(a) Explain what is meant by “income by ordinary concepts”. a) Ordinary income (s6-5) is an element of Assessable income. In the context of the Income Tax Assessment Act 1936 and ITAA 1997 assessable income is made up of Ordinary Income and Statutory Income. Assessable income includes income according to ordinary concepts which is called ordinary income s6-5(1). Legislatures and courts have consistently declined to define the limits of the term “Income” and have referred to “income according to ordinary concept and usages”.
Numerous tests have been defined by the courts, but “income” is not a term of art and there is no single test that meets every situation. Ordinary income is a judicial concept that emerged from trust law and has been elaborated and refined by the courts. Each case is decided on its own facts. Ordinary income is not defined so takes on its ordinary judicial meaning. The description “ordinary income” comes from the decision in Scott v CT (NSW). Income according to ordinary concepts generally includes 3 categories:
ncome from rendering personal services including employment income.
2. Income from carrying on a business. TR2008/1,TR2005/1, TR98/11 and TR97/11
3. Income from property such as rent, interest and dividends. Characteristics of income by ordinary concepts are: 1. To be income, an amount must be beneficially derived- This proposition comes from the case Constable v FCT (1952): the case law states that the amount needs to be characterised at the point of its derivation. Income and derivation must co-exist. 2.
Income is to be judged from the character it has in the hands of the recipient. Hayes v FCT (1956). 3. Income generally exhibits recurrence, regularity and periodicity, FCT v Stone (2005). 4. Amounts derived from employment or the provision of services are income. FCT v Blake (1984). 5. Amounts derived from carrying on a business are income. Ferguson v FCT 6. Amounts derived from property are income,Federal Wharf Co. Ltd. v DCT (1930). 7. Amounts received as substitutes for or compensation for lost income are themselves income ,Liftronic Pty Ltd. V FCT(1996).
b) Tax consequences that arise in respect of: “Mahler and Schubert” Issue 1 Schubert and Mahler were awarded an Order of Australia medal by the Australian Government and $100,000 each from Lloyds of London, the insurer of SS Titan, who had been saved a billion dollar payout. Issue The issue is whether the Order of Australia medal and $100000 received from Lloyds of London, the insurer of SS Titan comes to Schubert and Mahler in connection with the performance of services or is a mere gift. The relevant cases would be Hayes v FCT, Scott v FCT. Rule and Application.
Mahler and Schubert were awarded an Order of Australia medal and $100,000 in relation to the voluntary services. The test in Hayes v FCT (1956) 6 AITR 248 the proposition grounded is that a “voluntary payment from A to B prima facie is not income but the presumption will not apply when the payment is in relation to product or services and from the standpoint of the recipient whether the amount accrues by virtue of an income producing activity on their part. ”(Gilders et. al,2012, pg. no. 108 ).
Mahler and Schubert were not employed by Lloyds of London, the insurer of SS Titan nor were they employed by SS Titan therefore the payment received by them was not in relation to any income producing activity nor was it related to any services performed. They voluntarily risked their lives in boarding the vessel . Therefore the order of Australian medal and the $100,000 received is not income assessable under ordinary concepts. In Scott v FCT it was held that the amount of ? 10000 was a gift. It was gratuitous, not made in discharge of an obligation and not taken by the recipient as discharging an obligation and not income by ordinary concepts. Neither was it assessable under sec 26(e). Conclusion:
Similarly the amount of $100,000 and the order of Australia medal received by Mahler and Schubert were not made in discharge of an obligation they were gratuitous payments and therefore not income by ordinary concepts under sec 6-5(1) In Scott, the court said that the motive of the donor is a relevant factor and The Australian Government and the Lloyds of London motives are evident. Tax Consequences that arise in respect of the payments to “Schubert” “Schubert was offered $10,000 for his OA medal. He was in poor health at the time and required medical treatment so accepted the payment.
” The amount received by Schubert will be assessable under sec6-5 of ITAA 1997 as Ordinary income in the hands of the recipient. In this case his income is ordinary because the medal is convertible into money . Tax Consequences that arise in respect of the payments to “Mahler” Issue 2 Mahler entered into a contract to write an article for a magazine. He was paid $20,000 and an additional $10,000 for signing an agreement not to give interviews on television or to journalists. Issue 2 (i) “Mahler entered into a contract to write an article for a magazine. He was paid $20,000”
The primary issue is whether the consideration received by Mahler is capital or income. If the amount is income then it will be assessable under s 6-5(1) of ITAA 1997, but if it is capital the application of the general capital gain tax provision must be considered. Rule and Application Relevant cases include the Brent v FCT (1971), Heavy Minerals Pty Ltd. V FCT (1966) 10 AITR 140. Special knowledge or skill may be exploited in the course of employment or provision of services, through sale or hire to another, or through agreement to restrict its use.
In the case of Mahler the question of what has been sold arises. Mahler has only carried out a service by entering into a contract to write an article for a Magazine. He has no copyrights to sell because he has not prepared the material. This can be related to the case Brent v FCT (1971) 125 CLR 418; 71 ATC 4195, the wife of Ronnie Biggs, the great train robber, was paid $65250 to sell the exclusive rights of her “life story”. She was obliged to be available for interview and to co-operate in providing information.
The High court held that the payments was for providing personal services and it is in nature of income and not capital. The mere fact that the agreed amount is a once only payment does not of itself make the amount capital in Heavy Minerals Pty Ltd. V FCT (1966) 10 AITR 140. Wages may be received as a lump sum but they will still be income because they are a return from personal exertion and do not represent the sale of any property. Conclusion In this case Mahler is being paid for writing an article for a magazine which would be income and not capital.
The sum of $20,000 would be assessable under sec 6-5(1) of ITAA 1997 as payment received for performance of a contract or provision of service and it clearly gives rise to income. Issue 2 (ii) Mahler was paid an additional $10,000 for signing an agreement not to give interviews on television or to journalists. Issue The primary issue is whether the amount received by Mahler is of an income or capital nature. If an amount is income then it will be assessable under sec 6-5 of ITAA 1997, but if it is capital the application of Pt 3-1 the general capital gains tax provisions must be considered.
Rules and Application
If a contract is entered to restrict one’s use of the information, the consideration may be capital. Relevant cases include Dickenson v FCT (1958), Beak v Robson (1943), Higgs v Olivier (1951), FCT v Woite (1982) 13 ATR 579 . In Dickenson v FCT (1958) 98 CLR 460;7 AITR 257, a majority of the high court held to be capital, amounts paid to a petrol station proprietor to sell only shell products for the next 10 years from that site and for the next five years to sell only Shell within a five mile radius of his premises.
The payments represented a restriction of the taxpayers profit yielding structure and so were on capital account. The payments were not a normal or natural incident of carrying on such a business. In Beak v Robson (1943) AC 352, a UK decision a lump sum in consideration of a five year restriction of competition was on capital account. In Higgs v Olivier (1951) Ch 899;(1952) 33 TC 136 a payment made to Laurence Olivier to refrain from acting in films for a period of 18 months was held to be capital.
FCT v Woite (1982) 13 ATR 579 the amount received for agreeing not to play for another competing club was held to be capital as it altered the taxpayer’s profit yielding structure. Payments made for giving up an income producing pursuit relate to structure and are capital. Conclusion It is concluded that the receipt of $10000 is capital in nature and it is necessary to consider whether Pt 3-1 applies. The first consideration under Pt 3-1 is whether a CGT event under Div 104 has occurred as a result of an agreement not to give interviews on television or to journalists.
The capital proceeds from creating a right are $10000, which would therefore be assessable as capital gain, as cost base would be any incidental costs that are related to the event s104-35(3). Tax Consequences that arise in respect of the payments to “Tull” Tull sold the video to Channel 9 for $8,000 and it was shown exclusively on that station throughout Australia. Later that year he was paid $50,000 to travel to the USA to provide technical advice on a proposed telemovie of the event tentatively entitled ‘Aqualung’.
He plans to stay in the US indefinitely and pursue other filmmaking opportunities. Issue The primary issue in this case is whether the amount received by Tull is a windfall gain or income from business. Rules and Application In general terms it may be stated that capital receipts and profits arising from the mere realization of a capital asset are not income but where what is done is truly the carrying on of a business, the proceeds will be on revenue account”. Relevant cases California Copper Syndicate Ltd v Harris (Surveyor of Taxes) (1904); and FCT v Myer Emporium Ltd (1987).
Capital receipts that generate capital gains are assessable under ITAA97 Div 102. Later that year he was paid $50,000 to travel to the USA to provide technical advice on a proposed tele-movie, which shows that he accepted the contract of working in US and decided to stay there for indefinite period which shows that he accepted the contract of work in US and decided to stay there for indefinite period. The common law has identified a number of indicators that are relevant in determining whether a taxpayer’s activities constitute the carrying on of a business.
A taxpayer’s activities are characterized as a business is primarily a matter of general impression and degree as Ferguson ATR 884; ATC 4271. Conclusion Tull is an Australian resident therefore he is liable to pay the tax on the income which he earned by selling the video to channel 9 for $8,000 as well as for his contract for $50,000 in US because his income is ordinary under s6-5(2). Requirement 2 Part 2 (a) Ruby has owned and rented a residential property since 2008. Rental income for the current year is $15,000.
During the year the company replaced the old kitchen fittings, including cupboards that had deteriorated through water damage and wear and tear. The new cupboards were of the same type as the old ones and the kitchen layout was not altered substantially. The cost was $6,500. Ans (a) Issue The primary issue is whether the amount of $6500 is deductible or not deductible under sec 8-1. Rule and Application The kitchen cupboards are separately identifiable capital items with their own function. This means the cost of completely replacing them is a capital cost.
Loss or outgoing of capital nature is a negative limb under sec 8-1(2)(a) and therefore not deductible. Division 43 of the ITAA 1997 provides for a system of deducting capital expenditure incurred in the construction of capital works used to produce assessable income. Conclusion Ruby can only claim a Capital works deduction for the construction cost of this work and deduction for the decline in value of the kitchen appliances under Div. 43 of ITAA1997. (b) In another of the rental properties a visitor to the tenants slipped on the steps and sustained injuries requiring medical attention.
She claims one of the steps was loose and commenced legal proceedings against Ruby alleging her injuries were caused by the poor condition of the building. Ruby incurred legal expenses of $4,000 and the action has not been settled at 30 June. Ans(b) Issue The primary issue is whether the legal expenses are incurred in gaining or producing assessable income and are deductible under sec 8-1 Whether an expense incurred by an individual is tax deductible is generally decided by reference to section 8-1 of the Income Tax Assessment Act 1997 (ITAA).
Rule and Application
This section provides that you can deduct from your assessable income any “loss or outgoing” to the extent that it is incurred in gaining or producing your assessable income or it is necessarily incurred in carrying on a business for the purpose of producing assessable income. However, you cannot deduct a loss or outgoing to the extent that: it is of capital, or a capital nature, or it is of a private or domestic nature.
For expenditure to be an outgoing incurred in (i. e.‘in the course of’) gaining or producing assessable income there must exist the requisite connection between it and the earning of income, that is, the expenditure must be ‘incidental and relevant’ to that end i. e. it must also have the “essential character” Relevant case laws Charles Moore &Co. (WA) Pty ltd. v FCT (1956) in which it was held that “involuntary outgoings and unforeseen or unavoidable losses were allowable deductions when they were a kind of misfortune that was a natural or recognised incident of a trade or business.
” The outgoing must be incurred in deriving assessable income as in the case of Herald and Weekly Times Ltd. V FCT (1932) and W Nevill & Co. Ltd. V FCT (1937) In the case Herald and Weekly Times Ltd. V FCT (1932) it was held that “the expenditure was wholly and exclusively laid out for the production of income and deductible under sec 23(1)(a). ” Conclusion Ruby incurred the legal expenses of $4000 which is an expenditure actually incurred in gaining or producing assessable income and it is an unavoidable loss arising as one of the consequences of carrying on the business of having a rental property.
Therefore it is deductible under sec 23(1)(a). (c) In 2006 Ruby sold a batch of parts that were subsequently found to be defective. The buyer, an Australian car manufacturer lodged a claim for damages in the Federal Court. The claim was settled in November 2012 and Ruby paid $750,000 to the manufacturer. Ans(C) Issue The primary issue is whether the claim for damages paid by Ruby are incurred in gaining or producing assessable income and are deductible under sec 8-1 Rule and Application Section 8-1 provides that you can deduct from your assessable income any “loss or outgoing” to the extent that it is incurred in gaining or producing your assessable income or it is necessarily incurred in carrying on a business for the purpose of producing assessable income.
For expenditure to be an outgoing incurred in (i. e. ‘in the course of’) gaining or producing assessable income there must exist the requisite connection between it and the earning of income, that is, the expenditure must be ‘incidental and relevant’ to that end i. e. it must also have the “essential character” Relevant case laws Charles Moore &Co.
(WA) Pty ltd. v FCT (1956) in which it was held that “involuntary outgoings and unforeseen or unavoidable losses were allowable deductions when they were a kind of misfortune that was a natural or recognised incident of a trade or business. ” A business loss may be deductible even though it occurs in the year when the taxpayer is not actively carrying on a business. Relevant cases are AGC (Advances) Ltd. v FCT (1975), Placer Pacific Management Pty Ltd. v FCT (1995) AGC (Advances) Ltd. v FCT (1975) 132 CLR 175; 5 ATR 243; 75 ATC 4057.
The case concerned the deductibility of certain debts that had arisen sometime in the past. These debts were subsequently written off and a deduction was claimed under the former ITAA36 sec 51(1). Placer Pacific Management Pty Ltd. v FCT (1995) In this case the taxpayer continued to be liable for claims arising out of a particular contract even after the division was sold. Subsequently the taxpayer paid the damages plus legal fees which it sought to deduct under the former ITAA36 sec 51(1).
Provided the outgoing is found in business operations directed to income production, it will be deductible in a later year therefore as discussed in the above two cases Ruby can claim the deduction of $750,000 under sec8(1) of ITAA1997 (d) The directors of Ruby were concerned about the claim in (c) and the effect it had on the year’s reported profit. They resolved to set aside a small amount of funds annually to meet any future claims. Accordingly, an amount of $100,000 was set aside in a provision in the accounts for the year ended 30 June.
Ans (d) Issue The primary issue is whether the amount of $100,000 set aside as a provision is deductible under sec 8-1. Rules and Application In general, ‘provisions’ are not deductible under sec 8-1 as they are not incurred. s26-10 applies to deny such amounts until they are paid. Relevant cases are James Flood and Nielsen Development laboratories. The court held that nothing that was decided in Neville was intended to imply that a liability to pay an ascertained sum is never incurred until the sum becomes due and payable”. Conclusion Deductions are not allowable for provisions, as they are not incurred.
The directors of Ruby decided provision for future consequences but the amount has not been paid yet therefore it is not deductible under s8-1 and s8-25. (e) In August 2012 Ruby decided to investigate the possibility of re-entering the car parts manufacturing industry using a new type of alloy. An amount of $120,000 was paid to consultants investigating the proposal but the directors decided not to proceed at this time because the project did not appear commercially viable. Ans (e) Issue The primary issue is whether the amount of $120000 is deductible under Sec 8-1 of ITAA1997. Rule & Application.
“The common law has identified a number of indicators that are relevant in determining whether a taxpayer’s activities constitute the carrying on of a business whether a taxpayer’s activities should be characterized as a business is primarily a matter of general impression and degree, Ferguson v FCT. Service fee are disproportionate or excessive in relation to the benefits. The fee paid to an investment advisor for the initial drawing up of an investment plan isn’t tax deductible but it can be included in the cost base of the investment Woellner, R, Barkoczy, S, Murphy, S and Evans.
A business is being carried on is based on the overall impression gained after looking at the activity as a whole and the intention of the taxpayer undertaking it. The expenses incurred by Ruby are at a point too soon and therefore are not deductible. Conclusion The directors decided not to proceed with the project, therefore Ruby cannot include the fee of $120,000 paid to consultants as expense in the cost base of the investment. Service fee or any service charges which are not related to the carrying on business are not deductible because they are not related to producing the assessable income.
The expenditure was incurred as a pre-requisite to earning assessable income it was not incurred in the course of earning assessable income. These expenses are a onetime payment and may be classified as capital in nature. These expenses are incurred at a point too soon and therefore not deductible under s8-1
Gliders, F, et. al (2012). Understanding Taxation Law, (6th ed). LexisNexis/Butterworths.
Barkoczy, S. (2012). Foundations of taxation law (4th ed. ). Sydney, NSW: CCH. Woellner, R, Barkoczy, S, Murphy, S and Evans, C (2011). Australian taxation law 2013 (22nd ed. ).
Sydney, NSW: CCH Case References: Hayes v FCT (1956) 6 AITR 248 Scott v FCT (NSW) Placer Pacific Management Pty Ltd. v FCT (1995) Brent v FCT (1971) Heavy Minerals Pty Ltd. V FCT (1966) 10 AITR 140 Dickenson v FCT (1958) Charles Moore &Co. (WA) Pty ltd. v FCT (1956) Beak v Robson (1943) Higgs v Olivier (1951) FCT v Woite (1982) 13 ATR 579 . California Copper Syndicate Ltd v Harris (Surveyor of Taxes) (1904) FCT v Myer Emporium Ltd (1987) Herald and Weekly Times Ltd. V FCT (1932) and W Nevill & Co. Ltd. V FCT (1937) AGC (Advances) Ltd. v FCT (1975) 132 CLR 175; 5 ATR 243; 75 ATC 4057. Ferguson v FCT.