: Year of income ended 30 June 2018 | Year of income ended 30 June 2019 | Year of income ended 30 June 2020 | Year of income ended 30 June 2021
Date scheme commenced: 1 July 20XX

Ruling: Q1: Is the receipt by the Company of specified fees from members subject to the common law principle of mutuality, and not assessable income of the company? | A1: Yes

Relevant facts and circumstances: The members of the Company all operate within the same industry in Australia. The mutual cooperative synergy between members has been very beneficial and has facilitated the development and enhanced functionality of software services provided by the Company. The Company was previously an unincorporated association of entities operating within the same industry in Australia. On incorporation, and in accordance with its Memorandum of Association, the Company acquired the assets and liabilities of its predecessor unincorporated association and also acquired the intellectual property and other assets relating to the software system for the purpose of providing it for the exclusive use by members. Since incorporation, the Company has continually developed, acquired, enhanced, provided and supported software for the members of the Company, who are all participants in a specific insurance industry in Australia. The collaborative provision of mutual services means that software is developed and improved, and intellectual property developed, by the Company and all modules are made available for the benefit of all members. The Company members are all smaller entities within the industry who require a degree of ‘pooling’ of resources in order to provide effective competition with larger participants. The software and services which are provided by the Company to its members is essential to the ability of these smaller entities to operate effectively in the competitive environment of the industry in Australia. The Company has developed and made available to members, various software and support systems and has the ability to restrict access to the Company software and services. Currently, the Company licences the software and provides associated support to its members and several non-members that also operate within the same industry. The Company provides services to these non-member entities on the same basis as members with a margin earned on the cost. In addition to licencing the software and providing associated support services, the Company undertakes several other activities, including an annual conference for members. The conference involves demonstrations of software releases and technology improvements. The conference is attended by representatives of members and also third party IT suppliers. Funding arrangements On incorporation, the initial members of the Company contributed funds to the Company in equal proportions for the acquisition by the Company of the Company software and related intellectual property and assets by way of non-refundable licence fees. New members are required to pay an entrance fee (or joining fee), in accordance with the constitution. This fee is a recognition of the contributions made by existing members to the acquisition and development of the Company software and assets. Funds for the Company’s activities are contributed by members. Member contributions are made by way of software licence and associated support fees in equal proportions or in proportion to the number of members. When additional funding is required for major initiatives such as technology upgrades and software redevelopment, members make additional contributions of funds in equal proportions. Fees for members are determined annually by the Board with subsequent endorsement by members. The fees to be contributed by members are calculated with a view to ensuring that the Company has adequate financial resources to carry out all its activities for mutual benefit of members, and to ensure a surplus of funds available to the Company to meet any contingent adverse economic event, and to ensure adequate resources for ongoing enhancement and upgrading of software and technology. Each year, members approve a general software improvement schedule based on planned resources. Occasionally a small number of members may request a special project outside of the improvement schedule which will be jointly funded through contributions to the Company. Any software developed from such special projects will become available to other members at the time of release, and if taken up by other members, an additional charge is passed back as a credit to the initial group of members that funded the project. Some fees are charged on the basis that at least x% of the total fees are paid by members on an equal apportionment basis and the remaining y% is apportioned on a variable basis based on certain characteristics of the member. The Company provides support services for all members to enable the utilisation of the Company software and services. Expenses, such as site visit travel, accommodation hardware and software purchases, site based data services provided by Telco carriers etc, incurred by the Company in providing the support services to members, are recovered on a cost-recovery basis from the member. The cost of the annual conference is subsidised by sponsorship payments from third party IT suppliers with members contributing to costs by payment of registration and accommodation fees. Surplus funds of the Company are invested from time to time and earn interest. The Company’s constitution prevents distribution of income and property to members while it operates, but allows for the surplus property of the Company to be distributed among its members on winding up or dissolution.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 section 59-35

Reasons for decision: Summary: Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that ‘assessable income’ includes income according to ordinary concepts. 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 p. 526. However, receipts from mutual dealings are not assessable income. The mutuality principle provides that where a number of people come together 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 purposes that is then distributed to the contributors, is a return of funds and not income or profit ( Social Credit Savings and Loans Society Ltd v Federal Commissioner of Taxation (1971) 125 CLR 560). That is, income is not derived from dealings with oneself. A mutual association has all of the following characteristics: ● a voluntary association of persons (contributors) who make contributions out of their own moneys to a common fund (which they create, own, control and all have an interest in) for a common purpose (which may also be for their personal benefit as participators) and that purpose is not undertaken for profit; ● contributions are based on an estimate of expected expenses of the common purpose (mutual liabilities), 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; ● complete identity as a class between the contributors and the participators; and ● a reasonable relationship between what a member contributes and what the member may be expected or entitled to receive in respect of the common fund. the Company generally has the characteristics of a mutual association: ● it was incorporated to purchase software using contributions from members; ● the software is used to enable members to manage their business; ● members make regular contributions to ensure that the software is current and complies with statutory, regulatory and business requirements; ● member contributions are calculated with a view to ensuring that the Company has adequate financial resources to carry out its activities and to ensure that funds are available if needed; the assets of the Company are beneficially owned by the members; and ● members are entitled to a portion of the assets on winding up in such manner as shall be determined by the members at or before the time of dissolution, and in default thereof, equally among such members. However, not all receipts received by a mutual association will necessarily be mutual. In North Ryde RSL Community Club Ltd v FC of T 2002 ATC 4293 the court stated … not all receipts by a club from members or from a third party on account of services or facilities made available to members are necessarily mutual receipts… They may be no more than trading receipts. It is the nature of the actual transactions in question, and not the fact that a benefit was received or a service used by members that will determine whether receipts derived are liable to, or immune from, tax (at 4306). The Company receives a number of different fees from members, and it is therefore necessary to consider whether each fee represents a mutual dealing. Some fees must be paid by members regardless of whether they use the service (not all members use the network). In the case of both the software and service fees, they are charged on a fixed/variable model whereby X% of the total fees are paid by Members on an equal apportionment basis and the remaining y% is apportioned on a variable basis based on certain characteristics of the member. It is accepted that a reasonable relationship exists between what each member contributes and what they are entitled to receive. Members contribute as a class, they are entitled to use the software and network whilst the Company continues, and they are entitled to a portion of the Company’s assets on winding-up. Therefore, these fees by members to the Company are considered to be mutual dealings and not assessable income of the Company. Other additional fees are to be paid if members use the services. One of these additional fees is payable by all members who use the network and is additional to the service fee. It is charged out on a similar basis to the service fee (X% fixed and Y% apportioned). All other fees are charged out on a cost recovery basis. The Company hosts an annual conference for Members. The conference showcases software releases and technology improvements and is attended by representatives of Members and also third party IT suppliers. It is accepted that, in relation to these additional fees, a reasonable relationship exists between what each member contributes and what they are entitled to receive. Members contribute on a cost/recovery basis and these fees, when paid by members, are considered to be mutual dealings and not assessable income of the Company. In case there is any doubt, any fees that are paid to the Company from non-members for the use of any of the Company software and related services, or for attendance at the annual conference, are not mutual dealings and will be assessable income of the Company.