Chapter 5 Assessable income 2020 Thomson Reuters Professional

Recall from chapter 1 • Assessable income is subject to income tax as it is added to “taxable income”: Assessable Income Ordinary Income Statutory Income • This chapter focuses on the general concepts of ordinary income. Po. TL 2020 paragraph [5. 10]

Ordinary income – general: What is ordinary income? • Ordinary income is “income according to ordinary concepts” and is assessable under s 6 -5 Income Tax Assessment Act 1997. • “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 and usages of mankind”. Po. TL 2020 paragraph [5. 20]

Ordinary income – general: Commonly recognised categories of income • Income is commonly categorised into three broad areas: 1 2 3 • Income from personal services and employment • Income from business • Income from property Po. TL 2020 paragraph [5. 30]

Ordinary income – general: Characterisation of a gain • Central issue in the application of the Australian income tax legislation is the characterisation of a gain as: Gain Ordinary Income Capital Not capital or ordinary income Po. TL 2020 paragraph [5. 40]

Prerequisites of ordinary income • A receipt cannot be ordinary income unless it fulfils both prerequisites: Cash or convertible to cash Real gain to the taxpayer Prerequisites of ordinary income satisfied • Note, even if the above prerequisites are satisfied, it is not by itself sufficient for the gain to be ordinary income (see later, characteristics of ordinary income). Po. TL 2020 paragraph [5. 50]

Prerequisites of ordinary income: Cash or cash convertible • A gain cannot be ordinary income if it is not cash or not cash convertible. – See, Tennant v Smith (1892); FCT v Cooke and Sherden (1980) • What is cash convertible? – The item must be readily convertible to cash – It must not be illegal to sell the good: Payne v FCT (1996). • Note, statutory provision of s 21 A Income Tax Assessment Act 1936 for non-cash business benefits. Po. TL 2020 paragraph [5. 60]

Prerequisites of ordinary income: Real gain • If a receipt is not a genuine gain (ie, the taxpayer is better off financially), it is not ordinary income. • More likely to apply in employment situations and clubs: – Reimbursement of a work-related expense held not to be a real gain: Hochstrasser v Mayes (1960). Po. TL 2020 paragraph [5. 70]

Characteristics of ordinary income • Provided both prerequisites of income are satisfied, a gain will be ordinary income if it shows sufficient characteristics of income: 1 2 • Regular / periodical receipts; or • The flow concept. • Note, the above characteristics are only indicia as to what constitutes ordinary income: – Courts can widen their views to reflect modern day practices: for example, FCT v Myer Emporium (1987). Po. TL 2020 paragraph [5. 80]

Characteristics of ordinary income: Regular/periodical receipts • A gain that is regular or periodic is more likely to be ordinary income than a gain that is paid as a lump sum: – Regular receipts characterised as income nature: FCT v Blake (1984). – One-off receipts not ordinary income: FCT v Harris (1980). • Lump-sum gains may also be ordinary income, for example: – One-off receipt of interest under a loan agreement – Contract to do a one-off job. • Regular gain may not be ordinary income (less common): – See, Foley v Fletcher (1843 -1860) where a taxpayer received instalments for the sale of a capital asset. Po. TL 2020 paragraph [5. 90]

Characteristics of ordinary income: Flow – the concept • The flow concept is expressed in terms of “fruit” and “tree” in Eisner v Macomber (1920) by Pitney J: “Tree” represents: capital “Fruit” represents: income Po. TL 2020 paragraph [5. 100]

Characteristics of ordinary income: Flow – important traits • For a gain to be considered ordinary income where it is likened to the fruit from the tree, it will have the following two related traits: 1 2 • Nexus (a connection) with the earning source • Severable from its earning source • ie, the gain can be extracted without the affecting the underlying earnings. Po. TL 2020 paragraph [5. 110]

Characteristics of ordinary income: Flow concept – examples • Examples demonstrating the fruit / tree analogy: Context “Tree” “Fruit” Employment Taxpayer’s ability to work / contract Payment for services Business Goodwill of the business Sales / services Investment property Rent Po. TL 2020 paragraph [5. 120]

Some gains are ordinary income despite no earnings source • 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) – Youth Allowance payments: Anstis v FCT (2010) – “Top-up” payments offered to employees who resigned to enlist in World War II. “Top-up” is the difference between former salary and military salary: FCT v Dixon (1952). Po. TL 2020 paragraph [5. 130]

Other general principles of income • Compensation takes on the character of the loss being compensated. • Unrealised gains are not ordinary income. • Legality of receipts does not affect their assessability: Minister of Finance (Canada) v Smith (1927); Taxation Ruling TR 93/25. • Whether a receipt is ordinary income is to be characterised in the taxpayer’s hands: Federal Coke Co Pty Ltd v FCT (1977). • Constructive receipt rule: – The taxpayer who is entitled to receive the income is the person who will be assessable on it, even if the actual gain is directed to someone else. Po. TL 2020 paragraphs [5. 140] – [5. 160]

Other general principles of income • Benefit that saves taxpayer from incurring expenditure is not ordinary income if it is not cash or cash convertible. • “Mutuality”: if the taxpayer makes a payment to himself or herself, there is no gain and the payment will not be income: – Funds paid to a club/association by its members are not assessable income of the club, as members are the club. Similarly, a refund of fees to a club/association’s members also not assessable to members as no real gain: see Bohemians Club v Acting FCT (1918). Po. TL 2020 paragraphs [5. 165] – [5. 170]