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HMRC internal manual

Business Income Manual

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HM Revenue & Customs
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Meaning of trade: mutual trading and members clubs: incorporation: a company trading only with its members may be non-mutual

To satisfy the conditions for carrying on a mutual trade the trader must show that any surplus arising from the trade will go back to the contributors and to no one else - see BIM24110. The surplus must go back in the form of returned contributions and not in any other form. This can pose difficulties for a company limited by shares. Rowlatt J. commented on this difficulty, at pages 822-823 in Jones v The South-West Lancashire Coal Owners’ Association Ltd [1927] 11TC790 (see BIM24110):

‘The principle laid down in the New York Insurance Company [see BIM24035] case is that no one can make a profit out of himself. Now that is very true, but I am not at all certain that it does not confuse us in this particular case. It is true to say a person cannot make a profit out of himself, if what is meant is that he may provide himself with something at a lesser cost than that at which he could buy it, or if he does something for himself instead of employing somebody to do it. He saves money in those circumstances, but he does not make a profit. But a company can make a profit out of its members as customers, although its range of customers is limited to its shareholders. If a railway company makes a profit by carrying its shareholders, or if a trading company, by trading with its shareholders - even if it is limited to trading with them - makes a profit, that profit belongs to the shareholders, in a sense, but it belongs to them qua shareholders. It does not come back to them as purchasers or customers. It comes back to them as shareholders, upon their shares.’

You should not interpret Rowlatt J’s remarks as always precluding a company limited by shares from carrying on a mutual trade. Rowlatt J makes the point that it makes no difference that a mutual association takes the form of an incorporated body. This is because what was returned to the members of the association was returned to them in their capacity as contributors to a surplus and not as shareholders sharing in a profit. If there is no profit where people do something for themselves, there will be no profit if they incorporate a legal entity to do it for them.

Incorporation can present a significant hurdle to be overcome when considering the constitutional and financial framework necessary for mutuality. That is, for mutual trading to be present, the profits/surpluses have to be distributed to the contributors in that capacity, i.e. as contributors, not as shareholders. To achieve mutual trading a company limited by shares may need to override Company’s Act provisions.

The normal Company’s Act rules provide that in the event of a winding up any surplus available to distribute to members will be distributed pro rata to shareholding. The normal rules also provide that any such distribution will only be to the members on the register at that time. To satisfy the conditions for mutual trading the company’s rules/articles will need to specify that:

  • on a winding up any surplus available for distribution will be returned to contributors in a reasonable proportion to their contribution to that surplus (to satisfy BIM24115); and
  • that any distribution will also need to include contributors who have left in the last five years (also to satisfy BIM24115).

From a practical point of view you may limit consideration to those who have been shareholders at any time in the previous five years - see BIM24115.