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HMRC internal manual

Business Income Manual

Meaning of trade: mutual trading and members clubs: introduction: early attempt at taxing surplus

As explained in BIM24025, the underlying principles of mutual trading rest in case law. There was a legislative attempt to abolish mutual trading for tax purposes and for corporate taxpayers. S31 Finance Act 1933 (FA 1933) sought to impose a charge to tax on the profits of corporate mutual concerns. The legislation sought to charge surpluses arising from transactions with members as if the transactions were with non-members. Ayrshire Employers Mutual Insurance Association Ltd v CIR [1946] 27TC331 established that the legislation was defective. It is possible to carry on business with non-members on mutual terms so the distinction in the legislation between members and non-members was irrelevant. Please also see BIM24605.

Although the legislation in question is no more, the case retains its importance. The decision shows that it is not the fact of membership or non-membership that determines immunity from or liability to tax. It is the nature of the transactions themselves. If the transactions are in the nature of mutual trading (be it mutual insurance or some other trading activity) the resulting surplus is not taxable. The transactions can only amount to mutual trading if the contributors are entitled to a return of their share of the surplus contributions (see BIM24110).

The Association was a company limited by guarantee whose members were all colliery owners. The company insured its members against employers’ liabilities in case of injury. The company did no business with non-members. Each year, each member was entitled to a bonus of 50% of the excess of their contributions over expenditure. The bonus was credited to a reserve. In a winding up, any surplus of assets was to be distributed among members in proportion to their contributions.

The company was clearly carrying on a mutual trade and the Revenue invoked S31 FA 1933 in an attempt to tax the surplus. The courts found the provision to be ineffective. S31 assumed that surpluses on transactions between a body corporate and its members was not taxable. So S31 required that the surplus be treated as arising from transactions with non-members - the assumption being that such would give rise to taxable profits. The courts did not support this assumption.

In the Court of Session the Lord President, Normand, observed, at page 343 of 27TC, that on the facts it mattered not that the transactions were with members or with non-members and so the legislation did not impose a charge:

‘Section 31(1) of the Finance Act, 1933, shortly read, makes surpluses arising from the transactions of an incorporated company or society with its members taxable as if those transactions were transactions with non-members. But if the transactions in this case had been with non-members, the result would have been precisely the same as regards profits. Instead of members sharing losses, non-members would have been sharing losses, and no profit could have resulted. … the Sub-section does not seem to warrant a construction which involves a hypothetical modification of the actual transactions as well as the hypothetical substitution of non members for members as the parties to those transactions.

My conclusion is, therefore, that since those transactions could beget no profit, whether the parties to them were members of the Company or not, there is no hypothetical profit within the meaning of the Sub-section. My opinion is thus in agreement with the opinion delivered by Lord Fleming. But I have thought it right, at the risk of some repetition, to say so much, because I feel great difficulty in stating more positively the intention of the Sub-section, and in defining its ambit. It is not wholly satisfactory to me to say that this Company and others like it lie outside the ambit, while confessing my uncertainty about what companies or societies fall within it. For, take any kind of association of persons whose transactions inter se were outside the scope of Income Tax till 1933, because in the nature of things they could yield no taxable profit, how could a hypothetical profit spring into being from the mere supposition that the same transactions took place between non-members instead of between members of the association? Yet it appears to me that the underlying assumption of the enactment is that somehow the substitution of non-members for members would have just that miraculous result. I seem in the end to be driven to that last refuge of judicial hesitation when confronted with a difficulty of interpretation, the doctrine that no tax can be imposed on the subject without words in an Act of Parliament clearly showing an intention to lay a burden on him. It might be some consolation to reflect that that is a doctrine which might be allowed special force against the Crown’s contention that the Act entitled it to treat as profits sums which in reality are not profits at all and which a modification of the Company’s book-keeping for future years would entirely eliminate, were it not that, in Income Tax questions, complete equity is mere error unless it is based on a sound construction, however difficult to arrive at, of the statutory provisions.’

The House of Lords agreed that the legislation did not achieve its intended object.