Income Taxation : Commentary and Materials [Eighth edition.] 9780864608345, 0864608349


361 17 4MB

English Pages [1137] Year 2017

Report DMCA / Copyright

DOWNLOAD PDF FILE

Recommend Papers

Income Taxation : Commentary and Materials [Eighth edition.]
 9780864608345, 0864608349

  • 0 0 0
  • Like this paper and download? You can publish your own PDF file online for free in a few minutes! Sign Up
File loading please wait...
Citation preview

INCOME TAXATION Commentary and Materials

Thomson Legal & Regulatory Australia 19 Harris Street PYRMONT NSW 2009 Tel: (02) 8587 7000 Fax: (02) 8587 7100 [email protected] http://legal.thomsonreuters.com.au For all customer inquiries please ring 1300 304 195 (for calls within Australia only) INTERNATIONAL AGENTS & DISTRIBUTORS NORTH AMERICA Thomson Legal & Regulatory North America Eagan United States of America

ASIA PACIFIC Thomson Legal & Regulatory Asia Pacific Sydney Australia

LATIN AMERICA Thomson Legal & Regulatory Latin America São Paulo Brazil

EUROPE Thomson Legal & Regulatory Europe London United Kingdom

INCOME TAXATION Commentary and Materials

GRAEME S COOPER Professor of Taxation Law, University of Sydney

MICHAEL DIRKIS Professor of Taxation Law, University of Sydney

MIRANDA STEWART Professor of Law, University of Melbourne and Australian National University

RICHARD J VANN Challis Professor of Law, University of Sydney

EIGHTH EDITION

LAWBOOK CO. 2017

Published in Sydney by Thomson Reuters (Professional) Australia Limited ABN 64 058 914 668, 19 Harris Street, Pyrmont, NSW First edition 1989 Second edition 1993 Third edition 1999 Fourth edition 2002 Fifth edition 2005 Sixth edition 2009 Seventh edition 2012 Eighth edition 2017 National Library of Australia Cataloguing-in-Publication entry Creator: Cooper, Graeme S., author. Income taxation : commentary and materials / Graeme S. Cooper, Miranda Stewart, Richard J. Vann, Michael Dirkis. 8th edition Includes index ISBN 9780864608345 (pbk) Income tax – Law and legislation – Australia. Income tax – Law and legislation – Australia – Cases. Other Authors/Contributors: Stewart, Miranda, author. Vann, Richard J., author. Dirkis, M. J. (Michael J.) author. © 2017 Thomson Reuters (Professional) Australia Ltd This publication is copyright. Other than for the purposes of and subject to the conditions under the Copyright Act, no part of it may in any form or by any means (electronic, mechanical, microcopying, photocopying, recording or otherwise) be reproduced, stored in a retrieval system or transmitted without prior written permission. Inquiries should be addressed to the publishers. All legislative material herein is reproduced by permission but does not purport to be the official or authorised version. It is subject to Commonwealth of Australia copyright. The Copyright Act 1968 permits certain reproduction and publication of Commonwealth legislation. In particular, s 182A of the Act enables a complete copy to be made by or on behalf of a particular person. For reproduction or publication beyond that permitted by the Act, permission should be sought in writing. Requests should be submited online at www.ag.gov.au/cca, faxed to (02) 6250 5989 or mailed to Commonwealth Copyright Administration, Attorney-General’s Department, Robert Garran Offices, National Circuit, Barton ACT 2600. This edition is up to date as of 15 December 2016. Editor: Lalitha Vyamajala Product Developer: Lucas Fredrick Publisher: Robert Wilson Printed by Ligare Pty Ltd, Riverwood, NSW This book has been printed on paper certified by the Programme for the Endorsement of Forest Certification (PEFC). PEFC is committed to sustainable forest management through third party forest certification of responsibly managed forests. For more info see www.pefc.org

PREFACE This is the 8th edition of this book. We have used the preface to each edition to tell a common story – about rapid and extensive change in the tax world, the impermanence of tax law and the brief life expectancy of any book that aspires to being current. And we have made the point that tinkering with the tax system seems to be the inevitable output of frustrated and powerless politicians whose influence over the real economy and the lives of citizens is at best tangential. For this edition we can add to our customary lament, the increasing influence of external actors, especially the OECD, as a force driving rapid change to Australian tax law – no country is island when it comes to tax law. Given that stability in the tax system is never going to be the norm, we remain firmly of the view that the object of a work such as this should be about preparing readers for the future, not simply understanding the present. In the past, we have put it this way, and we continue to think the original sentiment got it just about right: … to provide students with an understanding of the dialectics of tax law, not an historical snapshot of its status at a given point in time. Tax students must learn how to understand the technical rules of legislation and how to apply judicial precedents to given hypothetical situations, but these skills are not to be acquired as ends in themselves. The technical formulae are merely examples of how Treasury and the Commissioner’s Office have chosen to implement policy decisions and the pedagogic objective of the exercise is to provide students with the ability to read, analyse and work their way through whatever rules are adopted in response to changed policy objectives. We persevere in the view that, while students must learn how to understand, manipulate and apply obscure legislative directions, case law precedents and the dictates of the tax administration, they must also know how to evaluate their conclusions critically in terms of external policy considerations then to and predict, first for their examiners and later for their clients, the likely response of the Australian Taxation Office and Treasury to their decisions. Only then can a professional properly advise on the course of action most appropriate for a taxpayer. Once again cases and articles in this edition have been heavily edited by us. While large omissions have sometimes been identified by ellipses, some less significant jumps in the text have not been explicitly marked. We have taken liberties with texts but always with the hope of ensuring that in an abbreviated form, each extract is still a clear and accurate reflection of the author’s point. We are grateful for the assistance provided by generations of students and research assistants who have helped in the preparation of this book. We also wish to thank Alexandra Mills, Sandie Vann, Kristen Walker and Helen Dirkis. We also greatly appreciate the support and contributions of the staff at Thomson Reuters, especially Lucas Frederick and Lalitha Vyamajala. This book incorporates research that was originally funded by the Australian Research Council. The law is not stated exhaustively but what there is, is stated as at an indeterminate time in mid-2016. Graeme Cooper, University of Sydney Michael Dirkis, University of Sydney Miranda Stewart, University of Melbourne and Australian National University Richard Vann, University of Sydney February 2017

v

TABLE OF CONTENTS

Preface .............................................................................................................................................. v

Abbreviations .................................................................. ......................................................................... ix Table of Cases .................................................................................................................................. xi Table of Statutes ........................................................................................................................... xxv Table of Rulings ............................................................................................................................ xlvii

Part 1. Income Tax in Context 1. Tax Policy and Process ............................................................................................ 3 2. Fundamental Principles of the Income Tax System ......................................... 35

Part 2. The Tax Base – Income and Exemptions 3. Income from Property .......................................................................................... 75 4. Income from the Provision of Services ............................................................ 139 5. Business Income .................................................................................................. 259 6. Compensation Receipts and Periodic Receipts ............................................... 351

Part 3. The Tax Base – Deductions 7. The Positive Limbs – Nexus Issues .................................................................... 395 8. Personal and Non-personal Expenses ............................................................... 455 9. Current and Capital Expenses ........................................................................... 487 10. Specific Deductions and Restrictions on Deductions .................................. 519

Part 4. Allocating Income and Deductions to Periods – Timing 11. Tax Accounting .................................................................................................. 557 12. Statutory Accounting Regimes ....................................................................... 609

Part 5. Income Derived Through Intermediaries 13. Partnerships, Trusts and Income Splitting ................................................... 691 14. Taxation of Companies and Shareholders .................................................... 747 vii

Income Taxation

15. Special Topics in Company Tax ..................................................................... .. 809

Part 6. Income Derived From International Transactions 16. Principles for Taxing International Transactions ...................................... .. 863 17. Taxation of Residents ..................................................................................... .. 909 18. Taxation of Non-residents ............................................................................. .. 921

Part 7. Tax Administration 19. Administering the Tax Regime ..................................................................... .. 949 20. Containing Tax Avoidance and Evasion ..................................................... .. 1011 Index........................................................................................................................... 1051

viii

ABBREVIATIONS AAT ABN ACOSS ADF ADJR ATO ATR BAS CAA CGT COT CTBR DCT ETP FBT FBTAA 1986 FCT FDT FIFO GST HECS IRC IT ITAA 1936 ITAA 1997 JCPA LIFO MT OECD OSSA PAYE PAYG PE PPS PR RBL RPS RSA SBT

Administrative Appeals Tribunal Australian Business Number Australian Council of Social Securities Approved Deposit Fund Administrative Decisions (Judicial Review) Act 1977 Australian Tax Office Australian Tax Reports Business Activity Statement Civil Aviation Authority Capital gains tax Continuing of ownership test Commonwealth Taxation Board of Review Deputy Commissioner of Taxation Eligible termination payment Fringe benefits tax Fringe Benefits Tax Administration Act 1986 Federal Commissioner of Taxation Franking deficit tax First-in first-out Goods and Services Tax Higher Education and Education Contribution Scheme Inland Revenue Commissioner Income Tax Ruling Income Tax Assessment Act 1936 Income Tax Assessment Act 1997 Joint Committee of Public Accounts Last-in first-out Miscellaneous Taxation Ruling Organisation for Economic Co-operation and Development Occupational Superannuation Standards Act 1987 Pay As You Earn Pay As You Go Permanent Establishment Prescribed Payments System Product Ruling Reasonable benefit limit Reporting Payments System Retirement Savings Accounts Same business test ix

Income Taxation

SIS Act SIS Regulations Syd LR TAA 1953 TBRD TD TFN TLIP TR UWALR VAT WHT

Superannuation Industry (Supervision) Act 1993 Superannuation Industry (Supervision) Regulations Sydney Law Review Taxation Administration Act 1953 Taxation Board of Review Decisions Taxation Determination Tax File Number Taxation Laws Improvement Project Taxation Ruling University of Western Australia Law Review Value added tax Withholding tax

x

TABLE OF CASES [Where an extract from a case is reproduced, the name of the case and its paragraph number appear in bold type.] A AAT Case [2006] AATA 100; (2006) 61 ATR 1192 ....................................................................... 8.185 AAT Case 10,267 (1995) 31 ATR 1027 .................................................................................... 10.225 AAT Case 10,475 (1995) 31 ATR 1328 ...................................................................................... 7.315 AAT Case 10,700 (1996) 31 ATR 1375 ...................................................................................... 8.225 AAT Case 11,523 (1996) 34 ATR 1165 ..................................................................................... 11.225 AAT Case 12 (1987) 18 ATR 3056 ........................................................................................... 10.105 AAT Case 4611 (1988) 19 ATR 3895 ........................................................................................ 11.225 AAT Case 4708 (1988) 19 ATR 4040 ....................................................................................... 20.180 AAT Case 4880 (1989) 20 ATR 3255 ......................................................................................... 3.440 AAT Case 5181 (1989) 20 ATR 3694 ........................................................................... 11.365, 11.585 AAT Case 5219 (1988) 20 ATR 3777 ....................................................................................... 20.110 AAT Case 5593 (1989) 20 ATR 3140 ......................................................................................... 5.180 AAT Case 6253 (1990) 21 ATR 3703 ......................................................................................... 3.285 AAT Case 9451 (1994) 28 ATR 1108 ......................................................................................... 3.285 AAT Case 9605 (1994) 30 ATR 1001 ......................................................................................... 7.395 AAT Case 9824 (1994) 29 ATR 1246 ......................................................................................... 4.440 AGC (Advances) Ltd v FCT (1975) 132 CLR 175 ................................................... 2.500, 7.370 AGC (Investments) Pty Ltd v FCT (1992) 92 ATC 4239 ....................................... 5.750, 5.760 ANZ Bank v FCT (1993) 25 ATR 369 ....................................................................................... 12.710 ARM Constructions v FCT (1987) 19 ATR 337 ......................................................................... 13.135 Abbott v Philbin [1961] AC 352 ............................................................................. 2.260, 4.660 Aktiebolaget Volvo v FCT (1978) 8 ATR 747; 78 ATC 4316 ........................................................ 3.610 All States Frozen Food Pty Ltd v FCT (1990) 20 ATR 1874; 90 ATC 4175 ................................... 12.50 Allen, Allen & Hemsley v DFCT [1989] FCA 125 ...................................................................... 19.440 Alliance Holdings Ltd v FCT (1981) 21 ATR 509; 81 ATC 4637 ................................................ 12.490 Allied Mills v FCT (1989) 20 ATR 457 .................................................................... 5.570, 5.580 Allsop v FCT (1965) 113 CLR 341; 39 ALJR 201 ......................................... 6.120, 6.230, 6.240 Amalgamated Society of Engineers v Adelaide Steamship Co Ltd (1920) 28 CLR 129 ............... 20.70 Amalgamated Zinc (de Bavay’s) Ltd v FCT (1935) 54 CLR 295 .................................... 7.350 Archer Brothers Pty Ltd v FCT [1953] HCA 23; (1953) 90 CLR 140 ........ 14.1020, 14.1030, 14.1040 Armco (Australia) Ltd (1948) 76 CLR 584 ................................................................................. 5.770 Arthur Murray (NSW) Pty Ltd v FCT (1965) 114 CLR 314; 9 AITR 673; 14 ATD 98 .... 11.350 AusNet Transmission Group Pty Ltd v FCT [2015] HCA 25; 2015 ATC 20-521 ..... 9.25, 9.30 Australasian Catholic Assurance Co v FCT (1959) 100 CLR 502 ........................ 5.700, 5.710 Australasian Jam Co Pty Ltd v FCT (1953) 88 CLR 23; 5 AITR 566; 10 ATD 217 ...... 12.110, 12.120, 12.130 Automatic Totalisators Ltd v FCT (1968) 119 CLR 666 .............................................................. 6.285 Avco Financial Services v FCT (1982) 150 CLR 510 ................................................................... 5.770 Avondale Motors (Parts) Pty Ltd v FCT (1971) 124 CLR 97 ........................... 15.450, 15.460 Ayrshire Pullman Motor Services v IRC (1929) 14 TC 754 ......................................................... 20.40

B BHP-Billiton Petroleum (Bass Strait) [2002] FCAFC 433; 51 ATR 520 ........................................ 11.335 BHP Billiton Finance Ltd v FCT [2010] FCAFC 25 ............................................. 10.340, 10.350 BP Australia Ltd v FCT (1965) 112 CLR 386 ........................................... 9.130, 11.460, 11.465 BP Oil Refinery (Bulwer Island) Ltd v FCT (1992) 23 ATR 65 ....................................... 10.105, 10.225 Babka v FCT (1989) 20 ATR 1251 ............................................................................................... 5.60 Bailey v FCT (1977) 136 CLR 214 ........................................................................................... 19.510 Baker v Campbell (1983) 153 CLR 52 ............................................................... 19.450, 19.460 xi

Income Taxation

Ballarat Brewing Co v FCT (1951) 82 CLR 364; 5 AITR 151; 9 ATD 254 .................... 11.320 Balnaves v DFCT (1985) 85 ATC 4429 .................................................................................... 19.400 Barclays Mercantile Finance Ltd v Mawson [2004] UKHL 51 ................................................... 20.190 Barnett v FCT (1999) 99 ATC 2444 ............................................................................................. 6.75 Barratt v FCT (1992) 36 FCR 222; 23 ATR 339; 92 ATC 4275 ...................................... 11.175, 11.335 Barrett v FCT (1968) 118 CLR 666 ............................................................................................ 3.585 Bellinz Pty Ltd v FCT (1998) 84 FCR 154; 98 ATC 4634 ............................................................. 19.20 Bellinz Pty Ltd v FCT 39 ATR 198 .............................................................................................. 19.50 Bennett v FCT (1947) 75 CLR 480; 4 AITR 12 .................................................................. 4.810 Bernard Elsey Pty Ltd v FCT (1969) 121 CLR 119; 1 ATR 403; 69 ATC 4126 ................ 11.590, 12.440 Beville v FCT (1953) 10 AITR 458 ............................................................................................ 13.155 Bidencope (1978) 140 CLR 533 ............................................................................................... 5.240 Binetter v DCT [2012] FCAFC 126 .......................................................................................... 19.500 Blank v FCT [2015] FCAFC 154 ................................................................................................. 4.670 Bluebottle UK Ltd v DCT (2007) 232 CLR 598; [2007] HCA 54 .......... 14.310, 14.320, 18.10 Bonnell v DCT (No 5) [2008] FCA 991 .................................................................................... 19.420 Booth v Commissioner of Taxation (1987) 164 CLR 159 ............................... 13.570, 13.580 Boulder Perseverance Ltd v Taxation, Commissioner of (WA) (1937) 4 ATD 389 ...................... 14.755 Brackenreg and FCT, Re (2003) ATC 2196 .................................................................................. 6.75 Brajkovich v FCT (1989) 89 ATC 5227 ........................................................................................ 5.60 Brent v FCT (1971) 125 CLR 418; 2 ATR 563; 71 ATC 4195 .... 2.170, 4.730, 4.1220, 11.210, 19.200 Briggs v DFCT (1985) 85 ATC 4569 ........................................................................................ 19.400 British American Tobacco Australia Services Ltd v FCT [2010] FCAFC 130 ............................... 20.280 British Insulated and Helsby Cables Ltd v Atherton [1926] AC 205 .............................................. 9.20 British Mexican Petroleum Co Ltd v Jackson (1931) 16 TC 530 ................................................. 5.770 British South Africa Co v Varty [1965] 2 All ER 395 .................................................................... 15.50 Broken Hill Theatres Pty Ltd v FCT (1952) 85 CLR 423 ................................................... 9.70 Brooks v FCT (2000) 44 ATR 352 .............................................................................................. 3.295 Brookton Co-operative Society Ltd v FCT [1981] HCA 28; (1981) 147 CLR 441 ...... 14.310, 14.330, 14.340 Brown v FCT (1998) 39 ATR 226 ............................................................................................... 7.395 Brown v FCT [2002] FCAFC 318 ............................................................................................... 4.205 Burrill v FCT (1996) 67 FCR 519; 33 ATR 133; 96 ATC 4629 ........................................... 2.245, 3.470 Bywater Investments Ltd v FCT [2016] HCA 45 .......................................................... 16.200, 16.215

C C of T v Consolidated Press Holdings Ltd (2001) 207 CLR 235 ............................................... 15.170 C of T v Consolidated Press Holdings Ltd (No. 1) (1999) 91 FCR 524 ..................................... 15.170 C of T (NSW) v Ash (1938) 61 CLR 263 ............................................................................ 7.210 C of T (Vic) v Phillips (1936) 55 CLR 144 ....................................................... 6.10, 6.20, 6.320 CC (NSW) Pty Ltd v FCT (1997) 34 ATR 604 ........................................................................... 20.400 CMI Services Pty Ltd v FCT (1990) 90 ATC 4428; 21 ATR 445 ........................................ 5.230, 5.750 CPH Property Pty Ltd v Commissioner of Taxation [1998] FCA 1276 ....................................... 20.310 CPT Custodian v Commissioner of State Revenue (2005) 224 CLR 98 ..................................... 13.490 CTC Resources NL v FCT 27 ATR 403 ........................................................................................ 19.60 Californian Copper Syndicate v Harris (1904) 5 TC 159 ............................................................ 5.470 Californian Oil Products v FCT (1934) 52 CLR 28 ................................................ 5.510, 5.520 Caltex Ltd (1960) 106 CLR 205 ................................................................................................ 5.770 Cameron Brae v FCT (2006) 63 ATR 488; [2006] FCA 918 ........................................................ 4.920 Campbell v CIR (NZ) (1967) 14 ATD 551 ................................................................................ 14.130 Canny Gabriel Castle Jackson Advertising Pty Ltd v Volume Sales (Finance) Pty Ltd (1974) 131 CLR 321 ...................................................................................................................... 13.250 Carapark Holdings Ltd v FCT (1967) 115 CLR 653 .................................................. 6.80, 6.90 Carlaw and FCT, Re (1995) 31 ATR 1190 .................................................................................. 8.225 Case 1/97 (1997) 97 ATC 101 ................................................................................................ 11.225 Case 10/94 (1994) 94 ATC 168 ................................................................................................ 8.185 Case 110 (1955) 5 CTBR (NS) 656 ........................................................................................... 18.55 Case 111 (1981) 24 CTBR(NS) 898 ........................................................................................ 20.180 xii

Table of Cases

Case 16 (1993) 93 ATC 208 ...................................................................................................... 8.185 Case 17/93 (1993) 93 ATC 214 ................................................................................................ 7.315 Case 23 (1944) 12 CTBR 379 ................................................................................................... 8.185 Case 23/94 (1994) 94 ATC 234 ................................................................................................ 7.545 Case 24/94 (1994) 94 ATC 239 ................................................................................................ 3.285 Case 26/94 (1994) ATC 258 ..................................................................................................... 7.315 Case 29/94 (1994) 94 ATC 280 ................................................................................................ 8.225 Case 41/95 (1995) 95 ATC 361 ................................................................................................ 8.105 Case 48/93 (1993) 93 ATC 520 ................................................................................................ 8.105 Case 49/95 (1995) 95 ATC 422 ................................................................................................ 7.315 Case 51/93 (1993) 93 ATC 542 ................................................................................................ 8.245 Case 58/94 (1994) 94 ATC 498 ................................................................................................ 4.440 Case 61 (1979) 23 CTBR (NS) 537 ........................................................................................... 2.175 Case 68 (1967) 13 CTBR (NS) 463 ........................................................................................... 2.205 Case 8145 (1992) 23 ATR 1243 ................................................................................................ 4.815 Case 8775 (1993) 26 ATR 1056 ................................................................................................ 18.55 Case B9 (1970) 70 ATC 42 .......................................................................................................... 8.45 Case F43 (1974) 74 ATC 245 ...................................................................................................... 8.45 Case J53 (1977) 77 ATC 468 ..................................................................................................... 8.125 Case K89 (1959) 10 TBRD 477 ................................................................................................. 8.125 Case L54 (1979) 79 ATC 399 .................................................................................................... 2.175 Case N97 (1981) 81 ATC 521 ................................................................................................... 8.185 Case R50 16 TBRD .................................................................................................................... 2.205 Case S65 (1985) 85 ATC 469 .................................................................................................... 8.125 Case S80 (1985) 85 ATC 589 .................................................................................................... 8.125 Case V142 (1988) 88 ATC 891 ................................................................................................ 11.225 Case V15 (1988) 88 ATC 177 .................................................................................................... 8.125 Case V52 (1988) 88 ATC 402 .................................................................................................... 8.185 Case V6 (1987) 87 ATC 140 ...................................................................................................... 5.305 Case V95 (1988) 88 ATC 631 .................................................................................................. 11.585 Case W27 (1989) 89 ATC 4946; AAT Case 4946; 20 ATR 3340 .................................................. 5.350 Case W57 (1989) 89 ATC 517 .................................................................................................. 3.440 Case W58 (1989) 89 ATC 524 ................................................................................................. 20.110 Case W61 89 ATC 558 ............................................................................................... 11.365, 11.585 Case X81 90 ATC 594 ............................................................................................................... 3.285 Case Z1 (1992) 92 ATC 101 ..................................................................................................... 8.105 Case Z21 (1992) 92 ATC 218 ................................................................................................... 5.595 Case Z28 (1992) 92 ATC 264 ................................................................................................. 19.290 Case Z42 (1992) 92 ATC 381 ........................................................................................ 8.105, 8.265 Case Z9 92 ATC 267 ................................................................................................................. 4.815 Cecil Bros Pty Ltd v FCT (1962) 8 AITR 523 ..................................................................... 7.450 Cecil Bros Pty Ltd v FCT (1964) 111 CLR 430; 8 AITR 523; 13 ATD 261 ........... 7.460, 12.240, 20.120 Chamber Of Manufacturers Insurance Ltd v FCT (1984) 84 ATC 4315 ...................................... 5.720 Channel Pastoral Holdings Pty Ltd v Commissioner of Taxation [2015] FCAFC 57 ................... 20.290 Charles v FCT (1954) 90 CLR 598 ................................................................................ 5.730, 13.530 Charles Moore & Co (WA) Pty Ltd v FCT (1956) 95 CLR 344 ............................... 7.190, 8.10 Chevron Australia v FCT [2015] FCA 1092 .............................................................................. 16.300 Citibank v FCT (1989) 20 FCR 403; 89 ATC 4268 .......................................................... 19.480 Citibank v FCT [1989] FCA 126 .............................................................................................. 19.440 Clarke and Kann v DFCT (1983) 83 ATC 4764 ........................................................................ 19.400 Cliffs International Inc v FCT (1979) 142 CLR 140; 9 ATR 507; 79 ATC 4059 ............. 2.540, 9.270 Clough Engineering Ltd and DCT, Re (1997) 35 ATR 1164 ...................................................... 20.400 Coal Developments (German Creek) Pty Ltd v FCT (2008) 71 ATR 96; [2008] FCAFC 27 ........ 15.510 Coles Myer Finance Ltd v FCT (1993) 176 CLR 640; 25 ATR 95; 93 ATC 4214 ............ 3.440, 11.450 Colonial Mutual Life Assurance Society v FCT (1946) 73 CLR 604 ............................................. 6.430 Colonial Mutual Life Assurance Society Ptd Ltd v FCT (1953) 89 CLR 428 ................ 9.240 Commercial Union Australia Mortgage Insurance Co Ltd v FCT (1996) 69 FCR 331; 33 ATR 509; 96 ATC 4854 .............................................................................................................. 11.505 xiii

Income Taxation

Commercial and General Acceptance Ltd v FCT (1977) 137 CLR 373 ....................................... 5.770 Commissioner v Glenshaw Glass Co (1955) 348 US 426 ............................................................ 2.60 Condell v FCT (2007) 66 ATR 100; [2007] FCAFC 44 .......................... 14.130, 14.260, 14.270 Constable v FCT (1952) 86 CLR 402; 5 AITR 371; 10 ATD 93 ........................................ 2.190 Cooper Brookes (Wollongong) Pty Ltd v FCT (1981) 147 CLR 297 ................ 20.50, 20.100 Countess of Bective v FCT [1932] HCA 22; (1932) 47 CLR 417; 2 ATD 80 ........................ 2.70, 2.215 Country Magazine Pty Ltd v FCT (1968) 117 CLR 162; 10 AITR 573; 15 ATD 86 ....... 6.315, 11.500 Coward v FCT (1999) 99 ATC 2166 ............................................................................................ 6.75 Craven v White (1988) 62 TC 1 .............................................................................................. 20.190 Creer v FCT (1985) 16 ATR 246; 85 ATC 4104 ........................................................................ 11.460 Crommelin v DCT (1998) 39 ATR 377 .................................................................................... 13.240 Cumins [2007] FCAFC 21 ........................................................................................................... 3.30 Curran v FCT (1974) 131 CLR 409 .................................................................. 11.590, 12.445, 20.50 Cyprus Mines Corp v FCT (1978) 78 ATC 4468 ........................................................................ 8.250

D DCT v Broadbeach Properties [2008] HCA 41; (2008) 69 ATR 357 .......................................... 19.420 DCT v de Vonk (1995) 31 ATR 481 .......................................................................................... 19.500 DFC of T v Black (1990) 25 FCR 274; 101 ALR 535; 90 ATC 4699 ................ 14.130, 14.400, 14.410 DFCT v Trustees of Wheat Pool of Western Australia (1932) 48 CLR 5 ..................................... 13.305 Daihatsu Australia Ltd v FCT (2000) 46 ATR 129; [2000] FCA 1658 ......................................... 19.440 Danmark Pty Ltd v FCT (1944) 7 ATD 333 .............................................................................. 19.290 David Jones Finance and Investments Pty Ltd v FCT (1991) 21 ATR 1506; 91 ATC 4315 ........................................................................................................ 19.40, 19.260, 19.270 Dawson v IRC (1978) 78 ATC 6012 .......................................................................................... 2.245 Dean and McLean v FCT (1997) 37 ATR 52; 97 ATC 4762 ......................................................... 4.155 Delacy v FCT [2006] AATA 198 .................................................................................................. 8.230 Deloitte Touche Tohmatsu v DFCT (1998) 40 ATR 435 ............................................................ 19.490 Denlay v Commissioner of Taxation [2011] FCAFC 63 ............................................................ 19.440 Denver Chemical Manufacturing Co v FCT (1949) 79 CLR 296 .............................................. 19.220 Dibb v FCT (2004) 136 FCR 388; [2004] FCAFC 126 .............................................................. 4.1120 Dickenson v FCT (1958) 98 CLR 460 ........................................................... 4.840, 5.420, 5.430 Dingwall v FCT (1995) 30 ATR 498 ........................................................................................... 15.40 Dolby v FCT 2002 ATC 2325 .................................................................................................... 15.40 Donaldson v FCT [1974] 1 NSWLR 627; (1974) 4 ATR 530; 74 ATC 4192 ...................... 2.250, 4.270 Donoghue v FCT [2015] FCA 235 ........................................................................................... 19.280 Donovan v DFCT (1992) 92 ATC 4114 .................................................................................... 19.500 Dormer [2002] FCAFC 385; (2002) 51 ATR 353 ...................................................................... 11.490 Dwight v FCT (1992) 37 FCR 178; 23 ATR 236; 92 ATC 4192 ................................................. 13.375

E EHL Burgess Pty Ltd v FCT (1988) 88 ATC 4517 ........................................................................ 7.225 Eastern Nitrogen v FCT (2001) 45 ATR 474; 108 FCR 27; [2001] FCA 366 ..... 10.187, 9.320 Egerton-Warburton v Deputy FCT (1934) 51 CLR 568 ...... 6.370, 6.410, 6.420, 6.430, 9.210 Eisner v Macomber 252 US 189 (1920) ......................................................................... 2.50, 14.350 Elberg v FCT (1998) 38 ATR 623 ............................................................................................... 7.165 Electricity Supply Industry Superannuation (Qld) Ltd v DFCT (2003) 53 ATR 120; [2003] FCAFC 138 ........................................................................................................................ 14.950 Elmslie v FCT (1993) 46 FCR 576; 26 ATR 611; 93 ATC 4964 .................................................... 3.285 Employers Mutual Indemnity Association Ltd v FCT (1991) 91 ATC 4850 .................................. 5.750 Emu Bay Railway Co Ltd v FCT (1944) 71 CLR 596 ................................................................. 14.690 Ensign Tankers (Leasing) Ltd v Stokes [1992] STC 226 ............................................................ 20.190 Erdelyi v FCT (2007) 60 ATR 872 .............................................................................................. 3.390 Esquire Nominees v FCT (1973) 129 CLR 177 ........................................................... 16.215, 18.100 Essenbourne v FCT (2002) 51 ATR 629; [2002] FCA 1577 ......................................................... 4.640 Esso v FCT (1998) 40 ATR 76 ...................................................................................................... 8.75 xiv

Table of Cases

Esso Australia Ltd v FCT (1998) 40 ATR 76 ................................................................................ 4.560 Esso Australia Resources Ltd v FCT (1999) 43 ATR 506 ............................................................ 19.470 Europa Oil (NZ) Ltd (No 2) v IRC (1976) 5 ATR 744; 1 WLR 464 .......... 7.470, 20.50, 20.120 Evans v DCT (SA) (1936) 55 CLR 80 ....................................................................................... 14.210 Evans v FCT (1989) 20 ATR 922 .................................................................................................. 5.60 Evenden v FCT [1999] AATA 731 ............................................................................................... 7.395

F F & C Donebus Pty Ltd v FCT (1988) 19 ATR 1521 ................................................................. 10.225 F J Bloemen Pty Ltd v FCT (1981) 147 CLR 360 ...................................................................... 19.260 FCT v AGC Ltd (1984) 2 FCR 483; 15 ATR 982; 84 ATC 4642 ....................................... 11.430 FCT v AXA Asia Pacific Holdings Ltd [2010] FCAFC 134 ........................................................... 20.350 FCT v Anstis [2009] HCA 40 ...................................................................................................... 8.105 FCT v Applegate (1979) 9 ATR 899; 79 ATC 4307 ............................................ 16.150, 16.160 FCT v Ashwick (Qld) No 127 Pty Ltd [2011] FCAFC 49 .............................................. 10.340, 20.350 FCT v Australia & New Zealand Savings Bank (1998) 39 ATR 419 ............................................. 7.640 FCT v Australian Gas Light Co (1983) 15 ATR 105; 83 ATC 4800 ............................... 11.300 FCT v Bamford (2010) 240 CLR 481 ....................................................................................... 13.400 FCT v Batagol (1963) 109 CLR 243 ........................................................................................ 19.220 FCT v Blake (1984) 15 ATR 1006; 84 ATC 4661 .............................................................. 4.125, 6.405 FCT v Brand (1995) 31 ATR 326 ..................................................................................... 5.190, 7.315 FCT v Brian Hatch Timber Co (Sales) Pty Ltd (1972) 128 CLR 28 ............................................ 19.510 FCT v Broken Hill Pty Co Ltd (2000) 45 ATR 507 ............................................................ 3.430, 9.355 FCT v CSR Ltd (2000) 104 FCR 44; 45 ATR 559; [2000] FCA 1513 ...................... 2.300, 5.410, 6.120 FCT v Citibank Ltd (1993) 44 FCR 434; 26 ATR 423; 93 ATC 4691 .... 11.550, 11.560, 12.55, 12.710 FCT v Clark (2011) 190 FCR 206 ............................................................................................ 13.500 FCT v Collings (1976) 76 ATC 4254 ............................................................................................ 8.45 FCT v Comber (1986) 10 FCR 88; 17 ATR 413; 86 ATC 4171 .................................................... 4.700 FCT v Commercial Nominees of Australia Ltd (2001) 47 ATR 220 ............................................ 13.500 FCT v Consolidated Fertilizers Ltd (1991) 22 ATR 281 ............................................................... 9.100 FCT v Consolidated Media Holdings Ltd [2012] HCA 55 ................................ 14.150, 14.160 FCT v Consolidated Press Holdings Ltd (2001) 207 CLR 235; [2001] HCA 32 ......... 15.180, 20.270, 20.310 FCT v Cooke (2004) 55 ATR 183; [2004] FCAFC 75 .................................................................. 20.20 FCT v Cooke and Sherden (1980) 10 ATR 696; 80 ATC 4140 ......... 1.320, 2.230, 4.30, 5.280 FCT v Cooling (1990) 90 ATC 4472 .......................................................................................... 5.640 FCT v Coombes (1999) 42 ATR 356 ........................................................................................ 19.470 FCT v Cooper (1991) 21 ATR 1616 ................................................................................ 8.190, 8.225 FCT v Creer (1986) 86 ATC 4318 .............................................................................................. 7.630 FCT v Cyclone Scaffolding Pty Ltd (1987) 87 ATC 5083 ............................................................ 5.490 FCT v Dalco (1990) 20 ATR 1370; 90 ATC 4088 ...................................................................... 19.350 FCT v Day (2008) 236 CLR 163; 70 ATR 14; [2008] HCA 53 ........................................... 7.160 FCT v Dixon (1952) 86 CLR 540; 5 AITR 443 ...................................... 4.80, 6.10, 6.330, 6.340 FCT v Donoghue [2015] FCAFC 183 ...................................................... 19.280, 19.285, 19.495 FCT v Dunn (1989) 20 ATR 356; 89 ATC 4141 ........................................................................ 11.175 FCT v Edwards (1994) 28 ATR 87 .............................................................................................. 8.185 FCT v Efstathakis (1979) 9 ATR 867 ......................................................................................... 18.200 FCT v Email Ltd (1999) 42 ATR 698 .......................................................................................... 9.100 FCT v Emmakell Pty Ltd (1990) 21 ATR 346 .............................................................................. 5.190 FCT v Energy Resources of Australia (2003) 135 FCR 346; [2003] FCAFC 314 ........................... 12.50 FCT v Energy Resources of Australia Ltd (1996) 185 CLR 66 ...................................................... 3.440 FCT v Equitable Life & General Insurance Co Ltd (1990) 90 ATC 4438 ...................................... 5.750 FCT v Everett (1980) 143 CLR 440; 80 ATC 4076 .......................................... 13.250, 13.375, 13.570 FCT v Finn (1961) 106 CLR 60 ....................................................................... 7.270, 8.10, 8.120 FCT v Firstenberg [1977] VR 1; (1976) 6 ATR 297; 76 ATC 4141 ................................ 11.150 FCT v Firth (2002) 50 ATR 1 ............................................................................................... 7.520 FCT v Forsyth (1981) 148 CLR 203 .................................................................................... 8.160 FCT v Foxwood (Tolga) Pty Ltd (1981) 147 CLR 278 ................................................................ 5.790 xv

Income Taxation

FCT v Futuris Corporation [2012] FCAFC 32 ........................................................................... 20.320 FCT v Futuris Corporation Ltd (2008) 69 ATR 41; [2008] HCA 32 ............................................ 19.280 FCT v GKN Kwikform Services Pty Ltd (1991) 91 ATC 4336 ...................................................... 5.490 FCT v Guest (2007) 65 ATR 815; [2007] FCA 193 ..................................................................... 7.395 FCT v Gulland, Watson, Pincus (1985) 160 CLR 55; 85 ATC 4765 ................... 4.940, 13.590, 20.240 FCT v Guy (1996) 67 FCR 68; 32 ATR 590; 96 ATC 4520 .......................................................... 3.295 FCT v Gwynvill Properties Pty Ltd (1986) 13 FCR 138 ............................................................... 7.630 FCT v Harris (1980) 10 ATR 869; 80 ATC 4238 ........................................................ 4.70, 4.110 FCT v Hart [2004] HCA 26 ...................................................................................................... 20.260 FCT v Hatchett (1971) 125 CLR 494 .......................................................................... 8.10, 8.90 FCT v Holmes (1995) 58 FCR 151; 31 ATR 71; 95 ATC 4476 .......................................... 4.170 FCT v Hyteco Hiring Pty Ltd (1992) 24 ATR 218; 92 ATC 4694 ....................................... 5.470, 5.490 FCT v Ilbery (1981) 12 ATR 563 ........................................................................ 7.310, 7.630, 20.190 FCT v James Flood Pty Ltd (1953) 88 CLR 492; 5 AITR 579; 10 ATD 240 ................... 11.390 FCT v Janmor Nominees (1987) 19 ATR 254; 87 ATC 4813 ..................................................... 13.395 FCT v Jenkins (1982) 12 ATR 745; 82 ATC 4098 ...................................................................... 16.175 FCT v Kurts Development Pty Ltd (1998) 39 ATR 493 .................................... 12.190, 12.200 FCT v La Rosa (2002) 50 ATR 450 ............................................................................................. 7.170 FCT v La Rosa (2003) 129 FCR 494; 53 ATR 1; [2003] FCAFC 125 ....................... 5.350, 5.355, 7.170 FCT v Lacelles-Smith (1978) 78 ATC 4162 ................................................................................ 8.105 FCT v Lamesa Holdings BV (1997) 36 ATR 589 ........................................................................ 16.100 FCT v Lau (1984) 6 FCR 202; 16 ATR 55; 84 ATC 4929 ...................... 5.190, 11.460, 12.605, 20.230 FCT v Lenzo (2008) FCR 255; [2008] FCAFC 50 ....................................................................... 20.20 FCT v Levy (1961) 106 CLR 448 ............................................................................................... 7.225 FCT v Ludekins [2013] FCAFC 100 ......................................................................................... 20. 210 FCT v M I Roberts (1992) 92 ATC 4781 ..................................................................................... 8.105 FCT v Macquarie Bank Ltd [2013] FCAFC 13 .......................................................................... 20.290 FCT v Maddalena (1971) 2 ATR 541 ......................................................................................... 7.320 FCT v Manchester Unity IOOF (1994) 94 ATC 4235 and 4309 .................................................. 7.425 FCT v McClelland (1969) 118 CLR 353; 1 ATR 31 .................................................................... 11.590 FCT v McDonald (1987) 18 ATR 957 ...................................................................... 13.80, 13.90 FCT v McNeil (2007) 229 CLR 656; [2007] HCA 5 .................. 3.420, 14.130, 14.300, 14.350, 15.50 FCT v McPhail (1968) 117 CLR 111 .......................................................................................... 8.250 FCT v Midland Railway Company of Western Australia Ltd (1952) 85 CLR 306 ........................ 14.690 FCT v Mitchum (1965) 113 CLR 401 ......................................................................... 18.200, 18.240 FCT v Mochkin [2003] FCAFC 15; (2003) 52 ATR 198 ................................................ 13.590, 20.380 FCT v Montgomery (1999) 198 CLR 639 .................................................................................. 5.660 FCT v Murphy (1961) 106 CLR 146 ........................................................................................ 12.430 FCT v Murry (1998) 39 ATR 129; 98 ATC 4585 ......................................................................... 3.285 FCT v Myer Emporium Ltd (1987) 163 CLR 199; 18 ATR 693; 87 ATC 4363 ...... 2.60, 5.360, 5.370, 6.10 FCT v NF Williams (1972) 127 CLR 226; 3 ATR 283; 72 ATC 4188 ........................................... 11.590 FCT v National Commercial Banking Corp of Australia Ltd (1983) 72 FLR 116 ........................ 10.330 FCT v Orica Ltd (1998) 39 ATR 66; 98 ATC 4494 ............................. 3.50, 3.130, 5.770, 5.780 FCT v Patcorp Investments Ltd (1976) 140 CLR 247 .................. 14.80, 14.90, 19.40, 19.280 FCT v Payne (2001) 46 ATR 228 ....................................................................................... 8.40, 10.30 FCT v Peabody (1994) 123 ALR 451 ....................................................................................... 20.390 FCT v Phillips (1978) 36 FLR 399; 8 ATR 783 ...................................................... 7.560, 20.120 FCT v Pitcher (2005) 146 FCR 344; [2005] FCA 1154 ............................................................. 4.1120 FCT v Prestige Motors Pty Ltd (1998) 38 ATR 568 ................................................................... 13.460 FCT v QANTAS [2014] FCAFC 168 ............................................................................................ 4.450 FCT v Rabinov (1983) 83 ATC 4437 .......................................................................................... 8.250 FCT v Radnor Pty Ltd (1991) 91 ATC 4689 ............................................................................... 5.750 FCT v Ramsden (2005) 58 ATR 485 ......................................................................................... 13.380 FCT v Raymor (1990) 24 FCR 90; 21 ATR 458; 90 ATC 4461 ..................................................... 12.50 FCT v Reynolds (1981) 11 ATR 629; 81 ATC 4131 ............................................ 19.290, 19.300 FCT v Roberts & Smith (1992) 37 FCR 246; 23 ATR 494; 92 ATC 4380 ......... 13.140, 13.150 FCT v Rothmans of Pall Mall (Australia) Ltd (1992) 23 ATR 620 ................................................. 9.185 FCT v Rowe (1997) 187 CLR 266 ................................................................. 4.155, 6.250, 6.260 FCT v Rozman [2010] FCA 324 ............................................................................................... 14.370 xvi

Table of Cases

FCT v Ryan (2000) 201 CLR 109; [2000] HCA 4 ...................................................................... 19.220 FCT v Seven Network [2016] FCAFC 70 .................................................................................. 18.185 FCT v Sherritt Gordon Mines Ltd (1977) 137 CLR 612; 7 ATR 726; 77 ATC 4365 ......... 3.610, 18.170 FCT v Slater Holdings Ltd [1984] HCA 78; (1984) 156 CLR 447 .................... 14.190, 14.200 FCT v Slaven (1984) 1 FCR 11 ........................................................................... 6.60, 6.70, 6.320 FCT v Sleight (2004) 136 FCR 211; [2004] FCAFC 94 ......................................... 5.120, 5.180, 20.20 FCT v Smith (1981) 147 CLR 578 ............................................................................ 6.100, 6.110 FCT v Snowden and Willson Pty Ltd (1958) 99 CLR 431 ...................................... 7.70, 7.110 FCT v South Australian Battery Makers Pty Ltd (1978) 140 CLR 645 ............. 7.490, 7.500, 20.50 FCT v Spedley Securities Ltd (1988) 19 ATR 938 ............................................................ 5.380, 6.120 FCT v Spotless Services Ltd [1996] HCA 34 ............................. 20.250, 20.330, 20.340, 20.380 FCT v Squatting Investment Co Ltd (1954) 88 CLR 413 ............................ 4.30, 5.280, 5.290 FCT v St Hubert’s Island Pty Ltd (1978) 138 CLR 210; 8 ATR 452; 78 ATC 4101 ..... 12.260, 12.310 FCT v Star City Pty Ltd [2009] FCAFC 19 .......................................................................... 9.170 FCT v Stone (2005) 222 CLR 289; [2005] HCA 21 ..................................... 4.160, 5.140, 6.365 FCT v Studdert (1991) 91 ATC 5006 .............................................................................. 7.640, 8.105 FCT v Subrahmanyam (2001) 116 FCR 180; 49 ATR 29 .......................................................... 16.170 FCT v Sun Alliance Investments Pty Ltd (in liq) (2005) 222 ALR 286 ........................................ 14.210 FCT v Sydney Refractive Surgery Centre Pty Ltd (2008) 172 FCR 557; [2008] FCAFC 190 .......................................................................................................................... 6.40 FCT v Tasman Group Services Pty Ltd (2009) 180 FCR 128 ..................................................... 10.340 FCT v The Myer Emporium Ltd (1987) 163 CLR 199 .............................................................. 15.715 FCT v Thiel (1990) 171 CLR 338 ................................................................ 18.40, 18.50, 18.280 FCT v Totledge (1982) 12 ATR 8309 ....................................................................................... 13.375 FCT v Tully Co-operative Sugar Milling Association Ltd (1983) 14 ATR 495 ............................. 10.180 FCT v Uther [1965] HCA 42; (1965) 112 CLR 630 ............... 14.280, 14.290, 14.300, 14.1010 FCT v Vogt (1975) 75 ATC 4073 ................................................................................................. 8.40 FCT v Wade (1951) 84 CLR 105 ................................................................................................ 6.140 FCT v Western Suburbs Cinemas Ltd (1952) 86 CLR 102 ................................... 10.70, 10.80 FCT v Westraders Pty Ltd (1980) 144 CLR 55 ...................................................... 20.30, 20.60 FCT v Whitfords Beach Pty Ltd (1982) 150 CLR 355; 12 ATR 692; 82 ATC 4031 ....... 5.210, 5.220, 10.40, 11.530, 11.540, 11.570, 11.590, 12.440, 20.70 FCT v Woite (1982) 31 SASR 223; 13 ATR 579; 82 ATC 4578 ........................................ 4.850 FCT v Woolcombers (1993) 27 ATR 302; 93 ATC 5170 .............................................................. 12.50 Fairway Estates Pty Ltd v FCT (1970) 123 CLR 153 ............................................. 5.160, 5.170 Federal Coke Co Pty Ltd v FCT (1977) 7 ATR 519; 77 ATC 4255 ............ 2.160, 5.260, 5.270, 15.715 Ferguson v FCT (1979) 9 ATR 873 .............................................................................. 5.60, 5.70 Ferris v FCT (1988) 20 FCR 202; 19 ATR 1705; 88 ATC 4755 ............................ 4.690, 14.440 First Provincial Building Society Ltd v FCT (1995) 30 ATR 207 ......................... 5.330, 5.340 Fletcher v FCT [1991] HCA 42; (1991) 173 CLR 1 .................... 7.640, 20.150, 20.160, 20.170 Fowler v FCT (2008) 167 FCR 425; [2008] FCA 528 ................................................................ 4.1220 Freeman v FCT (1983) 14 ATR 457 .............................................................................. 4.1120, 7.380 French v FCT (1958) 98 CLR 398 ............................................................................................ 18.200 Fullerton v FCT (1991) 91 ATC 4983 ........................................................................................... 8.45 Furniss v Dawson [1984] 2 WLR 226 ...................................................................................... 20.190

G G v CIR (NZ) [1961] NZLR 994 ................................................................................................. 5.155 GE Capital Finance v FCT (2007) 159 FCR 473; 66 ATR 447 ...................................................... 16.80 GP International Pipecoaters Pty Ltd v FCT (1990) 170 CLR 124 ..................... 5.310, 5.320 Gair v FCT (1944) 71 CLR 388; 7 ATD 443 ................................................................... 2.170, 13.585 Gandy Timbers Pty Ltd v FCT (1995) 95 ATC 4167 ................................................................... 7.545 Gas Lighting Improvement Co Ltd v IRC [1923] AC 723 ........................................................... 14.20 Gilbert v FCT [2010] AATA 882 ................................................................................................. 8.230 Gillespie v FCT (2001) 49 ATR 1012; [2001] AATA 1009 .......................................................... 4.1120 Giris Pty Ltd v FCT (1969) 119 CLR 365 ............................................................ 19.370, 19.380 xvii

Income Taxation

Glenboig Union Fireclay Co v IRC (1922) 12 TC 427 ................................ 5.550, 5.560, 6.150 Gray v FCT (1989) 20 ATR 649 ............................................................................................... 20.110 Grollo Nominees Pty Ltd v FCT (1997) 36 ATR 424 .................................................... 13.135, 20.110 Guinea Airways Ltd v FCT (1949) 83 CLR 584; 5 AITR 58; 9 ATD 197 ...................................... 12.380 Gwynvill Properties v FCT (1986) 13 FCR 138; 17 ATR 344; 86 ATC 4512 ............................... 11.460

H HR Sinclair & Son Pty Ltd v FCT (1966) 114 CLR 537 .......................................... 6.210, 6.220 HW Coyle Ltd v IRC (NZ) (1980) 11 ATR 122; 80 ATC 6012 .................................................... 11.550 Hallstroms Pty Ltd v FCT (1946) 72 CLR 634; 3 AITR 436 ............................................... 9.50, 11.465 Hance v FCT [2008] FCAFC 196 ............................................................................................... 5.120 Handley v FCT (1981) 148 CLR 182 .................................................................................. 8.140 Haritos v Commissioner of Taxation [2015] FCAFC 92 ............................................................ 19.330 Harris v FCT (2002) 125 FCR 46; [2002] FCAFC 226 ................................................................. 4.920 Hayden v FC of T (1996) 33 ATR 352; 96 ATC 4797 ................................................................ 13.395 Hayes v FCT (1956) 96 CLR 47 .................................................................................... 4.10, 4.40 Heaton v Bell [1970] AC 728 .................................................................................................... 2.175 Heavy Minerals v FCT (1966) 115 CLR 512 ................................................ 5.530, 5.540, 6.150 Henderson v FCT (1970) 119 CLR 612; 1 ATR 596; 70 ATC 4016 ...... 6.315, 11.130, 11.270, 11.480, 12.350 Henry Jones (IXL) Ltd v FCT (1991) 91 ATC 4663 ...................................................................... 5.415 Hepples v FCT (1991) 22 ATR 465; 91 ATC 4808 ......................................... 3.150, 3.160, 6.55 Hepples v FCT (No 2) (1992) 173 CLR 492; 22 ATR 852 ................................................ 3.150, 4.860 Herald and Weekly Times Ltd v FCT (1932) 48 CLR 113 ......................................... 7.70, 7.90 Higgs v Olivier [1951] 1 Ch 899 ........................................................................... 4.830, 4.1125 Hobart Bridge Co v FCT (1951) 82 CLR 372 ............................................................................. 15.10 Hobbs v FCT (1957) 98 CLR 151; 6 AITR 490 ......................................................................... 13.590 Hochstrasser v Mayes [1960] AC 376 .......................................................................................... 2.80 Howard v FCT [2014] HCA 21 .................................................................................................. 2.215 Howland-Rose v FCT (2002) 118 FCR 61; [2002] FCA 246 .................................. 5.120, 5.180, 20.20 Hunter Douglas Ltd v FCT (1983) 14 ATR 629 .......................................................................... 5.770 Hurley Holdings (1989) 20 ATR 1293 ........................................................................................ 3.440

I ICI Australia v FCT (1994) 29 ATR 233 (Ryan J); (1996) 33 ATR 174 ........................................... 5.770 IRC v Blott [1921] 2 AC 171 ................................................................................................... 14.350 IRC v British Salmson Aero Engines Ltd [1938] 2 KB 482 ............................................................. 9.25 IRC v Burmah Oil Co Ltd [1982] STC 30 ................................................................................. 20.190 IRC v Duke of Westminster [1936] AC 1 ................................... 13.460, 20.50, 20.120, 20.130 IRC v Falkirk Ice Rink (1975) 51 TC 42 ...................................................................................... 5.305 IRC v Forrest (1924) 8 TC 704 .................................................................................................. 15.20 IRC v McGukian [1997] UKHL 22 ............................................................................................ 20.190 IRC v Scottish Provident Institution [2004] UKHL 52 ............................................................... 20.190 IRC v Sir John Oakley (1925) 9 TC 582 ..................................................................................... 15.20 IRC v Warnes & Co [1919] 2 KB 444 ........................................................................................... 7.70 IRC v Wattie [1999] 1 WLR 873 ................................................................................................ 5.660 IRC v von Glehn & Co Ltd [1920] 2 KB 553 ................................................................................ 7.70 IRC (NZ) v Mitsubishi Motors (NZ) Ltd (1995) 31 ATR 350; 95 ATC 4711 ............................... 11.360 IRG Technical Services Pty Ltd v FCT (2007) 165 FCR 57; [2007] FCA 1867 ............................ 4.1220 Idlecroft Pty Ltd v FCT (2004) 56 ATR 699 .............................................................................. 13.460 Ikea Ltd v Canada (1998) 1 SCR 196 ........................................................................................ 5.660 Ilbery’s case [1981] FCA 188 .................................................................................................. 12.540 Imperial Chemical Industries of Australia and New Zealand Ltd v FCT (1970) 120 CLR 396 .... 10.150, 10.180 Indooroopilly Children Services Qld v FCT (2006) 63 ATR 106; [2006] FCA 734 and on appeal (2007) 158 FCR 325; [2007] FCAFC 16 .................................................................... 4.640 Industrial Equity Ltd v DFCT [1990] HCA 46 ........................................................................... 19.430 xviii

Table of Cases

Inland Revenue, Commissioners of v Burmah Oil Co Ltd (1981) 54 TC 200 .............................. 6.205 International Business Machines v FCT [2011] FCA 335 .......................................................... 18.185 International Nickel Australia Ltd v FCT (1977) 137 CLR 347 .................................................... 5.770 Investment and Merchant Finance Corporation Ltd v FCT (1971) 125 CLR 249 .......... 12.320, 15.10, 15.110, 20.50

J J & G Knowles v FCT (2000) 44 ATR 22 ....................................................................... 4.420, 14.435 J & G Knowles, Re (2000) 45 ATR 1101 ..................................................................................... 4.420 J Rowe & Son Pty Ltd v FCT (1971) 124 CLR 421; 2 ATR 497; 71 ATC 4157 ................ 12.40 James v United States (1961) 366 US 213 ................................................................................ 5.350 John v FCT (1989) 116 CLR 417; 20 ATR 1; 89 ATC 4101 .............................. 11.590, 20.190, 20.200 John Fairfax & Sons Pty Ltd v FCT (1959) 101 CLR 30 ................................................................ 9.90 Jones v FCT (2002) 49 ATR 188 ................................................................................................ 7.395 Jones v Leeming [1930] AC 415 ...................................................................................... 3.10, 20.70 Jupiters Ltd v Deputy FCT (2002) 50 ATR 236 ........................................................................... 9.160 Just v FCT (1949) 8 ATD 419 ........................................................................ 6.430, 6.440, 9.230

K Kafataris v FCT (2008) 172 FCR 242; [2008] FCA 1454 ........................................................... 13.490 Kajewski v FCT (2003) 52 ATR 455; [2003] FCA 258 ................................................................. 4.640 Keily v FCT (1983) 83 SASR 494 ............................................................................. 6.380, 6.390 Kelly v FCT (1985) 16 ATR 478; 85 ATC 4283 ........................................................................... 4.160 Kennedy Holdings and Property Management Pty Ltd v FCT (1992) ATR 321 ........................... 9.185 Knight-Ridder Newspapers v United States (1984) 743 F 2d 781 ............................................ 11.100 Knuckey v FCT [1998] FCA 1143 ............................................................................................ 19.430 Kordan Pty Ltd v FCT (2000) 46 ATR 191 ................................................................................ 20.390 Krampel Newman Partners Pty Ltd v FCT (2003) 126 FCR 561; [2003] FCA 123 ....................... 20.20 Kratzmann’s Hardware Pty Ltd v FCT (1985) 16 ATR 274; 85 ATC 4138 .................................. 12.430 Kwikspan Purlin Systems Pty Ltd v FCT (1984) 84 ATC 4282 ............................ 5.620, 5.630

L L’Estrange v FCT (1978) 9 ATR 410; 78 ATC 4744 ................................................................... 19.210 Lamesa Holdings v FCT [1997] FCA 134 ................................................................................. 18.280 Lancey Shipping Co Pty Ltd v FCT (1951) 9 ATD 267 ............................................................. 19.290 Lau v FCT (1984) 84 ATC 4618 ................................................................................................. 7.630 Law Shipping Co v Inland Revenue 1924 SC 74 ..................................................................... 10.105 Lawford v C of T (NSW) (1937) 1 AITR 89 ................................................................................ 5.420 Lawrence v FCT [2009] FCAFC 29 .......................................................................................... 15.190 Le Grand v FCT (2002) 124 FCR 53; [2002] FCA 1258 ............................................................ 4.1120 Leary v FCT (1980) 80 ATC 4438 .............................................................................................. 8.250 Lees & Leach v FCT (1997) 36 ATR 137 .................................................................................... 5.660 Leighton v FCT [2011] FCAFC 96 .............................................................................. 13.300, 13.375 Liftronic Pty Ltd v FCT (1996) 96 FCR 175 ................................................................................ 6.120 Lighthouse Philatelics Pty Ltd v FCT (1991) 22 ATR 707; 91 ATC 4942 .................................... 19.290 Lilyvale Hotel Pty Ltd v FCT [2009] FCAFC 21 .................................................. 15.490, 15.500 Lindsay v FCT (1961) 106 CLR 377 ......................................................................................... 10.105 Lodge v FCT (1972) 128 CLR 171 .............................................................................................. 8.60 Lomax v Peter Dixon (1943) 25 TC 353 ................................................................ 3.440, 3.450 London Australia Investment Co Ltd v FCT (1977) 138 CLR 106 ........... 5.730, 5.740, 15.10 London and Thames Haven Oil Wharves Ltd v Attwooll [1967] Ch 772 .................................... 6.205 Lonsdale Sand and Metal Pty Ltd v FCT (1998) 38 ATR 384 .................................................... 14.130 Lunney v FCT (1958) 100 CLR 478 .................................................................... 8.10, 8.30, 8.60

xix

Income Taxation

M MIM Holdings Ltd v FCT (1997) 36 ATR 108 ........................................................ 5.440, 5.450 MLC Ltd v FCT (2002) 51 ATR 283 ......................................................................... 1.330, 1.340 MNR v Anaconda American Brass Ltd [1956] AC 85 ................................................................ 12.110 MacCormack v FCT [2001] FCA 1700 ..................................................................................... 19.440 MacFarlane v FCT 86 ATC 4477 ................................................................................. 14.130, 14.240 Macniven v Westmoreland Investments Ltd [2001] UKHL 6 .................................................... 20.190 Macquarie Finance Ltd v FCT (2004) 57 ATR 115; [2004] FCA 1170 ........................... 14.680, 20.380 Macquarie Finance Ltd v FCT (2005) 146 FCR 77; 61 ATR 1; [2005] FCAFC 205 ..................... 14.680 Madad (1984) 15 ATR 1118 ........................................................................................................ 7.70 Madad Pty Ltd v FCT (1984) 84 ATC 4115 .................................................................................. 7.70 Magna Alloys & Research Pty Ltd v FCT (1980) 49 FLR 183 ................................ 7.70, 7.130 Malayan Shipping Co Ltd v FCT (1946) 71 CLR 546 ....................................... 16.180, 16.190 Mallalieu v Drummond [1983] BTC 380 ................................................................................... 8.185 Mansfield v FCT (31) ATR 367 ................................................................................................... 8.185 Martin v FCT (1953) 90 CLR 470 ................................................................................ 5.40, 5.50 Martin v FCT (1984) 2 FCR 260 ........................................................................................... 8.60 Martin v FCT (1993) 27 ATR 282 .............................................................................................. 8.265 Martin v Lowry [1927] AC 312 ................................................................................................. 5.210 Mayne Nickless Ltd v FCT (1984) 84 ATC 4458 .......................................................................... 7.70 McCauley v FCT (1944) 69 CLR 235; 3 AITR 67 ........................................................................ 3.580 McClelland (1970) 120 CLR 487 .............................................................................................. 5.240 McCurry v FCT (1998) 39 ATR 121 ........................................................................................... 5.230 McDermott Industries (Aust) Pty Ltd v FCT (2005) 59 ATR 358 ............................................... 18.190 McGrouther v FCT [2015] FCAFC 34 ...................................................................................... 19.310 McIntosh v FCT (1979) 10 ATR 13; 79 ATC 4325 .................................................................... 4.1100 McLaurin v FCT (1961) 104 CLR 381; 8 AITR 180; 1 ATD 273 ...... 2.280, 2.290, 6.120, 6.250 Memorex Pty Ltd v FCT (1987) 87 ATC 5034 ........................................................................... 5.490 Meredith v FCT (2002) 50 ATR 528 ........................................................................................ 20.390 Millar v Commissioner of Taxation [2015] FCA 1104 ............................................................... 20.180 Millar v Commissioner of Taxation [2016] FCAFC 94 .............................................................. 20.180 Mills v FCT [2012] HCA 51 ...................................................................... 14.960, 14.970, 20.310 Modern Permanent Building & Investment Society (in liq) v FCT (1958) 98 CLR 187 ............. 12.320 Moneymen Pty Ltd v FCT (1991) 91 ATC 4019 .................................................... 6.450, 6.460 Montgomery v FCT (1998) 38 ATR 186 .................................................................................... 5.660 Montgomery v FCT (1999) 198 CLR 639; [1999] HCA 34 ..................................... 2.60, 5.670 Moriarty v Evans Medical Supplies [1958] 1 WLR 66 ................................................................. 6.205 Morris v FCT (2002) 50 ATR 104 ............................................................................................... 8.185 Morrison and Commissioner of Taxation, Re [2015] AATA 114 ................................................ 20.180 Murray v Imperial Chemical Industries Ltd [1967] Ch 1038 ............................. 3.590, 3.600 Mutual Acceptance Ltd v FCT (1984) 15 ATR 1238; 84 ATC 4831 .................................. 3.455, 5.770

N NF Williams (1972) 127 CLR 226 ............................................................................................ 13.220 National Australia Bank v FCT (1993) 46 FCR 252; 26 ATR 503; 93 ATC 4914 ........................... 4.520 National Bank of Australasia v FCT (1968) 118 CLR 529 ............................................................ 5.720 National Revenue, Minister of v Olva Diana Eldridge [1964] CTC 545 ........................................ 7.75 Naval, Military & Airforce Club of South Australia (Inc) v FCT (1994) 28 ATR 161 ..................... 3.265 Newton v FCT (1958) 98 CLR 1 ................................................................................................ 20.30 Nilsen Development Laboratories Pty Ltd v FCT (1981) 144 CLR 616; 11 ATR 505; 81 ATC 4031 .......................................................................................................... 11.410 Norman v FCT (1963) 109 CLR 9 ........................................................................................... 13.570

O O’Connell v FCT (2002) 121 FCR 562; [2002] FCA 904 ............................................................ 5.680 xx

Table of Cases

O’Reilly v Commissioners of the State Bank of Victoria (1982) 13 ATR 706; 153 CLR 1; 57 ALJR 130 .................................................................................................... 19.20, 19.450, 19.460 O’Reilly, Re; Ex parte Australena Investments Pty Ltd (1983) 15 ATR 162; 83 ATC 4807 ........... 19.310 Oakey Abbattoir Pty Ltd v FCT (1984) 15 ATR 1059 ................................................................ 20.190 Official Receiver v FCT (case) (1956) 96 CLR 370; 6 AITR 331; 11 ATD 119 ............................. 12.440 Ogilvy & Mather v FCT (1990) 21 ATR 841; 90 ATC 4836 ....................................................... 11.455 Orica v FCT [2001] FCA 1344; (2001) 48 ATR 588 .................................................................... 3.285 Ounsworth v Vickers Ltd [1915] 3 KB 267 ................................................................................... 9.20

P P and P, In the Marriage of (1985) FLC 79,911 ....................................................................... 19.430 PBL Marketing v FCT (1985) 85 ATC 4416 ................................................................................ 9.100 Packer v DFCT (1984) 84 ATC 4666 ........................................................................................ 19.470 Parke Davis & Co v FCT (1959) 101 CLR 521 ......................................................................... 18.100 Patcorp Investments v FCT (1976) 140 CLR 247 ..................................................................... 12.320 Paykel v FCT (1994) 49 FCR 41; 28 ATR 92; 94 ATC 4176 ......................................................... 4.860 Payne v FCT (1994) 28 ATR 58; 94 ATC 4191 ............................................................................ 4.180 Payne v FCT (1996) 66 FCR 299; 32 ATR 516; 96 ATC 4407 ..................... 2.205, 4.180, 4.190 Peabody v FCT (1992) 24 ATR 58 ........................................................................................... 20.110 Peabody v FCT [1993] FCA 74 ................................................................................................ 20.380 Peabody v FCT [1994] HCA 43 .................................................................................. 20.260, 20.290 Pech and Federal Commissioner of Taxation, Re [2001] AATA 573 ............................................. 9.100 Permanent Trustee Co of NSW Ltd v FCT (1940) 2 AITR 109; 6 ATD 5 ......................... 2.170, 11.200 Perron Investments v Deputy Commissioner of Taxation (WA) (1989) 20 ATR 1299 ................ 19.440 Perrott v DCT (1925) 40 CLR 450 ........................................................................................... 11.580 Peterson v FCT (1960) 106 CLR 395 .................................................................. 13.200, 13.210 Philip Morris Ltd v FCT (1979) 10 ATR 44; 79 ATC 4352 ............................................. 12.160 Placer Pacific Management Pty Ltd v FCT (1995) 31 ATR 253 ..................................... 7.390 Point v FCT (1970) 119 CLR 453 ..................................................................................... 10.310 Poole & Dight v FCT (1970) 122 CLR 427 ......................................................... 13.120, 13.130 Pratt Holdings Pty Ltd v FCT (2004) 136 FCR 357; [2004] FCAFC 122 .................................... 19.490 Prebble v FCT (2003) 131 FCR 130; [2003] FCAFC 165 ............................................................ 4.920 Pridecraft and Spotlight Stores v FCT (2004) 55 ATR 745; [2004] FCA 650 and on appeal (2004) 58 ATR 210; [2004] FCAFC 339 ................................................................................ 4.640 Primary Health Care Ltd v Commissioner of Taxation [2010] FCA 419 .................................... 10.175 Princi v FCT (2008) 68 ATR 938; [2008] FCA 441 ...................................................................... 20.20 Puzey v FCT (2002) 51 ATR 616 .............................................................................................. 20.390 Puzey v FCT (2003) 131 FCR 244; [2003] FCAFC 197 ......................................... 5.120, 5.180, 20.20

R RAC Insurance Pty Ltd v FCT (1990) 90 ATC 4737 .................................................................... 5.750 RCI v FCT [2011] FCAFC 104 .................................................................................................... 17.60 RCI Pty Ltd v Commissioner of Taxation [2011] FCAFC 104 ....................................... 20.350, 20.360 Raftland Pty Ltd v FCT (2008) 238 CLR 516; 68 ATR 170; [2008] HCA 21 .................. 13.460, 20.180 Rapistan Canada Limited v MNR (1974) 48 DLR (3d) 613 .......................................................... 3.75 Re Esso Australia Ltd v FCT (1998) 38 ATR 1160; 98 ATC 2085 .................................................. 4.560 Read v Commonwealth (1988) 176 CLR 57 ............................................................................ 13.530 Registrar of the Accident Compensation Tribunal v FCT (1993) 178 CLR 145; 26 ATR 353; 93 ATC 4835 ...................................................................................................................... 13.305 Remuneration Planning Corporation v FCT (2001) 46 ATR 400; [2001] ATC 4130 ..................... 19.20 Reseck v FCT (1975) 133 CLR 45; 5 ATR 538; 75 ATC 4213 ....................................................... 2.550 Reuter v FCT (1993) 27 ATR 256; 93 ATC 5030 ............................................................... 4.790 Roads and Traffic Authority of NSW v FCT (1993) 43 FCR 223; 26 ATR 76; 93 ATC 4508 .................................................................................................................................. 4.360 Roche Products v FCT (2008) 70 ATR 703 ............................................................................... 16.300 Rolls-Royce Ltd v Jeffrey [1962] 1 WLR 425 .............................................. 5.600, 5.610, 6.205 Ronpibon Tin NL v FCT (1949) 78 CLR 47 .................................................... 7.360, 7.420, 8.60 xxi

Income Taxation

Rose v FCT (1951) 84 CLR 118 ............................................................................ 13.170, 13.180 Rotherwood v FCT (1996) 32 ATR 276 ...................................................................................... 5.660 Rowe & Son Pty Ltd v FCT (1971) 124 CLR 421 ....................................................................... 12.30 Russell v FCT (2009) 74 ATR 446 ............................................................................................. 18.215 Rutledge v IRC (1929) 14 TC 490 ............................................................................................. 5.210

S SNF Australia [2011] FCAFC 74 ............................................................................................... 16.300 Saffron v FCT (1991) 22 ATR 131 .............................................................................................. 5.350 Saffron v FCT (No 2) (1991) 22 ATR 307 ................................................................................... 5.350 St George Bank Ltd v FCT [2009] FCAFC 62 ........................................................................... 14.680 Sanctuary Lakes Pty Ltd v FCT [2013] FCAFC 50 ..................................................................... 19.530 Saunders v Vautier (1841) 4 Beav 115; 49 ER 282 ...................................................... 13.375, 13.490 Scanlan v Swan (1983) 83 ATC 4112 ...................................................................................... 19.500 Schokker v FCT (1998) 38 ATR 91 ............................................................................................. 7.165 Scoble v Secretary of State for India [1903] AC 299 .......................................... 3.500, 6.410 Scott v Commissioner of Taxation (NSW) (1935) 35 SR (NSW) 215 ......... 2.20, 4.750, 6.10 Scott v FCT (1966) 117 CLR 514 ................................................................................. 4.10, 4.60 Seabright v FCT (1998) 40 ATR 1160; [1998] AATA 985 .......................................................... 4.1120 Selleck v FCT (1997) 36 ATR 558 .............................................................................................. 5.660 Service v FCT [2000] FCA 188 .................................................................................................. 7.575 Sharkey v Wernher [1956] AC 58 ............................................................................................ 12.430 Shepherd v FCT (1965) 113 CLR 385 ..................................................................................... 13.570 Slutzkin v FCT (1977) 140 CLR 314 ................................................................... 15.150, 15.160 Smith v FCT (1987) 164 CLR 513 ............................................................................. 4.10, 4.140 Snook v London West Riding Investments Ltd [1967] 2 QB 786 .............................................. 20.180 Snow v DFCT (1987) 18 ATR 439; 87 ATC 4078 ...................................................................... 19.420 Softex Industries, Re [2002] AATA 1232 .................................................................................... 5.345 Softwood Pulp & Paper Ltd v FCT (1976) 7 ATR 101 ................................................................. 5.180 Sommer v FCT [2002] FCA 1205 .............................................................................................. 6.125 Southern Estates Pty Ltd v FCT (1967) 117 CLR 481 ................................................................. 5.180 Southwestern Indemnities Ltd v Bank of New South Wales and FCT [1973] HCA 52 ............... 19.440 Spotless Services Ltd v FCT (1993) 25 ATR 334 ............................................... 16.260, 16.270 Spriggs v FCT; Riddell v FCT [2009] HCA 22 ......................................................... 7.320, 7.330 Stanton v FCT (1955) 92 CLR 630; 6 AITR 216 ......................................................................... 3.580 Starrim Pty Ltd v FCT (2000) 44 ATR 487 .................................................................................. 4.420 State Chamber of Commerce and Industry v Commonwealth (1987) 163 CLR 329 .................. 1.300 Steele v Commissioner of Taxation (1996) 31 ATR 510 .................................................. 7.290, 9.340 Steele v DFC of T (1999) 41 ATR 139 ..................................................................... 7.300, 9.350 Steinberg v FCT (1975) 134 CLR 640 ....................................................................................... 5.240 Stergis v FCT (1988) 88 ATC 4442 .......................................................................................... 19.500 Stewart v FCT (1973) 3 ATR 603 ..................................................................................... 10.480 Stone v FCT (2002) 51 ATR 297; [2002] FCA 1492 ........................................................ 5.130, 6.365 Stone v FCT (2003) 130 FCR 299; [2003] FCAFC 145 .................................................... 5.130, 6.365 Stone v FCT (2005) 222 CLR 289; [2005] HCA 21 .................................................................... 5.130 Strick v Regent Oil Co Ltd [1966] AC 295 ....................................................................... 9.150 Strong & Co Ltd v Woodifield [1906] AC 448 ............................................................................. 7.80 Summers [2008] AATA 152 ....................................................................................................... 3.390 Summons (Kenneth A) Pty Ltd v FCT 86 ATC 4979 ................................................................. 14.130 Sun Alliance Investments Pty Ltd (in liq) v FCT (2005) 225 CLR 488; [2005] HCA 70 .............. 15.120 Sun Newspapers Ltd v FCT (1938) 61 CLR 337 ........................................................ 9.20, 9.40 Sunraysia Broadcasters Pty v FCT (1991) 91 ATC 4530 .............................................................. 9.100 Sweetman v CIR (1996) 34 ATR 209 ......................................................................................... 7.220

T TNT Skypak International (Aust) Pty Ltd v FCT (1988) 19 ATR 1067 .......................................... 5.790 Taneja v FCT [2009] AATA 87 .................................................................................................. 4.1230 xxii

Table of Cases

Task Technology v FCT [2014] FCAFC 113 ................................................................. 18.185, 18.280 Taxation, Commissioner of v Consolidated Media Holdings [2012] HCA 55 .............................. 15.80 Taxation, Commissioner of v Sara Lee Household & Body Care (Australia) Pty Ltd [2000] HCA 35; (2000) 201 CLR 520; 44 ATR 370; 2000 ATC 4378 ........ 3.270, 3.280 Taxation (WA), Commissioner of v Boulder Perseverance Ltd (1937) 58 CLR 223 .................... 14.680 Taxation (WA), Commissioner of v Newman (1921) 29 CLR 484 ............................................ 12.250 Taxes (SA), Commissioner of v Executor Trustee & Agency Co of SA Ltd (Carden’s case) (1938) 63 CLR 108; 1 AITR 416; 5 ATD 98 ..................................... 11.110 Taxes (Vic), Commissioner of v Phillips (1936) 55 CLR 144 ......................................... 4.770 Taxpayer and Federal Commissioner of Taxation [2013] AATA 3 ................................................ 8.230 Taylor v DFCT (1970) 119 CLR 444 .................................................................... 13.330, 13.340 Tech Mahindra v FCT [2015] FCA 1082 ..................................................................... 16.240, 18.230 [2016] FCAFC 130 .................................................................................................................. 18.230 Tennant v Smith [1892] AC 150 .................................................................................... 2.220, 4.250 Texas Co (Australasia) Ltd (1940) 63 CLR 382 .......................................................................... 5.770 Thiel v FCT (1990) 171 CLR 338; 21 ATR 531 ......................................................................... 16.100 Thorpe Nominees Pty Ltd v FCT (1988) 19 ATR 1834 ..................................... 16.240, 16.250 Tikva Investments Pty Ltd v FCT (1972) 128 CLR 158 .................................... 13.220, 13.230 Tilley v Wales [1943] AC 386 .................................................................................................... 2.295 Tinkler v FCT (1979) 79 ATC 4641 .............................................................................................. 6.75 Traknew Holdings Pty Ltd v FCT (1991) 21 ATR 1478; 91 ATC 4272 ....................................... 13.450 Trautwein v FCT (1936) 56 CLR 63 ............................................................................ 19.200, 19.530 Trevisan v FCT (1991) 21 ATR 1649 ........................................................................................ 20.110 Truesdale v FCT (1970) 120 CLR 353 ..................................................................................... 13.590 Trustees of Estate Mortgage Fighting Fund Trust v FCT (2000) 45 ATR 7 ............... 13.360, 13.370 Trustees of the Lisa Marie Walsh Trust v FCT (1983) 14 ATR 399 ............................................. 13.590 Tubemakers of Australia Ltd v FCT (1993) 25 ATR 183 .............................................................. 4.350 Tyco Australia Pty Ltd v FCT (2007) 67 ATR 63 .......................................................................... 9.175

U Unilever Australia Securities Ltd v FCT (1994) 28 ATR 422 (Spender J); (1995) 30 ATR 134 ........ 5.770 Unisys Corporation v FCT (2002) 51 ATR 386 ......................................................................... 16.100 United Aircraft Corporation v FCT (1943) 68 CLR 525 ............................................................ 18.100 United Dominion Corporation Ltd v Brian Pty Ltd (1985) 157 CLR 1 ........................................ 13.65 United Energy v FCT (1997) 78 FCR 169 .................................................................................... 9.60 United States v Kirby Lumber Co (1931) 284 US 1 ................................................................... 5.770 Ure v FCT (1981) 50 FLR 219 ............................................................................................. 7.590

V VBI v Federal Commissioner of Taxation [2005] AATA 683 ......................................................... 8.240 Vallambrosa Rubber Co Ltd v Farmer (1910) 5 TC 529 ............................................................... 9.20 Van den Berghs Ltd v Clark [1935] AC 431 .................................................................... 6.150, 6.160 Vestey v IRC [1962] Ch 861 ..................................................................................... 3.520, 6.410 Vincent v FCT (2002) 124 FCR 350; [2002] FCAFC 291 ................................................. 5.120, 5.180 Vincent v FCT (2002) 50 ATR 20 ............................................................................................. 20.390 Virgin Blue v FCT [2010] FCAFC 137 ......................................................................................... 4.450

W W D & H O Wills (Aust) Pty Ltd v FCT (1996) 32 ATR 168 ....................................................... 20.110 W Nevill & Co Ltd v FCT (1937) 56 CLR 290; 1 AITR 67 .................................... 7.240, 11.465 W Thomas & Co Pty Ltd v FCT (1965) 115 CLR 58 ............................................ 10.90, 10.100 WD & HO Wills (Australia) Pty Ltd v FCT (1996) 32 ATR 168 ................................................... 20.400 WT Ramsay Ltd v IRC [1982] AC 300 ...................................................................................... 20.190 Walsh Bay Developments Pty Ltd v FCT (1995) 31 ATR 15; 95 ATC 4378 ................................ 13.375 Walstern v FCT (2003) 138 FCR 1; [2003] FCA 1428 ................................................................. 4.920 xxiii

Income Taxation

Wangaratta Woollen Mills Ltd v FCT (1969) 119 CLR 1 .................... 10.150, 10.160, 10.170 Warner Music Australia v FCT (1996) 34 ATR 171 ........................................................... 6.285, 6.310 Western Gold Mines NL v C of T (WA) (1938) 59 CLR 729 ........................................................ 5.250 Westfield v FCT (1991) 21 ATR 1398 ......................................................................................... 5.380 Westpac Banking Corporation v FCT (1996) 32 ATR 479; 96 ATC 4366 ..................................... 4.370 Westpac Banking Corporation v FCT (1996) 70 FCR 52; 34 ATR 143; 96 ATC 5021 .... 4.340 Whitaker v FCT (1998) 82 FCR 261; 38 ATR 219; 98 ATC 4285 ................................................... 6.75 White v FCT (1969) 120 CLR 191 ............................................................................................. 3.585 Whitfords Beach Pty Ltd v FCT (1982) 150 CLR 355; 12 ATR 692; 82 ATC 4031 ...................... 11.585 Wilkins v Rogerson [1961] Ch 133 ............................................................................................ 2.245 Willingale v International Commercial Bank Ltd [1978] AC 834 .............................................. 12.330 Woolcombers Pty Ltd v FCT (1993) 25 ATR 487; 93 ATC 4342 ................................................ 11.460

X XCO Pty Ltd (1971) 124 CLR 343 ............................................................................................. 5.240

Z Zarin v Commissioner (1990) 916 F.2d 110 .............................................................................. 5.795 Zobory v FCT (1995) 64 FCR 86; 30 ATR 412; 95 ATC 4251 .................................. 2.70, 2.215, 5.350

xxiv

TABLE OF STATUTES s 231: 14.80 s 254A: 15.60 s 254K: 15.60 s 254S: 14.800 s 254T: 14.210, 14.220, 14.530 s 254SA: 14.190 s 256B: 14.250

COMMONWEALTH A New Tax System (Australian Business Number) Act 1999: 19.90 s 5: 19.90 s 7: 19.90 s 8(2): 19.90 s 28: 19.90 s 38: 19.90 s 41: 19.90

Crimes Act 1914: 19.440 s 3E: 19.440, 19.450 s 4AA: 20. 210 s 10: 19.450

A New Tax System (Commonwealth–State Financial Arrangements) Act 1999: 1.305

Family Law Act 1975 Pt VIIIA: 3.335

A New Tax System (Goods and Services Tax) Act 1999 Div 129: 12.750 Div 132: 12.750

Federal Court Rules O 52B, r (v): 19.510 Foreign Account Tax Compliance Act: 16.430

Acts Interpretation Act 1901: 1.330, 20.70, 20.90 s 15AA: 16.100, 20.90, 20.110 s 15AB: 16.100, 20.90, 20.110

Freedom of Information Act 1982: 19.40, 19.510 ss 32 to 47: 19.510 s 36: 19.510 s 37(1)(a): 19.510 s 37(1)(b): 19.510 s 37(2): 19.510 s 38: 19.510 s 41: 19.510 s 42: 19.510 s 43(1): 19.510 s 45(1): 19.510

Administrative Appeals Tribunal Act 1975 s 29(7): 19.320 s 33: 19.330 s 37: 19.400, 19.510 s 44: 19.330 Administrative Decisions (Judicial Review) Act 1977: 19.400 s 5: 19.400, 19.420 s 6: 19.400 ss 8 to 10: 19.400 s 13: 19.400 Sch 1: 19.400

Fringe Benefits Tax Act 1986: 1.300, 12.450 Fringe Benefits Tax Assessment Act 1986: 1.300, 4.250, 4.320, 4.330, 4.350, 4.430, 4.440, 4.530, 8.75 s 5B: 4.320 s 5B(1B): 4.600 s 5B(1C): 4.600 s 5C(3): 4.600 s 5C(4): 4.600 s 5E(3): 4.620 s 6: 4.330 s 7(1): 4.440 s 7(2): 4.440 s 7(2A): 4.440 s 7(3): 4.440 s 7(4): 4.370, 4.440 s 8(2): 4.440 s 8(3): 4.440 s 9(1): 4.440 s 9(2)(a): 4.440 s 9(2)(c)(ii): 4.440, 4.445 s 10: 4.440

Bills of Exchange Act 1909: 3.440 Broadcasting Act 1942: 9.100 Commonwealth of Australia Constitution Act 1901: 1.300 s 51(ii): 1.300 s 53: 1.300 s 55: 1.300, 19.530 s 75: 19.260 s 90: 1.305 s 96: 1.305 s 99: 1.300 Convention on Mutual Administrative Assistance in Tax Matters: 16.430 Corporations Act 2001: 5.120, 14.10, 14.30, 14.80, 14.130, 14.210, 14.310 s 44: 14.220 s 202-45(e): 14.530 xxv

Income Taxation

Fringe Benefits Tax Assessment Act 1986 — cont s 10(3): 4.440 ss 10A to 10B: 4.440 s 14: 4.460 s 14ZZM: 19.420 s 14ZZR: 19.420 s 16: 4.460 s 17: 4.460 s 18: 4.460, 4.510 s 19: 4.510, 4.520 s 19(1): 4.510 s 20: 4.155, 4.375, 8.265 s 22: 4.350, 4.555 s 24: 8.265 s 30(1)(b): 4.520 s 39A: 4.450 s 39A(1)(f): 4.450 s 39B: 4.450 s 39C: 4.450 s 39D: 4.450 s 39E: 4.450 s 39AA: 4.450 s 39AB: 4.450 s 39DA: 4.450 s 39FA: 4.450, 4.640 s 39GA: 4.450 s 39GB: 4.450 s 40: 4.155, 4.375 s 41: 4.375, 4.555 s 42: 4.480 s 42(1)(a)(i): 4.480 s 42(1)(a)(ii): 4.480 s 42(1)(a)(iii): 4.480 s 42(1)(b): 4.480 s 42(1)(c): 4.480 s 43: 4.480 s 44: 4.480, 4.520 s 45: 4.155, 4.375 s 47(2): 4.350, 4.560, 8.70 s 47(3): 4.560 s 47(4): 4.560 s 48: 4.490 s 49: 4.490 s 52: 4.490, 4.520 s 58A: 4.500 s 58B: 4.500 s 58C: 4.500, 4.555 s 58D: 4.500 s 58F: 4.500 s 58G: 2.450, 4.450 s 58G(2): 2.450 s 58H: 4.500 s 58P: 4.500 s 58X: 4.525 s 58X(2): 4.525 s 58Z: 4.500 s 58GA: 4.450 s 62: 4.500 s 65J(2A): 4.610

s 65J(1): 4.610 s 66: 2.450, 4.320, 4.590 s 66(1): 4.320, 4.430 s 72: 19.190 s 135M: 4.620 s 135P(2): 4.620 s 136: 4.380, 4.390, 4.440, 4.450, 4.480 s 136(1): 4.45, 4.65, 4.95, 4.125, 4.330, 4.350, 4.370, 4.380, 4.390, 4.450, 4.530, 4.670, 4.705, 4.865, 4.920, 5.300, 12.705 s 136(1)(ha): 4.670 s 148: 4.390 s 148(1): 4.45, 4.390 s 148(3): 4.370 s 150: 4.375 s 158: 4.380 s 159: 4.380 Pt IIA: 4.590, 4.600 Pt III: 4.490, 4.510 Pt III, Divs 2 to 11: 4.330 Pt IVC: 19.420 Div 2: 4.330 Div 3: 4.330 Div 4: 4.330 Div 5: 4.330 Div 6: 4.330 Div 7: 4.330 Div 8: 4.330 Div 9: 4.330 Div 9A: 4.330, 4.470, 8.210 Div 10: 4.330, 4.470 Div 10A: 4.330, 4.450 Div 11: 4.330 Div 12: 4.330 Div 13: 4.500 Div 14: 4.500 Divs 2 to 12: 4.500 Income Tax Act 1986 s 5: 2.310 Income Tax (Arrangements with the States) Act 1978: 1.305 Income Tax Assessment Act 1922: 19.200 s 4(d): 6.430 Income Tax Assessment Act 1936: 2.10, 2.320, 2.330, 2.340, 2.360, 2.370, 2.380, 2.430, 2.470, 2.550, 3.10, 3.40, 3.120, 3.210, 3.255, 3.320, 4.840, 4.920, 5.310, 6.290, 7.460, 8.75, 8.240, 11.10, 11.510, 12.420, 12.530, 13.50, 13.250, 13.260, 13.300, 13.320, 13.450, 15.700, 16.80, 17.110, 18.100, 19.50, 20.30, 20.70, 20.110, 20.240 s 4(2): 18.280 s 6: 12.420, 12.440, 16.230, 19.220 s 6(1): 3.610, 4.10, 5.30, 13.300, 14.50, 14.80, 14.130, 14.135, 14.140, 14.260, 14.280, 14.310, 14.370, xxvi

Table of Statutes

Income Tax Assessment Act 1936 — cont 14.420, 14.535, 15.320, 16.120, 16.130, 16.175, 16.220, 18.40, 18.170, 18.190 s 6(4): 14.820 s 6D: 14.140 s 6BA: 14.350, 14.840 s 6CA: 16.240, 18.20 s 7: 18.40 s 11S(2): 16.240 s 12(1): 2.350 s 14ZU: 19.260 s 16: 19.400 s 17A(4): 18.110 s 19: 2.170, 2.205, 11.200 s 20(1): 2.220 s 21: 2.220, 14.130 s 21A: 1.320, 2.250, 4.380, 5.280, 5.300, 5.305, 5.660, 8.210, 10.510 s 21A(1): 5.300 s 21A(2): 5.300 s 21A(3): 5.300 s 23(1): 7.260 s 23(1)(a): 7.280, 7.340 s 23J: 3.440 s 23L: 4.530 s 23L(1A): 2.450, 4.530 s 23M: 4.530 s 23AH: 16.240, 16.290, 17.40, 17.45, 17.60, 17.100, 17.170, 18.40 s 23AH(15): 16.80 s 23AI: 17.120 s 23AJ: 17.50, 17.60 s 25: 4.160, 4.250, 4.780, 5.570, 5.660, 5.770, 6.60 s 25(1): 2.550, 3.10, 4.30, 4.45, 4.180, 4.250, 4.1080, 5.210, 5.490, 6.60, 6.450, 19.290 s 25A: 2.410, 3.10, 5.240, 5.770, 11.510, 12.30, 12.300, 12.320, 12.430, 12.440 s 25A(1A): 5.240, 5.770 s 25A(1): 5.200 s 26AAAA: 4.250 s 26AAAB: 4.250 s 26: 6.290 s 26(a): 3.10, 5.200, 5.210, 5.240, 5.490, 5.730, 11.590, 19.290, 20.70 s 26(b): 13.450 s 26(d): 2.550, 4.700, 4.890, 4.1080, 4.1190 s 26(e): 2.100, 2.180, 2.240, 2.410, 4.10, 4.30, 4.45, 4.130, 4.150, 4.155, 4.160, 4.180, 4.250, 4.270, 4.660, 4.1080, 5.280, 8.260 s 26(f): 2.410 s 26(g): 5.310 s 26(j): 6.120, 6.290, 6.300 s 26(k): 6.290 s 26(l): 6.290 s 26C: 3.440 s 26BB: 3.470, 11.510, 13.550 xxvii

s 26BB(4): 15.50 s 26BB(5): 15.50 s 26AAA: 2.100, 3.10, 5.200, 19.290 s 26AAA(1A): 5.200 s 26AAB: 4.250, 4.380 s 26AAB(14): 4.380 s 26AAB(15): 4.380 s 26AAC: 4.250, 4.270, 4.660, 4.670 s 27A: 4.125, 4.760, 4.1080 s 27A(1): 6.445, 12.705 s 27H: 3.480, 3.485, 4.120, 4.890, 4.1040, 4.1080, 6.370, 6.405, 6.410, 6.430, 7.640, 11.180, 20.160 s 27H(1): 6.370 s 27H(1)(b): 4.125 s 27H(2): 6.370, 6.445 s 27H(4): 3.480 ss 28 to 37: 12.20 s 31(1): 12.220 s 31C: 7.650, 12.240, 19.390 s 36: 12.250, 13.170 s 36(1): 12.270, 12.430 s 36A: 13.190, 20.50 s 44: 2.410, 3.420, 14.180, 14.210, 14.260, 14.280, 14.330, 14.500, 14.570, 14.620, 14.720, 14.830, 14.1020, 15.20, 15.80, 15.320, 15.330, 17.100 s 44(1): 3.420, 4.680, 4.700, 11.180, 14.130, 14.135, 14.140, 14.370, 16.240, 18.100, 18.120, 18.130 s 44(1)(b): 14.640 s 44(1A): 14.210 s 44(1B): 14.830 s 44(2): 11.590 s 44(2) to (4): 15.330 ss 44(5) and (6): 15.330 s 45: 14.840 s 45A: 14.840, 14.845, 18.130, 20.200 s 45A(5): 14.840 s 45B: 14.840, 14.845, 15.320, 15.330, 18.130 s 45B(8): 14.840 s 45B(9): 14.840 s 45C: 14.840 s 45C(3): 14.840 ss 45 to 45C: 14.535 s 46: 14.450, 15.100, 15.110, 15.120, 19.260 s 46A: 15.120 s 46B: 15.120 s 46FA: 14.650 s 46FB: 14.650 s 47: 14.280, 14.1000, 14.1020, 14.1030 s 48: 2.320 s 51: 8.110 s 51(1): 7.10, 7.140, 7.280, 7.360, 7.410, 7.440, 7.460, 7.550, 7.570, 7.600, 7.630, 7.640, 8.150, 8.175, 9.340, 20.160 s 51(2): 12.30

Income Taxation

s 82KL: 10.580, 12.600, 12.605, 20.200, 20.230 ss 82KZC to 82KZJ: 7.600 s 82KZL: 12.550 s 82KZL(2): 12.550 ss 82KZL to 82KZO: 11.460 s 82KZM: 11.465, 12.450, 12.530, 12.540, 12.550, 12.580, 12.590, 12.595 s 82KZM(1)(ba)(ii): 12.550 s 90: 13.110, 13.390 ss 90 to 92: 13.250 s 91: 13.110 s 92: 13.110, 13.590 s 92(2AA): 13.270, 13.275 s 94: 13.590 s 94(1)(a): 13.590 s 94D(2): 13.270 s 94D(3): 13.270 s 94D(4): 13.270 s 94D(5): 13.270 s 94J: 13.260 s 94K: 13.260 s 94P: 13.265 s 95: 13.390 s 95(2): 16.220 s 95A(1): 13.380 s 95A(2): 13.320, 13.350, 13.360, 13.460, 13.470 s 95B: 13.460 s 95AAD: 13.555 s 96: 2.215, 13.320, 13.375 s 97: 13.320, 13.390, 13.420 s 97(1): 13.400 s 97(2): 13.460 s 98: 13.320, 13.390, 13.420, 13.430, 13.460, 13.555 s 98(1): 13.390 s 98(2): 13.390 s 98(2)(aa): 13.460 s 98(4): 13.460 s 98A: 13.460 s 98B: 13.460 s 99: 13.320, 13.390, 13.395, 13.420, 13.440, 19.370, 19.390 s 99A: 13.320, 13.330, 13.360, 13.390, 13.395, 13.400, 13.420, 13.440, 13.460, 13.590, 19.360, 19.370, 19.390 s 99A(2): 13.440 s 99A(3): 13.440 s 99B: 13.450, 17.150, 17.155 ss 99B to 99D: 13.450 s 100: 13.390 s 100A: 20.180, 20.200 s 100A(6A): 13.460 s 100A(1): 13.460 s 100A(5): 13.460 ss 100A(7) to (12): 13.460 s 100A(13): 13.460 s 100AA: 13.460

Income Tax Assessment Act 1936 — cont ss 51(2) to (2A): 12.20 s 51(4): , 7.650 s 51(4A): 4.590 s 51AE: 4.470 s 51AH: 6.310 s 51AK: 10.550 s 51AAA: 2.540, 7.600 s 51AEA: 4.470 s 52A: 12.320 s 53AA: 6.290 s 54(2): 10.150 s 57AF: 11.550 s 59: 5.490, 13.170 s 59AA: 13.190 s 63: 5.160 s 63(3): 6.290 s 63E: 10.370 s 63E(3)(a): 10.370 s 63E(3)(b): 10.370 s 63F: 10.370 s 64A: 7.140 s 65: 10.470 s 69(2): 6.290 s 70B: 3.470, 13.550 s 70B(4): 12.500 s 72(2): 6.290 s 73B: 10.440 s 74(2): 6.290 s 75: 5.180 s 78(1)(c): 4.700 s 78A: 8.250 s 80: 11.50 s 80B(5): 20.90 s 80E: 15.440 s 82: 2.520, 10.110, 11.510 s 82KZMD: 7.650, 12.530 s 82KZMA: 12.530, 12.560 s 82KZMF: 12.530, 12.540, 12.570 s 82KZME: 12.530, 12.540, 12.570 s 82KZMD(2): 12.560 s 82KZME(2): 12.570 s 82KZMB(3): 12.560 s 82KZME(3): 12.570 s 82KZME(5): 12.570 s 82KZME(9): 12.570 ss 82KZMA to 82KZMD: 12.540 s 82A: 8.100 ss 82A to 82K: 8.250 ss 82C to 82CE: 18.130 s 82AA: 8.250 s 82AF(2)(a): 3.375 s 82KH(1B): 12.600 s 82KH(1D): 12.600 s 82KH(1F): 12.600 s 82KH(1AD): 12.600 s 82KH(1): 12.600 ss 82KH to 82KL: 7.510, 12.580, 20.230 s 82KJ: 10.580, 12.600, 20.200, 20.230 s 82KK: 10.580, 12.590, 12.595, 20.230 xxviii

Table of Statutes

ss 128B(9A) to (9C): 18.160 s 128B(2): 18.140 s 128B(3)(h)(ii): 18.110 s 128B(3)(ga): 14.640, 14.650, 18.130 s 128B(5): 18.140 ss 128B(6) to (9): 18.140 s 128D: 14.650 s 128F: 18.140 s 128AC: 14.745, 18.195 s 128AE: 18.150 s 128FA: 18.140 s 128GB: 18.150 s 136: 7.480 s 159GZZZP: 15.70 s 159GZZZR: 15.70, 15.90 ss 159GZZZQ(1) to (4): 15.95 ss 159H to 159Z: 8.250 s 159J: 2.360 s 159J(1B): 2.365 s 159N: 6.380 s 159P: 2.365, 8.240 s 159T: 8.100 s 159GP(1): 3.480, 12.490 s 159GP(3): 12.490 s 159GP(10): 3.480 s 160AAAA: 6.380 s 160APHM: 14.920 s 160APHT: 14.920 s 160APHD: 14.920 s 160APHE: 14.920 s 160APHU: 14.930 s 160APHL: 14.930 s 160APHR: 14.930 s 160A: 3.50, 3.210 s 160M: 3.120 ss 160M(1) to (5): 3.120 ss 160M(1) to (7): 3.120 s 160M(6): 3.150, 3.210, 4.860 s 160M(7): 3.150, 3.170, 3.210, 4.860 s 160N: 3.120 s 160U: 3.40, 3.270 s 160ZA(4): 12.700 s 160ZI: 3.135 s 160ZO: 2.410 s 160ZS: 20.110 s 160AAA: 6.380 s 161: 19.180 s 161A: 19.35, 19.180 s 161A(2): 19.180 s 161AA: 19.180 s 162: 19.180 s 163: 19.180 s 166: 19.190 s 166A: 19.190, 19.250 s 167: 19.200, 19.210 s 168: 19.200 s 170: 6.315, 11.40, 11.50, 12.50, 19.190, 19.220 s 170(1): 19.220 ss 170(2) to (4): 19.220

Income Tax Assessment Act 1936 — cont s 101: 13.380, 13.450 s 101A: 5.420, 11.100 s 102: 13.500, 13.590 s 102AAZD: 17.140 s 102(1)(a): 13.590 s 102M: 13.540 s 102N: 13.540 s 102P: 13.540 s 102Q: 13.540 s 102R: 13.540 s 102AC: 13.430 s 102AE: 13.430 s 102AG: 13.430 s 102CA: 13.570 ss 102MA to 102MD: 13.545 s 102NA: 13.545 s 102UG: 13.460 s 102UH: 13.460 s 102UK: 13.460 s 102UM: 13.460 s 102UT: 13.460 s 102AAH: 17.150 s 102AAL: 17.145 s 102AAM: 17.155 s 102AAT: 17.140, 17.150 s 102AAT(a)(i)(C): 17.145 s 102AAT(a)(i)(D): 17.145 s 102AAU: 17.140 s 102AAU(2): 17.140 s 102AGA: 13.430 s 103A: 14.40, 14.370 s 108: 4.680, 14.400 s 109: 4.10, 4.210, 4.350, 4.680, 4.700, 4.705, 4.1080, 7.250, 7.540, 7.545, 10.450, 14.420, 14.440 s 109A: 14.370 s 109C: 14.370 s 109D: 14.370 s 109E: 14.380 s 109F: 5.795, 14.370 s 109J: 14.380 s 109K: 14.380 s 109L: 14.370, 14.380 s 109M: 14.380 s 109N: 14.380, 14.420 s 109R: 14.370 s 109Y: 14.390 s 109CA: 14.370 s 109RB: 14.430 s 109RC: 14.430 s 109ZB: 14.435 ss 121F to 121L: 13.460 s 125-55(2): 15.330 s 128A(1AB): 14.720 s 128A(1): 14.720 s 128B: 18.120 s 128B(2B): 18.160 s 128B(3E): 18.110 s 128B(5A): 18.160 xxix

Income Taxation

s 202B: 19.90 s 202C: 19.90 ss 202D to 202DM: 19.90 s 202CB: 19.90 s 221YHAAA: 2.370 s 224: 19.500 s 255: 14.310, 18.10, 18.250, 19.520 s 255(1)(a): 19.420 s 257: 19.520 s 260: 7.440, 7.460, 13.590, 15.150, 15.170, 20.190, 20.230, 20.240, 20.250, 20.390 s 262: 3.490, 3.525 s 262A: 5.30, 19.440, 19.530 s 263: 19.440 s 264: 19.400, 19.440, 19.450, 19.470, 19.490, 19.500 s 264A: 16.410, 19.440 s 266-125: 13.470 s 267-20: 13.470 s 267-20(1)(c): 13.470 s 269-55: 13.470 s 271-105: 13.470 s 272-5: 13.470 s 272-65: 13.470 s 272-70: 13.470 s 272-80: 13.470 s 272-100: 13.470 s 278(2): 4.990 s 318: 13.300 s 340: 17.120 s 361: 17.120 s 456: 17.120 s 461: 17.120 s IVA: 20. 210 Pt IIIA: 2.380, 3.10, 3.120, 3.150 Pt IIIA, Div 1A: 14.920 Pt X: 17.110 Pt X, Div 7: 17.120 Pt X, Div 8: 17.120 Pt IX: 4.990 Pt VA: 19.90 Pt XI: 17.110 Pt III, Div 3, subdiv D: 12.580 Pt III, Div 5: 13.40, 14.600 Pt III, Div 6: 14.610 Pt III, Div 6AAA: 17.110, 17.140 Pt III, Div 9C: 13.460 Pt III, Div 13: 4.350 Pt III, Div 13A: 2.270 Pt III, Div 17 to 19: 2.360 Pt IVA: 1.310, 3.30, 4.640, 4.1220, 7.540, 10.360, 13.590, 14.940, 15.30, 15.170, 16.80, 16.260, 16.290, 18.40, 18.280, 19.220, 20.30, 20.110, 20.150, 20.180, 20.190, 20.230, 20.240, 20.250, 20.260, 20.290, 20.380, 20.390, 20.400 Div 5: 13.320, 18.235 Div 5A: 13.260, 13.270, 13.540

Income Tax Assessment Act 1936 — cont s 170(3): 6.315 s 170(7): 19.330 s 170(9): 11.510 ss 170(9D) to (11): 19.220 s 170A: 19.220 s 170B: 19.220 s 170C(1): 20.300 s 170C(1)(a): 20.300 s 170C(1)(b): 20.300 s 170C(1)(ba): 20.300 s 170C(1)(bb): 20.300 s 170C(1)(bc): 20.290, 20.300 s 175: 19.260 s 175A: 19.250, 19.260 s 177: 19.260 s 177A: 20.250 s 177A(1): 20.260 s 177A(3): 20.260 s 177A(5): 20.260, 20.380 s 177B(3): 20.250 s 177B(4): 20.250 s 177C: 15.170, 20. 210, 20.250, 20.290 s 177C(1): 20.290, 20.300, 20.320, 20.350, 20.370 s 177C(1)(ba): 20.290 s 177C(1)(bb): 20.290 s 177C(2): 20.300 s 177D: 20.250, 20.310, 20.380, 20.390 s 177D(1): 20.250, 20.260, 20.380 s 177D(2): 20.250, 20.290, 20.380 s 177D(3): 20.250 s 177D(4): 20.250 s 177D(b): 20.380 s 177E: 15.130, 15.170, 15.185, 15.190, 20.310 s 177F: 19.360, 20.390 s 177F(1): 20.390 ss 177F(2) to 177F(3): 20.390 s 177F(3): 20.390 s 177G: 19.220 s 177CA: 20.290 s 177CB: 20.250, 20.370 s 177CB(1): 20.370 s 177CB(2): 20.370 s 177CB(3): 20.370 s 177CB(4): 20.370 s 177DA: 18.280, 20.310 s 177EA: 14.940, 14.950, 14.960, 14.990, 18.130, 20.310 s 177EA(3): 14.940 s 177EA(4): 14.940 s 177EA(5): 14.940 s 177EA(13): 14.940 s 177EA(14)): 14.940 s 177EA(17): 14.940 s 177EB: 14.940 s 185: 19.260 s 190: 8.260 s 190(b): 4.660, 19.350 xxx

Table of Statutes

s 8-1(2()c): 7.600 s 3-5(1): 19.95 s 3-5(2): 19.95 s 4-1: 2.310, 14.20 s 4-10: 2.310, 11.20 s 4-10(3): 2.360 s 4-10(3A): 2.360 s 4-15: 2.40, 10.280, 11.20 s 4-15(1): 2.320 s 5-5: 19.190 s 5-10: 19.190 s 6-1: 2.550 s 6-5: 2.10, 2.165, 2.330, 2.370, 2.380, 2.400, 2.550, 3.370, 3.420, 3.455, 3.570, 3.610, 4.10, 4.30, 4.45, 4.130, 4.155, 4.205, 4.210, 4.220, 4.700, 4.865, 4.1080, 5.10, 5.200, 5.230, 5.240, 5.310, 5.480, 5.490, 6.10, 6.60, 6.140, 6.370, 9.360, 12.250, 12.430, 12.440, 12.500, 14.130, 15.50, 16.240, 18.10 s 6-5(1): 5.490 s 6-5(3): 3.30, 16.240, 18.10, 18.70 s 6-5(4): , 2.170, 2.205, 3.30, 4.270, 4.1210, 11.200 s 6-10: 2.10, 2.100, 2.330, 2.550, 4.1080, 12.640, 16.240, 18.10 s 6-10(1): 2.550, 3.20 s 6-10(3): 2.205, 3.30, 4.270, 11.200 s 6-10(5): 3.30, 16.240, 18.10, 18.70 s 6-15: 2.330, 2.420 s 6-20: 2.330, 2.550 s 6-23: 2.330 s 6-25(1): 2.550 s 6-25(2): 2.550 s 8-1: 2.340, 2.370, 2.490, 2.500, 2.540, 3.610, 4.530, 4.640, 4.920, 5.30, 5.190, 7.10, 7.40, 7.50, 7.140, 7.230, 7.260, 7.280, 7.315, 7.395, 7.400, 7.410, 7.430, 7.460, 7.540, 7.545, 7.600, 8.10, 8.40, 8.45, 8.100, 8.130, 8.180, 8.185, 8.210, 8.220, 8.225, 8.265, 8.270, 9.25, 9.260, 9.360, 10.10, 10.20, 10.30, 10.40, 10.50, 10.65, 10.110, 10.120, 10.250, 10.260, 10.290, 10.360, 10.370, 10.490, 10.560, 11.360, 12.30, 12.150, 12.250, 12.340, 12.380, 12.440, 12.470, 12.500, 12.540, 15.50, 17.170, 20.150, 20.160 s 8-1(1): 7.10, 7.60, 7.620, 7.630, 7.640, 10.370, 10.460 s 8-1(1)(a): 4.1230, 7.10, 7.30 s 8-1(1)(b): 4.1230, 7.10, 7.30 s 8-1(2): 8.270, 10.460 s 8-1(2)(a): 7.140, 9.10 s 8-1(2)(b): 8.10, 8.210, 10.460 s 8-1(2)(d): 10.20 s 8-1(3): 10.10 s 8-5: 2.340, 10.10

Income Tax Assessment Act 1936 — cont Div 6: 2.215, 4.990, 12.690, 13.320, 13.350, 13.390, 13.410, 13.420, 13.425, 13.450, 13.490, 13.510, 13.545, 13.550, 13.555, 14.610 Div 6A: 13.570, 13.585 Div 6B: 13.540, 13.545 Div 6C: 13.540, 13.545, 13.550 Div 6D: 13.460 Div 6E: 13.410, 14.610 Div 6AA: 13.430, 13.560, 13.570, 13.590 Div 6AAA: 17.150, 17.155 Div 7A: 4.350, 4.680, 13.590, 14.370, 14.380, 14.390, 14.420, 14.430, 14.435, 14.535 Div 9A: 18.150 Div 10C: 12.660 Div 10D: 12.660 Div 11: 2.330 Div 11A: 16.240, 18.10, 18.110, 19.160 Div 13: 7.480 Div 13A: 4.660, 4.670 Div 14: 4.350 Div 16D: 10.580 Div 16E: 3.120, 3.460, 3.475, 5.770, 6.445, 11.460, 12.490, 12.540, 12.590 Div 16K: 15.70 Div 36: 15.350 Div 70: 12.30 Div 230: 13.550 Div 266: 13.470 Div 267: 13.470 Div 269-B: 13.470 Div 269-D: 13.470 Div 269-E: 13.470 Div 269-F: 13.470 Div 270: 13.470 Div 271: 13.470 Div 272: 13.470 Div 272-D: 13.470 Div 275: 13.555 Div 276: 13.555 Div 815: 16.300 Div 815-B: 16.305 Sch 2C: 3.110, Sch 2E: 12.710 Sch 2F: 13.470, 14.930 Sch 7, Pt I: 2.350 Sch 7, Pt II: 2.350 Income Tax Assessment Act 1997: 2.10, 2.175, 2.205, 2.320, 2.330, 2.360, 2.370, 2.380, 2.430, 2.470, 2.550, 3.10, 3.40, 3.50, 3.100, 3.105, 3.135, 3.255, 3.320, 3.375, 3.540, 4.10, 4.530, 5.310, 6.290, 7.40, 11.10, 12.420, 12.440, 12.740, 13.50, 13.300, 13.470, 15.210, 15.700, 16.80, 19.390 s 1-3(2): 6.290 s 2-15: 13.300 s 2-15(3): 13.40 xxxi

Income Taxation

s 26-10: 5.790, 11.420 s 26-20: 8.105, 10.465 s 26-25: 18.110 s 26-26: 14.680, 14.720 s 26-30: 8.210, 10.465 s 26-30(3): 4.530 s 26-35: 7.540, 10.465, 10.470, 20.200 s 26-35(4): 10.470 s 26-40: 10.465 s 26-45: 8.210, 10.520 s 26-45(3): 4.530 s 26-47: 5.30, 5.125, 10.520 s 26-50: 8.210, 10.520 s 26-52: 10.500 s 26-53: 10.500 s 26-54: 5.355, 7.170, 10.500 s 26-55(1)(ba): 10.60 s 27-5: 7.40, 12.750 s 27-10: 12.750 s 27-15: 7.40, 12.750 s 27-20: 7.40 s 27-80: 7.40, 12.750 s 27-90: 12.750 s 27-95: 12.750 s 30-5: 8.220 s 30-15: 10.60 s 30-15(1): 8.250 s 30-25: 8.250 s 30-45: 8.250 s 32-5: 8.210, 8.220, 8.225, 8.270, 10.530 s 32-10: 8.210, 8.220, 8.265, 10.530 s 32-20: 4.530, 8.210, 8.215, 8.270, 10.530 s 32-30: 8.210, 8.215, 10.530 ss 32-30 to 32-50: 8.215, 8.270 s 32-35: 8.210, 8.225 s 32-40: 8.210 s 32-45: 8.210, 8.215 s 32-50: 8.220, 8.225 s 32-55: 8.215 s 32-65: 8.225 s 35-5: 8.230 s 35-10(1): 5.190 s 35-10(1)(a): 5.190, 8.230 s 35-10(2): 5.190 s 35-10(2E): 5.190, 8.230 s 35-10(3): 5.190, 8.230 s 35-10(4): 8.230 s 35-15(2): 5.190 s 35-20: 5.195 s 35-30: 5.190, 8.230 s 35-35: 5.190, 8.220, 8.230 s 35-40: 5.190, 8.230 s 35-40(4): 5.190 s 35-45: 5.190, 8.230 s 35-55: 5.190, 8.230 s 35-55(1): 5.190 s 35-55(1)(a): 8.230 s 35-55(1)(b): 8.230 s 35-55(1)(c): 8.230 s 36-10(4): 10.280

Income Tax Assessment Act 1997 — cont s 8-5(2): 10.20 s 8-10: 2.500, 2.550, 9.360, 10.20, 10.40 s 10-5: 2.550, 3.20 s 15-2: 2.100, 2.180, 2.240, 2.250, 2.410, 4.10, 4.30, 4.45, 4.220, 4.390, 4.650, 4.670, 4.700, 4.740, 4.760, 4.815, 4.820, 5.300, 11.180 s 15-2(3): 4.670 s 15-2(3)(d): 4.10 s 15-3: 4.210, 12.705 s 15-5: 5.790 s 15-10: 5.30, 5.300, 5.310, 5.330 ss 15-10 to 15-30: 2.550 s 15-15: 2.410, 2.510, 3.10, 4.735, 5.200, 5.235, 5.240, 5.245, 5.490, 5.770, 10.40, 11.510, 12.30, 12.70, 12.300 s 15-15(2)(a): 5.240 s 15-15(2)(b): 5.240, 5.245 s 15-20: 2.410, 3.570, 3.580, 3.585, 3.610 s 15-25: 3.550 s 15-30: 6.10 s 15-50: 13.240 s 15-70: 4.210, 4.555 s 15-80: 4.210 s 17-5: 2.330, 7.40, 12.750 s 17-10: 12.750 s 20-10: 6.10 s 20-20(1): 6.290 s 20-20(2): 6.290, 6.300 s 20-20(3): 6.290 s 20-25: 6.290 s 20-25(4): 6.210, 6.250 s 20-30(1): 6.290 s 20-30(2): 6.290 s 23: 16.420 s 25-5: 7.140, 10.50, 19.420 s 25-10: 3.550, 10.40, 10.50, 10.65, 11.180 s 25-15: 3.550, 3.555, 10.50, 11.180 s 25-20: 10.30 s 25-25: 4.520, 10.50, 12.530, 12.540 s 25-30: 10.50 s 25-35: 2.500, 5.160, 6.310, 10.370, 11.180, 11.335, 11.455 s 25-35(1): s 25-35(1)(a): 10.290, 10.300, 10.320, 10.330 s 25-35(1)(b): 10.330 s 25-40: 5.235, 10.40, 10.110 s 25-45: 7.220, 7.225, 10.50 s 25-47: 7.220 s 25-50: 4.700, 7.250, 10.50 s 25-55: 10.50 s 25-55(1): 10.40 s 25-60: 10.30 s 25-85: 14.720 s 25-90: 12.500, 14.720, 17.170 s 25-95: 13.240 s 25-100: 8.40, 8.45, 10.50 s 26-5: 7.70, 7.75, 7.650, 10.465, 10.500 xxxii

Table of Statutes

s 40-K: 10.230 s 42-18: 10.150 s 42-190: 5.490 s 42-215: 8.210 s 43: 10.140 s 43-20(1): 10.270 s 43-25: 10.270 s 43-30: 10.275 s 43-70(1): 10.270 s 43-70(2): 10.110 s 43-70(2)(e): 10.140, 10.270 s 43-210: 10.270 s 43-230: 10.270 s 43-235: 12.660 s 43-250: 10.270 s 45-40: 10.140, 10.150 s 47(2): 8.75 s 51-10: 6.360, 6.380 s 51-35: 6.360 s 51-50: 6.320, 6.360 s 51-55: 6.75 s 52-10: 6.380 s 52-15: 6.380 s 52-65: 6.380 s 52-65(4): 6.380 s 53-10: 3.30 s 59-40: 14.130, 15.50 s 61-470: 8.70 s 63-10(1): 17.80 s 67-25(1DA): 18.130 s 70-5(1): 5.480 s 70-10: 5.480, 12.290 s 70-15: 12.50, 12.230 s 70-20: 7.460, 7.650, 12.240, 19.390, 20.200 s 70-25: 12.30, 12.470 s 70-30: 12.440 s 70-30(4): 12.440, 12.445 s 70-35: 12.30, 12.60, 12.250, 12.340, 12.440 s 70-35(2): 12.30, 12.470 s 70-35(3): 12.30 s 70-40: 12.30, 12.90 s 70-45: 12.70, 12.80, 12.90, 12.220 s 70-45(1): 12.750 s 70-45(1A): 12.750 s 70-50: 12.80 s 70-55: 12.80 s 70-90: 5.420, 5.470, 5.480, 12.250, 12.300, 12.430, 12.750, 13.170, 13.235 s 70-95: 12.270, 12.750 s 70-100: 12.275, 13.190, 13.195 s 70-105: 12.250, 12.750 s 70-110: 12.430 s 70-115: 5.480, 6.140 s 80-5: 4.1080 s 80-10: 4.1080 s 80-15: 4.1080, 4.1125 s 80-20: 4.1080

Income Tax Assessment Act 1997 — cont s 36-15: 10.280 s 36-17: 14.20, 14.590, 14.595, 15.350 s 40: 10.120 s 40-25: 10.120, 10.180, 10.185, 10.190, 10.200, 10.260 s 40-25(2): 10.210 s 40-30: 10.210 s 40-30(1): 10.130 s 40-30(2): 10.175 s 40-30(3): 10.140 s 40-30(4): 10.180 s 40-35: 13.195 s 40-40: 10.185, 10.187, 12.720, 13.195 s 40-45(2): 10.270 s 40-70: 10.200 s 40-70(1): 10.210 s 40-75: 10.200 s 40-75(1): 10.210 s 40-80(2): 10.140 s 40-85(7): 10.190 s 40-95(3): 10.175 s 40-95(7): 10.190 s 40-100: 10.190 s 40-102: 10.190, 10.210 s 40-105: 10.190 s 40-180: 10.195 s 40-180(2): 10.225, 16.305, 20.200 s 40-190: 10.195 s 40-195: 10.225 s 40-215: 10.110 s 40-230: 10.540, 11.550 s 40-285: 5.490, 6.180, 6.205, 10.220 s 40-285(1): 5.490, 6.180, 10.220 s 40-285(2): 6.180, 10.220 s 40-290: 10.220 s 40-295: 10.225, 13.170 s 40-295(1): 6.180 s 40-295(2): 13.190, 13.235 s 40-300(2): 6.180, 16.305 s 40-305(1)(b): 10.220 s 40-340(1): 15.250, 15.340 s 40-340(2): 13.235 ss 40-340(3) to (7): 13.190 s 40-365: 6.180, 6.205, 10.225 s 40-425(2): 10.410 s 40-440: 10.200 s 40-645: 10.230 s 40-730: 10.230 s 40-735: 7.400 s 40-750: 7.30 s 40-830: 7.310, 9.185, 10.230 s 40-840: , 7.315 s 40-840(2)(d)(i): 10.230 s 40-840(2)(d)(iv): 7.310 s 40-880: 7.310, 7.315, 9.90, 10.250, 10.260, 10.265 s 40-880(2A): 10.410 s 40-880(5): 10.260 s 40-880(6): 10.260 xxxiii

Income Taxation

s 83A-305: 4.670 s 83A-310: 4.670 s 83A-335: 4.670 s 83A30(2): 4.670 s 84-5: 4.1220 s 84-5(1): 4.1220 s 84-5(2): 4.1220 s 85-5: 4.1230 s 85-10: 4.1230, 10.560 s 85-10(1): 4.1230 s 85-10(2): 4.1230, 10.560 s 85-15: 4.1230, 10.560 ss 85-15 to 85-25: 4.1230 s 85-20: 4.1230, 10.560 s 85-25: 4.1230, 10.560 s 85-30: 4.1230 s 85-35: 4.1230 s 86-15: 4.1230 s 86-15(1): 4.1230 s 86-15(2): 4.1230 s 86-15(3): 4.1230 s 86-15(4): 4.1230 s 86-20: 4.1230 s 86-20(1): 4.1230 s 86-30: 4.1230 s 86-35: 4.1230 s 87-5: 4.1230 s 87-15: 4.1230 s 87-15(1): 4.1230 s 87-15(1)(c): 4.1230 s 87-15(2): 4.1230 s 87-15(3): 4.1230 s 87-18: 4.1230 s 87-18(1): 4.1230 s 87-20(1): 4.1230 s 87-25(1): 4.1230 s 87-30: 4.1230 s 100-40(2): 12.660 s 102-5: 2.100, 2.410, 2.470, 3.20, 12.640, 12.690, 13.420 s 102-5(1): 12.640, 12.690 s 102-10: 3.20, 12.640, 15.350 s 102-15: 3.20, 12.640, 15.350 s 102-20: 3.40 s 102-22: 3.40 s 102-25: 3.210, 13.500 s 102-25(3): 3.210 s 102-30: 3.20 s 102-33: 3.40 s 103-5: 3.30 s 103-10: 3.30, 3.530, 12.650 s 103-15: 3.530, 12.660 s 103-25: 3.325 s 104-5: 3.40 s 104-10: 6.190, 13.500 s 104-10(1): 3.40 s 104-10(2): 13.500 s 104-10(3): 3.290, 12.520 s 104-10(4): 3.40, 12.660 s 104-10(5): 3.40

Income Tax Assessment Act 1997 — cont s 82-10(2): 4.1130 s 82-10(3): 4.1130 s 82-10(4): 4.1130 s 82-65(2): 4.1130 s 82-65(3): 4.1130 s 82-130: 4.815, 4.1080 s 82-130(1)(a)(ii): 4.1080, 4.1140 s 82-130(1)(b): 4.1120 s 82-130(2): 4.1080 s 82-130(3): 4.1080 s 82-135: 4.860, 4.865, 4.1080 s 82-135(a): 4.1080 s 82-135(b): 4.1080, 4.1125 s 82-135(c): 4.1080 s 82-135(d): 4.1080 s 82-135(e): 4.1160 s 82-135(h): 4.705, 4.1080 s 82-135(i): 4.1080, 4.1125 s 82-135(j): 4.1080, 4.1125 s 82-140(a): 4.1130 s 82-140(b): 4.1130 s 82-145: 4.1130 s 82-150: 4.1180 s 82-150(1)(d): 4.1180 s 82-150(2): 4.1180 s 82-155: 4.1130 s 82-160: 4.1130 s 83-10(2): 4.1190 s 83-15(a): 4.1190 s 83-80(1): 4.1190 s 83-85: 4.1190 s 83-130: 4.860 s 83-130(1)(b): 4.1120 s 83-135(e): 4.1080 s 83-170: 4.1160 s 83-170(2): 4.1160, 4.1170 s 83-170(3): 4.1160 s 83-180: 4.1160 s 83-180(2): 4.1170 s 83A: 4.670 s 83A-5(b): 4.670 s 83A-5(c): 4.670 s 83A-10(1): 4.670 s 83A-10(2): 4.670 s 83A-20(2): 4.670 s 83A-25: 4.670 s 83A-25(1): 4.670 s 83A-30(1): 4.670 s 83A-33: 4.670 s 83A-35: 4.670 s 83A-35(1): 4.670 s 83A-45: 4.670 s 83A-105: 4.670 s 83A-105(3): 4.670 s 83A-105(4): 4.670 s 83A-110: 4.670 s 83A-115: 4.670 s 83A-120: 4.670 s 83A-125: 4.670 xxxiv

Table of Statutes

s 109-5: 3.290 s 109-10: 3.290 s 110-10: 12.660 s 110-25: 9.100, 12.660 s 110-25(2): 3.530, 9.180, 12.660 s 110-25(2)(a): 9.100 s 110-25(3): 7.140, 12.660 s 110-25(4): 12.660 s 110-25(4)(a): 7.600 s 110-25(5): 9.80, 12.660 s 110-25(6): 7.140, 9.80, 9.90, 12.660 s 110-35: 2.540, 12.660 s 110-35(2): 9.100 s 110-40(2): 12.660 s 110-45: 2.540 s 110-45(1B): 2.540, 12.660 s 110-45(2): 12.660 s 110-45(3A): 12.750 s 110-45(4): 10.110 s 110-55: 2.540, 3.300, 12.660 s 110-55(1): 12.660 s 110-55(3): 12.660 s 110-55(7): 15.120 s 110-55(8): 15.120 s 112-20: 3.270, 16.305 s 112-20(2): 15.40 s 112-20(3): 15.40 s 112-25: 3.260 s 112-30: 3.135 s 112-35: 13.250 s 112-37: 15.50 s 114-1: 12.660 s 114-10: 12.660 s 114-10(1): 3.270, 12.660 s 115-10: 12.690 s 115-15: 12.690 s 115-20: 12.640, 12.690 s 115-20(1): 12.660 s 115-25: 3.40, 12.690 s 115-25(3): 12.690 s 115-30: 3.40 s 115-30(1): 15.300 s 115-40(1): 12.690 s 115-45: 12.690 s 115-100: 12.690 s 115-230: 13.420 s 116-20: 3.540, 6.445, 12.650 s 116-20(1): 3.530 s 116-20(5): 12.750 s 116-25: 3.540 s 116-30: 12.650, 16.305 s 116-30(1): 3.270, 6.190, 12.650 s 116-30(3): 6.190, 12.650 s 116-30(3)(b): 12.650 s 116-30(3A): 6.190, 12.650 s 116-40: 2.300, 12.650 s 116-45: 12.650, 12.660 s 116-50: 9.100, 12.650 s 116-55: 12.650, 13.250 s 116-75: 3.540

Income Tax Assessment Act 1997 — cont s 104-15(3): 3.40 s 104-15(4): 3.40 s 104-20: 3.120, 6.190 s 104-20(3): 3.40 s 104-20(4): 3.40 s 104-25: 3.120, 6.190, 9.180, 12.650, 14.170, 15.50 s 104-25(1): 5.245 s 104-25(3): 3.40, 12.660 s 104-25(5): 3.40 s 104-30: 15.50 s 104-30(1)(c): 15.50 s 104-30(5): 15.50 s 104-35: 3.40, 3.210, 4.860, 15.40 s 104-35(3): 3.40, 12.660 s 104-35(5): 3.40 s 104-35(5)(c): 3.290 s 104-35(5)(d): 3.290, 13.530 s 104-40: 15.40 s 104-40(6): 15.50 s 104-55: 13.490 s 104-60: 13.490 s 104-70: 12.690, 13.450 s 104-71: 13.450 s 104-75(1): 13.440 s 104-135: 14.170 s 104-135(6): 14.1020 s 104-145: 14.1020 s 104-155: 2.165, 3.40, 3.210, 4.860, 5.685, 15.40 s 104-155(3): 3.40, 12.660 s 104-165(2): 18.90 s 104-165(3): 18.90 s 104-175: 15.340 s 104-180: 15.340 s 104-182: 15.340 s 104-220: 12.440 s 104-230: 15.200 s 104-235: 5.490, 10.220 s 106-5: 13.40, 13.110, 13.250, 13.255 s 106-50: 13.490 s 106-60: 3.35 s 108: 3.100 s 108-5: 3.50, 9.80, 9.360, 15.10 s 108-5(1): 3.100 s 108-5(2): 3.105, 13.40 s 108-5(2)(a): 3.100, 3.105 s 108-5(2)(d): 13.255 s 108-7: 3.105, 3.385, 13.255 s 108-10: 3.410 s 108-10(1): 12.670 s 108-10(2): 12.670 s 108-10(4): 12.670 s 108-15: 3.410, 12.670 s 108-20: 3.410 s 108-20(1): 12.670 s 108-20(2): 12.670 s 108-20(3): 12.670 s 108-25: 3.410, 12.670 xxxv

Income Taxation

Income Tax Assessment Act 1997 — cont s 118-5: 2.470, 3.50 s 118-5(b): 3.370 s 118-10(1): 3.410, 12.670 s 118-10(1)(2): 3.410 s 118-10(3): 3.410, 12.670 s 118-20: 2.470, 3.300, 3.570, 5.240, 5.245, 5.470, 9.360, 12.700, 13.250, 14.1020 s 118-20(1): 12.700 s 118-20(4): 12.700 s 118-24: 3.300, 3.610, 5.470, 5.490, 6.205, 10.110, 10.220, 12.700 s 118-25: 3.300, 5.470, 12.315, 12.700 s 118-27: 12.500 s 118-37: 3.370, 5.125, 5.355 s 118-37(1)(a): 6.75 s 118-37(1)(b): 6.75 s 118-37(1)(f): 3.30 s 118-37(1)(g): 3.30 s 118-115: 3.385 s 118-130: 3.385 s 118-145: 3.385 s 118-150: 3.385 s 118-170: 3.385 s 118-185: 3.385 s 118-190: 3.385, 8.175 s 118-195: 3.385 s 118-197: 3.385 s 118-300: 6.190 s 122-15: 15.260 s 122-20: 15.260 s 122-25: 15.260 s 122-35: 15.260 s 122-37: 15.260 s 122-40: 15.270 s 122-45: 15.270 s 122-50: 15.275 s 124-70: 6.190 s 124-70(1)(c): 3.325 s 124-75: 3.325, 15.330 s 124-75(1): 6.190 s 124-75(4): 3.320 s 124-85: 15.330 s 124-85(2): 3.320, 6.190 s 124-85(3): 3.320 s 124-90: 15.330 s 124-780(1): 15.300 s 124-780(2): 15.300 s 124-780(3): 15.300 s 124-783: 15.310 s 124-784A: 15.310 s 124-785: 15.300 s 124-790: 15.300 s 124-795(1): 15.300 s 124-800: 15.300 s 125-65: 15.330 s 125-70(1)(2): 15.320 s 125-70(2): 15.330 s 125-80: 15.330 s 125-155: 15.330 xxxvi

s 125-160: 15.330 s 125-165: 15.330 s 125-170: 15.330 s 126-5: 3.330 s 126-15: 3.330 s 128-15: 3.385 s 128-50: 3.385 s 130-20(4): 13.540 s 130-80: 4.670 s 134-1(4): 15.50 s 149-10: 3.40 s 149-30: 15.200 s 149-70: 15.200 s 152-10: 3.350 s 165-12: 15.390 s 165-12(7): 15.410 s 165-20: 15.390 s 165-37(4): 15.410 ss 165-80 to 165-200: 15.400 s 165-115A(1A): 15.530 s 165-115A(1): 15.530 s 165-115A(1)(b): 15.530 s 165-115A(1)(c): 15.530 s 165-115A(2): 15.530 s 165-115A(3): 15.530 s 165-115B: 15.530 s 165-115B(4): 15.530 s 165-115C(4): 15.410 s 165-115E: 15.530 s 165-115E(2): 15.530 s 165-115BA: 15.530 s 165-115BA(4): 15.530 s 165-115GC(4): 12.450 s 165-123(7): 15.410 s 165-150: 15.400 s 165-155: 15.400 s 165-160: 15.400 s 165-165: 15.410 s 165-208: 15.400 s 165-210: 15.450 s 165-215: 15.400 s 166-15: 15.420 s 166-175: 15.420 s 166-240: 15.420 s 166-272: 15.420 s 170-5: 7.460 s 202-5(a): 14.555, 18.130 s 202-5(c): 14.555 s 202-20: 14.555, 18.130 s 202-30: 14.720 s 202-35: 14.530 s 202-40: 14.530, 14.540 s 202-45: 14.530, 14.535, 15.95 s 202-45(d): 14.720 s 202-45(e): 14.530, 14.830 s 202-45(g): 14.430 s 202-45(g)(iii): 4.705 s 202-45(h): 14.840 s 202-60(2): 14.555 s 202-65: 14.555

Table of Statutes

s 207-145(2)(b): 14.900 s 207-145(2)(c): 14.990, 15.130 s 207-150(1)(a): 14.920 s 207-150(1)(e): 14.610 s 207-155: 14.990, 15.130 s 207-160: 14.610 s 207-165: 14.610 s 207-170: 14.610 s 214-150: 14.550 s 230-15: 12.500 s 230-15(1): 12.500 s 230-15(2): 12.500, 12.510 s 230-15(3): 12.500, 17.170 s 230-20: 12.500 s 230-25: 12.500 s 230-25(1): 12.500 s 230-25(3): 12.500 s 230-45: 12.500 s 230-50: 12.500, 12.520 s 230-100(2): 12.510 s 230-100(2)(b): 12.510 s 230-100(5): 12.510 s 230-105(2)(a): 12.510 s 230-115: 12.510 s 230-115(2): 12.510 s 230-115(4): 12.510 s 230-115(5): 12.510 s 230-125: 12.510 s 230-125(2)(b): 12.510 s 230-125(c): 12.510 s 230-130(1): 12.510 s 230-135: 12.510 s 230-135(4): 12.510 s 230-170: 12.510 s 230-170(2): 12.510 s 230-175: 12.510 s 230-175(1): 12.510 s 230-175(2): 12.510 s 230-185: 12.510 s 230-185(2): 12.510 s 230-190: 12.510 s 230-190(3): 12.510 s 230-190(4): 12.510 s 230-190(5)(b): 12.510 s 230-210(2): 12.520 s 230-220: 12.520 s 230-230: 12.520 s 230-300(3): 12.520 s 230-310: 12.520 s 230-310(4): 12.520 s 230-315: 12.520 s 230-320: 12.500 s 230-325: 12.520 s 230-360: 12.520 s 230-365: 12.520 s 230-435: 12.510 s 230-445: 12.500 s 230-445(1): 12.510 s 230-455: 12.490, 12.500 s 230-455(1)(e): 12.490

Income Tax Assessment Act 1997 — cont s 202-75(2): 14.555 s 202-75(3): 14.555 s 202-80: 14.510, 14.555 s 202-85: 14.555 s 203-20: 14.860 s 203-25: 14.860 s 203-30: 14.860, 14.870 s 203-35: 14.555 s 203-40: 14.860 s 203-45: 14.860 s 203-50(1)(a): 14.870 s 203-50(1)(b): 14.870 s 203-50(2): 14.870 s 203-50(3): 14.870 s 203-50(4): 14.870 s 203-55: 14.860 s 204-30: 14.905 s 204-30(3): 14.900 s 204-30(3)(a): 14.900 s 204-30(3)(c): 14.900 s 204-35: 14.900 s 204-40: 14.900 s 204-45: 14.900 s 204-75: 14.860 s 205-10: 14.540 s 205-15: 14.500, 14.550, 14.555, 14.570, 14.595 s 205-20: 14.550 s 205-25: 14.595, 18.130 s 205-30: 14.500, 14.595, 14.870, 14.900, 15.95 s 205-45(2): 14.550 s 205-50: 14.550 s 205-70: 14.550, 14.555 s 207-20: 14.570, 15.130 s 207-20(1): 14.500, 14.570 s 207-20(2): 14.500, 14.570, 14.650 s 207-35(1): 14.600, 14.610 s 207-35(2): 14.600, 14.610 s 207-35(3): 14.600, 14.610 s 207-35(4): 14.610 s 207-45: 14.600, 14.610 s 207-50(2): 14.600 s 207-50(2)(b): 14.605 s 207-50(3): 14.610 s 207-50(3)(b): 14.615 s 207-55(3): 14.600, 14.610, 14.615 s 207-57: 14.600, 14.610 s 207-70: 18.130 s 207-75(1): 18.130 s 207-75(2): 18.130 s 207-110: 14.520 s 207-120: 14.520 s 207-125: 14.520 s 207-130: 14.520 s 207-135: 14.520 s 207-145(1)(a): 14.920 s 207-145(1)(b): 14.900 s 207-145(1)(c): 14.990, 15.130 xxxvii

Income Taxation

s 292-80: 4.930 s 292-85: 4.930 s 292-85(3): 4.930 s 292-85(4): 4.930 s 292-90(2): 4.930 s 293-15: 4.920 s 295-5(2): 4.970, 4.990 s 295-10: 4.990 s 295-85: 5.690 s 295-85(2): 4.990 s 295-90: 4.990 s 295-95: 16.220 s 295-165: 4.960, 4.990 s 295-170: 4.990 s 295-170(1): 4.950 s 295-190: 4.990, 4.1010 s 295-380: 4.990 s 295-385: 4.990 s 295-550: 4.990 s 301-5: 4.1030 s 301-10: 4.1030 s 301-25: 6.370 s 305-5: 4.1050 s 306-5: 4.1010 s 306-10: 4.1010 s 307-15: 4.1010, 11.200 s 320-355: 12.520 s 328-10: 12.460 s 328-10(1): 12.450 s 328-10(2): 12.450 s 328-50: 12.450 s 328-110: 10.410, 12.460 s 328-110(1)(b): 12.460 s 328-110(1)(b)(i): 12.460 s 328-110(1)(b)(ii): 12.460 s 328-110(3): 12.460 s 328-110(4): 12.460 s 328-110(5): 12.460 s 328-115: 12.460 s 328-120(1): 12.460 s 328-120(2): 12.460 s 328-120(4): 12.460 s 328-125: 12.460 s 328-130: 12.460 s 328-180(1): 10.410 s 328-220: 12.460 s 328-285: 12.470 s 328-295: 12.470 s 328-295(1): 12.470 s 328-295(2): 12.470 s 355-25: 10.440 s 355-25(2): 10.440 s 355-30: 10.440 s 385-100: 6.140 s 395-495: 4.1010, 4.1020 s 700-1: 15.630 s 700-10: 15.730, 15.840 s 701-1(1): 15.680 s 701-1(2): 15.680 s 701-1(3): 15.680

Income Tax Assessment Act 1997 — cont s 230-460(1): 3.480 s 230-460(5): 3.480 s 230-530: 12.500 s 230-530(2): 12.520 s 240-20: 12.720 s 240-25: 12.720 s 240-25(5): 12.720 s 240-35(1): 12.720 s 240-35(2): 12.720 s 240-40: 12.720 s 240-50: 12.720 s 240-55: 12.720 s 240-60: 12.720 s 240-85: 12.720 s 245-10: 5.790 s 245-35: 5.790, 5.795 s 245-40: 5.790, 5.795 s 245-195(1): 5.790 s 250-20: 12.450 s 275-10: 13.550 s 275-10(1)(b): 13.550 s 275-10(3)(a): 13.550 s 275-10(4): 13.550 s 275-15: 13.550 s 275-20: 13.550 s 275-25: 13.550 s 275-30: 13.550 s 275-35: 13.550 s 275-110: 13.550 s 275-115: 13.550 s 275-605: 13.555 s 276-10: 13.550 s 276-15(1): 13.550 s 276-80: 13.555 s 276-105(2): 13.555 s 276-205: 13.555 s 276-210(2): 13.555 s 276-255: 13.555 s 276-260(2): 13.555 s 276-405: 13.555 s 276-410: 13.555 s 276-415: 13.555 s 280-105(1): 19.420 s 280-105(2): 19.420 s 284-150: 20. 210 s 290-10: 4.920 s 290-60: 4.920 s 290-60(3): 4.920 s 290-75: 4.920 s 290-100: 4.920 s 290-130: 4.960 s 290-150: 4.930, 4.940 s 290-155: 4.940 s 290-160: 4.930, 4.940 s 290-165: 4.940 s 290-170: 4.930, 4.940 s 291-15: 4.940 s 291-15(a): 4.920 s 291-15(b): 4.920 xxxviii

Table of Statutes

s 900-55: 8.270 s 900-115: 8.265 s 900-125: 8.265 s 900-150: 8.265 s 900-155: 8.265 s 900-205: 8.265 s 900-215: 8.270 s 960-50: 2.220 s 960-100: 13.300 s 960-120: 14.130, 14.310 s 960-275: 3.10, 12.665 s 960-275(2): 12.660 s 960-275(4): 12.660 s 960-280(1): 12.660 s 974: 14.535 s 974-5(4): 14.730 s 974-15: 14.720, 14.730 s 974-20: 14.720 s 974-20(4): 14.750 s 974-25: 14.740, 14.745 s 974-35: 14.750, 14.770 s 974-40: 14.750, 14.770 s 974-45: 14.750, 14.770 s 974-50: 14.750 s 974-55: 14.750 s 974-60: 14.750 s 974-65: 14.720, 14.740 s 974-70: 14.720, 14.730 s 974-70(1)(b): 14.730 s 974-75: 14.720 s 974-75(4): 14.740, 14.745 s 974-75(6): 14.745 s 974-80: 14.720, 14.740 s 974-85: 14.760 s 974-90: 14.760 s 974-95: 14.760 s 974-100: 14.770 s 974-105: 14.730, 14.750 s 974-130: 14.720 s 974-135: 14.750 s 974-135(5): 14.750 s 974-140: 14.750 s 974-145: 14.750 s 974-150: 14.720, 14.730 s 974-155: 14.730 s 974-165: 14.770 s 975-300: 14.720, 14.810 s 975-300(1)(b): 15.60 s 977-50: 5.470 s 995-1: 4.440, 4.970, 5.30, 8.210, 12.720, 12.750, 14.30, 14.80, 14.390, 16.170 s 995-1(1): 2.330, 2.340, 13.50, 13.260, 13.270, 16.220 Pt IIIA, Divs 1 to 4: 3.40 Pt 2-1: 2.380 Pt 2-15: 2.330 Pt 2-20: 2.360 Pt 3-1: 2.100, 2.380, 2.460, 2.470, 3.10, 3.40, 7.600, 12.30 Pt 3-2: 3.40

Income Tax Assessment Act 1997 — cont s 701-5: 15.690 s 701-10: 15.720 s 701-15: 15.860 s 701-30: 15.810 s 701-40: 15.870 s 701-60: 15.720, 15.860 s 701-85: 15.700 s 703-5(3): 15.650 s 703-30: 15.650 s 703-50: 15.650 s 703-50(2): 15.650 s 705-25: 15.740, 15.750 s 705-35: 15.740, 15.750 s 705-40: 15.750 s 705-60: 15.740, 15.750, 15.760 s 707-145: 15.760, 15.820 s 707-305: 15.830 s 707-335: 15.830 s 709-55: 15.780 s 709-60: 15.780 s 711-15: 15.860 s 711-20: 15.860 s 711-30: 15.860 s 721-15: 15.790 s 721-25: 15.790 s 721-30: 15.790 s 727-470(2): 12.450 s 768-5: 17.50, 17.55, 17.100, 17.170, 18.130 ss 768-905 to 768-980: 17.20 s 770-10: 17.80 s 770-75: 17.80, 17.170 s 770-130: 17.90 s 770-135: 17.120 s 770-140: 17.80 s 775-10: 16.240 s 775-15: 12.740, 17.80 s 775-30: 12.740 s 775-45: 12.740 s 775-55: 12.740 s 775-75: 12.740 s 775-85: 12.740 s 775-95: 12.740 s 775-110: 11.200 s 815-115: 16.290 s 815-120: 16.290 s 815-120(3): 16.290 s 815-125: 16.290, 16.300 s 815-130: 16.290, 16.300 s 815-135: 16.300 s 815-145: 16.290 s 815-215: 16.290, 16.300 ss 815-215 to 815-230: 16.290 s 820-960: 18.60 s 830-45: 13.270 s 830-50: 13.270 s 840-815: 18.20 s 855-35: 18.70 s 900-50: 8.270 xxxix

Income Taxation

Div 108-A: 13.585 Div 109: 3.40, 3.270, 3.290 Div 110: 2.530, 3.40, 12.750 Div 112: 3.40, 12.750 Div 114: 12.660 Div 115: 3.10, 3.20, 3.290, 3.400, 12.690, 13.420, 14.170, 15.20 Div 116: 3.40, 12.750, 13.585 Div 118: 3.40, 3.370 Div 121: 3.40 Div 122: 3.40 Div 124-Q: 13.545 Div 125: 13.530, 15.320, 15.330 Div 126-G: 13.500 Div 128: 3.360, 13.440, 13.525 Div 130: 12.680 Div 130-D: 4.670 Div 132: 3.540, 12.680 Div 134: 3.265, 12.680, 15.50 Div 149: 15.200, 15.770 Div 152: 3.20, 3.350, 3.400, 12.690, 13.420 Div 165: 15.390 Div 166: 15.420 Div 167: 15.400 Div 170: 12.240, 15.590 Div 175: 15.430 Div 197: 14.810 Div 200: 14.450 Div 203: 14.860 Div 204: 18.130 Div 205: 14.650 Div 208: 14.650 Div 214: 14.540 Div 215: 14.720 Div 216: 14.910 Div 220: 17.100, 18.130 Div 230: 6.430, 7.640, 12.490, 12.500 Div 240: 10.580, 12.710, 12.720, 12.730, 14.745 Div 242: 12.730, 14.745 Div 245: 5.790, 5.795, 15.430 Div 247: 7.530 Div 250: 10.580, 14.745 Div 275-A: 13.550 Div 275-B: 13.545 Div 275-L: 13.550 Div 276-B: 13.555 Div 276-C: 13.555 Div 276-D: 13.555 Div 276-E: 13.555 Div 276-F: 13.555 Div 276-G: 13.555 Div 276-H: 13.555 Div 280: 4.900, 19.420 Div 290: 4.900, 4.910 Div 291: 4.920 Div 293: 4.920 Div 294: 4.920 ,4.1040 Div 295: 4.900, 4.970, 4.990 Div 295-190: 4.930

Income Tax Assessment Act 1997 — cont Pt 3-3: 2.100, 2.380, 2.460, 2.470, 3.10, 3.40, 12.30 Pt 3-6: , 14.80, 14.450 Pt 3-90: 10.360, 15.550, 15.630, 15.740, 15.850 Pt III, Div 5A: 16.370 Pt IVA: 18.280 Div 5: 13.40, 13.120 Div 6: 2.370, 2.550 Div 8: 2.340, 2.370, 3.480 Div 13A: 15.50 Div 16E: 12.510 Div 17: 12.750 Div 20: 6.10, 6.290 Div 25: 10.10, 10.30, 10.290 Div 26: 10.20, 10.450 Div 27: 12.750 Div 28: 8.260 Div 30: 8.250, 10.10, 10.60 Div 32: 4.470, 10.450, 10.530 Div 34: 8.180, 10.490 Div 35: 5.30, 5.150, 5.190, 8.230, 8.235, 10.285, 10.450, 12.540, 20.160, 20.220 Div 36: 2.330, 10.10, 10.30, 10.280, 11.50, 13.110, 17.170 Div 40: 3.610, 4.520, 5.490, 6.180, 9.290, 10.10, 10.30, 10.110, 10.140, 10.150, 10.195, 10.220, 10.230, 10.270, 12.540, 12.660, 12.750, 15.250, 15.860 Div 41: 10.420 Div 43: 10.10, 10.30, 10.110, 10.140, 10.150, 10.270, 12.540, 12.660, 12.665 Div 45: 10.140 Div 50: 10.60, 13.115 Div 51: 6.380, 6.405 Div 52: 6.380, 6.405 Div 53: 6.380, 6.405 Div 61: 2.360 Div 65: 2.360 Div 67: 2.360, 14.500 Div 70: 5.30, 9.360, 10.130, 12.20 Div 82: 4.700, 4.705, 4.740, 4.860, 4.1130 Div 82-A: 4.1130 Div 82-B: 4.1130 Div 83: 4.1080 Div 83A: 4.10, 4.45, 4.250, 4.660, 4.670, 18.225 Div 83A-C: 4.670 Div 85: 4.1230, 10.450, 10.560 Div 86: 4.1230 Div 87: 4.1230 Div 100: 3.20, 12.660 Div 102: 3.400 Div 104: 3.40, 3.120, 3.300, 13.585 Div 106: 3.30 Div 108: 3.40 xl

Table of Statutes

Subdiv 124F: 15.50 Subdiv 130-A: 13.530 Subdiv 152-A: 3.400 Subdiv 207-B: 13.410 Subdiv 230-B: 12.520 Subdiv 230-C: 12.520 Subdiv 230-D: 12.520 Subdiv 230-E: 12.520 Subdiv 230-F: 12.520 Subdiv 230-H: 12.500 Subdiv 290-B: 4.910 Subdiv 290-C: 4.910 Subdiv 290-D: 4.960 Subdiv 307-C: 4.1030 Subdiv 328-C: 3.350 Subdiv 855-B: 18.90 Subdiv 900-E: 8.260 Subdiv 900-F: 8.260 subdiv 27-B: 12.750 subdiv 30-B: 10.60 subdiv 36-C: 14.590, 15.350 subdiv 40-C: 10.195 subdiv 40-E: 10.200, 10.230 subdiv 40-F: 10.230 subdiv 40-G: 10.230 subdiv 40-H: 10.230 subdiv 40-I: 10.230 subdiv 40-J: 10.230 subdiv 52-A: 6.380 subdiv 52-B: 6.380 subdiv 61-G: 8.240 subdiv 86-B: 4.1230 subdiv 87-B: 4.1230 subdiv 108-B: 3.410 subdiv 108-C: 3.410 subdiv 108-D: 3.105 subdiv 118-B: 3.40, 3.380 subdiv 122-A: 15.250, 15.260, 15.270, 15.275 subdiv 122-B: 15.250 subdiv 124-B: 3.320, 3.325 subdiv 124-C: 3.340 subdiv 124-G: 15.340 subdiv 124-J: 3.340, 3.545 subdiv 124-L: 3.340 subdiv 124-M: 15.280, 15.300, 15.310 subdiv 124-N: 15.340 subdiv 126-A: 3.330 subdiv 126-B: 15.340, 15.600 subdiv 130-A: 14.350, 15.40 subdiv 130-B: 15.50 subdiv 130-C: 15.50 subdiv 130-D: 15.50 subdiv 130-E: 15.50 subdiv 152-A: 3.350 subdiv 152-B: 3.400 subdiv 152-C: 3.400 subdiv 152-D: 3.400 subdiv 152-E: 3.350, 3.400 subdiv 165-A: 15.390

Income Tax Assessment Act 1997 — cont Div 301: 4.900, 4.1030, 4.1080 Div 302: 4.1030 Div 305: 4.1030 Div 306: 4.1010 Div 328: 10.10, 10.410, 12.450 Div 355: 10.440 Div 385: 12.250 Div 392: 11.50 Div 405: 11.50 Div 700: 15.550 Div 703: 15.650 Div 705: 15.720, 15.740, 15.750, 15.870 Div 707: 15.800, 15.820 Div 709: 15.780, 15.870 Div 711: 15.860 Div 719: 15.670 Div 721: 15.790 Div 725: 15.210, 15.220 Div 727: 15.210, 15.230, 15.600 Div 755: 12.740 Div 768: 15.300 Div 768-A: 16.370 Div 768-G: 17.60 Div 770: 7.30, 17.80 Div 775: 5.770, 12.740 Div 815: 12.240 Div 815-B: 16.290, 16.300, 16.360 Div 815-C: 16.290, 16.300 Div 815-E: 16.430 Div 820: 10.450, 17.170 Div 830: 13.270 Div 840: 18.20 Div 840-M: 13.545 Div 842: 7.30 Div 855: 3.30, 16.240, 18.70, 18.185 Div 900: 8.260, 8.270 Div 974: 10.450, 14.80, 14.535, 14.680, 14.690, 14.700, 14.720, 14.960, 15.650 Divs 4 to 21: 3.40 Divs 80 to 83: 4.210, 4.1070 Divs 84 to 87: 4.1220, 10.560, 18.215 Divs 85 to 87: 13.590 Divs 301 to 307: 4.1030 Divs 723 to 727: 3.255 Divs 815-B to 815-D: 16.290 Subdiv 28-G: 8.260 Subdiv 28-H: 8.260 Subdiv 83-B: 4.1190 Subdiv 83-C: 4.1160, 4.1170 Subdiv 83A: 4.1190 Subdiv 87-A: 4.1230 Subdiv 104-E: 13.440 Subdiv 108-D: 13.445 Subdiv 115-C: 13.420 Subdiv 118-B: 13.395, 13.445 Subdiv 124-H: 13.530 Subdiv 124-M: 13.530 Subdiv 124E: 15.50 xli

Income Taxation

s 13: 13.430 s 14: 13.430 s 18: 16.175 s 23A: 2.350 s 26(1): 4.990 s 26(2): 4.990 s 28(b): 13.460 Sch 7, Pt II: 18.200 Sch 7, Pt III: 18.200 Sch 10, Pt I: 13.320 Sch 11, Pt I: 13.430

Income Tax Assessment Act 1997 — cont subdiv 165-B: 15.390 subdiv 165-C: 15.390 subdiv 165-D: 15.400 subdiv 165-F: 15.400 subdiv 165-CA: 15.390 subdiv 165-CB: 15.390 subdiv 165-CC: 15.530 subdiv 170-D: 15.590 subdiv 202-B: 14.555 subdiv 202-C: 14.530 subdiv 202-E: 14.500, 14.650 subdiv 204-B: 14.880, 14.890, 14.895, 14.900 subdiv 204-C: 14.890 subdiv 204-D: 14.900 subdiv 204-E: 14.860 subdiv 207-B: 14.100, 14.600, 14.610 subdiv 207-E: 14.520 subdiv 230-B: 12.510, 12.520 subdiv 230-E: 12.520 subdiv 230-G: 12.510 subdiv 230-H: 12.500 subdiv 292-B: 4.920, 4.930 subdiv 292-C: 4.930 subdiv 328-C: 12.460 subdiv 328-D: 12.450, 12.480 subdiv 328-E: 12.450 subdiv 328-F: 10.430 subdiv 705-A: 15.740 subdiv 705-B: 15.770 subdiv 705-C: 15.770 subdiv 705-D: 15.770 subdiv 707-A: 15.820 subdiv 707-C: 15.830 subdiv 707-D: 15.870 subdiv 768-G: 17.60 subdiv 802-A: 14.640, 18.130 subdiv 815-B: 20.200 subdivs 815-B to 815-D: 7.480 subdiv 815-C: 20.200 subdiv 855-A: 18.70 subdiv 960-E: 14.30 subdiv 960-F: 14.30 subdiv 960-G: 14.80, 15.650 subdiv 960-M: 12.660 subdiv 974-E: 14.720

Inspector-General of Taxation Act 2003 s 7(1): 19.410 s 7(2): 19.410 s 9: 19.410 s 15: 19.410 s 18: 19.410 International Tax Agreements Act 1953: 16.80 s 3(11A): 18.170 s 4: 16.80 s 20: 16.440 s 24: 16.300 Judiciary Act 1903 s 39B: 19.260, 19.280 Medicare Levy Act 1986: 2.360 s 6(1): 2.365 Model Tax Convention: 16.360 New Business Tax System (Capital Allowances) Act 2001: 5.490 New Business Tax System (Debt and Equity) Bill 2001: 14.710 Ombudsman Act 1976: 19.410 Patents Act 1952: 3.285 Public Governance, Performance and Accountability Act 2013: 19.20 s 63: 19.540 Public Service Act 1999: 19.20 Retirement Savings Accounts Act 1997 s 960-275(3): 15.40

Income Tax Assessment Amendment (Capital Gains) Act 1986: 4.860

Social Security Act 1991: 6.380

Income Tax (Dividends, Interest and Royalties Withholding Tax) Act 1974: 18.110

Superannuation (Excess Concessional Contributions Charge) Act 2013: 4.920

Income Tax (Managed Investment Fund Withholding Tax) Act 2008 s 4: 18.20

Superannuation (Excess Concessional Contributions Tax) Act 2007: 4.920 Superannuation (Excess Non-concessional Contributions Tax) Act 2007: 4.930

Income Tax Rates Act 1986: 2.310, 2.350, 2.360, 4.1130, 11.50 s 12(1): 13.320 s 12(9): 13.320

Superannuation (Government Co-contribution for Low Income Earners) Act 2003: 4.950 xlii

Table of Statutes

s 14S: 19.520 s 14S(1): 19.420 s 14ZL: 19.250 s 14ZU: 19.250, 19.260 s 14ZW: 19.190, 19.250 s 14ZW(1A): 19.250 s 14ZW(1): 19.250, 19.310 s 14ZW(2): 19.290, 19.310 s 14ZW (3): 19.290 s 14ZW(3): 19.310 s 14ZX(4): 19.310 s 14ZY: 19.310 s 14ZY(3): 19.510 s 14ZZ: 19.310, 19.320 s 14ZZ(1): 19.320 s 14ZVA: 19.250 s 14ZYA: 19.310 s 14ZYA(2): 19.310 s 14ZYA(3): 19.310 s 14ZZC: 19.320 s 14ZZE: 19.330 s 14ZZF: 19.510 s 14ZZK: 4.660, 19.290, 19.340, 19.350 s 14ZZN: 19.320 s 14ZZO: 4.660, 19.290, 19.340, 19.350 s 14ZZQ: 19.330 s 290-60(1): 20. 210 s 353-10: 19.440 s 353-10(1)(b): 19.440 s 353-10(1)(c): 19.440 s 353-15: 19.440 s 353-15(1): 19.440 Pt IIA: 19.420 Pt III: 19.530 Pt IVC: 19.250, 19.290, 19.540 Pt IVC, Div 4: 19.510 Div 12: 4.380 Div 284: 19.530 Div 340: 19.540 Div 360: 19.70 Sch 1: 2.360, 19.35, 19.87 Sch 1, Div 12: 19.100 Sch 1, Div 12-D: 18.70 Sch 1, subdiv 12-E: 19.90 Sch 1, Subdiv 12-F: 18.110 Sch 1, subdiv 12-F: 19.160 Sch 1, Div 12-H: 13.550 Sch 1, Subdiv 12-H: 18.20 Sch 1, subdiv 12-H: 19.160 Sch 1, Subdiv 12-FB: 18.250 Sch 1, subdiv 12-FC: 19.160 Sch 1, Div 45: 19.120 Sch 1, subdiv 45-B: 19.120 Sch 1, subdiv 45-C: 19.120 Sch 1, Div 95: 4.920 Sch 1, Div 96: 4.920 Sch 1, Div 135: 4.920 Sch 1, Div 284: 19.530, 20. 210 Sch 1, Div 290: 20.200, 20. 210 Sch 1, subdiv 290-B: 20. 210

Superannuation Industry (Supervision) Act 1993: 4.900, 4.970, 4.980, 4.1000 s 19: 4.1000 s 34(4): 4.1000 s 42(1A): 4.1000 s 42A: 4.1000 s 45: 4.900 s 52(2): 4.1000 s 58: 4.1000 s 62: 4.1000 s 65: 4.1000 s 67: 4.1000 s 67(4A): 4.1000 Pt 3: 4.1000 Pt 8: 4.1000 Pt 9: 4.1000 Pts 12 to 14: 4.1000 Superannuation Industry (Supervision) Regulations Pt 5: 4.1000 Pt 6: 4.1000 Superannuation (Sustaining the Superannuation Contribution Concession) Imposition Act 2013: 4.920 Tax Administration Act 1953 Div 12-H: 13.545 Tax Agent Services Act 2009: 2.360 Tax Law Improvement Act 1996: 4.10 Tax Laws Amendment (Countering Tax Avoidance and Multinational Profit Shifting) Act 2013: 20.360 Tax Laws Amendment (Repeal of Inoperative Provisions) Act 2006: 4.10 Tax and Superannuation Laws Amendment (2015 Measures No 6) Act 2016 Sch 1, s 38: 19.220 Sch 1, s 39: 19.220 Tax and Superannuation Laws Amendment (2016 Measures No 2) Bill 2016: 19.87 Taxation Administration Act 1953: 5.350, 12.450, 18.60, 19.50, 19.260, 19.520 s 3A: 19.20 s 3B: 19.20 s 3C: 16.430 s 4: 19.20 s 4A: 19.20 s 5: 19.20 s 6D: 19.20 s 8: 19.20 s 8C: 19.500 s 8D: 19.500 s 8ZE: 19.530 s 8AAG(1): 19.420 s 8AAG(2): 19.420 xliii

Income Taxation

Sch 1, s 284-160(a)(i): 19.530 Sch 1, s 284-160(a)(ii): 19.530 Sch 1, s 284-215: 19.530 Sch 1, s 284-220(1)(a): 19.530 Sch 1, s 284-225(1): 19.530 Sch 1, s 284-225(2): 19.530 Sch 1, s 290-50: 20. 210 Sch 1, s 290-60(1)(a): 20. 210 Sch 1, s 290-60(2): 20. 210 Sch 1, s 290-60(3): 20. 210 Sch 1, s 290-65: 20. 210 Sch 1, s 298-20: 19.530 Sch 1, s 298-25: 19.530 Sch 1, s 298-30: 19.530 Sch 1, s 350-10: 19.260 Sch 1, s 353-10: 19.35, 19.440, 19.450, 19.500 Sch 1, s 353-15: 19.35, 19.450, 19.500 Sch 1, s 357-60: 19.50, 19.60 Sch 1, s 359-35(4): 19.510 Sch 1, s 361-5: 19.80 Sch 1, s 370-5(1): 19.87 Sch 1, s 370-5(4): 19.87 Sch 1, s 388-50: 19.35 Sch 1, s 388-55: 19.180 Sch 1, ss 12-80 to 12-90: 19.100 Sch 1, ss 359-60 to 359-70: 19.60 Sch 1, Pt VA: 19.35 DIV 284: 19.530

Taxation Administration Act 1953 — cont Sch 1, Div 340: 19.540 Sch 1, Div 353: 19.440 Sch 1, subdiv 353-B: 19.440 Sch 1, Div 355: 16.420, 19.20 Sch 1, Div 370: 19.87 Sch 1, Div 393: 19.35 Sch 1, Div 396: 16.430 Sch 1, subdiv 396-A: 19.35 Sch 1, subdiv 396-B: 19.35 Sch 1, subdiv 396-C: 19.35 Sch 1, Div 410: 19.35 Sch 1, Divs 357 to 360: 19.40 Sch 1, s 12-1(1): 19.110 Sch 1, s 12-1(2): 19.110 Sch 1, s 12-1(3): 19.110 Sch 1, s 12-35: 19.100 Sch 1, s 12-140: 19.90, 19.120, 19.150 Sch 1, s 12-155: 19.120 Sch 1, s 12-175: 13.460 Sch 1, s 12-180: 13.460 Sch 1, s 12-190: 19.90, 19.130, 19.150 Sch 1, s 12-190(1)(a): 19.150 Sch 1, s 12-190(4)(a): 19.150 Sch 1, s 12-190(4)(b): 19.150 Sch 1, s 12-300: 19.160 Sch 1, s 12-315: 18.60 Sch 1, s 12-325: 18.20 Sch 1, s 12-330: 18.20 Sch 1, s 12-335: 18.20 Sch 1, s 12-383: 13.550 Sch 1, s 14-5(3): 19.110 Sch 1, s 15-10: 19.100, 19.110 Sch 1, s 15-15: 19.110 Sch 1, s 15-25: 19.100, 19.110 Sch 1, s 16-5: 19.100 Sch 1, s 16-25: 19.100 Sch 1, s 16-30: 19.100 Sch 1, s 16-70: 19.100 Sch 1, s 42-325: 19.120 Sch 1, s 45-15: 19.140 Sch 1, s 45-50: 19.120 Sch 1, s 45-70(1): 19.120 Sch 1, s 45-110: 19.120, 19.130, 19.140 Sch 1, s 45-120: 19.140 Sch 1, s 45-120(3): 19.140 Sch 1, s 45-125: 19.120, 19.130 Sch 1, s 45-140: 19.120 Sch 1, s 45-170: 19.120 Sch 1, s 45-205: 19.140 Sch 1, s 55(1): 19.90 Sch 1, s 255-5: 19.190, 19.420, 19.520 Sch 1, s 255-10: 19.420 Sch 1, s 260-5: 19.420, 19.520 Sch 1, s 284-15: 19.530 Sch 1, s 284-75(1): 19.530 Sch 1, s 284-75(2): 19.530 Sch 1, s 284-75(3): 19.530 Sch 1, s 284-80: 19.530 Sch 1, s 284-90: 19.530

Taxation Administration Regulations 1976: 18.120 reg 12F: 19.440 regs 39 to 42: 18.110 reg 40(1)(b): 18.120 reg 44B: 18.250 reg 44C: 18.60 Taxation (Interest on Overpayments and Early Payments) Act 1983: 19.420 Taxation Law Amendment Bill (No 4) 1988 cl 13: 1.320 Taxation Laws Amendment Act (No 4) 1992 Pt IIIA: 4.860 Taxation Laws Amendment Bill (No 2) 1996: 5.790 Taxation Laws Amendment Bill (No 4) 1988: 1.320, 5.300 Taxation Laws Amendment (Self-Assessment) Act 1992: 19.60 The Explanatory Memorandum to Tax Laws Amendment (Countering Tax Avoidance and Multinational Profit Shifting) Bill 2013: 20.370 Treasury Laws Amendment (Enterprise Tax Plan) Bill 2016: 14.10 xliv

Table of Statutes

Art 10(5): 18.230 Art 11(3)(b): 18.140 Art 11(4): 18.140 Art 11(6): 18.230 Art 11(7): 18.315 Art 12: 18.185 Art 12(3): 18.230 Art 12(4): 18.195 Art 13: 18.185 Art 13(5): 18.90 Art 14: 18.235 Art 15: 18.215, 18.225 Art 16: 18.280, 18.315 Art 17: 18.245 Art 17(2): 18.240 Art 23: 18.320 Art 25(5): 16.440 Art 27: 16.240

Trust Recoupment Tax Assessment Act 1985: 13.460 Veterans’ Entitlements Act 1986: 6.380 Voluntary Tax Transparency Code: 16.430

NEW SOUTH WALES Companies Act 1936: 14.55 Conveyancing Act 1919 s 144: 13.390 Income Tax (Management) Act 1928 s 11(i): 4.740 s 11(j): 4.740 Income Tax (Management) Act 1941: 19.220 Mining Partnership Act 1900: 14.55

UNITED KINGDOM

Trustee Act 1925: 13.290

Income Tax Act: 12.110

QUEENSLAND

Income Tax Assessment Act 1997 Arts 6 to 21: Art 25:

Trusts Act 1973: 13.290

VICTORIA

UK treaty: 16.230, 16.235, 18.65, 18.220, 18.230, 18.280, 18.320, 18.325 Arts 1 to 5: 16.90 Art 2: 18.225 Art 3(1)(m): 18.230 Art 3(2): 16.100, 16.375 Art 3(3): 16.100 Art 4: , 16.230 Art 4(1): 16.235 Art 4(2): 16.235 Art 4(3): 16.230 Art 5: 18.40, 18.230 Art 5(3)(a): 18.195 Art 6: 18.20, 18.55, 18.60 Arts 6 to 8: 16.240 Arts 6 to 21: 16.90 Art 7: , 16.300, 18.40, 18.55, 18.60, 18.170, 18.185, 18.230, 18.245 Art 7(2): 16.300 Art 7(7): 18.60 Art 8: 18.60, 18.195 Art 8(5)(b): 18.60 Art 9: , 16.300, 16.305, 18.55 Art 9(3): 16.300 Art 10(1): 18.120 Art 10(2): 18.120 Art 10(2)(a): 18.130 Art 10(2)(b): 18.120 Art 10(3): 18.130 Art 10(5): 18.110 Art 10(6): 18.120 Art 10(7): 18.280 Arts 10 to 19: 16.240 Art 11(3)(b): 18.140

Electricity Industry Act 1993: 9.25 Motor Accidents Act 1973: 6.60, 6.75

CANADA Income Tax Act, 1985: 12.110

GERMANY German treaty Art 23: 18.280

UNITED STATES Constitution Art 1: 2.40 Internal Revenue Code 1986 s 111(a): 6.310 US Treasury Regulations reg 62, Art 545(1)(c): 5.770 US treaty: 16.230, 18.65, 18.90, 18.215, 18.315, 18.320 Art 1(3): 18.320 Art 1(4): 18.320 Art 2: 18.225 Art 3(2): 16.100 Art 5(4)(b): 18.195 Art 6: 18.90 Art 7: 18.185, 18.245 Art 8: 18.195 xlv

Income Taxation

Art 26(3): 16.465 Art 26(4): 16.465 Art 27: , 16.465 Art 27(2): 16.465 art 4(4): 16.230

UK treaty — cont Art 11(4): 18.140 Art 11(6): 18.110 Art 11(7): 18.140 Art 11(9): 18.280 Art 12: 16.290, 18.185 Art 12(2): 18.160 Art 12(3): 18.170, 18.195 Art 12(4): 18.110 Art 12(7): 18.280 Art 13: 18.185 Art 13(3): 18.60 Art 13(5): 18.90 Art 13(6): 18.80 Art 14: 18.215, 18.225, 18.260 Art 14(3): 18.60 Art 15: 18.225 Art 16: 18.245, 18.260 Art 16(2): 18.240 Art 17: 16.230, 18.260 Art 18: 18.260 Art 19: 18.260 Art 20: 18.260, 18.270 Art 20(5): 18.280 Art 21: 16.240 Art 22: , 16.240, 18.225 Art 23: 16.90, 16.240 Art 23(3): 18.320 Art 24: 16.90, 16.375 Art 25: 16.450, 18.320 Arts 25 to 27: 16.90 Art 26: Art 26(1): 16.465

TREATIES AND CONVENTIONS Australia–UK treaty: 16.80 Australia–US treaty: 16.80 Model Tax Convention: 18.230 Art 1: 16.370 Art 17: 18.240 Art 23: 16.370 Art 27: 16.440 Protocol: 16.80 Switzerland treaty: 18.280 Taxation Administration Act 1953 Sch 1, Div 263: 16.440 Vienna Convention on the Law of Treaties: 16.80 Art 27: 18.280 Arts 31 to 33: 16.100

FIN Finland 2006 treaty Art 13(5): 18.80 Swiss treaty Art 7: 18.245 Art 17: 18.245

xlvi

TABLE OF RULINGS [Where an extract from a ruling is reproduced, the name of the ruling and its paragraph number appear in bold type.] TR 98/9: 8.100 TR 98/11: 16.300 TR 98/16: 16.300 TR 98/17: 16.140 TR 98/21: 16.370, 18.195 TR 98/22: 11.245 TR 99/6: 4.380 TR 1999/1: 16.300 TR 1999/5: 4.640 TR 1999/6: 2.205, 4.200, 4.205 TR 1999/9: 15.480 TR 1999/16: 3.285, 15.200 TR 1999/17: 5.110 TR 2000/4: 4.560 TR 2000/8: 5.120, 5.190, 20.230 TR 2000/16: 16.300 TR 2001/2: 4.600 TR 2001/7: 4.1220 TR 2001/8: 4.1230 TR 2001/10: 2.175, 4.910, 4.1210, 11.225 TR 2001/11: 16.300 TR 2001/13: 16.105, 18.280 TR 2001/14: 5.190 TR 2002/5: 18.55 TR 2002/14: 3.390 TR 2002/18: 13.395 TR 2003/3: 5.190 TR 2003/4: 5.110, 5.125 TR 2003/6: 4.1230 TR 2003/8: 14.130, 14.300, 15.320 TR 2003/10: 4.1230 TR 2003/13: 4.1120 TR 2004/1: 16.300 TR 2004/6: 19.110 TR 2004/7: 15.200 TR 2004/11: 15.700, 15.710 TR 2004/15: 16.200, 16.210 TR 2004/16: 10.140, 10.150 TR 2004/18: 15.200 TR 2005/1: 5.110, 5.190 TR 2005/7: 13.135 TR 2005/12: 13.155, 13.390, 13.395 TR 2005/16: 19.100 TR 2005/20: 12.720

RULINGS Tax Rulings TR 92/3: 5.390, 5.400, 5.410, 5.415 TR 92/4: 5.410 TR 92/8: 7.640 TR 92/15: 4.370 TR 93/2: 4.180, 4.200 TR 93/6: 11.245 TR 93/11: 11.280 TR 93/12: 18.170 TR 93/15: 12.650, 12.660 TR 93/20 12.360, 12.370 TR 93/25: 5.350 TR 93/26: 5.90 TR 93/30: 8.170 TR 93/38: 4.380 TR 94/8: 13.60, 13.65 TR 94/14: 16.300 TR 94/22: 8.185 TR 94/26: 11.460 TR 94/30: 3.80, 3.90, 3.240, 3.250, 3.255, 15.15 TR 95/6: 5.90, 5.190 TR 95/8: 8.240 TR 95/19: 8.240 TR 95/25: 13.155 TR 95/35: 6.190, 6.200, 6.205 TR 96/14: 15.50 TR 96/20: 11.330 TR 96/26: 4.450 TR 96/27: 4.560 TR 97/5: 11.285 TR 97/7: 11.230, 11.240, 11.505 TR 97/11: 5.90, 5.100, 5.110 TR 97/12: 8.180 TR 97/15: 11.360 TR 97/17: 4.470, 8.210, 8.220 TR 97/20: 16.300 TR 97/25: 10.270 TR 98/1: 11.160, 11.170, 11.175 TR 98/3: 3.50, 3.60, 3.220, 3.230, 3.570 TR 98/7: 12.380, 12.390 TR 98/8: 12.380, 12.400, 12.410

xlvii

Income Taxation

Tax Rulings — cont TR 2006/2: 7.570, 13.590 TR 2006/8: 12.190 TR 2006/10: 19.50 TR 2006/14: 13.445 TR 2007/2: 15.820 TR 2007/6: 5.190 TR 2007/8: 5.120 TR 2007/10: 18.195 TR 2008/1: 3.30, 15.30 TR 2008/2: 5.110 TR 2008/5: 15.50 TR 2008/7: 18.170, 18.185 TR 2008/8: 18.195 TR 2009/2: 4.1170 TR 2009/6: 17.90 TR 2011/6: 10.260, 10.265 TR 2012/5: 14.220, 14.230, 14.530 TR 2013/1: 18.215 TR 2014/6: 16.300 TR 2016/1: 10.190 Draft Tax Rulings TR 2004/D25: 13.490, 13.495 TR 2007/D10: 12.650 Income Tax Rulings IT 1: 19.50 IT 54: 8.185, 8.240 IT 333: 12.360, 12.380 IT 360: 5.190 IT 2026: 4.680, 4.690 IT 2162: 11.550 IT 2170: 3.375 IT 2195: 5.190 IT 2329: 13.460 IT 2350: 12.170, 12.180 IT 2402: 12.190 IT 2405: 6.365 IT 2450: 11.550, 11.580 IT 2483: 15.300 IT 2484: 3.285 IT 2485: 3.385 IT 2494: 3.120 IT 2495: 5.240, 5.770 IT 2500: 19.60 IT 2534: 11.455 IT 2540: 13.250 IT 2550: 5.490 IT 2561: 3.215 IT 2582: 13.155 IT 2604: 11.195 IT 2613: 11.40, 11.240 IT 2614: 4.555 IT 2625: 11.455 IT 2627: 15.170 IT 2631: 5.640, 5.650, 5.660 IT 2648: 11.360 IT 2655: 5.60 IT 2660: 18.170 IT 2675: 4.470, 8.215

Class Rulings CR 2001/1: 19.50 CR 2004/51: 13.540 CR 2004/56: 13.540 CR 2014/90: 15.80 CR 2015/27: 15.80

DETERMINATIONS Tax Determinations TD 2: 3.115 TD 46: 3.565 TD 48: 3.565 TD 92/162: 8.215 TD 93/235: 3.215 TD 93/238: 3.250 TD 94/54: 4.450 TD 95/4: 13.590 TD 1999/34: 4.200 TD 1999/43: 3.390 TD 1999/46: 3.335 TD 1999/55: 3.335 TD 1999/58: 3.335 TD 1999/60: 3.335 TD 1999/61: 3.335 TD 1999/67: 3.390 TD 1999/74: 3.390 TD 2000/10: 15.15 TD 2000/13: 3.390 TD 2000/16: 3.390 TD 2000/27: 15.400 TD 2000/31: 3.105 TD 2000/32: 13.530 TD 2000/33: 3.75 TD 2000/34: 3.105 TD 2000/35: 3.415 TD 2000/36: 3.320 TD 2000/37: 3.325 TD 2000/45: 3.320 TD 2000/50: 15.300 TD 2000/51: 15.300 TD 2001/9: 3.325 TD 2001/26: 13.525 TD 2003/1: 3.30 TD 2003/28: 13.455 TD 2004/3: 13.445 TD 2004/33: 15.710, 15.715 TD 2004/83: 15.715 TD 2004/84: 15.715 TD 2004/85: 15.715 TD 2008/23: 17.60 TD 2008/27: 11.245 TD 2008/32: 12.250 TD 2010/20: 18.280 TD 2011/22: 17.55 TD 2014/1: 15.190 TD 2015/14: 19.110 xlviii

Table of Rulings

ATO Interpretative Decisions ATO ID 1009/135: 13.195 ATO ID 2002/775: 8.240 ATO ID 2011/58: 13.425 ATO Law Administrations Practice Statements PS LA 2003/3: 19.50 PS LA 2003/7: 19.310 PS LA 2003/12: 13.525 PS LA 2008/3: 19.60 PS LA 2008/4: 19.80 PS LA 2011/4: 19.420 PS LA 2011/17: 19.540

SUPERANNUATION Superannuation Guarantee Rulings SGR 2009/2: 19.110

COMMONWEALTH INDIRECT TAXES GST Rulings GSTR 2001/3: 4.600 GSTR 2004/2: 13.65 Product Rulings PR 98/2: 19.50

OTHERS

Miscellaneous Tax Rulings MT 2016: 4.380, 4.390, 4.400 MT 2019: 4.380, 4.390, 4.410 MT 2021: 4.440, 4.450

OTHERS 92/201: 11.195 ID 2009/28: 10.180 LCG 2015/1: 19.50

xlix

INCOME TAX IN CONTEXT 1. Tax Policy and Process ......................................................................... .. 3

PART1

2. Fundamental Principles of the Income Tax System ...................... .. 35

1

CHAPTER 1 Tax Policy and Process [1.10]

1. TRADITIONAL APPROACH TO TAX POLICY....................... ............................. 4

[1.20]

(a) Why Do We Need Taxes? ......................................................................................... 4

[1.30]

(b) Criteria for Judging Tax Systems .............................................................................. 5

[1.60] [1.70] [1.80] [1.100] [1.120]

(c) Alternative Tax Bases ................................................................................................ 7 (i) Income ..................................................................................................................... 8 Henry Simons, Personal Income Taxation: The Definition of Income as a Problem of Fiscal Policy ................................................................................................................ 8 (ii) Consumption ........................................................................................................ 13 (iii) Wealth .................................................................................................................. 14

[1.130] [1.140]

(d) Tax Expenditures ................................................................................................... 14 Reform of the Australian Tax System, Draft White Paper .................................................. 14

[1.160]

2. WELFARE ECONOMICS AND TAX POLICY....................... ............................. 16

[1.170]

(a) Two Theorems of Welfare Economics and Taxes ..................................................... 16

[1.180]

(b) Market Failure ....................................................................................................... 17

[1.190]

(c) Optimal Taxation in a Second-Best World .............................................................. 17

[1.200]

(d) Ramsey Taxes and the Equity–Efficiency Trade-Off ................................................. 18

[1.210]

(e) Haig-Simons Comprehensive Income Revisited ...................................................... 18

[1.220]

(f) Insights and Limitations of Optimal Taxation .......................................................... 19

[1.230]

3. THE HENRY REVIEW ...................................... ................................................ 20

[1.240]

Australia’s Future Tax System, Report to the Treasurer, Pt 1 Ch 2.1 .................................. 20

[1.250]

(a) Progressive Marginal Tax Rates and the Tax-Transfer Unit ....................................... 24

[1.260]

(b) Critique From an Optimal Tax Perspective ............................................................. 25

[1.270]

4. TAX PROCESS........................................... .................................................... 26

[1.280]

(a) Tax Reform and the Democratic Process ................................................................ 26

[1.300]

(b) Constitutional Constraints ..................................................................................... 28

[1.310]

(c) Development of Tax Policy into Legislation ............................................................ 30

[1.320]

(d) Legislation by Press Release ................................................................................... 31

[1.330] [1.340]

(e) Interpretation of Tax Legislation ............................................................................. 33 MLC Ltd v FCT ............................................................................................................. 33

3

Income Tax in Context

1. TRADITIONAL APPROACH TO TAX POLICY It was Alistair who said, on national television, that being a Tax Officer was the most pleasant work imaginable, like turning on a tap to bring water to parched country. It felt wonderful to bring money flowing out of multinational reservoirs into child-care centres and hospitals and social services … He sold taxation as a public good. Peter Carey, The Tax Inspector (Vintage International, 1993, 124) [1.10] It has been traditional to analyse tax policy by first taking the revenue needs of

government as given, then applying criteria of equity, efficiency and simplicity to the tax system and in particular analysing the income tax in terms of the Haig-Simons comprehensive definition of income. This chapter begins with a brief introduction to this method of analysis which was the dominant official (bureaucratic) approach until recently. Much of the public finance literature since the 1970s, however, has departed from this approach and based the analysis of tax and social policy on welfare economics. Accordingly, in the second part of the chapter, we give an introduction to the use of welfare economics for tax policy analysis. The last major tax review, Australia’s Future Tax System (2009), commonly called the Henry Review after the former Secretary of the Treasury Ken Henry who was its chair, applied a mixture of the traditional and modern approach. Major tax reform is contested, difficult and always partial. Australia’s tax system, in particular the income tax which is the main focus of this book, has demonstrated remarkable stability over the last century, while also being the subject of many large and small reforms. Most recently, the Abbott government issued the Re:Think Tax Discussion Paper (March 2015) to start a “national conversation” about tax reform. This goal seems to have been abandoned by the Turnbull government as too politically challenging, although various specific changes are underway to which we refer in later chapters of the book. The chapter concludes with a brief discussion of the process of tax law in Australia: how it is made – the process of putting tax policy into legislation, and how it is interpreted – the process of giving meaning to legislation. Chapter 2 discusses the fundamental concepts that underlie the statutory concept of income. Then the following chapters in Pts 2–6 are a detailed step-by-step analysis of income tax using the various materials available for interpretation. The final step in the tax process – putting legislation into action by the tax administration and taxpayers – is covered in Pt 7 which canvasses the means of dealing with tax avoidance, including a more detailed analysis of interpretation of the legislation.

(a) Why Do We Need Taxes? [1.20] The cost of government is large. The Commonwealth Government estimates

expenditure of about $431 b in the 2016-17 budget, of which 80% is expended directly and about 20% is given to State governments to spend. One justification for the existence of government is to provide public goods. The benefit theory of taxation suggests that we pay taxes in order to fund public goods. The concept of public goods has a long history; for example, Adam Smith, writing 250 years ago, explained public goods as being “in the highest degree advantageous to a great society” but in which no one individual would invest sufficiently and which should be provided for all; for example, Smith included education for children in this category (An Enquiry into the Nature and Causes of the Wealth of Nations (1776) Book V, V.1.69, http://www.econlib.org). In modern economic theory, public goods are those goods and services that either will not be supplied by the market or will be supplied by the market in insufficient quantity. They have two critical 4

[1.10]

Tax Policy and Process

CHAPTER 1

properties. First, it costs nothing for an additional individual to enjoy their benefits. Second, they are non-excludable – it is not possible to exclude anyone from their benefit. National defence is an often cited example. However, today less than 5% of government expenditure in Australia is on defence while about 50% of government expenditure is on health and education which are commonly described as public goods. The other justification for the existence of government and for the raising of taxes is to fund redistribution so as to address economic inequality and poverty. Since the 19th century, redistribution has become a major function of many governments. In Australia, more than one third of Commonwealth government expenditures are on social security and welfare payments including the age pension, family payments, childcare benefits, disability support, Newstart unemployment benefits and youth allowance. These are called “transfer” payments in economic parlance. Governments can finance themselves by a variety of means including commandeering resources from private individuals, creating money, borrowing, user charges or taxation. Adam Smith said that only taxes could provide “That sure, steady, and permanent revenue which can alone give security and dignity to government … defraying the necessary expence of any great and civilized state.” (An Inquiry into the Nature and Causes of Wealth of Nations (1776), Book V, V.2.13, V.2.22, http://www.econlib.org). The size of government has increased massively since Adam Smith’s time, but this statement remains true for most countries today. Taxes account for around 95% of Australian Government revenue. This book focuses on the income tax, which is Australia’s most important tax. Income tax on individuals, companies and other entities generates about 70% of Commonwealth tax receipts and about 60% of all tax revenues in Australia. The income tax has been seen by many as an ideal tax for funding public goods and to achieve the goal of redistribution because payment is based on ability to pay and its rates can be (and almost inevitably are) progressive, so that those with more income pay more in taxes. This was expressed by Attorney General Billy Hughes in his second reading speech on introducing the federal income tax in Australia in 1915 (Hansard, House of Representatives): The Commonwealth has hitherto not resorted to taxation of income but I have always regarded this form of direct taxation as particularly, peculiarly appropriate to the circumstances of a moderate community. Not only as an effective means for raising money for the conduct of government, but serving as an instrument of social reform.

(b) Criteria for Judging Tax Systems [1.30] In traditional policy analysis of taxation, it is usual to take the need for revenue as

given. The focus is on the best way to raise taxes. In order to debate this question it is necessary to have criteria against which to test various tax measures and suggested changes to the tax system. Although there has been discussion of the criteria at least since the time of Adam Smith, in the 1970s it was generally agreed in Australia that the criteria could be reduced to three – equity (fairness), efficiency and simplicity. Equity was seen as having two dimensions: horizontal equity – taxpayers in like situations should be treated alike; and vertical equity – taxpayers in different positions should pay appropriately different amounts of taxes. For example, taxpayers with more income, reflecting greater capacity to pay, would be liable to pay more income tax. Efficiency was essentially interpreted as saying that taxes should not influence individual choices (neutrality). Simplicity means that taxes should be collected with [1.30]

5

Income Tax in Context

the minimum of cost of administration by government, or of compliance by taxpayers. These objectives can obviously conflict and not surprisingly taxation and different, and often controversial, judgments may be made on the trade-offs between them. Surprisingly, there was broad agreement over many years on the general direction of tax reform in Australia – broadening the base of taxes and lowering tax rates. The general idea was that if all income or expenditure was taxed without exclusions or concessions, that produced horizontal equity as well as efficiency and simplicity. In turn, lower tax rates could then produce the same revenue and interfere less with individual choices, contributing to efficiency. Progressive tax rates, especially in the income tax, could be retained to the extent it was desired to differentiate between taxpayers and ensure that taxpayers with more income paid higher income tax, achieving vertical equity. [1.40] There have been several major reviews of the tax system since the 1970s which all

accepted the general tax reform strategy of broadening the base and lowering the rates. In 1975, the Taxation Review Committee presented its Full Report (Asprey Report) (AGPS, Canberra, 1975). Owing to the dismissal of the Whitlam Labor Government in that year, this report never received the full attention of government. Nonetheless the Asprey Report set the tax policy agenda for the following three decades. It proposed a goods and services tax (GST), – called in the Asprey Report a value added tax (VAT); a capital gains tax (CGT); corporate-shareholder imputation; and reform of the taxation of foreign income – to mention some issues which have been current since then. In 1985, the Hawke Labor Government embarked on major tax reform which gave us the fringe benefits tax (FBT), CGT and the imputation system. The debate was commenced by the release of the government’s tax reform options in Reform of the Australian Tax System, Draft White Paper (AGPS, Canberra, 1985). The Draft White Paper proposed broadening the income tax base and introducing a broad-based consumption tax. The latter proposal failed for political reasons at the 1985 Tax Summit but the income tax proposals formed the basis for most of Australia’s tax reform measures in the decade from 1985. At the same time, the base-broadening allowed maximum individual tax rates to decline from around 60% to around 50%. [1.50] In the early 1990s, the Liberal/National Coalition led by John Hewson in Opposition

proposed a major tax reform including a broad based GST and lowering income tax rates (presented in the 630 page Fightback!proposal). The Coalition lost the “unloseable election” and so the package did not proceed. However, led by John Howard, the Coalition won office in 1996 and returned to tax reform in 1998. The Howard government presented in Tax Reform – Not a New Tax, a New Tax System (AGPS, Canberra, 1998) its plans to introduce a GST to deal with federal–State financial relations by passing the revenue from the tax to the States, lowering personal income tax rates and reforming the business income tax. The GST was introduced in 1999 at a rate of 10%, with all revenues going to the States, income tax rates were lowered and family welfare benefits were significantly increased. [1.55] The Howard Coalition government also commenced a Review of Business Taxation

which produced the report, A Tax System Redesigned (AGPS, Canberra, 1999). This report proposed company tax base-broadening changes which were immediately adopted including the abolition of accelerated depreciation so as to fund cutting the company tax rate. It also abolished indexation for CGT and introduced the 50% CGT discount for individuals. Other changes that were proposed and apparently accepted by the government were never enacted, 6

[1.40]

Tax Policy and Process

CHAPTER 1

including a new method of calculating taxable income (the tax value method) and a unified entity tax regime under which, in particular, trusts would be taxed the same way as companies. The tax value method did not proceed because it did not change very much at a substantive level while requiring an entire rewrite of the income tax law and administration systems, while the unified entity regime would have taken away the effectively transparent taxation that trusts achieved for small and privately owned businesses. However, the recommended tax regime for consolidation of corporate groups was introduced in 2002 (see Chapter 15) and changes were made to taxation of financial arrangements (see mainly Chapter 12 and Chapter 14), which took full effect only in 2010.

(c) Alternative Tax Bases [1.60] The three major tax bases available to governments in modern times are income,

consumption and wealth (which are closely related, as we shall see). Most taxes can be classified into one or other of these tax bases. In each case the tax base can be broader or narrower, and tax can be levied on the base in varying ways. No developed country relies on a single tax base to raise government revenue. The combination of taxes is sometimes called the “tax mix”. However, the emphasis on certain bases or types of tax is greater in some countries than in others. Recent tax reform debates in Australia have focused on the balance between income and consumption taxes. It has been argued that, compared with its principal trading partners, Australia relies excessively on the income tax as its major tax base (see, for example, Re:Think Discussion Paper, Treasury, 2015). Comparing tax statistics in different countries is, at best, a risky business. The first problem arises from the different federal systems in various jurisdictions, as the example of income taxation illustrates well. In Australia, a single income tax is levied at the Commonwealth level. In other federal jurisdictions, there are often separate federal and State (or provincial) income taxes. Sometimes, as is the case in the United States, taxpayers may receive a third income tax assessment from their city or municipality. How then does one compare the level or rates of Australian income tax with those of the United States – by looking at United States and Australian federal income taxes only; or by looking at federal, State and municipal income tax in the United States and federal income taxes in Australia? A second problem is the use of different instruments with the same economic effect where one instrument is classified as a tax while the other is not. While at first glance, Australia’s reliance on the income tax appears to be relatively higher than that of other comparable countries, Australia’s income tax is used to fund programs paid for by social security taxes on wages in many other countries. Once these are taken into account, Australia drops towards the bottom in the OECD in terms of reliance on income and social security taxes relative to other forms of taxes. Even this adjustment is misleading, however, as Australia funds an increasingly large amount of retirement income out of superannuation funds. In other countries, retirement pensions are mainly funded out of social security. The superannuation guarantee means that most superannuation saving is compulsory in Australia (as are social security taxes overseas) but contributions to superannuation funds are not treated as taxes in standard OECD revenue statistics A third source of difficulty in comparing tax systems relates to tax expenditures, which are tax concessions that are functionally equivalent to government expenditures (effectively, the government collects the tax and pays out amounts by way of grants to the activity or taxpayer [1.60]

7

Income Tax in Context

that benefits from the concession). There is no internationally agreed method for comparing tax expenditures across countries. Without adjusting tax revenues for tax expenditures, comparisons of tax revenue will miss differences in the tax base, arising where one country taxes and spends revenue on particular activities while other countries use tax expenditures to the same end. (i) Income [1.70] The best-known articulation of the income concept in English is by Henry Simons. The

definition of income in Simons’ analysis is often referred to as the Haig-Simons “comprehensive income” tax base.

Henry Simons, Personal Income Taxation: The Definition of Income as a Problem of Fiscal Policy [1.80] Henry Simons, Personal Income Taxation: The Definition of Income as a Problem of Fiscal Policy, University of Chicago Press, Chicago, 1938 [at pp 49–57, 105–106, 122–124, 150–151, 153] Personal income connotes, broadly, the exercise of control over the use of society’s scarce resources. It has to do not with sensations, services, or goods but rather with rights which command prices (or to which prices may be imputed). Its calculation implies estimate: (a) of the amount by which the value of a person’s store of property rights would have increased, as between the beginning and end of the period, if he had consumed (destroyed) nothing, or (b) of the value of rights which he might have exercised in consumption without altering the value of his store of rights. In other words, it implies estimate of consumption and accumulation. Consumption as a quantity denotes the value of rights exercised in a certain way (in destruction of economic goods); accumulation denotes the change in ownership of valuable rights as between the beginning and end of a period.

happen in subsequent periods. All data for the measurement would be found, ideally, within the period analysed.

The relation of the income concept to the specified time interval is fundamental – and neglect of this crucial relation has been responsible for much confusion in the relevant literature. The measurement of income implies allocation of consumption and accumulation to specified periods. In a sense, it implies the possibility of measuring the results of individual participation in economic relations for an assigned interval and without regard for anything which happened before the beginning of that (before the end of the previous) interval or for what may

This position, if tenable, must suggest the folly of describing income as a flow and, more emphatically, of regarding it as a quantity of goods, services, receipts, fruits, etc. To conceive of income in terms of things is to invite all the confusion of the elementary student in accounting who insists upon identifying “surplus” and “cash”. If one views society as a kind of giant partnership, one may conceive of a person’s income as the sum of his withdrawals (consumption) and the change in the value of his equity or interest in the enterprise. The essential

8

[1.70]

Personal income may be defined as the algebraic sum of (1) the market value of rights exercised in consumption and (2) the change in the value of the store of property rights between the beginning and end of the period in question. In other words, it is merely the result obtained by adding consumption during the period to “wealth” at the end of the period and then subtracting “wealth” at the beginning. The sine qua non of income is gain, as our courts have recognised in their more lucid moments – and gain to someone during a specified time interval. Moreover, this gain may be measured and defined most easily by positing a dual objective or purpose, consumption and accumulation, each of which may be estimated in a common unit by appeal to market prices.

Tax Policy and Process

CHAPTER 1

Henry Simons, Personal Income Taxation: cont.

income vary with considerable regularity, from one income class to the next, along the income scale.

connotation of income, to repeat, is gain – gain to someone during a specified period and measured according to objective market standards. Let us now note some of the more obvious limitations and ambiguities of this conception of income.

A similar difficulty arises with reference to receipts in the form of compensation in kind. Let us consider here another of Kleinwachter’s conundrums. We are asked to measure the relative income of an ordinary officer servicing with his troops and a flugeladjutant [a military officer] to the sovereign. Both receive the same nominal pay; but the latter receives quarters in the palace, food at the royal table, servants, and horses for sport. He accompanies the prince to theatre and opera, and, in general, lives royally at no expense to himself and is able to save generously from his salary. But suppose, as one possible complication, that the flugeladjutant detests opera and hunting.

In the first place, it raises the unanswerable question as to where or how a line may be drawn between what is and what is not economic activity. If a man raises vegetables in his garden, it seems clearly appropriate to include the value of the product in measuring his income. If he raises flower and shrubs, the case is less clear. If he shaves himself, it is difficult to argue that the value of the shaves must also be accounted for. Most economists recognise housewives’ services as an important item of income. So they are, perhaps; but what becomes of this view as one proceeds to extreme cases? Do families have larger incomes because parents give competent instruction to children instead of paying for institutional training? Does a doctor or an apothecary have relatively large income in years when his family requires and receives an extraordinary amount of his own professional services? Kleinwachter suggests that the poorest families might be shown to have substantial incomes if one went far in accounting for instruction, nursing, cooking, maid service, and other things which the upper classes obtain by purchase. A little reflection along these lines suggests that leisure is itself a major item of consumption; that income per hour of leisure, beyond a certain minimum, might well be imputed to persons according to what they might earn per hour if otherwise engaged. Of course, it is one thing to note that such procedure is appropriate in principle and quite another to propose that it be applied. Such considerations do suggest, however, that the neglect of “earned income in kind” may be substantially offset, for comparative purposes (for measurement of relative incomes), if leisure income is also neglected. For income taxation it is important that these elements of

The problem is clearly hopeless. To neglect all compensation in kind is obviously inappropriate. On the other hand, to include the perquisites as a major addition to the salary implies that all income should be measured with regard for the relative pleasurableness of different activities – which would be the negation of measurement. There is hardly more reason for imputing additional income to the flugeladjutant on account of his luxurious wardrobe than for bringing into account the prestige and social distinction of a (German) university professor. Fortunately, however, such difficulties in satisfactory measurement of relative incomes do not bulk large in modern times; and, again, these elements of unmeasurable psychic income may be presumed to vary in a somewhat continuous manner along the income scale. If difficulties arise in determining what positive items shall be included in calculations of income (in measuring consumption), they are hardly less serious than those involved in determining and defining appropriate deductions. At the outset there appears the necessity of distinguishing between consumption and expense; and here one finds inescapable the unwelcome criterion of intention. A thoroughly precise and objective distinction is inconceivable. Given items will represent business expense in one instance and merely consumption in another, and often the motives will be quite mixed. A commercial artist buys paints and brushes to use in making his living. Another person may buy the same articles [1.80]

9

Income Tax in Context

Henry Simons, Personal Income Taxation: cont.

as playthings for his children, or to cultivate a hobby of his own. Even the professional artist may use some of his material for things he intends or hopes to sell, and some on work done purely for his own pleasure. In another instance, moreover, the same items may represent investment in training for earning activity later on. The latter instance suggests that there is something quite arbitrary even about the distinction between consumption and accumulation. On the face of it, this is not important for the definition of income; but it must be remembered that accumulation or investment provides a basis for expense deductions in the future, while consumption does not. The distinction in question can be made somewhat definite if one adopts the drastic expedient of treating all outlays for augmenting personal earning capacity as consumption. This expedient has little more than empty, formal, legalistic justification. On the other hand, one does well to accept, here as elsewhere a loss of relevance or adequacy as the necessary cost of an essential definiteness. It would require some temerity to propose recognition of depreciation or depletion in the measurement of personalservice incomes – if only because the determination of the base, upon which to apply depreciation rates, presents a simply fantastic problem. It is better simply to recognise the limitations of measurable personal income for purposes of certain comparisons (for example, by granting special credits to personal-service incomes under income taxes). Our definition of income may also be criticised on the ground that it ignores the patent instability of the monetary numeraire [the currency], and it may also be maintained that there is no rigorous, objective method either of measuring or of allowing for this instability. No serious difficulty is involved here for the measurement of consumption – which presumably must be measured in terms of prices at the time goods and services are actually acquired or consumed. In periods of changing price levels, comparisons 10

[1.80]

of incomes would be partially vitiated as between persons who distributed consumption outlays differently over the year. Such difficulties are negligible, however, as against those involved in the measurement of accumulation. This element of annual income would be grossly misrepresented if the price level changed markedly during the year. These limitations of the income concept are real and inescapable; but it must suffice here merely to point them out … Another difficulty with the income concept has to do with the whole problem of valuation. The precise objective measurement of income implies the existence of perfect markets from which one, after ascertaining quantities, may obtain the prices necessary for routine valuation of all possible inventories of commodities, services, and property rights. In actuality there are few approximately perfect markets and few collections of goods or properties which can be valued accurately by recourse to market prices. Thus, every calculation of income depends upon “constructive valuation”, that is, upon highly conjectural estimates made, at best, by persons of wide information and sound judgment: and the results of such calculations have objective validity only in so far as the meager objective market data provide limits beyond which errors of estimates of income, especially upon problems centering around the “realisation criterion”. Our definition of income perhaps does violence to traditional usage in specifying impliedly a calculation which would include gratuitous receipts. To exclude gifts, inheritances, and bequests, however, would be to introduce additional arbitrary distinctions; it would be necessary to distinguish among an individual’s receipts according to the intentions of second parties. Gratuities denote transfers not in the form of exchange – receipts not in the form of “consideration” for something “paid” by the recipient. Here, again, no objective test would be available; and, if the distinctions may be avoided, the income concept will thus be left more precise and more definite … Since the devices of accounting and tax legislation contemplate only very rough approximation to income, it is decisively important to see behind these methods of calculation an ideal income, calculable by

Tax Policy and Process

Henry Simons, Personal Income Taxation: cont.

different and less practicable methods. Only on the basis of some broader conception is it possible to criticize and evaluate merely practicable procedures and to consider fruitfully the problem of bettering the system of presumptions. Indeed, if there be any excuse for a treatise like this, it must lie in the importance of maintaining some broad – and perhaps quite impractical – conception in terms of which existing and proposed practices in income taxation may be examined, tested, and criticized. … Indeed, it may be regarded as a sort of thesis that income, as already described, is essentially identical with that base on which it would be most nearly equitable to levy upon individuals … [W]hen property is employed directly in consumption uses, there is the strongest case for recognising an addition to taxable income. This is widely recognised in criticism of our federal tax for its egregious discrimination between renters and homeowners, and perhaps more strikingly in the almost consistently different practice among income taxes abroad … Receipts in kind may also take the form of compensation for services rendered. Our federal law provides for inclusion of compensation of whatever kind and in whatever form paid … The courts and the treasury distinguish strangely between cases where the taxpayer effects a saving but receives no income and those where the perquisites may be regarded as additional compensation. In England perquisites are taxable as income only in cases where the taxpayer is free to convert them into cash. Such arbitrary rules do invite caustic criticism. Anyone who condemns them hastily, however, will be placed in a most awkward position by a request for constructive proposals. There is here an essential and insuperable difficulty, even in principle. The problem of Kleinwachter’s flugeladjutant is insoluble and certainly is not amenable to reasonable solution on the basis of simple rules which could be administered by revenue agents. Obviously there are many instances where taxpayers are too favorably treated. The sporting-goods salesman, who lives

CHAPTER 1

at the best hotels and clubs and spends much time entertaining good customers “on the company”, might well be taxed on something more than his salary – providing he doesn’t dislike such life, as the flugeladjutant did the operas! Yet, after all, these are merely one kind of perquisite. Other positions may be equally attractive, at the same nominal salary, for prestige, freedom, leisure, or what not. And one must surely hesitate to propose graduation under income taxes according to the pleasurableness of people’s occupations. The taxation of compensation in kind, under our own law, presents another instance of clear discrimination against recipients of personalservice incomes. If one obtains use of one’s residence as part of one’s salary, the rental value must be included for income tax. On the other had, a neighbour, obtaining use of an identical house by virtue of ownership in fee, is quite exempt so far as concerns this item … It does seem thoroughly unsound, as a matter of definition, to set up a category of capital profits outside (or even within) the income concept. Although no satisfactory line can be drawn between these and other gains, and although any separation violates the underlying principle of income taxation, still it is not surprising that an issue should be found here. The case of capital gains reveals most strikingly those shortcomings of income tax which arise from instability of the numeraire. Moreover, such speculative profits invite special attention because of their peculiarly unstable, irregular, and fortuitous character. The irregularity of personal income presents a real problem for equitable taxation and one of special relevance here. Any tax graduated according to income for single years must impose undue burden upon persons with widely fluctuating incomes. Where the fluctuation arises from windfalls and gratuities, the discrimination may be unobjectionable, for heavy levies upon such receipts are generally approved. The same feeling as to capital gains is, however, surely less common, for they have at some flavor of “earnings”. Besides, losses fluctuate as well as gains, thus aggravating the situation. To eliminate both capital gains and losses in computing taxable income, however, would simply prohibit fairness in relative levies among [1.80]

11

Income Tax in Context

Henry Simons, Personal Income Taxation: cont.

persons. To do this, or even to make the more moderate concessions of our federal law, is to undermine the very basis of income taxation … The case in favor of some allowance for the irregularity of taxable income, however, is strong, for prevailing methods of measurement do

[1.85]

aggravate the inequities. The real culprit here is the realisation criterion. Gains and losses from capital transactions are recognised only when the investor “gets out”. One may complain of this practice; but to demand that it be abandoned outright is to display little regard for practical considerations. Escape from it is possible in the case of actively traded securities; but, unfortunately, the realisation criterion must be accepted as a practical necessity.

Questions

1.1

What according to Simons is the relationship between income, consumption and wealth? Can it be argued that a tax system with an income tax, a consumption tax and a wealth tax is taxing the same matter three times over?

1.2

Why is it necessary to choose a period over which to measure income? Would it be possible to operate a system that measures income over a lifetime rather than a year? Is lifetime income a better measure of ability to pay tax than income over one year? (Compare the lifecycle income of a professional sportsperson or a rock star with that of a public servant.)

1.3

Would Simons tax income as it accrues or when it is realised? For example, if a taxpayer buys an asset, holds it for more than a year and sells it at a profit, would the profit be taxed year by year over the period the asset was held as it increased in value, or would the profit only be taxed in the year when the asset is sold?

1.4

Would Simons tax as income benefits in kind from employment and, if so, how would those benefits be valued? Would Simons tax imputed income, for example, the imputed rent an owner-occupier of a house obtains? If imputed rent is taxed, how would expenses relating to the property like mortgage interest, rates, repairs and insurance be treated? Australia in fact taxed imputed rent under income tax from 1916 to 1923. Why do you think this tax was abandoned? Would Simons tax potential income? Take, for example, the case of a person who chooses to work for only three days a week when he can get full-time work, and spends the rest of the week surfing. Should he be taxed on the amount he would have earned if he worked for five (or seven) days a week, rather than the amount actually received for three days’ work?

1.5

1.6

1.7

Simons would levy tax on the basis of net gain rather than gross receipts, that is, receipts are reduced by the costs of earning income. How are costs of earning income and personal consumption expenses to be distinguished?

[1.90] As we shall see throughout this book, the concept of comprehensive income has been

influential in Australia so far as legislative changes to the income tax are concerned, although it has not had any marked impact on the judicial concept of income. When considering the Australian statute and case law in the rest of this book, you should ask yourself two questions. (1)

12

To what extent does Australian law reflect the concept of income elaborated by Simons? [1.85]

Tax Policy and Process

CHAPTER 1

(2)

Where the law departs from Simons’ concept, is the explanation that the law is bad, or that the concept is flawed as a theoretical or practical guide for taxing income? Schedular systems of taxing income are often contrasted to Simons’ comprehensive concept. Under a schedular system, income is divided into categories and each category is taxed separately. Deductions against one category of income are not usually allowed against other categories of income. As will become apparent in the various English cases you will read in this book, the UK system is schedular in origin, although the actual “Schedules” of income that historically existed in the UK tax statute are no longer there. Australia’s system on the other hand, like that of the United States, is apparently comprehensive or “global” in its drafting of the concept of income but not necessarily in operation. In origin, the UK schedular system had to do with preventing tax officials knowing the full extent of any taxpayer’s income (as each schedule was separately administered). It has been maintained not only out of the British respect for tradition and privacy, but also because it prevents tax planning based on using (artificial) deductions against one category of income being used against another. For example, the UK system does not have the same issue that is often discussed in Australia of current interest deductions on money borrowed to finance an investment that exceed the income from the investment being used against employment or business income of an individual taxpayer (so-called negative gearing). (ii) Consumption [1.100] Consumption taxes are generally levied as indirect taxes on businesses which are

passed on to consumers in the price of goods and services supplied – in Australia, the Goods and Services Tax (GST) is a consumption tax of this kind. These taxes are referred to as “indirect” because they are levied on the intermediary (though they could equally be levied as a matter of law on the consumer and collected from business like withholding of income tax on wages). The arguments in favour of indirect consumption taxes generally focus on perceived benefits in terms of complexity, avoidance, evasion and political acceptance. They are generally regarded as problematic in terms of vertical equity (fairness) as they usually have a flat rate and do not tax saving. Economic arguments in favour of indirect consumption taxes focus on horizontal equity and efficiency. During the 1970s and 1980s there was a lot of academic and some policy attention paid to the design of a personal or direct consumption, or expenditure tax. This tax would be levied like income tax directly on the individual rather than indirectly on businesses. Using the relationship between income and consumption noted by Simons, the tax base could be calculated as the individual’s income minus savings in a period. Another way of achieving a similar result is to exempt income derived from capital from tax (a so-called wage tax). For an analysis of consumption taxes see Head, “Alternative tax instruments and tax reform strategies” (1984) 1 Australian Tax Forum 16. [1.110] No country has yet enacted a direct consumption or expenditure tax. . However,

Australia’s income tax is sometimes described as a “hybrid” income-consumption tax because it taxes some forms of saving or capital lightly. In addition, Australia has long had various forms of indirect consumption tax. Until 1998, proposals to enact a broad-based consumption tax by both Labor (in the 1985 Draft White Paper) and the Hewson-led Liberal-National Coalition (in Fightback!) failed to garner support. In 1998, the Howard Government fought and (just) won its second term election giving it a mandate to introduce the GST. However, the GST reform package did not contain such a significant switch in the tax mix from income tax [1.110]

13

Income Tax in Context

to consumption tax as had originally been proposed. The GST was introduced at a rate of 10% with many exemptions in the base and the reform package was replete with compensation measures. The GST commenced on 1 July 2000 (see Cooper and Vann, “Implementing the Goods and Services Tax” (1999) 23 Sydney Law Review 337-436). Today, the GST is Australia’s second most important tax. (iii) Wealth [1.120] Wealth taxes (annual levies on a taxpayer’s wealth) or wealth transfer taxes (taxes on

the transfer of wealth by gift or will) have until very recently played a role in the tax bases of every developed country except two, Australia and Canada. Wealth taxes can be narrowly based (such as land taxes) or broadly based on total wealth; they can be annual levies based on wealth holdings or periodic levies on wealth transfers (such as estate and gift duties). Until the late 1970s Australia had, at the Commonwealth and State levels, a comprehensive system of gift and estate duties. In the mid-1970s the Asprey Report commended the gift and estate taxes as an integral part of the Australian tax system and made detailed proposals to overcome many of the problems in levying the taxes effectively. However, as chronicled by Willard Pedrick in “Oh, to Die Down Under! Abolition of Death and Gift Duties in Australia” (1982) 14 UWALR 438, tax competition between the States and political events at the federal government level led to the demise of these taxes not long after the release of the Asprey Committee’s final report. In recent years, many countries have found it increasingly difficult, whether politically or practically, to retain significant taxation of wealth. The problems of taxing wealth mean that other proposed reforms of the tax system (eg introducing a progressive consumption tax) may not be achievable if they are be premised on the existence of effective wealth taxes. We do not consider wealth taxes further in this book. A good review of the arguments for such taxes and the ways in which they can be constructed is found in Groenewegen, “Options for the Taxation of Wealth” (1985) 2 Australian Tax Forum 305.

(d) Tax Expenditures [1.130] The tax system serves a large number of functions in Australia. For example, it clearly influences behaviour, and the government often utilises this feature of the system to pursue a host of social and economic policy objectives. This phenomenon was noted in the 1985 tax reform debate.

Reform of the Australian Tax System, Draft White Paper [1.140] Reform of the Australian Tax System, Draft White Paper, AGPS, Canberra, 1985 Need to review Government spending programs in tax system 1.14

14

Equity, efficiency and simplicity are criteria that are used to evaluate technical tax provisions. In addition to technical provisions, however, the tax act contains a number of provisions that are functionally equivalent to direct spending programs. [1.120]

1.15

These tax concessions, or tax expenditures as they are sometimes termed, were placed in the act to deliberately influence private decisions and the allocation of resources in favour of particular sectors. A proper assessment of such concessions depends both on whether their resource allocation effects have net benefits for the Australian economy and on whether the tax system is the best method of delivering

Tax Policy and Process

receive the same amount, nontaxpayers – usually low-income individuals – will be excluded from the program.

Draft White Paper cont.

the assistance implicit in them. Judgments on the first point need to be reached on a case-by-case basis, but some general comments can be made about the use of the tax system to deliver government subsidies. 1.16

Once the need for any program of government assistance has been demonstrated, the question becomes what policy instrument should the government use in achieving the program’s objectives? The government has a wide range of possible instruments available to it such as grants, loans, guarantees, interest subsidies, regulation, the use of public institutions and tax concessions. Most of the criteria normally used in selecting the appropriate instrument would suggest that while tax concessions may sometimes be the most appropriate instrument, they should be used sparingly. • Equity – If the tax concession is structured as an exclusion or deduction from income it will be of greatest benefit to taxpayers with high marginal rates. Even if it is structured as a tax rebate so that all qualifying taxpayers

CHAPTER 1

Because tax • Controllability – concessions must necessarily be openended – available to any taxpayer who meets the eligibility requirements – once they are enacted the government generally has no way of controlling the public money spent through them. Consequently, tax concessions can end up costing the government more than anticipated and more than the government, in setting its spending priorities, had intended to spend in encouraging the particular activity or industry. • Accountability – Tax concessions are less visible than direct outlays and may therefore be subject to less public scrutiny. 1.17

Tax expenditures can be less efficient than direct outlays in targeting intended beneficiaries and ensuring their administration, including the control of abuse, by the most appropriate area of the bureaucracy. They also increase the complexity of the tax system and can contribute to the belief that the system is unfair.

[1.150] To calculate the budget cost, let alone the effectiveness, of such measures is not an

easy matter. The Treasury attempts to measure cost in its annual publication, the Tax Expenditures Statement.The Treasury explains that “a tax expenditure arises where the actual tax treatment of an activity or class of taxpayer differs from the benchmark tax treatment” (Tax Expenditures Statement 2015, Chapter 1). The estimate of revenue foregone by a particular measure is determined by measurement against the benchmark, holding all else in the system constant. The list of tax expenditures that this methodology throws up is extensive (the Tax Expenditures Statement 2015 reports 290 tax expenditures) and the measures arise in virtually all policy areas of government. As an estimate of revenue foregone, tax expenditures cannot be summed together as they are estimated on the basis that each exists independently, holding the remaining tax system constant. For the income tax, the tax expenditure benchmark is close to the Haig-Simons comprehensive definition of income (which is an explicit recognition of the underlying policy which Treasury regards as being incorporated in the income tax). Against this comprehensive income benchmark but ignoring imputed rent from living in your own home, the largest estimated tax expenditure in the income tax is the exemption from CGT of a taxpayer’s main residence (about $50 b revenue foregone in 2015-16). The second largest is the concessional [1.150]

15

Income Tax in Context

tax treatment of superannuation savings (about $30 b revenue foregone in 2015-16). For the GST, the benchmark is a broad-based consumption tax that applies to most goods and services. Against this benchmark, the next largest estimated tax expenditure is the exemption of food from the GST (revenue foregone of $6.8 b in 2015-16). When tax reform is in the air and there is talk of broadening the tax base and lowering tax rates, the estimates of tax expenditures assume particular significance as they identify candidates for base broadening. For example, the revenue estimates in the 1998 business tax reform were significantly based on eliminating accelerated depreciation so as to fund the reduction of the company tax rate from 36% to 30% (Review of Business Taxation, A Tax System Redesigned, pp 28-31). Accelerated depreciation has crept back into the system since that reform but the Tax Expenditure Statement 2015 states that it is unable to estimate revenue foregone from “caps” on depreciation as “unquantifiable” (but potentially large).

2. WELFARE ECONOMICS AND TAX POLICY [1.160] In recent years much attention has been given by economists to the application of

welfare economics to tax policy questions.1 This work started in the 1970s. Drawing on developments in the economics of information, the new models recognised from the outset that a government cannot tax what it cannot observe, and therefore cannot tax income comprehensively. For example, it is usually not possible to observe an individual’s gain from activities outside the market place. The tax literature of the 1970s instead showed that, without full information, it was necessary for governments to levy differential taxation and take account of behavioural responses of individuals to this differential taxation in deriving rules for an ideal tax system. This result led to the rejection of the Haig-Simons approach in public economics.

(a) Two Theorems of Welfare Economics and Taxes [1.170] Welfare economics starts with the question of why we need taxes, or more

fundamentally why we need government. The key to the answer is provided by what are referred to as the two fundamental theorems of welfare economics. The first theorem states that under certain conditions, competitive markets lead to an allocation of resources in which there is no change in the allocation that can make someone better off without making someone else worse off. This is called a Pareto efficient allocation. This does not mean that there is only one distribution of resources among individuals that is Pareto efficient; there are a number of such possible distributions. The second theorem states that every Pareto efficient allocation of resources can be attained by a competitive economy, provided we begin with a particular distribution of resources among individuals. Hence by taking resources from one individual and giving them to another, it is still possible to have a Pareto efficient outcome. This has the important consequence that if we do not like the distribution of income generated by a competitive market economy, the government can carry out a redistribution and we need not abandon the use of the competitive price mechanism. If the ideal conditions for the first and second welfare theorems hold, then government has the simple but important role of setting lump sum taxes on individuals to achieve the socially 1

16

We are indebted to Professor Patricia Apps for most of this section, which is extracted and summarised from unpublished material written by her. [1.160]

Tax Policy and Process

CHAPTER 1

desired distribution of income. This is known as the “first-best” solution to the tax problem. A lump sum tax does not distort competitive prices by making one kind of goods relatively more or less expensive than another. Lump sum taxes change behaviour in one way only, called an “income effect”. Those individuals whose incomes fall under application of the redistributive tax will reduce at least some of their purchases and those whose income rises as a result of redistribution, will increase them. But the outcome is still Pareto efficient. In contrast to a lump sum tax, a differential tax (most taxes in reality) does distort prices. For example, if a tax is levied on one particular kind of good but not on other goods, this will increase the price of the taxed good. This tax produces both an “income effect” and a “substitution effect” on behaviour of individuals. The substitution effect is a behavioural response to the fall in the relative price of the untaxed goods. The individual in the presence of the differential tax is likely to buy less of the taxed goods and will substitute a purchase of more of the untaxed goods than otherwise would be the case. This contrasts to the lump sum tax, where the individual buys less goods in total but does not change the mix of the goods purchased. This outcome of the differential tax is not Pareto efficient. The resulting efficiency loss is referred to as the deadweight loss or excess burden of the tax. It is measured by the difference between the amount of tax that an equivalent lump sum tax would produce and the lesser amount that the differential tax produces. An equivalent lump sum tax is one that leaves the individual at the same level of wellbeing as the differential tax (but with a different mix of goods purchased). The deadweight loss is entirely due to the substitution effect.

(b) Market Failure [1.180] There are many assumptions required for the ideal competitive market which

underlies the two theorems of welfare economics such as perfect information, no collusion between firms in setting prices and no risks of adverse events for which full insurance is not available at fair premiums. The assumptions cannot be achieved in the real world. This does not mean the formulation of a competitive model is a pointless exercise. The competitive model, and the assumptions on which it is constructed, provide the theoretical framework for defining market failure as the rationale for government intervention in almost all areas of the economy. The literature on different types of market failure is vast and is not covered here. It provides the economic justification for many of the activities undertaken by governments today, including the provision of public goods and the levying of particular kinds of taxes, such as taxes on pollution, tobacco or road congestion, sometimes called Pigouvian taxes.

(c) Optimal Taxation in a Second-Best World [1.190] Optimal tax models assume that the pre-tax economy satisfied all the conditions

necessary for Pareto efficiency, that society has well-defined preferences regarding the distribution of individual welfares and that lump sum taxes cannot be used to achieve that distribution. The innovative step was to combine distributional concerns with recognition that lump sum taxes are not possible, so that the second theorem of welfare economics does not hold. It was recognised that lump sum taxes were not feasible because individual endowments cannot be directly observed due to an information asymmetry. The government does not know the endowment (or potential income) of each individual, and is therefore limited to taxing proxies or surrogate measures of endowment. Examples of such proxies are the individual’s [1.190]

17

Income Tax in Context

observed income from work in the market place or their expenditure on market consumption goods. In both cases, the gains from time allocated to activities outside the market or household production are untaxed. Taxes on proxies imply differential taxation, which distorts relative prices. A tax on wage income reduces the net wage and therefore the implicit price of non-market activities. A tax on market consumption raises the price of market goods relative to that of goods or services produced outside the market. Given that the policy instrument for a first-best solution is not available, the aim of optimal tax theory has been to derive rules for tax design in a second-best setting. The literature of the 1970s combined, in a formal model, the government’s concern for redistribution taking account of efficiency loss due to differential taxation.

(d) Ramsey Taxes and the Equity–Efficiency Trade-Off [1.200] Much earlier, in 1927, Frank Ramsey presented an analysis of the tax problem for an

economy in which he assumed that all individuals were identical. He asked the question: what taxes should the government impose on different commodities, assuming it could not levy lump sum taxes? In other words, what is the least distortionary pattern of tax rates? Should, for instance, every commodity be taxed at the same rate in order to minimise distortions, as was widely believed at the time? Ramsey not only showed that this was wrong, but also derived a formula for the optimal rate of tax on each commodity. Differential taxes that minimise the excess burden are now called Ramsey taxes. Ramsey’s basic insight was to observe that commodities with a low elasticity of demand (that is, commodities for which the demand does not change greatly with the price) have a lower deadweight loss and thus should face higher tax rates. A disturbing feature of this result is that it suggests that high tax rates should be imposed on commodities with low price elasticities, such as food, with the result that the poor will bear a larger burden than the rich. The approach was thus largely dismissed when it was published. The approach was, however, accepted in the 1970s because the new models extended Ramsey’s original analysis to include redistributive goals. Where only indirect taxation is feasible, the extent to which one chooses between taxing necessities that are inelastic, as opposed to luxuries that are elastic, depends on the concern for income distribution. Optimal tax theory shows that the optimal policy, on the one hand, minimises the efficiency cost of achieving a particular distributional outcome and, on the other, attains the outcome which appropriately balances the social gain from redistributing income against the social cost of using distortionary taxes. This balancing of the social gain against the social loss at the optimum is the equity–efficiency trade-off. The optimal point is where the marginal social gain from the government giving an extra dollar to an individual is just equal to the marginal social loss caused by raising an additional dollar of tax revenue.

(e) Haig-Simons Comprehensive Income Revisited [1.210] A central motivation of Simons’ treatise was to find an ideal measure of income as a

reference for identifying shortcomings in the tax policy and law of the time. In common with the optimal tax theorists, Simons was concerned with redistribution and he recognised that an ideal measure of income could not be taxed in practice. He identified many of the same information problems that are of concern in optimal tax theory. In discussing inevitable exclusions from the tax base, he acknowledged that gains from the allocation of time to leisure and home production cannot be taxed. In economics, the gain from the allocation of time to 18

[1.200]

Tax Policy and Process

CHAPTER 1

both market and non-market activity is defined as full income, computed as the product of the wage and total time available where the wage measures earning power. Optimal tax models which assume that only wage income and/or consumption can be taxed, derive results for optimal tax rates taking account of the disincentive effect of not taxing the gains from non-market time. From this perspective, the Haig-Simons approach is internally inconsistent because Simons ignores disincentive effects. For the income tax, the relevant elasticity is about a decision to work in the market or the household (in traditional literature called the work-leisure choice) and the levying of a tax on (market) work may be a disincentive to do that work. Although Simons recognised that it was not possible to tax a comprehensive measure of income, he recommended that “practices in income taxation” be “examined, tested and criticised” in terms of departures from such a measure. Thus he ruled out the possibility of a gain in social welfare from not taxing a particular source of income, which is contrary to the Ramsey insight in relation to differential taxation. It could turn out to be true that, ideally, the income tax base should be as broad as possible, but this is not the point. The optimal tax base and rate scale can be determined only on the basis of empirical evidence on behavioural responses of individuals to differential taxation. In regard to neglected sources of gain, such as “earned income in kind” and “leisure”, it is interesting to note Simons’ comment that that these “vary with considerable regularity from one income class to the next, along the income scale”. In making this point, Simons is concerned here, as elsewhere, with equity. However, empirical evidence shows that this might not be correct. For example, two-parent families with the same observed market (“earned”) income actually make very different choices between market work and “leisure” (or work from home). These families may have one parent who does not work in the market or only works part-time and takes primary responsibility for childcare and work in the home (a “homemaker/breadwinner” household model), which contrasts with a family with two parents working full-time in the market, who must pay for childcare and home services.

(f) Insights and Limitations of Optimal Taxation [1.220] Under optimal tax theory, debates about society’s ethical views on distribution can, in

principle, be differentiated from arguments about the efficiency cost of distortionary taxation. Optimal tax theory for the first time recognised that cash welfare payments, or social security, known as “transfers” in the economic literature, can be analysed as “negative taxes”. The revenue from positive taxes on individuals with higher incomes finances negative taxes (or transfers) for those on lower incomes. In today’s world, where more than one third of Commonwealth government expenditures fund transfers, it makes no sense to analyse income taxes independently of these transfer or social security payments. The idea of an equity–efficiency trade-off in tax design has strongly influenced the way many economists think about taxation. It is often accepted without question that a tax reform designed to redistribute income necessarily involves such a trade-off – that there is no possibility of a gain in both equity and efficiency. This assumes that the first welfare theorem holds in the pre-tax world and there is no market failure. The assumption implies an “initial endowments” theory of inequality, which implicitly attributes inequality in observed income to differences in innate earning power. However, casual observation as well as extensive empirical research suggests that income inequality is to a large extent the result of market failure. [1.220]

19

Income Tax in Context

The idea of an inevitable equity–efficiency trade-off also ignores discrimination in the market on the basis of race, gender and other characteristics which are not related to innate ability. In these circumstances, redistributive policies may increase efficiency as well as equity. The models also fail to give direction on the problems of taxing two-parent households and market failure. Because they compare a tax change with a pre-tax equilibrium, they are of limited relevance to real-world tax changes which involve changes in the existing tax system.

3. THE HENRY REVIEW [1.230] The Henry Review signalled a shift in the official approach to tax reform. The Review

adopted an analysis of the tax and transfer system as a whole and drew on both comprehensive income concepts and optimal tax theory. The Review was intended to provide strategic direction for the tax system for many years ahead, rather than to present a package that would develop all the recommended policy changes in detail. However, for political reasons, two issues were off-limits: the rate and base of the GST and the exemption from income tax of superannuation payments that had been enacted in 2007. As the Rudd government which initiated the Review had come to government on a platform of enacting a carbon emissions trading scheme (carbon tax), the Review also did not deal with this topic in any detail. The Henry Review reported just after the Global Financial Crisis, at the end of the commodities boom and start of the current period of slow economic and wage growth and what has turned out to be a long period of fiscal deficits for Australia (now in its eighth year). Tax reform has proved difficult and contested in this period. The immediate response of the Rudd government on release of the Henry Review was a limited range of announcements but including one of great economic and political significance, the adoption of a Minerals Resource Rent Tax (MRRT). The way this issue was handled politically was partly responsible for the demise of Prime Minister Rudd. The Gillard government won the next election and succeeded in enacting the MRRT and the carbon emissions trading scheme. However, it subsequently lost office and the Abbott Liberal/National Coalition government came to government on a platform of “scrap the tax”. It repealed both the MRRT and the carbon emissions trading scheme.

Australia’s Future Tax System, Report to the Treasurer, Pt 1 Ch 2.1 [1.240] Australia’s Future Tax System, Report to the Treasurer, Pt 1 Ch 2.1 (2009) New insights about the design of taxes and transfers In redesigning the tax and transfer system, the Review has taken advantage of better and stronger understandings developed recently about the way taxes and transfers affect people’s

20

[1.230]

behaviour and the economy. The international consensus on these matters has moved some way since the last major reviews of the tax and transfer systems, the Asprey review of the tax system in 1975 and the Social Security Review initiated in 1986.

Tax Policy and Process

CHAPTER 1

Australia’s Future Tax System, Report to the Treasurer, Pt 1 Ch 2.1 cont.

Box 2.1: Design principles for the tax and transfer system Equity The tax and transfer system should treat individuals with similar economic capacity in the same way, while those with greater capacity should bear a greater net burden, or benefit less in the case of net transfers. This burden should change more than in proportion to the change in capacity. That is, the overall system should be progressive. Considerations about the equity of the system also need to take into account exposure to complexity and the distribution of compliance costs and risk. Efficiency The tax and transfer system should raise and redistribute revenue at the least possible cost to economic efficiency and with minimal administration and compliance costs. All taxes and transfers affect the choices people and businesses make by altering their incentives to work, save, invest or consume things of value to them. The size of these efficiency costs varies from tax to tax … and from transfer to transfer, reflecting, in part, the extent to which they affect behaviour. Instability in policy settings can reduce economic efficiency by increasing uncertainty about the expected payoffs to long-term decisions such as investing in education, choosing retirement products, investing in long-lived productive assets and the choice of business structure. These costs represent a net loss to society as a whole, whereas revenue raised through a tax is redistributed among members of society through government expenditure, including transfer payments. Simplicity The tax and transfer system should be easy to understand and simple to comply with. A simple and transparent system makes it easier for people to understand their obligations and entitlements. People and businesses will be more likely to make the most beneficial choices for themselves and respond to intended policy signals. A simple and transparent system may also involve lower compliance costs for taxpayers and transfer recipients. Sustainability A principal objective of the tax system is to raise revenue to fund government programs, including transfer payments. The tax system should have the capacity to meet the changing revenue needs of government on an ongoing basis without recourse to inefficient taxes. To be sustainable the tax system, together with the transfer system, must contribute to a fair and equitable society. The cost of the transfer system needs to be predictable and affordable in the light of demographic change. Sustainability also means that the structural features of the system should be durable in a changing policy context, yet flexible enough to allow governments to respond as required. Legal and administrative institutions and frameworks should also be robust to maintain the effectiveness of the system and underpin the legitimacy of the system. Policy settings should also contribute to environmental outcomes that are sustainable. Policy consistency Tax and transfer policy should be internally consistent. Rules in one part of the system should not contradict those in another part of the system. To the extent possible, tax and transfer policy should also be consistent with the broader policy objectives of government. However, the primary objectives of the tax and transfer system, to raise revenue and provide assistance to those in need, should not be compromised by other policy objectives.

The impact of taxes and transfers on economic growth Encouraging strong economic growth is one of the most effective ways of dealing with the fiscal pressures that are likely to be associated with the ageing of Australia’s population. Recent empirical studies suggest that economic growth is affected by the structure of the tax system. Company income tax has been found to have the

largest adverse effects on economic growth, followed in rank order by taxes on personal income, consumption and land (assuming all these taxes are on suitably broad bases) … This ranking reflects the higher efficiency costs of a tax levied on a base that can be moved or changed. For this reason, there should be a lighter tax burden on more mobile bases, particularly investment. [1.240]

21

Income Tax in Context

Report to the Treasurer, Pt 1 Ch 2.1 cont. Tax and transfer policy should support productivity through the efficient allocation of investment and productive resources to their most highly valued uses. When products are taxed at the same rate, relative prices will be unaffected and there will be less impact on the decisions of individuals and businesses. A broad base also enables a lower rate of tax for a given revenue objective, which results in smaller distortions to people’s and businesses’ choices. Broadly-based taxes are, therefore, more consistent with an allocation of resources in the economy that supports a high rate of economic growth and individual satisfaction. Narrowlybased taxes can, however, improve resource allocation where they address cases of market failure or support improved social outcomes. People’s choices about participating in the workforce are affected by both taxes and transfer payments. International and Australian research has highlighted the different ways in which tax and transfer rules impact on the workforce participation of men, single and partnered women and women with children. In particular, partnered mothers and single parents are quite sensitive to the impact of taxes, transfer withdrawal rates and the level of transfer payments in deciding whether to undertake paid work. Associated with increased female workforce participation and the growth of two-income households, there is now also a greater awareness of the importance of policies that enable primary carers of children to make workforce participation choices that are in the best interests of their children and themselves. Studies generally confirm that in the period immediately following childbirth, both the mother and the baby benefit from the mother being at home. However, extended absences from the labour market tend to affect a person’s longer-term labour market prospects, with detrimental effects on longer term outcomes for both children and their parents, especially women. However, the potential for improved family wellbeing as a consequence of the primary caring parent returning to work while children are young depends on the availability of high quality affordable child care. 22

[1.240]

The tax and transfer system also affects people’s choices to save and invest. Recent theoretical and empirical research has brought a new perspective to the long-standing debate about the relative merits of comprehensive income taxation, under which savings income is taxed at a taxpayer’s marginal rate, and expenditure taxes, under which savings income is exempt. This work strengthens the argument that while there are potential benefits from taxing savings income, it should be taxed at a lower rate than labour income. Designing transfers to improve lifetime wellbeing In framing policies to alleviate disadvantage, a simple focus on the adequacy of income, judged against criteria such as the Henderson Poverty Line, has been replaced by broader goals that focus on lifetime income and the capacity of people to engage in work and other social activities. [The Henderson poverty line defines the amount of income below which a particular household would be considered to be in poverty. The benchmark level relating to 1973 was established by the Henderson Commission of Inquiry. This level is adjusted by per capita household income and is therefore a relative, rather than absolute, measure of poverty (Henderson 1975).] In particular, there is greater awareness that assistance should not encourage short-term choices which compromise the development of capabilities that offer potential medium to long-term improvements in a person’s wellbeing. For example, government assistance, and its interaction with taxation, should not lock people into welfare dependency by discouraging them from working, working longer hours, studying or retraining. This has seen increased emphasis on requiring people to work, actively seek employment or participate in training. Similarly, housing assistance should not lock people into geographical disadvantage. The distributional implications of taxes All taxes ultimately bear on or benefit people, not businesses or other entities. It is the distribution of the economic burden of taxes that is important for equity, not who remits a tax. Different community perspectives about the

Tax Policy and Process

Report to the Treasurer, Pt 1 Ch 2.1 cont. merits of a specific tax setting often reflect a difference of view about who ultimately bears the burden of a tax. It has long been understood that the person or entity legally obliged to remit a tax may not be the person, or the only person, whose income or consumption opportunities are altered. For example, taxes are shifted from businesses to households through higher prices for products or through lower returns to the use of domestic factors of production such as reduced wages, reduced rent or reduced prices for the use of natural resources (see Chart 2.2). The distribution of the burden of a tax can also vary over time as markets adjust. It is generally accepted that the burden of a tax will fall to a greater extent on: • a person consuming a product or owning a factor of production for which the demand or supply is unresponsive to a change in its price; • a person consuming a product with no ready substitutes; or • a person owning a factor of production that is relatively immobile. There has been less agreement about the extent to which tax shifting occurs in practice and where the burden of most taxes ultimately rests. It follows, however, that in a small open economy like Australia’s, where capital and products can move relatively freely between Australian and overseas markets, the burden of most taxes ultimately is likely to fall largely on Australian residents. It also follows that the extent to which this occurs is likely to be higher in the longer term, as there is greater capacity for resources to be reallocated across the economy in response to changes in prices or the return to investment. Recent empirical work using economic models is shedding greater light on this issue. At least some of the burden of company income tax is shifted onto labour. This is because investors can avoid the tax by moving their capital abroad. Less capital in the economy means lower productivity of labour and land and this means lower wages and lower rents for the owners of land. These effects are less pronounced where a tax is levied on profits that arise because of the specific location of an investment, as is often the case with non-renewable resources.

CHAPTER 1

Taxes (such as payroll tax, insurance tax and GST) on the factors of production and other business inputs tend to be shifted to households through lower returns to those factors or higher product prices. Taxes that appear to be borne by the business owner end up being borne by them either as a supplier of labour or as an owner of specific capital. In contrast, the burden of a broad-based uniform tax on land will fall primarily on existing landowners. The fixed supply of land limits the ability of landowners to pass the tax onto others. Instead, the price of land would adjust to restore the market rate of return to holding land as an asset. Policy measures that compensate people for the indirect impacts of taxes, such as changes to the rates of transfer payments by indexation or other compensation measures and increases to first home owner grants, effectively shelter the recipients from the burden of those taxes. A consequence of such indexation is that it adds a degree of progressivity, even to broadly based indirect taxes that are fully passed on through consumer prices. The principle underlying compensation measures in this context is that where taxpayers have arranged their affairs on the basis of the existing arrangements or are poorly placed to rearrange their financial affairs (either because they are not able to do so, or because it would be unreasonable to expect them to absorb the cost of doing so), it is necessary to effectively shelter them from the burden of those taxes. Compensation measures have also reflected judgements about the distributional impact of taxation changes. However, compensation measures can be complex. Grandfathering arrangements can result in service delivery agencies administering two sets of rules. Measures to insulate income support and family assistance recipients from the price changes of major shifts in the tax base can also result in complex arrangements. A payment indexed only to the CPI will automatically adjust to changes in prices (though in some circumstances special measures will be needed to bring forward the payment of the CPI increase). However, if it is important that payments benchmarked to community living standards do not reduce in real value, other changes in addition to normal indexation are necessary. [1.240]

23

Income Tax in Context

Report to the Treasurer, Pt 1 Ch 2.1 cont. The Report does not outline specific compensation measures for the recommended changes to taxation. The design of any such measures will depend on government decisions about policy reform packages. However, in this context it should be noted that if payment or taxation rates are effectively adjusted to compensate low and middle income households for changes that are often regarded as regressive (such as flat rate taxes and consumption taxes), such taxes can have an overall progressive effect. Consistent with the principles articulated in Part Two, the personal income tax and transfer system is the most appropriate mechanism for compensating lowand middle-income households for major tax changes. The costs of complexity The complexity of the tax system and the costs of complying with it are perennial concerns, particularly of the business community. Recent research suggests a range of costs associated with this complexity. It reduces transparency, impeding optimal decision making by businesses and individuals and their ability to respond to intended policy signals. It can cause people inadvertently to pay the wrong amount of tax or claim more or less than they are entitled in

transfer payments. It is regressive in its impact, affecting mostly those people with the least capacity to deal with complexity and the least access to professional help. Significant among the causes of complexity are the pursuit of finely calibrated equity and efficiency outcomes, instability in policy settings and people’s incentives to maximise their aftertax and transfer incomes or after-tax business profits. The provision of choice in determining a tax liability can increase complexity and result in higher compliance costs where taxpayers seek to discover the best tax outcome. Complexity may also be compounded where policy settings within the system do not draw on “natural” taxpayer systems or are inconsistent with broader policy objectives of government. Related to the issue of complexity are the costs of administering and complying with the tax and transfer system. These costs represent a net loss to the economy, because the resources engaged in these activities could otherwise be put to more highly valued uses. Recent research suggests there is an optimal level of system complexity and operating costs, one that balances administration and compliance costs with improved efficiency and distributional outcomes.

(a) Progressive Marginal Tax Rates and the Tax-Transfer Unit [1.250] Australia’s income tax has always applied progressive marginal tax rates to an

individual tax unit. However, the transfer (social security or welfare) system has mostly been targeted based on a joint spouse or family unit, in particular since the establishment of substantial “family tax benefits” (cash transfers) for low and middle income families with children by the Howard government in the 1990s. Australia also provides childcare benefits for children in paid childcare that are means-tested and withdrawn based on family income. One recommendation of the Henry Review for the individual income tax was a restructuring of the tax rate scale with a large tax-free threshold or zero bracket of $25,000, a tax rate of 35% on income in the range $25,000–$180,000 and of 45% above that range. While continuing to support the individual tax unit, in the transfer system, the Henry Review recommended keeping the family tax benefit means-tested by withdrawing the benefit based on family (couple) income. The tax rate reforms have been partly enacted by Labor and Liberal/National Coalition governments, while joint testing of family and childcare benefits remains. The zero tax bracket was expanded from $6,000 to $18,200 in 2012 (about $20,000 for low income earners or pensioners, as a result of the Low Income Tax Offset and Seniors and 24

[1.250]

Tax Policy and Process

CHAPTER 1

Pensioners Tax offsets). The remaining marginal tax rates are 19%, 32.5% (up to $80,000), 37% (up to $180,000) and 45% above that. In addition, most individuals pay the Medicare Levy, now 2% of taxable income. Top marginal taxpayers have for the last three years been subject to an additional 2% Temporary Budget Deficit Repair Levy. The Henry Review also suggested that a standard deduction be given to each individual taxpayer which would eliminate the need for the large majority of individuals to claim (and keep records for) specific deductions for income-related expenses. The Review further recommended that investment income and capital gains of individuals be calculated separately, net of related expenses and with a general 40% discount for net investment income to take account of inflation. These recommendations have not been implemented by governments to date.

(b) Critique From an Optimal Tax Perspective [1.260] The tax and transfer system recommendations of the Henry Review, and adopted by

governments, have been subject to considerable criticism led by Professors Apps and Rees, Why the Henry Review Fails on Family Tax Reform and Rees, “A New Perspective on Capital Income Taxation” in Evans, Krever & Mellor (eds), Australia’s Future Tax System: The Prospects After Henry (2010) 103, 129. Apps and Rees observe that these tax rate changes and targeted family benefits continue a trend of recent decades that shifts tax burdens on labour income from upper income taxpayers to lower and middle income taxpayers. The current system also taxes secondary earners (largely women) at significantly higher effective marginal and average tax rates than primary income earners (largely men). These effects are caused by flattening marginal tax rates and targeting or means-testing various transfer (welfare) payments which in the past were universal. The targeting limits the transfer to persons below a certain income and then withdraws it as their income from other sources (such as wages) increases. Viewing the tax and transfer systems as a single system, this generates high “effective marginal tax rates”, as the withdrawal rate operates as an additional implicit tax on the earned income, on top of the regular income tax rate applicable to the income. The saving from limiting the previously universal benefit is then returned to all taxpayers in the form of a tax cut. Those above the limit for the transfer payment will benefit from the tax cut, whereas those below the limit keep the benefit and have a tax cut plus an additional implicit tax. In a zero sum (revenue neutral) game there will be winners and losers from the change. The highest income taxpayers get more benefit from the tax cut (whose value is greater the higher the income) than they lose from forgoing a universal benefit. In addition, such a change inevitably produces a crazy pattern of effective marginal tax rates where the highest effective marginal rates fall on middle income earners. The withdrawal of most family and childcare benefits based on family (couple) income, not individual income, means that if an extra dollar of income comes from the second member of the household getting a job, the withdrawal mechanism for the benefit will apply and it acts as an implicit additional tax on that income. Primary earners in families (typically, men) who keep working and earning a similar level of income over many years are not generally affected by this. Consequently, the high effective marginal tax rate typically impacts on women as secondary earners, who get taxed more than men earning similar incomes. The alternative for many women in such cases is to work in the home, providing untaxed household production particularly in the form of childcare. There is a very significant economic inefficiency created by this higher effective tax on a group (women with children) whose labour supply is very [1.260]

25

Income Tax in Context

responsive to tax because of the untaxed production choices available to them. The empirical evidence also shows that the effect of discouraging secondary earners with young children from market work has persistent effects across their working life, caused by the degradation of workplace skills (loss of human capital) from choosing household production over paid employment. It is argued by economists that saving is “double taxed” under the income tax (because the return to saving is taxed). This has been linked to low saving rates. Common solutions suggested have been a progressive direct expenditure (consumption) tax (as discussed above) or a lower rate of tax on income from capital. The general impression from this analysis is that most saving comes from the highest income earners and that it is the high rates of tax on their investment income under a progressive income tax that are the cause of the low level of saving. However, impressions can be deceiving. The data on which such statements are based relate to family, not individual, incomes. What they disguise is that most of the saving in volume terms is done by dual-earner households with average incomes. Critically, the amount of saving in the household is closely related to the income of the secondary earner. Hence the deleterious effect of the current tax system on labour supply of women carries over to the amount of saving that occurs in Australia. It is this which is the major adverse impact of the tax system on saving, not the tax treatment of income from saving directly. In this context, reducing the effective marginal tax rates on the second earner in the household would produce a double benefit, including both higher saving in households and increased productivity of the workforce.

4. TAX PROCESS [1.270] The process of turning tax policy into legislation has attracted criticism for many

years because all interested groups – politicians, bureaucrats, tax professionals and taxpayers – are dissatisfied with the length and complexity of tax legislation and the ongoing requirement to continually amend it to overcome policy or technical deficiencies. Various experiments have been tried over the years and new processes have often been put into place, but it remains to be seen whether the product is any better. As you proceed through this book you should consider the particular vintage of tax legislation you are analysing to judge for yourself whether legislation has improved or not.

(a) Tax Reform and the Democratic Process [1.280] There are many players in the tax reform process and their goals are undoubtedly

diverse. Leaving to one side the role of the judiciary, institutional players in the reform process include the politicians in the government and opposition parties and public servants in Treasury and the Australian Tax Office. These participants are constantly addressed by pressure groups representing particular interests, such as business and industry, unions, community or welfare representatives, tax and financial law and accounting advisers and more specialised interests. All of these groups regularly call for particular changes, make comments on proposed changes and today, are almost always consulted prior to change. Political scientists, sociologists, economists and psychologists have developed a bewildering variety of theories about how and where special interest groups exercise their influence on government policy, and many of these theories could be applied to studying the formation of tax policy. They range from the highly theoretical to the entertaining – for example, the 26

[1.270]

Tax Policy and Process

CHAPTER 1

account of the US reforms in J Birnbaum and A S Murray, Showdown at Gucci Gulf – Lawmakers, Lobbyists and the Unlikely Triumph of Tax Reform (New York, Vintage, 1988). In this discussion we can do no more than highlight a few of the theories about a few of the players. Broadly, the theories about how government policy is formed tend to align themselves into two groups: those which emphasise the interactions between policymakers and private groups; and those which emphasise the goals of policymakers within the apparatus of the state. A concise summary of one interactive explanation of the behaviour of politicians is given in S Ross and P Burgess, Income Tax: A Critical Analysis (2nd ed, Law Book Co Ltd, Sydney, 1996), p 205: Politics is the realm of power and ideas, but in a democracy, politics can be viewed as a market where the traded commodity is votes. Politicians seek votes by promising public expenditures on areas favoured by a sufficient section of the electorate to ensure them office. To fund that expenditure they must raise taxes, preferably from that part of the electorate which did not vote for them. In practice, taxes are raised from both relatively small groups (for example, as with land tax, now paid by a small number of non-farming landowners) and from virtually everybody (for example, as with income tax). But it remains true that, other things being equal, the government of the day will tend to tax more lightly its supporters and will tend to be less mindful of the interests of its opponents.

This description sees politicians as captured to a greater or lesser degree by the social groups on which they depend for their existence. In fact, as the system develops, the influence of the interest groups would not even need to be exercised openly – their views would be anticipated by the policymaker without the need for consultation, often because the policymaker came from the same background and was aware of their views. Many examples could be marshalled to support this theory, but contradictory examples would also soon appear. Why, for example, did the Labor government abolish a form of subsidy to business in the investment allowance in 1985 and then reintroduce a version of it in 1992? Why did the Howard Government take the benefit of accelerated depreciation away from business in 1999 and the Rudd Government introduce another investment allowance beneficial to business in 2008? While anomalies might be explained as examples of diffusion of power or choices between competing interest groups within a pluralist system, other theories explain inconsistencies by arguing that policymakers may have independent goals. Their goals may be for advancement within a party or bureaucracy, or strengthening the power of their particular faction or group. In other words, the goals of policymakers might not come from their need to address the concerns of particular interest groups, but rather be generated from within the structure of the state. So, a politician might seek to be a more important politician, rather than a politician who is more responsive to electors. Policymakers might then seek to achieve these goals by forming transient coalitions on particular issues and on particular occasions. Like all good theories, these competing views of the goals of policymakers may both be “right” or “wrong” for different policymakers, on different occasions and on different issues. It should also be stressed that there are serious constraints on the ability of policymakers, even willing policymakers, to effect some reforms. For example international competition between nations for capital (including human capital) and investment, as well as the substantial network of international bilateral treaties allocating shares of tax revenue to each state, may prevent countries from making some kinds of tax changes unilaterally. [1.290] More complete and convincing answers to questions such as these would also have to

take into account the roles and goals of senior policymakers within the public service. They [1.290]

27

Income Tax in Context

must undoubtedly be viewed as active players in the process of public policy formation, rather than the mere administrators of the policies of the government of the day they were once conceived to be. In a rather grand description of senior bureaucrats, M Pusey, Economic Rationalism In Canberra (Sydney, Cambridge UP, 1991), p 2: Nothing remains of the old positivist distinction … which says that politicians choose the values of public policy and public servants the neutral means for its implementation. Along with elected politicians and some types of intellectuals, top public servants are the “switchmen” of history; when they change their minds, the destiny of nations takes a different course.

Pusey’s sociological analysis of the elite echelons of the Canberra bureaucrats described a group who, for the most part, were young, almost exclusively male, came from privileged family backgrounds, were educated in private schools, concentrated their tertiary study in economics, and “far more conservative than they say or believe” (p 74). He observed: The central agency officers [in the departments Treasury, Finance, and Prime Minister and Cabinet] did not seek to hide the enjoyment of their power. … The central agency people were nearly four times more likely to mention the satisfactions of political influence than were their counterparts in [other] departments. The central agency people were more inclined to stress the private ego satisfactions of personal achievement. Over and over again the interviews were suddenly charged with a certain intensity as the respondents warmed to their own phrases about “the challenge” of the work and to their own feelings of “success” and personal achievement. … The stress that central agency people set on power, political nous and intellectual acumen tells us a good deal about the nature of their work and their place within the state apparatus. For the most part they are not “client-oriented”. It is true that in their role as brokers between Ministers and a great variety of powerful outside interest groupings, they do indeed have relationships with a variety of influential “outside” organisations. But they are not primarily oriented to delivering services to these outsiders.

Pusey’s analysis of 25 years ago may be less applicable today. Rather, the analysis by Laura Tingle of politicians and a public service which has lost its “memory” and, by implication, its analytical capability and its power to make policy, may be more apposite for contemporary times. (See Laura Tingle, Political Amnesia: How We Forgot How to Govern, Quarterly Essay 60, Black Inc Press, 2015).

(b) Constitutional Constraints [1.300] Australian governments are not entirely free to change the tax system as they want. The Australian Constitution provides some constraints, particularly for the States and Territories. Section 51(ii) empowers the Commonwealth Parliament to make laws with respect to taxation. The main issue that has arisen under this provision is whether a particular law amounts to a tax or a user charge or financial penalty. While the distinctions can be difficult to draw in various situations, no one doubts that the income tax is a tax under this provision. The section also provides that tax law must not discriminate between States or parts of States, which is reinforced by s 99 forbidding the Commonwealth giving “preference” to any State in a revenue law. Again this is the source of little controversy in the income tax. Other constraints upon the imposition of taxation are contained in s 55 of the Constitution. This section dictates a formal, rather than substantive, limitation on the Commonwealth’s powers, requiring the Parliament to deal only with tax matters in taxation laws and to deal with only one matter in each tax law. The operation of the section thus contains two separate elements: one ensures but limits the superiority of the House of Representatives over the Senate in financial matters by limiting tax Acts (which under s 53 of the Constitution can only 28

[1.300]

Tax Policy and Process

CHAPTER 1

originate in the House of Representatives and cannot be amended by the Senate) to deal only with tax. The second element limits the House to enacting one tax per Act. The first element has led to the process of separating the Tax (Imposition) Act from the Tax Assessment Act which is apparent throughout the income tax system, though whether this is required may be doubted. There is an Income Tax Act and an Income Tax Assessment Act; a Fringe Benefits Tax Act 1986 and a Fringe Benefits Tax Assessment Act 1986. It was apparently thought prudent to isolate the fringe benefits tax from the rest of the income tax system by including it in separate Acts but it was not thought necessary to separate the capital gains tax, nor the withholding tax for payments of dividends, interest and royalties to non-residents, although there is a separate imposition Act for the latter. As to the second element, occasionally what appears to be simply a formal requirement can become a potential impediment to governments. It was argued in State Chamber of Commerce and Industry v Commonwealth (1987) 163 CLR 329 that the fringe benefits tax dealt with more than one subject of taxation. The various subjects were said to flow from the anti-avoidance provisions of the Act: it taxed fringe benefits paid to employees, but it also caught a benefit paid to an associate of the employee; it taxed a fringe benefit paid by an employer, but it also caught a payment by an associate of the employer; and it caught a payment connected to the employment, but it also caught a payment only indirectly connected to the employment. The Court observed: clearly enough the legislation has been framed on the footing that there is but a single subject of taxation, formulated according to a broad conception of what constitutes fringe benefits. The conception embraces benefits, not being salary or wages, referable to the employment relationship, whether provided by the employer or not and whether received by the employee or not. So understood, the legislation presented for the consideration of each House of the Parliament [has] a unity of subject matter rather than distinct and separate subjects of taxation. [1.305] In Australia’s federal system, the allocation of taxing and spending power between

the Commonwealth and State governments has been controversial over the last century. In any federal system, there are problems of allocating jurisdictional responsibilities and resolving overlaps of authority. Some matters may be reserved exclusively for the central government, some for the regional government, and power over some matters may be shared. An example of the first class is the power of levying customs duties and excise taxes, which is specifically reserved for the Commonwealth by s 90 of the Constitution. This provision has been interpreted broadly by the High Court so that it effectively precludes the States from levying sales taxes on goods. The power to levy income tax is concurrent for the federal and State governments. After Federation, income tax was originally imposed only by State governments in Australia, with the Commonwealth relying until 1915 upon customs duties for most of its revenue. From 1915 until 1942 both State and Commonwealth governments shared this tax, each imposing their own income tax. The Commonwealth assumed exclusive control of the income tax in 1942, a procedure which was twice validated by the High Court, including a decision that the “grants” power in s 96 of the Constitution permitted grants from the Commonwealth to the States on conditions. The States were formally permitted to re-introduce income taxes from 1978 to 1989 by the now repealed Income Tax (Arrangements with the States) Act 1978, no State did so. The Commonwealth’s superior economic position effectively permits it to control the manner in which the States can raise revenue, and any move to impose a State income tax would almost certainly be met by a corresponding reduction in Commonwealth grants to that State. [1.305]

29

Income Tax in Context

The exclusion of States from taxing income or goods creates a problem usually referred to as vertical fiscal imbalance. The problem is simply that the States are expected by citizens to provide a level of public goods which costs far more than the States can raise from their available revenue sources – principally payroll tax, land tax, stamp duties and miscellaneous transaction taxes. In short, the Commonwealth collects most of the revenue but the States spend much of it. As noted above, 20% of the Commonwealth revenues are distributed to the States and Territories and these grants make up 45% of their budgets. The introduction of the GST and its allocation in full to the States under the Intergovernmental Agreement of 1998 has probably given the States greater financial independence, although this is declining as the GST revenues grow more slowly than originally anticipated while State expenditure demands, especially in health expenditures, are increasing significantly as the population ages. In return for the GST revenue, the State governments agreed to repeal many of their business transaction taxes such as stamp duty on leases, conveyances of shares, business assets and various instruments executed for borrowing money, financial institutions duties and bank accounts debits tax. After originally promising much, the States were reluctant to proceed and in the end less was achieved than promised. The Inter-Governmental Agreement on the Reform of Commonwealth–State Financial Relations is enacted in A New Tax System (Commonwealth–State Financial Arrangements) Act 1999. The Henry Review returned to the theme of reforming the more inefficient state taxes, however, the politics are challenging and it seems unlikely that major reform will be achieved in the near future.

(c) Development of Tax Policy into Legislation [1.310] In 1990, Canadian tax academic Brian Arnold asserted (“The Process of Tax Policy

Formulation in Australia, Canada and New Zealand” (1990) 7 Australian Tax Forum 379, p 393): [T]here is no question that … all governments should consult with the public, including tax professionals, concerning major tax reform proposals. This public consultation is one of the most important features of modern tax reform, since previously the making of tax policy was often shrouded in secrecy. The issue, however, is not whether consultation is desirable, but what form it should take.

Arnold’s comment refers specifically to “major” tax reform. For example, the Asprey Committee inquiry of 1975 received 600 submissions. At the other end of the spectrum, consultation on some important reforms has sometimes been targeted and confidential, as when the government obtained the advice of Mr G Hill QC (subsequently Justice Hill of the Federal Court) and Mr M Gleeson QC (subsequently Justice Gleeson of the High Court) in respect of the introduction of the General Anti Avoidance Rule in Part IVA of the Income Tax Assessment Act 1936 (see Chapter 20). The Review of Business Taxation in 1998 paid attention to improving and integrating tax policy and legislation processes and consultation in tax reform. On 1 July 2002, responsibility for the detailed the development of tax legislation was transferred from the Australian Taxation Office (ATO) to Treasury. It recommended establishment of a Board of Taxation, which continues with quasi-independent status within the Treasury, including representatives of business and the tax profession. The Board often reviews policy areas before government makes announcements and conducts post-implementation reviews to test whether tax legislation has achieved its purpose. More generally, consultation is now a matter of course for 30

[1.310]

Tax Policy and Process

CHAPTER 1

most tax reforms, whether large or small, including through inquiries, discussion papers, the release of exposure draft bills and, once a Bill is in Parliament, through mechanisms such as Parliamentary Inquiries. Today, the ATO has re-established a Policy and Law Design branch which works closely with the Treasury on tax reforms. [1.315]

1.8

Question

Can issues of complexity in legislation be solved by different bureaucratic arrangements and increased consultation? Is there something peculiar to taxation that makes tax legislation the most complicated in the land?

(d) Legislation by Press Release [1.320] One of the causes of concern to practising tax advisers that emerged in the mid-1980s

was the practice of the Treasurer to amend the Act by issuing a press release. For example, the capital gains tax was introduced effective 19 September 1985, but legislation was not enacted until 1986. Retrospectivity was again in the news in recent reforms to superannuation tax concessions, in the 2016-17 Budget. A good example of this process is the introduction of s 21A into the ITAA 1936. The section was foreshadowed in a press release issued on 4 February 1985 after the decision by the Federal Court in FCT v Cooke and Sherden (1980) 80 ATC 4140 (which is discussed in Chapter 5). The decision in that case held that a “fringe benefit” (that is, a non-cash benefit) paid to the owners of a business would not, in certain circumstances, be included in the assessable income of the recipients. The press release indicated that from February 1985, business fringe benefits would be included in the recipient’s assessable income. No legislation was produced until s 21A was released in Taxation Laws Amendment Bill (No 4) 1988. In the meantime, however, taxpayers had been informed that, despite the law as it stood in Cooke and Sherden, the ATO would nevertheless treat a business fringe benefit as assessable income. During those three years, of course, the Act had not been changed, nor had Cooke and Sherden been overruled by a court. The ATO might nevertheless have assessed individuals on the basis of the law as it would become, confident that the section, when it was eventually released, would be backdated to February 1985. Clause 13 of the Taxation Law Amendment Bill (No 4) 1988 did make the section apply to benefits provided after 4 February 1985. In fact the procedure was even more complicated than this, because before the Bill was enacted the government announced that s 21A would be amended in three material ways which would differ from the press release issued in February 1985. Here, therefore, was a press release and a Bill being amended by a further press release. When the amendments to overcome the Cooke and Sherden decision were introduced into Parliament, after pressure from the opposition parties in the Senate, the legislation was eventually expressed to apply from the date of its introduction into the House of Representatives – 31 August 1988, not 4 February 1985. You might care to ponder the position of taxpayers who paid tax on business fringe benefits in the intervening years after the first press release. The virtue of legislation by press release is that whenever a defect in revenue legislation is exposed by a court decision or otherwise, the government can immediately announce that it will enact legislation to overcome the defect before too many schemes are mounted to exploit the loophole. It can also be used for a distinct purpose of announcing major policy changes even though legislation may not have been completed if it is feared that details will leak or some urgent announcement is necessary. The process can also prevent major economic [1.320]

31

Income Tax in Context

dislocation that would arise if tax changes were signalled. For example, when the capital gains tax on shares was introduced in Canada, the valuation day nominated was some days before the announcement to prevent any dramatic changes in the market by a rush of trades. However, it is a fundamental principle of our legal system that (leaving aside the role of the courts) the law can only be changed by Parliament and until Parliament does so (or the case is overturned on appeal) it is inappropriate for the ATO to assess individuals except on the basis of the law as it stands. The ATO has no express power to assess an individual on the law as it might be and certainly would not be able to collect assessed tax on the basis of anticipated law. But the reality of court delays means that if the ATO wanted to assess tax on the basis of the law as it would become, by the time it sought to collect the tax the law will usually have been amended to support the assessment that he has raised. The issuing of an assessment on the basis of a press release does also assume the complete acquiescence of Parliament in the will of the ATO or Treasurer which the events in the Cooke and Sherden episode show might not always be accurate. Apart from questions as to legal validity, legislation by press release can create uncertainty in the tax system. Whether uncertainty is necessarily bad was discussed by H Reicher in “Legislation By Press Release” (1978) 7 Australian Tax Review 31. He noted that a degree of uncertainty might be exactly what a government would prefer. He suggested that: the effect of using the technique of legislation by press release – of merely threatening future retrospective legislation – is, it is suggested, far more potent from the government’s point of view than the actual legislation itself … When … a practitioner is faced with no more than an amorphous threat of retrospective legislation, he is placed in an unenviable dilemma. It is impossible to offer an informed opinion, as it is not known which particular provisions of existing legislation will be altered, what form the amendments will take and what may be their precise ramifications. … If taken to its logical extreme, governments may use legislation by press release to threaten retroactive amendments to revenue legislation and then, as a matter of deliberate policy, refrain from drafting amendments on the basis that the threat will be more effective than the deed itself.

Some other commentators have suggested that this response is exaggerated. The role of the tax adviser is to give advice on the law as it now stands, on the law as it may stand if proposed changes are enacted and on the law as it could stand if political or social pressures change. Some practitioners cautioned clients on the probability of a capital gains tax many months before it was introduced. After all, it had been actively discussed at the Tax Summit more than two months before the official announcement in September 1985. Similarly, some practitioners advised corporate clients to defer the realisation of income until the next year – anticipating a fall in the company tax rate in 1988. Concern about the process of legislation by press release provoked a response from the Senate in November 1988. The Senate’s resolution (reported in Hansard, Australia, Senate, Debates 1988, Vol 17, p 2220) announced that where the government “has announced by press release its intention to introduce a Bill to amend taxation law and that Bill has not been introduced into Parliament or made available by way of a publication of a draft Bill within six calendar months of the date of that announcement, the Senate shall, subject to any further resolution, amend the Bill to provide that the commencement date of the Bill shall be a date that is no earlier than either the date of introduction of the Bill to Parliament or the date of publication of the draft Bill as the case may be”. The 2008 review of tax policy and legislative process referred to above also suggested limits on retrospective tax legislation and the matter 32

[1.320]

Tax Policy and Process

CHAPTER 1

seems to have provoked less contention in recent times. The ATO has a process for dealing with unenacted announcements that will apply from the day of announcement or other time prior to the passage of legislation. [1.325]

1.9

Question

Is legislation by press release contrary to the rule of law?

(e) Interpretation of Tax Legislation [1.330] The interpretation of tax legislation by judges has been a vexed topic over the years.

Influenced by English decisions, the Australian courts tended to take the view that tax legislation was to be strictly construed in favour of the taxpayer. If the taxpayer could structure a transaction to fall within (or without) the terms of particular provisions in the tax law, then the tax result followed accordingly whether or not this seemed in accord with the intent of the legislation. Beginning in the 1980s, the judges moved to a more purposive interpretation of the law partly of their own accord and partly as a result of changes to the Acts Interpretation Act 1901. The current approach to interpretation was summarised as follows by Hill J in MLC Ltd v FCT (2002) 51 ATR 283 at 291-292:

MLC Ltd v FCT [1.340] MLC Ltd v FCT (2002) 51 ATR 283 It is now clear, if it ever was in dispute, that the task of construction is not one simply of taking each word used in a statute and applying the dictionary meaning of that word to arrive at a conclusion. The task is not as mechanical as that. While it is clear that the construction of a statute will commence with the words used and that it is a good start to assume that the words mean what they say, that is only a start to the process. As Gibbs CJ said in Cooper Brookes at 305: if the language of a statutory provision is clear and unambiguous, and is consistent and harmonious with the other provisions of the enactment, and can be intelligibly applied to the subject matter with which it deals, it must be given its ordinary and grammatical meaning, even if it leads to a result that may seem inconvenient or unjust. However, the English language is seldom so clear and unambiguous that only one construction is open. It is for that reason that in judicial decisions in recent times which have discussed the process of construction great importance has been attached to “context”. Perhaps the most famous and often cited passage to this effect is to be found in the judgment of the

High Court in CIC Insurance Ltd v Bankstown Football Club Limited (1997) 187 CLR 38 at 408 where Brennan CJ, Dawson, Toohey and Gummow JJ in a joint judgment wrote: It is well settled that at common law, apart from any reliance upon s 15AB of the Acts Interpretation Act 1901 (Cth), the court may have regard to reports of law reform bodies to ascertain the mischief which a statute is intended to cure. Moreover, the modern approach to statutory interpretation (a) insists that the context be considered in the first instance, not merely at some later stage when ambiguity might be thought to arise, and (b) uses “context” in its widest sense to include such things as the existing state of the law and the mischief which, by legitimate means such as those just mentioned, one may discern the statute was intended to remedy. Instances of general words in a statute being so constrained by their context are numerous. In particular, as McHugh JA pointed out in Isherwood v Butler Pollnow Pty Ltd, if the apparently plain words of a provision are read in the light of the mischief which the statute [1.340]

33

Income Tax in Context

MLC Ltd v FCT cont. was designed to overcome and of the objects of the legislation, they may wear a very different appearance. Further, inconvenience or improbability of result

may assist the court in preferring to the literal meaning an alternative construction which, by the steps identified above, is reasonably open and more closely conforms to the legislative intent.

[1.350] As you proceed through this book, you should consider to what extent this approach

is followed by the judges in the cases and by the ATO in public Rulings. Even in the most recent cases it is hard to find complete consistency in approach. We return to interpretation of tax legislation in more detail in Chapter 20.

34

[1.350]

CHAPTER 2 Fundamental Principles of the Income Tax System [2.10]

1. AUSTRALIAN TAX LAW CONCEPTS OF INCOME .................. ........................ 36

[2.20] [2.30] [2.40] [2.50]

(a) Income According to Ordinary Concepts ............................................................... (i) Influence of trust law .............................................................................................. (ii) Influence of other jurisdictions ............................................................................... Eisner v Macomber .......................................................................................................

[2.70] [2.80]

(b) Contrasting Judicial and Economic Concepts of Income: Income as Gain .............. 41 Hochstrasser v Mayes ................................................................................................... 42

[2.100]

(c) Statutory Modifications to Ordinary Income and the 1985 Tax Reforms ................. 43

[2.110]

2. ELEMENTS OF THE JUDICIAL CONCEPT OF INCOME .............. ................... 45

[2.120] [2.130]

(a) Realisation – Income as a Flow ............................................................................... 45 R W Parsons, Income Taxation: An Institution in Decay? ................................................. 45

[2.150] [2.160] [2.170] [2.180] [2.190] [2.215]

(b) Identifying the Taxpayer and the Taxable Event ..................................................... Federal Coke Co Pty Ltd v FCT ....................................................................................... (i) Constructive receipt ............................................................................................... (ii) Benefits received from intermediaries ..................................................................... Constable v FCT ........................................................................................................... (iii) Amounts received but for the benefit of others .....................................................

[2.220] [2.230] [2.260]

(c) Valuation ............................................................................................................... 54 FCT v Cooke and Sherden ............................................................................................. 55 Abbott v Philbin ........................................................................................................... 58

[2.280] [2.290]

(d) Apportionment ...................................................................................................... 59 McLaurin v FCT ............................................................................................................ 59

[2.310]

3. STATUTORY FRAMEWORK FOR TAXING INCOME ................. ....................... 61

[2.320]

(a) Taxable Income ..................................................................................................... 61

[2.330]

(b) Assessable Income ................................................................................................. 61

[2.340]

(c) Deductions ............................................................................................................ 62

[2.350]

(d) Rate Scales ............................................................................................................ 62

[2.360]

(e) Tax Offsets ............................................................................................................. 62

[2.370]

4. STRUCTURE OF THE AUSTRALIAN INCOME TAX SYSTEM ........... ................ 64

[2.370]

(a) Volume and Numbering of Legislation ................................................................... 64

[2.380] [2.390] [2.480]

(b) Integrating Elements of the Income Tax System .................................................... 65 (i) Method for inclusions in tax base ........................................................................... 65 (ii) Method for cost and outlays .................................................................................. 68

[2.550]

(c) Overlapping Assessment Sections .......................................................................... 70

37 38 38 39

47 48 49 50 50 53

35

Income Tax in Context

Principal Sections ITAA 1936 s 17

ITAA 1997 ss 4-1, 4-10

s 19

ss 6-5(4), 6-10(3)

s 21

s 25

Div 6

Effect These sections are the principal charging provisions in the Act. They bring into the charge to tax the taxable income of any person, resident or non-resident. These sections deem a person to have derived income realised indirectly by way of constructive receipt. This section applies to all non-cash transactions and values the consideration in such circumstances as its money value. These are the principal assessing provisions in the Act. They encompass all gains which fall within the judicial concept of income and in the 1997 Act statutory income.

1. AUSTRALIAN TAX LAW CONCEPTS OF INCOME [2.10] What is income for the purposes of Australian tax law? If you look at the ITAA 1997

for an answer, you will see that s 6-5 covers “income according to ordinary concepts which is called ordinary income.” The legislation offers little guidance on what is “ordinary income” and we have to turn to case law for assistance. Section 6-10 adds that assessable income also includes amounts covered by other sections that are not ordinary income, which are called statutory income. So, for income tax law, the meaning of income thus comes from two sources: the opinions of judges and the elaborations in the ITAAs. Sometimes in this book we will use the term “income” in a broad sense to encompass gains subject to taxation, including fringe benefits taxed under the fringe benefits tax (FBT) and capital gains taxed under the capital gains tax (CGT). At other times we use the term income (tax) in contradistinction to fringe benefits (tax) and capital gains (tax), that is, to identify the taxing provisions that apply, with some significant enhancement, to income according to ordinary concepts. Students will quickly and intuitively learn to distinguish the usages. The term “income” is qualified where it is used in the ITAAs by epithets such as “ordinary”, “statutory”, “taxable” or “assessable”. There are important consequences attached to these epithets and distinctions between the various meanings need to be kept in mind. One major difference between the ITAA 1936 and the ITAA 1997 is that the term “income” is intended not to be used unadorned. This has important implications for the structure of the legislation which is discussed at the end of this chapter. Finally, although we might think of the term “income” as relevant principally for tax law, in fact the concept is important (and has its own meaning) in other areas of law as well. For example, in trust law it is necessary to determine the income of the trust, as the beneficiaries are often divided into two categories with one entitled to the income of the trust and the other entitled to the capital of the trust. Similarly, under social security law, the entitlement to a pension is often reduced where the pensioner is in receipt of income as defined in the relevant legislation. Our concern is with tax law, but it will be seen that other areas of law where the 36

[2.10]

Fundamental Principles of the Income Tax System

CHAPTER 2

concept of income is important are not unrelated to tax law. In some situations, you will see the movement of definitions or concepts from one context to another.

(a) Income According to Ordinary Concepts [2.20] Despite the large accretions to the income tax legislation in recent years, most income

which is taxed in Australia enters the statutory calculation as income according to ordinary concepts, that is, what the judges say is income in case law. It was never likely that judges reared in the common law which elaborates concepts on a case-by-case basis, reasoning by common understanding, common sense and analogy, would depart from their traditions in the taxation area and state an overriding concept of income applicable to all cases. Indeed it is difficult to find any Australian cases conceptualising the matter and the High Court has rejected any such approach (see below). When making general statements about the law on the meaning of income for income tax purposes, many judges content themselves with a repetition of the words of Jordan CJ in Scott v Commissioner of Taxation (1935) 35 SR (NSW) 215; 3 ATD 142: The word “income” is not a term of art, and what forms of receipts are comprehended within it, and what principles are to be applied to ascertain how much of those receipts ought to be treated as income, must be determined in accordance with the ordinary concepts and usages of mankind, except in so far as the statute states or indicates an intention that receipts which are not income in ordinary parlance are to be treated as income, or that special rules are to be applied for arriving at the taxable amount of such receipts.

On the basis of this passage, the judicial elaboration of income was often referred to as the “ordinary concepts” notion of income, and this label was simply appropriated by the drafter and given statutory force in s 6-5 of the ITAA 1997. In deciding particular cases, the judges rely on decided cases with similar facts and apply or distinguish them in the normal common law way. It has been largely left to text writers to try to classify these cases and see what common ideas arise. There is general agreement in dividing the judicial concept of income into three broad areas: • income from services; • income from business; and • income from property. It is not possible to fit all decided cases into this framework, however, and some wider search for a conceptual framework has been attempted. For example, Professor Ross Parsons in Income Taxation in Australia, Law Book Co, Sydney, 1985 seeks to relate the law to Simons’ concept of income (Personal Income Taxation: The Definition of Income as a Problem of Fiscal Policy (1938)) by insisting that gain is an essential element in the judicial concept of income and delineating five categories of gain that are within it: • rewards for services; • profits from carrying on a business; • return from property; • receipts in compensation for income or allowable deductions; and • periodical receipts. Others seize on the distinction between intended and unintended receipts in trying to elaborate the concept. Thus gifts and profits on the sale of property not bought with a profit-making [2.20]

37

Income Tax in Context

purpose are excluded from income, while receipts from services, business and property are included as they are cases where the taxpayer set out to obtain the receipt. As with most areas of judge-developed law, there will always be disagreements as to the precise classification of the judicial pronouncements on the meaning of income. For the purposes of this book we have adopted the traditional classification with some modification based on Parsons’ framework. Although the Australian judges have created most of the law on what constitutes income for Australian income tax purposes, they have not worked in a vacuum, for concepts of income were available in other areas of the law and in overseas jurisdictions. We will briefly look at two other influences on the meaning of income. (i) Influence of trust law [2.30] It has already been noted that trust law for many centuries has had to elaborate a

meaning for income to divide trust property among beneficiaries with differing rights in the trust. It is clear in a number of areas that trust concepts of income have been influential in developing the tax law concept of income. The failure of the judicial concept of income to include capital gains can be attributed to the influence of trust law concepts of income. The division of trust property between beneficiaries is usually effected by the income–capital distinction, that is, there will be income beneficiaries and capital beneficiaries of the trust. For example, if property is left by a will on trust to the spouse of the deceased for life and the remainder to the children of the deceased after the death of the spouse, the life tenant (the spouse) will be entitled to the income from the property for life and then the property will pass to the capital beneficiaries (the children) on the spouse’s death. If the property increases in value and is sold by the trustees pursuant to a power in the will of the deceased to be replaced by other property, any increase in value of the property sold will inure to the capital beneficiaries and hence may be described as a capital gain (in contrast to the income, such as rent from the property, which belongs to the life tenant). This explanation of the income capital distinction and the influence of trust law are not always accepted; see Ault and Arnold, Comparative Tax Law (2nd ed) pp 25 26, 116, 198; Prebble, “Income Taxation: A Structure Built on Sand” (2002) 24 Sydney Law Review 301. (ii) Influence of other jurisdictions [2.40] So far as the influence of overseas jurisdictions is concerned, it should be noted that

Australia is not a “colony” of the United Kingdom in the income tax area, in contrast to many other areas of the law. The United Kingdom income tax is based on the schedular system introduced in the early 19th century, that is, income is by legislation divided into various categories (schedules in the original legislation) and separate rules as to deductions, etc are enacted for each category. The schedular system and the reasons for it are described in Chapter 1. The Australian income tax system by contrast was based, from its earliest expressions, on a more global concept of income. Although income is now split into ordinary and statutory income, generally the two categories are added together as assessable income and deductions of all kinds are similarly aggregated and deducted from assessable income: see s 4-15 of the ITAA 1997. There is no need, for example, to subtract deductions relating to income from property only from that income. This has meant that the Australian courts have adopted a take 38

[2.30]

Fundamental Principles of the Income Tax System

CHAPTER 2

it or leave it attitude to United Kingdom cases in the income tax area. Sometimes the United Kingdom case law is distinguished as being based on different legislation, while at other times it is accepted as relevant to the Australian statute without question. Students should observe for themselves in the Australian cases extracted in this book which approach is adopted to United Kingdom case law in the particular instance in question. Like Australia, the United States adopts a global approach to income in its statute and leaves it largely to the courts to elaborate the concept. Unlike Australia, the United States courts have accepted the challenge to state a general concept of income. In Eisner v Macomber, the United States Supreme Court was concerned with the constitutional validity of taxation of a stock dividend (or in Australian parlance, a bonus share issue) whereby the company capitalised its retained profits and issued to shareholders new shares in the company in proportion to their existing shareholdings. Under the United States Constitution Art 1, direct taxes are required to be apportioned among the states in accordance with population, but the Sixteenth Amendment creates an exception to this rule in the case of taxes on incomes. The taxpayer argued the stock dividends were not income and hence the tax levied on them was unconstitutional. Pitney J delivered the judgment of the court, as follows.

Eisner v Macomber [2.50] Eisner v Macomber 252 US 189 (1920) In order, therefore, that the clause cited from Article I of the Constitution may have proper force and effect, save only as modified by the Amendment, and that the latter also may have proper effect, it becomes essential to distinguish between what is and what is not income, as the term is there used; and to apply the distinction, as cases arise, according to truth and substance, without regard to form. Congress cannot by any definition it may adopt conclude the matter, since it cannot by legislation alter the Constitution, from which alone it derives its power to legislate, and within whose limitations alone that power can be lawfully exercised. The fundamental relation of capital to income has been much discussed by economists, the former being likened to the tree or the land, the latter to the fruit or the crop; the former depicted as a reservoir supplied from springs, the latter as the outlet stream, to be measured by its flow during a period of time. For the present purpose we require only a clear definition of the term income, as used in common speech, in order to determine its meaning in the Amendment; and, having formed also a correct judgment as to the nature of a stock dividend, we shall find it easy to decide the matter at issue.

After examining dictionaries in common use … we find little to add to the succinct definition adopted in two cases … “Income may be defined as the gain derived from capital, from labour, or from both combined”, provided it be understood to include profit gained through a sale or conversion of capital assets … Brief as it is, it indicates the characteristic and distinguishing attribute of income essential for a correct solution of the present controversy. The Government, although basing its argument upon the definition as quoted, placed chief emphasis upon the word “gain”, which was extended to include a variety of meanings; while the significance of the next three words was either overlooked or misconceived. “Derived-fromcapital”; “the gain-derived-from-capital”, etc. Here we have the essential matter: not a gain accruing to capital, not a growth or increment of value in the investment; but a gain, a profit, something of exchangeable value proceeding from the property, severed from the capital however invested or employed, and coming in, being “derived”, that is, received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal; that is income derived from property. Nothing else answers the description. [2.50]

39

Income Tax in Context

Eisner v Macomber cont. The same fundamental conception is clearly set forth in the Sixteenth Amendment – “incomes, from whatever source derived” – the essential thought being expressed with a conciseness and lucidity entirely in harmony with the form and style of the Constitution. Can a stock dividend, considering its essential character, be brought within the definition? To answer this, regard must be had to the nature of a corporation and the stockholder’s relation to it. We refer, of course, to a corporation such as the one in the case at bar, organised for profit, and having a capital stock dividend into shares to which a nominal or par value is attributed … The dividend normally is payable in money, under exceptional circumstances in some other divisible property; and when so paid, then only (excluding, of course, a possible advantageous sale of his stock or winding-up of the company) does the stockholder realise a profit or gain which becomes his separate property, and thus derive income from the capital that he or his predecessor has invested … We are clear that not only does a stock dividend really take nothing from the property of the corporation and add nothing to that of the shareholder, but that the antecedent

accumulation of profits evidenced thereby, while indicating that the shareholder is the richer because of an increase of his capital, at the same time shows he has not realised or received any income in the transaction. It is said that a stockholder may sell the new shares acquired in the stock dividend; and so he may, if he can find a buyer. It is equally true that if he does sell, and in doing so realises a profit, such profit, like any other, is income, and so far as it may have arisen since the Sixteenth Amendment is taxable by Congress without apportionment. The same would be true were he to sell some of his original shares at a profit. But if a shareholder sells dividend stock he necessarily disposes of a part of his capital interest, just as if he should sell a part of his old stock, either before or after the dividend. What he retains no longer entitles him to the same proportion of future dividends as before the sale. His part in the control of the company likewise is diminished … Yet, without selling, the shareholder, unless possessed of other resources, has not the wherewithal to pay an income tax upon the dividend stock. Nothing could more clearly show that to tax a stock dividend is to tax a capital increase, and not income, than this demonstration that in the nature of things it requires conversion of capital in order to pay the tax.

[2.60] With its emphasis on the nexus between gain and its source (“Income may be defined

as the gain derived from capital, from labour, or from both combined”), the income concept adopted by the United States Supreme Court in Eisner v Macomber is quite close to the Australian concept that arises out of, but is not articulated in, the Australian cases, apart from the fact that the United States concept clearly included capital gains (in the phrase “provided it be understood to include profit gained through a sale or conversion of capital assets”). Subsequent to Eisner v Macomber the United States judicial concept of income moved away from a particularised notion in which income could be divided into various categories depending on its source to a more global (and correspondingly broader) concept. In Commissioner v Glenshaw Glass Co (1955) 348 US 426, the United States Supreme Court said the definition of income in Eisner v Macomber served a useful purpose but was not meant to provide a touchstone to all future gross income questions. Instead, the Court adopted an income concept based on “instances of undeniable accessions to wealth, clearly realised, and over which the taxpayers have complete dominion”. The judicial concept of income expressed in Glenshaw Glass is not greatly different from the economic concept set out by Simons. The case exemplifies a judicial approach to the 40

[2.60]

Fundamental Principles of the Income Tax System

CHAPTER 2

income concept that goes far beyond anything to be found in the Australian cases. Although United States authorities have been quoted from time to time in Australia, the broad and conceptual style of formulating an income definition has generally not been followed in this country. However, many commentators have suggested the High Court adopted a more comprehensive approach to the income concept in FCT v Myer Emporium Ltd (1987) 163 CLR 199; 18 ATR 693; 87 ATC 4363 (extracted in Chapter 5). This issue was considered by the High Court of Australia in Montgomery v FCT (1999) 198 CLR 639; [1999] HCA 34, a case concerning a lease incentive paid by a landlord to induce a tenant to sign a lease (see Chapter 5). The majority judgment states: As was noted in FCT v Myer Emporium Ltd, both the “ordinary usage meaning” of income and the “flow” concept of income derived from trust law have been criticised. But both the ordinary usage meaning and the flow concept of income are deeply entrenched in Australian taxation law (Parsons, “Income Taxation: An Institution in Decay?” (1986) 12 Monash University Law Review 77) and it was not suggested by either party that there should be any reconsideration of them. Nor was it suggested that they should be replaced by concepts of gain or realised gain, concepts that some economists consider preferable (Simons H C, Personal Income Taxation: The Definition of Income as a Problem of Fiscal Policy (1938)). [2.65]

Questions

2.1

Should the legislature spell out in detail what is to be treated as income rather than leaving the question to the courts? What advantages does the judicial approach have over the legislative solution?

2.2

Is it better to tax income under a schedular system or under a global system?

(b) Contrasting Judicial and Economic Concepts of Income: Income as Gain [2.70] You will recall from Chapter 1 the comprehensive definition of income which emerges

from the economic literature in the Haig-Simons tradition. The relationship between the legal definition of income for tax purposes and the economists’ comprehensive concept has been mentioned at a number of points above, and the impression may have been conveyed that the judicial concept is always smaller than economic notions. In fact ordinary income is both under-inclusive and over-inclusive when compared with the economic definition. In addition to the lack of a capital gains tax, ordinary income does not generally include gifts, and gambling and lottery winnings. On the other hand, ordinary income includes the gross amount of annuities and royalties paid to a person even though the payments include some recovery of the purchase price or property involved in the transaction and do not represent pure gain. Ordinary income also involves a defective valuation principle as discussed below. On the other hand, the law on income according to ordinary concepts in some areas seems to follow the logic of Simons’ concept of income by regarding a receipt as not being income on the basis that there is no gain in the particular situation. For example, generally a person will not be treated as deriving income for tax purposes where he or she is not beneficially entitled to the receipt. The classic case is the trustee, but as the legislation has express provisions to deal with the trust, the principle does not often have to be relied on. Nonetheless, where the trust provisions seem likely to produce taxation on a person in her or his personal capacity on income to which he or she has no beneficial entitlement, the courts will seek to prevent this result. A very good example of this process is the judgment of Dixon J in Countess of Bective v [2.70]

41

Income Tax in Context

FCT (1932) 47 CLR 417; 2 ATD 80. The issue in the case was whether the Countess was taxable on amounts paid to her under a trust but which she was obliged to spend on the maintenance of her daughter. Dixon J said: The question is whether the payments to her form part of her assessable income. [They] appear to have been included in the taxpayer’s assessment upon the view that she took [them] beneficially, the statement of the purpose contained in the provision for maintenance amounting to no more than an expression of the donor’s motive, or of his expectation. [Their] inclusion in her assessable income could be supported if the statement of the purpose were understood as annexing to a gift to her a condition which she was bound to perform. Possibly, it might be supported also if the condition were construed as a gift of income to the taxpayer subject to a charge for maintenance. But if either of these two constructions were adopted, a corresponding deduction should be allowed for expenditure upon maintenance, a deduction which would not, of course, necessarily amount to the same sum. On the other hand, if she is not an object intended to be benefited at all by the provision for maintenance, the payments ought not, in my opinion, to be included as assessable income of the taxpayer, although if it appeared she had appropriated to her own use an unexpended surplus after discharging her duty of maintaining her daughter, the surplus would be taxable as part of her income.

More recently (and doubtfully), the courts have held that an embezzler is not taxable on interest earned on amounts embezzled because it is subject to a trust in favour of the true owner of the money: Zobory v FCT (1995) 64 FCR 86; 30 ATR 412; 95 ATC 4251. Another way of reinforcing the gain idea is to identify a rule that an amount received by a taxpayer must belong to that taxpayer absolutely if it is to be taxed on it. Parsons expresses a rule that “there is no gain [and therefore no income] unless an item is derived by the taxpayer beneficially”: see R W Parsons, Income Taxation in Australia, Law Book Co, Sydney, 1985, p 36. A similar idea explains why a person may not be taxable where an amount is received which he or she is obliged to expend in benefiting another or which compensates for a detriment suffered in serving another, although there is not strictly a trust involved as regards the amount. For example, in Hochstrasser v Mayes, the taxpayer was an employee of a company which had a scheme whereby employees were compensated for any loss they made on the sale of their homes when being transferred from one location to another by the company. The taxpayer was assessed on an amount received under this scheme but the House of Lords held that the receipt was not taxable. Lord Denning explained the conclusion as follows.

Hochstrasser v Mayes [2.80] Hochstrasser v Mayes [1960] AC 376 My Lords, tried by the touchstone of common sense – which is, perhaps, rather a rash test to take in a revenue matter – I regard this as a plain case. No one coming fresh to it, untrammelled by cases, could regard this £350 as a profit from the employment. Mr Mayes did not make a profit on the resale of the house. He made a loss. And even if he had made a profit, it would not have been taxable. How, then, can his loss be taxable, simply because he has been indemnified against it? I can readily appreciate the case which was put in argument – namely, that if an employer, by 42

[2.80]

way of reward for services, agrees to indemnify his employee against his losses on the Stock Exchange, the payments which the employee received under the indemnity would be taxable. But that would be because the losses were his own affair and nothing to do with his employment: the payments of indemnity would there be a straight reward for services. This payment of £350 was nothing of that kind. It was a loss which Mr Mayes incurred in consequence of his employment and his employers indemnified him against it. I cannot see that he gets any profit

Fundamental Principles of the Income Tax System

Hochstrasser v Mayes cont. therefrom. If Mr Mayes had been injured at work and received money compensation for his injuries, no one would suggest that it was a profit from his employment. Nor so here, where all he receives is compensation for his loss. Why, then, if this case is as plain as I think it is, has it got so far as to reach your Lordships’ House? Only, I suggest, because of a broad proposition which the Crown advanced about “profits”. This proposition was put forward almost as if it were a definition of what the law regards as the “profits” of an employment. It was supported with quite a show of authority. So much so that the Court of Appeal were induced to accept it as correct – though the majority, to be sure, refused to hold that it applied in this case. I need hardly say that, if there were available to your Lordships a definition of “profits”, it would be a pearl of great price. But I am afraid that this pearl turned out to be cultivated and not real. It was culled

CHAPTER 2

from the cases and not from the statute. It did not survive the critical examination of your Lordships. When subjected to close scrutiny, it was found to be studded with ambiguities and defaced by exceptions. It would, if accepted, put a greater burden on the taxpayer than ever the statute warrants, and it would introduce more confusion into a subject where enough already exists. I would ask your Lordships, therefore, to put on one side the proposition submitted by the Crown and to go back to the words of the statute. I do not find much help in any of the previous decisions: and the speeches in them cannot rule the day. They show the way in which judges look at cases, and in that sense are useful and suggestive, but in the last resort each case must be brought back to the test of the statutory words. So tested the question simply is: was this £350 received by Mr Mayes a “profit” from his employment? I think not, for the simple reason that it was not a remuneration or reward or return for his services in any sense of the word.

[2.90] The fringe benefits tax and capital gains tax may now affect the outcome in both the

case and analogous situations (though not always clearly so). The reasoning of the remainder of the House of Lords in Hochstrasser v Mayes was different from Lord Denning. They held that the payment was not taxable as it was the equivalent of a gift by the employer to the employee unrelated to the employee’s services. There are many cases dealing with gifts to employees, some of which are extracted in Chapter 4. It may be doubted whether the reasoning of the majority of the House of Lords in this case is consistent with the principles emerging from those cases.

(c) Statutory Modifications to Ordinary Income and the 1985 Tax Reforms [2.100] Although the judicial concept of income has moved over time in Australia, the speed of change has been too slow for the legislature which has intervened increasingly from the 1980s to correct perceived aberrations in the law. Until 1985, much of the legislative intervention was simple repair of the law, but since then the interventions have changed the face of Australian income tax law so as to reduce greatly the practical significance of the concept of ordinary income in the sense that many gains falling outside ordinary income are now usually subject to tax. The reforms in the area of the income tax announced on 19 September 1985 are often described as “base broadening” measures by which is meant the reforms bring the income tax base as it operates under the law closer to the comprehensive tax base of Simons. Although the changes were many, two stand out: the capital gains tax and the fringe benefits tax. It has [2.100]

43

Income Tax in Context

already been explained that the judicial concept of income did not generally include profits made on the sale of capital assets (capital gains). Some statutory changes had been made to the judicial rules before 1985, for example, profits on property purchased and sold within 12 months had been taxable under s 26AAA of the ITAA 1936 (which was repealed with effect for sales occurring after 25 May 1988), but now generally all assets acquired after 19 September 1985 are subject to tax as capital gains under Pts 3-1 and 3-3 of the ITAA 1997. Although it is common to speak of the capital gains tax as if it were separate from the income tax, in fact the tax works by an inclusion of net capital gains in assessable income as statutory income under s 6-10 by the effect of s 102-5 of the ITAA 1997. Nonetheless the calculation of the tax payable on capital gains is the subject of many special rules and calculations and the capital gains tax is often for convenience spoken of as if it were separate from the income tax. In general terms, the capital gains tax operates to tax a profit made on the happening of a CGT event, most commonly the disposal of an asset that was acquired on or after 20 September 1985. Capital gains will be studied in greater detail in Chapter 3. It will then become apparent that the so-called capital gains tax not only applies to profits made on the sale of assets, but also catches a number of other gains that escaped the income tax prior to 1985. The other major base-broadening initiative of 19 September 1985 was the fringe benefits tax. Here the problem under the previous system was of a different kind to that dealt with by the capital gains tax. Fringe benefits are benefits, usually in kind, given by employers to employees in addition to salary or wages, such as the use of a company car for private use by the employee. There had long been in the income tax a provision designed to tax such benefits to employees, namely s 26(e) of the ITAA 1936, now s 15-2 of the ITAA 1997, but because the provision did not provide any specific guidance on the valuation for tax purposes of the various kinds of benefits to which it could apply, it was not generally enforced at the administrative level. As a result, the use of fringe benefits, especially in the case of high-income employees such as company executives, grew enormously in the 1970s and early 1980s. The fringe benefits tax is designed to provide the concrete valuation rules and collection mechanism to ensure that tax is collected on fringe benefits. Partly for administrative convenience and partly for political reasons, the tax is levied on the employer and not the employee, but nonetheless the tax should be considered as part of the income tax in the comprehensive sense. Although the structural changes to the tax legislation in the capital gains tax and the fringe benefits tax are fundamental to the income tax system, in general they build on the existing edifice of ordinary income rather than demolishing it. An understanding of the current legislation and the impact of the 1985 tax reforms is therefore best obtained by starting with ordinary income. Hence in most chapters of this book the materials will begin with the legislation and cases on the pre-1985 law, and then the impact of the 1985 tax reform measures on that law will be assessed. Coincidentally Parsons’ text on the income tax referred to above was published in 1985 and thus encapsulates the income tax system as it was just before the 1985 tax reform. The text is now often quoted by judges as the authoritative text on income according to ordinary concepts. It is available online at http:// www.setis.library.usyd.edu.au/oztexts/parsons.html. 44

[2.100]

Fundamental Principles of the Income Tax System

CHAPTER 2

2. ELEMENTS OF THE JUDICIAL CONCEPT OF INCOME [2.110] The following four chapters explore in detail the boundaries of the judicial concept of

income as it applies to different categories of cases. Some fundamental features which characterise ordinary income generally will arise time and again throughout those materials. This section of this chapter explores these basic foundations. You should try to keep these materials in mind as you read the next chapters and identify how each concept is applied in the particular instances looked at in those chapters. The income tax is levied on particular taxpayers at particular times in particular Australian dollar amounts, but it is not always easy to identify who is the relevant taxpayer, what is the relevant time for taxing the income, and what is the amount of the income. For example, if a landlord rents premises for 10 years to a tenant on the basis that the tenant pays the rent to the landlord’s spouse, who is to be taxed on the rent, the landlord or the spouse? If the rent is to consist of the transfer every two years to the spouse of certain company shares owned by the tenant, when is the rental income derived? And if the shares will probably have different values every two years, how much income is there?

(a) Realisation – Income as a Flow [2.120] We saw above that Simons was of the view that whatever the theoretical ideal, in most

cases practical considerations will mean income can only be taxed when it is realised, that is, severed from its source, and not as it accrues. This realisation principle for a time achieved quasi-constitutional status in the United States in Eisner v Macomber (extracted above). The realisation requirement provides a general timing rule for the taxation of income which is implicitly accepted as part of Australian income tax law (though there are many more specific statutory rules which express the general concept of realisation and even a few which contradict this requirement). An example of the realisation requirement is that tax is not collected from the owner of a share in a company which has just earned substantial profits until either the profits are distributed to the shareholder as dividends or the shareholder sells the shares and collects the value of the profits from the purchaser. In other words, the requirement of realisation before an amount can be defined to be income postpones the time at which accretions to economic power are taxed until the time when the appropriate event “releasing” the gain occurs. But does the realisation requirement have a deeper significance? On occasions, the realisation notion seems to be used to justify a corollary – that an amount which is realised must be income, without the need to find any real accretion to economic power. The proposition that an amount is not income until realised becomes confused with a proposition that an amount which is realised must be income. R W Parsons takes up this point and argues that realisation is inextricably tied to a concept of income other than gain, that is, income as a flow.

R W Parsons, “Income Taxation: An Institution in Decay?” [2.130] R W Parsons, “Income Taxation: An Institution in Decay?” (1986) 3 Australian Tax Forum 233 The trust law concept of income is built on the idea of flows, which Simons rejects. The flows that are income are commonly identified, in judicial statements about the concept of income,

as dividends, interest, rent and royalties and proceeds of a business. There is another flow, that from human capital, which is the judicial explanation of how it is that rewards for services [2.130]

45

Income Tax in Context

R W Parsons, “Income Taxation: An Institution in Decay?” cont.

royalty receipts. There will be no accretion to economic power if the proceeds of sale of goods do not exceed their cost.

are income, without regard for the costs of human capital consumed in performing those services. To describe these as flows is to call on a metaphor. Metaphors and Latin are used by lawyers as substitutes for, and not aids to analysis. It may be more helpful to say that a flow is the consequence of some act or event in relation to property that is seen as capital, which triggers a receipt by the owner which is not a receipt in realisation of that property. The act or event may be the declaration of a dividend, or the coming of a day when interest is due, or the grant of a lease or licence, or the sale of goods in the course of business operations. The flow may be an accretion to economic power, a phrase that Simons made his own as a description of a gain, but often it will not be. In the case of a dividend on a share, there will not generally be an accretion to economic power if the dividend is received immediately after the acquisition of a share purchased cum dividend or the share has fallen in value since it was acquired. In the case of interest on debentures, there will not generally be a realised accretion to economic power if the debenture was purchased immediately before the due date for payment of interest, or if, as a result of an increase in interest rates, the debenture has fallen in value since it was acquired. Nor will there generally be an accretion to economic power if the new owner of property not yet leased, immediately leases the property and takes rent in advance, or a premium. There has been only a conversion to cash of some part of the new owner’s property rights – the right to possession – which one might expect to be reflected in a decline in the value of his property rights that remain following the conversion. The allowing by the owner of the use of an asset may generate flows in the form of royalties, but there will be no gain to the owner if use will cause a diminution of the value of his property below its cost, and that diminution equals or exceeds the amount of the

The lawyer’s response to Simons is to say that, however inspiring Simons may be, his ideas belong in some other world and are beyond achievement on earth. Simons sought to answer that challenge by conceding that (at 207): The proper underlying conception of income cannot be directly and fully applied in the determination of year-toyear assessments. Outright abandonment of the realisation criterion would be utter folly; no workable scheme can require that taxpayers reappraise and report all their assets annually; and, while this procedure is implied by the underlying definition of income, it is quite unnecessary to effective application of that definition … The recognition of capital gains and losses may wisely be postponed while the property remains in an owner’s possession. The concession goes far towards destroying Simons’ revelation. If “appraisals” of value are to be avoided, the gains in the value of property that will be included in the base of the income tax will be confined to gains realised on disposal. And flows will continue to be included whether or not they reflect gains. If flows that are income are to be confined to gains, there will be need of a valuation of the shares on which dividends have been received; of the debenture on which interest has been received; of the property on which a lease premium has been received; and of the property in respect of which royalties have been received. That valuation must be made after the receipt of the dividends, interest, premium or royalties. If, for example, the payment of a dividend has reduced the value of the shares below their cost to the taxpayer who receives the dividend there is gain only to the extent that the dividend exceeds the reduction in value below cost.

[2.140] You will see many examples in the next four chapters of the constant tension between

the competing gain and flow notions of income. Unfortunately, despite the efforts of Simons to 46

[2.140]

Fundamental Principles of the Income Tax System

CHAPTER 2

tie the economic meaning of income exclusively to the gain notion, it is clear that tax law tries to embrace both notions simultaneously even though they may be in fundamental conflict. [2.145]

Questions

2.3

Do you agree with Parsons that the realisation requirement contradicts the notion of income as economic gain?

2.4

Is the notion of income as a flow a better explanation of the current law on what is income than the concept of gain? (You may wish to reconsider this question after more detailed study of Chapters 3 to 6.)

2.5

Are the United States cases of Eisner v Macomber (extracted above) and Commissioner v Glenshaw Glass Co (referred to above) more consistent with a flow concept of income or a gain concept? The realisation requirement is expressed in Australian law in the timing rules covered in Chapters 11 and 12. In brief, a taxpayer is required to account for tax purposes on one of two bases: a cash/receipts basis (that is, when an item is actually received); or on an accruals/ earnings basis (that is, generally when a right to receive an item arises). Generally speaking, employees will be on a cash basis and businesses on an earnings basis. (Beware the word “accruals” in income tax law. Sometimes it is used to refer to mere increases in value without any realisation having occurred, while at other times it is used to describe the particular case of realisation in the form of a right to receive a payment having arisen.) A realisation will give rise to assessable income if it has an income nature within the many rules on that topic: see Chapters 3 to 6.

(b) Identifying the Taxpayer and the Taxable Event [2.150] The rules referred to in the previous paragraph do not serve to identify the taxpayer in ambiguous cases. Rather, they assume that the taxpayer is identified. Although the correct taxpayer usually is self-evident, the Australian Taxation Office (ATO) found to its cost in Federal Coke Co Pty Ltd v FCT that the self-evident taxpayer is not always the correct taxpayer. Bellambi Coal Company Pty Ltd (Bellambi) was a coal mining company and the parent of coke-producing subsidiaries, one of which was Federal Coke. The arrangement between the companies was for Bellambi to supply coal to Federal Coke who would convert it to coke for a fee (ownership of the coal/coke remained at all times with Bellambi). In April 1970 Bellambi contracted to supply coke to Le Nickel SA, a French nickel processing company, and proposed to upgrade Federal Coke’s coking works to meet the contract. After a downturn in world demand for nickel, Le Nickel sought variation of the contract. Le Nickel agreed to pay $1 m to Bellambi for the variation in two equal instalments and forwarded the first instalment to Bellambi. Having sought tax advice, Bellambi refused the payment and under a renegotiated agreement Le Nickel agreed to pay the $1 m to Federal Coke in consideration of the closure of the company’s coking works necessitated by the change to the supply contract between Bellambi and Le Nickel. The ATO assessed the sums in the years they were received as income to Federal Coke. He argued that if the sums had been received by Bellambi they would have been assessable and therefore they were equally assessable to Federal Coke. Bowen CJ considered that the sums may well have been income if received by Bellambi, on a number of possible bases. [2.150]

47

Income Tax in Context

Federal Coke Co Pty Ltd v FCT [2.160] Federal Coke Co Pty Ltd v FCT (1977) 7 ATR 519; 77 ATC 4255 Had an assessment then been raised against Bellambi, it might perhaps have been argued that the $500,000 which Bellambi refused to accept had accrued due to Bellambi as income and had been paid by Le Nickel to a subsidiary of Bellambi in accordance with the order and directions of Bellambi … In the result, none of these bases of assessment were adopted by the Commissioner. He assessed Federal upon the receipts so that the question for determination by the court is not what would have been the character of the receipts in the hands of Bellambi, but what, for the purposes of income tax, is the character of the receipts in the hands of Federal … Counsel for the Commissioner further submitted that the payments were to compensate Bellambi for loss of profits and for this reason acquired an income character and that they retained this character and did not lose it when the deed was interposed whereby the arrangement was altered and the payments were made to Federal. Nothing had been done, so it was argued, which would indicate that the character of the payments was altered … But under the deed of 22 March 1972, they were not received by Bellambi. A consequence of this is that one of the factors, which would have

[2.165]

impressed them with the character of income, disappears. One is left only with the method of formulation and the original purpose of Bellambi and Le Nickel. It appears to me that this is insufficient to impress upon the sum an essential and unchangeable character of income. Indeed, it appears to me that the starting point of this argument for the Commissioner is wrong. When one is considering the character of an amount received by a taxpayer, the inquiry must start with the question: what is the character of the receipt in the hands of the taxpayer? It appears to me to be wrong to ask: what would have been the character of the amounts had they been received by Bellambi? And then to pose the question: has their character been changed by the fact that they were paid to Federal Coke? One must, I think, pose the essential question and start from that question: what is the nature of the receipts in the hands of Federal? It then becomes less than decisive to observe that, in their origin, and if they had been received by Bellambi, they may have been of an income character. Each receipt in the hands of Federal is broadly in the nature of a gift, being a sum received without consideration. [He went on to hold that the gift was not assessable to Federal Coke: see Chapter 6.]

Questions

2.6

Why did Federal Coke escape taxation? For what fundamental principle of income taxation is the case authority?

2.7

Section 6-5 of the ITAA 1997 speaks of “income … derived” by a person and so suggests that a receipt may have an income character independent of its derivation (receipt) by the person. Is this reasoning consistent with Federal Coke?

2.8

If a business person assigns receivables arising from the business to a family member before the debts are due for payment, will the family member receive income? Would it make any difference if the business person did not assign the receivables but directed payment to a family member?

2.9

Would Federal Coke nowadays be taxed under capital gains provisions, especially CGT event H2, s 104-155 of the ITAA 1997? (See Chapter 3.)

48

[2.160]

Fundamental Principles of the Income Tax System

CHAPTER 2

(i) Constructive receipt [2.170] The result in Federal Coke (above) may suggest that virtually all taxpayers may be

able to avoid income tax simply by directing payment of the income to a related party. For example, all wage earners could direct their employer to pay their wages to their spouse or their mortgagee. The case, however, left open the question of whether Bellambi was taxable on the payment. This is a real possibility because of s 6-5(4) of the ITAA 1997 (formerly s 19 of the ITAA 1936) which is directed to this kind of situation, that may be conveniently referred to as constructive receipt. Under the constructive receipt concept, a payment received by one party is treated as having been first (constructively) received by another party and then paid over to the actual recipient. Indeed, as Bellambi was a business taxpayer it presumably was accounting for tax purposes on an earnings basis and so the full $1 m could be treated as having been derived by Bellambi when it entered into the original agreement with Le Nickel. In order to prevent the income tax being subverted by payments directed in all manners to other parties, it would seem that a very extensive doctrine of constructive receipt is necessary; however, surprisingly there is little authority for it. Indeed the authorities may be thought to restrict the operation of the doctrine, for example, Permanent Trustee Co of NSW Ltd v FCT (1940) 2 AITR 109 at pp 110-11 and Brent v FCT (1971) 125 CLR 418; 2 ATR 563; 71 ATC 4195: see further Chapter 11. A more encouraging view is found in the following dicta of Latham CJ in Gair v FCT (1944) 71 CLR 388; 7 ATD 443: If X, not being a dealer in houses and land, sells his home to Y upon terms, and Y pays an instalment of the purchase money by transferring to X a right which he (X) has to receive, a sum due to him by way of salary, then, though, if Y had received the salary, the money would have been part of his income, when it is received by X in part payment for the house which he has sold, it is certainly not part of the income of X. He would receive merely part of the consideration for the sale of a capital asset. If Y were to deal with his salary in this way, he would be liable to tax upon the amount of the salary with which he had so dealt, because the Income Tax Assessment Act, s 19, provides that “income shall be deemed to have been derived by a person although it is not actually paid over to him but is … dealt with on his behalf or as he directs”. Accordingly, the amount of salary would have been part of Y’s assessable income, but it would not have been part of X’s assessable income. Thus the same sum of money may be income in relation to one person and capital in relation to another. [2.175]

2.10

2.11

2.12

2.13

Questions

Consider the position of Bellambi Coal Company Pty Ltd in Federal Coke Pty Ltd v FCT in light of the doctrine of constructive receipt. Should the assessment have been issued to Bellambi? What happens (apart from FBT) when an employer pays an employee’s child’s private school fees? (See Case 61 (1979) 23 CTBR (NS) 537; Case L54 (1979) 79 ATC 399.) Does it matter whether the employee previously paid the fees or whether the employee is under a contractual liability to pay the fees? In Heaton v Bell [1970] AC 728, the House of Lords held that an employee was taxable on a constructive receipt basis when the employee accepted a reduction in salary in exchange for the use of a car (the employee being able to cancel the deal at any time and revert to the previous salary). What does this suggest is required for salary packaging in order to avoid the employee being treated as having in effect received salary which is then used to purchase a benefit? See the Ruling on salary sacrifice, TR 2001/10. Do the changes in wording in the ITAA 1997 in relation to constructive receipt represent any change in the former law? Do they affect salary packaging? [2.175]

49

Income Tax in Context

2.14

Would the result in Federal Coke under current law be that Bellambi would be subject to income tax and Federal Coke to CGT? (See Question 2.9 above in relation to CGT.)

2.15

The Court in Federal Coke did not consider the significance of the fact that Bellambi was an earnings basis taxpayer, in which case it would have possibly derived the settlement amount when it became entitled to the amount. This occurred on the making of the original deed, prior to the alteration under which the money was paid to Federal Coke. Does this make a difference to your answer to Question 2.10?

(ii) Benefits received from intermediaries [2.180] Even where the taxpayer and the basis on which the taxpayer is accounting (cash or

accruals) are clear, there may be a question of the appropriate event to treat as a realisation, and whether the necessary income characteristics are present at that time. This type of problem is typified by Constable v FCT. The taxpayer was an employee of Shell Co of Australia Ltd, an oil company. Both the taxpayer and his employer were contributing members to a superannuation trust fund, the taxpayer (employee) contributing 10% of his salary, which was recoverable in certain events. The employer contributed equal amounts to the fund, but the taxpayer’s entitlement to these contributions was contingent. For example, if the member retired before a certain period of service or before a certain age, he was not entitled to the employer’s contributions. Under Art 23 of the trust deed, if the fund altered the regulations so that the rights or obligations of the members were changed in various ways, then any member was entitled to withdraw the amount credited to the member’s account in the fund, including the member’s own contributions, employer contributions and interest on both. As a result of changes to superannuation arrangements in the oil industry, the rules were changed to prevent any new members being admitted to the fund. This was an event within Art 23 of the trust deed and the taxpayer withdrew £403 in the 1947–1948 year of income. The Commissioner assessed the taxpayer under s 26(e) of the ITAA 1936 (s 15-2 of the ITAA 1997) to tax on the amounts representing: 1. the employer contributions; 2. interest on employer contributions; and 3. interest on employee contributions. It was assumed that the employee’s contributions were paid out of income which had already been derived by the employee at the time of the payment of salary, even though the amounts of contributions were never actually received by the employee (since they were withheld from the employee’s salary and sent directly by the employer to the fund). This is an example of constructive receipt. This element of the payout sum was not in issue. All members of the High Court held that the remaining elements of the payout were not assessable to the taxpayer, though there were different reasons given by the majority Dixon CJ, McTiernan, Williams and Fullagar JJ, on the one hand, and Webb J, on the other. The majority reasoned as follows.

Constable v FCT [2.190] Constable v FCT (1952) 86 CLR 402; 5 AITR 371; 10 ATD 93 Section 26(e) provides that:

50

[2.180]

The assessable income of a taxpayer shall include the value to him of all allowances, gratuities, compensation,

Fundamental Principles of the Income Tax System

Constable v FCT cont. benefits, bonuses and premiums allowed, given or granted to him in respect of, or for or in relation directly or indirectly to, any employment of or services rendered by him, whether so allowed, given or granted in money, goods, land, meals, sustenance, the use of premises or quarters or otherwise … Upon the text of the paragraph it would seem that the liability of the sum, or any part of the sum, received by the present taxpayer during the year of income to inclusion in his assessable income must depend upon the answers to one or other or all of the following questions. Can that sum or any part of it be described as an allowance, gratuity, compensation, benefit, bonus or premium? If so, can it be said of it that it was “allowed, given or granted to him” during that year? If an affirmative answer is given to these two questions, then is it correct to say of the amount or any part of it that it was so allowed, given or granted to him “in respect of, or for or in relation directly or indirectly, to any employment of him or services rendered by him”? The employment or services must be employment by, or services rendered to, the Shell Company of Australia Ltd. It is evident that it is enough for the taxpayer if any of the foregoing questions is answered in the negative … On these facts we are of opinion that, whether or not the payment or any part of it may be described as an allowance, gratuity, compensation, benefit, bonus or premium in respect of or for or in relation to the taxpayer’s employment or services rendered by him, it cannot correctly be said it was such an allowance, etc “allowed given or granted to him” during the year of income under assessment. It appears to us that the taxpayer became entitled to a payment out of the fund by reason of a contingency (viz: an alteration of the regulations curtailing the rights of members)

CHAPTER 2

which occurred in that year enabling him to call for the amount shown by his account. It was a contingent right that became absolute. The happening of the event which made it absolute did not, and could not, amount to an allowing giving or granting to him of any allowance, gratuity, compensation, benefit, bonus or premium. The fund existed as one to a share in which he had a contractual, if not a proprietary, title. His title was future, and indeed contingent or, at all events, conditional. All that occurred in the year of income with respect to the sum in question was that the future and contingent or conditional right became a right to present payment and payment was made accordingly. This, in our opinion, cannot bring the amount or any part of it within s 26(e). The amount received by the taxpayer from the fund is a capital sum, and, unless it or some part of it falls under s 26(e) (there being no other applicable imposition of liability), it is not part of the assessable income. While we prefer to place our decision of the case upon the simple ground stated, that does not mean that we think that the actual payments by the company to the fund in respect of the taxpayer formed, in the year in which they were so paid, any part of his assessable income. It is not, of course, a matter that arises for decision in the present case, but, to avoid misunderstanding, it is, we think, desirable to say that on the frame of the regulations we find it by no means easy to see how the sums so contributed can be regarded as allowed, granted or given to the employee when they are paid to the administrators of the fund. It is only after the administrators have exercised their discretion that any moneys paid to the special account are reflected in the member’s (employee’s) account, and even then that does not mean that the member becomes presently entitled to the moneys credited to that account. We do not think that s 19 can be used to eke out s 26(e) and extend its operation or application.

The difference in the judgment of Webb J concerns the treatment of contributions to the fund at the time of contribution. He said:

[2.190]

51

Income Tax in Context

[2.200] I think that the moneys paid into the fund by the company were, as counsel for the Commissioner submitted, really part of the remuneration of the appellant, or in any event were a “benefit … given or granted to him in respect of, or for or in relation directly or indirectly to” his employment, within s 26(e). Moreover, I think they became a benefit to the appellant as from the time when the company paid them into the fund. Upon such payment into the fund they ceased to be the property of the company and the payment then enured for the benefit of the appellant, although contingently on his serving for the necessary period to qualify to receive them (Article 16), which the appellant did in 1941. But I do not think that because the moneys in fact paid out of the fund to the appellant purported to be identified, in the yearly accounts given to him under Article 10 and in the receipts which he gave for these moneys, with moneys paid in by the company and interest thereon, that the moneys when paid out of the fund to the appellant still retained their identity as remuneration of the appellant and interest thereon. By Article 12 moneys of the fund, which included foundation moneys, were to be invested and earnings allocated to the members’ accounts among other accounts. Investment in the manner indicated in Article 12 would, I think, cause the moneys paid into the fund to lose their identity as remuneration of the employees. They were

[2.205]

invested, but a record was kept showing the exact amount of each contribution and interest earned thereon. The regulations required this to be done, as in certain cases they permitted payments to be made to an employee before his retirement of the amounts paid in by him and interest thereon; and also in some cases of the amounts paid in by his company. If the money received by the appellant from the fund had been paid to him without purporting to show how it was made up it could not, I think, have been held to be taxable as remuneration of the appellant in respect of his employment. But this requirement of the regulations was merely one of keeping a record and did not, I think, have the effect of preserving the identity of the moneys in the fund as employers’ and employees’ contributions and interest thereon, so that when they were paid out of the fund to the appellant under Article 23 they still retained that character. In my opinion, then, the moneys paid out of the fund to the appellant were not moneys paid for or in respect of his employment; nor were they in the events that happened a retiring allowance. Moreover, they were of a capital nature. That applies also to the appellant’s contributions and interest thereon. For these reasons I think that none of the amounts in question was assessable income of the appellant.

Questions

2.16

What was the view of the majority concerning payments into the fund in Constable? Why was s 19 of the ITAA 1936 of no assistance? How does Webb J differ on this issue? What was the view of the majority concerning payments out of the fund? How, if at all, does Webb J differ on this issue?

2.17

The ITAA 1997 includes an additional provision for constructive receipt in s 6-10(3). Why is it expressed differently from s 6-5(4) of the ITAA 1997? Would it make any difference to the result in Constable? The result in Constable may have been complicated by the fact that a superannuation fund was involved and that special tax rules apply to such funds (see Chapter 4). The reasoning in the case gives no sign of this, however, and the case is still regarded as the basis in Australia for not taxing employees on employer contributions to superannuation funds at the time of contribution. Nowadays, most employer contributions to superannuation funds on behalf of employees are required by law to be vested from the outset. What, if anything, does this mean for the tax treatment of such employer contributions in the light of Constable?

2.18

52

[2.200]

Fundamental Principles of the Income Tax System

2.19

2.20

CHAPTER 2

An employer with 10 employees pays $1,000 per week to a trustee under a discretionary trust. The beneficiaries under the trust are the employees and their relations. Each week the trustee distributes varying amounts to the beneficiaries amounting in total to $1,000. Are the receipts of the employees or their relations under the trust, income? See Case 68 (1967) 13 CTBR (NS) 463; Case R50 16 TBRD. What is the effect of Constable on air tickets received under frequent flyer schemes? Does it matter if the tickets are received by the member of the scheme or a relation of the member? Does it matter if the miles were from flights paid for by the member’s employer or if the employer paid any membership fee? See Payne v FCT (1996) 66 FCR 299; 32 ATR 516; 96 ATC 4407 (extracted in Chapter 6), and Ruling TR 1999/6.

[2.210] If Constable is to be accepted at face value, it stands for a further fundamental

proposition that income characteristics have to be judged at the time when a receipt is claimed to be taxable by the ATO. The fact that at an earlier or later event it may have the relevant income characteristics is not to the point, just as it was not to the point in Federal Coke that the receipt may have had an income character in the hands of Bellambi. Thus, on the reasoning of the majority in Constable, the fact that the employer contribution may have had an income character when paid into the fund did not matter, as it was not constructively received then by the employee, and when actually received by the employee it no longer had the necessary income characteristics. Similar problems involving employee benefit trusts have recently attracted a great deal of media attention and been litigated in the courts: see Chapter 4. (iii) Amounts received but for the benefit of others [2.215] It was noted above [2.70] that the case law in Australia has also offered some

instances where the income tax problem is exactly the reverse – an amount has been received by someone but the person argues that the amount is not their income because it is being held by them for the benefit of someone else. Section 96 of the ITAA 1936 sets out the proposition that a trustee is not liable to tax on amounts they collect, except in the circumstances set out in the Act. Other provisions in Div 6 of the ITAA 1936 will then allocate the income tax liabilities among various parties involved in the trust, but this section probably captures an idea that already exists as part of the judicial notion of income. The High Court decision in Countess of Bective v FCT [1932] HCA 22 discussed above is an example of this idea. The Commissioner assessed the Countess on money received from the estate of her late husband which she received, as the guardian of their daughter, to pay for the daughter’s living expenses. Dixon J observed that, “the income of the trust fund appears to have been included in [the Countess’] assessment upon the view that she took it beneficially …” but, he observed, “if she is not an object intended to be benefited at all by the provision for maintenance, the payments ought not, in my opinion, to be included as assessable income of the taxpayer …”. The decision in Zobory v FCT (1995) 64 FCR 86; 30 ATR 412; 95 ATC 4251 is another example where this idea was successfully employed by a recipient but the argument is not always successful. The High Court decision in Howard v FCT [2014] HCA 21 is a recent example of a case where a taxpayer tried to invoke this principle, in order to avoid being assessed on money he had received. The taxpayer had been a participant in a joint venture which ultimately ended in an acrimonious and protracted legal dispute with some of the other joint venturers. Eventually the taxpayer was awarded damages but the taxpayer argued that [2.215]

53

Income Tax in Context

the amounts he received were not his income because he had been involved in the joint venture on behalf of his company and, in bringing the action, he was acting to vindicate the rights of the company. If anyone had to pay tax on the amount, it was the company for whom he was a trustee, and not him. Ultimately the High Court disagreed that the taxpayer owed any fiduciary duties to the company as a matter of law, and the Commissioner’s assessment of Howard personally was upheld. It is thus not always obvious whether a person is receiving money which properly belongs to another, or whether the person is receiving money in their own right, and thereafter becomes subject to various obligations. In the first case, the recipient is not deriving income, while in the second, the recipient is assessable on the amounts received and must therefore look to some explicit provision in the legislation to allow a deduction for the amounts which must then be disbursed.

(c) Valuation [2.220] Having identified the relevant taxpayer and the relevant time of income derivation, it

remains to assign a number of Australian dollars to the amount of assessable income: s 960-50 of the ITAA 1997 (until 2003, s 20(1) of the ITAA 1936). If the income is a cash amount, the valuation problem would seem to solve itself, but if the income is in another form, then it is necessary to provide a valuation test. Several possibilities suggest themselves: the amount that the provider spent to provide the benefit; the amount that the recipient would have had to spend to acquire the benefit; or the market value of the benefit, for example. At first sight, s 21 of the ITAA 1936 would seem to solve the problem and to indicate a simple market value test. Valuation has proved, however, not to be such a straightforward problem. First, the cases seem to ignore s 21 in favour of an English judicial test deriving from Tennant v Smith [1892] AC 150, which held that for the purposes of the relevant Schedule of the United Kingdom tax legislation, income had to be cash or convertible to cash. In that case, the taxpayer was a bank employee who was required as a condition of his employment to live in a flat above the bank, which was provided rent-free to him. He was specifically prohibited from subletting the flat and would have to leave the flat when he left the bank’s employment. The Revenue claimed that occupying the flat rent-free provided income of £50 to the taxpayer – why the Revenue decided upon £50 is not clear from the case – but, when combined with his salary, it had the effect of putting the taxpayer’s total income above an income threshold. The result of the case was that the employee’s total income fell below the threshold. But the exact principle for which Tennant v Smith is authority is not absolutely clear, as we shall see. Second, there is a subtlety present of the Federal Coke and Constable kind – what exactly is it that is being valued? For example, even in the simple case of a cash payment, if the payment is not due until well into the future, the present value of the right to the payment will be less than its face value: is the amount of income the face value of the payment or its present value? (You will see in later chapters that the treatment of the present value of future payments is a considerable problem under the income tax.) The basic valuation test that is applied under the income tax is exemplified in FCT v Cooke and Sherden. The taxpayers were engaged in selling home delivery soft drinks. The product, the areas to be covered, the trucks used and generally the whole infrastructure of the operation were supplied by the soft drink manufacturers, but the taxpayers were able to choose their own times for canvassing in the designated areas and acted as independent contractors. The taxpayers were provided with “free” holidays under a holiday scheme operated by the soft 54

[2.220]

Fundamental Principles of the Income Tax System

CHAPTER 2

drink manufacturers on the basis of satisfactory performance during the year. It was not possible to take a cash payment in lieu of the holidays and the tickets, accommodation, etc could not be transferred or sold. The ATO sought to tax the taxpayers on the amounts paid by the soft drink manufacturers for the holidays taken by the taxpayers under the scheme. The Full Federal Court held that the taxpayers were not taxable. Brennan, Deane and Toohey JJ (subsequently all members of the High Court) reasoned as follows.

FCT v Cooke and Sherden [2.230] FCT v Cooke and Sherden (1980) 10 ATR 696; 80 ATC 4140 It is convenient first to look at the concept of income, to which the Act frequently refers but which it does not define. Whether a receipt is to be treated as income or not is determined according to “the ordinary concepts and usages of mankind” … except where statute sweeps in particular receipts or amounts which would not ordinarily be taken to fall within the concept. There are other provisions which indicate the nature of an income receipt. By s 25, the gross income of a taxpayer is divided into assessable income and exempt income; by the definition of taxable income in … s 17 income tax at the rates declared by the Parliament is levied upon taxable income. The operation of this complex of provisions requires that taxable income must be, or be expressed as, a pecuniary amount. An item of income which could not be reckoned as money could not find its way into taxable income so as to be subjected to tax at a rate declared by the Parliament. And s 20 requires that income wherever derived and expenses wherever incurred be expressed in terms of Australian currency. So the Act sufficiently shows that the items of income are to be money or to be reckoned as money. Consistently with this notion, the Act makes particular provision for some nonpecuniary receipts by including within assessable income the value to the taxpayer of those receipts (see s 26(e) and (ea)), and thus brings a pecuniary amount to tax. The notion that the items of income are money or are to be reckoned as money accords with the ordinary concepts of income as “what comes into (the) pocket” to adapt Lord Macnaghten’s phrase in Tennant v Smith [1892] AC 150 at 164. That is not to say that income must be received as money; it is sufficient if what is received is in the form of money’s worth … Nor is it necessary that an item

of income be paid over to the taxpayer; it is sufficient, according to ordinary concepts and usages, that it be dealt with on his behalf or as he directs, as s 19 of the Act recognises. Although Tennant v Smith was concerned with the operation of legislation different in structure from the Income Tax Assessment Act 1936, some parts of their Lordships’ speeches applied ordinary conceptions to the construction of the terms of the Act there under consideration. Thus Lord Halsbury LC said (at 157): I come to the conclusion that the Act refers to money payments made to the person who receives them, though, of course, I do not deny that if substantial things of money value were capable of being turned into money they might for that purpose represent money’s worth and be therefore taxable. If a taxpayer receives a benefit which cannot be turned to pecuniary account, he has not received income as that term is understood according to ordinary concepts and usages. The conversion of an item into money may occur, of course, in a variety of ways. It is not desirable (even if it be possible) to define in advance the ways in which conversion may possibly occur in order that a non-pecuniary item of receipt might be treated as an item of income. However, it will not often occur that a benefit to be enjoyed by a taxpayer cannot be turned to pecuniary account if the benefit be given up, or if it be employed in the acquisition of some other right or commodity. If one were so to vary the facts of the present case that the tickets with which the taxpayers were provided could be surrendered by them for cash, the benefit which, on that hypothesis, the taxpayers would have received would have been [2.230]

55

Income Tax in Context

FCT v Cooke and Sherden cont. converted into money, and would have constituted income if the origins of the receipt gave that character to it. Indeed, as the authorities show, it is not necessary that the pecuniary alternative be available by way of direct conversion of the benefit received: Heaton v Bell [1970] AC 728; Abbott v Philbin [1961] AC 352. In Heaton v Bell the taxpayer was an employee of a company which had introduced a voluntary car loan scheme for certain employees. Under the scheme the company bought cars, insured them, paid road fund tax and lent them to employees from whose weekly wages money was deducted according to the type of car on loan. If an employee cancelled the arrangement, as he was free to do on notice, the deduction from his pay ceased. By a majority it was held that on the true interpretation of the arrangement between company and employee, the monetary wage remained unaltered and that accordingly the respondent’s emoluments, taxable under Schedule E of the Income Tax Act 1952 were his gross wage before deduction. On that footing, of course, the relevant receipt was the monetary wage, part of which was applied to the hire of the car. But an alternative basis of assessment was upheld by a majority of their Lordships who held that the free hire of the car was a “perquisite” of the taxpayer’s employment because he could have surrendered the free hire of the car and become entitled to a higher monetary wage than he was receiving … [T]he respondents in the present cases could not have turned the benefits in fact received by

them to pecuniary account. It is immaterial that the respondents would have had to expend money themselves had they wished to provide holidays for themselves. If the receipt of an item saves a taxpayer from incurring expenditure, the saving is not income; income is what comes in, it is not what is saved from going out. A nonpecuniary receipt can be income if it can be converted into money; but if it be inconvertible, it does not become income merely because it saves expenditure. The holidays which were enjoyed by the taxpayers in the present case provided them, at a cost to the manufacturers, with a non-convertible benefit. It seems curious that a benefit which has cost money is not convertible into money, either by sale or by some less direct mode of realisation, and it may be that cases of this kind are to be found only where the benefit is gratuitously provided. If this be so, the inconvertible benefit falls outside the revenue net not because it is a gratuity, for a taxpayer may receive as income a benefit gratuitously provided … it falls outside the revenue net because it is not money or money’s worth, and there is no statutory provision which widens the net to catch it. In particular, it falls outside s 20 which brings to tax the money value of consideration which is paid or given upon any transaction otherwise than in cash. In the present case, the Commissioner disavowed any reliance on that section … The benefit not being convertible into money or money’s worth, there was no receipt of income according to ordinary concepts, and the assessments are not supported by s 25(1). The alternative foundation is s 26(e).

[2.240] The Court held that s 26(e) of the ITAA 1936 (s 15-2 of the ITAA 1997) was not

applicable, as the taxpayers were not employees of the soft drink manufacturers nor were the taxpayers rendering services to them; rather the taxpayers were engaged in the business of buying the soft drinks from the manufacturers and selling the products on their own account. [2.245]

2.21

2.22

56

Questions

How is income not in cash or its equivalent brought to account for tax purposes in a money sum? Why does a non-convertible benefit in kind go untaxed on ordinary income concepts? What conditions are required to make a benefit non-convertible? Can the distinction between cash and accruals tax accounting produce any difference in the amount

[2.240]

Fundamental Principles of the Income Tax System

CHAPTER 2

brought to tax as ordinary income (because the time of taxation arises in the latter case before the payment is received)? Consider, for example, Burrill v FCT (1996) 67 FCR 519; 33 ATR 133; 96 ATC 4629. 2.23

A taxpayer invests $5,000 with a finance company in debentures that do not pay interest but provide the taxpayer with the rent-free personal use of a colour television set. Is the taxpayer taxable on the use of the set? See Dawson v IRC (1978) 78 ATC 6012.

2.24

What if the finance company in Question 2.23 provided, instead of the television set, a suit which cost $500 and which the taxpayer could sell for $200 (second-hand value)? See Wilkins v Rogerson [1961] Ch 133.

2.25

If the holidays had been held to be taxable in Cooke and Sherden, what amount should have been brought to tax? Should it make any difference that the taxpayers were engaged in business and presumably on an earnings basis of tax accounting?

[2.250] The actual decision in Cooke and Sherden was reversed some years later by s 21A of

the ITAA 1936 in the business context (see Chapter 5) but the principle that it espouses remains the general principle. There is a significant issue about the relationship between the valuation rules and the meaning of income in the judicial concept of income arising out of Cooke and Sherden, and it is important to be clear about the exact principle that emerges from cases such as Tennant v Smith. The case may be trying to say one of two things: either, that because the value of the flat could not be turned into cash, the employee did not derive income; or, because the value of the flat could not be turned into cash, the employee derived income of zero. In other words, the case may be stating a principle that what the employee has is not income or that the employee does have income but its value is to be recorded at zero. The difference is important because some sections of the income tax legislation such as s 15-2 of the ITAA 1997 set out a different valuation rule from this “realisable value” test. Those sections will be effective to change the zero value to something else but that may not be enough to make the amount taxable. In other words, all that they may achieve is to give a non-income amount a different value, not to turn it into an income amount. While the language of Tennant v Smith is less than clear about which principle it is stating, it is suggested that the correct principle that emerges from Tennant v Smith is simply the valuation rule: that a benefit which cannot be turned into cash is (or is not) income with a zero value. You may wish to reread the extract from Cooke and Sherden above to decide which view it is expressing. Share options given to employees as part of their salary raise both valuation and derivation issues. The problems are well displayed in Abbott v Philbin and the later Australian decision in Donaldson v FCT [1974] 1 NSWLR 627; 4 ATR 530; 74 ATC 4192 (extracted in Chapter 4). In 1954 Abbott paid £20 for an option to purchase 2,000 shares in the company which employed him. The option was exercisable at any time over the next 10 years at the price of 68s 6d, which was the market price of the shares at the time the option was granted. By 1956 the value of the shares had risen to 82s and he exercised his option in respect of 250 shares, paying the agreed price of 68s 6d and retaining the shares. The Revenue included £166 in his assessable income in 1956, being the difference between the option price and current market price. The House of Lords by a majority held expressly that no amount could be included as income in 1956. Their Lordships also implied that any tax consequences arose only in 1954 when the option had been granted. [2.250]

57

Income Tax in Context

In finding against the Revenue, the House of Lords had to contend with the rule in Tennant v Smith. The possible application of this rule arose because the terms of the grant of the option prevented the taxpayer from assigning the option. This was probably the reason that the Revenue had waited until some convertible benefit was generated in 1956 before assessing the taxpayer. So in this case it was the Revenue rather than the taxpayer who relied upon Tennant v Smith because it aided their argument that there was no income in 1954, but only in 1956. Viscount Simonds observed:

Abbott v Philbin [2.260] Abbott v Philbin [1961] AC 352 How, then, can it be said that an option to take up shares at a certain price is not a valuable or at least a potentially valuable right? Its genesis is in the desire of the company to give a benefit to its employees and at the same time, no doubt, to enhance their interest in its prosperity. It is something which the employee thinks it worth his while to pay for: not a large sum truly, but £20 deserves a second thought. And it is something which can assuredly be turned to pecuniary account. This was challenged because the option was itself not transferable, but this objection is without substance. There was no bar, express or implied, to a sale of the shares as soon as the option was exercised and there could be no difficulty in the grantee arranging with a third party that he would exercise the option and transfer the shares to him … I have little doubt that, if the Revenue authorities had addressed their minds to the proper question, they could have ascertained whether it had any and what value. But … I must say that it is really irrelevant whether a value could be ascribed to it or not. If it had no ascertainable value then it was a perquisite of no value – a conclusion difficult to reach since

£20 was paid for it. In my opinion, the Crown cannot succeed in this essential aspect of the case unless it is established as a general proposition that an option to acquire shares at a fixed price in such circumstances as those of the present case is not a perquisite of office. It must be shown that, even if at the date of the option being granted the market price is higher than the option price, the option is not a perquisite which falls within the Schedule. This appears to me an impossible proposition. What distinguishes such a right from that commonly given to a shareholder in a commercial company, when upon an issue of shares he is given in the form of a provisional allotment letter the right to take up new shares at a certain price? He can exercise his right and take up the shares or he can sell his right to do so, or he can do neither and let the offer go by default. But from the moment he has the letter he has a right of more or less value according to the circumstances. So, too, the grantee of such an option as that which we are considering has a right which is of its nature valuable and can be turned to pecuniary account. He has something at once assessable to tax.

[2.270] There are now specific provisions dealing with employee share schemes in Pt III

Div 13A of the ITAA 1936 which are discussed in Chapter 4. Although the principle in Tennant v Smith has been reversed in a number of specific contexts, it is mystifying why the legislature simply does not reverse the principle generally. A related question to valuation is how the tax system handles cases where amounts change after the tax relevant event or transaction occurs, for example, a person repays an amount because the price was wrongly calculated. In Australia it has been established that there are no general principles which simply reverse the original tax treatment to the necessary extent to give effect to the change. In dealing with ordinary income it is necessary to analyse the subsequent events or transaction giving rise to the change to decide whether they give rise 58

[2.260]

Fundamental Principles of the Income Tax System

CHAPTER 2

independently to ordinary income (or a deduction). This result, which is analysed in detail in Chapter 6, is consistent with the approach to the issues considered in this chapter. As a result, there are many statutory provisions dealing with the issue that are referred to throughout this book, but again there is still no broad statutory enactment of a general principle.

(d) Apportionment [2.280] The final issue that may arise in deciding the income character of a receipt or of

determining the amount of assessable income in a receipt is apportionment. It is possible that a taxpayer may receive a payment in respect of a number of matters, some of which are clearly of an income character and some of which are clearly not of an income nature. In such a case the ATO will seek to apportion the amount into its income and non-income elements but the tax authority’s power to do so in Australia seems to be very circumscribed and if apportionment is not possible the payment is treated as not being income at all. The leading authority on apportionment is McLaurin v FCT (1961) 104 CLR 381; 8 AITR 180; 1 ATD 273. The taxpayer was a grazier whose land, fixtures, chattels and stock were extensively damaged by a fire which commenced on an adjoining property owned by the Commissioner of Railways. The taxpayer commenced an action against the Commissioner of Railways and claimed that losses to the value of £30,000 were incurred. The valuation was the sum of the items on a list of expenses compiled for the action. A lump sum of £12,350 was paid out of court in full settlement of the taxpayer’s claim. This figure was recommended by a valuer for the Commissioner of Railways and was based on a list of particular items of damage. However, the taxpayer was never informed of the means by which the lump sum was calculated. The Commissioner of Taxation sought to assess the taxpayer to £10,640 of the sum on the basis that this represented the compensation for damage to items on income account on the basis of the Commissioner of Railway’s list. It was contended that where a sum had capital and income components, then it must be dissected. (The excluded component related to compensation for damage to capital items.) The High Court held that none of the payment was assessable.

McLaurin v FCT [2.290] McLaurin v FCT (1961) 104 CLR 381; 8 AITR 180; 1 ATD 273 It is difficult in these circumstances to see how the dissection which the respondent has made can possibly be justified. All that has been urged in support of it is that the Commissioner for Railways should be considered to have paid the £12,350 as the total of the separate amounts which were allowed in [the valuer’s] list, and that each of those amounts must be separately included in or excluded from the appellant’s assessable income upon consideration of the nature of the item to which it related in the list. The submission neither accords with fact nor squares with legal principle. It does not accord with fact, for an account of the manner in which [the valuer] reached his total is only an account of his reasons for the

recommendation he made to the Assistant Solicitor for Railways; and even though those reasons may have been adopted by that officer, or even by the Commissioner for Railways himself, the offer that was made was not of a total of itemised amounts, but was a single undissected amount. And in point of law it would plainly be unsound to allow a determination of the character of a receipt in the hands of the recipient to be affected by a consideration of the uncommunicated reasoning which led the payer to agree to pay it. It is true that in a proper case a single payment or receipt of a mixed nature may be apportioned amongst the several heads to which it relates and [2.290]

59

Income Tax in Context

McLaurin v FCT cont. an income or non-income nature attributed to portions of it accordingly … But while it may be appropriate to follow such a course where the payment or receipt is in settlement of distinct claims of which some at least are liquidated (cf Carter v Wadman (1946) 28 Tax Cas 41) or are otherwise ascertainable by calculation (cf Tilley v Wales [1943] AC 386) it cannot be appropriate where the payment or receipt is in respect of a claim or claims for unliquidated damages only and is made or accepted under a compromise which treats it as a single, undissected amount of damages. In such a case the amount must be considered as a whole: Du Cros v Ryall (1935) 19 Tax Cas 444 at 453 …

[2.295]

But it is impossible to see a basis in fact for the contention that the £12,350 which the appellant accepted in settlement of his claims for every kind of damage which the fire had caused him was in truth of the nature of compensation for loss of profits. The fire caused him losses of sheep and cattle, and damage to wool on surviving sheep; it put him to expense for the eradication of rabbits to the incursion of which the destruction of fences had exposed the property, it also caused losses of or damage to capital assets such as pastures, fencing and buildings. But the whole of the damage which it did, whether covered by the appellant’s list of particulars or not, was compensated for by the one entire sum; and it is simply not true that that sum took the place in the appellant’s hands of assessable income.

Questions

2.26

What is meant by claims being ascertainable by calculation if the basis adopted by one party is not able to be used? Would it have made any difference if the taxpayer in McLaurin was aware of the calculations of the valuer for the Commissioner of Railways but had not accepted them, though agreeing to accept the total sum offered?

2.27

In Tilley v Wales [1943] AC 386, the taxpayer was assessed on a payment that consisted of an amount for the reduction of the taxpayer’s pension rights and an amount for a reduction in future salary. In the Court of Appeal both amounts were held taxable and in the House of Lords the Revenue conceded that if the amount in respect of the pension rights were held not to be of an income nature, then it could be apportioned out and escape taxation. What does this imply as to the tax treatment of an undissected amount where part of the amount is admittedly attributable to income? For what proposition has the High Court used the case as authority?

2.28

Would it make any difference in apportionment cases if the settlement payment clearly exceeded the “capital” amount claimed by the taxpayer?

2.29

How (if at all and apart from FBT) is apportionment relevant to the following items: • a car provided by an employer for use by an employee for both the employer’s purposes and the employee’s private purposes; • the provision of an airline ticket by an employer for an employee to spend two weeks in Hong Kong, one week on the employer’s business and one week on holiday; and • a Christmas gift given at work by an employer to an employee who is the employer’s best friend?

[2.300] The Taxation Review Committee (Asprey Committee) in its Full Report (AGPS,

Canberra, 1975), recommended the adoption of a general apportionment power (paras 7.101–7.102) but this has yet to occur. There is a power of apportionment in the capital gains tax under s 116-40 of the ITAA 1997, but how far this provision resolves the problem 60

[2.295]

Fundamental Principles of the Income Tax System

CHAPTER 2

under the income tax is unclear. The ATO recently sought to litigate the matter again before the High Court but the Court refused leave to appeal the decision in FCT v CSR Ltd (2000) 104 FCR 44; [2000] FCA 1513. The principles outlined here in relation to identifying the taxpayer and the taxable event, valuation and apportionment have generally been analysed in the context of ordinary income. However, it is possible to use them (along with the issue of income character) as a general tool for thinking about all forms of taxes – who is taxable, when, on what characteristics, and on how much?

3. STATUTORY FRAMEWORK FOR TAXING INCOME [2.310] This section describes the mechanics of the various processes and calculations that

have to be undertaken in order to calculate the annual amount of a taxpayer’s liability under the income tax system. Formally, the income tax is imposed upon an amount referred to as the taxable income of the taxpayer. The tax is levied under s 5 of the Income Tax Act 1986 at the rates declared by the Income Tax Rates Act 1986 (see also ss 4-1, 4-10 of the ITAA 1997). So the first step in calculating a tax liability is to identify the taxpayer’s taxable income.

(a) Taxable Income [2.320] The taxable income of the taxpayer is calculated under the ITAA 1997 which, with

the ITAA 1936, is by far the most important legislation in the process: the use of separate assessment and taxing Acts is a result of constitutional issues. Section 4-15(1) (equivalent to s 48 of the ITAA 1936) says the calculation of taxable income requires the subtraction from all the taxpayer’s assessable income of all the taxpayer’s deductions. In brief then: Assessable income – deductions = Taxable income

(b) Assessable Income [2.330] The assessable income of a taxpayer is defined in s 995-1(1) of the ITAA 1997 to have

the meaning given by ss 6-5, 6-10 and 6-15. The first encompasses ordinary income, the second statutory income and the third exempt income and non-assessable non-exempt income, which both are excluded from amounts which would otherwise be assessable income. Statutory income includes all amounts included in assessable income under the ITAA 1997 and ITAA 1936, putting aside ordinary income. Thus, it includes the increasingly fewer survivals in the ITAA 1936 and the many statutory inclusions under the ITAA 1997, including net capital gains. Exempt income is defined in s 995-1(1) to have the meaning given by s 6-20 which has slightly different rules for ordinary income and statutory income. Various provisions of the Act then exempt from income tax certain types of income or certain types of taxpayers – see the lists located in Div 11 and the operative provisions in Pt 2-15. In 2003 another category of income was introduced, non-assessable non-exempt income, which s 6-15 makes clear also is not part of assessable income even if it is ordinary or statutory income. Section 6-23 provides that non-assessable non-exempt income is an amount that the Act provides is not assessable income and not exempt income. For example, the part of the price collected by a seller in respect of a sale of trading stock that represents GST is non-assessable non-exempt income: see [2.330]

61

Income Tax in Context

s 17-5. The main significance of this category of income is that carry-forward tax losses are reduced by exempt income but not by non-assessable non-exempt income: see Div 36 of the ITAA 1997.

(c) Deductions [2.340] Deductions (defined in s 995-1(1) not very helpfully to mean “amounts you can

deduct”) are provided for primarily in Div 8 of the ITAA 1997. They were formerly called allowable deductions under the ITAA 1936 and this terminology is still commonly used in practice. The most important provision is s 8-1, which provides deductions for any loss or outgoing incurred in the gaining or producing of assessable income, for example, rent paid on a factory in which the taxpayer conducts its business. These deductions are called general deductions. Section 8-5 also provides for deductions allowed by specific provisions elsewhere in the Act (of which there are many). These are called specific deductions.

(d) Rate Scales [2.350] When taxable income has been calculated, it is then necessary to decide which is the

appropriate rate scale to apply to that taxable income in order to determine income tax liability. The Income Tax Rates Act 1986 has many different rate scales for different types of taxpayers. Most of us will have experience with the rate scale in s 12(1) and Sch 7 Pt I applicable to most resident individual adult taxpayers, with a zero bracket for taxable income up to $6,000, and tax rates ranging from 15% to a maximum of 45% where income exceeds $180,000. But if the taxpayer is not a resident individual, a different rate scale will be applicable. For example, a company’s taxable income is taxed at the rates in s 23A of the Income Tax Rates Act 1986 (currently 30% but scheduled to decline to 29%) and a non-resident individual’s taxable income at the rates in s 12(1) and Sch 7 Pt II. These rates are, of course, subject to fairly frequent changes – for example, there is a temporary 1% “flood levy” in 2011–12 and further changes will happen to the rate schedule and thresholds with the government’s “carbon tax” measures.

(e) Tax Offsets [2.360] This calculation of tax payable under the rate scale is not the end of the story. It remains to take into account any tax offsets (previously called tax rebates or tax credits) to which the taxpayer is entitled: s 4-10(3) of the ITAA 1997. These provide direct subtractions from the income tax liability of the taxpayer in order to produce finally the income tax payable by the taxpayer. Tax offsets are granted to taxpayers for a variety of purposes such as to correct overtaxation that would otherwise occur, to modify tax rate scales or to grant subsidies to taxpayers. Tax offsets are granted directly by the ITAA 1936 and ITAA 1997 rather than through the Income Tax Rates Act 1986. See, for example, the spouse rebate under s 159J of the ITAA 1936. Most tax offsets are located in Pt III Divs 17–19 of the ITAA 1936 and Divs 61, 65 and 67 of the ITAA 1997. Hence, the full calculation of income tax payable is: (Taxable income × Rate scale) – Tax offsets = Income tax payable

The treatment of tax offsets needs to be distinguished from refunds to taxpayers of excess tax payments. Until recently, if the amount of a tax offset exceeded the income tax liability of 62

[2.340]

Fundamental Principles of the Income Tax System

CHAPTER 2

a taxpayer there was no refund of the excess. For example, if a taxpayer was entitled to a spouse rebate that exceeded tax payable (a not very likely event), the excess was not refundable to the taxpayer. This treatment should be contrasted with that under the Pay-As-You-Go (or PAYG) system for taxing salary income. Under this system, the employer withholds tax and pays it to the ATO on behalf of the employee and the employee is entitled to have this amount subtracted from her or his eventual tax liability. If it is found that the amount paid by the employer exceeds the amount of tax payable by the employee, the overpayment is refundable. More recently, refundable tax offsets have been created, most notably imputation tax rebates from 1 July 2000. So it is important now to distinguish tax offsets that do not give rise to a refund right and those that do. Refundable tax offsets are similar to PAYG deductions, while non-refundable tax offsets are similar to the treatment of the spouse rebate. The calculation and ordering of tax offsets is found in s 4-10(3A) and Pt 2-20 of the ITAA 1997. The concept of taxable income is also used to levy other taxes besides the income tax, notably the Medicare Levy under the Medicare Levy Act 1986 and the Higher Education Contribution Scheme (HECS). Many would regard the former as simply a 1.5% surcharge on taxable income and as indistinguishable from the income tax, but there is one important difference, namely income tax offsets cannot be used to reduce the levy. Thus for most students using this book, the full calculation of tax payments arising on taxable income will be: Taxable income × Tax rate scale – Tax offsets + Taxable income × Medicare levy rate scale + Taxable income × HECS rate scale = Total tax payable

The collection of tax in most cases proceeds relatively independently of these calculations. The government does not trust us to turn up at the Australian Taxation Office with a cheque for a whole year’s tax after it has issued tax assessment! Thus there are various withholding mechanisms to collect tax from the payer of income rather than the recipient, and advance payment procedures. One major element of the recent tax reform has been a revamp and rewrite of these provisions, which are now found in Sch 1 of the Taxation Administration Act 1953: see Chapter 19. An assessment is issued to the taxpayer with the previous payments credited against the tax payable. The taxpayer is obliged to pay any deficit on the assessment and (in some cases) is entitled to receive a refund for any surplus of tax paid in advance over final tax liability. (In the case of non-residents, the withholding tax system usually operates as a final tax for interest, dividends and royalties.) The income tax system has become so complex that fewer and fewer taxpayers are preparing and submitting their own tax returns. Increasingly, tax returns are submitted on behalf of taxpayers by tax agents registered to provide tax services. It is not permitted to charge for professional services in relation to preparation of a return unless the preparer is so registered. Many readers of this book may one day become a tax agent and profit from the complexity of the income tax law. The regulation of the tax profession is governed by the Tax Agent Services Act 2009, which sets up a comprehensive regulatory system, overseen by the Tax Practitioners Board, to govern those who, for a fee, assist taxpayers to meet their tax obligations. [2.360]

63

Income Tax in Context

[2.365]

Questions

2.30

A and B are resident adult individuals and each has assessable income of $180,000. A has a dependent spouse with no income but no deductions, while B has deductions of $2,000. Who pays more income tax? Who pays more income tax and Medicare Levy combined? See s 159J(1B) of the ITAA 1936 and s 6(1) of the Medicare Levy Act 1986.

2.31

Some tax offsets are calculated by applying a fixed rate to the amount of expenditure that qualifies for the offset, for example, s 159P for medical expenses above a certain threshold. What is the difference between granting an offset in this way and granting a deduction for the same expenditure?

4. STRUCTURE OF THE AUSTRALIAN INCOME TAX SYSTEM (a) Volume and Numbering of Legislation [2.370] The ITAA 1936 passed the dubious milestone of one million words, making it by far

the largest piece of legislation in Australia. Action to try to get this under control began with the Tax Law Improvement Project (TLIP). While the ITAA 1997, which has replaced parts of the ITAA 1936, is shorter and generally easier to read, we are currently caught in an uncomfortable halfway house between the two Acts. The TLIP has been abandoned and the promise in 1998 of a unified tax code now seems unlikely to be fulfilled, so we do not know if or when the law will be reunited in one Act. The Board of Taxation took the first step through recommending the formal repeal of the many inoperative provisions in the tax legislation, especially in ITAA 1936, which occurred in 2006, but the process of moving legislation in to the 1997 Act is still occurring on a piecemeal basis as various areas of the income tax are reformed. It is a forbidding prospect for a student to be faced with legislation that, when placed on the desk at the commencement of the course, is some 25 cm thick, printed on wafer-thin paper, and out of date almost as soon as it is purchased (the income tax legislation has grown at the rate of hundreds of pages each year for the last decade). Do not despair! We (and your lecturer) will be selective. Indeed, to stave off student panic, your lecturer may have kindly prescribed one of the abridged versions of the legislation which is a mere 5 cm thick though still bigger than this book. It is a healthy exercise to become accustomed to reading the inimitable “styles” in which the legislation is drafted, so pick the legislation up off the desk and browse at random when you have finished your current reading assignment. It may assist if we explain the method of numbering the legislation. In the ITAA 1936, apart from the fact that the numbers are in sequence (1 before 2 etc), and that this applies no matter how many letters follow the number (s 221YHAAA enacted in 1986 had the honour of being the first five letter “number” in the Act – can you find a six letter number?), there was no fixed system to the way in which the letters crowd around the number. Generally the lettered sections come after the section with the same commencing number. Then AAAAA comes before AAAAB, which comes before AAAA, which comes before AAAB, which comes before AAA, etc, and ZAAAA comes after Z, which comes after YZZZZ etc. These mind-numbing combinations led to a revised system in the ITAA 1997. The ITAA 1997 is broken into divisions and the sections within the divisions numbered with the division number hyphenated with a fresh sequence of numbers. Thus the ordinary income provision is s 6-5 (the second section in Div 6) and the general deduction provision s 8-1 (the first section in Div 8). Gaps are left in the sequences of division numbers and within divisions to allow for 64

[2.365]

Fundamental Principles of the Income Tax System

CHAPTER 2

later amendments without the need for the alpha-numeric combinations of the ITAA 1936. Even so, the alphabet has already crept back into the ITAA 1997 at all levels of numbering.

(b) Integrating Elements of the Income Tax System [2.380] It will soon become apparent that the income tax is not a unified and consistent

system. Today it is comprised of many units which are intended to fit together to form one consistent whole, yet often fail to achieve this result. Elements have been grafted onto the original system with less than perfect results. Moreover, the ITAA 1997 has only replaced parts of the ITAA 1936. The “income tax system” now mainly comprises: 1.

The tax on ordinary income contained in s 6-5 of the ITAA 1997.

2.

The statutory additions to ordinary income. Many sections in Pt 2-1 of the ITAA 1997 are examples of statutory additions to the income tax base.

3.

The tax on net capital gains in Pts 3-1 and 3-3 of the ITAA 1997, replacing Pt IIIA of the ITAA 1936. This system, grafted onto the income tax, represents the single largest example of the Parliament stepping in to increase the income tax base.

4.

The fringe benefits tax imposed by the FBTAA 1986. This taxes non-wage benefits paid to employees which, mainly due to the inadequacies of the tax administration, were frequently not taxed.

(i) Method for inclusions in tax base [2.390] Ultimately, the “bottom line” is always how much tax the taxpayer will have to pay

or be entitled to as a refund. The answer to this problem is determined most usually by answering the questions: Is this amount included in assessable income? Or, is this amount a deduction? These questions cannot be answered without considering the effects of other elements in the income tax system – the fringe benefits tax or capital gains tax – whether they apply, and if they do, how overlaps, inconsistencies and omissions are to be reconciled. In order to resolve even the most basic tax problems, it is often necessary to have a detailed knowledge of all of these disparate elements of the tax system, how they function and how they fit together. The purpose of this section is to try to do that: to provide a little information about the pieces that make up the income tax system and how they fit together or fail to fit together. It is, of course, an impossible task to explain the whole of the income tax system in a few pages. We will spend many chapters discussing what is income, what is a fringe benefit and what is a net capital gain, so you need to be aware that the following few pages simplify very complex issues. A methodical and logical way to resolve a tax problem would be to work through each of the elements of the tax system in turn. When faced with a tax problem, one way to answer the problem would be to use a method which asks the questions outlined below. Step 1 – Is the amount included in assessable income as “ordinary income” – the judicial concept of income? [2.400] The first question to ask is whether the amount comes within s 6-5 of the ITAA 1997.

This has to be the first place to start for most problems and it is the subject of Chapters 3 to 6 of this book. The answer to the question will be given in the cases, since the question is really asking in different words, have judges said that the word “income” in s 6-5 of the ITAA 1997 includes this type of amount? [2.400]

65

Income Tax in Context

The types of payments, which according to the cases are included as income according to ordinary concepts, can be grouped into five classes. 1.

The first principle is that a gain which is a return from property has the character of income. This is the principle by which dividends, interest, rent and royalties are taxable. It also distinguishes a gain which is a return from property from a gain on the sale of property, which is usually called a capital gain, and does not have an income character. This is discussed in Chapter 3.

2.

The next principle (explored in Chapter 4) is that a gain which is a reward for services (eg salary, wages, certain gifts, etc) has the character of income.

3.

A further principle is that a gain which is the product of carrying on a business has the character of income. This is the subject of Chapter 5.

4.

The fourth principle is that a gain which is compensation for an amount that would be income has the character of income. There may also be a corollary that a payment which is reimbursement for an amount that has previously been allowed as a deduction has the character of income. This is explored in Chapter 6.

5.

The fifth principle is that a gain which is derived periodically, such as a pension, scholarship, or annuity, has the character of income. This is also explored in Chapter 6.

Step 2 – Is the amount included in assessable income by some specific statutory provision? [2.410] The next question is to ask whether the payment is included in the taxpayer’s assessable income by some specific statutory provision. Usually these are situations where the government has intervened by inserting a section to make some amount taxable because it is dissatisfied with the position that would apply if ordinary concepts were allowed to operate alone. There are many provisions which have the effect of including payments in the taxpayer’s assessable income such as:

• s 15-15 (previously s 25A): gains from carrying out profit-making schemes; • s 15-20 (previously s 26(f)): royalties; • s 102-5 (previously s 160ZO): a net capital gain; • s 15-2 (previously s 26(e)): allowances from employment and services; and • s 44: company distributions. Some of these statutory provisions merely repeat that an amount which would already be within ordinary income is included in assessable income – they are apparently superfluous. But others clearly change what would be the tax consequences if the concept of ordinary income were allowed to operate alone. For example, a capital gain would not be ordinary income and so would not be included in assessable income and taxed apart from s 102-5. Step 3 – Is the amount excluded from tax by being classified as exempt income or non-assessable non-exempt income? [2.420] There are some types of payments which would have an income character according

to the judicial test of income or under express provisions, but which are effectively excluded from the tax base at this stage. Although they would be included in assessable income, an excluding provision classifies some payments as exempt income or non-assessable non-exempt income, and s 6-15 then excludes any such income from the taxpayer’s assessable income. 66

[2.410]

Fundamental Principles of the Income Tax System

CHAPTER 2

Step 4 – How are amounts included as ordinary income and statutory income reconciled? [2.430] If an amount would be ordinary income and is also included in assessable income by a

specific section, is the payment taxed twice? This is an important issue that the courts did not resolve satisfactorily in relation to the ITAA 1936. The ITAA 1997 has attempted a solution which is taken up in more detail below. Step 5 – Does the payment also create a “fringe benefit”? [2.440] The next layer of complexity arises when FBT is introduced. Even though a payment

may be included in assessable income either as ordinary income or statutory income, where the payment is connected to some employment it must next be asked whether the payment also gives rise to a fringe benefit. If it is a fringe benefit, the employer will be taxable on the value of the fringe benefits provided to employees. Step 6 – How are the amounts to be reconciled if the payment would be both included in assessable income and be a fringe benefit? [2.450] If the amount would be both included in assessable income (and so taxed as income to

the employee) and is a fringe benefit (and so taxed to the employer) what reconciliations are possible? There are three mechanisms designed to integrate fringe benefits tax and the income tax, as outlined below. 1.

The payment may not be a “fringe benefit” at all. For example, wages, retirement payments and employee share schemes are not fringe benefits and so the employer is not taxable on them. The FBTAA 1986 has no application and they are dealt with only under the provisions already contained in the ITAAs.

2.

The payment also may not be a taxable “fringe benefit” because it is an exempt benefit. For example, certain employee car parking paid for by the employer is an exempt benefit (under s 58G of the FBTAA 1986). This means that the employer will not be taxed on the specified kind of benefit because it is not a fringe benefit and is not included in the “fringe benefits taxable amount” for s 66 of the FBTAA 1986. The employee also will not be taxed on the benefit if it is an exempt benefit even though it would otherwise be included in assessable income. This is because s 23L(1A) of the ITAA 1936 treats exempt benefits as exempt income and so the employee does not pay tax on them. Your lecturer may be interested in this outcome: see s 58G(2). In effect, there is no tax: there is no FBT because it is an exempt benefit, and no income tax because it is still treated as exempt income.

3.

If the payment is a “fringe benefit” taxable to the employer and would otherwise be included in assessable income, the amount will then be excluded from the employee’s assessable income. This means that only the employer has to pay tax on the benefit – it is no longer included as assessable income of the employee.

Step 7 – Does the payment include an amount in assessable income and also create a net capital gain? [2.460] The capital gains tax contained in Pts 3-1 and 3-3 of the ITAA 1997 is not a separate

tax. In fact, calling it a capital gains tax is a misnomer because it is a tax on the profitable realisation of nearly all assets. It can and does overlap with amounts included in assessable income as ordinary income or other statutory income. [2.460]

67

Income Tax in Context

Step 8 – How are the amounts to be reconciled if the payment would be both included in assessable income outside Pts 3-1 and 3-3 and be a net capital gain under those Parts? [2.470] Obviously some amounts will potentially be included in assessable income in both

ways. For example, every sale of a pair of shoes by a shoe store could be dealt with under capital gains tax, since the shoe store has sold an asset, just as much as it can be dealt with under ordinary concepts as the product of carrying on a business. In the ITAA 1936 there were several mechanisms to obviate double inclusion of the same amount. The ITAA 1997 simplifies the mechanisms down to two: certain capital gains are disregarded (eg exempt assets covered by s 118-5) while other capital gains are reduced by the amount otherwise included in assessable or exempt income: see s 118-20. Note that the treatment for reconciling capital gains tax suggested here is a little misleading on two counts: (1) capital gains tax is really an example of Step 3: amounts being included in assessable income by a specific statutory provision: s 102-5; and (2) the CGT mechanics strictly require that the reconciliation in Step 8 be done before the netting of capital gains and losses in Step 7. In other words, there is no net capital gain derived until s 118-20 has been applied to exclude whatever part of the capital gain has to be excluded because it is also taxed outside Pts 3-1 and 3-3. Nevertheless, the scheme is still helpful even if not absolutely formally accurate. (ii) Method for cost and outlays [2.480] The steps outlined above have attempted to reconcile the various elements of the

income tax system in so far as they operate to include amounts in the tax base. Similar issues arise for the exclusion of sums from the tax base or, at least, the reduction of gross sums to the net sums that will eventually be the subject of the tax. The treatment of costs and outlays raises the same problems and a suggested approach is as follows. Step 1 – Is the outlay deductible from current assessable income? [2.490] Section 8-1 of the ITAA 1997 is the primary section which allows a taxpayer to

deduct a loss or outgoing from assessable income, reducing assessable income to taxable income. Outlays will be deductible if they are incurred in producing assessable income or in carrying on a business to produce assessable income. The section will, however, prevent many overlaps with capital gains tax by excluding capital costs from being deductible from assessable income. In addition to s 8-1, there are many sections which grant specific deductions from assessable income for other revenue expenses. Step 2 – How are deductions reconciled if they are allowed under s 8-1 and under some other section? [2.500] It is clear that some of the specific deduction sections merely confirm the operation of

s 8-1 while some others will vary its effect in some respects. For example, s 25-35 allows a deduction for bad debts which are written off during the year of income and in addition some of these bad debts might be deducted from assessable income under s 8-1, according to the High Court in AGC (Advances) Ltd v FCT (1975) 132 CLR 175. This type of overlap is specifically resolved for all allowable deductions by s 8-10 which allows the deduction under the provision that is most appropriate. 68

[2.470]

Fundamental Principles of the Income Tax System

CHAPTER 2

Step 3 – Is the outlay subtractable from revenue in calculating the profit on a venture? [2.510] Most expenses are deducted from assessable income to produce a net figure of taxable

income on which tax is levied (this operation was discussed above). But some gains from business operations and under s 15-15 are accounted for on the basis that only a net figure is included in the taxpayer’s assessable income. In these circumstances, the costs of deriving the profit are subtracted from the receipts to disclose a profit and it is that profit figure which enters the taxpayer’s accounts as an item of assessable income. Step 4 – If the outlay is both deductible from assessable income and subtractable in calculating a profit, how are the overlaps reconciled? [2.520] If the expense is subtracted in calculating the profit of a business venture, might the

expense also be deducted from assessable income so that it is counted twice? This possibility is partly prevented by s 82 of the ITAA 1936 which provides that where a profit is included in assessable income, any expenditure incurred which has been allowed as a deduction is not to be subtracted in calculating the profit. Step 5 – Is the outlay subtracted from capital gain? [2.530] An outlay incurred by a taxpayer might also be subtracted in the calculation of a

capital gain derived by the taxpayer. The outlay will affect the calculation of a capital gain if it is included in the cost base of the asset. The cost base of an asset is generally set out in Div 110 of the ITAA 1997. One form of integration occurs at this stage by including some costs which were not allowed as deductions from assessable income in the cost base of the asset. Step 6 – How is the overlap reconciled if the outlay is both deductible from current income and is subtracted from capital gain? [2.540] Section 8-1 will prevent many overlaps with CGT from occurring, as it permits

taxpayers to deduct expenses only if they are not of a capital nature. There was originally no general rule under the CGT that any outlay allowed as a deduction from assessable income was automatically excluded from forming part of the cost base of some asset. This meant that it was possible for an outlay to reduce assessable income and to reduce a capital gain. It could happen, therefore, that an expense which is an allowable deduction is included in the cost base of an asset. This possibility probably arose in Cliffs International Inc v FCT (1979) 142 CLR 140; 9 ATR 507; 79 ATC 4059 where the taxpayer paid as part of the price of some shares a periodic royalty payment which was allowed as a deduction. This payment could also have been the money paid in respect of acquiring the asset and so formed part of the cost base of the asset. The taxpayer was allowed to deduct the royalty payment from its assessable income, and when the taxpayer sold the shares it might have been entitled to subtract the royalty to calculate any capital gain. Some specific situations of overlap are provided: • Incidental costs are excluded from forming part of the cost base of the asset if they have been allowed as a deduction from assessable income: s 110-45(1B) of the ITAA 1997. These “incidental costs” are defined in s 110-35 and include certain professional fees, the costs of transferring the property including stamp duty and advertising expenses. • Section 110-55 also integrates some allowable deductions and the cost base of an asset. It provides that the reduced cost base of an asset is to be reduced by any amount that is allowed as a deduction. The reduced cost base is used if the taxpayer will generate a capital [2.540]

69

Income Tax in Context

loss on the sale of the asset. The effect of this is to minimise the sum of the capital loss generated by reducing the size of the reduced cost base and hence reducing the amount by which it falls short of the price originally paid for the asset. This treatment was extended to the calculation of the cost base for calculating capital gains from 1997: see s 110-45. This deals with the Cliffs International situation but has also created problems and complexities of its own. • Section 51AAA provides that where an amount which would be an expense incurred in earning assessable income is allowable only because a net capital gain has been included in assessable income, the amount will not be an allowable deduction.

(c) Overlapping Assessment Sections [2.550] As noted in the previous section, the courts did not conclusively resolve the

relationship between ordinary concepts of income embodied in s 25(1) of the ITAA 1936 and specific sections including amounts in assessable income. As an example of the problem consider Reseck v FCT (1975) 133 CLR 45; 5 ATR 538; 75 ATC 4213. Section 26(d) (repealed in 1983) included in assessable income 5% of amounts some of which would otherwise be assessable in full as ordinary income and some of which would otherwise not be assessable. The ATO sought to assess a taxpayer in full on an amount that was ordinary income, apart from the effect of s 26(d). The High Court held that the taxpayer was only assessable on 5% of the amount. In their view s 26(d) had both an including and an excluding effect. It included 5% of amounts that would otherwise not be assessable and excluded 95% of amounts from assessable income that would otherwise be assessable in full as ordinary income. In effect the High Court held that s 26(d) occupied the field and prevented ordinary concepts of income from operating. While this case settled the matter for s 26(d), it did not provide any guidance for other cases where there was apparently an overlapping but different scope as between ordinary income and specific assessment provisions. Further, the issues at stake in cases like this extended far beyond the relationship of s 25(1) and other assessment provisions, affecting Australia’s international income tax jurisdiction, the concept of exempt income (was the 95% excluded in Reseck exempt income?), issues of double counting, and any provisions in the ITAA 1936 containing the word “income” without any attached epithet such as assessable or exempt. Much intellectual effort has been devoted to these problems. There is no need to dwell here on this effort, as the ITAA 1997 has sought to meet the problems head-on by the following means: • ss 6-5 and 6-10 on ordinary income and statutory income contain equivalent international jurisdiction rules; • s 6-20 on exempt income distinguishes clearly between the treatment of ordinary and statutory income; • the word “income” is intended not to be used on its own; rather sections indicate whether they are dealing with ordinary income, statutory income or both; • an attempt is made to indicate the relationship between ordinary and statutory income for cases such as Reseck; and • an attempt is made to deal with the possibility of double inclusion of an amount in assessable income under more than one provision. 70

[2.550]

Fundamental Principles of the Income Tax System

CHAPTER 2

It is the attempts referred to in the last two points that are of most interest. If an amount can be covered by provisions on both ordinary and statutory income, what is the result? And if more than one provision seems applicable is there any rule against double counting? At the general level it is by no means clear whether ordinary income takes precedence over statutory income under the ITAA 1997 or vice versa. Section 6-10 on statutory income provides in subs (1) that such assessable income includes amounts that are not ordinary income, suggesting a priority for ordinary income. By contrast, s 6-25(2) provides that in the absence of contrary intention, provisions outside Div 6 prevail over the rules about ordinary income. As all the specific rules on statutory income are outside Div 6, this section suggests a contrary view. The notorious diagram in s 6-1 provides no help, as it conveniently does not depict overlapping circles (so infamous is the diagram that it was reduced from operative provision to guide during the debates on the diagram). Other non-operative provisions variously suggest different relationships such as s 10-5. On balance it is likely that a priority for statutory income is intended similar to Reseck. Fortunately, a number of provisions on statutory income such as ss 15-10 to 15-30 are explicit on the issue, making clear that ordinary income prevails (and perhaps suggesting that otherwise the reverse would be true). However, s 6-25(1) seems to indicate that it is possible for provisions on both ordinary income and statutory income to be operative in a particular case (as well as more than one provision on statutory income). The effect of the provision is that where the “same amount” is otherwise included more than once in assessable income, it is to be included only once. How does this apply where different sections produce different amounts for inclusion in assessable income as in Reseck? Does the provision mean that there is no rule against double inclusion if the amounts are different? Or does it mean that there is a rule against double inclusion to the extent of overlap, with the consequence that effectively the higher amount is always included, reversing the result in Reseck? It should be noted that these types of overlap problems are differently structured for deductions. It is clear by s 8-10 that the provisions which allow deductions are intended to operate independently and that overlap is avoided by choosing the provision that is most appropriate. However, the “same amount” terminology also appears there and raises similar questions as for assessable income.

[2.550]

71

THE TAX BASE EXEMPTIONS



INCOME

AND

4. Income from the Provision of Services ......................................... .. 139 5. Business Income .................................................................................. 259 6. Compensation Receipts and Periodic Receipts ............................ .. 351 [Pt2.10] This Part starts our examination of the “income” portion of the income tax. As we will see, the base of the income tax starts from amounts that are, and are deemed to be, income. Determining the total of these amounts for a tax year is the first step in calculating the amount of tax that has to be paid. But one reason why this book is over 1,000 pages long is that the answer to the question – is this amount taxable or not? – is straightforward for some amounts, and horribly complex for others.

PART2

3. Income from Property ....................................................................... .. 75

As we noted in Chapter 2, some amounts are income because they are the kind of amounts that people think of when they hear the word, “income”. The following chapters have instances of these kinds of amounts – interest on a bank account, rent paid to a landlord, wages received by employees, the fees earned by a lawyer. These amounts are all taxable and all for the same reason – they are what people include within the meaning of the term “income”. In the following chapters we try to do two more things. First, we try to be more analytical about these examples. We break down these items into constituent groups. Interest and rent may be taxable but they are taxable for reasons that are different from the reasons that are invoked when taxing wages received by employees or the fees earned by a lawyer. Chapters 3 to 6 try to delineate and then coordinate the different jurisprudential theories that the courts have expressed to explain why one receipt is income and another isn’t. In breaking down the examples into groups, we try to define the boundaries of the groups, to see where each starts and stops. The second thing we do is to see how the ordinary meaning of the word “income” is expanded by the tax legislation. That is, defining the limits on the ordinary meaning of the word income uncovered during our exploration doesn’t exhaust our inquiry; we also have to be satisfied that there is no statutory provision which extends the ordinary meaning to capture the kind of transaction we are examining. The most extensive statutory extensions to the income tax are the capital gains tax (CGT) provisions in Pts 3-1 and 3-3 of the ITAA 1997. Because virtually every difficult tax issue nowadays involves consideration of the CGT, we deal with it first in the chapters that follow, and return to it constantly thereafter.

73

CHAPTER 3 Income from Property [3.10]

1. INCOME FROM USE AND SALE OF PROPERTY ................... ......................... 77

[3.20]

2. CAPITAL GAINS TAX ...................................... ............................................... 80

[3.20]

(a) CGT Framework .................................................................................................... 80

[3.50] [3.50] [3.60] [3.90] [3.120] [3.130] [3.150] [3.160] [3.230] [3.250] [3.270] [3.280] [3.300] [3.310] [3.370] [3.410]

(b) Principal CGT Concepts ......................................................................................... 83 (i) CGT asset ............................................................................................................... 83 Ruling TR 98/3 ............................................................................................................ 84 Ruling TR 94/30 .......................................................................................................... 87 (ii) CGT events ............................................................................................................ 91 FCT v Orica Ltd ............................................................................................................ 93 (iii) The terrible twins: CGT events D1 and H2 ............................................................ 96 Hepples v FCT .............................................................................................................. 98 Ruling TR 98/3 .......................................................................................................... 100 Ruling TR 94/30 ........................................................................................................ 102 (iv) Time of acquisition and CGT events .................................................................... 104 Commissioner of Taxation v Sara Lee Household & Body Care (Australia) Pty Ltd ............ 105 (v) Calculation of capital gain or capital loss .............................................................. 109 (vi) Rollovers ............................................................................................................. 109 (vii) Exclusions .......................................................................................................... 114 (viii) Personal use assets ............................................................................................ 116

[3.420]

3. GAINS FROM THE USE OF PROPERTY......................... ................................ 116

[3.430] [3.440] [3.450] [3.460] [3.470] [3.480] [3.500] [3.520]

(a) Interest, Discounts and Premiums ........................................................................ 117 (i) Discounts and premiums ...................................................................................... 118 Lomax v Peter Dixon ................................................................................................... 119 (ii) Deep discount debt securities – Div 16E and TOFA .............................................. 124 (iii) Traditional securities ........................................................................................... 124 (iv) Annuities ............................................................................................................. 125 Scoble v Secretary of State for India ............................................................................. 127 Vestey v IRC ............................................................................................................... 128

[3.540] [3.540] [3.550] [3.560]

(b) Rent, Premiums, Repairs and Leasehold Improvements ........................................ 130 (i) Rent and premiums .............................................................................................. 130 (ii) Repairs ................................................................................................................. 131 (iii) Leasehold improvements .................................................................................... 132

[3.570] [3.580] [3.590] [3.600]

(c) Royalties .............................................................................................................. (i) Payments for natural resources ............................................................................. (ii) Intellectual property and know-how .................................................................... Murray v Imperial Chemical Industries Ltd ...................................................................

132 134 135 136

75

The Tax Base – Income and Exemptions

Principal Sections ITAA 1936 s 25A

ITAA 1997 –

s 26(a)

s 15-15

s 26(f)

s 15-20

s 26(l)

s 15-25

s 26AAA

s 15-15

ss 26BB, 70B



s 27H



s 160ZO(1)

s 102-5

s 160ZC

ss 102-5 to 102-22

ss 160L, 160M

Div 104

s 160ZS s 160U ss 160B, 160ZQ s 160ZZQ

Subdiv 118-B

s 104-110 Divs 104, 109 160Z(7), Subdivs 108-B, 108C

ss 160ZZK, 160ZZL

Subdiv 124-B

s 160X

Div 128

76

Effect This section replaced s 26(a) and included measures designed to overcome the deficiencies of s 26(a). This section included in a taxpayer’s assessable income profit realised on the sale of property acquired for the purpose of resale and profit realised from a profitmaking scheme. This section includes royalties in a taxpayer’s assessable income. This section includes in a lessor’s assessable income compensation or damages for breach by the lessee of a covenant to repair. This section included in assessable income gains realised on the sale of property acquired within a year of its disposal. These sections deal with traditional securities. This section provides a pro-rata formula for recognising the cost of a purchased annuity. This section includes a net capital gain in assessable income. These sections define a net capital gain as the excess of capital gains realised during the year over capital losses suffered during the year or carried forward from previous years. They also incorporate the CGT discount for individuals and trusts enacted in 1999. These provisions define when a capital gain arises and exclude from CGT gains realised on the disposal of assets acquired prior to 20 September 1985. This section deals with the grant of a lease. These contain the timing rules for CGT. These contain rules on collectables and personal use assets. These contain the CGT exclusion for the main residence. These contain rollovers for assets compulsorily acquired, lost or destroyed. These contain rollovers on death.

Income from Property

ITAA 1936 Pt III Div 16E

ITAA 1997 Div 230

CHAPTER 3

Effect The provisions in this Division provide for the recognition of income gains on deep discount securities as if they were realised as compound interest.

1. INCOME FROM USE AND SALE OF PROPERTY [3.10] Although the ITAA 1936 apparently adopted a global notion of income, the schedular

UK system had a considerable influence in limiting the apparently broad and undefined concept of income. Section 25(1) included gross income in assessable income but the courts limited this (in the absence of specific provisions) to income according to the ordinary concepts and usages of mankind, which were largely based on the schedules in the UK legislation: see Chapters 1 and 2. Nowhere was this limitation more obvious than in relation to income from property. Gains from the use of property (including money) such as rent, royalties, interest and dividends were included in ordinary usage income, but gains (profits) from the sale of property generally speaking were not. We have already noted in Chapter 2 that this result was probably influenced by trust law, which distinguished between income and capital beneficiaries. The major exception to this position was gains made on the sale of (some kinds of) property owned by a business. Profit on the sale of the trading stock (inventory) of a continuing business was clearly income according to ordinary concepts – the very purpose of the business was to trade and make profits on such items. It was also accepted that profits on some non-trading-stock assets sold by a business were income according to ordinary concepts; a common example was the asset portfolios of banks and insurance companies: see Chapters 5 and 11. The most contentious situation arose in respect of gains arising from one-off business-like transactions. The UK legislation imposed tax on profits from an adventure in the nature of trade. This provision was apt to encompass where there was no continuing business if there were “badges of trade” in the transaction, that is, the transaction had a commercial flavour. The House of Lords apparently held in Jones v Leeming [1930] AC 415 that profits on the one-off sale of certain property were not income within these principles, even though the taxpayer had bought the property with the intention of selling it at a profit. While the exact decision in this case came to be much debated in subsequent years, the Australian legislature reacted by enacting a provision that included in assessable income “profit arising from the sale by the taxpayer of any property acquired by him for the purpose of profit-making by sale, or from carrying on or carrying out any profit-making undertaking or scheme” (which came to be s 26(a) of the ITAA 1936). The precise effect of this provision was, in turn, much debated in cases and elsewhere over a 50-year period: did it just restate the law on ordinary usage income or did it extend the type of gains subject to tax? Judicial decisions over the years also revealed technical shortcomings in the first part of the provision relating to property acquired with the intention of resale at a profit and the provision was re-enacted as s 25A in 1984 with amendments to deal with the problems. This history is further elaborated in Chapter 5. The Labor Government of the early 1970s enacted s 26AAA of the ITAA 1936 which brought into assessable income profits on property acquired and sold within 12 months. This provision could be viewed as seeking to overcome evidentiary problems in demonstrating the [3.10]

77

The Tax Base – Income and Exemptions

necessary intention under s 26(a), but equally it was seen as the thin edge of the wedge leading ultimately to a capital gains tax (CGT). The Asprey Committee in its Interim Report of 1974 recommended the introduction of a CGT and the Labor Government promptly announced its adoption of this recommendation. In its Full Report of 1975, the Committee recommended that introduction of the CGT be delayed in view of the high level of inflation at the time (up to 20%) and the momentous political events of that year ensured that nothing further happened on the CGT front for the next 10 years. The Labor Government elected in 1983 quickly identified tax reform as a priority issue. It had undertaken not to introduce a CGT in its first term and contented itself with enacting s 25A of the ITAA 1936. After winning the 1984 election on a platform of consulting about tax reform, it introduced a CGT effective immediately after the announcement date of 19 September 1985. Clearly the comprehensive income tax base discussed in previous chapters includes gains on assets whether as part of a business or not. The equity and efficiency arguments for the comprehensive tax base were hence deployed in justifying the CGT; indeed as noted in Chapters 1 and 2, the tax reform of 1985 can be characterised to some degree as grafting the Simons’ comprehensive income tax base onto ordinary usage income. In order to win the approval of minority parties in the Senate and mindful of the history of CGT in Australia, the government decided only to apply the CGT to assets acquired on or after 20 September 1985, with the amount of gain being adjusted to eliminate the effects of inflation if assets were held for more than 12 months and effectively averaged gains over five years to moderate the effect of the gain all being reported in one tax year. Legislation for CGT was introduced into Parliament on 22 May 1986. The oddity of introducing such a major change in the tax system by government announcement was ameliorated by the existence of s 26AAA – property acquired after 19 September 1985 and sold before 19 September 1986 was covered by this provision, so that the CGT in most cases really bit from 20 September 1986. Having done its transitional work and ironically having become the source of CGT avoidance, s 26AAA was effectively repealed in 1988 and actually deleted from the ITAA 1936 in 1994. The 12 months indexation rule, which has its origin in part in that section, is still with us, though fading as explained below. Section 25A was partly repealed as from 20 September 1985 but is still in part with us (as explained in Chapter 5) as s 15-15 of the ITAA 1997. The CGT was contained in a separate part as an add-on to the income tax (Pt IIIA of the ITAA 1936 is now Pts 3-1 and 3-3 of the ITAA 1997) but was not entirely separate from it. On one hand, the amount included in assessable income under the CGT was capital gains reduced by capital losses (to give a net capital gain each year). On the other hand the CGT could apply to assets subject to the income tax, and if the capital gain amount exceeded the income tax amount, the excess was included in the calculation of net capital gain. The CGT legislation extended far beyond profits from the purchase and sale of property as we would understand that idea. Over the years the courts had held that many amounts were not income according to ordinary concepts. These amounts were often referred to as “capital gains” as a shorthand way of saying they were not subject to income tax, even though they had nothing to do with the purchase and sale of property; for example, the premium received on granting a lease or a payment received by an employee for agreeing to a restrictive covenants sought by a former employer. The government used the CGT as the means of dealing with these defects in the income tax base as well. The original concept underlying the CGT – the profit arising from the sale of an asset – was designed to reflect the basic transaction: it applied to the disposal of an asset, and the capital gain or loss on the asset was calculated by deducting 78

[3.10]

Income from Property

CHAPTER 3

the indexed or reduced cost base from the consideration in respect of disposal. But the decision to use the CGT to remedy other holes in the income tax base meant that these basic building blocks of the CGT had to be manipulated to accommodate these other amounts which did not arise from selling assets – the provision had to, for example, deem the existence of an asset, deem the disposal of the asset, deem the cost base or deem the consideration in respect of disposal. As we will see below, even this extensive deeming was not sufficient for taxing the employee restrictive covenant. Many of the items which these extensions were directed at were flows rather than gains, but even with the extensive drafting adjustments, the CGT could not reconcile the conflict of the flow and gain concepts of income, discussed in Chapter 2. When the tax legislation came to be rewritten as part of the Tax Law Improvement Project (TLIP), the global concept of income in the ITAA 1936 was partly given up. Income was explicitly divided into ordinary income and statutory income as explained in earlier chapters. Capital gains tax is included as part of statutory income but still retains its essentially separate character in Pts 3-1 and 3-3 of the ITAA 1997 with the special procedure allowing the offset capital losses only against capital gains. The breadth of the tax was recognised by abandoning the disposal of asset concept of the ITAA 1936. Now the tax applies in relation to a CGT event in relation to an asset. Whether this approach is clearer than the ITAA 1936 may be doubted. It would be much simpler to put the additions to the tax base beyond profits on the sale of assets into the income tax and not the CGT (as the UK, for example, has long since done for employee restrictive covenants). Indeed it may be simpler to collapse the CGT and income tax into one so far as the sale of property is concerned. The Ralph Report recommended extensive change to the regime for taxing capital assets in 1999, not all of which were adopted. Indexation was terminated at the end of the September 1999 quarter (s 960-275 of the ITAA 1997) and CGT averaging as from 21 September 1999. As compensation for the loss of indexation, individuals are able (in most cases) to exclude 50% of net capital gains from their assessable income and superannuation funds one-third of net capital gains; these discounts are available for gains on assets held for more than one year (Div 115 of the ITAA 1997). For assets acquired before 21 September 1999, individuals and superannuation funds have the choice of indexation up to September 1999 or the discount, but not both. Companies retain indexation up to 21 September 1999 and had their tax rate reduced to 30% from 36% as a result of Ralph recommendations; they do not, however, benefit from the CGT discount. In addition, the government has enacted Ralph reforms in relation to removing depreciable assets from the CGT net, rollovers for scrip for scrip takeovers and demergers, exemption of certain foreign pension funds from CGT on venture capital investments (since effectively overtaken by much broader measures in the venture capital area), and small business CGT relief. In the following parts of this chapter we consider the CGT and then gains from the use of property. This reverses the usual order of considering ordinary usage income before statutory income, which characterises later chapters. We think the reversal is justified by the all-pervasive nature of the CGT today, which extends far beyond simple sales of property at a profit. Although superseded by the ITAA 1997 provisions in 1998, Pt IIIA of the ITAA 1936 was only finally repealed in 2006. We still refer at various points to the 1936 provisions in what follows to compare how they solved various issues differently from the 1997 Act and in particular in relation to extracts which deal with the ITAA 1936. [3.10]

79

The Tax Base – Income and Exemptions

2. CAPITAL GAINS TAX (a) CGT Framework [3.20] There are two possible ways to enter the capital gains world. One is to go directly to Pt

3 and read Div 100 which contains the guide to capital gains and losses. This guide provides a helpful summary of the CGT and can appropriately be read at this point. Alternatively, we can start with s 6-10(1) of the ITAA 1997, which includes in assessable income some amounts that are not ordinary income (and as we have noted, capital gains are not ordinary income). A note to this provision points to the list of relevant inclusions in s 10-5. One item in the list is capital gains, which in turn points to s 102-5. When we turn to s 102-5 we find that what is included in assessable income is a “net capital gain.” The method statement indicates that the taxpayer calculates separately each capital gain and capital loss for the year, and subtracts the losses from the gains. • If the result for the year is a negative amount, no amount is included in assessable income. Instead, the taxpayer has a net capital loss for the year which may be taken into account in later years; it cannot be deducted from other assessable income of that year: see s 102-10. • If the result is a positive amount, the taxpayer then subtracts any net capital losses of previous years from that amount. Section 102-15 provides that net capital losses are deducted in the order in which they were incurred, that is, the earliest such losses are subtracted first, then the next earliest and so on. If a positive amount remains after taking account of all prior net capital losses, this is the “net capital gain” for the year. Although this is the normal calculation, there are a number of exceptions and modifications for which a list is found in s 102-30. The method statement has been significantly altered to incorporate the Ralph changes relating to the CGT discount for individuals and superannuation funds now provided in Div 115, and the small business CGT relief now found in Div 152. The method statement, along with Div 115, is designed to give the relevant taxpayers the option of calculating capital gains using indexation up to September 1999 or taking the appropriate discount where the asset has been held for more than one year. The discount is only available after capital losses have been offset against capital gains. The calculation of capital gains is discussed briefly below and elaborated further in Chapter 12. [3.25]

3.1

Question

The taxpayer, which is a company, has the following capital gains and losses over a period of five years: Year 1 2 3 4 5

Capital gains 100,000 150,000 100,000 150,000 200,000

Capital losses 50,000 250,000 150,000 75,000 100,000

What is the net capital gain or net capital loss for each year? In which years are the net capital losses of any previous year utilised? [3.30] A number of important consequences flow from the CGT method of calculation. First,

capital losses can only be applied against capital gains, not against other forms of income. This 80

[3.20]

Income from Property

CHAPTER 3

quarantining is used because capital gains are taxed on a realisation basis (when a CGT event occurs) and not as they accrue. Hence, if capital losses could be offset against other types of income, taxpayers would be encouraged to realise their capital losses but not their capital gains and use the loss to reduce tax on other income such as wages or interest. If taxpayers do make a capital gain, however, they can generally realise any capital losses on assets which have fallen in value and reduce or eliminate tax on the capital gain, though it has been held in Cumins [2007] FCAFC 21 that the general anti-avoidance rule in Pt IVA of the ITAA 1936 can apply to manufactured sales, and the ATO has tried to deter sales if the same or a similar asset is immediately repurchased (a “wash sale” – see TR 2008/1). Second, the calculation for capital gains is separate from the calculation employed for other assessable income and deductions. As the same amounts may be entering as positive or negative elements in the calculation under capital gains and elsewhere, there are a number of complex adjustments that may have to be made to avoid double counting. Third, for similar reasons, the CGT contains repetitions of many rules that are found under the income tax. For example, the CGT has its own provisions on identifying the taxpayer, (Div 106), constructive receipt (s 103-10, compare ss 6-5(4), 6-10(3) and see TD 2003/1), valuation (s 103-5), and international jurisdictional rules for non-residents (Div 855, compare ss 6-5(3), 6-10(5)). Moreover, any tax exemptions have to be delivered twice – one rule eliminating tax under the ordinary rules and a further rule eliminating CGT (compare, s 53-10, Items 4B and 4C, which exempt amounts paid under sugar and tobacco industry adjustment schemes from income tax, with s 118-37(1)(f) and (g) which exempt the amounts from CGT.) [3.35]

3.2

3.3

Questions

Why does the CGT have a separate constructive receipt provision? How (if at all) does the constructive receipt provision for CGT differ from those for the income tax? What is the relationship between the income tax and CGT constructive receipt provisions? What is the effect of s 106-60? What happens if a mortgagee takes possession of a mortgaged property because the mortgagor has defaulted on payments under the mortgage, sells the property and uses the proceeds to pay off the mortgage? Would the result be any different under the income tax if the profit on sale was taxable under the income tax? If a mortgagee in possession of a rented property directs the tenant to pay the rent to the mortgagee instead of to the mortgagor landlord, whose income is it?

[3.40] Capital gains and capital losses used in the calculations only arise if a CGT event

happens (s 102-20 of the ITAA 1997). The list of CGT events is contained in Div 104 with a summary in s 104-5. A CGT event is the ITAA 1997 equivalent of the “disposal” of an asset in the CGT provisions of the ITAA 1936. The first and most important CGT event in the ITAA 1997, s 104-10(1), still refers to the case where “you dispose of a CGT asset”. For each event the provisions set out the nature of the event, the time when the event occurs and the calculation of the capital gain or capital loss arising on the event (which is generally done by comparing two different amounts: the disposal proceeds and the cost base (see s 102-22)). The nature of most CGT events involves an asset in one way or another, either through referring to that term directly or to particular kinds of assets. Hence the concept of an asset remains central to the CGT. The basic definition of asset is in Div 108, as well as rules for determining when assets are aggregated or kept separate for CGT purposes. Division 108 also contains special rules for assets of a personal nature (referred to as collectables and personal use assets). [3.40]

81

The Tax Base – Income and Exemptions

The time when a CGT event occurs is important, as the calculations of net capital gain and net capital loss require allocating capital gains and capital losses to an income year. In the ITAA 1936 the rules for determining when an asset was disposed of and when it was acquired were found in one place, s 160U. The use of separate CGT events means that the time of each event is now separately stated in every section prescribing an event which can involve some repetition. The time when an asset is acquired – which is important for various purposes including transition, indexation (to a reduced extent following the Ralph changes) and the CGT discount – is set out separately in Div 109, which generally mirrors the event rules. In the discount case there are modifications of the acquisition rules, especially s 115-30, as not all CGT events attract the discount: see s 115-25. The methods used to switch off the CGT are complex. In a number of cases the CGT event sections provide that certain capital gains or losses “are disregarded.” This is the general method adopted for excluding various capital gains or losses from CGT. In the same way, Div 118 of the ITAA 1997 also provides many instances where the gain or loss is “disregarded.” The fact that the gain or loss is excluded from tax calculations does not mean that the CGT event is regarded as not having occurred: see s 102-33. This general method for effecting exclusions is to be contrasted with ITAA 1936 where various methods were used, and is one of the improvements effected in the ITAA 1997. Although the same general method is used, the purpose of the exclusions differs. Some are part of the reconciliation with the income tax, such as the “anti-overlap provisions” in Div 118, some defer taxation to a later time (including, but not limited to, so-called rollovers), while others effectively exclude amounts from taxation altogether such as the main residence exemption in Subdiv 118-B. There are a few situations where the legislation specifically provides that a CGT event does not occur (as opposed to being disregarded) such as s 104-35(5). One of the most important exclusions relates to the transition rule – that CGT does not (usually) apply to assets acquired before 20 September 1985. Due to the CGT event structure of the ITAA 1997 it is necessary to repeat this exclusion for each CGT event to which it is relevant, for example, ss 104-10(5), 104-15(4), 104-20(4), 104-25(5). CGT events do not require this transitional rule if they do not depend on the acquisition of an asset, for example, ss 104-35, 104-155. Assets excluded by this transitional rule are commonly called “pre” assets to distinguish them from “post” assets (acquired after 19 September 1985) which are subject to CGT and this usage continues even though it is not precisely accurate in the structure of the ITAA 1997. Indeed, “pre-CGT asset” is a defined term for one area of the law: see s 149-10. This transitional rule was one of a number of political compromises (others can be seen in the various exclusions) necessary to secure Senate acceptance of the CGT. The common practice in other jurisdictions (such as the UK) which decided to introduce a CGT is to use a “valuation” day at the time the tax comes into effect and to assess gains on all assets, as measured from the value of the property at the time the tax is introduced. This approach avoids the problem of retrospectivity while furthering the aims of equity (all future gains and losses are recognised) and economic efficiency (all assets are treated the same). The consequences of the pre- and post-asset system are serious from both equity and efficiency perspectives. From an equity perspective, it favours existing wealth-holders, who have acquired assets prior to the commencement date, as all future gains realised by them will be exempt from taxation. From an efficiency perspective, it led to an enormous lock-in problem as taxpayers holding pre-assets are reluctant to dispose of them and reinvest in post-assets that would be subject to CGT, even if the post-assets could generate higher rates of return before 82

[3.40]

Income from Property

CHAPTER 3

tax. From a legal perspective, the most significant consequence of the pre- and post-asset system is the significant degree of complexity it adds to the legislation. In cases where a CGT event occurs and the gain or loss is not going to be disregarded, the next step is to calculate the capital gain or loss. This calculation is specified separately for all events though in many cases it is the same as the single calculation under the ITAA 1936: the disposal proceeds (called consideration in respect of the disposal under the ITAA 1936) less cost base. A capital gain arises if disposal proceeds exceed the cost base and a capital loss arises if the reduced cost base exceeds disposal proceeds, for example, ss 104-10(4), 104-15(3), 104-20(3) and 104-25(3). Surprisingly the CGT event provisions do not specify the precise amount of the capital gain or capital loss. This is left to the second sentence of s 102-22 which indicates that it is the amount of the difference. In those cases where the CGT taxes flows rather than gain, the cost base is not relevant, and the capital gain or capital loss is measured by reference to the disposal proceeds less the transaction costs involved in the event, for example, ss 104-35(3) and 104-155(3). If cost is used in the calculation, then the CGT event sections employ two concepts: cost base for capital gains and reduced cost base for capital losses. In the case of capital gains, later sections indicate that the cost base, in turn, has two alternative calculations. The cost base rules are found in Div 110 with modifications of those rules for special cases indicated in Div 112. Both the cost base and the reduced cost base start with five elements, which effectively are what was paid for the asset, transaction costs of acquisition and of the CGT event, and certain capital and non-capital costs of ownership. The reduced cost base makes adjustments to what was paid to acquire the asset mainly for amounts that have been deducted under other provisions of the income tax legislation. It is, in effect, one of the adjustment mechanisms for reconciling the CGT with other provisions. Similar adjustments effective in 1997 were introduced for the cost base calculation also. The calculation of disposal proceeds is set out in Div 116. Essentially it is the amount paid on the happening of the CGT event. There are several modifications of disposal proceeds similar in many respects to those for the cost base and reduced cost base, for example, where a transaction involves a gift. The final division in Pt 3-1 is Div 121 on record-keeping which completes the general part of the CGT. Part 3-3 starting with Div 122 then covers special CGT topics. (It is odd that a gap has been left in the numbering of the parts but not the divisions here – how will divisions in any future Pt 3-2 be numbered?) The organisation of the CGT into general and specific provisions also occurred in the ITAA 1936 though there was not any formal separation of the two. Divisions 1 to 4 of Pt IIIA were the general provisions, and Divs 4 to 21 the specific provisions.

(b) Principal CGT Concepts (i) CGT asset [3.50] The definition of CGT asset found in s 108-5 has gone through three versions since 1986 (in the ITAA 1936 under s 160A, it was simply an asset and we will often use this term as well). The first version was open to an argument that it only applied to property or rights that were assignable. The second version made clear that rights could be assets even if not regarded as property but otherwise retained the awkward form of the original definition which first said what asset “means”, then what it “includes” and finally excluded motor vehicles. The 1997 [3.50]

83

The Tax Base – Income and Exemptions

definition is much cleaner – but not necessarily any clearer. It first states what CGT asset means – any kind of property, and a legal or equitable right that is not property. Then for the avoidance of doubt it states that certain things are CGT assets – goodwill and interests in partnership assets and partnerships (which approximately corresponds to the inclusive part of the former definition). Finally it has a note giving examples of assets, which includes one item that was previously in the inclusive list – foreign currency (the ITAA 1997 is no more forthcoming on the status of Australian currency). The exclusion of motor vehicles has been deleted and replaced by a provision that the disposal of a motor vehicle is disregarded, s 118-5, as part of the general change which seeks to use the same mechanism for all exclusions, as discussed above. In all its forms the definition raises the question whether it will be interpreted expansively or not. After some inconclusive case law in Australia, the High Court recently decided emphatically in favour of an expansive interpretation even for the first version of the definition in FCT v Orica Ltd (1998) 39 ATR 66; 98 ATC 4494 (extracted below). The difficulty is that the broader the definition of asset is cast, the more difficult transactions become to characterise for CGT purposes and the more complex is the CGT analysis; and at the same time the greater becomes the potential application of the CGT, so that it may apply unexpectedly in common situations. Information is an area where the borderline of the asset concept is unclear. The law gives quite formal legal protection to certain kinds of information (or its presentation) by patent and copyright. Confidential information also can be protected by the law. Is information an asset? Are the rights arising from the law protecting confidential information assets? Issues of these kinds are dealt with in Ruling TR 98/3 on mining, quarrying and prospecting information.

Ruling TR 98/3 Nature of mining, quarrying or prospecting information [3.60] 16. Mining, quarrying or prospecting information is not property. Of course, such information can ripen into a form of property such as copyright, trademarks, designs and patents … 17. This Ruling deals with information transactions whose essential character is not the transfer of a “literary work” under copyright law (analogous to the sale of copyrighted works such as books or computer programs). Rather, the transaction’s essential character is the passing across of information about existing or potential mining or quarrying business. To pass across this information it may be necessary to transfer ownership in reports, maps, computer tapes, etc, but the transfer of the recording medium is merely incidental to the character of the transaction.

948; 88 ATC 4190, the Full Court of the Supreme Court of Queensland considered the dutiability of an agreement for the sale of an interest under a mining joint venture including information arising from feasibility studies and exploration work. The court rejected an argument by the Commissioner that the information comprised tangible property on the basis that it related to documents and records. The court said at ATR 950; ATC 4193:

18. In Pancontinental Mining Ltd v Commissioner of Stamp Duties (Qld) (1988) 19 ATR

19. In determining the dutiability of a transaction or instrument the first step taken by

84

[3.60]

I am not persuaded that the information referred to in cl 2.2(c) is necessarily to be found in those documents. But if some of the information does appear in them, the communication of that information is clearly not for that reason converted into a transfer of property. It would be quite wrong to confuse the information with the physical record: Rolls Royce, supra, at p 431. The information itself remains intangible.

Income from Property

Ruling TR 98/3 cont. the court in Pancontinental was to characterise the transaction or instrument having regard to all relevant factors. The mere fact that title to property (eg the physical medium recording information) passed did not determine the outcome of the characterisation. The court decided that the passing of title to property was merely ancillary or incidental to what it regarded as the provision of a service. Therefore, no liability to ad valorem conveyance duty was imposed on that element involving the transfer of property. 20. In circumstances analogous to those in Pancontinental, it is accepted that the transfer of exploration or prospecting information involves the provision of a service, and the transfer of title to any documents and chattels comprising the media upon which the information is stored is incidental and subservient to the passing across of the information. Exploration or prospecting information is akin to know-how, ie technical knowledge that is peculiar and unique to a specific business operation. 21. The term “know-how” is difficult to define with precision. One leading description was given by Lord Radcliffe in Rolls-Royce Ltd v Jeffrey (Inspector of Taxes) (1962) 40 TC 443; 1962 1 All ER 801. This description has been summarised in Strouds Judicial Dictionary of Words and Phrases, 5th Edition, Sweet and Maxwell, at 1.395, as follows: “Know-how” is the fund of technical knowledge and experience acquired by a highly specialised production organisation; although it may be, and usually is, noted down in documents, drawings etc, it is itself an intangible entity whose category may vary according to, and may even be determined by, its use. Like office or factory buildings, patents and trademarks, and goodwill, it may be described as a “capital asset” while it is retained by a manufacturer for his own purposes, but, unlike these, its supply to another is not a transfer of a fixed capital asset because it is not lost to the supplying manufacturer.

CHAPTER 3

22. Know-how is therefore an intangible asset and, from a practical perspective in relation to exploration or prospecting information, can be viewed as undivulged knowledge or information residing with the supplier that enables, or may enable, a mining or quarrying business to be carried on, eg knowledge about the presence of mineral bearing ore or quarry materials needed to facilitate extraction. In supplying know-how, the seller is passing to the buyer the seller’s special knowledge or information that remains unknown to the public. 23. There is a view expressed by Gummow J in the Federal Court’s decision in Hepples v FCT (1990) 90 ATC 4497; 21 ATR 42 that confidential information has a proprietary character. His Honour said at ATR 69; ATC 4520: … that the degree of legal protection afforded by the legal system (especially in equity) to confidential information (and this would be true particularly of trade secrets) makes it appropriate to describe such confidential information as having a proprietary character, not because this is the basis on which that protection is given, but because this is the effect of that protection. 24. However, the views of Gummow J were not followed when the matter was considered on appeal to the Full High Court. Moreover, they are in direct conflict with the decisions of the High Court in such cases as Victoria Park Racing and Recreation Grounds Company Limited v Taylor and Ors (1937) 58 CLR 479 and FCT v United Aircraft Corporation (1943) 68 CLR 525; 2 AITR 458; 7 ATD 318 where information was held not to be property. 25. In the United Aircraft Corporation case Latham CJ said, at CLR 534: Knowledge is valuable, but knowledge is neither real nor personal property. A man with a richly stored mind is not for that reason a man of property. Authorities which relate to property in compositions, &c, belong to the law of copyright and have no bearing upon the question whether knowledge or information, as such, is property. It is only in a loose metaphorical sense that any knowledge as such can be said to be property. [3.60]

85

The Tax Base – Income and Exemptions

Ruling TR 98/3 cont. 26. The decision in the United Aircraft case that information is not property has been confirmed in other cases such as: Brent v FCT (1971) 125 CLR 418; 2 ATR 563; 71 ATC 4195, Rolls-Royce Ltd v Jeffrey (Inspector of Taxes); Pancontinental Mining Ltd v Commissioner of Stamp Duties (Qld); Nischu Pty Ltd v Commissioner of State Taxation (WA) (1990) 21 ATR 391; 90 ATC 4391; and its subsequent appeal to the Full Supreme Court of Western Australia reported as Commissioner of State Taxation (WA) v Nischu Pty Ltd (1991) 21 ATR 1557; 91 ATC 4371. Unless and until the courts decide otherwise, the better view is that information is not property. 27. Information can be and is dealt with independently from any mining, quarrying or prospecting right. In a situation where the mining information was unavailable, for example, as a result of destruction of technical records by fire, the mining right would remain entirely unaffected. The right would still be in existence and capable of being dealt with and exploited in exactly the same manner. Prospectively, it would still yield the same profit. It is only its value to a potential purchaser that would be diminished without the information. 28. The separateness of “mining information” from the “mining right” to which it relates is highlighted and confirmed in the stamp duty cases of Pancontinental and Nischu. 29. Mining, quarrying or prospecting information is not goodwill. It is separate and distinct from the goodwill of a mining business. It might be a source of the goodwill of the business but it is separate from the goodwill. Goodwill does not attach to mining, quarrying or prospecting information. Rather it attaches to the mining business which uses the information. 30. As the High Court explained in FC of T v. Murry 98 ATC 4585; (1998) 39 ATR 129, it is the legal definition of goodwill, rather than its accounting and business definitions, that applies for capital gains tax purposes. Goodwill has the meaning attributed to it by the High Court in that case. Unlike goodwill (which cannot be dealt with separately from the business with which it is associated) mining, quarrying or prospecting information can be and is often disclosed or dealt 86

[3.60]

with independently of the mining tenement or any other asset of the mining business. Is mining or prospecting information an asset? 63. For something to be an asset within the definition of asset in s 160A, it must be either a form of property or it must be a right which falls within the scope of paragraph (a) of that section. As mining, quarrying or prospecting information itself is not property (for the reasons outlined in paras 16 to 26) and is not otherwise within the scope of para 160A(a), it is not an asset as defined in s 160A. 64. However, the sale of mining, quarrying or prospecting information is often accompanied by the sale of items of property such as core samples, plant and equipment, etc. Consideration received for the disposal of these items of property comes within Pt IIIA. Is the medium containing mining, quarrying or prospecting information an asset? 65. Strictly speaking, the medium in which mining, quarrying or prospecting information is contained (eg paper, computer memory, floppy disk, etc) is an asset for the purposes of Pt IIIA. 66. However, although the medium is an asset, it is not an asset that necessarily carries the value of the information. Generally, the value of the medium is negligible. Unless the facts indicate otherwise, it will be accepted that the medium containing the information has negligible value such that, in practical terms, no amount has to be allocated to the medium under subs 160ZD(4) in transactions where information itself is being disclosed. Are rights in relation to mining, quarrying or prospecting information an asset? 67. A taxpayer agreeing to disclose mining, quarrying or prospecting information brings into existence certain contractual rights by entering into a contract to disclose that information. The right to have information disclosed is a right for the provision of a service. Other rights could also be created, including rights to hold, use, enjoy, disclose or destroy mining, quarrying or prospecting information. These rights in relation to mining, quarrying or prospecting information, considered together, are an asset in terms of Pt IIIA.

Income from Property

CHAPTER 3

[3.70] The Ruling goes onto consider other CGT issues which are extracted below. Question

[3.75]

3.4

Is know-how an asset? How, if at all, is it different from information and goodwill? (A similar issue is considered in the Canadian decision of Rapistan Canada Limited v MNR (1974) 48 DLR (3d) 613: see TD 2000/33.)

[3.80] The final paragraph of the previous extract considers that the bundle of rights created

by a contract to disclose information is a single asset. Whether a single asset exists in a particular case or a bundle of assets is often an important issue in deciding whether a CGT event has occurred and, if so, under which CGT event provision. The question of whether a share in a company is a single asset, or a bundle of assets consisting of each individual right inherent in the share, is considered in Ruling TR 94/30.

Ruling TR 94/30 Nature of a share [3.90] 18. In examining the capital gains tax (CGT) implications of any variations in the rights which are attached to shares, it is necessary to consider whether a share is one asset or whether a series of assets are contained in the bundle of rights that comprise a share. Furthermore, we need to consider whether a change in rights attaching to a share results in the creation of a new share comprised of a new bundle of rights. 19. The explanation which follows considers the nature of a share and then relates relevant concepts from that discussion to the statutory requirements of Pt IIIA. 20. The precise legal nature of a share has not been made clear by the courts but some assistance can be obtained by turning to company law concepts as well as to death duty cases on the subject. 21. The rights of each shareholder in relation to each class of share are usually contained in the memorandum and articles of association of the company. The rights attaching to a share are not ordinarily thought of as a separate piece of property.

“aliquot” part is part of a total such that, if the total is divided by that part, there is no remainder. For example, 5 is an aliquot part of 15.) Farwell J followed this interpretation when describing the legal nature of a share in Borland’s Trustee v Steele Bros & Co Ltd 1901 1 Ch 279 at 288: The contract contained in the articles of association is one of the original incidents of the share. A share is not a sum of money settled in the way suggested, but is an interest measured by a sum of money and made up of various rights contained in the contract, including the right to a sum of money of a more or less amount. 23. This description was endorsed by Williams J in the High Court decision of Archibald Howie and Others v Commissioner of Stamp Duties (NSW) (1948) 77 CLR 143 at 156. Dixon J at 152 also endorsed this approach in the following terms: While a shareholder has not a proprietary right or interest in the assets of an incorporated company, his “share” is after all an aliquot proportion of the company’s share capital with reference to which he has certain rights.

22. An often-used description of a share is that it is an aliquot interest of a shareholder in a company as measured by a sum of money. (An [3.90]

87

The Tax Base – Income and Exemptions

Ruling TR 94/30 cont. 24. The Corporations Law defines a share as personal property which is transferable or transmissible and, subject to the articles, able to be devolved (s 1085). 25. The nature of a share was considered in the death duty case of Re Alex Russell, deceased 1968 VR 285. McInerney J of the Supreme Court of Victoria considered the question of whether the right to convert a preference share to an ordinary share could be transferred at death. His Honour found that this right was still “locked up” and it could not be separated out of the actual estate. Also examined was the question of whether the right to convert could be separated out from the preference shares. McInerney J commented at 299-300: It follows that while it is correct to speak of the testator’s preference shares as consisting of a bundle or congeries of rights, it is not correct to speak of a shareholder owning each of those rights as a separate piece of property, or as a separate chose in action … It is not permissible, therefore to separate out the various rights appertaining to the holder of preference shares and to treat some of those rights as “actual estate” and others as “notional estate”. 26. Accordingly while shares are comprised of a bundle of rights, those rights are not separate pieces of property capable of being divided out and held separately. 27. The implications of incidental changes to rights attaching to shares was considered in the decision of the New South Wales Court of Appeal in Rofe & Others v Commissioner of Stamp Duties (NSW) 88 ATC 4865. This was a death duty case where the court had to consider whether the conversion of ordinary shares into cumulative preference shares not long before the death of the testator was a “disposition of property” and so dutiable under the Stamp Duties Act 1920 (NSW) (SDA (NSW)). 28. The special resolution passed by the company in altering the rights and liabilities of the shares set down that the shares after conversion bore the same share numbers but different rights (most notably the new right to a 88

[3.90]

fixed dividend) and privileges than the ordinary shares before conversion. Mahoney JA, in finding that there was a disposition of property, said that the effect of the conversion of ordinary shares to cumulative preference shares was that (at 4874): … The deceased ceased to hold property of one kind and acquired property of another kind … The rights of the two classes of shares were, of course, fundamentally different. 29. The reasoning in this case relies heavily on the provisions of the SDA (NSW). It ultimately was decided in its particular statutory context of the definition of “disposition of property”. The question in this case was not whether there was a “disposition of property” as this point was conceded by the executors of the estate. Rather, the question was whether there was a “disposition of property” because it was a “transaction entered into with intent to diminish the value of the shares”, in the words of this Act. Therefore the question of whether there was a disposition arose only because it fell within the extended definition of “disposition of property” in the SDA (NSW). As such, the analysis is not applicable in the context of the ITAA. 30. The High Court has also looked into the nature of a share in the death duty case of Robertson v FC of T (1952) 86 CLR 463. In that case, the articles of the company had been altered so that upon the testator’s death the shares standing in the register in his name became No 2 class shares with very limited rights. The shares were valued by the Court on the basis of these reduced rights. Williams J at 479-480 commented: The contract between the company and its members created by section 20 of the Companies Act or the contract thereby created between the members inter se, if there be any such contract, could not cause the beneficial interest in the shares of one member to pass or accrue to or devolve upon the shares of another member (perhaps “accrue” is the most apt word for present purposes). The property in the shares is the property that exists in the shares themselves. Shares do not give an aliquot proprietary right in the property of the company. The whole effect of Article 6 upon the

Income from Property

Ruling TR 94/30 cont. death of the deceased was to alter the existing contractual rights of the shareholders against the company inter se. The article did not cause any beneficial interest in any property owned by one person to accrue in any other person. It merely altered the contractual rights upon death of the deceased. It did not alter any proprietary rights. 31. Clearly in this case there was a change in the relative interests of shareholders following the change in rights. For taxation purposes, the issue that needs to be determined is whether the variation in relative interests in a share amounts to a disposal of that share. A disposal of rights attaching to a share (or asset) for the purposes of Pt IIIA of the ITAA, or a part disposal of the share, envisages that the rights be capable of being separated out of the share or assigned. That is, they would need to be regarded as assets in their own right. Whether a right attaching to a share is a CGT asset 32. In considering the nature of a share, it has been the prevailing view of the courts that the rights attaching to shares cannot be dealt with separately from the share itself. It is clear that these rights were not assets under the definition of asset in s 160A as it existed before being amended by the TLAA (No 4) 1992. 33. We also consider that the current extended definition of “asset” in s 160A, which applies to the construction or creation of assets after 25 June 1992, does not alter this position. The expression “any other right” is a general provision which, under the rules of statutory interpretation, does not take precedence over a more specific provision. As a share is a chose in action, subpara 160A(a)(iii) takes precedence over subpara 160A(a)(iv) to the effect that a share itself is the asset and not its constituent rights. The concept of a share as a whole being the relevant asset is also supported by other provisions in Pt IIIA: see, for example, paras 160M(5)(a), 160T(1)(c) and 160T(1)(j). Disposal Full disposal

CHAPTER 3

34. Section 160M is the provision dealing with disposals for CGT purposes. For a disposal to occur under subs 160M(1), there must be a “change in the ownership” of the asset. Generally, this occurs where there is both a disposal of the asset by the person who owned it immediately before the change and an acquisition of the asset by the person who owned it immediately after the change. However, a variation in share rights may not necessarily result in an acquisition by a person (for example, where shareholders relinquish rights without any other shareholders gaining those rights). 35. Paragraph 160M(3)(c) is the disposal provision which specifically refers to a share. It provides that a change in ownership of an asset, being a share, is deemed to occur where the share is redeemed or cancelled. If there is no redemption or cancellation, no disposal takes place in terms of that paragraph. 36. The terms “cancel” and “redeem” are defined at paras 16 and 17 above. Cancellation of a share certificate does not mean that the share itself is cancelled. Share scrip is of evidentiary value and may be cancelled for a variety of reasons all of which have no CGT consequences. Examples of where a company may cancel a share certificate include where: (a)

the balance of a partly paid share is later paid by the shareholder. A new certificate may issue to show that the share is now fully paid;

(b)

a company changes its name and new certificates are issued;

(c)

a share certificate is lost or damaged and a substitute or replacement or substitute certificate is issued;

(d)

a shareholder having one certificate as evidence of a share holding transfers part of that share holding. The company may cancel the original share certificates and issue two new certificates: one to evidence the new share holding and the other to evidence the shares transferred. The shares transferred will of course be subject to the provisions of Pt IIIA.

37. Of course, a company may specify in the articles that a cancellation of shares is to occur at a particular time or on the happening of an event such as giving up the share scrip. [3.90]

89

The Tax Base – Income and Exemptions

Ruling TR 94/30 cont. 38. The administration of the ITAA is not constrained by the usage of terms in the Corporations Law. However, if it is clearly a requirement that a transaction calls for a redemption and cancellation of shares, in terms of the Corporations Law, a disposal has to have taken place for the purposes of the ITAA, by virtue of para 160M(3)(c). 39. A variation in share rights that does not involve a cancellation or redemption of the share does not amount to a disposal of the share for the purposes of subs 160M(1). Part disposal 40. It could be argued that a variation in share rights amounts to a part disposal of the share on the basis that some of the rights are relinquished. Paragraph 160M(3)(c) refers to a redemption of a share in whole or in part. However, the specific section dealing with part disposals is s 160R, which is premised on the basis that Pt IIIA applies to that part of an asset which is capable of disposal. If it cannot in fact and at law be

separately disposed of, the section does not deem it to be capable of being separately disposed of. 41. By way of judicial comment on s 160R is an obiter dictum comment by Deane J in the High Court case of Hepples v FCT (1991) 173 CLR 492; 22 ATR 465; 91 ATC 4808 at 516 (CLR), 480 (ATR), 4821 (ATC): It seems to me that the preferable approach is to treat section 160R as applying to a case where there has been a disposal, in the sense of a change of ownership of any part of the rights involved in the ownership of an asset, those rights themselves constituting an asset for the purposes of Pt IIIA. (emphasis added) 42. His Honour’s view still requires that there be a change of ownership for s 160R to apply. We consider that there is no change in ownership of a share (or part of a share) where a company varies one or more of the rights attaching to the share. This is because there is no redemption of part of a share and the rights attaching to a share are not assets separate from the share.

[3.100] This Ruling also considers further issues which are extracted below. As is evident

from the extract it is difficult to separate out the questions whether there is an asset, what that asset is and whether there is a relevant event in relation to the asset. The concept of part disposal of an asset does not appear in the ITAA 1997. Instead the definition of asset in s 108-5(2)(a) – the avoidance of doubt part – states that “part of, or an interest in, an asset” referred to in s 108-5(1) is an asset. The Explanatory Memorandum states at p 58, “The rewritten provisions will also put beyond doubt that a divided part of a CGT asset and an undivided interest in a CGT asset are also CGT assets”. Division 108 also contains a subdivision titled “Separate CGT assets” which contains rules for particular cases (mainly involving land) which will be treated as involving more than one asset. [3.105]

3.5 3.6

3.7

90

Questions

Does the Ruling still correctly state the law in light of the change in the ITAA 1997 to refer to part of an asset as an asset in s 108-5(2)? When will it be appropriate to treat groups of rights or individual rights as the relevant asset? Does it follow from the change in the ITAA 1997 that groups of assets can themselves be treated as a single asset? (You should revisit these questions after consideration of the material under the next heading, especially the High Court decision in Orica.) If you own an interest in a CGT asset and you acquire another interest in that asset, do the interests remain separate CGT assets for capital gains purposes or do they become a single asset? (See TD 2000/31.) [3.100]

Income from Property

CHAPTER 3

3.8

Can property or a right, the “market value” of which is nil, be a CGT asset? (See TD 2000/34.)

3.9

Is s 108-7, which states that the interest of a joint tenant is to be treated as an interest as tenant in common, necessary in the ITAA 1997? (The principal difference between joint tenancy and ownership of property in common is that the doctrine of survivorship applies to property owned by joint tenants. Where one joint owner dies, the other joint owner(s) automatically have their interest in the asset increased. On the other hand, property owned by a taxpayer as a tenant in common will pass under the will of the deceased, and does not automatically enure to the benefit of the other co-owner.) What happens if a taxpayer transfers a block of land which she owns to herself and another as joint tenants or tenants in common? For each of the sections in Subdiv 108-D, consider the following matters: • why has the provision been enacted?

3.10 3.11

• is the provision necessary disregarding s 108-5(2)(a)? • is the provision necessary in the light of s 108-5(2)(a)? [3.110] Although the definition of asset extends beyond transferable property, it is evident

from the materials above that it is based on an analysis of legal rights. Accounting has a different concept of asset, namely, anything of future economic benefit. This much wider concept is not reflected in the law. For example, work in progress of a professional firm is not an asset for CGT purposes though it is for accounting purposes. For the income tax treatment of work in progress see Chapter 11. It also follows from the focus on assets that the CGT does not deal directly with gains and losses on liabilities. An often-cited example is gains on “forgiveness of debt” realised by taxpayers who borrow and then have the debts cancelled so they do not have to repay the borrowed funds. As we shall see in Chapter 5, gains from forgiveness of debt are considered ordinary income in some circumstances. Debt forgiveness measures were introduced in 1996 (Sch 2C of the ITAA 1936) to deal with such gains but not by an inclusion in assessable income. [3.115]

3.12

Question

In 1992 the taxpayer borrowed $10,000 from his father. Fourteen months later, in 1993, the father waived the debt (at which time it was cancelled) and the taxpayer was able to keep the $10,000 without an obligation to pay it back. Are there any CGT consequences for the lender or borrower from these events? (See Determination TD 2.)

(ii) CGT events [3.120] Under the ITAA 1936 the CGT revolved around the concept of disposal of an asset. The principal “disposal” provision in Pt IIIA is s 160M. Subsections 160M(1) to (5) dealt with actual disposals and the remaining subsections dealt with “deemed disposals”. One purpose of these latter provisions was to bring into the operation of Pt IIIA capital gains generated in transactions that did not involve actual property dispositions but which gave rise to gains that were labelled by the courts as “capital” receipts as they were not ordinary income. Section 160N made clear that the loss or destruction of assets was a disposal of that asset. There were many other special provisions in Pt IIIA dealing with individual transactions that had to be deemed to generate a “disposal”. All these disposals are now gathered as CGT events in Div 104 of the ITAA 1997. For the purposes of exposition, however, we will track the treatment of the ITAA 1936. In this part of [3.120]

91

The Tax Base – Income and Exemptions

the chapter which covers general CGT concepts, we will deal with the events that correspond to the disposals covered by s 160M(1) to (7) and s 160N of the ITAA 1936. The CGT event rules which relate to special cases will be covered to the extent they are relevant to the subject matter of this book at the points where the special cases are discussed. The CGT event sections also provide the time of the event and the calculation of capital gain or capital loss in relation to that event. We shall also follow the ITAA 1936 treatment by considering timing of events (and acquisitions) and the calculation of capital gain or capital loss together, but separately from CGT events. The main CGT events are A1, B1, C1 and C2. The first two deal with disposals of CGT assets. Event A1 defines disposal as a change of ownership from the taxpayer to another person (putting aside mere changes in legal title). Because it only operates when someone else becomes the owner of the asset, it is necessary to have two further provisions in ss 104-20 and 104-25 (events C1 and C2) to deal with the cessation of assets, respectively the loss or destruction of a tangible asset, and the coming to an end of an intangible asset like a right. The latter provision has the potential to be very far-reaching if a wide range of rights are treated as separate CGT assets or separable parts of a single CGT asset even though bundled together, for example, the variety of rights that arise whenever two parties enter into a contract. A way of limiting this conclusion would be to say that the event constituted by the coming to the end of the right would only apply if a right is terminated by breach of the agreement as opposed to being carried out by the parties to the agreement. These issues were dealt with by the High Court in Orica. The taxpayer had borrowed money from the public using debentures. A trustee for debenture holders represented the interests of the individual debenture holders and as protection for them the trust deed contained many restrictions and ratios which limited the business operations of the taxpayer. As commercial conditions changed, the restrictions and ratios became a barrier to the development of the taxpayer’s business and like many other taxpayers in similar positions, the taxpayer sought ways to satisfy the debentures. Partly because the debentures were widely held it was not practical to buy them all back – and in any event, some debenture holders may simply refuse to sell. Hence the taxpayer entered into what was called an “in-substance debt defeasance” transactions. These were effected by entering into transactions with other parties of substantial creditworthiness (typically banks or government instrumentalities) which, in exchange for payments from the taxpayer, undertook to make payments of interest and principal on the debentures as they fell due. As a result, in a practical, though not a legal, sense the taxpayer was relieved from the obligations under the debentures. The trustee for debenture holders agreed to release the taxpayer from the restrictions and ratios and the company’s auditors agreed to the removal of the liability for the debentures from its balance sheet. In this particular case, under debenture trust deeds of 1966 and 1970, various debentures were issued which had repayments dates (so far as relevant to the case) between 30 November 1986 and 31 January 2000. On 6 June 1986, the taxpayer entered into a principal assumption agreement with the Melbourne and Metropolitan Board of Works (MMBW) and an interest assumption agreement with the State Bank of New South Wales. Under the former, the taxpayer paid the Board $62,309,546 on 1 July 1986, being the present value of the future obligation to pay the principal on the debentures as at that date. The aggregate of the principal amounts payable was $98,662,800. The present values of the several principal amounts payable on their respective maturity dates were calculated by discounting those amounts at a rate equal to the Commonwealth Bond rate for bonds maturing on or reasonably close to the 92

[3.120]

Income from Property

CHAPTER 3

respective maturity dates less 0.03% per annum. The accounts of the taxpayer dealt with the difference between the two amounts by reporting a profit of $36,353,254. The ATO sought to tax this profit either when it was made (in the 1986 year of income as the taxpayer balanced for tax purposes on 30 September) or over the period of the transaction based on Div 16E of the ITAA 1936, on that basis that the profit was ordinary income. This position was based on a Ruling IT 2494 on debt defeasance in reliance on the Myer Emporium case, which is extracted in Chapter 5. The High Court by majority rejected this basis of assessment: see Chapter 5. An alternative that found acceptance with a majority of the High Court was that each time the Board effected payment of principal, the taxpayer was assessable under the CGT. The difference between the ATO’s approach to the events of July 1986 and the ultimate finding of the Court is really quite fundamental. The ATO saw the transaction as involving something akin to a disposal (the elimination of a liability) while the Court regarded the transaction as a purchase of rights. It is not surprising that the tax treatment which the Court approved looked nothing like the way the ATO had assessed the taxpayer. Gaudron, McHugh, Kirby and Hayne JJ reasoned as follows:

FCT v Orica Ltd [3.130] FCT v Orica Ltd (1998) 39 ATR 66; 98 ATC 4494 Capital gains tax 88. Two issues were debated: whether, by making the Principal Assumption Agreement, the taxpayer acquired an asset and whether, when MMBW performed its obligations under the Principal Assumption Agreement, a change occurred in the ownership of an asset. An asset? 89. Section 160A provides that in Pt IIIA, unless the contrary intention appears, asset: … means any form of property and includes – (a) an option, a debt, a chose in action, any other right, goodwill and any other form of incorporeal property … (Nothing turns on the amendments later made to s 160A by the Taxation Laws Amendment Act (No 4) 1992 (Cth)). 90. We have no doubt that the rights acquired by the taxpayer against MMBW under the Principal Assumption Agreement are an asset for the purposes of Pt IIIA. The contention, accepted by the majority of the Full Court, that the right acquired by the taxpayer “was merely a personal right … which was incapable of being assumed by a third party” (ICI Australia Ltd v FCT (1996) 68 FCR 122; 33 ATR 174; 96 ATC 4650 at 138 (FCR),

188-9 (ATR), 4694 (ATC) per Lockhart J) must be rejected. The conclusion that the taxpayer’s right against MMBW was only a right to compel MMBW to specifically perform its obligations appears to have been founded in the proposition, adopted by the primary judge, that “no conceivable assignee would have any interest in enforcing MMBW’s obligation which was to discharge the taxpayer’s obligation to the debenture holders” … It may be doubted that enquiring whether there is any person who would have a commercial interest in taking an assignment will determine whether something is an item of property capable of assignment … The question is whether the rights are capable of assignment, not whether anyone is interested in taking an assignment. 91. Furthermore, in construing the term “any form of property” in s 160A, it is important to bear in mind the following statement by Kitto J in National Trustees Executors & Agency Co of Australasia Ltd v FCT (1954) 91 CLR 540 at 583: It may be said categorically that alienability is not an indispensible attribute of a right of property according to the general sense which the word “property” bears in the law. Rights may be incapable of assignment, either because assignment is considered incompatible with their nature, as was [3.130]

93

The Tax Base – Income and Exemptions

beneficiary is absolutely entitled to the asset as against the trustee;

FCT v Orica Ltd cont. the case originally with debts (subject to an exception in favour of the King) or because a statute so provides or considerations of public policy so require, as is the case with some salaries and pensions; yet they are all within the conception of “property” as the word is normally understood … In any event, we do not accept that there is “no conceivable assignee” who would have an interest in taking an assignment from the taxpayer of its rights against MMBW. The debenture holders are an obvious class of persons who would have a real and lively commercial interest in having MMBW perform its obligations. It follows that the rights which the taxpayer had against MMBW under the Principal Assumption Agreement are an asset for the purposes of Pt IIIA. Disposal? 92. Section 160M provided in 1986 and 1987: (1)

(2)

(3)

94

Subject to this Part, where a change has occurred in the ownership of an asset, the change shall be deemed, for the purposes of this Part, to have effected a disposal of the asset by the person who owned it immediately before the change and an acquisition of the asset by the person who owned it immediately after the change. A reference in subsection (1) to a change in the ownership of an asset is a reference to a change that has occurred in any way, including any of the following ways: (a)

by the execution of an instrument;

(b)

by the entering transaction;

(c)

by the transmission of the asset by operation of law;

(d)

by the delivery of the asset;

(e)

by the doing of any other act or thing;

(f)

by the occurrence of any event.

into

of

a

Without limiting the generality of subsection (2), a change shall be taken to have occurred in the ownership of an asset by – (a) a declaration of trust in relation to the asset under which the [3.130]

(b)

in the case of an asset being a debt, a chose in action or any other right, or an interest or right in or over property – the cancellation, release, discharge, satisfaction, surrender, forfeiture, expiry or abandonment, at law or in equity, of the asset;

(c)

in the case of an asset being a share in or debenture of a company – the redemption in whole or in part, or the cancellation, of the share or debenture; …

The ATO submitted that s 160M(3)(b) applied to deem performance by MMBW of its obligations under the Principal Assumption Agreement to be a change in the ownership of the taxpayer’s asset (its rights under that agreement). It was submitted that MMBW’s performance of its obligations was the “discharge” or “satisfaction” of the asset being the “chose in action or any other right” constituted by the taxpayer’s rights under the Principal Assumption Agreement. 93. The Full Court held that “discharge” and “satisfaction”, when used in s 160M(3), were not to “be construed as extending to the performance of obligations under an agreement giving rise to the rights in accordance with the terms of the agreement” (ICI Australia Ltd v FCT (1996) 68 FCR 122; 33 ATR 174 at 139 (FCR), 189 (ATR) per Lockhart J) and were words which “must be confined to cases where the rights are satisfied or discharged otherwise than by performance of the obligations which give rise to the rights by the other party to the contract” ((1996) 68 FCR 122 at 139; 96 ATC 4680 at 4694 per Lockhart J). 94. There is no basis for confining “discharge” or “satisfaction” in this way. First, as a matter of ordinary language, “discharge” can be used in the sense of “the act of clearing off a pecuniary liability; payment” (The Oxford English Dictionary, 2nd ed (1989), “discharge” sense 5) or “fulfilment, performance, execution (of an obligation, duty, function, etc)” (The Oxford English Dictionary, 2nd ed (1989), “discharge” sense 6).

Income from Property

FCT v Orica Ltd cont. 95. Second, it is common for lawyers to speak of a contractual obligation being discharged by performance. No doubt there are other ways in which the obligation can be discharged but performance is one. There is nothing in the ordinary usages in the law of the terms the “discharge” or the “satisfaction” of an obligation which would suggest that the use of the terms in s 160M(3) is to be confined in the manner suggested. 96. Third, when the subsection speaks, as it does, of the “discharge” of a debt it is plainly using the word “discharge” in a way that at least includes payment of the debt according to the terms of the obligation incurred by the debtor. 97. Fourth, far from the other provisions of Pt IIIA (or s 160M in particular) providing a sound basis for reading down the apparent generality of s 160M(3)(b), the context in which the provision sits discloses an intention to give it a very wide operation. Subsections (1) and (2) of s 160M centre upon a change in ownership of an asset. Subsection (1) deems a change in ownership to effect a disposal of an asset by one person to another and subsection (2) amplifies what is meant by a “change in the ownership”. Subsection (3) provides that a change “shall be taken to have occurred in the ownership of an asset” upon the happening of any of several events or transactions. It is clear from the reference to redemption or cancellation of shares or debentures in par (c) that the events that are to be taken to amount to a change in ownership include events where the asset ceases to exist as an item of property. Similarly, subsection (6) demonstrates that there can be a disposal of an asset for the purposes of Pt IIIA where an asset is created by the disposal. 98. It was submitted that unless the provision was read down by confining “discharge” and “satisfaction” to discharge or satisfaction otherwise than by performance of the obligation undertaken, performance of every executory contract would be brought within the reach of the capital gains provisions. No doubt that is so but it does not mean that a party to an executory contract will always be liable to tax. It is necessary

CHAPTER 3

to recall that tax will be payable only if there is a capital gain, that is, only “if the consideration in respect of the disposal exceeds the indexed cost base to the taxpayer in respect of the asset”, s 160Z(1)(a). If what the taxpayer receives on performance of the obligation undertaken by the other party to an executory contract does exceed the indexed cost base to the taxpayer in respect of the acquisition of the right to have the obligation performed, we see no incongruity in concluding that the taxpayer has made a capital gain. 99. Accordingly, there is no basis for confining the word “discharge” (or, for that matter, the word “satisfaction”) to discharge or satisfaction otherwise than according to the tenor of the obligation incurred. 100. In all these circumstances it follows that for the purposes of Pt IIIA performance by MMBW of its obligations under the Principal Assumption Agreement, and discharge pro tanto of those obligations by performance, is a disposal of part of the taxpayer’s asset (being its rights against MMBW under the Principal Assumption Agreement). (By s 160R “a reference to a disposal of an asset” in Pt IIIA “includes, unless the contrary intention appears, a reference to a disposal of part of an asset”. No contrary intention is to be found in s 160M(3)). 101. The taxpayer contended that if the difference between the amount paid by the taxpayer under the Principal Assumption Agreement and the face value of the debentures was income or profit from a profit-making scheme the Commissioner’s appeal in respect of the 1987 year should nevertheless be dismissed because the taxpayer made no gain until MMBW had paid out more than the $62,309,546 that the taxpayer paid under the Principal Assumption Agreement. Debentures maturing between 30 November 1986 and 31 May 1990 were for principal amounts totalling $61,869,800. Accordingly, not until payment in relation to debentures maturing on 31 July 1990 (which had a face value of $4,275,000) would MMBW pay out more than the taxpayer had paid under the Principal Assumption Agreement. Because we consider that the difference between the two amounts is not income or profit, we need not decide whether this argument is good. It is, however, an argument [3.130]

95

The Tax Base – Income and Exemptions

FCT v Orica Ltd cont. that does not arise under Pt IIIA because where, as here, part of an asset is disposed of, s 160ZI requires apportionment of the cost base attributable to the asset. 102. MMBW having made no payment under the Principal Assumption Agreement during the 1986 year, the Commissioner’s appeal in respect

of that year should be dismissed with costs. MMBW having made payments in the 1987 year, the appeal to this Court in respect of that year of income should be allowed, the orders made by the Full Court set aside, and in lieu it should be ordered that the appeal to that Court should be allowed, the decision of the Commissioner disallowing the taxpayer’s objection set aside and the Commissioner directed to amend the assessment concerned.

[3.135]

3.13

3.14

3.15

Questions

Does the majority of the High Court consider the principal assumption agreement to be a single asset or a bundle of assets? Does it matter if a right is assignable in characterising it as an asset? Were the amendments made to the definition of asset on this issue necessary? Does the different approach to part disposals in the ITAA 1997 make any difference to facts like Orica? How does the majority analyse each payment made by MMBW for CGT purposes? How is the amount of the capital gain to be calculated in relation to each payment? How would the calculation be done under the ITAA 1997? (Section 112-30 is the equivalent provision to s 160ZI.) Do you agree with the view of the majority that their approach is unlikely to give rise to practical problems? Consider a case where a person contracts to buy land for $100,000 which rises in value to $120,000 at the time when the contract is settled a few months later. (The ATO for some years has been developing approaches to deal with cases of this kind, but nothing is yet concluded. The dissent of Gummow J on this point was partly founded on the inconvenience of the majority view.)

[3.140] Event C1 deals with the loss or destruction of a tangible asset. It raises a number of

issues about the correct analysis when compensation is involved (eg an insurance payout). These issues are dealt with in Chapter 6. Event B1 deals with the case where legal and beneficial title do not change immediately, but in economic substance the asset has just been sold. The simplest example is a hire purchase transaction. This is one of a number of cases in the CGT where substance prevails over legal form. The tax legislation overall is still not fully consistent in treating such cases as the equivalent of a sale and a loan, though the trend is to adopt that characterisation in an increasing number of areas of tax law. (iii) The terrible twins: CGT events D1 and H2 [3.150] The most controversial measures in Pt IIIA were the deemed disposal provisions in

s 160M(6) and (7). Labelled the “terrible twins” by many commentators, their form was subject to strong criticism when originally adopted. The criticism was not in respect of their aim – few disputed that gains such as payments for entering into restrictive covenants, payments for agreeing not to enforce contractual rights or to withdraw from a contract, and so forth, should be included in taxable income. Rather, criticism was directed at the execution of the objective through convoluted provisions that relied on artificial deeming. It was suggested that the preferable approach would be to adopt specific inclusion provisions that operated 96

[3.135]

Income from Property

CHAPTER 3

independently of the CGT. Thus, for example, it was suggested that payments to employees or ex-employees in respect of restrictive covenants could be dealt with as employment income or in the FBT legislation. Predictions that the two deemed disposal provisions would prove inadequate to the task intended for them were proved correct when the High Court finally had an opportunity to consider their scope in the 1991 case of Hepples v FCT (1991) 22 ATR 465; 91 ATC 4808. The case involved a payment to an employee for a restrictive covenant agreement. A majority of the High Court agreed the gain was assessable under s 160M(6) or s 160M(7), but no clear majority emerged for either provision alone – one judge thought the gain was caught under s 160M(6) only, one judge thought it was caught under s 160M(7) only, and two judges thought it was caught under both provisions. So, although four of seven judges thought the gain was assessable under Pt IIIA, only a minority of three could be found in favour of any particular charging provision. The Court invited the parties to make further submissions on the appropriate decision in the circumstances and in Hepples v FCT (No 2) (1992) 173 CLR 492; 22 ATR 852; 92 ATC 4013, the High Court said the gain was not assessable on the basis that two distinct issues were raised and there was a majority against the ATO on each issue. To understand the changes that were subsequently made to s 160M(6) and (7), a brief review of the perceived problems with the original provisions is helpful. Section 160M(6) applied to the disposal of an asset “that did not exist … before the disposal, but was created by the disposal”. Section 160M(7) applied where “an act or transaction has taken place in relation to an asset or an event affecting an asset has occurred”, and “a person has received, or is entitled to receive, money or other consideration by reason of the act, transaction or event”. Two cases when the latter provision could apply were included in the legislation although they were not exhaustive: (i) if the asset was a right, for surrendering the right or agreeing not to exercise the right; or (ii) for use or exploitation of the asset. On their face, the provisions contained problems. One view of the first provision was that it applied where a new asset was carved out of an existing asset (such as granting an easement over land). The problem of this interpretation was to distinguish it from a part disposal. Another view was that it applied to cases such as the grant of an option for consideration where, before the option was granted, it did not exist. On this view, the provision could catch a restrictive covenant agreement. Prior to the agreement, there was no asset but following the agreement there was, namely a contractual undertaking by the taxpayer not to do something such as compete or divulge trade secrets. The contract would be an asset in the hands of the other party and could be used as the basis of a suit for damages if the taxpayer breached the agreement. The problem with this approach was that it meant that a borrower in a loan transaction might be taxed on the amount borrowed (as the same analysis would apply as for the restrictive covenant). The second provision, s 160M(7), some suggested was intended to catch gains for forfeiting existing rights. An example would be a taxpayer with a contract for sale of stock who is approached by the purchaser and offered consideration to forgo the contractual rights (so that the purchaser could buy the goods from another supplier at a lower cost). The problems with s 160M(7) were said to arise out of the relationship between the two paragraphs: (a), which mentioned a transaction, act or event taking place in relation to an asset; and (b), which spoke of a person receiving consideration as a result of the act. The provision did not make clear the connection, if any, needed between the asset in paragraph (a) and the receipt of consideration in paragraph (b). If no direct connection were needed, the scope of the provision would be [3.150]

97

The Tax Base – Income and Exemptions

virtually limitless – some asset to satisfy paragraph (a) could be found in almost every transaction involving the receipt of money, thus technically satisfying the words of the provision. Some advisers suggested a compromise approach in which the provision would be read so that paragraph (b) would be invoked only if the asset mentioned in paragraph (a) were an asset belonging to the taxpayer. The Explanatory Memorandum released with the provisions in Bill form was not of much assistance. It gave the grant of options and leases as examples of cases covered by s 160M(6), even though there were other specific provisions dealing with these cases, and the employee restrictive covenant as covered by s 160M(7) without making clear what was the relevant asset. In the High Court, McHugh J, one of the majority who concluded the provisions would not catch the gain derived by the taxpayer, said the following with respect to s 160M(6).

Hepples v FCT [3.160] Hepples v FCT (1991) 22 ATR 465; 91 ATC 4808 The difficulties in construing the sub-section are very great. One reading is sufficient to confirm the statement of Hill J in Cooling (at p 61) that it “is drafted with such obscurity that even those used to interpreting the utterances of the Delphic oracle might falter in seeking to elicit a sensible meaning from its terms”. How can a person dispose of an asset that did not exist before the disposal even as part of another asset? In his written submissions, counsel for the respondent argued that where the word “disposal” first appears in the sub-section “it is an elliptical description of an act whereby an asset, not before that act in existence, is brought into existence such that it is vested in a person other than the creator”. This construction would mean that a person who had borrowed money and promised to repay it had disposed of an asset (the promise to repay the money) and would be subject to tax under Pt IIIA on the whole amount of the borrowing because that is “the consideration in respect of a disposal” of the asset: see s 160ZD(1)(a) or, alternatively, s 160ZD(2)(a). This result is so absurd that it is difficult to believe that Parliament intended it. If Parliament had intended the creation of rights in another person to constitute a disposal of those rights by the person creating them, it would have been easy enough for it to have said so. Significantly, the explanatory memorandum does not suggest that s 160M(6) was intended to apply to the creation of rights generally... 98

[3.160]

Neither legal parlance nor the ordinary meaning of the words “disposal of an asset” could justify interpreting those words to cover the case where the asset is a personal right to sue the grantor of that right. When a person creates a right in another person to sue him or her, the grantor does not dispose of any asset of his or her own. The personal right to sue is never vested in the grantor, even momentarily. It is only when the right to sue is vested in the grantee, and not before, that it bears the character of a proprietary right. It would require a very strained construction of s 160M(6) to hold that a transaction in which A incurred an obligation giving rise to a correlative right in B constituted a “disposal of an asset” (the right to sue) by A to B. There is nothing to suggest that Parliament intended s 160M(6) to cover such a case: neither the explanatory memorandum nor the language of the subsection supports it. In Cooling and in the present case, the Full Court of the Federal Court held that s 160M(6) operates only where new proprietary rights have been created out of or over an existing asset … The principal argument against the construction which the Full Court placed on s 160M(6) is that to give effect to it contradicts the words in brackets in that sub-section. It is true that the Full Court’s construction requires that the asset be created out of or over an existing asset while s 160M(6) in terms applies only to a case where the asset “did not exist (either by itself

Income from Property

Hepples v FCT cont. or as part of another asset) before the disposal”. But I do not think that there is any conflict between the Full Court’s construction and the words in brackets. Although a lease, an easement and a profit à prendre are created out of land, for

CHAPTER 3

example, it is not a misuse of language to say that they were not part of the land before their creation. Consequently, I would hold that s 160M(6) applies only where the asset disposed of was created out of or over an existing asset.

[3.170] Not all the judges who concluded s 160M(7) did not apply to the taxpayer’s gain said

that provision only operated where the asset referred to in para (a) of the subsection was an asset of the taxpayer. Deane J did place this restriction on the section. He said: [3.180] I consider … that the provisions of s 160M(7) should be construed as confined to a case where the person who has received the money or other consideration was, immediately before the deemed disposal, the owner of the pre-existing asset referred to in the subsection.

When s 160M(7) is so construed, it is apparent that it is not applicable to the present case where the suggested existing asset for the purposes of the subsection is the goodwill and trade secrets which were owned by the employer and not by the appellant.

[3.190] Brennan J explained the connection between the asset in para (a) and the transactions

in para (b) that a majority of the judges thought necessary in these terms: [3.200] The question then arose as to whether the asset referred to in para (a) had to be an asset of the taxpayer. The majority of the court below gave a negative answer to this question. I forbear from answering the same question because in my respectful opinion there was no connection between the assets of Hunter Douglas the taxpayer’s employer and the appellant’s taxpayer’s entry into the deed containing the covenant which satisfies the requirements of para (a). The only way in which the appellant’s covenant affected these Hunter Douglas assets was to add to them the benefit of the appellant’s covenant. The appellant’s entry into the deed

containing the covenant did not relate to the then existing assets of Hunter Douglas which were wholly unaffected thereby. The asset created by the covenant in no way depended on the enjoyment by Hunter Douglas of its other assets. Ex hypothesi, the benefit of the covenant did not exist before the covenant took effect. As there was no existing asset in relation to which the appellant’s entry into the deed took place (thus no relevant “act or transaction”) nor any asset which was affected by the appellant’s entry into the deed (thus no relevant “event”), I would hold that subs (7) has no application in this case.

[3.210] The legislature reacted to the High Court decision by amending the definition of asset

in s 160A, as noted earlier, and redrafting s 160M(6) and (7). When the provisions were re-enacted in 1997, they were separated by some considerable distance and placed in separate subdivisions as events D1 (s 104-35) and H2 (s 104-155). The special nature of these events and the relationship between them is only revealed by s 102-25 dealing with the order of application of CGT events. This section is dealing with the possibility that more than one CGT event section may be potentially applicable to a particular transaction and states the general order of application (with the not necessarily always helpful rule that the more specific is [3.210]

99

The Tax Base – Income and Exemptions

applied). Subsection (3) makes it clear that all other CGT events apply before D1 and H2 (ie if any other event applies, neither of these apply). Failing the application of any other event, D1 is considered first and then if it is not applicable, H2. The ordering of subs (3) was also present in the ITAA 1936. [3.215]

3.16 3.17

3.18 3.19

Questions

Which of events D1 and H2 would now apply to taxpayers in cases like Hepples? How does the legislation deal with the problem of loans being caught by the provisions? Has the problem of giving a clear operation to both provisions been resolved? What is the analysis of the grant of an easement? (See on easements Ruling IT 2561 and Determination TD 93/235.) What are the consequences of the application of events D1 and H2 in relation to the general transitional rule that assets acquired before 20 September 1985 are not subject to CGT and the rule that a taxpayer recovers the cost in a transaction and so is only taxed on the gain made?

[3.220] In analysing any particular transaction, events D1 and H2 need always to be

considered if it appears that no other events apply. This is exemplified in the rulings on mining and prospecting information, and rights attaching to shares which have been partly extracted above. Ruling TR 98/3 in relation to the former (after the amendments to deal with Hepples) states:

Ruling TR 98/3 [3.230] Application of subsection 160M(6) 68. Subsections 160M(6) to 160M(D) apply to an asset created by a person if: • that asset is not a form of corporeal property; and • on the creation of the asset, it is vested in another person.

new provisions; that a person creates an asset, the asset is not a form of corporeal property, and on its creation the asset is vested in another person. Hence it is to apply in much the same way as subsection 25(1) of the ITAA applies to include “gross income” in assessable income.

69. The reference to an asset that is not a form of corporeal property is a reference to an asset of a non-physical or intangible nature (eg rights under a contract, patents, or goodwill).

71. The amendment made by the Taxation Laws Amendment Bill (No 4) 1992 first applied to any transactions where money or other consideration was received after 25 June 1992.

70. In the explanatory memorandum to the Taxation Laws Amendment Bill (No 4) 1992, which introduced subsection 160M(6) in its present form, the Treasurer stated, at 66-67:

72. If a person, A, agrees to supply mining or prospecting information to another person, B, the transaction gives rise to a provision of a service by A to B. By entering into the agreement, it could be said that A has also created in B a right to require A to supply the mining or prospecting information to B. The agreement might go on to restrict A from further disclosing the mining or prospecting information to other persons and could also confer on B rights to hold, use, enjoy, disclose or even destroy the mining or prospecting information.

The new provisions are intended to apply to a wide range of circumstances where a person receives consideration for creating incorporeal assets in another person. It is not practicable for the legislation to refer specifically to all those circumstances. Rather, the new subsection 160M(6) will provide the general criteria for the application of the 100

[3.215]

Income from Property

Ruling TR 98/3 cont. 73. However, the rights that are created are something separate from the information itself. In FCT v Sherritt Gordon Mines Limited (1977) 7 ATR 726; 77 ATC 4365, Jacobs J recognised rights under a contract as property but, at the same time, recognised “know-how” as not being property when he said, at ATR 736; ATC 4374: A right to put to use know-how as it is defined in the present agreement is not a right in respect of property because the possessor of the know-how has no right in it against the world … However, once he reveals and makes available know-how as defined to another in return for a payment rights are created between him and the payer, rights which are governed by the terms express or implied upon which that “know-how” is revealed. 74. In Pancontinental the court recognised a distinction between the information itself and the rights under which it was obtained, and said, at ATR 950; ATC 4192: Now one readily accepts that the assignment of rights under a contract may amount to a transfer of property. See Danubian Sugar Factories Ltd v IR Commrs (1901) 1 QB 245 at p 257 and Allgas Energy Ltd v Commr of Stamp Duties (Qld) 80 ATC 4020 at 4024 (1979) 10 ATR 593 at 596. The information referred to in cl 2.2(c) of this agreement may not however be characterised as rights under a contract, in this case the joint venture agreement. The information is likewise not to be regarded as part of the benefit of a contract being assigned. The fact that Isa may have acquired the information through exercising rights under the joint venture agreement obviously does not give the information itself the quality of a chose in action, or place it into the category of contractual rights being assigned: it remains mere information. 75. Likewise, in Canada the Federal Court of Appeal has distinguished information, or “knowhow”, from the rights to have that information

CHAPTER 3

disclosed. In Rapistan Canada Limited v Minister of National Revenue 1974 CTC 495 at 499, the court said: The asset that the appellant acquired in this case was the knowledge of how to commence and carry on the particular manufacturing operation. That was, from the businessman’s point of view, an asset. It was not, however, “property”. It is true that the appellant did, by the “Deed of Gift”, acquire, by implication, a promise that the donor would do certain things and that that promise is a “right” that falls within the definition of the word property. That right is not, however, the “know-how” that is the subject matter of the claim for capital cost allowance. 76. In the light of the above authority, it is accepted that where mining, quarrying or prospecting information is being disclosed for its market value, any consideration received by the “vendor” for its disclosure is not for the creation of rights but rather for the information itself. In these circumstances, subsection 160M(6) does not apply to generate a capital gain as a result of the creation of the rights, because the consideration is received for the information itself and not the created rights. 77. As a practical matter, the “purchaser” pays for, and receives, the information itself. The right of the “purchaser” to require the “vendor” to supply the information on payment of the consideration is only a means to an end of actually getting the information. The consideration received by the “vendor” is not, in terms of paragraph 160ZD(1)(a), consideration in respect of the disposal by the “purchaser” of rights to receive the information. 78. The market value of mining, quarrying or prospecting information is a question of fact. As a general proposition, its value would represent the present day costs of reproducing the information, taking into consideration the losses that would result from the consequential delay in the development of mining, quarrying or prospecting right. From this value it would be appropriate to make deductions for all or some of the following factors: [3.230]

101

The Tax Base – Income and Exemptions

Ruling TR 98/3 cont. (a)

knowledge that some of the information was available from public records, such as reports available from State government authorities;

(b)

general knowledge that certain work need not be duplicated, for example, a purchaser who had a knowledge of the mining information for the purposes of negotiating a price for the tenement would know that some exploration had revealed little or no evidence of mineralisation in particular areas and would know that this work would not need to be repeated; and

(c)

more recent test results that affect the accuracy of the older information.

Application of subsection 160M(7) 79. For subsection 160M(7) to apply, the owner of an asset must have received money or other consideration by reason of an act or transaction taking place in relation to the asset (whether it affects the asset or not), or an event affecting the asset has occurred. It does not matter whether the asset is affected adversely or beneficially or neither adversely nor beneficially.

80. When consideration is received for dealing with or disclosing mining, quarrying or prospecting information, it is difficult to regard it as an act or transaction that takes place in relation to another asset or as an event that affects another asset. It has already been explained in this Ruling that mining, quarrying or prospecting information is something separate from the mining, quarrying or prospecting right and also something separate from the goodwill of a business (see paragraphs 27 to 30). 81. The disclosure of mining, quarrying or prospecting information is an act, transaction or event that relates to, or affects, the information itself. By sharing the information with others, the number of people who have knowledge of the information is increased and thus the information is more widely circulated and its value may be affected. However, mining, quarrying or prospecting information itself is not an asset as defined in section 160A and, therefore, it is not an asset as that term is used in subsection 160M(7). 82. Accordingly, subsection 160M(7) does not apply to the consideration received for the disposal of mining, quarrying or prospecting information.

[3.240] Similarly, the provisions are canvassed in Ruling TR 94/30 on changes to rights

attaching to shares as follows:

Ruling TR 94/30 Subsection 160M(6) [3.250] 44. Before their amendment by the TLAA (No 4) 1992 with effect after 25 June 1992, the previous subsections 160M(6) and 160M(7) operated. The former subsection 160M(6) was interpreted by the Full Federal Court in Hepples v FCT (1990) 21 ATR 42; 90 ATC 4497 to apply only to assets which were created out of or over existing assets. In Reuter v FCT (1993) 24 ATR 527; 93 ATC 4037 at 545 (ATR), 4051 (ATC), the Federal Court (Hill J) observed that this view also represented the majority judgment of the Full High Court in Hepples v FCT (1991) 173 CLR 492; (1991) 22 ATR 465; 91 ATC 4821. We accept that the former subsection 160M(6) applied only to 102

[3.240]

assets created out of or over an existing asset. Accordingly, this subsection did not apply to a variation of share rights during the period of its operation. 45. The present subsection 160M(6) applies to the construction or creation of assets after 25 June 1992. The broad criteria which trigger the new subsections 160M(6) to 160M(6D) are that a person must create an asset, not being corporeal property, which on its creation is vested in another person. As all these requirements are not present when a company resolves to vary the rights attaching to its shares, the subsection will not apply.

Income from Property

Ruling TR 94/30 cont. Subsection 160M(7) 46. The former subsection 160M(7) deemed a disposal of an asset where an act, transaction or event occurred and money or other consideration was received or was entitled to be received as a consequence of the action or event. 47. The same applies for the new subsection 160M(7) which applies only if the other provisions of Pt IIIA do not apply. The present subsection operates where a person who owns an asset has received, or is entitled to receive, consideration by reason of an act or transaction that has taken place in relation to the asset (whether it affects the asset or not) or an event that has affected the asset. It does not

[3.255]

CHAPTER 3

matter whether the asset is affected adversely or beneficially or neither adversely nor beneficially. Where subsection 160M(7) applies, the person is deemed to have acquired the notional asset created by the disposal immediately before the deemed disposal. There is necessarily a broad spectrum of possible variations to share rights which can be carried out and differing financial implications attached to those situations. However, we consider that the section applies to a variation of share rights where money or other consideration is received or is entitled to be received as a result of the variation. 48. Subsection 160M(7) does not apply to a variation in share rights if the taxpayer does not receive, or is not entitled to receive, money or other consideration in relation to the relevant transaction (see Determination TD 93/238).

Questions

3.20

Do you see the statement in para 48 of Ruling TR 94/30 as a problem? If, so how might it be solved? (Value shifting provisions were introduced into the ITAA 1936 as a result of the conclusion drawn in the ruling: see now Divs 723 to 727 of the ITAA 1997.)

3.21

Do you agree with the analysis in each of the extracts? Would the conclusion be any different under ITAA 1997?

[3.260] The CGT provisions also contemplate that assets can be split, changed or merged

without there being a relevant CGT event and provide for cost base adjustments in such cases in s 112-25. In other cases, for example, options, the CGT provides that while at one stage of an ongoing transaction there may be a CGT event, if a later CGT event occurs, the earlier CGT event is undone and replaced by cost base adjustments. Because of the possible varying analyses available under the CGT which all have different taxing outcomes – disposal of an asset (including part of an asset), termination of an asset; creation of rights; transactions affecting assets; and splitting, changing or merging of assets – in many more complex transactions, courts find it difficult to settle on any particular analysis with certainty. The Hepples case is but one example of such problems. [3.265]

Questions

3.22

Can you think of examples where CGT assets are split, changed or merged without there being a CGT event? How can such cases occur without falling within event H2 if no other event is relevant?

3.23

In the case of an option, how does the CGT deal with the kinds of issues raised by the case of Abbott v Philbin (extracted in Chapter 2)? Consider in particular the CGT position on grant of the option, exercise of the option and sale of property acquired pursuant to the exercise of the option? In answering this question, consider the case of options generally, not the case of employee share options which was covered in that case: see event D2 and Div 134. [3.265]

103

The Tax Base – Income and Exemptions

3.24

The taxpayer owned property, acquired prior to 20 September 1985, in the City of Adelaide. The property was zoned for floor space much larger than that found in the taxpayer’s old building and the value of the land was based, in part, on the floor space that could be incorporated into a building on the site. In 1987, the City of Adelaide declared the property a heritage property. To protect the interests of persons whose property was subject to a heritage order and therefore declined in value to the extent the zoned floor space could not be erected, the heritage legislation allowed taxpayers subject to a heritage order to sell the unused rights to other owners who could add the extra space on to buildings they were constructing. In 1988, the taxpayer sold its transferable floor rights for $338,750. 1. Are the rights an asset for CGT purposes? 2. If not, will the transaction be caught under one of the CGT events not requiring disposal of an asset? See Naval, Military & Airforce Club of South Australia (Inc) v FCT (1994) 28 ATR 161.

(iv) Time of acquisition and CGT events [3.270] As noted above, the time of acquisition of an asset is important for a number of

reasons. One reason is for indexation purposes; a 12-month holding rule applies for getting indexation (s 114-10(1)). With the ceasing of indexation from the end of the September quarter 1999, this factor will fade in significance as years pass. Second, the time of acquisition is important in cases where there is no consideration (as in a gift) or the consideration cannot be valued. As we shall see, in these cases the market value of the property at the time of acquisition becomes the cost base for the property: s 112-20 of the ITAA 1997. Finally, and most importantly of all, the time of acquisition will determine whether the asset is a pre-asset, on which gains are generally exempt from CGT. The time of acquisition rules, previously found in s 160U, are now in Div 109 of the ITAA 1997. Similarly, the time of a CGT event determines in which income year a capital gain or loss arises. This can be very important if a taxpayer is trying to match particular gains and losses – as losses cannot be carried back, only used in the current or future years. It is also relevant to indexation (and accordingly of diminishing significance over time), as the end of the period for the 12-month holding rule is the time of the CGT event. Again, if a CGT event involves an element of gift, then market value at the time of the event may be relevant: see s 116-30(1) of the ITAA 1997. In many large commercial transactions, there will be a series of contracts, variations and related documents created in carrying out the deal. It is not always easy to apply a simple date of contract rule in such cases. A good example is the High Court of Australia decision in Commissioner of Taxation v Sara Lee Household & Body Care (Australia) Pty Ltd [2000] HCA 35; (2000) 201 CLR 520; 44 ATR 370; 2000 ATC 4378. There the taxpayer was a subsidiary of the US multinational, Sara Lee Corporation, which sold its worldwide pharmaceutical and health care business to the Swiss multinational, Roche Holding Ltd. A purchase and sale agreement was entered into on 31 May 1991 between Sara Lee and its subsidiaries on the one side (including the Australian subsidiary) and Roche on the other. Roche had the capacity under section 12.3 of the agreement to nominate subsidiaries or associates to take on various assets and liabilities dealt with in the sale agreement. Roche nominated an Australian subsidiary, Nicholas Products Pty Ltd, as the purchaser of the Australian assets. This company only came into being on 25 June 1991 and Roche took up shares in it only on 28 August 1991. An amendment agreement was executed by Sara Lee and 104

[3.270]

Income from Property

CHAPTER 3

Roche on 30 August 1991 which changed the price allocated to the Australian assets and the treatment of its employees. Nicholas was named as the purchaser of these assets in this agreement but was not a party to it. The amendment agreement provided in clause 11 that, subject to the changes, the sale agreement of 31 May 1991 remained in force. The transaction was settled on 30 August 1991, with Nicholas for its part entering into a deed of assignment and a deed of assumption of liabilities and contracts. The taxpayer argued that the disposal occurred on 30 August 1991 so that it could offset its capital gains against losses available in that year. The ATO argued that the date of disposal was 31 May 1991. The High Court found in favour of the ATO.

Commissioner of Taxation v Sara Lee Household & Body Care (Australia) Pty Ltd [3.280] Commissioner of Taxation v Sara Lee Household & Body Care (Australia) Pty Ltd (2000) 201 CLR 520; [2000] HCA 35 37. Both parties to the present appeal argued the case upon the basis that the relevant change in the ownership of assets occurred on 30 August 1991, by the deed of assignment of that date, and that what was effected was a disposal of the assets by the respondent and an acquisition of the assets by Nicholas Products Pty Ltd. The difference between the parties related to the operation of s 160U which, so far as relevant, provides: 160U(1) Subject to the provisions of this Part other than this section, where an asset has been acquired or disposed of, the time of acquisition or disposal for the purposes of this Part shall be ascertained in accordance with this section. 160U(3) Where the asset was acquired or disposed of under a contract, the time of acquisition or disposal shall be taken to have been the time of the making of the contract. 160U(4) Where the asset was acquired or disposed of otherwise than under a contract, the time of acquisition or disposal shall be taken to have been the time when the change in the ownership of the asset that constituted or gave rise to the acquisition or disposal occurred. 38. The present appeal is concerned with the time of disposal of assets. The time of acquisition will be an important matter in relation to the liability of Nicholas Products Pty Ltd to tax in the event of a disposal of the assets, or part of them,

by that company, but it is not determinative of this case. It is to be noted that the section refers to “the time of acquisition or disposal”, not the time of acquisition and disposal. 39. The appellant argued, and North J held, that the case is governed by s 160U(3), and that the time of the making of the relevant contract was 31 May 1991. The respondent argued, and the Full Court held, that the case is governed by s 160U(3), and that the time of the making of the relevant contract was 30 August 1991. Alternatively, the respondent argued that the case is governed by s 160U(4). On that basis, it is agreed that the relevant time would have been 30 August 1991. 40. The Full Court, before coming to the issue to be resolved, made the following observations as to the legislative scheme. There is no reason why the date of disposition and the date of acquisition referred to in s 160U are necessarily the same. The section refers to the time of acquisition or disposal. Other provisions make it clear that disposal and acquisition are not necessarily contemporaneous, and it is not difficult to think of cases where they may be different. In order for there to be a disposal under a contract for the purposes of s 160U(3) it is not necessary that the contract be unconditional or specifically enforceable. What is relevant is the time of the making of the contract, not the time when it became unconditional, or specifically enforceable. Nor is there any reason why an asset [3.280]

105

The Tax Base – Income and Exemptions

Commissioner of Taxation v Sara Lee Household & Body Care (Australia) Pty Ltd cont. cannot be said to be disposed of under a contract even though the transferee of the asset was not a party to the contract. Application of the legislation 41. Taking into account the later ratification of the signature by Mr Patten, on 31 May 1991 the respondent entered into a contract with Roche by which it was bound to transfer to Roche, on completion of the contract, the assets in question, in consideration for the payment of a sum of money and the assumption of certain obligations. The contract gave Roche the capacity, subject to certain conditions, (including the retention by Roche of its own liability under the contract), to assign its rights to a subsidiary. 42. The words “under a contract”, in s 160U(3), direct attention to the source of the obligation which was performed by the transfer of assets which constituted the relevant disposal. From 31 May 1991, until completion on 30 August 1991, there was a contractual obligation upon the respondent to dispose of its assets to Roche, or to an entity of the kind referred to in s 12.3 of the purchase and sale agreement. The content of that obligation did not change. The price was varied, as were certain other terms and conditions of the sale, but the agreement of 31 May 1991 was the source of the obligation which the respondent discharged by performance on 30 August 1991. 43. The Full Court accepted that the respondent’s assets were disposed of under a contract. Subject to one argument, which was advanced for the first time in this Court, that conclusion appears inevitable. The transfer of ownership of the assets in question was, as is usual in such commonplace disposals as conveyances of real estate, effected pursuant to a contractual obligation which the respondent had previously undertaken. The transferor was acting in performance of a preexisting contract. Whether the same was true of the transferee is beside the point. 44. The new argument put by the respondent was to the effect that s 160U(3) can have no application to a case where there is more than 106

[3.280]

one contract to which a disposal is potentially referable, and where there is no compelling reason to relate the disposal to one of those contracts rather than to another. Where s 160U(3) applies, it can only produce one result. The legislation does not countenance the possibility that there can be two different times of disposal. In a case where s 160U(3) cannot produce a single answer to the question as to the time of disposal, then s 160U(4) applies. 45. It is true that s 160U(3) assumes that, in a case to which it applies, there is a single time of disposal which can be established by reference to the contractual background to the change of ownership. Even so, the circumstance that, in a given case, there may be room for doubt about the correct conclusion does not make the task of reaching it impossible. If, in some case, it were impossible to relate a change of ownership to a contract in such a way as to produce a single time of disposal, then it may be necessary to apply s 160U(4). That is not this case. If it were, the practical operation of s 160U(3) would be seriously curtailed. 46. The Full Court emphasised that the legislation operates in relation to particular dispositions and on the basis of the consideration in respect of each particular disposition. Their Honours said: “In the present case the disposition is a disposition from the respondent to Nicholas Products; the consideration in respect of that disposition is US$62,461,000.” That disposition, for that consideration, they held was referable to the amendment agreement. They said: In the context of s 160U(3), the first time that there was a contractual obligation on the part of the respondent to transfer assets for a consideration of US$62,461,000 was in August 1991 and as a result of the Amending Agreement. The contract under which the disposition which brought into play the provisions of Part IIIA of the Act occurred was not the contract which was made in May, but the contract which was made in August and was brought into existence by the Amending Agreement. That contract was, in our view, the contract under which the disposition was made.

Income from Property

Commissioner of Taxation v Sara Lee Household & Body Care (Australia) Pty Ltd cont. 47. It appears that it was the variation in the consideration effected by the amendment agreement that was seen as being of particular significance. As was noted, Nicholas Products Pty Ltd was not a party to the amendment agreement, and although it was identified in a schedule to that agreement as the purchaser of the assets, that was done pursuant to a right given to Roche by s 12.3 of the agreement of 31 May 1991. Insofar as the identity of the disponee can be related to a contract anterior to the deed of assignment of 30 August 1991, there is less reason to relate it to the contract of 30 August, than to relate it to the contract of 31 May, pursuant to which Roche acted in assigning its rights to Nicholas Products Pty Ltd. Both the deed of assignment and the deed of assumption of liabilities and contracts of 30 August 1991 were expressed to be pursuant to the agreement of 31 May, as amended.

CHAPTER 3

conclusion. It was that the assumption of obligations by Nicholas Products Pty Ltd, by the further deed of 30 August 1991, was an important aspect of the acquisition of the respondent’s Australian business, and that was only effective by reason of the contractual operation of the deed into which Nicholas Products Pty Ltd entered on 30 August. However, that assumption of obligations was referable to s 12.3 of the agreement of 31 May, (the concluding words of that provision having continuing importance), and, as was noted, it was said to be pursuant to the agreement of 31 May, as amended. 49. Where there are two or more contracts which affect the rights and obligations of the parties to a disposal of assets, the identification of the contract under which the assets were disposed of, for the purpose of applying s 160U of the Act, requires a judgment as to which of the contracts is properly to be seen as the source of the obligation to effect the disposal. In the present case, that contract is the purchase and sale agreement of 31 May 1991.

48. There was an additional reason advanced by the respondent in support of the Full Court’s

[3.285]

Questions

3.25

Would the result of the case be the same under the different structure of the 1997 Act?

3.26

When did Nicholas acquire the Australian assets in the Sara Lee case?

3.27

How are transactions involving powers to nominate the purchaser to be analysed under the CGT?

3.28

Did the High Court unwittingly ignore the date of contract rule in the Orica case extracted above? (See Orica v FCT [2001] FCA 1344; (2001) 48 ATR 588.)

3.29

When does a taxpayer acquire an asset subject to hire purchase – at the date of signing the hire-purchase contract, at the date of taking possession of the asset, or at the date of transfer of legal title to the asset at the end of the hire-purchase period?

3.30

In the leasing industry, it is standard practice that leases of equipment do not include options to purchase but the lessee (or an associate of the lessee) is invariably allowed, as a matter of commercial practice, to purchase the equipment on expiry of the lease for the residual value under the lease. Can a lessee rely on this practice to argue under CGT event B1 that the equipment is acquired when the lease is entered into and not on its expiry? (See AAT Case 6253 (1990) 21 ATR 3703; Case X81 90 ATC 594.)

3.31

When does a taxpayer dispose of a business if the contract of sale was expressed to be “subject to finance”? (See AAT Case 9451 (1994) 28 ATR 1108; Case 24/94 (1994) 94 ATC 239.) [3.285]

107

The Tax Base – Income and Exemptions

3.32

A patent is only fully recognised for legal purposes when the patent is registered under the Patents Act 1952 (Cth) or the law of another country recognised by Australia for this purpose, but reliance on this date could create hardship as it may take many years to register a patent. In 1982 the taxpayer began work on a process that led to the granting of a patent in 1986. When did the taxpayer acquire the patent? (See Ruling IT 2484.)

3.33

A taxpayer commenced writing a novel in 1984 and finished it in 1998 when it was published. When did the taxpayer acquire the copyright in the novel?

3.34

The taxpayer started a business in 1983. It grew slowly at first but increased rapidly after 1996. The taxpayer sold the business in 2001. When did the taxpayer acquire the goodwill of the business? (See FCT v Murry (1998) 39 ATR 129; 98 ATC 4585, Ruling TR 1999/16 especially paras 120-123.)

3.35

The taxpayer acquired a supermarket in 1984. In 1996 the taxpayer acquired a liquor outlet and integrated it with the supermarket. The supermarket/liquor outlet was sold in 1997. When was the goodwill in the business acquired? (See references for Question 3.35.)

3.36

The partners in a partnership agreed to sell their business to a company in which they would receive shares. A verbal agreement was entered into in May 1985 and heads of agreement (which contemplated a formal agreement which never eventuated) in July 1985. The partners applied for shares in the company in October and their applications were accepted and the shares allotted in November 1985. When were the shares acquired for CGT purposes? (See Elmslie v FCT (1993) 46 FCR 576; 26 ATR 611; 93 ATC 4964.)

[3.290] Frequently the acquisition and event rules are the mirror image of each other and

most of the acquisition rules in Div 109 are expressed as relating to CGT events: see s 109-5 which starts with the general rule that a taxpayer acquires an asset on becoming its owner. It is possible to have a CGT event without there being an acquisition by another, such as events C1 and C2, or an acquisition by one person without there being a CGT event for another person (such as the grant of an option, an allotment of shares in a company or units in a unit trust: s 104-35(5)(c) and (d)). In the latter type of case, acquisition rules are separately stated in s 109-10. The rules in Div 109 are supplemented by special rules elsewhere which are signposted in Div 109. Division 115 has some special rules for the date of acquisition in relation to the CGT discount. It is possible for an acquisition or CGT event to be regarded as occurring, and then by reason of later events, the acquisition, event or timing is reversed or altered. For example, if a person enters into a contract to sell an asset, this is a CGT event at the time of the contract. If the contract subsequently falls through so that the sale does not proceed, there is no change of ownership of the asset and so no CGT event. If this occurs in a subsequent income year, it may be necessary to amend the original tax assessment for the year when the contract was made: see Note 1 to s 104-10(3). [3.295]

3.37

108

Questions

A buyer enters into a contract to buy a block of land for $250,000 and pays a deposit of $25,000 on 31 December 2008. The seller acquired the land in 1990 for $150,000. The contract is rescinded and the deposit forfeited by the seller on 31 July 2009 because the buyer breaches the contract by not settling the contract on time. What is the CGT [3.290]

Income from Property

CHAPTER 3

result? (See CGT events A1, H1, H2, FCT v Guy (1996) 67 FCR 68; 32 ATR 590; 96 ATC 4520 overruled in Brooks v FCT (2000) 44 ATR 352.) 3.38

A enters into a hire purchase contract with B for some equipment in 2008. B repossesses the equipment in 2009 because A fails to make the required rental payments under the hire purchase agreement. What is the CGT result?

3.39

X grants an option to Y to purchase land in exchange for $1,000 in July 2008. The land was acquired by X for $100,000 in 1999. The option is to be exercised by 31 December 2009, the exercise price being $200,000 (with the option fee creditable against the purchase price). What happens if Y does not exercise the option? What happens if Y exercises the option in July 2009? What would be the result if X originally purchased the land in 1984?

(v) Calculation of capital gain or capital loss [3.300] The calculation of capital gain or loss is spelt out individually for each CGT event in

Div 104 as explained above. The details of the calculations are considered in Chapter 12. The calculation involves, in effect, two main steps: first, the calculation of the capital gain or loss disregarding the rest of the Act; and second, reconciliation with the rest of the Act to avoid double counting. The two steps are not kept distinct in the legislation and a number of reconciliation devices are employed. For now it should be noted that the disposal of a depreciating asset or trading stock is disregarded for CGT purposes as a result of ss 118-24 and 118-25. If a CGT event also has income tax consequences under other provisions, a subtraction method is provided for capital gains by s 118-20. Capital losses in equivalent situations are dealt with by cost base adjustments under s 110-55. There are also a number of other cost adjustments to prevent double counting of costs. It may not be necessary to perform a calculation of capital gain or capital loss for a CGT event because a rollover or exclusion for CGT is available. Special rules also apply to calculations for collectables and personal use assets. These issues are considered under the next three headings. (vi) Rollovers [3.310] The CGT contains a number of rollover provisions that reflect commonly accepted

tax policy grounds. These fall into three broad groups: rollovers for involuntary CGT events; rollovers for changes in legal ownership where economic interests remain the same; and rollovers for renewable licences. Further rollovers were introduced for small businesses designed to remove obstacles to the expansion of a small business and to provide equivalent retirement income treatment as for employees. These rollovers were expanded following the Ralph Report and were amended again in 2007 in an effort to achieve greater commonality among the various special measures in the income tax legislation dealing with small business. While these addressed a political constituency of the then government, it is undoubted that the current tax system bears heavily on small businesses which seek to comply with their tax obligations. The rollover on death by contrast is a result of political compromise. On the one hand some consider that death should be treated as a normal disposal event like a gift (as in Canada). On the other hand, in some countries death is an event which effectively excludes capital gains arising during life from taxation by giving the beneficiaries a market value cost (as in the UK and the US). [3.310]

109

The Tax Base – Income and Exemptions

The rollover provisions follow a general pattern. Where there is a CGT event under which an asset is transferred to or created in another person that qualifies for a rollover, the CGT event is disregarded and the tax attributes of the transferred property (its cost base or reduced cost, as the case may be, and – usually but not invariably – its pre-CGT or post-CGT status) continue for the next owner. Where there is a disposal of an asset and acquisition of a replacement asset by the same taxpayer that qualifies for a rollover, the rollover transfers the tax attributes of the original asset to the replacement asset. Rollovers are generally limited to CGT, though some are extended into other parts of the system such as depreciation. The result is that they do not apply to assets which are effectively outside the CGT (such as trading stock). In many other countries similar rollovers apply across the board. Can you think why Australia has so limited its rollovers? Involuntary disposal rollovers [3.320] An involuntary disposal may result from an act of State such as expropriation by the

government or an act of nature or accident, such as destruction in a storm or by fire. These cases are dealt with in Subdiv 124-B of the ITAA 1997 which covers situations where the taxpayer receives cash compensation for the disposal and uses the proceeds to acquire new property, and where the taxpayer receives another asset as compensation for the disposal. The rollover in the case of receipt of money is subject to more restrictions than in the case of receipt of an asset. The restrictions require a qualifying taxpayer to spend at least part of the money to acquire a replacement asset within certain time limits and provide that the taxpayer must use the replacement asset for the same purposes as the original asset: see s 124-75(4). The ITAA 1936 apparently required that all of the expenditure be incurred within the time limits, but this has been changed in the ITAA 1997. In the case of a pre-asset (acquired before 20 September 1985), the expenditure in respect of the acquisition of the replacement asset must not exceed 120% of the market value of the original asset when the event happened: see s 124-85(3). If the original asset was acquired after 20 September 1985, then the complicated provisions of s 124-85(2) come into play. These provide a partial rollover and partial recognition of gain when the amount received in respect of the original asset exceeds the amount paid for the replacement asset. The ATO released a number of determinations in 2000 dealing with involuntary disposal rollovers: see TD 2000/36 – TD 2000/45. [3.325]

Questions

3.40

What is the CGT result in respect of an original asset that was acquired before 20 September 1985 where the cost of the replacement asset exceeds the value of the original asset by more than 20%?

3.41

What is the CGT result in respect of an original asset acquired on or after 20 September 1985 if the original asset has a cost base of $100, and the amount received in respect of the original asset is $200, if the replacement asset costs alternatively $210, $190 or $90?

3.42

What is the purpose of s 124-70(1)(c)?

3.43

Why do you think it has been made more difficult to satisfy the requirements of the rollover where money is received as opposed to another asset?

3.44

Is a choice or an election required to obtain these rollovers? (See s 103-25 on choices.)

110

[3.320]

Income from Property

3.45

3.46

CHAPTER 3

For the purposes of Subdiv 124-B, can you purchase a replacement CGT asset before an Australian government agency has given you a formal notice of intention to compulsorily acquire a CGT asset? (See TD 2000/37.) The taxpayer owned a rental house that was destroyed in a fire. He used his insurance proceeds to acquire a replacement investment. Which of the following would qualify for the s 124-75 rollover? 1. the taxpayer used the insurance proceeds to build on the same site a block of units to be used for rental purposes; 2. the taxpayer used the insurance proceeds to build a house to be used for rental purposes on a different site; 3. the taxpayer used the insurance proceeds to acquire an existing house and land to be used for rental purposes; 4. the taxpayer used the insurance proceeds to acquire shares in a public company to be used for income-producing purposes.

3.47

These provisions on involuntary disposals apparently regard any amount received under an insurance policy as being the capital proceeds from the disposal of the asset that is acquired, damaged or destroyed. Is this a correct CGT analysis of the situation?

3.48

If you receive compensation for a compulsory acquisition of part of a CGT asset which you own, how do you treat that compensation – for cost base purposes – to the extent to which it reflects a reduction in value of the remaining part of your asset? (See TD 2001/9.)

Marital breakdown rollovers [3.330] There are a large number of rollover provisions applicable to CGT events which result

legally in a change in ownership but not in the underlying economic interest of the original owner. Most of the rollovers in this category apply to investment or business assets and are considered in other chapters. The exceptions are the marriage breakdown rollovers in Subdiv 126-A of the ITAA 1997. The family law measures that provide for the transfer of assets upon breakdown of a marriage from one spouse to the other spouse (or former spouse) have their origins in trust law. Particularly in the case of assets owned within a family, legal title may not reflect the actual contributions of the parties to the acquisition of the property. In the context of a family, parties to a marriage can make direct contributions to the acquisition of property or indirect contributions by assuming household responsibilities that enable the other spouse to work and acquire assets. In these circumstances, a court can use trust law principles, and now family law provisions, to order a transfer in legal ownership to reflect the recipient spouse’s beneficial or economic interest in the transferred property. The marriage breakdown rollover provisions allow the transferor to avoid realisation of gains when this happens. Despite the use of the term “marriage” in the title of the subdivision, the rollover now extends to many de facto marriage situations. In 2008 under the initiative of the Rudd Labor Government to end many of the discriminations against same-sex couples without, however, conferring the title “marriage” on such relationships, the heading was amended to include relationship breakdowns and the operation of the subdivision now extends rollovers to same-sex couple relationship breakdowns. Section 126-5 applies to transfers directly between the spouses. Section 126-15 applies to transfers of assets from a family company or trust to one of the spouses. Both provisions [3.330]

111

The Tax Base – Income and Exemptions

employ similar rollover mechanisms with respect to the asset received by the transferee spouse. The latter contains further provisions to adjust the cost base of shares in the company or the interest in the trust from which the asset is transferred. The provisions also adjust the cost of any loans to the company or trust so that the person who owned the transferred asset indirectly through a company or trust is not taxed on any illusory gains or able to recognise any apparent losses resulting from the transfer. [3.335]

Questions

3.49

Is the operation of these rollovers automatic or is a choice required by the relevant taxpayer(s)? (See TD 1999/60.)

3.50

A husband and wife separate and obtain a divorce. They amicably agree to the division of their property, and transfers are effected accordingly without reference to the Family Court or any agreement under family law. Is a rollover available?

3.51

The Family Law Act 1975 Pt VIIIA now permits persons to enter into binding financial agreements before, during or after marriage. The agreements do not require the approval of the Family Court though the parties have to have legal advice. Would transfers under such agreements qualify for rollover?

3.52

A husband and wife separate and obtain a divorce. Pursuant to an agreement approved by the Family Court, property is transferred from a family company controlled by the wife to a family trust controlled by the husband. Is a rollover available? (See TD 1999/46 – TD 1999/55 for this and related questions.)

3.53

A same-sex de facto couple separate and their property is divided pursuant to litigation under state legislation dealing with de facto spouses. Is a rollover available? (See TD 1999/61.)

3.54

How do you calculate the cost base of shares in a family company after an asset has been transferred to a spouse from the company and a rollover obtained? (See TD 1999/58.)

Renewable licences [3.340] The expiry of an asset is treated as a CGT event. There are several types of statutory

licences such as liquor licences or taxi licences that regularly expire but which are normally renewed more or less as of right. To avoid triggering deemed disposals and acquisitions every time a statutory licence expires and is then renewed, taxpayers are granted a rollover in Subdiv 124-C. Note that this rollover is not elective – it occurs automatically if the licence is renewed. Similar concepts are applied to Crown leases under Subdiv 124-J and prospecting and mining entitlements under Subdiv 124-L. Small business [3.350] The provisions of the income tax dealing with small business have proliferated over

the last decade (see the discussion of the Simplified Tax System in Chapters 10 and 12). Included among these are four important CGT regimes in Div 152 which are part rollover, part tax reduction and part exemption. The rollover is covered here and the other parts of Div 152 in relation to CGT exclusions below. There are three main common requirements under s 152-10 for all of the Div 152 benefits: a small business entity test, a maximum net asset value test and an active asset test. The benefits extend beyond sale of a small business directly by an individual owner to cases where the business is owned by a company or trust 112

[3.335]

Income from Property

CHAPTER 3

and the CGT event relates to interests in the company or trust. In these cases, additional tests about the ownership or control of the company or trust are applicable. The small business entity test is found in Subdiv 328-C which is the new uniform test for small business. The test requires an annual turnover of less than $2 m (taking into account the turnover of businesses operated by associated entities of the taxpayer). The maximum net asset value test is net assets of less than $6 m owned by the taxpayer (disregarding personal use assets and the main residence) and including business assets of associates. The active asset test requires that the asset disposed of be an active asset. An asset is an active asset if it is used in a business or in the case of an intangible asset is inherently connected with a business (like goodwill), but typical investment assets like shares in companies or loans are generally excluded. Shares in companies or interest in trusts can qualify as active if the company or trust has 80% or more of its assets constituted by active assets, loans or cash connected with the business. The rollover is found in Subdiv 152-E but it simply refers back to the qualifying conditions in Subdiv 152-A. The real limitations applicable to the rollover are found in CGT events J2, J5 and J6. The taxpayer has a period of one year before to two years after the CGT event for which the rollover applies to acquire a replacement asset – if not, a separate CGT event occurs to tax the original gain. Even if a replacement asset is acquired, CGT events taxing all or part of the original gain can still occur (eg if the asset stops being an active asset because it is no longer used in a business). Death [3.360] Division 128 of the ITAA 1997 provides that a CGT event arising from death is

disregarded and instead gives a rollover of the cost bases of post-property to the new owners for the purpose of calculating their gains or losses. The new owners are deemed to have acquired pre-assets at their market value on the date of death so that gains on pre-assets up to the time of death are exempt from taxation. This approach was adopted as part of a trade-off that ensured passage of the CGT by the Senate. It is further considered in Chapter 13. The testamentary rollover may be criticised on efficiency grounds. The inefficiency it is said to cause is “lock-in”. Persons old enough to see the prospect of death in the foreseeable future are unlikely to dispose of assets to fund their bequests when they can avoid the tax by holding on to property and giving it directly. Thus, they will retain property that generates a lower rate of return than other possible investments simply to avoid the tax. The problem remains after their death because the recipient beneficiaries will have cost bases inherited from the deceased (or earlier owners if the deceased is bequeathing property that he or she also inherited!) Their cost bases, therefore, will be low and they will face a tax liability on significant accrued gains, much of which accrued before they acquired the property. It is thought that the prospect of the large tax bill will “lock” the new owners into retaining the property when they would have otherwise sold it if the decision were based on market factors only. Over a period of time political pressure is likely to build to free the inherited gain from tax – especially in relation to rural properties, which tend to be willed from one generation of the family to the next. [3.365]

3.55

Question

Can you think of any way the problems with the testamentary rollover can be avoided if the rollover is retained? [3.365]

113

The Tax Base – Income and Exemptions

(vii) Exclusions [3.370] A number of transactions and gains are excluded from the application of CGT. Some

of these are for technical reasons relating to integration of the CGT with the rest of the Act (see above), some for policy reasons, some for administrative reasons, and some for political reasons. As noted earlier, they are largely gathered together in Div 118 and generally subject to the same device of providing that the capital gain or loss is disregarded. The first exclusion encountered in Div 118 is for motor vehicles. There are two reasons for this exclusion. First, there are a number of special provisions applicable to motor vehicles and these largely cover the field. Second, and more importantly, motor vehicles are more likely to depreciate in value than to appreciate. Excluding motor vehicles from the definition of “asset” ensures that taxpayers will not be able to claim capital losses for depreciation due to personal consumption. This exclusion has been criticised on the basis that some motor vehicles, particularly collectibles and antiques, do appreciate in value, while losses due to personal consumption can be dealt with by other provisions such as the personal-use asset measures described below. The government has not considered changing the treatment of motor vehicles but the ATO has indicated that it believes it will be able to use s 6-5 to catch such gains realised by motor car traders and speculators. The next exclusion in s 118-5(b) is decorations for valour unless they were purchased. In view of the small amount of revenue involved, the social and political cost of taxing heroes on awards or the descendants who inherit them is sensibly avoided. If, however, a Victoria Cross is purchased, the CGT may subsequently apply to any sale by the purchaser. Exempted receipts under s 118-37 include damages for personal injuries, and lottery and gambling winnings. These are discussed in later chapters. [3.375]

3.56

3.57 3.58 3.59

Questions

Is a semi-trailer subject to the CGT? (See the ITAA 1997 definition of “car”, (previously s 82AF(2)(a)), Business Assessing Handbook, para 2.8.30 and Ruling IT 2170 – now withdrawn.) What happens if an athlete wins an Olympic Gold Medal and subsequently sells it? What if the purchaser on-sells it? See further Chapter 5. Why do you think gambling winnings and losses, and some damages claims but not others, have been excluded from the CGT? Is an amount which is effectively excluded from tax by a disregard of the capital gain exempt income, non-assessable non-exempt income or something else?

Main residence [3.380] One of the most important exclusions relates to the taxpayer’s main residence: Subdiv 118-B. Various forms of concession for gains on personal residences are common in overseas tax systems. If the capital gain on a main residence is taxed then consistency suggests that the imputed rent realised while the owner occupies it should also be taxed, and the costs of mortgage, insurance, rates and depreciation for improvements etc deducted: see Chapter 1. This would involve considerable compliance costs for many taxpayers. Further, it is likely that the tax would produce little revenue except from inner Sydney because historically little real gain is made on housing on average, after improvements and inflation are taken into account. On the other hand it has been argued that the exemption has significant equity and economic efficiency implications (both positive and negative). Certainly the main residence exemption raises several problems of definition. 114

[3.370]

Income from Property

[3.385]

3.60 3.61 3.62 3.63

3.64

3.65

3.66

CHAPTER 3

Questions

What do you think that the arguments for and against the main residence exclusion are? Does the exclusion apply where a taxpayer holds a leasehold interest in the main residence? (See s 118-130.) A doctor has a surgery attached to her home. To what extent, if at all, does the home qualify for the exclusion? (See ss 118-115, 118-190.) A husband and wife own a house in the city and a country cottage that they use on weekends. The husband seeks to treat the city dwelling as his main residence for CGT purposes while the wife seeks to treat the country cottage as her main residence. What is the result? What would happen if the husband owned outright the city dwelling and the wife the country cottage? (See ss 118-170, 118-185.) A newly married couple buy a block of land and save for four years to build a house on the land while living in rented accommodation. Are they entitled to any exclusion? What would be the result if they lived on the land in a caravan while saving to build their house? Would there be any difference if they lived on the land in a mobile home that was a fixture and thus treated under property law as part of the land? (See ss 118-115, 118-150.) A home is owned jointly by a wife and husband. The husband dies and the wife continues to live in the home until she becomes too frail. She then lets out the home and moves into a nursing home for three years. She then sells it. How does the exclusion operate in this case? (See ss 118-145, 118-195, 118-197, 128-15, 128-50.) The taxpayer and her brother owned (as joint tenants) a house in which the taxpayer lived. The brother lived separately, in another city. The house was acquired by the taxpayer and her brother in 1987 and sold for a considerable profit in 2009. How does the exclusion apply? (See s 108-7 and Ruling IT 2485.)

[3.390] These and other issues arising under the main residence rules have been the subject of

many tax determinations, reflecting the importance of the exemption to many taxpayers: see, for example, TD 1999/43, TD 1999/67 – TD 1999/74, TD 2000/13 – TD 2000/16, TR 2002/14 as well as some case law [2003] AATA 342, Erdelyi v FCT (2007) 60 ATR 872, Summers [2008] AATA 152. Small business [3.400] As noted above under rollovers at [3.350], small business is the subject of a number of special CGT rules. Subdivision 152-B provides an exemption from CGT for sale of assets of a small business that qualify under the Div 152 general conditions outlined above if held for 15 years and the gain occurs in effect in conjunction with retirement or permanent disability. Subdivision 152-D provides an exemption without a retirement condition up to a lifetime maximum of $500,000 but if the taxpayer is less than 55 years old the amount must be rolled into the superannuation system described in Chapter 4. Complex rules seek to replicate the same outcome in both cases if shares in a company or an interest in a trust is sold. The 15-year rule takes priority over the lifetime exemption rule. Both of these rules seek to recognise that small business owners are less likely to be able to provide for themselves through the superannuation system because they tend to plough every spare penny back into the business – their business is their superannuation. Finally Subdiv 152-C provides an additional 50% discount for capital gains if the basic conditions in Subdiv 152-A are satisfied. This may be applied after the general 50% discount [3.400]

115

The Tax Base – Income and Exemptions

under Divs 102, 115 meaning in such cases a total discount effectively of 75%. The remaining gain may then by election be subject to the benefits in Subdiv 152-D and/or Subdiv 152-E already described. (viii) Personal use assets [3.410] Subdivisions 108-B and 108-C carve out from the general definition of CGT asset two

related categories of property known as “collectables” and “personal-use assets”. These are, as one of the names suggests, assets applied primarily for the personal use and enjoyment of the taxpayer. A combination of policy and administrative concerns explain the separate identification of these assets and the special rules that apply to them in the CGT. The policy concerns relate to the fact that most personal-use assets depreciate in value due to use. To allow a taxpayer to recognise a capital loss on the decline in value of her or his refrigerator, stove, bed, and so forth would be tantamount to allowing a tax deduction for personal consumption, a policy that would violate fundamental principles of income taxation. The administrative concerns arise mostly because of the relatively small cost of many personal assets. Taxpayers are unlikely to retain records of cost or sale price and it is unlikely that any paper trail will be available for auditors; in any case, the amount of tax imposed on the small gains would probably not equal the cost of administering CGT with respect to these assets. A three-part solution to these concerns was adopted. The first has already been mentioned – the dissection of such assets into collectables and personal-use assets. Collectables are assets such as jewellery, coin collections, artwork, and so forth, whose value is more likely to rise or decline in response to market forces, rather than as a result of usage by the owner. Also, for a variety of reasons such as insurance, owners are more likely to retain records for such assets and a paper trail for auditors is more likely to exist. For these reasons, all gains realised on the disposal of these assets are recognised for CGT purposes, provided the cost or market value of the asset at the time of acquisition exceeds $500: s 118-10(1), (2) (a figure that may be in need of upward revision). At the same time, losses suffered on the disposal of collectables will be recognised, but are subject to special provisions which require taxpayers to offset losses on collectables only against gains realised on collectables: s 108-10. The second special rule is the prohibition in s 108-20 on recognition of losses suffered on the disposal of personal-use assets. Finally, s 118-10(3) establishes a minimum floor for calculating gains on personal-use assets; if the cost is $10,000 or less, any capital gain is disregarded. The various provisions involving monetary limits are protected by ss 108-15 and 108-25 which prevent taxpayers from selling separately assets that would normally constitute a set of articles. [3.415]

Questions

3.67

Is an interest in a racing horse acquired by a lawyer who races horses as a hobby subject to the $10,000 floor for personal-use assets?

3.68

Is a capital gain or capital loss made from an antique car, a veteran car or a vintage car disregarded? (See TD 2000/35.)

3. GAINS FROM THE USE OF PROPERTY [3.420] The discussion so far has focussed on rules that were introduced to tax (non-income)

gains made from selling assets (albeit that their scope extends beyond that paradigm case). We now shift to examining the rules which tax gains that are made while holding and using assets. 116

[3.410]

Income from Property

CHAPTER 3

The “fruit and tree” analogy used to explain the distinction between “income” gains generated by property and “capital” gains realised on the disposal of property was also used to construct judicial doctrines on the characterisation of gains related to the use of property. Severed and periodic gains for the use of property, such as interest for the use of borrowed money, rent for the use of leased property, and royalties for the right to use intellectual property or to exploit resources on real property were all characterised as income gains, analogous to the fruit that could be realised without disposing of the underlying property. But payments for the creation or redemption of legal contracts (loans, leases, royalty agreements, and so forth) that give rise to severed income gains for the use or exploitation of property are generally considered capital amounts, given their direct nexus with the underlying property rather than its actual use. Examples are premiums paid for entry into a lease or on redemption of a loan (in addition to the rent or interest payable). From an economic perspective, the distinction between the two types of gains is quite artificial. And, for that matter, their legal distinction is also somewhat tenuous. Virtually any contract that gives rise to a right to receive income can be restructured to provide an entitlement to less income and a premium or similar consideration for agreeing to enter into the contract. The remainder of this chapter considers three areas where the distinction between income and capital gains in respect of the use or exploitation of property has been subject to litigation and specific legislative provisions. The CGT acts as an overlay on both the judicial and prior and subsequent legislative initiatives. One type of gain from the use of property not considered in this chapter is dividends paid by companies to shareholders for the use of their “capital”. From an early stage in the development of Australian income taxation, dividends have been subject to a special statutory inclusion provision, currently s 44(1) of the ITAA 1936. Because of this, there has been little exploration by the courts of the status of dividends according to the judicial concepts of income, although the High Court decision in FCT v McNeil [2007] HCA 5 is an important reminder that there is room for s 6-5 to operate as well as s 44, when considering the benefits received by shareholders in cash or property from companies. More importantly the taxation of dividends is completely entwined in the imputation system of company taxation that now operates in Australia, and is more properly regarded as an issue of taxing income derived through an intermediary rather than as a separate issue of income from property. Hence dividends are considered in Chapter 14.

(a) Interest, Discounts and Premiums [3.430] Interest on a loan is one of the most commonly encountered types of income from

property. It is a periodic payment by the borrower to the lender for the use of the lender’s money by the borrower and is paid in addition to repayment of the lender’s principal. As it exhibits all the characteristics of ordinary income (severed from the source, periodic, expected by the recipient), interest is characterised as ordinary income for tax purposes. Not all returns for the use of borrowed money are paid as interest, however. Often a lender will realise gain in the form of a discount or premium on a loan in lieu of interest. The characterisation for tax purposes of these related types of gains is less certain. Conversely, what the parties call interest may turn out to be something else such as purchase price on closer analysis: see FCT v Broken Hill Pty Co Ltd (2000) 45 ATR 507. [3.430]

117

The Tax Base – Income and Exemptions

(i) Discounts and premiums [3.440] Where a loan is made at a discount, the “lender” will provide the “borrower” with

less money than the amount (apart from interest if any) that will actually have to be repaid. Where a “loan” is made at a premium, the “borrower” will be required to repay an amount (again apart from interest, if any) in addition to the amount advanced or will be required to pay an initial sum to have the lender advance the amount. We have put the terms lender, borrower and loan in quotation marks because discount and premium transactions may not involve loans in a legal sense, even though they clearly do in economic substance. A discount arising at the outset of a transaction is commonly called “original issue discount”. Subsequent “market discount” may arise if interest rates rise or the creditworthiness of the borrower weakens. Similar terminology could be used for premiums but is not common. A debt instrument may offer no return apart from a discount. Common forms of these are stripped bonds and zero coupon bonds. The former are ordinary debt instruments that entitle the lender to annual interest payments. The debt notes are issued in “bearer” form, as a single document evidencing a right to repayment of principal, to which are attached coupons evidencing a right to payment of interest each year. A purchaser, usually a financial institution, acquires the debt and then separates the interest coupon from the principal repayment note and markets each part separately. For example, if a company issued 21-year $1,000 debentures or bonds with $100 interest coupons attached, a lender who acquired the bond could sell the right to $1,000 in 21 years to one purchaser for the present value of that payment, the right to $100 in 20 years to another, the right to $100 in 19 years to a third, and so forth. Zero coupon bonds are debt instruments issued by the borrower on the understanding that they will pay no interest so that the lender’s entire return is based on the original issue discount. Traditionally – although zero coupon bonds were sometimes issued by private borrowers – the most frequent users of this method of borrowing were governments. Government-issued zero coupon bonds are often called “T-bills”, meaning Treasury bills. They have a fixed redemption value and date, but the discount is determined by the market at the time they are issued as they are auctioned and sold to the highest bidder (who will, therefore, receive the lowest rate of return). In Australia, for reasons having to do with past regulatory practices in the banking sector, large private markets utilising bills of exchange and promissory notes (as dealt with in the Bills of Exchange Act 1909 (Cth)) issued at a discount became a very common form of private sector financing. Two recent examples in High Court cases are Coles Myer Finance Ltd v FCT (1993) 176 CLR 640 (see Chapter 11) and FCT v Energy Resources of Australia Ltd (1996) 185 CLR 66. While discounts exhibit few of the usual characteristics of ordinary income, it is clear that they substitute for ordinary interest in most cases, particularly where a zero coupon note has been issued and there is no other return paid to the lender. In these cases, as a substitute for an income amount, the discount would ordinarily be held to have acquired an income character. Nevertheless, the government decided to make certain of this result, at least for the purpose of government-issued zero coupon securities, by enacting s 26CITAA 1936. It might be inferred from the adoption of s 26C of the that discounts were not income in the absence of a specific statutory inclusion provision. Further, even if original issue discount is income (as seems fairly clear: see Hurley Holdings (1989) 20 ATR 1293), it is certainly not as clear that market discount is income. When the ATO assessed individual taxpayers on both kinds of discounts, there was an outcry and the government enacted s 23J of the ITAA 1936 that exempted 118

[3.440]

Income from Property

CHAPTER 3

discounts from assessment provided the instrument was acquired prior to the effective date of the provision, 30 June 1982. The exclusion provision applied to all taxpayers (other than dealers) – not only those who had not expected their gains to be assessable – and, as AAT Case 4880 (1989) 20 ATR 3255; Case W57 (1989) 89 ATC 517 showed, exempted taxpayers who acquired discounted notes only for the purpose of realising a gain and whose gains clearly would have constituted assessable income according to ordinary concepts. There are two strands to the judicial tests used to distinguish discounts that are “income” and those that are “capital” gains. The first is based on the character of the lender. If the lender is a financial institution or regularly acquires discounted securities to generate business profits, the gains will be treated as business income. For other lenders, the character of a discount will depend on whether there is evidence the discount was paid in substitution for interest or whether the taxpayer can establish another plausible explanation for the discount. The leading authority on this issue is Lomax v Peter Dixon (1943) 25 TC 353. The taxpayer company manufactured newsprint and had organised a Finnish company, in which the shareholders were its nominees, to supply wood pulp to it. It had loaned £319,600 to the Finnish company and entered into an agreement for the repayment of the loan. Under the agreement the Finnish company issued 640 notes to the taxpayer with a face value of £500 each (total face value £340,000). The notes were issued at 94% or a discount of 6% and carried interest 1% above the lowest rate charged by the Bank of Finland. The notes were to be redeemed on a regular basis by repayment of £600 each (a premium of 20%). The UK Revenue assessed the taxpayer on the interest, discount and premium on the notes. The Court of Appeal held that only the interest was taxable. Lord Greene MR reasoned as follows.

Lomax v Peter Dixon [3.450] Lomax v Peter Dixon (1943) 25 TC 353 In a Scottish case, CIR v Thomas Nelson & Sons Ltd 22 TC 175, a loan was made to an Indian company repayable in ten years or earlier on the happening of certain specified events, with a power to the company to repay one tenth of the principal on three months’ notice, the rate of interest being 3%. The agreement provided (and this is the important matter) that on payment of the principal sums or any part thereof there should be paid a premium varying with the date on which such principal sums or any part thereof should become payable. From this it appears that the amount to be paid by way of premium must have been calculated by reference, not to any element of capital risk, but to the period of the loan, whatever it might turn out to be, a circumstance, which, prima facie at any rate, stamped the premium with a revenue character. The Lord President in his judgment placed great reliance on the fact that the rate of interest (3%)

was, for a loan of that character, a remarkably low one. He also pointed out that under the power given to the borrower to make yearly repayments, if it had been exercised, the lenders would have received in the form of interest, plus premium, a return varying between 5 and something over 5.5%, and this he said could only be regarded as a reasonable return on the capital lent. He also pointed out that there was no resemblance between the case before him and that of a debenture issued at a discount. The case before him turned on “the specialities of the contract” (22 TC 175 at 180), and forms a good example of a case where the contract itself gives the answer to the question … But in many cases mere interpretation of the contract leads nowhere. If A lends B £100 on the terms that B will pay him £110 at the expiration of two years, interpretation of the contract tells us that B’s obligation is to make this payment; it tells us nothing more. The contract does not explain the nature of the £10. Yet who could doubt that [3.450]

119

The Tax Base – Income and Exemptions

Lomax v Peter Dixon cont. the £10 represented interest for the two years? The justification for reaching this conclusion may well be that, as the transaction is obviously a commercial one, the lender must be presumed to have acted on ordinary commercial lines and to have stipulated for interest on his money. In the case supposed, the £10, if regarded as interest, is obviously interest at a reasonable commercial rate, a circumstance which helps to stamp it as interest. In Lord Howard de Walden v Beck 23 TC 384, the appellant became entitled to receive sets of promissory notes payable without interest at three monthly intervals. The consideration moving from the appellant was an amount which represented the present value of the promissory notes calculated in the case of one set of notes on a 4% basis, and in the case of the other sets at a rate approximating to 4%. Wrottesley J pointed out that the documents threw no light on the problem whether or not the difference between the present value and the nominal amounts of the notes represented capital or income. Nor did he find any assistance in the surrounding circumstances. He rejected the view that the appellant had purchased an annuity (a view which was not pressed by the Crown), and held that the appellant had stipulated for the return of his capital. This at once stamped the transaction as one of loan, and on that basis it does not seem to have been seriously argued that the difference between the present and the nominal value of the notes ought not to be regarded as interest. It is to be noted (1) that the contracts did not in terms provide for payment of interest; (2) that 4% was a reasonable commercial rate. These facts led really as a matter of common sense to the inference that the 4% was interest. A rather different case is that of a moneylender who stipulates for payment by instalments of a sum very much larger than that which he lends. From a business point of view, the excess, one would have thought, is referable largely, if not mainly, to the capital risk. So long as the moneylender is carrying on his business this is immaterial since he will be assessed. … It is part of his business to take capital risks. But in Bennett 120

[3.450]

v Ogston 15 TC 374, the moneylender had died, and the question arose in relation to instalments collected by his administrator. … It does not seem to have been seriously argued that the difference between the amount of the loan and the amount of the instalments did not represent interest. As Rowlatt J says (at 378): “Each of these instalments is found in the case to contain principal and interest and we know, of course, that it is so, and we are familiar with the way in which these instalments are broken up into principal and interest.” On this basis the insurance against capital risk was provided for by means of a high rate of interest; and, where this is the case, interest it is and not capital. In saying that the case was one of interest, Rowlatt J apparently based himself on the well-known practice of moneylenders; and if the deceased had been alive he would no doubt have admitted that he fixed the amount of instalments by reference to an interest table, a circumstance which would be sufficient to stamp the whole excess as interest … The position is more complicated when A lends £100 to B at a reasonable commercial rate of interest and stipulated for payment of £120 at the maturity of the loan. In such a case it may well be that A requires payment of the £20 as compensation for the capital risk; or it may merely be deferred interest. If it be proved that the former was the case by evidence of what took place during the negotiations, it is difficult to see on what principle the £20 ought to be treated as income. In the absence of such proof, what inference ought to be drawn? Something may, perhaps, depend on the length of time for which the money is lent. If the period is short it is perhaps easier to treat the £20 as deferred interest. The longer the period the greater the element of risk, and if it was, say ten years, the probability that the £20 was not intended to be deferred interest would seem to be greater. A good example of the difficulty is to be found in the contracts of loan which used to be made on a gold basis when the currency had left, or was expected to leave, the gold standard. In such contracts the amount to be repaid was fixed by reference to the price of gold ruling at the repayment date, and if the currency depreciated in terms of gold, there was a corresponding increase in the amount of sterling to be repaid at

Income from Property

Lomax v Peter Dixon cont. the maturity of the loan. It could scarcely be suggested that this excess ought to be treated as income when the whole object of the contract was to ensure that the lender should not suffer a capital loss due to the depreciation of the currency. I refer to these problems, not for the purpose of attempting to solve them, but in order to show that there can be no general rule that any sum which a lender receives over and above the amount which he lends ought to be treated as income. Each case must, in my opinion, depend on its own facts and evidence dehors [outside] the contract must always be admissible in order to explain what the contract itself usually disregards, namely, the quality which ought to be attributed to the sum in question. I will now consider the case of an ordinary issue of debentures by a limited company. If the credit of the company is good and the security an ample one, the issue can be made at par at a normal reasonable rate of interest. If the company’s credit and the security offered are exceptionally good, the issue can be made at a premium. In such a case the calculation of the rate of interest which the subscriber will receive on the capital which he invests is a simple matter. It will be less than the nominal rate; but this does not entitle the subscriber to avoid taxation on the difference between the nominal rate and the actual rate. He is taxed on what he in fact receives. The premium which he pays is capital. He pays it because the security which he is getting is a particularly good one. Here the excellence of the security is expressed in terms of capital. Such a company, however, may prefer to issue its debentures at par at a lower rate of interest. Here the excellence of the security is expressed in terms of interest. The subscriber receives less interest but does not pay a premium. Actuarially the result is the same in both cases; but the subscriber pays less tax in the latter case than he does in the former because his income is less. Now let me take the opposite case where the credit of the company and the security which it offers are not such as to enable it to offer its

CHAPTER 3

debentures at par at a normal rate of interest applicable to sound securities. The object of the company is to make its issue attractive and various alternatives are open to it. It may make the issue at par but give a high rate of interest. The whole of the interest is unquestionably income and is taxable as such although the high rate of interest is, in part, attributable to the capital risk. Another course which the company may take, and for commercial reasons probably will take, is to fix the rate of interest at a more normal level and make the issue at a discount; or it may make the issue at par and offer a premium on redemption; or it may combine both methods. Here the defect in the security is expressed in terms of capital. I venture to think that no business man would regard the discount or the premium as anything but capital matters. In each case the result is the same – the subscriber is paying for a more or less hazardous investment less than the figure at which it is to be redeemed, and in exchange has to be content with a lower rate of interest. Another way of making good the defect in the security would be for the company to take out a guarantee policy … In such a case the issue might be at par. The subscriber would be paying more for a safer investment than he would have paid if the guarantee policy had not been taken out. No one would suggest that the premiums paid by the company were part of the subscriber’s income. Yet the policy would be playing exactly the same part as would have been played by a reduction in the issue price, or the offer of a premium on redemption, or a combination of the two. The amount by which the issue price falls short of par or the redemption price exceeds par can, of course, as has been done in the present case, be reduced to terms of income if any one chooses to make the calculation; and this is often done by a stockbroker advising a client, particularly when the redemption date is drawing near. But this does not mean that these amounts are income. If they were income and taxable as such when received on redemption, it would appear to follow that in the case of a debenture issued at a premium and redeemable at par, the amount of the premium ought to be treated as an income loss. A premium on redemption and a premium on issue are in their nature precisely the same and [3.450]

121

The Tax Base – Income and Exemptions

Lomax v Peter Dixon cont. come into existence for the same reason, viz, the desire to express in the former case the greatness, in the latter, the smallness, of the risk in terms of capital rather than in terms of interest. I have for simplicity considered only the case where the variations in issue price and rates of interest are due only to differences in the security offered. This, of course, is not necessarily always the case. The precise terms of an issue may be affected by a variety of other considerations – the taste of the market; the terms of previous issues by the company; the political or international situation; the expectation of changes in money rates; the instability of the currency, etc. But these matters do not affect the principle. It is perfectly true that a company may be able to obtain subscribers by issuing debentures at par at a high rate of interest just as well as it can by issuing them at a lower rate of interest below par or with a premium on redemption. The two methods are, however, essentially different although actuarially they will normally produce the same result. But for income tax purposes the result is, I think, different, according as the company chooses the one method rather than the other. The Crown is, in my opinion, bound by the company’s choice and cannot go behind it. I can find no ground for distinguishing the present case from that of an ordinary issue of debentures by a trading company. If at the date of the agreement the appellants had lent to the Finnish company a sum of £319,600 to be secured by an issue of notes at 94 repayable over 20 years at 120 and bearing interest at a rate fixed by reference to bank rate in the usual way, the Revenue authorities would not have claimed tax on the discount or the premium. The element of capital risk was quite obviously a serious one, and the parties were entitled to express it in the form of capital rather than in the form of interest if they bona fide so chose. It is said, however, that there is a difference between the case of a security issued for a present loan and that of a security issued to cover an existing loan. This argument found favour with Macnaghten J but, with all respect to him, I cannot follow it. The parties to the transaction, faced with an existing 122

[3.450]

debt which the Finnish company was obviously not in a position to repay there and then, did what in effect amounted to writing down the capital value of the debt which by the terms of the agreement was not to be repaid over a long period of years, bearing interest in the meantime at a normal commercial rate. I can see no difference between writing down the capital value of a new debt which is what is done where a company makes an ordinary issue of debentures at a discount or repayable at a premium. Moreover, it is quite common for a company to issue debentures as security for an existing loan. This is often done in the case of a company’s bankers who call for security, and also not infrequently under schemes of arrangement when debentures are issued to existing creditors of the company. In such cases circumstances may well call for a writing down of the value of the debts. An additional argument was presented on behalf of the Crown to the effect that the difference between the price at which the notes were issued and the redemption price, or, at any rate, the difference between the issue price and the nominal par value of the notes, was income from “discounts” within the meaning of para (b) of Rule 1 to Case III. But, in my opinion, the word “discounts” in that paragraph does not cover such a case as the present. I agree with what was said by Rowlatt J, in The National Provident Institution v Brown 8 TC 57 at 66: “It is clear”, he said, “that it is not every difference in amount between a sum payable in future and the same sum represented by cash down which is an annual profit or gain by way of discount, even though popularly the word ‘discount’ may be used to describe it.” It was conceded (and in my opinion rightly) that in the case of a debenture, the difference between issue price and redemption price when received by the holder is not income from “discounts” within the meaning of the paragraph. It is impossible to suppose that the legislature intended to include under the one word “discounts” two such entirely different commercial transactions as the discounting of a bill of exchange or a Treasury Bill (which normally are short-dated and carry no interest) and a subscription for debentures issued at a discount. The issue of debentures or other obligations by companies was unknown in 1805 when profits

Income from Property

Lomax v Peter Dixon cont. on “discounts” were for the first time expressly subjected to income tax … In The National Provident Institution v Brown, Lord Sumner says (8 TC 57 at 96) that there is no restriction of the word “discount” in the statutes to transactions in use in the year 1842 – he might have said 1805 – and that the rule relates to profits on all discounts from whomsoever made. This observation does not, however, throw much light on the question whether any particular transaction is one of “discount” within the meaning of the rule. If the case of the debenture fell under the word “discount”, it would follow from the National Provident case that profits realised by selling debentures on the market would be taxable as income as well as those made by an original subscriber who holds his debenture until maturity. The storm which would be aroused in the city of London if this were found to be the law is perhaps the best proof that it cannot be the law, since it shows at once the fundamental difference from the business point of view between the case of the debenture and the case of the discounted bill. It is conceded that the word would not cover the “discount” in the case of a debenture issued “at a discount” and, as I have already said, for present purposes I can see no difference between that case and this. In the discounting of bills of exchange, Exchequer Bills, etc., the discount is the reward, and in the normal case, since such bills do not as a rule carry interest, the only reward which the person discounting the bill obtains for his money. It may be convenient to sum up my conclusions in a few propositions:

[3.455]

CHAPTER 3

(1)

Where a loan is made at or above such a reasonable commercial rate of interest as is applicable to a reasonably sound security, there is no presumption that a “discount” at which the loan is made or a premium at which it is payable is in the nature of interest.

(2)

The true nature of the “discount” or the premium, as the case may be, is to be ascertained from all the circumstances of the case …

(3)

In deciding the true nature of the “discount” or premium, in so far as it is not conclusively determined by the contract, the following matters together with any other relevant circumstances are important to be considered, viz, the term of the loan, the rate of interest expressly stipulated for, the nature of the capital risk, the extent to which, if at all, the parties expressly took or may reasonably be supposed to have taken the capital risk into account in fixing the terms of the contract.

In this summary I have purposely confined myself to a case such as the present where a reasonable commercial rate of interest is charged. Where no interest is payable as such, different considerations will, of course, apply. In such a case, a “discount” will normally, if not always, be a discount chargeable under para (b) of Rule 1 to Case III. Similarly, a “premium” will normally, if not always, be interest. But it is not necessary or desirable to do more than to point out the distinction between such cases and the case of a contract similar to that which we are considering.

Questions

3.69

When a transaction involves discounts, premiums and interest as in Peter Dixon what principles are applied in determining which elements in the transaction are taxable apart from the effect of legislation? Is there any inconsistency in suggesting that where the parties choose to express the risk in a transaction in an interest rate, the interest is taxable, while where they choose to express it in a discount or premium, it may not be taxable?

3.70

Would it make any difference in Peter Dixon if the lender were a financial institution? (Compare Mutual Acceptance Ltd v FCT (1984) 15 ATR 1238; 84 ATC 4831.) [3.455]

123

The Tax Base – Income and Exemptions

3.71

Discounts might now be assessable under CGT. In what circumstances would a taxpayer prefer to be assessed on a discount under CGT rather than under s 6-5?

(ii) Deep discount debt securities – Div 16E and TOFA [3.460] In the absence of any special recognition rules, a fully assessable discount would still

be far more desirable than ordinary interest to most taxpayers. That is because the discount would not be taxable until it is realised upon redemption or sale of the security, while annual interest would be taxable each year, as it is derived. In effect, the taxpayer deriving her or his gain by way of a discount can “reinvest” each year’s gain, since the final discount will be based on a compounding formula, while the taxpayer deriving annual interest will lose up to half of the gain to tax and have far less to reinvest each year. Division 16E of the ITAA 1936 was enacted to eliminate the disparity in treatment between assessable discounts and ordinary interest. Div 16E treated assessable discounts as the equivalent of compound interest and provided for annual assessment of an appropriate part of the gain. Division 16E was not a base-broadening provision, however. It only applied to discounts that would be assessable income; if a discount is not otherwise assessable, it would not be affected by the Division. As we shall see in Chapter 12 (on Statutory Accounting Regimes), Div 16E was replaced by the Taxation of Financial Arrangements (TOFA) regime which was more ambitious – it applies to all discounts on qualifying securities, whether or not the discount would have an income nature. Division 16E, and now TOFA, only apply to securities issued at a deep discount (and other securities where the return is other than by way of normal interest). The legislation uses the term “eligible return” to describe the discount. The formula in the legislation which measures whether the discount is large enough compares the eligible return to a benchmark return calculated as 1.5% of the payments to be made to the lender apart from interest (ie in most cases, simply the nominal principal amount) multiplied by the number of years of the loan. If the eligible return exceeds the benchmark return and other conditions are satisfied (such as the term being more than one year), the security is one to which TOFA will apply. The operation of the formula can be illustrated with two loans, each with a face value of $100 and each with a 10-year term. The first note is issued at $90, while the second is issued at $80. In both cases, the benchmark return will be .015 × 100 × 10 = $15. The eligible return for the first note is $10, while the eligible return for the second is $20. The first is not a qualifying security, while the second is. Notice also that note has to be issued at a discount to fall within TOFA – if discount is pure market discount (a note with a face value of $100 was bought on market for $80), TOFA does not apply. (iii) Traditional securities [3.470] The only inclusion provision explicitly covering non-assessable discounts apart from

the TOFA regime is s 26BB, which applies to “traditional securities” as they are called in the section. Traditional securities are defined as discounted notes with no eligible return (ie they carry only interest), or with an eligible return but less than the benchmark return. Typically this provision will apply to market discount. Like TOFA, s 26BB changes the character of gains and renders assessable discounts and other gains that might not have been assessable as income according to judicial concepts. Although discount and other returns which are not ordinary income would nowadays 124

[3.460]

Income from Property

CHAPTER 3

generally be caught by the CGT, s 26BB ensures that indexation and the CGT discount are not available to what are essentially interest equivalents. Section 26BB is complemented by s 70B, which allows taxpayers a deduction for losses suffered on the disposal of a traditional security. Section 70B was amended in 1992 in response to the collapse of a number of financial institutions. It was feared that investors in those institutions would be able to utilise s 70B to deduct losses that were not related to ordinary discounts or redemptions (based on fluctuations in interest rates and market conditions) but which were instead the result of financial collapse. Such losses can be recognised as capital losses. The Court held in Burrill v FCT (1996) 67 FCR 519; 33 ATR 133; 96 ATC 4629 that s 70B is based on historical cost and not the time value of money. In the case, a depositor in a failed financial institution received 25% of the amount deposited from the liquidator and the remaining 75% by way of a government note payable in four years without interest. Even though the depositor had clearly made a loss in being kept out of his money for four years, the Court held that no loss arose under s 70B. Nevertheless s 70B has been the source of claims for substantial deductions and it is likely that on balance the government has lost rather than gained revenue from the enactment of ss 26BB and 70B. [3.475]

3.72

Question

In 1999 A acquires a low-interest note, which does not fall within Div 16E, at below its issue price because of market discount. One year later A gifts the note to B when its market price has risen but is still below the issue price. B holds the note to redemption. How are A and B taxed, if at all, with respect to the note?

(iv) Annuities [3.480] Annuities are a regular series of payments received by a person usually for a fixed

term of years, or for life. Originally annuities were created under wills and trusts, but in modern times they are generally paid to a person in return for a single premium provided to the financial institution paying the annuity. Modern annuities are akin to a principal and interest (blended) loan made by the annuitant to the financial institution, one in which the borrower (financial institution) pays interest and principal over the life of the loan through a series of regular payments. (Most home mortgages and consumer loans such as car loans are principal and interest loans, though in these cases it is the financial institution that is making the loan rather than receiving it.) In such loans, the first payments are mostly interest, with a small principal repayment amount, but the principal repayment component increases over the life of the loan as the outstanding principal is reduced and the resulting interest charge lowers. Although purchased annuities are effectively comprised partly of interest and partly of principal, annuity payments are characterised entirely as income according to judicial concepts. The earliest annuities were charges on trusts or estates (usually to provide for a dependant and consequently for the life of the dependant). They were not purchased and payments were treated as “income” payments under the periodical receipts principle: see Chapter 6. English courts applied the same treatment to purchased annuities for UK income tax purposes and, not surprisingly, Australian courts followed the UK approach despite the different basis of our legislation. In the case of purchased annuities, the courts speak of a “capital” amount being transformed to a stream of “income” amounts. Modern annuities are effectively an alternative form of investment. However, the application of old UK doctrines to modern annuity payments is not as irrational as it might [3.480]

125

The Tax Base – Income and Exemptions

appear to be at first glance. Many modern annuities are “life” annuities, issued by life insurance companies. Payments are calculated as if the annuitant (the person who receives the payment) were to receive them for a fixed period, namely the rest of their life, as determined by the insurance company’s actuaries. But the exact total of the payments is unknown, since the annuitant’s actual lifespan is unknown. Annuitants who live longer than expected are paid from the extra funds available to the insurance company from annuitants who die earlier than expected. Since the total amount of the payments is unknown, the principal and interest components of each payment are not obvious – hence the judicial rule to characterise all the payments as income. The rule is applied to fixed-term annuities as well, even though the interest and principal can be easily calculated in these cases. To assess all of a purchased annuity payment is obviously unfair, since there would be no recognition of the amount paid by the annuitant to acquire the annuity payments. Not surprisingly, legislation has long since overturned the judicial rule in part by allowing a taxpayer to reduce the amount of income by allowing for the cost of the annuity (it is not, however, a deduction in the sense of Div 8 of the ITAA 1997). The reduction formula, in s 27H of the ITAA 1936, is not based on the actual proportions or estimated proportions of interest in each payment. Instead, the taxpayer is allowed to pro-rate the capital (called the “undeducted purchase price”) over each payment and reduce each annuity payment by an equal amount. In the case of a life annuity, the deductible amount is calculated as if the taxpayer were going to live the exact period estimated by the Commonwealth actuary. In terms of elderly persons investing in annuities to be paid for the rest of their lives, this treatment makes sense. They wish to secure money for the rest of their lives and to have an even profile of income for tax purposes over that period. As s 27H originally applied to all purchased annuities, however, it gave rise to opportunities for tax planning because the taxation of the income in an annuity differs from the taxation of the interest component in a principal and interest loan. Hence taxpayers with different tax positions could exploit the timing differences. The legislative response to such schemes is found in s 159GP(10) which defines annuities other than ineligible annuities to be qualifying securities. Ineligible annuities are defined in s 159GP(1) as annuities issued by insurance companies to individuals. Annuities that are treated as qualifying securities are specifically taken out of the s 27H pro-rata recognition formula by s 27H(4). The effect of these provisions is to treat purchased annuities (issued by someone other than an insurance company) as principal and interest loans and to recognise the “interest” component on a compounding basis over the life of the annuity. The sections have no effect on annuities issued by insurance companies and have done nothing to inhibit the marketing of investment annuities by that sector. This treatment will effectively continue under the TOFA regime, see s 230-460(1), (5). The taxation of annuities and other periodic payments is further considered in Chapter 6. [3.485]

3.73

126

Question

A purchases an annuity of $30,000 per year for a cost of $250,000. The term of the annuity is for the life of A and on her death, for the life of B with the annuity payable after A’s death to B. How are A and B taxed, if at all, on the annuity payments? Assume that for the purposes of s 27H, A’s life expectancy is five years and B’s 12.5 years. [3.485]

Income from Property

CHAPTER 3

Implicit interest or purchase price [3.490] One effect of the exemption from taxation of long-term capital gains prior to 1985

was the encouragement of vendor-provided finance by way of instalment sales. If the purchaser of property did not have the cash to pay for the asset at the time of purchase, the vendor could lend the purchase price to the purchaser and, in addition to the non-assessable capital gain realised on the sale of the asset, derive interest income over the loan period. An alternative arrangement was for the vendor to allow the purchaser to pay for the property on an instalment basis, over time. From an economic perspective, an instalment sale was similar to a vendor-provided principal and interest loan. Quite clearly, no vendor in a normal commercial transaction would allow a purchaser to pay over an extended period of time without explicitly charging interest on the unpaid balance or implicitly imposing an interest charge by adjusting the “sale” price upwards to reflect the delayed payments. The legislature adopted s 262 of the ITAA 1936 to ensure the implicit interest component of instalment sale payments was assessable. This section forestalls arguments against apportionment of the kind discussed in Chapter 2. To successfully assess the implicit interest component of instalment sale payments, the ATO had to show that the payments contained an “income” component in the face of the taxpayer’s assertion that the entire amount was merely a delayed payment of part of the purchase price. One of the leading examples of judicial characterisation of instalment payments is the House of Lords’ decision in Scoble. The case contains an interesting twist in that it was the taxpayer who sought dissection of the instalment payments into interest and principal components, not the UK revenue authorities. The tax dispute arose out of a transfer of land by the East India Company to a railway company. The agreement provided that the East India Company could purchase the railway after 50 years and in that event, instead of paying the purchase price in one sum, could elect to “pay an annuity” over 49 years. The agreement stated that “the rate of interest which shall be used in calculating such annuity” was to be tied to the Bank of England interest rate. The powers of the East India Company were vested in the Secretary of State for India who exercised the option to purchase the railway and elected to pay for it by the annuity. The issue raised was whether the “annuity” was taxable in full or only as to the interest element. The House of Lords held that only the interest element was taxable.

Scoble v Secretary of State for India [3.500] Scoble v Secretary of State for India [1903] AC 299 The loose use of the word “annuity” undoubtedly renders a great many of the observations that have been made by the Attorney-General and Solicitor-General very relevant to the question under debate. Still, looking at the whole nature and substance of the transaction (and it is agreed on all sides that we must look at the nature of the transaction and not be bound by the mere use of words), this is not the case of a purchase of an annuity; it is a case in which, under powers reserved by a contract, one of the parties agrees to buy from the other party what is their property

and what is called an “annuity” in the contract and in the statute is a mode of making the payment for that which had become a debt to be paid by the government. If it was to be a debt paid by the government, it introduces this consideration: was it the intention of the Income Tax Act ever to tax capital as if it was income? I think it cannot be doubted, both upon the language of the Act itself and the whole purport and meaning of the Income Tax Acts, that it never was intended to tax capital, as income at all events. [3.500]

127

The Tax Base – Income and Exemptions

Scoble v Secretary of State for India cont. Under the circumstances, I think I am at liberty so far to analyze the nature of the transaction as to see whether this annual sum which is being paid is partly capital, or is to be treated simply as income; and I cannot disagree with what all the three learned judges of the Court of Appeal pointed out, that you start upon the inquiry into this matter with the fact of an antecedent debt which has got to be paid; and if these sums, which it cannot be denied are partly in liquidation of that debt which is due, are to be taxed as if they were income in each year in which it is being exacted, the result is that you are taxing part of the capital. As I have said, I do not think it was the intention of the Legislature to tax capital, and therefore the claim as against a part of those sums fails.

My Lords, as I have already said, I do not think it is a matter on which one can dogmatize very clearly. Where you are dealing with income tax upon a rent derived from coal, you are in truth taxing that which is capital in this sense, that it is a purchase of the coal and not a mere rent. The income tax is not and cannot be, I suppose from the nature of things, cast upon absolutely logical lines and to justify the exaction of the tax the things taxed must have been specifically made the subject of taxation, and looking at the circumstances here and the word “annuity” used in the Acts, I do not think that this case comes within the meaning which (using the Income Tax Acts themselves as the expositors of the meaning of the word) is intended by the word “annuity” and that is the only word that can be relied upon here as justifying what would be to my mind a taxation of capital.

[3.510] In Vestey v IRC, the taxpayer sold shares valued at £2 m for the sum of £5.5 m

expressed to be payable without interest by 125 annual instalments of £44,000. In default of payment of an instalment, interest on the unpaid instalments became payable at 4%. There was evidence in correspondence that the £5.5 m had been derived using a net interest figure of 2% on £2 m but there was no evidence that the taxpayer was aware of this correspondence or had assented to it. The Revenue sought to tax the whole amount of each instalment as an annuity while the taxpayer claimed that none of it was taxable, and as a fall-back position argued for apportionment of the instalments into principal and interest elements. Cross J chose to apportion each payment into principal and interest components.

Vestey v IRC [3.520] Vestey v IRC [1962] Ch 861 But the agreement takes the form of a sale for a purchase price equal to the aggregate of all the instalments and that, says counsel for the appellant, differentiates this case from the Scoble case. He says that the provision for payment of the whole balance of the purchase price on default of payment of an instalment … shows – if the point be material – that the figure of £5,500, 000 is a real figure. He says further, and says truly, that no case can be found in which the courts have dissected sums which were expressed to be instalments of a purchase price into capital and

128

[3.510]

interest elements. Finally, he relies strongly on a statement of the law by Romer LJ in CIR v Ramsay (1935) 20 TC 79 at 98. Romer LJ, in the Ramsay case said: If a man has some property which he wishes to sell on terms which will result in his receiving for the next 20 years an annual sum of £500, he can do it in either of two methods. He can either sell his property in consideration of a payment by the purchaser to him of an annuity of £500 for the next 20 years, or he can sell his property to the purchaser for £10,000, the £10,000 to be paid by

Income from Property

Vestey v IRC cont. equal instalments of £500 over the next 20 years. If he adopts the former of the two methods, then the sums of £500 received by him each year are exigible to income tax. If he adopts the second method, then the sums of £500 received by him in each year are not liable to income tax, and they do not become liable to income tax by it being said that in substance the transaction is the same as though he had sold for an annuity. The vendor has the power of choosing which of the two methods he will adopt, and he can adopt the second method if he thinks fit, for the purpose of avoiding having to pay income tax on the £500 a year. The question which method has been adopted must be a question of the proper construction to be placed upon the documents by which the transaction is carried out. In this case counsel submitted that the parties have clearly chosen the second of the two methods to which Romer LJ referred. Counsel for the Crown first submitted that this was a sale in consideration of an annuity, and not a sale for a purchase price payable by instalments at all. The sum of £5,500,000, they said, is simply the aggregate of the instalments, and cannot properly be described as the purchase price. If there was any purchase price it was £2,000,000. Further, even if periodic payments of sums without interest, the aggregate of which exceeds the present value of the property sold, can be properly described as instalments of purchase price if the period is relatively short, they cannot be so described if the period is as long as this. Finally, on this branch of the argument they submitted that the wording of the agreement was more consistent with a sale for an annuity than a sale for a purchase price payable by instalments. In my judgment, this last point has no substance in it. The agreement follows closely the wording of familiar precedents for a sale in consideration of a purchase price payable by instalments … with, of course, the difference that the precedents envisage that the purchase price will be the value of the property at the date of

CHAPTER 3

sale and provide for payment of interest from time to time on the outstanding balance whereas here no interest is payable but the purchase price is far more than the value of the property sold at the date of sale. Again, if Romer LJ is right, it seems to me to follow that the £5,500,000 can properly be regarded as the purchase price of these shares. The £10,000 in his example must clearly have been more than the value of the property at the date of the supposed sale. If it had been worth £10,000 the annuity would have been more than £500 a year. He is, I think, saying, quite clearly and unmistakably, that a man who wishes to exchange a capital asset for a right to receive annual sums over a period of years can avoid paying any tax on the annual sums by selling the asset for a sum in excess of its then value, to be paid by instalments over a period without interest. That is precisely what the appellant has done here. It is, of course, true that the period chosen is longer than the 20 years given by Romer LJ, but, as I have already said, I cannot see how the length of the period can make a difference. I asked counsel where he would draw the line. He suggested that a proper limit to take might be the expectation of life of the vendor; but this would mean that a transaction which would have one result for tax purposes if the vendor was 25 would have another if he was 75. The question cannot be one of degree. It is a point of principle, and if Romer LJ was right I think that the appellant is entitled to succeed. Then was Romer LJ right? I am conscious that it must appear presumptuous in me to question the correctness of a clear and positive statement of the law made by Romer LJ, but, try as I will, I cannot see how the second branch of the proposition can be reconciled with the decision of the House of Lords in Scoble’s case … It is, of course, true that in Scoble’s case the value of the property sold and the rate of interest taken for the purpose of fixing the amount of the annuity appeared on the face of the documents whereas in this case these facts have been established by outside evidence. But I think that later cases … make it clear that this makes no difference. Then, if it is not the law that by selling property for an annuity for a fixed period you subject the whole annuity to tax, why should it be the law that by [3.520]

129

The Tax Base – Income and Exemptions

Vestey v IRC cont. selling property for a purchase price greater than its present value payable by annual instalments you free the whole of each instalment from tax? If

the Crown cannot say that there is any magic in the use of the word “annuity”, why should the taxpayer be able to say that there is any magic in the use of the words “purchase price”?

[3.525]

Questions

3.74

Where property is sold in return for a series of payments, on what basis, in view of these cases and Peter Dixon, may all the payments be taxable? When are none of them taxable? When will the courts dissect such payments into taxable and non-taxable elements?

3.75

What is the effect of s 262 of the ITAA 1936 in cases of this kind? How does that section relate to the attitude to apportionment revealed in McLaurin v FCT: see Chapter 2.

3.76

To what extent were the courts influenced by the notion of income as a gain in deciding these cases?

[3.530] Another legislative response to the difficulties in dissecting the interest and principal

components of instalment sale payments appears in ss 103-10 and 103-15 which operate through ss 116-20(1) and 110-25(2). These include in the capital proceeds or cost base all amounts paid or payable in the future to the vendor (and correspondingly for the purchaser). The effect of the provisions is to bring forward to the time of sale all future payments, including implicit interest components. They are dealt with further in Chapter 12. It will be apparent that the current law in relation to the taxing of financial assets and liabilities consists like much else of a patchwork of provisions added to ordinary concepts of income over the years. Seventeen years after the original announcement in 1992, the TOFA regime came into effect in 2009 and 2010 to deal with financial instruments more consistently (see Chapter 12) but it will be apparent from the brief comments on TOFA above that the rules will still to some extent be a patchwork.

(b) Rent, Premiums, Repairs and Leasehold Improvements (i) Rent and premiums [3.540] The term rent is traditionally applied to the receipt by an owner of property of payments for the use of the property by another. In the case of real estate, rent is the periodic payment by the tenant/lessee (user of the property) under a lease to the landlord/lessor (owner). Property law regards the grant of a lease as a conferring on the tenant/lessee of an interest in the land, and so the transaction may be characterised as the disposal of property by the owner to the lessee, on the one hand, or as the use of the lessor’s property by the lessee, on the other. Rental payments, received in respect of the use of property, have always been considered income according to ordinary concepts. On the other hand, premiums or payments given in respect of the grant of a lease have often been characterised as non-assessable capital gains, unless they could clearly be identified as amounts paid in lieu of ordinary rent or were received 130

[3.525]

Income from Property

CHAPTER 3

in the ordinary course of a property business. The distinction between rent and premiums is thus similar to that between capital premiums or discounts and interest payments drawn by Lord Greene in Lomax v Peter Dixon. The artificiality of this distinction led to a number of different approaches to lease premiums in the income tax legislation over the years. In the ITAA 1997 the matter is primarily left to the CGT in cases where a premium is not ordinary income. Event F1 on premiums is designed to tax lease premiums without a cost base and without the benefit of the transitional rule for pre-CGT assets. Otherwise it was argued that it may have become common to replace rent with lease premiums for any pre-20 September 1985 land. Other F events deal with various transactions in leases and there are also special rules on leases in the capital proceeds rules in ss 116-20, 116-25 and 116-75, and in Div 132. [3.545]

3.77

3.78 3.79

3.80 3.81

Questions

Do you agree with the argument referred to above that treating leases as disposals of part of an asset would have led to the conversion of rent of assets acquired prior to 20 September 1985 to premiums? In answering this question consider the position of the lessee. Do you think that the rules on lease premiums as regards the lessor and lessee are correct in principle? Are the special CGT lease rules confined to land or do they encompass “leases” of other assets? What happens if a lease is prematurely determined in return for a payment from the lessee to the lessor, or from the lessor to the lessee? What happens if a lease is extended in return for a payment from the lessee to the lessor, or from the lessor to the lessee? (See also the discussion of FCT v Cooling and following cases in Chapter 5.) What happens if the lessee acquires the interest of the lessor in the leased property? Why are there special rules for long-term leases and Crown leases in the CGT? (See also Subdiv 124-J.)

(ii) Repairs [3.550] Almost all lease agreements provide for one or both of the parties to the lease to

assume some responsibility for repairing the leased property. A common arrangement is for the lessee to assume responsibility for repairs caused by day-to-day wear and tear, and for the lessor to assume responsibility for structural repairs. Does the assumption by the tenant of this obligation to repair defects represent additional (non-cash) income to the landlord? The division of responsibility for repairs will usually be reflected in the rate of rent charged. In theory, so long as the lessee is using the rented premises to derive assessable income, he or she should be indifferent between higher rent and less responsibility for repairs, and lower rent and more responsibility for repairs – rent will be deductible as an ordinary business expense and the cost of repairs will be deductible under s 25-10. The lessor, in theory, should also be indifferent between these two options. If the first alternative is incorporated into the lease agreement, higher rental income will be offset by larger repair deductions. If the lessee fails to comply with a lease covenant to repair the premises, the lessor will have grounds for recovering compensation. In the absence of statutory measures, payments of this type usually would neither be deductible to the lessee nor assessable to the lessor as ordinary income. Section 25-15 allows the lessor a deduction for such expenses, provided the rented property is used to derive assessable income. That section is complemented by s 15-25 which [3.550]

131

The Tax Base – Income and Exemptions

includes the compensation or damages in the lessor’s assessable income where the lessee would be allowed a deduction for the payment under s 25-15. [3.555]

3.82

Question

The taxpayer rented a house to a tenant for a weekly rental. The parties signed a standard form rental agreement purchased at a local stationery store. The agreement provided for a bond of six weeks’ rent to be held in trust until the end of the lease period, at which time it would be returned to the tenant provided the property had been kept in good repair. In the event of non-compliance with the repair covenant, the lessor would be entitled to keep the bond. Shortly before the lease was due to expire, the tenant abandoned the premises, leaving them in a poor state of repair. The landlord withdrew the bond payment and used it to help pay the repair costs she incurred. Is the bond money assessable to the landlord under CGT? Does the CGT render s 25-15 unnecessary?

(iii) Leasehold improvements [3.560] We noted earlier that basing the CGT on assets may enable some gains that would be

encompassed by a comprehensive income concept to continue to escape taxation. One type of gain that may fall into this camp is leasehold improvement gains. Leasehold improvement gains are realised by lessors when their tenants improve leased property and leave the improvements on the property when they vacate at the end of the lease. Leasehold improvement gains generally will not be assessable as ordinary income. [3.565]

Questions

3.83

In 1986, an English company with operations in Australia leased a rental property for an employee it was transferring to Sydney from the head office in London for a six-year period. When negotiating the lease arrangements, the lessee requested permission to pave the driveway on the property and construct a garage. The understanding of the parties was that under relevant State property law both the driveway and garage would revert to the lessor at the end of the lease. The lessee put in a paved driveway that cost $3,000 and a garage that cost $15,000. At the end of the lease period, both the driveway and garage remained in good condition. Because building costs had climbed substantially over the intervening six years, the estimated value of the paved driveway and garage was $26,000 at that time (ie valuers said the property was worth $26,000 more with the improvements than it would have otherwise been). Does a CGT event occur for the lessor as a result of these events? (See Determinations TD 46 – TD 48.)

3.84

What happens under the CGT if a lessor pays a lessee on termination of a lease for fixtures that the lessee has attached to the leased property?

(c) Royalties [3.570] Many payments called royalties will constitute ordinary income from property and be

assessable under s 6-5. Amounts which are “royalties” but do not fall within s 6-5, are assessable under a specific inclusion provision, s 15-20. Notice that s 15-20 goes to some pains to say that it only applies to royalties “disregarding the definition of royalty” that exists in the Act. The point being emphasised is to ignore the definition of royalty because that definition was enacted only for the flat-rate gross withholding on payments made to non-residents. So, the scope of s 15-20 is limited by two 132

[3.555]

Income from Property

CHAPTER 3

exclusions: it does not apply to amounts which are already ordinary income, and it only applies to amounts that are royalties in common parlance. It is not clear what payments, if any, will nowadays fall within s 15-20. The term “royalties” has a broad range of meanings, not all of which carry over to its usage in the tax law. In general speech it is used to describe a range of gains that, apart from bearing a common label, have little resemblance to each other in a legal or economic sense. The royalties with which most laypersons are familiar are royalties paid for the use of intellectual property such as patents, copyrights or registered designs. Royalties for the use of intellectual property are commonly paid on a per-unit basis – a set amount for every book, tape or CD sold, so much for every watch produced with a particular brand name, so much for every product made using a protected process, and so on. With changing commercial practice, royalty entitlements have been extended to intellectual knowledge that falls short of “property” but nevertheless may receive legal protection under the law relating to confidential information. Examples of such knowledge include secret processes and “know-how”: compare Ruling TR 98/3 which has been extracted above. The term “royalties” may also be used to describe the periodic payments made for the assignment of intellectual property rights. The authors of this book, for example, will receive payments called royalties in the contract based on its sales, even though they have retained no legal interest in the copyright. That has been transferred lock, stock and barrel to the publisher in return for periodic payments calculated on a “per book sold” basis. “Royalties” has another quite different usage to describe the payments made to a real property owner for the exploitation of natural resources such as minerals or timber located on the property owner’s land. These payments are usually calculated on a “per unit of measurement” basis – so much per tonne of gravel, per linear metre of timber, and so forth. The distinction between a payment for use and a payment for assignment is very tenuous in the case of intellectual property, which may be broken up by time and geography, and in the case of land where part of the land is being removed (which may in turn be renewable like timber or non-renewable like minerals). Further, it is quite common in both these areas for transactions to contain both lump sum and periodic per-use payments. This is particularly common where the purchaser has some doubts about the value of property and the vendor some confidence about its value. For example, the vendor of mining rights might “sell” the rights for $1 m plus $10 per tonne of mineral extracted. Similarly, the Parisian owner of a clothing design might “license” all Australian rights to her “designer label” to an Australian manufacturer for a lump sum and a payment per item of clothing produced. Even where property is transferred outright, as was the case with the copyright to this book, subsequent payments will be considered ordinary income provided they are based on use or exploitation of the property. On the other hand, if payments are for the transfer of the property, without reference to subsequent use or exploitation, they will be capital amounts even if paid on a periodic basis (as in an instalment sale situation). The correct characterisation of payments remains important – though much less so than previously – even following the enactment of CGT for a number of reasons. Leaving aside the obvious case of a “sale” of a pre-20 September 1985 asset, the most important consequence of characterisation is timing. If future payments are assessable as ordinary income or under s 15-20, they are in effect excluded from the calculation of an assessable capital gain from the sale by s 118-20 and enter assessable income only as received. As s 15-20 has only a residual operation, if any, we consider the case law on it very briefly. [3.570]

133

The Tax Base – Income and Exemptions

(i) Payments for natural resources [3.580] The gains realised by a land owner for the sale of resources found under, or on, or

growing on her or his land may be assessable as income from business – a mining, quarrying or farming business, as the case may be. If the land owner instead allows another person to extract a resource from the property, payment for the resource may be a capital or income payment, depending on how the land owner structures the transaction. Prima facie, a sale of resources on a per-unit basis will generate ordinary income (and royalties within s 15-20 apart from the exclusion of ordinary income from that provision), while the sale of a “right to remove” minerals or timber for a lump sum calculated without direct reference to the amount of resources extracted will be a capital receipt, consideration for the sale of a property interest and not within s 15-20. These propositions flow from two cases concerning removal of timber from land. In McCauley v FCT (1944) 69 CLR 235; 3 AITR 67, the taxpayer was a dairy farmer who had trees growing on his land. He made a written agreement with one Thomas Laver, in which he was described as the vendor and Laver as the purchaser. The vendor agreed to sell and the purchaser agreed to purchase the right to cut and remove the standing milling timber then growing on specified land “at or for a price or royalty of three shillings (3s) for each and every one hundred (100) superficial feet of such milling timber so cut”. The purchaser agreed to cut and remove all the milling timber from the property within a period of 12 months and to pay the price or royalty under the contract monthly. The agreement contained provisions for monthly statements of timber removed and for what may be described as a minimum of interference with the use of the property, as a grazing property. The High Court held that the payments received were assessable under s 15-20. In the next case, Stanton v FCT (1955) 92 CLR 630; 6 AITR 216, the taxpayer went out of his way to draft the agreement for the taking of timber so as to avoid the result in McCauley’s case. The taxpayer, who was a grazier, was entitled as tenant in common with another grazier to a piece of land upon which stood a quantity of pine timber and of hardwood timber. On 12 September 1951 they entered into an agreement with a sawmiller in which they sold 500,000 super feet of millable pine timber and 2,500,000 super feet of millable hardwood timber with the right to cut and remove the timber from the land. If trees were less in girth than certain measurements they were excluded. The price was £17,500, of which £7,500 was apportioned to the pine timber and £10,000 to the hardwood timber. Of the price, £500 was to be paid as a deposit and £17,000 by equal quarterly payments of £1,416 13s 4d without interest. For s 15-20 to apply the Court considered that, “it is inherent in the conception expressed by the word royalty that the payments should be made in respect of the particular exercise of the right to take the substance and therefore should be calculated either in respect of the quantity or value taken or the occasions upon which the right is exercised”. This element was lacking in the agreement in this case, unlike McCauley’s case, and the payment was therefore outside s 15-20. Ordinary income did not receive specific consideration in the judgments in either case. It was apparently assumed that the two questions (ordinary income and royalty) were identical. A number of cases from other common law jurisdictions quoted in the judgments concerned income tax statutes where this identity is clear and perhaps this is why the High Court did not deal separately with the two issues. 134

[3.580]

Income from Property

[3.585]

CHAPTER 3

Questions

3.85

Can you see any convincing distinction between McCauley and Stanton? In Stanton, although not explicitly mentioned in the judgment, the payments were to be made over a three-year period, and the timber was to be removed over the same period in a steady progression. Is this relevant to any distinction between the cases?

3.86

A taxpayer who owns land, but not the minerals on the land (a common position in Australia where minerals are reserved to the Crown), grants a miner the right to cross his land to remove minerals to which the miner is entitled under mining legislation. The agreement provides for a payment per tonne of minerals removed and expresses the payment to be for damage to the land from the transport of the minerals and for putting the land back into its original condition. Are the payments pursuant to the agreement taxable under s 15-20 or otherwise? (See Barrett v FCT (1968) 118 CLR 666.) A taxpayer who owns a company, the business of which is the sale of timber sleepers to the railways, purchases a farm for a hobby and then enters into a series of Stanton agreements for the sale of timber on the land to the company. Are the payments under the agreements taxable under s 15-20 or otherwise? (See White v FCT (1969) 120 CLR 191.) How do the results in the cases accord with the concept of income as gain? Can any distinction be drawn between the taxation of timber and minerals because the former is a renewable resource whereas the latter is not? How would the CGT apply to the agreements in McCauley’s and Stanton’s cases? Would it make any difference if the land on which the trees were growing was acquired before 20 September 1985, and in that event if the relevant trees were planted after 1985? Do these cases reflect an income concept based on gains or flows? What do you think is the most appropriate way to tax these kinds of transactions?

3.87

3.88

3.89

3.90

(ii) Intellectual property and know-how [3.590] Unlike tangible property, which has a physical basis, intellectual property and

know-how exist only as intangible legal rights and information. The inherent value of intellectual property and know-how is minimal; its value derives from exclusivity: a patent is of value only because it entitles the holder to produce something that no one else is legally able to produce without the permission of the owner of the patent. Similarly, know-how can be marketed only so long as the knowledge is not freely available elsewhere. The importance of exclusivity to the value of intellectual property and know-how add an important dimension to the problem of characterising payments received in respect of these rights and information. Payments may be made not only for the transfer of property or right to use property or information, but also for the vendor’s or owner’s agreement to refrain from continuing to use the rights or communicating the information to others. Depending on exactly what the taxpayer has provided for the payment received, the consideration may be characterised as a royalty payment, as an income amount but not a royalty, or as an assessable capital gain. The difficulties inherent in the process of distinguishing the purpose of payments and their consequent income or capital characterisation is well illustrated in the judgment of Lord Denning MR in Murray v Imperial Chemical Industries Ltd [1967] Ch 1038. [3.590]

135

The Tax Base – Income and Exemptions

Murray v Imperial Chemical Industries Ltd [3.600] Murray v Imperial Chemical Industries Ltd [1967] Ch 1038 In the 1950s, the taxpayer company, Imperial Chemical Industries Ltd were exploiting a new fibrous material which they called Terylene. They manufactured it on a large scale at Wilton, but they could not make enough to meet the world demand. So they granted exclusive licences to foreign companies in various countries. In each licence they covenanted that they would not themselves enter the market for that country. They covenanted to “keep out” of that country. In return for these “keep out” covenants, they received considerable sums of money from the overseas companies. The question is whether these sums are part of the profits of the taxpayer company which should be brought into tax. The amount of tax involved is over £1 million … The master patents for Terylene were owned by the Calico Printers’ Association (CPA), who granted the taxpayer company an exclusive licence to exploit them and to grant sub-licences to others. The ancillary patents were owned by the taxpayer company themselves but they were unable themselves to exploit the world market for Terylene. So they granted sub-licences … A typical sub-licence was that granted by the taxpayer company to a Dutch company covering the Netherlands and Belgium. (i) The taxpayer company granted to the company an exclusive licence to use the major patents (owned by CPA) in return for a royalty based on the net invoice value of the Terylene products sold or utilised. (ii) The taxpayer company granted an exclusive licence to use the ancillary patents (which they owned) in return for a royalty of £10,000 a year for ten years. (iii) The taxpayer company agreed to provide “know-how”. No separate consideration was stated for “know-how”, because they expected to get their return by way of the royalties coming in sooner. (iv) The taxpayer company agreed to “keep-out” of the Netherlands, Belgium, and, in addition, Luxembourg, and not to operate there in the patented article Terylene or in products similar to Terylene for the period of the patent and a little longer. In return for this “keep-out” covenant, the licensee agreed to pay the sum, described as 136

[3.600]

a capital sum, of £400,000 payable by six equal annual instalments, but the licensee had the option of discharging the annual instalments by one payment … The question for decision is as to the £400,000 payable for the “keep-out” covenant by annual instalments. Was it a trading receipt and taxable as part of the income of the taxpayer company or was it a capital receipt which is not taxable? In considering this question, I would point out that this “keep-out” covenant is not a covenant “in gross”. It does not stand by itself. It is ancillary to the grant of a licence. Its effect can best be understood by remembering the different kinds of licence with which we are familiar. An ordinary “licence” is a permission to the licensee to do something which would otherwise be unlawful. It leaves the licensor at liberty to do it himself and to grant licences to other persons also. A “sole licence” is a permission to the licensee to do it, and no one else, save that it leaves the licensor himself at liberty to do it. An “exclusive licence” is a permission which is exclusive to the licensee, so that even the licensor himself is excluded as well as anyone else. A “keep-out” covenant is a covenant which bolsters up an exclusive licence. It makes express that which would otherwise be implied. The licensor covenants expressly with the licensee that he will not enter on the domain which he has granted to the licensee. In the present case the “keep-out” covenants are somewhat wider than the exclusive licence in area, time and products; but this makes no difference to the tax position. The receipts by the taxpayer company bear the same character – capital or income – no matter whether the “keepout” covenant is co-extensive with the licence or somewhat wider than it. In these circumstances I do not think that it would be correct to consider a “keep-out” covenant as a thing by itself. The essence of the transaction in each case is that the taxpayer company granted to the foreign company an exclusive licence to use the patents in the country concerned for the term of the patents and in return received remuneration in the shape of: (a) a royalty

Income from Property

Murray v Imperial Chemical Industries Ltd cont. payable on the net invoice value of products sold or utilised. (This was for use of the master patents of CPA.) (b) A royalty of a fixed sum payable each year. (This was for use of the ancillary patents of the taxpayer company.) (c) A lump sum payable by instalments over six years. (This was said to be for the “keep-out” covenant.) Now the taxpayer company is not a dealer in patent rights or patent licences. When they granted this exclusive licence, they were to my mind disposing of a capital asset. If this had been an assignment of patent rights, there could be no doubt that the taxpayer company would be disposing of a capital asset. I see no difference in this regard between an assignment of patent rights and grant of an exclusive licence for the period of the patent. It is the disposal of a capital asset. But this does not determine the quality of the money received. A man may dispose of a capital asset outright for a lump sum, which is then a capital receipt. Or he may dispose of it in return for an annuity, in which case the annual payments are revenue receipts. Or he may dispose of it in part for one and in part for the other. Each case must depend on its own circumstances; but it seems to me fairly clear that if and in so far as a man disposes of patent rights out-right (viz., by an assignment of his patent, or by the grant of an exclusive licence) and receives in return royalties calculated by reference to the actual user, the royalties are clearly revenue receipts. If and in so far as he disposes of them for annual payments over the period, which can fairly be regarded as compensation for the user during the period,

then those also are revenue receipts (such as the royalties of £10,000 a year in the present case). If and in so far as he disposes of the patent rights outright for a lump sum, which is arrived at by reference to some anticipated quantum of user, it will normally be income in the hands of the recipient … If and in so far as he disposes of them outright for a lump sum which has no reference to anticipated user, it will normally be capital … It is different when a man does not dispose of his patent rights, but retains them and grants a nonexclusive licence. He does not then dispose of a capital asset. He retains the asset and he uses it to bring in money for him … Similarly a lump sum for “know-how” may be a revenue receipt. The capital asset remains with the owner. All he does is to put it to use. Applying these criteria, in the present case it is quite clear that the royalties for the master CPA patents and the royalties for the ancillary patents of the taxpayer company were revenue receipts. That is admitted. So far as the lump sum is concerned, I regard it as a capital receipt, even though it is payable by instalments. I am influenced by the facts: (i) that it is part payment for an exclusive licence, which is a capital asset; (ii) that it is payable in any event irrespective of whether there is any user under the licence. Even if the licensees were not to use the patents at all, this sum would still be payable; (iii) that it is agreed to be a capital sum payable by instalments and not as an annuity or a series of annual payments. In these circumstances I am quite satisfied that the lump sum was a capital receipt and the taxpayer company is not taxable upon it.

[3.605]

3.91

CHAPTER 3

Questions

How are the following payments with respect to patents and similar rights treated under ordinary income principles in the cases of disposal, and non-exclusive and exclusive licences: 1.

payment for each use of the patent;

2.

annual payments related to usage;

3. lump sum payments related to usage; and 4. lump sum payments not related to usage? (See also Rolls-Royce Ltd v Jeffrey, Kwikspan Purlin Systems Pty Ltd v FCT in Chapter 5.) [3.605]

137

The Tax Base – Income and Exemptions

3.92

3.93

Did Lord Denning draw any distinction between the tax treatment of intellectual property and know-how in Murray v Imperial Chemical Industries Ltd? Is it necessary that payments of the kinds in these cases be characterised as royalties for them to be taxable as ordinary income? What do you consider is the most appropriate way to tax transactions of these kinds?

[3.610] The operation of s 15-20 in the case of intellectual property has also been the subject

of two decisions. Because of international tax issues, the question of whether the payments were ordinary income did not arise. In each case, applying the words of the High Court in Stanton’s case in characterising royalties, it was held that the payments were not within s 15-20. In FCT v Sherritt Gordon Mines Ltd (1977) 137 CLR 612; 7 ATR 726; 77 ATC 4365 the taxpayer was a Canadian company which entered into an agreement with Western Mining Corporation Ltd under which it agreed to provide technical assistance and know-how (none of which had been patented) to Western in respect of the Sherritt system for treating nickel ores that Western was mining in Australia. In return, Western agreed to pay the taxpayer an amount calculated as a percentage of the sale value of the nickel treated by the process. Mason J in the majority said, “Here the substantial, if not the sole, consideration for the payments was not the grant of a right but for the provision of technical assistance and information which Western was entitled to use once it was supplied, without the grant of any additional right so to do”. In the second case, Aktiebolaget Volvo v FCT (1978) 8 ATR 747; 78 ATC 4316, the taxpayer was a Swedish car company which entered into an agreement with its Australian assembler and distributor, Volvo Australia Pty Ltd, not to sell its products to any other company in Australia; to use its best endeavours to prevent companies in other countries to which it sold its products from exporting those products to companies in Australia; and not to allow any other company in Australia to use the word “Volvo”. Under the agreement Volvo Australia was obliged to pay to the taxpayer an amount equal to 4% of its sales. Jenkinson J held that the payments were not a royalty within s 15-20 again on the basis that the payments were not in respect of the grant of a right of the relevant kind as described in Stanton’s case. It was made clear in both these cases that the term “royalties” in s 15-20, putting aside the legislative definition, does not mean the same thing as it may do in everyday speech. Amendments to the definition of “royalties” in s 6(1) of the ITAA 1936 ensure that the definition catches both types of payments (see paras (c) and (f)) but the definition is mainly relevant to international situations, not domestic cases. Domestically nowadays transactions in patents and copyrights are largely dealt with both on the income and deductions side through Div 40 of the ITAA 1997 which is discussed in Chapter 10, ordinary income under s 6-5 and deductions under s 8-1. The operation of CGT is normally excluded by s 118-24. [3.615]

3.94

138

Would the payments in these two cases be ordinary income?

[3.610]

Question

CHAPTER 4 Income from the Provision of Services [4.10]

1. INTRODUCTION........................................ ................................................. 142

[4.10]

(a) The General Principle ........................................................................................... 142

[4.20]

(b) Taxation and Work Effort ..................................................................................... 144

[4.30]

2. DETERMINING INCOME QUALITY – GIFTS AND OTHER BENEFITS.... ....... 146

[4.40] [4.60] [4.80] [4.110] [4.140] [4.170] [4.190]

Hayes v FCT ............................................................................................................... Scott v FCT ................................................................................................................ FCT v Dixon ............................................................................................................... FCT v Harris ............................................................................................................... Smith v FCT ............................................................................................................... FCT v Holmes ............................................................................................................. Payne v FCT ...............................................................................................................

[4.220]

3. FRINGE BENEFITS ....................................... ................................................ 165

[4.230] [4.240] [4.260] [4.280]

(a) Background to the FBT ........................................................................................ David Collins, Taxation of Fringe Benefits – An Economist’s Perspective ........................... (i) Reasons for the non-taxation of fringe benefits ..................................................... (ii) Possible solutions .................................................................................................

165 166 168 169

[4.320] [4.330] [4.340] [4.360] [4.380] [4.390] [4.400] [4.410] [4.430] [4.510] [4.530]

(b) Operation of the FBT ........................................................................................... (i) Concept of fringe benefits provided ..................................................................... Westpac Banking Corporation v FCT ............................................................................ Roads and Traffic Authority of NSW v FCT .................................................................... (ii) Provided to employees/associates by employer/associate/arranger ...................... (iii) In respect of employment ................................................................................... Ruling MT 2016 ......................................................................................................... Ruling MT 2019 ......................................................................................................... (iv) Taxable value of benefits ..................................................................................... (v) Otherwise deductible rule .................................................................................... (vi) Integrating FBT and the ITAA ..............................................................................

170 172 172 174 176 178 179 179 181 190 193

[4.540] [4.550] [4.570] [4.580] [4.590] [4.600] [4.610] [4.620] [4.630] [4.640]

(c) Problems of FBT ................................................................................................... 194 (i) Over- and under-inclusiveness of the FBT base ...................................................... 195 (ii) Taxable value ....................................................................................................... 196 (iii) Tax rate ............................................................................................................... 196 (iv) FBT-inclusive tax base ......................................................................................... 197 (v) GST-inclusive tax base .......................................................................................... 198 (vi) Tax-exempt employers ........................................................................................ 199 (vii) Interaction with surcharges – reportable fringe benefits ..................................... 200 (viii) Problems of FBT for international placements .................................................... 200 (ix) Unallocable benefits ............................................................................................ 201

[4.650]

4. SPECIAL CATEGORIES OF EMPLOYEE REMUNERATION ............ ................. 203

[4.660]

(a) Employee Share Schemes .................................................................................... 203

147 150 153 154 155 159 161

139

The Tax Base – Income and Exemptions

[4.680] [4.690]

(b) Deemed Dividends – s 109 .................................................................................. 208 Ferris v FCT ................................................................................................................ 209

[4.710]

5. PAYMENTS FOR RESTRICTIVE COVENANTS AND VARYING SERVICE CONTRACTS ............................................ ...................................................... 211

[4.720] [4.730]

(a) Income from Services or the Sale of an Asset ........................................................ 211 Brent v FCT ................................................................................................................ 212

[4.740] [4.750] [4.770] [4.790] [4.810]

(b) Payments for Varying Contract Rights .................................................................. Scott v Commissioner of Taxation (NSW) ..................................................................... Commissioner of Taxes (Vic) v Phillips .......................................................................... Reuter v FCT .............................................................................................................. Bennett v FCT ............................................................................................................

[4.820] [4.830] [4.850]

(c) Payments for Restrictive Covenants ...................................................................... 219 Higgs v Olivier ............................................................................................................ 219 FCT v Woite ............................................................................................................... 220

[4.870]

6. TERMINATION PAYMENTS AND RETIREMENT INCOME............ ................. 223

[4.880]

(a) Retirement Incomes Policy ................................................................................... 223

[4.900] [4.910] [4.970] [4.1000] [4.1010] [4.1020]

(b) Superannuation ................................................................................................... (i) Contributions to a superannuation fund ............................................................... (ii) Tax position of the fund ....................................................................................... (iii) Regulation of superannuation funds .................................................................... (iv) Moving amounts between funds ........................................................................ (v) Taxing payments out of superannuation funds .....................................................

[4.1070] [4.1080] [4.1130] [4.1140]

(c) Other Termination and Retirement Payments – Golden Handshakes etc ............... 240 (i) Employment termination payments ...................................................................... 240 (ii) Assessment of employment termination payments ............................................... 244 (iii) Death benefit termination payments ................................................................... 245

[4.1150] [4.1160] [4.1170] [4.1180] [4.1190]

(d) ................................................................................................................................. Early Retirement, Redundancy and Invalidity Payments, and Unused Leave (i) Early retirement schemes ...................................................................................... (ii) Redundancy ........................................................................................................ (iii) Invalidity payments ............................................................................................. (iv) Unused leave payments ......................................................................................

213 214 215 216 218

225 226 233 235 237 237

246 246 246 247 247

[4.1200] 7. SALARY PACKAGING AND INCOME SPLITTING.................. ....................... 247 [4.1210]

(a) Salary Packaging .................................................................................................. 247

[4.1220]

(b) Alienation of Personal Services Income ................................................................ 251

Principal Sections ITAA 1936 s 6(1)

ITAA 1997 –

s 23L



140

Effect This section contains various definitions for the Act including a definition of “income from personal exertion”. This definition does not appear in ITAA 1997. This section attempts to integrate the FBT and income tax by deeming fringe benefits to be exempt income.

Income from the Provision of Services

s 25(1)

CHAPTER 4

s 6-5

This section includes a taxpayer’s gross income in her or his assessable income. ss 26(d), 27C Divs 82, 301 These rules include termination payments in the assessable income of employees if the payment is made by the employer or a superannuation fund. s 26(e) s 15-2 This section includes in assessable income the value to the taxpayer of certain benefits provided in respect of the taxpayer’s services. ss 26AC, 26AD Divs 83-B, 83-C These provisions deal with accrued long service and annual leave payments paid in a lump sum. ss 27E, 27F, 27G Div 83-C This Division deals with early retirement scheme payments, bona fide redundancy payments or invalidity payments. s 109 – This section deems excessive payments for services and retirement allowances paid to associates of a private company to be dividends. Div 13A Div 83A This Division taxes employees on the value of shares provided under an employee share acquisition scheme. Divs 84 – 87 – These Divisions enact rules trying to eliminate the tax advantages associated with being self-employed, rather than being an employee. s 290-60 – This section allows an employer to deduct (without limit) contributions to superannuation funds made for the benefit of employees. s 290-150 – This section allows self-employed taxpayers to deduct (without limit) contributions to superannuation funds made for their own benefit. Div 290-D – This Division provides a tax offset to a taxpayer who makes a contribution to a superannuation fund for the benefit the person’s spouse. Pt IX Div 295 This Division defines the amount of taxable income of a superannuation fund. Div 301 – This Division imposes tax on benefits paid by a superannuation fund to a (living) member, aged under 60. Div 302 – This Division imposes tax on benefits paid by a superannuation fund to the estate or dependents of a deceased member. Fringe Benefits Tax Assessment Act 1986 ss 9, 10 These sections provide the taxable value of a car benefit. s 18 This section provides the taxable value of a loan benefit. s 19 This section provides the “otherwise deductible” rule for loan benefits. s 20 This section defines an expense payment benefit. s 40 This section defines a property benefit. 141

The Tax Base – Income and Exemptions

s 42 s 44 s 45 ss 48, 49 s 66

s 136(1)

s 148(1)

s 148(3)

This section provides the taxable value of a property benefit. This section provides the “otherwise deductible” rule for property benefits. This section defines a residual benefit. These sections provide the taxable value of residual benefits. This section imposes FBT on the sum of all fringe benefits paid by an employer in respect of employees. This section contains the definitions necessary for FBT including the definitions of “fringe benefit”, “employer” and “employee”, and “in respect of employment”. This section broadens the definition of “in respect of” the employment of the employee given in s 136(1). This section deems a benefit to be provided where the employer does not enforce a prohibition preventing employees enjoying the benefit.

1. INTRODUCTION (a) The General Principle [4.10] In this chapter we examine the principle that an amount which is a reward for

providing services has an income character. Care needs to be taken when reading any of the extracted cases because most of the leading cases on this topic were decided according to the law pre-1985, and so without regard to the effects of CGT, FBT, etc. The cases should be approached through the sort of analysis we have already tried to outline in Chapter 2: • Is the payment in question included in assessable income because it is within the judicial concept of income? In this area, that is s 6-5 of the ITAA 1997. • Whether or not it would be within the judicial concept, is the payment included in assessable income by virtue of some specific statutory regime (for example, the payment would give rise to a capital gain)? • Does it create a fringe benefit taxable to the employer? • If the payment is included in assessable income by more than one regime, or gives rise to both assessable income and a fringe benefit, how are the tax overlaps reconciled? Nevertheless, the analysis – particularly of taxing income from services, even after 1985 – should still commence with an examination of whether the amount is income according to ordinary concepts (for which the cases are the only source). To look only at specific sections of the Act (as the High Court did in Smith v FCT (1987) 164 CLR 513) is apt to lead to the error of ignoring the lacunae, overlaps and inconsistencies of treatment with which the Act abounds. Unfortunately this method of analysis means that you will have to know something about

142

[4.10]

Income from the Provision of Services

CHAPTER 4

almost every part of the income tax before you can begin to study any part of it. So it may be worthwhile to take a moment now to revise the material in Chapter 2 before proceeding further. The principle that a reward for providing services has an income nature, has a broad application. A payment can be income as a reward for providing services regardless of the form of the receipt, the time of remuneration or the character of the services performed. So, assessable receipts can include: an employee’s wages or the managing director’s salary; contemporaneous weekly payments, a deferred lump sum, or even anticipated payments; payments for the provision of an isolated service or for regular ongoing employment; payments which are contractually required or an unexpected bonus; payments directly from the employer or from third parties such as tips. Notice that the principle refers to a payment for providing services, and this term could refer just as easily to the activities of an independent contractor as it obviously does to those of an employee. For independent contractors, it applies to their fees, commissions, bonuses and so on. Although the principle that a reward for the performance of services is income is simple to state, it is often difficult to apply. Where difficult questions of interpretation arise, the Act, as is common with fundamental issues, gives little assistance except at the periphery. Section 6(1) of the ITAA 1936 contains a definition of “income from personal exertion” but it derives from the days when different rates of tax applied to income from personal exertion and income from property, and adds nothing to our definition of income from services except perhaps a few examples. There is a comment to this effect in Scott v FCT (1966) 117 CLR 514. The definition was not rewritten for the ITAA 1997 because the “distinction between income from personal exertion and income from property … no longer has any practical effect” according to the Explanatory Memorandum to the Tax Law Improvement Act 1996. It is interesting, therefore, that it was not for that very reason removed from the Act by the Tax Laws Amendment (Repeal of Inoperative Provisions) Act 2006. In addition to the general inclusion provision in s 6-5 of the ITAA 1997, s 15-2 of the ITAA 1997 (the rewritten version of s 26(e) of the ITAA 1936 which is mentioned often in the extracts below) contains quite a comprehensive statement that the taxpayer’s assessable income will include “the value … of all allowances, gratuities, compensation, benefits, bonuses and premiums provided to you in respect of, or for or in relation directly or indirectly to, any employment of or services rendered by you”. It includes amounts in income whether received “in money or in any other form”. Section 15-2 is obviously quite broad, but there is a question whether it does more than state the ordinary concepts notion of income. There are suggestions in many of the early cases that its predecessor, s 26(e) of the ITAA 1936, was probably otiose (Hayes v FCT (1956) 96 CLR 47). Section 15-2(3)(d) makes it clear that the section operates only as a fallback after s 6-5 of the ITAA 1997 has been exhausted, so there will not be overlap between s 6-5 and s 15-2, but whether s 6-5 leaves any room for s 15-2 to operate is an important issue discussed later. Notice, however, that s 15-2 contains its own valuation rule – it includes in income “the value to you of …” certain benefits. This is a different formulation from the ordinary income rule which would include in income the amount into which a benefit is convertible. Hence s 15-2 may have some room for operation if it generates a different value. This chapter will examine the major issues that arise in the taxation of income from services in the following order. [4.10]

143

The Tax Base – Income and Exemptions

1.

2. 3.

First we will explore how the courts have formulated a test to state the requisite connection between the services and the payment such that the payment should be called a product of those services. The issue is essentially one of finding a sufficient connection between the taxpayer’s services and the payment in question, and it arises most often in connection with gifts and other windfalls. We will then break from the examination to explore the effect upon the ordinary usage notion and the income tax generally of the FBT introduced from 1986. Later we will look at some of the specific regimes in the ITAA to tax special types of employee remuneration: Div 83A and s 109.

4.

We will also explore the boundaries of the concept of income from services, looking for example at payments which capitalise existing employment contract rights or which are the price for employees accepting restrictions on their ability to work.

5.

The taxation of retirement income and, in particular, the taxation of superannuation funds and payments from them to fund members will be examined. Finally, we will explain the important practice of salary packaging seen in the modern workplace.

6.

(b) Taxation and Work Effort [4.20] It is one of the ironies of studying taxation to realise that Western societies decided

almost without exception to impose taxes upon the very things that the societies claim to value highly: working hard and saving for the future. The reasons that led them to this view will not be explored here. Rather, we will examine very briefly some of the potential consequences for modern societies of policies which collect large proportions of the government’s revenue by taxes on wages: the product of work. It should be borne in mind, however, that the effect of the tax on wages on the working patterns of individuals is an extremely complicated issue and we will necessarily be simplifying the issue greatly. Impose a tax on something and the government must expect various things to happen in response. For example, some individuals will stop doing whatever is taxed if there is an untaxed alternative, some individuals will continue what they were doing but try to find a lawful way around the tax, some will cheat, while others will just battle on and suffer the tax cost. In this context, generations of economists have grappled with the question: which of these consequences follow from the tax on wages? Ignoring for the moment the cheating solution, in general terms, it is argued that two different effects can be expected from taxing the returns from working. The first and deleterious consequence is a substitution effect: some individuals will decide that it is not worthwhile working longer or harder and will substitute (untaxed) leisure for (taxed) labour. They might decide not to work overtime, or not to apply for a promotion or to take early retirement. Alternatively, some individuals will decide that it is necessary to work even harder in order to regain the level of income and lifestyle that they enjoyed before the imposition (or increase in the rate) of the tax on the product of their work. Much recent tax debate and tax reform has centred on the first proposition – the reduction in tax rates that occurred throughout the Western world in the late 1980s was justified in part by arguments that high rates of income tax on wages discouraged people from working. You will have noticed that these two effects work in opposite directions and there is no reason to suppose a priori that one effect is stronger. Hence, economists spend a large amount of time and effort in empirical research trying to estimate the size of these effects. This research 144

[4.20]

Income from the Provision of Services

CHAPTER 4

is made even more complicated because other social and cultural factors influence the work decision. For example, rigid working hours set in industrial agreements limit the ability of employees to vary their labour supply slightly – in many industries, working is still largely an “all or nothing” decision. Because for many people hours of work cannot readily be changed, the pattern which seems to emerge is that for the primary income earner in a household, the level of taxation has little effect on work effort. In contrast, the effect of taxes on the working patterns of the secondary income earner in the household is estimated to be much larger. In more concrete terms, the effect of the tax on work may have a differential impact, discouraging women in particular from entering or remaining in the paid workforce. Further, some effect of the tax on work might be seen in decisions such as taking early retirement, working less overtime, working less strenuously, emigrating to work overseas or moving into employment where the taxed pecuniary reward is not such an important motivation (for example, moving out of the more highly paid production line and into the more congenial but less well-paid cleaning staff). It is important to remember that the substitution effect of a tax is a function of the marginal tax rate of the employee – the tax rate that would be payable on the next dollar of income. At first glance this might be understood to mean that the disincentive to work becomes more pronounced as income (and marginal tax rates) increase – that is, that the tax on working is most discouraging to those who already earn a great deal. But it is unfortunately the case that our entire tax and transfer system – that is, including the social security system – also has high marginal tax rates at the bottom of the income range. (How the high rates on low-income earners come about is described in Chapter 6.) This means that there may also be a pronounced substitution effect for low-income earners, discouraging them from entering the paid workforce and contributing to their continued poverty. Attributing a decision not to pursue paid work to laziness simply ignores financial disincentives. For this reason also, much of the debate about flattening the tax rate scale stems from the fact that substitution effects increase with increases in marginal rates and this is what a progressive tax scale promises. But reducing high marginal rates due to the progressive income tax rates at high-income levels does not solve the problem of high implicit rates for low-income earners. If we assume for the moment that the substitution effect of the tax on wages is strong, is there some way to solve the problem without abandoning vertical equity? Economists from the optimal tax school suggest that taxes should be designed to minimise the “excess burden” of a tax. That is, an important criterion in imposing a tax should be whether it imposes a cost on the economy over and above the amount of the tax which the government collects. In the case of the tax on wages, the excess burden is seen in the lower amount of work that individuals do (and the higher amount of leisure that they consume) than would be the case if the tax was not there. An excess burden benefits no one because it is a loss to the taxpayer which is not reflected in revenue to the government – the individuals would prefer to work more and take less leisure, but the effect of the tax both discourages them from doing what they would prefer, and means that the government receives less revenue in the process. One solution to the disincentive effect of the tax on wages is, some economists have suggested, to tax income earning potential rather than its product. Under such a system the measure of a taxpayer’s labour income (I) would be something like:

[4.20]

145

The Tax Base – Income and Exemptions

I = wh where: “w” represents the wage rate per hour

“h” represents the number of hours in the week Defining income in such a way would have the effect of eliminating any substitution effect – the employee pays tax on leisure as well as labour. Such a solution also has the important effect of making a vertical equity comparison more comprehensive. At the moment, the income tax only measures the observable product of labour rather than the less obvious endowment of the ability to work. Hence we treat as equal someone who works one day per week for $1,000 (and cruises the Whitsunday Islands for the other six) and someone who works six days per week plus overtime and also earns $1,000 per week. Some would argue that the person who relaxes six days of every week has a higher capacity to pay tax than the other and so should pay more tax but implementing such a system, is, of course, no easy matter.

2. DETERMINING INCOME QUALITY – GIFTS AND OTHER BENEFITS [4.30] This chapter examines one aspect of the ordinary usage notion of income – that an

amount which is a reward for performing a service is considered to be income. However not every payment received by an employee will be taxable as income. Indeed, not even every payment received by an employee from her or his employer will be taxable as income. Some payments are excluded from the tax base because it is said in the particular circumstances of the case that the amount is insufficiently connected to the employment for it to be called the product of the employment. The cases arise in two different situations: benefits provided to employees by their employers which are said to be a gift; and benefits received by employees from third parties which are tenuously connected to the employment. Gifts, prizes and other windfalls show a glaring shortcoming of our income tax base when compared with the comprehensive tax base ideal, as they present a situation where the taxpayer admits that there is gain but asserts that there is no assessable income for taxation purposes. The problem is essentially a clash between two conflicting principles: the principle that a mere gift is not income; and the principle that a reward for services is income. So these cases usually turn on questions of fact and degree, and are consequently never easily reconciled. The test of adequate connection is whether the receipt is a product of the employment but, as Parsons tellingly observes, “the notion of product may be illustrated; it cannot be defined” (R W Parsons, Income Taxation in Australia, Law Book Co, Sydney, 1985, para 2.135). Given this prospect, perhaps the best that can be hoped for is to know the tests that are applied in the cases and how they are formulated and reformulated in each case, to recognise which facts have significance and what their significance is, and to be able to muster the competing arguments from each side. In other words, one should not expect that answers will be predictable from some sort of mechanical application of a formula. In all of these cases care should be taken to identify what is sufficient to connect the payment to the income concept of a reward for services, and then how an income characterisation is imparted to a payment through that connection. It may help to understand the problem of defining whether there is an adequate connection to an income-producing category, if we represent it diagrammatically: 146

[4.30]

Income from the Provision of Services

CHAPTER 4

where: “A” represents a situation in which the employment is the sole and motivating cause of the payment “B” represents a situation in which the employment is an important cause of the payment although there are other less important causes “C” represents a situation in which the employment is one of many causes of the payment with no particular importance “D” represents a situation in which the payment is motivated by one or more causes, and the fact that the recipient is also an employee is almost fortuitous. The problem for the courts is twofold: to define and then accurately communicate to others the point to the left of which there is (and to the right of which there is not) a sufficient connection between the employment or services for the payment to be called a product of the employment or services, and then to locate the facts of the particular case to be decided in relation to that point. In this chapter we will look only at cases where the connection (if any) will be to services provided by the recipient, but it needs to be stressed that gifts and other windfalls can also be income because they are related to some other income-producing activity. An example arose in FCT v Cooke and Sherden (1980) 10 ATR 696 where the alleged gifts were considered by the Federal Court to be adequately connected to the taxpayers’ businesses for the gifts to be taxable (although they were not in fact taxed for other reasons). Another example of the same issue arose in FCT v Squatting Investment Co Ltd (1954) 88 CLR 413, which is often referred to in the extracts below, where an unexpected bonus distribution to the taxpayer from the proceeds of a wool transaction was held to be sufficiently connected to the taxpayer’s business to have an income character. Both cases are discussed in Chapter 5. We will begin by looking at the first group of cases – cases of benefits provided to employees by their employers or former employers. An example of a gift paid to an employee which was held not to have an income character arose in Hayes v FCT. Hayes was an accountant and had once been employed by Richardson as a general financial adviser. Richardson’s business expanded and was incorporated on Hayes’ advice, with Hayes subscribing for some shares. Richardson was apparently satisfied with what he had achieved and retired. The company soon began to flounder without his active participation and so he was prevailed upon to return. He agreed to do so only upon the condition that he had full control of the company and so all shares (including Hayes’) were sold to Richardson, subject to an understanding that they would probably be returned later. The company flourished under Richardson’s renewed control and a public company was formed to raise capital and expand the business. “In a spirit of generosity” Richardson made several large gifts, including parcels of shares in the public company, which he directed the company to allot to Hayes. The ATO included the par value of the shares in Hayes’ assessable income as deferred income from services (rendered either to Richardson or to the company) relying upon both ordinary concepts expressed in s 25(1) and upon s 26(e) of the ITAA 1936 (now s 6-5 and s 15-2 of the ITAA 1997 respectively). Fullagar J in the High Court held that the payment did not have an income character.

Hayes v FCT [4.40] Hayes v FCT (1956) 96 CLR 47 The Commissioner contended that the receipt was an income receipt because it fell within the

general conception of income, or alternatively that it fell within the terms of s. 26(e) of the Act [4.40]

147

The Tax Base – Income and Exemptions

Hayes v FCT cont. … I doubt very much whether s. 26(e) has the effect of bringing into charge any receipt which would not be brought into charge in any case either by virtue of the general conception of what constitutes income or by virtue of the definition of income from personal exertion in s. 6. The words “directly or indirectly” are doubtless intended to cast the net very wide, but it is clear that there must be a real relation between the receipt and an “employment” or “services” … If the receipt in the present case does not fall within the general conception of “income”, it is not, in my opinion, caught by s. 26(e) … A voluntary payment of money or transfer of property by A to B is prima facie not income in B’s hands. If nothing more appears than that A gave to B some money or a motor car or some shares, what B receives is capital and not income. But further facts may appear which show that, although the payment or transfer was a “gift” in the sense that it was made without legal obligation, it was nevertheless so related to an employment of B by A, or to services rendered by B to A, or to a business carried on by B, that it is, in substance and in reality, not a mere gift but the product of an income earning activity on the part of B, and therefore to be regarded as income from B’s personal exertion. A very simple case is the case where A employs B at a salary of £1,000 per annum, and at the end of a profitable year “gives” him a “bonus” of £100. Obviously the bonus is income. It is paid without obligation, but it is clearly in truth part of what B has earned during the year … A clear example on the other side of the line would be provided if the staff of a company were to collect voluntary subscriptions and make a presentation to a retiring manager … While I would not say that the motive of the donor in making the payment or transfer is, in cases of this type, irrelevant, motive as such will seldom, if ever, in my opinion, be a decisive consideration. In many cases, perhaps in most, a mixture of motives will be discernible. On the one hand, personal goodwill may play a dominant part in motivating a voluntary payment, and yet the payment may be so related to an employment or a business that it is income in the hands of the 148

[4.40]

recipient. On the other hand, the element of personal goodwill may be absent – the dominant “motive” may have been of the most purely selfish and “commercial” character – and yet it may be impossible to find any connection with anything that can make it income. The question in each particular case is as to the character of the receipt in the hands of the recipient … The test to be applied is an objective, not a subjective, test. This, I think is the whole point of a passage in the judgment of Kitto J in the Squatting Investment Co Ltd v FCT (1953) 86 CLR 570 at 633 case … [where] His Honour speaks of “gifts” as being “taxable” if they are “made in relation to some activity or occupation of the donee of an income producing character”. The point is illustrated by reference to expressions used in some of the English cases, and his Honour then contrasts “mere gifts” – “gifts” which are not related in any such activity or occupation and have no significant character except as expressions of a desire to benefit the donee … The view that what the appellant received in this case was income seems to rest on the view that the gift of the shares was motivated, at least to a substantial extent, by gratitude for services rendered, and advice and assistance given, by the donee to the donor in the past. But this is clearly not enough to make what he received income in his hands. It may be conceded that this motive of gratitude played a part in the donor’s decision to make the gift … But gratitude for services rendered was by no means the sole or exclusive motive. It is clear that the donor was moved very largely by a general feeling of goodwill arising from a close relationship which had both a business aspect and a personal aspect. It is clear also that he was moved to no small extent by the fact that Hayes had, some three years before, parted very much against his will with his shares in the proprietary company. He had told Hayes that he “would make it up to him”, and he was now “making it up to him”. So much for the donor’s motives. But as I have said, motive as such cannot be a decisive factor in cases of this kind. What is decisive in my opinion, is the fact that it is impossible to relate the receipt of the shares by Hayes to any income producing activity on his part. It is impossible to point to any employment or “personal exertion”, of which the

Income from the Provision of Services

Hayes v FCT cont. receipt of the shares was in any real sense an incident, or which can fairly be said to have produced that receipt. Hayes was only employed by Richardson from 1939 to 1944, and it seems absurd to say that the shares represented additional remuneration for work done in that employment. From 1944 to 1950 he was employed by the proprietary company, but it seems equally out of the question to say that the shares represented additional remuneration for work done for the company during that period. I accept of course, what was said by Dixon CJ and Williams J in Dixon’s case … I agree that, “if payments are really incidental to an employment, it is unimportant whether they come from the employer or from somebody else”. It is perfectly consistent with this to say that, in determining whether a payment is “really incidental to an employment”, the fact that it is not made by the employer but by some third party may be a very relevant consideration. Its relevance in the present case, however, need not be considered, for the position simply is that there is nothing whatever to suggest that the gift can properly be regarded as money earned by Hayes as director or secretary of the proprietary company. It was not paid to him in any such capacity. It was in no true sense a product or an incident of any employment in which Hayes had engaged or any business which he had carried on.

[4.45]

CHAPTER 4

The only other way, so far as I can see, in which the case can be put for the Commissioner is to say that the gift of the shares represented a reward or recompense for the general advice and guidance given informally on a number of occasions to Richardson personally, and proving of benefit in the long run to Richardson himself or to the company in which he had a controlling interest. I think that the gift was intended in part, though only in part, as such reward or recompense. But surely it is utterly unreal to say that, whenever Hayes expressed a particular opinion or recommended a particular course, he was engaging in an activity capable of producing income for him. Such an idea is foreign to the whole idea of what constitutes income from personal exertion. If Hayes had been employed to give such advice or guidance, or if he had carried on a business of giving such advice or guidance, the position might well have been different. But he was doing neither of those things. If A tells his friend B in a casual conversation that he thinks that the shares of the Z company will rise greatly in a short time, and B buys shares in the Z company and makes a large profit, it will be impossible to contend that a gift of £1,000 by a grateful B to his friend A is income earned by A. A has earned the money only in the loose sense that he has done something for which B is grateful. He has not earned it in the sense – the only relevant sense – that it is the product of a revenue-earning activity on his part.

Questions

4.1

Richardson gave some more shares to his sons. Would the value of these shares have been assessable as income to his sons? Richardson also gave some shares to Hayes and another employee to hold “on behalf of” the employees of the company. Would the value of those shares have been included in their assessable income? (Recall the discussion in Chapter 3.)

4.2

What test does Fullagar J suggest should be used to ascertain whether the connection between the payment and the employment is sufficient for the gift to have an income character?

4.3

How is the relationship between the general inclusion rule s 25(1) and s 26(e) explained? Is the relationship between s 6-5 and s 15-2 the same?

4.4

Could the gift of the shares now be taxed to Hayes as part of an employee share scheme under Div 83A? You may wish to come back to this question after reading further. [4.45]

149

The Tax Base – Income and Exemptions

4.5

4.6

How would Hayes be decided after FBT? (See the definition of fringe benefit in s 136(1) of the FBTAA 1986 and consider whether the shares were given “in respect of the employment of the employee”. See also the definition of “in respect of” also in s 136(1) and read s 148(1).) Would it make any difference to your answer to the previous question if you had concluded that the shares would be covered by Div 83A? (See para (ha) of the definition of fringe benefit in s 136(1) of the FBTAA 1986.)

[4.50] The same problem of gift payments arose in the later case of Scott v FCT. The taxpayer was a solicitor and received a gift of £10,000 from Mrs Freestone, the widow of a former client and friend of Scott. Mrs Freestone was herself currently a client of Scott in respect of the administration of her late husband’s estate. During the course of the administration of the estate, Scott assisted in developing and realising one of the assets of the estate (a block of land near Parramatta) at greatly enhanced values, and he also helped her create a monument to her late husband and his comrades in submarines in World War II. (It is the K13 monument on Pennant Hills Road, Carlingford, Sydney.) The circumstances of the gift are detailed in the extract from the judgment of Windeyer J in the High Court.

Scott v FCT [4.60] Scott v FCT (1966) 117 CLR 514 On 19 August 1960 … Mrs Freestone went with the taxpayer in his car on … [a] mission relating to her property outside Parramatta … As they were returning to Parramatta she told the taxpayer that she intended to distribute some of her money as gifts and that she proposed to give him £10,000. He was, he says, astounded by this. It was entirely unexpected. She confirmed this. He was “speechless” … The story is a remarkable one. But I am satisfied that, except in one or two matters as to which their recollection was faulty, the events occurred as Mrs Freestone and the taxpayer said they did … Mrs Freestone having told the taxpayer in the car that she wanted to give him £10,000 – having, she said, “thought about it well beforehand”, went on to tell him of other gifts she proposed to make … She produced her cheque book; and on her instructions the taxpayer wrote out four cheques … [including one drawn]: “LG Scott & Co, £10,000” … The taxpayer paid his into his private bank account at Epping. The taxpayer stated that he applied the whole of the sum of £10,000 given to him to his personal advantage. In answer to questions that I asked he said that there was not any understanding that he should disburse any of the 150

[4.50]

money in any way on Mrs Freestone’s behalf and that he did not do so. He said, and I accept his evidence, that the sum of £10,000 went in part in reduction of his overdraft with the bank and in part for various purposes of his own including the construction of a swimming pool. I am satisfied that Mrs Freestone expected the taxpayer to charge his ordinary professional costs for all work that he did for her. Whatever the extent of his services to his client had been, £10,000 must have greatly exceeded any charges that could properly be made for them. … The case for the Commissioner is that the £10,000 formed part of the taxpayer’s assessable income, either as within the general concept of income upon which the tax is levied, or because it was brought into charge by s. 26(e) of the Act. It was also argued that, independently of the rest of the Act, it could be regarded as brought into charge by the definition of income from personal exertion in s. 6. I am unable to follow the last proposition. It seemed to be based upon a misunderstanding of an observation by Dixon CJ and Williams J in FCT v Dixon (1952) 86 CLR 540 at 555. Their Honours there said that expressions used in the definition of income from personal exertion could, in an appropriate case, be used as an indication that a given receipt is income. The

Income from the Provision of Services

Scott v FCT cont. definition enumerates certain forms of income which, for the purpose of the Act, are income from personal exertion … The definition does not I think bring anything into charge as income. It refers to what is already by its nature income. By describing what income from personal exertion is, the definition is indirectly indicative of what income is. That is all: but otherwise it is irrelevant. I reject the contention that of its own force it makes the receipt of £10,000 income of the recipient. The answer to the question in this case depends therefore on a general conception of the nature of income, bearing in mind s. 26(e) … Counsel for the Commissioner pointed to the wide words “in respect of, or for or in relation directly or indirectly to, any employment of or services rendered by him” and said that they must be given their full meaning and effect. This of course is so. But what is their full meaning and effect? That is the question. It is no doubt an orthological question. But it is not to be answered by reading the words in the abstract with the aid of a dictionary. Their meaning and the limits of their denotation must be sought in the nature of the topic concerning which they are used. They are in an income tax statute. Dixon CJ and Williams J said [in Dixon’s case]: “We are not prepared to give s. 26(e) a construction which makes it unnecessary that the allowance, gratuity, compensation, benefit, bonus or premium shall in any sense be a recompense or consequence of the continued or contemporaneous existence of the relation of employer and employee or a reward for services rendered given either during the employment or at or in consequence of its termination.” … It was said that if a testator left by will a legacy to a servant in his employment whose wages had been fully paid, and by his will expressed the legacy as given because of long and faithful service, it would be within the words of s. 26(e) and thus be income of the legatee. I do not think that the words of s. 26(e) compel that conclusion. And I do not think that a legacy given by a grateful testator to, say, his physician would ordinarily be income in his hands. And the position would, it seems to me, be no different if the same gifts were made, not by will but by the

CHAPTER 4

donor in his lifetime. That is not because the words of s. 26(e) could not describe such gifts but because it stands in an Act the purpose of which is to impose a tax on income. To take another illustration: suppose members of a society made a gift to a man because he had rendered some special services to the society. In terms such a testimonial gift, whatever form it took, money or plate or a picture, although the product solely of the donors’ appreciation of the donee’s services would be within the words of s. 26(e). But would it therefore necessarily be income of the recipient liable to tax? I think not. And would a person who on restoring lost property to its owner was given a reward for his services be taxable on the basis that the reward was part of his income? Again I think not, but again the words of s. 26(e) would cover the case. As I read s. 26(e) its meaning and purpose is to ensure that certain receipts and advantages which are in truth rewards of a taxpayer’s employment or calling are recognised as part of his income. In other words the enactment makes it clear that the income of a taxpayer who is engaged in any employment or in the rendering of any services for remuneration includes the value to him of everything that he in fact gets, whether in money or in kind and however it be described, which is a product or incident of his employment or a reward for his services. If, instead of being paid fully in money, he is remunerated, in whole or in part, by allowances or advantages having a money value for him they must be taken into account. The enactment does not bring within the tax-gatherer’s net moneys or moneys’ worth that are not income according to general concepts. Rather it prevents receipts of moneys or moneys’ worth that are in reality part of a taxpayer’s income from escaping the net … I return to the general concept of income. Whether or not a particular receipt is income depends upon its quality in the hands of the recipient. It does not depend upon whether it was a payment or provision that the payer or provider was lawfully obliged to make. The ordinary illustrations of this are gratuities regularly received as an incident of a particular employment. On the other hand, gifts of an exceptional kind, not such as are a common incident of a man’s calling or occupation, do not [4.60]

151

The Tax Base – Income and Exemptions

Scott v FCT cont. ordinarily form part of his income. Whether or not a gratuitous payment is income in the hands of the recipient is thus a question of mixed law and fact. The motives of the donor do not determine the answer. They are, however, a relevant circumstance … An unsolicited gift does not, in my opinion, become part of the income of the recipient merely because generosity was inspired by goodwill and the goodwill can be traced to gratitude engendered by some service rendered. It was said for the Commissioner that if a service was such as the recipient was ordinarily employed to give in the way of his calling, and the gift was a consequence, however indirect, of the donor’s gratitude and appreciation of that service, then it must necessarily be part of the donee’s income derived from the practice of his calling, and caught by s. 26(e). But as thus expressed, this proposition is, I think, a mistaken simplification. It was based upon the fact that in Hayes v FCT (1956) 96 CLR 47 at 56 Fullagar J regards as decisive that it was impossible to relate the receipt of the shares there given to any income-producing activity on the part of the recipient. In the present case the taxpayer was

[4.65]

engaged in an income-producing activity, his practice as a solicitor, to which it was said the gift could be related. But because the absence of a particular element was decisive in favour of the taxpayer in one case it does not follow that the presence of that element is decisive in favour of the Commissioner in another case. The relation between the gift and the taxpayer’s activities must be such that the receipt is in a relevant sense a product of them … To analyse motives and seek the ultimate causes of conduct can seldom yield any single or simple result. Mrs Freestone, I assume, would not have made her gift to the taxpayer if she had not appreciated his help to her and his friendship. If he had not acted for her as he did in relation to her husband’s estate, if he had not been a friend of her husband, it probably would not have occurred to her to make him a beneficiary in her distribution of part of the moneys that she got from the estate. He no doubt was aware of this. Nevertheless I do not think that her gift to him was in a relevant sense given or received as a remuneration or recompense for services rendered so as to form part of his assessable income.

Questions

4.7

What test does Windeyer J suggest should be used to ascertain whether the connection between the payment and the employment is sufficient to characterise the payment as having an income quality? Is it different from the test in Hayes v FCT?

4.8

How would Scott be decided after FBT? Would Scott be an employee and would the gift be “in respect of any employment” to satisfy the definition of fringe benefit in s 136(1) of the FBTAA 1986?

[4.70] You will already have noticed several references in the extracts to the decision of the

High Court in FCT v Dixon. The case contains many strands of reasoning, and as Bowen CJ later observed in FCT v Harris (1980) 10 ATR 869 at 873: “it is difficult to derive a simple ratio decidendi from the reasons for judgment.” Here we are primarily concerned with the question whether the payments made to the taxpayer were assessable as a product of services. The taxpayer in Dixon volunteered for service in World War II and his former employer made voluntary supplementary payments to him to make up the difference between the military pay and his former salary. The High Court held that the supplement was income but not because it was a product of services rendered. In their joint judgment, Dixon CJ and Williams J observed as follows. 152

[4.65]

Income from the Provision of Services

CHAPTER 4

FCT v Dixon [4.80] FCT v Dixon (1952) 86 CLR 540; 5 AITR 443 The Commissioner’s case has been supported on the ground that according to ordinary conceptions of what is income the derivation by the taxpayer of £104 from Macdonald, Hamilton & Co, as well as the derivation of his military pay, formed his income, and therefore became part of his assessable income … The Commissioner further relies, but this time as an independent ground only, on the provisions of para (e) of s. 26 … Before turning to the other grounds upon which the Commissioner rested his case, we shall state our reasons for declining to apply s. 26(e) to the supplementary payments provided by Macdonald, Hamilton & Co as allowances, etc given, etc in relation, directly or indirectly, to the taxpayer’s employment by that firm or services rendered by him to them. There can, of course, be no doubt that the sum of £104 represented an allowance, gratuity or benefit allowed or given to the taxpayer by Macdonald, Hamilton & Co. Our difficulty is in agreeing with the view that it was

allowed or given to him in respect of, or in relation, directly or indirectly, to any employment of or, services rendered by him. It is hardly necessary to say that the words “directly or indirectly” extend the operation of the words “in relation to”. In spite of their adverbial form they mean that a direct relation or an indirect relation to the employment or services shall suffice. A direct relation may be regarded as one where the employment is the proximate cause of the payment, and an indirect relation as one where the employment is a cause less proximate, or indeed, only one contributory cause … We are not prepared to give s. 26(e) a construction which makes it unnecessary that the allowance, gratuity, compensation, benefit, bonus or premium shall in any sense be a recompense or consequence of the continued or contemporaneous existence of the relation of employer and employee or a reward for services rendered given either during the employment or at or in consequence of its termination.

[4.90] All the judges held that the payments were assessable and also agreed that they were

not the product of his services, although they disagreed on the reasons for finding that the payments had an income nature. The other reasons are discussed in Chapter 6. [4.95]

4.9

4.10

Questions

How would Dixon be decided after FBT? Is he an employee? (See the definitions of “employee” and “former employee” in s 136(1) of the FBTAA 1986.) Is the payment “in respect of the employment” for the definition of “fringe benefit” in s 136(1)? Might the payment not be a fringe benefit because it is “salary or wages” for para (f) of the definition of “fringe benefit”? What test of connection is stated in the first three cases between the receipt and the provision of services to establish an income nature? What factors are taken into account?

[4.100] The judgments in Dixon’s case were carefully analysed in FCT v Harris. A retired

bank employee received an ex gratia payment of $450 from his former employer to supplement the superannuation payments which he already received in the form of a pension. The bank’s apparent concern was to boost the pensions of retired employees as the value of their pensions had been seriously eroded by inflation. The Full Federal Court held by a majority that the supplementary payment was not income despite the apparent similarity to Dixon. One interesting feature of the case is the attempt, at least by Deane J, to expound a methodology for solving these gift cases. [4.100]

153

The Tax Base – Income and Exemptions

FCT v Harris [4.110] FCT v Harris (1980) 10 ATR 869; 80 ATC 4238 In the present case, there are circumstances pointing in different directions and the decision whether the receipt was income according to ordinary concepts turns on questions of emphasis and degree. Bowen CJ and Fisher J have pointed to a number of factors which militate against regarding the receipt as such income and I am conscious of the force of the matters to which they have referred. Ultimately, however, I am persuaded by the combination of a number of considerations that the preferable conclusion is that the receipt constituted income according to ordinary concepts and was properly included by the Commissioner in the taxpayer’s assessable income of the tax year … The first is the relationship of the receipt and the taxpayer’s former employment … Notwithstanding the fact that the receipt could not properly be regarded as the product of that employment, the relationship between the receipt and the taxpayer’s former employment with the bank points, in my view, towards the receipt being income. The receipt could not properly be seen as being a mere gift or present made to the donee on personal grounds … It was

received by the taxpayer because he was one of a class of ex-employees of the bank whose wellbeing the bank was, for proper commercial reasons, concerned to protect. Secondly, the payment was related to an annual period and was part of one group of a series of annual groups of payments. Regularity and periodicity are factors of some importance in determining whether particular receipts possess the character of income in the hands of the recipient … Thirdly, the payment was made to supplement income because of the erosion of the value of such income as a result of inflation and was made by the entity which was entitled to direct an increase in that income and which would, in the event of resulting deficiency of pension funds, be liable to make up the deficiency. A payment of capital can, of course, be made to supplement an inadequate income. The fact that a payment, which is a periodic payment, is made to supplement income is however, in my view, a factor pointing to the receipt of the amount paid being a receipt of income …

[4.120] The result, although not the reasoning, of Harris has since been changed by statute

with the introduction of s 27H of the ITAA 1936. [4.125]

Questions

4.11

Identify the issues common to Dixon and Harris. What facts distinguish them – apart from the result?

4.12

What factors are taken into account in determining the income quality and how do they differ from those previously analysed?

4.13

Does the method of analysis, particularly of Deane J, differ from the analysis of previous cases and is it satisfactory?

4.14

Would it make any difference if the payments in Harris had been frequent and he had relied upon them to meet recurrent expenses? (See FCT v Blake (1984) 15 ATR 1006; 84 ATC 4661.)

4.15

How would the payment in Harris be taxed today? (See s 27H(1)(b) of the ITAA 1936.) Might the payment also give rise to a fringe benefit? (See para (k)(i) of the definition of “fringe benefit” in s 136(1) of the FBTAA 1986 and para (a)(ii) of the definition of

154

[4.110]

Income from the Provision of Services

4.16 4.17

CHAPTER 4

“eligible termination payment” in s 27A of the ITAA 1936.) What difference would it make to your conclusion if the payments had been made by the trustees of the superannuation fund? What if Harris had taken a lump sum and then received a supplementary payment? Try this quick revision. Answer and cite the relevant authority which discusses the following problems. (a) Can there be income from services where there is only an isolated service? (b) Does it matter that at the time of receiving the payment, the employment has come to an end?

[4.130] The position reached by the cases extracted so far seemed tolerably clear – at least as

clear as one can ever hope to be when dealing with cases that depend very much on their own facts. They also appeared to settle the issue of the relationship between ordinary usage under s 6-5 of the ITAA 1997 and the effect of s 26(e) of the ITAA 1936. Yet these issues nevertheless continue to engender debate and controversy as illustrated by the High Court decision in Smith v FCT. The issue in Smith was whether $570 paid by Westpac to Smith under its “Encouragement to Study Scheme” was assessable as income of the taxpayer. Under the scheme, the bank made payments to employees who successfully completed approved subjects and courses of study (approval being given to courses related to banking). The bank made it clear that the scheme was intended to assist in staff development and it encouraged employees to participate. What is surprising about the case is not simply that it reached the High Court (why did the Court grant leave to appeal on such a case post-FBT?), but more importantly, that judges in both lower courts and the High Court could have concluded that the payment was not assessable income and, in doing so, could have developed some of the reasoning to be found in the extract below. The authors of the Butterworths Weekly Tax Bulletin put the matter very succinctly: “Not the least interesting aspect of this case is that, in the course of three appeals, no less than nine eminent justices have considered the case and have held, by a bare majority of five justices to four, that the payments fell within s 26(e); this in a case the facts of which in the editors’ respectful opinion, would appear to admit of very little doubt” ([1987] Butterworth’s Weekly Tax Bulletin, para [639]). A majority of the Court (Toohey, Wilson and Brennan JJ) held the amount assessable. Justices Deane and Gaudron dissented.

Smith v FCT [4.140] Smith v FCT (1987) 164 CLR 513 Wilson J: The problem presented by the present case is whether the facts establish the requisite relationship between the benefit received by the appellant and his employment. It is not sufficient to find that the appellant received the benefit at a time when there was an employment relationship existing between himself and the Bank. The mere temporal connection would not enable the payment to be characterised as a benefit given to him in relation directly or indirectly to his employment. It is tempting to strive to identify criteria which will assist in the process of characterisation. But however helpful such criteria

may be, it is unwise to expect any paraphrase to provide a final or overriding test. Ultimately, it is the words of the statute that must prevail … On the facts of the present case, I conclude that the benefit received by the appellant was a product or incident or a consequence of his employment. The gift, if it be so described, in no sense carried the overtones of a personal gift from the donor to the donee personally. Nor is it sufficiently described merely as a gift from an employer to an employee. When all the circumstances are taken into account, the benefit [4.140]

155

The Tax Base – Income and Exemptions

Smith v FCT cont. is the product of a scheme embodied in the rules of the Bank, and administered within that organisation, designed to encourage not only the efficiency of employees within it but to provide them with the incentive to advance their prospects of promotion within the Bank. In my view, the requirement of a relationship between the benefit and the employment necessary to attract the provisions of s. 26(e) is satisfied. Brennan J: Liability to tax under s. 26(e) does not arise merely because the taxpayer is an employee of or has rendered services to the person from whom the allowance is received: for example, a father’s employment of a child does not necessarily make the value of a gift from the father to the child part of the child’s assessable income. It is necessary that there be some connection between the payment of an allowance to the taxpayer and either his employment or services he has rendered … It is not necessary that an allowance be paid as remuneration for the work which an employee is employed to perform; it is sufficient to attract s. 26(e) that the allowance be paid to an employee in consequence of his employment. When is an allowance paid in consequence of employment? … There is no doubt that voluntary payments may fall within s. 26(e) … If an allowance is paid under a contract between the payer and the taxpayer, the consideration for the payment is usually decisive of the matter “in respect of, or for or in relation … to” which the allowance is paid, but if the allowance is paid voluntarily, it is necessary to inquire “how and why it came about that the gift was made” … When an allowance is paid voluntarily by an employer to an employee, the ascertainment of any relationship between the payment and the employment raises some evidentiary problems. The motives of the employer might be thought to be the most direct evidence of how and why the employer made the gift, but an unexpressed motive, uncommunicated to the employee, can hardly be determinative of the character of the receipt in the hands of the employee … 156

[4.140]

If the motive of the employer is communicated to the employee or is known by him, the common understanding of the motive for the payment may be cogent evidence of “how and why it came about that the gift was made” … [T]he character of the allowance paid by the Bank to the appellant is not in doubt. Its character is established by the scheme promulgated by the Bank and acted on by the appellant. The allowance was paid because the Bank had a scheme for paying allowances to its employees and the appellant fulfilled the two requirements on which the payment of allowances under the scheme depended: the appellant was employed by the Bank and he completed a prescribed course. The question of law that arises on those facts is whether such a payment was made in consequence of the appellant’s employment … Of course, it will frequently be a difficult question of fact to decide whether a particular allowance which is paid voluntarily is paid for a reason which brings the allowance into or for a reason which carries it out of the tax net. But if the employment (or some aspect of the employment) is the reason or one of the reasons why the allowance is paid, the allowance falls within s. 26(e) … In this case, an allowance was payable only to those in the Bank’s employment, and the scheme provided for payment of the allowance to any employee who qualified by completing a prescribed course. Although no course of study was mandatory for any employee, the approved courses were calculated to improve the skills of the Bank’s employees. The scheme was an aspect of their employment. The allowance was not paid as a mere mark of an employer’s personal esteem for particular employees. I am quite unable to say that the allowance was paid for considerations extraneous to the employment. On the contrary, the allowance was paid because it was an incentive to an employee to improve his skills to his own advantage and to the anticipated advantage of the Bank. The relationship between the employment of the appellant and the payment of the allowance was substantial. In my opinion, the employment was a direct cause of the payment. It follows that the allowance was paid “in consequence of” the employment, and thus was paid “in respect of … or in relation …

Income from the Provision of Services

Smith v FCT cont. to” the employment. The relationship prescribed by s. 26(e) was established. Toohey J: Although not formally stated, there was an assumption underlying the argument of counsel for the respondent that if the sum of $570 was not assessable by reason of s. 26(e), it was not assessable under s. 25(1). The precise relationship between ss 25(1) and 26(e) was therefore not fully argued. As Gibbs J pointed out in Reseck v FCT (1975) 133 CLR 45 at 47; 5 ATR 538 at 539: “Speaking generally, s. 26 does not limit s. 25 but includes as assessable income some receipts that might not ordinarily have been regarded as income.” Whether receipts falling within s. 26(e) are within that description is a question that has not yet been determined. Gibbs J left the matter open in Reseck for that case was concerned with the operation of s. 26(d). In Hayes v FCT (1956) 96 CLR 47 at 54; 6 AITR 248 at 253 [11 ATD 68] Fullagar J said: “I doubt very much whether s. 26(e) has the effect of bringing into charge any receipt which would not be brought into charge in any case either by virtue of the general conception on what constitutes income or by virtue of the definition of income from personal exertion in s. 6.” Because of the way in which this

CHAPTER 4

appeal has been argued, it is unnecessary to try to resolve the doubt raised by Fullagar J. The matter must remain open though, having regard to the breadth of language used in s. 26(e), there are strong arguments for the conclusion that receipts that might not ordinarily be regarded as income are included … The amount received by the present appellant was an amount allowed, given or granted to him in respect of his employment. It was paid by the bank in accordance with a policy designed to encourage its employees to increase their knowledge in subjects relevant to the banking industry and therefore to increase their proficiency as employees. It is not to the point that the courses might stand employees in good stead if they later changed their employment. The sum paid to the appellant was one of many such sums paid by the bank to its employees under its “Encouragement to Study” scheme. There was an evident connection between the appellant’s employment and the sum he received. And in a very real sense the payment was a consequence of the existing relation of employer and employee. It was only as an employee that the appellant qualified for the benefits payable under the scheme … [T]here is no element of gift or personal bounty or of considerations extraneous to the appellant’s employment.

The minority opinion was delivered by Gaudron J, dissenting, with whom Deane J agreed. The subject payment of $570 to the taxpayer was neither recompense for the relationship of employer and employee nor reward for services rendered. It was recompense or reward for completing an approved course of study which, although approved by the Bank, was required neither as a condition of the relation of employer and employee, nor as a qualification necessary for the rendering of services in that relationship. The consequential relationship between payment of the benefit and the relation of employer and employee is not constituted simply by a definitional requirement of a continuing employer and employee relation as a condition of eligibility to receive payment, for the paragraph is

concerned with the allowing, giving or granting of the relevant benefit, and not with eligibility to receive the benefit. In the present case the Commissioner of Taxation relies on a number of matters, additional to the eligibility requirement, to establish that the amount paid was paid in consequence of the employment relationship. Those matters are the highly organised nature of the bank’s “Encouragement to Study” policy, the large number of employees who have participated therein, the publication of the policy within the bank’s staff rules, the bank’s requirement that the courses undertaken have some relevance to banking, the advantages to the bank of having suitably qualified staff, and the bank’s practice of [4.140]

157

The Tax Base – Income and Exemptions

Smith v FCT cont. making payments pursuant to the policy in the same manner and at the same time as ordinary salary. It seems to me that, apart from the two matters relating to the nature of approved courses and the advantages to the bank of having suitably qualified staff, these are matters of administration, rather than matters indicative of a relationship between employment and the payment in question. On the other hand, the advantages to the bank of the policy and the bank’s requirement that courses have relevance to banking indicate that the bank’s motives in the establishment, maintenance and administration of the policy are employment related. But the motivation of the bank in establishing and maintaining the policy does not provide any relevant causal link between the employment of the taxpayer and the making of any particular payment. The proximate case of

that payment is the successful completion of a subject or a course of study. Less proximate causes of the payment include the employee’s undertaking the requisite course work, and enrolling in the course of study. Still less proximate is the existence of the bank’s policy under which payments are made. The fact that the policy exists because of the advantages to the bank in having suitably qualified employees does not serve, in my view, to make the payment a payment made in consequence of the relation of employer and employee, or in the words of the paragraph “in respect of, or for or in relation directly or indirectly to, [the] employment of” the taxpayer, for the paragraph looks not to a relationship between payment and employmentrelated benefits to an employer but to a relationship between a particular benefit allowed, given or granted to a taxpayer and his employment. I would allow the appeal …

[4.150] Consider these facts about Smith v FCT: the payment was made by an employer to an

employee during current employment; it was payable only to employees; no personal or other altruistic motive was raised; the activity of which the payment was the direct product was one which the employer had encouraged and sought; to put it more bluntly, this may not really have been a “gift” case at all, but rather one where the payment had become virtually a contractual obligation of the employer. In other words, the bank rewarded those of its employees who performed another service which the bank asked of them – upgrading their qualifications. Further, the possibility that these payments might be income according to ordinary concepts seems never seriously to have been considered by the Court, as all the discussion centres on s 26(e). These features are disturbing not because a majority of the High Court reached the wrong result, but because it took such angst and tortuous efforts to reach the right result and, in doing so, the Court both questioned matters which were not raised and ignored simple approaches which could have resolved the case. [4.155]

Questions

4.18

What does the majority in Smith identify as the requisite connection between the payment and the employment or services?

4.19

What is the relationship between s 6-5 of the ITAA 1997 and s 26(e) post-Smith?

4.20

How would Smith be dealt with after FBT? In particular consider what sort of fringe benefit this might be. (See ss 20, 40 and 45 of the FBTAA 1986.) An employer offers a prize of $5,000 for the best suggestion by an employee for improving productivity in the company. Is this prize assessable? Would it make any difference if the winner had resigned by the time the prize was awarded? A parent company is proposing to sell a subsidiary as a going concern. In order to maximise the price obtained on the sale, the company makes a payment to several

4.21

4.22

158

[4.150]

Income from the Provision of Services

4.23

CHAPTER 4

senior managers who are employed by the subsidiary, to ensure they remain with the subsidiary after it is sold. Is the amount assessable to the recipients? (See Dean and McLean v FCT (1997) 37 ATR 52; 97 ATC 4762.) A taxpayer is threatened with dismissal as a result of complaints lodged with his employer. He institutes proceedings to restrain his dismissal and is eventually successful. His employer decides that, in addition to reinstating him, it will make a voluntary contribution to his legal expenses. Is this amount assessable as income from his employment? (See FCT v Rowe (1997) 187 CLR 266; 35 ATR 423; 97 ATC 4317 – extracted in Chapter 6.)

[4.160] At the beginning of this section we mentioned that a second group of cases also arises

in this area – cases where the benefit is provided to the employee but by someone other than the employer. In the UK there are many such cases usually involving professional athletes who win prizes donated by third parties (such as TV stations) or receive amounts raised at testimonials, matches and dinners. Australia has similar cases: Kelly v FCT (1985) 16 ATR 478; 85 ATC 4283 (the Sandover Medal awarded by Channel 7). This issue was considered by the High Court in the case of FCT v Stone (2005) 222 CLR 289; [2005] HCA 21 which concerned appearance money, endorsements and government grants given to a part-time athlete. The problem, albeit in a different context, was considered by the Full Federal Court in FCT v Holmes. The taxpayer in Holmes was employed on a tug owned by P & O Maritime Services. The owners of a stricken oil tanker, the Kirki, contracted with United Salvage to salvage the ship. United Salvage in turn subcontracted with P & O, whose ship Lady Kathleen had been first on the scene and initially rescued the ship. The Lady Kathleen was later assisted by two other ships. The head salvage agreement provided for a “salvage reward” if the Kirki was saved and no compensation if it was lost. The subcontract between United Salvage and P & O repeated these terms. This contract was signed by P & O on behalf of itself and its employees on the Lady Kathleen, though they were not direct parties to the contract. An arbitrator determined first the share of the reward to be paid to each of the ships, the share of the amount going to the Lady Kathleen to be paid to P & O and the share to be paid to the crew members and, finally, of the amount going to the crew members of the Lady Kathleen, the amount to be paid to each member. Four members were awarded larger amounts for their bravery in the rescue and the remaining amount was divided among crew members on a pro rata basis by reference to their salary entitlements. The ATO assessed the taxpayer on the amount he received, relying on s 25 or, in the alternative, s 26(e). In a joint judgment, Hill, Cooper and Kiefel JJ said the following.

FCT v Holmes [4.170] FCT v Holmes (1995) 58 FCR 151; 31 ATR 71; 95 ATC 4476 In summary therefore, it can be said that Mr Holmes, a seaman who participated in a successful salvage operation, became entitled under the common law of Admiralty to a reward. The question is whether the receipt of that reward constitutes assessable income to him.

concepts emphasised that Mr Holmes was in receipt of his normal salary or wages in accordance with the relevant award and that the right he had to payment arose not from his employment with the Lady Kathleen but out of the success of the salvage operation …

The tribunal in concluding that the payment to Mr Holmes was not income in ordinary

Likewise the tribunal rejected a submission on behalf of the Commissioner that the payment [4.170]

159

The Tax Base – Income and Exemptions

FCT v Holmes cont. received by Mr Holmes was made assessable income under s. 26(e). In so doing, the tribunal placed emphasis upon the fact that in no sense could the amount paid to Mr Holmes be said to have any relationship with his employment with P & O, albeit that if he had not been an employee of that company he would not have been on board when the salvage operation took place. Accordingly the tribunal concluded that the payment received by Mr Holmes fell outside s. 26(e). The conclusion of the tribunal that the salvage payment to Mr Holmes was unrelated in any relevant sense to his employment with P & O was clearly correct. The law of Admiralty imposes on the owner of properties salved an obligation to pay those who save them. The obligation does not rest in contract … The right to a salvage award is personal to the salvor who renders the salvage service. It is not, in the case of a crew member, a derivative right through the ship owner or employer … We find it unnecessary to determine whether the payment made to Mr Holmes constituted income in ordinary concepts. If the payment falls within s. 26(e) of the Act it will constitute assessable income and it would no longer seem to matter whether it might also form part of assessable income by virtue of being income in ordinary concepts within s. 25… In Smith v FCT (1988) 164 CLR 513 Brennan J pointed to the width of the language of s. 26(e) reflected in part by the words “in respect of” and in part by the words “directly or indirectly” … His Honour pointed to the difficulty which arises where the allowance was paid voluntarily rather than pursuant to a legal obligation. That difficulty divided the court in Smith.

There is no question in the present case, however, of the payment to Mr Holmes being voluntary. He had a legal right to it, even if it can be said that his participation in the salvage operation which gave rise to that obligation was voluntary. Toohey J, in Smith (in a judgment with which Wilson J agreed), cited with approval, as illustrating the width of the language of s. 26(e), what was said by Dickson J of the Supreme Court of Canada in Nowegijick v R (1983) 144 DLR (3d) 193 at 200: The words “in respect of” are, in my opinion, words of the widest possible scope. They import such meanings as “in relation to”, “with reference to” or “in connection with”. The phrase “in respect of” is probably the widest of any expression intended to convey some connection between two related subject-matters. The question thus becomes whether there was a real connection between the payment received by Mr Holmes and the services rendered by him in the course of the salvage operation. Once the question is posed it is difficult to see how it can be answered other than in favour of the Commissioner. The fact that the obligation to make a payment to Mr Holmes arose only in the event that the salvage operation was successful can hardly operate to break the connection between the payment and the rendering of services. To the contrary, it renders clear that which the law of Admiralty itself makes clear, that the payment to a person participating in a successful salvage operation is a payment in recognition of the services which the participant in the salvage has performed. The payment to Mr Holmes was a reward for the services rendered by him and, as such, falls squarely within the language of s. 26(e).

[4.180] A more common, and potentially more important, example of the same problem

arose in relation to benefits under frequent flyer and similar customer loyalty schemes. In essence, these schemes involve a volume discount – “buy 10 flights and get the eleventh free”. The problem for the ATO was that it was usually the employer who purchased the 10 flights (and deducted their cost as a business expense), while it was the employee who took the 11th free flight and used it to fly off on vacation. In January 1993, the ATO released Taxation 160

[4.180]

Income from the Provision of Services

CHAPTER 4

Ruling TR 93/2 on the tax consequences of frequent flyer schemes. It took the view that the value of the free flight was assessable as income of the employees (where the benefit was in cash, could be redeemed for cash, or could be transferred to a third person) to the extent to which the points used to accumulate the free ticket had accrued as a result of work-related travel. If the free flight was partly attributable to business travel and partly from other personal travel, the value of the free flight would have to be apportioned. The same rule applied to self-employed people. In general terms, the ATO might have tried to impose tax on the value of benefits under frequent flyer schemes in three ways. It might have tried to attack the employer’s tax deductions for the 10 flights. As we shall see in later chapters, the provisions which permit the ATO to deny deductions where private benefits arise as an incident of business expenditures would be hard to trigger in these circumstances for various reasons. So, because the ATO was generally precluded from attacking the deduction, it had to rely on his powers to impose tax on the employee for the value of the 11th flight and/or to impose FBT on the employer. Qantas was unhappy with the Ruling and decided to try to attack it on two fronts. First, it changed the Terms of Membership of its frequent flyer scheme so members could elect that their points would not be available to acquire tickets in the name of someone other than the member – points had never been redeemable for cash, but by ensuring that they could not be transferred to or for the benefit of a third person, it was hoped that the Ruling could be rendered irrelevant. Second, Qantas decided to initiate a court challenge to test the ATO’s position. An employee of KPMG, the firm of accountants advising Qantas, was chosen and she sought a Private Ruling from the ATO that she would not be taxable if she either used her points to bring her parents from the UK to visit her, or if she went to visit her parents. She indicated that the points to be redeemed for the tickets would arise solely from work-related travel and hotel accommodation. The Private Ruling was refused, consistent with Ruling TR 93/2, and she appealed to the Federal Court against the denial. The action, Payne v FCT (1994) 28 ATR 58; 94 ATC 4191, did not reach a resolution because Hill J in the Federal Court found he lacked adequate information to determine whether there was a sufficient connection between Payne’s employment and the benefit. This line of attack was abandoned. Instead, Payne decided to bring her parents to Australia on free tickets in late 1993, disclosed this in her return, was assessed by the ATO to tax on the value of the tickets as the Ruling indicted, and in Payne v FCT (1996) 32 ATR 516, challenged that assessment in the Federal Court. The ATO argued that the value of the tickets was assessable under either s 25(1) or s 26(e) of the ITAA 1936. Foster J in the Federal Court rejected both arguments. He relied in part on the rules of valuation and derivation drawn from cases we have examined already in Chapter 2: Cooke and Sherden and Constable.

Payne v FCT [4.190] Payne v FCT (1996) 66 FCR 299; 32 ATR 516; 96 ATC 4407 Was there liability to tax under s. 25(1)? [I]n this appeal, the Commissioner has submitted that the provision, at Payne’s request, by Qantas of the relevant flight tickets to her parents constituted a derivation of “income” by her pursuant to that section.

The concept of “income” was fully considered by a Full Court of this court in FCT v Cooke & Sherden (1980) 10 ATR 696; 29 ALR 202, where a comprehensive review of earlier decisions was undertaken … The analogy with the present case is obvious. The reward tickets available because of the accrual [4.190]

161

The Tax Base – Income and Exemptions

granted to him” during the year of income under assessment.

Payne v FCT cont. of the required number of points could be used only by the program member or his or her permitted nominee. They were not transferable and, if sold, were subject to cancellation. They were not money and, in my view, could not be turned to pecuniary account. They could not therefore be regarded as “income” within the meaning of s. 25(1). I should note that a submission was but faintly made on the part of the Commissioner that it was conceivable that the recipient of a ticket under the scheme could transfer it to a permitted family nominee in consideration of an undisclosed payment. Such a transaction would be in flagrant breach of the terms of the contract, would render the ticket liable to cancellation and would, undoubtedly, smack of fraud. I cannot entertain the submission as having been seriously put. I reject it … Is the benefit taxable under s. 26(e)? Considerable argument has been addressed as to the meaning and application of this section …

It appears to us that the taxpayer became entitled to a payment out of the fund by reason of a contingency (viz: an alteration of the regulations curtailing the rights of members) which occurred in that year enabling him to call for the amount shown by his account. It was a contingent right that became absolute. The happening of the event which made it absolute did not, and could not, amount to an allowing giving or granting to him of any allowance, gratuity, compensation, benefit, bonus or premium … All that occurred in the year of income with respect to the sum in question was that the future and contingent or conditional right became a right to present payment and payment was made accordingly. This, in our opinion, cannot bring the amount or any part of it within s. 26(e). The amount received by the taxpayer from the fund is a capital sum, and, unless it or some part of it falls under s. 26(e) (there being no other applicable imposition of liability), it is not part of the assessable income.

[T]here are relevantly three requirements under s. 26(e), all of which must be met before the flight reward tickets can be treated as assessable income. First, there must be a “… benefit …”. Secondly, that benefit must be “allowed, given or granted” to Payne. Finally, the benefit must be allowed, etc, “in respect of … any employment … or services rendered” by Payne. I turn first to the second of these requirements.

This reasoning was relied upon by counsel for Payne. In the same way as the payment to Constable occurred by virtue of a contingent contractual right becoming absolute and was not, therefore, the “allowing, giving or granting to him of any … benefit”, the provision of the free airline ticket in the present case, which occurred by reason of the crystallising of a contractual entitlement, did not fall within the wording of the section …

Is the benefit granted”?

I am satisfied that the submission made on behalf of Payne is correct. The provision of the free travel by Qantas to her parents at her request, consequent upon the accrual to her of the requisite number of “points”, resulted from a personal contractual entitlement on her part and could not be properly characterised as a “benefit … given” within the meaning of the section …

“allowed,

given

or

The majority in Constable decided that case on the basis that the second requirement was not fulfilled. They considered the regulations governing the administration of the fund and the basis upon which the taxpayer had withdrawn the relevant moneys. They then said (at CLR 417-8): [W]e are of the opinion that, whether or not the payment or any part of it may be described as an allowance, in respect of the taxpayer’s employment, it cannot correctly be said that it was such an allowance, etc “allowed given or 162

[4.190]

Are the flight reward tickets a “benefit” within s. 26(e)? As I consider that this case can be disposed of on other grounds, I think it both unnecessary and undesirable that I further consider this submission …

Income from the Provision of Services

Payne v FCT cont. Are the flight reward tickets sufficiently connected to Payne’s employment? The remaining question in the case was one to which considerable argument was directed. That is whether the provision of free travel to Payne was “in respect of, or for or in relation directly or

CHAPTER 4

indirectly,” to her “employment” with KPMG. It was the Commissioner’s contention that this requirement was clearly satisfied insofar as the relevant points would not have been earned by Payne under the program had she not undertaken the necessary flights in the course of her employment, it being emphasised that the flights (and also qualifying accommodation expenses) had been paid for by her employer.

His Honour then considered the decisions in Dixon, Scott, Hayes and Smith. He continued: The effect of Smith’s case in the present context The Commissioner puts a simple argument. He says that whatever might have been the previous effect of the judgments in Dixon, Hayes and Scott, the situation since Smith is transparently simple. If the payment or benefit sought to be brought to tax under s. 26(e) is a “consequence” in a completely objective sense of the employment relationship, then it is caught by the section. It is sufficient if the employment relationship is a mere causa sine qua non, even though there be another cause of the payment or benefit which could be described as the causa causans or the predominant or effective cause. Payne’s free ticket was a “consequence” of her employment in that the flights which earned the necessary points were undertaken in the course of her employment and paid for by her employer. By parity of reasoning her employment was a “contributory cause” of the receipt of a free ticket. There can be no doubt that if the section requires only a “but for” or “causa sine qua non” connection between employment and receipt, then Payne’s free ticket can be attributed to her employment, and the section brought into play. Does Smith’s case require this result? In my view, it does not. In order for Smith’s case to be properly analogous to the present case, its facts would require alteration. It would be necessary for the employer to have required the employee to undertake the courses at the expense of the employer and as part of his employment. If, in those circumstances, the employee, through

zealous application to his studies, had been so successful as to receive a money prize awarded independently by the institution providing the courses then a more clearly analogous question would have arisen. Would that independently awarded prize have been taxable in his hands as a benefit caught by s. 26(e)? In my view, if those had been the facts in Smith’s case, the decision would have been against taxation of the benefit … In my view, s. 26(e) clearly requires that the relevant benefit be given or granted by the donor or granter in view of the taxpayer’s employment by himself or some other employer. Although questions of motive may not require any close examination, in my opinion, the section, nevertheless, requires a recognition on the part of the donor or granter of the relationship between the benefit granted, and the employment of the donee or grantee taxpayer. In other words the employment must be either wholly or partly the reason for the donor or granter making the gift or the grant … [I]n the present case, Qantas provided the free ticket not because of Payne’s employment with KPMG, but because she had become entitled to it under Qantas’ own scheme. I consider that this analysis of the situation is consistent with the approach to the section adopted in the lengthy passage that I have cited above from the judgment of Windeyer J in Scott. I am also satisfied that it is in accord with the passages I have cited from the judgment of Wilson, Brennan and Toohey JJ in Smith’s case. It must be remembered that there were significant differences between the facts in Smith’s case and those in the instant case, and statements in the judgments in Smith must be read against the [4.190]

163

The Tax Base – Income and Exemptions

Payne v FCT cont. background of those differences. In Smith, the payment was made by the employer. It was made pursuant to a scheme instituted by the employer. It was a scheme from which the employer derived benefit, namely enhancement of its employees’ skills in the performance of their work. The payment was intended to be an encouragement to employees to undertake the extra training involved in the scheme. It was accepted as such by the employees who undertook the training. In the present case, these features are totally lacking. The benefit was received under a scheme instituted by Qantas for its benefit. The employer had no part in the scheme as such. The employer did not arrange for the employee to participate in the scheme. It did not pay for the employee’s participation in the scheme. It did not even, so far

as the facts show, encourage its employees to participate in the scheme. It did nothing to provide the benefit alleged to be taxable in the employee’s hand. In my opinion, it is the factors present in Smith’s case but absent in the present case which must be kept squarely in mind when reading and considering the passages which have been cited above … In my view, the judgments in Smith illustrate rather than depart from the view of the section established in Dixon, Hayes and Scott insofar as those cases established, in my opinion, that, for a benefit, etc, to be caught by the section, there needed to be a role played by the employer in the giving, etc, of the benefit. In Smith’s case there was a clear and positive role played by the employer, which is totally lacking in the present case.

[4.200] In the light of this decision, Ruling TR 93/2 and a number of other consequent

Rulings were withdrawn and replaced. Taxation Ruling TR 1999/6 states unequivocally, “8. Flight rewards received by employees from employer-paid expenditure are not assessable income”. The Ruling also says that free flights do not (usually) give rise to a fringe benefit and do not (usually) give rise to business income to an independent contractor. At the same time, a separate Taxation Determination TD 1999/34 was issued. It reaches the unremarkable conclusions that a benefit derived under a “consumer loyalty program” as a result of making private expenditure is not assessable income. [4.205]

Questions

4.24

Would the ATO have succeeded in FCT v Holmes if it had based the assessment on s 6-5 of the ITAA 1997 alone?

4.25

Would the ATO have succeeded in FCT v Holmes if it had based the assessment on the CGT regime?

4.26

The frequent flyer Ruling TR 1999/6 takes the view that FBT would not usually be payable on benefits provided to employees. This is a trifle odd at first glance because it is a non-cash amount, typically the kind of thing thought of as a fringe benefit. Why might this be – consider who the parties are to this transaction?

4.27

Consider again the position taken by Foster J in Payne in relation to the words “allowed, given or granted”. He held that all that had happened in the year of income was that a contingent right became absolute and that this was not a “benefit given”. Is this conclusion supported by the passage quoted from Constable? The passage from Constable concludes that the amount in question was not income because it had been derived in a prior year. Is this timing aspect what Foster J is focusing on? Or is he saying something else?

164

[4.200]

Income from the Provision of Services

4.28

CHAPTER 4

The taxpayer introduced a prospective foreign buyer to a property developer and assisted with the Foreign Investment Review Board application when the foreign buyer decided to buy the property. The property developer gave the taxpayer a Gold Coast unit worth $1 m, which it described as “commission payable to you pursuant to the sale …”. Is the taxpayer assessable on the value of the home unit? (See Brown v FCT [2002] FCAFC 318.)

[4.210] The emphasis of this part of the chapter has been on income according to ordinary

concepts – whether or not s 6-5 has been triggered. There are a number of other specific statutory regimes that we will examine later in the chapter such as the FBT regime, s 109 of ITAA 1936, the termination payments regime in Divs 80 – 83 of the ITAA 1997 and the rules governing superannuation and CGT which always have to be borne in mind for amounts that are not ordinary income or added into statutory income. But with these exceptions, there are few other provisions which include amounts arising from employment as statutory income: • s 15-3 of the ITAA 1997 includes in income an amount received for agreeing to return to work; • s 15-70 of the ITAA 1997 includes in income an amount received as reimbursement of the expenses incurred in using your car for work purposes where the reimbursement is calculated on a cents-per-kilometre basis; and • s 15-80 of the ITAA 1997 includes in income an amount which an employer contributes to a first home saver account on behalf of an employee.

3. FRINGE BENEFITS [4.220] We have deliberately left until now the detailed discussion of the regime that is

probably the most important mechanism (apart from ss 6-5 and 15-2 of the ITAA 1997) for taxing benefits received during employment – the FBT. Although it is levied under separate legislation and forms a discrete tax, FBT – like CGT – has to be considered first as an independent source of tax liability and then be correlated with the income tax. In fact, the FBT regime applies to every benefit provided by an employer to an employee – it is only because of specific exceptions that salaries, for example, end up being taxed only under the ITAA. In other words, if one looks at the drafting of the laws, everything provided to an employee in respect of the employment is a fringe benefit unless there is an exception which removes it. Much of what follows will by now be relatively familiar to you from the discussion in Chapter 2, and because we have already asked you to examine the FBT consequences of payments to answer accurately the questions asked earlier in this chapter. In this part of the chapter we will give some background to the introduction of FBT and we will approach, in a systematic way, the formalities of its operation.

(a) Background to the FBT [4.230] A working definition of a fringe benefit is: it is a reward for service, in a form other

than contemporaneous payments in cash. In other words, they are benefits provided to employees which form an integral part of the employee’s total package. The Asprey Committee (Taxation Review Committee, Full Report, AGPS, Canberra, 1975, para 9.2) defined fringe benefits to be “any benefit, other than salary and wages, derived from an [4.230]

165

The Tax Base – Income and Exemptions

employment”. So fringe benefits include benefits in kind (which may or may not be convertible into money) that increase the employee’s purchasing power or relieve her or him of an obligation. The possible range of fringe benefits is enormous but common examples of non-cash benefits are providing free (or at a subsidised rate): the use of a car; car parking; low-interest personal and housing loans; subsidised goods and services; subsidised holidays and travel; an entertainment allowance and unverified expense account; paying some of the employee’s bills such as telephone and electricity accounts, educational costs for employees’ children, and health insurance premiums; payment of subscriptions to clubs, professional associations and unions; and establishing employee share acquisition schemes. Fringe benefits also encompass deferred payments and could easily include payments such as superannuation, termination and special leave payments, golden handshakes and so on. Items such as these often comprise major elements in the employee’s remuneration. The 1985 Draft White Paper (Reform of the Australian Tax System; Draft White Paper, AGPS, Canberra, 1985, p 96) suggested that benefits other than salary often comprised almost 20% of the total remuneration of senior white-collar employees. Although fringe benefits form part of the employee’s reward for service, prior to FBT they often escaped tax completely or were taxed at less than their full value. It is necessary to tax fringe benefits in order to preserve the underlying idea that a gain should be treated as income, and also to maintain the idea of horizontal equity (preventing taxpayers receiving income in one form from being treated more favourably than taxpayers receiving the same amount in another). And if it is true that fringe benefits are more common for high-income earners than for wage and salary earners, then there is also implicit vertical inequity if fringe benefits are allowed to go untaxed. While this may be true as a starting position, the recognition that fringe benefits were difficult to tax led to increasingly sophisticated negotiations for salary packages, even by trade unions, as well as employees in professions. But it would be a mistake to think that the push to substitute fringe benefits for cash salary came exclusively from employees. Employers also benefited where a fringe benefit could be provided cheaply, reducing the employer’s total labour costs. The employer would benefit if it could give rewards such as access to an employee share scheme or a superannuation scheme for employees costing (say) $15,000 in lieu of cash, where the employee would have to spend (say) $20,000 to acquire these same benefits. It is clear that the non-taxation of fringe benefits seriously distorted choices about the form of remuneration. David Collins, in “Taxation of Fringe Benefits – An Economist’s Perspective” (1987) 4 Australian Tax Forum 95, provides an explanation why economic distortion is a significant problem.

David Collins, “Taxation of Fringe Benefits – An Economist’s Perspective” [4.240] David Collins, “Taxation of Fringe Benefits – An Economist’s Perspective” (1987) 4 Australian Tax Forum 95 The preferential tax treatment of some types of income will, inevitably, involve reallocation of productive resources in such a way that income receipts are biased towards the favoured form. The allowance for tax purposes of entertainment expenses would imply much higher levels of such 166

[4.240]

expenditure, since the effective (net of tax) cost of entertainment would be below its true resource cost, the difference being borne by the taxpayer. The non-taxation of the private use of employers’ cars has almost certainly led to the purchase of more expensive vehicles since the private car use

Income from the Provision of Services

David Collins, “Taxation of Fringe Benefits – An Economist’s Perspective” cont. has been subsidised by the taxpayer, with the employer being able to determine the extent of subsidy from the public purse through the ability to determine the outlay on the vehicle. A narrow income base distorts relative rates of return since the tax concessions produce artificially low after-tax rates of return in some areas. Thus the allocation of productive resources is distorted, and productivity will decline since resources will shift from areas of high gross rates of return to areas of relatively low gross but relatively high net rates of return. At the same time, a deadweight loss is being experienced because the value of the subsidised fringe benefit to the recipient will usually be less than the resource costs to the community of producing that benefit. We have all heard stories of people who dined out regularly on untaxed expense allowances because it was cheaper than eating at home. All other things being equal, the recipient should prefer a benefit in cash to a benefit in kind provided at the same cost because the recipient has the discretion to spend the cash in accordance with her or his own preference patterns.

CHAPTER 4

In relation to taxes on business generally, the argument is often put that the level of taxation is too high and that the absence of taxes such as those on fringe benefits or capital gains is desirable on allocative grounds because of the resulting lower level of business taxation. If the desirability of lower levels of business taxation is, for the purposes of argument, accepted it can still be shown that partial and discriminatory tax concessions are inferior to the application of lower rates to a more comprehensive income base. This is an argument about the inefficiency of “taxation expenditures”. Although FBT clearly has the potential to be an important revenue-raiser, the case for FBT does not rest solely on revenue-raising considerations. Advocacy of the taxation of fringe benefits is not inconsistent with support for lower levels of business taxation and support for lower levels of business taxation provides a weak case for the non-taxation of fringe benefits. Similarly, the suggestion that a broad-based consumption tax could be used as an alternative source for the revenue yield of the FBT misses the point that the FBT’s rationale is not simply revenue-raising.

[4.250] Until 1 July 1986 fringe benefits were taxable under the general provisions of ss 25(1)

and 26(e) of the ITAA 1936. But the general impression seemed to be that fringe benefits were simply not being taxed. Taxing fringe benefits under s 25(1) was obviously difficult given the Tennant v Smith [1892] AC 150 requirement that the benefit be cash or convertible into cash. But observe the neglected words in s 26(e) “whether … granted in money, goods, land, meals, sustenance, the use of premises or quarters or otherwise” – this formula obviously rendered taxable non-cash benefits and benefits in kind. In addition to these sections, there were, and still are, some more specific regimes for a range of identified fringe benefits. For example, the former s 26AAC (now Div 83A of the ITAA 1997), taxes the income from employee share acquisition schemes and has survived both the introduction of the FBTAA 1986 and a concerted attempt to impose FBT on them in the mid-1990s. Sections 26AAAA and 26AAAB, applicable from 1 July 1977, taxed the value of employee housing but have now been replaced by FBT provisions. Section 26AAB attempted to tax the value of cars, but fared even more poorly than s 26AAAA – it was enacted in 1974 and repealed in 1975 without ever becoming operative. But ss 25 and 26(e) were alleged to be unable to catch fringe benefits and that problem, according to the Draft White Paper, cost the government about $700 m in lost tax revenue. It is important to spend some time considering why, despite the breadth of s 26(e) and the precision of other regimes, and despite the fact that they were clearly taxable, fringe [4.250]

167

The Tax Base – Income and Exemptions

benefits nevertheless often escaped tax. We will then consider how and to what extent the regime implemented to overcome this problem – FBT – has changed this. (i) Reasons for the non-taxation of fringe benefits

Administrative difficulties [4.260] One obvious difficulty for the revenue is detection. In most cases, the ATO only

knows what taxpayers voluntarily disclose in their annual tax returns. If no amount appears on an employee’s payment summary (a document produced by the employer, one copy of which is given to the employee and another filed with the ATO) stating how much income has been paid to the employee and how much tax has been withheld, it is almost impossible for the ATO to know of the existence of a fringe benefit except by correlating the employer’s return with that of each employee. But even that cross-checking might not be sufficient for accurate taxation of fringe benefits unless the amount of the benefit is separately identified in the employer’s return and some allocation to individual employees is made. A second difficulty is valuation. Most tax returns (even before the system of self-assessment) are accepted by the ATO at face value so that even when a taxpayer disclosed the receipt of a fringe benefit, the ATO would rely on the taxpayer’s assessment of its value. This allowed employees, who were minded to do so, to under-disclose the value of a benefit. But even for those who wanted to “do the right thing”, it was often difficult to provide any accurate value of some fringe benefits. [4.265]

4.29

4.30

4.31

Questions

Consider a low-interest housing loan, say of $100,000 at 5% per annum interest rate when savings bank rates were 7.5% – how much income was received by the employee? What amount was income if the employee would not have been eligible for a loan from a savings bank, but might have been able to get a loan at a higher rate from a non-bank lender? What if the employee would not have been able to secure a loan at all from usual sources? What amount of income was derived by an employee who could drive to and from work in the company car? What if the car could be used on weekends? What if the employee was prohibited from using the car on weekends but did so anyway? On what basis could the ATO have disagreed with the value chosen?

Legal problems [4.270] Even assuming that a fringe benefit has the character of income as a reward for

service, there is a problem of determining that an employee has derived a benefit, especially if the fringe benefit is paid to an associate rather than the employee. The problem arises because employees are usually on a cash basis of tax accounting which means that income only arises when it is received by the employee. Even a doctrine of constructive receipt (see ss 6-5(4) and 6-10(3) of the ITAA 1997) which renders assessable amounts paid on behalf of an employee, did not cope well with amounts paid to third parties if the payment was not made at the direction of the employee. This lacuna was compounded by the fact that there is no necessary correspondence between assessability to the employee and deductibility to the employer – so that the employer might be assured of the deduction for making the payment whether or not the employee was assessed. More importantly, it was possible to manipulate the nature of the fringe benefit so that it no longer possessed the characteristics of income that courts had identified as essential. For 168

[4.260]

Income from the Provision of Services

CHAPTER 4

example the most common manipulation was to invoke the Tennant v Smith requirement that the benefit be in cash or convertible into cash. Even though this common law rule was supplemented by s 26(e) taxing the “value to the taxpayer” of some benefits which were neither cash nor convertible, this valuation rule was not always applied. The rules for the valuation of fringe benefits were never successfully resolved. Courts could choose, and often fluctuated between, a variety of rules: the cost to the employer – but what is the cost to an employer of employee share schemes; the market value of the benefit provided – but there were problems where there was no real market equivalent; the replacement value – but this was always met by the counterfactual argument that the employee would not have driven a Rolls Royce or lived in Toorak if he or she had to pay for it herself; and subjective value, the Donaldson test (Donaldson v FCT [1974] 1 NSWLR 627; (1974) 4 ATR 530; 74 ATC 4192) discussed below. The availability of alternative valuation methods made it difficult to administer the tax rules well. These legal difficulties could often be manipulated to facilitate a low-tax outcome – by working with the interplay between the timing and valuation rules. An employer would provide something which, when derived, had a market value of almost nil because of the conditions attaching to it. In such a case, the benefit would be taxed only at the time it was provided because there is only one tax accounting event when the income was derived. When the conditions lapsed, the benefit would later become very valuable, but by then it had already been taxed. But was it correct to say that the law was totally inadequate as the Draft White Paper suggests? Some very specific regimes appeared to cope well such as s 26AAC (which is discussed below). It has been suggested that the real problem was that the rules were difficult to administer and people realised that escaping detection was easy. Richard Vann has argued: “s 26(e) is not a limited or defective provision as some have suggested … The failure to tax fringe benefits in full up until the present has resulted as much from the faint-hearted practice of the revenue as defects in the law.” (R J Vann, “General Principles of the Taxation of Fringe Benefits” (1983) 10 Sydney Law Review 90). Under a comprehensive income tax, there is no doubt that fringe benefits should be taxed, but in essence they raise problems primarily of administration rather than principle. Being taxable counts for little if the tax cannot be enforced. (ii) Possible solutions [4.280] In theory at least, there are three possible ways to tax fringe benefits. One is simply to

enact a series of valuation rules, include the value of fringe benefits together with the cash component, and then withhold tax at the source out of the cash component on the sum of the cash plus benefits. This would tax fringe benefits under the personal income tax system at the employee’s marginal rate. A second alternative would be to deny an allowable deduction to the employer for the cost of providing fringe benefits. This would tax fringe benefits under the corporate income tax system at the employer’s marginal rate – usually 30% as most employers are companies, but less if the employer was tax exempt or in tax loss that year. The third alternative would be to impose a special excise tax on employers on the value of fringe benefits they provide. Governments that have grappled with the problem of taxing fringe benefits have contemplated all three systems. [4.280]

169

The Tax Base – Income and Exemptions

Asprey Committee [4.290] The Asprey Committee considered the real problem was the failure by employees to

disclose the existence of benefits and so it suggested that an adequate solution would be for all amounts given as fringe benefits to be included in the PAYG system and be shown on payment summaries. The effect of their solution would be to make the ATO aware of the existence of the fringe benefit. The Committee recognised that this solution would not solve valuation problems but they said that a comprehensive system requiring employers to calculate cash values would not be practical because the valuation problem for employers was too great. Their compromise solution was to increase the disclosure obligations of employers to require the disclosure of all fringe benefits of which the employer knows, to take tax instalment deductions from regular benefits (examples were given of motor vehicles, low-interest loans and expense accounts), and ensure that the calculation of a value for benefits be made by the employer but with the ability of the employee to assign a different value and then for the ATO to revalue.

New Zealand Task Force on Tax Reform (McCaw Committee 1982) [4.300] This Committee suggested two different solutions for different types of fringe

benefits: for easily calculable items (for example, education expenses for executives’ children) tax would still be imposed on the employee. The fringe benefit would be included as wages for PAYG purposes and the tax would be calculated upon the basis of cost to the employer. For other specified items (motor vehicles, low-interest loans, subsidised goods and services provided by employer) they recommended as an interim measure (although it was ultimately enacted by the government) that a tax be imposed upon the employer at the top personal marginal rate which was non-deductible to the employer, and that the value of the benefit taxed should be determined by a formula regardless of the subjective benefit to the employee.

Draft White Paper [4.310] The authors of the Draft White Paper considered that there were two options open to

curb the abuse of fringe benefits. The first would be to enforce existing laws more vigorously and to include a defined value for fringe benefits in the employee’s assessable income. This would be “the best approach” because it would tax the employee’s total remuneration in whatever form at the employee’s marginal rate. But this would require “clear but necessarily arbitrary rules” for valuing benefits given to the employee or related person and strengthening the reporting requirements on employers to disclose all non-cash benefits not presently appearing on payment summaries. The second approach would be to tax benefits in the hands of the employer and exempt the receipt from income tax in the hands of the employee. This was the preferred solution because it was thought to be administratively simpler, “less disruptive” and “would go a long way to creating more equitable arrangements”. That system was eventually introduced in the FBT. In the years since its introduction, the FBT has become the focus of much criticism. We will look at “the problems with the solution” after we have a more complete grasp of the operation of the FBT system.

(b) Operation of the FBT [4.320] The FBT regime introduced from 1986 adopts the second position taken in the Draft White Paper: taxing the employer rather than the employee, at a rate which is the highest 170

[4.290]

Income from the Provision of Services

CHAPTER 4

marginal rate for individuals, using often arbitrary values for fringe benefits, and exempting the employee from income tax on fringe benefits. Unlike CGT, the FBT is enacted in separate legislation not within the body of the ITAA, although it clearly has to be integrated with the income tax. The tax imposed in s 66 of the FBTAA 1986 and the Fringe Benefits Tax Act is currently set at a rate of 49% – the same rate as the top personal marginal rate (45%) plus the Medicare levy 2% and the temporary budget repair levy of 2%). From 1 April 2017, it is scheduled to return to 47%. Under s 66(1) of the FBTAA 1986 tax is “imposed in respect of the fringe benefits taxable amount of an employer [and] is payable by the employer”. The “fringe benefits taxable amount” is defined in s 5B to mean the sum of the taxable value of all benefits provided by the employer during the year (“the aggregate fringe benefits amount”), adjusted to deal with the GST and grossed-up by the FBT payable on those benefits. In other words, FBT is payable on a tax-inclusive base – the total of the value of the benefit plus the FBT payable on the benefit. This is just the same as the taxation of salary – employees are taxed on their total wages (which includes the amount that will be deducted as income tax). There are five essential steps to be considered in determining the liability of an employer to FBT. 1.

First, there is a scope and classification issue. Tax is payable where an employer provides a “fringe benefit” but not all the items we have identified as fringe benefits in common parlance are caught by the FBT regime. The first issue is to identify whether a transaction involves a “fringe benefit” that is within the scope of the FBTAA 1986 and, if so, what category of fringe benefit the transaction falls into. 2. There is then a timing dimension. The employer must have provided the fringe benefit in the FBT year. For some reason, the FBT year runs from 1 April to 31 March in each year. 3. Thirdly, the transaction must involve the right parties. The fringe benefit must be provided to an employee or associate by an employer, associate or arranger. All of these terms are defined and, as is usual, extended in a variety of ways to encompass extraneous relationships which, at first sight, would not appear to be current employment relationships. 4. Next there is a connection test. The fringe benefit must be provided “in respect of” the employment. This is the same issue that was discussed above in relation to gifts: determining whether there is a sufficient connection between the employment and the benefit. 5. Finally, there is valuation. The employer is taxed on the grossed-up sum of the taxable values of all the fringe benefits provided. The valuation rules are the core of any system of taxing fringe benefits and are a function of the category of fringe benefit. The assigned value can be a realistic measure of the cash equivalent, but can also be an arbitrary number or the vehicle for providing some degree of concessional treatment. It is important to examine each element separately because, as with much of the recent tax legislation, inclusions and exemptions are introduced at each stage. For example, some items are not fringe benefits, such as employee share acquisition schemes and superannuation; some people whom one would not normally consider employers are included; the connection between the employment and the provision of the benefit may be wider than under common law tests; and some items are given preference by concessional taxable values or exemptions such as in-house child care, staff dining rooms or some staff discounts. Notice, however, that some of these steps are elided in the way the legislation is put together – while conceptually [4.320]

171

The Tax Base – Income and Exemptions

there are five discrete issues, the legislation deals with some of them together. The discussion below sets out the issues in the order that the legislation presents them. (i) Concept of “fringe benefits provided” [4.330] We will examine first the scope and classification issues. In order to understand the

ambit of the FBTAA 1986, we can start with the general definition of “benefit” contained in s 136(1). Divisions 2 to 11 of Pt III of the Act feed into this definition by defining the specific goods, services and payments with which they deal to be benefits. Divisions 2 to 11 expressly define as benefits: • providing cars and car parking facilities to employees (Divs 2 and 10A); • making low-interest loans to employees, and waivers of loans (Divs 3 and 4); • paying an employee’s expenses (Div 5); • providing housing and meals, and payment of living-away-from-home allowances (Divs 6, 7 and 9); • subsidised airline fares offered to employees (Div 8); • entertainment, particularly in the form of meals (Divs 9A and 10); and • other forms of property provided by an employer to an employee (Div 11). In addition to these specific definitions, there is an important group of residual benefits in Div 12 which is a category of fringe benefits comprised of all “benefits” not dealt with under more specific provisions. Section 6 says that the specific inclusions do not limit the generality of the term “benefit”. This residual category can be important as Westpac bank discovered. It realised that the low-interest loans it offered to bank employees were fringe benefits and paid FBT on them. It failed, however, to pay FBT on the establishment fees on those loans (amounting to almost $2 m) that it would usually charge to customers but did not charge for employees. Westpac argued that the checking it undertook prior to granting a loan was something it did for its own purposes to protect its investment, and that process conferred no benefit on its employees. So doing this activity for nothing was not a benefit for its employees, but rather for itself. The most that could be said was that it was one less cost of borrowing money, but Div 4 of the Act set out exhaustively the taxable value of making a loan of money. In Westpac Banking Corporation v FCT, the Full Federal Court held that Div 4 is not an exhaustive statement of the FBT consequences of making a low-interest loan and a residual fringe benefit did arise where the bank accepted and assessed the loan application, and did other things in order to process the loan. Lindgren J in the Full Federal Court was able to discern a benefit in addition to charging at a low interest rate.

Westpac Banking Corporation v FCT [4.340] Westpac Banking Corporation v FCT (1996) 70 FCR 52; 34 ATR 143; 96 ATC 5021 In the case of both ordinary and employee applicants for financial accommodation, the bank assesses the application in all its relevant respects, takes a decision, and, if the decision is a favourable one, writes advising the applicant of the approval and of the terms and conditions on which the 172

[4.330]

financial accommodation will be made available and inviting the applicant to sign and return an “acknowledgment” agreeing to those terms and conditions. When the applicant does this, an

Income from the Provision of Services

Westpac Banking Corporation v FCT cont. establishment fee is payable by an ordinary customer, but not, at least ordinarily, by an employee. In my view, the steps taken by the bank to which I have referred involve the provision of a benefit or service by it to the applicant, whether the applicant is an ordinary customer or an employee. It is true that, in the case of both outsiders and employees, the bank acts in what it perceives to be its own commercial interests. But this is not inconsistent with the proposition that its conduct as described also constitutes or includes the provision of a benefit or service to the applicant. Where the benefit or service begins and ends may be arguable. According to the narrower view, it comprises only the writing of the letter of offer or commitment and the receipt, by way of return, of the applicant’s written acknowledgment. On the other hand, and more

CHAPTER 4

broadly, it may be that it extends back to include the antecedent steps of investigation, assessment and decision. What is important is that at least that for which outsiders pay an establishment fee includes the writing of the letter of offer or commitment and receipt of the applicant’s signed acknowledgment. Although the evidence did not include the form of letter written to outsiders, the writing of the letter of offer or commitment, whether to them or to employees, at least once the signed acknowledgment is returned, gives rise to a legal or moral obligation on the part of the bank to make the financial accommodation available. I have no difficulty in regarding this as a benefit or service provided by the bank. It is beside the point that it may not be proper to view each isolated act of the bank, such as the inspection of any security offered, as the provision of a benefit or service by it to the applicant. Again, the acts with which we are concerned in the present case are those for which ordinary customers pay an establishment fee.

[4.350] The next step in the legislative trail is to move from “benefit” to “fringe benefit.” Not

all “benefits” will be “fringe benefits”. Fringe benefits are defined in s 136(1) of the FBTAA 1986 to include certain benefits and to expressly exclude other benefits from being subject to FBT. Most of the excluded benefits are excluded from FBT because they are dealt with in the ITAA under special schemes. Examples of exclusions from the concept of fringe benefit are: salary and wages; employee share acquisition schemes; payments to superannuation funds; eligible termination payments on cessation of employment; payments of a capital nature for restrictive covenant; personal injury settlements; and deemed dividends under Div 7A and s 109. All of these are dealt with in the ITAA. There is also an exclusion for exempt benefits. Examples of exempt benefits can be found scattered throughout the FBTAA 1986. Many are contained in Div 13 of Pt III and others are in earlier Divisions dealing with particular types of fringe benefits, for example: s 22 exempts the reimbursement of some costs paid to an employee who uses a car for work; and s 47(2) exempts in-house child care facilities. For exempt benefits and other benefits which are excluded from being fringe benefits, the employer is not taxed on the benefit under FBT and any tax consequence must be found in the ITAA. Finally, there is a group of benefits which enjoy reduced taxable values in Div 14. Finding, and then properly classifying, a benefit is an important task for the parties to any remuneration arrangement. Wrongly classifying a sum will lead to difficulties – for the employee who has failed to report it believing it to be a fringe benefit and therefore the employer’s responsibility, and for the employer who has treated it, say, as a pension and therefore the employee’s responsibility. An example of this problem arose in Tubemakers of Australia Ltd v FCT (1993) 25 ATR 183. The taxpayer had been in the habit of paying premiums to its associated medical benefits fund to provide hospital, medical, pharmaceutical [4.350]

173

The Tax Base – Income and Exemptions

and similar benefits for its current and former employees with 25 years’ service. In order to reduce its FBT cost (and presumably also the cost to its employees) the company decided to stop paying premiums and, instead, to pay cash to former employees which they could use to pay fund premiums or as they wished. The ATO nevertheless assessed Tubemakers to FBT on the cash payments. The taxpayer argued that the amounts paid to ex-employees were excluded from the definition of fringe benefit in s 136(1) either as a payment of “salary or wages” or as a “pension or retiring allowance”. The Federal Court held that the amount was no longer a retiring allowance, but was in the nature of a pension and so not a fringe benefit. Another example arose in Roads and Traffic Authority of NSW v FCT. The ATO assessed the taxpayer to FBT on three types of benefits that it provided to its employees – travel allowances, camping site allowances and camping accommodation. The employees in question were road workers who were entitled under relevant State awards to receive variously designated cash amounts and accommodation on-site in remote areas. The ATO argued that these were expense payment fringe benefits, living-away-from-home allowances and residual benefits, respectively. The ATO failed on all counts. The Court held that the travel allowances were simply additional salary. The camping allowance and the provision of camping accommodation were potentially taxable as fringe benefits, but were protected by the operation of the otherwise deductible rules discussed below. The extract below considers the position of the cash travel allowance. Hill J observed as follows.

Roads and Traffic Authority of NSW v FCT [4.360] Roads and Traffic Authority of NSW v FCT (1993) 43 FCR 223; 26 ATR 76; 93 ATC 4508 The Authority paid amounts in respect of travel to its employees in the relevant years of $938,209 and $1,298,232, respectively. Travelling allowances were required to be paid pursuant to the various Awards under which employees worked. Section 25(2)(a) of the General Construction and Maintenance, Civil and Mechanical Engineering &c (State) Award (agreed by the parties to be typical of provisions found in all relevant awards) provided as follows: Employees of NSW Government Departments and instrumentalities … shall be paid as follows: (a) Fares … (1) An employee who travels to and from his place of work by a public conveyance shall be paid all fares actually and necessarily incurred in excess of $1.00 per week or 20 cents per day … (3) Where an employee elects to travel by his own conveyance, or does so because the use of available public transport is impracticable, fares shall be 174

[4.360]

calculated and paid for as if travel were made in the ordinary way by public transport … Sample forms in evidence show that the employee was asked to fill in the actual transport used by him, the public transport route appropriate and the fare charged for that public transport. In some cases the employee was required to certify the information to be correct and that either the fare in question was actually and necessarily incurred by the employee, or an entitlement existed to an equivalent fare under the Award. In other cases there was no requirement for certification. Where certification was required it was not always completed. A perusal of forms in evidence indicate that some employees travelled by car, others by private bus and others by public transport. In some cases the actual mode of travel was not filled out. It seems that a substantially large number of employees travelled by car, presumably their own car. When the form was completed by the employee, it was handed to the timekeeper at the works office and checked to ensure that the

Income from the Provision of Services

Roads and Traffic Authority of NSW v FCT cont. public transport route claimed for was the shortest route and that the fares claimed accorded with those published by the relevant transport authority … At the end of each fortnight the time sheets were certified as correct by the foreman at the job site and forwarded to the works office for processing when the relevant fare allowance was calculated and paid to the employee in accordance with the terms of the award. As a matter of procedure, the Authority did not check whether the employee did in fact use public transport or indeed whether the employee incurred any expenditure at all. New forms were only completed where an employee changed job sites. The Commissioner claims that these payments fell to be taxed as expense payment benefits defined by s. 20 of the [FBTA] Act … It was submitted for the Commissioner that each of the payments made to employees by the Authority “reimbursed” the employees in whole or in part in respect of expenditure incurred by the employee … For the Authority it was submitted that none of the payments in question operated to reimburse the employees in respect of expenditure incurred by them, but that even if a payment did so operate, the amounts in question would fall within the definition of salary or wages within s. 221A of the ITA Act. The word “reimburse” is defined in the Macquarie Dictionary as meaning “to make repayment to for expense or loss incurred; to pay back; refund; repay”. Thus an employee who travelled by government bus and who had the whole, or perhaps substantially the whole, of the amount he had paid refunded to him would, in ordinary parlance, be said to have been reimbursed that amount. On the other hand, an employee who travelled in his own car but who was paid an amount dependent upon the cost of public transport less a small sum, would not, in ordinary parlance, be said to have been reimbursed anything.

CHAPTER 4

The ordinary meaning of the word reimburse, however, is expanded by the definition in s. 136(1) so that if the result of a payment is indirectly a reimbursement, the payment in question will be taken to be a reimbursement and the payment thus fall within s. 20. Notwithstanding the width of the definition of reimburse contained in s. 136(1), I doubt if it could properly be said that a payment of an amount of money having no relationship at all to the actual cost (for example, of private car transport) operated so as to have the effect or result, directly or indirectly, of reimbursing the whole or part of the expenditure of operating the vehicle. It seems to me that the concept of re-imbursement requires that the payment in question be made by reference to actual cost, that is to say that there would need to be some correspondence between the payment and the expenditure incurred, even if the reimbursement were to be but partial reimbursement. Under the Award, an employee could, it would seem, elect to travel by bicycle at no, or minimum, cost, but nevertheless be paid what it would have cost had he travelled by public transport less $1 per week or 20 cents per day. A payment to such a person could by no stretch of the imagination be said to involve a reimbursement … However, in my view it is ultimately unnecessary to determine the issue because the payments in question fall within the definition of salary or wages within s. 221A of the ITA Act and, accordingly, do not fall within the definition of fringe benefit … [T]he payments in question have little relation, except in the case of an employee who actually uses public transport, to the actual cost incurred by the employee. The amount is payable whether or not the employee travels by public transport, provided he travels by some form of conveyance. The payment is made to persons who are employees and made to them pursuant to their Award. No question arises of the payment being a mere gift. There is no question of employees being required to account for the moneys they receive.

[4.360]

175

The Tax Base – Income and Exemptions

[4.370] You may care to contrast this view of the difference between an allowance and a

reimbursement with that expressed by the Commissioner in Taxation Ruling TR 92/15. The second issue on our list was timing. Assuming there is a benefit, it must be provided or deemed to be provided – this is the term which allocates benefits to various years. Section 136(1) of the FBTAA 1986 gives a definition of “provided” which probably adds nothing to the natural meaning of the word. Section 148(3) of the FBTAA 1986 defines “deemed to be provided” as arising where: a thing which would be a benefit is done; the thing is prohibited; but the prohibition is not consistently enforced, that is, the employer “turns a blind eye”. Similar provisions exist for some of the specific benefits dealt with under other Divisions, for example, s 7(4) says a prohibition on using a car that is not consistently enforced means that the employee is entitled to use the car. The meaning of “provided” was considered by Hill J at first instance in Westpac Banking Corporation v FCT (1996) 32 ATR 479; 96 ATC 4366. In that case, the bank decided not to collect almost $2 m in establishment fees on low-interest loans made to employees. It argued that in order to “provide” a benefit it had to undertake some affirmative action: “the word ‘provide’ is defined in relation to a benefit to include, to ‘allow, confer, give, grant or perform’. It is said that each of these expressions require some positive act and that to fail to charge an amount cannot be the provision of any benefit.” Hill J disagreed and found that the benefit had been relevantly provided. [4.375]

Questions

4.32

Are these items benefits and, if so, what kind of benefit are they: a payment of $100 to the taxpayer in Smith prior to enrolment to assist him to (a) meet all the costs of the course (such as books and fees): consider ss 20, 40, 45; (b) meals provided to an employee in the staff canteen: consider ss 40, 41; (c) meals provided to an employee at a restaurant for which the employee is reimbursed: see s 20; (d) meals provided to an employee at a restaurant where the employee charges the bill to the employer’s credit card: see ss 20, 40, 45, 150.

4.33

Was a benefit provided, and if so of what kind, in the case of: (a) Smith v FCT? (b) FCT v Dixon? (c)

4.34

FCT v Harris?

Consider the taxpayer in Payne and assume that the employer was involved in the scheme in such a way that a fringe benefit arises – that is, assume the airline is an arranger for the employer. In what year would the benefit have been provided – in the year she joined, as she accrues points, or in the year that tickets are issued? Would there be more than one benefit?

(ii) Provided to employees/associates by employer/associate/arranger [4.380] The third issue in our list involves identifying the proper parties to the transaction. In

order to be a fringe benefit, something must be provided to an employee or its associates, by 176

[4.370]

Income from the Provision of Services

CHAPTER 4

the employer or its associate or an arranger. “Employee” and “employer” are defined in s 136(1) to include current, future and former employees and employers. Current and former employees and employers are also defined in s 136(1) and that definition takes you to the definition of “salary or wages” also in s 136. The definition of “salary or wages” takes you to the withholding rules in Div 12 of the Taxation Administration Act 1953. If a person receives one of these payments, he or she is receiving salary or wages with the result that he or she is an employee and the person making the payment is an employer. A future employee is defined in s 136(1) of the FBTAA 1986 to mean someone who “will become a current employee”. This definition is apparently intended to catch signing-on bonuses but there has been some speculation that it could catch a multitude of other payments. Who can say that any given person may not become an employee at some future time? The better view is probably that “will” means that you can say at the time the gift is made that the person will (not may) become an employee. (See Rulings MT 2016 and MT 2019 extracted below.) An associate of an employee or employer is defined in s 136(1) of the FBTAA 1986 to have the same meaning as it does in s 26AAB of the ITAA 1936. The definitions in s 26AAB(14) and (15) include as an associate: certain relatives, a partner and the spouse or child of a partner, trustees of trusts of which the taxpayer could become a beneficiary, companies informally controlled by the taxpayer either because the directors usually act in accordance with the taxpayer’s directions or because the taxpayer can (alone or with others) control 50% of the voting power. Note also that s 159 of the FBTAA 1986 needs to be considered even though the s 136(1) definition of “associate” does not refer to the existence of the section. Section 159 includes as associates individuals such as de facto spouses, related companies (defined in s 158 to include parent, subsidiary and sister companies), and former partners. An employer can also act by an arranger. The idea is that, while the benefit is provided by another person, it does so at the behest of the employer. A common example would be where the employer, say a university, places its account with a particular bank on the understanding that all of the university’s employees will be offered home loans on slightly advantageous terms. This is captured in para (e) of the definition of “fringe benefit” in s 136 – a benefit provided under “… an arrangement … between the employer … and the arranger …” In such a case, the employer pays tax on the value of the benefit provided to the employee by the third party arranger. At the other extreme there are the kinds of situations seen in the frequent flyer schemes examined in Payne. Here, there was no explicit arrangement between KPMG and Qantas that Qantas would provide flights to Ms Payne. Indeed, Qantas probably had no idea who employed Ms Payne, and KPMG probably had no idea just how many frequent flyer schemes Ms Payne belonged to (although they undoubtedly knew that she was in the Qantas scheme in order to set up the test case). The ATO took the view, however, that unless the employer was a party, no arrangement existed between the airline and the employer to provide benefits to the employees, and he has maintained this position in Taxation Ruling TR 99/6. But employers and third parties will not always be unaware of the other’s situation and it can be a difficult matter to determine when an implicit understanding might amount to an arrangement. For example, the bank might take a unilateral action based on a business judgment that it is in the bank’s best interests to offer low-interest loans to university employees – it will make the university happy and less likely to shift its account to another bank. (Of course, the university might quickly become very unhappy if that generous act on the bank’s part unwittingly [4.380]

177

The Tax Base – Income and Exemptions

triggered an FBT liability for the university.) The legislation now tries to address these situations in para (ea). There will only be a fringe benefit provided if “the employer … participates in or facilitates the provision or receipt of the benefit or … a scheme or plan involving the provision of the benefit and the employer or associate knows, or ought reasonably to know, that the employer or associate is doing so …” So, if the university advertises that its employees qualify for low-interest loans with this bank, there may well an arrangement, but if the bank advertises it, there may not. At present, FBT does not apply to income in kind derived outside the employment context. For example, in Taxation Ruling TR 93/38 the ATO expresses the view that FBT has no application to low-interest loans provided by insurance companies to insurance agents, as they are independent contractors and not employees of the insurance company. Consequently, the interest saving is a non-cash business benefit and assessable as income under s 21A of the ITAA 1936. [4.385]

4.35

Question

Would the payments have been made between an employer and an employee in: (a) Hayes v FCT? (b)

FCT v Dixon?

(c)

FCT v Harris?

(iii) In respect of employment [4.390] The fourth element in defining the scope of FBT is the connection test – the

requirement that a benefit be provided in respect of employment. It is this requirement that identifies those benefits which are the real target of the tax. Every benefit, even those provided to associates of employees, must be “in respect of” the employment of some employee. Section 136(1) of the FBTAA 1986 defines “in respect of” to include “for or in relation directly or indirectly” to an employment. This is the same wording as is used in s 15-2 of the ITAA 1997 so that the connection between the employment and the benefit is not initially different under s 136(1). But s 148(1) of the FBTAA 1986 substantially extends the s 136 definition of “benefits provided in respect of an employment”, by stating that there may nevertheless be a benefit provided in respect of employment, even though the employer provides the benefit in respect of some other matter; the employer provides it in respect of past or future employment; the employer provides a benefit that is partially detrimental; the employer provides a benefit that is surplus to the employee’s needs; the employer provides a benefit that is not “in the nature of income” (for example, one not convertible into money); and whether or not the employer provides the benefit as “a reward for services rendered”. When the legislation was released, the extension of the requisite connection in s 148 caused an outcry because it was thought the definition extended to catch payments not even remotely connected with employment. The ATO issued Rulings MT 2016 and MT 2019 which retreated from some possible interpretations of the section perhaps almost to the point of re-establishing the common law test. The first ruling states:

178

[4.385]

Income from the Provision of Services

CHAPTER 4

Ruling MT 2016 [4.400] 2. An essential element of the definition of fringe benefit is that the benefit must be one provided in respect of the employment of the employee. Unless a benefit is provided in the context of an employer-employee relationship the tax has no application … 5. Sub-section 148(1) does not remove in any circumstances the fundamental requirement that, before there can be a tax liability, the benefit under consideration has to be provided in respect of the employment of the employee … 7. It has been suggested that subsection 148(1), particularly when read in the context of the definition of “employee” in section 136 which takes in current, future and former employees, extends the meaning of “in respect of the employment of an employee” and, consequently, gives excessive width to the coverage of the Fringe Benefits Tax Assessment Act. Some examples of benefits said to be thus brought within the scope of the Iclude: (a)

the value of accommodation and meals provided in the family home where children of a primary producer work on the famiIfarm …

(c)

birthday presents given to children who work in small businesses run by their parents;

(d)

a wedding gift given by parents to an adult child who had some years earlier worked after school in the family business;

(e)

an interest-free or concessional loan given to such a child for the purpose of buying a matrimonial home;

(f)

the rental value of a farm homestead occupied by a family whose private company conducts the farmingIiness in which they work and holds the title to the homestead. 9. The reference in the law to future or former employees does not curtail the requirement that the benefit also be provided in respect of the employment of the employee. In the context of “future” or “former” employees the reference to employment is, by virtue of the definitions of those terms and the definition of “current employee”, a reference to the employment activities ultimately undertaken in the case of a future employee or formerly undertaken in the case of a former employee. 10. Seen in context, therefore, the reference to future and former employees ensures only that a benefit provided in respect of employment activities does not escape fringe benefits tax merely by virtue of the fact that it is given in advance of the employment commencing or after the employment ceases. For example, the inclusion of former employees ensures that a benefit (for example, a low interest loan) that continues to be provided to a former employee by virtue of his or her former employment remains subject to fringe benefits tax … 11. In each of the examples … above, the facts as presented lead strongly to the conclusion that the benefits and gifts were given in an ordinary family setting and would have been a normal incidence of family relationships. It would not be concluded that they were to any extent provided in respect of either past or current employment of the recipient members.

Ruling MT 2019 [4.410] This ruling deals with the application of the FBT to benefits provided by a family private company to a shareholder of the company who is also a past or current employee of the company or an associate of such an employee …

3. [T]he first point to note is that for the benefit to be liable to FBT, it must be provided to the shareholder at a time when that person is an “employee” or an associate of an employee. The term “employee” is defined in the legislation to mean a current employee, a future employee or a [4.410]

179

The Tax Base – Income and Exemptions

Ruling MT 2019 cont. former employee. The term “current employee” is, in turn, defined to mean, in effect, a person who is an employee for the purposes of the PAYE provisions of the income tax law. A shareholder will meet this definition if at the time when the benefit is provided he or she is in receipt of salary or wages from the company or is a director who receives directors’ fees … 6. By virtue of para 148(1)(a) of the Fringe Benefits Tax Assessment Act, a benefit provided to a person by reason of both his or her employment activity and shareholding will be taken to be provided in respect of the person’s employment. If, however, it can be established that a benefit is provided to a shareholder/ employee solely by reason of that person’s position as a shareholder of the company and not to any extent by reason of that person’s employment by the company, the benefit will not be subject to FBT … 8. Where a benefit is provided to a shareholder/employee of a family company in connection with the performance of his or her

duties as an employee, it is considered that the benefit is provided in respect of the person’s employment. For example, where a car owned by a family company is used by a shareholder/ employee in the course of his or her employment by the company, it is considered that any use, or availability for use, of the car by the employee (or an associate) for private purposes is a benefit provided in respect of his or her employment … 9. In relation to benefits that are not expressly linked to the carrying out of the employee’s duties, it is necessary to examine all the facts and circumstances of the case to establish whether the benefit is fairly to be regarded as having been granted to the shareholder/employee in his or her capacity as an employee or as a shareholder. Factors such as the nature of the benefit, any cash remuneration paid, the nature and extent of any trading activities of the company, the extent of any services rendered by the shareholder/ employee and the extent of his or her shareholding may be relevant in concluding whether a non-cash benefit was provided as remuneration for services or in the capacity of shareholder.

[4.420] The connection test, that a benefit must be provided “in respect of employment”, has

become a matter of some dispute. In two recent cases, J & G Knowles v FCT (2000) 44 ATR 22 and Starrim Pty Ltd v FCT (2000) 44 ATR 487, courts examined whether the payment was made to a company director (who is an employee for FBT purposes) because of their position as director, or for some other reason – say, because they were shareholders of the company or in some other capacity. In Knowles, the company was a trustee of a unit trust. The units were held by the family trusts of the four directors. So effectively, the income and assets of the head trust belonged to the four directors and their families. This was at the heart of the dilemma. Were the benefits provided to the directors because they were directors of the company (in which case FBT would apply) or because they were beneficiaries of the trust? The issue arose because the company allowed each director to write cheques for personal expenses on the company’s cheque account. When the cheques were met, the amount paid out was treated by the company as a loan to the director’s trust. As the Court noted, “there was no relationship between the amount of money each director requested be paid and the personal effort involved in working as a director. Nor was there any relationship between the amount paid at the request of one director and the amount paid at the request of the others.” The ATO argued that amounts were loan fringe benefits because loans had been made to the directors in respect of their duties. The Full Federal Court, however, considered the facts ambivalent: “the material before the AAT pointed in 2 directions. The first was that the directors drew upon the assets of the unit trust because ultimately the trust was established, and its assets were to be 180

[4.420]

Income from the Provision of Services

CHAPTER 4

held and applied, for their benefit and that of their families. The second is that it was agreed between the directors that, as an incident of their directorship, each of them were entitled to draw upon the appellant’s funds by way of loans for their personal benefit. In the first case it is unlikely that there would be a sufficient connection with the employment, while in the second the loans are likely to be an incident or product of it.” The Court remitted the matter to the AAT to re-examine the facts, but with the benefit of a re-expression of the connection that must be found. They said: The words “in respect of” have no fixed meaning. They are capable of having a very wide meaning denoting a relationship or connection between 2 things or subject matters. However the words must, as with any other statutory expression, be given a meaning that depends on the context in which the words are found … The AAT was correct in stating that the phrase requires a “nexus, some discernible and rational link, between the benefit and employment”. That, however, does not take the matter far enough. For what is required is a sufficient link for the purposes of the particular legislation. It cannot be said that any causal relationship between the benefit and the employment is a sufficient link so as to result in a taxable transaction. For example, a discretionary trust with a corporate trustee might be established to purchase a family home for the benefit of its directors and their family. It does not follow that the rent free occupation of that home on the authority of the directors is a benefit provided “in respect of” their employment for the purposes of the FBTAA. While there is a causal relationship between the provision of the benefit and the employment it is not a sufficient or material relationship. The rent free occupancy arises because the trust was established for that purpose; a reason extraneous to the employment of the directors.

When the case was reconsidered by the AAT, it concluded that the loans had not been made to them as directors, but rather because they were “ultimate owners of the business and its assets” – that is, as trust beneficiaries: Re J & G Knowles (2000) 45 ATR 1101. In Starrim, the company lent money to the directors who were also shareholders of the company in order that the shareholders could finance the purchase of a block of land. The land in question was actually the site of a business that the company had just purchased, so it was clearly in the company’s interest to have the purchase completed. Again, the ATO argued that the funds had been advanced to the shareholders as directors of the company. The Court upheld the AAT’s view that the funds had been advanced to them as purchasers of the property. [4.425]

4.36

Question

Would there have been an adequate connection between the payment and the services for FBT to apply to the payment (assuming it was otherwise applicable) in Hayes, Dixon, Harris, Smith, Scott, Kelly and Payne?

(iv) Taxable value of benefits [4.430] Once it is concluded that there is a fringe benefit, its taxable value must be determined

– the final issue in our list. By s 66(1) of the FBTAA 1986, FBT is payable by the employer on the fringe benefits taxable amount which is defined to be the sum of the taxable values of all fringe benefits provided during the year grossed-up for the tax and adjusted for GST. Individual taxable values must be calculated under the rules provided by each Division for each benefit, because the FBTAA 1986 gives separate valuation rules for each type of benefit. We will deal with five examples of the valuation rules: cars and car parking; loans; entertainment; property fringe benefits; and residual benefits. [4.430]

181

The Tax Base – Income and Exemptions

Cars [4.440] In general terms, s 7(1) of the FBTAA 1986 says a car benefit arises where a car that is

owned or leased by an employer is either made available for private use or is actually used by an employee for private purposes at any time on any day during a year. Note that almost every word in this summary is given extended definitions by the FBTAA 1986. Section 7(2) says that a car is made available for the employee’s private use if it is garaged at the employee’s residence (although there is an exception in subs (2A) if the employee drives home an ambulance or police car). In AAT Case 9824 (1994) 29 ATR 1246; Case 58/94 (1994) 94 ATC 498 the Tribunal applied this rule to a car that was used exclusively in a business which was run from the home of a director just because it was garaged at that home. In Ruling MT 2021, the ATO takes the view that s 7(2) would apply if the car is garaged at the employee’s home even if the employee was overseas at the time. Section 7(3) says that a car is made available for an employee’s private use if the employee has custody or control of the car and is not performing employment duties at the time. Notice in subs (4) that even if private use is prohibited by the employer, that prohibition will be disregarded if it is not consistently enforced. Section 8(2) exempts a car benefit if the private use is “minor, infrequent and irregular”. Notice also that not every vehicle is a “car” – the definition in s 136 of the FBTAA takes one to the definition in s 995-1 of ITAA 1997 which excludes vehicles designed to carry more than 1 tonne or more than eight passengers – and not every “car” gives rise to a taxable car fringe benefit – s 8(3) exempts the benefit if the car was unregistered. To determine the taxable value of a car fringe benefit, the employer can elect to use either a statutory formula or the operating cost method. The statutory method is somewhat arbitrary but involves less paperwork. As the operating cost method attempts to follow the actual costs of running the vehicle, it generally requires more documentation in the form of log books to be kept. An employer can use different systems for different cars and for different years. Statutory formula: The statutory formula is given in s 9(1) of the FBTAA 1986. At its simplest, the statutory value is (the car’s value × stipulated fraction based on annual kilometres driven × the number of days of private use per year/number of days on which the car was used or made available for private use) minus the employee’s contribution to running costs. The car’s value is initially its cost, but declines to two-thirds of its cost after the fourth year: see s 9(2)(a). The stipulated fraction which is given in s 9(2)(c)(ii) used to vary with the numbers of kilometres driven per year, but was changed to a fixed rate of 20% in 2011. The amount of the benefit is then reduced by any amount which is the recipient’s contribution. Operating cost method: The operating cost method of valuation is provided in s 10 of the FBTAA. The operating costs are defined in s 10(3) to include fuel, maintenance and repairs, registration, insurance, and either depreciation and imputed interest or lease costs. These costs are then pro-rated to exclude business use, leaving the proportion of costs attributable to private use as the amount of the taxable value. Employers must establish the percentage of business use by keeping log books. If log books are not kept for 12 typical weeks per year or are defective, the whole use is assumed to be private. The log book rules are contained in ss 10A to 10B.

182

[4.440]

Income from the Provision of Services

[4.445]

CHAPTER 4

Questions

4.37

Alpha Pty Ltd purchases a car on 1 April for $30,000 and makes it available to B who drives it primarily on business. B garages the car at home. During the next year the car travels 45,000 kilometres. Alpha pays the following expenses: insurance $500; registration $500; fuel, oil and maintenance $2,000. What is the taxable value of the car using the statutory method?

4.38

Assuming that the log books record 30,000 kilometres travel for business trips, what is the taxable value of the car using the operating cost method, if the depreciation rate is 22.5% and the imputed interest rate 14%.

4.39

Ignoring FBT, how much should a conscientious taxpayer have disclosed as assessable income if all these facts had occurred in 1984?

4.40

Why do you think the government changed to the fixed rate of business use in s 9(2)(c)(ii)? For example, if a car is driven less than 15,000 kilometres in a year, what would be your guess about the proportion of the travel that would be business-related?

4.41

Consider the FBT consequences of this transaction. On 1 April 2001, an employer enters a lease of a new car for five years. The employer will provide the use of the car to the employee as a car fringe benefit for the next five years. According to the terms of the lease, the car will have a residual value at the end of the lease of $15,000 and the understanding in the industry is that the employer will be able to buy the car for this amount from the lessor at the expiry of the lease. On the same day, the employer enters a contract to sell the car to the employee in five years’ time for $15,000. It is expected that the car will have a market value in 2006 of $25,000. What are the FBT ramifications in 2001? What are the FBT ramifications in 2006?

4.42

What difference would it make if, rather than execute a separate agreement, the employer simply assigned to the employee its rights under the lease agreement (with the consent of the lessor) in 2006?

[4.450] Car parking is rather oddly one of the more complex FBT areas and is in many ways

emblematic of the problems of the FBT. Initially, car parking facilities provided by an employer were treated by the ATO either as an expense payment benefit or as a residual benefit: see Ruling MT 2021. But in 1987, s 58G was inserted into the FBTAA 1986 to provide that car parking was exempt from FBT. This exemption was removed in 1993 – the government’s target was clearly the free provision of valuable parking spots in the CBD to high-income executives. Implementing the proposal has proved something of an administrative nightmare, as we shall see. Division 10A enacts the FBT on car parking – it is one of the longest regimes in the Act. A parking benefit can arise independent of any associated car fringe benefit. Section 39A provides that a car parking benefit arises on any day where: • the vehicle being parked falls within the definition of a “car” in s 136(1) of the Act; • the car is parked for a period or periods that total more than four hours during a day; • it is parked between 7 am and 7 pm (“daylight period”); • it is parked either at the employer’s business premises or at the business premises of someone else (the car park operator) that is in the vicinity of the employer’s premises; • the car is parked at a place that is within 1 kilometre of a “commercial parking station”;

[4.450]

183

The Tax Base – Income and Exemptions

• that parking station charged at least $5 (indexed from 1995; $7.07 for the 2008–2009 FBT year) to members of the public for all-day parking on the first of April of that year (“car parking threshold”), provided that the price on that day was “representative” (see ss 39AA and 39AB); • the car is either the employer’s vehicle but is provided as a fringe benefit, or it is the employee’s car; • the employee has a primary place of employment and the car is parked close to that primary place of employment; and • the car was used by the employee that day to travel between home and work. These rules have proved to be an administrative quagmire. Many important details are left to be dealt with by Taxation Ruling TR 96/26. It may give you some idea of the complexity involved if you realise that Ruling TR 96/26 consolidated and replaced eight prior Rulings trying to make these rules more workable. Consider the following questions. • How is the 1 km measured – by road, by foot, as the crow flies? Where is it measured from and to? Section 39B assists a little by saying that the 1 km is measured to the car entrance of the commercial car park. According to TR 96/26 the entrance is within the 1 km radius if it can be reached “by the shortest practicable route … travelled by foot, car, train, boat, etc., whichever produces the shortest practicable route. Where the shortest route can be travelled on foot, we expect that public thoroughfares such as arcades through shopping centres will be utilised in determining the distance. However, illegal or impractical shortcuts through, eg private property, will not be considered to be part of a practicable route.” • How many benefits arise if there are only five spots but someone inconsiderately parks across two lanes? What happens if one shift finishes at 2 pm and another starts immediately? What happens if the same employee works from 7 am till noon and from 2 pm till 7 pm? According to TR 96/26, “one car parking space can give rise to more than one benefit on a day if more than one car is parked in a space for more than four hours in total. This may occur because vehicles are coming and going from the car park during a day, where cars are made available to employees for use on a pool basis or where employees work in shifts.” As a result, there is an alternative method of valuing just the individual car spaces in s 39FA. • What is a “commercial” car park? Does it include vacant sites and parking meters? What about a shopping centre car park where there is no charge, provided the driver produces a receipt for a purchase of at least $10 from a shop in the centre? What about a council car park where there is no charge for the first two hours but a fine of $20 for vehicles parked beyond that time? According to TR 96/26 none of the following are commercial car parks: parking provided for short-term shoppers or hotel guests; all-day parking where the fee is nominal; car parking for a short period to cater for a special function; parking facilities provided by a sporting venue to persons associated with the venue; parking provided by a business for its own employees and those of a nearby business, but to no other person, if there is no commercial car park within 1 km; and a kerbside parking meter. And TD 94/54 says that the showroom of a car dealer is not a “parking facility”. • Does the commercial car park charge a fee above the threshold? For example, what if it charges $10 per day on weekdays and $5 per day on weekends; it charges $10 per day for casual parking but $150 per calendar month; does it make any difference if the month has only 20 weekdays or if it has 22? Section 39E says to pro-rate the fee (weekly, monthly, yearly) by the number of business days in the period, which would suggest that a car benefit can arise in the first month but not the second. 184

[4.450]

Income from the Provision of Services

CHAPTER 4

• What happens if the employee usually works at one place but visits another work site during a day? The policy seems to be to catch employees who regularly park in the CBD but TR 96/26 states “employer-provided parking for vehicles used for work-related purposes, which are parked next to temporary places of work (eg electricity substations)”. Consider an employee who goes to service a ski lift in the Snowy Mountains. • There is a threshold figure of $5 (indexed annually from 1995) to try to eliminate small benefits. What happens if a local commercial car park has an early bird special for all-day parking? What if it has lower effective rates for taking a space on a monthly basis? What if your factory happens to be alongside an airport with a very expensive short-term parking facility? According to TR 96/26 “the lowest all-day fee may include a fee which a commercial parking station charges for bona fide early bird parking where a reasonable number of parking spaces are set aside for those purposes”. Sections 39AA and 39AB were introduced to require that the comparison rate must be “representative”. History has confirmed that this is a difficult area, even for sophisticated taxpayers. In Virgin Blue v FCT [2010] FCAFC 137, the issue was whether the parking lot which Virgin provided for its Melbourne staff to park their cars were “at or in the vicinity of” their workplace at Tullamarine airport as required by s 39A(1)(f). The lot was almost 2 km from Terminal 3 where Virgin operates, and was a 15 minutes bus ride or 20 minutes on foot. The Full Court held that the car park was not “in the vicinity” of Terminal 3 (the portion of Melbourne airport where the employees worked), and so no fringe benefit arose. The Court said, “that the bus trip, taken twice a day, between the car park provided and the primary place of employment takes 15 to 20 minutes, excluding waiting time, serves only to strengthen this conclusion.” In FCT v QANTAS [2014] FCAFC 168, the employer allowed staff to park free on Qantas’ bases at various airports while they were working at the airport. The ATO argued that QANTAS had to pay FBT on the value of the parking provided to its employees because the parking stations at airports constituted a “commercial parking station” within a kilometre of the QANTAS base. The definition of a “commercial parking station” in s 136 refers to, “… a permanent commercial car parking facility where any or all of the car parking spaces are available in the ordinary course of business to members of the public for all-day parking on that day on payment of a fee …” QANTAS had two imaginative (but unsuccessful) arguments why these car parks were not “commercial parking stations.” First, it argued when the definition referred to parking spaces being made available to “members of the public”, the section was referring just to people who were commuters, and the people who parked at airports were not commuters. Secondly, the airport is only in the business of offering parking to a small subset of “the public” – just to passengers and their relatives dropping them off or collecting them. (This restriction was actually stipulated on the ticket for the car park at Canberra airport.) These matters all go to the question whether or not a taxable car parking fringe benefit has been provided. When it comes to finding the taxable value of a car parking fringe benefit, matters become more complicated. For the 1993 and 1994 FBT years, there were only two methods for calculating the taxable value of car parking fringe benefits: the commercial parking station method (s 39C); and the market value method (s 39D). For the FBT years beginning 1 April 1995 and later years, a further three methods for calculating the taxable value were added: the average cost method (s 39E); the car spaces method (s 39FA); and the 12-week register method (s 39GA). An employer may elect to use any of the methods, but where no election is made, the employer must keep records of actual benefits provided. [4.450]

185

The Tax Base – Income and Exemptions

• Where the commercial parking station method is used, the value of the benefit is the lowest all-day parking fee charged in the ordinary course of business at any permanent commercial parking station available to the public within 1 km of the parking facilities provided by the employer: s 39C of the FBTAA 1986. • Where the market value method is used, the value of the benefit is the amount that the recipient could be expected to pay for the benefit if the provider and the recipient were dealing with each other at arm’s length: s 39D. The employer must obtain a valuation report from an independent valuer to substantiate the amount used. TR 96/26 sets out a number of requirements about the qualifications that will be accepted as suitable and the form of the valuation report. • Where the average cost method is used, the value of the benefit is the average of the lowest fees charged by an operator of a commercial parking station within a 1 km radius of the employer’s parking premises on the first and last day the benefit is provided during the FBT year: s 39DA. • Where the spaces formula method is used, the value of the benefit is based on the number of car parking spaces available for employees, rather than the number of individual car parking benefits provided during the year: s 39FA. The amount is still derived from the commercial parking station method, the market value method or the average cost method, but the method assumes that a parking space will be used on 228 days during a year. Importantly, it caps the benefit by reference to the number of employees who work for the employer. • Finally, the 12-week register method allows an employer to calculate the taxable value of car parking benefits provided during an FBT year on the basis of the taxable value of benefits provided during a representative 12-week period: s 39GB. Like the statutory formula method, this is primarily a record-keeping system that avoids the need for the employer to keep detailed records of the number of car parking fringe benefits for a full 12-month period. If all of this sounds ludicrously complex, the government probably secretly agrees with you. In 1999, the government decided to enact a number of exceptions as a result of the report of the Small Business Deregulation Task Force. Section 58GA now contains an exemption if the employer provides car parking on its premises (or at least not in a commercial car park), provided the employer is not a government body or a listed public company and has an annual turnover of less than $10 m.

Loans and waivers [4.460] A loan benefit arises where an employer lends money (though not goods) or extends

an existing loan to an employee at a reduced interest rate (s 16). If the employer is a bank, loans at current market interest rates to employees are exempt under s 17 of the FBTAA 1986 (even though this could just as easily have been dealt with by recognising that a loan on these terms has a nil taxable value). In essence, the taxable value of a loan benefit is defined in s 18 as the difference between the interest actually charged to the employee and a notional amount referred to as the benchmark interest rate which, when you follow all the re-definitions, means the “large bank housing lenders variable interest rate for loans on housing for owner occupation last published by the Reserve Bank of Australia before the commencement of the year of tax”. Loans and extensions to existing loans are also subject to the “otherwise deductible” rule which will reduce the FBT value where the employee uses the benefit to produce assessable income. This rule is discussed in more detail later. 186

[4.460]

Income from the Provision of Services

CHAPTER 4

A loan waiver benefit arises where an employer decides to forgive an existing debt (s 14). It is not clear what happens if the employer does not formally waive the debt, but the debt just becomes irrecoverable because of the effect of the statute of limitations.

Entertainment [4.470] The treatment of expenditure on entertainment is one of the perennial difficulties of

an income tax. Images of business conferences held in exotic locations, corporate hospitality boxes at major sporting events and long business lunches lubricated by expensive wines, all subsidised by a tax deduction, are understandably not ones that appeal to the taxpaying public or their elected representatives. Consequently, governments have tried various measures to curb the extent to which these kinds of activities are subsidised by the tax system. The technical problem is to differentiate the business component of these expenditures from the personal consumption element of business entertainment – how to dissect the part that is just like promotional expenses incurred in representing the firm to its clients from the part that is a form of personal consumption for the employees. The approach adopted in the Draft White Paper in 1985 was simply to deny deductions to employers for the cost of all forms of entertainment provided by a business – in other words, to tax entertainment under the employer’s tax and at the employer’s tax rate by refusing to reduce the employer’s profits by the amount expended on entertaining both employees and clients. This was enacted as s 51AE of the ITAA 1936, now Div 32 of the ITAA 1997. The consequence of this position was to impose (usually) 30% tax on these benefits, rather than 46.5%. It was recognised from the beginning that this policy would not work where the employer was exempt from tax – simply denying a tax deduction to a person who did not pay tax to begin with was not going to result in imposing tax on these kinds of benefits. Consequently, Div 10 of the FBTAA 1986 stipulated that a taxable fringe benefit would arise where entertainment was provided by an employer who was wholly or partly exempt from income tax. The expenditure incurred by the employer in providing the entertainment or reimbursing the employee for its cost would be the taxable value of the fringe benefit. But where the entertainment expenses remained deductible under the income tax (such as provision of meals to employees in staff cafeterias, the cost of meals at certain business seminars, meals on business travel away from home) no fringe benefit would arise. In 1994, the government decided that this approach was no longer suitable. Instead, it decided to impose FBT on entertainment given by taxable (as well as tax-exempt) employers and to reinstate the tax deductibility of entertainment expenditure for employers where the expenditure gave rise to a fringe benefit. This would have the effect of taxing the business-related component of the entertainment at the employer’s rate (eg the cost of the client’s lunch) while taxing the part that was a taxable fringe benefit (eg the cost of the employee’s lunch) at the FBT rate. But businesses complained again about the compliance difficulties associated with this system for entertainment – some was not deductible; some was subject to FBT. (Who ordered the chicken? Was it the employee or was it the client?) So, in 1995 the government introduced another system – an option for a 50/50 split (half would be non-deductible and the other half deductible but subject to FBT) for entertainment in the form of meals provided to employees, and also for the “entertainment facility leasing expenses” of corporate boxes and similar hospitality facilities. A new s 51AEA of the ITAA 1936 (now Div 32 of the ITAA 1997) was introduced to allow a deduction to an employer of [4.470]

187

The Tax Base – Income and Exemptions

50% of its expenses for meal entertainment, and Div 9A was introduced into the FBTAA 1986 to impose FBT on the same 50%. Under the 50/50 split method, the taxable value of meal entertainment fringe benefits is 50% of the employer’s meal entertainment expenditure during the FBT year. Again this can be determined by using a 12-week register of the employer’s meal entertainment expenditure. The idea that food is itself “entertainment” is a trifle odd – contrast a long lubricated business lunch at the latest Michelin 2-star restaurant with the instant coffee, dubious milk and packet of stale biscuits provided in the tea room – and the ATO takes the view in IT 2675 and Taxation Ruling TR 97/17 that only the provision of food or drink that has an element of entertainment satisfies the definition, ie the provision of food or drink must confer entertainment on the recipient. So the Ruling considers that “the provision of morning and afternoon tea to employees … on a working day, either on the employer’s premises or at a worksite of the employer, is not entertainment. The provision of light meals (finger food, etc), for example in the context of providing a working lunch, is not considered to be entertainment. The provision of food or drink in these circumstances does not confer entertainment on the recipient” (TR 97/17, para 19). But at “business lunches and drinks, dinners, cocktail parties and staff social functions … the provision of the food or drink confers entertainment on the recipient [and this is so] whether or not business discussions or business transactions occur at the same time” (para 20). On the other hand, “food or drink provided where an employee is travelling in the course of performing their employment duties … is not provided by the employer in order to confer entertainment on that employee [and] the meal does not have the character of entertainment” (para 21). Ruling TR 97/17 contains a long table setting out various permutations and combinations that will and will not amount to meal entertainment for the purposes of Div 32 of the ITAA 1997 and Divs 9A and 10 of the FBTAA 1986. Some examples will give you a flavour of the complexity of this area. In the ATO’s view: • if the employer provides food and drink at a social function at its premises, the employer is providing entertainment; • if the employer provides food and drink at a morning or afternoon tea or light lunch at its premises, the employer is not providing entertainment; • if the employer provides food and drink at a restaurant, the employer is providing entertainment; • if the employer provides food and drink, including alcohol, at a restaurant but the employee is travelling on business, the employer is not providing entertainment; • if the employer pays for an employee to attend a seminar at which coffee and pastries are served, the employer is not providing entertainment; • if the employer pays for an employee to attend a convention at which there is a gala dinner including alcohol, the employer is providing entertainment.

Property fringe benefits [4.480] A property fringe benefit arises when an employee gives an item of property to an

employee for nothing, or the employee pays less than the required amount. (Notice that if the employer just lets an employee use an item of property, this is not a property benefit; it is a residual benefit or maybe a car benefit.) The taxable value of a property benefit depends on whether or not the goods are an “in-house benefit”, in which case concessions apply. An “in-house property benefit” is defined in s 136 to mean something like trading stock – tangible 188

[4.480]

Income from the Provision of Services

CHAPTER 4

property that the employer sells in its business principally to outsiders. A different taxable value is calculated for external property benefits – generally ones the employer does not ordinarily deal in and so has probably had to buy in especially from an external supplier. Section 42 sets out the taxable value of in-house property benefits. The taxable value of the benefit value will be the difference between the amount charged to the employee and some other amount – an amount that differs depending on whether the employer is a manufacturer or a trader, and whether it operates in the wholesale or retail market: • if the employer is a manufacturer of this kind of property which it sells principally to other businesses, the amount is the lowest price charged to commercial buyers (s 42(1)(a)(i)); • if the employer is a manufacturer and it sells directly to the public, the amount is 75% of the retail sales price (s 42(1)(a)(ii)); • if the employer is not a manufacturer of this kind of property, but instead purchased the property, the amount is the lower of the employer’s cost and the “notional value” of the property (s 42(1)(b)). Notional value probably means “retail price” in ordinary parlance – it is defined in s 136 to mean the amount that the employee could expect to have to pay if it wanted to buy the item; and • if none of these apply, the amount is 75% of the “notional value” of the property (s 42(1)(a)(iii), (1)(c)). So there is still a substantial tax concession available for fringe benefits in this form. It means, for example, staff discounts provided by a retailer are only taxed if the goods are sold to employees below cost. For manufactured goods, the employer can still deliver a benefit FBT free if the employee pays wholesale prices. For external property benefits, the taxable value is usually the difference between the cost to the employer and the price charged by the employer to the employee (s 43). Just as the “otherwise deductible rule” allows an employer to reduce the taxable value of loan fringe benefit because of the use to which the employee puts the loan, so too s 44 reduces the taxable value to the employer of property fringe benefits because the employee would be entitled to an income tax deduction for the cost of the benefit, if he or she had paid for it. We will return to this idea later.

Residual benefits [4.490] A residual benefit is, as its name suggests, any fringe benefit not specifically dealt with

under the other Divisions of Pt III of the FBTAA 1986. For residual benefits, the taxable value again varies according to whether the benefit is an “in-house benefit” or an “external benefit” and also whether it is a “period” or “non-period” benefit – whether a benefit is provided on a single occasion or whether it is provided over a period. For in-house period and non-period residual benefits, ss 48 and 49 provide that if the goods are also provided to the public, the taxable value will be the difference between the price to employee and 75% of the price charged to the public. For external residual fringe benefits, the taxable value will be the difference between the price to employee and the cost to employer. Again an “otherwise deductible” rule is provided in s 52.

Exemptions and concessions [4.500] We need finally to refer to the various exemptions and concessions offered for some

types of fringe benefits through their taxable value. Exemptions and concessions exist in many places, and work generally in one of four ways: [4.500]

189

The Tax Base – Income and Exemptions

• in the conditions, found in Divs 2 – 12, which determine whether or not a fringe benefit exists; • in determining the taxable value of those fringe benefits; • in the various exempt benefits provided in Div 13; and • in the reductions to taxable value found in Div 14. The main examples of exempt benefits are grouped in Div 13. They include reimbursing expenses for job interviews (s 58A), various job relocation expenses (ss 58B, 58C, 58D, 58F), newspapers (s 58H), after-hours taxi travel to or from home (s 58Z). There is also a $1,000 general threshold for certain kinds of in-house benefits provided by employers contained in s 62. There is also a general exemption for certain kinds of minor and infrequent benefits where the notional taxable value of the benefits provided during the year would be under $300 (s 58P). Division 14 contains reductions to taxable value of various benefits. Examples include the housing, fuel and holiday benefits provided to employees working in remote areas. [4.505]

4.43

4.44

4.45

Questions

How are the following cases treated (if at all) under the FBT? You will need to consider whether the item is a fringe benefit and, if so, of what type; whether it is provided by an employer in respect of an employee; and then determine its taxable value. (a) a car is provided by an employer to an employee which is used exclusively for the private purposes of the employee. No log book is kept. All the running and garage costs at a city parking station are paid by the employer; (b) the car is kept on the employer’s premises and is available only for business use by employees. No log book is kept. The employer pays all the costs of the car. Consider how these potential fringe benefits are dealt with: (a) a loan is made by the Australian branch of a Japanese bank to an employee stationed in Sydney, the loan being in yen with an interest rate of 6% which is a commercial rate for yen; (b) interest-free loans made by a family company to its employee directors are cancelled, the loans being repayable at call. Consider these potential fringe benefits: (a) conveyancing services are provided to an employee of a solicitor free of charge; (b) the solicitor permits the employee to do her or his own conveyance using the firm’s facilities free of charge; (c) (d) (e) (f)

4.46

a private school provides places free of charge to the children of the teachers; a brewery provides free beer to all employees at lunch; a company provides a free lunch to senior executives in the board room; a company provides free use of a house that it owns to a husband and wife who are directors of the company. The company was formed in the 1970s as a death duty avoidance device. The husband and wife draw directors’ fees. What kind of benefit arises where an employer reimburses the parking station expenses of an employee?

(v) “Otherwise deductible” rule [4.510] Many fringe benefits – loan and property benefits, for example – are subject to a

special valuation rule known as the “otherwise deductible rule”. Its operation is complicated 190

[4.505]

Income from the Provision of Services

CHAPTER 4

to explain and may be more easily demonstrated by an illustration. In essence, these rules are needed to deal with situations created by the way FBT operates – that is, FBT is collected directly from the employer rather than at the level of the employee, and it is collected on the gross value of the benefit provided, not on a net value. The two examples below show one situation where the employee will already be adequately taxed on a fringe benefit under the income tax regime (and so her employer should not be liable to FBT as well), and another where no tax, either FBT or income tax, should actually be paid. Consider first what happens if the employee uses the fringe benefit represented by a low-interest loan to generate assessable income? What would happen if, for example, she lends the money borrowed from her employer at a low interest rate to some other institution at a higher interest rate? For example, assume that she earned $40,000 salary and borrowed $50,000 at 10% from the employer under an employer-subsidised loan scheme which she on-lent at 15%, which we will assume is the current benchmark rate. Her income tax position would have been: Salary Interest received Interest paid Taxable income

$40,000 $7,500 (5,000) $42,500

The employee is effectively taxed on both the salary and the low interest portion of the loan under the income tax and is taxed on the right amount – the net $42,500. But the low interest element is also a loan fringe benefit and is taxed to the employer as a fringe benefit. Unless something is done, the employee will pay on the $2,500 under the income tax and the employer will also pay tax (FBT) on the same $2,500 – remember the amount of the fringe benefit is the difference between the benchmark rate (15%) and the rate actually charged (10%) which equals 2.5% of $10,000, that is $2,500. The double tax problem is addressed in the FBT by the otherwise deductible rule. Under the otherwise deductible rule in s 19 of the FBTAA 1986, the taxable value to the employer of the loan made to the employee will be reduced to the extent the loan is used by the employee to generate assessable income. Similar otherwise deductible rules are a common feature of the valuation rules in other Divisions of Pt III and so we will look at s 19 in some greater detail to see how they work in this relatively straightforward circumstance. We will use the example just given: The employee on-lends at 15% the loan of $50,000 originally made by the employer at 10% and assume that all the events occurred after 1 April 1988. Now begin reading s 19(1). You will see after para (d) that “the taxable value … of the loan fringe benefit” is calculated using the formula given there rather than the s 18 calculation where the earlier paras (a) to (d) are satisfied. [4.515]

4.47 4.48 4.49

Questions

Is para (a) of s 19(1) satisfied; is she an employee? Is para (b) of s 19(1) satisfied; would she have been entitled to a once-only allowable deduction under the ITAA if she had paid interest as postulated? Is para (ba) of s 19(1) satisfied; is the gross deduction (see para (b)(i)) larger than the amount of interest that would have been allowable as a deduction to her? [4.515]

191

The Tax Base – Income and Exemptions

4.50

Is para (c) of s 19(1) satisfied; is this an “employee credit loan benefit”? If not, assume that the declaration has been given.

4.51 4.52

Are either of para (ca) or (d) of s 19(1) applicable? Assuming that paras (a) to (d) of s 19(1) have been satisfied, now calculate the taxable value using the formula TV–ND. (See para (ba) for the definition of the notional deduction.) Assume for s 18 that the notional amount of interest is 14%.

[4.520] Section 19 is clearly a complex provision to apply and it can be made even more

difficult where the taxpayer’s position is slightly out of the ordinary. What happens, for example, if the employer lends not to the employee alone, but to the employee and their spouse jointly? The total low-interest amount is clearly still a fringe benefit – it is provided to an employee and an associate of the employee – but can s 19 still apply where the loan is then applied by them together to generate other income? In National Australia Bank v FCT (1993) 46 FCR 252; 26 ATR 503; 93 ATC 4914 the ATO argued that s 19 could not apply because the once-only income tax deduction required for s 19 was actually attributed to a different taxpayer under the income tax – the partnership of the taxpayer and spouse. The argument was unsuccessful. Another variation also arose in that case from sequential loans – where the employee borrowed at the low interest rate (say 10%), lent to the spouse at a slightly higher rate (say 11%), and the spouse then used the loan to produce a greater amount of assessable income (say 15%). This is a common income splitting technique designed to use the income-earner’s creditworthiness to secure the loan but to channel most of the income to the spouse who faces the lower marginal tax rate. A line of cases discussed in Chapter 7 has held that in certain circumstances, the first borrower is not entitled to deduct the full amount of interest incurred. Ryan J applied these cases to s 19 to hold that in the application of s 19, the “once only deduction” allowable would not be the amount of interest actually charged to the employee but only a fraction of that amount. The second instance where an “otherwise deductible” rule is needed arises where an employee would not be subject to tax if he or she had taken the cash instead and then spent to buy the fringe benefit at a store. This will commonly arise where an employer provides a benefit in kind that would, if purchased by the employee, have given rise to an offsetting allowable deduction. In other words, the employee would have had no income tax liability if they had received cash and then spent it to buy the fringe benefit. But because FBT is levied at the employer level, there is the possibility of FBT where there would not have been income tax on the cash equivalent. Consider the position of an employer, say an accounting firm, that decides to purchase a book costing $100 and give a copy to each employee involved in providing tax advice. This would be a property fringe benefit. However, if the employees had been paid $100 salary and purchased the book themselves, they could have deducted its cost and no income tax liability would be imposed on the $100 of salary. Section 44 attempts to recreate this result by again reducing the taxable value of the fringe benefit where the employee would be entitled to a once-only deduction. The operation of the otherwise deductible rules can be seen in Roads and Traffic Authority of NSW v FCT. The case involves the explicit otherwise deductible rule in s 52 of the FBTAA 1986 for property benefits, and a hidden one in s 30(1)(b) for living-away-from-home allowances. The ATO tried to impose FBT on the employer for the cash camping allowances and accommodation in camp sites that it provided to its employees who worked in remote areas. Hill J found that although the camping allowance was a living-away-from-home allowance, it was paid to meet expenses that would be deductible to the employee and so was 192

[4.520]

Income from the Provision of Services

CHAPTER 4

not taxable. Similarly, in relation to the accommodation provided to employees in camp sites, the employees would be entitled to a “once-only deduction” where they were required to reside at the work site for periods of time and to bear the cost of the accommodation as part of their employment. Consequently, the otherwise deductible rule applied and the benefit had no taxable value. One important term in the otherwise deductible rules is the requirement of a “once-only deduction”. This creates serious problems where the benefit provided would not be immediately deductible if purchased, but would be fully deductible over time through the depreciation provisions in Division 40 of the ITAA 1997 or similar provision. So, for example, assume that the employer provides the employee with a low-interest loan to buy an investment property and pays the employee’s legal expenses of $500 in seeking advice about whether to take up the loan. The low interest component would be dealt with under s 19 of the FBTAA 1986 because the loan will be used to produce further income. But the $500 legal expenses will create a problem. They are deductible in part only, and over a period of five years under s 25-25 of the ITAA 1997; the employee is not entitled to a “once-only deduction”. Consequently, the full value of the payment of the legal expenses is taxable in full where the employer pays the amount as a fringe benefit, even though the employee would have been entitled to exclude the $500 from his income, albeit over five years. [4.525]

4.53

Question

What would happen if an employer provided its employees each with a notebook computer for use at home, in the expectation that it would be used at least in part for work purposes, but in all likelihood mostly for private purposes? Consider whether s 58X would apply. Until 13 May 2008, s 58X(2) used to refer specifically to mobile phones, pocket calculators, PDAs, notebook computers and laptops. Do you think the new wording includes notebook computers? What happens if it does not?

(vi) Integrating FBT and the ITAA [4.530] FBT can be viewed as if it were a discrete tax, distinct and isolated from the income

tax. It is imposed: • under a different Assessment Act (compare the integration of CGT into the ITAA); • upon another class of taxpayers, that is, employers, so that it is not at least formally on those who gain but those who pay; • upon a different tax base than the income tax – that is, the gross value of benefits provided; and • using a different assessment period (April to March). But there has to be a means of integrating the FBT with the ITAA because they both deal with a common matter – rewards provided to employees – and are interrelated by express terms. There are exemptions within each relating to the other, definitions needed for one can be found in the other and, of course, the subject matter of each tax could often be dealt with under either – or both. The goal of FBT is to ensure that all remuneration to employees is taxed but that it is taxed only once either in the hands of the employer or the employee. There are many ways in which the FBT and the ITAA are integrated to achieve this result: 1.

Some benefits are excluded from the operation of FBT by the definition of “fringe benefit”. For example, s 136(1) of the FBTAA 1986 excludes from FBT wages and [4.530]

193

The Tax Base – Income and Exemptions

salaries, share schemes, and eligible termination payments. These of course are all taxed under ITAA 1997, hence the exclusion from FBT. 2.

For benefits which are covered by FBT, s 23L of the ITAA 1936 makes non-assessable non-exempt income any “income” derived by a taxpayer by way of the provision of a fringe benefit. This prevents double tax and allows the FBT to have primacy.

3.

Not only are taxable fringe benefits removed from the income tax, so too are exempt fringe benefits – that is, no income tax is payable on income that is a fringe benefit, whether the benefit is taxed under the FBT or not. Section 23L(1A) of the ITAA 1936 makes exempt income a fringe benefit that is made an exempt benefit because of para (g) of the definition in s 136(1) of the FBTAA 1986. Here the issue is not one of double tax, but rather of preserving the exemption offered in the FBT from being negated by the imposition of income tax.

4.

Some benefits are included as fringe benefits taxable to the employer where the employee is already adequately taxed and where the employee would not ultimately have paid tax if he or she had been paid in cash instead. This would arise where the employee was entitled to a deduction against the cash salary if it had simply bought the fringe benefit. The otherwise deductible provisions attempt to alleviate this situation. They effectively pass back the employee’s deduction to the employer in ways discussed above.

5.

Since 1999, employees have been required to report certain kinds of fringe benefits in their income tax returns. These benefits are not reported so that they can be taxed; they are reported in order to judge whether the employee is a high-income or low-income person. For example, the amount of fringe benefits received during a year affects whether the person is entitled to enjoy the tax rebate for low-income earners, is required to pay the Medicare levy surcharge imposed on high income earners or is required to start repaying a HECS-HELP debt. Amounts which are non-deductible to employers under the ITAA have to be adjusted with the FBTAA 1986. Special rules deny deductions to employers for some entertainment expenses, fines and so on. Without some adjustment, the employer (rather than the employee) would pay income tax on these benefits (by having its taxable income increased by the amount which it was not allowed to deduct from its assessable income) and again under FBT. Where these two regimes overlap, the FBT regime is given priority, so that the benefit is made deductible but only where it will be subject to FBT. (See, for example, ss 26-30(3), 26-45(3) and 32-20 of the ITAA 1997.)

6.

7. 8.

Employers are entitled to a deduction for the payment of FBT under s 8-1. Also, an employer is assessable on a payment made by an employee in reimbursement of the FBT liability (due to the repeal of s 23M of the ITAA 1936).

(c) Problems of FBT [4.540] The discussion above suggests that there are reasons of horizontal and vertical equity

for taxing fringe benefits as if ordinary income. It also suggests that economic efficiency would be enhanced if the tax system did not influence choices about the manner in which remuneration is taken and offered. FBT was designed to accomplish these goals, but how successful is it? If one were to judge by the ongoing condemnation of the tax by industry since its inception, and the level of tinkering undertaken by government enacting carve-outs, concessions and qualifications, it has serious shortcomings. 194

[4.540]

Income from the Provision of Services

CHAPTER 4

In this section we will look again at what FBT was intended to achieve and will explore some of the problems that it has created in the process. All stem from the design of the tax – it is a flat rate, excise tax on gross benefits provided. The simplest way to tax fringe benefits would have been to enact a series of valuation rules and then to require employer withholding – it is the valuation part that is crucial; the rest is relatively simple. Chapter 9 of the Asprey Committee report suggested just this. The Committee suggested that an adequate solution would be for all amounts given as fringe benefits to be included for PAYG withholding and be shown on group certificates. The FBT solution came from the New Zealand Task Force on tax reform (the McCaw Committee), but it recommended the FBT only for certain difficult-to-tax items and only as an interim measure. The Draft White Paper picked up this approach because it was said to be administratively simpler and “less disruptive”. But the criticism levelled against FBT has been lasting. The report of the Review of Business Taxation in 1999 recommended that “all employee fringe benefits (with the exception of entertainment and on-premises car parking) provided to an individual employee be taxed to that employee, with that tax being collected under the PAYG system” (recommendation 5.1). This recommendation was immediately rejected by the Treasurer, Mr Costello, on the fallacious ground that, “there are about 70,000 employers that are subject to [FBT] at the moment, about 1,000,000 employees [and this would imply] taking [tax] off a smaller group and putting it onto a larger group …” (Treasurer’s press conference, 24 February 1999). The fallacy is that the 1,000,000 employees would actually have much of a role in the payment of tax. If the tax on fringe benefits were collected by PAYG withholding, the main work would still be done by the 70,000 employers. Certainly, employees would have to report their fringe benefits in their tax return as income; at the moment, they report fringe benefits in their tax return as a reportable fringe benefit. (i) Over- and under-inclusiveness of the FBT base [4.550] The evil which FBT was introduced to remedy is obvious enough, but the FBT scheme is not a completely consistent and exhaustive solution to it. As D J Collins observed in “Taxation of Fringe Benefits – An Economist’s Perspective” (1987) 4 Australian Tax Forum 95: “not all … employment benefits have been defined to be fringe benefits for the purposes of the current FBT legislation and some benefits which have been included in the tax base are, it could be argued, not genuine benefits.” In simpler terms, the FBT base is both over- and under-inclusive. [4.555]

4.54

Question

How does FBT deal with payments such as the following? the reimbursement to employees of employment expenses; (a) (b) the reimbursement of petrol costs for undertaking an isolated errand: see s 22 of the FBTAA 1986 and s 15-70 of the ITAA 1997; (c) a payment of the type made in Hochstrasser v Mayes: see s 58C of the FBTAA and compare it to the result in that case – see also Ruling IT 2614; (d) study leave; (e) long service or annual leave beyond award requirements; (f) employer-funded superannuation; and (g) food and drink provided on the taxpayer’s premises: see s 41.

[4.560] But the problem of the tax base being under-inclusive is not the matter that has so

focused the complaints from industry, as one might expect. The matter that has concerned [4.560]

195

The Tax Base – Income and Exemptions

them is the over-inclusive nature of the base where it picks up items that are not gains from employment. Consider as an example s 47(3) and (4) which states that using the office toilet is not a fringe benefit. It is odd to think that such a provision is necessary. If it is, there is clearly an over-reaching definition of benefit somewhere if it includes items that are better seen as “working conditions” than “fringe benefits”. And while this provision has addressed some working conditions, the issue will not be a simple one as the exception is qualified. What is the status, for example, of the toilet in the shopping centre for a person who works in one of the shops? This is not just an idle question. In long-running litigation Esso has been arguing with the ATO over the term “business premises”. This term is used in s 47(2), which creates an exemption from FBT for a fringe benefit being the provision of a child care facility on the business premises of the employer. The ATO had taken the sensible view that the exemption was triggered if the premises in question was “off-site” – that is, if main offices were in the CBD, a dedicated child-care facility located in a leafier suburban site would be “business premises” of the employer; the child care facility did not have to be in the basement or on the roof of the head office (TR 96/27, para 41). But in the Ruling, the ATO had expressed the view that this exemption did not apply where two or more employers shared control of the child care facility, or the site was owned as tenants in common because a shared facility was not the exclusive business premises of the employer. This view was upheld in AAT Case 12,826; Re Esso Australia Ltd v FCT (1998) 38 ATR 1160; 98 ATC 2085 but overturned by Merkel J on appeal in Esso Australia Ltd v FCT (1998) 40 ATR 76. The ATO accepted the decision and issued an extensively revised ruling, TR 2000/4, outlining what he believes the words “business premises” mean. (ii) Taxable value [4.570] The problems of defining the base are compounded by difficulties in calculating the

taxable value of many benefits. It is not sufficient to guarantee neutrality for the FBT to have a base which covers most fringe benefits. Incentives to substitute fringe benefits for cash will still persist if the FBT regime gives a more favourable tax result than the income tax in other ways – for example, by subjecting a smaller amount to the tax, or by having the amount included taxed at a preferential rate. There are examples in FBT where less than the full value of a fringe benefit included in the FBT base is subject to the tax. For example, where an item of property is provided by an employer from its own stock it is an “in-house benefit” and is usually taxable at either a wholesale market price or 75% of retail. Where the item was purchased, the taxable value is the employer’s cost which again might be a wholesale price. Perhaps the most concessionary valuation rules apply to car fringe benefits. The nature of the concessions and their impact on their environment is analysed in Celeste Black, “Fringe Benefits Tax and the Company Car: Aligning the Tax with Environmental Policy” (2008) 25 Environmental and Planning Law Journal 182. (iii) Tax rate [4.580] Once the choice is made to tax the employer rather than the employee on the value of

fringe benefits, a decision must be made on an appropriate tax rate to apply to the fringe benefit. Some of the problems of setting a rate are obvious: • if the employee had paid the tax, he or she would have paid tax at progressive rates so ought the employer pay at progressive marginal rates; 196

[4.570]

Income from the Provision of Services

CHAPTER 4

• if the employer does not pay tax at a rate related to the employee, does it pay at a rate applicable to an individual or pay at the company rate? Revenue neutrality will be encouraged if the FBT rate produces the same resulting revenue as that payable if the tax is paid by the employee, but the tax will only be comparatively efficient if it creates no greater substitution incentives. FBT is often regressive because the rate of tax has been set at the top personal marginal rate plus Medicare levy without regard to the employee’s actual marginal rate. This would not be a serious problem if all fringe benefits could in practice be “cashed out” by employees – that is, the employee could revert to their marginal tax rate by electing to take cash instead of fringe benefits. The taxpayer in Tubemakers (above) was trying to reduce the total tax cost of providing benefits to retired workers, few of whom would have been facing a lower marginal tax rate. But that will not be possible for all benefits. You may wish to consider what cash alternative is available to a taxpayer in the position of the taxpayer in Roads and Traffic Authority where its employees are working on a stretch of road 200 km from the nearest town – there is likely to be little practical alternative to providing accommodation in kind. The first Discussion Paper of the Ralph Committee, A Strong Foundation (AGPS, Canberra, 1998, p 20) notes that even where both the employee and employer are willing and it is possible as a practical matter, the ability to cash out benefits can sometimes be constrained by industrial awards and enterprise agreements. Again, Roads and Traffic Authority displays the kind of benefits that still commonly exist under awards. (iv) FBT-inclusive tax base [4.590] Another dimension to this problem arises from the decision in 1994 to include the

FBT in the tax base – that is, the decision that the tax base should be a tax-inclusive base, like the income tax base. Prior to 1994, FBT was levied on a tax-exclusive base – the value of the fringe benefit did not include the FBT that had to be paid on it. This was the first step. There was another step, which was the treatment of the payments of FBT itself. It was made non-deductible to employers for income tax purposes becoming an additional cost to the employer (s 51(4A) of the ITAA 1936). Under that system, once the highest marginal tax rate for employees (49% today) significantly exceeded the company tax rate (then 36%), there was still an incentive for remuneration to be provided by way of fringe benefit rather than salary. The employer could provide (or the employee could receive) larger benefits to employees at the same cost to it as providing the remuneration in the form of salary. The reason was that the provision of a fringe benefit under the FBT system really consists of two benefits – the actual fringe benefit and the employer (not the employee) paying tax on it. But these two benefits were taxed at different rates: the benefit was taxed at the FBT rate, but the second benefit was taxed only at the corporate rate. Now, s 66 imposes on employers a liability to pay FBT on their “fringe benefits taxable amount”. Part IIA sets out how the “fringe benefits taxable amount” is calculated. It basically takes the after-tax value of a fringe benefit and adds back the amount of FBT. The FBT rate is then applied to the grossed-up amount of taxable values to determine an employer’s FBT liability. The reason why this was done, and how it works, probably deserves some clearer exposition. The table below compares paying cash salary to paying a fringe benefit under both [4.590]

197

The Tax Base – Income and Exemptions

systems. (Note that, to avoid complicating things too much, the table uses current tax rates, not the actual tax rates in 1994.) Cash salary Cost to employer Employer’s tax deduction at 30% FBT at 49% Employer’s tax deduction for FBT at 30% After tax cost to employer

196 (58) – – 138

Fringe benefit pre-1994 100 (30) 49 – 119

Employee’s benefit Employee’s income tax at 49% After-tax benefit to employee

196 96 100

100 – 100

Fringe benefit post-1994 100 (30) 96* (28) 138 100 – 100

*

96 is the tax rate of 49% applied to $196. The $196 is derived from the taxable value of the fringe benefit: $100 multiplied by (49% / (1 – 49%)) = $196. The example assumes that the employee is getting $100 worth of reward for her efforts, either as after-tax cash or tax-free fringe benefit; the employer used to pocket the $19 tax saving. And remember that these figures will change from 1 April 2017 if the temporary budget repair levy is repealed and the FBT rate declines to 47%. (v) GST-inclusive tax base [4.600] The FBT gross-up procedure was made even more complicated with the introduction

of the GST in 2000. Now it is necessary not only to gross-up the value of a benefit for the FBT on it, it is also necessary to gross-up for the GST that has not been paid (and the tax on the GST). Indeed, the interaction of FBT and GST which the rules in Part IIA try to solve is so fiendishly difficult that most of the permutations are ignored here. The complication arises in part because GST is meant to be a cost to consumers, but not to businesses (like employers). In other words, if the employee had to buy a fringe benefit that is subject to GST such as a book, he or she would have to earn $110 (after payment of income tax), but his or her employer can buy the same item for $100 (after the refund of the GST of $10 charged to it). However, not all employers (banks and insurance companies, for example) are entitled to recover all the GST embedded in their costs. This kind of employer has to pay $110 because it will not get a full refund of the GST of $10. A third part of the puzzle arises because not all commodities are subject to GST, even when purchased by consumers. So, for a fringe benefit which is not subject to GST to begin with, such as a prescription medication, the employee would only have to earn $100 (after payment of income tax) in order to buy the fringe benefit. For the easiest cases, the gross-up formulas are now contained in s 5B(1B) and (1C) of the FBTAA. Subsection 5B(1B) provides the gross-up rate for “Type 1 fringe benefits”. Type 1 benefits are those which are subject to GST and for which the employer can recover a GST input credit (s 5C(3)). Section 5B(1C) provides the gross-up rates for “Type 2 fringe benefits” (defined in s 5C(4) as those benefits that are not subject to GST, and so no input tax credit 198

[4.600]

Income from the Provision of Services

CHAPTER 4

arises for the employer). The formula in s 5B(1B) converts to a gross-up rate of 2.14. The formula in s 5B(1C) converts to a gross-up rate of 1.96. To see how these gross-up formulas work, consider an employee who is offered either a GST-taxable fringe benefit by an employer or is offered the cash to buy the same benefit. Cash salary Cash salary Employee’s tax (at 49%) Value of salary

$214 (114) $110

Fringe benefit Value of benefit Employee’s tax Value of benefit

$110 Nil $110

Now consider the position of the employer who offers either a GST-taxable fringe benefit to the employer or else the cash to buy the same benefit. Cash salary Cash salary

$214

Tax deduction (at 30%) Cost of salary

(64) $150

Fringe benefit Cost of benefit (after input credit) FBT ($110 × 2.14 x 49%) Tax deduction (at 30%) Cost of benefit

$100 $114 (64) $150

For GST-free benefits, the gross-up formulas do not need to take into account the GST and so work as did the old gross-up rules – that is, $100 of GST-free fringe benefit becomes a benefit with a taxable value of $196. The relationship between GST and FBT is discussed more fully in two Rulings: TR 2001/2 and GSTR 2001/3. (vi) Tax-exempt employers [4.610] For taxable employers the change from a tax-exclusive to a tax-inclusive calculation

in 1994 worked as designed, but these changes had important consequences for employers in tax loss and tax-exempt bodies, particularly charities and hospitals. The value to them of a tax deduction for FBT was reduced (to zero in the case of a tax-exempt employer) so that their cost of providing fringe benefits increased substantially. In other words, a tax-exempt employer was required to calculate its FBT liability by the gross-up method but was unable to utilise the tax deduction for FBT. Therefore, from 1 April 1994, the government amended s 65J(1) of the FBTAA to allow many tax-exempt employers to claim a rebate against their FBT liability. The rebate is available, for example, to religious institutions, research bodies, charities and many not-forprofit organisations. The rebate is calculated under s 65J(2A). It results in most cases in the organisation being able to pay benefits with a value of up to $30,000 per employee per annum before FBT will be triggered. If the benefits exceed $30,000 it must pay FBT on the excess. [4.615]

4.55

4.56

Questions

What incentives will operate where an employer, prior to the introduction of FBT, paid the car insurance premiums of its employees where most of them earned less than $30,000 per annum? What if most earned over $130,000? Will FBT have the somewhat perverse effect of encouraging more staff discounts and executive dining rooms? [4.615]

199

The Tax Base – Income and Exemptions

(vii) Interaction with surcharges – reportable fringe benefits [4.620] We made the point above that FBT is designed to leave employees out of the system so

far as possible: to collect the tax from the employer; to make the benefit exempt from tax at the employee level; and to have no final reconciliation at the employee level, which means passing the benefit of employee deductions back to the employer through the “otherwise deductible” rules. But in 1999, the government decided to require all employers to report the value of fringe benefits on their PAYG Payment Summaries and for employees to transfer this amount onto their tax returns: see s 135M of the FBTAA 1986. Why bother? The intention of this measure was to ensure that access to social security benefits and other regimes, which depend upon a person’s income, would be calculated based on a person’s cash salary and fringe benefits, not just on the person’s cash salary. So we now have requirements to report “reportable fringe benefits”. The measure affects the computation of the low income tax offset, Medicare Levy surcharge and HECS-HELP debts. What seems like a simple idea has again been implemented with an enormous degree of complexity. An employer is required to report on an employee’s Payment Summary any fringe benefit where the taxable value of the benefit exceeds $1,000. For some reason, however, not all benefits are counted. Section 135P(2) and s 5E(3) combine to exclude car parking fringe benefits and meal entertainment fringe benefits from the reporting requirement, and these exemptions from reporting have gradually expanded over time with special exemptions for military personnel, police and so on: s 5E(3) of the FBTAA. Further, even some benefits which were exempt from FBT so far as the employer was concerned, now have to be identified and valued by the employer so that they can be reported on the group certificate. Notice, finally, that the amount which has to be reported is the “grossed-up” taxable value of the benefit – that is, the value of the fringe benefit is grossed-up for FBT, but not for GST. (viii) Problems of FBT for international placements [4.630] One of the most significant issues with the entire FBT edifice – and there are many – is

the way that the FBT works internationally. The international norm is that employees are taxable on their salaries and benefits, they pay that tax to the country where they work, and if they also owe tax to their home country, they are entitled to a credit for the paid abroad to reduce the tax payable in their home country – a position which is reflected in the international tax treaties that Australia executes with other countries. Employers may have withholding obligations, but it is the employee who bears the formal and effective burden of the tax. Fringe benefits tax departs from this model. The formal incidence of FBT is on the employer, not the employee. So consider a foreign employer who brings staff to work in its Australian branch. It will face FBT in Australia if it, say, provides them with short-term rented accommodation for a year or so. If the employees remain residents of their own country, they may be liable to tax in their home country on these fringe benefits, and would be entitled to a credit against the tax in their home country for any Australian tax they paid. Unfortunately, they have not paid any Australian tax, notwithstanding that their employer may well have debited their salary package for an amount of Australian FBT. This means that an employee is potentially subject to double tax on things which we choose to call fringe benefits and tax in that manner. No unilateral mechanism in a foreign country is likely to solve the problem, nor will most of our tax treaties accomplish this task unless, and until, we renegotiate all our treaties to include appropriate provisions. 200

[4.620]

Income from the Provision of Services

CHAPTER 4

In reality, what is likely to happen is that the employer will simply bear the cost of the Australian FBT and probably also the employee’s home country income tax, but it unnecessarily adds to the cost of having Australian operations. And while Australia may argue that it has the prime right to tax fringe benefits in these circumstances, and it is for the home country to work out some way to recognise this, we have made it a problem by adopting a practice which departs from the international norm. (ix) Unallocable benefits [4.640] There is one very plausible reason for using FBT in substitution for withholding from

wages. That reason arises from the problem of non-individualised benefits. Taxpayers often enjoy global benefits like a subsidised canteen or health clinic, which are provided indiscriminately to all employees and probably in different amounts. With these benefits, there is real difficulty in isolating a benefit that is attached to only one employee and valuing it accurately. Where benefits cannot easily be allocated to individual employees, there is good reason to use an undifferentiated employer-based tax like FBT as the mechanism for taxing the benefit. (Indeed this is probably the best argument in favour of the FBT way of doing things – there is no need to work out who had the chicken for lunch; who used the medical clinic last year; who parked in Bay 12 last Thursday.) The alternative is to deny the employer any income tax deduction. Unfortunately, the Australian FBT failed for a long time to grasp this point. So, when the first car parking rules were introduced all the requirements of the section looked to the employee and not the car space. Eventually, it was considered that if the parking spot was the valuable item, one quite acceptable way to tax it was simply to tax the spot – see the spaces method in s 39FA. But this is the only example in the law, and the basic pattern of insisting on trying to allocate benefits to individual employees has been followed elsewhere. This lesson was forgotten when the government announced the reportable fringe benefits scheme in 1999 – it requires benefits to be attributed to individual employees, although not all benefits are reportable benefits, in recognition of the difficulty of doing this. This issue of being able to (or having to) allocate benefits to individual taxpayers has cropped up in another way in the FBT regime. During the 1990s, a number of mass-marketed tax schemes were promoted to employers as tax-effective ways of reducing their income tax, while not triggering FBT. These schemes were investigated by the Senate Economics Committee and described in its 2002 report, Inquiry into Mass Marketed Tax Effective Schemes and Investor Protection. Some of these schemes involved superannuation and are described below; others involved setting up “employee benefit trusts” or “employee incentive schemes”. They operated in this fashion: the employer would set up a trust, with itself or a related entity as trustee, and then contribute cash to the trust. The beneficiaries of the trust were described in discretionary terms: the employees, directors or others, to be designated by the employer at some later time, because of meritorious service. (In another variant, the beneficiaries of the trust were denominated by holding units, but those units were only issued – to employees, directors or others – by the trustee at some later time in response to a request from the employer to issue units because of meritorious service.) The trustee would then invest the contributions in various ways, sometimes lending the contributions back to the employer. The taxpayers were told that this resulted in a tax saving – the contribution to the trust was deductible to the employer as a cost of employing its employees; the trustee did not pay on the amount it received because it represented the corpus of the trust, not income of the trust, and [4.640]

201

The Tax Base – Income and Exemptions

no fringe benefit arose to the employer because no particular employee had been designated as entitled to the amount contributed to the trust, and in any event, the benefit had not yet been provided to an employee or an associate of the employee. The ATO disagreed. The ATO took the view in TR 1999/5 – Employee benefit trusts and non-complying superannuation funds – that the trustee was an associate of the employee and the inability to allocate the benefits to a particular employee did not matter for FBT purposes: 5. A trustee of a trust … that is constituted to provide benefits to employees can be an associate of an employee … notwithstanding that no employee (or associate of the employee) is a beneficiary or member when the benefit is provided to the trustee. It is sufficient if, at the time the benefit is provided to the trustee, there is an arrangement to benefit the employees and an employee will subsequently be made a beneficiary.

This view was subsequently tested in the courts in a number of cases starting with Essenbourne v FCT (2002) 51 ATR 629; [2002] FCA 1577. This company had contributed $252,000 to an employee benefit trust which the ATO assessed to FBT as either a property benefit or a residual benefit. Kiefel J disagreed with the ATO’s view: 54 In my view, Essenbourne is correct in its contention that the definition of “fringe benefit” requires reference to a particular employee in connexion with the benefit said to have been provided. This is reflected in the references to a benefit being “provided to the employee or to an associate of the employee” and to the benefit being provided “in respect of the employment of the employee”. The latter reference, in particular, can only be to a particular person’s employment.

The ATO decided not to appeal against this decision and continued administering the law on the basis of the views in TR 1999/5. The ATO lost this point in a series of cases: Kajewski v FCT (2003) 52 ATR 455; [2003] FCA 258; Pridecraft and Spotlight Stores v FCT (2004) 55 ATR 745; [2004] FCA 650 and on appeal (2004) 58 ATR 210; [2004] FCAFC 339; Indooroopilly Children Services Qld v FCT (2006) 63 ATR 106; [2006] FCA 734 and on appeal (2007) 158 FCR 325; [2007] FCAFC 16. Eventually the Federal Court lost its patience with the ATO’s refusal to accept defeat. In February 2007, Allsop J in the Full Court said in Indooroopilly: 3. … [the] taxpayers appeared to be in the position of seeing a superior court of record in the exercise of federal jurisdiction declaring the meaning and proper content of a law of the Parliament, but the executive branch of the government, in the form of the Australian Taxation Office, administering the statute in a manner contrary to the meaning and content as declared by the Court; that is, seeing the executive branch of government ignoring the views of the judicial branch of government in the administration of a law of the Parliament by the former. This should not have occurred. If the appellant has the view that the courts have misunderstood the meaning of a statute, steps can be taken to vindicate the perceived correct interpretation on appeal or by prompt institution of other proceedings; or the executive can seek to move the legislative branch of government to change the statute.

The ATO withdrew TR 1999/5 in June 2007 and appears to accept the position expressed in Essenbourne. When TR 1999/5 was withdrawn, the notice of withdrawal says: 3. The decision of the Full Federal Court in Indooroopilly … found that, for the purposes of determining whether there was a fringe benefit, it was necessary to identify, at the time a benefit was provided, a particular employee in respect of whose employment the benefit was provided. 5. TR 1999/5 is withdrawn as the Commissioner accepts the finding of the Full Court in Indooroopilly, as set out in paragraph 3 of this Notice.

Before we leave this point it is worth noting that while the ATO might have lost the battle in these cases, it by no means lost the wars. The taxpayers in Kajewski, Pridecraft and Spotlight 202

[4.640]

Income from the Provision of Services

CHAPTER 4

Stores and Indooroopilly all failed, but for other reasons. They were denied the benefit of the deductions claimed for the contribution to these funds either under s 8-1 or because Pt IVA was applied, and so the ATO collected some tax – 30% from the companies under income tax, rather than 49% from the companies as FBT.

4. SPECIAL CATEGORIES OF EMPLOYEE REMUNERATION [4.650] In this part of the chapter we return to focus on the operation of the ITAA and will

consider two of the statutory regimes which are found there to tax certain forms of employment income. Unlike FBT, these regimes complement and modify ordinary usage income and s 15-2 of the ITAA 1997, supplementing rather than attempting to completely supplant them with some other tax. But because they are so specialised, there are suggestions, at least in one of the cases, that there will often be little residual room for ordinary usage and s 15-2 to operate if, through some oversight, the specific regimes do not apply.

(a) Employee Share Schemes [4.660] One important regime in the Act to include a particular kind of employment income is

the set of rules dealing with employee share schemes. These rules were previously found in s 26AAC of the ITAA 1936 and then Div 13A of the ITAA 1936. The new rules are now in Div 83A of the ITAA 1997, enacted in 2009, and these rules were subject to significant tinkering in 2015. The history is important because the old rules continue to apply to the older schemes and shares or options issued under them. The regime provides a series of rules for taxing the value of shares and options to purchase shares given to employees as part of their salary package. It was introduced to overcome what were seen as the practical and administrative difficulties arising from the decision of the House of Lords in Abbott v Philbin [1961] AC 352 (extracted in Chapter 2) and the later Australian decision in Donaldson. It is worthwhile having dedicated rules to deal with one of the most significant forms of high-income executive remuneration. A simple example may help to see just why this can be a complex area: • Day 1: assume the company allots to an executive for free an option to acquire a share in the company on the following terms: the employee must pay $20 if she wishes to exercise the option and acquire the share, the option cannot be exercised for 2 years, any shares acquired cannot be sold for a further 2 years, and the option expires after 4 years. On Day 1, the shares in the company are trading at $18 (ie the exercise price is more than the current value of the shares); • 2 years later: the employee exercises the option, pays $20 and is issued 1 share. On this date, the company’s shares are trading at $23; • 2 years later: the restriction on selling the shares lapses. On this date, the shares are trading at $24; • 3 years later: the employee sells the share on market for $25. Clearly, the employee has made $5 (sale price of $25 less exercise price of $20) but when was it made, and how much of it is employment income and how much is (potentially discount) capital gain? Employee share acquisition schemes raise these fundamental questions of derivation, timing and valuation: what was the item of income (the grant of the option, the issue of the share, the sale proceeds); when was it realised (Day 1, Year 3, Year 5, Year 8); and what was its value at the time it was derived (nil, $3, $4 or $5); if the employment income is [4.660]

203

The Tax Base – Income and Exemptions

less than $5, is there a further amount of capital gain involved? And to make matters worse, what happens if the shares were bought for $23 but sold for $19? In Abbott v Philbin the revenue authorities had taken the view that the employment income in question was the sale proceeds but the Court disagreed. Similar issues arose in the subsequent Australian case Donaldson v FCT in the Supreme Court of New South Wales. In this case the taxpayer participated in an employee share scheme designed to reward key employees for satisfactory performance. The terms of the scheme (in essence) provided for the trustee of the scheme to be granted notes, which were convertible into shares in the company with a par value of 50 cents upon the exercise of an option. The notes were held upon trust for the employees and Donaldson had rights as a beneficiary of the trust to 1350 notes. In addition to the right to require conversion of the note into a share, the note also bore interest payable by the company at 6.5% per annum. The employee, Donaldson, paid 0.1 cents per share on the grant of the notes and had to pay the remaining 49.9 cents plus a premium of 41 cents per share on the exercise of the option – that is, at the time the notes were issued, the company’s shares were probably trading at around 91 cents, even though they only had a face value of 50 cents. As in Abbott v Philbin, the employee’s interest in the shares (through the trust mechanism) could not be readily assigned, and in addition, because this scheme was intended to encourage and reward future performance, the options to convert the notes into shares could not be exercised unless, and until, the employee had successfully completed each of three succeeding periods of satisfactory performance. The ATO, having no doubt observed the result in Abbott v Philbin, claimed that the value of the employee’s interest in the notes was taxable under s 26(e) of the ITAA 1936 in the year in which he received that interest and decided, by a more or less arbitrary calculation, that the value of the options exercisable in three years was 10 cents per share, those exercisable in seven years were valued at 5 cents per share and those exercisable after 10 years were valued at 2 cents per share. Bowen CJ found in favour of the ATO because of the onus of proof rule in s 190(b) of the ITAA 1936 (now ss 14ZZK and 14ZZO of the TAA 1953), but did, in the course of the judgment, point out some major differences between s 26(e) and the position under the judicial concept of income. Again the main problems concerned the time of derivation, the valuation of the notes and the expected shares into which they could be converted. [4.670] It is against this background of cases, Tennant v Smith, Abbott v Philbin and

Donaldson, that statutory rules – first s 26AAC, then Div 13A and now Div 83A – were introduced. They are intended to declare both the time of derivation of the income that employee shares and options represent, and the amount of income that is derived. The correct tax policy position is easy to understand in the abstract – employees should be taxable on the market value of benefit they receive, less any amount which the taxpayer has to pay for it – but there have been many disagreements about how to implement this position. Some issues revolved around the time at which the income is derived – in particular, whether income was derived when options were granted or only when they were exercised and turned into shares. Secondly, how should the rules deal with shares which were allotted but were subject to restrictions on transfer (having managers dump their shares is a bad look!) or risk of forfeiture (benefits could be cancelled for misbehaviour) – should these matters defer derivation or affect the value, or be ignored unless and until they materialise? In addition, there has been a competing policy stemming from corporate law theory that share-based remuneration gives the proper incentives to management, and that in order to encourage 204

[4.670]

Income from the Provision of Services

CHAPTER 4

employers to offer such schemes, some concessions should be attached to income derived from approved employee share schemes. (This can be seen in s 83A-5(b).) And a new concern emerged – cash-poor start-up companies in the IT industry often pay their staff in shares but our rules were less generous than the US rules, creating an incentive, so it was argued, for fledgling IT firms to leave Australia. (This can be seen in s 83A-5(c).) In this space, decisions about what to tax and when to tax are hotly contested and the answers on those issues can have vastly different consequences on how much. Division 83A, the current regime governing the taxation of shares provided to employees under employee share acquisition schemes was introduced in 2009 and substantially amended in 2015. It applies where the taxpayer acquires an “ESS interest”, defined to mean a share, a stapled security (typically a share in a company and a unit in a trust which are traded as a single investment) or an option to acquire a share (s 83A-10(1), s 83A-335). An ESS interest also includes an interest in a trust which owns shares or options (s 83A-10(1)). The inclusion of interests in trusts is important because many of the largest companies will operate their share schemes through trusts – they will either allocate shares directly to a trustee to hold the shares for the benefit of the employees, or they will pay cash to the trustee and it will then use the money to subscribe for shares in the employer or acquire shares on market. At the big end of town, employees of multinationals will typically have an interest in a trust which owns shares rather than being given shares directly, and the shares will typically be shares of the listed parent rather than any particular subsidiary for which the executive works. Secondly, the taxpayer must acquire their ESS interest under an “employee share scheme”, defined to mean a scheme under which ESS interest are issued to employees of the company or to employees of one of its subsidiaries “in respect of their employment” (s 83A-10(2)). We will start our analysis of Div 83A with a simple example: the employer company issues for free a share worth $20 directly to the employee. Division 83A requires the employee to include the amount of the discount on the issue of the share in assessable income – ie difference between the market value of the share ($20) and any consideration paid or given by the employee to acquire the share (nil): s 83A-25(1). The amount is included in the year in which the ESS interest (the share) is acquired. The amount is included in the assessable income of the employee even if the share is actually allocated to an associate (eg the spouse or family company) of the employee: s 83A-305. Because these rules can apply to shares in unlisted companies, regulations set out a framework for valuing those shares. A number of concessions can then apply to reduce the amount included in the employee’s income or to defer the income (and thus, the tax) to a later year: 1.

One concession exists for start-up companies: s 83A-33. The amount of the employee’s income is reduced to nil if a long list of conditions about the employer, the shares and the terms of the share plan is met: the employer must be a resident, not listed on a stock exchange, incorporated for less than 10 years, the corporate group has a turnover under $50m, the discount is no more than 15% of the market value of the shares, the value of the employee shares represents less than 10% of the value of the shares on issue, there is at least a 3-year time limit on being able to dispose of the shares and the scheme is open to at least 75% of employees who have served longer than 3 years with the company. Where all these conditions are met, no amount is included in assessable income, but that doesn’t mean the employee’s shares are entirely tax-free. Rather, the implication of the exemption is that the employee will pay CGT instead. CGT will be applied to the [4.670]

205

The Tax Base – Income and Exemptions

gross proceeds (the employee has no cost base in the shares because of s 83A30(2)) at the time the employee eventually sells the shares. The capital gain will likely be eligible for the 50% discount. 2.

A second, much less generous, concession is available for minor discounts: s 83A-35. Employees with (adjusted) taxable income under $180,000 can exclude up to $1,000 of discount from their assessable income under s 83A-35(1) provided the shares are ordinary shares, there is at least a 3-year time limit on being able to dispose of the shares, the value of the employee shares represents less than 10% of the value of the shares on issue and the scheme is open to at least 75% of employees who have served longer than 3 years with the company. Where all these conditions are met, the taxpayer can save up to $490. Where these conditions are met, the amount included in assessable income is reduced by up to $1,000 and to ensure that this concession is not reversed by the CGT rules, the employee is treated as having a cost base in the shares of the full market value at the time of issue: s 83A-30(1).

3.

A third concession exists where the shares are issued subject to conditions which mean there is a “real risk” that the shares might be subsequently forfeited or cancelled: s. 83A-105(3). It is not obvious what circumstances are within this concept of a “real risk” of forfeiture. It probably applies if there are performance hurdles or a requirement to serve a minimum term of employment. It is less obvious whether cancellation on dismissal for bad conduct is included. Where the shares are issued but with a “real risk” of forfeiture, the employee need not include the discount in its income until the year in which the “ESS deferred taxing point” occurs: s 83A-110. The “ESS deferred taxing point” is the earliest of a number of possibilities: the shares are sold, the risk of forfeiture evaporates, any restrictions on disposal lapse, the employee leaves employment or 15 years has expired: s 83A-115. In addition to the real risk of forfeiture, a multitude of other conditions must be met: the shares must be ordinary shares, there is at least a 3-year time limit on being able to dispose of the shares, the value of the employee shares represents less than 10% of the value of the shares on issue and the scheme is open to at least 75% of employees who have served longer than 3 years with the company: s 83A-45, s 83A-105. If it turns out that an employee has already been taxed on the value of a share and the share or option is then forfeited, the entire Division is deemed never to have applied to the taxpayer: s 83A-310. The implication of this is that (subject to the tax statute of limitations), the taxpayer can then file an amended return for the relevant year excluding the amount from that year’s income. With regard to the CGT consequences, the employee is treated as having acquired the share at its market value at the time of the ESS deferred taxing point: s 83A-125. 4. A fourth concession exists where the shares are acquired under a scheme where employees can sacrifice up to $5,000 of their cash income for free shares: s 83A-105(4). Again, for these kinds of schemes, the employee need not include the discount in his or her income until the year in which the “ESS deferred taxing point” occurs: s 83A-110. A list of further conditions must be met for these kinds of schemes and, again for CGT purposes, the employee is treated as having acquired the share at its market value at the time of the ESS deferred taxing point: s 83A-125. With regard to options, the rules are even more complex and so we give here a highly simplified outline of their effects. The enactment of Div 83A in 2009 enacted a rule insisting taxpayers would derive assessable income at the time an option was allotted to them (or a 206

[4.670]

Income from the Provision of Services

CHAPTER 4

trustee for them) if it was allotted at a discount. This rule is still in s 83A-25(1). Prior to this date, options were typically taxed only at the time they were exercised or sold, so the 2009 amendments had the important effect of advancing the time at which income was derived from the issue of options. But taxing at the time an option is granted involves reduced accuracy in determining the amount of income. As you can imagine, accurately valuing an option that may last for several years (in an unlisted company!) is a very difficult matter. Consequently, the regulations contained detailed provisions to determine the market value of an option. While any discount on the issue of options is in theory still taxable at the time of issue, it will almost always be the case that s 83A-25 will not apply because the options will be issued subject to a real risk of forfeiture or with conditions on sale or exercise: s 83A-105. This means the discount will be dealt with under Div 83A-C instead and the taxing point deferred under s 83A-120. The “ESS deferred taxing point” for options will be the earliest of a number of possibilities: • the option is sold, • the risk of forfeiting the unexercised option and any restrictions on disposal of the unexercised option have lapsed, • the employee leaves their employment, • 15 years has expired since the grant of the option, • if the option has been exercised and the employee receives shares, that date when those shares can be sold without restriction and can no longer be forfeited. Notice that the date of exercise per se is not in this list. So if the option is exercised and the employee acquires shares which cannot be sold for a further period, the taxing point has not yet been reached. And notice also that the share acquired as a result of exercising an option is not within these rules – they have done their work once they have dealt with the option: s 83A-20(2). Because employee share schemes involve benefits that are archetypal fringe benefits and will also likely be capital assets of individuals, correlation is needed with both FBT and CGT. Correlation is also needed with ordinary usage income and s 15-2 of the ITAA 1997. • Section 15-2(3) excludes amounts under employee share schemes from being included in income under s 15-2. • Shares or options acquired under employee share schemes covered by Div 83A are excluded from FBT by s 136(1)(ha) of the definition of “fringe benefit” in s 136(1) of the FBTAA 1986. • Some of the interaction with CGT has been noted above. Rules in Div 83A and Div 130-D of the ITAA 1997 dictate the CGT consequences for an employee who acquires shares or options under an employee share scheme. First, the employee’s cost base in a share will begin with the market value of the share at the time that it was acquired: s 83A-30(1). (Other rules in the CGT which might apply are switched off: s 130-80.) This means the embedded discount (taxed at the time the share was issued) is not taxed again when the share is sold. If the share was issued subject to a real risk of forfeiture, and the taxing point deferred, s 83A-125 deems the share to have been acquired at the ESS deferred taxing point for its market value on that date. For shares and options where the employee has enjoyed the $1,000 income exclusion, the same rule applies so that the benefit of the $1,000 is not recaptured on a subsequent sale of the shares. And if the share is acquired by exercising an option, the transaction with the option does not generate a separate capital gain: s 130-80. [4.670]

207

The Tax Base – Income and Exemptions

Finally, it is worth remembering that the rules in Div 83A only apply to an “ESS interest” issued under “an employee share scheme”. Many companies operate so-called “phantom” schemes where the employees actually receive cash, albeit an amount of cash based on the share price. An “ESS interest” is defined mean a beneficial interest in “a share in [a] company or a right to acquire a beneficial interest in a share in the company” so if the employee receives cash equivalent to the value of a share, but not an actual share, the arrangement is not within Div 83A. The Full Federal Court decision in Blank v FCT [2015] FCAFC 154 is an example of such an arrangement. Blank worked for various companies in Glencore mining group in Switzerland, Hong Kong and Australia from 1993 to 2006 and, as an employee, was entitled receive amounts under the terms of several generations of the profit participation plans it established for employees. Under the plan, amounts were only payable on termination of employment, and another term required participants to use some of the money they received to purchase shares in the company (and to deposit the shares in a blocked safe keeping account so that they could not be sold for a period after they left employment). On his retirement in 2007 he signed a Deed relinquishing his rights under the schemes and over the next 3 years received amounts exceeding USD 160 m. Blank’s main argument was that the conferring of the rights under the schemes was the amount that was income – ie an argument basically invoking Abbott v Philbin. The implication of this argument was that, at the time the rights were conferred, he was not a resident of Australia and was working overseas so the amounts were not taxable in Australia. However, he conceded that in 2007, he derived a capital gain but argued he had a significant cost base in the rights he abandoned and this reduced the amount of tax payable. The Court held (by majority) that the amounts received by Blank were ordinary income as a reward for services. They disagreed with his argument because, they held, the various provisions of the plan documents, “were not the benefit (or even part of the benefit) conferred on the appellant under the relevant profit sharing arrangements but only mechanisms for calculating his profit share to be paid on termination exposes the fact that it was the payment of this profit share that was the actual benefit conferred on the appellant.” Pagone J dissented based on his view of the plan documents. He held, “Mr Blank had a chose in action upon the grant of the GS and phantom units under the participation agreements similar to that considered in Abbott v Philbin.” Instead, he held the amount Blank received represented a capital gain from the cancellation of these rights. Neither the ATO nor the taxpayer argued that the arrangement was within the rules for employee share schemes. At the time of writing, the High Court is set to hear the appeal in this case so we may yet learn more about the treatment of these plans.

(b) Deemed Dividends – s 109 [4.680] Section 109 of the ITAA 1936 deems certain payments made to associates of private

companies to be dividends with the intention that they will be included in the assessable income of the recipient. Initially, the intention of this section (and s 108 which has since been replaced by Division 7A) was to catch “disguised dividends” paid by private companies to their shareholders in order to avoid the double tax on dividends in a classical system of company taxation: the system which taxed the company on its profits and the shareholder on dividends paid from those taxed profits. The effect of these sections is that deemed dividends become assessable income of the taxpayer through s 44(1) of the ITAA 1936 which includes in 208

[4.680]

Income from the Provision of Services

CHAPTER 4

the assessable income of a shareholder dividends paid to the shareholder by a company out of its profits. Section 109 is relevant to the current discussion of income from services because it operates to deem excessive amounts paid as remuneration for services rendered, or retiring allowances to be dividends. The main effects of deeming the services payment or retiring allowance to be a dividend will be on the private company that pays it – the company could claim a deduction for a payment of salary but it is denied any deduction for the payment of a dividend so that it will have an extra amount included in its taxable income. For the recipient, however, there are also deleterious consequences even though both remuneration for services rendered and retiring allowances would ordinarily be included in assessable income quite apart from s 109 of the ITAA 1936. Even though s 109 makes assessable a payment that would be assessable anyway, s 109 remains because government policy has always ensured that retirement allowances are taxed at lower rates than ordinary income, so that it can make a substantial difference to the total tax paid by the employee if the payment is taxed as ordinary income as a deemed dividend, rather than as a retirement allowance. We have reviewed this policy because, although the drafting appears to give the ATO an unfettered discretion to deny a deduction and deem an excessive amount to be a dividend, it is not quite this simple. Rather, courts have indicated that it is necessary for the ATO to look at the purpose of s 109 in the framework of the Act to see if the mischief that it was designed to cure is evident before he invokes it. For example, it seems that mere size is insufficient to support the ATO’s decision to trigger the provision. In Ferris v FCT, the ATO attacked a $270,000 retiring allowance paid to the departing managing director. The ATO took the view that only $78,000 was reasonable and deemed the balance to be a dividend. He formed this judgment based on one of his Rulings, IT 2026, a Ruling which has now been archived, but which dealt implicitly with the size of reasonable benefits that the ATO would allow a taxpayer to save for in a superannuation fund. Davies J in the Federal Court analysed the policy of s 109 and the position of Ferris. He noted that Ferris did not hold many shares in the company, with the implication that it was hard to see how such a large payment could represent a dividend paid on so few shares, or give to Ferris the kind of control of the company that he would need if he was trying to take money out of the company as salary or a retiring allowance rather than a dividend.

Ferris v FCT [4.690] Ferris v FCT (1988) 20 FCR 202; 19 ATR 1705; 88 ATC 4755 Section 109 is concerned with the payment of sums which are so high as to amount to a diversion to remuneration or retiring allowance of profits that ought to have been retained by a company and taxed as such or distributed and taxed on their distribution as dividends. Necessarily, the mischief which the section is designed to prevent is most clearly seen in those instances where the recipient of the payment is a shareholder or is related to a shareholder, particularly in those cases where the recipient of the payment has sufficient influence by virtue of

his shareholding or of the shareholding of a related person to influence or direct the destination to which profits of the company will be put. Section 109 requires for its operation a decision by the Commissioner that a sum paid or a part of a sum paid was unreasonable in amount. In a simple case where a sum is paid by a company to directors who are also the shareholders in the company or are closely associated to shareholders in the company, the Commissioner may readily form his own view as [4.690]

209

The Tax Base – Income and Exemptions

Ferris v FCT cont. to whether the sum paid was a fair payment by way of remuneration or retiring allowance, for if the sum were not paid as remuneration or retiring allowance it would nevertheless enure to the benefit of the directors or their associated shareholders by virtue of being retained or distributed as profits of the company. However, when remuneration is paid to a director who has no, or no significant, shareholding in the company and the payment is made in good faith by directors who are independent of the recipient, on what basis is the Commissioner to decide that the sum paid is unreasonable? Clearly, if the sum is paid, it must be paid by way of remuneration or retiring allowance for the director has no shareholding interest which would justify it …

into account the standard he has enunciated in Ruling IT 2026. Particularly that will be the case where the payment would have enured to the benefit of or would have gone to the recipients in any event and the sole question is whether it ought to have gone by way of remuneration or retiring allowance on the one hand or by way of profits on the other. But Ruling IT 2026 will not necessarily be relevant to or, if relevant, will not necessarily carry weight in a s 109 determination. The question in s 109 is not whether a payment or the amount thereof was excessive having regard to standards laid down by the Commissioner for the administration of s 23F superannuation funds but whether in the particular circumstances of the case, the payment by the company to the recipient or its amount was unreasonable.

In making a decision under s 109, the Commissioner may in an appropriate case take

[4.700] It is also necessary to take some care to see how the regimes in ss 6-5, 15-2, Div 82 of

the ITAA 1997, and ss 44(1) and 109 of the ITAA 1936 all fit (or do not fit) together. The non-meshing of these provisions is illustrated by the decision of the Federal Court of Australia in FCT v Comber (1986) 10 FCR 88; 17 ATR 413; 86 ATC 4171. The taxpayer set up and was managing director of a private company, but he was not a shareholder. He was employed for 11 years at a lower salary than he deserved and on his retirement the company paid him a large golden handshake of $100,000. The company sought to deduct this payment under s 78(1)(c) of the ITAA 1936 (now s 25-50 of the ITAA 1997) and the taxpayer included 5% of the sum in his assessable income as a retirement allowance under s 26(d), the predecessor of the rules in Div 82 of the ITAA 1997. The ATO concluded that only $41,500 was reasonable and included 5% of this amount in his income, arguing that the remaining $58,500 was deemed to be a dividend under s 109 and thus included in the taxpayer’s assessable income under s 44(1) as a dividend. Section 44(1) taxes dividends which are paid to shareholders but the problem in this case was that Comber was not a shareholder. The Federal Court held that s 26(d) imposed tax on 5% of the $41,500 but that s 109 did not apply to the balance, nor did any other section of the Act. In the light of this and other unfortunate experiences, s 109 was amended so that it now meshes fully with s 44(1) by deeming the following elements necessary for s 44(1) to operate: • any excess over the appropriate amount being distinguished as a separate sum; • the excess will be deemed to be a dividend; • the recipient will be deemed to receive the sum as a shareholder; • the sum will be deemed to be paid out of profits; • the sum will be deemed to be paid on a particular day. The following questions examine how s 109 meshes with the other sections of the Act. 210

[4.700]

Income from the Provision of Services

[4.705]

CHAPTER 4

Questions

4.57

What happens when the excess is deemed to be a dividend? Will it remain an employment termination payment and be taxed again under Div 82 as an employment termination payment? (See s 82-135(h) of the ITAA 1997.)

4.58

Will the payment be a fringe benefit to the employee? (See para (n) of the definition of “fringe benefit” in s 136(1) of the FBTAA 1986.)

4.59

Can a s 109 deemed dividend be franked so that the shareholder/employee obtains a franking credit and might effectively receive the deemed dividend tax-free? (See the list of unfrankable distributions in s 202-45(g)(iii) of the ITAA 1997.)

5. PAYMENTS FOR RESTRICTIVE COVENANTS AND VARYING SERVICE CONTRACTS [4.710] This part of the chapter looks at a number of characterisation issues and allows us to combine the three regimes examined – ordinary usage income and statutory income, FBT and CGT. The cases fall into three categories.

1.

Is a payment for the provision of knowledge a reward for service or the sale of an asset? 2. Is a payment for varying agreed rights under an existing service contract a capital sum, as if on the disposal of a capital asset, or should it be treated as equivalent to the income that would have been earned under the contract? 3. Is a payment for the grant of a restrictive covenant a capital sum or received in substitution for income and so to be treated as if income? As will be seen, these payments may raise many possible tax consequences. Not only might the payments have an income nature according to ordinary concepts or statutory income, give rise to fringe benefits, or generate capital gains, they might also be employment termination payments and subject to the special rules for these payments.

(a) Income from Services or the Sale of an Asset [4.720] Even after CGT, important consequences still attach to distinguishing between a

reward for service and the sale of an asset. In Brent v FCT the taxpayer was the wife of Ronald Biggs, one of the Great Train Robbers. Biggs was later to gain even more fame by singing with the soi-disant musical group – the Sex Pistols. Brent executed an agreement purporting to sell for $65,250 “the exclusive right to publish and/or reproduce throughout the world … the life story of the vendor and especially the story of the vendor’s life with her husband, Ronald Arthur Biggs” and was paid $10,000 on signing the agreement. Two journalists questioned her for most of five days and took notes of her answers to their questions. She was shown typescript prepared by journalists and could comment upon it but did not often do so and was generally ignored when she did. She eventually signed the manuscript but was paid nothing further for reasons which do not appear in the report. The ATO included the whole of the $65,250 in her assessable income as a reward for services. She contended that the payment was a capital receipt on the sale of her pre-CGT asset. Gibbs J in the High Court disagreed with her.

[4.720]

211

The Tax Base – Income and Exemptions

Brent v FCT [4.730] Brent v FCT (1971) 125 CLR 418 The question whether the amount payable under the agreement was income in my opinion depends on whether it should properly be regarded as a sum earned by the appellant in relation to services rendered by her for the company. If so, it would not only be income within ordinary usages and concepts, but would also be within the scope of s. 26(e) of the Act. If the moneys were, in truth, earnings from the performance of services by the appellant, it would not matter that she carried on no business or vocation, or that the moneys became payable as the result of an unexpected stroke of fortune or that there was no element of regularity or periodicity about their receipt. The question, therefore, is whether the moneys she received answer that description or whether they were rather, as the appellant contended, the consideration for the sale of proprietary rights or of rights analogous to rights of property. That question must be answered by examining the agreement and the manner in which the parties to it carried it out. By cl 1 of the agreement the appellant purported to sell to the company the exclusive right to publish and reproduce her life story and especially the story of her life with Biggs. This provision was of doubtful value. At the time the agreement was signed no story had been written. As a matter of construction “the life story” referred to in cl 1 would appear to mean the life story embodied in the manuscript which was in due course to be signed by the appellant … If cl 1 purported to confer on the company an exclusive right to publish any account of the life of the appellant, it would be quite illusory, for anyone who could obtain enough information to enable him to do so would be entitled, subject to such restrictions as the law of copyright and defamation might impose, to write a biography of the appellant. By cl 4 the appellant purported to assign to the company her copyright in the manuscript which she intended to sign. It is clear, however, that, in the events which happened, the appellant had no copyright to assign. The stories were about her life but she did not write them 212

[4.730]

and they were not told in her words; the journalists who made the notes were not mere amanuenses who took down and transcribed word for word what she said, but they gave to the stories the form in which they finally appeared. In those circumstances the appellant, who had provided the ideas but not the form in which they were expressed, had no copyright. Clauses 5 and 7 of the agreement required the appellant to perform certain services for the company – to assist its agents, to make herself available for interview and to give information and to sign the manuscript. She, in fact, did these things. Clause 6 also required the appellant to make available (but not to sell or give away) all photographs and tokens in her possession relating to the subject matter of the agreement. It may be inferred from the fact that the articles when published did contain photographs that the appellant made some available; whether she made available any tokens (whatever they might be) does not appear. Clause 8 contained an undertaking by the appellant not to communicate with or make statements to others relative to the subject matter of the agreement and, in particular, not to give press, radio or television interviews on any subject within sixty days from the signing of the manuscript. This negative covenant was no doubt of real value to the company, but it was ancillary to the main purposes of the agreement. In substance, the appellant earned the money payable under the agreement by devoting her time to the interviews at which she was questioned, by disclosing all the facts about her life with her husband that were thought worth printing and by lending her name to the stories which the journalists produced. The agreement to make available, apparently on loan, the photographs and tokens may rightly be regarded as a subsidiary matter and the negative covenant in cl 8 was ancillary to the main purpose of the agreement. The purported grant of the exclusive right to her life story and the purported

Income from the Provision of Services

Brent v FCT cont. assignment of the copyright were, in truth, inefficacious to convey any rights to the company … It is not possible speaking strictly to say that in communicating the information to the agents of the company the appellant was parting with property. Neither know-ledge nor information is property in a strictly legal sense, although they can be said to be property in a loose metaphorical sense … As a matter of law the agreement entitled the appellant to payment for services rendered to the company in making herself available for interview, in communicating information and in signing the manuscript which the journalists produced and which was not her property … There is no special reason as a matter of fact to treat the information which she possessed as equivalent to a right of property; it was not acquired in the conduct of a business, and could

not be described as property in a business sense, it did not relate to anything in which copyright existed, and there was no other justification for regarding it as having in fact a character which the law denied it. The fact that the appellant had secret information made her services more valuable but moneys paid as the consideration for services rendered are income notwithstanding that the person rendering the services is employed only because of the special knowledge or information that she possesses. It is impossible to hold that the appellant sold any property to the company. As I have said, the purported sale of the right to publish her life story and the purported assignment of copyright were illusory and the agreement to make available photographs and tokens and the negative covenant contained in cl. 8 of the agreement were subsidiary to the main objects of the agreement. In my opinion the consideration provided by the agreement was for services rendered by the appellant to the company and was properly treated as income.

[4.735]

4.60

4.61

4.62

CHAPTER 4

Questions

What would have been the result in Brent if the taxpayer had written the story herself and simply assigned the copyright to the newspaper? What if Mrs Brent died leaving a diary of her experiences and the diary was sold to a newspaper? If the sale of property characterisation is adopted, on what grounds may there nevertheless be an amount included in assessable income? What is the effect of s 15-15 of the ITAA 1997 – could this have been a profit-making undertaking? Even if Brent’s argument had been successful, what result would follow post-CGT if she had entered into the contract after 19 September 1985? Would it make a difference if the events in her story pre-dated CGT? Would it make any difference if the facts pre-dated CGT but she only learned of them post-CGT?

(b) Payments for Varying Contract Rights [4.740] When the parties to an employment contract agree to bring it to an end, the

employee’s right to wages for the balance of the term is bought out and the employee’s rights are “capitalised” in the sense that future periodic wages are usually commuted into a present lump sum. Is this sum liable to be included in assessable income? In Scott v Commissioner of Taxation the taxpayer had been appointed chairman of a board established under the Metropolitan Meat Industry Act for 10 years at a salary of £2,500 per annum from 1 August 1931. The board was dissolved by a later Act and his position abolished but the later Act provided that he was entitled to compensation calculated on the same basis as if he had been wrongfully dismissed. He recovered £7,000 compensation in an action for wrongful dismissal which the Commissioner then included in the taxpayer’s assessable income on any one of three [4.740]

213

The Tax Base – Income and Exemptions

different grounds: the amount was income according to ordinary concepts; it was included in income as a retiring allowance under s 11(i) of the Income Tax (Management) Act 1928 (NSW), the equivalent of the current Div 82 of the ITAA 1997; or it was included in his assessable income under s 11(j) of the New South Wales Act, the equivalent of s 15-2 of the ITAA 1997. Jordan CJ in the Supreme Court of New South Wales held that the payment was not included in assessable income under any of these provisions.

Scott v Commissioner of Taxation (NSW) [4.750] Scott v Commissioner of Taxation (NSW) (1935) 35 SR (NSW) 215 Now, according to the ordinary meaning of “income”, as an English word, there can be no doubt that such a receipt as that now in question is not income. If a business consists in the making of numbers of commercial contracts in the hope of making profits by their performance, any damages that may be recovered as compensation for the breach of one of those contracts is a receipt that must be taken into account for the purpose of arriving at the total profits, and ultimately at the net income, of the business. So, too, must any receipt in the nature of compensation for a partial restriction of general trading opportunities. But a price received as a consideration for going out of business or compensation received for being prevented from carrying on business any further, or for being

prevented from continuing in employment, is not income, according to the natural meaning of the word. The sum in question in the present case was compensation made payable because the appellant’s office had been abolished before the period for which he had been appointed to hold it had expired, and was measured by the amount of damages which he would have been entitled to recover if he had been wrongfully dismissed. The mere fact that this particular measure was adopted is not, of course, conclusive; but it is, I think, manifest that such a sum is not liable to be taxed as income unless an intention is to be found in the Act that the word is to be read with an extended meaning large enough to cover such a receipt.

[4.760] Stephen J agreed that the payment was not income according to ordinary concepts

nor caught by the equivalent of s 15-2, but dissented from the view that it was not a retiring allowance. The reasoning of Jordan CJ in relation to the statutory provisions turned on the interpretation of words “allowances or gratuities” in the section given the legal obligation to make the payment. This aspect of the holding was later overcome, at least in relation to retiring allowances, by adding the words “made (whether voluntarily, by agreement or by compulsion of law)” to s 27A of the ITAA 1936. Interestingly, those words were not retained when s 27A was moved and rewritten as Divs 80 – 83. You should contrast the attitude of Jordan CJ to the relevance of the measurement chosen, with the reasoning expressed and the result reached in Commissioner of Taxes (Vic) v Phillips. The taxpayer in Phillips had an agreement to serve as managing director of Central Theatre Company for 10 years. The terms of the agreement provided that he would receive the normal director’s fee, and in addition an amount equal to 12.5% of Central’s net annual profits from one of its theatres, payable monthly. Central sold the theatre but the purchaser did not want to retain Phillips as manager and so Central cancelled Phillips’ contract agreeing to pay him compensation. The compensation agreed upon was £20,301 calculated at £5,252 for each remaining year in Phillips’ contract. The figure of £5,252 was calculated at £101 per week which was estimated by the parties from past experience to be the amount Phillips would have 214

[4.750]

Income from the Provision of Services

CHAPTER 4

been likely to receive if the agreement had run its course. During the year of income Phillips received £4,444 by instalments of £404 every four weeks. Dixon and Evatt JJ in the High Court found that the amounts had the character of income.

Commissioner of Taxes (Vic) v Phillips [4.770] Commissioner of Taxes (Vic) v Phillips (1936) 55 CLR 144 The substance of what the taxpayer obtained under the agreement he made was a right to receive a monthly payment of £404 during the unexpired residue of his agreement of service with the company. The agreement of cancellation or rescission substituted this payment for the monthly payments which he would have earned by directing the theatre, payments of uncertain amount representing 12.5% of the profits. An estimate of these future payments of uncertain amount produced the regular monthly sum of £404. He gave up the right to the future payments calculated upon the profits and was relieved of the duties of management. While, if his agreement had gone on, the performance of that agreement would have been the proximate source of the income and its amount would have fluctuated, under the new arrangement the receipts were derived from the mere subsistence of the contract, which needed no performance on the part of the taxpayer, and the amount of the monthly payment was fixed. It appears to us that, for future income which he had a right to earn by performing the agreement, he exchanged a right to receive, through the same duration of time and at the same intervals of time, amounts estimated as equivalent to the income otherwise payable to him. It is true that to treat a sum of money as income because it is computed or measured by reference to loss of future income is an erroneous method of reasoning. It is erroneous because, for example, the right to future income may be an asset of a capital nature and the sum measured by reference to the loss of the future income may be a capital payment made to

replace that right. Or, again, the computation may be done for the purpose of ascertaining what capitalised equivalent should be paid for the future income. But, where one right to future periodical payments during a term of years is exchanged for another right to payments of the same periodicity over the same term of years, the fact that the new payments are an estimated equivalent of the old cannot but have weight in considering whether they have the character of income which the old would have possessed. Even in the case of a sale of land, the parties may, if they choose, adopt a consideration consisting of annual payments which are income and not merely deferred payments of capital. A contract of service is valuable only because of the income it will bring during the residue of its term. It is not a piece of marketable property. Unless it is rescinded or broken, it is not usually possible to obtain a lump sum or any other consideration representing its value. When such an occasion arises its value is likely to be expressed in terms of income and is by no means certain to be translated into capital. No prima facie reason exists for regarding as instalments of capital annual payments which are taken in place of the contractual rights such a contract gave. In the present case, the contract expressed the total of the monthly payments as a lump sum. But the period being fixed, the rate of payment being estimated and the intervals being already established, the statement is no more than an arithmetical equivalent. Indeed, it is not the present value of the future payments but merely their sum.

[4.780] In Phillips the taxpayer gave up one income stream from his employer in return for

another. The principle that the case displays is that where an amount substitutes for another amount that would be income if it were received, the first amount is also income. It is another aspect of ordinary usage income and we will explore it more fully in Chapter 6. But does it [4.780]

215

The Tax Base – Income and Exemptions

make any difference if the replacement comes not from the employer, but from a third party? This issue was explored by the Full Federal Court in Reuter v FCT, a case which emerges from the turmoil of the 1980s and involves some of its most infamous characters and events – Laurie Connell and his merchant bank Rothwells, Alan Bond and his company Bond Media Limited, Warwick Fairfax and his company Tryart, the 1987 stock market collapse, and the battle for the Fairfax media empire. Warwick Fairfax engaged Rothwells to advise and assist Tryart in connection with the proposed acquisition of John Fairfax Limited in return for a success fee of $100 m. Rothwells then engaged Reuter as a consultant on the deal, with Laurie Connell promising Reuter a share of the success fee, likely to total about $45 m. When the stock market collapsed in November 1987, Rothwells ran into financial difficulty and sought to sell the anticipated success fee to Bond Media Limited (BML) in return for an immediate cash payment. Reuter feared that Rothwells might go into liquidation and that he would have to battle with the bank’s creditors for a share of the success fee, and so to protect his position, he threatened to seek an injunction blocking the sale of the success fee to BML. To prevent this, Rothwells and BML entered into a multi-stepped transaction. First, Rothwells agreed to pay BML a procurement fee as consideration for BML agreeing to purchase the anticipated success fee. BML, in turn, agreed that it would pay $8 m of the proceeds of the procurement fee to Reuter. In return for the payments, Reuter entered a Deed of Covenant under which he promised not to undertake any action that would hinder the assignment by Rothwells of its anticipated success fee to BML. The Commissioner assessed Reuter on the basis that s 25 of the ITAA 1936 applied. In a joint judgment, Jenkinson, Lee and O’Loughlin JJ upheld the following assessment.

Reuter v FCT [4.790] Reuter v FCT (1993) 27 ATR 256; 93 ATC 5030 Counsel for Reuter contends in this appeal that whilst it is appropriate to look at all the circumstances which bear upon the character of the payment made, a clear statement in the Deed of Covenant that the payment had been made in return for Reuter’s acceptance of a restriction of his right to claim, or commence proceedings in relation to, the Tryart fee demonstrated the character of the payment, namely a receipt in the nature of capital and not one received as income according to ordinary concepts … The consideration for the payment described in the Deed of Covenant is only part of a matrix of relevant events providing the context in which the Deed was executed and in which the character of the payment must be found. The record in the Deed that the payment made to Reuter had connection with the covenants to be provided by Reuter in the Deed, did not exclude connection with other events and was not conclusive of the nature of the payment received by Reuter. The issue to be decided was whether, 216

[4.790]

in fact, the payment was a “product” of the taxpayer’s services having regard to all relevant material. The following facts found by his Honour were relevant to the character of the payment. Reuter was aware that the threat of administration in insolvency was overhanging Rothwells and that any payment to him by Rothwells may have to be disgorged to a liquidator subsequently appointed. Reuter was also aware that if Rothwells succeeded in assigning or charging its right to be paid a fee by Tryart, Rothwells would not be able to pay any fee to Reuter. On 10 November 1987 Reuter and Dougherty had indicated to Rothwells that they would agree, or had agreed, to accept $10m in payment for the services they had provided to Rothwells. On 19 November 1987, as part of the Facility Agreement made between Reuter and BML, Rothwells required BML to contract with Rothwells that BML would apply $10m of a $17m “procurement advisory fee” payable to BML by Rothwells upon delivery of the loan, to discharge

Income from the Provision of Services

Reuter v FCT cont. the sum of $10m to be paid by BML to Reuter and Dougherty to obtain their execution of a Deed of Covenant of even date for the purpose of facilitating the loan transaction between Rothwells and BML and the delivery of the loan to Rothwells. It is clear from the foregoing that events outside the Deed bore upon the character of the payment received by Reuter from BML. Such events relevant to characterisation of the payment were the willingness of Reuter and Dougherty respectively to accept a fee of $8m and $2m from Rothwells and the agreement between BML and Rothwells that BML would use a fee payable by Rothwells to BML to pay $8m and $2m to Reuter and Dougherty respectively to obtain covenants from them sufficient to encourage BML to perform the Facility Agreement and put Rothwells in funds by the delivery of the loan from BML. If the anticipated covenants in the Deed provided the sole foundation for the payment of $8m to Reuter by BML, Rothwells had no interest in securing from BML a contractual obligation to make that payment from a fee to be paid to BML by Rothwells. The tripartite nature of the arrangements provided a nexus between the services rendered by Reuter to Rothwells which had earned a fee of $8m, the obligation of Rothwells to pay $8m for those services and the sum of $8m received by Reuter from BML. It may be noted that the Deed of Covenant between BML and Reuter did not effect an assignment or

CHAPTER 4

relinquishment by Reuter of any rights or of any property. BML paid $8m for Reuter’s agreement not to claim any part of the Tryart fee without the prior approval of BML and for Reuter’s agreement to indemnify BML to the extent of $8m if Reuter did claim, presumably against BML as assignee of the Tryart fee, any part of that fee. The connection between Reuter’s entitlement to a fee for the provision of his services to Rothwells and the sum paid by BML is patent. As long as Reuter continued to acquiesce in the Rothwells proposal that he be paid a fee of $8m for his services, the sum of $8m paid by BML replaced the need for Reuter to make any claim on the Tryart fee. Whether the sum received by Reuter effected a compromise of Reuter’s claim against Rothwells for the payment of the agreed percentage of the Tryart fee is unnecessary to decide and is irrelevant to a conclusion that the sum received by Reuter from BML was so connected with the services provided by Reuter to Rothwells as to be a product of those services. It is in that context that the question of the character attached to the sum received by Reuter had to be determined. Part of the relevant evidence was within the Deed but significant evidence outside the Deed made it obvious that the nexus between the sum of $8m received by Reuter from BML and the services provided by Reuter to Rothwells was such that it could be said that the sum received, however described, was a product of those services and properly characterised as income according to ordinary concepts.

[4.800] The transaction contrasts nicely with the course of action chosen by the taxpayer in

Bennett v FCT. The taxpayer in Bennett was employed as the managing director of radio station 2GB under a seven-year contract entitling him to a salary of £1,040 plus 5% of gross revenue plus 10% of the proceeds of the sale of transcripts. During negotiations for the sale of the company which owned the radio station, he agreed to the cancellation of his contract and entered a new one reappointing him as managing director but for a shorter term (although there was an option to extend the term), and with fewer powers. In consideration, he was promised three payments totalling £12,255 which the Commissioner assessed as income. Williams J in the High Court held that the amounts were of a capital nature and therefore not assessable as income.

[4.800]

217

The Tax Base – Income and Exemptions

Bennett v FCT [4.810] Bennett v FCT (1947) 75 CLR 480; 4 AITR 12 It was contended for the respondent that the sums of £3,000, £4,000 and £5,255 were part of the remuneration of the appellant for his services as managing director under his new appointment commencing on 12 November 1936, and as such part of his assessable income. But the payment of these sums had no relation to any services which he had rendered to 2GB in the past or was bound to render to 2GB in the future. The whole of the £12,255 was payable whether he rendered any services as managing director between 12 November 1936 and 1 January 1940 or not. The payments were not made to him as compensation for the remuneration which he would have received if he had remained managing director for the original term ending on 24 August 1942 instead of his term being shortened to 1 January 1940 because he had the option to extend the term to 24 August 1942. If the company exercised the option to extend the term the payments would not increase his remuneration, because he was entitled to them whether he served the company as managing director during the further term or not. If the appellant exercised the option, they would not increase his remuneration because he had then to refund them wholly or pro tanto. The effect of the

[4.815]

cancellation of the indenture of 24 August 1935 and the re-appointment of the appellant as managing director of 2GB under the indenture of 12 November 1936 was that the appellant, instead of having unfettered control of the business of 2GB, was relegated to a position of subordination to the directors. The fluctuating portion of his remuneration as managing director depended upon the success of the company’s business … But the substance of the matter is that the sum of £12,255 was a lump sum payable by instalments as compensation for the cancellation of the indenture of 24 August 1935, and such payments are of a capital nature unless the compensation is some form of equivalent for the loss of the income which the taxpayer would have earned under the agreement but for its cancellation, as in the case of the payments in C of T (Vic) v Phillips (1936) 55 CLR 144. The payments in the present case are simply payments made as part of the consideration for the appellant agreeing to cancel one agreement under which he had certain rights and entering into a fresh agreement under which he had different rights.

Questions

4.63

What is the distinction between Bennett and Phillips? Why was the payment in one case characterised as income and in the other as capital?

4.64

When an employment relationship continues between the parties, in what circumstances will a payment be treated as one made in exchange for giving up contractual rights? If it is so treated, on what grounds may the payment still be classified as income?

4.65

These cases exhibit some of the possible tax treatments but the particular result in each case may no longer follow – we may now reach another combination of three different results. What ought to be the result if Scott, Phillips and Bennett were litigated today? You will need to consider the effect of s 15-2, the definition of “employment termination payment” in s 82-130, FBT and CGT.

4.66

Under the terms of the award, the employer can require the employee to work during a rostered meal break but must pay a meal penalty – an additional $7.50. Is this amount assessable to the employee?

218

[4.810]

Income from the Provision of Services

4.67

CHAPTER 4

The taxpayers had been entitled to one rostered day off (RDO) per fortnight, but in February 1988, the employer, Shell, unilaterally varied the terms of employment, increasing formal working hours from a nine-day fortnight to a five-day week. The taxpayer received a lump sum equal to three months’ salary, payable in three instalments, as compensation for the loss of the RDOs. Are these sums income or capital? (See AAT Case 8145 (1992) 23 ATR 1243; Case Z9 92 ATC 267.)

(c) Payments for Restrictive Covenants [4.820] Employees sometimes receive payments from their former employers in return for

agreeing to submit to restrictions on their future behaviour. The payments are designed to reduce the employee’s value to another potential employer who is in competition with the former employer. In most cases, the payment is made on retirement and is designed to neutralise the value of the information in the employee’s head, and to allow the former employer to capitalise on its investment. This is a different fact pattern from Bennett where the employee agreed to accept restrictions on his powers while continuing in his employment, but it raises similar tax issues to those we have just examined with a few additional complications. This area is very fertile territory for legal analysis because of the multitude of taxing possibilities, for example: • the payment might be taxable as ordinary usage income as a reward for a service, or included as statutory income under s 15-2 or some other provision; • the payment for the restrictive covenant might be subject to CGT; • the payment might be a fringe benefit; • because it is paid at about the time that the employment has ceased, it might be taxable as an employment termination payment; and finally • it might be taxable as ordinary usage income under the compensation receipts principle just discussed. The analysis of the ordinary usage position usually begins with Higgs v Olivier. The taxpayer, Lord Olivier, made an agreement following the completion of a film version of Henry V not to act in any film made by other movie producers for 18 months so that the producer could market the film without competition from other films featuring the taxpayer. The revenue authorities argued that the payment of £15,000 he received was a reward for service but Harman J denied that it had an income character.

Higgs v Olivier [4.830] Higgs v Olivier [1951] 1 Ch 899 If there were any evidence that the agreement of 1945 was a device of some sort whereby the taxpayer obtained, as his reward for playing in and producing Henry V, a further remuneration, it would be easy to see that that would be a taxable sum. There appears to have been some suggestion before the Commissioners to that effect, but the Commissioners found that there was no evidence to support it … The Crown had to face the fact that the agreement of 1945 was an agreement not to act, and their answer was

that money might be made by refraining just as by ceasing to refrain, and that this was an incident in the career of a popular actor by which he exploited his personality, just as he might have exploited it in the opposite way, by acting. On the other hand, the taxpayer’s argument was that, so far from being an incident of his vocation, the payment was a payment for not exercising his vocation – for refraining from exercising it, from putting his art and his [4.830]

219

The Tax Base – Income and Exemptions

Higgs v Olivier cont. personality to a profitable use. With that submission, in substance, the Commissioners have agreed. They held that the agreement and the Deed of Covenant could not be read together. The taxpayer had performed all his services under the former, before the latter came into existence. They found it impossible to say that the sum of £15,000 under the deed of 1945 came to the taxpayer as part of the income from his vocation. On the contrary, it came to him for refraining from carrying on his vocation, and in their opinion was a capital receipt. Had there been evidence that it was a regular practice with actors to accept sums as a condition of not exercising their art, it would not be right to come to the conclusion that it was not an incident of the vocation of such persons …

Numerous cases were cited, but I do not think that a review of them would be of value. Possibly Glenboig Union Fireclay Co Ltd v IRC – on which both sides rely – is nearer to the present case than any other … That seems to be analogous to the present case. The respondent had, as he testified, ample opportunities in the year in question of making a profit by the exploitation of his art as a film actor. Those he agreed to forgo, and for that forbearance he received a sum of money … Consequently, if I were at liberty to regard the matter, as the Attorney-General invited me to do, as res integra, I should come to the same conclusion as that at which the Commissioners have arrived. All I need say is that there is evidence on which they could come to the conclusion which they reached, and that conclusion, being one of fact, it is not for me to dispute it.

[4.840] The proposition that a payment to an individual for entering into a restrictive

covenant is a capital amount is usually based on the judgment in Higgs v Olivier but it was never expressly held that the same result would be reached in Australia. In Dickenson v FCT (1958) 98 CLR 460; 7 AITR 257 at 280 Kitto J suggested that the result in Higgs v Olivier might have been different in Australia had the case been decided on the basis of the ITAA 1936 rather than UK legislation. Be that as it may, a similar, if more unusual, payment was made in FCT v Woite with a similar result. The taxpayer was a football player who lived in South Australia and received a payment of $10,000 for agreeing (in a form of contract referred to as Form 4) not to play football in Victoria unless it was for North Melbourne. He retired from play without leaving South Australia but was not required to refund the payment to the Victorian club. The Commissioner argued that the amount was income according to ordinary concepts but Mitchell J, in the Supreme Court of South Australia, disagreed. The Commissioner’s argument picks up the argument, rejected in the last two paragraphs of Olivier, that the payment was for the surrender of rights so insubstantial that it could not be for the surrender of a capital asset.

FCT v Woite [4.850] FCT v Woite (1982) 31 SASR 223; 13 ATR 579; 82 ATC 4578 [Counsel for the Commissioner] submitted that the respondent had not established that the $10,000 paid to him was not a reward received by him as a professional footballer and that such an award was subject to taxation. The Board of Review had rejected this argument and said that

220

[4.840]

it treated the sum of $10,000 as “a non-assessable receipt of a capital nature”, and as “a payment for giving up a permanent asset and no more” … Of course, if the advantage which was given up was shown to be merely illusory, there might be reason for saying that the payment was not in

Income from the Provision of Services

FCT v Woite cont. fact for the surrender of this advantage but for some other purpose and the taxpayer might not then discharge the onus of establishing that the payment was not income. In the present case, however, the effect of the signing by the taxpayer was that he deprived himself of the opportunity, which otherwise would have been open to him, of accepting any offer, which might be made at any time by any Victorian football club other than North Melbourne to play professional football in Victoria. In the events which happened he remained in South Australia until his retirement from playing football but the bar to his acceptance of a contract with any football club other than the North Melbourne Football Club

CHAPTER 4

remained and still remains. The payment of the $10,000 did not in any way affect the income from football which the respondent received in South Australia. Had the signing of Form 4 by the respondent been followed by a contract with the North Melbourne Club to play football for that club it may well have been difficult, if not impossible, for the respondent to discharge the onus of establishing that the $10,000 was not income … In the case at bar the restriction was not an obligation undertaken incidentally to the playing of football for reward by the taxpayer. It did not affect his playing in South Australia for which he received income. It simply restricted him from seeking or accepting a contract with all but one of the football clubs in Victoria.

[4.860] It was thought in 1985 that the inclusion of payments (such as those listed above) in

assessable income would be more likely after the introduction of CGT. The Explanatory Memorandum to the Income Tax Assessment Amendment (Capital Gains) Act 1986 (Cth) states quite unequivocally that s 160M(7) of the ITAA 1936 would apply to payments such as these even though it would be difficult (without such an open-ended and ambiguous section) to argue that there was a transaction involving an “asset”. Yet the Explanatory Memorandum states: [S]ubsection 160M(7) [now s 104-135 of ITAA 1997] also applies, subject to the other provisions of Pt IIIA, in situations where there is a disposal of an asset created by the disposal. Examples of the acts, transactions or events affected by this provision include that of an amateur sportsman who receives a payment on becoming a professional, the receipt of consideration for entering into exclusive trade tie agreements or restrictive covenants, or in connection with the variation, cancellation or breach of business contracts or agency agreements.

But despite the optimism of the drafter of the legislation, the ability of the CGT to collect tax on payments for restrictive covenants was rejected (albeit unconvincingly) by the High Court in Hepples v FCT (No 2) (1992) 173 CLR 492; 22 ATR 852. The taxpayer, who had been employed as a manager of Hunter Douglas, signed a restraint of trade agreement limiting his ability to use the knowledge and information he had acquired while an employee for two years after he left employment. In return, he received payment of $40,000. The ATO sought to tax the payment only under the CGT, and did not argue that it was income under ordinary concepts, apparently accepting Higgs v Olivier as authoritative in Australia. The High Court held by majority that neither s 160M(6) [now s 104-35] nor s 160M(7) of the ITAA 1936 applied to the case, although different majorities decided each issue – Mason CJ, Deane, Toohey and McHugh JJ (Brennan, Dawson and Gaudron JJ dissenting) holding that s 160M(6) did not apply; Mason CJ, Brennan, Deane and McHugh JJ (Dawson, Toohey and Gaudron JJ dissenting) that s 160M(7) did not apply. Because of the confusion caused by the High Court’s divided judgment and its contradiction of Parliament’s expressed objective (expressed at least in the Explanatory Memorandum if not [4.860]

221

The Tax Base – Income and Exemptions

in the text of the legislation) of trying to tax such payments, Parliament intervened to overturn the Hepples decision. Several major amendments were made to Pt IIIA by the Taxation Laws Amendment Act (No 4) 1992 (Cth), expanding the definition of an asset to include “incorporeal property” and deeming more of the requisite elements for s 160M(6) of the ITAA 1936. According to the Explanatory Memorandum to the second Bill, the new s 160M(6) was still intended to tax payments made to a taxpayer for “agreeing not to compete with another person”, “agreeing to only play sport with a particular club”, and “agreeing with a film company not to appear in a film made by another company”. These amendments appear to have overcome the shortcomings that prevented the section from applying to the payment for a restrictive covenant received by the taxpayer in Hepples. These amended provisions are now to be found in ss 104-35 and 104-155 of the ITAA 1997. The focus of the legislative flurry which succeeded Hepples was s 160M(6). However, in Paykel v FCT (1994) 49 FCR 41; 28 ATR 92; 94 ATC 4176 the ATO decided to test s 160M(7) (s 104-155 of the ITAA 1997) to see if it would support an assessment of tax on a restrictive covenant payment. It is the provision in CGT that most clearly taxes capital receipts which do not involve actual disposals of assets. The taxpayer was the principal shareholder and managing director of Paykel Bros, an oil and chemical company. In 1989, the company was sold to a US buyer, Efhco. At the same time, the taxpayer entered into an agreement with Efhco by which he agreed to retire as a director and employee of Paykel Bros and covenanted not to divulge any of the company’s confidential information nor to carry on any business in Australia or South East Asia in competition with the company for the following five years. The taxpayer received a payment of $400,000 for the agreement, which the ATO assessed under s 160M(7). Heerey J upheld the taxpayer’s appeal and adopted the view that “Hepples stands for the proposition that a payment by an employer to an employee in consideration of the employee’s covenant not to compete after the termination of his or her employment is not within s. 160M(7)”. Even apart from the ordinary usage income idea of a reward for service and the CGT provisions, the ATO had another potential provision to apply in his efforts to impose tax on restrictive covenant payments. Division 82 includes an employment termination payment in a taxpayer’s assessable income. Section 83-130 defines an employment termination payment to mean “a payment … received … in consequence of the termination of your employment”. Paragraph (j) of s 82-135, however, specifically excludes from the definition “a capital payment for, or in respect of, a legally enforceable contract in restraint of trade by you so far as the payment is reasonable having regard to the nature and extent of the restraint”. There is one final possibility for taxing income from restrictive covenants to be explored. This is the principle: where an amount substitutes for another amount that would be income if it were received, the first amount is also income. This is another aspect of ordinary usage income and we will explore it more fully in Chapter 7. If it was clear that a payment under a restrictive covenant by a person merely substituted for an amount that would be income, the covenant payable under the covenant is also income, taking on the character of the amount for which it substituted. [4.865]

4.68 4.69

222

Questions

Can a payment for an agreement not to do a particular thing, or if it is ever done, not to do it in a particular way, be a reward for service? In some jurisdictions, payments such as those in Paykel would be considered ordinary income on the basis that the taxpayer’s right to retain the payment only continues so [4.865]

Income from the Provision of Services

4.70

4.71

CHAPTER 4

long as the taxpayer does exactly what he has been contracted to do, namely not divulge secrets and not work in competition with the former employer. In other words, the “negative” covenant is viewed as a positive act because it requires continuously renewed restraint on the part of the taxpayer. Had the ATO assessed the taxpayer in Paykel on the basis of s 6-5 of the ITAA 1997, might this argument have succeeded? Might the payment in Olivier have been an employment termination payment? What is the effect of para (j) of s 82-135? Would the contract in Woite have been within para (j)? Could the payments in either of these cases have been a fringe benefit taxable to the employer under FBT? (See para (m) of the definition of “fringe benefit” in s 136(1) of the FBTAA 1986.)

6. TERMINATION PAYMENTS AND RETIREMENT INCOME [4.870] We now turn to consider the tax treatment of payments which are made at or about

the end of a taxpayer’s (current) employment. You will soon see that there is a myriad of payments encompassed within this description, many with their own idiosyncratic tax treatment. We need to consider how tax is imposed on the many different sorts of payments made, either once or over a period of time, after a taxpayer leaves their current employment and eventually leaves the paid workforce. There are many complicated provisions because the rules need to deal with the diversity in: • the variety of types of payments: for example, a “golden handshake” made voluntarily by a former employer, payments from a superannuation fund, agreed termination payments, statutory redundancy payments, payments to induce early retirement, lump sums for unused holidays, long service or sick leave, ex gratia payments to dependants of deceased employees, lump sums paid on retirement or total disability, pensions and annuities on retirement and insurance payouts to the relatives or estate of a deceased worker; • the variety of payers: for example, the payments might come from an employer, the government or third parties such as superannuation funds or insurance companies; • the variety of times involved: payments might be made upon a change of job, upon retirement, and after retirement; • the variety of recipients: for example, the employee, her or his spouse and dependants, her or his estate. If we try to organise all these permutations into the groups that raise similar issues, three main distinctions appear: 1. payments made from private sources when the taxpayer leaves the paid workforce; 2. payments made from public sources when the taxpayer leaves the paid workforce; 3. payments made as part of a career change. Obviously these different groupings raise different policy issues, suggesting that different rules are needed for each group, but rules to treat them differently have only recently emerged in Australia. We will begin by looking at payments that occur when a taxpayer leaves the paid workforce completely and collects – whether from their savings or direct from their employer – the money which will have to support them (at least in part) for the rest of their lives.

(a) Retirement Incomes Policy [4.880] Australia has two systems intended to provide income for citizens to live on after they

retire from the paid workforce. One is the private system (superannuation) and the other is a [4.880]

223

The Tax Base – Income and Exemptions

public system (the aged pension). While it has always been governmental policy to encourage citizens to save during their working life for their retirement – a policy which has been reflected in provisions offering generous tax treatment to these savings – for many low-income taxpayers, retirement income meant relying exclusively upon the aged pension. It may seem strange to some to view these systems as complements, but the similarities are striking. For example, both involve the taxpayer saving some of their income while they work – those in the private system save by making contributions into a private fund; for those in the public system, their saving is by paying higher taxes. Both systems involve a large element of government expenditure – for those in the private system, the subsidy is given in the form of tax concessions at the point when the taxpayer makes contributions to a fund and the fund earns income on those contributions; in the public system, the subsidy occurs when the taxpayer draws against the pension. In other words, it would be a mistake to view the superannuation system as not involving a cost to society or to suggest that only the aged pension is a “government hand-out”. For most of the rest of this section we will concentrate on the private superannuation system but the existence of the parallel public system should not be forgotten. We will look more closely at some of the aspects of the aged pension system in Chapter 6. The level of government support for the private superannuation system has raised claims by civil society groups that retirement savings have been too favourably treated and that the tax concessions are unfairly distributed predominantly to high-income taxpayers. These criticisms have been taken seriously and the great complexity in the Act that you will all too soon encounter has been caused by the efforts of governments, on the one hand, trying to encourage taxpayers to save for their retirement through granting tax concessions, but at the same time, trying to control the size of the cost to government of the tax concessions and to change their distribution. As a consequence, Australia’s tax rules in this area have been changed more or less continuously since 1983 and we are now up to the fifth major revision of the rules. More changes will undoubtedly follow from current parliamentary inquiries and the research work of other bodies. In addition, because taxpayers must plan for their retirement over their entire working life, major changes must, if they are not to operate retrospectively, deal with difficult transitional issues for income saved at one time but withdrawn from saving at another time and under a different tax system. [4.890] Before we get too far into the analysis, it is important also to remember that the

Australian tax system only recently began to distinguish between payments that were made on a change of employment (ie resignation or retrenchment) from payments made on the permanent cessation of paid employment (ie retirement). The reason was that until the 1980s, most workers stayed with their employers for much of their working life, few workers enjoyed superannuation benefits and so the main tax issue was how to deal with the gold watch – a token present (and hopefully a big cheque), given at the retirement party. This changed with compulsory superannuation and increased employee mobility, and so we now have two discrete sets of rules – one dealing principally with payments from employers on resignation, and the other dealing with payments from superannuation funds on retirement. It is also worth drawing to your attention early in the discussion the fact that since 1983, Australia has been gradually heading in a different direction from most of the rest of world by taxing contributions to superannuation funds and the earnings of the funds, in order to reduce the size of the tax subsidy for retirement saving. That is, we have been heading toward income tax treatment rather than a consumption tax treatment of savings for retirement – the difference is that amounts are taxed when they are earned under an income tax, but are taxed 224

[4.890]

Income from the Provision of Services

CHAPTER 4

when they are consumed under a consumption tax. This process took another step in 2006 when the Treasurer announced that, after 1 July 2007, superannuation payments received by people over 60 would be tax-free. The following table shows how the government’s strategy for taxing superannuation has shifted forward the point at which the tax is collected:

Contributions Fund earnings Benefits

Pre-1983 Exempt Exempt Exempt

1983–88 Exempt Exempt Taxed

Post-1988 Partly taxed Partly taxed Exempt/partly taxed

Post-2007 Partly taxed Partly taxed Typically exempt

Lump sum payments made on termination or retirement might be capital or income according to ordinary concepts. If the payment is characterised as representing deferred compensation for services rendered, it will be income as in Blank’s case (discussed above). The payment might be deferred compensation where it is stipulated in the contract of employment – an employee cannot convert contemporaneous income into capital (one would hope) simply by having the employer agree that the employee would be paid $1 per week during the employment and another $500 for every week worked, the latter sum to be paid if the employee resigns or the employer terminates the employment. Further, some payments made on retirement might be income by the periodicity principle (as in Commissioner of Taxes (Vic) v Phillips). But payments made on retirement can be capital if they are paid for the loss of the opportunity to serve (as in Scott v Commissioner of Taxation (NSW), extracted above) even if paid in the form of several instalments (as in Bennett v FCT). The common law was, however, superseded in most cases by the statutory rule, s 26(d) of the ITAA 1936, which largely avoided the need to make these capital-or-income distinctions. The section provided for the inclusion in assessable income of only 5% of an amount paid in a lump sum “in consequence of retirement from or the termination of any office”. This very favourable treatment of lump sums was not extended to pensions or annuities. If an employer paid a pension to an ex-employee, the whole of the pension was treated as income according to ordinary concepts and taxed. If the employer or the employee used their savings to purchase an annuity from an insurance company (an annuity is a series of recurrent payments purchased by the taxpayer from some third party, usually an insurance company), again the whole of each payment would be income according to ordinary concepts. However, because each payment contained a repayment of the purchase price paid by the taxpayer, the former s 26AA of the ITAA 1936 (now s 27H of the ITAA 1936) allowed the taxpayer to exclude from each recurrent payment an amount representing the “undeducted purchase price” of the annuity, that is, the taxpayer’s personal after-tax contributions to her or his superannuation fund. Compared to the treatment of lump sums, however, pensions and annuities were heavily taxed and effectively discouraged.

(b) Superannuation [4.900] Most private saving for retirement occurs through the superannuation system and we will spend most of our time looking at this system. The private system is now pervasive because of the policy of successive governments expressed in the Superannuation Guarantee Scheme, which commenced in 1992. The Superannuation Guarantee Scheme was designed to [4.900]

225

The Tax Base – Income and Exemptions

ensure that all employees had a percentage of their wages diverted into a private superannuation fund during their working life so that future demands on the age pension could be commensurately reduced. While the almost universal coverage of superannuation has been applauded, the design and operation of the system and the amount of money not being collected because of the tax concessions for superannuation, has become a major source of angst for governments. The 2016 election was fought around competing options for curbing the cost of the tax concessions embedded in the rules. At the time of writing it is not clear just how the system will be changed to deliver more government revenue but further tinkering is inevitable. While we will pay most attention to the rules in the tax legislation, there are extremely important regulatory rules in the Superannuation Industry (Supervision) Act 1993 (the “SIS Act”) and accompanying regulations. One important concept found in those rules is the distinction between a complying and non-complying superannuation fund. A complying superannuation fund is defined in s 45 of the SIS Act to mean a superannuation fund that has elected to be regulated under the SIS Act and meets the requirements of the Act. As we will see, one consequence of making the election is that the fund becomes subject to tax at the rate of 15%. The superannuation system involves three main players (the employer, the employee and the fund) and three time periods (when contributions are made usually by employers and sometimes by members, when the invested contributions earn income, when the accumulated contributions and earnings are withdrawn by the employee on retirement or sometimes change of job). These elements are described in Div 280 of the ITAA 1997, which is a guide to the taxation of superannuation. At its simplest, we need to consider the following three things: 1.

What is the tax treatment of contributors (the employer, the employee or sometimes the government) who pay amounts to superannuation funds? The rules about this are principally in Div 290 of the ITAA 1997.

2.

How is the fund treated on the contributions received and the earnings made from investing those contributions? The rules about this are in Div 295 of the ITAA 1997.

3.

How is the employee taxed on payments out of the fund? The rules about this are principally in Div 301 of the ITAA 1997.

(i) Contributions to a superannuation fund [4.910] The treatment of contributions to superannuation funds is stipulated in Div 290 of

the ITAA 1997. For reasons which are now lost in history, you will see that different rules are provided which depend upon whether the contribution is made by the employer (Subdiv 290-B) or the employee (Subdiv 290-C). The rules about employees are less generous. This is a strange distinction to draw as, simply by manipulating the source of the payment, the same transaction will generate substantially different tax consequences. That is, an employee will suffer less tax overall if they arrange to take less cash salary and have the employer pay a higher amount to a superannuation fund, compared to taking the full cash salary and then putting some of it into a superannuation fund themselves. Indeed, the ATO has even issued a Ruling, TR 2001/10 – Salary Sacrifice Arrangements – which describes when the ATO will accept that the taxpayer has effectively substituted a higher employer superannuation contribution for lower cash salary. 226

[4.910]

Income from the Provision of Services

CHAPTER 4

Contributions by employers [4.920] Employer contributions to superannuation funds raise a number of important issues –

is the amount deductible to the employer, does it involve a fringe benefit and does it give rise to any income tax or FBT consequences to the employee? Employer deductions. It has usually been the case in Australia that payments to funds by employers for their employees have been treated as tax deductions for the employer. This is provided in s 290-60 of the ITAA 1997 which allows employers a deduction for contributions paid to a “superannuation fund” to provide “superannuation benefits” for an “employee”. Section 290-10 makes it clear that this Division is the exclusive source of the deduction for contributions to superannuation funds for the purpose of providing superannuation benefits – s 8-1 of the ITAA 1997 is not available to employers. Until 2001, the ITAA 1936 allowed an employer to claim an unlimited deduction for amounts contributed to both a complying and a non-complying superannuation fund. While this may seem oddly generous, the ATO expected that contributions to non-complying funds would be fringe benefits for the purposes of the FBTAA 1986 and so attract FBT at 49% removing any tax advantage (while contributions to complying funds would not be fringe benefits). But various tax scheme promoters in the 1990s saw opportunities here and “non-complying super fund schemes” were created in two flavours – controlling interest superannuation schemes and off-shor