Lecture 3: Assessable Income

Module 1: Income From Personal Exertion - Income From the Provision of Services
Module 2: Income from Carrying on a Business
Module 3: Compensation Payments
Module 4: from Property

MODULE 1: INCOME FROM PERSONAL EXERTION

1. Distinguish between Employees v Independent Contractors
2. Tax Treatment: income from Personal Exertion – (an overview)

EMPLOYEES

Payments Received During Tenure of Employment Payments received after Employment Relationship Has Ended

ASSESSED AS INCOME NOT SUBJECT TO INCOME TAX ASSESSED AS INCOME

 Common Law
 Statutory Provisions
Certain types of non-cash benefits (eg, a
car) received in lieu of salary and wages
Employer usually pays Fringe Benefits
Tax (Lecture 12)
 Unused Annual Leave
S 83-10 to 83-15
 Unused Long Service Leave
S 83-65 to 83-115
 Employment Termination Payments
 Redundancy or early retirement payments

Salary Sacrifice See slide 31

1. Personal Exertion Income: How such payments are treated under common law
a) Gifts and Windfall Gains
b) Payments for service contracts
c) Restrictive covenants
2. Statutory Extensions

1(a) Receipts that Relate to the Performance of Contracts or the Provision of Services
Principles:
 It is the character of the payment in the hands of the recipient that is important
 There is a sufficient nexus between the amount and an earning activity
 The amount is characterised as a product or incident of employment or a reward for services rendered: Hayes v FCT (1956) *
Krever 20

1(a) Gratuitous Payments

Payments made after employment relationship has ended may not have the character of income:
SCOTT V FCT (1966) * Krever 22
Solicitor received gift

Hayes v FCT (1956) * Krever 20

Gift of a parcel of shares in conjunction with payments

Payments that are incidental to employment

FCT v Dixon (1952) * Krever 19
Soldier’s salary topped up

Kelly v FCT (1985) * Krever 32

Football player’s prize paid by third party

Compare with Moore v Griffiths -- Woellner 4-043

Stone *Krever 47

1(b) Payments for entering Into Contracts -

Issue: Providing Services or Selling an Asset?
Brent (1971) * Krever 27

* Too Good To Refuse (source abc.net.au)

1(c) Restrictive Covenants

A lump sum payment made in return for a taxpayer’s promise to accept restrictions on the right to earn income is generally
considered to be capital in nature - tax free before 1985

Beak v Robson (1943): taxpayer received a lump sum from his employer (while employed) after agreeing that, when his
employment ended, he would not compete within 50 miles of his employer’s premises for the next 5 years.

Higgs v Olivier (1951) * Krever 28

Caught by capital gains tax since 1985.
 2. STATUTORY EXTENSIONS: EMPLOYMENT ALLOWANCES
Section 15-2 includes the value of allowances, benefits, grants etc in relation to employment or services rendered in a
taxpayer’s assessable income:

1. There must be a benefit:

TR 92/15: Allowances v Reimbursements

2. The Benefit must be allowed, given or granted to the taxpayer:

Constable (1952)* Krever 30
Payne (1996) -- frequent flyer points

TR 1999/6: Benefits received by employees under frequent flyer programs as a result of employer-paid expenditure are
not assessable income.

3. Employment or Services Nexus:

The benefit must be allowed…in respect of or in relation directly or indirectly to any employment of or services rendered
by the taxpayer

FCT v Cooke & Sherden *Krever, p.42

Smith v FCT (1987) *Krever, p.23

4. Valuation Rule
The amount included in assessable income is the value of the benefit to the taxpayer

Donaldson v FCT (1974) : A subjective test

Limitations of Section 15-2

 The Valuation rule
 Compliance issues – who would declare?
 Inapplicability of the constructive receipts doctrine
 Does not apply to an amount that is assessable as ordinary income (e.g. salary)
 Inapplicability Largely replaced by Fringe Benefits Tax 1986

2. STATUTORY EXTENSIONS: EMPLOYEE SHARE SCHEMES ITAA 97 Div 83A (ss83A-1 to 83A-340)
Arrangements in which employees can acquire:
 Shares at a discount, or
 Rights to acquire shares at a price below their market value (described as “stock options”)

Assessable Discount** = Market value of shares or rights LESS Any amount paid by the employee.

Tax Treatment:
 Inclusion of the discount in assessable income is deferred, or
 The first $1,000 of the assessable discount is exempt. Woellner 4-440
 ** Note: The assessable discount that an employee receives as part of an ESS is taxed at the time of acquisition
of the shares or rights

2. STATUTORY EXTENSIONS: INCOME ON TERMINATING EMPLOYMENT

UNUSED LONG SERVICE LEAVE PAYMENTS

Lump sum payment Period of accrual % to be included as Rate of tax

assessable income applied 

Unused General retirement or termination Prior to 16-8-78 5% Marginal Rate

long
service 16-8-78 to 17-8-93 100% Max. rate (30%)
leave
After 17-8-93 100% Marginal Rate

If paid in relation to genuine redundancy, After 17-8-93 100% Max. rate (30%)
early retirement or invalidity

ATSM (27th edition) - Revision Questions

Restrictive Covenants: 36, 56
Employment Allowances: 13, 14, 22, 32, 39
Employee Share Acquisition Schemes:10, 42
 MODULE 2: INCOME FROM CARRYING ON A BUSINESS – THE KEY ISSUES
1. What is a Business? -- Identification
2. Tax consequences of an activity being characterised as a business
3. Tax treatment of Business Income:
 Normal Proceeds of a Business Operation
 Isolated/Extraordinary Business Transactions
 Non-Cash Benefits

Identification of a Business
What Is a Business?
a) The significance of establishing whether a transaction/an activity constitutes a business
b) The common law tests for identifying whether a business exists

The significance of establishing whether a transaction / activity constitutes a business

 The proceeds of certain quasi-business activities would not be treated as ordinary income –
Examples:
 hobbies/pastime pursuits
 The gambler’s hurdle: Brajkovich v FCT (1989) *Krever, 46
 Feasibility studies / pilot projects
 Softwood Pulp and Paper P/L v FCT (1976) *Krever, 146
 Relevant for determining the eligibility of certain expenses for deductibility as well as the assessability of receipts

Tax Consequences of a transaction /an activity being Characterised as a Business

1. Receipts may be assessable in the following circumstances:
 When they are identified as the “normal proceeds” of a business: Californian Copper Syndicate v Harris (1904) *Krever, 56
 When they are derived from an “isolated transaction” by a taxpayer whose purpose is to engage in a commercial venture with a
view to profit: Whitfords Beach (1982) *Krever, 50
 Where they are derived from an extraordinary transaction by a taxpayer intending to make a profit or gain: Myer Emporium
(1987) *Krever, 58

2. Deductibility of expenses:
The potential for deductions to be claimed by a taxpayer is much greater for taxpayers carrying on a business
Issue arises: has the business started?; or
has the business ended?
These same issues arise when the ATO argues that a taxpayer is assessable on amounts received in carrying on a business.

3. Certain provisions of the tax legislation only apply to businesses:

 The trading stock provisions only apply to businesses
 Certain tax concessions are only available to taxpayers carrying on certain types of business (such as primary production)
 The small business entity tax concessions are only available to a taxpayer carrying on a business in the year. Woellner 15-100.
 The non-commercial loss rules may prevent deductions in certain circumstances. Woellner 11-550.

The common law tests for determining whether a business exists

I. System and Organisation:
 Were the business methods and procedures ordinarily used in that field applied? Case T 58 (1968)
 Ferguson v FCT (1979) *Krever, 170
 FCT v Walker (1985) *Krever, 171
 If an activity is primarily enjoyable, a higher level of system and organisation will be required to prove that it constitutes a business –
Brajkovich v FCT (1989) *Krever, 46

II. Size and Scale of Activities

Thomas v FCT (1972)  Business may still be small
*Krever, 169
Ferguson v FCT (1979)  5 cows

FCT v Walker (1985)  one goat

 However, the larger the scale of the activity, the more likely it is to be a business

III. Sustained, Regular and Frequent Transactions

 Most business engage in frequent and regular transactions to maximise turnover
 “One-off”/ Isolated transactions can also constitute a business:
o Rutledge v IRC (1929) **
o Whitfords Beach Pty Ltd v FCT (1982) *Krever, 50

IV. Profit Motive

The ATO’s view is that the “prospect of profit” is a very important indicator” : Taxation Ruling TR 97/11 para 47
 Ferguson v FCT (1979): Immediate profit not necessary – even for a very small preliminary business
 Brajkovich v FCT (1989): The taxpayer had a strong profit motive – yet was found not to be in business – WHY?
Must there be a reasonable prospect of a profit?
 Daff v FCT (1998): The fact that a venture fails commercially, does not prevent it from qualifying as a business
 V. Commercial Character of Transaction
 Is the person willing to trade on the open market (i.e. – with anyone?)
 Often important where a taxpayer has lent money to a related party and claims it is in the business of lending money:
Case No S39 (1966)
FCT v Bivona P/L (1989) (both Woellner 6-100)

VI. Characteristics or qualities of Property dealt in

 If goods are inherently unsuitable for domestic purposes, more likely to be a business

Identification of a Business: Other Issues

i) Illegal transactions can constitute a business: FCT v La Rosa (2003) - drug dealer *Krever, 166
iii) It is not necessary for the taxpayer to conduct the business personally. It can be run by a manager: Ferguson v FCT (1979)
v) A business can exist where a person converts her/his talent into a business: Stone v FCT (2005) *Krever, 47
vii) In weighing up the various factors, the Court will look at the substance of the transactions: Deane v Crocker (1982)** - Woellner 6-150

Tax Treatment of Business Income

1) Normal Proceeds of Business Operations
 The test in Californian Copper Syndicate Ltd v Harris (1904)
 Applications of the normal business proceeds test
2) Profits from Isolated or Extraordinary Transactions
3) Non Cash Benefits

Tax Treatment: Normal Proceeds of Business Concept

The test in the Californian Copper Syndicate Case
 Normal proceeds of business operations are assessable as ordinary income under section 6-5 ITAA97.
Test: To determine whether a receipt is part of the normal proceeds of a business:
STEP 1 – Ascertain the scope of the taxpayers business; and
STEP 2 – The relationship between the business and the transaction

Interpret the scope in a wide or narrow way?

 GP International Pipecoaters: wide interpretation – taxpayer assessable
 Merv Brown: narrow interpretation – taxpayer not assessable.
Woellner 6-420

Trading Stock (Div 70 ITAA 97)

 Definition sec 70-10 ITAA 97: -- “Trading stock:
a) includes anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary
course of business; and
b) livestock” .

The trading stock provisions deal with the ascertainment of:

 how much of an amount is income and / or deductible; and
 when amounts are assessable as income and allowable as deductions.
NOTE: Students need a basic understanding of how these rules operate.
Read Woellner 14-000 to 14-060, and study slides 34 to 41 in this presentation

INCIDENTAL RECEIPTS OF A BUSINESS:

Examples include:
 Compensation payments – see slides 29 to 32
 Bounties and Subsides received by a taxpayer who is carrying on a business are assessed under section 15-10 ITAA97
A bounty is a gift or sum paid as a state reward, while a subsidy is a sum paid by the government or a public body to artificially
maintain prices at a desirable level.
o FCT v Squatting Investment Co Ltd (1954)**
o R&D grant to a manufacturing company
o Seniors Employment Incentive Payment – “Restart”: (ATSM, 25thed, p. xxiv)
 Foreign exchange regime Div775 ITAA97 – Woellner 22-300

Income From One-off or Isolated Transactions

Originally, the “mere realisation” of a capital asset, even to its best advantage including improvements, was held to yield a non-assessable
capital profit
Scottish Australian Mining Co Ltd v FCT (1950) *Krever, 48

Inclusion of Profits into Assessable Income

Statutory Provisions
FCT v Whitfords Beach P/L (1982)
Woellner 6-490
Extraordinary Transactions and the Ordinary Course of a Taxpayers Business
FCT v The Myer Emporium (1987) Woellner 6-440 to 6-455
 Myer lent $80m to its subsidiary Myer Finance as part of a plan to diversify its business operations
 Myer was entitled to receive an income stream over a 7 year period at an interest rate of 12.5% on the loan – totalling $72 million
 It assigned the right to receive the income stream to Citicorp, in return for a lump sum of $45.37m

Issue:
Was the amount of $45.37m received by Myer from the assignment of future interest payments assessable income to Myer under
section 6-5 ITAA97 (formerly sec 25(1) ITAA36) or sec 26 (a) ITAA36?

$45.37m was not assessable as normal proceeds of the business because Myer Emporium had entered into an extraordinary
transaction.

First Strand of Myer

High Court said that a profit or a gain arising from an extraordinary transaction (i.e., not part of the taxpayer’s ordinary business
activities) will be ordinary income:
 if the taxpayer’s intention or purpose in entering into the transaction was to make a profit or gain;
 notwithstanding that the transaction was extraordinary;
 if the property generating the profit or gain was acquired in a business operation for the purpose of profit-making by the means
giving rise to the profit.
 Read the High Court statement of principle at Woellner 6-445.

 The first strand of the Myer principle has been applied to lease incentives
 Common arrangement – taxpayer (e.g. firm of accountants) is paid large sum in return for agreeing to lease business premises—
landlord happy because gets “big name” tenant: – Are the partners in the firm assessable on their share of the payment?
FCT v Cooling (1990) *Krever, 64 - $162,000 -- assessable
Selleck v FCT (1996) *Krever, 68 – $1.06 million - not assessable
Lees & Leech v FCT (1997) *Krever, 66 – $40,000 contribution to the cost of fitting out a shop - not assessable
FCT v Montgomery (1999) *Krever, 70 - $21.77 million
 Taxation Ruling IT2631: Lease Incentives
 Westfield Ltd v FCT (1991) *Krever, 60 - imposed certain restrictions on the applicability of the Myer principle (Woellner 6-445)

Second Strand of Myer

Exchanging a lump sum for an income stream
 High Court said that, where a lender sells a mere right to interest for a lump sum:
 “the lump sum is received in exchange for, and ordinarily as the present value of, the future interest which he would have
received, and
 this is a revenue not a capital item – the taxpayer simply converts future income into present income.”
Application of the second strand: Henry Jones IXL 1991
Woellner 6-455

Non-Cash Benefits
Sec 21A ITAA36
Enacted to overcome the effect of the decision in Cooke & Sherden (1980) -- retailers won a holiday package that was not
transferable nor convertible into cash – not ordinary income because not money or convertible to money
Where a non-cash benefit is income derived by a taxpayer in respect of a business relationship:
 it will be treated as if it is convertible into cash; and
 the assessable amount for the taxpayer is the arm’s length value (i.e., market value) of the benefit.

Section 21A ITAA36: exceptions

Circumstances in which a non-cash benefit is not treated as convertible to cash
1) If the taxpayer had incurred the cost of the benefit it would have been deductible (sec 21A (3)).
2) If the expense is non-deductible entertainment expenditure to the provider: s.21A (4)
3) If the total value of the non-cash business benefits received by the taxpayer in the year is less than $300 (section 23L(2))
 MODULE 3: COMPENSATION PAYMENTS
The compensation principle: a compensation receipt generally takes the character of the item it replaces (Meeks).
-- Sommer (2002)
-- Sydney Refractive Surgery Centre (2008): *Krever, 93
Woellner 6-800 and 6-805
Insurance or indemnity for the loss of assessable income – may be assessable under s 15-30 ITAA97 if not ordinary income
 Examples:
Compensation for the loss of income or profits
FCT v DP Smith (1981) Woellner 10-450

Compensation Payments
1) Compensation for the cancellation of business contracts
Allied Mills (1989) *Krever, 98
But Cf: Van den Berghs (1935) *Krever, 95– cancellation of a “structural” agreement
2) Compensation for lost trading stock
FCT v Wade (1951) *Krever, 270
Sec 70-115 – includes such amounts in assessable income
3) Reimbursements received in the course of business:
a reimbursement received by a business of a loss or outgoing is statutory income if that loss or outgoing was claimed as a
deduction -- Subdivision 20-A ITAA97 Woellner 3-420.
4. Compensation for the loss of a depreciating asset
Compensation received by a business for the loss of a depreciating asset will give rise to a balancing adjustment under the
capital allowances regime.
Memorex P/L v FCT (1987) – read **Krever, 99
The term “depreciating asset” generally excludes buildings
5. Compensation received for the loss of a capital asset which is not a depreciating asset
Compensation received by a business for the loss of an asset – which has been permanently disabled would be capital in nature.
Glenboig Union Fireclay (1922) *Krever, 89 – permanent loss of a fixed asset Van den Berghs (1935) *Krever, 95 – cancellation of a
“structural” agreement
If received post-19 September 1985, the payment may be liable to capital gains tax: – ie, CGT event C2 – sec 104-25

Apportionment of Composite Receipts

1) Lump sum payments that represent compensation in part for assessable items and in part for non-assessable (capital) items are:
Assessable where a separate amount of income is identifiable and quantifiable: Federal Wharf (Company) Ltd v FCT
(1930)
Treated as capital in nature where a lesser sum is accepted in compromise of wholly unliquidated claims: McLaurin v
FCT (1961) *Krever, 90
2) Compensation received as an undissected lump sum for the settlement of rights of action accruing post–19 September 1985 may
be liable to capital gains tax: CGT event C2 – sec 104-25

Student Tasks
 Read the ATSM (27th edition) for sample questions on the following topics for your own private study:
o Section 15-15 –Profit making schemes:- question 33 (part 3);
o Non Cash Business Benefits: - questions 33 (parts 1 & 4), 39, and 82
o Compensation Payments:- questions 2, 12, 30, 33, & 35

Type of incentive Tax result

Cash payment Fully assessable
Rent-free periods and rent discounts Non taxable if rent or higher rent would have been deductible to lessee: s21A(3)
Interest-free loans Effectively tax-free, provided they are genuine business loans
Free fit-outs If landloard owns the fit-out – not taxable:s21A(3)
If tenant owns the fit-out – assessable but depreciation allowed
Free plant eg. Computers Assessable to lessee but depreciation allowed
Holiday packages Complete packages effectively tax-free to the tenant
Removal expenses Generally fully assessable
Surrender payments Generally fully assessable

TAX RATES ON BUSINESS INCOME

1): Entities Using the Corporate Structure

Standard Corporate tax rate – 2016/17 and earlier years 30%
Two-tiered Company Tax Rate
From 1 July 2015
a): Standard Corporate tax rate: 30%
(i.e. – For companies whose turnover is more than $20 million)

b): Incorporated SBE’s 28.5%

2): Unincorporated SBE’s
Sole traders, Partnerships, & Trusts 5% tax discount – provided as a tax offset that will apply to income
tax payable on business income – (capped at $1,000 per individual
per year)
 MODULE 4: INCOME FROM PROPERTY

INCOME FROM PROPERTY

ANNUITY:
 Purchase the right to an income stream e.g. Transfer $200,000 lump sum on retirement to insurance company – guaranteed
certain amount each year for life – amount depends on life expectancy.
 Section 27H ITAA 36 – amount of annuity received in a year divided into:
1) return of capital – tax free
2) interest - taxed

INTEREST- TAXATION TREATMENT:

Generally taxed as ordinary income – Section 6-5.
 Interest Offset Accounts: Taxation Ruling TR93/6;
 Interest on early/overpayment of tax;
 Interest on late/underpayment of tax: see- General Interest Charge - Woellner 33-040
 Interest from overseas – (gross up to include foreign tax paid) before including in assessable income; and…
 Interest on Children’s Savings Accounts: Taxation Ruling IT 2486 – Test: “Whose money is it?”

Leases & Rental Income

Rent Premium

Periodic payments made by a tenant A payment made to be given access (for the
for the use of property grant/assignment of a lease) to a particular premises

Income Capital in nature

Royalties
Periodic payments for the right to:-
 use intangible personal property (intellectual property), or
 exploit natural resources

Common Law Royalties – Characteristics

 Paid for the right to exercise a privilege
 Payable when the privilege is exercised (if there is no use there is no payment)
 Payment is measured by the quantum of the benefit (the more it is used the more paid); and
 Paid to the owner of the right

The tax treatment of royalties raises issues relating to the distinction between income and capital
Cases:
McCauley 1944 * Krever 105
Stanton 1955 * Krever 106

Assessable Provisions: Royalties are either assessable under:

Section 6-5 – assesses the common law royalties;
Extended meaning of Royalties
Section 15-20: This section extends the ordinary meaning of a royalty by providing a technical meaning to the definition
The scope of the technical meaning was considered in FCT v Sherritt Gordon Mines Ltd (1977) – Woellner, (23rd ed), 5-520

DIVIDENDS
 The treatment of dividends has been made more complicated by the statutory definition of a dividend in s 6(1) ITAA 1936
 The notion of a “deemed dividend” under the legislation means that it is no longer necessary for the recipient of the deemed
dividend to be a shareholder.
 The taxation of dividends will be covered in detail in Lecture 11.