TAXATION LAW 505 Week 2 Assessable income INCOME

TAXATION LAW 505 Week 2 Assessable income

INCOME TAX Assessable income – Deduction = Taxable income Assessable income (Div 6 ITAA 97) Assessable income = Ordinary Income + Statutory Income Deduction (Div 8 ITAA 97) Divided into 1. General Deductions (s 8 -1 ITAA 97) 2. Specific Deductions (s 8 -5 ITAA 97)

ORDINARY INCOME Ordinary Income s 6 -5 ITAA 97 Income according to ordinary concepts “Ordinary income” is not defined in the legislation It is decided by case laws

CHARACTERISTICS OF ORDINARY INCOME Amount has a sufficient nexus with an earning activity Is money or money’s worth Compensation may have the characteristic of ordinary income Often exhibit periodicity, recurrence and regularity Illegal, immoral or ultra vires receipts may be ordinary income Capital gains are not ordinary income Generally must have some gains to the taxpayer Money must come from outside sources – mutuality principle

SUFFICIENT NEXUS WITH AN EARNING ACTIVITY Insufficient nexus are not normally ordinary income - Gifts - Windfall gains - Competition & prize money Are these ordinary income?

GIFTS AND WINDFALL GAINS Usually does not constitute ordinary income Case law Scott v FCT(1996) 117 CLR 514 Facts A lawyer acted on behalf of his client for many years providing legal and personal advice. The lawyer was paid adequately for his services. Sometime later, following the client’s death the lawyer was retained by the client’s wife. She made a huge sum of money from a sale of property following the advice of the lawyer. She made a gifts to a number of people including the taxpayer a sum of £ 10000 as a result of personal friendship and not legal services. Held It is not income but a gift as the connection between the services rendered and the gift was too indirect

ANOTHER CASE ON GIFT Case law Hayes v FCT(1956) 96 CLR 47 Facts A former employer made substantial gifts of shares to the taxpayer. The taxpayer had over the no of yrs provided informal financial advice. There was a friendship between the former employer and the taxpayer and no evidence that the taxpayer was inadequately remunerate when he was employed. Held The shares are not income as there was insufficient nexus between the gift and financial services

TIPS How about tips? Is it a gift? Case law Calvert v Wainwright(1947) 27 TC 475 Facts Taxi driver under fixed employment income received tips in the course of his work. Contended tips were gifts Held Tips were assessable even if it was voluntary in nature but was given as a reward for services rendered. It would not be assessable income if the gift were given on personal grounds

PRIZE MONEY Usually it is not income but : Case law FCT v Stone (2005) 222 CLR 289 Facts Police officer compete as javelin thrower at national & international level & received prize money, appearance fees, grants and sponsors Held The prize rewards is income

IS MONEY OR MONEY’S WORTH Ordinary income must be able to convert into money. Case Tennant v Smith(Surveyor of Taxes)(1892)AC 150 Facts The taxpayer was an agent for the Bank of Scotland. He was provided to occupy a house owned by the bank to transact after hours business. He is not allowed to sublet nor use it for other than bank business. The Surveyor of Taxes included a sum of £ 50 for his privilege of residence in the bank’s house and is assessable. Held The free residence is not income as it is not money’s worth Note : In current scenario he would be subjected to FBT

MONEY & MONEY’S WORTH Case law FCT v Cooke and Sheren (1980) 10 ATR 696 Facts The taxpayers carried on a business of selling soft drinks. In order to increase sales the manufacturer started a scheme of sales incentive, whereby if the sales achieves the quota set, the award of free holiday would be given. The free holiday is non-assignable. The taxpayer took up the free holiday and the Commissioner assessed it under assessable income Held As the award was non-assignable it cannot convert to money. Income is what “comes in” and not what is “saved from going out” Thus it is non assessable income. However it is assessable under s 21 A ITAA 36. Can this be under FBT? If no, why not.

ANOTHER CASE LAW Case Payne v FCT 96 ATC 4407 Facts An employee of an accounting firm travelled frequently for work purposes. She joined the frequent flying program and the membership was paid herself. Tickets could be assigned to other family members but they were not transferable and is subject to cancellation if sold. The points were used to obtain flight tickets. Held The frequent flyer points were not income because they are not money as they could not be converted or transferred and subject to cancellation if sold

COMPENSATION Compensation for loss of earnings and income capacity is usually considered as income Case law FCT v DP Smith(1981) 147 CLR 578 Facts Taxpayer and employee was involved in an accident. He received monthly indemnity of $600, receiving in total $2112 from his personal disability policy covered his loss of income. Commissioner assessed receipts as income. Held The receipts were ordinary income as it acts as a “substitution for income”

DISTINGUISH THIS Case law Coward v FCT 99 ATC 2166 Facts Taxpayer, a Commonwealth employee suffered permanent injury and retired by reason of incapacity to work. He was paid a weekly payment. When he turned 65 his payment was reduced but was able to redeem his full sum of his entitlement. Held The weekly receipt was income for compensation for loss of earnings but the lump sum was a compensation for loss of earning capacity and is capital receipt.

PERIODICITY, RECURRENCE & REGULARITY Ordinary income has the features of periodic, recurring and regular receipts. Case law FCT v Dixon Facts A taxpayer who had enlisted in the army on the basis that he would receive a supplement from his former civilian employer to “make up” the difference between his previous civilian wage and his military wage. The payments were made periodically. Held Payments received were ordinary income

ANOTHER CASE Case law FCT v Harris (1980) 10 ATR 869 Facts A former bank employee received a lump sum payment of $450 from his former employer as a goodwill gesture to offset the effects of inflation on his pension Held It is not assessable ie capital in nature as the amount receive were infrequent and unexpected

FURTHER CONFIRMED Case FCT v Blake 84 ATC 4661 Facts A retired bank officer received regular unsolicited exgratia payments to off set the increased cost of living. He was paid 3 years after his retirement but the payment continued on. Held The receipts were ordinary income

ILLEGAL, IMMORAL OR ULTRA VIRES RECEIPTS These receipts may be ordinary income The income from all the cases below were assessable Partridge v Mallandaine (1886) 2 TC 179 – burglary Minister of Finance (Canada) v Smith (1927) AC 193 – illegal bookmaker Lindsay, Woodward and Hiscox v IR Commrs (1933) 18 TC 43 - whisky smuggler No 275 v MNR - prostitution England v Webb (1898) AC 758 - ultra vires activities of company

CAPITAL GAINS ARE NOT ORDINARY INCOME Capital gains may be taxed under Capital Gains Tax (CGT) Note CGT is still under Income Tax regime Capital gains are not ordinary income Net capital gains are to be included into assessable income Why is it then necessary to differentiate if it is capital or revenue? Would discuss CGT in a separate class

REVENUE VS CAPITAL General guidelines Fruit v Tree Circulating capital v Fixed capital Recurring payment v Lump sum

FRUIT V TREE The flow concept of capital and income is well described by Pitney J in the case Eisner v Macomber (1920) 252 US 189 “The fundamental relation of “capital” to “income” has been much discussed by economist, the former being likened to the tree or the land, the latter to the tree or 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”

CAPITAL OR INCOME? Case law GP International Pipecoaters Pty Ltd v FCT Facts A co was established to perform a pipe coating contract with the State Energy Commission of WA. Under the contract, the co received payments of $4. 675 m in 3 instalments to construct a plant which it required to have in order to coat the pipes. Taxpayer argued the payment was capital in nature as it was paid to construct a capital asset Held Payments to the plant to the establishment of the plant were assessable as they were received for the performance of the taxpayer’s obligations under the contract

CASE LAW - CAPITAL VS REVENUE Case Law Bennett v FCT (1947) 75 CLR 480 The taxpayer was employed as the managing director of a radio station under a 7 year service agreement entitling him to a salary of £ 1040 pa + a % of profits. As part of the negotiations for the sale of the station, he agreed to cancel the services agreement for a new contract. In the new contract new would be appointed as managing director for a shorter term with reduced power. In consideration for the cancellation of the contract he was paid a sum of £ 12255 in 3 instalments. Held It is capital in nature as the taxpayer had given up valuable rights Current scenario may subject him to CGT

ONE OFF PAYMENT Lump sum payment may be considered as income Case law FCT v The Myer Emporium Ltd (1987) 163 CLR Taxpayer, the parent co of a group of co carried on a variety of business. It needed money to fund a planned diversification but was restricted to do so by the debenture deed trust. On 6 March 81 it lend its subsidiary which was just incorporate a sum of $80 mil to be repaid on but not prior to 30 June 88 with 12. 5% The taxpayer was able to assign the loan. On 9 March 81 the taxpayer assigned the interest of the loan to Citicorp for a lump sum consideration of $45. 37 mil. The Commissioner claimed the lump sum amount was income Held Although it is a one off lump sum payment, it has the characteristic of profit making scheme. As such it is assessable income.

GENERALLY MUST HAVE SOME GAINS Generally to be assessed for ordinary income there must be some form of gains to the taxpayer. Case law Hochstrasser v Mayes (1960) AC 376 Facts The taxpayer was employed by a company which compensated employees for any loss incurred on their sale of their homes when they relocate, and paid £ 350 to compensate for the loss. Held The amount of £ 350 were not assessable as the taxpayer suffered losses. Payments were not income as there were insufficient nexus with the taxpayer’s employment

MUTUALITY PRINCIPLE Income must have “come in” to be considered as ordinary income Case law The Bohemians Club v FCT (1918) 24 CLR 334 Facts The taxpayer was a social club that collected membership dues from its members and applied the funds towards activities for the members. Held A person cannot be the source of his own income. It has to be derived from outside the person.

DISTINGUISH Case law Coleambally Irrigation Mutual Co-operative Ltd v FCT (2004) FCA 2; (2004) 54 ATR 811 Facts The taxpayer an irrigation mutual cooperative was established for local irrigators. Members made contributions to maintain & build irrigation infrastructure. The cooperative agreement does not allow the surplus made by members to be distributed back on winding up. Held Mutuality principle could not be applied since as the surplus could not be distributed back thus the funds could be said to belong to the members.

INCOME FROM HOBBY Income from hobby is not assessable income. Usually a hobby has a small scale in activity. However a small scale activity does not mean it is a hobby. Has to refer to factors to determine. Case law Ferguson v FCT 79 ATC 4261 Facts A retired navy officer wished to engage in primary production. He began his activity while he was in the navy. He employed a management co to look after an breed the cows. He spend much time researching cattle, raising and breeding and kept records relating to his activities. Held It is a business as it was done in a systematic manner.

MORE CASES ON BUSINESS V HOBBY Case law FCT v J R Walker 85 ATC 4179 Facts Real estate agent ventured into a very small scale goat breeding business of one Angora goat which can be artificially inseminated. The goat was kept in a stud farm care for by experts at considerable costs. Held It constituted business activity even though the scale of activity was small.

DISTINGUISH THIS Case law Case T 58 (1968) 18 TBRD 306 Facts A taxpayer fish irregularly with far shorter than normal commercial hours. He uses fishing techniques which is different from those used by most professionals. Held It is merely a hobby

GAMBLING Gambling are generally considered as hobby. But the following factors are to be considered : is there systematic, organised and business like way, The scale ie volume & size of the bets Betting related to part of or other activities of a business like character eg horse breeding is the winnings based on skill or chance and is there any profit motive Whether the gambling activity is of a kind is ordinarily thought as a pass time or hobby

EXAMPLES OF GAMBLING CASE LAWS Case law Babka v FCT 89 ATC 4963 Facts Retiree spent considerable time on betting activities. Had no business premise, did not employ any assistants, never owned a horse, did not subscribe to betting information services, did not maintain a line of credit with any bookmaker, did not maintain accounting records Held Not a business activity and merely a “keen follower of the turf”

HOW ABOUT THIS CASE Case law Brajkovich v FCT (1989) 20 ATR 1570 Fact A retiree gamble heavily on races, card games, two up and football games. He was sent to several trainers which were kept primarily to assist him in his gambling pursuit. Attends 2 -3 times a week and usually bet on credit. Settles his bets with book makers on Mondays. He took steps to enhance his gambling success by studying the form guides in the newspapers and watch tv. He did not operate his gambling activities in an organised or systematic way. Held Not carrying on gambling business. Has to refer to 6 factors of what constitute of a business of gambling

ANOTHER GAMBLING CASE Case law Prince v FCT Facts A retired bookmaker who maintained a horse training establishment. Gambled heavily and systematically Held It is a business income as taxpayer had extensive experience knowledge of the horse racing industry, derived from his previous vocation as a bookmaker

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