Sydney Water Board Employees' Credit Union v Federal Commissioner of Taxation

[1973] HCA 47

HIGH COURT OF AUSTRALIA

. Barwick C.J., Menzies, Walsh, Stephen and Mason JJ.

SYDNEY WATER BOARD EMPLOYEES' CREDIT UNION v. FEDERAL COMMISSIONER OF TAXATION.

(1973) 129 CLR 446

17 October 1973

Income Tax (Cth)

Income Tax (Cth)—Income—Mutuality—Credit union—Interest received from principal moneys lent by union to members—Principal moneys borrowed mainly from members—Lack of identity between classes of lending and borrowing members—Annual surpluses of taxpayer returnable to borrowing members either at once or on winding up—Whether interest received by taxpayer assessable income—Income Tax Assessment Act 1936-1969 (Cth), s. 25.

Decisions

October 17.
The following written judgments were delivered:-
BARWICK C.J. In the reasons for judgment prepared by my brother Mason the facts of the case stated under s. 18 of the Judiciary Act 1906-1971 for the opinion of the Court so far as relevant to the resolution of the questions asked by the case are fully set out along with the material provisions in the rules of the taxpayer. (at p449)

2. The question is whether the amount of interest received by the taxpayer on loans made to its borrowing members constitutes income in the taxpayer's hands within the meaning of the Income Tax Assessment Act 1936-1968 (the Act). The reason offered by the taxpayer for a negative answer to that question is that the "mutuality principle" would in the circumstances of the taxpayer and its borrowing members deny the quality of income to such interest payments. The description "mutuality principle" is used, unfortunately as I think, to express the reason for the conclusion that the return to a taxpayer of a share of the surplus of a fund to which he has contributed in common with others after its use for a purpose agreed between them is not income. There is, in my opinion, no independent principle involved in reaching such a result and the description of mutuality is apt to be misleading. The creation of such a fund, its intended use and the repayment of a surplus or unused amount to the contributors will have their origin in agreements governing the amount of contribution, the purpose for which the fund may be employed, and the occasions for and the extent of any refunds. What mutuality there is, is to be found in those agreements and, in some instances, in the purpose for which the fund is to be used, i.e. for some common benefit. What distinguishes the amount refunded in such circumstances from profit or income is that the payment is made out of moneys which are in substance the moneys of the contributors. This, in the final analysis, is all that was decided by the House of Lords in New York Life Insurance Co. v. Styles (1889) 14 App Cas 381 . There the premiums paid were in substance pro forma; their ultimate amount was to depend on the experience of the assurance fund administered by the company. If the amount then paid exceeded the requirement of the fund, refunds were made to policy holders. Such refunds were thus no more than a return of the contributors' own money. (at p450)

3. I see no reason why such a conclusion should only be possible in connexion with mutual insurance or in the case of social and sporting clubs. The decided instances have been of this kind: but they do not set the parameters within which such a conclusion may be drawn. Further, I see no reason why in appropriate circumstances it may not be decided in relation to the provisions of a statute such as the Act that what has been received is in truth no more than a repayment of the taxpayer's own money. Statutes such as the Act may, as it does, for example in s. 121, set some limit to the occasions in which such a conclusion may be drawn. (at p450)

4. In the course of the extrapolation in later cases of the reasoning in New York Life Insurance Co. v. Styles (1889) 14 App Cas 381 , complete identity of the person contributing to the fund and the person receiving the refund therefrom has not been insisted upon when concluding that the repayment is not profit or income in the hands of the recipient. But there is no need for me in this case to explore the precise limits within which such a lack of identity may be acceptable. (at p451)

5. In my opinion, for these reasons and those given by my brother Mason, with which I fully agree, the payment of interest by the borrowing members of the taxpayer cannot be regarded in any sense as being a pro forma payment, the actual amount of the interest being determined by the experience of the taxpayer as the agent of the borrowing members in the provision and management of the money from which the lending was made. Further, the total of interest payments cannot be regarded as a fund to which contributions are made and which is to be used or managed for purposes agreed upon by the borrowing members. (at p451)

6. In my opinion, the amount of interest received by the taxpayer constituted income in its hands within the meaning of the Act. The questions in the case stated should be answered: 1. (a) - No. (b) - No. 2. (a) - No. (b) - No. (at p451)

MENZIES J. I have had the advantage of reading the judgment prepared by Mason J. and I agree with it. (at p451)

WALSH J. I agree with the judgment of Mason J. In my opinion the questions asked in the case stated should be answered in the manner proposed by him. (at p451)

STEPHEN J. I agree with the judgment of Mason J. and would answer the questions asked in the case stated in the sense proposed by him. (at p451)

MASON J. In these appeals by the taxpayer against income tax assessments for the years ended 30th June 1968 and 30th June 1969 I stated a case pursuant to s. 18 of the Judiciary Act 1906-1971. The first question asked is:

"On the facts referred to in this Case, am I (a) entitled to, or (b) bound to hold in light of the constitution and nature of the appellant and of the relationship which the persons who contributed the sums comprising the amount of $177,050 hereinafter referred to bear to the appellant, that the said amount of $177,050 being the amount of interest paid to the appellant by its members during the year ended 30th June 1968 was not assessable income of the appellant under the provisions of the Income Tax Assessment Act 1936-1968." (at p451)

2. The second question is in similar terms: it differs only in that it relates to the year ended 30th June 1969 in which a sum of $248,789 was paid by way of interest to the taxpayer by its members. (at p452)

3. The taxpayer was incorporated under the Co-operation Act, 1923 (N.S.W.). It is, as its name suggests, a credit union which borrows money from its members and lends money to them. It is this circumstance which gives rise to the questions asked, for it is the taxpayer's contention that according to the so-called "mutuality principle" the interest paid to the taxpayer by members on moneys borrowed from it does not form part of its assessable income. To examine this contention as it relates to the second question, it is necessary to refer to the rules of the taxpayer in the year ended 30th June 1969. If the second question is answered adversely to the taxpayer, it is conceded that the rules, as they applied in the first year, are such that a similar answer must also be given to the first question. (at p452)

4. The taxpayer's members are holders of shares in the taxpayer. Its objects are:

"To raise a fund by subscription of members and as otherwise authorized by the Act, and to make loans therefrom to members in accordance with these rules." (at p452)

5. Its capital consists of money subscribed by members for shares. It is empowered to borrow and to receive money on deposit from members, subject to ss. 65 and 66 of the Act. (at p452)

6. Loans can be made only to members, but not all members are eligible to receive loans. Only those members who are employees of the Metropolitan Water, Sewerage and Drainage Board or of four employees' co-operatives or associations connected with the Board are so eligible. The husband or wife of such an employee is eligible for membership but is not eligible as a borrower. (at p452)

7. Under r. 67 any surplus resulting from the taxpayer's operations during a financial year shall be applied, first, in payment of at least five per centum per annum to a reserve fund (which shall not be distributed to members except in the event of the winding up of the taxpayer and in that event only to members to whom loans have been made); secondly, in payment to members as a rebate of interest paid or due by borrowing members, "such rebate being based on the business done by such members" with the taxpayer. (at p452)

8. The entitlement of members on a winding-up is regulated by r. 75, which provides:

"On winding-up, members shall not, in respect of any shares held by them, be entitled to receive any amount in excess of the amount paid thereon. Any surplus shall be distributable only to members to whom loans have been made."

The meaning of the expression in rr. 67 and 75, "only to members to whom loans have been made", is not clear, although it seems to refer to members who at any time have borrowed money from the taxpayer. Likewise, there is some doubt as to the persons entitled to the rebate and as to the basis on which they are entitled to receive it. (at p453)

9. Some indication of the relationship between the taxpayer's borrowing from, and its lending to, members in the year ended 30th June 1969 is given by the following material recited in the stated case:

"(i) Total amount on loan to members $2,543,429 (ii) Total number of members who had money on loan from taxpayer 2,685 (iii) Total amount of members savings or deposit $2,479,223 (iv) Number of members who had money on deposit 4,758 (v) Number of members included in (iv) above who made deposits during the year 4,732"

There were 53 members who had money on loan from the taxpayer but had no money on deposit with it. There were 2,126 members who had money on deposit with the taxpayer but did not have money on loan from it. Interest was charged on loans made to members at the rate of 10.87 per centum per annum reducible, and interest was paid on members' deposits at the effective rate of six per centum per annum. (at p453)

10. As at 30th June 1969 the taxpayer's funds were:

"Members paid up share capital $49,341.44 Fixed Deposits $41,638.00 Loan from New South Wales Credit Union League Ltd. $75,897.75 Building Mortgage $209,761.00 $376,638.19"

The taxpayer had income-earning investments in outside bodies totalling $122,810 on which it received $9,771 interest. It also received $10,149 rent. Both amounts were included in its assessable income. (at p453)

11. In the year ended 30th June 1968 the taxpayer had declared an amount of $8,549 as a rebate of interest on members' loans. No such rebate was declared in the following year. (at p454)

12. In its return of income for the year ended 30th June 1968 the taxpayer omitted the sum of $177,050 and declared a taxable income of $1,948. In the next year it omitted the sum of $248,789 and declared a taxable income of $2,374. The Commissioner assessed the taxpayer in each year upon a sum representing the excess of total receipts over total expenditure. In the result he included the sum of $177,050 in the first year and $248,789 in the second year. It is to the inclusion of these amounts in the taxpayer's assessable income that objection has been taken. (at p454)

13. The taxpayer acknowledges that in ordinary circumstances interest received by a money-lender forms part of his assessable income but its case here is that, according to the mutuality principle, when a group of persons subscribe to a common fund for a common purpose a return to the contributors of surplus contributions, that is, money in excess of what is required for the common purpose, does not constitute assessable income in their hands. In this case it is said that the relevant common fund is not the sum of moneys lent by members, but rather the sum of interest paid by borrowing members on the loans made to them by the taxpayer, and that this interest is paid for the common purpose of enabling the taxpayer to meet its administrative expenses and outgoings, including interest on moneys deposited by members. The interest is paid, so the argument runs, on the footing that so much of it as is not required to meet the expenses and outgoings of the taxpayer will be refunded to the borrowing members by way of rebate on interest or by means of a distribution of the reserve fund. The case so made is that which was put on behalf of the appellant in Social Credit Savings and Loans Society Ltd. v. Commissioner of Taxation (1971) 125 CLR 560 , but it has the advantage that by amendments to rr. 67 and 75 the taxpayer has sought to overcome the deficiencies which led Gibbs J. to hold that the principle had no application because there was no identity between the contributors and the participators in the surplus. (at p454)

14. The Commissioner makes three answers to this case. He submits, first, that there is no place for the mutuality principle in the Income Tax Assessment Act - the question is whether the moneys are income within s. 25, that is, whether they are income within the ordinary concept and usage of that expression; secondly, that the mutuality principle is confined to the field of insurance and does not extend beyond it; and thirdly, that in any event the case does not fall within the mutuality principle. (at p455)

15. New York Life Insurance Co. v. Styles (1889) 14 App Cas 381 established the principle on which the taxpayer relies. There the sole 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 members paid premiums which were fixed in the light of a calculation made of the probable death rate among members, and of probable expenses and liabilities. The greater part of the surplus of premiums over expenditure was returned annually to the policy holders as bonuses or by way of reduction of future premiums. The balance of the surplus was carried forward and held for the benefit of the general body of members. It was held that no part of the surplus was "gains or profits" within the meaning of Sch. D in the Income Tax Act of 1853. (at p455)

16. The ratio of the decision was expressed in the following passage taken from the speech of Lord Watson (1889) 14 App Cas, at p 394 :

"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."

To the same effect were the observations of Lord Herschell (1889) 14 App Cas, at pp 409-410 , and Lord Macnaghten said (1889) 14 App Cas, at p 412 :

"I do not understand how persons contributing to a common fund in pursuance of a scheme for their mutual benefit - having no dealings or relations with any outside body - can be said to have made a profit when they find that they have overcharged themselves, and that some portion of their contributions may be safely refunded." (at p455)

17. These observations make it plain that the decision turned not on any special concept of the expression "gains or profits" in the Income Tax Act of 1853, but on the view that, in the circumstances in which the premiums came to be paid, the return to contributors of the surplus was not "gains or profits" in the natural and ordinary meaning of those words, for in truth there was a refund to the contributors of part of their own moneys which they had overpaid. See also Colonial Mutual Life Assurance Society Ltd. v. Federal Commissioner of Taxation (1946) 73 CLR 604, at pp 618, 619 . (at p456)

18. It is evident from the terms in which the principle was expressed that it extends beyond the field of insurance, although it is most frequently applied in cases of mutual insurance. It is equally apparent that, just as the receipt of the surplus contributions was not in the circumstances "gains or profits" in the ordinary sense of that expression, so also it does not constitute in the hands of the recipients "income" in the natural and ordinary sense of that word. (at p456)

19. In this respect the decision and the judgment of Griffith C.J. in Bohemians Club v. Acting Federal Commissioner of Taxation (1918) 24 CLR 334 are illuminating. It was decided that the receipt by a social club of annual subscriptions from its members was not income of the club. In reaching that conclusion Griffith C.J. pointed out that the subscriptions were advances of capital for a common purpose which were expected to be exhausted, and went on to say: "If anything is left unexpended it is not income or profits, but savings, which the members may claim to have returned to them" (1918) 24 CLR, at p 337 . His Honour went on to say (1918) 24 CLR, at p 338 that Styles' Case (1889) 14 App Cas 381 was indistinguishable. This was because in each case there was identity between those who paid and those who received the contributions in question. (at p456)

20. More recently, in Social Credit Savings and Loans Society Ltd. v. Federal Commissioner of Taxation (1971) 125 CLR, at p 571 Gibbs J. rejected the argument that the principle has no application under the Income Tax Assessment Act. After referring to the Bohemians Club Case (1918) 24 CLR 334 and to Revesby Credit Union Co-operative Ltd. v. Commissioner of Taxation (1965) 112 CLR 564, at p 574 , his Honour said (1971) 125 CLR, at p 571 :

"A return to contributors, or a saving for them, of the surplus of their contributions to a common fund is no more income than it is a profit. The mutuality principle has been rendered inapplicable to certain cases by the specific provisions of the Act, but where not excluded it will in appropriate circumstances lead to the conclusion that the surplus arising from a transaction within the principle cannot be treated as income." (at p456)

21. The submission made on behalf of the Commissioner that the mutuality principle has no application to the concept of income under the Income Tax Assessment Act is therefore inconsistent with expressions of that principle and with authority. The principle has been displaced by specific provisions in the Act, viz. Pt III, Div. 8 and Div. 9, but in other fields, where it has not been excluded by statutory provision, it still applies. Likewise, the submission that the principle is confined to cases of insurance is opposed to authority and must be rejected (see Fletcher v. Income Tax Commissioner (1972) AC 414, at pp 421-422 ). (at p457)

22. There are several established applications of the principle from which the taxpayer seeks to obtain some additional support. First, the circumstances that the contributors are shareholders in a company which has been incorporated as a convenient agent for them and that their contributions are paid to a fund in the hands of the company, are not enough in themselves to invest any refunds with the character of income. Secondly, the Court will determine for itself whether the contributions have the character of income notwithstanding that they have been described in the taxpayer's documents as having that character. Thirdly, the principle may be invoked by an association which engages in business activities with outsiders, in addition to the transactions which it has with its members, to the extent that it is possible to sever from the business activities the fund which consists of receipts from mutual dealings. (at p457)

23. However, these propositions do not in any way detract from the formulation in Styles' Case (1889) 14 App Cas 381 of the conditions according to which the principle will come to the aid of a taxpayer. In later cases different language has at times been employed in giving emphasis to particular aspects of the principle in its application to new circumstances. 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 an "identity" between the contributors and the participators. In Municipal Mutual Insurance Ltd. v. Hills (H.M. Inspector of Taxes) (1931) 16 TC 430, at p 448 , Lord Macmillan said there must be a "complete identity". On other occasions it has been pointed out that the identity required is not an identity between individuals but an identity between classes (see Social Credit Savings and Loans Society Ltd. v. Federal Commissioner of Taxation (1971) 125 CLR, at p 576 ). Again, with the same end in view, 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 (Fletcher v. Income Tax Commissioner (1972) AC 414 ). (at p458)

24. Once attention is given to the relationship which exists between the taxpayer and its borrowing members (who, according to the argument, comprise the relevant class of contributors), and the nature of the transactions in which they engage, it is apparent that the mutuality principle has no application here. The taxpayer lends money to members under individual contracts of loan by which the borrowers are bound to pay the stipulated interest to the taxpayer for its benefit. Again, it borrows money from its members under individual contracts of loan by which it is bound to pay interest to them. (at p458)

25. The so-called "contributors", the borrowing members, are, as the facts show, a proportion only of the total class of members. The taxpayer was not incorporated as a convenient agent for them, as distinct from the entire class of members. The suggestion that the amount of interest paid in a particular year is the common fund is artificial for neither the taxpayer's rules, nor its accounts, nor its mode of conducting business lends any support to the suggestion or to the notion that it is a fund in which the borrowing members as a class have any rights. Indeed, the suggestion is at odds with the concept which underlies the objects of the credit union, that is, that a fund will be created from loans by members having money to lend at interest and that the fund will be lent at interest to members desiring loans. (at p458)

26. In other important respects the circumstances do not come within the mutuality principle. Interest is paid by borrowers in discharge of a legal obligation to pay it; when paid it forms part of the general funds of the taxpayer to be dealt with as it thinks fit; payment by a borrower is not in any sense a pre-estimate of the amount which will be required to meet his proportion of mutual liabilities incurred on behalf of all borrowers; nor is interest paid on the footing that there will be a refund to the borrower of any part of the payment which is not required to meet mutual liabilities. (at p458)

27. To overcome these criticisms the taxpayer relies on rr. 67 and 75. These provisions do not, however, demonstrate that the borrowing members have any right to a refund of part of the interest which they have paid; on the contrary, they make it clear that the interest so paid forms part of the funds of the taxpayer and that the borrowing members are entitled to participate in a distribution of the surplus which results from the taxpayer's use of its general funds. The taxpayer attempts to discount the language of rr. 67 and 75 by pointing to Styles' Case (1889) 14 App Cas 381 where the House of Lords went behind the description of "profits" contained in the appellant's documents. There the facts independently demonstrated that the moneys in question were not profits. Here, as I have shown, the facts are otherwise and the taxpayer seeks to give the rules an operation which is inconsistent, not only with their terms, but also with the facts. (at p459)

28. The argument presented does not deny that interest paid may find its way into the hands of another class, the depositing members, by way of interest due to them by the taxpayer. It is then given the character of an outgoing. An outgoing of the taxpayer it certainly is, but it cannot with accuracy be described as an outgoing in respect of a mutual liability of the borrowing members. Likewise, the argument seeks to avoid the conclusion that there is not an identity between the class of contributors and the class of participators. It may be doubted whether the uncertain language of rr. 67 and 75 to which I have already referred avoids this conclusion, but it is unnecessary to explore this problem for other reasons have emerged for answering the questions asked adversely to the taxpayer. (at p459)

29. For the reasons already expressed it is my view that the interest paid by borrowing members is income in the hands of the taxpayer; what the borrowing member receives by way of rebate of interest or distribution of surplus is not a return to him of his own moneys. I am unable to distinguish the case in any material respect from English and Scottish Joint Co-operative Wholesale Society Ltd. v. Commissioner of Agricultural Income-Tax, Assam (1948) AC 405 . (at p459)

30. In the result I am of opinion that the questions asked in the stated case should be answered as follows:
1. (a) - No. (b) - No. 2. (a) - No. (b) - No. (at p459)

Orders

Questions in the case stated answered as follows:
1. a No.

b No.

2. a No. b No.

Appellant to pay respondent's costs of the case stated.