Income

TABL2751 Business Taxation
LAWS3147 Elements of Taxation Law

Week 3 Income

Semester 2, 2014

Copyright School of Taxation and Business
Law, UNSW & Kathrin Bain
1
Income overview
Competing concepts of income
Accounting: Revenue less expenses = profit
Economic: Income = consumption + change in wealth
(savings)
Judicial concept: Income is what comes in distinguishes
between income (flow) and gain (profit)
For income tax purposes: assessable income =
ordinary income + statutory income
Taxable income is arrived at in the following way (s 4-
15(1)):
taxable income = assessable income deductions

2
Income under ITAA97
Ordinary income (s6-5): income according to ordinary
concepts. No statutory definition.
Statutory income (s6-10): specifically specified in legislation
Exempt income
Exempt income consists of amounts which, although
received as income and otherwise taxable, are expressly or
implicitly made exempt from income tax (ITAA97 s 6-20).
The principal exemptions are listed in ITAA97 s 11-15.
Non-assessable non-exempt income
Non-assessable non-exempt income is ordinary or statutory
income that is expressly made neither assessable income or
exempt income (ITAA97 s 6-23). Non-assessable non-
exempt income provisions are listed in ITAA97 s 11-55.

3
Relationship between income
concepts
See s6-1 for diagram; and s6-25
More than one provision may include an
amount in your assessable income.
Income is only included ONCE
Statutory provisions prevail over ordinary
income provisions

4
Ordinary income
Ordinary income:
As no statutory definition, propositions have been
developed from past cases (unique factual
scenarios)
Negative propositions: Amounts that are not
ordinary income
Positive propositions: Characteristics of ordinary
income
Unnecessary to meet all characteristics

5
Amounts not convertible into money
are not ordinary income
Ordinary income: must either be money or
convertible into money.
Cooke & Sherden: non-transferable holidays
Tennant v Smith: accommodation
Payne v FCT: Frequent flyer points
6
Amounts not convertible into money
are not ordinary income
Cooke & Sherden
If the receipt of an item saves a taxpayer
from incurring expenditure, the saving is not
income ... Income is what comes in, it is not
what is saved from going out
Tennant v Smith
A person is chargeable for income tax ... Not
on what saves his pocket, but on what goes
into his pocket
7
Capital amounts not ordinary income
Ordinary income does not include amounts of
capital
Capital amounts can only be assessed through
statutory provisions: e.g. Capital gains tax
provisions
Also relevant when we examine deductions
cannot deduct capital amounts under general
deduction provision. Need to refer to specific
provisions.
8
Capital amounts
What is capital?
Different approaches
Process/Structure (Dixons criteria from Sun
Newspapers)
Fruit and tree
Mere realisation (California Copper Syndicate)
Fixed vs. circulating capital
Approaches not mutually exclusive
9
Dixons Criteria
Sun Newspapers case
Payment to restrict publication by rival publisher
Distinction between business structure set up to
earn income and process by which income is
earned
Receipts arising in the ordinary operation of
business will be on revenue account
Receipts relating to the loss or destruction of
profit-making structure will be capital

10
Dixons Criteria
3 matters to consider:
(1) Character of advantage sought. Lasting qualities
may play a part.
(2) Manner in which it is to be used, relied upon and
enjoyed. Recurrence may play a part.
(3) Means adopted to obtain it. Periodical payment or
one-off payment for future use or enjoyment?
Does the expenditure relate to the structure within
which the profits are earned or to part of the money-
earning process

11
Fruit and tree analogy
Eisner v Macomber 252 US 189 (1920)
Tree represents capital.
Income represents fruit from tree.
Payment for sale of tree, or compensation for its
destruction would be capital.
Payment for fruit or compensation for damage to
fruit would be income.
12
Mere realisation
California Copper Syndicate
Amount from sale of land was income as it was
always companys intention to profit from land.
Issue:
Is the gain that has been made a mere
enhancement of value by realising an asset?
Is the gain made in the operation of a business in
carrying out a scheme of profit making?
13
Mere realisation
Proceeds from a mere realisation of an asset
are not ordinary income.
EG: Sale of shares
Could be a passive investor in which case
proceeds from sale will be capital
Could be share trader in which case proceeds
from sale would be income
See also Myer Emporium and Whitfords Beach cases
(discussed under business income).
14
Fixed and circulating capital
Accounting distinction between fixed and working or
circulating capital
Current (circulating) assets: cash or other assets to be
consumed or converted in to cash within 12 months.
Non-current (fixed) assets: all other assets
Sale of current assets: revenue
Sale of fixed assets: capital
Whether an asset is fixed or circulating will depend on
nature of business
Imperfect distinction when it comes to tax

15
Fixed and circulating capital
Memorex Pty Ltd v FCT
In the business of leasing computer equipment
At end of lease equipment sold
Company argued profits from sale were on capital account
Court held it was ordinary income
Selling computers was an inevitable part of taxpayers
business
There is no analogy between this case and the case of
plant or equipment that a taxpayer may have and may use
as part of the structure of an enterprise. The subject
goods were part of the goods in which the applicant is
dealing.
Decision reached based on the characteristics of the business

16
Income/capital distinction applied
Why is the distinction important?
Pre-1985, no capital gains tax. Capital receipts not
included in income.
Now, capital receipts included in income via CGT
provisions, but there are various exemptions and
concessions
17
Income/capital distinction applied
Licence and know-how payments
Knowledge is not property
Brent v FCT (1971) 125 CLR 418:
Sale of life story by wife of great train robber
Had to make herself available for interviews
Deemed to be ordinary income rather than sale of capital asset
No asset was sold
If patent or copyright involved, sale of exclusive rights will
normally be capital (but not always!)
Distinguish: Evans Medical Supplies (capital) vs. Rolls Royce (income).

18
Income/capital distinction
Restrictive covenants
Agreement to not divulge information / not to work for
competitor / not to operate in set radius etc.
Can be capital or income, depends on length of
restriction
Dickenson v FCT (1958) 98 CLR 460: 10 year agreement
for petrol station to only sell Shell petrol: capital
Higgs v Olivier [1951] Ch 889: 18 month agreement for
Lawrence Olivier not to act in firms: Capital
CGT provisions also relevant.

19
Cancellation of agreements
What is the size of the contract?
Does losing contract result in loss of organisational
structure?
Examples
Cancellation resulting in termination of taxpayers business:
compensation is capital - California Copper Products Ltd (in liq) v
FCT (1934 42 CLR 28)

20
Compensation for injury
What is compensation for?
Is it to compensate for permanent impairment? Capital.
Tinkler v FCT 79 ATC 4641
Is it to compensate for loss of earnings? Income. FCT v
Smith (1981) 147 CLR 578
Unliquidated damages (one lump sum): Treated as capital as
couldnt be dissected into various components
See for example: McLaurin v FCT (1961) 104 CLR 381 and Allsop
v FCT (1965) 113 CLR 341

21
Prizes & windfall gains are not income
Prizes won by sportspersons:
Is sportsperson amateur or professional?
Prizes awarded to amateurs would not normally be
income.
But if professional, may be carrying on business as a
sportsperson, and prizes will be income: see FCT v
Stone; Kelly v FCT:
Quiz contestants:
Normally not income even if contestant is successful;
and returns several times.
May be different if there is contract to regularly
appear or appearance fees are paid.

22
Gambling / windfall gains
Proceeds of gambling and windfall gains are not
ordinary income.
Windfall gains:
Lack commercial element. Luck and good fortune
EG: Lottery winnings
Gambling:
Martin v FCT: winnings from betting on horse races
not income
Evans v FCT: Won nearly $430,000 in one year, not in
business of gambling.
Brajkovich: no deduction available for gambling losses

23
Gambling / windfall gains
Illegal activities: Gains from illegal activities
are income:
Lindsay v IRC (1933) 18 TC 14: proceeds of whisky
smuggling during American prohibition was
income
FCT v La Rosa 2003 ATC 4150: business of drug
dealing

24
Mutual receipts are not ordinary
income
Mutual receipts are not income
One cannot derive income from oneself
Members subscriptions and payments for
services are not income of a non-profit club or
association to pursue a common object

25
Judge income in hands of recipient
Income is to be judged from character it has in the
hands of the recipient, NOT by the character of the
expenditure: Colonial Mutual Life Assurance Society
Ltd v FCT

26
Judge income in hands of recipient
Federal Coke Co P/L v FCT
Did Commissioner attempt to assess incorrect
taxpayer?
Notion of constructive receipt: s6-5(4)
In working out whether you have derived an
amount of ordinary income, and (if so) when you
derived it, you are taken to have received the
amount as soon as it is applied or dealt with in any
way on your behalf or as you direct.

27
Ordinary income -
Recurrence, Regularity and Periodicity
Income generally will be a series of recurring
or periodic payments.
EG: Wages, interest, dividends, pensions etc.
BUT:
Certain regular payments may not be income
One-off payments can be income
28
Substitutes for income are income
Amounts received as substitutes for or compensation
for lost income are themselves income
Myer Emporium:
Myer Emporium (ME) lent $80M to subsidiary at 12.5% for 7.5
years.
Total interest would have been $72M
ME assigned the right to receive interest to a finance company
for $45M (discounted value of interest)
$45M was considered income for two reasons:
1) Intention to profit from transaction (will consider this further next Wk
under business income)
2) Lump-sum amount received as compensation for lost income will be
treated as income.

29
Substitutes for income are income
Tinkler: compensation due to motor accident,
payments substitute for loss of income
Allman: wrongful dismissal. Payment substitute
for income that would have been earned
Heavy Minerals Pty Ltd: compensation for
cancellation of business contract will be
substitute for income (if profit-making structure
left intact)
California Copper Products Ltd: compensation for
cancellation of business contract was capital as it
resulted in termination of taxpayers business
30
Income from employment/services
Amounts received in connection with
employment or provision of services will be
ordinary income.
Salary / wages is obvious example
Voluntary payments received by an employee
may also be ordinary income: what was the
reason for payment?

Income from employment - Gifts
Gifts unrelated to employment, services or
business are not income
Squatting Investment Co Ltd
Gifts v. Mere gift. Mere gift unrelated to earning
activities.
Voluntary payments (gifts) that are related to
employment / business etc. will be income
EG: Tips paid to a waiter

Law & Kathrin Bain
Income from employment - Gifts
Scott v FCT:
Gift made to solicitor by longstanding client.
Unexpected.
Friendship.
Scott adequately renumerated for services.
Several other gifts also made.
Not ordinary income
Law & Kathrin Bain
Non-cash employee benefits
Remember that to be ordinary income, the
benefit received must be cash or convertible
to cash
Tenant v Smith security guard allowed to live
rent-free. Not income.
How are such benefits taxed?
Section 15-2: Statutory income provision
Fringe benefits tax

Income

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TABL2751 Business Taxation

LAWS3147 Elements of Taxation Law

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