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TAX LAW Semester 2, 2016
BTF3931
WEEK 5: Extraordinary & isolated transactions; compensation receipts Extraordinary and Isolated Incomes Legislation: Sec 6-‐5 & Sec 15-‐2 of ITAA97 • A receipt from the normal proceeds of a business constitutes ordinary
income (s6-‐5) • Alternatively, transactions may be categorized as:
o Extraordinary transactions: where the receipt arises outside normal proceeds of the business.
o Isolated transactions: where the receipts is one off in nature and not undertaken by an existing business operation JP International
• Ancillary income: Monash replacement charges & printing academic records charges. According to JP International
• While extraordinary and isolated transactions may appear to take a CAPITAL characterization, it may be ORDINARY income if it falls into any of the following category:
Forms a business itself: Under the California Copper Syndicate V Harris (1904) principle, a GAIN derived from AN ISOLATED TRANSACTION is distinguish between: 1. A “mere realization” of a capital good resulting in a capital gain: Scottish
Australian Mining Co Ltd V FCT (1950) and 2. A “gain” made, carrying on a business, resulting in ordinary income (s6-‐5) PROFITS from isolated (& extraordinary) transactions that has exhibited sufficient indicators of a business is considered ORDINARY INCOME from BUSINESS ACTIVITY:
1. Mere RealizationStratham V FCT (1988) àsold farm land did not generate ordinary Casimaty V FCT àNot involved in the sales processàup to point of subdivision
2. Carrying on a Business FCT V Whitfords Beach Pty Ltd & Stevenson V FCT (1991)
Answering Question 1. Are we establishing a business
• Income from business?? Ordinary course of business
2. Normal Proceeds • Nature and Nexus
Or Extraordinary/Isolated Transaction • Peta -‐ carrying on a business? 3. Is there a profit making intention. • Resurfaced and built fences o Development occurred was it enough
though to be classified as Whitfords o Or was it not extensive enough
FCT v Myer Emporium: Extraordinary and Isolated can be ordinary First Strand of Myer • Extraordinary/isolated transaction will
satisfy the FIRST STAND OF MYER when the following are ALL MET: 1. There was a business operation or
commercial transaction 2. There was a profit making intention
when entering the transaction 3. The profit was made by the means
consistent with the original intention
If satisfies all three = First strand of Myer = gain constituting ORDINARY INCOME (s6-‐5) Key Limitations (Profit made by means MUST BE consistent with original intention) • Westfield Ltd V FCT (1991) Therefore Westfield = Myer cannot apply!
Example: Myer Strand 1 0. Commercial transaction/business operations
o Build tennis courts/sell profit 1. Profit Making intention
o Original intention was to build units and sell them at a profit o Also Private purpose was to live in the house
3. Consistent with original profit making intention
o However the intention is abandoned because now she is going a different way. Westfield Case
o However she developed them in a different way Moana sands case o And still to sell the for a profit even though it wasn't the direct way o She acquired with a view to develop and sell but it didn't happen in a
way she proposed for it to happen she still went ahead to develop the land
So based on Moana sands it is ordinary income however based on Westfield it is not
Second Strand of Myer • Proceeds from transaction = ORDINARY income if the taxpayer sells the right to income from an asset, without selling the
underlying asset o Sale of “right to interest” (i.e. income), while retaining the loan principal (i.e. the underlying asset): Myer Emporium
• Sale of rights to royalties, while retaining underlying property (being trademarks): Henry Jones (IXL) Ltd V FCT (1991) àSPC he owns the trademark
Statutory provisions for extraordinary and isolated transaction (if it doesn’t fit in the other three categories • Common statutory provision that apply to BUSINESS ACTIVITIES are: àCapital Gains Tax (CGT) o Profit Making Undertaking or Plan s15-‐5 Profits from a profit-‐making undertaking or plan constitute statutory under s15-‐5
exclusions: à Gains that are ordinary income: s15-‐15(2)(a) or à Gains that involve asset purchased on or after 20th September 1985 s15-‐15(2)(b) àCGT would apply now or else it would be doubled taxed à S 6-‐25 included in assessable income only once and normally taxed under statutory provision if receipt is both ordinary and statutory à S 15-‐10 Bounties and subsidies: payment from the government in order to assist the recipient in carrying a business
Business Compensation Replacement Principle
o A compensation receipt or damages award takes on the character of the item it replaces FCT V Dixon o Periodic or lump sum receipts do not alter the character of what it is replacing • Breach of contract: Capital v Ordinary
Compensation for Business Losses: Breach of Contract
Application of the replacement principle to payment received for the breach/cancelation of contracts: Income (can replace) • Breach of an ordinary trading contract, contract for the sale of goods, loss of anticipated profits
o Heavy Minerals Pty Ltd V FCT (1966) àLost contracts but have assets due to collapse of market= can replace = Ordinaryo Allied Mills Industries Pty Ltd V FCT (1989) àopted out of a contract earlyàpaid for the remaining yearsàTaxpayer was not parting with substantial part of business risk/ceasing to carry on business or disposing of its business therefore Ordinary
Capital (can’t replace) • Breach of contracts that goes to the fundamental structure of business
o California Oil Products Ltd (in liq) V FCT (1934)àcloser of taxpayers business (termination of agreement) payments made over the same period as original contractà payments = capital àtermination of contracts results in cessation of business
Compensation for Business Losses: Breach of Contract
Application of the replacement principle to payment received for the breach/cancelation of contracts: Income (can replace) • Breach of an ordinary trading contract, contract for the sale of goods, loss of anticipated profits o Heavy Minerals Pty Ltd V FCT (1966) àLost contracts but have assets due to collapse of market= can replace
= Ordinary o Allied Mills Industries Pty Ltd V FCT (1989) àopted out of a contract earlyàpaid for the remaining years
àTaxpayer was not parting with substantial part of business risk/ceasing to carry on business or disposing of its business therefore Ordinary
Capital (can’t replace) o Breach of contracts that goes to the fundamental structure of business o California Oil Products Ltd (in liq) V FCT (1934) àcloser of taxpayers business (termination of
agreement) payments made over the same period as original contract à payments = capital àtermination of contracts results in cessation of business
Compensation for Business Losses: Loss of a Business Asset
Loss of Depreciable Asset Division 40 • Compensation received for the loss or damage to a depreciable asset = Division 40 capital allowance
e.g. computer, depreciationo Disposal triggers a balancing adjustments Loss of Capital Asset • Characterization depends on extent of damage to the asseto Permanently destroyed/disabled: Generally
capital in nature Glenboig Union Fireclay V IR Commissioner àpart of the company was sterilized and destroyed from the exercise of statutory powers.
• Temporarily disabled: general income=Ordinary in nature Ensign Shipping Co Ltd Compensation for Business Losses: Insurance
Statutory inclusion (s15-‐30) • Amounts received by way of insurance or indemnity are still assessable if the amount would have been
included in assessable income but not ordinary income
Compensation for Business Losses: Composite Claims
• UnDissected lump sum receipt, comprising compensation for à Loss of income AND Loss of capital or capital assets
• Where payment received is for unliqudated damages, courts are reluctant to apportion the sum into income and capital • Whole sum treated as capital = Mc Laurin V FCT (1961)
o Taxpayers property was damaged in a fire, compensation was paid for damages o Courts: no part of the lump sum was assessable as ordinary. Payment was in respects of a
claim of unliquidated damages and is made or accepted under a compromiseàtreats settlement as a single undissected amount
• Capital gains tax may applyàAllsop V FCT (1965) FCT V Dixon (1952) (Compensation payment for wages/salary = Ordinary) Loss of Salary/Wages
Taxpayer = Originally worked for an employer buy was enlisted into the army. • Intention: Employer made payments (top up payments, army payment = low) = made voluntarily • Court: Ordinary income = compensation for wages (periodical payments) would have otherwise been
received
Week 7: General Deductions (part 1) The main provision that provides taxpayers a deduction for an expense is the general deduction provision:
• Section 8-‐1 has the potential to apply to ANY TAXPAYER • A loss or outgoing (i.e. an expense) may:
-‐ be deductible under s8-‐1 and a specific provision -‐ not quality for deductions under a specific provision
General deductions rule:
Positive Limbs • A taxpayer can deduct from his/her assessable income a loss
or outgoing to the extent that it is, s8-‐1 (Charles Moore)
• Only ONE of the 2 positive limbs need to be satisfied Negative Limbs (more on next page) • However, a loss or outgoing is not deductible under the general deduction rule if it satisfies any of the negative limbs (s8-‐1(2))
• Deductibility is determined from the perspective of the taxpayer which incurs the loss/outgoing
Losses or outgoings • Section 8-‐1 applies to both a loss and outgoing: • Loss: depletion of a taxpayer’s financial position: Charles Moore & Co (WA) Pty Ltd V FCT (1956)
• Outgoing: E.g. an expense • Determining whether there is a loss or outgoing is not generally an issue in claiming a s8-‐1
General deductions: Positive Limbs (Nexus test)
Gaining or producing assessable income Requires a NEXUS between:
• “Gaining or producing assessable income” to be interpreted as “in the course of gaining or producing assessable income” -‐ Amalgamated Zinc (De Bavay’s Ltd) v FCT (1935)
• Nexus/Connection must be sufficient & necessary that the
LOSS or OUTGOING is: 1. Productive of assessable income OR 2. Expected to produce assessable income Carrying on a business Requires a NEXUS between:
Judicial Tests The courts have adopted a number if approaches to determine whether a loss or outgoing is incurred in the course of GAINING or PRODUCING assessable income
1. Incidental & Relevant test
-‐ A loss or outgoing is sufficiently connected to the production of assessable income where: “the expenditure is incidental and relevant to the operations or activities regularly carried on for the production of income” W Nevill & Co Ltd v FCT (1937)
2. Essential Character Test -‐ Courts have looked at the “essential character” of an expense: * Home to work travel expense: essential character was to put the taxpayer in a position to gain or produce assessable income – not the production of assessable income Lunney v FCT + Hayley v FCT (1958)
3. Occasion of the expenditure test -‐ Courts have considered whether the occasion of the expenditure arises out of income-‐producing activities FCT v Payne (2001) + FCT v Day (2008) -‐ Requires an ASSESSMENT as to what is PRODUCTIVE of the taxpayer’s assessable income
Nexus sufficiently direct or too remote?
• If the nexus between the expense and the production of assessable income is TOO remote = not deductible
• Some cases exist where it is questionable as to whether a nexus can be established, for example:
Non-‐deductible expense: Negative limbs
1. Capital or Capital in Nature -‐ Distinction between “revenue” (not capital) and “capital”
* Expenditure spent on a “once and for all” basic (capital) or recurring basic (revenue): Vallambrosa Rubber Co Ltd V Farmer (1910) * Expenditure made to bring an asset into existence or to bring an advantage for an enduring benefit (capital): British Insulated and Helsby Cables Ltd v Atherton (1926) -‐ Key judicial decision to distinguish business processes (revenue) and business structure (capital): * Sun Newspapers Ltd and Associated Newspapers v FCT (1938): Has three factors to be considered:
2. Private or domestic
e.g. additional food consumed by a professional sportsperson was to put the taxpayer in a position to carrying out income-‐producing activities (private/domestic) FCT v Cooper (1991)
3. Incurred in gaining/producing certain income -‐ Assessable income: sales = deductible -‐ Non-‐assessable income: exempt foreign source income = not deductible
4. Denied deductions -‐ A loss or outgoing will not be deductible when it has been specifically denied by the tax legislation * Certain penalties imposed under Aus. Foreign law s26-‐5 * Political gifts or donations s26-‐22 * Relatives travel expenses s26-‐30 * Bribes to foreign public officials s26-‐52 * Expenditure relating to illegal activities s26-‐54 Denied deductions: entertainment expenses -‐ NOT DEDUCTIBLE under s8-‐1 unless an exception applies * Definition of ‘entertain’ is broad = food, drink or recreational s32-‐10(1) -‐ Exceptions include * Entertainment provided by way of a FRINGE BENEFIT s32-‐20
1. Expenses involving alleged or actual wrongdoing -‐ Nexus satisfied for expense arising from alleged or actual wrongdoing incurred by: * Employees defending improper conduct charges which are “quasi-‐personal” FCT v Day (2009) * Business taxpayers in respect of defending claims (e.g. for libel actions) arising out of the ordinary course of business Herald and Weekly Times v FCT (1932) + FCT v Snowden & Wilsons Pty Ltd (1958) * Company directors incurring costs to defend criminal charges Magna Alloys & Research Pty Ltd v FCT (1980)
2. Expenses to reduce future expenses -‐ nexus established between an expense that improves the taxpayer’s business overall and reduces future expenses * Termination payment to end a contract of employment for poor performing staff: W Nevill and Co Ltd v FCT (1937)
3. Involuntary losses or outgoing -‐ Nexus established between an involuntary loss where it arises out of the taxpayer’s income-‐producing activities * Days earnings stolen while on the way to the bank: Charles Moore & Co (WA) Pty Ltd v FCT
Sufficient temporary nexus
1. Expenses related to the production of assessable income in
future years -‐ An expense incurred to gain or produce assessable income in the future may satisfy the nexus requirement * Interest associated with the purchase of an asset which was expected to produce income the future was deductible: Steele v DCT (1999) -‐ However, nexus may not be established where: * The expense is too preliminary for a business that has yet to commence: Softwood Pulp & Paper Ltd v FCT (1976)
2. Expenses related to the production of assessable income in prior years -‐ Likely to be DEDUCTIBLE providing the expense relates to the time when the business was operating: e.g. * Satisfaction of obligation arising from previous business: Placer Pacific Management Pty Ltd v FCT (1995) * Interest expense on a business: FCT v Jones (2002)
Expenses related to production of income in prior years 10. Pacer Pacific Management pty Ltd v FCT (1995): Expenses related to the production of assessable income in prior years – deductible on the basis that they arose out of or were caused by the taxpayers past business activities 11. Jones v FCT (2002) + Brown v FCT (1999): Post interest incurred on a loan of a business that is ceased = deductible – loan taken out for the business to run
Non-‐deductible expenses Capital or capital in nature (judicial tests) 12. Sun newspapers Ltd & Associated newspapers Ltd v FCT (1938): Capital expenses – payment resulted in an addition to the goodwill of the business – benefited the business as a whole and was a monopoly for capital assets 13. BP Australia Ltd v FCT: Exclusive payments not capital in nature 14. Strick v Regent Oil Co Ltd: Exclusive payments capital in nature Capital or Capital in nature (form and substance) 15. NAB Ltd v FCT (1997): lump sum payment held to be revenue expenses – deductible – income – character of advantage sought was the expansion of customer base and increase in its income – payment not considered to create monopoly or add structure to business 16. Colonial Mutual Life Assurance Society Ltd v FCT (1953): Monthly “rental” payments held as capital expenses – paid as parts of the purchase price of an asset forming part of a fixed capital of a company – non-‐deductible – capital Domestic or Private 17. FCT v Cooper (1991): Private or domestic expense (eat more meat and potatoes from coach to build core) = capital – non-‐deductible – incurred in PUTTING the taxpayer in a position to carry out his income producing activity and not incurred in GAINING or PRODUCING income. 18. FCT v Day (2008): Expenses not private or domestic
Apportionment – deductibility of dual purpose expense Dual purpose expense 19. Ronpibon Tin No Liability v FCT (1949): Taxpayer = incurred administrative and management expenses = there is no precise formula to apportionment necessary to determine a fair and reasonable division = only deductible against Australian investments
Amount of deduction Tax minimisation situations (purpose) 20. Ure v FCT (1981): Expenses incurred with a tax minimization purpose – courts did not rest its decision on the taxpayers PURPOSE – only 1% was domestic/private – limited the deductions – deductible to interest expenditure to the amount of interest income gained/produced under on-‐lent 21. Fletcher v FCT (1991): Expenses incurred with a tax minimisation PURPOSE. INTENTION – if shown that outset the taxpayer intended to end the arrangement prior to it being profitable then interest expense = non-‐deductible. But taxpayers dominant purpose incurring the expense was to MINIMISE tax and not to gain assessable income.
* Provision of food or drink to an employee under industrial arrangements relating to overtime s32-‐30 * Promotion and advertising expenses s32-‐45
Apportionment – deductibility of dual-‐purpose expenses • Apportionment for expenses that have a dual-‐purpose: -‐ No precises formula for apportionment but it is necessary to determine a fair and reasonable division on a case-‐by-‐case basis on exactly how much one has spent in obtaining income Ronpibon Tin No Liability v FCT (1949)
Case studies
Deductible expenses s8-‐1 Loss/outgoing 1. Charles Moore & Co (WA) Pty Ltd (1957): (losses incurred in the course of producing assessable income = claim deduction) -‐ Taxpayer = retail company -‐ Conditions: Normal operations include employee taking days earnings to the bank = employee was robbed on way -‐ Courts: Taxpayers normal business operations – the loss was incurred in the production of assessable income and satisfy the positive limbs of s8-‐1
Nexus direct or too remote to satisfy positive limbs Alleged or actual wrongdoing by the taxpayer 2. FCT v Day (2008): Legal expenses incurred in defending improper conduct charges. Deductible = incurred to look after income stream 3. Herald and Weekly Times Ltd v FCT (1932): Necessary incurred in carrying on a business = Deductible – incurred in the course of reporting (newspaper report wrong things – gets sued – legal fees are part of the business) 4. FCT v Snowden & Wilson Pty Ltd (1958): Necessary incurred in carrying on a business = expenses are deductible – expenditure is dictated by business purposes – purposes being part of incidental to the business itself 5. FCT v La Rosa: Expenses related to illegal business – illegal expenses doesn’t mean income is not assessable or expenses deductible Expenses related to reduce future expenditure 6. W Nevill & Co Ltd v FCT (1937): Necessarily incurred in carrying on a business – deductible Expenses related to involuntary losses or outgoing 7. Charles Moore & Co (WA) Pty Ltd v FCT: losses involuntary incurred while carrying on a business to produce assessable income
Sufficient temporal nexus to satisfy POSITIVE limbs Expenses related to production of income in future years 8. Steele v DCT (1999): expenses related to income gained or produced in future years – deductible if taxpayer could demonstrate that the expenses were incurred in order to gain or produce assessable income (showed purpose & commitment of incurring that expense) – taxpayer property developer – builds on land – a lot of interest incurred – deductible 9. Softwood Pulp & Paper Ltd FCT (1976): Expenses are too preliminary for a business that has yet commenced = NOT DEDUCTIBLE, not committed
