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Tutorial Week 5 Income I Short Answers 1. ‘Assessable income’ comprises which types of income? S6-5 Ordinary Income: S 6-10 Statutory Income 2. What is not included in assessable income? s 6-20 Exempt income s 6-23 Non-assessable non-exempt income (NANE) eg. Fringe benefit 3. How does the judicial concept of income differ from the economic concept of income? Judicial concept is what the judges say is the meaning of ordinary income in the case law. Economic concept is the consumption over a period + any increase in wealth over the period. 4. Explain the reconciliation rule ins 6-25ITAA97. s 6-25 Reconciliation Rules – Where an amount may be included in the taxpayer’s assessable income as either ordinary income or statutory income, use the statutory income provision (No double taxation) 5. In the case of Federal Coke, which taxpayer should the Commissioner have sought to assess? Explain your reasoning. The ATO went after federal Coke but they should have gone after Balambi as they could of applied the doctrine of constructive receipt. Balambi would be liable to tax on that amount. S6-5 (4) doctrine of constructive receipt. This prevents people from escaping tax by directing payments to third parties. Question 1 Consider whether the taxpayer has derived ‘ordinary income’ in the following situations. Make sure you refer to relevant cases and Parson’s Propositions in your answer. a) $1m won in a lottery – Proposition 9: A mere windfall gain does not have the character of income. b) Tips received by a taxi driver – Ordinary income as it’s a continuous activity from completing a service. c) Half of the taxpayer’s salary, paid by his employer, at the taxpayer’s direction, to his wife – Doctrine of constructive receipt s 6-5 (4) yes he has derived the ordinary income. d) Proceeds of selling ice cream from an ice cream parlour – Income from business = ordinary income. e) Profit from sale of a factory – Proposition 10: The factory is a capital asset therefore the sale is a capital gain. If the taxpayer was in the business of selling factory’s than that would be ordinary income. f) $50,000 embezzled by an employee from an employer – employer is the beneficiary g) $1,000 won in a bet on a grey hound race - Proposition 9: A mere windfall gain does not have the character of income. h) 5kg of macadamia nuts consumed by a farmer from his macadamia nut farm – Proposition 6: Taxpayers cannot derive income from dealing with themselves therefore no income.

i) $500 discount on a new iphone – Proposition 1&2 not income just a discount on a product j) A gift of $1,000 received from grandparents – Proposition 8: A gain which is a mere gift does not have the character of income. k) $30,000 proceeds of illegal drug dealing – yes still need to declare income from illgal activity l) $10,000 borrowed from the bank – No not ordinary income, the principal amount of a loan is not ordinary income. m) rent-free accommodation (valued at $1,000 per week) provided by an employer to an employee – Not ordinary income because it’s a mere saving of expenditure Question 2 Geoff is employed as a full-time architect. In his spare time, Geoff participates in rowing competitions. He is committed to the pursuit of excellence in rowing and over the last couple of years he has achieved world ranking as a rower. Geoff has competed successfully in a range of national and international competitions. In the 2018/19 year of income, Geoff received the following amounts:  $100,000 architect salary  $40,000 prize money from local and international events  $30,000 fees for his appearances at rowing conventions  Fridge (valued at $10,000) from a major sponsor Advise Geoff regarding the assessability of the above receipts. - Salary is included in the taxpayer’s ordinary income under s6-5 - FCT v Stone 2005 ATC 4234 - Mrs Stone was a policewoman and javelin thrower who made around $39,000 in salary plus over $180,000 in endorsements and prize money, she was found to be carrying on business as a professional athlete and therefore the money was income. - Similar to the stone case Jeff has already received world ranking and many prizes. - Viewed as a whole Geoff’s activities amount to carrying on a business as a professional rower, therefore Geoff’s $40,000 prize money is included in his assessable income. - $30,000 would be considered ordinary income as well - Fridge valued at $10,000 is a non cash benefit but is convertible to cash and there is a connection with personal exertion as the major sponsor is sponsoring for the sport he competes in. - S21 – deals with transactions, in a transaction if there is a non cash payment then the money value is deemed to have been paid

Question 3 While studying full-time at university, Shelly works part-time as a waitress, in a seafood restaurant. For the 2018/19 income year Shelly receives wages of $30,000 from working in the seafood restaurant. Her employer pays her an allowance of $300 per fortnight to cover the estimated costs of her clothing and dry cleaning. Shelly usually does not actually spend more than $50 per fortnight on her clothing and dry cleaning, however her employer lets her keep the $300. She is very popular with the customers and also receives $700 cash in tips during the 2018/19 year of income. In December 2018, Jack, a regular customer and friend of Shelly’s at university, also gives Shelly a very large box of expensive Haigh’s chocolates worth $200, around Christmas time. For the 2018/19 year of income, Shelly also receives

$5,000 in scholarship payments, under a university scholarship that is for educational purposes and not part of an employment agreement. Advise Shelly regarding the assessability of the amounts and/or benefits received (above) in the 2018/19 year of income. Shellys salary of $30,000 is considered assessable income. Issue 1: Issue 2: Is the $700 received in tips included in shellys assessable income? The tips are incidental to shellys income as a waitress from personal exertion. Issue 3: Is the box of chocolates a mere gift or income from personal exertion? The personal friendship suggests the chocolates are more of a gift as well as the timing of Christmas is when she receives the gift. The $200 value of chocolate does not reflect the value of waitressing service. Refer to Scott case where he received $10,000 gift. Issue 4: Is the $5000 of scholarship payments included in shellys assessable income. Scholarship money is technically exempt from assessable income provided it is for education purposes and a fulltime student.

Question 4 Qian is a food magazine editor who works full time at a high profile magazine publishing company, MagCo Pty Ltd. Qian enjoys writing about food, and in her spare time she writes short reviews about the food that she eats at restaurants. In January 2018, Qian enters an Australia-wide food-writing competition with a first prize of $30,000. She writes an excellent review on some deep-fried chilli prawns that she tastes at a restaurant in Sydney Harbour, and she wins the first prize of $30,000 in the competition. A few weeks later, Qian is approached by a representative of the Food Network TV Channel. Qian enters into an agreement with the Food Network TV Channel in which she agrees to make herself available for a series of interviews about food offered at various restaurants in Sydney, in consideration of a payment of $20,000 to Qian, by the Food Network TV Channel. One weekend in April 2018, Qian visits Star City casino with some friends. She wins $1,000 in a game of Mahjong. Advise Qian regarding the assessability of the amounts received (above) in the 2018/19 year of income. Issue 1: Is the prize of $30,000 a mere prize or income from personal exertion. Product of personal effort and skill of writing a high-quality review. This is incidental to her professional skill, therefore is considered ordinary income. Issue 2: Is the payment of $20,000 by the Food network income from personal exertion. Similar to Brent v FCT: Wife of train robber granted media company exclusive right to publish her life story. Court held that the amounts she received for making herself available for a series of interviews were a reward for services, Therefore income from personal exertion. Issue 3: Is the $1000 a mere windfall gain or a product from personal exertion. The money is a mere windfall gain as it’s a one off and has no personal connection to the income. Question 5

Alan is an accountant who works full time at a top tier accounting firm. In his spare time he likes to watch movies and he dabbles in film script-writing which he enjoys immensely (even though he is not very good at it). After a short holiday during which he goes hiking in the wilderness of Canada, Alan returns home to Sydney, he is inspired and writes a script about a hiker’s encounter with a werewolf. He enters it in a national film script-writing competition for fun. It so happens by chance that the judge of the competition has a particular fascination/interest in the possible existence of mythical creatures such as werewolves. He awards Alan the first prize of $20,000 in the competition. Several months later, Alan is approached by the Australian National Film Association (ANFA). He enters into an agreement with ANFA in which he assigns copyright in the film script to ANFA for consideration of $80,000. In the agreement, Alan also agrees not to write a similar film script for a period of 18 months following the release of the film. ANFA pays him $40,000 for agreeing to this provision in the agreement. The premiere screening of the film ‘Encounter with a WereWolf’ is held in Perth. Alan attends the premiere and ANFA provides Alan with free, non-transferable accommodation for two weeks at a hotel/resort in Perth. The film is an overwhelming success. Advise Alan as to whether any of the amounts or benefits he receives are ordinary income to him. (At this stage, do not consider s21 and 21A ITAA36, s15-2 ITAA97, FBT or CGT). Issue 1: Is the prize of $20,000 a mere prize of windfall gain or income from personal exertion. He is not a professional script writer, not very good at it and is only experimenting. By chance it so happens that the judge of the competition is interested in the topic he has written about and therefore awarded the prize. Therefore, this is a product of mere windfall gain. Issue 2: Is the $80,000 ordinary income or capital in nature. Capital in nature because there is an assignment of copyright therefore essentially it is a sale of property and is only a one off. Refer to the Brent case, these facts distinguish from the Brent case as there is an assignment of copyright and therefore the $80,000 is capital in nature. Issue 3: Is the $40,000 ordinary income or capital in nature. Higgs and Olivere case is similar as he is giving up his freedom/ capital right in return for the payment of $40,000. It is capital in nature as he is giving up a valuable capital right. Issue 4: Is the free accommodation ordinary income to Alan. It is non transferrable and cannot be convertible into cash therefore it is not ordinary income. Case that is similar Cook and sherdan. Could still be assessable income but not ordinary income.

Lecture 4 notes Ordinary Income: Generally, the concept of ordinary income means the following types of receipts: 1. ‘Income from Personal Exertion’ amounts that a person receives as a reward for performing services (eg, salary/wages received by an employee); 2. ‘Income from Business’ amounts that a person receives from carrying on a business (eg, the proceeds from selling shoes by a shoe shop); and 3. ‘Income from Property’

amounts that a person receives which are a return on their investments (eg, interest on bank deposits, dividends on shares, rent on investment properties, royalties paid for allowing someone to use a patent or copyright etc) Scott v CT (1935) 35 SR (NSW) 215 Compare: - Economic concept (Haig-Simons) Income = consumption + savings Y= C + W - Accounting concept P&L Account represented by revenue minus expenses s 6-25 Reconciliation Rules – Where an amount may be included in the taxpayer’s assessable income as either ordinary income or statutory income, use the statutory income provision (No double taxation) Parson’s propositions 1. An item of an income character is derived when it has “come-home” to the taxpayer. The presence of illegality, immorality or ultra vires does not preclude derivation. - Must ‘come in’ to the taxpayer, must be cash or readily convertible into cash - Licences to sell cigarettes so not convertible to cash - Cooke & Sherden 80 ATC 4140 The value of free overseas holidays (non-transferable & could not be converted into money) provided to retailers as part of sales incentive scheme was not ordinary income - NOTE Legislative Response - s21A ITAA36 ‘non cash business benefits’ may be treated as if they are convertible into cash. (Note also s23L(2)) 2. An item of an income character that has been derived will be income in the amount of its realisable value. - Must be ‘derived’ (accrual vs cash accounting basis) Tennant v Smith [1892] AC 150 The value of free accommodation provided to bank employee (prohibited from subletting) was not ordinary income “[Income Tax] is a tax on what comes in…on actual receipts…a person is chargeable for income tax…not on what saves his pocket, but on what goes into his pocket” - Unrealised gains are NOT income - Compare Economic concept - NOTE that a gain on discharge of liabilities may be income: Debt defeasance - FCT v Unilever Australia Securities Ltd 95 ATC 4117 International Nickel Australia Ltd v FCT (1977) 137 CLR 347 Foreign currency gain was assessable income - Illegality/immorality etc is irrelevant: Partridge v Mallandaine (1856) 2 TC 179 (‘business’ of burglary) Lindsay v IRC (1993) 18 TC 43 (whisky smuggling when alcohol was banned) No 275 v MNR (1955) 13 Can Tax ABC 279 (prostitution) 3. The character of an item as income must be judged in the circumstances of its derivation by the taxpayer, and without regard to the character it would have had if it had been derived by another person. - Is the amount income to this taxpayer? FCT v McNeil 2007 ATC 4223 Shareholder received $576.64 from participation in share buy-back scheme. Court looked at character of the amount in the hands of the taxpayer, ie, the shareholder (not the nature of the bank’s capital reduction), and held this was ordinary income to the shareholder. - Federal Coke Co Pty Ltd v FCT (1977) 34 FLR 375

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o Federal Coke was subsidiary of Bellambi (parent company). o Bellambi had a contract to supply coke to Le Nickel. o Le Nickel was unable to accept the full amount of coke originally contracted for, Le Nickel negotiated with Bellambi, and paid compensation to Federal Coke. o Court held that in the hands of Federal Coke (not a party to the contract), the compensation was a gift. NOTE: Doctrine of Constructive Receipt was not taken into account in the case. If it had been, the result may have been different.

4. To have the character of income an item must be a gain by the taxpayer who derived it. - Hochstrasser v Mayes [1960] AC 376 Employer company set up scheme to compensate employees for any loss made on sale of their home when being relocated for work. Amount received by employee under the scheme was not assessable – no gain. 5. There is no gain unless an item is derived by the taxpayer beneficially. - Countess of Bective v FCT 47 CLR 417 Amounts paid to Countess under a trust for the benefit of her daughter (not for the benefit of Countess) Note: modern approach to child support payments s51-50 ITAA97 - Zobory v CT (1995) 64 FCR 86; 95 ATC 4251 - employee earned interest on money that he stole from his employer. The interest was NOT assessable income because he was not beneficially entitled to it and the funds were held on constructive trust for his employer.

6. There is no gain if an item is derived by the taxpayer from himself: the principle of mutuality. - Income must ‘come in’ from outside sources, ie taxpayers cannot derive income from dealing with themselves - The Bohemians Club v FCT (1918) 24 CLR 334 Subscriptions to clubs/associations by their members (where members are entitled to participate in any surplus) 7. There is no gain if an item is derived by the taxpayer as a contribution to capital. - Foley v Fletcher (1858) 157 ER 678 instalments of purchase price of capital asset (land) 8. A gain which is a mere gift does not have the character of income. - Hayes v FCT (1956) 96 CLR 47- accountant received shares in company from former boss/business owner, court held it was a gift, NOT income from personal exertion - Scott v FCT (1966) 117 CLR 514– solicitor received 10,000 pounds from longstanding client’s wife out of husband’s estate, court held it was a gift, NOT income from personal exertion - Scott v FCT (1966) 117 CLR 514 Factors considered: o ‘An unsolicited gift does not...become part of the income of the recipient merely because generosity was inspired by goodwill and the goodwill can be traced to gratitude engendered by some service rendered..The relation between the gift and the taxpayer’s activities must be such that the receipt is in a relevant sense a product of them’

o Windeyer J: The connection between the 10,000 pounds gift and the provision of services as Mrs Freestone’s solicitor was too indirect for the gift to be regarded as a product or incident of the employment relationship. o 10,000 pounds was a huge sum at the time and completely out of proportion to services rendered so not a bonus. The taxpayer had already been fully remunerated o The gift was unsolicited o Made with a range of other gifts 9. A mere windfall gain does not have the character of income. - Gambling/lottery winnings are not income (unless taxpayer is carrying on a business of gambling, very rare) - Compare United States approach

10. A capital gain does not have the character of income. - Income= fruit, capital = tree Eisner v Macomber 252 US 189 (1920) - “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” - Sun Newspapers Ltd and Associated Newspapers Ltd v FCT (1938) 61 CLR 337 “distinction between the business entity structure or organisation set up or established for the earning of profit and the process by which the organisation operates” - Return generated from the exploitation/use of capital asset or ordinary operation of the business is generally income - Gain from realisation/loss/destruction of a capital asset is generally capital in nature NOT income 11. A gain which is one of a number derived periodically has the character of income. - consider ‘recurrence regularity and periodicity’ and recipient’s reasonable reliance on receiving the amount - FCT v Dixon (1952) 86 CLR 540 - Keily v FCT 83 ATC 4248- taxpayer was a pensioner who received an aged pension under the Social Security Act. The Commissioner assessed the aged pension on the regularity and recurrence doctrine. The Court agreed, White J stated that in the case of aged pensions the generally accepted characteristics of income recurrence and periodicity are all present and an expectation that it will be used as an income substitute. - Distinguish windfall amounts received infrequently and unexpectedly (FCT v Harris 80 ATC 4238) - Distinguish instalments received for the sale of a capital asset (Foley v Fletcher(1858) 157 ER 678)

Income from personal exertion General Principles: - There must be a sufficient connection between the amount/benefit received, and personal exertion - Amount/benefit received is a reward/product of personal exertion

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Employment relationship/business is not necessary Personal exertion = personal effort eg, providing a service Salary/wages are income from personal exertion

Reward for services Brent v FCT: - Wife of train robber granted media company exclusive right to publish her life story. Court held that the amounts she received for making herself av...