Po TL Chapter 5-6 PDF

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PoTL Week 2 (Chapters 5 to 6.250) Chapter 5 – Assessable Income Key Points      

Gains that are ordinary income will be assessable income under s 6-5 of ITAA 1997. Gains will be ordinary income if they are the type of gains that courts of law consider to be of an income character. For a gain to be ordinary income, it must be cash or cash convertible as well as a genuine gain. A gain that flow from an earnings source is likely to be ordinary income. Compensation takes the form of the loss being compensated. Whether or not a gain arises from an illegal activity does not affect whether it is ordinary income.

5.10 Introduction  

Assessable income includes gains that are ordinary income/ statutory income, thus ordinary income is assessable unless the legislation states otherwise. Ordinary income is income according to ordinary concepts.

5.20 Ordinary Income – General 

The definition of income is determined by case law, most intuitive guesses by the general public as to what income is (e.g., salaries) are income and those which are not (e.g., gifts and lottery winnings).

5.30 Three Categories of Income  

Income can be covered in 3 areas which are income from personal services and employment, income from business and income from property. There are rare instances where the income may not belong to any of these groups.

5.40 Capital Gains are not Ordinary Income   

Courts have decided that capital gains will not be ordinary income. Vice versa. Gains are either Capital, ordinary income or not capital and not ordinary. The distinction is relevant since it involves the assessability of receipts and deduction of expenses.

5.50 Prerequisites and Characteristics of Ordinary Income  

For a gain to be considered ordinary income it must have these two prerequisites which are cash or convertible to cash and a real gain to the taxpayer. Fulfilling the two requirements does not guarantee that the gain is ordinary income, only that it may be ordinary income.

5.60 Cash or Cash Convertible 

As long as the item is not illegal, anything that can be readily turned into cash can be considered a cash convertible.

Case Study 5.1 – Receipt of free accommodation was not income – Tennant v Smith An agent for a bank lived in free accommodation supplied via the bank. The taxpayer was not allowed to sublet the accommodation. [Sublet: Lease the property]. Case Study 5.2 – Receipt of non-cash-convertible holiday not ordinary income – FCT v Cooke and Sherden A worker received a free holiday from their company. The holidays were not transferrable and therefore could not be sold thus were not convertible and not ordinary income.

5.70 Real Gain  

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Real gains are when the taxpayer is better off. Expenses which you incur and then are reimbursed as a result of your employment is not a real gain, an expense which you are reimbursed which would benefit you over and above your wage is a real gain (e.g., being reimbursed for a holiday you took). Predetermined amounts given to employees for work related expenses and are allowed to keep whatever remainder are regarded as allowances. Allowances constitute ordinary income and an offsetting deduction is allowed on the money spent for allowable income purposes.

Cast Study 5.3 – Reimbursement for work-related loss upon moving premises not assessable – Hochstrasser V Mayes A taxpayer had to move houses for work, sold his home for less than purchased and was reimbursed for the difference by his employer. The payment the employer made on the loss was not assessable, the taxpayer was reimbursed for a receipt which wasn’t a work-related loss then it would be a real gain. 5.80 Characteristics 

The main characteristics of income are grouped into two broad areas being regular/periodical receipts and the flow concept.

5.90 Regular/Periodic  

Regular/periodic gains are likely gains to be ordinary income, regularity of a receipt does not solely determine whether it is ordinary income or not. (Example: One off contract job(s) are still income) A gain can be regular but not ordinary in the case of instalments received when for sale of a capital asset. (Example: Sale of a block of land for $100,000 receiving it over 10 instalments. The payments will remain capital and not ordinary income since its in regard to sale of a capital asset.)

5.100 Flow   

Concepts form trust law are used when considering what is or is not income character. The concept of flow is used to describe whether or not a trust gain is an income gain or capital gain. A house which is being rented out ‘flows’ thus the rent from the investment property is income but as the house appreciates in value that is regarded as capital. This also works with dividends from shares being income but selling them for a profit/loss is a capital loss/gain.

5.110 Attributes of the Gain (Income)  

The income or gain with have a ‘nexus’ i.e. a connection with the earning source. (Example: Rent with property, accounting firms profit and the accounting business). The income or gain will be severable from its source; meaning, the gain is extracted without effecting the capital.

5.120 Examples 

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Receipt of rent and proceeds from property sale: o Rent collected is cash and a genuine gain while simultaneously is regular (monthly) and has a nexus with the house as well as being severable from the house without effecting it. o Upon sale of the property genuine cash is received as well as a gain but there is no nexus and the income does not ‘flow’ from a source thus it is regarded as capital. Businesses that regularly buy and sell houses: o Selling homes as part of a business does generate cash and is a genuine gain thus fulfilling the perquisites of ordinary income. The selling of homes seems to have a nexus with the business which sells homes and sale of a home is severable since it does not harm a business.

5.130 Some gains are ordinary income despite having no earnings source 

If receipts are regular and expected depended upon by the taxpayer, then they can be ordinary income. (Example: Government payments or compensation when serving the military from original employer).

5.140 Other General Principles – Compensations takes on the character of the loss being compensated 

Compensation receipts take on the character of what they are compensating aka compensation of income is, therefore, ordinary income and compensation for loss of capital is therefore capital.

5.145 Unrealised gains are not ordinary income 

Eisner V Macomber 1920 states unrealised gains are not ordinary income, i.e., If you own shares which appreciate and have no sold them then no realisation of gains has occurred.

5.150 Legality of receipts does not affect their assessability 

Illegal activities are still assessable provided it would have been assessable had the activity been legal. (Example: Drug dealing is assessable on the proceeds of the drug sales).

5.155 Whether a receipt is ordinary income is to be characterised in the taxpayer’s hands 

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If an employee receives an income then it is ordinary income, however, if the employee asked their employer to pay their spouse instead then it is not ordinary income due to the income does not flow from their property, business or service they have provided. The salary in the above example is still regarded as the employee’s income due to the principle of constructive receipt.

5.160 Constructive Receipt 

The constructive receipt principle is that income is treated as being derived by a person when that income has been dealt with as that person direct. (i.e. you earned some income and opted for it to be given to someone else, it is effectively still your income, hence you are assessable).

5.165 Benefit that saves taxpayer from incurring expenditure and not ordinary income 

If a benefit is received by a taxpayer or has been received and is not cash or cash convertible, then it will generally not constitute ordinary income.

5.170 Principle of Mutuality   

A perquisite of income is there must be a gain to the taxpayer. Members of a club who give the club funds and similarly, funds which are given from the club to members are not assessable because the members are the club. This is the principle of mutuality. Sources of funds other then members will not be subject to the principle of mutuality.

Examples – Receipts subject to mutuality principle     

Local not for profit football club collects a membership fee from members. The fees are subject to mutuality. A football club holds a lunch and charges members to cover the cost. Lunch is members only and is subject to mutuality. A wine-tasting club has collected fees from its members. A tour is organised for members and fees collected are partially spent, with the remainder being refunded. The money refunded is subject to mutuality. An owner’s corporation collects cash from members. The collection is subject to mutuality and is not assessable on the income of the owner’s corporation. An owner’s corporation earns interest from the bank on fees collected. The interest is assessable.

Chapter 6 – Income from Personal Services and Employment

Key Points        

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Receipts that show a nexus with the provision of a service are ordinary income. It does not matter whether the service has been performed in the past or will be performed in the future or who makes the payment. Unexpected or voluntary payments will be ordinary income If they are linked to personal service. However, they will not be ordinary income if they are paid for personal qualities rather than service. Prizes are not normally ordinary income unless the are the direct result of an income-earning activity or a reward for particular skills. Benefits earned from personal service that are not cash or convertible to cash are not ordinary income but may be statutory income. Receipts paid for giving up valuable rights may be capital receipts and therefore would not be ordinary income. Capital receipts may be subject to capital gains tax. Some employment and services gains that are not ordinary income will be assessable under s 15-2 of ITAA 1997 if they satisfy all three of its requirements. Payments given as an inducement for an employee to return to work will be assessable under s 15-3 of ITAA 1997. Payments given as a consequence of termination of employment will generally be assessable under the Eligible Termination Payment ETP provisions in Div 82 of ITAA 1997. The relevant tax rates that apply will depend on various factors, including the taxpayers ages, the amount received and who received the payment. Payments given to an employee who has been made genuinely redundant or under an early retirement scheme will generally be tax free under Dive 83 of ITAA 1997 as long as they are under the relevant threshold. Payments given to an employee upon his or her termination for unused annual leave and long service leave are assessable under div 83 of the ITAA 1997 and are generally assessable at the taxpayers’ marginal tax rates.

6.10 Introduction  

Ordinary income refers to income that is derived directly or indirectly from all sources such as your salary, income from personal services and; Statutory income is everything else such as capital gains, dividends, franking credits, allowances and redundancy payments.

6.20 Ordinary Income as a Reward for Services  

Income from ‘personal exertion’ may be assessed as ordinary or statutory, non-cash benefits may be subject to fringe-benefits-tax (FBT). Moorhouse v Dooland states amounts directly/indirectly earned via personal services will constitute ordinary income, it is important to understand the reward for personal services is the ‘nexus’.

6.30 Does the receipt show a nexus with the service? 

Approach a question like this in two steps being; What is the activity undertaken; and second, determining whether the receipt is a reward for performing that particular activity.

Case Study 6.1: Property received as a reward for service was assessable 

Brown v FCT: Brown received an expensive beach front property after completing a major development project, the FCT determined the value of the property equalled the amount owed for the services provided thus nexus was established and the property was assessable.

6.40 Does the timing of the payment matter?  

Once nexus is established the timing does not matter for the payment. (Hochstrasser v Mayes) Whether the benefit is provided by the entity who requested the task or an unrelated third party, it is irrelevant (Kelly v FCT).

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Example of third-party payment: An accountant did work on a firm which was super pleased with him, so they give him something, even though he receives renumeration on behalf of the firm which he works this is still counted as income.

Example 6.1: Income earned from personal services 

A guy contacts his lawyer and pays him so whenever he needs him the lawyer is available. The money hits but the lawyer is never called, the lawyer still must treat the money as income and tax assessable.

How can we determine when a receipt is a product of service? 

The negative approach states you should ask whether the receipt rose from a reason other than employment or the provision of a service.

Case Study 6.2: Payments to retired employee to help reduce effect of the inflation on pension payment 

Old timer who worked for a bank receives a check from the bank which was used to counter the effects of inflation on his pension. The court decided that sure he got the check because of his past employment with the bank but not exactly a resultant of his efforts/quality of work which he produced, rather it was a gift or ‘one-off’ related specifically to his pension and thus, not assessable. (FCT v Harris)

6.60 Salary Sacrifice 

Diverting income before it is earned is called ‘salary sacrifice’, this is a negotiation which foregoes income for another benefit. [Check the other benefits tax effects]

6.70 Prizes, voluntary payments and unexpected payments  

Unexpected/ Voluntary payments for personal services are assessable for ordinary income, receiving something for personal qualities instead may constitute a gift. If all you did was receive unexpected/voluntary payments and relied on them for your wellbeing, then it too would be assessable.

Case study 6.3: Christmas bonus was ordinary income 

Company gave out voucher which can be redeemed for goods, the vouchers was determined to arise out of employment as they didn’t arise out of anything else (Answered in Negative) but were not cash so they were assessable but under Fringe-Benefit-Tax. (Laidler v Perry)

6.80 Tips 

Tips are assessable as ordinary income; this is because of the level of service provided and not for any other reason. (ATO you’re a fucking monster).

6.90 Personal gifts and voluntary payments 

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Income from personal services or qualities is not ordinary income. The court holds the notion to look at the receipt from the point of the recipient when considering the connection if it may or may not have been received because of a service rendered. The givers motive is less important. Unsolicited gifts due to gratitude are not assessable.

Case Study 6.4: Characteristics of a personal gift 

A chick’s husband dies and so the solicitor is hired to sell off all his land which he owned as instructed by the widow, the solicitor is fully renumerated for his services but as sales occur, he receives some gifts which include cash. The cash was not assessable mainly due to the renumeration being fully paid. (Scott v FCT)

6.100 Characteristics of a gift

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Is it expected? Is it a lump-sum or regular payments? The motive of the donor? Has the recipient already been renumerated? And whether there was a personal relationship?

6.110 Prizes and chance winnings  

Chance based earning are not assessable, the exception here is whether or not the recipient is in the business of gambling. (Babka v FCT) The degree of which personal service was involved in the winnings needs to be measured in order to determine whether it constitutes ordinary income.

Case Study 6.6: Professionals Sportsperson’s Prize  

A professional athlete gets paid per game they play, a tv station says whoever wins the player of the year will receive $20,000, a player wins player of the year and receives the money. Even though it is unexpected the payment is a direct resultant of skill and thus is assessable as income.

6.120 Factors to consider when making distinctions 

The degree of professionalism, whether the reward is for service rather than for personal qualities, whether the reward is paid before or after service and whether the reward is related to the taxpayer’s contract.

6.130 Non-cash benefits 

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Benefits that are not cash or cannot be converted to cash are not assessable as ordinary income, unless some other means allows it to become cash then the assessability will rest on whether the benefit shows a nexus with personal service. This can include customer loyalty programs such as frequent flyer points.

6.140 Capital receipt or personal service  

Capital receipts are not ordinary income under general principles, generally you can tell whether a payment received is capital if a valuable capital right has been surrendered in order to receive the payment. If nothing substantial is surrendered, then consider whether a nexus exists to base your judgement on whether or not it is ordinary income.

Case Study 6.8: Payment for service of giving up valuable rights  

(Brent v FCT 1971) is a case which defines what really constitutes a surrendering of valuable capital. In this case the wife of an infamous train robber was approached by a news outlet who made her sign an exclusivity contract with that news outlet to publish her story. She argues she gave of the valuable capital (the ability to publish wherever she wanted) with that particular news outlets thus, she argued it was a capital receipt; however, the court stated it was ordinary income since A. She is essentially paid for services of telling a story. B. The knowledge isn’t property, it didn’t relate to any business so no copyright could be attached and C. The ‘exclusive right’ didn’t mean much since it wouldn’t stop any author from collecting the information and producing their own version.

6.150 Changes to entitlements 

Changes to entitlements under employment contracts may give rise to capital receipts thus are not assessable as ordinary income.

Case study 6.9: Relinquishing employment rights 

(Bennet v FCT 1947) shows how a managing director who had full control of a company, was terminated and re-appointed with the loss of total power was then given yearly payments by the company due to surrendering this power, those payments and changes to his contract employment are examples of changes to entitlements and were not assessable as ordinary income.

6.160 Receipts for entering a restrictive covenant 

Restrictive covenants may be formed during, whilst or after operation/service.

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This is most common for actors and sportspersons, the characterising of th...