Income and Exceptions Introduction

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Income and Exceptions Introduction

• The assessable income of a taxpayer for an income year is the sum of their ordinary and statutory income for that year (s 6-‐1(1) ITAA97). The term “income” is not defined in the legislation, though descriptions of ordinary income and statutory income are provided.

• An amount may be brought into assessable income either as:

o “ordinary income” under s 6-‐5, or o “statutory income” (s 6-‐10).

• There are two types of income that are not assessable income

• They are:

(a) non-‐assessable non-‐exempt income; and (b) exempt income

Overlap

• A sale of shares by a share trader may result in the derivation of both:

o ordinary income from the carrying on of a share trading business, and o statutory income when a capital gain results from the sale of the shares.

• Statutory income will prevail over ordinary income: s6-‐25

• CGT s118-‐20: where a CGT event gives rise to both a capital gain and an amount that is assessable under another provision such as s 6-‐5

• Amount is taxed under s6-‐5 and only CGT to the extent that the gain > assessable amount

Income Concepts

• The two components of assessable income in ITAA97, ordinary and statutory income, have their source in fundamentally different notions of income

• The concept of ordinary income has been developed in judicial decisions in which the underlying principle is that of income as a “flow”

• Despite this, the inclusion of amounts in assessable income, particularly in recent years, has been based on the traditional economic thinking of income as a “gain”.

Economic: Income as a Gain Henry Simons statement

“Personal income may be defined as the algebraic sum of (1) the market value of rights exercised in consumption, and (2) the change in value of the store of property rights between the beginning and end of the period in question. In other words, it is merely the result obtained by adding consumption during the period to ‘wealth’ at the end of the period and then subtracting ‘wealth’ at the beginning.

The sine qua non of income is gain, as our courts have recognised in their more lucid moments — and gain to someone during a specified time interval [and measured according to objective market standards] …

This position, if tenable, must suggest the folly of describing income as a flow …”

• Economists generally regard both realised and unrealised gains as income

• Statutory income provisions are designed to bring into the tax base gains that fall outside the ordinary concept of income and, for the most part, these are included in assessable income on a realisation basis

o Capital gains are included in the income base only when there is a disposal of the property generating the gain or when the taxpayer’s ownership of the property otherwise ends.

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Judicial: Income as a Flow

Scott v C of T (NSW) per Jordan CJ

“The word ‘income’ is not a term of art, and what forms of receipts are comprehended within it, and what principles are to be applied to ascertain how much of those receipts ought to be treated as income, must be determined in accordance with the ordinary concepts and usages of mankind, except in so far as the statute states or indicates an intention [to the contrary] …”

• The judicial notion of income, therefore, is income according to the ordinary concepts and usages of mankind

• This changes over time to reflect changes in society itself: FC of T v Whitfords Beach Pty Ltd; FC of T v Myer Emporium Ltd

• Eisner v Macomber suggests the proposition that income is something that has its source in an earning activity

o An amount that has no relationship to an earning activity (eg a pure gift) is not generally within the judicial notion of income.

Diminishing Influence of Flow Concept

• Until recent times the “flow” concept of income dominated Australian tax law, to the virtual exclusion of any notion of “gain” as a criterion of taxability

• However, over time, the dominance of the flow concept has been eroded by two key developments:

(1) Changes in judicial attitudes:

§ In the area of income from business, the High Court in FC of T v Whitfords Beach Pty Ltd and FC of T v Myer Emporium Ltd has held that a net gain can be income according to ordinary concepts.

o Myer Emporium: net gain on profit making isolated transactions outside ordinary course of business

§ Hill J stated in Warner Music Australia Pty Ltd v FC of T:

“It is now too late to argue in the case of a taxpayer carrying on a continuing business and thus required to account on an accruals basis, that income is confined to that which comes in. Gains, at least if they are capable of being converted into money in a practical and commercial sense, may clearly constitute assessable income.”

(2) Legislative enactment of “gain” principles:

§ There are a number of specific provisions in the tax law which reflect a “gain” approach to the concept of income

§ The most striking of these are the capital gains tax rules which expressly include within the income tax base many gains which would be excluded from the judicial notion of income, eg because they involve the mere realisation of a capital asset, which, being of a capital character, is not ordinary income

• The result of these judicial and legislative initiatives is that the notion of income as a gain has become firmly entrenched in Australian tax law, and income as a flow has receded

Income and Exceptions Introduction

Contents

Income and Exceptions Introduction

Income Concepts