Taxation Law Exam Notes PDF

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TAXATION LAW NOTES Assessable Income: S6-1 Diagrammatic representation of components that go into makeup of assessable income Assessable income= •

Ordinary income o S 6-5(1) definition of ordinary income

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Statutory income o 6-10(2) definition of statutory income

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Exempt income o Div 6 – determination of components that makeup assessable income

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Other non assessable or non-exempt income o S6-15 definition of no assessable income o S6-20 definition of non-exempt income

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S6-5 Ordinary income

Look at the positive and negative indicators and see if can characterise the gain / receipt under Section 6-5(1) which defines ordinary income as ‘income according to ordinary concepts’. ‘The word income is not a term of art … how much of those receipts ought to be treated as income, must be determined in accordance with the ordinary concepts and usages of mankind’ - Scott v C of T (NSW) [1935] SR (NSW) 215 at 219 per Jordan CJ •

Must have an earning activity underpinning it – investment of capital (investment from property), carrying on a business or labour

Indicia of Income: A.

The negative indicators:

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Benefits or benefits that cannot be converted to cash are not ordinary income: FC of T v Cooke & Sherden (1980) 10 ATR 696

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a. Holiday in return of good work itself is not transferable and thus not capable of sale b. Sufficient to be of money’s worth Tennant v Smith [1892] AC 150 o Value of use of flat did not constitute income- could not sub let flat, rent was not transferable and thus not convertible to money In Payne v FC of T (1996), reward tickets could only be used by the taxpayer or her permitted nominee. The tickets weren’t transferable and if sold were subject to cancellation. The court found that they were not therefore convertible into cash and so could not be classified as ordinary income. 1

Capital receipts are not ordinary income

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Not every amount which comes in is ordinary income. Generally capital flows and capital gains (that is profits on the disposal of capital assets ) are not ordinary income. There are three reasons that exist which distinguish income from capital for income tax purposes. o Ordinary income under s 6-5 doesn’t include capital, so if an amount of capital is to be assessable to tax – then it must come through the statutory income provisions o Capital receipts that general capital gains under Div 102 ITAA 97 are assessable income – again under statutory provisions o Losses and outgoings of capital are not allowable deductions under s 8-1. §฀ Other expenditure’s of a capital nature may be excluded under specific provisions. However depreciating assets (capital in nature) may be depreciated (amount deductible) under Div 40 ITAA97. The Income/ Capital dichotomy §฀ Dixons criteria: Sun Newspapers Ltd and Associated Newspapers Ltd v FCT (1938) 61 CLR 337; 1 AITR 353; Eisner v. Macomber (1920) 252 US 189 • This case sets out the test for distinguishing outgoings on revenue as opposed to capital account. • TEST: ♦ Distinguish b/w the business entity structure or organisation set up or established for the earning of profit and ♦ The process by which the organisation operates to obtain regular returns by way of regular outlay, the difference between the outlay and returns representing profit or loss. ♦ 3 matters to be considered; 1. The character of the advantage sought, and in this its lasting qualities may play a part; 2. The manner in which it is to be used, relied upon or enjoyed and in this and under the former head recurrence may play its part; and 3. The means adopted to obtain it; that is by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to provide future use or enjoyment. • The process-structure distinction is often illustrated by reference to the US decision Eisner v Macomber 252 US 189 (1920). • Fruit and Tree Analogy ♦ “The fundamental relation of ‘capital’ to ‘income’ has been much discussed by economists, the former being likened to the tree or the land, the latter to the fruit or the crop; the former depicted as a reservoir supplied from springs, the latter as the outlet stream, to be measured by its flow during a period of time.” §฀ California Copper principle: California Copper Syndicate Ltd v Harris (1904) 5 TC 159, FCT v Myer Emporium Ltd (1987) 163 CLR 199; 18 ATR 693; 87 ATC 4353; a gain from a once-off transaction with the intention to profit—in contrast to capital transaction: Whitfords Beach – mere realisation doctrine §฀ TEST • Is the gain that has been made a mere enhancement of value by realising an asset?- not income • Is the gain made in the operation of a business in carrying out a scheme of profit making? 2

FCT v Myer Emporium Ltd (1987) 163 CLR 199; 18 ATR 693; 87 ATC 4363, ◦ A receipt may constitute income from an isolated transaction entered into otherwise than in the ordinary course of income production so long as the taxpayer entered into the transaction with the intention of making a profit. ◦ ‘Mere’ ◦ Don’t agree with proposition that sale of land that has been subdivided is necessarily no more than the realisation of an asset mainly because mainly it was an enterprising way of realising the asset to the best of its advantage FCT v Whitford’s Beach Pty Ltd (1982) 150 CLR 355; 12 ATR 692; 82 ATC 4031 Mason J at CLR 385: ◦ Crt did not agree with taxpayers that it was mere realisation of an asset (enterprising) (therefore not assessable). ◦ Here the subdivision took place on a massive scale, involving the laying-out and construction of roads, the provision of parklands, services and other improvements. ◦ All this amounted to development and improvement of the land to such a marked degree that it is impossible to say that it was a mere realization of an asset. §฀

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Nature of consideration for a receipt: Federal Coke Pty Ltd v FCT (1977) 34 FLR 375; 7 ATR 519; 77 ATC 4255; GP International Pipecoaters Pty Ltd v FCT (1990) 170 CLR 124; 21 ATR 1; 90 ATC 4413 Examine the consideration provided by the recipient of money. ◦ Income is to be judged from the character it has in the hands of the recipient. ◦ Federal Coke Co Pty Ltd v FCT (1977) 34 FLR 375; 7 ATR 519 at 539; 77 ATC 4255: ◦ Consideration for the sale of a capital asset that was not acquired for profit-making by sale or relevantly used in a business is on capital account. ◦ Unwise to use case alone because ◦ 6-5(4) ITAA ◦ 6-10(3) ITAA ◦ Assess ability of Bilamby Crts in Aust tend to take a broad approach – ie: business related or incidental activities are more likely to be treated as part of a single business with the effect of broadening the tax base: ◦ Memorex Pty Ltd v. FCT (1987); ◦ GP International Pipecoaters Pty Ltd v. FCT (1990) §฀

Fixed or working capital

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The return from operations is in the form of working or circulating capital: BP Australia Ltd v FCT (1965) 112 CLR 386; 9 AITR 615; §฀ Losses of circulating capital, such as debts and expenditure to acquire items of circulating capital, for example, trading stock, are on revenue account. §฀ Receipts from transactions that are made in the ordinary course of a business are clearly on revenue account and receipts arising from the mere realisation of an investment are on capital account: California Copper Syndicate Ltd v Harris (Surveyor of Taxes) (1904) 5 TC 159; FCT v Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363. Thus, the sale of (fixed) capital assets will generate a capital receipt. §฀ Sale of trading stock and revenue assets will produce an income receipt. Whether an item of circulating capita l is a capital or revenue asset depends on the nature and scope of a particular business. 3

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Apply the dichotomy: Licences, Restrictive covenants; cancellation of agreements and damages; compensation for loss of reputation; compensation for personal injury, unliquidated damages, exchange rate losses/ gains ◦

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Licence and know how payments ◦ Knowledge itself is not property unless it can be attached to an item of property such as a patent or copyright. Brent v FCT (1971) 125 CLR 418; 71 ATC 4195. Murray v ICI Ltd [1967] 2 All ER 980, Lord Denning divided licences into three categories ◦ Ordinary licence (non exclusive licences) – receipts are income in the hands of the grantor ◦ Exclusive licence - generally the consideration received is capital in nature ◦ Sole licence – where the licence is granted to a single grantee but the grantor is still at liberty t exploit the knowledge also. This is a grey area. If the grant sufficiently restricts the grantors right to earn income then the consideration may be a capital receipt. Restrictive covenants ◦ Higgs v Olivier [1952], Ch 311, - non assessable – tax payer received a fixed sum and right to percentage of profit- for contribution to making of a film- received extra 50,000 pounds for agreeing not to act produce tor direct any other films for next 18 months to ensure success of film would not be compromised – represented giving up right to earn income as an actor not part of exercise of the profession, out of scope of profession- if only for services rendered- ordinary income ◦ Riley v Coglan [1967] 1 WLR 1300- tax payer played armature rugby union- agreed to join club and relinquish armature status- in return he received 2 lump sum payments of 500 pounds- agreement bound tax payer for certain period- he will need to pro rata payment if breached agreement– assessable income- held that it was an amount represented advance payment for services Cancellation of agreements and damages ◦ Heavy Minerals Pty Ltd v. FCT (1966) 115 CLR 512, 10 AITR 140, 14 ATD 282 Compensation or damages awarded for defamation- generally not income ◦ Sydney Refractive Surgery Center P/L v FCT (2008) ATC ◦ Liftronic Pty Ltd v FCT (1996) 66 FCR 175; 32 ATR 557 Compensation for injury ◦ Capital if it is paid to compensate for destruction or permanent impairment of that capacity: Tinkler v FCT 79 ATC 4641; FCT v Slaven 84 ATC 4077. Unliquidated damages ◦ Where compensation contains both capital and revenue elements, its taxable nature will depend on whether these components may be separated: McLaurin v. FCT (1961) 104 CLR 381, 8 ATR 180, 12 ATD 273. ◦ If lump sum can be split, revenue component will be treated as income in ordinary concepts and the capital as capital in nature ◦ If cant split it- aus courts will treat whole amount as non assessable as long as there is a capital component and you cant determine how to split it up

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Exchange Rate gains (losses) ◦ ITAA36 s 20 (ITAA97 s 960-50) ◦ There must be different currencies involved if there is to be an exchange rate gain. FCT v Energy Resources Australia Ltd (1996) 185 CLR 66; 96 ATC 4536. ◦ There must also be an external transaction.

Gifts unrelated to employment, services or business do not have character of income: a. Windfall gain (not earned) Scott v FCT (1996) 117 CLR 514, 10 ATR 367; 14 ATD 286; FCT v Harris (1980) 80 ATC 4238; b. Mere gift, after a services relationship had ended Hayes v FCT (1956) 47; FCT v Harris (1980) 80 ATC 4238; c. Distinguish from FCT v Dixon (1952) 86 CLR 540;

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Gambling and windfall gains: (not absolute) Gamblers: (unless in the business) • Babka v FCT (1989) 89 ATC 4963; • Martin v FCT (1954) 90 CLR 470; 5 AITR 548; • Evans v FCT (1989) 890 ATC 4540; Quiz Contestants: • (1966) 13 CTBR(NS) Case 37; (1966) 17 TBRD Case s 17 Income Taxation Ruling IT 167 Illegal Activities: • FCT v La Rosa (2003) 53 ATRI; 2003 ATC 4150; [2003] FCAFC 124- does not prevent it from being income

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Mutual receipts: FCT v Australian Music Traders Association 90 ATC 4536 a. This would apply where moneys come into a club or society from fees paid by its members. It cannot income because the club is its members. b. Also Fletcher v IRC [1972] AC 414 at 421,

B. 6.

The positive Indicators To be income, an amount must be beneficially derived: Constable v FCT (1952) 86 CLR 402; 5 AITR 371; a. S6-5 states that an amount has come into an entity if it has been derived by the entity. This means that unrealised amounts ie: those that have not yet come into the taxpayer cannot be classified as ordinary income for that particular year. b. Also FC of T v Cooke & Sherden (1980)

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Income is to be judged by character in the hands of the taxpayer: Federal Coke Pty Ltd v FCT (1977) 34 FLR 375; 7 ATR 519; 77 ATC 4255; Gair v FCT (1944) 71 CLR 388; 3 AITR 143, s 19 ITAA36.

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Income generally exhibits recurrence, regularity and periodicity: Just

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v FCT (1949) 4 AITR 185 (Sale of property-Payments of an indeterminate periodincome) ; 8 ATD 419; FCT v Dixon (1952) 86 CLR 540; FCT v Harris (1980) 80 ATC 4238 a. Capital has also been distinguished from income through the characteristics of the receipt. b. For example, if the receipt is regular then it is more likely to have the character of income, whereas if it is once-off it is more likely to be capital in nature. c. Fixed payments by instalments- most likely still capital

9. NEXUS - Ordinary Income - Income from Personal exertion a. b.

Income from personal exertion generally Where earning activity is employment or rendering of services Need sufficient nexus between the amount and an earning activity. Ask is it a "product or incident of employment or a reward for services rendered". • An amount is ordinary income, and therefore may included in assessable income under s 6-5(1) ITAA97, if there is a sufficient nexus between the amount and an earning activity: • Tennant v Smith; • FC of T v Cooke & Sherden

c. Characterise the amount • In characterising an amount, the court will not confine itself to the form of the supporting documentation, but rather will look at the whole of the circumstances surrounding the receipt. •

Payne v FCT (1966)

d. Voluntary Payments: Austraza v Mays 1960 LOOK •

The fact that a payment is voluntary (not earned or given for free ) doesn’t preclude it from being classified as ordinary income.

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Where there is no nexus between the receipt and the services provided, the receipt is not income: Payne v. FCT (1996)

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In contrast to earned income, receipts received as a gift are not earned and are therefore not income in ordinary concepts but are a windfall gain (not earned): Scott v. FCT (1966), Hayes v FCT (1956), FCT v Harris (1980)

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Compare with FCT v Dixon (1952). Here a necessary link was made b/w the gift and the taxpayers employment.

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By third parties? Kelly v FCT (1985) 85 ATC 4283 An amount may be characterised as a product of employment or services rendered even though it is paid by a third party. Eg Tips

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Sports related payments? Moore v Griffiths (1972) 3 All ER 399; Comm of Taxation v Stone [2005] ATC 4234; o Prizes will not be income in ordinary concepts unless they are earned as a result of income-producing activities. 6

o If a sportsperson is regarded as being in the business of playing that sport, then prizes will be considered ordinary income • Preliminary or sign on Fees? Jarrod v Boustead (1963) 41 TC 701; In this case the sign on fee was made once and for all. Taxpayer gave up amateur status that could not be reinstated. Therefore amount was capital. Compare this with Riley v Coglan [1967]. Amount here received in 2 lump sums. These represented an advance payment for services. No mention in agreement that the amounts were made for taxpayer to relinquish amateur status (even though he did). So amounts assessed as ordinary income. •

Performance Fees? In some instances the court will also characterise prizes as being ordinary income due to the prize having a strong nexus with the sportsperson’s personal exertion Kelly v FCT (1985) 85 ATC 4283;

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Testimonial payments? Seymore v Reed (1927) 11 TC 625; Moorhouse v Dooland (1954) 36 TC 1

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Termination Payments? Where the taxpayer is compensated for the lost employment income through early termination of a contract the receipt will be income in ordinary concepts: C of T (Vic.) v. Phillips (1936) 55 CLR 144, 3 ATD 330.

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Surrender of Rights? Scott v C of T (NSW) (1935) 35 SR (NSW) 215. Consideration for giving up valuable rights of a capital nature under a service agreement will not constitute ordinary income. Bennett v FC of T (1947) 75 CLR 480

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If benefit cannot be converted to pecuniary= not ordinary income- cooke case

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NEXUS - Income is earned from the carrying on of a business •

The main issues relevant to business activities and the definition of income in ordinary concepts are: ◦ Is there a business? ◦ What is the business exactly? ◦ Is a particular transaction within that business as precisely defined?

1. Argue that under Common law principle: normal proceeds of a business are income under s 6-5 •

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What is a business? o We know what income is, but what is a business? o ‘any profession, trade, employment, vocation or calling, but does not include occupation as an employee’ s.995-1 o Inclusive definition – not exhaustive o Look to cases to determine whether or not a business is being conducted o Ferguson v. FCT (1979) 37 FLR 310 o California Copper Syndicate Ltd v Harris (Surveyor of Taxes) (1904) 5 TC 159mere realisation of an asset or carrying on a business Qsn: Whether or not there is some sort of Gain come into entity because there was a mere enhancement or value by enhancing an asset or was the gain made in the operation a business in carrying out a scheme of profit making §฀ Widfordbeach case and myers case

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You may need to discuss - if a business is being carried on Discuss indicia- factors that are important include: Look at which factors are present and/or missing 1.

Profit Making Purpose: A business is ordinarily carried on or the purpose of making profits – therefore a profit motive is a common feature of business activities. A mere hope may not be sufficient to indicate a business. -Brajkovich v FCT 89 ATC 5227 a. No reasonable prospect of a profit? b. The crts in UK and Aust are prepared to hold that a taxpayer may be carrying on a business notwithstanding that there is no likelihood of profits being made (at least in the short term) c. Tweddle v FCT (1942) 180 CLR 1; 2 AITR 360 at 364. d. Ferguson v FCT –immediate purpose of profit making in a certain year is not essential not mere hope is not enough e. Ell & Ors v FCT (2006)

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Repetition and regularity: Businesses generally are evidenced by sustained and regular activity, a. Ferguson v FC of T, (1989) –every business has to start somewhere and even an isolated transaction may be the commencement of a business or it may amount to a business in its own rightb. London Australia Investment Co Ltd v FCT (1977) 138 CLR 106; 7 ATR 757; 77 ATC 4398.

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System and organisation: Generally, to carry on business means to "conduct some commercial enterprise systematically and regularly ... and implicit in this idea are the features of continuity and system.’ Hyde v Sullivan (1955) 73 WN (NSW) 25; Ferguson v FC of T (1989) 9 ATR 873 ; 79 ATC 4261; CoT v JR Walker (1985) 85 ATCV 4179,

Commencement/ termination: • • • •

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Sometimes an isolated transaction may mark the commencement of a business. Fairway estates P/L v FCT 70 ATC 4061, (1970) 123 CLR 153 In some ci...