Private ruling: mutuality principle
Published: May 2013
Ruling period: · Year ending 30 June 2013 | · Year ending 30 June 2014 | · Year ending 30 June 2015 | · Year ending 30 June 2016 | · Year ending 30 June 2017
Date scheme commenced: 01 July 2012

Ruling: Q1: Where a company limited by guarantee (the Company) is wholly owned by the Club, will receipts received by the Company from members of the Club be non-assessable, non-exempt income under the mutuality principle? | A1: No | Q2: Where a company limited by shares (the Company) is wholly owned by the Club, will receipts received by the Company from members of the Club be non-assessable, non-exempt income under the mutuality principle? | A2: No | Q3: Where a company limited by guarantee (the Company) forms a tax consolidated group with the Club as the head entity, will receipts received by the Company from members of the Club be non-assessable, non-exempt income under the mutuality principle? | A3: No | Q4: Where a company limited by shares (the Company) forms a tax consolidated group with the Club as the head entity, will receipts received by the Company from members of the Club be non-assessable, non-exempt income under the mutuality principle? | A4: No | Q5: If the Club sells strata title apartments to its members, will the receipts from the sale of the apartments be non-assessable, non-exempt income under the mutuality principle? | A5: No

Relevant facts and circumstances: The Club is a non-profit organisation which operates to provide facilities to club members and their guests. The Club is an incorporated association, taxable at the company tax rate, however the mutuality principle applies to membership subscriptions and fees paid by members for use of the facilities. The Club is considering redeveloping some property which it owns to construct a facility. The facility will then be provided to members of the Club. It is intended that a new company will be established to own and operate the facility. The shares in this new company will be 100% owned by the Club. It has not been decided whether the newly formed company will be a company limited by guarantee, or a proprietary limited company limited by shares. It is intended that the facility be limited to members of the Club and their non-member spouses. Users of the facility will be required to pay fees for the services provided by the facility operator. As the Club is taxed as a company, and the facility operator will be a 100% owned subsidiary of the Club, they will be eligible to form a consolidated group for income tax purposes with the Club as the head entity. The Club is considering constructing a small number of units as part of the overall development of the land. The units will not be part of the facility and will be sold to members of the Club.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5, | Income Tax Assessment Act 1997 Section 59-35 and | Income Tax Assessment Act 1997 Section 701-1

Reasons for decision: Detailed Reasoning - Detailed reasoning: The principle of mutuality recognises that one cannot make a profit out of oneself and that income can only be derived from sources outside of oneself. The principle of mutuality applies so that receipts derived by a taxpayer from mutual dealings with its members will not have the characteristic of income according to ordinary concepts and are not assessable. The principle was established in New York Life Insurance Company v. Styles (1889) 14 App. Cas. 381. There the members of a life insurance company were participating policy holders each of whom was entitled to a share of the assets and liable to all losses. The surplus on premiums paid by policy holders were returned annually to them as bonuses or by way of reduction of future premiums. Any balance was carried forward and held for the benefit of the general body of members. The ratio of the decision was expressed in the following passage taken from the speech of Lord Watson: When a number of individuals agree to contribute funds for a common purpose, such as the payment of annuities, or of capital sums, to some or all of them, on the occurrence of events certain or uncertain, and stipulate that their contributions, so far as not required for that purpose, shall be repaid to them, I cannot conceive... why contributions returned to them should be regarded as profits.... a member of the appellant company, when he pays a premium, makes a rateable contribution to a common fund, in which he and his co-partners are jointly interested, and which is divisible among them.... He pays according to an estimate of the amount which will be required for the common benefit; if his contribution proves to be insufficient he must make good the deficiency; if it exceeds what is ultimately found to be requisite, the excess is returned to him (at 394). In Revesby Credit Union Co-Operative Ltd v Federal Commissioner of Taxation (1964-1965) 112 CLR 566 McTiernan J explained the principle of mutuality as follows: 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... (at 574-575). A number of authorities have established the application of the mutuality principle in Australia. They include The Bohemians Club v. Acting Federal Commissioner of Taxation (1918) 24 CLR 334, Revesby Credit Union Co-operative Ltd v. FC of T (supra), The Social Credit Savings & Loan Society Ltd v. FC of T (1971) 125 CLR 560; (1971) 2 ATR 612; 71 ATC 4232, Sydney Water Board Employees Credit Union Ltd v. FC of T (1973) 129 CLR 446; (1973) 4 ATR 157; 73 ATC 4129, R.A.C.V. v. FC of T (1973) 4 ATR 567; 73 ATC 4153, and FC of T v. Australian Music Traders Association (1990) 21 ATR 471; 90 ATC 4536. 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 (however under section 59-35 of the Income Tax Assessment Act 1997 (ITAA 1997) an amount of ordinary income is non-assessable non-exempt income where the only thing preventing it from being a mutual receipt is a prohibition on actual distribution to the members); · 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. Under the proposed arrangement the Club will redevelop land that it owns. The Club will establish a company limited by guarantee (the Company) that will own and operate the land and the developed facility. The Company will be wholly owned by the Club. Use of the facility will be limited to the Club's members, who will pay to use the facility. The above shows that the Company will be established by the Club to run and operate the facility. The Company will not be a voluntary association of the Club's members, and the above characteristics of the mutuality principle will be absent in the formation of the Company. As such, the Company is not an association of the Club's members, and the receipts that it receives from the members of the Club will not be treated as mutual receipts. | Detailed Reasoning - Detailed reasoning: For the reasons discussed in question one (1), the fees will not be treated as mutual receipts. The conclusion is not changed by the fact that the company to be established by the Club to own and operate the facility is a company limited by shares. | Detailed Reasoning - Detailed reasoning: The principle of mutuality and its application to the head company of a consolidated group needs to be viewed within the context of the Single Entity Rule (SER) in section 701-1 of the Income Tax Assessment Act 1997 (ITAA 1997). Section 701-1 of the ITAA 1997 provides: 701-1 Single entity rule 701-1(1) If an entity is a subsidiary member of a consolidated group for any period, it and any other subsidiary member of the group are taken for the purposes covered by subsections (2) and (3) to be parts of the head company of the group, rather than separate entities, during that period. The meaning and application of the SER are considered in Taxation Ruling 2004/11 Income tax: consolidation: the meaning and application of the single entity rule in Part 3-90 of the Income Tax Assessment Act 1997 . The ruling explains the SER principle and its application to members of consolidated groups as follows: 3. Section 701-1 of the ITAA 1997 is a key provision of the consolidation regime. It is the means by which the members of a consolidated group are treated as a single entity (being the head company) for income tax purposes. 4. The intended operation of the SER is to apply the income tax laws to a consolidated group as if it were a single entity. … Consequences of the SER 7. For income tax purposes the SER deems subsidiary members to be parts of the head company rather than separate entities during the period that they are members of the consolidated group. 8. As a consequence, the SER has the effect that: (a) the actions and transactions of a subsidiary member are treated as having been undertaken by the head company; (b) the assets a subsidiary member of the group owns are taken to be owned by the head company (with the exception of intra-group assets) while the subsidiary remains a member of the consolidated group; … 17. The principle underlying the SER is to treat a consolidated group as a single entity, with the head company being that entity for income tax purposes. To this end the SER deems the subsidiary members of the consolidated group to be parts of the head company rather than separate entities. Where a mutual association forms a consolidated group with its subsidiary, the SER applies to treat the subsidiary as part of the head mutual association (Head Company). Any transactions of the subsidiary will be treated as transactions of the Head Company. Paragraph 31 of TR 2004/11 explains as follows: 31. A consequence flowing from the SER is that while an entity is a subsidiary member of a consolidated group, actions and transactions of that member are treated as having been undertaken by the head company. In addition, the assets owned by subsidiary members of the group are taken to be owned by the head company. A transaction between a club member of the Club and the facility operator (which will be a wholly-owned subsidiary of the Club being the head company of the consolidated group) will, under the SER, be treated as a transaction between the club member and the head company. However, not all receipts from club members will be mutual receipts, and it is necessary to consider the nature of the transaction to determine if a receipt is a mutual receipt. 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 character of a receipt from a transaction between the facility operator and a club member is determined by the nature of the transaction. Each transaction must be considered independently. In considering the nature of the transaction Lord Wilberforce in Fletcher v Income Tax Commissioner (1971) 3 ALL ER 1185 drew a distinction between mutual activity and trading activity, and stated (at 1189): …the issue is better framed as one question…: is the activity, on the one hand, a trade, or an adventure in the nature of trade, producing a profit, or is it, on the other, a mutual arrangement which, at most, gives rise to a surplus? Under the proposed arrangement the Club will form a company limited by guarantee (the Company) to operate the facility. The Company will be wholly owned by the Club. The Club will form a consolidated group with the Company, with the Club as the head company of the consolidated group and the Company as the subsidiary. In accordance with the SER, the transactions/receipts of the Company will be treated as transactions/receipts of the Club. Whether the amounts paid by members of the Club to the Company (the Club for the purposes of consolidation) are mutual receipts depends on the nature of the transaction giving rise to the receipt. The ruling application states that the Club's members will have to pay a security deposit and ongoing service fees to use the facility. Based on the discussion of the mutuality principle in question one (1), these payments are not considered to have the character of mutual receipts. They are not a contribution to a common fund for a common purpose. Rather, the security deposit and service fees are obligations that must be paid under agreement (or contract) so that an individual member can receive the benefit of the contract; the security deposit is paid so that the member can use the facility, and the service fees are paid so that the member can avail themselves of the services of the facility. In Sydney Water Board Employees Credit Union Ltd v. FC of T (supra), Mason J held that payments made in discharge of a legal obligation do not come within the mutuality principle (at CLR 458). | Detailed Reasoning - Detailed reasoning: For the reasons discussed in question three (3), the receipts will not be treated as mutual receipts. The conclusion is not changed by the fact that the company to be established by the Club to own and operate the facility is a company limited by shares. | Detailed Reasoning - Detailed reasoning: As discussed in question three (3), payments made in discharge of a legal obligation do not come within the mutuality principle. Under the proposed arrangement the Club will build units that will be sold to the members of the Club. As the payment from the Club's members will be made in accordance with a contract for sale, the payment will be a discharge of a legal obligation. Such receipts are not mutual receipts, and would be treated as assessable income under section 6-5 of the ITAA 1997.