BIM24605 - Mutual trading & members clubs: distributions: ICTA88/S491: taxable on first principles or statute

The situation where you may be able to tax a distribution on first principles is discussed briefly at BIM24555.

Traders who are members of a mutual entity may make payments to that entity. These payments are allowable if they are not capital (BIM35000) and are incurred wholly and exclusively for the purposes of the trade (ICTA88/S74, BIM42100).

Any payments received by a trader from the entity are treated, on first principles, as a receipt of the recipients trade to the extent that they constitute a return of contributions made.

The following distributions out of the mutual surplus from a mutual business are taxable as trading income without recourse to legislation:

From a corporate mutual concern (other than in a dissolution or winding up), or

From a non-corporate concern in all circumstances.

Anything that is not a return of contributions must have arisen from the mutual entity’s non-mutual operations and should therefore have been taxed in the mutual’s hands. Hence ICTA88/S490 applies the distributions legislation to such sums.

The decision in Brogan v Stafford Coal & Iron Co Ltd [1963] 41TC305 allowed distributions made on the winding up of a mutual concern (or a body which had previously been involved in a mutual trading business) to be treated as capital distributions (and, therefore, subject to TCGA92/S122).

This was reversed in, what is now, ICTA88/S491 which acts to bring into charge to Corporation Tax or Income Tax any sums received from a body corporate carrying on a business that is, or is in part, a mutual trade. Such a distribution is treated as a post cessation receipt of the trade.

The legislation is structured to ensure that the charge cannot be avoided by:

• arranging for assets to be distributed as part of a wider scheme of reconstruction or amalgamation, or
• transferring the right to receive a distribution, or
• disposing of the right, other than at arm’s length, at undervalue.

The legislation only applies if a deduction has previously been allowed for a contribution to the body corporate. This is a simple qualitative test. The charge is not linked to the extent of any previous claimed deduction.

There is an exclusion from charge for ‘assets representing capital’. The definition of capital includes such matters as loans and subscribed capital. It also extends to assets that represent profits of the body that have been taxed.

Under ICTA88/S491 trade does not include any trade where all the profits have been chargeable to tax (ie non-mutual trade) or to a trade carried on by an IPS.

So ICTA88/S491 does not tax distributions that:

• represent the return of capital, or
• are made out of profits which have been chargeable to tax.