Private ruling: Application of mutuality principle
Date of advice: 12 February 2020
Published: July 2020
Ruling period: From 1 July 20XX to 30 June 20XY
Date scheme commenced: 1 July 20XX

Ruling: Q1: Does the mutuality principle apply to contributions received from members of XYZ? | A1: The mutuality principle applies to the part of the membership subscription that relates to non-insurance benefits. However, the mutuality principle will not apply to the part of the membership subscription that relates to the procurement of insurances.

Relevant facts and circumstances: Constitution and Objects 1. XYZ is a company limited by shares and guarantee that operates for the benefit of its members of a specific profession. It is a company that has both shareholders and general members. 2. The objects of XYZ are set out in the Constitution of XYZ. 3. All income and property derived or held by XYZ must be applied solely towards the objects of the company. No portion of the company's income or property may be paid to Members or shareholders by way of dividend, bonus or otherwise to members or shareholders except on winding up the company. 4. In the event of XYZ being wound up, the Constitution states that each member is required to contribute to the assets of the company a fixed amount for the payment of the debts and liabilities of XYZ on its dissolution. Allocation of surplus on Winding Up 5. In the event that XYZ is dissolved, the surplus is to be paid to General Members. Each entitled Member will receive a share of the surplus in proportion to their contribution to XYZ by way of subscription fees, which will be on an equitable basis to be determined by the Board. 6. The business of XYZ is run by its Board of Directors. 7. The power to elect and remove the directors is with the shareholder. 8. The Taxpayer has provided copies of insurance policies which the Taxpayer has procured from third-party insurers. The Taxpayer procured these policies on behalf of the Taxpayer's members.

Relevant legislative provisions: Income tax Assessment Act 1936 Section 121 | Income tax Assessment Act 1997 Section 6-5 | Section 6-10

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, which is called ordinary income. Whether a receipt is income depends upon its quality in the hands of the recipient. Section 6-10 of the ITAA 1997 provides that assessable income also includes statutory income, which are amounts that are included in assessable income as stipulated by specific legislative provisions. The mutuality principle recognises that a person's income consists only of moneys derived from external sources, that is, from sources other than the person. The essence of the mutuality principle is that you cannot derive any gain, and therefore income, from dealings with yourself. In The Bohemians Club v The Acting Federal Commissioner of Taxation [1918] 24 CLR 334 (Bohemians Club), Griffith CJ stated at 337-338: 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 above comments of Griffith CJ form the basis of the principle of mutuality as it applies in Australia. That is, 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 ITAA 1997. 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, the effect is that generally, contributions by way of fees and subscriptions received from members, for the provision of mutual services, will not be included in a mutual association's assessable income. 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. Revesby Credit Union establishes that a mutual association has all of the following characteristics: · existence of a common fund controlled by the contributors for a common purpose; · identity between the contributors and the participants; · dealings are not in the nature of trade; and · an incorporated entity must be an entity for the convenience of its members. | Detailed Reasoning - Common fund for a common purpose: The Subscription fees paid by XYZ members are paid to XYZ. XYZ was established by members for the common purpose of assisting members in the event that there is an adverse outcome in the course of their professional practice. The Constitution requires that income and property of the XYZ are to be applied solely toward promoting the objects of XYZ. Contributing members have rights as provided for under the Constitution including voting at meetings. However, members do not vote to elect directors who manage the business of XYZ. The shareholder has the power to appoint and remove the directors. The subscription fees paid by XYZ members allow them access to the following main categories of benefits: · Insurance benefits: a number of different insurances - these are provided by third-party insurers. · Non-insurance benefits: support and education. The insurance benefits are provided by third-party insurers under commercial trading arrangements. As such, the portion of the membership fees that relates to the procurement of the insurance covers does not represent a contribution to a common fund for a common purpose where members have rights to any surplus. The above shows that the portion of the membership fees that relate to the non-insurance benefits provided by the Taxpayer to its members are contributions to a common fund for a common purpose (XYZ is the vehicle for providing the common purpose). However, control of XYZ, through the powers of appointment and removal of the Board of Directors is not with the members (contributors) but is with the shareholder. The shareholder owns the shares as a custodian for the trustee of a discretionary trust whose beneficiaries are the members of XYZ. The shareholder holds the shares beneficially for members. Although control of the common fund does not directly sit with the members, it is the shareholder who has the power, the shareholder must act beneficially for members (contributors). As such, it is considered that the common fund is sufficiently owned or controlled by the members (contributors). Based on the foregoing, the portion of the membership fees that relate to the non-insurance benefits are contributions to a common fund controlled by the contributors for a common purpose. | Detailed Reasoning - Identity between the contributors and participants: The element of identity is required between the contributors to a fund of the entity and the participants in the surplus. The constitution of XYZ contains clauses which achieve this. The constitution states that in the event that XYZ is wound up, the surplus is to be paid to members. Each entitled member will receive a share of the surplus in proportion to their contribution to XYZ by way of subscription fees, which will be on an equitable basis. There is a reasonable relationship between what a member contributes and what they are entitled to from the common fund. All income and property derived or held by XYZ must be applied solely towards the objects of the company. Only members are eligible for XYZ membership benefits while it is operating, and can share in the surplus on winding-up. Further, on winding-up, the contributors are entitled to the capital of the common fund through the shareholder. The shares are held beneficially for members. Accordingly the element of identity between the contributors and those entitled to participate in any surplus is satisfied. | Detailed Reasoning - Not in the nature of trade: To determine whether the principle of mutuality applies it is necessary to look at the nature of a transaction. If a transaction is in the nature of trade, for a profit, the principle of mutuality will not apply. As stated above, XYZ membership provides insurance and non-insurance benefits. In the case of the non-insurance benefits, XYZ provides these benefits to members for the shared purpose for which contributions are made (assisting members). Any surplus of contribution will be returned to members (contributors) in the event that XYZ is wound up, otherwise the contributions must be used to further the purposes and services of XYZ. These services are not in the nature of trade. In the case of insurance benefits, XYZ does not keep the portion of members' contributions that relates to insurance benefits, but instead uses those funds to purchase insurance policies on behalf of members from third-party insurance entities. These policies are obtained by XYZ from third-party insurers. In procuring these insurance policies for its members, XYZ is involved in commercial activities. As such, that part of the subscription fee that relates to those activities is income according to ordinary concepts and is assessable under section 6-5 of the ITAA 1997. | Detailed Reasoning - Incorporation: Incorporation will not affect the operation of the mutuality principle ( New York Life Insurance Co v Styles 2 TC 460) provided the incorporated body can properly be treated as an entity for the convenience of the contributors ( Coleambally Irrigation Mutual Co-operative Ltd v Federal Commissioner of Taxation 2004 ATC 4835 at 4842). XYZ is the vehicle used to pursue the common purpose of its members. The use of XYZ as a vehicle of convenience will not affect the operation of the mutuality principle. | Detailed Reasoning - Mutual insurance associations: Section 121 of the ITAA 1936 provides that an association of persons formed for the purposes of insuring those persons against loss, damage or risk of any kind is taken, for the purpose of ITAA 1936, to be a company carrying on the business of insurance, and are referred to as mutual insurance associations. The premiums paid by members to a mutual insurance association are assessable income. ATO ID 2005/98 Income tax: application of section 121 of the ITAA 1936 to a mutual discretionary fund (ATOID 2005/98) provides guidance on the application of section 121 to associations formed for the purposes of providing financial assistance to their members. ATO ID 2005/98 provides that the expression 'formed for the purpose of insuring...persons' refers to the purpose for which the taxpayer was established and the purpose for which it is currently conducted; Cronulla Sutherland Leagues Club Ltd v FCT (1990) 23 FCR 82; 90 ATC 4215; 21 ATR 300. The Taxpayer has provided us with copies of two examples of policies obtained from third-party insurers. The Membership process for XYZ refers an applicant to the Members' Handbook for information about the insurance services. The Handbook identifies the various policies that a member can be entitled under, and who the insurer is. It is clear from documents provided, that XYZ is not the insurance provider but holds different policies with the insurers for the benefit of its members, and that members claim against the policy and receive payments on the policy from the insurance provider and not XYZ. We also note that XYZ is not under any legal obligation to pay amounts under an insurance policy. It is the third-party insurer that makes a payment against the insurance policy when a claim is made. Therefore, XYZ is not formed for the purpose of insuring, and is not a mutual insurance association for the purposes of section 121 of the ITAA 1936. | Detailed Reasoning - Application of the mutuality principle to XYZ: In summary, XYZ is not a mutual insurance association and is not prevented from applying the principle of mutuality under section 121 of ITAA 1936. The portion of subscription fees paid by members for non-insurance benefits satisfies the elements of a mutual receipt. The portion of the subscription fees paid by members for insurance benefits does not satisfy the elements of a mutual receipt, as they are in the nature of trade, and are therefore assessable income in the hands of XYZ under section 6-5 of the ITAA 1997.