This is not a definitive guide to Mutual Trading Status but is intended to be an introduction.
Considerations regarding Mutual Trading Status:
HMRC website has a section on Mutual Trading Status in its Business Income Manual 24000 and in the subsections.
The HMRC rules are strict on ensuring that there is no way for money to come out to anything but members: i.e. the profit distribution clause states profits can only be distributed to members or put into reserves and the dissolution clause states that on dissolution reserves can only be given to members. Your governing document (the "Rules") must include the necessary wording.
You can apply to your local tax office for Mutual Trading Status. CAN has been successful with helping co-operative consortia achieve MTS. However, in general you will not get a definitive answer from HMRC and it is important to ensure that you are operating systems correctly and that the legal structure set out in your governing document (the “Rules”) is compliant. You can download a template letter that you may wish to use. Even if HMRC do not give a useful response, having this letter on their file may be useful in case they follow the matter up in years to come.
A co-operative has 17 members, each paying £50 per week as a member subscription. The subscriptions are used to provide central services to members of the co-operative. At the end of the year, any surplus is distributed as profit share. Profits are distributed in proportion to member subscriptions paid during the year (i.e. in proportion to trade with the co-operative). If costs for the next year are projected (e.g. advertising or equipment purchase), then some of the profits are held back in reserves and not paid out as a member dividend at year end. In future years, it is envisaged that more profits will be retained by the co-operative and not be paid to members as a member dividend at year end. Any money paid to the co-operative by clients for members passes straight through the co-operative, with the full amount received being paid to the member.
So, there are two streams of money to the co-operative:
1. Member subscriptions
2. Money received from clients paid in totality through the co-operative to members.
The subscriptions are used to pay for the running of the co-operative. Any surplus is either paid to members or held in reserves as a member dividend. No surplus is made from income stream 2.
Money that is paid to members as a member dividend is taxable – the simplest way is to pay the member and they declare it as income or net it off against their "Subscription to the co-operative" expense. Either is allowable and it is up to you how you regard it; we recommend you net it off as a reduction of the cost of the co-operative subscription.
Any reserves from profits due to income stream 1 left in the business after payment of the member dividends is not subject to corporation tax. This is due to Mutual Trading Status. The profits are members' money held in the business.
Whilst profit is held by the co-operative for members it is not taxable but when any profit that is paid out to members (as a member dividend) it is taxable. Effectively the taxation on profits held in the co-operative is deferred until it ends up with the members. Service co-operatives can end up with large profit reserves; they can use these profit reserves to buy property etc., all from untaxed members' money.
There would be a third income stream if the co-op has an external contract. If the co-operative were to receive a chunk of money to carry out a particular project, were to pay its members from that money, pay other suppliers and pay something towards the overheads of the co-operative, then the surplus from the project would be taxable. This is because the money held would not be members' money held on behalf of members. If the money were all paid to members and then they paid a proportion of it back that would be a different matter but that is not necessarily practical.
You need to distinguish between different types of cash income from members so that you know if it is an income or something that needs to be repaid:
Member regular subscription: this is part of the co-operative's income.
Member one-off payment: this is part of the co-operative's income. It is used for specific larger costs beyond what could be covered by the subscriptions. This may be for advertising costs or some capital items that all members want to pay towards. If this happens often, then it would be useful to put up the regular member subscription.
Start up loans or on-going loans: it may be that an item is for the longer term and members want the cost to be spread over whoever is a member in years to come (e.g. a new computer system). This makes sense if current members may leave in the near future or new members will join so current members do not want to put in more than an on-going cost. In this case any money put into the co-operative by members can be a loan to the co-operative (this is particularly relevant for a start-up situation as well as an upgrade or growth scenario). Regular subscription can be increased to cover the regular repayment of loans to those members who have loaned money.
You can make a loan of say £1k to the co-operative a condition of membership (this is distinct from a joining fee as the loan would be repayable).
It is important to be clear when money is being loaned to the co-operative and what money is a subscription (one is repayable and one is not). A standard CAN loan agreement template is downloadable should you wish to use it – this provides clarity and that is important.
Shares: instead of money being put in for capital investment as a loan, money could be put in as a shares – actually simpler than loans if the co-operative is an Industrial & Provident Society (IPS). Some "Rules" state that one £1 share and no more must be held by each member, so taking investment by way of member share is not possible. However, where the “Rules” permit, investment can be made up to the maximum level set out in the rules (the current legal maximum is £100k though the maximum stated in the rules may restrict this to a lower level).
This version: May 2014