Private ruling: Mutuality Principle
Published: December 2014
Ruling period: The year ended 30 June 2014
Date scheme commenced: 1 July 2013

Ruling: Q1: Are business receipts received from the Organisation's members assessable income of the Organisation under section 6-5 or section 6-10 of the Income Tax Assessment Act 1997 ('ITAA 1997)'? | A1: Yes.

Relevant facts and circumstances: The Organisation's principal activities are the operation of a registered club. These principal activities assist in achieving the objectives of the Club, which include amongst other things, to operate a Business. Prior to the Organisation taking over the Business, the Business operated as a separate entity. The Business was wound up and all of its assets transferred to the Organisation. The Organisation's Memorandum of Association contains clauses to the effect that income and property of the Organisation shall be applied for the promotion of the objects of the Organisation and also prevents it from making any distribution to its members, both during its operation and upon its winding up. One of the objects of the Organisation, as per its Memorandum of Association, is to engage in lawful business pursuits, including but not limited to the Business. The Organisation executed a Deed of Agreement with the original owner of the Business for the transfer of the Business and its assets to the Organisation. The Organisation agreed to assume control of these assets and to continue the operation of the Business. The Deed contains clauses to the effect that the Organisation will establish a Fund in the form of separate bank accounts for the sole purpose of the operation of the Business. On completion of all transfer of assets, the Organisation also agreed that any assets and income derived from the Business would be applied solely for the furtherance of the Business, and that no members of the Organisation would receive any benefit. Similarly, the Deed prevents any distribution of a surplus to the Organisation's members on winding up of the Business. The Business and related assets were transferred to the Organisation in the year ended 30 June 2014. The Business is located on separate premises to the Organisation. The Business's services are available to non-members of the Organisation, subject to availability. Currently, less than half of the Business's customers have at least one family member that is a member of the Organisation.

Relevant legislative provisions: Income Tax Assessment Act 1997 s ection 6-5

Reasons for decision: Summary: The business receipts of the Organisation from both members and non-members are assessable income under section 6-5 of the ITAA 1997 as the principles of identity and proportion have not been established. As a result, the mutuality principle will not apply, and the business receipts will be assessable income. | Detailed Reasoning - Detailed reasoning: Section 6-5 of the ITAA 1997 provides that assessable income includes income according to ordinary concepts, which is called ordinary income. The principles and tests for ascertaining whether a receipt is income according to ordinary concepts have been laid down by the courts over the years. One of these principles is the principle of mutuality. The mutuality principle is not specifically mentioned in the ITAA 1997. However, it has been accepted and applied narrowly in relation to Australian taxation law. The principle is based on the proposition that a taxpayer cannot derive income from itself. The principle recognises that contributions by a club's members are not in the nature of income because income consists of monies derived from sources outside of the taxpayer ( Bohemians Club v. Acting Federal Commissioner of Taxation (1918) 24 CLR 334 at 337). The principle is summarised in Revesby Credit Union Co-operative Ltd v. Federal Commissioner of Taxation (1965) 112 CLR 564 at 574 where McTiernan J said: 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…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. In Social Credit Savings & Loans Society Ltd v. Federal Commissioner of Taxation (1971) 125 CLR 560; [1971] HCA 61; 71 ATC 4232 considered the importance of establishing the principle of identity between the contributors to a fund and the participants in the surplus. Gibbs J provided the following summary at paragraph 15: The principle can however only apply if "the contributors to the common fund and the participators in it are two identical bodies"', because it is based on "the impossibility that contributors should derive profits" (or in Australia income) "from contributions made by themselves to a fund which could only be expended or returned to themselves" ( English and Scottish Joint Co-operative Wholesale Society Limited v. Commissioner of Agricultural Income-Tax, Assam , supra, at pp.417, 419). In Municipal Mutual Insurance, Limited v. Hills (H.M. Inspector of Taxes) , supra, at p.448, Lord Macmillan said - "The cardinal requirement is that all the contributors to the common fund must be entitled to participate in the surplus and that all the participators in the surplus must be contributors to the common fund; in other words, there must be complete identity between the contributors and the participators. If this requirement is satisfied, the particular form which the association takes is immaterial." However the identity of which Lord Macmillan speaks is identity as a class. In Faulconbridge (H.M. Inspector of Taxes) v. National Employers' Mutual General Insurance Association, Ltd. (1951-52) 33 T.C. 10, at p.125, Upjohn J. said - "Finally, viewed in the light of the other cases, I think it is clear that when Lord Macmillan speaks of the cardinal requirement being complete identity between the contributors and the participators, he is not referring to individual identity but to identity as a class, so that at any given moment of time the persons who are contributing must be identical with the persons who are entitled to participate; whereas it follows, in my judgment, that it matters not that the class has been diminished by persons going out of the scheme or that others may come in in their place in the future." Further, the principle of proportion must also be established. In Sydney Water Board Employees' Credit Union Ltd. v. Federal Commissioner of Taxation [1973] HCA 47; (1973) 129 CLR 446; 73 ATC 4129, Mason J commented at paragraph 23: although it has not been insisted that the refund to contributors should be in precisely the same proportions in which they have contributed to the fund, it has been said that there must be 'a reasonable relationship' between what a member contributes and what he may be expected or entitled to receive from the fund... In Federal Commissioner of Taxation v. Australian Music Traders Association [1990] FCA 192; (1990) 90 ATC 4536; (1990) 21 ATR 471 (' AMTA case' ), moneys were received by the association from a portion of its members as a result of a contract with an external party. Those members paid funds in to a separate bank account to be applied for the organisation of an exhibition. The excess of the members' contributions were then paid by the external party to the association under the contract. Wilcox J, with Davis J agreeing, found at paragraph 26 that there was no 'reasonable relationship' between the contributors and the beneficiaries of the funds. Not all members had contributed to the organisation of the exhibition. Further, any surplus on the funds would not be returned to the contributing members, nor to the members as a whole. | Detailed Reasoning - Application to the taxpayer's circumstances: The Organisation provides services through its Business. The Business's services are available to non-members, subject to availability. In the year ended 30 June 2014, the Organisation received business receipts from both members and non-members. Currently, less than half of the Business's customers have at least one family member that is a member of the Organisation The Organisation acquired the Business and related assets in the year ended 30 June 2014, pursuant to a Deed of Agreement. Under the Deed of Agreement, the Organisation agreed to establish a Fund, in the form of separate bank accounts, for the sole purpose of operating the Business. The Organisation also agreed that it would carry on the Business, and it would ensure that any income derived from the Business would be applied solely for the furtherance of the Business. It agreed that no portion of the income would be applied for the benefit of the Organisation's members, except for bona fide commercial transactions. Similarly, it agreed that, on dissolution of the Fund, any surplus remaining would not be transferred to its members, but to another similar business organisation. While the Organisation receives funds from some of its members who utilise its Business services, neither these members nor the Organisation's members as a whole are entitled to participate in the surplus of these funds. Any distribution of the Business's surplus funds is prevented under certain clauses of the Deed of Agreement. As a result, the principle of identity is not established. Further, in similar circumstances to the AMTA case , there is no 'reasonable relationship' between contributions to the funds of the Business and what those contributors might be expected to receive. Again, any distribution from the surplus is prevented by the Deed of Agreement. Therefore, the principle of proportion is also unable to be established. As there neither the principle of identity nor the principle of proportion can be established, the mutuality principle will not apply to the business receipts received by the Organisation, irrespective of whether they are received from members or non-members. Accordingly, the business receipts received from the Organisation's members is assessable income of the Organisation under section 6-5 of the ITAA 1997.