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Week 5 :Ordinary Income: Income from business (Normal proceeds of business) + Isolated and extraordinary transactions NOTE: please support your answers to these tutorial questions with relevant case law and legislation where applicable - Isolated and extraordinary transactions - Ordinary income v Capital gain - an isolated transaction that is a mere realisation of capital with some improvements in order to maximise its value on re-sale (profits not ordinary income; capital- CGT rules will apply) -

an isolated transaction that forms a one-off business in itself and results in ordinary income (profits are ordinary income)

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Mere realisation’ = sale of a capital asset for its best value, with the gain being characterised as ‘capital’ is not ordinary income, it will be taxed under CGT rules ( net capital gain = statutory income see s. 102-5 ITAA97)

FCT v Whitfords Beach Pty Ltd (1982) - Not simply ‘mere realisation’. Instead  land development business. Factors: - Intention of the taxpayer, must be profit making beyond ‘mere realisation’ - Scale of the activities- effort and planning-significant - Scale expenditure aimed at achieving profit- significant Proceeds from an extraordinary (or isolated transaction) will be ordinary income if the first or second strand of Myer Emporium applies 1st stand 1. Profit resulted from “business operation or commercial transaction” “Extraordinary transaction”: this requirement is satisfied “Isolated transaction” likely to be satisfied when transaction is highly entrepreneurial in nature, see TR 92/3 2. Profit-making intention upon entering the transaction “Entering the transaction”: in relation to selling assets, this is the time of asset purchase Profit-making intention need not be the taxpayer’s sole or dominant intention but it must be a significant intention: FCT v Cooling (1990) 3. Profit made by means consistent with original intention The way profit is eventually made must be consistent with the original profit-making intention. Eg. Westfield Ltd v FCT (1991) 2nd stand 1. Proceeds from a transaction will be ordinary income if the taxpayer sells the right to income from an asset, without selling the underlying asset Examples: Sale of “right to interest” (ie income), while retaining the loan principal (ie the underlying asset): Myer Emporium

Question 26

Discuss the following cases by providing a brief explanation of the facts, and explaining the key legal principle from each case: a) Memorex Pty Ltd v FCT (1987) Facts: - taxpayers carried out biz of leasing computers -also less frequently but fairly regularly sold computer equipment - sale of equipment was not a major part of biz - commissioner characterised saels as normal biz proceeds court decision: - court took a broad approach - held that gain on both lease and sale were ordinary biz proceeds b) GP International Pipecoaters Pty Ltd v FCT (1990) Facts: - Taxpayer, company, was established as a joint venture to: construct a pipe coating facility and then  carry out pipe coating (for natural gas in WA) - Taxpayer received $5 million to cover the constructed work - Taxpayer pleaded that the above amount was capital Court decision: - court took a broad approach in this case as well - held that the receipt of $5 million was within normal biz proceeds

Question 27 Jethro bought 100 hectares of vacant land in country Victoria in 1980. He built a homestead on the land for himself and his family and used the rest of the land for farming. He did this for more than 35 years, until he became too old to continue with the physical work of farming. In 2016 he decided to give half of the farm (including the homestead) to his son Patrick and sell off the rest of the farm. Jethro saw an opportunity to make some money by subdividing the remaining land. He organised subdivision of the land into 5 separate blocks. Each of these blocks were fenced off, new roads were built and sewerage, electricity and water were connected for each block. No buildings were constructed. He did not need take out a bank loan to carry out this work. A local real estate agent was used to sell the subdivided blocks. Jethro made a profit of $2,000,000 on the sales in the 2017/18 tax year.

Advise Jethro on the tax consequences of the sale of the subdivided blocks of land. The general approach:  The gain is ordinary income. If it: 1. Is the normal proceed of business (eg. Memorex); (in isolated and extraordinary transactions) 2. is caught by the rules in Whitfords Beach v FCT; or 3. satisfies the rules in Myer v FCT (any of the strand 1 or 2) - Isolated transaction= one off project, transaction that has a large amount, usually capital unless caught by no.2 and no.3 above. -Extraordinary transaction = Someone already doing business, does not look like normal proceeds of the business, but may be OI. - Mere realisation = before 1985 it was no tax= therefore automatically mere realisation. (selling of asset is mere realisation before CGT) -capital tax= after the capital gain tax came through = they both are the same but timing is different. ANS: 1. Whether the gain in question is a normal biz proceed - Taxpayer (Jethro) is not into the biz of property development - Insufficient indicators of a biz- let’s apply isolated transaction rules 2. Whether the gain is caught by the rules in Whitfords Beach - Whitfords Beach rule: For an isolated transaction to qualify as OI, it must have sufficient biz characteristics even if not frequent. + Key factors in this rule are: 1. Intention to carry on a biz= profit- making intent beyond “mere realisation” ?? 2. The scale of activities= A high level of biz planning/ effort will satisfy this condition; mere subdivision of land (as in Casimaty v FCT) is not sufficient…?? 3. Scale of expenditure: Courts seem to be influenced by the expenditure such as obtaining finance (as in Stevenson v FCT)…?? 3. Whether the gain satisfies the rule in Myer Strand 1 (strand 2 not relevant here)  To qualify OI under Strand 1, an isolated transaction satisfies: (all 3 must be satisfied) 1. That the profit resulted from “biz operation or commercial transaction” 2. That the profit making intent must exist upon entering the transaction… 3. That the profit made by means consistent with original intention…  Apply the above 3 requirements to Jethro- the question at hand…? 1. Whether highly entrepreneurial activity (as in TR 92/03) … First condition does not apply in this case, as he had purchased land for the use of farming and decided to sell the land as his physical condition stopped him from being able to properly work as a farmer.

2. Whether Jethro purchased land with profit making intent in 1980… Assuming first condition hold, would the second condition hold, in 1980, Jethro had purchased the land to use for farming, it was only until 2016 that he came up with the idea to prepare the lad for subdivision, thus it does not hold 3. Whether Jethro made profit by means consistent with original intention…

The profit was not made consistent with the original intention

Question 28 Two years ago Peta purchased a house in Kew. This house had two old tennis courts down the back which were in poor condition. She purchased the property for two reasons: 1. so that she and her family could live in the house; and 2. so that she could build three units on the tennis courts and sell them at a profit. In the current tax year the tennis club next door offered to buy the old tennis courts, but only if Peta first restored them to good condition. Peta decided to accept the club’s offer instead of going ahead with her plan to build and sell units. Peta spent $100,000 on preparing the tennis courts for sale. This involved a great deal of work.

Peta had to resurface the tennis courts and build new fences around them. She then sold the tennis courts in the current tax year to the tennis club for $600,000. Required: Ignoring capital gains tax, discuss whether the receipt of $600,000 is ordinary income under s 6-5.

The general approach apply again as in last question:  The gain is ordinary income. If it: 1. Is the normal proceed of business (eg. Memorex); (in isolated and extraordinary transactions) 2. is caught by the rules in Whitfords Beach v FCT; or 3. satisfies the rules in Myer v FCT (any of the strand 1 or 2) (Strand 2 not relevant here) 1. Whether the gain in question is a normal biz proceed - Petra is not into the Biz of property development - Let’s see if isolated transaction rules apply 2. Whether the gain is caught by the rules in Whitfords Beach - Whitfords Beach rule: For an isolated transaction to qualify as OI, it must have sufficient biz characteristics even if not frequent. + Key factors in this rule are: 1. Intention to carry on a biz= profit- making intent beyond “mere realisation” ?? 2. The scale of activities= A high level of biz planning/ effort will satisfy this condition; mere subdivision of land (as in Casimaty v FCT) is not sufficient…?? 3. Scale of expenditure: Courts seem to be influenced by the expenditure such as obtaining finance (as in Stevenson v FCT)…??

+ Judgement call sometimes. High level of planning was involved, and level of effort involved for Petra. Yes or no?? perhaps no, not enough activities done?? Renovating something which pre existed, might not be enough? If it’s a huge expense, a business would not do that on their own. Sometimes 100k is a big amount in some cases, in others not much. Did she get finances??  she did not go to bank to get finance  not as big to label it an isolated business to classify it OI  not OI?? 3. Whether the gain satisfies the rule in Myer Strand 1 (strand 2 not relevant here)  To qualify OI under Strand 1, an isolated transaction satisfies: (all 3 must be satisfied) 1. That the profit resulted from “biz operation or commercial transaction” 2. That the profit making intent must exist upon entering the transaction… 3. That the profit made by means consistent with original intention…

 Apply the above 3 requirements to Petra’s transaction…?? 1. Whether highly entrepreneurial activity (as in TR 92/03) … 2. Whether Jethro purchased land with profit making intent in 1980… 3. Whether Jethro made profit by means consistent with original intention…

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She purchased property for 2 reasons  live in the property and also sell the units made on tennis courts. (1.) Was it a business/ commercial transaction??= Just sell the tennis court, however she fixed them for 100k, but required no additional

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Tute

finance. Building 3 units’ costs more than fixing the tennis courts= Approval needed?? Maybe not as the tennis court is already there. (1.) Does not seem like a commercial transaction. (1.) Petra  intention to build units and sell them= INTENTION when entering the transaction (2.) Profit made by Petra was not consistent with original intention to build the units, as she just sold the renovated tennis court instead of building houses. Original intention and the actual transaction was different  same form of idea= to sell that bit of land (either in the form of units or courts) is the same, profit intention is the same  but units involve more expenses and materially different from selling tennis courts. continued on next page

Question 29 Aussie Minerals Ltd (‘Aussie’) is a large Australian company engaged in minerals exploration, development and processing activities in

Australia. It owns a coal mine in the NSW Hunter Valley Region called ‘The Harsh Coal Mine.’ The Harsh Coal Mine was acquired by Aussie for $800 million in 2009. The purchase price included the right to mine (ie. mining rights) certain areas for coal. The mining rights associated with the site included an undeveloped area close to a local township - development would be difficult due to community opposition to the expansion. During the 2016-17 year Aussie submitted an application to the NSW Government for expansion of the mine and spent $100,000 for preparation of an environment impact assessment. In the same year Aussie also engaged a public relations firm to carry out a local advertising campaign. The advertising included information about the benefits of mining to the region and urged people to support the mine. The advertising cost $200,000. The NSW Govt approved the mine expansion soon after, whereupon the local anti-mine expansion group commenced legal action to overturn the approval decision. ‘Aussie’ came under pressure from its shareholders to shift away from fossil fuel developments. It decided to sell the Harsh Mine to another company for $2 billion on 1 May 2018. Required: Advise Aussie Minerals Ltd whether the receipt of the $2 billion dollars is ordinary income or capital. . Ans: Summary: - Company is in biz of exploration, development, and processing activities and revenue from mineral slices are its “normal proceeds” - Buying and selling mining or mining rights as is not its biz - Whether the speculative purchase was in anticipation of increased cool prices in future was extraordinary transaction?? (Whitfords; Myer) - With initial intention, facts seemed quite consistent to carry out development but it changed thus mere realisation…? Facts:

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$2 billion- OI or capital?? + whether the transaction qualifies rules in Whitfords or Myer +which of the 2 cases more suitable to Extraordinary transaction? + For an Extraordinary transaction- Myer Strand 1 rules are a better test + The 3 requirements test of Myer Strand 1 1. Was there a biz operation or commercial transaction?? Was commercial  in the business

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2. Was there profit making intent when purchase was made?? Intention to sell the coal, and continue the business They sold the tree not fruit

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3. Was profit made by means consistent with original intention?? It is likely that the final intention and original intention not consistent

Conclusion= No.2 and 3 don’t apply = capital in nature not ordinary income...