Income Tax (Cth) - Credit union - Distribution of dividend to shareholders - Whether income - Principle of mutuality.

Sydney, 1964, August 12-14; 1965, January 22. 22:1:1965

APPEAL under the Income Tax and Social Services Contribution Assessment Act 1936-1958 (Cth).

MCTIERNAN J. delivered the following written judgment:-

The first issue in this case is whether the appellant is a "co-operative Contribution Assessment Act 1936-1958 (Cth), and, accordingly can claim by virtue of s. 120 (1) that a dividend of 606 pounds paid by the appellant in the year of income ending 30th June 1958 to its members is an allowable deduction. This question largely depends on whether the appellant company "is established for the purpose of carrying on any business having as its primary object or objects one or more of the following . . . (d) the rendering of services to its shareholders". The second issue is whether the principle of mutuality applies to deprive the dividend of the character of income. The Commissioner of Taxation refused to allow the dividend as an allowable deduction. The appellant requested the Commissioner to refer the assessment to the Board of Review which unanimously decided that the appellant was not a "co-operative company" within the terms of s. 117 and that the principle of mutuality did not apply and upheld the Commissioner's decision. The appellant then appealed to this Court. (at p568)

2. The facts are not in dispute. Two witnesses were called on the appellant's behalf, and their testimony was not seriously challenged by counsel for the respondent. No evidence in rebuttal was adduced. (at p568)

3. The appellant is a company incorporated in New South Wales and registered with the Registrar of Co-operative Societies as a Small Loans Society under the Co-operation Act, 1923-1954 (N.S.W.). For its rules it has adopted the Model Rules of a Small Loans Society prescribed by the Co-operation Act with some amendments. (at p569)

4. Clause 5 sets out the objects of the Society and is as follows:

"(1) (a) to assist its members to purchase furniture for a home;

(b) to assist its members to pay the expenses of removing

household furniture and effects;

(c) to assist its members to acquire tools, implements,

machinery, material or stock-in-trade for any business,

trade or industry;

(d) to assist its members to commence, acquire, or carry

on any business, trade or industry;

(e) to assist its members to pay a deposit in respect of any

purchase or lease of a home or place of business, trade

or industry;

(f) to assist its members to defray the cost of painting or

effecting any additions or repairs to their homes;

(g) to assist its members in paying off a second mortgage

on a home;

(h) to assist its members or their dependants in defraying

expenses incurred in connexion with any accident,

sickness, or death to or of a member or any of his

dependants;

(i) to assist its members to discharge any financial

(j) to make or arrange loans to its members for any such

purpose or for any purpose prescribed by regulation ;

(k) to guarantee loans made by any person to the members

of the society for any such purpose ;

(1) to supervise and report on the expenditure of loans

made to its members for any such purpose.

(2) A loan made for the purpose of enabling a member to

pay any debt or liability incurred for any purpose for

which a loan may be made, arranged, or guaranteed under

clause one of this rule shall be deemed to be within the

purposes therein mentioned."

These objects, rather than being the usual heterogenous collection found in the memoranda of trading companies, reveal a singular aim, namely that the society is to assist its members in the management of the great variety of financial difficulties which may arise in the ordinary man's life. It is to be noted that the objects are not confined to the lending of money to members but include assistance generally and supervision. (at p569)

5. Clause 6 gives the appellant society power to raise money on loan, to receive money on deposit, to acquire shares in any other society, to make advances to any other small loans society, and to purchase out of its reserve fund members' shares, so long as these things are incidental to its objects. (at p570)

6. Clause 7 provides that loans may be made or guaranteed only to members so long as the member is a member of the Catholic parish of Revesby. This is a geographical qualification as a member of a parish is defined by the rules of the Catholic Church as any person living within the borders of the parish whatever are his religious beliefs. The total amount owing by a member in respect of any loans made or guaranteed by the society shall not exceed 250 pounds. (at p570)

7. The Rules go on to provide a procedure for membership application. Application for membership shall be made in the prescribed form with a deposit of two shillings on each share applied for. Provision is also made for a formal procedure for the making of loan applications. (at p570)

8. The capital of the society is divided into 1 pound shares all ranking equally. Each member is to hold at least one share and no more than two thousand. No member may hold any number of shares exceeding one-fifth of the total number of shares issued by the appellant society. The shares can be obtained by payment of a deposit of two shillings on application and by payment of the balance in instalments. (at p570)

9. Clause 128 prohibits the quotation of shares for sale or purchase at any Stock Exchange or in any public manner whatever within the meaning of the income tax laws of the Commonwealth of Australia. (at p570)

10. A general meeting of members must be held annually. Its business is to confirm the minutes of the last annual meeting, to receive reports and financial statements from the appellant society's office bearers, to determine the rates of dividend on share capital and rebate of interest, and to elect auditors and directors. The executive affairs of the appellant society are in the hands of a board of five directors who must be members. The Board is empowered to manage and control the business of the operations of the appellant society and to exercise the powers of the society generally. (at p570)

11. Lastly it is necessary to mention cl. 111 which provides that the funds of the appellant society shall be applied to carrying out the objects of the appellant society. Any surplus resulting from operations after provision is made for depreciation and for contingent liability for loss shall be applied in payment of a dividend on shares and/or as a rebate of interest paid or due by borrowing members with the society. However, the maximum dividend on shares shall not exceed five per cent, or the amount recommended by the Board. (at p571)

12. The appellant society was founded in accordance with the principles and ideals of the Antigonish Movement which arose in Nova Scotia. This Catholic group considered that as the ordinary man no longer possessed property in any large measure he had lost economic power and with it the ability to defend himself against other groups in the community. The means formulated to remedy this situation were group education and community saving. Accordingly the more specific purposes of the founders of the appellant society were twofold. The first was to promote community discussion of the members' financial problems. This is done in the present case in informal gatherings called "cottage discussions" at which general problems would be talked out and in particular at which new or prospective members would have the aims, purposes and methods of the appellant society explained to them. Further to this the opportunity was to be given to members to take their financial troubles to a fellow member or a director for specific aid and advice. Here they would get a sympathetic hearing from people who were fellow members, who were interested in assisting them and who made a specialty of counselling in such cases. The second purpose is to provide a source of cheap credit through co-operative saving. Members would be able to obtain loans from the appellant society to help them when in need at lower rates of interest than were available elsewhere and often where no other source of credit was available. (at p571)

13. The evidence was that the appellant society began in a very small way. Funds were obtained from the purchase of shares by members, from interest-bearing deposits made by members, and from some loans from outsiders. Many of the members were unable to pay the full price for their shares in one lump sum but paid a deposit of two shillings a share and the balance by small instalments. Rev. Father Gallagher, a Catholic priest who founded the society and who was their first witness, regarded this as a very beneficial practice as it imposed the discipline of saving upon many people who had never saved before. (at p571)

14. The balance sheet for the year of income reveals a paid-up share capital of 17,971 pounds. There is no evidence as to the number of share-holders. Interest-bearing deposits with the appellant society total 3,985 pounds. All but 241 pounds was contributed by members. Often members left their dividends and rebates with the appellant society as an interest-bearing deposit. Aslo, if a loan was granted but was not to be used by the borrower immediately, it was put on deposit for him. Any deposit contributed by non-members was paid either by people who were relatives or friends of a borrowing member in order to secure the loan, or as a gesture of goodwill and support. However, the appellant society did not seek or actually raise any significant portion of its capital from non-members. Thus, together with a capital reserve of 1,000 pounds and some small sundry items, the total funds amounted to 27,942 pounds. These funds were dealt with in the following manner. The amount of 20,238 pounds was disbursed in loans to members: 3,576 pounds was invested in five associated co-operative companies inspired by the same principles and organized by the same group of people. These companies were shareholders in the appellant society. The sum of 3,000 pounds was laid out in debentures, the nature of which is not disclosed by the evidence. The balance of 1,128 pounds is accounted for by cash on hand, sundry debtors and furniture and fittings. Thus it is apparent that by far the greater part of the appellant society's capital is used for making loans to members. (at p572)

15. The financial business of the appellant society is conducted on the traditional Rochdale co-operative principles. Loans are made to members out of the funds and interest at rates comparable to current market interest rates is charged. At the end of the financial year the profit or loss is calculated by deducting running expenses, any necessary charges, and interest on deposits with the appellant society from the income received. Provision is made for taxation and reserves and the balance is distributed to members as a dividend on shares and as a rebate to borrowers in proportion to the amount borrowed. Thus in the year of income the effective rate of interest paid by borrowers was reduced from ten per cent to somewhere between four to six per cent by the payment of rebates. In the year of income, the income of the appellant society was 2,366 pounds . Of this figure the interest paid by members on loans yielded 1,908 pounds, investments provided 420 pounds and the balance of 38 pounds was made up by entrance fees, fines and commissions. Running expenses amounted to 1,153 pounds and 227 pounds was paid as interest on the interest-bearing deposits. Three hundred and nineteen pounds was credited to members who had borrowed from the appellant society as the rebate on the interest payable on the loans. This left a net profit of 667 pounds of which, after deductions for reserves and taxation, the 606 pounds in question was distributed to the members as a dividend. (at p572)

16. A description of the business of the appellant society is not complete without an account of its actual day-to-day activities. The evidence was to the effect that a person seeking assistance, whether he be a member or not, would approach the directors and put his problem to them. He would be interviewed by the directors or a number of them and the matter would be discussed. They would then confer, usually in the absence of the applicant, and work out possible solutions which may or may not involve the granting of a loan and suggest them to him. If he disagreed a fresh solution may be devised. If a loan was part of the solution the directors often suggested a figure either above or below that sought by the applicant. Occasionally loan applications were refused. (at p573)

17. Once it was settled that a loan was needed and a figure was reached, the procedure for the granting of loans would be set in motion. If the applicant was not a shareholder he would fill out a form of application for membership and pay a deposit of two shillings on each of the shares for which he sought to subscribe. Usually only one was applied for. Once he was accepted by the Board as a member, they having been satisfied that he resided within the parish, he would make an application for a loan on the usual form which would be formally considered and approved by the Board in meeting and recorded. It was suggested that in some cases loans were made before the applicant in question was admitted to membership but the evidence was not conclusive. Although the appellant society's records appeared to reveal this situation Mr. Cullen, a director, was certain that this was not the case. In any event it appears such an occurrence would be rare and due to a casual oversight rather than deliberate policy. It was also suggested in cross-examination to Mr. Cullen that advice was given to non-members in order to advertise the appellant society's business and thus attract new members, but he denied this and asserted that the society did not advertise in any way at all. (at p573)

18. Once the loan is granted the directors would cause a cheque for the amount to be given either to the applicant or to be dealt with according to his direction. The money would frequently be paid directly to the applicant's creditors. The directors would also, as the occasion required, hold the amount of the loan in an interest-bearing deposit for the applicant pending the receipt of an account or the accrual of a debt, cause the account to be sent directly to the society by the creditor and pay the account itself. (at p573)

19. Besides the actual lending of money, the advice and assistance given to the members was of a diverse and general nature, going far beyond the sort of advisory services which might be regarded as incidental to the conduct of a money-lending business, and not related at all to the supervision or collection of repayments or the assessment or enforcement of securities. Cases were presented in evidence as representative examples. The directors had advised a woman suffering from cancer to seek further medical opinions and to investigate the possibility of obtaining cheap specialized treatment at a public hospital. Members were advised to seek legal advice from Chamber Magistrates. On occassions representatives of the appellant society had appeared in court to speak on a member's behalf. A member who drank to excess would be advised to consult Alcoholics Anonymous. On one particular occasion when a member's wife had deserted him, the directors arranged for his children to be cared for and for school clothes to be selected and purchased for them on his behalf. A member would be advised as to the wisdom of a proposal he had in mind if making purchases or an important investment in respect of which he contemplated applying for a loan. Also the directors were prepared to, and did, instruct members who sought the benefit of their experience in the general management of their day-to-day financial affairs. Not every consultation led to the making of a loan. Evidence was given of a member who desired a loan to purchase land. He was told that he should be using his money to establish a home for his ageing mother. It was a practice of the appellant society to grant loans where a member was in urgent need of financial assistance. When a member urgently needed money to extricate himself from a difficult situation, his application would be given priority. (at p574)

20. Before considering the interpretation of s. 117 I will deal with the appellant's contention that by virtue of the principle of mutuality the dividend paid to the members is not income at all but is merely a repayment of part of their contributions made to a common fund for a common purpose. 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. (Bohemians Club v. Acting Federal Commissioner of Taxation [1918] HCA 16; (1918) 24 CLR 334 ). Incorporation of the fund is not relevant (New York Life Insurance Co. v. Styles (1889) 14 App Cas 381 ). 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 (Equitable Life Assurance Society of the United States v. Bishop (1900) 1 QB 177 ). Furthermore any contributions to the fund derived from sources other than the contributors' payments, such as interest from the investment of part of the fund, or income from a business activity conducted by the members, cannot be taken into account in computing the surplus (Carlisle and Silloth Golf Club v. Smith (1912) 2 KB 177 ). 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 (New York Life Insurance Co. v. Styles (1889) 14 App Cas 381 ). In the instant case it is clear that the principle cannot apply to deprive the dividend of the character of income. The dividend in question is the surplus of revenue over expenditure as set out above. The greater part of the revenue is drawn from two sources namely, interest on loans to members and interest on investments in associated credit societies. The contributors to the revenue are those members who have current loans and the societies in which money is invested. However the beneficiaries of the payment of the dividend are all the members. Thus it is immediately apparent that there must be a disparity between the contributors and beneficiaries at any given point in time. First of all members are current borrowers, and secondly some members are not entitled to obtain loans as they live outside the parish of Revesby and do not satisfy the geographical qualification that a member must satisfy before he can obtain a loan. Thus some members who are not contributors to the fund from which the surplus is drawn are beneficiaries and accordingly the dividend cannot be regarded as a repayment to the members of their own money which they had previously contributed, as many of them had not made a contribution to the revenue at all. It should be regarded as the proceeds of the society's business dealings with a number of its members and should be classed as income. (at p575)

21. I have next to determine whether the appellant society is a co-operative company within the meaning of s. 117. The question raised in the application of this section to the present case is whether the appellant society is "established for the purpose of carrying on a business having as its primary object or objects . . . (d) the rendering of services to its shareholders". This involves an inquiry to ascertain the primary object or objects of the carrying on of the business and then a consideration of whether the objects so ascertained fall within the description of par. (d) of s. 117. The method of ascertaining the primary objects of a business was discussed in the joint judgment of Dixon C.J., Williams and Webb JJ. in A. & S. Ruffy Pty. Ltd. v. Federal Commissioner of Taxation [1958] HCA 18; (1958) 98 CLR 637, at pp 648, 649 . Their Honours first noted that the section refers not to the objects of the company but to the objects of the business, and then that as the object clauses in the memoranda of association of most commercial institutions contain "the customary heterogeneity of objects" it is extremely difficult to form a judgment as to which objects are "primary" and which are not. Accordingly their Honours took the view that one should not look exclusively or even initially at the objects set out in the memorandum, and went on to examine the actual conduct and structure of the business to ascertain the "primary" object of the business. However in the present case the objects (quoted above) expressed in the Model Rules governing the constitution of the appellant society are not a collection of unrelated purposes of which none can be considered to be paramount. Taken as a whole they reveal the unified and single purpose to assist the members of the appellant society in solving the various economic problems which arise in the course of a man's life and in particular to achieve this end by lending money to the members and supervising the expenditure of the money lent. But in view of what was said by Dixon C.J., Williams and Webb JJ., I cannot let the matter end there. I consider that I can take this into account but if the conduct of the business by the appellant society reveals that the primary objects are other than that indicated by the object clause in the Model Rules I cannot give the Model Rules precedence. The main test to be adopted in ascertaining the primary object is to ask what the actual activities of the appellant society indicate it to be. The activities of the appellant society have been fully described above. Generally it engages firstly in the leading of money to its members with or without security at rates of interest, which, after the rebate is taken into account are lower than current market rates, and in many cases where credit on any terms would not be otherwise available ; secondly, in the giving of advice and guidance where sought to its members in respect of the circumstances surrounding the making of a particular loan and in respect to the management of their financial affairs generally ; thirdly in assisting members in certain cases by positive acts for example, appearing in court or paying an account ; and fourthly in organizing and promoting the education of members in financial affairs by the "cottage" discussions. The object of a business is, to my mind, what the business in fact does. In this case the appellant society does not merely lend money. Its activities are not directed to making profits for the members because its funds could be invested at rates of interest far higher than the rates paid by the borrowing members, and also because part of the profits are returned to the borrowers. The various activities are not isolated and unrelated to each other but taken as a whole form an integrated scheme for the assistance of members in overcoming their financial problems and in particular to achieve this end by providing a ready source of cheap credit together with incidental advice and assistance as each case may require. The facts that in making a loan, the appellant society puts little emphasis on valuing and obtaining adequate security and that it gives loans to persons who commercially would be regarded as bad risks rather than to those who could afford to repay the loan indicates that it is not conducting itself like a money-lending institution and that its object is not mere money lending. Thus I must differ from the Board of Review on the nature of the primary object of the appellant society in concluding that the actual primary objects of the business conducted by the appellant society are quite in accordance with those expressed in the Model Rules. (at p577)

22. The next question to be determined is whether the conduct of these activities which I have designated to be the primary object of the business of the appellant society amount to "the rendering of services" within s. 117 (d). These activities must be considered as a whole and not separately and accordingly the question is not whether the lending of money by itself or the giving of advice and assistance by itself is the rendering of services but whether the whole of the appellant society's activities taken together constitute "the rendering of services". The Shorter Oxford Dictionary defines "service" as "the act of helping or benefiting", and in the plural, "friendly or professional services". This is a broad definition. It would include all the things contemplated by the word "services" in the common phrase "goods and services". It would include any consideration given in the performance of any ordinary commercial contract, as well as all those activities more specifically called services, which do not actually involve the production or processing of goods, for instance, banking and financing, transportation, and insurance. In the case of Employers' Mutual Indemnity Association Ltd. v. Federal Commissioner of Taxation [1943] HCA 36; (1943) 68 CLR 165 the Full Court had to consider whether a mutual insurance company in issuing policies and in investigating and either resisting or paying on claims was engaged in "the rendering of services" to its policy holders. The Court with Rich J. and myself dissenting held that neither the issuing of insurance policies nor the investigation, resisting and paying of claims was "the rendering of services" to the policy holders. In the opinion of Latham C.J. "the rendering of services" must involve the doing of work of some kind. The mere making of a contract, such as the issuing of an insurance policy cannot be put into this category, even though work may be done in pursuance of the contract. Furthermore, the Chief Justice did not regard ordinary commercial dealing on terms acceptable to each party as the rendering of services. But he did not further define the phrase. I would have thought that the performance of work for the benefit of another if in pursuance of a contract would fall within the Chief Justice's general definition but this has been specifically excluded if it merely amounts to a performance of consideration already promised. Starke J. held that "the rendering of services" necessarily involved the "doing of a positive act" and his example was the shearing of sheep. The third majority opinion, that of Williams J., decided that the services which are to be rendered must be of the kind that could result from a contract of services and accordingly must involve a personal and confidential relationship so as to make them unenforceable specifically in Equity. The minority opinions of Rich J. and myself agreed that the word "services" refers to services of the same nature as those rendered by a business enterprise in satisfying the business needs of persons having recourse to it. It is immediately apparent that the majority judgments do not reveal a common opinion as to the nature of "the rendering of service". However in the light of the decision the broad meaning of the phrase cannot be adopted. But what restriction is to be placed on it ? I consider that "the rendering of services" should consist of the doing of an act for the benefit of another, which is more than the mere making of a contract and which goes beyond the performance of an obligation undertaken in the course of an ordinary commercial contract. In this view I adopt the reasoning of Latham C. J. I regard the activities of the appellant society as clearly falling within the description of "the rendering of services". They are more than the making of an agreement and involve positive acts, as the payment of money to the members, the giving of advice and the provision of facilities for consultation and the doing of the specific acts of assistance mentioned in the evidence. They are clearly the doing of work for the benefit of another and clearly go beyond the performance of the terms of an ordinary commercial agreement. When the appellant society agrees to lend money it only contracts to make a payment. It does not enter into an obligation to give the advice and assistance of which so much evidence was given and which are such an integral part of its activities. Furthermore, the facts that the appellant society is so much a co-operative organization rather than a commercial money-lender, that its effective rates of interest are lower than current market rates, and that it gives loans without regard to security and in many cases where commercial institutions would not venture to risk their money, in my view deprives the transactions of the appellant society of that commercial element which characterizes the activites of ordinary commercial and financial institutions. Even though a member who has obtained a loan is obliged to repay the capital and pay interest, the terms are such that by comparison with current market standards a benefit is being conferred upon him. (at p579)

23. For these reasons I hold that the appellant society is a co-operative company within the meaning of s. 117. Consequently the dividend of 606 pounds paid to the members is an allowable deduction under s. 120 (1) and the appeal should be allowed. (at p579)

Appeal allowed with costs. Assessment remitted to the Commissioner in order that it may be amended by excluding from the assessable income of the appellant the dividend mentioned in the objection.