Application of Mutuality Principle in Taxation | Audit and Accounting Firm in Kenya
Application of Mutuality Principle in Taxation in SACCOs

The Mutuality Principle

The mutuality principle is a legal standard established by case law. It is based on the proposition that an organization cannot derive income from itself. The principle provides that, where several persons contribute to a common fund created and controlled by them for a common purpose, any surplus arising from the use of that fund for the common purpose is not income. The principle does not extend to include income that is derived from sources outside that group.

Organizations that can access mutuality

The characteristics of organizations that can access mutuality typically include:

  • The organization is carried on for a collective benefit of its members not individually
  • The members of the organization share a common purpose in which they all participate.
  • The members contribute to a common fund that gives effect to the common purpose
  • All the contributions to the common fund are applied for the collective benefit.
  • The members have ownership and control of the common fund.
  • The contributors to the common fund are entitled to participate in any surplus of the common fund.

Mutual Dealings

  As a result of the mutuality principle,

  1. Receipts from mutual dealings with members are not taxable since they are mutual receipts.
  2. The expenses incurred in the production of mutual receipts are non-deductible.

      Not all dealings involving members are mutual dealings.

It is important to note that, mutuality principle does not apply to dealings that go beyond mutual arrangement and are characteristic of a trade.

 In tax law, the terms ‘business’ and ‘ trade’ refers to commercial activities  intended to produce a profit. These activities are taxable

Nature of trade

The definition of ‘business’ under tax law includes ‘a trade’. The terms ‘business’ and ‘trade’ are commonly used to refer to commercial activities intended to produce a profit. These activities are usually for a taxable purpose.

A mutual organization may be carrying on a business (or trade) if various indicators are present.

A mutual organization’s business can either be for a taxable purpose (producing assessable income) or non-taxable purpose (producing mutual receipts), or a combination of both.

If a mutual organization is carrying on a business, it may, in certain circumstances, be eligible for concessions available to small business entities (for example, capital gains tax concessions and immediate deductions for prepaid expenses).

Dealings with members

In a mutual arrangement, there must be complete identity between contributors and participants as a class, not individually, in the surplus of common funds. The members collectively contribute and collectively benefit from the common fund.

Where an organization transacts with members collectively to produce a surplus of common funds, the activity is for a non-taxable purpose and is a mutual arrangement.

Mutuality ceases to apply when a member individually ‘contributes’ to secure a right over the use of a collectively owned asset where that right is not available to members as a class and the member benefits from the use of that asset for their own purposes. This breaks the complete identity between contributors and participants as a class in the common fund.

Where the organization transacts with a member in this way, the activity is in the nature of trade and is for a taxable purpose.

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