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Week 2 Chapter 5&6 Friday, 17 April 2020 3:51 pm

Assessable Income Taxable Income • ITAA97 S3-5(1) (Imposes the duty to pay tax) "income tax is payable for each year by each individual and company, and by some other entities" • ITAA97 s4-15(1) (Defines taxable income Taxable income= Assessable Income- deductions What is ordinary income? • Ordinary income is "income according to ordinary concepts" and is assessable under ITAA97 s6-5. • "Income according to ordinary concepts" Gains require characterisation by the courts to determine if the gain has an income character. Jordan CJ in Scott v Commissioner of Taxation (1935) interpreted income to be determined"… in accordance with the ordinary concepts of usages of mankind. Categories of Ordinary Income • "Assessable income [AI] consists of ordinary income [OI] and statutory income [SI]": s6-1 (1) ITAA97 • AI= OI (s6-5) + SI (s6-10) - Exempt Income (s6-20) • Categories of Ordinary Income 1. Income from personal services and employment- Ch6 2. Income from business- Ch8 3. Income from property- Ch9 NB Capital gains are not ordinary income. • S6-1(1) Statutory income always takes precedence over ordinary income. • S6-5(1) Note the circular definition- clarified by case law. Introduction to Ordinary Income • Any gain regarded by courts as being as an income character will be "ordinary income" and therefore assessable. • Courts have a range of rules and guidelines to help discern whether gain constitutes ordinary income. • Rules are not always clear and consistent • In difficult/borderline cases can only make educated guesses. • S3-5 Imposes the duty to pay tax • S4-15 defines 'taxable income' Foundation Case FCT v Dixon (1952) 86 CLR 540 (pg130 2020) Taxpayer's employer voluntarily topped up the difference between army pay and civilian pay, a sum of 104 pounds a year. Was this gift income? Held that it had the character of income because it was; 1. "derived by Dixon in his capacity as a soldier" not from prior employment 2. Periodical receipts 3. Expected 4. Relied upon for maintenance of family Prerequisites of Ordinary Income 1. Cash or convertible to cash • In FCT v Cooke and Sherden (1980) 10 ATR 696 (pg.124 2020) holiday was held not to be ordinary income because it was not convertible to cash. • NB if illegal to sell a good (e.g. alcohol), then it cannot cash convertible: Payne v FCT (1996) 32 ATR 516 (pg.152 2020) • Legislative response - ITAA36 s21A, for non-cash business benefits and ITAA97 s15-2(1) for individuals 2. • • •

Real Gain Hochstrasser v Mayes [1960] AC 376 (pg.125) Employee relocated for work sold home at loss. Employer reimbursed employee for loss. Not a 'real gain' as employee was only being compensated for a work related expense.

Characteristics of Ordinary Income 1. Regular and periodic: A gain that is regular or periodic more likely to be ordinary income: • Contra FCT v Blake (1984) 15 ATR 1006 and FCT v Harris (1980) 10 ATR 869 (pg.143 2020). 2. Flow - this means that income must be a nexus with an earning source and able to be severable from the source: see Eisner v Macomber 252 US 189 (1920) (pg.127, 131 2020) (Tree and fruit analogy). • Contra Keily v FCT (1983) 83 SASR 494 where pension held to be ordinary income because regular, expected and relied upon despite lack of flow. 3. Compensation takes on the character of the loss being compensated (Ch10). 4. Legality of receipts does not affect their assessability. 5. Constructive receipt: • ITAA97 s6-5(4) Ordinary Income https://studentuwsedu-my.sharepoint.com/personal/18653205_student_westernsydney_edu_au/_layouts/15/Doc.aspx?sourcedoc={5090833d-0a… 1/4

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• • 6. •

ITAA97 s6-10(3) Statutory Income Federal Coke Co Pty Ltd v FCT (1977) 7 ATR 519 (pg.132 2020) Principle of 'mutuality' No gain if taxpayer makes payment to himself. E.g., refund of fees paid by members of a club/ association. • RACV v FCT (1973) 4 ATR 567 (pg.134 2020).

Some gains are ordinary income despite no earnings sources • Receipts that are regular, expected and depended upon for support can constitute ordinary income, even if they do not flow from an earnings source: • Government aged pension: Keily v FCT (1983) (pg.130 2020). • Youth Allowance payments: Anstis v FCT (2010) ( pg.130 2020). • "Top-up" payments offered to employees who resigned to enlist in WW2. "Top-up" is the difference between former salary and military salary: FCT v Dixson (1952) (pg.130 2020). Statutory Income • "Your assessable income also includes some amounts that are not ordinary income": s6-10(1) ITAA97. • "Amounts that are not ordinary income, but are included in your assessable income, are called statutory income": s6-10(2) ITAA97. • Where the same gain can be classified as either ordinary or statutory income, then it will be included only once in assessable income: s6-25(1) ITAA97. • The following are classic examples of overlapping categories: ▪ Non-cash business benefits (s21 A ITAA36) ▪ Employment allowances or benefits (s15-2 ITAA97) ▪ Profit-making undertaking (s15-15 ITAA97) Non-cash business benefits • S21A ITAA36 introduced to deal with Cooke & Sherden- type scenario by treating non-cash business benefits as convertible to cash: • The amount of benefit included in assessable income is the arm's length value reduced by recipient's contribution, if any (s21A(2)). • The non-cash benefit is not assessable to the extent: ▪ It would have been fully deductible (s21A(3) ITAA36), or ▪ Includes non-deductable entertainment expenses (s21A(4) ITAA36). ▪ NB Div 32 ITAA97 separately taxes entertainment expenses. Employee Allowances or Benefits • ITAA97 s15-2 • ITAA97 s15-2(1): "Your assessable income includes the value to you of all allowances, gratuities, compensations, benefits, bonuses and premiums provided to you in respect of, or for or in relation directly or indirectly to, any employment of or services rendered by you". • ITAA97 s15-2(2): "this is so whether thew things were provided in money or in any other form". Profit making undertaking or plan • ITAA97 s15-15 • S15-15(1): "your assessable income includes profit arising from the carrying on or carrying out of a profit-making undertaking or plan". • S15-15(2): Only applies if profit not ordinary income and property acquired before 20 Income from Personal Exertion September 1985. • Statutory A receipt from employment and providing personal services may be subject to Other Income income tax for the employee (or entity providing services), or fringe benefits tax 1. Capital Gains Tax forexpenses the employer. 2. Car reimbursements (ITAA97 s26(eaa)) 3. Return to work payments (ITAA97 s15-3) = Reward for Services 4.Ordinary AccruedIncome leave transfer payments (ITAA97 s15-5) Incomeand fromsubsidies the taxpayer's personal exertion (labour, employment, services) is 5. •Bounties (ITAA97 S15-10) 6. Interest onbe overpayments and early payments of tax (ITAA97 s15-35) likely to ordinary income. • Key is to identify relevant nexus or to ask if the receipt is properly a reward for service. ▪ Brown v FCT (2002) 49 ATR 301 (pg.141 2020) • If nexus exists then OI even if made before, during or after service or even by unrelated third party. ▪ Kelly v FCT (1985) 16 ATR 478 (pg.150 2020) • A connection or "nexus" with a receipt resulting from a taxpayer's personal services constitutes ordinary income. • Courts have used a 2 step approach to determine if an amount is ordinary income from personal services: 1. Identification of the activity undertaken 2. Determining whether the receipt is a reward for performing that particular activity. • A genuine salary sacrifice has no nexus under ordinary concepts. Nexus clearly established • Nexus clearly established for common items of personal services, including: ▪ Salary and wages ▪ Commissions ▪ Bonuses ▪ Fees charged for services rendered ▪ Ancillary payments that are an incident of labour • Nexus not impacted by lump-sum or one-off receipts for the performance of a specific task. Brent v FCT (1971) (pg.153 2020) • It is irrelevant who pays or when it is paid: Kelly v FCT (1985) (pg. 150 2020) https://studentuwsedu-my.sharepoint.com/personal/18653205_student_westernsydney_edu_au/_layouts/15/Doc.aspx?sourcedoc={5090833d-0a… 2/4

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Nexus with Provision of services • Brown v FCT (2002) 49 ATR 301 (pg.141 2020) ▪ Issue: was value of free apartment (> $1m) OI? ▪ Held: OI because received from property developer as reward for introducing buyer to property developer rather than out of friendship. • Contra: FCT v Harris (1980) 10 ATR 869 (pg.143 2020) ▪ Issue: was the $450 lump sum top-up of pension income or a gift? ▪ Held: not OI as payment was not expected and there was no evidence of future payments ▪ Query: top-up made to reduce effect of inflation! Voluntary Payments- Gift • Unexpected payments = OI if received as reward for service: Christmas bonus): Laidler v Perry [1965] 2 A11 ER 121 (pg.144 2020) • Tips received by taxi driver: Calvert v Wainwright (1947) • Contra Scott v FCT (1966) 117 CLR 514, where gift of 10,000 pounds held not OI because: 1. Taxpayer had been paid for his services 2. A number of gifts were made on the day 3. Gift was unexpected and out of proportion to the services 4. Gift was made away from the office 5. Motive of donor 6. Personal relationship Prizes • Where prize is recognized as incident of profession then ordinary income • Question of fact and degree: • If more closely aligned with professional skill and systematic approach more likely to be income (see Topic 7 below) • If more closely aligned with luck more likely to be non assessable windfall gain • In Kelly v FCT (1985) 16 ATR 478, Court rejected TP’s argument that prize was not incidental to employment because skills shown enabled him to win best & fairest prize Frequent Flier Points Payne v FCT (1996) 32 ATR 516 Issue: were reward tickets given to parents assessable income? Held: • Benefit was not allowed given or granted in respect of employment • The employment relationship lacked the necessary connection to the rewards Reward for Service or Sale of Property? Brent v FCT (1971) 125 CLR 418 (the Ronald Biggs train robber case) Issue: was the payment for sale of story to newspaper income or capital? Held: 1. Her knowledge was not property as not acquired through the conduct of a business nor was copyright attached. 2. 60 day restrictive covenant was part of service agreement 3. Taxpayer simply provided a service Restrictive Covenant Payments • Whether restrictive covenant payment is income or capital depends on whether or not connected to current employment • In Higgs v Olivier [1952] Ch 311; held payment not to appear in another film for 18 months was capital: 1. Payment could not be regarded as a reward for services 2. Payment was not related to the service contract 3. No evidence that such payments were an ordinary incident of vocation as actor • In FCT v Woite (1982) 13 ATR 579; held: $10,000 payment not to play football with any other club except North Melbourne was capital Statutory Income from services and employment: s15-2 • As mentioned, s15-2 ITAA97 (previously s26(e) ITAA36) treats gains (whether or not cash convertible) from employment or non-business services as statutory income: 4. There must be an “allowance, gratuity, compensation, benefit, bonus or premium” 5. The gain must be “provided to you” the TP 6. The gain must be directly or indirectly related “any employment of or services rendered by the taxpayer” 7. The gain must not be OI (s15-2(3)(d)) or fringe benefit (s23L ITAA36) https://studentuwsedu-my.sharepoint.com/personal/18653205_student_westernsydney_edu_au/_layouts/15/Doc.aspx?sourcedoc={5090833d-0a… 3/4

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Return to work payments • Payments made to a TP as an inducement to return to work or provide services will be assessable as statutory income under ITAA97 s15-3.

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