Private ruling: Application of the mutuality principle
Published: December 2013
Ruling period: 1 January 2013 to 31 December 2013
Date scheme commenced: 1 January 2013

Ruling: Q1: Does the principle of mutuality apply so as to exclude membership subscriptions received by The Society from its resident Australian Voting Members from assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes | Q2: Does the principle of mutuality apply so as to exclude membership subscriptions received by The Society from its resident Australian Associate Members from assessable income under section 6-5 of the ITAA 1997? | A2: No

Relevant facts and circumstances: The Society assists members with legal, ethical and related problems. The objects for which The Society is established are set out in its constitution (The Constitution). The objects of The Society, set out in its Constitution, do not include anything which could be constructed as trading activities, all objectives aim to achieve a common benefit in which all members participate. The Constitution requires that the income and property of the Society shall be applied solely towards the promotion of its objects. The Constitution allows The Society to the extent permitted by law from time to time, to distribute among the Members in any manner whatsoever any property of the Society, any proceeds of sale resulting from disposal of any property of The Society, or any income of The Society. The Constitution makes provision for voting members and associate members. The Constitution defines 'Member', except where the context otherwise requires, to mean a Voting Member and/or an Associate Member. 'Associate Member' is defined as a Member who is not entitled to receive notice of or attend or vote at any meetings of the Society. A 'Voting Member' is defined as a Member who is entitled to receive notice of or attend or vote at any meetings of the Society. The annual contribution fees for Voting and Associate Members is determined according to an assessment of their risk to the membership fund. The subscription is not determined by whether or not a member has voting rights. The Constitution provides that The Society is subject to the control of its Voting Members and the Council appointed by the Voting Members. The Society accepts that income from investment and management fees are non-mutual receipts.

Relevant legislative provisions: Income Tax Assessment Act 199 7 section 6-5

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. 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. 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 principle of mutuality 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. Mutuality is a common law principle developed in the United Kingdom and first considered in connection with mutual insurance companies. The mutuality principle is summarised in by McTiernan J in Revesby Credit Union Co-operative Ltd v. FCT (1965) 112 CLR 564 ( Revesby Credit Union ) as follows: 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 and 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 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. Australian cases have shown that there are three main elements to the principle of mutuality: i. A number of people must contribute to a common fund for a common purpose. ii. The fund must be owned and controlled by the contributors. iii. The contributors to the fund must be entitled to participate in the surplus of the fund and all participants in the surplus must be contributors to the common fund. | Detailed Reasoning - Whether there is a common fund for a common purpose: The existence of a common fund is essential to the principle of mutuality. In New York Life Insurance Company v. Styles (1889) 14 App Cas 83 ( Styles ), Lord Herschel (at 209) referred to the following situation which illustrates the operation of a common fund: The members contribute for a common object to a fund which is their common property; it turns out that they have contributed more than is need, and therefore more than ought to have been contributed by them, for this object, and accordingly their next contribution is reduced by an amount equal to their proportion of excess. The decision FCT v Australian Music Traders Association 90 ATC 4536 ( Music Traders ) emphasised the importance of determining the purpose of the members making the payments in ascertaining whether those payments are to be characterised as contributions to a common fund. The exhibition fees paid by members participating in the trade fair were to secure individual exhibition space. The court held there was no common purpose, concluding at 4538-39 that the music fair in: …essence was that of trading for profit by individual traders, though through the medium of a common activity, the fair. Members of The Society make contributions to a common fund for the common purpose of assisting the members in relation to with legal, ethical and related problems. None of the objectives of The Society involve trade or profit; all objectives aim to achieve a common benefit in which all members participate. All income and property derived or held by The Society must be applied solely towards the objects of The Society. These factors indicate that there is a common fund for a common purpose. | Detailed Reasoning - Whether the fund is owned and controlled by the contributors: Ownership and control of the common fund by members is necessary for the principle of mutuality to apply. The Constitution provides that The Society is controlled by its Voting Members. The Society also has Associate Members. The Constitution allows any of The Societies property or income to be distributed among its members 'in any manner whatsoever'. Therefore only the Voting Members are able to control the common fund, and only the Voting Members have the rights to determine the distribution of the surplus. These factors show that while both Voting Members and Associate Members contribute to the fund, Associate Members do not exercise any control over the fund. As such a common fund, consisting of only the contributions of Voting Members, can be owned and controlled by the contributors being the Voting Members. | Detailed Reasoning - Whether there is identity between the contributors and the participants: Voting Members and Associate Members have essentially the same rights to participate in the benefits of membership except Associate Members do not have an entitlement to vote which, due to the construction of the dissolution clause, also impacts on their entitlement to distributions. Australian cases have shown that the principle of mutuality may be displaced where there is a difference of identity between those who contribute and those who can receive a distribution of surplus, or where the distribution of surplus is disproportionate to the amount contributed. This factor is described by Mason J in Sydney Water Board at 4135 as follows: Conformably with the original concept that the return of surplus funds is a refund to the contributors of their own money, it has been said that there must exist and 'identity' between the contributors and the participators. In Municipal Mutual Insurance Ltd v. Hills (1931) 16 TC 430 at 448, Lord Macmillan said there must be 'complete identity'. On other occasions it has been pointed out that the identity required is not identity between individuals but an identity between classes (see The Social Credit Savings and Loans Society Ltd v. FC of T at 4238). Again, with the same end in view… it has been said there must be 'a reasonable relationship' between what a member contributes and what he may be expected or entitled to receive from the fund ( Fletcher v Income Tax Commissioner ( supra)). The Constitution allows distribution among the Members in any manner whatsoever any property of The Society, any proceeds of sale resulting from disposal of any property of The Society, or any income of the society. The Constitution of The Society allows distributions to be made to all Members, but is dependant upon the determination by Voting Members as to how a distribution will be made. If all Members of The Society were able to determine the distribution to Members it would be assumed that a 'reasonable relationship' exists between a Member's contributions and their entitlements. In this case only the Voting Members are able to control the common fund and determine the amount of surplus returned to Voting Members and/or Associate Members. In the absence of a clause that specifies that a distribution to Members is based upon a relationship to the Member's contributions there is no 'identity' between Members as contributors and Members as participants for the purposes of mutuality. That is there is no assurance that there is 'a reasonable relationship' between the contributions made by all Members and the entitlement by all Members to receive distributions from the fund. However it is accepted that identity exists between Voting Members as contributors to a common fund, consisting of Voting Member's subscriptions, and Voting Members as participants to that fund. The contributions by Associate members do not form part of the common fund. | Detailed Reasoning - Conclusion: In summary the principle of mutuality does not apply to receipts from Associate Members because: - Associate Members have no control of their funds once they are contributed to The Society; and - there is no identity between Associate Members as contributors and as participants in any surplus. However we accept the receipts from Voting Members are mutual dealings since all the following elements of mutuality are present: - there is a common fund, consisting of contributions by Voting Members only, for a common purpose; - the common fund consisting of contributions from Voting Members is owned and controlled by Voting Members; and - there is identity between Voting Members as contributors and Voting Members as participants to the fund, including participation in any surplus.