Mutuality Principle

Is income from the sale of clothing to club members assessable income of the taxpayer under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

No. The principle of mutuality would apply to the sale of clothing by the taxpayer, a club, and section 6-5 of the ITAA 1997 would not apply.

The taxpayer an incorporated club, arranges for clothing to be made to their own design once or twice a year. The clothing is sold to the members at or near cost.

Sales are put into the taxpayer's general funds which are used to pay operating costs.

The taxpayer is prohibited from distributing any surplus to members.

The principle of mutuality is based on the proposition that a taxpayer cannot derive income from itself. In the case of corporate entities, the principle recognises that contributions by proprietors are not in the nature of income because 'income consists of moneys derived from sources outside' of the taxpayer ( The Bohemians Club v. Acting Federal Commissioner of Taxation (1918) 24 CLR 334 at 337).

There are exceptions to this principle where receipts from members may constitute income for the purpose of the ITAA 1997, section 6-5. The principle will not apply to activities that are considered to be in the nature of trade. Nor will it apply where there is a distinct disparity between the identity of the contributors and the recipients of any surplus.

The first question that must be considered is: '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?' ( Fletcher v. ITC (1971) 3 All ER 1185). The taxpayer's activities do not suggest a trade. The production of clothing is infrequent and is sold at cost or near cost to members. Any surplus that may arise is prohibited from being distributed to members and becomes general funds of the taxpayer.

There must also be complete identity between the people who are contributing and the people who are entitled to participate in the surplus. Each class must be identical (Taxation Ruling IT 2505 para.14). Although not all members choose to purchase clothing from the taxpayer, this is not crucial to the mutuality principle ( Royal Automobile Club Victoria v. FC of T (1973) 4 ATR 567; 73 ATC 4153). Any surplus becomes part of the taxpayer's general funds and thus the recipients are all the members of the taxpayer. Consequently, a reasonable relationship exists between the contributors and the participants in any surplus.

The mutuality principle will apply to the sale of clothing to members and consequently any such receipts will not form part of the assessable income of the taxpayer.