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HMRC internal manual

Business Income Manual

HM Revenue & Customs
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Meaning of trade: mutual trading and members clubs: introduction: origins of the concept

There is no statutory definition of mutual trading, although the term does appear in the Taxes Acts, for example in S1070 Corporation Tax Act 2010 (see BIM24550) and S101 Corporation Tax Act 2009 (see BIM24600).

Our understanding of the concept of mutual trading derives from case law. The majority of the cases predate such legislation as exists. In the earliest cases the doctrine that has become mutual trading was not fully established. The concept developed through a series of cases. The case law can be confusing and some of the decisions are difficult to reconcile with others. In later cases judges ‘clarified’ remarks made by their predecessors. Blinkered application of quotations from particular judgments can lead to the incorrect conclusion. The body of case law should be seen in the context of a process leading (not always sure-footedly) to the current state of affairs.

The case of Municipal Mutual Insurance Ltd v Hills [1932] 16TC430 concerned a company limited by guarantee that was set up to enable local authorities to insure against fire and other risks, mainly employers’ liability. Over the years the company extended coverage to all forms of insurance except marine and life. By 1922 half of the business was fire insurance and half ‘other’. Separate funds were maintained for fire and ‘other’ business. The company claimed not to distinguish between members of the company and policyholders. But the surpluses on both fire and ‘other’ business were applied as a reduction of the fire premiums. No such reduction was made in respect of ‘other’ premiums. The Revenue conceded that the surplus from fire business arose from mutual trading. The company conceded that profits from business done with persons who were neither members of the company nor holders of fire policies were taxable. The point at issue was the taxability of the profits arising from the employers’ liability business.

Rowlatt J, as mentioned in BIM24015, gave the classic definition of ‘mutual trading’ at page 438 as the relationship existing where:

‘…a certain class of people are associating together to put up money to achieve an object for each other, and divide what is not wanted among themselves in that character, namely, in the character of the persons who put it up.’

Rowlatt J went on to explain that as there was no return of surpluses to the contributors in their capacity as contributors, there was no mutual trading. Viscount Dunedin in the House of Lords said that the matter depended on to whom the profits went:

  • if they go to the insurer (trader), there is a profit; but
  • if they go to the insured (contributor), there is not (and it does not matter whether they go in cash, or as an increase in the sum assured or as a reduction of premiums).

Lord McMillan explained at page 448:

‘The cardinal requirement is that all the contributors to the common fund must be entitled to participate in the surplus and that all the participators in the surplus must be contributors to the common fund; in other words, there must be complete identity between the contributors and the participators. If this requirement is satisfied, the particular form which the association takes is immaterial.’

There was no such identity in Municipal Mutual Insurance Ltd so the surpluses on the ‘other’ business were taxable.

As explained in BIM24015, a mutual association may carry on a mutual trade. But it is important to recognise at the outset that not all mutual associations carry on a trade. As ever you will need to establish the underlying facts.

An example is a group who, for a social occasion, establishes a ‘kitty’. Each member contributes a sum to the kitty. After the event any surplus is returned to the contributors; perhaps in accordance with their contribution and/or the extent to which they have derived benefit from the communal purse. The reason why the surplus is not taxable is not because of mutual trading but because it does not arise from trading at all.

If the entity does not carry on a trade then there is no source of trading income and so nothing to tax. The issue is discussed in greater detail at BIM24045.

You should also recognise that an entity carrying on a mutual trade with its members (and which will not be liable to tax on the trade profits) may also carry on a trade with non-members. The trade with non-members is not covered by the exemption for mutual trading. Any profits are taxable as trade profits. The issues are discussed in greater detail at BIM24480 onwards.