MLL406: Taxation Law Exam Notes
TABLE OF CONTENTS
Assessable Income ... 5
Ordinary Income ... 5
Characteristics ... 5
What isn’t considered ordinary income? ... 5
Income from personal exertion ... 7
Capital receipt or personal exertion? ... 8
S 15-2 Statuory income from services and employment ... 11
Exempt income 6-20 ... 14
General Deductions s 8-1 ... 15
Nexus Test ... 15
Negative Limbs ... 17
Substance over form: ... 17
General Deductions ... 19
Commonly incurred non-deductible expenses ... 19
Travel expenses ... 19
Self-educaiton ... 20
Home Office ... 21
Clothing and dry cleaning expenses ... 21
Legal expenses ... 22
Interest expenses ... 22
Specific deductions s 8-5 ... 22
Repairs ... 22
Not deductible: S 25-10(3) ... 23
Bad debts ... 23
Tax related expenses ... 24
Payments to associations ... 24
Borrowing costs ... 24
Gifts/Donations ... 24
Travel between workplaces ... 24
Prior year tax losses ... 25
Black hole expenses – ITAA97 Subdivision 40-I ... 25
Captial expense options ... 27
Income from propery and income from carrying on ordinary business 29 Interest ... 29
Rent ... 29
Dividends ... 29
Annuities ... 29
Royalties ... 30
Ordinary income from carrying on a business ... 31
Indicia of business carried on ... 31
STEP 2: Has the business commenced? ... 32
STEP 3: Ordinary Course of Business? ... 33
Isolated and extraordinary transations/Profit-making scheme ... 34
Isolated Transaction forms a business in itself under the principle in Whitfords Beach ... 34
Mere realisation application ... 34
EXTRAORDINARY TRANSACITONS ... 36
Second strand of Myer ... 36
CGT ... 38
STEP 2: CALCULATE THE GAIN OR LOSS FROM THE TRANSACTION ... 39
STEP THREE: CONCESSIONS/DISCOUNTS ... 41
STEP FOUR: CALCULATE THE NET CAPITAL GAIN OR LOSS FOR THE YEAR ... 41
Other specific rules: ... 43
Trading Stock ... 44
Summary ... 44
Meaning of trading stock ... 44
Types of trading stock ... 45
Accounting for trading stock ... 45
When is trading stock on hand? ... 46
Valuation of TS/Year-end adjustments ... 46
Year-end adjustments ... 47
Different valuation methods: ... 47
Taxation of individuals, companies and trusts ... 49
Individuals ... 49
Taxation of Minors ... 49
Other taxes and offsets ... 49
Companies ... 50
What is a company? ... 50
Taxation of dividends ... 50
Deemed dividends for private companies: Division 7A ... 51
Mechanisms of imputation system ... 52
Company maintains a franking account: s 200-15 ... 52
Maximum franking credit rule ... 52
Shareholder perspective ... 52
Refundable franking credit tax offset ... 53
Partially franked dividend ... 53
Partnerships ... 55
Trusts ... 56
Types of trusts ... 56
1. Presently entitled ... 56
2. Presently entitled and under a legal disability ... 56
3. No beneficiary is presently entitled to the trust income. ... 56
Non-resident beneficiaries ... 56
Fringe benefits tax ... 57
9 STEP PROCESS ... 57
GST ... 61
Legal principles summary ... 61
When does a taxable supply exist? ... 61
What is GST free? ... 62
Input Tax Credits ... 63
Anti Avoidance: Part IVA ... 64
STEP 1: Is there a scheme? ... 64
STEP 2: Did the scheme result in a tax benefit? ... 64
STEP 3: Did the TP enter into the scheme for the sole or dominant purpose of enabling the relevant taxpayer to obtain a tax benefit? ... 64
STEP 4: Where part IVA applies ... 65
The spectrum of tax minimisation ... 66
Common tax minimisation techniques ... 66
Common tax avoidance techniques ... 66
Specific vs general anti-avoidance provisions ... 66
Key elements of Part IVA ... 66
High Court case on Part IVA: Hart v FCT (2004) 217 CLR 216 ... 67
High Court case on Part IVA: FCT v Spotless Services (1996) 186 CLR 404 ... 67
High Court case on Part IVA: FCT v Spotless Services (1996) 186 CLR 404 ... 67
Assessable Income
Tax Payable= (Taxable Income x Tax Rate) − Tax Offsets: s 4-1013) Taxable Income = Assessable Income − Deductions: s 4-15
(AI) Assessable Income s 6-1 includes:
• (OI) Ordinary income: s 6-5(2)
• (SI) Statutory income: s 6-10(4)
Ordinary Income
s 6-5 ITAA97: Ordinary income as ‘income according to ordinary concepts’, determined according to ordinary usage of mankind: Scott v FCT.
For a gain to be OI, it must fulfil 2 prerequisites:
ü Cash or cash convertible and ü Must be real gain
Characteristics
In addition to which OI must satisfy ONE the two characteristics expressed below: Hochstrasser v Mayes.
• A gain that comes regularly/periodically is more likely to be ordinary income than a lump sum gain:
FCT v Blake and FCT v Harris
o In Blake, the receipt was regular while in Harris the receipt was one-off. Thus, Ct held in Blake the receipt was OI, Harris receipt was not OI but capital.
o Cf Premier Automatic Ticket Issuers v FCT: a lump sum receipt was considered to be OI because of interest received from loan agreement. A one-off receipt of interest under a loan agreement which provides for one interest payment at the end of the loan term would be OI. Another example is receiving a lump sum under a contract to do a one-off job.
• If something ‘flows’ it is more likely to be ordinary income.
o Fruits and trees to illustrate this concept: Eisner v Macomber. E.g., the sale of a business is the sale of the ‘tree’, so the gain is likely to be capital and not ordinary income. In contrast, everyday profit from the bus are the ‘fruits’ that flow from the bus tree and likely to be OI. Notion that gains flowing from an asset are income but gains to the value of the asset are not
Cash or Convertible to Cash
If a gain is not cash or cash convertible it definitely won’t be OI: FCT v Cooke & Sherden
• FCT v Cooke & Sherden TP won holiday. Holiday was non-transferrable & can’t be sold Ct held because the holiday wasn’t cash-convertible, it wasn’t OI. (Gift voucher is not OI because it’s NOT transferrable and NOT related to employment and NOT regular)
• Tennant v Smith: TP was an agent for a bank and lived in free accommodation supplied by bank. TP wasn’t allowed to sublet accommodation. Ct held not OI because not cash or cash-convertible as accommodation couldn’t be converted into cash because TP couldn’t sublet
• Payne v FCT 1996: Payne worked as an accountant and as part of her work had to travel a lot. Flights paid for by employer as they related to business. Joined FF program. Accumulated a lot of FF points. Held not to be cash convertible as they were non-transferable, not readily convertible to cash so not OI.
Real Gain:
• Have to be truly better off
• If receipt isn’t genuine gain, then it won’t be OI: Hochstrasser v Mayes o Therefore, things such as reimbursement are not income
o Principle of mutuality: You can’t gain if the money is really yours anyway
§ E.g. Reimbursing EE for work-related transport expense, isn’t real gain bc EE being compensated for work-related expense. BUT, EE who’s reimbursed for holiday is seen as receiving a real gain as s/he has been given a benefit over & above their wage].
• Hochstrasser v Mayes: TP’s ER required him to move cities. TP sold house for less than he purchased it.
TP’s ER reimbursed him for the loss from selling his house. Ct held that the pmt wasn’t assessable bc it’s not real gain but rather a compensation for work-related expense. Reimbursement isn’t real gain bc EE has been effectively reimbursed for the expense they incurred on behalf of his ER.
What isn’t considered ordinary income?
o Capital receipts o Personal Gifts
o Chance winnings
o Income from recreational activities o Non-cash receipts
Compensation
• Compensation takes on the character of the item it replaces, either OI loss (FCT v Dixon) or capital loss (Bennet v FCT)
• Whether compensation is categorised as ordinary income will be dependent upon the character of whatever it is replacing.
• Compensation for a loss of profits or revenue will be considered OI.
• Whereas compensation for permanent loss of a capital asset or consequent closure of a business will be capital.
o FCT v Dixon: ER offered EE’s “top-up” paymnts if they enlisted during WWII. He said to them if they ceased working for him & conscribed, he’d pay them difference bw former salary & military salary. Ct held “top-up” pmt was OI bc they were regular, expected and depend upon by TP for living expenses. Also the pmt compensated for lost salary which wld’ve been OI, so pmts themselves were OI, due to the fact tht compensation paid takes on the character of what it replaces, in this case OI.
Constructive receipt
• If someone is entitled to receive income but arranges for someone else to receive it then the person originally entitled to income has constructively received it and hence will be assessable on it.
• Therefore the character of any receipt is determined by the person who derived it and not the character of the expenditure which produced it.
o s 6–5(4) for constructive receipts for ordinary income; s 6–10(3) for constructive receipts for statutory income.
§ Although wife gets husband salary, it’s still OI of Alex, bc the salary is OI and Alex has constructively received salary, so s 6–5(4) applies to make the salary the assessable income of Alex: Federal Coke
o Federal Coke v FCT: FC was a Bellambi subordinate. Contract bw Bellambi and Le Nickel to buy coke. But, it was cancelled by Le Nickel. Le Nickel compensated Federal Coke.
o The FCT found that had compensation been paid to Bellambi, it wld’ve been OI.
§ Applying s 6-5(4) ITAA97 – which prescribes that a receipt is OI derived by a person when that income has been dealt with as that person directs – to the Federal Coke case, will result in the pmt being classed as part of the assessable ordinary income of Bellambi.
§ Bellambi is entitled to receive income, but arranges for Federal Coke to receive it instead, bc the income has been dealt with according to the directions of Bellambi, it will be treated as ordinary income of Bellambi in accordance with s 6-5(4) ITAA97.
Principle of mutuality
• Mutual receipts are not OI
• One of the pre-requisites of OI is there must be gain. Thus, it follows, if TP makes pmt to himself, there is no gain and pmt is not OI.
• The principle of mutuality shows that funds given to clubs/ associations from its members and the refund of those fees back to members are not assessable income bc there is no real gain: RACV v FCT. These receipts are a type of “non-assessable non-exempt income”: s 6-23 ITAA97. The principle usually applies to NFP recreational clubs or Body Corp.
• The principle of mutuality does not extend to amounts received by the club from non-members where the receipts arise in the nature of trade or business dealings (Sydney Water Board Employees’ Credit Union Ltd v FCT).
o BUT if the contributions are simply made to a common fund for the benefit of all members, then the proceeds aren’t assessable.
o The amount of profit which is assessable would depend on the X (golf) club maintaining accurate records to determine the nature of receipts and whether they came from non-members.
Illegally obtained income
• Assessability is not precluded by illegality
• This means that just because a receipt is from an illegal activity does not mean it is not assessable. It is assessable provided it would have been assessed had the activity been legal.
La Rosa: Was a drug dealer, kept all his gear in the car which was stolen. As the gear was used in the illegal activity, he listed it as a deduction which was accepted by the HCA. This was overturned by legislation
Income from personal exertion
• An amount will be considered income from personal services whereby their income is a product or incidence of their employment or it is a reward for services rendered by the person.
• An amount will therefore be assessable under s 6-5(1) – Ordinary Income, where there is a sufficient nexus between an amount and the income earning activity: Tennant v Smith; FCT v Cooke &
Sherden
• Where a receipt or benefit accrues directly by virtue of the taxpayer’s office it will be income derived from personal services: Moorhouse v Dooland
o Payments that are a reward for services are clearly OI, based on the nexus bw the activity and the benefit, and isn’t affected by whether the amount is received regularly or as a lump-sum pmt. (eg.
wages, salaries, commissions, bonuses, fees for services etc).
• In characterising an amount, courts will not look solely to documentation but the surrounding circumstances as a whole.
• As long as there is a nexus between the services of the taxpayer and remuneration received, it will not matter if it is for past, present or future services: Hochstrasser v Mayes
• It will also be irrelevant if they are paid by a third party and not the person receiving the services: Per Kelly v FCT gratuities related to earning activities will be regarded as OI.
o Payments from a third party will be ordinary income for the TP if they are a reward for services, but it is also necessary to consider if they are a personal gift for some other reason: Kelly v FCT.
o Tips: Made voluntarily but are made bc of the service provided, thus establishing the nexus with service and making them assessable as OI: Penn v Spiers, Squatting Investments
The question of whether X is ordinary income from personal services under s 6-5 ITAA97 will be resolved by looking at the activity that is being performed and whether the receipt is a reward for performing that activity: Brown v FCT.
Steps applied in determining income from Ordinary Services 1. Identify the work or service being performed
2. Discuss whether the payment was given as a result of those services being performed VOLUNTARY PAYMENT
Gift or Voluntary payment? FCT v Stone;
• Receipts that constitute gifts are not earned and are therefore not income in ordinary concepts but are merely a windfall gain unless the gift is incidental to employment/ services provided by the TP.
• It is necessary to establish a nexus bw the receipt and the TP’s personal exertion through the provision of services, such a connection is indicative of earned income as opposed to windfall gain: Hayes v FCT
• Unexpected, voluntary pmts received as a reward for services are ordinary income as the benefit is an incident of employment: Laidler v Perry (ie. bonus – in L v Perry certain gift vouchers were held to be ordinary income as they were incidental to employment and easily convertible to cash)
• BUT if pmt is made for other reasons, such as personal qualities, then it will be a gift and not OI as there is no connection with any personal exertion. Where there is no nexus bw the receipt and the services provided, the receipt is not income: Payne v FCT
When determining if something is a gift as opposed to OI there are a number of factors that may be considered:
• The character of the [$X] should be assessed as a receipt in the hands of the taxpayer: Scott v FCT
• The receipt must be a product of the relevant activity to be ordinary income; if it is a product of friendship or other personal characteristics, then it is a personal gift: Scott v FCT, Hayes
• The fact that the TP was fully remunerated for his services separately from the payment supports the case that the amount was a personal gift: Scott v FCT, Hayes
• As the gift was unexpected more likely it was a personal gift. Expected receipts r more likely OI: Scott v FCT
• Motive of the donor (Scott).
o The motives of the donor do not normally determine whether the character of the receipt is ordinary income, although it might be one of the factors to consider in deciding whether FCT v Harris
Issue: Was the money received income or capital?
• Mr Harris was a retired bank employee
• Received one off payment $450 from bank as a ‘pension top up’ to reduce
• effects inflation
o Majority of FFC held that not a product of past services or current employment o and had been fully remunerated for such services anyway.
o Therefore could not be OI, receipt of $450 was capital.
o Also stated was once off, which was not determinative but a consideration
the receipt is ordinary income: Scott. If the donor intends the gift to be a reward for services the gift is more likely to be OI: Scott v FCT
• Lump sum or recurring (Dixon, Scott, Harris) Scott v FCT
Personal qualities
The receipt was a gift not OI bc TP had been paid for his services, the receipt was a product of friendship and not a product of the relevant activity to be OI, gift was unexpected
& out of proportion to the services rendered Laidler v Perry –
Christmas bonus was OI
Bonus was OI bc was a reward for service, even tho pmt was voluntary & unexpected, it arose out of employment
FCT v Dixon
Top up payments were OI
Top up payments were regular, expected and depended upon by the TP Other judge said because compensation for lost salary and therefore OI
PRIZES AND CHANCE WINNINGS
• Prizes are a windfall gain generally. This includes things like winnings from lotteries, betting etc.
• HOWEVER: prizes as part of business may be considered OI if they require a lot of skill or are in the business of gambling e.g. A bookie, a professional gambler
Babka v FCT Issue: Was the TP engaged in the business of betting?
• TP when he retired commenced spending a lot of money on gambling. Mainly horse racing but also some other activities. No employees or office
• Comm said he was in business of gambling because he had no other income and kept detailed records and was organised with betting system.
HELD
• Not OI despite organisation and only way he got money.
• Just because TP devoted a significant amount of time to the activity and kept detailed records, his activities were not systematic and organised enough to the extent he was engaged in the business of betting and producing OI.
Kelly v FCT – ISSUE: Was amount received OI or non-
assessable prize?
• TP played football at high level WA competition. Paid fixed amount for each match played. There was upcoming award for ‘best and fairest’. Prior to award being announced a local TV station said they would pay $20k to winner of the award. TP won the award and received $20k HELD
• It was held prize was OI bc the amount was directly related to employment, even though it was unexpected he was awarded the prize due to his skills and abilities.
Sports related payments? FCT v Stone
• Prizes won’t be income in ordinary concepts unless earned as result of income-producing activities.
• If sportsperson is held as being in the business of playing tht sport, then prizes r considered ordinary income
• Performance Fees? In some instances the court will also characterise prizes as being ordinary income due to the prize having a strong nexus with the sportsperson’s personal exertion Kelly v FCT
Factors to consider professional sportspeople:
• Degree of professionalism
• Whether reward for services rather than for personal qualities
• Whether reward is paid before or after service
• Whether reward is related to taxpayer’s contract
Windfall gains in the form of chance winnings or prizes which primarily depend on luck lack a sufficient nexus with income earning activity and are therefore not ordinary income: Evans v FCT. Although in some cases can be income from business: Babka v FCT. For prizes to be classified as ordinary income they would have to be earned as a result of a business activity or the degree of personal services and skill wld have to outweigh the element of chance.
Capital receipt or personal exertion?
• Capital receipt is not OI
• Distinction is generally concerned with whether amount is reward for services (OI) or payment for giving up a capital right (C)
• Consider are they giving up a capital right (eg restrictive covenant) or is the money replacing income.
Restrictive covenants
• Generally, if the restrictive covenant operates outside the employment period of the taxpayer, any amounts received are treated as capital, as compensation for the loss of the right/or restricting the right to work.
