LWB364 Introduction to Taxation Law[7] (1)

LWB364 Taxation Law Semester 1 - 2010 Matthew Robinson IndexPage INTRODUCTION TO TAXATION LAW...........................................................................................................5 1. TAX SYSTEM.....................................................................................................................................................5 2. THE ADMINISTRATIVE SYSTEM.........................................................................................................................5 INCOME TAX.........................................................................................................................................................7 1. INTRODUCTION..................................................................................................................................................7 2. RESIDENCE........................................................................................................................................................7 .2.1.Essentials..................................................................................................................................................7 .2.2.Is an Australian resident?...................................................................................................7 3. WHAT INCOME IS ASSESSABLE?......................................................................................................................11 .3.1.General rule: Is it ordinary income?.....................................................................................................11 .3.2.How to determine ordinary income from first principles.......................................................................11 .3.3.Personal exertion...................................................................................................................................13 .3.4.Income from property.............................................................................................................................15 .3.5.Business..................................................................................................................................................16 .3.6.Is it statutory income?............................................................................................................................24 .3.7.Is it exempt income?...............................................................................................................................24 .3.8.Non-assessable, non-exempt income?....................................................................................................24 .3.9.Conflict rules / double counting.............................................................................................................24 4. DERIVATION OF INCOME.................................................................................................................................25 5. SOURCE OF INCOME........................................................................................................................................26 .5.1.Introduction............................................................................................................................................26 .5.2.Source Rules...........................................................................................................................................26 6. ALLOWABLE DEDUCTIONS..............................................................................................................................28 .6.1.General deductions................................................................................................................................28 .6.2.Specific Deductions................................................................................................................................36 CAPITAL GAINS TAX........................................................................................................................................45 1. KNEECAPS.......................................................................................................................................................45 2. STATUTORY INCOME.......................................................................................................................................46 3. HAS THERE BEEN A CGT EVENT?...................................................................................................................46 .3.1.What event?............................................................................................................................................46 4. IS A CGT ASSET?.............................................................................................................................47 .4.1.Definition of CGT Asset.........................................................................................................................47 .4.2.Collectable assets...................................................................................................................................47 .4.3.Personal use assets.................................................................................................................................48 5. TIMING & CALCULATION................................................................................................................................48 .5.1.Acquisition date generally......................................................................................................................48 .5.2.A1...........................................................................................................................................................50 .5.3.C1...........................................................................................................................................................50 .5.4.D1...........................................................................................................................................................50 .5.5.F1...........................................................................................................................................................51 .5.6.I2.............................................................................................................................................................51 6. IS THERE AN EXEMPTION / SPECIAL RULES?....................................................................................................51 .6.1.Certain assets.........................................................................................................................................51 .6.2.Main residence.......................................................................................................................................52 .6.3.Deceased estates....................................................................................................................................60 .6.4.Deemed separate assets.........................................................................................................................61 .6.5.Marriage breakdown..............................................................................................................................61 7. CAPITAL PROCEEDS........................................................................................................................................64 .7.1.General rule...........................................................................................................................................64Matthew Robinson LWB364 Introduction to Taxation Law 1

.7.2.Modification...........................................................................................................................................64 8. COST BASE......................................................................................................................................................66 .8.1.Ordinary cost base.................................................................................................................................66 .8.2.Reduced cost base..................................................................................................................................70 .8.3.Is indexation available?.........................................................................................................................70 .8.4.Discount.................................................................................................................................................70 .8.5.Discount v indexation comparison.........................................................................................................70 9. ANTI-OVERLAP PROVISIONS............................................................................................................................72 10. CGT CALCULATION......................................................................................................................................72 GOODS AND SERVICES TAX..........................................................................................................................73 1. IS REQUIRED TO BE REGISTERED?.............................................................................................73 .1.1.Carrying on an enterprise......................................................................................................................73 .1.2.Turnover threshold.................................................................................................................................73 2. IS IT A TAXABLE SUPPLY?..............................................................................................................................75 .2.1.Did make a supply?............................................................................................................75 .2.2.Was the supply for consideration?.........................................................................................................75 .2.3.Was it made in the furtherance of an enterprise the taxpayer carries on?............................................76 .2.4.Is there a connection to Australia?........................................................................................................76 .2.5.Is the taxpayer registered/required to be registered?............................................................................77 .2.6.The supply is not GST-free or input taxed..............................................................................................77 3. GST PAYABLE.................................................................................................................................................78 4. IS IT A CREDITABLE ACQUISITION?................................................................................................................78 .4.1.Acquisition..............................................................................................................................................78 .4.2.Creditable purpose.................................................................................................................................79 .4.3.It is a taxable supply...............................................................................................................................79 .4.4.You provide consideration.....................................................................................................................79 5. INPUT TAX CREDITS........................................................................................................................................79 6. TOTAL GST LIABILITY....................................................................................................................................80 FRINGE BENEFITS TAX...................................................................................................................................81 1. HISOTRY..........................................................................................................................................................81 2. FRINGE BENEFIT & S ASSESSABLE INCOME..............................................................................81 3. LIABILITY TO PAY...........................................................................................................................................81 4. IS THERE A FRINGE BENEFIT?..........................................................................................................................81 .4.1.Benefit.....................................................................................................................................................81 .4.2.Excluded benefits....................................................................................................................................81 .4.3.Provided during the FBT year...............................................................................................................82 .4.4.Provided by employer, associate, 3rd party arranger...........................................................................82 .4.5.Provided to an employee or an associate of the employee.....................................................................82 .4.6.In respect of the employment of the employee........................................................................................82 5. WHAT IS THE TAXABLE VALUE OF THE FRINGE BENEFIT?..............................................................................83 .5.1.Taxable value.........................................................................................................................................83 .5.2.Reductions..............................................................................................................................................83 6. FBT LIABILITY................................................................................................................................................84 .6.1.Fringe benefits provided........................................................................................................................84 .6.2.Grossing up............................................................................................................................................84 .6.3.Total FBT Liability.................................................................................................................................84 7. DEDUCTIBILITY OF FBT..................................................................................................................................84 8. ADMINISTRATIVE ISSUES................................................................................................................................85 OTHER CLASSES OF TAXPAYER..................................................................................................................86 1. PARTNERSHIPS................................................................................................................................................86 .1.1.Does a partnership exist?.......................................................................................................................86 .1.2.Interest in profit/loss..............................................................................................................................86 .1.3.Calculation.............................................................................................................................................87 2. TRUSTS............................................................................................................................................................88 .2.1.Types of trust..........................................................................................................................................88 .2.2.Net income of the trust (NITE)...............................................................................................................88 .2.3.Who is taxed?.........................................................................................................................................89 .2.4.Transfers of losses..................................................................................................................................92 .2.5.Anti-avoidance.......................................................................................................................................92Matthew Robinson LWB364 Introduction to Taxation Law 2

3. COMPANIES.....................................................................................................................................................93 .3.1.General rules..........................................................................................................................................93 .3.2.Residency................................................................................................................................................93 TAX EVASION AND TAX PLANNING............................................................................................................95 1. TAX PLANNING V AVOIDANCE........................................................................................................................95 2. ANTI-AVOIDANCE PROVISIONS........................................................................................................................95 3. MITIGATING UNCERTAINTY............................................................................................................................96 4. EXAMPLES.......................................................................................................................................................96

Matthew Robinson

LWB364 Introduction to Taxation Law

3

General process for answering general questions

Matthew Robinson


4

Introduction to Taxation Law 1. Tax systemTax is a compulsory levy of money that doesnt directly (or possibly indirectly) confer a benefit. Taxes can be either direct or indirect. Direct taxes are imposed directly on a person, whereas indirect taxes are not. Taxes may be either progressive or regressive. Progressive taxes are those that a positively correlated with the money a person earns, whereas a regressive tax is not necessarily correlated with a persons income. A good taxation system should aim to achieve simplicity, equity, and economic growth. Section 53 of the Constitution only permits the House of Representatives to pass and amend tax legislation. Due to section 55 of the Constitution, the tax scheme is divided into separate pieces of legislation:

Income Tax Assessment Act 1936 (Cth) (ITAA 1936); Income Tax Assessment Act 1997 (Cth) (ITAA 1997) this act has a pyramid structure, but is incomplete because of a lack of funding; Income Tax Rates Act 1986 (Cth) (ITRA) Taxation Administration Act 1953 (Cth) (TAA) Pyramid structure core provisions at the front of the legislation Robust numbering system Asterisk for defined terms Explanatory guides before Divisions Method Statements (see sec 4-15) Plain English Diagrams (see s 6-1)

Features of the ITAA 1997:

2.

The administrative system

The ATO has a national office in Canberra, and branch offices in each State & Territory. The ATO is headed by the Commissioner of Taxation, who has the power of administration of the tax acts (TAA s 3A and ITAA 1936 s 8). There are Second Commissioners (s 4), Deputy Commissioners (s 7) and Assistant Commissioners. The power of the Commissioner may be delegated (and the delegate can act in their own name), and authorised (a person may be authorised by the delegate to exercise power in the name of the delegate). The rulings system, is not delegated legislation, however it has some binding effect. A rulingMatthew Robinson LWB364 Introduction to Taxation Law 5

may be relied upon in good faith by a taxpayer ie a taxpayer cannot be prejudiced by reliance. However, the ruling is not binding upon a taxpayer who does not comply with it. There are public rulings (Division 358 Schl 1 TAA) and private rulings (Division 359 Schl 1 TAA). Public rulings regard matters of general tax interest and uses a sequential numbering system ie TR 2008/1. Private rulings apply to taxpayer specific issues. They are published on the ATO website as an edited version.

Matthew Robinson


6

Income Tax 1. IntroductionIncome tax must be paid for each financial year (ITAA 1997 s 4-10(1)). Income tax is calculated as: Income Tax = (Taxable Income x Rate) Tax Offsets (ITAA 1997 s 4-10(3)). A persons taxable income is: Taxable Income = Assessable Income Deductions (ITAA 1997 s 4-15(1)).

2.

Residence .2.1. Essentials

The assessable income of an Australian resident includes the ordinary income derived by the taxpayer, directly or indirectly, form all sources, whether in or out of Australia, during the income year (ITAA 97 s 6-5(2)). Assessable income also includes statutory income (ITAA s 6-10). The assessable income of a non-resident includes:

Ordinary income derived directly or indirectly from all Australian sources during the income year (ITAA 1997 s 6-5(3)(a)); Other ordinary income that a provision includes in your assessable income for the income year on a basis other than having an Australian source (ITAA 1997 s 6-5(3) (b)); Statutory income derived from all Australian sources (ITAA 1997 s 6-10(5)(a)); Other statutory income that a provision includes in your assessable income for the income year on a basis other than having an Australian source (ITAA 1997 s 6-10(5) (b)).

.2.2.

Is an Australian resident?

The residence of is determined from year-to-year (ITAA 1997 s 4-10). Australian resident means a person who is an Australian resident under the ITAA 1936 (ITAA 1997 s 995). ITAA 1936 s 6(1) enunciates 4 tests of residency:

common law test of residency; domicile test (ITAA 1936 s 6(1)(a)(i)); 183 day test (ITAA 1936 s 6(1)(a)(ii)); superannuation test {unlikely to need} (ITAA 1936 s 6(1)(a)(iii)).

Here, because the issue is whether has become a resident (from a non-resident), we must satisfy either the common law test or 183 day rule. Here, because the issue is whether has ceased to be a resident (was previously a resident) we must satisfy either the common law test or domicile test.Matthew Robinson LWB364 Introduction to Taxation Law 7

()a

Common law test of residency {Incoming or outgoing}The common law test of residence relies on the ordinary meaning of reside to determine residency. TR 98/17 at [14] adopts the dictionary definition of reside, being to dwell permanently or for a considerable time, or to be settled, or have ones usual place of abode in a particular place. Residency is a question of fact and degree (TR 98/17 at [9]). Events after the financial year may assist in determining residency status (FC of T v Applegate (1979) 9 ATR 899). The Commissioner considers 6 months to be a considerable amount of time for the purposes of this test, but this is not determinative (TR 98/17 at [22]). Relevant factors may include:

physical presence in Australia (TR 98/17 at [18]) frequency, regularity and duration of visits intention and purpose of visit (TR 98/17 at [20]) if the intent is to stay less than 6 months, but is extended beyond that, they are considered residents from their arrival (at [25]) maintenance of a home in Australia during absences (TR 98/17 at [20]) family and business ties in a particular country (TR 98/17 at [20]) present habits and way of life (TR 98/17 at [20]) nationality

Levene v IRC [1928] AC 217The taxpayer lived in London from 1918 1920. The taxpayer then sold house and floated around UK then lived overseas & UK until 1925. Where was his usual place of abode? Was not a resident until he signed a lease. Relevant factors included maintaining ties with the UK, purpose of travels, intent to return to UK, etc.

IRC v Lysaght [1928] AC 234

()b(a)

Domicile test {outgoing}Preliminary is a resident if their domicile is Australia, unless the Commissioner is satisfied that their permanent place of abode is outside Australia (ITAA 1936 s 6(1) (a)(i)). A person may have domicile by origin {fathers domicile at time of birth}, choice or operation of law. Here, s domicile is Australia, so we must determine whether they have a permanent abode outside Australia. Here, has chosen to permanently reside in , meaning that he/she is not an Australian resident on this test (FC of T v Applegate).

Matthew Robinson


8

(b)

Abode outside Australia? will not be a resident if the Commissioner is satisfied that they have a permanent place of abode outside Australia. The ordinary meaning of abode is a persons home/residence. This does not require an intention to move forever, however it must not be transitory (Applegate). A stay for a fixed term in another country does not prevent it from constituting a permanent place of abode (FCT v Jenkins). Per IT 2650 at [23], relevant factors may include:

Intented and actual length of stay 2 years is likely to constitute a permanent place of abode, whereas less than 2 years is likely to be considered transitory. Abandonment of place of abode in Australia Acquisition of place of abode outside Australia Intention to make place of abode 'home' Nature and quality of use made of place of abode Duration and continuity of presence in place Durability of association (ties) with place

Here, [does OR does not] have a permanent place of abode outside Australia.

(c)

ConclusionHere, [is OR is not] a resident of Australia.

FC of T v Applegate 79 ATC 4307Facts: A solicitor set up a new firm in Vanautu, with the intention of staying indefinitely. He gave up leased property in Australia and leased a home in Vanautu. He still retained life insurance etc in Australia. His wife returned to Australia. The Commissioner argued that the solicitor did not have a permanent place of abode outside of Australia. Held: The court held that permanent place of abode did not require a permanent move (because otherwise it would have been domicile by choice), thus permanent meant something less than forever. There must be a strong connection, but it need not be forever.

FC of T v Jenkins 82 ATC 4098The taxpayer was an employee of a bank, and had been transferred overseas for a period of 3 years. He returned after only 18 months due to ill health. The taxpayer had unsuccessfully tried to sell his house prior to leaving Aus, so instead rented it, having an Aus bank account to collect rent. The bank paid for storage of his furniture. It was held that the Taxpayer did have an abode outside of Australia.

()c

183 day test {incoming}A person will become a resident if they have been in Australia for more than half the year (183 days), unless:

Matthew Robinson


9

their usual place of abode is outside Australia; and they do not intend to take up residence.

(ITAA 1926 s 6 (1)). The 183 days must be in the income/financial year. The 183 days may be continuous or intermittent. It is uncertain whether you become a resident for the whole, or only part of the year (see text at 24-056). Usual abode Usual abode may be something less than permanent. The ordinary meaning of abode is a persons home/residence. Per IT 2650 at [23], relevant factors may include:

Intented and actual length of stay 2 years is likely to constitute a permanent place of abode, whereas less than 2 years is likely to be considered transitory. Abandonment of place of abode in Australia Acquisition of place of abode outside Australia Intention to make place of abode 'home' Nature and quality of use made of place of abode Duration and continuity of presence in place Durability of association (ties) with place

Here, [does OR does not] have a usual place of abode outside Australia.

()d

Superannuation testThe superannuation test applies to a(n):

Member of Superannuation scheme est. by deed under the Superannuation Act 1990; or eligible employee for the purposes of the Superannuation Act 1976; or spouse, or child under 16 covered by points 1 and 2 above.

This covers people such as embassy staff overseas.

Matthew Robinson


10

3.

What income is assessable?

A persons income is comprised of ordinary and statutory income (ITAA97 s 6-1). Process for determining whether it is assessable income: 1 2 3 4 Is the income ordinary income? Is the income statutory income (ie does a specific assessing provision apply)? Is it exempt income? {ie through specific provision or residence & source rules} If it does not fit into any of these, it is non-exempt, non-assessable income.

.3.1.

General rule: Is it ordinary income?

Assessable income includes ordinary income derived from [all sources {for Australian residents} OR Australian residents {for foreign residents}] (ITAA97 s 6-5). Ordinary income is determined according to the ordinary concepts and usages of mankind (ITAA s 6-1; Scott v C of T (NSW)). According to this concept, income is seen as a flow, but not the proceeds from the sale of an asset (Eisner v Macomber).

.3.2. How to determine ordinary income from first principlesWhere the receipt does not fit within an established category, we must examine a range of factors to determine whether it is ordinary income.

()a

RegularityOrdinary income will ordinarily exhibit periodicity, recurrence and regularity (FCT v Dixon {The taxpayers employer agreed to pay staff the difference between what their normal wageand what they earned in the armed forces. The payment was voluntary on the part of the employer. The court held that the payments were ordinary income because they were regular, periodic and the taxpayer relied upon them for his livelihood}; Keily v FCT {aged pension is income}).

Regularity is not decisive (Kelley v FCT {The taxpayer received a prize for best and fairest.Despite being irregular, the court held that the income was ordinary income because the taxpayer was contractually obliged to pay his best at all times and this gave it a clear nexus with his employment }).

One-off lump sums from profit making schemes have been held to be income (FCT v The Myer Emporium Ltd). Conversely, periodic payments representing payment for the purchase price of capital have been held to be capital in nature (Foley Fletcher). Here, ________________.

()b

Nexus with earning activityAn receipt will usually be ordinary income if it has a nexus with an earning activity. As such, windfall gains and gifts will not have a sufficient nexus. An expectation of receipt may aid in establishing the nexus. {see issues with voluntary payments at below} Here, _________________.

Matthew Robinson


11

()c

Comes to the taxpayer beneficiallyThe receipt must come in to the taxpayer beneficially (Tennant v Smith). Savings will not constitute an incoming receipt (Tennant v Smith {The taxpayersemployer rented an apartment, which the taxpayer lived in. The court held that this constituted a saving, and did not constitute a flow that comes in to the taxpayer.}).

A reduction in liability does not constitute ordinary income as it does not come in to the taxpayer (International Nickel Australia Ltd v FC of T). Amounts subject to a contingency do not come into the taxpayer beneficially (Case R107). In the course of business, saved expenditure may constitute income (FCT v Unilever Australia Securities Ltd). {Possibly look at fringe benefits.}

()d

Money or moneys worthUnder the common law the receipt must be money or moneys worth (Tennant v Smith). Case examples:

Tennant v Smith: The accommodation provided by an employer was not convertible into money because the taxpayer could not sell convert the benefit into money. FCT v Cooke and Sherden: A soft drink manufacturer gave away a holiday to encourage businesses to sell more soft drink. Because the tickets were not transferable, the tickets could not be converted into money and the tickets were therefore not moneys worth. Payne v FCT: The taxpayer accrued frequent flyer points through work. This was held not to be moneys worth because it could not be converted into money.

Statutory modification Section 21 ITAA36 deems non-cash benefits to be convertible into cash, at the value of the consideration provided. Section 21A ITAA36 deems non-cash business benefits to be convertible into cash, at its arms length value. Section 15-2 ITAA97 makes the value of benefits in respect of employment assessable income regardless of whether they are convertible into money {Statutory income}.

()e

Characterised in the hands of the recipientThe receipt must be characterised in the hands of the taxpayer, not by reference to another person or the expenditure that produced the receipt (Federal Coke Co Pty Ltd v FCT; FCT v McNeil). The relevant time to assess the character is at the time it is received (Constable v FCT).

Matthew Robinson


12

()f

Measured on a gross basisThe income is the gross receipt (ss 6-5, 6-10 & 6-15 ITAA1997 & FCT v James Flood Pty Ltd).

.3.3.()a

Personal exertion

Wages and salariesIncome from personal exertion (such as salary and wages) are generally ordinary income (ITAA36 s 6(1); Dean & Anor v FCT). There must be a connection between the receipt and the services rendered (FCT v Dixon).

()b

Voluntary paymentsVoluntary payments may constitute ordinary income. Where the receipt is incidental to employment, or the person is entitled by custom or employment contract, the amount will usually be income (Moore v Griffiths). {Christmas bonuses often fall into this category} Tips have been held to be income despite not legal obligation (Calvert v Wainwright {Tips received by taxi driver}). Key factors to consider are:

the degree of connection to employment or services rendered reasonable expectation payment would be made dependence upon payment to meet usual living expenses payment replaces income motive of the payer or donor (Hayes v FCT {not decisive}) periodical, concurrent and regular money or convertible into money

Case examples: Case S17: Prizes received from a quiz shoe because of a taxpayers skill and knowledge was held to be income. Hayes v FCT: The taxpayer received shares for giving casual financial advice to the donor, after an employment relationship had ceased. This was held not to be income because it could not be related to any income producing activities and the taxpayer was not in the business of providing financial advice. Scott v FCT: Solicitor received a gift from a client after many years of dealings. The receipt was not income because there was no link to services render, and was motivated by a personal relationship. It was irrelevant that the generosity was inspired by gratitude built up by services rendered. FCT v Harris: A former bank employee received a one-off sum of $450 toLWB364 Introduction to Taxation Law 13

Matthew Robinson

off-set the effects of inflation on his pension. This was held not to be income. Sporting case examples:

Moorhouse v Dooland: Professional cricketer was entitled under his contract to collections from the crowd for very good performances, and received 11 in the year. This was held to be income. Kelly v FCT: The taxpayer received a prize for best and fairest. Despite being irregular, the court held that the income was ordinary income because the taxpayer was contractually obliged to pay his best at all times and this gave it a clear nexus with his employment. Moore v Griffiths: The taxpayer, a member of the UK soccer World Cup squad, was paid a bonus. The bonus was paid to all members of the squad regardless of performance or the number of games played. The Court held that it was not income because it was received after the performance of services, he did not know about it prior to the contract, it was not likely to re-occur and each player got the same regardless of performance. Reed v Seymour: A cricket received an amount from a testimonial match. The court held this was not income because the money was given on personal grounds, it was given to express gratitude, and he was not entitled to the payment. FCT v Stone: The taxpayer was a javelin thrower as well as a police officer. She claimed that prize money and grants were not subject to income tax because she was not carrying on the business of a professional athlete. The High Court held that the amounts were ordinary income, and her activities did constitute the operation of a business.

()c

Payments for restriction of rights (restraint of trade)Generally, payments to restrict rights are of a capital nature (Beaks v Robson; Higgs v Olivier {paid not to appear in any movie for 18 months. this was held not to be income.}). {Note possible CGT implications CGT Event D1} If the employment contract and restriction operate concurrently, it is more likely to be income (Riley v Coglan). The substance of the agreement is examined; where the employment contract and restriction are interdependent, this indicates the payment is income (Case D38). Restrictive covenants are more likely to be income if they are ordinary in the course of a profession (Higgs v Olivier; Case A14 {it was held to be common for professional footballers}; Cf Jarrold v Boustead {payment for rugby player to give up amateur status held to be a capital receipt}) The fact that the person is not obliged to pay the amount despite not performing services is an indicator of capital, but is not determinative (Woite {footballer undertook that he would not play AFL for any other club but did not obliged to play for that club}). The greater the burden on freedom, the more likely the payment is to be capital (Woite).

Matthew Robinson


14

()d

Compensation paymentsCompensation payments will take the form of the thing they replace (Van den Berghs Ltd v Clark; FCT v Dixon). Here, the is in the nature of [income OR capital] so will be [income OR capital].

()e

Illegal / immoral receiptsIllegal or immoral receipts may be ordinary income {ie prostitution, drug smuggling, topless dancers} (Lindsay & Ors v Inland Revenue Commissioners) However, deductions will not be allowed for illegal or immoral activities (ITAA97 s 26-54 {denies deductions for illegal activities}; FCT v La Rosa {tried to claim deductions for illegal or immoral activities}). [Not sure the extent to which illegal activities are defined, and deductions denied for these]

()f

Mutual receiptsReceipts by body corporate or clubs from members are not income, because they are effectively paying money to themselves (The Bohemians Club v FCT).

()g

Capital in natureIncome of a capital nature is not ordinary income (Brents Case { ie The taxpayer signeda book deal that required a number of interview. The taxpayer claimed that it was a sale of capital, ie information, but the court held that this was income. Part of the reasoning was that the requirement to be interviewed equated to a performance of a service.}).

Here, the receipt is a capital gain and not ordinary income. Here, the receipt is proceeds from the use of an asset, and therefore may be ordinary income.

.3.4.

Income from property

Income from holding property will often come within the concept of ordinary income. Here, the receipt is income as it is:

Rent from the lease of property (Adelaide Fruit) Interest Dividends (ITAA36 s 44) {Statutory} Royalties (ITAA36 s 6(1)) {Statutory}

Matthew Robinson


15

.3.5.()a

Business

Is carrying on a business?

A business includes any profession, trade, employment, vocation or calling, but is not occupation as an employee (ITAA97 s 995-1). Whether a person carries on a business is a question of fact and degree, based on numerous factors (Evans v FCT).

(i)

System and organisation of record keeping

An activity that is a business will generally be organised and have a system associated with it (Ferguson v FCT {A naval officer wanted to become a cattle farmer when heretired, so leased a couple of cows and was permitted to keep the calves they gave birth to. In doing so the taxpayer paid various expenses which he claimed as deductions. Despite only having 5 cows, and not being a big business, the taxpayer had systems and plans in place, so was held to be in business.}).

A system may be shown by:

(d)

use of accounting systems expert advice professional membership use of methods and procedures similar to other businesses.

Scale of activitiesA business generally operates on a scale beyond that of ordinary domestic needs (Rutledge v IRC {Taxpayer bought a large quantity of toilet paper, which he immediately sold at aprofits. This was held to be a business because the toilet paper was of a quantity that would not be purchased for ordinary domestic needs, contrary to the argument of the taxpayer}).

However, the scale of the business is not decisive, and a person may conduct it on a small scale (FCT v Walker {The taxpayer wanted to go into the goat business. The taxpayer hada female goat, but was not good at breeding and many goats ended up dying, so that at any one time there was only ever 3 goats alive. The taxpayer earned some income, but lost much more, claiming these deductions. The court held that the Taxpayer was in the business of breeding goats because it was carried on in a business like way through, inter alia, agreements with vets, reading journals and joining of a goat society}).

(e)

Sustained, regular and frequent transactionsA business is usually expected to have regular transactions over a lengthy period of time. However, the courts recognise that a business may go through ordinary periods of quiet. However, a sufficiently large one-off transaction will be sufficient (FCT v Sheild {thetaxpayer was employed with a finance company buying and selling shares. The taxpayer argued that he was not in a business because there were not sustained transactions. The court disagreed, holding that there was a business notwithstanding a lack of sustained transactions }).

(f)

Profit motiveBusiness is usually motivated by a profit motive, however the fact that a profit is orLWB364 Introduction to Taxation Law 16

Matthew Robinson

is not made is not decisive (Thomas v FCT {A barrister who worked full time planted fruitand nut producing trees. This was a long-term project because Avocado and Macadamia trees take a long time to produce fruit or nuts. The trees ended up being planted on unproductive land and no income was ever possible. The commissioner argued that it was only a hobby and the taxpayer could not claim the losses. However the court held that it wasnt a hobby, partly because the amount of fruit could not be used for domestic use. The fact that no profit was in fact available, did not prevent it from being a business}).

The absence of a profit motive is not decisive (FCT v Stone {Policewoman was also anOlympic athlete, who argued that athletics was undertaken for the enjoyment of it. She earned sponsorship. The court held that the taxpayer was in business despite no profit motive. }).

In Brackavich, the court held that the taxpayer was not in the business of gambling, and therefore not able to claim losses, despite having a profit motive, because inter alia, there were no records. The court found it irrelevant that the taxpayer had purchased a horse, because it believed that this was only to obtain inside information. In Spriggs v FCT; Riddle v FCT, the High Court held that footballers were in the business of sport, because they were commercially exploiting their football prowess to make money {this allowed them to claim management fees as deductions}.

(g)

Commercial character of transactionsA business will usually trade on the open market, on terms and conditions similar to other businesses. However, some businesses are inherently different; one example is the art business (TR2005/1).

(h)

Characteristics or quantities of property / taxpayerThere will not be a business where the goods (or quantity thereof) are inherently unsuited to domestic use (Rutledge v IRC).

(i) (j)

Inherent characteristics of the taxpayerA company may not engage in a hobby.

Other

(k)

Illegal transaction can constitute a business (FCT v La Rosa {drug dealing}; Partridge v Mallandaine {illegal gambling}) Being employed does not prevent you from carrying on a business in another area being compelled to do something does not prevent it from being a business

Common categories(a.A) Gambling

In Brajkobich, the court outlined 6 factors relevant in determining whether a person is in the business of gambling:

Matthew Robinson

is it conducted in a systematic, organised and businesslike way its scale (ie size of wins and losses) whether the betting is related to other business-like activities (ieLWB364 Introduction to Taxation Law 17

breeding horses)

a pleasure or profit motive whether the form of betting involves skill and judgment or purely chance whether the gambling activity in question is of a kind ordinarily thought of as a pastime or hobby. Evans v FCT In Brajkovich v FCT, the court held that the taxpayer was not in the business of gambling, and therefore not able to claim losses, despite having a profit motive, because inter alia, there were no records. The court found it irrelevant that the taxpayer had purchased a horse, because it believed that this was only to obtain inside information. Trautwein: The taxpayer was held to be in the business of gambling because he owned a number of horses and kept very clear records. Prince v FCT: Retired book-maker who gambled heavily was held to be in business.

Case examples:

(a.B)

Primary Production

Primary production: TR 97/11 Thomas v FCT {A barrister who worked full time planted fruit and nutproducing trees. This was a long-term project because Avocado and Macadamia trees take a long time to produce fruit or nuts. The trees ended up being planted on unproductive land and no income was ever possible. The commissioner argued that it was only a hobby and the taxpayer could not claim the losses. However the court held that it wasnt a hobby, partly because the amount of fruit could not be used for domestic use. The fact that no profit was in fact available, did not prevent it from being a business}

FCT v Walker {The taxpayer wanted to go into the goat business. Thetaxpayer had a female goat, but was not good at breeding and many goats ended up dying, so that at any one time there was only ever 3 goats alive. The taxpayer earned some income, but lost much more, claiming these deductions. The court held that the Taxpayer was in the business of breeding goats because it was carried on in a business like way through, inter alia, agreements with vets, reading journals and joining of a goat society}

Ferguson v FCT {A naval officer wanted to become a cattle farmer when heretired, so leased a couple of cows and was permitted to keep the calves they gave birth to. In doing so the taxpayer paid various expenses which he claimed as deductions. Despite only having 5 cows, and not being a big business, the taxpayer had systems and plans in place, so was held to be in business.}

(a.C)

Sports

Matthew Robinson

FCT v Stone {Policewoman was also an Olympic athlete, who argued that athletics was undertaken for the enjoyment of it. SheLWB364 Introduction to Taxation Law 18

earned sponsorship. The court held that the taxpayer was in business despite no profit motive.}

In Spriggs v FCT; Riddle v FCT, the High Court held that footballers were in the business of sport, because they were commercially exploiting their football prowess to make money {this allowed them to claim management fees as deductions}.

(a.D)

Artist

()b

Professional artist: TR 2005/1

Is the receipt business income?(i) Too soon / late?

Not all receipts are income because the taxpayer is carrying on a business.

Feasibility studies for a business that never eventuated was held to be too soon (Softwood Pulp {expenses relating to the establishing of a paper production facility were notdeductible, as they were held to be entirely preliminary and directed at deciding whether or not an undertaking would be established to produce assessable income.}).

Losses incurred during a break in the business are likely to be still claimable (ADC (Advances) Ltd {AD was in the money lending business, but stoped before later resuming. Theyclaimed bad debts as deductions. The ATO asserted that these were not claimable because the business was not continuing. However, the court held that the losses were referable to the business}).

(l)

Sale of assets / One-off & extraordinary transactionsTraditional approach Traditionally, the mere realisation of an asset is capital in nature, however where the sale occurs in the carrying out of the business and there is a sufficient nexus, the receipt will be income (Californian Copper Sundicate v Harris {The taxpayer was acopper miner who sold the land the mine was on after the copper reserves ran out. The taxpayer asserted that the sale was a mere realisation of the land and was not income. The court agreed.}; Scottish Australian Mining Ltd v FCT {Californian Copper was adopted by the High Court. In this case, the taxpayer carried on a mining business and sold the land when the coal reserves were exhausted in 1924. Upon deciding to sell the land, the company built roads, railways and granted land to the public for schools, hospitals & parkland. The taxpayer received large profits. The Commissioner argued that this was not a mere realisation, due to the additional work that the company did to bring the land to a saleable condition. The court held that the receipt was capital in nature, and the facts would need to be very strong in order to find that a business that was bought for a purpose other than making a profit by sale, was in the business of selling land.}).

In Californian Copper, the court adopted a 2 step test for determining whether a receipt from a sale of an asset was income:

What is the exact nature and scope of the business? Is there a nexus between the business and the receipt?

Proceeds from large-scale sub-division and development constitute income (FCT v Whitfords Beach Pty Ltd {involved subdivision, road works, installation of road lights and provision of parklands}; Cf Scottish Australian Mining although may beable to distinguish on the basis that was not the primary purpose of the land, rather was a way of acquiring the best price).

The court looks at the substance of the transaction and business, so that the sale ofMatthew Robinson LWB364 Introduction to Taxation Law 19

shares in the company, rather than the asset itself will not prevent the sale from constituting income if that was its true purpose (FCT v Whitfords Beach Pty Ltd {Agroup of developers wanted to purchase land, but in an attempt to avoid it being classified as income, purchased shares in the company that owned the shares. The company did not originally purchase the land with the intent of selling it to make a profit. This would have meant that the receipt would have been capital in nature. However the change of shares meant a change in the business of the company, so that the receipt was held to be income}).

New Approach However, the Californian Copper principle has potentially been broadened by Myer Emporium Ltd v FCT {There, to avoid a restrictive loan covenant, the company had to artificially borrow money off their balance sheet. To do this, the taxpayer sold subsidiaries and lent the money to a shelf company on commercial terms. The taxpayer sold the interest repayments to Citibank for $45 million. The taxpayer argued that the transaction was not income because it was a one-off transaction. However, the court held that the receipt was income. While they endorsed the logic behind Californian Copper, the court held that an extra-ordinary transaction does not preclude a the receipt from being income.}. Under this test, profits or gain realised in the ordinary course of business are income, in addition to certain receipts through extraordinary transaction (Myer Emporium v FCT). However, such a wide discrimen has been criticised given the capital / income distinction in the tax acts (FCT v Spedley Securities Ltd). Extraordinary transactions Relevant factors in determining whether the transaction is a business one are:

the Nature of the entity undertaking the transaction nature and scale of the activities the amount of money and profit involved complexity of the transaction manner it was entered into complexity of the transaction manner it was entered into connections between parties to the transaction nature of any property acquired or disposed of timing of the transaction or steps involved in the transaction.

(TR 92/3 at [13]; Myer Emporium; Westfiled Ltd v FCT). Where a not-insignificant purpose of the transaction is making a profit, it is likely to be income (FCT v Cooling; Cf where there is no intention: SP Investments Pty Ltd v FCT). The actual method the profit was made must relate to the profit making purpose contemplated when assets were purchased (Westfeild Ltd v FCT {Westfield bought landto develop into a shopping centre, but at a later stage sold the land to AMP ata profit. The court held that this was capital in nature because the purposes of the profit making venture (to develop and leaseMatthew Robinson LWB364 Introduction to Taxation Law 20

retail space) were different from the actual method of realisation}; TR

92/3 at [9]).

{as statutory provision, CGT will trump this, so even if it is ordinary income, you will apply CGT to get discount/index provisions}

(m)

Income conversionsAmounts received as compensation for lost income are themselves income (Myer Emporium Ltd v FCT). Factoring debts owed to the company, where the debts would be income, are income (FCT v Unilever Australia Securities Ltd).

(n)

Payments for restriction of rights (restraint of trade)Generally, payments to restrict rights are of a capital nature (Beaks v Robson; Higgs v Olivier {paid not to appear in any movie for 18 months. this was held not to be income.}). However, this will not always be the case, and the court will look at, inter alia, how regular such payments are in the industry. {Note possible CGT implications CGT Event D1} Agreements to sell certain products is capital in nature (Dickenson v FCT).

(o)

Banking, insurance and investment casesGenerally investments in the sale of income-earning investments are not assessed under s 6-5 ITAA97. However, the court makes exception for banks and insurance and investment companies. Although the assets are not trading stock, they are considered to be revenue assets. As such, the realisation of assets by these companies will be ordinary income (Colonial Mutual Life Assurance Society Ltd v FCT). However, not all sale of shares will come within this concept (National Bank of Australia v FCT {NAB acquired a Queensland bank through the purchase of shares. NAB later divested the bank, selling the shares at a profit. This receipt was held to be of a capital nature.}).

(p)

LeasingIf a company is in the business of leasing assets, they may also be in the business of selling the assets after the expiry of the lease making receipts income (Memorwx Pty Ltd v FCT), but not where there was no intention of sale (FCT v Hyteco Hiring Pty Ltd). Lease incentive payments are generally income (FCT v Cooling {received inducement to move solicitors premises to a new building. This was held to be income.}).

(q)

Intellectual propertyWhere the company is in the business of developing intellectual property for profit, the sale of it may be income, provided that sale was contemplated (Ducker v Rees Roturbo Development Syndicate {Set up to develop IP. Main revenue was royalties from licensing, but also contemplated sale. This was held to be income. }; Cf Moriarty v Evans Medical Supplies Ltd {drug supplier sold the secret processes to make drugs to the Burmese government. This was held to be capital in nature.}).

Matthew Robinson


21

()c

Trading stockBecause is carrying on a business, the level of trading stock will affect their assessable income. This ensures that the business assessable income and allowable deduction accurately reflects their profits from trading activities.

(i)

Is trading stock?Trading stock is defined as live stock, or anything produced, manufactured or acquired that is held for purposes of manufacture, sale or echange in the ordinary course of a business (ITAA97 s 70-10). Trading stock may include:

land (ie if you are a property developer) (FCT v St Huberts Island Pty Ltd) shares (ie if you are a share trader) (Investment and Merchant Finance Corp Limited v FCT) CDs for a music store Clothes for a retailer Work in progress for a manufacturer

Trading stock does not include: spare parts goods for hire {they are not being sold} Crops which are not yet harvested {they still form part of the land} work in progress for a professional firm or long term construction project.

Here, the [is OR is not] trading stock.

(r)

Trading stock adjustment(a.A) Rule

The difference in the value of the trading stock on hand at the beginning and end of the income year will be either assessable income or an allowable deduction (ITAA97 s 70-35). {The rationale of this is that it will stop people from building up large amounts of trading stock, claiming the purchases as a deduction.}(a.B) Is the trading stock on hand?

Trading stock is on hand if has the legal power to dispose of the goods (Garnsworth v FCT; IT 2670). A lack of ownership does not preclude the trading stock from being on hand (FCT v Suttons Motors (Chullora) Wholesale Pty Ltd {floor plan finance}). A lack of physical possession is not decisive (All States Frozen Foods Pty Ltd v FCT).Matthew Robinson LWB364 Introduction to Taxation Law 22

(a.C)

What is the value of trading stock

Under ITAA97 s 70-45, Trading stock can be valued at its:

cost this includes all amounts incurred in acquiring the item or brining it into existence (Philip Morris Ltd v FCT). This is not available where the transaction is not at arms length and the Taxpayer pays above market value at the time (ITAA97 s 70-20); You can elect between FIFO and weighted cost (IT2350). market selling value ie the amount it could be sold for in the Taxpayers ordinary course of business (Austalasian Jam Co Pty Ltd v FCT); replacement value.

The taxpayer can elect which method they use, and switch between income years, provided that the value of an item at the end of one income year is the same as its value at the start of the next income year (ITAA97 s 70-40). The Taxpayer may also elect to use a lower, reasonable value if the stock has become obsolete, or for some other special reason (ITAA97 s 70-50). If the asset is disposed outside the ordinary course of business, then the relevant value is its market value (ITAA97 s 70-90). {Change in ownership see ITAA97 s 70-100}(a.D) Outcome

Here, the value of the trading stock at the start of the year is $__________, and its value at the end of the year is $___________. ValueEnd > ValueStart Assessable income includes the costs of goods that were purchases but not soled ValueStart > ValueEnd Allowable deduction provides a deduction for the cost of goods purchased in prior years that were sold in this income year. Therefore, because:

the value at the end is $_________ more than at the start, this amount become assessable income of . the value at the start is $_________ more than at the ends, so this amount becomes an allowable deduction for .

Matthew Robinson


23

.3.6.

Is it statutory income?

Assessable income also includes statutory income derived from [all sources {for Australian residents} OR Australian residents {for foreign residents}] (ITAA97 s 6-10). {Division 10 has a list of all provisions dealing with assessable income}

Section 15-2 ITAA97 makes the value of benefits in respect of employment assessable income regardless of whether they are convertible into money {3 elements (1) benefit or allowance (2) allowed, given or granted (3) nexus with employment / services rendered} {but if it is ordinary income, it is excluded from this provision: s15-2(3)(d) ITAA97} {not as important now given the FBT regime} {will apply to allowances cf reimbursement} Return to work payments (s15-3 ITAA97) Royalties (s15-20 ITAA97) Indemnity for loss of assessable income (s15-30 ITAA97) Interest on early payment or overpayments of tax (s 15-35 ITAA97) Reimbursed car expense (s 15-70 ITAA97) Capital Gains Tax (s 102-5 ITAA97).

.3.7.

Is it exempt income?

Exempt income is not included in the income tax equation. An amount may be expressly or implicitly exempt. This may be because:

the entity is an exempt entity (s11-5 ITAA97) The type of income is exempt (s11-10 ITAA97) The income is exempt because it is derived from certain entities (s11-15 ITAA97)

.3.8.

Non-assessable, non-exempt income?

Income can be non-assessable, non-exempt income (ITAA97 s 6-1(4)). Non-assessable, non-exempt income is not used to calculate taxable income, but is counted in reducing prior year tax losses. Section 11-55 lists the non-assessable, non-exempt provisions; FBT and GST fall within this. Division 59 details particular amounts.

.3.9.

Conflict rules / double counting

A receipt may be both ordinary and statutory income, however the amount is only included as assessable income once (s 6-25 ITAA97). Generally, the statutory provisions prevail over rules about ordinary income unless otherwise provided {as occurs in s 15-2} (s 6-25 ITAA97).

Matthew Robinson


24

4.

Derivation of Income

Ordinary income is only assessable if it is derived in the income year (ITAA97 s 6-5(2)). There are two methods of accounting for income: the cash or accrual methods. The taxpayer must uses the one that substantially reflects the taxpayers true income (Cardens Case {Theexecutor of the Taxpayers estate received money for outstanding debts of the Taxpayers business. The Taxpayer was a sole practitioner, had no trading stock, had a mainly cash business, only recorded money when it was received and the receipts related to personal exertion. This was held to be ok to work on a cash basis}).

There is only one correct method for determining each type of the Taxpayers income. Commissioners view In TR 98/1, the Commissioner expresses the view that:

salary and wages should be assessed on a cash basis. rent and interest should be assessed on a cash basis. dividends should be assessed on a cash basis (s 44 ITAA36). Business that focus primarily on the application of person expertise, should use a cash method. Business should use the accrual method if:

Case Examples

producing activities involve the sale of trading stock outgoings directly relate to the income derived relies on circulating capital or consumables to produce income rely on staff or equipment to produce income.

Cardens Case: The executor of the Taxpayers estate received money for outstanding debts of the Taxpayers business. The Taxpayer was a sole practitioner, had no trading stock, had a mainly cash business, only recorded money when it was received and the receipts related to personal exertion. This was held to be ok to work on a cash basis. FCT v Firstenberg: taxpayer was a sole practicing solicitor, who employed a secretary. The cash basis was appropriate. Arthur Murray (NSW) Pty Ltd v FCT: The taxpayer taught dance classes, which were paid for in advance. Students were not entitled to refunds, however refunds were given in practice. The court held that the accrual method was appropriate. Although the court did consider the issue of refund (ie if no refunds were given, it may be on a cash basis), but the court also looked at the scale of operations and the fact that the taxpayer put the receipts into a special account and only drew upon them once the lessons had been taken. Brent v FCT: The taxpayer sold his/her life story. Payment was made in 3 instalments: singing, upon the manuscript and at the end of the process. For the relevant year, the taxpayer had done all the work, but had only received some of the payments. The court held that an cash basis was reasonable.LWB364 Introduction to Taxation Law 25

Matthew Robinson

Henderson v FCT: The taxpayer was in professional practice as a partnership of accountants (19 partners and 295 staff), and changed from cash to accrual. The court said that all the factors pointed to the taxpayer operating on an accrual basis.

5.

Source of income .5.1. IntroductionThe source of income is a question of fact, determined by practical concepts of the meaning of source (Nathan v FC of T (1918) 25 CLR 183 {Getting dividends from UK was itsourced in UK or Aus this issue is not relevant now, but it sets the source rule: Q of F. Per Isaacs J: The Legislature in using the word source meant, not a legal concept, but something which a practical man would regard as a real source of income. Legal concepts must, of course, enter into the question when we have to consider to whom a given source belongs. But the ascertainment of the actual source of a given income is a practical, hard matter of fact. }).

.5.2.

Source Rules

Generally, the court will look at where the economic activity arose (Thorpe Nominees Pty Lrtd v FCT). Where the income arises primarily out of contractual dealings, the place of contract will be significant; whereas if performance is the main factor, the place of performance will be the source (CT (NSW) v Cam and Sons Ltd). The court may apportion the source of income.

()a

ServicesThe source of salary and wages will usually be where the service was performed (FC of T v French (1957) 98 CLR 398 {work was sent to NZ, held that the income was sourced in NZ}; FC of T v Efstathakis 79 ATC 4256 {Greek Government employed person to work in Australia. Australia was the source of the income.}). However, the place of contract may be the source of the income (FCT v Mitchum (1965) 113 CLR 401 {Mitchum contracted overseas to make a film for 7 week in Australia. Held to be sourced in the place the contract was made.}).

()b

Business income / trading stockThe source of business income will generally be determined where the trading activities took place (C of T (WA) v D & W Murray (1929) 42 CLR 332 {where goods sold}; FC of T v United Aircraft Corporation (1943) 68 CLR 525 {where business transacted}). The income may be apportioned between multiple sources (FCT v Lewis Berger & Sons (Australia) Ltd).

()c

Rental incomeWhere real property is leased, the rental income is sourced at the location of the real property (Rhodesia Metals Ltd (in liq) v C of T [1940] AC 774). Where chattels are leased, rental income will be sourced at the place where the contract was entered into (Rhodesia Metals Ltd (in liq) v C of T [1940] AC 774).

()d

Sale of property (non-trading stock)Where property is sold, the income will generally be sourced from the place the contract was entered into, except for certain types of property {eg shares}.

Matthew Robinson


26

However, in the case of immoveable property, it may be the location of the property (Rhodesia Metals Ltd )in liq) v FCT).

()e

InterestInterest income is sourced from the place the contract is made, or the money advanced (FC of T v Spotless Services Ltd 95 ATC 4775).

()f

Financial transactions / insuranceThe source of financial transactions are the place where the services are performed (Tariff Reinsurances Ltd v CT (Vic) (1938) 59 CLR 194 {The source was the UK where the company carried on the business of reinsuring risks accepted by others}; Thorpe Nominees v FCT (1988) ATC 4886 {Must look at the substance of the agreement, not its form involved an artificial shift of income offshore}).

()g

DividendsThe source of dividends are the place from which the profits of the company are sourced (ITAA 1936 s 44 (1)). The source of the companys profits are a question of fact (Esquire Nominees Ltd v FCT). Withholding tax may apply where a resident company pays dividends to a nonresident (TAA schl 1 s 12-210). Withholding will only apply when the dividend is unfranked.

()h

RoyaltiesThe source of royalties are deemed to be the location of the IP, unless it is a royalty leaving Australia, in which case the income is sourced in Australia (ITAA 1936 s 6C).

Matthew Robinson


27

6.

Allowable deductions .6.1.

An allowable deduction is a general deduction or specific deduction.

General deductionsit is incurred in gaining or producing your assessable income; or it is necessarily incurred in carrying out a business for the purpose of gaining or producing your assessable income

A general deduction is a loss or outgoing to the extent that:

(ITAA 1997 s 8-1(1)). ITAA 1997 s 8-1(2) sets out losses that cannot be deducted {negative limbs}.

()a

Does the loss or deduction fall under s 8-1(1)?(i) Loss or outgoingHere, there is clearly a(n):

loss, as there was [an obligation to pay the amount OR there was no choice whether to pay the amount]; or outgoing, as voluntarily paid the amount.

Case examples: Theft was held to be a loss (Charles Moore & Co (WA) Pty Ltd v FCT (1935) {the taxpayer was doing his banking, and was robbed on the wayto the bank. He claimed the theft as a deduction, which was upheld by the court.})

(s)

Bad debts were held to be a loss (AGC (Advance) Ltd v FCT)

Thus, this element [is OR is not] satisfied.

To the extent thatThe term to the extent that indicates the concept of apportionment (Ronpibon Tin NL v FCT). Apportionment is appropriate where the costs can be clearly distinguished, or where there is a lump sum that serves multiple purposes (Ronpibon Tin NL v FCT). Apportionment rules are likely to apply when the transaction is not at arms length (Ure v FCT {taxpayer wanted to buy a house, but to make it an allowablededuction they lent the money to a related entity for 1% interest, allowing the taxpayer to claim the 12.5% interest as a deduction. The court held that only the 1% could be claimed}).

Here, may need to apportion the [loss OR outgoing] between the and . We are told that was used for meaning only that amount may be claimed. Ronpibon Tin NL v FCTFacts: The taxpayer operated a mining company that ceased mining during WWII. During the time it wasMatthew Robinson LWB364 Introduction to Taxation Law 28

shut down, the company still had administrative costs from their mining operations and income from other investments. The taxpayer claimed the costs as deductions. Law: The court held that some of the administrative costs could be referable to the income generating activity there are two situations where expenditure could require apportionment: (1) where they are clearly distinguishable, so that you can see which expenses relate to which; and (2) where there is a lump sum of costs that serve both purposes. The court held that the directors fees could be apportioned between the mining and non-mining activities, allowing a proportion of them to be an allowable deduction. The court did not allow the expenses from the mining operations to be included as allowable deductions.

(t)

Non-business: Incurred gaining assessable income(a.A) Was it incurred?

There must be a definite liability to pay, not merely an impeding, threatened or expected loss or outgoing. A loss may be incurred even if it is unpaid, if the taxpayer has completely subjected themselves to the liability (Commonwealth Aluminium Corporation Ltd). Provisions for losses or outgoings (such as provisions for bad and doubtful debts, and employment leave) are not incured. In some cases, subjecting yourself to the liability will not mean the outgoing is deductible in that year, and it may be apportioned (Coles Myer Finance Ltd v FCT {at the beginning of the contract paid an amount to cover expenses over the 2year term of the contract. The court held that just because the taxpayer subjected themselves to the expense in one year, that does not mean that the full amount is deductable, apportioning it across 2 years}; TR 94/26). However, in FCT v

Woolcombers (WA) Pty Ltd, losses under forward contracts were held to be deductible in the year they were entered into. Here, has been incurred.(a.B) Was it incurred gaining or producing your assessable income?

The loss or outgoing must be incurred in gaining or producing the taxpayers assessable income (ITAA97 s 8-1(1)(a)). The court will be lenient with regards to the deductibility of outgoings incurred for subsidiary companies (FCT v Total Holdings (Australia) Pty Ltd). This nexus can be demonstrated by showing that the outgoing:

was incidental and relevant to the production of income; or had the essential characteristic of being related to gaining assessable income.

{only need to show one} Is the outgoing incidental and relevant? To establish the relevant nexus, the expenditure must be incidental and relevant to the production of assessable income (Ronpibon Tin NL v FCT).Matthew Robinson LWB364 Introduction to Taxation Law 29

This involves a comparison of the scope of the income producing activities and the relevance of the expenditure to the scope, rather than the purpose of the expenditure in itself (Herald Weekly Times {Legal costs to defend defamation actions were held to be deductible for anewspaper company because, inter alia, the liability was encountered because of the act of publishing the newspaper, which was done to produce income. The expenditure was a natural consequence of the publication of the allegedly defamatory material to produce profits}; W Nevil & Co Ltd v FCT {Company paid a director a fee to resign. It was held that this was incidental and relevant to gaining assessable income because it was designed to improve the operations of the company.}).

There must be something more than a causal connection (Payne {Travel between work as a pilot and deer farm business. Court held that this was incidental and relevant.}). Here, the expenditure on [was OR was not] productive of assessable income, and the nexus [will OR will not] be established. Essential characteristic The court will look to the essential characteristic and nature of the outgoing to determine whether it is productive of assessable income (Charles More & Co (WA) Pty Ltd v FCT {Daily banking of retail store was stolen. Held to be an allowable deduction.}) The mere fact that the expenditure is a pre-requisite to deriving income is not sufficient (Lunney and Hayley v FCT {Fares between home and work not allowable}; Lodge v FCT {childcare}). A requirement by an employer to incur an expense does not automatically make it a deduction (FCT v Cooper {professionalfootballer was denied a deduction for additional food and drinks his coach instructed him to consumer to bulk up}).

Objective or subjective The court will generally examine the outgoing objectively (Cecil Bros Pty Ltd v FCT {High Court allowed deductions for a shoe retailer, even though it was overpriced}). The courts will generally leave it to the taxpayer to determine how they run their business, and will not inquire into the price paid, unless it is grossly excessive (FCT v Phillips {The taxpayer was a group of accountants who set up a servicescompany to deal with the secretarial and other expenses. The service company charged the partnership commercial rates for the services. The high court held that because this was commercially realistic, and not grossly excessive, the expense was deductible.}).

However, in certain circumstances the court will go behind the objective circumstances to determine the taxpayers true purpose for incurring the expenditure (Magna Alloys & Research Pty Ltd v FCT; Ure v FCT {borrowed money at 12.5% and lent the money at 1% to hiswife and the family company, which was used to discharge mortgages on property. The taxpayer argued that he was entitled to a deduction for the entire 12.5% in interest as it was used to generate the 1% interest. The High Court looked behind the transaction and only allowed 1% of the interest to be deducted.}). This will arise particularly where the deduction is

greater than the income (Fletcher).Matthew Robinson LWB364 Introduction to Taxation Law 30

Alternative test? In FCT v Day, it was suggested that the 2 tests were of little help, and that the test should be whether the outgoing was productive of actual or expected income.

(u)

Business: Necessarily incurred carrying on a business for the purpose of gaining assessable income(a.C) Necessarily incurred

Necessarily incurred means that it is clearly appropriate and adapted (Ronpibon Tin NL; TR 95/33). The court will examine the business ends to which it is directed and often use a reasonable business person as a benchmark (FCT v Snowden & Wilson Pty Ltd {advertising to show its side of the story, was held to be deductible}).(a.D) Carrying on a business for the purpose of gaining assessable income

There must be a nexus between the outgoing and the business, which may require a temporal connection (Steele v FCT). Before business Outgoings that are preliminary to the commencement of business are not deductable (Softwood Pulp and Paper Ltd v FCT {feasibility study to determine whether to establish a paper mill}; Griffin Coal Mining Company Ltd v FCT {feasibility study into analuminium smelter. It was held that this did not relate to the taxpayers business, but rather a potential source of new income.}).

After the cessation of a business It has been traditionally believed that deductions were not available after the cessation of business (Amalgamated Zinc (De Bavays) Ltd v FCT {had closed down a mine, but was still liable for workers compensation contributions. This was held not to be deductible.}). However, the better view is that a cessation in business will not prevent deductibility (AGC (Advances) v FCT {there was a pause in theoperation of the taxpayers business, and during the break, the company claimed deductions. The court allowed these deductions}; Placer Pacific Management Pty Ltd v FCT {Allowed deductions for expenditure incurred settling a dispute with a customer after it had left that business.}).

A practical approach is taken to assess deductibility after the cessation of business (FCT v Brown). Costs involved in selling a business are not deductible (Peyton v FCT).

Matthew Robinson


31

()b

Does anything in s 8-1(2) exclude the deduction?(i) Capital or capital natureLosses and outgoings are not deductible to the extent that they are capital in nature (ITAA97 s 8-1(2)(a)). There are a number of different tests to determine whether an outgoing is capital in nature. The leading test is the business entity test.(a.A) Business entity test

The business entity test established in Sun Newspapers v FCT, considers:

(a.B)

Whether the expenditure relates to the business tructure or the process of operating the business the nature of the asset or advantage sought the degree of recurrence of the expenditure.

Here, is [likely OR unlikely] to be capital in nature because___.Once and for all test

An expenditure that is spent once and for all is more likely to be capital in nature, whereas a reoccurring expenditure is more likely not to be capital (Ballambrosa Rubber Co Ltd v Farmer).(a.C) Enduring benefit test

The outgoing is more likely to be capital in nature if it is made with the view of bringing into existence an asset or advantage for the enduring benefit of a trade (British Insulated & Helsby Cables v Atherton).(a.D) Fixed or circulating capital test

An expense related to fixed capital will be capital, wherease outgoings related to circulating capital will not be capital in nature(BP Australia v FCT). Conclusion Here, [is OR is not] capital in nature, meaning it [may be OR is not] an allowable deduction.

(v)

Private or domestic natureLosses and outgoings are not deductible to the extent that they are private or domestic in nature (ITAA97 s 8-1(2)(b)). Private expenses relate to a person as an individual, while domestic expenses relate to a persons house or family organisation.(a.E) Home Study / Office

There are two different types of expenses that may be claimed: occupancy expenses and home study expenses (TR 93/30). Occupancy expenses (which include rates, repairs & interest on mortgages)Matthew Robinson LWB364 Introduction to Taxation Law 32

are only deductible if the premises is a place of business (Swinford; Thomas v FCT). It is not sufficient that the place is used as a matter of convenience (Handley; Forsyth). Home study expenses (ie lighting, depreciation on computer, etc) will be deductible if there is a sufficient nexus with income. Unlike occupancy expenses, these can be deducted even if the study is only used as a matter of convenience (Handley). Apportionment may be required, which is usually done on a time and floor area basis.(a.F) Clothing

Clothing may fall into one of 5 categories:

Conventional clothing compulsory uniforms non-compulsory uniforms occupational specific clothing protective clothing.

Conventional clothing is not generally deductible. However, in certain circumstances it will be deductible (FCT v Edwards {The taxpayer was the private secretary to the governor, and had to have significantly expensive formal gowns to attend balls. The court allowed these as deductions for a number of reasons, including that she had to change multiple times throughout the day.}). Items of clothing to protect against harsh working conditions may be deductible (Mansfield v FCT {an airline attendent claimed stockings and skin cream, claiming that they protected her from various things associated with flying. The court upheld this.}). Protective clothing is not private or domestic in nature, even if it could be classified as conventional clothing, provided in the circumstances it is used as protective clothing (TR 2003/16 at [10]). For example, sun protection items are not private in nature and are deductible (Morris v FCT). A compulsory uniform is not private or domestic in nature if it creates a distinctive image a requirement to wear a particular colour, brand or style is not sufficient {but a very strict definition of compulsory must be in guidelines and be strictly enforced} (TR 96/16 at [6] & [7]).(a.G) Travel

The cost of travelling between home and work is private in nature (Lunney). Exceptions include:

Matthew Robinson

commencing work at home prior to travelling to work an itinerant worker whose home is their base of operations where there is a need to transport heavy or bulky material (FCT v Vogt {musician carrying instrument}).LWB364 Introduction to Taxation Law 33

The cost of travel between unrelated workplaces are deductible under ITAA97 s 25-100 (see also Payne). Capital expenditure cannot be deducted (s 25-100(5)). You cannot deduct the cost of an accompanying relative, if their presence is not related to producing assessable income (ITAA97 s 26-30).(a.H) Child Care

Child care is not deductible because it is private or domestic in nature (Lodge v FCT).(a.I) Physical Fitness / Food

Food will generally not be deductible, however, it is not impossible that food is not private or domestic in nature (FCT v Cooper).(a.J) Self education

Self-education expenses are generally deductible because there is usually a nexus to assessable income. A deduction will not be allowable for an initial qualification because this is capital in nature (FCT v Finn). Self-education expenses will be deductible where they improve or maintain the taxpayers skills, or objectively is likely to lead to an increase in income from the taxpayers current income producing activities (TR 98/9; FCT v Hatchett {lead to a promotion}; FCT v Highfield {improve earnings}). In Anstis v FCT, the court held that various university expenses were deductible because they related to the youth-allowance, which was assessable income and conditional upon passing, and therefore met the deductibility requirements. Deductions will be available even if the training involves an overseas trip (ie to go to a conference) (FCT v Finn). A deduction is not available for HECS or HELP (ITAA97 s 26-20). Section 82A ITAA36 renders the first $250 of self-education expenses from prescribed education courses non-deductible.

(w)

Incurred in relation to exempt income or non-assessable, non-exempt incomeLosses and outgoings are not deductible to the extent that they are incurred in relation to exempt income or non-assessable, non-exempt income (ITAA97 s 8-1(2)(c)).

(x)

Provision of actAn outgoing is not deductible if a specific provision denies it (ITAA97 s 81(2)(d)).

Matthew Robinson

Penalties (s 26-5) Higher education contributions (s26-20) Family maintenance payments (s26-40) Entertainment expenses (s32-5)LWB364 Introduction to Taxation Law 34

Recreational club expenses (s26-45) Non-compulsory uniforms (Div 34) Car packaging expenses (s 51AGA) First $250 of certain self education expenses (s 82A).

Matthew Robinson


35

.6.2.()a Repairs

Specific Deductions

Repairs to a premises or depreciating asset are deductible to the extent that the assets are used to generate assessable income (ITAA97 s 25-10(1)&(2)).

(i)

Was expenditure incurred?An expenditure must occur a saving is not sufficient. Here, the s expenditure of $__________ on has clearly been incurred.

(y)

Was it a repair?The item must have needed repair or restoration (Case J47). The repair must be for the purposes of restoring the item (W Thomas & Co v FCT). Alterations and additions are not repairs. Distinguishing from capital expenditure A repair is not capital expenditure (ITAA97 s 25-10(3)). Part v entirety A repair is not a reconstruction of the entirety (Lurcott v Wakely and Wheeler). Whether it constitutes a part or the entirety is a question of fact (TR 97/23). To determine this, the court looks at whether the item is a subsidiary of an other item, or an entirety in itself. The courts have applied a test as to whether it is a physically, commercially or functionally inseparable part of a large unit, or a unit in itself (Lindsay v FCT {The taxpayer replaced a slipway that was in need of repairwith a concrete one, also making it longer. The Commissioner argued that the slipway was the entirety, whereas the taxpayer argued their shipping business was the entirety. The court held that it is to be determined according to physical things not profit making entity.}; W Thomas & Co Pty Ltd {held that

when repairing a building, the floors, windows, etc were the parts.}). In Alcoa of Australia Ltd, a bake furnous was held to be the entirety, despite its two main components (brickwork and a waste gas duct) being listed separately in the companys books. In Rhodesia, the whole railway track system was held to be the entirety. Repair v improvement An improvement is not a repair (FCT v Western Suburbs Cinema Ltd {The cinema needed to replace its roof that was made out of a materialsimilar to tin. Because the actual type of metal that the old roof was not available, it was replaced with a fibro roof. This was held to lead to a functional improvement in the cinema.}; BP Oil Refinery (Bulwer Island) Limited v FCT {BP claimed expenses for encasing wooden pylons supporting a wharf in concrete to protect against damage from marine organisms. This w

LWB364 Introduction to Taxation Law[7] (1)

western suburbs

complying

ronpibon tin

local government

3rd party

naval officer

whitfords

majority voting

Text of LWB364 Introduction to Taxation Law[7] (1)

2007-2014 Taxation Law

LAW 124 Taxation

Taxation Law Rev1

UP 2008 Taxation Law (Taxation 1)

Taxation Law I

Taxation Law Assignment...Taxation Law Assignment Author Emily Parker Subject LAW Keywords Taxation Law Assignment Samples Case Study

Salary taxation law

Syllabus - Law on Taxation

Taxation Law 2012

Ateneo Law Taxation Law Reviewer

Course Manual LAW OF TAXATION & LAW OF TAXATION - I LL. B

UP 2008 Taxation Law (Taxation 2)

TAXATION+LAW San Beda.doc

Taxation Law - StudentVIP

Taxation Law Assignment

Law on Taxation

Taxation Law Review

LWB364 - Introduction to Taxation Law - 2011

Taxation Law

taxation law cases.docx

Taxation Law Review.doc

TAXATION Law Rev 1

Taxation Law 2019 - eurospanfiles.comeurospanfiles.com/files/catalogues/2019_WES_Taxation_Law.pdf · Taxation Law 2019 HIGHLIGHTS FEDERAL INCOME TAXATION Fourteenth Edition Marvin

Taxation Law Cases

Law and taxation

taxation law review1

Uae Taxation Law

Law on Taxation(en)

philippine taxation law

MCQ - Taxation Law Review

Documents

LWB364 Introduction to Taxation Law[7] (1)

Text of LWB364 Introduction to Taxation Law[7] (1)