Private ruling: Mutuality principle
Published: May 2015
Ruling period: Year ended 31 January 2011 (in lieu of 30 June 2011) (2011 year) | Year ended 31 January 2012 (in lieu of 30 June 2012) (2012 year) | Year ended 31 January 2013 (in lieu of 30 June 2013) (2013 year) | Year ended 31 January 2014 (in lieu of 30 June 2014) (2014 year) | Year ended 31 January 2015 (in lieu of 30 June 2015) (2015 year) | Year ended 31 January 2016 (in lieu of 30 June 2016) (2016 year) | Year ended 31 January 2017 (in lieu of 30 June 2017) (2017 year)
Date scheme commenced: The scheme has commenced

Ruling: Q1: If the non-member percentage data is available for both the Accumulated Credits Payout Formula (ACPF) and the Waratahs Formula (WF) for all Company X's premises, can Company X calculate its taxable income from poker machine trading activities based on the ACPF only, with the WF used for balancing of Company X's other trading activities each year for mutual receipts and expenses? | A1: Yes. Company X may use the ACPF to determine member and non-member percentages only for its poker machine revenue and expenses to arrive at the assessable income and deductible expenses components where the ACPF is calculated by an examination of Company X's poker machine payout records for the whole year. The WF should be used by Company X to determine the apportionable assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) or deductible expenses under section 8-1 of the ITAA 1997 for all Company X's other trading activities. | Q2: Can member surveys of payout figures by Company X in this ruling be relied upon to determine the non-member percentage so that the ACPF can be applied to each year and each premises to determine Company X's apportionable assessable income under section 6-5 of the ITAA 1997 and deductible expenses under section 8-1 of the ITAA 1997? | A2: No. The ACPF must be calculated by an examination of Company X's poker machine payout records for the whole year in each individual year. Company X may apply the ACPF to its poker machine trading activities for each individual premises where the poker machine profits form the overwhelming majority of the overall profit for each individual premises. Survey information should only be relied on to support the WF where accurate information cannot be determined by a summation of visitor/member daily attendance books. | Q3: Can Company X choose on a year by year basis to apply either the ACPF or the WF to its poker machine trading activities to determine Company X's lower apportionable assessable income under section 6-5 of the ITAA 1997 and deductible expenses under section 8-1 of the ITAA 1997? | A3: Yes. However, the method Company X chooses must reasonably and accurately reflect its revenue and expenses for its poker machine trading activities for each income year specifically in relation to the mutuality principle. Further, Company X may be required to explain why using different methods in different years to determine an accurate apportionment of member and non-member percentages for its poker machine trading activities is reasonable and appropriate, apart from producing a lower taxable income result. | Q4: Can Company X choose either the ACPF or the WF to determine its non-member percentage to calculate Company X's lower apportionable assessable income under section 6-5 of the ITAA 1997 and deductible expenses under section 8-1 of the ITAA 1997? | A4: No. The ACPF may only be applied to poker machine trading activities in limited circumstances where the poker machine profits form the overwhelming majority of Company X's overall profit. The WF should be used in all other circumstances to determine Company X's apportionable assessable income under section 6-5 of the ITAA 1997 and deductible expenses under section 8-1 of the ITAA 1997? | Q5: If Company X records are not acceptable for the ACPF to apply, is there an alternate acceptable method of determining the non-member percentage from poker machine trading activities across each of WSNLC's premises. | A5: Refer above and apportionment methods discussed in Chapter 6 of the Guide for taxable non-profit organisations - Mutuality and taxable income

Relevant facts and circumstances: Company X is a registered club which derives a significant proportion of its revenue and profit from poker machine trading activities. Company X owns and operates several separate premises: Company X states the spending characteristics of non-members differ markedly from that of members and therefore has obtained poker machine payout data and conducted surveys to determine the proportion of non-members receiving payouts from poker machines over the period of the surveys. The survey process was as follows: a/ Conducted over two separate periods (1 week and 2 weeks) once per day of patrons attending the gaming rooms; b/ membership cards were used for verification c/ conducted by a staff member on the floor and one at the entry/exit doors. Supervised by duty managers. d/ contemporaneous surveys across all individual premises Company X intends to conduct similar surveys over two one week periods contemporaneously across all individual premises on a financial year by year basis in future. Registered clubs are required to maintain significant controls and documentation over player payouts including monitoring gaming play by sophisticated computer systems, which establish a strong audit trail for payouts and gaming revenue. The payout data is subject to audit by Company X's auditor and is also subject to inspection by Department of Gaming and Racing's inspection branch. Company X provided statistical data and survey results for all premises. Prior years For prior income years Company X lodged income tax returns using the WF method to determine the reasonable basis of apportionment between member and non-member revenue and expenses. Company X applied the mutuality percentage across all premises combined as opposed to individual percentages per premises. Company X's states that a review of trading income across all premises shows poker machine income contributed on average a majority of the divisional mutual profit and gross mutual income for the prior income years.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 section 8-1

Reasons for decision: Detailed Reasoning - Question 1 to 5: Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that 'assessable income' includes income according to ordinary concepts (ordinary income). Whether a receipt is income depends upon its quality in the hands of the recipient (see Scott v. Federal Commissioner of Taxation (1966) 117 CLR 514 ( Scott ) at 526). In circumstances where it can be established that the mutuality principle applies, mutual receipts from associated entities sharing a common purpose, contributing to a common fund have been found not to constitute ordinary income and as such are not subject to income tax under section 6-5 of the ITAA 1997. | Detailed Reasoning - Principle of mutuality: 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 (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). In Carlisle and Silloth Golf Club v. Smith [1912] 2 KB 177 it was held that to the extent that the club received payment for green fees from non-members for the use of the club's golf course, these receipts were from trading and were liable to tax in respect of profits attributable to non-members' green fees. There was mutuality as far as members were concerned, but not so far as non-members were concerned (RACV v. FCT (1973) 4 ATR 567 at 570). Thus with clubs, societies and associations in circumstances where it can be established that the mutuality principle applies, mutual receipts from associated entities sharing a common purpose, contributing to a common fund have been found not to constitute ordinary income. Whereas receipts from outsiders who are not members are not contributing to a common fund, these amounts, provided they exhibit the characteristics of income are considered ordinary income and taxable under section 6-5 of the ITAA 1997. The clubs and societies will need to classify its expenses as: 1/ non-deductible 2/ deductible, or 3/ apportionable. Taxation Determination TD 93/194 Income tax: how should a licensed club apportion expenses when calculating its taxable income? (TD 93/194) at paragraph 2 identifies expenses being: a/ non allowable (non-deductible): as those that relate specifically to members such as members functions b/ wholly allowable expenses (deductible): being specifically related to non-members (for example, non-member only promotions), expenses relating to wholly assessable income (such as investment expenses) and non-apportionable deductions including contributions to staff superannuation, where the Act provides for claims to be deductible in full, and c/ partially allowable (apportionable): expenses which cannot be specifically identified as either member or non-member related, relating to both. Company X operates its premises and trading activities for both members and non-members, therefore expenses will be incurred in producing both assessable income and mutual receipts. In other words there will be partly allowable or apportionable expenditure. Such expenditure must be apportioned on a reasonable basis. In this situation, WSNLC can choose a practical and suitable method of apportioning the expenses. The method will be acceptable provided: 1/ There is a reason for apportioning the expenditure. 2/ The method chosen is suitable for that type of expenditure. 3/ The method chosen is reasonable and is not arbitrary. 4/ It gives a correct reflection of the expenditure incurred. | Detailed Reasoning - Apportionment methods: Mutuality principle apportionment methods are explained in Chapter 6 of the ATO Guide for taxable non-profit organisations - Mutuality and taxable income ('the Guide') as follows: Before choosing one or more methods, it is important that you correctly identify whether an individual is a member or non-member as the separation of the apportionable items relies on this accurate identification. Apportionment methods include: a/ simple methods b/ the Waratahs formula, and c/ other methods. The method (or methods) an organisation chooses must reasonably and accurately reflect its revenue and expenses. An organisation may use one or more methods to separate its apportionable items for the year in question. In determining a method of apportionment, consideration of a basis for such will only relate to those expenses which cannot be identified specifically as a member or non-member expense. On page 32 of the Guide the Commissioner provides guidance in relation to the appropriate method of apportionment for registered and licensed clubs which states: The Waratahs formula is a base formula for isolating member and non-member contributions to income of an organisation, and it simplifies the process for separating expenses that cannot be easily identified as either member or non-member. The formula is accepted as a reasonable basis for apportionment, particularly for registered and licensed clubs. When determining total visitors and average daily percentage of member's attendance the WF relies on the accuracy of visitor and member registers, and survey results. Where an organisation is required by state licensing laws to maintain a register, total visitors can be determined by summation of the visitors, temporary and honorary members' book(s). If an organisation does not have permanent door staff, a survey should be conducted. On page 33 of the Guide the Commissioner provides guidelines in relation to 'conducting surveys': If an organisation does not have records of total visitors and member attendance to include in the [Waratahs] formula, it should conduct regular surveys of visitor and member attendance. Therefore, Company X would only be required to conduct surveys when applying the WF to determine its apportionable assessable income under section 6-5 of the ITAA 1997 and deductible expenses under section 8-1 of the ITAA 1997 where it does not have sufficient records obtained via visitors, temporary and honorary members' book(s) supervised by permanent door staff. On page 34 of the Guide the Commissioner provides guidelines in relation to using alternate apportionment methods. In relation to the use of the ACPF the Commissioner states: This method is used in limited circumstances only. It may not be suitable for organisations that do not have many poker machines, or if the poker machines are not used frequently. This method should only be used to apportion revenue and expenses that relate to poker machines. This is because it does not take into account the members and non-members who attend the organisation and do not play the poker machines. Registered clubs are required to maintain significant controls and documentation over player payouts including monitoring gaming play by sophisticated computer systems, which establish a strong audit trail for payouts and gaming revenue. The payout data is subject to audit by Company X's auditor and is also subject to inspection by Department of Gaming and Racing's inspection branch. Therefore, Company X as a registered club would be expected to have sufficient records in relation to its poker machine trading activities to be able to apply the ACPF to determine its apportionable assessable income under section 6-5 of the ITAA 1997 and deductible expenses under section 8-1 of the ITAA 1997 for each respective income year. Any survey information obtained by Company X has no application when applying the ACPF to poker machine trading activities. This view is reinforced by the conclusion reached by Professor Ian Gordon PhD, AStat, in his report on taxation formula, dated 19 November 2003, where he states (in relation to the use of the ACPF): The Accumulated Credits formula, calculated on data over a whole year, will reflect the proportion of visitor revenue better than the Waratahs' Formula. The [ACPF] should not be applied using data collected in the two week study, but across the whole year, as it seems it can be. Company X reviews of trading income over a four year period across all premises shows poker machine income contributed an overwhelming majority of Company X's overall profit. Accordingly, the Commissioner accepts that it is reasonable for Company X to apply the ACPF to determine an accurate apportionment of member and non-member percentages of revenue and expenses that relate only to poker machines for the prior years. Where appropriate data has been contemporaneously collected in the prior years which supports using the ACPF to calculate more accurate apportionable assessable income under section 6-5 of the ITAA 1997 or deductible expenses under section 8-1 of the ITAA 1997 in relation to Company X's poker machine trading activities, the Commissioner may amend prior year returns to include the revised calculations. The Commissioner also accepts that it would be reasonable for Company X to apply the ACPF for the current and future years to determine an accurate apportionment of member and non-member percentages of revenue and expenses that relate only to poker machines in those years in circumstances where the poker machine profits continue to form an overwhelming majority of Company X's overall profit. The WF should be used by Company X to determine the apportionable assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) or deductible expenses under section 8-1 of the ITAA 1997 for all Company X's other trading activities.