Principles of taxation law 2020 [(2020 Edition)]
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Copyright © 2019. Thomson Reuters. All rights reserved.

PRINCIPLES OF TAXATION LAW 2020

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Principles of Taxation Law 2020 Kerrie Sadiq

Richard Krever

Professor Queensland University of Technology, QUT Business School

Professor University of Western Australia Law School

Celeste Black

Wes Obst

Associate Professor The University of Sydney Law School

Taxation Consultant

Rami Hanegbi

Antony KF Ting

Senior Lecturer Deakin University, Faculty of Business and Law

Associate Professor The University of Sydney Business School

Sunita Jogarajan

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Professor University of Melbourne, Melbourne Law School

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Lawbook Co. 2020

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Published in Sydney by Thomson Reuters (Professional) Australia Limited ABN 64 058 914 668 19 Harris Street, Pyrmont, NSW 2009 ISBN: 9780455243115

© 2019  Thomson Reuters (Professional) Australia Limited

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This publication is copyright. Other than for the purposes of and subject to the conditions prescribed 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 submitted 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. Product Developer: Stephen Rennie Edited and typeset by Newgen Digitalworks 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: http://​www.pefc.org

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PREFACE This is the 13th edition of a book prepared by a group of experienced tertiary tax teachers with the goal of making the Australian income tax system accessible and comprehensible to students. The book is written from the perspective of the current law and proposed changes. Tax reform continues to be debated in the public forum with issues such as international tax, taxation of the digital economy and the cash economy all featuring heavily in the media over the last 12 months. After a particularly busy time in tax reform, legislative amendments to the Australian taxation regime have slowed somewhat recently. Although there is no doubt that the law continues to evolve with both changes to the Income Tax Assessment Acts and court decisions, the most current of which have been noted in this edition of Principles of Taxation Law. In addition to these updates, each chapter contains new questions, all dealing with contemporary issues. Tax affects everyone and is paid by individuals and entities earning income from personal exertion, business or property, as well as buying goods or services subject to GST. Because the Government uses the tax legislation as a means of introducing economic policy measures, all citizens who vote have an opportunity to follow tax policy and contribute to the debate. Tax issues are regularly discussed in the daily media.

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The Australian tax system consists of four major stakeholders: taxpayers, the Australian Taxation Office which administers the system, the Australian Government which levies taxes and makes and amends the tax laws with input from Government Departments and tax agents, many of whom are members of professional bodies, who assist taxpayers to manage their tax affairs. This book contains chapters on key areas of income tax, FBT, GST and State taxes and is divided into seven parts: an overview and structure, principles of income, deductions and offsets, timing issues, investment and business entities, tax avoidance and administration, and indirect taxes. The division of 26 chapters into seven separate parts makes it easier for students to understand the conceptual framework within which tax operates. Each chapter contains references to relevant legislation, important court decisions, rulings issued by the Australian Taxation Office and other materials. Diagrams, case studies and examples are included throughout the text. Questions at the end of each chapter provide students with the opportunity to apply their knowledge to solve practical problems. Significant contributions were made to earlier editions of this book by Cynthia Coleman, Geoffrey Hart, John McLaren and Jonathan Teoh. Cynthia, Geoffrey and John were part of the inaugural team of authors and the current team wishes to acknowledge their commitment to making the book what it is today. We wish to thank the staff at Thomson Reuters, particularly Stephen Rennie who has worked diligently to bring into being this 13th edition.

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PRINCIPLES OF TAXATION LAW 2020

People who work in tax share a passion for their discipline. The authors of this book hope that students who use it will gain knowledge, skills and also a love of the subject.

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December 2019

CELESTE BLACK RAMI HANEGBI SUNITA JOGARAJAN RICHARD KREVER WES OBST KERRIE SADIQ ANTONY TING

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TABLE OF CONTENTS Preface................................................................................................................................  v Table of Cases...................................................................................................................  ix Table of Statutes............................................................................................................. xxi Rulings Table..............................................................................................................  xxxix

Part 1: Overview and Structure..................................................................... 1 Chapter 1: Sources of taxation law................................................................. 3 Chapter 2: Study skills for taxation law........................................................ 21 Chapter 3: The taxation formula................................................................... 63 Chapter 4: Residence and source................................................................. 87 Part 2: Income............................................................................................. 115 Chapter 5: Assessable income.................................................................... 119 Chapter 6: Income from personal services and employment................... 137 Chapter 7: Fringe benefits tax..................................................................... 187 Chapter 8: Income from business............................................................... 235 Chapter 9: Income from property............................................................... 285 Chapter 10: Principles of compensation..................................................... 309 Chapter 11: Capital gains tax....................................................................... 333

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Part 3: Deductions and Offsets.................................................................. 383 Chapter 12: General deductions................................................................. 385 Chapter 13: Specific deductions................................................................. 475 Chapter 14: Capital allowances................................................................... 503 Chapter 15: Offsets...................................................................................... 541 Part 4: Timing Issues................................................................................... 557 Chapter 16: Tax accounting........................................................................ 559 Chapter 17: Trading stock........................................................................... 585 Part 5: Investment and Business Entities................................................. 613 Chapter 18: Taxation of superannuation.................................................... 617 Chapter 19: Partners and partnerships....................................................... 649 Chapter 20: Trusts and beneficiaries.......................................................... 667 Chapter 21: Companies and shareholders................................................. 689 Chapter 22: International taxation............................................................... 731 Part 6: Avoidance and Administration...................................................... 767 Chapter 23: Tax avoidance.......................................................................... 769 Chapter 24: Tax administration................................................................... 799

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PRINCIPLES OF TAXATION LAW 2020

Part 7: Indirect and State Taxes................................................................. 861 Chapter 25: Goods and services tax........................................................... 863 Chapter 26: State taxes............................................................................... 907 Appendix.......................................................................................................................  947

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Index..............................................................................................................................  959

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TABLE OF CASES A

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AAT Case 4083 [2011] AATA 545 .................................................................................................. 8.90 AAT Case 5489A (1992) 23 ATR 1068 ....................................................................................... 12.310 AAT Case 7,752 (1992) 23 ATR 1057 ........................................................................................... 6.150 AAT Case 9824 (1994) 29 ATR 1246 ............................................................................................ 7.100 ABB Australia Pty Ltd v FCT (2007) 66 ATR 460 ....................................................................... 22.290 AGC (Advances) Ltd v FCT (1975) 132 CLR 175 ................................. 12.140, 16.140, 16.150, 16.240 AGC (Investments) Ltd v FCT (1992) 23 ATR 287 ......................................................................... 8.90 ARM Constructions Pty Ltd v DCT (1987) 18 ATR 407 ............................................................... 17.20 Agriwealth Capital Ltd v C of T [2019] FCA 56 .......................................................................... 24.420 All States Frozen Foods Pty Ltd v FCT (1990) 20 ATR 1874 ..................................................... 17.220 Allan J Heasman Pty Ltd v FCT [2015] FCAFC 119 ................................................................... 24.130 Allied Mills Industries Pty Ltd v FCT (1989) 20 ATR 457 ........................................................... 10.180 Allsop v FCT (1965) 113 CLR 341 ..................................................................... 10.250, 10.270, 10.290 Amalgamated Zinc (De Bavay's) Ltd v FCT (1935) 54 CLR 295 ........................ 12.40, 12.140, 16.140 Andriopoulos and FCT, Re (2009-​2010) 78 ATR 654 ................................................................ 24.203 Anstis v FCT (2010) 76 ATR 735 .................................................................................................. 5.130 Archer Bros Pty Ltd v FCT (1953) 90 CLR 140 ........................................................................... 21.140 Arnold v FCT [2017] AATA 1318 ................................................................................................ 13.130 Arthur Murray (NSW) Pty Ltd v FCT (1965) 114 CLR 314 ..................................... 16.30, 16.90, 23.50 Attorney-​General (NT) v Kearney (1985) 158 CLR 500 ............................................................. 24.570 August v FCT [2013] FCAFC 85 ......................................................................................... 8.240, 8.250 Australasian Jam v FCT (1953) 88 CLR 23 .................................................................... 17.160, 17.170 Australia and New Zealand Banking Group Limited v Konza [2012] FCAFC 2012 .................. 24.550 Australian Air Express Pty Ltd v Langford [2005] NSWCA 96; (2005) 147 IR 240 ................... 26.360 Australian Crime Commission v Stewart [2012] FCA 29 .......................................................... 24.570 Australian Crime Commission v Stoddart [2011] HCA 47 ........................................................ 24.550 Avondale Motors (Parts) Pty Ltd v FCT (1971) 124 CLR 97 ...................................................... 21.340

B BHP Billiton Petroleum v FCT (2002) 51 ATR 520 ..................................................................... 16.110 BP Australia Ltd v FCT (1964) 110 CLR 387 ............................................................................... 12.190 BP Australia Ltd v FCT (1965) 112 CLR 386 .................................................................. 12.190, 12.200 Babka v FCT (1989) 20 ATR 1251 ........................................................................................ 6.110, 8.70 Bailey v FCT (1977) 136 CLR 214 ............................................................................................... 24.220 Baker v FCT [2012] AATA 168 ...................................................................................................... 4.140 Barnes v FCT (2007) 67 ATR 284 ............................................................................................... 24.570 Batagol v FCT (1963) 109 CLR 243 .................................................................................. 24.60, 24.110 Beckett v Tax Practitioners Board [2019] FCA 353 ................................................................... 24.698 Bellinz Pty Ltd v FCT (1998) 39 ATR 198 ................................................................................... 24.380 Bennett v FCT (1947) 75 CLR 480 ................................................................................................ 6.150 Binetter v DCT (No 2) [2012] FCAFC 126 ................................................................................... 24.550 Blakeley v CIR (2008) 23 NZTC 21,865 ...................................................................................... 24.600 Bohemians Club v Acting FCT (1918) 24 CLR 334 ...................................................................... 5.170 Brajkovich v FCT (1989) 20 ATR 1570 .................................................................................. 8.30, 8.70 Brandon v FCT (2010) 2010 ATC 10-​143 ................................................................................... 12.420 Brent v FCT (1971) 125 CLR 418 .............................................................................. 6.40, 6.140, 16.20

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x

PRINCIPLES OF TAXATION LAW 2020 Brisbane Bears –​Fitzroy Football Club Ltd v Commr of State Revenue [2017] QCA 223 .................................................................................................................. 26.320 British Insulated and Helsby Cables Ltd v Atherton [1926] AC 205 ......................................... 12.180 Broken Hill Theatres Pty Ltd v FCT (1952) 85 CLR 423 ..................................... 1.110, 12.840, 12.850 Brookton Co-​operative Society v FCT (1981) 147 CLR 441 ...................................................... 16.100 Brown v Brown (2007) 69 ATR 534 ........................................................................................... 24.170 Brown v FCT (2002) 49 ATR 301 ........................................................................................... 6.20, 6.30 Burmah Steamship Co Ltd v IR Commissioner of Inland Revenue (1931) 16 TC 67 ............... 10.210 Burrell's Case [1924] 2 KB 52 ..................................................................................................... 21.140 Bywater Investments Limited &Ors v Commissioner of Taxation [2016] HCA 45 .......... 4.190, 4.200

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C C of IR (NZ) v Europa Oil (NZ) No 1 [1971] AC 760 ..................................................................... 2.165 C of T (Victoria) v Phillips (1936) CLR 144 ................................................................................... 10.70 C of T (WA) v D & W Murray Ltd (1929) 42 CLR 332 ................................................................... 4.240 Cadbury-​Fry-​Pascall Pty Ltd v FCT (1944) 70 CLR 362 ............................................................. 24.120 Californian Copper Syndicate v Harris (1904) 5 TC 159 .................................................. 8.130, 8.180 Californian Oil Products Ltd (in liq) v FCT (1934) 52 CLR 28 ......................................... 9.140, 10.190 Calvert v Wainwright (1947) 27 TC 475 ......................................................................................... 6.80 Carey v Field (2002) 51 ATR 40 .................................................................................................. 24.420 Carlisle &Silloth Golf Club v Smith [1912] 2 KB 177 .................................................................... 5.170 Carlos Sanchez v FCT (2008) 73 ATR 650 ................................................................................. 12.620 Carter and Tax Practitioners Board, Re [2017] AATA 528 ........................................................ 24.690 Case 1/​99 (1999) 41 ATR 1117 ..................................................................................................... 8.170 Case 36 (1949) 15 TBRD (OS) 287 ............................................................................................... 13.60 Case 37 (1966) 13 CTBR (NS) 235 ................................................................................................ 6.110 Case 40 (1968) 14 CTBR ............................................................................................................... 13.50 Case 44 (1963) 11 CTBR ............................................................................................................... 13.60 Case 58 (1962) 10 CTBR ............................................................................................................... 13.60 Case 64 (1944) 11 TBRD (OS) 202 ............................................................................................... 13.40 Case 7752 (1992) 23 ATR 1057 .................................................................................................... 6.230 Case 82 (1953) 3 CTBR ................................................................................................................. 13.50 Case 95 (1968) 14 CTBR (NS) 553 ................................................................................................ 19.20 Case J47 (1958) 9 TBRD 244 ........................................................................................................ 13.33 Case M28 (1980) 80 ATC 187 ..................................................................................................... 12.770 Case T75 (1968) 18 TBRD 377 ...................................................................................................... 13.50 Case U80 (1987) 87 ATC 470 ..................................................................................................... 12.750 Case Z42 (1992) 24 ATR 1183 .................................................................................................... 12.610 Casimaty v FCT (1997) 37 ATR 358 ............................................................................................. 8.180 Charles v FCT (1954) 90 CLR 598 ................................................................................................. 20.30 Charles Moore & Co (WA) Pty Ltd v FCT (1956) 95 CLR 344 ............................... 12.30, 12.40, 12.50, 12.90, 12.110, 12.150 Chevron Australia Holdings v FCT [2015] FCA 1092 ................................................................ 22.360 Chevron Australia Holdings Pty Ltd v Commissioner of Taxation [2017] FCAFC 62 .............. 22.360 Chief Commissioner of State Revenue v MetriconQld Pty Ltd [2017] NSWCA 11 .................. 26.284 Cliffs International Inc v FCT (1985) 16 ATR 601 ......................................................................... 4.250 Clowes v FCT (1954) 91 CLR 209 ................................................................................................. 8.290 Colonial Mutual Life Assurance Society Ltd v FCT (1953) 89 CLR 428 .................................... 12.200 Commercial Union Assurance v FCT (1977) 7 ATR 435 ........................................................... 16.240 Commissioner of State Revenue (WA) v Placer Dome Inc [2018] HCA 59 .............................. 26.170 Commr of Australian Federal Police v Propend Finance Pty Ltd (1997) 188 CLR 501 ............ 24.570 Commr of State Revenue (Vic) v Danvest Pty Ltd [2017] VSCA 382 ....................................... 26.170

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TaBle of Cases

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Confidential and Deputy Commissioner of Taxation (2000) 43 ATR 1273 .............................. 18.230 Consolidated Press Holdings v FCT (1995) 30 ATR 390 ........................................................... 24.620 Corrosion Control Engineering (NSW) Pty Ltd v Chief Commissioner of State Revenue [2017] NSWCATAD 20 ....................................................................................................... 26.350 Coward v FCT (1999) 41 ATR 1138 .............................................................................................. 10.80 Crommelin v FCT (1998) 39 ATR 377 ........................................................................................ 19.170 Cyclone Scaffolding Pty Ltd v FCT (1987) 19 ATR 674 ............................................................... 17.20

D Dadwal and Tax Practitioners Board [2018] AATA 2878 .......................................................... 24.690 Daniels Corp v ACCC [2002] HCA 49 ......................................................................................... 24.570 DCT v Bluebottle UK Ltd (2007) 67 ATR 1 ................................................................................. 24.175 DCT v Broadbeach Properties (2008) 69 ATR 357 .................................................................... 24.150 DCT v Conley (1998) 40 ATR 227 ............................................................................................... 24.170 DCT v De Vonk (1995) 31 ATR 481 ............................................................................................ 24.550 DCT v Hua Wang Bank Berhad [2010] FCA 1014 ...................................................................... 24.180 DCT v Rennie Produce (Aust) Pty Ltd (in liq) [2018] FCAFC 38 ................................................ 24.550 DCT v Richard Walter Pty Ltd (1995) 29 ATR 644 ....................................................................... 24.80 DCT (WA), Re; Ex parte Briggs (1986) 17 ATR 1031 ......................................... 24.90, 24.100, 24.130 DCT (WA), Re; Ex parte Briggs (No 2) (1987) 18 ATR 570 .......................................................... 24.90 Deloitte Touche Tohmatsu v DCT (1998) 40 ATR 435 .............................................................. 24.590 Denlay v Federal Commissioner of Taxation (2011) 193 FCR 412; 83 ATR 625 ...................... 24.140 Dickenson v FCT (1958) 98 CLR 460 ............................................................................................ 9.170 Dickson v R [2016] NSWCCA 105 .............................................................................................. 24.203

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E Eastern Nitrogen Ltd v FCT (2001) 46 ATR 474 ........................................................... 23.300, 23.320 Egerton-​Warburton v DCT (1934) 51 CLR 568 ............................................................................ 9.210 Eisner v FCT (1971) 2 ATR 3 ........................................................................................................ 8.300 Eisner v Macomber 252 US 189 (1920) ............................................................................ 5.100, 5.145 Elmslie v FCT (1993) 26 ATR 611 ................................................................................................. 11.50 Ensign Shipping Co Ltd v IR Commissioner of Inland Revenue (1928) 12 TC 1169 ............... 10.210 Esquire Nominees Ltd v FCT (1973) 129 CLR 177 ...................................................................... 4.280 Essenbourne Pty Ltd v FCT (2002) 51 ATR 629 ............................................................................ 7.65 Esso Australia Resources Ltd v FCT (2000) 43 ATR 506 .............................................. 24.570, 24.575 Europa Oil (NZ) Ltd v CIR (NZ) (No 2) (1976) 5 ATR 744 .......................................................... 12.310 Evans v FCT (1989) 20 ATR 922 ............................................................................................ 8.30, 8.70

F FCT v AGC (1984) 15 ATR 982 ....................................................................................................... 9.50 FCT v Anstis (2010) 76 ATR 735 ........................................................................ 12.60, 12.240, 12.640 FCT v Applegate (1979) 9 ATR 899 .............................................................................................. 4.110 FCT v Arnold (No 2) [2015] FCA 34 ........................................................................................... 24.207 FCT v Australia and New Zealand Banking Group Ltd, Smorgan v FCT (1976) 134 CLR 475 ............................................................................................................ 24.540 FCT v ANZ; Smorgon v FCT (1979) 143 CLR 499 (Smorgon (No 2) ........................... 24.540, 24.550 FCT v Australian Guarantee Corporation Ltd (1984) 15 ATR 982 ............................................... 23.50 FCT v BHP Billiton Finance Ltd [2010] FCAFC 25 ........................................................................ 13.85 FCT v BHP Billiton Ltd [2011] HCA 17 .......................................................................................... 13.85

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xii

PRINCIPLES OF TAXATION LAW 2020 FCT v Ballesty (1977) 7 ATR 411 ................................................................................................ 12.430 FCT v Barnes Development Pty Ltd (2009) 76 ATR 570 ........................................................... 24.170 FCT v Beville (1953) 10 ATD 170 ............................................................................................... 19.100 FCT v Blake (1984) 15 ATR 1006 ................................................................................ 5.90, 6.70, 6.100 FCT v Brent (1971) 125 CLR 418 .................................................................................................. 6.150 FCT v Brixius (1988) 19 ATR 506 ............................................................................................... 24.270 FCT v Brown (1999) 43 ATR 1 ....................................................................................... 12.140, 24.210 FCT v CSR Ltd (2000) 45 ATR 559 ............................................................................................. 10.290 FCT v Citibank Ltd (1989) 20 ATR 292 ................................................ 24.530, 24.560, 24.590, 24.650 FCT v Citibank Ltd (1993) 26 ATR 423 ....................................................................................... 23.320 FCT v Citilink Melbourne Ltd (2006) 62 ATR 648 ........................................................................ 23.50 FCT v Collings (1976) 6 ATR 476 ............................................................................................... 12.390 FCT v Consolidated Fertilizers Ltd (1991) 22 ATR 281 ................................................. 12.840, 12.850 FCT v Consolidated Press Holdings Ltd (2001) 47 ATR 229 ..................................................... 23.300 FCT v Cooke and Sherden (1980) 10 ATR 696 ........................................................ 5.60, 6.130, 8.160 FCT v Cooling (1990) 21 ATR 13 ....................................................................................... 8.240, 8.250 FCT v Cooper (1991) 21 ATR 1616 ............................................................................................ 12.220 FCT v Dalco (1990) 20 ATR 1370 ............................................................................................... 24.225 FCT v Darling (2014) 285 FLR 428 .............................................................................................. 24.550 FCT v Day (2008) 70 ATR 14 ............................................. 12.40, 12.50, 12.60, 12.80, 12.150, 12.220 FCT v De Martin (2011) 82 ATR 906 .......................................................................................... 24.170 FCT v Dixon (1952) 86 CLR 540 ......................................................... 5.130, 6.70, 6.220, 10.20, 10.70 FCT v Donoghue [2015] FCAFC 183 ............................................................................... 24.90, 24.570 FCT v EA Marr and Sons (Sales) Ltd (1984) 15 ATR 879 .......................................................... 12.140 FCT v Edwards (1994) 28 ATR 87 ................................................................................. 12.760, 12.770 FCT v Efstathakis (1979) 9 ATR 867 ............................................................................................. 4.260 FCT v Everett (1980) 143 CLR 440 ............................................................................................. 19.150 FCT v Faichney (1972) 3 ATR 435 .............................................................................................. 12.720 FCT v Finn (1961) 106 CLR 60 ....................................................................................... 12.620, 12.660 FCT v Forsyth (1981) 11 ATR 657 .............................................................................................. 12.720 FCT v French (1957) 98 CLR 398 .................................................................................................. 4.260 FCT v Futuris Corporation Ltd (2008) 69 ATR 41 ........................................................... 24.90, 24.130 FCT v Gulland; Watson v FCT; Pincus v FCT (1985) 160 CLR 55 ............................................. 23.160 FCT v Hacon Pty Ltd [2017] FCAFC 181 .................................................................................... 24.460 FCT v Harris (1980) 10 ATR 869 ............................................................................................ 5.90, 6.50 FCT v Hart (2004) 217 CLR 216 .................................................................................................. 23.290 FCT v Hatchett (1971) 2 ATR 557 ..................................................................... 12.590, 12.600, 12.660 FCT v Hoffnung& Co Ltd (1928) 42 CLR 39 .................................................................................. 24.80 FCT v Holmes (1995) 31 ATR 71 .................................................................................................. 6.220 FCT v Hurley Holdings (NSW) Pty Ltd (1989) 20 ATR 1293 .......................................................... 9.40 FCT v Hyteco Hiring Pty Ltd (1992) 24 ATR 218 ......................................................................... 8.150 FCT v Indooroopilly Children Services (Qld) Pty Ltd (2007) 158 FCR 325 ................................... 7.65 FCT v Inkster (1989) 20 ATR 1516 ................................................................................................ 6.230 FCT v International Indigenous Football Foundation Australia Pty Ltd [2018] FCA 528 ............ 24.207 FCT v J Walter Thompson (Australia) Pty Ltd (1944) 69 CLR 227 ................................................ 7.85 FCT v JR Walker (1985) 16 ATR 331 ..................................................................................... 8.40, 8.50 FCT v James Flood Pty Ltd (1953) 88 CLR 492 ............................................................ 16.190, 16.200 FCT v Jenkins (1982) 12 ATR 745 ................................................................................................ 4.110 FCT v Jones (2002) 49 ATR 188 .................................................................................... 12.140, 16.150 FCT v Kurts Development Ltd (1998) 39 ATR 493 .................................................................... 17.150 FCT v La Rosa (2003) 53 ATR 1 ....................................................................................... 12.90, 12.240 FCT v Lenzo (2008) 71 ATR 511 ................................................................................................. 23.290 FCT v Ludekens [2013] FCAFC 100 ............................................................................................ 24.207 FCT v Ludekens (No 2) [2016] FCA 755 ..................................................................................... 24.207

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TaBle of Cases xiii FCT v Luxottica Retail Australia Pty Ltd [2011] FCAFC 20 ........................................................ 25.175 FCT v MBI Properties Pty Ltd [2014] HCA 49 ............................................................................ 25.100 FCT v Macquarie Bank Ltd [2013] FCAFC 13 ............................................................................. 21.410 FCT v Maddalena (1971) 2 ATR 541 ............................................................................. 12.340, 12.350 FCT v McDonald (1987) 18 ATR 957 ............................................................................................ 19.30 FCT v McGrouther [2015] FCAFC 34 ......................................................................................... 24.230 FCT v McPhail (1968) 117 CLR 111 ............................................................................................ 13.130 FCT v Merv Brown Pty Ltd (1985) 16 ATR 218 ................................................................. 8.140, 8.150 FCT v Metals Manufactures Ltd (2001) 46 ATR 497 .................................................................. 23.320 FCT v Mitchum (1965) 113 CLR 401 ............................................................................................ 4.260 FCT v Munro (1926) 38 CLR 153 ................................................................................................ 12.810 FCT v Murry (1998) 193 CLR 605 ................................................................................................. 26.70 FCT v Myer Emporium Ltd (1987) 163 CLR 199 ............................... 5.80, 8.130, 8.150, 8.170, 8.210, 8.220, 8.250, 8.260, 10.150, 10.280 FCT v National Commercial Banking Corp of Australia Ltd (1983) 15 ATR 21 .......................... 13.85 FCT v Osborne (1990) 21 ATR 888 .............................................................................................. 8.110 FCT v Payne (2001) 202 CLR 93 ............................................................ 12.60, 12.150, 12.440, 13.110 FCT v Peabody (1994) 181 CLR 359 .............................................................................. 23.290, 23.310 FCT v Pilnara Pty Ltd (2000) 43 ATR 581 ................................................................................... 24.610 FCT v Prestige Motors Pty Ltd (1994) 28 ATR 336 .................................................................... 24.120 FCT v Qantas Airways Ltd [2012] HCA 41 ................................................................................. 25.100 FCT v Radnor Pty Ltd (1991) 22 ATR 344 ...................................................................................... 8.90 FCT v Regent Pacific Group Ltd [2013] FCA 36 ......................................................................... 24.180 FCT v Reliance Carpet Co Pty Ltd (2008) 68 ATR 158 .................................................. 25.100, 25.115 FCT v Resource Capital Fund IV LP [2013] FCAFC 118 ............................................................. 24.175 FCT v Roberts and Smith (1992) 23 ATR 957 ............................................................................ 19.100 FCT v Rowe (1997) 187 CLR 266 ................................................................................................ 10.260 FCT v Ryan (2000) 43 ATR 694 ......................................................................................... 24.50, 24.60 FCT v SNF (Australia) Pty Ltd (2011) 193 FCR 149 .................................................................... 22.350 FCT v Sara Lee Household & Body Care (Australia) Pty Ltd (2000) 44 ATR 370 ....................... 11.50 FCT v Seven Network Ltd [2016] FCAFC 70 .............................................................................. 22.310 FCT v Slade Bloodstock Pty Ltd (2007) 68 ATR 911 ..................................................................... 7.75 FCT v Slater Holdings Ltd (1984) 156 CLR 447 ........................................................................... 1.100 FCT v Snowden &Willson Pty Ltd (1958) 99 CLR 431 ......................................... 12.80, 12.90, 12.850 FCT v South Australian Battery Makers Pty Ltd (1978) 14 CLR 645 ......................................... 12.310 FCT v Spotless Services Ltd (1996) 34 ATR 183 ....................................................................... 23.300 FCT v St Hubert's Island Pty Ltd (1978) 8 ATR 452 .................................. 8.100, 17.20, 17.30, 17.210 FCT v Star City Pty Ltd (2009) 72 ATR 431 ................................................................................ 12.200 FCT v Stokes (1996) 34 ATR 478 ................................................................................................. 24.80 FCT v Studdert (1991) 22 ATR 762 .................................................................. 12.590, 12.600, 12.640 FCT v Suttons Motors (Chullora) Wholesale Pty Ltd (1985) 157 CLR 277 ............................... 17.220 FCT v Vogt (1975) 5 ATR 274 ..................................................................................................... 12.420 FCT v Wade (1951) 84 CLR 105 ...................................................................................... 10.220, 17.20 FCT v Western Suburbs Cinemas Ltd (1952) 86 CLR 102 .................................... 13.50, 13.60, 13.70 FCT v Whitfords Beach Pty Ltd (1982) 12 ATR 692 ................................... 8.170, 8.180, 8.190, 8.200, 8.260, 8.280, 8.290, 10.150 FCT v Whitfords Beach Pty Ltd (1982) 14 ATR 247 ..................................................................... 25.60 FCT v Whitfords Beach Pty Ltd (1982) 150 CLR 355 ................................................................... 12.30 FCT v Wiener (1978) 8 ATR 335 ................................................................................................. 12.410 FCT v Wilkinson (1983) 14 ATR 218 ............................................................................................ 12.50 FCT v Woite (1982) 13 ATR 579 ........................................................................................ 6.160, 6.170 FJ Bloemen Pty Ltd v FCT (1981) 147 CLR 360 ......................................................................... 24.130 Fairway Estates Pty Ltd v FCT (1970) 1 ATR 726 ........................................................................ 13.85 Farnsworth v FCT (1949) 78 CLR 504 ........................................................................................ 17.220

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xiv PRINCIPLES OF TAXATION LAW 2020 Federal Coke Co Pty Ltd v FCT (1977) 7 ATR 519 ............................................................ 5.155, 5.160 Federal Wharf Co Ltd v DCT (1930) 44 CLR 24 .................................................................... 9.80, 9.90 Ferguson v FCT (1979) 9 ATR 873 ............................................................................... 8.20, 8.40, 8.50 Finance (Canada), Minister of v Smith [1927] AC 193 ................................................................ 5.150 Fletcher v FCT (1991) 173 CLR 1 ..................................................................................... 12.310, 23.10 Fletcher v FCT (1992) 92 ATC 4611 ........................................................................................... 12.310 Foley v Fletcher [1843–​1860] All ER Rep 953 ................................................................................ 5.90 Ford v FCT (2014) AATA 361 ..................................................................................................... 12.420 Freeman v FCT (1983) 14 ATR 457 .............................................................................................. 6.300 Fullerton v FCT (1991) 22 ATR 757 ............................................................................................ 12.360

G GP International Pipecoaters Pty Ltd v FCT (1990) 21 ATR 1 ..................................................... 8.140 Gashi v FCT [2013] FCAFC 30 ......................................................................................... 24.90, 24.100 Gasparin v FCT (1994) 28 ATR 130 ............................................................................................ 17.230 George v FCT (1952) 86 CLR 183 ................................................................................................. 24.90 Gill v The Australian Wheat Board [1980] 2 NSWLR 795 ......................................................... 10.220 Glenboig Union Fireclay Co Ltd v IR Commissioner of Inland Revenue [1922] SLT 182 ........... 10.210 Glencore International AG v C of T [2019] HCA 26 ................................................................... 24.570 Goodman Fielder Wattie Ltd v FCT (1991) 22 ATR 26 ................................................................ 8.110 Granby Pty Ltd v FCT (1995) 30 ATR 400 .................................................................................... 17.70 Grealy v FCT (1989) 20 ATR 403 .................................................................................................. 6.310 Greig v FCT [2018] FCA 1084 .............................................................................................. 8.90, 8.230 Guinea Airways v FCT (1950) 83 CLR 584 ................................................................................... 17.30 Gulland v FCT (1984) 15 ATR 892 .............................................................................................. 24.220

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H HR Sinclair & Son Pty Ltd v FCT (1966) 114 CLR 537 .................................................. 10.270, 10.280 Hallstroms Pty Ltd v FCT (1946) 72 CLR 634 ............................................................................. 12.840 Harding v FCT [2019] FCAFC 29 .................................................................................................. 4.125 Handley v FCT (1981) 11 ATR 644 ............................................................................................. 12.720 Haritos v FCT [2015] FCAFC 92 .................................................................................................. 24.270 Hart v FCT (2004) 217 CLR 216 .................................................................................................. 23.310 Hayes v FCT (1956) 96 CLR 47 ............................................................... 6.20, 6.40, 6.90, 6.100, 6.220 Heavy Minerals Pty Ltd v FCT (1966) 115 CLR 512 ................................................................... 10.170 Henderson v FCT (1970) 119 CLR 612 ........................................................ 16.30, 16.60, 16.70, 17.30 Henry Jones (IXL) Ltd v FCT (1991) 22 ATR 328 ......................................................................... 8.260 Hepples v FCT (1991) 22 ATR 465 ............................................................................................... 6.170 Herald and Weekly Times Ltd v FCT (1932) 48 CLR 113 .................................... 12.80, 12.90, 12.240 Higgs v Olivier [1952] Ch 311 ........................................................................................... 6.160, 6.170 Hii v FCT [2015] FCA 375 ........................................................................................................... 24.130 Hill v FCT (2016) AATA 514 ........................................................................................................ 12.410 Hill and Tax Practitioners Board [2019] AATA 756 ................................................................... 24.698 Hochstrasser v Mayes [1960] AC 376 ................................................................................... 5.70, 6.40 Hogan v Australian Crime Commission (2010) 75 ATR 794 ..................................................... 24.590 Hogan v Australian Crime Commission (No 4) (2008) 72 ATR 107 .......................................... 24.590 Hollis v Vabu Pty Ltd [2001] HCA 44 ......................................................................................... 26.360 Howland-​Rose v FCT (2002) 49 ATR 206 .................................................................................. 23.330 Hua Wang Bank Berhad v FCT (No 19) [2015] FCA 454 ........................................................... 17.130 Hunter Valley Developments Pty Ltd v Cohen (1984) 3 FCR 344 ............................................. 24.210 Hutchins v DCT (1996) ATR 620 ................................................................................................ 24.650

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xv

I IR, Commissioner of v Philips Gleilampenfabrieken [1955] NZLR 868 ...................................... 4.270 IRC v British Salmson Aero Engines Ltd [1938] 2 KB 482 ........................................................ 12.190 IRC v Lysaght [1928] AC 234 ................................................................................................. 4.70, 4.80 Industrial Equity Ltd v DCT (1990) 170 CLR 649 ....................................................................... 24.530 Investment & Merchant Finance v FCT (1971) 2 ATR 361 .......................................................... 17.30

J J & G Knowles, Re (2000) 45 ATR 1101 ......................................................................................... 7.70 J & G Knowles & Associates Pty Ltd v FCT (2000) 44 ATR 22 ...................................................... 7.70 JJ Kerrison&Banich Management Pty Ltd v FCT (1986) 17 ATR 338 ....................................... 24.550 JMA Accounting Pty Ltd and Entrepreneur Services Pty Ltd v Carmody (2004) 57 ATR 365 .............................................................................................................. 24.570 Jarrold v Boustead (1963) 41 TC 701 .......................................................................................... 6.180 Joachim v FCT (2002) 50 ATR 1072 .............................................................................................. 4.70 John Fairfax & Sons Pty Ltd v FCT (1959) 101 CLR 30 ................................................ 12.840, 12.850 John Holland Group Pty Ltd v FCT (2015) FCAFC 82 ............................................................... 12.390 Jupiters Ltd v DCT (2002) 50 ATR 236 ...................................................................................... 12.200

K Kajewski v FCT (2003) 52 ATR 455 ............................................................................................ 24.140 Kameel Pty Ltd v Commissioner of State Revenue (Vic) [2016] VSCA 83 ............................... 26.220 Keily v FCT (1983) 83 SASR 494 .................................................................................................. 5.130 Kelly v FCT (1985) 16 ATR 478 ........................................................................ 6.40, 6.110, 6.120, 8.80 Koustrup v FCT, Re [2015] AATA 126 ......................................................................................... 4.130 Kosciusko Thredbo Pty Ltd v FCT (1983) 15 ATR 165 ................................................................ 9.170 Krok v FCT [2015] FCA 51 .......................................................................................................... 24.570

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L L'Estrange v FCT (1978) 9 ATR 410 ............................................................................................ 24.100 LHRC v DCT (No 3) [2015] FCAFC 184 ...................................................................................... 24.570 LHRC v FCT [2015] FCAFC 184 .................................................................................................. 24.570 Laidler v Perry [1965] 2 All ER 121 ....................................................................................... 6.50, 6.70 Lance, Re; Ex parte Nilant (1996) 34 ATR 573 ............................................................................ 19.20 Lansell House Pty Ltd v FCT (2011) 79 ATR 22 ......................................................................... 25.142 Law Shipping Co Ltd v Inland Revenue Commissioners (1923) 12 TC 621 ............................... 13.40 Le Grand v FCT (2002) 51 ATR 139 ............................................................................................. 6.290 Leonard v FCT (1919) 26 CLR 175 ............................................................................................. 19.100 Leppington Pastoral Co Pty Ltd v Chief Commissioner of State Revenue [2017] NSWSC 9 ................................................................................................................. 26.284 Levene v IRC [1928] AC 217 .................................................................................................. 4.70, 4.80 Lighthouse Philatelics Pty Ltd v FCT (1991) 22 ATR 707 .......................................................... 24.210 Lindsay v FCT (1960) 106 CLR 377 .............................................................................................. 13.60 Lindsay v IR Commrs (1932) 18 TC 43 ........................................................................................ 5.150 Living & Leisure Aus Ltd v Commissioner of State Revenue (Vic) [2018] VSCA 237 .............. 26.220 Lodge v FCT (1972) 3 ATR 254 .................................................................................................. 12.370 Lomax v Peter Dixon & Son Ltd [1943] 1 KB 671 ........................................................ 9.20, 9.30, 9.40 London Australia Investment Co Ltd v FCT (1977) 7 ATR 757 ..................................................... 8.90

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xvi PRINCIPLES OF TAXATION LAW 2020 Lui v FCT (2009) 76 ATR 633 ...................................................................................................... 24.190 Lunney v FCT; Hayley v FCT (1958) 100 CLR 478 ............................................. 12.60, 12.390, 23.180 Lurcott v Wakely and Wheeler [1911] 1 KB 905 .......................................................................... 13.33

M MLC Ltd v DCT (2002) 51 ATR 283 ............................................................................................ 14.170 MacCormick v FCT (1984) 15 ATR 437 .......................................................................................... 3.20 Maddalena v FCT (1971) 2 ATR 541 .............................................................................................. 8.80 Magna Alloys & Research Pty Ltd v FCT (1980) 11 ATR 276 ............... 12.90, 12.150, 12.270, 12.300 Mansfield v FCT (1995) 31 ATR 367 ............................................................................. 12.780, 12.790 MarevaCompaniaNaviera SA v International Bulkcarriers SA, “The Mareva” [1980] 1 All ER 213 ............................................................................................................. 24.180 Marijancevic v Mann (2008) 73 ATR 709 ........................................................................ 24.90, 24.170 Martin v FCT (1953) 90 CLR 470 .................................................................................................... 8.70 Martin v FCT (1984) 15 ATR 808 ................................................................................................ 12.370 Matthews v Chicory Marketing Board (1938) 60 CLR 263 ............................................................ 3.20 McCauley v FCT (1944) 69 CLR 235 ............................................................................................. 9.190 McCurry v FCT (1998) 39 ATR 121 .............................................................................................. 8.250 McDonald v FCT (1998) 38 ATR 563 ............................................................................................ 11.50 McIntosh v FCT (1979) 20 ATR 13 .................................................................................... 6.290, 6.300 McLaurin v FCT (1961) 104 CLR 381 .......................................................................................... 10.250 Memorex Pty Ltd v FCT (1987) 19 ATR 553 ..................................................................... 8.140, 8.150 Meridien Marinas Horizon Shores Pty Ltd v FCT (2009) 74 ATR 787 ....................................... 25.165 Midford v DFCT (2005) 60 ATR 1009 ......................................................................................... 25.148 Miller v FCT (1946) 73 CLR 93 ........................................................................................................ 4.70 Mills v FCT [2012] HCA 51 ......................................................................................................... 23.310 Moorhouse v Dooland [1955] 1 All ER 93 ..................................................................................... 6.20 Morris v FCT (2002) 50 ATR 104 ................................................................................... 12.780, 12.790 Mt Pritchard & District Community Club Ltd v FCT [2011] FCAFC 129 .................................... 24.380 Murdoch v Commr of Pay-​roll Tax (Vic) (1980) 143 CLR 629 ....................................................... 7.85

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N Nathan v FCT (1918) 25 CLR 183 ................................................................................................. 4.230 National Australia Bank v FCT (1993) 26 ATR 503 ...................................................................... 7.390 National Australia Bank Ltd v FCT (1997) 37 ATR 378 .............................................................. 12.200 Necovski and FCT, Re (2009) 75 ATR 152 .................................................................... 24.203, 24.205 Nilsen Development Laboratories Pty Ltd v FCT (1981) 11 ATR 505 .......................... 16.190, 16.200

P Parfew Nominees Pty Ltd v FCT (1986) 17 ATR 1017 ............................................................... 17.180 Pastoral & Development Pty Ltd v FCT (1971) 2 ATR 401 ........................................................ 17.110 Patcorp Investments Ltd v FCT (1976) 6 ATR 420 ................................................ 4.210, 17.30, 21.50 Pay-​Roll Tax (Vic), Commissioner of v Mary Kay Cosmetics (1982) 13 ATR 360 .............................................................................................................. 26.360 Payne v FCT (1996) 32 ATR 516 .......................................................... 5.60, 6.130, 6.210, 6.220, 7.58 Penn v Spiers& Pond Ltd [1908] 1 KB 766 ..................................................................................... 6.80 Peter Lenten v FCT (2008) 71 ATR 862 ...................................................................................... 12.620 Philip Morris Ltd v FCT (1979) 10 ATR 44 ................................................................................. 17.150 Pickford v FCT (1998) 40 ATR 1078 ............................................................................................. 6.180

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TaBle of Cases xvii Placer Pacific Management Pty Ltd v FCT (1995) 31 ATR 253 ....................... 12.140, 16.140, 16.150 Point v FCT (1970) 119 CLR 453 ................................................................................................... 13.80 Pratt Holdings Pty Ltd v FCT (2004) 56 ATR 128 ....................................................................... 24.570 Premier Automatic Ticket Issuers v FCT (1933) 50 CLR 268 ........................................................ 5.90 Prince v FCT (1959) 7 AITR 505 ..................................................................................................... 8.60

Q Quality Publications Australia Pty Ltd v FC of T [2012] FCA 256 ............................................. 11.470

R

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R v DCT; Ex parte Hooper (1926) 37 CLR 368 ............................................................................. 24.50 R v Issakidis [2018] NSWSC 378 ................................................................................................ 24.203 RACV v FCT (1973) 4 ATR 567 ..................................................................................................... 5.170 RACV Insurances Pty Ltd v FCT (1974) 4 ATR 610 ...................................................... 16.230, 16.240 Rafferty v FCT [1976] 2 All ER 801 ............................................................................................. 10.180 Raja's Commercial College v Gian Singh & Co Ltd [2017] AATA 636 ...................................... 12.420 Rawson Finances Pty Ltd v DCT [2011] FCA 1231 .................................................................... 24.150 Reany v FCT (2016) AATA 672 ................................................................................................... 12.420 Reseck v FCT (1975) 5 ATR 538 ........................................................................................ 6.290, 6.310 Reuter v FCT (1993) 27 ATR 256 .................................................................................................. 6.170 Rhodesia Metal Ltd (Liquidator) v Taxes Commr [1940] 3 All ER 422 ....................................... 4.250 Riches v Westminster Bank Ltd [1947] AC 390; 1 All ER 469 .......................................... 9.20, 12.810 Rigoli v FCT [2014] FCAFC 29 ...................................................................................................... 24.90 Rigoli v FCT [2015] FCA 803 ........................................................................................................ 24.90 Rigoli v FCT, Re [2015] AATA 169 ............................................................................................... 24.90 Rigoli v FCT [2016] FCAFC 38 ...................................................................................................... 24.90 Rio Tinto Services Pty Ltd v FCT [2015] FCAFC 117 ................................................................. 25.214 Roads & Traffic Authority of NSW v FCT (1993) 26 ATR 76 .............................................. 7.280, 7.85 Ronpibon Tin No Liability v FCT (1949) 78 CLR 47 ................... 12.40, 12.50, 12.270, 12.280, 12.300

S SNF (Australia) Pty Ltd v FC of T (2011) 193 FCR 149 .............................................................. 22.360 St George Bank Ltd v FCT (2009) 73 ATR 148 .......................................................................... 12.830 Saitta Pty Ltd v FCT (2002) 50 ATR 565 ..................................................................................... 24.170 Samuel Jones & Co (Devondale) Ltd v IRC (1951) 32 TC 513 .................................................... 13.60 Sanctuary Lakes v FCT [2013] FCAFC 50 .................................................................................. 24.201 Satyam Computer Services Ltd v FCT[2018] FCAFC 172 ........................................................... 4.290 Scott v C of T (NSW) (1935) 3 ATD 142 ....................................................................................... 3.150 Scott v Commissioner of Taxation (1935) 35 SR (NSW) 215 ....................................................... 5.20 Scott v FCT (1966) 117 CLR 514 ..................................................................... 6.20, 6.90, 6.100, 6.220 Scott v FCT, Re (2002) 50 ATR 1235 ............................................................................................ 19.90 Scottish Australian Mining Co Ltd v FCT (1950) 81 CLR 188 ........................................... 8.140, 8.180 Skase v FCT (1991) 32 FCR 206; 22 ATR 889 ............................................................................ 24.190 Slade Bloodstock Pty Ltd v FCT (2007) 68 ATR 911 ............................................................ 7.30, 7.70 Smith v FCT (1987) 19 ATR 274 ........................................................................................ 6.190, 6.220 Smith and Commissioner of Taxation [2010] AATA 576 .............................................................. 8.90 Softwood Pulp and Paper Ltd v FCT (1976) 7 ATR 101 ................................................... 8.110, 8.120 Sommer v FCT (2002) 51 ATR 102 .............................................................................................. 10.80 South Steyne Hotel Pty Ltd v FCT (2009) 71 ATR 228 .............................................................. 25.165

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xviii PRINCIPLES OF TAXATION LAW 2020 South Steyne Hotel Pty Ltd v FCT (2009) 74 ATR 41 ................................................................ 25.165 South Western Indemnities Ltd v Bank of New South Wales (1973) 129 CLR 512 ............................................................................................................ 24.530 Spencer v Commonwealth (1907) 5 CLR 418 ................................................................ 11.470, 17.70 Spotless Services v FCT (1993) 25 ATR 344 ............................................................................... 4.270 Spriggs v FCT; Riddell v FCT (2009) 72 ATR 148 ......................................... 8.20, 8.80, 12.350, 25.60 Squatting Investment Co Ltd v FCT (1953) 86 CLR 570 ................................................................ 6.90 Stanton v FCT (1955) 92 CLR 630 ................................................................................................ 9.200 Starrim Pty Ltd v FCT (2000) 44 ATR 487 ...................................................................................... 7.70 Statham v FCT (1988) 20 ATR 228 ............................................................................................... 8.180 Steele v DCT (1999) 41 ATR 139 ...................................................................... 12.130, 12.810, 16.170 Steinberg v FCT (1975) 5 ATR 565 .............................................................................................. 8.290 Stergis v Boucher (1989) 20 ATR 591 ........................................................................................ 24.550 Stevenson v FCT (1991) 22 ATR 56 ............................................................................................. 8.180 Stone v FCT (2005) 59 ATR 50 .............................................................................................. 8.40, 8.80 Strick v Regent Oil Co Ltd [1966] AC 295 ..................................................................... 12.190, 12.200 Sun Newspapers Ltd and Associated Newspapers Ltd v FCT (1938) 61 CLR 337 ................................................................................... 12.180, 12.210, 12.830, 12.840, 13.37 Sunchen Pty Ltd v FCT (2010) 78 ATR 197 ............................................................................... 25.165 Swan v Scanlan (DCT Qld) (1982) 13 ATR 420 ......................................................................... 24.550 Swinford v FCT (1984) 15 ATR 1154 .......................................................................................... 12.710 Sydney Refractive Surgery Centre Pty Ltd v FCT (2008) 73 ATR 28 ........................................ 10.210

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T T v FCT (1986) 18 ATR 1 ............................................................................................................ 24.190 Taxation, Commissioners of v Kirk [1900] AC 588 ..................................................................... 4.240 Taxes (South Australia), Commissioner of v Executor, Trustee and Agency Company of South Australia Limited (Carden's Case) (1938) 63 CLR 108 .......................................... 16.70 Tennant v Smith [1892] AC 150 .......................................................................................... 5.60, 6.130 Thiel v FCT (1990) 171 CLR 338 ................................................................................................. 22.460 Thomas v FCT (1972) 3 ATR 165 ................................................................................................... 8.50 Thorpe Nominees Pty Ltd v FCT (1988) 19 ATR 1834 ................................................................ 4.250 Tooheys Ltd v Commissioner of Taxation for NSW (1922) 22 SR (NSW) 432 ........................ 12.300 Toyama Pty Ltd v Landmark Building Developments Pty Ltd (2006) 62 ATR 73 ..................... 25.165 Trautwein v FCT (1936) 56 CLR 196 .............................................................................................. 8.60 Trustee for the Estate of the late AW Furse No 5 Will Trust v FCT (1990) 21 ATR 1123 .............. 17.70 Tweedle v FCT (1942) 7 ATD 186 .............................................................................................. 12.300

U Uber BV v Commissioner of Taxation [2017] FCA 110 ............................................................... 25.70 Undershaft (No 1) Ltd v FCT (2009) 74 ATR 888 ....................................................................... 22.480 Ure v FCT (1981) 11 ATR 484 ..................................................................................................... 12.310

V Vallambrosa Rubber Co Ltd v Farmer (1910) 5 TC 529 ............................................................ 12.180 Vidler v FCT (2009) 74 ATR 520 ................................................................................................. 25.165 Vidler v FCT (2010) 75 ATR 825 ................................................................................................. 25.165 Virgin Holdings SA v FCT (2008) 70 ATR 478 ........................................................................... 22.480

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TaBle of Cases xix

W

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W Nevill& Co Ltd v FCT (1937) 56 CLR 290 ..................................................... 12.100, 12.150, 16.160 W Thomas & Co Pty Ltd v FCT (1965) 115 CLR 58 ................................................ 13.40, 13.50, 13.60 WR Carpenter Holdings Pty Ltd v FCT (2008) 69 ATR 29 ......................................................... 22.350 WTPG v FCT, Re [2016] AATA 971 ............................................................................................ 12.240 Walstern Pty Ltd v FCT (2003) 138 FCR 1; 54 ATR 423 ............................................................ 24.201 Warner Music Australia Pty Ltd v FCT (1996) 34 ATR 171 .......................................... 10.270, 10.280 Westcott v FCT (1997) 37 ATR 1017 ............................................................................. 12.750, 12.770 Westfield Ltd v FCT (1991) 21 ATR 1398 .................................................... 8.150, 8.170, 8.220, 8.250 Westpac Banking Corporation v FCT (1996) 34 ATR 143 .................................................. 7.40, 7.280 Whitaker v FCT (1998) 38 ATR 219 .......................................................................... 9.80, 9.100, 9.110

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TABLE OF STATUTES

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Commonwealth A New Tax System (Goods and Services Tax) Act 1999:   1.190, 3.20, 25.10, 25.235, 25.255 s 9-​5:   25.90, 25.130, 25.150, 25.170 s 9-​10:   25.100 s 9-​10(4):   25.100 s 9-​15:   25.110 s 9-​15(2):   25.110 s 9-​20:   25.60 s 9-​20(1)(d) to (h):   25.60 s 9-​20(2):   25.60 s 9-​25:   25.120 s 9-​25(5)(d):   25.297 s 9-​25(7):   25.295 s 9-​30(3):   25.160 s 9-​40:   25.130 s 9-​70:   25.130, 25.230 s 9-​75:   25.130, 25.230 s 9-​75(1):   25.130 s 9-​75(3):   7.450 s 9-​80:   25.175 s 11-​5:   25.190, 25.220, 25.230 s 11-​10:   25.200 s 11-​15:   25.210 s 11-​15(2)(a):   25.214 s 11-​15(2)(b):   25.210 s 11-​15(4):   25.217 s 11-​20:   25.230 s 11-​25:   25.230 s 11-​30:   25.230 s 13-​1:   25.270 s 13-​5:   25.260 s 13-​5(4):   25.260 s 13-​10(b):   25.260 s 13-​15:   25.270 s 13-​20(1):   25.270 s 13-​20(2):   25.270 s 15-​1:   25.290 s 15-​5:   25.280 s 15-​15:   25.290 s 15-​20:   25.290 s 17-​5:   25.310 s 17-​5(1):   25.300 s 17-​5(2):   25.310 s 19-​10:   25.310 s 23-​5:   25.70 s 23-​10:   25.50

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s 23-​15:   25.70 s 27-​5:   25.300 s 29-​5:   25.300, 25.304 s 29-​10:   25.304 s 29-​10(2):   25.304 s 29-​10(3):   25.304, 25.306 s 29-​10(4):   25.306 s 29-​15(1):   25.304 s 29-​20(1):   25.310 s 29-​20(2):   25.310 s 29-​20(3):   25.310 s 29-​40:   25.304, 25.306 s 29-​70:   25.306 s 29-​75:   25.310 s 29-​80(1):   25.306 s 29-​80(2):   25.310 s 31-​5:   25.300 s 31-​8:   25.300 s 33-​15(1)(a):   25.304 s 38-​1:   25.150 s 38-​2:   25.142 s 38-​4:   25.142 s 38-​6:   25.142 s 38-​7:   25.144 s 38-​7(2):   25.144 s 38-​7(3):   25.144 s 38-​10:   25.144 s 38-​15:   25.144 s 38-​20:   25.144 s 38-​25:   25.144 s 38-​30:   25.144 s 38-​35:   25.144 s 38-​40:   25.144 s 38-​45:   25.144 s 38-​50:   25.144 s 38-​55:   25.144 s 38-​85:   25.146 s 38-​90:   25.146 s 38-​95:   25.146 s 38-​97:   25.146 s 38-​105:   25.146 s 38-​110:   25.146 s 38-​185(1):   25.148 s 38-​185(2):   25.148 s 38-​190:   25.297 s 38-​190(1):   25.148 s 38-​325(1):   25.148 s 38-​325(2):   25.148 s 38-​540:   25.148

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xxii PRINCIPLES OF TAXATION LAW 2020

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A New Tax System (Goods and Services Tax) Act 1999 — cont s 40-​1:   25.170 s 40-​65(1):   25.167 s 40-​65(2):   25.167 s 40-​70(1):   25.167 s 40-​70(2):   25.167 s 40-​75:   25.167 s 40-​75(2):   25.167 s 42-​5:   25.260 s 42-​10:   25.260 s 69-​5:   25.240, 25.280 s 69-​5(3A):   25.240 s 69-​10:   25.240 s 70-​5:   25.217 s 84-​55:   25.297 s 84-​75:   25.299 s 84-​77:   25.299 s 84-​79(3):   25.299 s 84-​81:   25.299 s 84-​100:   25.297 s 87-​15:   25.165 s 87-​25:   25.165 s 93-​5:   25.304 s 99-​10:   25.100 s 111-​5:   7.450, 25.330 s 144-​5:   25.70 s 188-​15:   25.70 s 188-​15(3):   25.297, 25.299 s 188-​20(3):   25.297, 25.299 s 189-​5:   25.217 s 189-​10:   25.217 s 195-​1:   25.120, 25.144, 25.146, 25.165, 25.167, 25.255 reg 29-​80.01:   25.306 Div 13:   25.250 Div 19:   25.310 Div 21:   25.310 Div 38:   25.140 Div 40:   25.160, 25.165 Div 48:   25.315 Div 60:   25.235 Div 69:   25.235 Div 72:   25.180 Div 75:   25.180 Div 78:   25.180 Div 84:   25.180, 25.255 Div 87:   25.165 Div 100:   25.180 Div 105:   25.180 Div 129:   25.310 Div 130:   25.310

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Div 136:   25.310 Div 137:   25.235 Div 153:   25.180, 25.235 Div 165:   25.300 Div 188:   25.70 Sch 1:   25.142, 25.260 Sch 2:   25.142 Sch 3:   25.144 subdiv 38-​A:   25.140, 25.150 subdiv 38-​B:   25.140, 25.144 subdiv 38-​C:   25.140 subdiv 38-​D:   25.140, 25.148 subdiv 38-​E:   25.140, 25.148 subdiv 38-​F:   25.140 subdiv 38-​G:   25.140 subdiv 38-​H:   25.140 subdiv 38-​I:   25.140 subdiv 38-​J:   25.140, 25.148 subdiv 38-​K:   25.140 subdiv 38-​L:   25.140 subdiv 38-​M:   25.140 subdiv 38-​N:   25.140 subdiv 38-​O:   25.140 subdiv 38-​P:   25.140 subdiv 38-​Q:   25.140 subdiv 38-​R:   25.140 subdiv 38-​S:   25.140 subdiv 38-​T:   25.140 subdiv 40-​A:   25.160 subdiv 40-​B:   25.160 subdiv 40-​C:   25.160 subdiv 40-​D:   25.160 subdiv 40-​E:   25.160 subdiv 40-​F:   25.160 subdiv 40-​G:   25.160 subdiv 84-​A:   25.295 A New Tax System (Goods and Services Tax Administration) Act 1999 :   25.10 A New Tax System (Goods and Services Tax) Bill 1998 :   25.20 A New Tax System (Goods and Services Tax Imposition –​Customs) Act 1999 :   25.10 A New Tax System (Goods and Services Tax Imposition –​Excise) Act 1999 :   25.10 A New Tax System (Goods and Services Tax Imposition –​General) Act 1999:   3.20, 25.10

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TABLE OF STATUTES xxiii A New Tax System (Goods and Services Tax) Regulations 1999 reg 23-​15.01:   25.70 reg 23-​15.02:   25.70 reg 29.80.02:   25.310 reg 40.5.09:   25.163 reg 40.5.11:   25.163 reg 40.5.12:   25.163 reg 40.5.13:   25.163 reg 70-​5.02:   25.217 reg 70-​5.02A:   25.217 reg 70-​5.03:   25.217 Sch 7:   25.163 Acts Interpretation Act 1901 s 29:   24.110 Administrative Appeals Tribunal Act 1975 s 29(7):   24.240 s 33(1)(c):   24.260 s 35:   24.260 s 41:   24.698 s 43(1):   24.270 s 43(2A):   24.270 s 44:   24.250

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Administrative Decisions (Judicial Review) Act 1977:   24.00, 24.630, 24.650 s 5(1):   24.650 s 5(2):   24.650 s 13:   24.650 s 16:   24.650 Sch 1:   24.650 Australian Crime Commission Act 2002:   24.570 Australian Participants in British Nuclear Tests and British Commonwealth Occupation Force (Treatment) Act 2006 :   3.70 Banking Act 1959:   22.410 Commonwealth of Australia Constitution 1901 :   3.20 s 51(ii):   3.00, 3.20 s 55:   3.20 s 90:   3.20 s 114:   3.20 Corporations Act 2001:   4.180, 20.30, 21.100, 21.390, 22.410 s 9:   24.420 s 46:   26.250 s 50:   26.350 s 254T:   21.100

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Corporations Amendment (Crowd-​sourced Funding for Proprietary Companies) Act 2018 8.107 Crimes Act 1914 s 3E:   24.510 s 3F:   24.510 s 4AA:   24.200 Crimes (Taxation Offences) Act 1980:   24.203 Criminal Code Act 1995:   24.203 Sch 1, s 135.1:   24.203 Sch 1, s 135.2:   24.203 Sch 1, s 135.4:   24.203 Domicile Act 1982 :   4.100 s 10:   4.100 Electronic Transactions Act 1999 s 14A:   24.110 Evidence Act 1995:   24.600 s 118:   24.600 s 119:   24.600 s 120:   24.600 Family Law Act 1975:   11.540 Federal Court of Australia Act 1976 s 24:   24.270 s 25:   24.270 s 33(3):   24.270 Financial Sector (Collection of Data) Act 2001:   22.410 Freedom of Information Act 1982:   24.00, 24.630 s 11:   24.640 s 11A:   24.640 s 33:   24.640 s 34:   24.640 s 47:   24.640 s 47C:   24.640 s 47E:   24.640 s 47F:   24.640 s 47G:   24.640 Fringe Benefits Tax Assessment Act 1986:   1.190, 1.240, 3.20, 7.10 s 5B:   7.410 s 5B(1A):   7.420 s 5C(3):   7.400

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xxiv PRINCIPLES OF TAXATION LAW 2020

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Fringe Benefits Tax Assessment Act 1986 — cont s 5C(4):   7.400 s 6:   7.30 s 7(1):   7.100 s 7(2):   7.100, 7.130 s 7(2A):   7.100 s 7(3):   7.100 s 7(4):   7.100 s 8(2):   7.110 s 8(2)(a):   7.110 s 8(3):   7.110 s 9:   7.120, 7.130 s 10:   7.120, 7.140 s 10(1):   7.120 s 10(3)(a)(v):   7.140 s 10(5):   7.120 s 10A:   7.140 s 10B:   7.140 s 11:   7.140 s 14:   7.150 s 15:   7.160 s 16:   7.170 s 17(1):   7.180 s 17(2):   7.180 s 17(3):   7.180 s 17(4):   7.180 s 18:   7.190 s 19(1)(i):   7.390 s 19(5):   7.390 s 20:   7.200 s 20A:   7.210 s 21:   7.210 s 22:   7.210 s 22A:   7.220 s 22A(4):   7.380 s 23:   7.220, 7.380 s 24:   7.220 s 37B:   7.240 s 37AA:   7.230 s 37AF:   7.230 s 37BA:   7.240, 7.320 s 37CA:   7.240 s 37CB:   7.240 s 37CC:   7.240 s 37CD:   7.240 s 37CD(2):   7.240 s 37CD(3):   7.240 s 40:   7.250 s 41:   7.260 s 42:   7.270 s 43:   7.270 s 45:   7.280

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s 47:   7.290 s 47(2):   7.290 s 47(3):   7.290 s 47(4):   7.290 s 48:   7.300 s 49:   7.300 s 50:   7.300 s 51:   7.300 s 53:   7.110, 7.130 s 58(4):   7.330 s 58A:   7.310 s 58B:   7.310 s 58C:   7.310 s 58D:   7.310 s 58E:   7.310 s 58F:   7.310 s 58H:   7.310 s 58K:   7.310 s 58L:   7.310 s 58M:   7.310 s 58P(f):   7.320 s 58X:   14.20 s 58X(2):   7.330 s 58X(3):   7.330 s 58AA:   7.310 s 62:   7.370, 7.380 s 66:   7.420 s 66(1):   7.10 s 68 24.20 s 136(1):   7.10, 7.20, 7.30, 7.40, 7.50, 7.58, 7.60, 7.70, 7.80, 7.85, 7.100, 7.140, 7.220, 7.250, 7.270, 7.320 s 137:   7.50 s 138(3):   7.390 s 148(1):   7.75 s 148(2):   7.65 s 148(3):   7.40 s 148(4):   7.40, 7.58 s 149A:   7.400 s 159:   7.55 Div 4:   7.280 Div 6:   7.90 Div 7:   7.90 Div 8:   7.90 Div 9:   7.90 Div 9A:   7.230, 7.240, 12.250 Div 10:   7.90 Div 10A:   7.90 Div 13:   7.310 Health Insurance Act 1973:   3.40, 3.70 s 3(1):   3.40 s 10:   3.40 s 21:   3.40

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TABLE OF STATUTES xxv Higher Education Support Act 2003:   12.240, 12.680 Income Tax Act 1986:   1.245, 3.20

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Income Tax Assessment Act 1922 s 116-​55:   11.470 Income Tax Assessment Act 1936:   1.130, 1.190, 1.200, 3.20, 10.00, 11.310, 12.240, 15.10, 24.130, 24.530 s 6:   3.70, 21.50 s 6(1):   4.40, 4.50, 4.170, 4.200, 9.150, 19.30, 21.60, 21.90, 21.140, 22.310, 24.50 s 6(1)(a)(i):   24.00 s 6(4):   21.70 s 6C:   4.290 s 6CA:   23.40 s 8:   24.510 s 16:   24.620 s 18:   3.120 s 21A:   5.60, 8.160 s 21A(1):   8.160 s 21A(2):   8.160 s 21A(2)(a):   8.160 s 21A(4):   8.160 s 21A(5):   8.160 s 23(q):   4.260 s 23L(1A):   7.440 s 23L(1):   3.170, 6.20, 6.240, 7.440 s 23L(2):   8.160 s 23AB(7):   15.190 s 23AF:   22.80 s 23AG:   12.230, 12.280, 22.80 s 23AH:   22.100 s 25(1):   5.10 s 25(1A):   8.300 s 25A:   8.300 s 26(e):   3.160, 6.100, 6.130, 6.190, 6.210, 6.220, 6.230, 7.10, 7.65 s 26(j):   10.290 s 26BB:   9.00, 9.60, 9.70 s 27H:   6.50, 9.210, 10.140 s 43B(1)(b):   21.50 s 44:   1.220, 3.160, 9.00, 9.150, 21.40, 21.50, 21.60, 21.70, 21.100, 21.200 s 44(1):   16.100, 21.100, 22.290 s 44(1A):   21.100 s 44(1B):   21.70 s 47:   21.140 s 47(1):   21.140 s 50:   6.10 s 51(1):   12.20, 16.170, 19.100

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s 51AH:   12.260 s 51AK:   25.240 s 51AEA:   7.430, 12.250, 25.240 s 63:   1.220 s 70B:   9.00, 9.60, 9.70 s 73BA:   11.150, 14.70, 14.140 s 78A:   12.240, 13.140, 13.160 s 78A(2)(a):   13.140 s 78A(2)(b):   13.140 s 78A(2)(c):   13.140, 13.160 s 78A(2)(d):   13.140 s 78A(3):   13.140 s 79A:   15.180 s 79B:   15.190 s 82A:   12.680 s 82A(2):   12.680 s 82KZL(1):   16.182 ss 82KZL to 82KZMG:   16.00, 16.180 s 82KZM:   16.185 s 90:   19.60, 19.70 s 91:   19.40 s 92:   19.60 s 92(2):   19.70 s 92(3):   19.70 s 94:   19.140 s 95(1):   20.80 s 95A(2):   20.120 s 97:   20.70, 20.90, 20.140, 20.150 s 98:   20.140, 20.150, 21.210 s 98(2A):   20.170 s 98(3):   20.170 s 99:   20.150 s 99A:   20.150, 21.210 s 100(2):   20.140 s 101:   20.120 s 102:   20.40, 20.160 s 102B:   23.130 s 102CA:   23.130 s 103A(1):   21.120 s 103A(2):   21.120 s 103A(3):   21.120 s 108:   21.130 s 109(1):   21.130 s 109C:   21.130 s 109D:   21.130 s 109E:   21.130 s 109F(1):   21.130 s 109F(6):   21.130 s 109G:   21.130 s 109J:   21.130 s 109K:   21.130 s 109M:   21.130 s 109N:   21.130 s 109Y:   21.130

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xxvi PRINCIPLES OF TAXATION LAW 2020

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Income Tax Assessment Act 1936 — cont s 109Z:   21.130 s 109ZC:   21.130 s 128B:   22.290 s 128D:   21.40, 21.260, 22.290 s 136(1):   7.55 s 159N:   15.170 s 159P:   15.200 s 160AAAA:   15.50 s 160APHO:   21.290 s 160APHD:   21.290, 21.300 s 160APHM:   21.290 s 160APHJ:   21.290 s 160APHT:   21.290 s 160APHN:   21.300 s 160APHO(3):   21.290 s 161:   24.20 s 161A(1):   24.20 s 161AA:   24.30:   s 162:   24.20 s 163:   24.20 s 166:   24.50, 24.90 s 166A:   24.40, 24.70 s 167:   24.00, 24.90, 24.100, 24.225 s 170:   24.60, 24.140, 24.520 s 170(1):   24.140 s 170BB:   24.380 s 174:   24.110, 24.120 s 175:   24.00, 24.120, 24.130 s 175A:   24.130 s 177:   24.130, 24.150, 24.190 s 177(1):   24.130 s 177A:   23.270 s 177A(1):   23.280 s 177A(3):   23.280 s 177C:   23.270, 23.290 s 177C(1)(ba):   23.340 s 177D:   23.270, 23.300 s 177D(1):   23.270 s 177D(2):   23.270 s 177D(a):   23.280 s 177D(b):   23.00 s 177F:   23.270 s 177F(3):   24.130 s 177CA:   23.290 s 177CB(3):   23.270 s 177CB(4):   23.270 s 177EA:   21.280 s 207-​145:   21.290 s 218:   21.170 s 251S(1)(a):   3.50 s 251T:   3.70 s 251U:   3.70

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s 252:   21.30 s 255:   24.175 s 255(1)(b):   24.175 s 255(1)(c):   24.175 s 255(1)(d):   24.175 s 260:   23.260 s 262A:   24.520 s 263:   24.200, 24.550, 24.560, 24.570 s 263(1):   24.530 s 264:   24.200, 24.540, 24.550, 24.560, 24.570, 24.590 s 264(2):   24.540 s 264A:   24.610 ss 316 to 468:   22.170 s 318:   7.55, 14.70, 14.90 Pt IIIAA, Div 1A:   21.290 Pt III, Div 3, subdiv H:   23.50 Pt III, Div 6B:   20.30 Pt III, Div 6C:   20.30 Pt III, Div 7A:   21.160 Pt III, Div 10B:   14.20 Pt III, Div 10BA:   14.20 Pt III, Div 11A:   22.280 Pt III, Div 16F:   22.380 Pt IVA:   1.130, 12.300, 12.310, 16.80, 20.40, 22.517, 23.00, 23.10, 23.20, 23.160, 23.260, 23.270, 23.280, 23.300, 23.310, 23.330, 23.350, 24.207,25.300 Pt VIIB:   3.40 Div 5:   19.10 Div 5A:   19.190 Div 6:   20.10 Div 6A:   23.130 Div 6B:   20.30 Div 6C:   20.30 Div 6AA:   20.160 Div 7A:   21.130, 21.460, 23.20, 23.140 Div 13:   22.350 Div 16E:   9.60 Income Tax Assessment Act 1997:   1.190, 1.210, 3.20, 3.110, 9.70, 9.80, 10.00, 10.20, 10.150, 10.290, 11.00, 11.310, 12.240, 14.90, 22.350 s 3-​5:   3.00, 3.110 s 4-​1:   21.10 s 4-​5:   3.110 s 4-​10:   3.110, 3.120, 12.10, 16.10 s 4-​10(1):   3.120 s 4-​10(3):   3.00 s 4-​15:   3.00, 3.130, 12.10 s 4-​15(1):   2.430, 24.50 s 5-​5:   24.150

06-Dec-19 14:01:15

TABLE OF STATUTES xxvii

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Income Tax Assessment Act 1997 — cont s 5-​5(2)-​(3):   24.30 s 5-​5(4):   24.30, 24.150 s 5-​5(5):   24.30, 24.150 s 5-​5(5):   24.30 s 6-​1:   5.170 s 6-​1(1):   3.140 ss 6-​1(2) to (4):   3.140 s 6-​5:   1.220, 2.30, 2.380, 4.230, 5.00, 5.10, 6.10, 6.20, 6.40, 6.100, 6.130, 6.200, 8.10, 8.20, 8.80, 8.105, 8.107, 8.120, 8.130, 8.150, 8.160, 8.265, 8.270, 8.310, 9.10, 9.20, 9.150, 9.200, 10.20, 10.40, 10.60, 10.90, 10.220, 10.230, 10.240, 11.310, 12.820, 16.40, 17.90, 17.210, 17.260 s 6-​5(1):   3.150, 5.10, 6.170 s 6-​5(2):   3.150, 6.60, 9.50 s 6-​5(3):   3.150 s 6-​5(4):   3.150, 5.160, 16.30, 16.40 s 6-​10:   4.230, 6.10, 8.265, 16.40 s 6-​10(2):   3.160 s 6-​10(3):   3.160, 5.160, 16.30 s 6-​25:   8.265, 9.10, 9.130, 9.150 s 6-​25(1):   3.160 s 6-​25(2):   3.160 s 8-​1:   1.220, 2.30, 2.90, 2.430, 2.450, 3.180, 6.200, 7.430, 8.80, 8.107, 8.110, 12.00, 12.10, 12.20, 12.30, 12.40, 12.50, 12.60, 12.70, 12.80, 12.100, 12.110, 12.130, 12.140, 12.160, 12.170, 12.210, 12.220, 12.230, 12.240, 12.250, 12.270, 12.280, 12.290, 12.300, 12.310, 12.330, 12.340, 12.360, 12.370, 12.390, 12.400, 12.410, 12.420, 12.430, 12.440, 12.450, 12.570, 12.580, 12.600, 12.610, 12.620, 12.630, 12.650, 12.660, 12.680, 12.690, 12.700, 12.710, 12.730, 12.750, 12.760, 12.770, 12.780, 12.790, 12.800, 12.810, 12.820, 12.840, 13.00, 13.10, 13.20, 13.30, 13.33, 13.37, 13.100, 13.110, 13.140, 13.160, 13.210, 14.10, 14.160, 14.180, 14.210, 16.120, 16.150, 16.160, 16.170, 16.190, 17.60, 17.210, 17.250, 17.260, 19.100 s 8-​1(1):   2.400, 2.410, 12.20, 12.40, 16.230 s 8-​1(1)(b):   2.430, 8.230 s 8-​1(2):   2.410, 12.20, 12.160 s 8-​1(2)(a):   12.170 s 8-​1(2)(b):   12.220

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s 8-​1(2)(c):   12.230 s 8-​1(3):   12.20 s 8-​5:   3.180, 12.10 s 8-​10:   3.180, 12.10, 13.10, 13.30, 13.210 s 9-​1:   3.110 s 11-​5:   3.170 s 11-​15:   3.170 s 11-​55:   3.170 s 12-​5:   13.10 s 13-​1:   3.220, 15.10, 15.140 s 15-​2:   2.380, 3.160, 6.00, 6.100, 6.130, 6.190, 6.200, 6.210, 6.220, 6.230, 6.240, 7.10, 7.65, 7.440 s 15-​2(3)(b):   2.380 s 15-​2(3)(d):   3.160, 6.190, 6.200, 6.230 s 15-​3:   6.00, 6.250 s 15-​10:   8.280 s 15-​10(b):   8.280 s 15-​15:   8.290, 13.210 s 15-​15(2)(a):   8.290 s 15-​15(2)(b):   8.290 s 15-​20:   8.265, 9.00, 9.10, 9.200 s 15-​20(2):   9.10 s 15-​25:   9.180 s 15-​30:   2.430, 10.00, 10.90, 10.230 s 15-​35:   9.130 s 15-​50:   19.170 s 17-​5:   3.170, 25.320 s 20-​20:   10.290 s 20-​20(2):   10.290 s 20-​20(3):   10.290 s 20-​30:   10.290 s 25-​5:   7.390, 13.20, 24.220 s 25-​5(2):   13.20 s 25-​5(2)(e):   13.20 s 25-​5(3):   13.20 s 25-​5(4):   13.20 s 25-​5(1)(c):   24.140 s 25-​5(5):   13.20 s 25-​10:   13.30, 13.33, 13.35, 13.37, 13.40, 13.50, 13.60, 13.70, 14.10, 14.90 s 25-​10(1):   13.30 s 25-​10(2):   13.35 s 25-​10(3):   13.37 s 25-​15:   9.180 s 25-​20:   13.210 s 25-​25:   13.210 s 25-​35:   13.80, 13.83, 16.00, 16.220 s 25-​35(1)(a):   13.80 s 25-​35(1)(b):   13.80 s 25-​40:   13.210 s 25-​45:   13.210 s 25-​47:   13.210 s 25-​50:   13.210

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xxviiiPRINCIPLES OF TAXATION LAW 2020

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Income Tax Assessment Act 1997 — cont s 25-​50(3):   13.210 s 25-​55:   13.100 s 25-​95:   19.170 s 25-​100:   12.440, 13.110 s 26-​5:   11.480, 12.240, 25.240 s 26-​5(a):   12.240 s 26-​5(b):   12.240 s 26-​10:   16.00, 16.200, 16.210 s 26-​19:   12.240, 12.640, 12.680 s 26-​20:   12.240, 12.680 s 26-​20(2):   7.430, 12.240, 12.680 s 26-​22:   12.240 s 26-​30:   12.240, 25.240 s 26-​30(2):   12.240 s 26-​30(3):   7.430, 12.240 s 26-​31:   12.240 s 26-​35:   12.240, 12.300, 23.120 s 26-​35(2):   12.240 s 26-​35(4):   12.240 s 26-​40:   25.240 s 26-​45:   12.240, 25.240 s 26-​45(2):   12.240 s 26-​45(3):   7.430, 12.240 s 26-​50:   25.240 s 26-​50(8):   7.430 s 26-​52:   12.240 s 26-​53:   12.240 s 26-​54:   11.480, 12.90, 12.240 s 26-​55:   12.240, 13.140, 13.160, 18.70 s 26-​55(1):   13.140 s 26-​105:   12.240 s 27-​5:   25.240, 25.320 s 27-​80:   14.90 s 28-​10:   12.450 s 28-​13:   12.550 s 28-​20(1):   12.450 s 28-​20(2):   12.450 s 28-​20(3):   12.450 s 28-​25:   12.460 s 28-​25(2):   12.480 s 28-​25(4):   12.460 s 28-​35:   12.470 s 28-​90:   12.550 s 28-​90(4):   12.550 s 28-​90(5):   12.550 s 28-​90(6):   12.550 s 30-​15:   13.130, 17.110 s 30-​242:   12.240, 13.150 s 30-​243:   12.240, 13.150 s 32-​5:   7.430, 12.250 s 32-​10:   12.250 s 32-​10(1):   12.250

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s 32-​10(2):   12.250 s 32-​20:   7.430, 12.250, 25.240 s 32-​30:   7.430, 12.250 s 32-​35:   12.250 s 32-​40:   12.250 s 32-​45:   12.250 s 34:   25.240 s 34-​10:   12.790 s 34-​10(3):   12.790 s 34-​15:   12.790 s 34-​20(1):   12.790 s 34-​20(2):   12.790 s 36-​10:   3.170, 13.180, 21.310 s 36-​15:   13.180, 13.190 s 36-​15(5):   13.180 s 36-​17:   13.180, 13.190, 21.230 s 36-​17(7):   13.180 s 36-​55:   21.240 s 40-​-​45:   14.165 s 40-​25:   14.40, 14.50 s 40-​25(1):   14.40 s 40-​25(2):   14.40, 14.100 s 40-​25(7):   14.100 s 40-​27:   14.20 s 40-​30(1):   14.30 s 40-​30(1)(b):   17.290 s 40-​30(2):   14.30 s 40-​30(4):   14.35 s 40-​35:   14.60 s 40-​40:   14.50, 14.60 s 40-​45(1):   14.20 s 40-​45(2):   14.20, 14.30 s 40-​45(5):   14.20 s 40-​50:   14.20 s 40-​55:   14.20, 14.125 s 40-​60:   14.70 s 40-​65:   14.70 s 40-​65(2):   14.70, 14.90 s 40-​65(3):   14.70 s 40-​65(5):   14.70 s 40-​65(6):   14.70 s 40-​70:   14.80 s 40-​70(1):   14.90 s 40-​70(2):   14.70, 14.90 s 40-​70(3):   14.90 s 40-​72:   14.80, 14.90, 14.125 s 40-​72(2):   14.70, 14.90 s 40-​72(3):   14.90 s 40-​75:   14.80, 14.90, 14.125 s 40-​75(2):   14.90 s 40-​75(3):   14.90 s 40-​75(5):   14.90 s 40-​80(1):   14.40 s 40-​80(2):   14.40, 14.140

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TABLE OF STATUTES xxix

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Income Tax Assessment Act 1997 — cont s 40-​80(2)(c):   14.40 s 40-​80(2)(d):   14.40 s 40-​85:   14.90, 14.110 s 40-​95(1):   14.90 s 40-​95(3):   14.90 s 40-​95(4):   14.90 s 40-​95(5):   14.90 s 40-​95(5)(c):   14.90 s 40-​95(5)(d):   14.90 s 40-​95(6):   14.90 s 40-​95(7):   14.90 s 40-​102:   14.90 s 40-​105:   14.90 s 40-​105(2):   14.90 s 40-​110:   14.90 s 40-​110(1):   14.90 s 40-​110(2):   14.90 s 40-​110(3):   14.90 s 40-​130:   14.70 s 40-​180:   14.90 s 40-​180(2):   14.90 s 40-​185:   14.90 s 40-​190:   14.90 s 40-​215:   14.90 s 40-​230:   14.90, 14.125 s 40-​230(2):   14.125 s 40-​285:   14.110, 14.115 s 40-​285(1):   14.110 s 40-​285(2):   14.110, 14.125 s 40-​290:   14.110, 14.115 s 40-​295:   14.110 s 40-​295(2):   14.120 s 40-​295(3):   14.110 s 40-​300:   14.110 s 40-​325:   14.125 s 40-​340:   19.180 s 40-​340(1):   14.120 s 40-​340(3):   14.120 s 40-​345:   14.120 s 40-​365(1):   14.120 s 40-​365(2):   14.120 s 40-​370:   14.125 s 40-​425:   14.140 s 40-​425(2):   14.140 s 40-​425(4):   14.140 s 40-​425(5):   14.140 s 40-​425(7):   14.140 s 40-​425(8):   14.140 s 40-​430(1):   14.140 s 40-​435:   14.145 s 40-​440(1):   14.150 s 40-​440(2):   14.150

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s 40-​445(1):   14.155 s 40-​445(2):   14.155 s 40-​450:   14.160 s 40-​450(1):   14.160 s 40-​450(2):   14.160 s 40-​450(3):   14.160 s 40-​450(4):   14.160 s 40-​455:   14.160 s 40-​460:   14.160 s 40-​830:   14.190 s 40-​840:   14.190 s 40-​840(2)(d):   14.190 s 40-​860:   14.190 s 40-​865:   14.190 s 40-​880:   1.110, 2.410, 8.107, 14.00, 14.200, 14.210, 14.215 s 40-​880(2):   14.200 s 40-​880(2A):   14.215 s 40-​880(5):   14.200 ss 40-​880(5)(h) to (j):   14.200 s 40-​880(7):   14.210 s 43:   14.170 s 43-​10:   14.170 s 43-​15:   14.170 s 43-​20:   14.170 s 43-​25:   14.170 s 43-​30:   14.170 s 43-​70:   14.170 s 43-​250:   14.170 s 50-​50(1)(c):   12.230, 12.280 s 51-​57:   9.100, 9.110, 10.100 s 58P:   7.430 s 61-​105:   15.170 s 61-​110:   15.170 s 61-​205:   15.40, 15.160 s 61-​610:   15.200 s 63-​10:   15.210 s 67-​23:   15.40 s 67-​25:   15.80, 21.210 s 70:   10.220 s 70-​5(2)(b):   17.90, 17.210 s 70-​10:   17.20, 17.210, 17.290 s 70-​15:   17.60, 17.210, 17.260 s 70-​20:   17.70, 17.100, 17.150, 23.120 s 70-​25:   17.60 s 70-​30:   17.250 s 70-​30(3):   17.250 s 70-​30(4):   17.250 s 70-​35:   17.120, 17.210 s 70-​40:   17.130 s 70-​45:   17.140, 17.170, 17.190, 17.250 s 70-​45(1A):   17.140 s 70-​50:   17.190 s 70-​55:   17.200

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xxx PRINCIPLES OF TAXATION LAW 2020

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Income Tax Assessment Act 1997 — cont s 70-​90:   17.110 s 70-​90(2):   17.110 s 70-​95:   17.110 s 70-​100:   19.180 s 70-​105:   17.110 s 70-​110:   17.260 s 70-​115:   10.220, 17.270 s 80-​10:   6.310 s 82-​10:   6.370 s 82-​10(1):   6.370 s 82-​10(2):   6.370 s 82-​10(4):   6.370 s 82-​10(6):   6.370 s 82-​10(7):   6.370 s 82-​65:   6.380 s 82-​65(1):   6.370 s 82-​70:   6.380 s 82-​70(1):   6.370 s 82-​130:   6.280 s 82-​135:   6.280 s 82-​140:   6.370 s 82-​145:   6.370 s 82-​150:   6.370 s 82-​150(2):   6.370 s 82-​155:   6.370 s 83-​10:   6.390 s 83-​10(7):   6.370 s 83-​15:   6.390 s 83-​85:   15.130 s 83-​170:   6.320, 6.360 s 83-​175:   6.330, 6.350, 6.370 s 83-​180:   6.340, 6.350 s 84-​5:   23.170 s 85-​10:   23.180 s 85-​15:   23.180 s 85-​20:   23.180 s 86-​10:   23.160 s 86-​15:   23.160 s 87-​15(3):   23.190 s 87-​18:   23.200 s 87-​20:   23.210 s 87-​25:   23.220 s 87-​30:   23.230 s 87-​60:   23.240 s 87-​60(4):   23.240 s 90:   19.70 s 100-​10(3):   11.20 s 102-​5:   3.160 s 102-​5(1):   11.10 s 102-​10(2):   11.570 s 102-​15:   11.530 s 102-​15(1):   11.570

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s 102-​20:   11.40 s 102-​25(1):   11.40 s 104-​5:   11.40, 11.440 s 104-​10:   11.50 s 104-​10(1):   11.50 s 104-​10(2):   11.50 s 104-​10(3):   11.50 s 104-​10(4):   11.50, 11.450 s 104-​15(1):   11.60 s 104-​15(2):   11.60 s 104-​20(1):   11.70 s 104-​20(2):   11.70 s 104-​25:   21.140 s 104-​25(1):   11.70 s 104-​25(2):   11.70 s 104-​30(1):   11.70 s 104-​30(2):   11.70 s 104-​35:   11.80 s 104-​35(1):   11.80 s 104-​40(1):   11.80 s 104-​45(1):   11.80 s 104-​47(1):   11.80 s 104-​125:   11.100 s 104-​130:   11.100 s 104-​135:   21.60, 21.140 s 104-​135(1):   11.110 s 104-​145(1):   11.110 s 104-​150(1):   11.120 s 104-​155:   11.120 s 104-​155(1):   11.120 s 104-​160(1):   11.130 s 104-​170(1):   11.130 s 104-​220:   17.250 s 106-​5(4):   19.130 s 108-​5:   11.170 s 108-​5(1):   11.170 s 108-​5(1)(a):   11.170 s 108-​5(1)(b):   11.170 s 108-​10:   11.180 s 108-​10(1):   11.240 s 108-​10(2):   11.180 s 108-​15:   11.180 s 108-​20(1):   11.240 s 108-​20(2):   11.190 s 108-​20(3):   11.190 s 108-​55(1):   11.200 s 108-​55(2):   11.200 s 108-​60:   11.200 s 108-​65:   11.200 s 108-​70:   11.200 s 109-​5(1):   11.210 s 109-​5(2):   11.210 s 109-​10:   11.210 s 110-​25(2):   11.480

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TABLE OF STATUTES xxxi

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Income Tax Assessment Act 1997 — cont s 110-​25(4):   11.480 s 110-​25(5):   11.480 s 110-​25(6):   2.450, 11.480 s 110-​35:   11.480 s 110-​38(1):   11.480 s 110-​38(2):   11.480 s 110-​38(3):   11.480 s 110-​38(4):   11.480 ss 110-​40(2) to 110-​45(1B):   11.480 s 110-​40(3):   11.480 s 110-​45(3):   11.480 s 112-​20:   23.120 s 112-​20(1):   11.490 s 112-​20(2):   11.490 s 112-​25:   11.490 s 112-​30:   11.490 s 112-​35:   11.490 s 112-​37:   11.490 s 112-​115:   11.430 s 112-​150:   11.430 s 114-​1:   11.495 s 115-​5:   11.15 s 115-​10:   20.130 s 115-​20(2):   11.540 s 116-​20:   11.470 s 116-​20(5):   11.470 s 116-​30:   11.470, 23.120 s 116-​40:   11.470 s 116-​45:   11.470 s 116-​50:   11.470 s 116-​60:   11.470 s 118-​5:   11.230 s 118-​10:   11.180 s 118-​10(1):   11.240 s 118-​10(3):   11.240 s 118-​12(1):   11.250 s 118-​13:   11.260 s 118-​20:   11.310, 21.140 s 118-​20(1):   11.310 s 118-​22:   11.310 s 118-​24:   14.30, 14.118 s 118-​24(1):   11.270 s 118-​25:   11.275, 17.250, 17.290 s 118-​30:   11.310 s 118-​35:   11.310 s 118-​37:   9.120, 10.100, 10.110 s 118-​37(1):   10.120 s 118-​37(1)(a):   10.100, 11.290 s 118-​37(1)(a)(i):   10.100 s 118-​37(1)(a)(ii):   10.100 s 118-​37(1)(b):   10.100, 11.290 s 118-​37(1)(c):   11.300

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s 118-​37(1)(ba):   10.100 s 118-​105:   11.380 s 118-​110(1):   11.390 s 118-​115(1):   11.390 s 118-​120:   11.390 s 118-​135:   11.400 s 118-​140(1):   11.400 s 118-​140(2):   11.400 s 118-​145:   11.420 s 118-​145(2):   11.400 s 118-​145(3):   11.400 s 118-​150(2):   11.400 s 118-​150(4):   11.400 s 118-​160:   11.400 s 118-​165:   11.410 s 118-​170(1):   11.410 s 118-​170(3):   11.410 s 118-​170(4):   11.410 s 118-​175:   11.410 s 118-​178:   11.410 s 118-​185:   11.420 s 118-​190:   11.420 s 118-​192:   11.420 s 128-​10:   11.425 s 128-​15(4):   11.425 s 136(1):   7.430 s 152-​5:   11.330 s 165-​10:   21.320 s 165-​12:   21.330 s 165-​12(1):   21.330 s 165-​12(7):   21.330 s 165-​13:   21.330, 21.340 s 165-​15:   21.330 s 165-​115A:   21.350 s 165-​115A(1B):   21.350 s 165-​115A(1):   21.350 s 165-​115B:   21.350 s 165-​115E:   21.350 s 165-​115L:   21.360 s 165-​115M:   21.360 s 165-​115R:   21.360 s 165-​115U:   21.360 s 165-​115X(1):   21.360 s 165-​115X(5):   21.360 s 165-​115Y:   21.360 s 165-​115Z:   21.360 s 165-​115ZA:   21.360 s 165-​115ZB:   21.360 s 165-​165:   21.330 s 165-​210:   21.330, 21.340 s 165-​210(3):   21.340 s 165-​211:   21.330, 21.340 s 165-​211(2):   21.340 s 165-​C:   21.320

06-Dec-19 14:01:15

xxxiiPRINCIPLES OF TAXATION LAW 2020

Copyright © 2019. Thomson Reuters. All rights reserved.

Income Tax Assessment Act 1997 — cont s 165-​CA:   21.320 s 165-​CB:   21.320 s 166-​5:   21.330 s 166-​175:   21.330 s 166-​225:   21.330 s 195-​1:   25.70 s 197-​45:   21.70 s 197-​50:   21.70 s 202-​5:   21.160, 21.170 s 202-​15:   21.160 s 202-​20:   21.160 s 202-​40:   21.160 s 202-​45:   21.160 s 202-​45(e):   21.70 s 202-​45(g):   21.110 s 202-​60(2):   21.170 s 202-​75:   21.170 s 202-​80:   21.170 s 203-​15:   21.270 s 203-​25:   21.270 s 203-​30:   21.270 s 203-​40:   21.270 s 203-​45:   21.270 s 203-​50(1)(a):   21.270 s 203-​50(1)(b):   21.270 s 203-​55:   21.270 s 204-​30:   21.280 s 204-​75:   21.270 s 204-​80:   21.270 s 205-​10:   21.180 s 205-​15:   21.180, 21.190, 21.220 s 205-​30:   21.180 s 205-​45(1):   21.190 s 205-​45(2):   21.190 s 205-​70(1):   21.190 s 205-​70(2):   21.190 s 207-​20:   15.80, 21.200 s 207-​35:   19.120, 21.250 s 207-​45:   21.250 s 207-​55:   21.250 s 207-​70:   21.260 s 207-​95:   21.260 s 207-​145(1)(a):   21.290 s 290-​60:   18.60, 18.70 s 290-​80:   18.70 s 290-​150:   18.60, 18.70 ss 290-​150:   18.70, 19.70 s 290-​160:   18.70 s 290-​165:   18.70 s 290-​170:   18.70, 18.90 s 291-​20(3)–​(7):   18.80 s 291-​25:   18.70

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s 292-​20:   18.80 s 292-​25:   18.70 s 292-​85:   18.100 s 292-​85(b):   18.140 s 292-​85(2)(b):   18.100 s 292-​85(3):   18.100 s 292-​85(5):   18.100 s 292-​90:   18.90 s 294-​35:   18.100, 18.140 s 295-​160:   18.70 s 295-​190:   18.70 s 301-​10:   18.210 s 301-​15:   18.210 s 301-​20:   15.90 s 301-​25:   18.210 s 301-​30:   18.210 s 301-​100:   18.210 s 301-​110:   18.210 s 301-​115:   15.90 s 301-​120:   18.210 s 302-​60:   18.230 s 302-​145:   18.230 s 302-​195:   6.380, 18.230 s 302-​200:   18.230 s 307-​70:   18.200 s 328-​180:   14.280 s 328-​175(1):   14.165 s 328-​175(2)-​(10):   14.165 s 328-​180:   14.165 s 328-​180(1):   14.165 s 328-​185:   14.165 s 328-​190:   14.165 s 328-​195:   14.165 s 328-​200:   14.165 s 328-​205:   14.165 s 328-​210:   14.165 s 328-​210(1):   14.165 s 328-​215:   14.165 s 328-​215(2):   14.165 s 328-​215(4):   14.165 s 328-​220(1):   14.165 s 328-​220(2):   14.165 s 328-​225:   14.165 s 328-​285:   17.280 s 328-​285(2):   19.200, 20.190 s 328-​295:   17.280 s 355-​15:   24.620 s 385-​130:   10.230 s 700-​10:   21.380 s 701-​1:   21.410 s 701-​5:   21.420 s 701-​10:   21.450 s 701-​15:   21.450 s 701-​40:   21.420

06-Dec-19 14:01:15

TABLE OF STATUTES xxxiii

Copyright © 2019. Thomson Reuters. All rights reserved.

Income Tax Assessment Act 1997 — cont s 703-​10:   21.390 s 703-​15(1):   21.390 s 703-​15(2):   21.390 s 703-​30:   21.390 s 703-​35:   21.390 s 703-​50:   21.390 s 707-​120:   21.440 s 707-​305(3):   21.440 s 707-​310:   21.440 s 707-​320:   21.440 s 707-​410:   21.440 s 713-​130:   21.390 s 719-​5:   21.400 s 721-​10(1):   21.430 s 721-​15:   21.430 s 721-​25:   21.430 s 768-​5:   22.90 s 770-​10:   15.100 s 770-​10(1):   22.130 s 770-​15(1):   22.130 s 900-​35:   12.320 s 900-​40:   12.320 s 900-​50:   12.320 s 900-​55:   12.320 s 900-​60:   12.320 s 900-​115:   12.320 s 900-​165:   12.320 s 960-​115:   21.20, 21.160 s 960-​120(1):   21.160 s 960-​130:   21.390 s 960-​275:   11.495 s 960-​555:   24.201 s 974-​10(1):   21.50 s 974-​115:   21.80 s 974-​120:   21.80 s 974-​120(2):   21.80 s 975-​300:   21.70 s 975-​300(3)(d):   21.70 s 975-​300(3)(ba):   21.70 s 995-​1:   3.120, 4.40, 7.55, 7.100, 11.230, 12.240, 13.20, 14.90, 14.125, 14.160, 17.20, 17.70, 19.30, 21.20, 21.80, 24.00, 24.50 s 995-​1(1):   8.20, 17.20 s 1675-​211(3):   21.340 Ch 3, Pt 3-​1:   11.10 Ch 3, Pt 3-​3:   11.10 Pt 2:   12.10 Pt 3-​1, subdiv 118-​100:   11.380 Pt 3-​6:   21.150 Pt 3-​30:   18.10 Div 6:   3.130, 4.20

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Div 8:   3.130, 12.10, 13.10 Div 8-​5:   13.10 Div 10:   3.160 Div 13:   22.360 Div 20:   10.290 Div 25:   13.00, 13.10, 13.210 Div 26:   12.240 Div 28:   12.380, 12.450, 12.860 Div 30:   13.00, 13.130, 13.140, 13.160 Div 32:   12.250, 25.240 Div 35:   13.200, 23.150, 23.190, 23.200 Div 36:   13.00, 13.180 Div 40:   10.200, 10.300, 12.800, 14.00, 14.20, 14.35, 14.160, 14.165, 14.170, 17.250, 17.260 Div 43:   14.00, 14.20, 14.30, 14.35, 14.170 Div 50:   8.107 Div 54:   10.00, 10.140 Div 61-​A:   15.150 Div 70:   11.275, 17.00, 17.10 Div 82:   6.00 Div 83:   6.00 Div 85:   6.60 Div 87:   23.190 Div 100:   11.20 Div 104:   11.10, 11.40, 11.220 Div 108:   11.10, 11.170 Div 109:   11.210 Div 110:   11.10 Div 115:   11.540, 18.140, 18.150 Div 116:   11.10 Div 118:   11.10, 11.220 Div 128:   11.425 Div 152:   11.320 Div 166:   21.330 Div 197:   21.70 Div 207:   21.210 Div 220:   21.160 Div 230:   9.00, 9.70, 17.20, 17.290 Div 293:   18.140 Div 294:   18.150 Div 295:   18.150 Div 328:   14.160, 17.10 Div 355:   15.40 Div 768:   4.150 Div 770:   22.130 Div 820:   22.380, 22.390 Div 815:   12.300 Div 900:   12.320 Div 961:   15.150 Div 974:   9.00, 9.150 Divs 84 to 87:   23.160 Subdiv 61-​K:   15.200 Subdiv 328-​F:   15.130

06-Dec-19 14:01:15

xxxivPRINCIPLES OF TAXATION LAW 2020

Copyright © 2019. Thomson Reuters. All rights reserved.

Income Tax Assessment Act 1997 — cont Subdiv 360-​A:   11.265 subdiv 20-​A:   13.210 subdiv 28-​G:   12.570 subdiv 32-​B:   12.250 subdiv 40-​C:   14.90 subdiv 40-​D:   14.110 subdiv 40-​E:   14.20, 14.70, 14.130 subdiv 40-​F:   14.20 subdiv 40-​G:   14.20 subdiv 40-​I:   14.180, 14.200 subdiv 40-​J:   14.20 subdiv 87-​B:   23.240 subdiv 104-​A:   11.40 subdiv 104-​B:   11.40 subdiv 104-​C:   11.40 subdiv 104-​D:   11.40 subdiv 104-​E:   11.40, 11.90 subdiv 104-​F:   11.40, 11.100 subdiv 104-​G:   11.40, 11.110 subdiv 104-​H:   11.40, 11.120 subdiv 104-​I:   11.40, 11.130 subdiv 104-​J:   11.40, 11.140 subdiv 104-​K:   11.40, 11.150 subdiv 104-​L:   11.40, 11.160 subdiv 108-​D:   11.200 subdiv 110-​A:   11.480 subdiv 112-​C:   11.430 subdiv 112-​D:   11.430 subdiv 115-​C:   20.100 subdiv 118-​A:   11.280 subdiv 118-​B:   11.380 subdiv 124-​N:   11.140 subdiv 152-​A:   11.330 subdiv 152-​E:   11.140 subdiv 165-​B:   21.320 subdiv 165-​D:   21.330 subdiv 165-​CC:   21.350, 21.360 subdiv 165-​CD:   21.360 subdiv 207-​B:   20.100, 21.250 subdiv 207-​F:   21.280 subdiv 328-​D:   14.20, 14.140, 14.165 subdiv 768-​R:   4.150 subdiv 815:   22.350 subdiv 815-​B:   22.350, 22.360 subdiv 815-​C:   22.350 subdiv 815-​D:   22.350, 22.360 subdiv 815-​E:   22.350, 22.375 subdiv 900-​C:   12.570 subdiv 960-​M:   11.495 Income Tax Assessment Regulations 1997 reg 995-​1.01:   18.200

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Income Tax (Dividends, Interest and Royalties Withholding Tax) Act 1974:   22.280 Income Tax Rates Act 1986:   1.245, 3.20, 3.190 Inspector-​General of Taxation Act 2003:   24.00, 24.630, 24.670 International Tax Agreements Act 1953 :   1.245 s 4(1):   22.440 Judiciary Act 1903 s 35A:   24.270 s 39B:   24.130, 24.210, 24.380, 24.650 Medicare Levy Act 1986 :   3.40 Migration Act 1958 :   4.150 Military Rehabilitation and Compensation Act 2004 :   3.70 Public Service Act 1922:   12.80, 12.90 Retirement Savings Accounts Act 1997 s 40-​880:   8.110 Sex Discrimination Act 1984:   10.120 Social Security Act 1991 :   4.150 Superannuation Act 1976 :   4.50 Superannuation Act 1990 :   4.50 Superannuation Industry (Supervision) Act 1993 s 10:   18.225, 18.230 s 10A:   18.225 s 59(1A):   18.225 Superannuation Industry (Supervision) Regulations 1994 reg 1.06(1):   18.200 reg 1.06(9A):   18.200 reg 6.17A:   18.125, 18.225 reg 6.22:   18.225 subreg 7.01(3):   18.125 reg 7.04:   18.125 Tax Administration Act 1953 :   1.245 s 353-​10:   24.560 s 353-​15:   24.560

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TABLE OF STATUTES xxxv Taxation Administration Act Regulations 2017 s 70:   24.330 Tax Agents Services Act 2009:   24.690 s 20-​5:   24.690 s 20-​15:   24.690 s 20-​20:   24.690 s 20-​25:   24.690 s 30-​5:   24.695 s 30-​10:   24.695 s 30-​15:   24.695 s 60-​95:   24.698 s 60-​100:   24.698 s 60-​105:   24.698 s 70-​10:   24.690, 24.698 Tax Agent Services Regulations 2009 Sch 2:   24.690 Tax Laws Amendment (2006 Measures No 1) Act 2006:   14.200, 14.210 Tax Laws Amendment (2008 Measures No 5) Act 2008 :   7.390 Sch 4:   7.390 Tax Laws Amendment (2009 Budget Measures No 1) Act 2009 :   22.80 Tax Laws Amendment (Combating Tax Avoidance) Act 2015:   22.375

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Tax Laws Amendment (Simplified Superannuation) Act 2007 :   18.10 Taxation Administration Act 1953:   24.150, 24.200 s 3A:   24.510 ss 8A–​13C:   24.203 s 8C:   24.20,24.203, 24.550 s 8D:   24.203 s 8K:   24.203 s 8L:   24.203, 24.520 s 8N:   24.203 s 8Q:   24.203 s 8T:   24.203 s 8U:   24.203 s 8ZE:   24.203 s 8AAB:   24.140, 24.150 s 8AAC:   24.150 s 8AAG:   24.140, 24.150 s 14E:   24.250 s 14R:   24.190 s 14S:   24.190

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s 14T:   24.190 s 14U:   24.190 s 14U(1)(b):   24.190 s 14V:   24.190 s 14Y:   24.190 s 14ZQ:   24.250 s 14ZU:   24.210 s 14ZV:   24.210 s 14ZW(1):   24.210 s 14ZW(1)(aa):   24.210 s 14ZW(1)(c):   24.206 s 14ZW(1B):   24.210 s 14ZW(1BA):   24.210 s 14ZW(1BB):   24.206 s 14ZX:   24.210 s 14ZY:   24.230 s 14ZZ:   24.240, 24.260 s 14ZYA:   24.230 s 14ZYB:   24.230 s 14ZZC:   24.240 s 14ZZE:   24.260 s 14ZZK:   24.210 s 14ZZK(b):   24.225 s 14ZZL:   24.270 s 14ZZM:   24.150 s 14ZZN:   24.240 s 14ZZO(b):   24.225 s 14ZZR:   24.150 s 18-​15:   24.150 s 45-​15:   24.150 s 45-​30:   24.150 s 284-​75(1):   24.201, 24.203 s 284-​75(1)(a):   24.203 s 284-​75(2):   24.201, 24.203 s 284-​75(4):   24.201, 24.203 s 284-​75(6):   24.201, 24.690 s 284-​145:   24.201 s 284-​160:   24.201 s 284-​220:   24.201 s 284-​224:   24.201 s 286-​75:   24.201 s 288-​25:   24.201 s 298-​30:   24.201 s 350-​10:   24.90, 24.130, 24.201, 24.540 s 353-​15:   24.201 s 353-​15(2):   24.530 s 353-​15(3):   24.530 s 353-​25:   24.610 s 353-​30:   24.610 s 357-​75:   24.390 Pt IVA:   24.130, 24.140 Pt IVC:   24.150, 24.210, 24.230, 24.250, 24.380, 24.470, 24.700 Pt 4-​25, Sch 1:   24.200, 24.201

06-Dec-19 14:01:15

xxxviPRINCIPLES OF TAXATION LAW 2020

Copyright © 2019. Thomson Reuters. All rights reserved.

Taxation Administration Act 1953 — cont Div 2 Pt III:   24.200 Div 284:   24.201, 24.205 Div 286:   24.201 Div 288:   24.201 Div 290, Sch 1:   24.200 Div 357:   24.390 Div 358:   24.390 Div 359:   24.390 Div 360:   24.390 Sch 1:   7.80, 7.85, 12.240, 24.90, 24.150, 24.203, 24.370, 24.610 Sch 1, Div 269:   24.202 Sch 1, Div 280:   24.140 Sch 1, Div 286:   24.20 Sch 1, Div 290:   24.207 Sch 1, Div 355:   24.620 Sch 1, Div 357:   24.370, 24.380 Sch 1, Div 358:   24.370, 24.410 Sch 1, Div 359:   24.370, 24.450 Sch 1, Div 360:   24.370, 24.490 Sch 1, Div 361:   24.370 Sch 1, Div 370:   24.305 Sch 1, Div 393:   24.330 Sch 1, Div 400:   24.330 Sch 1, s 10-​5:   24.160 Sch 1, s 12-​35:   7.80 Sch 1, s 12-​140:   24.330 Sch 1, s 12-​190:   24.340 Sch 1, s 18-​100:   24.520 Sch 1, s 255-​5:   24.150 Sch 1, s 255-​5(1):   24.150 Sch 1, s 255-​10:   24.150 Sch 1, s 255-​15:   24.150 Sch 1, s 260-​5:   24.170 Sch 1, s 260-​5(3)(b):   24.170 Sch 1, s 260-​15:   24.170 Sch 1, s 269-​20:   24.202 Sch 1, s 269-​30:   24.202 Sch 1, s 280-​160:   24.140 Sch 1, s 284-​75(5):   24.201, 24.205 Sch 1, s 284-​75(6):   24.205 Sch 1, s 286-​75(1A):   24.205 Sch 1, s 288-​25:   24.520 Sch 1, s 290-​50(3):   24.207 Sch 1, s 290-​60(2):   24.207 Sch 1, s 290-​65:   24.207 Sch 1, s 290-​125:   24.207 Sch 1, s 290-​200:   24.207 Sch 1, s 298-​10:   24.201 Sch 1, s 298-​20:   24.201, 24.206 Sch 1, s 298-​20(3):   24.201, 24.206 Sch 1, s 298-​30(1):   24.201

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Sch 1, s 298-​30(2):   24.201, 24.206 Sch 1, s 340-​5:   24.150 Sch 1, s 350-​10(1):   24.150 Sch 1, s 353-​15(1)(b):   24.530 Sch 1, s 355-​30:   24.620 Sch 1, s 357-​55:   24.380 Sch 1, s 357-​60:   24.380 Sch 1, s 357-​70:   24.380 Sch 1, s 357-​75(1):   24.390 Sch 1, s 357-​75(2):   24.390 Sch 1, s 357-​80:   24.390 Sch 1, s 357-​85:   24.390 Sch 1, s 357-​90:   24.390 Sch 1, s 357-​105(2):   24.400, 24.460 Sch 1, s 357-​110(2):   24.400 Sch 1, s 357-​120:   24.400 Sch 1, s 357-​125:   24.400 Sch 1, s 358-​20:   24.410 Sch 1, s 359-​30:   24.460 Sch 1, s 359-​35:   24.460 Sch 1, s 359-​35(4):   24.400, 24.460 Sch 1, s 359-​50(1):   24.470 Sch 1, s 359-​50(3):   24.470 Sch 1, s 360-​5(3):   24.490 Sch 1, s 388-​55:   24.20 Sch 1, Pt 2-​10:   24.160 Sch 1, Pt 4-​25:   24.200 Taxation (Interest on Overpayments and Early Payments) Act 1983 :   9.130 Treasury Laws Amendment (Combating Illegal Phoenixing) Bill 2019:   24.202 Treasury Laws Amendment (Medicare Levy and Medicare Levy Surcharge) Act 2018 :   15.00 Treasury Laws Amendment (Personal Income Tax Plan) Act 2018 :   15.00 Treasury Laws Amendment (Junior Minerals Exploration Incentive) Act 2018 :   15.00 Treasury Laws Amendment (Tax Integrity and Other Measures No 2) Act 2018 :   15.00 Veterans' Entitlements Act 1986 :   3.70

Australian Capital Territory Duties Act 1999 :   26.20 Land Tax Act 2004:   26.210 s 9:   26.280 Payroll Tax Act 2011:   26.300

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TABLE OF STATUTES xxxvii

New South Wales

Tasmania

Duties Act 1997 :   26.20 s 11(1)(i):   26.170 s 25:   26.120 s 32A:   26.130 s 104ZJA:   26.135

Duties Act 2001 :   26.20

Land Tax Act 1956:   26.210

Payroll Tax Act 2008:   26.300

Land Tax Management Act 1956:   26.210 s 7:   26.290 s 9:   26.230 s 9AA:   26.230 s 10AA:   26.284 Payroll Tax Act 2007:   26.300

Northern Territory Payroll Tax Act 2009:   26.300

Land Tax Rating Act 2000:   26.210

Victoria Alpine Resorts Act 1983:   26.220 Duties Act 2000 :   26.20 s 3H:   26.170 Land Tax Act 2005:   26.210 s 10:   26.220 s 19:   26.230 Pt 3, Div 2A:   26.270

Stamp Duty Act 1978 :   26.20

Partnership Act 1958 :   19.20 s 5:   19.20

Queensland

Payroll Tax Act 2007:   26.300 s 32:   26.370

Duties Act 2001 :   26.20 s 10(1)(d):   26.80 s 26:   26.80 s 27:   26.80 s 35(1)(f):   26.80 s 167:   26.170 Copyright © 2019. Thomson Reuters. All rights reserved.

Land Tax Act 2000:   26.210

Western Australia Duties Act 2008 :   26.20 Land Tax Act 2002:   26.210

Land Tax Act 2010:   26.210 s 1:   26.290

Land Tax Assessment Act 2002:   26.210

Payroll Tax Act 1971:   26.300

Metropolitan Region Improvement Tax Act 1959:   26.210

South Australia Land Tax Act 1936:   26.210 s 5:   26.282 Payroll Tax Act 2009:   26.300 Stamp Duties Act 1923 :   26.20 Div 6:   26.70

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Pay-​roll Tax Act 2002:   26.300 Pay-​roll Tax Assessment Act 2002:   26.300

New Zealand Taxation Administration Act 1994 s 20B:   24.600

06-Dec-19 14:01:15

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06-Dec-19 14:01:15

Copyright © 2019. Thomson Reuters. All rights reserved.

RULINGS TABLE Rulings

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Law Companion Ruling LCR 2018/​7 [12.240] Tax Rulings TR 92/​3 [8.170], [8.230] TR 92/​4 [12.30] TR 92/​15 [7.85] TR 92/​18 [13.83] TR 93/​20 [17.30] TR 93/​23 [17.190] TR 93/​25 [5.150] TR 93/​30 [12.710], [12.730] TR 93/​32 [19.30] TR 94/​8 [19.20], [19.30] TR 94/​11 [14.35] TR 94/​22 [12.770] TR 95/​7 [17.230] TR 95/​24 [7.430] TR 95/​25 [19.100] TR 95/​33 [12.310] TR 95/​34 [12.410] TR 95/​35 [10.190], [10.250], [11.290] TR 97/​2 [15.190] TR 97/​7 [16.130] TR 97/​12 [12.740], [12.790] TR 97/​15 [17.230] TR 97/​17 [7.230] TR 97/​20 [22.360] TR 97/​23 [13.33], [13.35], [13.40], [13.50], [13.60], [13.70] TR 97/​25 [14.170] TR 98/​1 [6.60], [16.40] TR 98/​7 [17.40] TR 98/​8 [17.20], [17.40] TR 98/​9 [12.220], [12.590], [12.610], [12.630], [12.680], [12.690] TR 98/​17 [4.60], [4.90], [4.130] TR 1999/​6 [7.58] TR 1999/​9 [21.340] TR 1999/​10 [13.160] TR 1999/​17 [6.180] TR 2000/​4 [7.290] TR 2001/​2 [7.450] TR 2001/​7 [23.160], [23.170] TR 2001/​8 [23.190], [23.240] TR 2001/​10 [6.60] TR 2001/​12 [22.480] TR 2003/​1 [22.420]

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TR 2003/​16 [12.780], [12.790] TR 2004/​4 [12.810] TR 2004/​6 [12.320] TR 2004/​11 [21.410] TR 2004/​15 [14.200] TR 2004/​16 [14.35] TR 2005/​4 [14.190] TR 2005/​7 [19.90] TR 2005/​13 [13.130], [13.160] TR 2006/​10 [24.410] TR 2006/​11 [24.450] TR 2006/​13 [23.320] TR 2007/​8 [23.330] TR 2007/​9 [14.35] TR 2007/​12 [7.320] TR 2008/​1 [23.340] TR 2008/​2 [17.20] TR 2011/​6 [14.210] TR 2013/​1 [22.490] TR 2017/​2 [14.90] TR 2017/​D1 [4.35] TR 2017/​D6 [12.390], [12.460] TR 2018/​2 [24.520] TR 2018/​5 [4.200] TR 2019/​1 [17.280] TR 2019/​2 [12.810] TR 2019/​5 [14.90] Income Tax Rulings IT 167 [6.110] IT 180 [13.35] IT 333 [17.30] IT 2197 [14.90] IT 2218 [19.90] IT 2289 [17.160] IT 2424 [10.120] IT 2615 [3.40] IT 2650 [4.120] IT 2655 [8.60] IT 2670 [17.220] Class Rulings CR 2001/​1 [24.430]

Determinations Tax Determinations TD 92/​198 [17.180] TD 93/​58 [10.70], [10.240]

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xl

PRINCIPLES OF TAXATION LAW 2020 TD 93/​97 [12.680] TD 93/​125 [17.120] TD 93/​195 [12.690] TD 94/​16 [7.100] TD 94/​42 [7.430] TD 95/​48 [17.230] TD 1999/​40 [11.180] TD 2003/​28 [20.180] TD 2006/​40 [14.125] TD 2007/​5 [14.70] TD 2008/​26 [17.20] TD 2013/​19 [11.200] TD 2014/​19 [12.320] TD 2016/​12 [11.200] TD 2016/​14 [13.160] TD 2017/​8 [13.20] TD 2017/​13 [11.400] TD 2017/​16 [11.200] TD 2018/​2 [7.190] TD 2018/​6 [25.240] TD 2018/​8 [11.200] TD 2018/​10 [17.260] TD 2018/​11 [12.320]

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Commonwealth Indirect Taxes GST Rulings GSTR 2000/​2 [25.310] GSTR 2000/​13 [25.304] GSTR 2000/​19 [25.310] GSTR 2000/​29 [25.304] GSTR 2001/​3 [25.210], [25.330] GSTR 2001/​4 [10.150] GSTR 2001/​7 [25.70] GSTR 2001/​8 [25.175] GSTR 2002/​2 [25.163] GSTR 2002/​5 [25.148] GSTR 2002/​6 [25.148] GSTR 2003/​3 [25.167] GSTR 2003/​9 [25.217]

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GSTR 2004/​1 [25.217] GSTR 2006/​3 [25.220] GSTR 2006/​4 [25.220], [25.310] GSTR 2006/​9 [25.100] GSTR 2008/​1 [25.210] GSTR 2012/​5 [25.165] GSTR 2012/​6 [25.165] GSTR 2012/​7 [25.165] GSTR 2013/​1 [25.306] GSTR 2013/​2 [25.310] GSTR 2017/​1 [25.295] GSTR 2018/​1 [25.120] GSTR 2018/​2 [25.120] GST Determinations GSTD 2012/​4 [25.144] Miscellaneous Tax Rulings MT 2008/​1 [24.201] MT 2016 [7.60], [7.75] MT 2019 [7.75] MT 2027 [7.100] ATO Interpretative Decisions ATO ID 2004/​940 [14.145] ATO ID 2005/​26 [12.240] ATO ID 2008/​127 [7.330] ATO ID 2008/​133 [7.330] ATO ID 2009/​25 [17.20] ATO Law Administrations Practice Statements PS LA 2003/​7 [24.210] PS LA 2004/​14 [24.595] PS LA 2007/​21 [3.120] PS LA 2007/​24 [24.90] PS LA 2008/​4 [24.480] PS LA 2008/​6 [24.140] PS LA 2011/​13 [24.170] PS LA 2011/​18 [24.170], [24.190] PS LA 2012/​5 [24.203]

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Part 1 Overview and Structure

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The purpose of this book is to guide business and law students through the laws of Australian taxation. To aid in this process, the book is divided into seven parts, each with its own introduction explaining how each part fits into the taxation process, as well as how the chapters contained within those parts contribute to the overall regime. Part 1 provides an overview and structure of the Australian tax regime and serves as a platform from which students can embark on their studies. The four chapters contained in this part should be revisited throughout the process. Chapter 1 provides students with an introduction to taxation law. The role of both legislation and cases is explained, along with the five major differences between taxation law and accounting. Also discussed is the use of the doctrine of precedent in tax law, a process not used in interpretation of financial accounting standards. Students are then introduced to the main tax legislation, consisting of two Income Tax Assessment Acts, a Fringe Benefits Tax Act and a Goods and Services Tax Act. Chapter 2 focuses on study skills for taxation law. This chapter assists students in gaining the most they can from their tax studies. Included in this chapter is advice on how to approach the course generally, as well as information on assignment writing for tax law, exam preparation and examination techniques. It is recommended that students continue to consult this chapter throughout their tax studies. Once students understand how to approach questions of taxation law and a taxation law course, it is possible to consider the overall structure of the Australian tax regime. Chapter 3, “The Taxation Formula”, explains the key concepts to be investigated and considers the relationships between

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PRINCIPLES OF TAXATION LAW 2020

them. Most importantly, it explains that to determine income tax payable for the financial year, the following formula must be used: Income tax = (Taxable income × Rate) − Tax offsets Where: Taxable income = Assessable income −Deductions

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While Chapter 3 discusses the key concepts to determine taxable income, Chapter 4 discusses the basis upon which income tax is levied on taxpayers under Australian domestic law, that is, residence and source. Prior to determining what is “assessable income” and “deductions”, it is necessary to understand that an Australian resident pays tax on income from all sources, while a foreign resident pays tax on income sourced in Australia. Therefore, it is necessary to understand the concepts of residency and source in order to determine the income to be taxed and the related deductions allowed. Chapter 4 explains the tests of residency for both individuals and companies and discusses the source rules applicable to different categories of income.

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Copyright © 2019. Thomson Reuters. All rights reserved.

Sources of taxation law Key points......................................................................................................  [1.00] Introduction..................................................................................................  [1.10] Understanding tax law and the doctrine of precedent.............................  [1.30] Technical differences between tax law and accounting...........................  [1.70] Not all receipts are recognised for tax purposes..................................  [1.80] Income tax law distinguishes between capital and revenue expenses..................................................................  [1.110] Income tax law excludes some income and expenses for policy reasons.........................................................................  [1.120] Income tax law ignores some transactions on the basis of anti-​avoidance provisions............................................................  [1.130] Timing rules differ in income tax law and accounting principles....................................................................  [1.140] Origins of judicial tax law concepts..........................................................  [1.150] Sources of tax law......................................................................................  [1.180] Legislation............................................................................................  [1.190]

Income tax legislation..............................................................................  [1.200] FBT legislation..........................................................................................  [1.240] Rates Act, Administration Act, and International Agreements Act...................................................................................  [1.245] GST legislation.........................................................................................  [1.250] Case law...............................................................................................  [1.270] Rulings..................................................................................................  [1.280] Private rulings..........................................................................................  [1.290] Public rulings............................................................................................  [1.300] Using this chapter......................................................................................  [1.310]

  

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[1.00]  PRINCIPLES OF TAXATION LAW 2020

Key points [1.00]  • The main tax legislation consists of two Income Tax Assessment Acts, Fringe Benefits Tax Act and Goods and Services Tax Act. • Tax legislation is interpreted using the doctrine of precedent, a process not used in interpretation of financial accounting standards. • There are five key differences between tax concepts and accounting principles. • Tax law exam problems usually involve facts that might attract two alternative characterisations of a receipt or expense, and a good answer will canvass both possibilities. • The main sources of tax law are statutes and case precedents used to interpret the provisions in tax law, but taxpayers can rely on Tax Office rulings to avoid penalties when interpreting the law.

Introduction

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[1.10]  Time and again, surveys show many commerce and business students view taxation law as one of the most difficult subjects they encounter in their studies. This need not be so provided, it is understood that the skills necessary for the successful study of taxation law are fundamentally different from other commerce subjects. If you understand the differences and learn the essential techniques of how to study taxation law, you should have no difficulty successfully completing the subject. [1.20]  This chapter gives valuable guidance on the skills that you need to develop to get the most out of your study of tax law and explains how tax law differs from other commerce subjects. The key points covered are as follows: • The importance of the doctrine of precedent in interpreting tax law and its absence from the interpretation of financial accounting standards: see [1.30]. • Five technical differences between financial accounting and tax law: see [1.70]. • Detail on how the doctrine of precedent led to different definitions of “income” for financial accounting and tax law purposes: see [1.160]. • How to use the principal pieces of tax legislation in Australia and how the main Acts work together: see [1.190]. • The importance of case law in the interpretation of the legislation: see [1.270]. How you can most effectively access the hints set out in this chapter to maximise higher grades in this subject is described at [1.310].

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1: SoUrces of taxation law  [1.40]

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Understanding tax law and the doctrine of precedent [1.30]  Interpretation of the financial reporting standards is based on accounting principles. The words in the standards are interpreted with a single aim: to ensure amounts are recognised on a prudent and conservative basis that reflects actual increases or decreases in a firm’s economic position. The process of interpreting words in the tax legislation is fundamentally different from the principle-​based interpretation of financial reporting standards. Terms in tax legislation are interpreted not by reference to any commercial or economic principles, but instead on the basis of a system of legal analysis known as the “doctrine of precedent”. The doctrine of precedent is the foundation of the common law legal system used in English-​speaking countries. The doctrine of precedent requires judges (and, as a result, tax officials) to interpret words in laws in a manner that is consistent with the interpretation of those words in earlier judgments. If the facts of a later case are the same as those in a previously decided case, a similar result should follow in the later case. If the facts in the later case are slightly different from the earlier case, the precedent may be distinguished and another result might follow.

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[1.40]  The first step in solving a tax law problem is to find the relevant rules in the tax legislation. Rarely, however, will only one rule be relevant. More likely, two or more provisions might potentially apply to the transaction described in the problem, with the borderline between competing rules unclear. To determine on which side of the borderline a given transaction will fall, the tax accountant must proceed to the second step in solving a tax law problem, which is to interpret the words in the different rules. This, as mentioned at [1.30], is completed by looking at the judicial precedents in earlier tax cases. The process is perhaps best explained with an illustration. Example 1.1: Using precedents A tax accountant is asked to advise a client who makes pottery whether there is any tax liability when she gives a piece of pottery to a friend. First, the accountant will turn to the tax legislation to find the relevant tax rules. They are very clear. If the client’s activities amount to a business, the item of pottery is trading stock and a tax liability is triggered when a taxpayer disposes of trading stock outside the ordinary course of business. If the client’s activities are merely a hobby, the pottery is a personal asset,

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[1.50]  PRINCIPLES OF TAXATION LAW 2020

not trading stock, and there is no tax liability when a personal asset is given away. The law is obvious –​there is one legal consequence if the client’s activities amount to a hobby and another if they amount to a business. The tax legislation is silent, however, as to when activities cross the threshold from being a hobby to becoming a business. To answer the crucial question as to whether the client’s activities constitute a hobby or a business, the accountant will look outside the legislation to the precedents of previously decided court cases and try to find a case that closely resembles the client’s situation. The outcomes in those precedents will provide a good indication as to whether the client’s activities will amount to carrying on a business as a matter of tax law.

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To the extent that the client’s situation is similar to the situations of taxpayers described in the precedents, the same characterisation is likely to apply to the client’s activities. To the extent that the client’s situation differs from the situations of taxpayers described in the precedents, a different characterisation may apply. The tax accountant must decide whether the precedents will apply to the client and yield the same characterisation of the client’s activities or whether the facts in the precedents are sufficiently different for them to be distinguished with a different characterisation applying to the client.    [1.50]  An important difference between tax law advice and accounting advice is the relative level of certainty. The accountant providing accounting advice can state with confidence that an outcome does or does not conform to accounting standards. In fact, on audit, an accountant must be completely certain before signing off on the audit. In contrast, the accountant dispensing tax law advice may only state a probability, based on the accountant’s interpretation of the precedents and indications in public rulings issued by the Australian Taxation Office (ATO) of how the Commissioner of Taxation (Commissioner) interprets those precedents (the roles of the ATO and Commissioner are explained at [1.280]). This advice will be expressed as a view of how the law is likely to apply to the client but will caution that, as with any advice on legislation, another interpretation is always possible. The fact that there are two alternative arguments does not mean that there is no “answer” to a tax question. When the facts of a particular case are considered in light of the precedents, a probable answer will emerge and, while there is no guarantee that a court will not prefer the alternative argument, advice should set out the likely outcome with a summary of the alternative answer that could prevail if the expected outcome does not occur.

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1: SoUrces of taxation law  [1.80]

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[1.60]  Example 1.1 illustrates two aspects of tax law that commerce students sometimes find troubling. The first is learning how to use the doctrine of precedent –​relying on decisions in previous cases to advise on how the law will apply to a new set of facts. The second is coming to grips with the inherent uncertainty of any advice based on precedents. By definition, there is always a correct answer to an accounting problem. Accounting students are trained to discover the answer by way of coherent facts and unambiguous rules. But in tax law, students can only offer opinions of how precedents are likely to apply. To provide an opinion that first explains one possible outcome and then canvasses other possible competing views or interpretations of precedent is contrary to everything that an accounting student has previously been taught. No wonder then that commerce students find tax law difficult until they master the new skills required to succeed in the subject.

Technical differences between tax law and accounting [1.70]  The commerce subject that at first glance seems most similar to taxation law is financial accounting. Both accounting and tax law scrutinise receipts and expenditures and measure net gains over an annual accounting period. However, these apparent similarities mask five key differences between the two subjects:

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• Not all receipts are recognised for tax purposes: see [1.80]. • Accounting principles recognise all outgoings but may record an offsetting asset if an expenditure gives rise to an ongoing benefit or property. Income tax law distinguishes between capital and revenue expenses and recognises expenditures depending on their classification: see [1.110]. • Income tax law excludes some income and expenses for policy reasons: see [1.120]. • Income tax law ignores some transactions on the basis of anti-​avoidance provisions: see [1.130]. • Timing rules differ in income tax law and accounting principles: see [1.140].

Not all receipts are recognised for tax purposes [1.80]  To begin with, accounting rules and tax law take substantially different approaches to recognising receipts.

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[1.90]  PRINCIPLES OF TAXATION LAW 2020

The objects of accounting are to measure net gains or losses over a period and to measure net assets and liabilities at the end of the period. To do this accurately, accounting must recognise all receipts, whatever their character. When preparing a set of accounts, an accountant starts with gross income, meaning all amounts received by a business; profits from business activities, returns on investments, an unexpected windfall and even a gift will be included in the income account. If a receipt is genuinely unexpected or unusual, the accountant will note that it is an unanticipated or one-​off receipt so readers of the accounts are alerted to the fact that the receipt should not be regarded as typical and likely to be repeated each year. But the receipt itself will be fully recognised for accounting purposes to the same extent as repeated receipts such as ordinary and regularly received business income. [1.90]  In contrast, some receipts are not recognised at all for tax law purposes while others are recognised but partially excluded from tax accounts. Many one-​ off or unusual receipts in particular are excluded or only partially recognised for tax purposes.

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Receipts that are recognised for tax purposes are known as “assessable income”. Early Commonwealth income tax Acts defined assessable income using language almost identical to that used in financial accounting. Indeed, the early income tax laws looked very similar on paper to accounting principles. However, drawing on concepts from other areas of the law, courts concluded that gross income for tax purposes comprised only a subset of gross accounting income. See [1.160] for more detail on how the courts developed this narrow concept of income, now known as “ordinary income”. As a result of the restricted judicial interpretation of “income” for tax purposes, when income tax was first imposed in Australia, only a slice of accounting gross income was transferred to the income side of a tax return: see [1.150]–​[1.170]. [1.100]  Soon after income tax was first adopted by the Commonwealth Government in 1915, the legislature began to broaden the tax base beyond “ordinary income”. Over the years, many sections were added to the income tax Acts to bring into assessable income various types of receipts, which had been excluded from the judicial concept of “ordinary income”. Since 1997, the receipts that have been brought into assessable income by specific inclusion provisions have been known as “statutory income”. As a result of these developments, the accountant’s gross income for accounting purposes must be categorised into three boxes for tax purposes: ordinary income, statutory income (now included in assessable income, but often subject to concessional treatment or partial exclusion), and other receipts. The third category of receipts –​amounts that are neither ordinary income nor statutory income –​still falls completely outside the scope of income tax law, though of course they are recognised for financial accounting purposes.

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1: SoUrces of taxation law  [1.110]

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Case study 1.1: Gifts In FCT v Slater Holdings Ltd (1984) 156 CLR 447, the father of shareholders in a company gifted money to the company. As gifts are not characterised as ordinary income under the judicial concept of income and there is no statutory income measure that includes gifts, the amounts had not been included in the assessable income of the company. However, the Full High Court agreed that the payments were nevertheless “profits” of the  company within the accounting sense of that word.

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Income tax law distinguishes between capital and revenue expenses [1.110]  A second significant difference between financial accounting and tax law is the treatment of expenses in the two systems. Accounting principles recognise outgoings as expenses in the profit and loss statement unless the expenditure yields an asset. In that case, it appears on the balance sheet as an asset (with a corresponding debit to cash if internal funds are used or an increase to debt if borrowed funds are used to purchase the asset). The cost of the asset is then recognised as deductions on the profit and loss statement as it is used or depreciates in value. In contrast, tax law distinguishes between two broad categories of expenditures: “revenue” expenses and “capital” expenses. Revenue expenses are deducted when they are incurred. Capital expenses are deducted over a period under a “capital allowance” or a “capital works” system. The distinction between capital and revenue expenses is based on judicial doctrines derived from case law. Whether an asset is acquired with the expenditure is not one of the factors considered directly in the judicial doctrines that distinguish between revenue and capital expenses, although how long a benefit acquired as the result of an expense will last is one factor used in the judicial doctrines. Others such as the frequency of similar expenses and the relationship between the expense and a business’ income earning “process” and income earning “structure” are more important factors in the judicial tests. As a result, income tax law permits immediate deductions for some expenses that would be depreciated over a period of years for accounting purposes while it requires deductions over many years for some expenses that would be expensed immediately on a profit and loss statement in accounting practice. Case study 1.2: Expenses to protect position In Broken Hill Theatres Pty Ltd v FCT (1952) 85 CLR 423, the taxpayer incurred legal expenses opposing a licence application by a potential competitor. Licence applications were heard annually, and, as a result of the expenditure, the taxpayer was protected from competition for at least

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10 [1.120]  PRINCIPLES OF TAXATION LAW 2020

12 months. The taxpayer argued that the expense should be deductible as a revenue expense as it did not alter or add to any asset of the taxpayer. However, the Full High Court viewed the expense as one related to the structure of the taxpayer’s business, namely its ability to continue to operate without a competitor. Therefore, although the expense would be immediately deductible for accounting purposes, the court characterised the outgoing as a capital expense for tax purposes and denied the taxpayer an immediate deduction. The expense would now fall into one of the statutory provisions that allow taxpayers to deduct capital expenses over a period. Under s 40-​880 of the Income Tax Assessment Act 1997 (Cth), a taxpayer would be able to deduct a capital expense of this type in equal  instalments over five years.

Income tax law excludes some income and expenses for policy reasons

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[1.120]  A third major difference between financial accounting and tax law emanates from the inclusion of many “policy” provisions in the income tax laws. In terms of the profit and loss account, accountants pursue a single objective of measuring net gains in the accounting period. The tax law, in contrast, is used by politicians to achieve a wide variety of social and economic objectives. Thus, for example, while an accountant records all income and receipts for financial accounting purposes, the tax law explicitly exempts some types of otherwise assessable receipts for policy reasons. On the expenditure side, the financial accountant does not distinguish between different types of expenses for policy reasons: if an expense was incurred in a business, it is recognised for accounting purposes. The tax law, however, explicitly denies taxpayers deductions for some types of payments. For example, to discourage taxpayers from engaging in prohibited activity when carrying on a business, the tax law denies deductions for expenses such as fines, bribes, and some expenses incurred in illegal businesses.

Income tax law ignores some transactions on the basis of anti-​avoidance provisions [1.130]  A fourth important difference between accounting and tax law derives from the effect of numerous anti-​avoidance provisions in the tax law. Financial accounting measures net profits on an entity-​by-​entity basis. If one entity pays an excessive amount to another related entity, accounting will ignore the relationship between the two entities and record an expenditure by the first entity and a receipt by the second. Tax law may ignore the transfer, however, if it falls afoul of an anti-​avoidance rule that seeks to prevent taxpayers shifting

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1: SoUrces of taxation law  [1.150]

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profits from one entity subject to high tax rates to a related entity (a relative or another entity owned by the same person) subject to low tax rates. In addition to a large number of specific anti-​avoidance provisions in the tax legislation, there is a general anti-​avoidance rule in the income tax law made up of several sections that operate together and which are collectively referred to as Pt IVA (pronounced “four A”, as the IV is the roman numeral for the number four) after the location of the rule in the Income Tax Assessment Act 1936 (Cth) (ITAA 1936). Like the specific anti-​avoidance measures, the general anti-​ avoidance provisions can lead to divergences between financial accounting and tax law. Another general anti-​avoidance rule is included in the goods and services tax law, and a further general anti-​avoidance rule is included in the fringe benefits tax law.

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Timing rules differ in income tax law and accounting principles [1.140]  Finally, a fifth major difference between accounting and tax law arises as a result of the different timing rules for when income receipts and expense payments are recognised. Financial accounting principles roughly align with a business’ economic position. Receipts are recorded on an accrual basis and offset by provisions if the receipts relate to future obligations. Outgoings are similarly recorded on an accrual basis and offset by assets if assets are acquired as a result of the expenditures. These receipts and expenditures are not reflected immediately in the profit or loss accounts; receipts encumbered by future obligations are brought into profit or loss accounts only as the offsetting obligations are satisfied and expenditures for assets lasting beyond the end of the year are brought into profit or loss account only as the offsetting assets are consumed. In contrast, income tax law measures receipts when they are “derived” and evaluates expenses when they are “incurred”. As a result of judicial interpretation, the terms “derived” and “incurred” have unique judicial meanings. Only sometimes do the tax rules relating to when income is derived and when expenses are incurred coincide with accounting principles that determine when receipts and outgoings enter profit and loss accounts.

Origins of judicial tax law concepts [1.150]  We have seen that there are five main areas of difference between accounting and tax law concepts: see [1.80]–​[1.140]. Only two of these differences are the result of specific rules in the tax legislation: the adoption of special rules to achieve policy objectives other than the measurement of net gains and the adoption of specific anti-​avoidance provisions and one general

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12 [1.160]  PRINCIPLES OF TAXATION LAW 2020 anti-​ avoidance rule. The remaining areas of divergence between financial accounts and tax accounts result from judicial concepts: the judicial distinction between ordinary income and other receipts, the judicial distinction between revenue expenses and capital expenses, and the judicial concepts of when amounts are derived and when expenses are incurred. Understanding the origins of those concepts is crucial to learning how to study tax law and write tax law exams. [1.160]  Income tax is imposed on a taxpayer’s “taxable income”, which is defined as a person’s assessable income minus deductions. Assessable income was defined in the original income tax laws as gross income while deductions were allowed for expenses other than capital expenses.

Copyright © 2019. Thomson Reuters. All rights reserved.

Australian courts were not encountering these terms –​“income” and “capital expenses” –​for the first time when they appeared in the original income tax laws. Both terms had been used much earlier in trust law. Trust law distinguished between two types of trust beneficiaries: income beneficiaries and capital beneficiaries. All receipts derived by the trustee had to be classified as either income gains or capital gains to determine which class of beneficiaries would be entitled to the receipts. All expenses incurred by the trustee had to be classified as either revenue expenses or capital expenses to determine which class of beneficiaries would be charged for the outgoings. When income taxation was first adopted in Australia, the courts concluded that the term “income” was intended to have the same meaning for tax law as it did for trust law. As a result, only receipts meeting the trust law concept of income were presumed to be income for tax purposes. Similarly, expenses labelled capital outgoings under trust law doctrines were treated as capital expenses for tax law purposes. As is pointed out at [5.20], while the original trust law notions of income may be much narrower than those used in accounting, they are probably similar to the understanding of income held by an “ordinary” person on the street. It is for this reason that gains fitting in the original judicial concept of income for tax purposes are usually labelled “ordinary income”. [1.170]  Later chapters in this book explore in detail the nature of ordinary income and the tests used by the courts to determine whether a receipt will constitute ordinary income. As will be seen, one of the main features of ordinary income is its identification with a source that generates the income. If a receipt can be seen to be a product of labour or business activity or the use or exploitation of property, it will acquire an income character under the judicial tests. Thus, for example, salaries are considered ordinary income from employment, proceeds from the sale of trading stock are considered ordinary income from business, and royalties or interest payments are considered ordinary income from property.

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1: SoUrces of taxation law  [1.190]

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The basic tests used by the courts to identify when a receipt might constitute ordinary income from labour, business, or the use of property are bolstered by two supplementary judicial tests. The first supplementary test treats a receipt as income if it has certain income-​like characteristics, namely that it is periodic in nature, expected by the recipient and applied to the same uses as other types of income might be applied. The second test treats a receipt as income if it is received as compensation for lost income or in substitution for what would have been income receipts.

Sources of tax law [1.180]  While tax law ultimately derives from the statutes that impose the tax, as we have noted, the coverage of the inclusion sections, exemption provisions, and deduction measures is based on interpretation of the law based on judicial precedents. Thus, court cases have become a second source of law in Australia. A third source for tax rules in practice, if not strictly as a matter of law, is the interpretations issued by the Commissioner in the form of “rulings”. These three sources are explained at [1.190]–​[1.300].

Legislation

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[1.190]  As taxation law is a creation of statute, its primary source lies in legislation, and the income tax part of a taxation course is based on the operation of three pieces of legislation: Income Tax Assessment Act 1936 (Cth) (usually referred to as the ITAA 1936), Income Tax Assessment Act 1997 (Cth) (usually referred to as the ITAA 1997) and Fringe Benefits Tax Assessment Act 1986 (Cth) (usually referred to as the FBTAA). This section of the chapter explains why there are two income tax laws and a separate fringe benefits tax law. A fourth piece of legislation, A New Tax System (Goods and Services Tax) Act 1999 (Cth) (usually referred to as the GST Act), is also relevant to the study of Australian tax law although it does not tax income but instead is a tax on final consumption. The background to the GST Act is described at [1.250]–​[1.260] and the operation of the GST system is described in Chapter 25. Four further laws are relevant: an “income tax act” contains the law which imposes the tax on the base set out in the two Income Tax Assessment Acts, a “rates” act sets out the actual rates of income tax, a “tax administration” act sets out the administrative rules for all tax laws, and an “international agreements” act modifies the income tax laws in the case of income derived overseas or by a non-​resident taxpayer, as explained in [1.245].

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14 [1.200]  PRINCIPLES OF TAXATION LAW 2020

Income tax legislation [1.200]  Parallel Commonwealth and State laws. The first Commonwealth income tax in Australia was adopted in 1915. All six States had previously adopted State income taxes, and, when the Federal Government adopted its income tax in 1915, the Commonwealth law operated in parallel to the State laws. As the States had already established income tax administrations, it was agreed that the States would collect the Commonwealth income tax on behalf of the Commonwealth. The Commonwealth law differed in some respects from the State laws and these, in turn, differed between each State. As a result, State income tax administrators had to deal with two sets of laws and also had to divide revenues, where businesses operated across State borders. An attempt to better harmonise the laws in the 1920s brought the different laws somewhat closer together for a brief period, and in 1936, the States and Commonwealth agreed on a fully harmonised model that was enacted in each State and by the Commonwealth to replace the differing laws. The Commonwealth adopted as a part of the harmonisation program the ITAA 1936.

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The parallel State and Commonwealth income taxes remained in effect only for a short time. In 1942, in the midst of the WWII, the Commonwealth effectively appropriated the exclusive power to levy income tax as a “temporary” wartime measure, instituting a system of transfer payments to the States to replace their lost revenue. The income tax has since remained a Commonwealth-​only tax. [1.210]  Tax law rewrite. The gaps in the Australian income tax laws caused by the somewhat narrow tax base (constrained by reliance on the judicial concept of ordinary income) provided numerous opportunities for avoidance. Rather than address the underlying problems that gave rise to resulting avoidance schemes, the legislature usually responded to costly avoidance arrangements with narrow and very ad hoc rules, including many piecemeal rules that brought different types of receipts into assessable income as statutory income. A deluge of avoidance arrangements in the late 1970s and early 1980s led to an explosion of complicated tax provisions, and by the mid-​1980s, the income tax law was, in the eyes of many, extraordinarily complex. Reforms in the mid-​1980s led to further income tax complexity, and in the early 1990s, the Government announced a project to rewrite the income tax law using plain-​ English drafting style. The Government hoped the different drafting style might simplify the law. The first parts of the rewritten law were released as the ITAA 1997. Over the following three years, many measures were shifted from the 1936 Act to the 1997 Act, but the plans to move the entire income tax law across stalled by 2000, when a major Business Tax Review known as the Ralph Review (named

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1: SoUrces of taxation law  [1.230]

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after the chairman of the review) proposed a range of amendments to tax laws. Since that time, drafting resources have been divided between enacting ongoing changes to the income tax law and moving existing measures in the 1936 Act to the 1997 Act and more than two decades after the process started, many important measures remain in the 1936 Act. [1.220]  Concurrent Income Tax Assessment Acts. Accordingly, there are two separate income tax Acts that tax students must consider when answering income tax law problems: the ITAA 1936 and the ITAA 1997. Students will mostly be concerned with the ITAA 1997 as the key statutory income measures have been moved from the ITAA 1936 to the ITAA 1997. As a general rule, it is easy to differentiate the provisions of the two principal Acts because each Act adopts a different numbering system. The sections of the ITAA 1936 are not hyphenated (eg, s 44, s 63) while sections in the ITAA 1997 are hyphenated (eg, s 6-​5, s 8-​1).

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[1.230]  Capital gains tax. Almost as soon as the Commonwealth income tax was enacted and the courts read the law as applying only to the category of gross income that they labelled “ordinary income”, the legislature started broadening the tax base. From 1915 until 1985, the broadening of the tax base was achieved through a continual stream of new inclusion amendments. Almost all amendments were narrow measures targeted at particular types of receipts or particular schemes aimed at taking taxpayers out of the tax net. The growth of statutory income sections was matched on the deduction side by the adoption of many provisions designed to recognise expenses that the courts had labelled capital expenses and which therefore fell outside the scope of the general deduction provision. Despite a growing array of statutory income and capital expense provisions, many gains and outgoings remained outside the tax system. In 1985, the Government shifted its approach from the use of piecemeal inclusion and deduction provisions to a more comprehensive solution, with the adoption of broad-​based capital gains measures designed to sweep up most gains and losses that remained outside the tax base. The provisions, which became known as the “capital gains” measures, were complex because they used many artificial deeming rules to capture gains that did not fall in the basic capital gains rules. The original capital gains rules were replaced in 1998 by a revised capital gains regime, labelled the “capital gains tax” or CGT provisions. A key feature of the new rules was the replacement of the artificial deeming rules found in the original provisions with a set of rules that described different CGT “events”, each aimed at a different type of capital gain to be brought into the income tax. The new CGT rules were placed in the ITAA 1997. The name of the new rules, the CGT or capital gains “tax” rules, is the source of some confusion as it suggests that capital gains are subject to a separate tax. This is not the case. The

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16 [1.240]  PRINCIPLES OF TAXATION LAW 2020 CGT rules are discrete in the sense of matching gains and losses to determine a net capital gain included in assessable income. But despite its misleading name, the CGT is not a separate tax. It is fine to talk about a gain being subject to the CGT, but it is important to understand that any gain brought into the tax system via the CGT will actually be taxed as part of assessable income subject to income tax under the ITAA 1997.

FBT legislation [1.240]  The judicial concept of “ordinary income” under the income tax legislation only included cash or non-​cash benefits that could be converted to cash. A receipt that otherwise would be treated as income from labour, business or property would not be considered ordinary income if it did not take the form of cash or a benefit that the recipient could turn into cash. The effect of this restriction on the ordinary income concept was to exclude from the tax base many types of fringe benefits (non-​cash benefits) provided by employers to employees. The legislature initially responded to the problem by inserting a provision in the income tax law that included non-​cash fringe benefits in assessable income. However, the original provision was not well drafted and, to the extent that it could function, it was poorly administered. As a consequence, many non-​cash benefits continued to escape tax.

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Rather than amend the income tax provision to repair its shortcomings, in the mid-​1980s, the Government decided to copy a New Zealand precedent and move most employment fringe benefits into a separate assessment Act, the FBTAA. FBT is collected from employers providing the benefits, rather than the employees receiving them. The income tax law explicitly excludes from an employee’s income for income tax purposes the value of any benefits that are fringe benefits as defined by the FBTAA. Since fringe benefits are explicitly excluded from the income tax, the FBTAA is the starting point for any problem involving a benefit to an employee other than salary or wages and, if the benefit satisfies the definition of a fringe benefit under the FBTAA, it is not necessary to consider other tax laws. The income tax law must be considered only if the problem involves a cash benefit that does not fall within the broad understanding of salary or wages since salary and wages are not a fringe benefit according to the FBTAA.

Rates Act, Administration Act, and International Agreements Act [1.245]  Four supplementary laws play important roles in the income tax system. The first of these is the Income Tax Act 1986 (Cth). It is thought that the

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Australian Constitution requires two separate laws to levy an income tax: an assessment Act that measures taxable income that will be subject to tax and an imposition Act that then imposes tax on that base. The Income Tax Act 1986 imposes a tax on taxable income at the rate of tax set out in a second supplementary Act, the Income Tax Rates Act 1986 (Cth). Third, the Tax Administration Act 1953 (Cth) contains the administration rules for collection of the tax and various penalties to ensure compliance with the tax laws. The fourth law is the International Tax Agreements Act 1953 (Cth). When Australian residents derive income overseas, they will be potentially subject to two tax systems. Australian residents are taxed on their worldwide income, including income derived abroad. The country in which the income was earned may also levy income tax as the “source” jurisdiction. Similarly, non-​residents who derive income in Australia will be subject to Australian tax on income with a source in Australia and quite possibly to their own country’s income tax on their worldwide income. While both countries’ tax systems can solve the problem of double taxation through their own various credit or exemption rules, the normal practice that has emerged in the international arena is an agreed division of taxing rights through a bilateral (two country) tax treaty. Australia has signed more than 40 tax treaties. The taxing rules in these treaties are given effect by the International Tax Agreements Act 1953, which allows the treaties to override the normal income tax assessment laws.

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GST legislation [1.250]  To bolster tax revenues during the economic downturn that became the Great Depression, the Commonwealth Government adopted in 1930 a wholesale sales tax that applied to the sale of goods. The tax was problematic in many respects, causing significant economic distortions by levying different rates on different types of goods and not applying to services at all. Over the following 70 years, there were many calls for its replacement with a broad-​ based consumption tax that would apply to final consumption only. This was finally achieved in 1999, with effect from mid-​2000, when the wholesale sales tax was replaced by the goods and services tax (known as GST). While the GST is intended to be a tax on final consumption only, it is levied at every level of the supply chain and then reimbursed by way of credits or refunds to registered businesses in the chain, leaving the full burden to be borne by the final consumer. [1.260]  The GST system operates independently of income tax and FBT systems. In other words, there is little reason to be concerned about GST when thinking of income tax or vice versa. However, for practical reasons, the two must be viewed in parallel as both GST liability (and entitlement to credits for

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18 [1.270]  PRINCIPLES OF TAXATION LAW 2020 GST included in the price of purchases) and certain income tax payments (in particular an employer’s liability for income tax withheld from the wages of employees) are reported on the same tax interim return known as a Business Activity Statement (BAS). FBT liability is reported separately. One point of intersection between the BAS and GST is the treatment of GST payments in the income tax. In most cases, a business paying GST on its purchases will be entitled to credit for the tax or a refund. Because the GST paid on acquisitions will be returned to the business, it is not considered a cost of doing business. Consequently, the income tax contains a provision denying a deduction for GST that will be credited or refunded back to the taxpayer. In some situations, a business is not entitled to credits or refunds of GST on purchases. In those cases, the tax is deductible as a cost of doing business for income tax purposes.

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Case law [1.270]  We have seen that the meaning of the words in tax laws derives from judicial precedents or decisions of courts interpreting the provisions in past cases. How binding the precedents will be depends on the level of the court. Decisions of the Australian High Court, the final court of appeal in Australia, are the strongest authority for interpretation of law. Decisions of the Federal Court or State courts are followed if there is no High Court decision on a point. In each case, the appeal levels (the “Full Federal Court” in the first case and State “Supreme Courts” in the second case) take precedence over decisions of lower courts. At the bottom of the precedent pole are decisions of the Administrative Appeals Tribunal or its predecessor in tax cases, the Board of Review. These are (or were, in the case of the Board) administrative bodies with less authority than a court. In the early days of tax jurisprudence in Australia, there was a significant reliance on precedents of UK courts. It is far less common today to look at UK decisions to interpret the provisions of the Australian tax law. However, many earlier UK cases continue to be influential, and you will find a number of instances of reliance on decisions by UK courts in the chapters which follow.

Rulings [1.280]  Australia’s income tax administration is built upon a somewhat unusual foundation. The tax laws are administered by a government agency, the ATO. However, the tax law does not actually create the agency. Rather, it empowers a statutory officer (a government official whose appointment is protected by a statute or public law) to administer the tax laws. That person is known as the Commissioner of Taxation (Commissioner). The ATO is the agency that carries out the actual administration, but in theory, it is doing so

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on behalf of the Commissioner. As a result, it is common to refer to actions of the ATO as acts of the Commissioner and to refer to advice from the ATO as coming from the Commissioner. Australia’s income tax law, FBT law and GST law all operate on what is known as a “self-​assessment” system. Under this system, taxpayers are responsible for interpreting the tax law and applying it to their transactions when they complete a tax return. The laws provide sometimes severe penalties for incorrect reporting of tax liability as an incentive for taxpayers (or, in reality, in most cases their professional advisers) to get it right.

Private rulings [1.290]  Taxpayers who are genuinely unsure how the law will apply to a particular transaction can protect themselves from the risk of a penalty by asking the Commissioner for a “private ruling” on how the ATO would apply the law to that transaction. These rulings are “binding” on the Commissioner, meaning that the Commissioner must honour the ruling and shield a taxpayer from any penalties if the taxpayer follows the advice in the ruling, even if a court later decides the ruling was not a correct interpretation of the law. While private rulings are delivered directly to taxpayers who request them, the ATO often produces a “sanitised” version that describes the question asked and the Commissioner’s answer without identifying the taxpayer who originally posed the question. These published versions of private rulings placed on the website are known as ATO IDs, an acronym for ATO interpretative decisions.

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Public rulings [1.300]  In addition to providing individual taxpayers with private rulings on request, the Commissioner often issues public rulings which set out more generally the ATO’s views on the way in which a provision of an Act should be applied to determine the extent of tax liability. A public ruling may also be used to explain which factors will be taken into account by the Commissioner when exercising a discretion provided in the tax law and how those factors will affect the decision the Commissioner is empowered to make. Like private rulings, public rulings are binding on the Commissioner, meaning that a taxpayer who relies on the view in a public ruling to complete a tax return cannot be penalised if that view is later found by a court to be an incorrect interpretation of the law.

Using this chapter [1.310]  This chapter outlines some of the key differences between commerce and accounting units and the tax law subject. Understanding these differences

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20 [1.310]  PRINCIPLES OF TAXATION LAW 2020 is important to understanding how to study for a tax law exam and how to answer a tax exam question. Chapter 2 provides some details on how to study taxation law and prepare for exams. This chapter contains examples of issues that will be covered in more detail in your tax law course. It only touches upon these issues for the purpose of showing two things: how tax law contains many borderlines between competing rules and how precedents will be used in an exam answer to characterise a transaction and explain on which side of the border a particular set of facts is likely to fall. The other chapters in this book explain in much more detail the tax rules mentioned in the examples in this chapter and the tests established in case law precedents that are used to decide which tax rule will apply to a transaction straddling the border between competing provisions.

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Return to this chapter periodically during the course. There is a risk that, as you learn about sections of the tax legislation and the case law tests used to interpret those sections, you will lose sight of how this information should be digested and used in an answer to a final exam question. Regular reviews of this chapter may help remind you of the bigger picture and provide guidance on translating what you learn about tax legislation and case law precedents into higher grades in the exam.

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2 Study skills for taxation law

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Key points......................................................................................................  [2.00] Introduction..................................................................................................  [2.10] Course aims..................................................................................................  [2.20] Level of understanding required...........................................................  [2.30] Nature and timing of assessment..........................................................  [2.40] Format of the examination....................................................................  [2.50] Prepare a study plan.....................................................................................  [2.60] Notes and summaries..................................................................................  [2.70] Overviews...............................................................................................  [2.80] Detailed notes........................................................................................  [2.90] Additional textbook resources............................................................  [2.100] Assignment writing for tax law.................................................................  [2.110] Research...............................................................................................  [2.120]

Step 1: Understand the question and the facts......................................  [2.130] Step 2: Identify the issues.......................................................................  [2.140] Step 3: Research the relevant legislation and cases.............................  [2.150] Step 4: Apply law to the problem...........................................................  [2.180] Step 5: Form a conclusion.......................................................................  [2.190] Planning and writing............................................................................  [2.200] Plan ..........................................................................................................  [2.210] Introduction..............................................................................................  [2.220] Body of the assignment...........................................................................  [2.230] Cite appropriate authority........................................................................  [2.240] Referencing and secondary sources.......................................................  [2.250] Conclusion................................................................................................  [2.260] Check you have answered the question.................................................  [2.270] Exam preparation.......................................................................................  [2.280] Identifying examinable material..........................................................  [2.290] Preparing revision notes and summaries...........................................  [2.300] Developing problem-​solving skills......................................................  [2.310] Working in small groups..........................................................................  [2.320] Traps to avoid...........................................................................................  [2.330]

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22 [2.00]  PRINCIPLES OF TAXATION LAW 2020 Examination techniques.............................................................................  [2.340] Reading time........................................................................................  [2.350] Open-​book exams................................................................................  [2.360] Answering multiple choice..................................................................  [2.370]

Strategy....................................................................................................  [2.380]

Answering problem questions............................................................  [2.390]

Identify the relevant law..........................................................................  [2.400] Apply the law to the facts........................................................................  [2.410] Present a conclusion................................................................................  [2.420] Sample examination answers and analysis...........................................  [2.430] Additional examination tips.....................................................................  [2.460] Using this chapter......................................................................................  [2.470] Resources....................................................................................................  [2.480] Internet.................................................................................................  [2.480] Glossary of terms used in assignments and exams................................  [2.490]

  

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Key points [2.00]  • Have a clear understanding of the requirements of your course, including the level of knowledge required for each topic and the assessment requirements. • Construct and implement a study plan. • Prepare reliable notes after each class. • Practise applying legislation and case precedent to tax law problems. • Instructors are normally looking for you to show an understanding of the law rather than answering a problem question with a simple “yes” or “no”. • In problem-​type questions, first identify the tax law issue(s) that are raised by the facts. • If you are having problems identifying the tax issue(s) in problem-​type questions, review your summaries of the law and look for key words in the facts. • In problem-​type questions, do not form your conclusion until you have explored and applied the law to the facts. • Prepare broad summaries of your notes, legislation and cases as preparation for the examination. • Organise your notes for open-​book exams and do not rely too heavily on the material you can take in; your summaries are your best support in the exam. • Practise sound exam technique so that you do not waste time in the exam.

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2: StUDY sKills for taxation law  [2.20]

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• In problem-​type exam questions, remember to: –​ clearly understand the facts and the question; –​ state the tax issue(s) you have identified from the facts; –​ identify the relevant law, legislation and cases; –​ apply the law to the facts; –​ form your conclusion based on your discussion of the law and state additional information that may be needed to clarify your conclusion.

Introduction [2.10]  To gain the most from the content of this chapter, it is important that you practise these skills early in your course so that you are well prepared to develop a sound study plan. However, it is also useful to return to this chapter to help with specific study or assessment issues that you may face during the course.

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The techniques presented in this chapter aim to improve the efficiency and effectiveness of your study skills to enable you to gain the most from your taxation law course and to perform your best in assessment tasks. These techniques can also be adapted to suit existing study and learning patterns. Practical examples are provided to help explain some aspects of these study skills, and these may make reference to taxation law which you have not covered when you are reading this chapter. It is not important that you understand the law used in these examples as they are for illustration purposes only. It is more important to concentrate on the approach outlined, rather than on the law used in the example.

Course aims [2.20]  Considerable variation exists between the approaches taken in taxation law courses at various institutions and between courses undertaken by accounting students, law students and legal studies students. Differences also exist between introductory and advanced courses as introductory courses are intended to provide an overview of the fundamentals underlying taxation law rather than an in-​depth understanding. The principles covered in a basic course may then be applied in advanced courses to explore more complex areas of the law and possibly tax planning techniques. Therefore, to help you construct your study plan, you should first identify the: • aims of the course; • level of understanding required;

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24 [2.30]  PRINCIPLES OF TAXATION LAW 2020 • nature and timing of the assessment; and • format of the examination. Identifying the course aims early will guide you in how you should approach your preparation for assessment and the examination. Course aims will usually be included in the subject outline or the reading guide. They may also be found in the institution’s handbook in the description of the subject; however, these are often brief and may not be sufficient. If you cannot determine the aims of the course from the materials provided, you should immediately contact your lecturer or tutor.

Level of understanding required

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[2.30]  Having identified the aims of the course, you should then determine the level and detail of knowledge required to meet these aims. In particular, you should establish the level of knowledge required with respect to legislation, texts, case law and other readings. It is common in introductory courses for this level to vary from topic to topic and even between areas in the same topic. You must therefore note the level of knowledge for each segment of the course before preparing your notes and other materials. Indication of the level of understanding required will be evident from the amount of legislation covered and the level of case law reading expected by your lecturer. Other indications include the amount of class time allocated to a particular topic or legal issue and any particular emphasis made by your lecturer. For example, it is likely that considerable class time will be spent on developing an understanding of the general assessable income provision (s 6-​5 of Income Tax Assessment Act 1997 (Cth) (ITAA 1997)) and the general deduction provision (s 8-​ 1 of ITAA 1997). However, other more specific provisions may only be mentioned in passing and therefore require less study time.

Nature and timing of assessment [2.40]  To plan your study approach and to determine the level of your note-​ taking, you should ascertain early in your course the assessments required and their due dates. You can then ensure that all relevant topics are prepared at the appropriate level well in advance of assignments or examinations. Ascertain the type of assessment and whether it is optional. Commonly, tax law assessment concentrates on problem-​type questions, where a set of facts is presented and you are required to discuss the relevant law and determine the likely application of the law to these facts. Other forms of assessment include multiple-​choice questions, short answer questions and theory-​type questions, which may require case analysis or commentary on controversial legal issues.

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2: StUDY sKills for taxation law  [2.60]

25

If you are required to research areas not covered elsewhere in the course, you will need to allow extra time for independent research using library and online resources: see [2.150] and [2.480].

Format of the examination [2.50]  Preparation of your notes and summaries will also depend upon the format of the examination paper(s) set for the unit. Taxation law exams tend to be either open book or a limited open book. Closed-​book examinations for taxation law are rare because of the breadth of material to be covered and because students need to refer to legislation. You should determine, before you commence your study, exactly what may be taken into the examination room. Knowing this, influences how resource materials can be marked during your studies. If underlining alone is permitted, you must not annotate or include any summaries in your texts or legislation. If you discover this late in your course, you will not be able to use material you have already annotated. If there are no restrictions on annotation, then it is very helpful to place page tabs in your texts and notes so that you can find major legislation and relevant summaries quickly.

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Prepare a study plan [2.60]  It is important to construct your study plan early in the teaching period to help map how you intend to cover the materials in the course. This will assist you to be well prepared for timely submission of assessment tasks and examinations. The plan should be based around a timetable appropriately dividing the available course time between the topics to be covered. The plan should allow for: • reading and annotating texts and materials; • preparing summaries of these readings and lecture notes; • note variation in time required for more or less difficult topics or course segments; • preparation time for examinations and assessments; and • critical workload periods for other subjects. Taxation law courses normally require a large amount of reading, so it is important to prepare your notes and summaries as you go as there will not be sufficient time at the end of the teaching period. A study plan is of no use unless you carry it out. Ideally, the plan should be sufficiently flexible so that it can be modified during the course if your

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26 [2.70]  PRINCIPLES OF TAXATION LAW 2020

Notes and summaries [2.70]  Developing the reliable topic notes and summaries is essential in studying taxation law and will be the most effective preparation for the exam. Summaries are a powerful tool for building an understanding of the fundamental issues within a topic. Without a clear awareness of the important issues, you may find it difficult to use general legal principles to solve unfamiliar problems of the kinds set in assessments. For example, Figure 2.1 shows the essential elements of the decision as to whether an expense is deductible or not. This summary, in a diagram form, shows that you need to consider whether the deduction could fall under the “general” or “specific” provisions and reminds you to consider any possible exclusion from deductibility and relationships with other provisions. This is a very broad summary, and each area listed would need to be expanded with more detailed notes. However, having such a broad overview of deductions is very valuable as it puts all the components into perspective and would be an excellent reminder in an examination.

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Figure 2.1: Map of basic issues relating to tax deductibility

Reliable summaries also enable you to identify the key taxation law issues in problem questions and the steps to their solution. To be most useful, each summary should:

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2: StUDY sKills for taxation law  [2.90]

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• provide you with an overview of the topic; • identify the important issues in the topic; • list and summarise the key sections of the legislation; and • list and summarise relevant cases. Writing summaries is a skill that can be learned and you can develop your own specific approaches, but the essential components of good summary notes are to: • provide an overview of the law and list the main headings and essential issues raised in the topic: see [2.80]; and • develop more detailed notes on the broad topic areas to enable you to build a better understanding of the relevant law: see [2.90]–​[2.100].

Overviews [2.80]  A logical and thorough approach to addressing a tax problem begins with identifying the legal issues raised by the facts presented. Your lectures and texts are the starting point for providing overviews of particular areas of taxation law. Wider reading of case law and other set readings are then vital for gaining a more in-​depth understanding. When studying taxation law, there is no substitute for careful reading of the Acts and cases. Practical guide books and tax law case extracts are also useful resources. Overviews of a topic can take many forms, which could include: Copyright © 2019. Thomson Reuters. All rights reserved.

• maps of the essential issues relating to a topic: see Figure 2.1; • flowcharts of the decision processes required (eg, residency of a company): see Figure 2.2; • lists of issues that the courts may use to define a term, such as “ordinary income”: see Example 2.1; • structure diagrams showing the steps required to apply relevant sections to a particular area of law: see Figure 2.2; and • lists of relevant cases with a very brief reminder of the facts and decisions.

Detailed notes [2.90]  The materials assigned for a tax course are generally intended to be adequate for normal study needs. However, you may wish to undertake further research to help clarify issues that you find confusing. When reading material from texts and other references, you should concentrate on recognising and

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28 [2.90]  PRINCIPLES OF TAXATION LAW 2020 understanding the legal principles that are being discussed. These principles are the most important aspect of the study of taxation law because they provide the rules for the application of the law in practice. When you are planning answers to problem questions, you will need to apply these rules to the facts so that you can support your arguments as to the likely outcome should these facts be considered by a court.

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Figure 2.2: Flowchart of decision to determine residency of a corporation

Example 2.1: Summary of legal principles –​distinction between capital and revenue expenditure Relevant cases: Sun Newspapers; Broken Hill Theatres (list all those that are relevant) Main issues to consider: • Is it a once-​off expense? • Does the expense have an enduring benefit? • Has the expense altered the profit yielding structure? Consider:

–​ the character of the advantage sought;



–​ the manner in which the benefit is used;



–​ the means adopted to obtain the benefit.

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2: StUDY sKills for taxation law  [2.110]

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Identifying these key principles from the relevant cases provides the basis of the analysis and discussion of a problem question relating to the distinction between a capital expense (not deductible under s 8-​1 of ITAA 1997), and an expense related to the operation of the business which may be deductible under s 8-​1 of ITAA 1997.   

Some students find it difficult to identify the major legal principles and tend to become frustrated by the detail. Taxation law is a very broad and complex area of study, and it is therefore important that you are clear about which areas your course concentrates on and which are of lesser or no importance. You can help yourself focus on the major principles by: • noting carefully the emphasis placed on different issues in classes and study material; and • following the basic heading structure of your text or study guide. You should avoid spending too much time on minor issues as there is so much material to be covered. If you are in doubt about the significance of a particular issue, clarify this with your instructors.

Copyright © 2019. Thomson Reuters. All rights reserved.

Additional textbook resources [2.100]  To support your note preparation, you may also find practitioner guidebooks a helpful complement to your textbooks. These guidebooks are designed to assist practitioners preparing tax returns for clients and tend to give broader coverage of the technical aspects of the legislation. Guidebooks are best used as a starting point for identifying relevant legislation for particular issues, but where general legal principles need to be understood, it is advisable to also refer to texts and other more comprehensive references. Taxation law casebooks are also a valuable reference for obtaining more detail of the facts and decisions in important tax law cases. Various styles of casebooks provide case summaries, case extracts and commentary. In courses where the emphasis is on practical problem-​solving, question and answer books may also be quite helpful. It is important to use a current edition of question and answer books as tax law is constantly changing. For a list of other resources that may be helpful during your studies, see [2.480].

Assignment writing for tax law [2.110]  Taxation law assignments are commonly set to assess whether you understand the law and its application. Most assessors are not looking

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30 [2.120]  PRINCIPLES OF TAXATION LAW 2020 for wrong or right answers nor do they want you to recite directly from the legislation. Instead, you should demonstrate that you can recognise the legal issues raised by the question and then apply the law in an attempt to predict the outcome should this go to court. Do not concentrate on the conclusion to an assignment question, but rather on demonstrating your knowledge of the law, your ability to recognise issues and your ability to apply the law to the facts in the problem. Your conclusion should then develop as you apply the facts to the problem. Assignment writing should be undertaken in two distinct steps. The first step is to carry out the necessary research which will provide the basis of the content for the second step, which is to plan and write the assignment. Each of these two stages plays a vital part in the development of a logical legal argument. However, the suggested approach is only a guide and may not exactly suit all students and styles of preparation. Different assignment types may require different approaches: see [2.40]. In these cases, it may be useful to adapt part(s) of the approach outlined into your existing style. If this is done, it is important to make certain that all requirements of the assessment are still covered.

Copyright © 2019. Thomson Reuters. All rights reserved.

Research [2.120]  Tax research requires a “broad principles” approach as the range of questions is limitless, and it is rare that questions can be substantially answered directly from secondary materials such as texts and legal reporting services. You will typically be asked to apply the law to a set of facts not previously encountered. This type of question requires you to apply legislation and legal principles to new situations and draw conclusions as to how the law may apply to these new facts. This type of analysis is extremely important because this is what is required in the application of taxation law when advising clients. Mistakes in your research approach often lead to poor assignment answers. Some common mistakes include: • Trying to find a case with similar facts and answering on that basis. Questions based on a set of facts are often best approached by identifying the relevant taxation law issue(s), rather than trying to find cases with similar facts. • Scanning the index of the Act or secondary sources, such as texts, journals and legal reporting services. This approach can lead you to irrelevant areas of the law and cause the broader general principles to be overlooked. Use indexes after the legal issues have been identified. • Trying to give a direct answer to the problem without identifying the relevant legal principles needed to resolve the problem. This approach

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is commonly seen in assignment answers that begin “the receipt is assessable because …” or “the expense is deductible because …”. It is important to first identify the issues and then discuss all aspects of these issues. The conclusion should then develop out of this discussion. To avoid these common mistakes, Figure 2.3 sets out the steps that can be used when researching and answering a taxation law problem.

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Figure 2.3: Steps to answer tax law problems

Each of these steps in the research process is mirrored in the preparation of the written assignment, but it is vital that these steps are first taken in the research stage so that the arguments presented in the written assignment are developed logically.

Step 1: Understand the question and the facts [2.130]  Poor answers to problem-​type questions often originate from a misreading or incomplete understanding of the question and related facts. Avoid this by reading questions carefully and highlighting key words. Complex facts can be better understood if they are summarised as a list of events, with a timeline showing when each transaction occurred or a diagram

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32 [2.130]  PRINCIPLES OF TAXATION LAW 2020 showing the transactions between parties. In Figure 2.4, the diagram of the facts helps highlight the flow of funds and the transfer of property to the parties concerned. For example, the fact that Kim’s guarantee of the rent is shown as a transaction should draw attention to whether it is relevant for income tax purposes.

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Figure 2.4: Diagram of assignment problem facts

As well as understanding the facts presented in the problem, it is also very important to understand the requirements of the question itself: see [2.490]. The first step is to understand who the question relates to. For example, are you required to discuss the tax consequences for all parties or just one of them? Where the question only requires discussion of one party, make certain that only the relevant transactions are discussed. Do not waste your time researching the other party’s tax situation unless their circumstances influence the tax of the taxpayer. Questions may also require only part of the law to be discussed, such as “whether the transaction gives rise to ordinary income” or “discuss the capital gains tax consequences only”. Where the requirements of the question are limited, it is important to restrict your discussion to these areas as marks will not be allocated for the discussion of irrelevant issues. You may also face the problem that the facts presented in the question are vague. This is often a deliberate mechanism used by instructors to test whether you can recognise which facts are essential to the conclusion. Irrelevant facts may also be included with the same intent. It is an important skill in taxation law to be able to ascertain which facts are relevant and to appreciate that part of the role of the tax adviser is to obtain these facts from the client.

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Step 2: Identify the issues [2.140]  Once the question and the facts are clearly understood, the next, and perhaps most critical stage, is to determine the legal issues that are relevant to the facts. If any legal issues are overlooked or are irrelevant to the question, your answer will be incomplete or irrelevant. Assessors cannot award marks for irrelevant discussion, and you lose marks for missing issues. Where a question requires discussion of the tax consequences of the transaction presented (eg, “Are the receipts assessable?”), there is a strong tendency for students to begin by answering “yes” or “no”. Avoid reaching a conclusion before identifying the relevant legal issues, as this approach does not show an understanding of the operation of the law. Most assessors are looking for you to first demonstrate that you recognise the legal issues raised by the facts and second, apply the relevant law to show that you understand how these issues may be resolved. A conclusion is important, but it is not the most important stage. In fact, if you use the approach suggested here, you may find that the conclusion becomes apparent from your research of the issues, rather than from a deliberate search for the so-​called answer.

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Most students need to actively work on the problem-​ solving nature of taxation law studies and need to develop effective and efficient strategies for identifying the relevant legal issues in problem-​ type questions. The most reliable method of developing these skills is through practice and by obtaining a broad understanding of the content of the subject. This can be achieved through consistent study and regular preparation of notes and summaries: see [2.70]. Practising this type of question through practical exercises is also important in developing these skills because it helps reinforce the legal principles and concepts being studied. Practice also assists with the recognition of key terms used in questions that point to the relevant issues.

Example 2.2: Identifying tax issues through key words An exam question states: Ashley has worked for his current employer for the past ten years and recently announced his engagement to his boss’s daughter. In his last pay packet Ashley was surprised and delighted to see an amount of $500 in addition to his normal pay and a note from his boss indicating that the additional amount was a gift from the firm in recognition of his engagement.

One of the factors affecting whether a receipt is assessable as ordinary income is whether it is earned as a result of work performed or whether it is a personal gift. The terms “gift” and “earned” therefore have specific

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34 [2.150]  PRINCIPLES OF TAXATION LAW 2020

relevance to the law. So, in this question, your starting point would be to identify the phrase “was a gift” as an important pointer to the relevant issue.    Complex questions may also contain a range of legal issues, with some being more important than others and some only being relevant after other issues are decided. For instance, some provisions of the legislation only apply once it has been determined that the transaction is not taxed under another provision. It is therefore very important that all issues are identified and followed through to their logical conclusion. A common mistake made by students is to identify a legal issue and discuss it fully and, having reached a conclusion, not realise that the conclusion raises other issues. For example, if you conclude that an expense is capital in nature and not deductible under the general deduction provision, you then need to consider whether a deduction is available under another specific provision of the Act, such as the capital allowances sections.

Step 3: Research the relevant legislation and cases

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[2.150]  Legislation. Taxation law only exists because of legislation, and therefore, all relevant legal principles originate from a specific provision of this legislation. Consequently, all the issues identified in Step 2 must now be related to relevant sections of the legislation. Where more than one section is applicable to the same transaction, it is important that you show an understanding of how these sections relate to each other and, ultimately, which must be applied to the facts under consideration. For reasons of both cost and practicality, condensed paper versions of the legislation may be prescribed, but if a full version of the legislation is required for your research, these can be accessed electronically from various sources: see [2.480]. The advantage of using online legislation is that it is usually more up to date than printed versions. Researching tax law issues is made easier because there is a wealth of resources available. These resources are commonly accessed in an electronic format, and excellent indexing makes researching these materials relatively easy: see [2.480]. Australian tax law is very well serviced with online primary research materials and commentary services. These services provide detailed commentary on taxation law, as well as full citation of all relevant tax cases decided by Australian courts and some leading overseas cases. They also report up-​to-​ date consolidated legislation and all public rulings issued by the Australian Taxation Office. Your institution will usually have access to these electronic

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databases for use in your research, and your librarian will be able to guide you on how to use the search facilities provided by these services. [2.160]  Case law. Relevant case authority should be introduced at this stage to support the legislation and legal principles used in your answer. Although the primary source of taxation law is legislation, the interpretation of this legislation by the courts is critical for the application of the law in practice. Cases relevant to the issues and principles that need to be discussed will arise from a variety of situations. Therefore, when identifying relevant cases, you should not only look for cases with similar facts but you must also research cases, where similar legal issues were considered by the court. For example, if the question requires discussion of the nature of a capital receipt, then look for the cases that consider this broader issue. A good starting point is to use prescribed texts and follow-​up the cases that they refer to. Once the relevant cases have been identified, it is essential that you read the cases carefully to obtain a detailed understanding of how you can use these legal principles in your discussion of the problem. Cases referred to in the decision should also be pursued if they are significant to the law being discussed.

Example 2.3: Sample search using AustLII (Australian Legal Information Institute)

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To search for the case Commissioner of Taxation v Hart:

1 Go to the AustLII website: http://​www.austlii.edu.au.



2 Click on “LawCite” which is located in the top red heading menu.



3 LawCite provides a number of options for finding a particular case. For example, if you know the full citation of the case (shown in the index or body of this text), this will be the most reliable search approach. To find FCT v Hart, you enter the citation “217 CLR 216” in the “Citation” search box and click “Search”. There will be a link to the full case shown under the case name at the top of the page and there is also a list of cases, where FCT v Hart has been cited.



4 If you do not have the full citation, you can enter the party’s name in the appropriate search boxes. The search may provide a list of cases with that name, so it is important to select the correct one. For example, FCT v Hart went all the way to the High Court, so unless you are looking at the history of the case, you need to select the High Court decision ([2004] HCA 26) rather than one of the lower court decisions.

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36 [2.165]  PRINCIPLES OF TAXATION LAW 2020



5 If the search returns too long a list of cases, you can limit the search by entering the court the case was decided in, for example, High Court of Australia. 6 LawCite can also be used to search for articles on areas of taxation law that you are researching. For example, if you type “avoidance” in the “Article Title” search box, a range of articles and cases will be returned and you can select any that seem to be relevant for your research. If you cannot easily find the case you are looking for on “LawCite”, there are other legal databases that may report the case and which may be available via your institution’s library: see [2.480].    [2.165]  Reading and understanding cases. If you have difficulties reading and summarising cases, you may find the following approach helpful: see Figure 2.5. This approach breaks the process into a number of steps that are aimed at gradually building up your understanding of the facts, issues and legal principles arising from the judgment. Although this approach may be helpful, it cannot be overemphasised that there is no substitute for practice. You should read cases carefully until you have a good understanding of them.

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Figure 2.5: Steps for reading tax law cases

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Step 1: Gather basic information about the case before reading it in full. This ensures that when you read the case in full, you will have some understanding of the decision and the facts. This can be done from the headnotes (summary at the beginning of the case) or the first reading of the case. A basic summary should be made of the following: • The parties involved and who is the plaintiff (appellant) and who is the defendant (respondent). This is important as the judges may not refer to the parties by name but as “plaintiff” or “defendant”. • The transactions under consideration –​for example, Sale of shares. • The taxation issues in dispute –​for example, Was the sale capital or revenue in nature? • The decision of the court –​for example, The sale was of a capital nature. Step 2: Summarise the relevant facts. One or more judges will describe the facts in detail, and this is usually found at the beginning of each judgment. Different judges may emphasise different facts, and this can impact on the decision reached by the particular judge(s). Once the facts are fully understood, it is important to summarise them in a diagram, a table or in text form: see Example 2.4.

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Example 2.4: C of IR (NZ) v Europa Oil (NZ) No 1 [1971] AC 760

  

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38 [2.170]  PRINCIPLES OF TAXATION LAW 2020 Step 3: Identify the legal issues that are the basis of the dispute. Read the majority decision(s) first. This will be identified in the headnote. The goal in reading the case at this point is to clearly understand the taxation law issues that are the basis of the case. For example, in Europa Oil No 1, the central issue was whether the general deduction provision allowed a deduction for the full amount of an expense, which was clearly excessive, even though it was related to the operation of the business. Step 4: Read the majority decision(s) to understand the reasons for the court’s decision and any legal principles arising from the decision. More recent case reports may include headings, which can be very useful for identifying where in the judgment the reasoning for the court’s decision is explained. However, in older reports, this is not the case, and it is therefore important to mark these parts of the judgment.

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[2.170]  Take detailed notes with references. As you read and research material for your assignment, you must take good notes and keep clear references of where you found your ideas and material. It can be very frustrating to remember that you read something relevant on a particular issue and then spend hours trying to find it again. It is also important to keep accurate references so that you are able to complete the necessary referencing when writing up your paper: see [2.250]. Keeping good notes will also help you organise the material into a logical sequence as the notes can be sorted and re-​sorted into the appropriate order before you begin writing the paper. Experience has shown that taking notes, either electronically or in handwriting, is far more effective than highlighting text on photocopies of cases, etc. Highlighting text does not force you to write the ideas and concepts gleaned from your readings in your own words and can mean that you need to read the material again so that you can recall the importance of the highlighted text. Making reliable notes will save time and help you understand what you have read.

Step 4: Apply law to the problem [2.180]  After identifying the relevant tax issues in the problem, applying the law to the facts is the second most important stage in your research. Some students perform poorly in their assessments because, even though they correctly identify the relevant law, they fail to apply it to the question asked. At this stage, it is critical that you apply the legal principles identified in the previous steps to the facts in the question. During the research phase, it is important to remember that the relevant legal principles need to be applied to the facts in the question. If this is done, it will assist with the final writing of the assignment because the relevance of the legislation and case authority will be constantly reviewed.

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When applying the law to the facts of the problem, it is essential that you consider both sides of any issue and never deliberately argue for the taxpayer or the Commissioner (unless asked to do so). Always research conflicting cases so as to gain a balanced and detached view of the law. A starting point in applying the law is to refer back to the facts being considered. You should then select one issue at a time and work on applying the relevant law to it. Example 2.5: Applying the case precedent to the facts Imagine a case where the relevant issue is whether the taxpayer is a resident of Australia for taxation purposes. How would you approach it? Here are the suggested steps: 1 consider which facts the courts have previously considered relevant when deciding this issue;

2 then consider to what extent these facts are present in the situation presented in the assignment;



3 then look in turn at each of the factors used by the court; and

4 this should help you reach a conclusion, as this approach often makes it apparent, where the strongest arguments lie.   

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Tax rulings may be investigated at this stage to determine whether a ruling has been issued, which expresses the Commissioner’s view on how the law should be applied. It is important to remember that rulings are not legally binding on the courts and should mainly be used to obtain ideas on the types of legal issues that are raised by the facts. Rulings must not be used as the sole justification for your conclusion as they are not the legal authority but they can be referred to as an indication of the Commissioner’s view on the issue. When applying the law to the assignment question, do not avoid conflicting points of view simply because they fail to support your current line of argument. Generally, assessors are looking for you to demonstrate that you can consider conflicting authorities and recognise that there are other points of view.

Step 5: Form a conclusion [2.190]  This is the final stage of assignment preparation. Although you should consider your possible conclusion during the writing process, it is important that you keep an open mind throughout the research phase so that you do not get locked into a narrow line of argument. It is dangerous to jump to conclusions as this can prevent different views emerging. The final stage of forming a conclusion is discussed in more detail at [2.260].

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40 [2.200]  PRINCIPLES OF TAXATION LAW 2020

Planning and writing [2.200]  Once the research stage is completed, the actual preparation of the assignment should be quite straightforward, but before you begin writing the final paper, it is advisable to prepare a plan so that your paper is logically presented: see [2.210]. Then you need to work on:

• • • • •

the assignment’s introduction: see [2.220]; the body of the assignment: see [2.230]; citing authority: see [2.240]; referencing: see [2.250]; and the assignment’s conclusion: see [2.260].

Plan

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[2.210]  It is important that you prepare a plan or a structure of how the assignment question is to be answered and how your arguments are developed. Much of the work for this plan has already been completed through the research stage, but now it is important that you organise the information collected into its logical structure. In your plan, briefly list the content of the introduction, the headings to be used in the body of the assignment and the main points to be made in the conclusion. Also, check that the order of headings is logical so that the assessor can follow the arguments presented. It is also important to gather together the information that you have on each of the issues and determine whether sufficient argument has been developed to support the conclusions. Some issues may be more important and require more discussion, but avoid concentrating on one issue and neglecting others.

Introduction [2.220]  Having completed the research and developed a plan for the assignment, it should be a relatively straightforward task for you to write the paper. The introduction serves the important role of providing the assessor with an overview of the assignment and facilitate a better understanding of the arguments you are about to present. The content of an introduction may vary depending on the style required for the course, so it is important to follow any style guides provided. Different style requirements may require a summary of the question, an indication of the relevant facts and the assumptions made and a brief summary of the conclusion drawn. These variations in style should be noted from faculty style guides. However, it is wise to keep an introduction as brief as possible as it is

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only intended to provide an overview. It certainly should not contain any of the arguments presented in the body of the assignment.

Body of the assignment [2.230]  Before writing the body of your assignment, check the requirements of the question to determine if any specific form of presentation is required, such as “advise the client”. Always present your answer using correct grammar and formal legal terms. Write using complete sentences and do not use slang. Assessors do not appreciate flippant assignments as they reflect badly on your attitude. Various approaches may be used for the body of the assignment. The essential objective, however, must be to discuss the law in relation to the issues identified in the introduction. If appropriate, the law should then be applied to the situation presented in the assignment question. It often helps use headings which will enable you to inform the marker about the particular aspect of the law or facts that are being discussed.

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Cite appropriate authority [2.240]  Appropriate authority must be used to support all answers to taxation law problems. As the primary source of income tax law is legislation, the first authority given must be the relevant legislation. Relevant legislation should be cited early in the discussion, and it is important to make certain that sections are cited correctly. If a section is not cited correctly, it is not possible for an assessor to ascertain the level of knowledge shown in the answer because the information provided is incorrect. Where more than one provision is applicable, it is also important to show that you understand which provision has precedence and how this is determined. However, if your institution specifies a different style guide, please follow it, for example, whether to use footnotes or in-​text referencing of legislation. The legal principles needed to resolve the issues arise from the legislation and, where relevant, appropriate case authority must be cited to show how the legislation has been interpreted. However, the extent of the discussion of these cases will vary depending on their importance to the resolution of the issue. It may be helpful to categorise cases as those to be discussed in detail because of their relevance to the problem and those merely cited to support a legal principle. When applying cases that are important to the discussion, it is not sufficient for you to summarise the facts and the decision of the court. What is required is an analysis of the decision and discussion of the court’s reasoning as applied to the facts. The aim is to show your understanding of the legal principles derived from the case and their application.

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42 [2.250]  PRINCIPLES OF TAXATION LAW 2020 Where conflicting authority exists, discuss this conflict and give an explanation of why one authority was found to be more persuasive than another. Care should also be taken to identify differing facts that may have affected these decisions. If there is evidence to support the view that a case would not now be followed, this should be presented, but it is important not to disregard cases simply because they do not support your line of argument.

Referencing and secondary sources [2.250]  Most assignments will require referencing, usually in the form of footnotes. This is essential to provide the assessor with details of your sources and to avoid claims of plagiarism. You must ascertain what referencing is required and the form of referencing expected. The Australian Guide to Legal Citation is an excellent reference for guidance on correct citation, and it is available online: https://​law.unimelb.edu.au/​mulr/​aglc/​about. However, if your institution specifies a different style guide, please follow it. Textbooks or other secondary sources must never be cited as authority because they themselves are interpretations of the law; only primary authority from legislation and cases should be referenced. Texts that are not primary authority should be listed only in the bibliography and not in the body of the assignment.

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Tax rulings are also not authority as to the law, but are the Commissioner’s view as to how the legislation could be applied to certain facts. Consequently, rulings must never be cited as authority and should only be used to report the Commissioner’s view, which may or may not be supported by your arguments.

Conclusion [2.260]  Your written answer must contain a conclusion that addresses the question asked in the assignment. It is not sufficient to cover all the issues and then avoid coming to a conclusion. It is also important that your conclusion is supported by your arguments, rather than being merely an afterthought. Do not introduce new arguments or discussion in the conclusion as this indicates poor planning or uncertainty about the validity of the arguments already presented. When forming a conclusion, it is very important that you make certain that it follows from the discussion and is not based on a preconceived notion formed before researching the assignment. At all stages, try to avoid jumping to conclusions as this often leads you into an approach, where the conclusion is formed at the start and then the body of the assignment attempts to justify the conclusion. This approach is dangerous because it creates a narrow view of the problem and limits the breadth of research and discussion. Also, if the

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original conclusion is poorly formulated, the whole direction of the answer could be wrong. If you determine that the conclusion depends on information that is not provided in the question, it is important not to make assumptions that avoid answering the question. A better approach is to state what information would be needed to assist in forming a reliable conclusion and explain why this information is important. A brief comment could then be made on the different conclusions that may be reached depending on the additional information. Taxation law questions often do not have precise answers. It is important to come to grips with this reality and recognise that it is not the conclusion, but the discussion of the law that normally contributes to the bulk of the assessment. Where no clear conclusion can be formed, discuss all the arguments for and against the issues that arise. However, following the approach set out above should help you to develop a supportable conclusion.

Check you have answered the question [2.270]  Finally, always ensure that you performed the precise task you have been set. A common mistake is that students merely outline the relevant area of law without actually applying it to the facts of the problem. Be thorough and logical in your analysis of the problem and ensure that you provide a clear justification, supported with authority, and explanation for each conclusion reached.

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Exam preparation [2.280]  Previous discussion in this chapter detailed methods of developing general study skills and techniques during your course: see [2.70]. In addition to these general skills, particular attention is required throughout your studies towards preparation for the examination. Preparation for the examination presents two very specific challenges. The first is identifying the key examinable issues in the course and the second is developing problem-​solving skills so that the key issues can be applied to new and unfamiliar tax law problems. The exam preparation techniques discussed at [2.290]–​[2.330] focus on these critical areas.

Identifying examinable material [2.290]  It is simply not possible for an examiner to cover every aspect of income tax law covered during your course in the final examination. Instead, the examiner will normally concentrate on the issues encountered in basic

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44 [2.300]  PRINCIPLES OF TAXATION LAW 2020 transactions of normal employment, business or investment arrangements, as well as specific areas such as depreciation, capital gains tax, fringe benefits tax and goods and services tax. If a transaction contains elements that may point towards more specialised rules, you might be expected to demonstrate to the examiner that you are aware of those rules, but you would not normally be expected to apply them in detail in an introductory unit. Keeping a realistic perspective on the materials and, in particular, identifying which issues are almost certain to arise will help you allocate your revision time more efficiently. It will also help you to organise your revision notes so that you have covered the points that will earn you marks in the exam and to avoid detail highly unlikely to be examined. It is therefore very important to ascertain from staff and unit resources, which are the key areas to be studied and which require less detail. Clues to identify the most important areas of study can be obtained from the structure of lectures and the headings used in subject study guides, textbooks and the type of questions set for tutorial discussion and for assignments. Preparing your own summaries is also an important method of identifying which issues are critical and which are less important: see [2.70].

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Preparing revision notes and summaries [2.300]  Preparing your own notes and summaries is crucial to your understanding of tax law, as merely reading your texts, however many times you do it, is generally not a reliable method of exam preparation. The exam lasts only a few hours, which means some 35 or more hours of lectures and many more hours of reading must be condensed into a manageable form. Preparing summaries will help you memorise key points and gain a better understanding of the law so that you are better equipped for answering problem-​ type questions. Thinking about how to express a point concisely and clearly, and writing it down once you have done this, will also embed the concept into your memory far better than continued reading of the same point. Preparing a summary will also help you quickly make the connections between differing arguments and differing issues. As you organise your notes by subject matter and issues, you will pull together all the arguments that must be raised in an exam answer. The importance of identifying key issues has already been made, and this must be your major objective when preparing summaries and review notes. Ideally, the final version of your review notes will be a summary of no more than 15–​20 pages that acts as a checklist of arguments to raise, whatever the facts of the question. In the exam, you would not have time to research the issues to be discussed in a problem question. However, a checklist of issues or steps will enable you to

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simply apply the key points from your summary to the tax law issues raised by the facts of the question: see Figure 2.6. Organising your review notes into a checklist of arguments to be raised in an exam will take time because it requires a thorough understanding of the materials being studied. However, once done, it will improve your understanding, increase the chances of recall and provide a valuable reminder in open-​book examinations.

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Figure 2.6: Summary of steps required to calculate net capital gain

Developing problem-​solving skills [2.310]  Taxation law is inherently complex and also considerably different from many other courses because it raises more questions than answers. However, there are some areas of certainty in tax law. For example, at one end of the spectrum are receipts that are unquestionably subject to tax (eg, wages and salaries) and at the other end are gains that are clearly not (eg, normal lottery winnings). Between these black and white ends of the spectrum is a vast range of murky greys. It is this grey area that provides the opportunity for assessors to set examination questions that require you to demonstrate your

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46 [2.320]  PRINCIPLES OF TAXATION LAW 2020 knowledge and application of the law. Therefore, it is important to develop the skills needed to identify these doubtful areas of the law. Technical aspects of tax law, such as indexation of capital gains, discounting of capital gains, depreciation calculations and valuation rules for trading stock, are less contentious and can provide an opportunity to provide a precise answer. Much more difficult are the troublesome intermediate questions, such as: “Can this receipt be characterised as ordinary income or a capital receipt?” More often than not, there are no clear answers to this type of question. As a result, examiners are not looking for definitive answers, but will give most marks for sound discussion of the competing arguments that will influence the final decision.

Working in small groups [2.320]  Working in a small group to practise past exam questions and problems set during the semester is a valuable means of developing and reinforcing the skills needed to identify the issues in problem-​type questions. If you sit and practise old questions yourself, you may catch one-​third of the issues raised by the questions. If you are very good, you may discover half the issues. But if you study with two or more other students, together you are more likely to find 80%–​90% of the issues.

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Traps to avoid [2.330]  There are no shortcuts to good exam preparation. Students who attempt to avoid the essential steps of preparing reliable and complete review notes and who do not practise identifying the issues in problem-​type questions, generally do not perform well. The following approaches are to be avoided as they can lead to a false impression as to your ability to write a high-​quality examination paper: • preparing answers to past exam questions or other problem questions before preparing and studying summaries can be very discouraging as it may lead you to think that the task is impossible; • using answers to past exam papers prepared by other students or supplied by instructors can lead to a false sense of security. When reminded of the issues, most students recognise the issues but are falsely led to believe that they could have recognised these issues themselves. Answers prepared by other students may also be wrong or incomplete; • preparing complete answers to past examination questions in the hope that similar questions will be asked in the current examination. Doing this tends to cause some students to hope that the prepared answer is relevant to the question and use it regardless;

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• trying to remember and understand cases and notes from just underlining and highlighting. Preparing summaries in your own words is a far more reliable method of study as it develops a better level of understanding.

Examination techniques

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[2.340]  Most students can improve their performance in any examination simply by applying basic exam techniques. Sitting examinations is a very stressful experience, and strategies need to be learned and practised so that they are automatically followed in an exam regardless of the level of stress. The following examination techniques comprise an effective strategy for tackling any exam. Using these guidelines should always enable you to present your best possible examination paper: • Well before the exam, carefully read the materials provided in subject outlines, etc that explains the structure and format of the examination. Finding the examination is not as expected can add to the level of stress experienced: see [2.50] and [2.490]. • Only spend the amount of time on a question that is indicated by the marks allocated to it. For example, if a question is worth one-​third of the marks, then only one-​third of the time allowed for the exam should be spent on the question. In most cases, you will earn most of your marks in the early part of your answer, and if you are struggling with your answer, there is no point persevering. You will typically earn more marks if you go on to a question you can answer. • Make the best use of reading time. • Select the easiest question and do that first. This can have a number of advantages: it allows you to earn marks easily, it reduces your level of anxiety and you may be able to complete the question more quickly, thereby allowing more time for other questions. • Structure your answer so that you come to the point immediately. Do not give background, repeat the question or restate parts of the legislation or facts from cases. • Plan your answers with an outline of the relevant issues, cases and sections. However, do not waste time on an outline and remember to come to a supported conclusion. • Always list relevant sections of the legislation and case names. Check with your lecturer what level of citation is required for the examination. • Wasted time is your greatest enemy, and this is a particular problem in open-​book examinations. Do not expect that you will have time to research an answer to a question during the examination time.

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48 [2.350]  PRINCIPLES OF TAXATION LAW 2020

Reading time [2.350]  In some taxation exams, reading and/​ or noting time is provided before the writing time commences. If this is available, it could turn out to be the most important 10 or 15 minutes in the exam. When the exam starts, there is an inevitable moment of panic. You can react to this phenomenon in one of the two ways. Some students switch into worry mode, losing valuable time and taking precious minutes to settle down to the point at which they can concentrate on the problems in front of them. Others exploit the time, turning directly to the exam questions and mentally noting (make notes if permitted) every point that comes to mind as they read through the questions.

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On the initial read through, you should, if permitted, use your summary notes and checklists to recall issues relevant to the problem. If writing is permitted during reading time, make brief notes to remind you of those issues when you later attempt the question. Also, use this time to make important decisions in relation to the time allocated to each question and which is the easiest question to start answering. During this time, you should also start to mentally prepare a plan for the first question you are going to attempt. If no separate reading or noting time is provided, it is important that you create your own reading and noting time by first reading the question carefully and then planning your answer. Avoid the temptation to immediately start writing and then find what you have done is incorrect. Too often, exam markers see large sections of an answer crossed out and started again. This is a serious waste of time. The only danger to be aware of when planning your answer is not to spend too much time on this task; a few minutes should be all that is necessary.

Open-​book  exams [2.360]  Taxation exams are normally an open-​book exam, meaning you will be allowed to bring into the exam any notes or texts or, at the very least, legislation. It is vital that you ascertain the conditions of the final examination at the start of the course because this will influence whether texts and Acts can be tabbed, noted and/​or cross-​referenced. Open-​book exams in tax are in some ways something of a sham. The more you are permitted to bring into the exam room, the less opportunity there will actually be to use the materials. Students rarely finish tax exams early, and it is much more common to see students still writing as time runs out. With time an overwhelming constraint, making effective use of texts, notes or study aids means knowing exactly when and how to use the extra materials.

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Most importantly, you should realise that the materials are there mostly as a crutch to jog your memory or remind you of the steps to take in answering a question. There will not be time in an exam to look for the answer to a question. You either know the tax issues and just need your notes to remind you of the relevant sections or cases or you do not know how to tackle the problem. If you do not know what law is relevant, you are far better off moving on to the next question than trying to research the area from scratch. It is unlikely you will win more than a mark or two from panicked research in the exam room, and the effort may cost you many more marks you could have earned in other questions.

Answering multiple choice [2.370]  Multiple-​ choice questions are sometimes used in taxation law examinations to enable the assessment of a wide range of the material covered in the subject. This type of question allows the examiner to broaden the coverage of the course content, enabling some of the more specific and technical areas to be examined. However, tax law differs from many other subjects in that there may not be a definitive answer to a question. This means that, in a multiple-​choice question, more than one answer could appear to be correct, and the trick is not to look for the “right” answer, but rather for the “better” or “most appropriate” answer.

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Good preparation for answering multiple-​choice questions is similar to the preparation used for most types of tax law examination questions. Reliable and concise summaries will enable you to quickly access the detail needed to answer these questions in an open-​book examination or to study for closed-​ book examinations. Before commencing multiple-​ choice questions, check whether marks are deducted for incorrect answers. It is important to do this because it is unwise to guess if marks are lost for wrong answers. Deducting marks for incorrect answers is not very common and is usually only the case, where you are not informed how many of the options are correct and you are required to select one or more of the options presented. It is also important to determine, before commencing, the amount of time that should be allowed for each question and whether all questions carry the same marks.

Strategy [2.380]  Most multiple-​choice questions commonly have four to five alternative answers to select from and, because of the nature of taxation law, more than one of the answers may appear to be correct, but only one will be the most appropriate. For example, if the facts presented in a question mean that more

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50 [2.390]  PRINCIPLES OF TAXATION LAW 2020 than one provision of the Act is applicable, the examiner is testing whether you understand which provision has precedence. More than one alternative may be correct, but the alternative that is the most appropriate is the one that applies the correct legislation. Example 2.6: Test of the most appropriate legislation Section 15-​2 of ITAA 1997 only applies if a benefit is not ordinary income under s 6-​5: see s 15-​2(3)(b). Therefore, if s 6-​5 makes the benefit in the question assessable, then s 15-​2 does not apply and would be an incorrect answer even if s 15-​2 is also applicable.    Where more than one alternative is correct, another strategy used by examiners is to include statements such as “none of the above” or “all of the above”. These alternatives need to be considered very carefully because they may be used to test whether you recognise alternative arguments. One of the most important tips in answering multiple-​choice questions is to first identify the possible answers by eliminating the obviously incorrect answers. For example, if the question requires a decision as to whether a receipt is assessable, two alternatives may say that it is assessable and two may say that it is not. In this case, it is first necessary to decide whether or not it is assessable and then to select the best answer from the remaining two options.

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Answering problem questions [2.390]  The notes on preparing for tax exams at [2.280] and preparing for assignments at [2.110] have stressed the importance of finding the legal issues used to answer questions, rather than finding the answers themselves. Problem questions test your ability to identify the law relevant to the problem and to distinguish competing arguments and then form a well-​supported conclusion. The facts of a problem question are very deliberately chosen, and so no clear-​ cut answer is possible. At the back of an assessor’s mind, there is probably an idea of a preferred conclusion. However, full marks could still be given to a student coming up with the different conclusion, provided the answer canvasses all the arguments and puts forward a persuasive conclusion using relevant cases and sections that support the answer. Problem questions are not marked according to a “right” answer. Instead, marks are awarded for developing arguments and pursuing any possible tax implication arising from the facts.

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Identify the relevant law [2.400]  A well-​constructed answer to a problem question first requires you to identify the relevant taxation law issues that relate to the facts presented in the problem: see [2.140]. This step is essential as problem-​type exam questions are meant to test your ability to apply the law to unfamiliar fact situations. If there is a range of issues raised by the facts, you should first identify all these issues and then commence to discuss the most important first. Example 2.7: Legal expenses Consider a question in which a taxpayer incurs a legal expense akin to a fine but which is not actually a fine or a penalty covered by the legislation. To approach this question, the first step would be to consider whether the expense satisfies the positive limbs of s 8-​1(1) of ITAA 1997. In other words, does the expense have a nexus with the derivation of assessable income either directly or through a business?

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There is some doubt about the tax effect of various types of legal expenses, and while generally the courts have been sympathetic to taxpayers seeking deductions for these expenses, in some situations, the outgoings have been characterised as quasi-​personal or insufficiently connected with income derivation to satisfy the positive limbs.   

If a problem question appears to have a very clear and definite answer, it would be wise to give the question additional thought as it is unlikely that an instructor would set a 20 or 30 mark question if the answer were that simple. In practice, the instructor will have deliberately chosen facts designed to give you the hooks on which you can hang a whole range of issues, so it is vital that you use your summaries to identify all these issues.

Apply the law to the facts [2.410]  It is not sufficient in the exam to just identify the issues and discuss the relevant law in general. Problem questions require you to apply the law to the facts and reach a supportable conclusion. At this point in your answer, it is necessary to describe the competing views and support your answer with case references. It is important not to immediately form a conclusion, but to explain the competing arguments so that the marker can see that you understand the alternative views that may exist.

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Example 2.8: Explore all options Every time you reach an apparent end of the road, you must look for and pursue all other possibilities. Following on from Example 2.7, if you conclude that an expense does not satisfy the positive limbs of s 8-​1(1) of ITAA 1997, be prepared to concede the matter is not certain and still consider what would be concluded if it does satisfy the positive limbs. At that point, you should move on to the negative limbs in s 8-​1(2). Some of these lead to their own dead ends. If the expense is personal, there is no deduction; if the expense is incurred to derive exempt income, there is no deduction; and if a deduction is expressly prohibited by another section of the Act, there is no deduction. However, the capital exclusion opens the door to a range of possibilities, all of which should be considered. For example: • It may be that the expense can be depreciated or amortised under one of the capital allowance regimes; for example, the depreciation provisions. • In some instances, the expense can be added to the cost of another asset for capital gains tax (CGT) purposes. • In other cases, a capital expense may be eligible for deduction under the “black hole” provisions in s 40-​880.   

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Present a conclusion [2.420]  Having presented the competing arguments, it is important to arrive at a view as to which case is stronger and therefore what you believe would be the outcome if the issue was decided by a court. The conclusion is important to show the examiner that you have weighed up the arguments and are able to ascertain what you believe is the stronger argument. If you believe the facts are too vague to be able to form a well-​supported conclusion, then you should explain what additional information would help to form a more certain conclusion. Examiners are not looking for a so-​called right answer, but will award marks for the identification of the correct issues, the appropriate application of the law supported by case and legislative authority and, finally, the formation of a well-​supported conclusion. Students who form different conclusions on the same question may still receive high marks provided they have made a well-​ argued case to support their analyses. In taxation law problems, it is not the conclusion that normally earns the majority of the marks, but the analysis used to support that conclusion.

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Sample examination answers and analysis [2.430]  To illustrate the important aspects of preparing sound exam answers, the following examples are used to highlight some of the common mistakes made and the characteristics of a well-​argued answer. The first example does not necessarily demonstrate a poor knowledge of the law, but it is poorly structured and shows poor exam technique. The question to which the following answers were given is in part as follows:

Example 2.9: Sample examination question and answer Microhard is a computer software company. Its principal product was a database program called Xhell. Microhard decided to expand its line of software to include a word-​processing program. It worked on the design of the new software, which it decided to release under the brand name “Wurdperphect”. The following events followed that decision. Soon after the release of the program, a competitor, the “Courelle” company, sued Microhard, claiming the name of its word-​processing program was copied off Courelle’s word-​processing software, “Wordepurfex”. Microhard incurred $500,000 legal fees to fight the action, which was eventually settled when Microhard paid Courelle $4 million to drop the suit. Required: Discuss the deductibility of the above transactions and events.

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To assist with the analysis of the answer, it has been broken down into parts, with each section identified by a letter. These letters are used as a reference for discussion. In some parts, the full answer has not been reproduced. ANSWER 1: A A taxpayer’s taxable income is determined by aggregating all assessable income and then deducting from such all allowable deductions (s 4-​15(1)). Under s 8-​1, there are six limbs to the general deduction provision, two positive and four negative limbs. Microhard would be seeking to claim the $500,000 and $4 million payments to Courelle as deductions therefore lowering its assessable income.

B Under s 8-​ 1(1)(b), you can deduct a loss or outgoing if it is necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income or for carrying on a business for the purpose of gaining or producing assessable income.



C As a general rule, the Commissioner cannot decide whether the expense incurred by the taxpayer was warranted. His only power is to decide whether it is wholly or partially deductible.

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D In Magna Alloys & Research v FCT (1980) 11 ATR 276, four agents and three directors were accused of conspiracy. Prosecutions went ahead against the company, and Magna Alloys incurred numerous costs. The question put was whether the company was able to deduct costs involved in defending the directors. E The Court held yes because: “necessarily does not mean that the loss of outgoing was unavoidable or essentially necessary, rather the expenditure must be appropriate given the taxpayers business and adapted for the ends of the business carried on, for the practical purposes and within the limits of reasonable human conduct, it is for he who conducts the business to decide what is necessarily incurred and what is not …” (more quotes from a text). F … Microhard appears to be relying on Magna Alloys, however the Commissioner will rely on the judgment in Herald and Weekly Times Ltd v FCT (1932) 48 CLR 113 (H&WT). In this case, certain articles … . G The compensation appears to replace some of the income stream; therefore, it is assessable under s 15-​30. However, in McLaurin v FCT (1961) 104 CLR 381, its assessability depends on whether the components of capital and income can be separated. It appears they cannot. H Thus, I believe the $500,000 will be held to be deductible because it was a necessary expense, and the $4 million will not be deductible because it is not a necessary expense in carrying on a business.    [2.440]  It is evident that the answer in Example 2.9 has not been planned. There is no clear identification of the critical issues that require discussion and no headings have been used. Consequently, the answer is disjointed and vague. Because no clear issue is first identified, there is no purpose or clear direction to the discussion. An obvious alternative approach to this question would have been to recognise that there are two different expenses and to discuss them separately, identifying the issues relevant to each. Failure to do this has made the answer disjointed, and it has been difficult to formulate the arguments for and against these issues. The introduction in paragraph A is irrelevant to the question. It does not come directly to the point of stating the issues that require discussion; instead, it makes a general statement that does not show that the student understands the question. Paragraph B comes the closest to identifying an issue “is the expense necessarily incurred?”, but unfortunately, this is not the primary issue and it does not state which expense it relates to and the section number is quoted incorrectly. It is difficult to understand why this issue was selected as

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the main area for discussion, but from later parts of the answer, it may be speculated that it is because it was taken directly from a text and that the real issues had not been understood. The statement made in paragraph C is an extension of the issue cited, but does not add to the answer and is no more than the obvious statement that the taxpayer will be arguing for the expenses to be deductible. Discussion in paragraphs D and E is relevant to the issue stated in paragraph B, but it is little more than a restatement of the facts and the decision of one case, and the language used suggests that it may have been copied directly from a secondary source. The case used is relevant to the issue, but paragraph E does not relate to the Court’s decision to the problem. The point in paragraph F that the Commissioner would rely on the case H&WT shows a lack of understanding of the case as it would also support the taxpayer’s view. Paragraph G is the first attempt to apply the law to the facts, but it is done without justification and introduces a new section of the Act without any discussion. The issue of whether the expense is a capital or income in nature (one of the main issues) is first mentioned, but in relation to an assessable income issue which is totally irrelevant given that this is a deduction question. Finally, in paragraph H, a conclusion is drawn, but it is based on a statement of belief, rather than deriving from the arguments.

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[2.450]  The following sample answer given in Example 2.10 demonstrates how the question could be answered in a more structured form, separately discussing the main issues raised. This answer also follows the analysis process described at [2.120]. Example 2.10: Sample examination question and answer ANSWER 2 $4 million settlement 1. Does it satisfy the positive limbs of s 8-​1? Is it incidental and relevant to the earning of assessable income? In H&WT, the Court said damages for defamation are an ordinary expense for a newspaper as it is impossible to publish a daily paper and not defame someone now and then. This may be distinguishable from our case, as releasing new products and passing off someone else’s name is not an ordinary day-​to-​day event for this company the way writing articles is for a newspaper. However, releasing products is part of a software business and you always run the risk of someone claiming your name is similar to theirs, so this should be considered ordinary enough to satisfy the positive limbs.

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The argument that “damages” or similar payments are non-​ deductible “quasi-​personal” expenses, that is, they are not incurred in a business capacity since businesses were not supposed to commit wrongs, appears to be defeated by H&WT. Damage expenses for wrongs can be ordinary business expenses and satisfy the positive limbs of s 8-​1 (H&WT).

2. Do any of the negative limbs deny the deduction?

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The only relevant negative limb is the “capital” exclusion. Could this be a capital expense? It is not regular, which suggests capital sometimes. Applying the Sun Newspaper arguments, it could be argued that the expense goes towards the income-​ earning process. In the highly competitive world of software, new products and new releases are an essential part of doing business and the risk of associated legal suits is a normal incident of the income-​earning process. The contrary argument is that this product is at the heart of the taxpayer’s business. This goes to structure more than process because it is not part of the software development and marketing process, but rather deals with the right to sell the product itself. In contrast, it could be argued that no-​one is stopping them from selling the product, just disputing the name they are using to label the product, so damages to use the name goes with the day-​to-​day marketing of the product. Both arguments are valid, but, in this day and age of rapid and changing product development, the name is less likely to be part of the profit-​earning structure itself and is more likely to be part of the process of operating the structure.

3. What if it is capital?

It is concluded above that this expense is not likely to be capital, but if it is, it is necessary to determine if any specific provision allows a deduction in part or in full. In this case, no specific provision is applicable unless the expense can be included in the cost base of an asset for CGT purposes. Legal expenses

1. Does it satisfy the positive limbs of 8-​1?

The Commissioner used to argue legal expenses incurred as a result of wrongdoing did not meet the positive limbs because they were not connected with the income-​earning process but rather with wrongdoing by the taxpayer. Snowden & Wilson and Magna Alloys show that courts have not accepted this argument, and legal expenses can be legitimate business expenses provided they are appropriate or adapted to the business activity.

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Since all business carries the risk of civil litigation and if you are sued in business you have to defend yourself, it is reasonable to conclude that Microhard is doing just that. Its legal expenses are therefore incidental and relevant, thus satisfying the positive  limbs. This argument is similar to that presented for the damages. 2. Is it knocked out by a negative limb? The arguments about revenue versus capital for the damages apply equally to the legal expenses. However, there is an additional element to consider for the legal expenses. There is a line of cases that holds expenses incurred to defend title to an asset are capital expenses. Originally, these were current expenses (Hallstroms), but this was changed by the tests in Sun Newspaper, which characterised them as capital expenses as in the Broken Hill case. The facts in this problem imply that Microhard is defending title to the name, and therefore, the legal expense is most likely capital. 3. What if it is capital? No specific provision allows any deduction in part or full for this expense. However, the fifth element of cost base for CGT (s 110-​ 25(6)) allows the inclusion of the costs of defending title of an asset. In this case, if Microhard has registered the name Wurdperphect, they can add the litigation costs to the cost of the asset (being their rights to use the name), meaning they will recognise the cost if they dispose of the name.   

Additional examination tips [2.460]  Following are some additional points that you should bear in mind when preparing answers to problem-​type examination questions: • Marks are given for developing an argument and counterargument. Never quote assertions from a text or handbook to back up an argument. The guides and handbooks contain summaries of the law generally, but they are not authority on the resolution of particular fact situations. • Identify cases sufficiently so the instructor will know which case you are referring to (check if there are rules on the citation required for exams at your institution). • Do not repeat the facts of the case without using them. Normally, there are no marks for explaining what happened in a case. Marks are usually awarded for showing how the facts support one conclusion or are distinguished to support another conclusion.

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58 [2.470]  PRINCIPLES OF TAXATION LAW 2020 • Do not quote from the legislation. Marks are allocated for the application of the legislation to the problem, not quoting from the legislation. It is essential to cite legislation correctly, but it is a waste of time quoting words from the Act. • Do not stop at your first answer. Remember, this is a problem question and there may be further issues. If you have prepared your review notes properly, you should be able to run through a full flowchart of issues likely to be raised by income and deduction problems. Every time you reach an apparent end of the road, you must look for other possible forks in the road and consider all the possibilities. • Organise your answer using headings and subheadings. An organised answer makes the instructor realise you appreciate the range of issues raised by the problem and helps ensure you do not miss any flow-​on issues. If you think of an additional point later, jot it down so you do not forget it and add it on at the end of the answer.

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• Write neatly. It seems trite to advise anyone to write legibly, but the importance of having a legible exam answer cannot be underestimated. If your handwriting is difficult to decipher, the instructor will lose the trail of your argument as too much effort is needed to actually read the words themselves. By the time the instructor reaches the end of a point, he or she could have forgotten points made earlier. Take the time to make it legible. • Who are you advising? In a general question, you might be expected to canvass all the tax consequences of a transaction for all parties. But if you are asked to give advice to a particular person, many issues can be ignored. For example, if the question says “Advise the employee”, it is irrelevant to the problem whether the employer can deduct an expense mentioned in the problem. In some cases, however, the impact on other persons might be important. For example, if the question asks you to advise the employee on the assessability to the employee of a non-​ cash benefit, you would first have to determine whether the benefit is a fringe benefit to the employer to determine if the benefit is excluded from the assessable income of the employee.

Using this chapter [2.470]  To gain the most from the content of this chapter, it is important that you use it early in your course so that you are well prepared to develop a sound study plan. However, it is also useful to continue to return to this chapter to help with specific study or assessment issues that you may face throughout the course. The techniques presented in this chapter aim to improve the efficiency and effectiveness of your study skills to enable you to gain the most from your

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taxation law course and to perform your best in the assessment. These techniques can also be adapted to suit existing study and learning patterns.

Resources Internet [2.480]  Internet resources are a very valuable source of information relating to current tax issues. Listed below are some useful sites.

General • Australian Taxation Office: http://​www.ato.gov.au. This site contains valuable information, such as rulings, court and tribunal decisions and information guides. These can be accessed from the “Legal Database” tab at the top of the page.

Reported cases • Australasian Legal Information Institute (AustLII): http://​ www.austlii. edu.au. This site has an extensive case database, as well as journals, consolidated legislation, Bills and Explanatory Memoranda to Bills. See Example 2.3.

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Legislation • Australian Taxation Office: http://​www.ato.gov.au. At the top right of the page, click on “Legal Database”. Then click on “Quick access” and then “Legislation”. Select the correct Act from the drop-​down box and type in the section you are looking for in the “Provision” box. • Parliament of Australia Bills: http://​www.aph.gov.au/​bills. This site contains the content of Bills (including income tax Bills) that have not yet become legislation. You can also track their progress through this website. • Australasian Legal Information Institute (AustLII): http://​ www.austlii. edu.au. This site publishes consolidated legislation, Bills, Explanatory Memoranda to Bills and cases. Use the search option at the top of the page to find a particular Act. • ComLaw: https://​ www.legislation.gov.au/​ . This site contains consolidated legislation, Bills, Explanatory Memoranda to Bills, Legislative Instruments and Statutory Rules. After selecting the appropriate area use the alphabetic list to find the required legislation  etc.

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Policy



Tax reform:  https://​treasury.gov.au/​review/​tax-​white-​paper/​why-​tax-​ reform-​and-​why-​now. This site brings together the submissions and discussion towards a review of the Australian taxation system.

• Australian Treasury –​Taxation policy: https://​treasury.gov.au/​policy-​ topics/​ taxation. This site details Tax Bills and current and future initiatives for the Australian taxation system. • Australia’s Future Tax System Review Panel: International Comparison of Australian Taxes: http://​comparativetaxation.treasury.gov.au. This site contains a 2006 Government study that compared Australia’s tax system to those of other developed countries. • Federal Budget: http://​ www.budget.gov.au/​ . This site contains the most recent Federal Budget. • Board of Taxation: taxboard.gov.au. This site contains information on proposed tax law changes. • Tax Practitioners Board: http://​www.tpb.gov.au/​. This site contains the policies and requirements for registration as a tax agent, BAS agent and Tax (financial) Advisor.

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Glossary of terms used in assignments and exams [2.490]  The following glossary lists some of the terms commonly used in assignments and exam questions. Note that a glossary of terms may be included with your course outline and the meanings given there should be used ahead of this list. • Analyse –​You should break the topic or case into its component parts or show the essential components of the topic or case. • Compare –​You are to show how the two (or more) things are alike. Note that it is sometimes necessary to show how they differ so that the essential likenesses are stressed. For example, “Compare the decisions of the High Court in Cecil Bros Pty Ltd v FCT (1964) 111 CLR 430 and FCT v Isherwood and Dreyfus Pty Ltd (1979) 9 ATR 473”. • Contrast –​You are to show how the two (or more) things differ. Note that it is sometimes necessary to show how they are similar so that the essential differences are stressed. For example, “Contrast the decisions in Myer Emporium v FCT (1987) 163 CLR 199 and Westfield v FCT (1991) 21 ATR 1398” or “Contrast the reasoning of the majority and the dissenting judgment of Brennan J in FCT v Suttons Motors (Chullora) Wholesale Pty Ltd (1985) 157 CLR 277; 16 ATR 567”.

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• Critically examine (or critically discuss) –​You are required to write a study of the good and bad points and come to some conclusions. • Define –​You should distinguish this topic from all others like it. The clarity of your definition will be the main consideration. • Discuss –​You should explain and assess the importance of the features of the topic with a fairly full treatment of all the main points. It may be necessary to introduce specific illustrations, quotations or details of cases where relevant. Any implications of the topic should be covered.

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• Explain –​You are to show the examiner that you understand the particular issue mentioned. • Evaluate –​You are required to weigh the topic carefully and make some judgments or come to some definite conclusions about the topic. For example, “Evaluate the significance of Lord Denning’s judgment in Newton v FCT (1958) 98 CLR 1 on the effectiveness of s 260 of ITAA 1936”. • Justify –​You are required to produce evidence for your decision or view. • Summarise –​Present briefly, but leave out nothing of importance. For example, “Summarise the reasoning of Barwick CJ in Curran v FCT (1974) 5 ATR 61 on why bonus shares have a cost to the person receiving them”.

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3 The taxation formula

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Key points......................................................................................................  [3.00] Introduction..................................................................................................  [3.10] Power to tax..................................................................................................  [3.20] Australian taxes............................................................................................  [3.30] Medicare levy................................................................................................  [3.40] Basic levy payable..................................................................................  [3.50] Relief for low-​income earners...............................................................  [3.60] Exemptions.............................................................................................  [3.70] Medicare levy surcharge.......................................................................  [3.80] Government study and training support loans..........................................  [3.90] Introduction to income tax........................................................................  [3.100] Income tax burden......................................................................................  [3.110] The income tax formula.............................................................................  [3.120] Taxable income....................................................................................  [3.130]

Assessable income..................................................................................  [3.140] Deductions................................................................................................  [3.180] Income tax rates...................................................................................  [3.190] Individuals................................................................................................  [3.200] Other entities............................................................................................  [3.210] Tax offsets............................................................................................  [3.220] Questions.....................................................................................................  [3.230]

  

Key points [3.00]  • The primary aim of the taxation regime is to provide government revenue and fund government expenditure, although the tax system also has broader socio-​economic purposes.

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64 [3.10]  PRINCIPLES OF TAXATION LAW 2020 • Over 90% of total Commonwealth Government revenue is sourced from taxation revenue, primarily income tax revenue. • Section 51(ii) of the Australian Constitution grants the Commonwealth Parliament the power to “make laws … with respect to … taxation”. • The income tax system also serves as a basis for the collection of certain other amounts, such as the Medicare levy and repayments under the higher education government assistance programs. • Section 3-​5 of ITAA 1997 provides that income tax is payable for each year by each individual, company and certain other entities. • Taxpayers are required to calculate their income tax for the financial year according to the formula: Income Tax = (Taxable Income × Rate) –​Tax Offsets, which is set out in s 4-​10(3). • Taxable income is calculated according to the formula: Taxable Income = Assessable Income –​Deductions, which is set out in s 4-​15.

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Introduction [3.10]  This chapter provides an overview of the Australian tax regime, in particular, the income tax system. The Australian tax system plays an important role in Australian society as it is the main source of funding for government expenditure. Government revenue is required to fund the provision of goods and services which are considered “public goods”. These are goods and services which the market is unlikely to satisfactorily provide due to the fact that there is no additional cost from additional use of these goods and services, and it is not possible to exclude a person from using these goods and services. One example of a public good is a lighthouse. It is not possible to exclude any ships at sea (or anyone in the area) from seeing the lighthouse, and there is no additional cost incurred for additional ships at sea using the lighthouse. A second function of government is to provide social goods, such as education, health and defence services. These are goods which could potentially be provided by the private sector, but which Australians have generally chosen to provide universally through government using universally paid tax revenue rather than user-​pays levies. A third function of government is one of redistribution. Through the welfare and social security systems funded by tax revenue, the government transfers funds from those who have benefited from the market and enjoy a greater ability to pay to those who have been less fortunate in the market economy. Chart 3.1 illustrates the distribution of projected Australian Commonwealth Government expenditure of $500.9 billion for the 2019–​2020 income year.

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65

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Chart 3.1 Projected Commonwealth Government expenditure 2019–​2020

In addition to funding the government functions discussed above, the tax system also has broader socio-​economic purposes. The tax regime may also be used for the purposes of social engineering, that is, encouraging certain behaviour and discouraging other types of behaviour. For example, the provision of a tax deduction for donations to charities is designed to encourage taxpayers to donate to needy causes. Similarly, tax offsets for expenditure on research and development are intended to promote research and development activity in Australia. On the other hand, the so-​called “sin taxes” on alcohol, tobacco and gambling are designed to discourage particular types of consumption. The “alcopops” tax is an attempt at curbing excessive alcohol consumption among younger Australians. The introduction of a tax on fast food or sugar is often suggested as a means of reducing obesity. Taxes on petrol are intended in part to discourage excessive usage of polluting fuel and to encourage manufacturers to produce more fuel-​efficient (and hence cheaper-​to-​operate) vehicles. When used in these ways, tax tends to be a blunt instrument with varying degrees of success. For the 2019–​2020 tax year, the income year we are focusing on, it is predicted that total taxation receipts will be approximately $466.4 billion. This amount is expected to contribute approximately 92% of total government revenue. Table 3.1 highlights the importance of taxation revenue in Australia.

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66 [3.10]  PRINCIPLES OF TAXATION LAW 2020 TABLE 3.1 Australian Government general government receipts Actual

Estimates

Projections

2017–​ 2018

2018–​ 2019

2019–​ 2020

2020–​ 2021

2021–​ 2022

2022–​ 2023

418.1

448.8

466.4

486.4

514.3

528.7

Growth on previous year (%)

10.2

7.4

3.9

4.3

5.7

2.8

Per cent of GDP

22.6

23.1

23.3

23.4

23.7

23.3

354.9

383.2

399.2

416.4

440.8

451.3

Growth on previous year (%)

11.1

8.0

4.2

4.3

5.9

2.4

Total taxation receipts ($b)

Tax receipts excluding GST ($b)

Per cent of GDP

19.2

19.7

19.9

20.0

20.3

19.9

Non-​taxation receipts ($b)

28.9

36.3

39.1

35.9

36.7

38.2

Growth on previous year (%)

−5.7

26.0

7.6

−8.1

2.1

4.0

1.6

1.9

2.0

1.7

1.7

1.7

446.9

485.2

505.5

522.3

551.0

566.9

9.0

8.6

4.2

3.3

5.5

2.9

24.2

25.0

25.2

25.1

25.4

25.0

Per cent of GDP Total receipts ($b) Growth on previous year (%) Per cent of GDP

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Source: Table 1, Budget Paper No 1 2019–​20, Statement 4: Revenue

As indicated by Table 3.1, non-​ taxation revenue contributes a very small percentage of total government revenue. In Australia, non-​taxation revenue generally consists of income from the sale of goods and services (privatisation or user-​pays levies) and returns on investments. Other means by which governments can raise revenue include nationalisation (where governments appropriate private assets for public good) or simply printing more money. However, these options are suboptimal as they are likely to have negative effects. Nationalisation deters private investment while printing money will cause inflation. Privatisation is one option for raising revenue, but also raises problems in that there are some goods or services which cannot or should not be privatised, and there are a finite number of goods and services which can be sold. User-​pays levies are one alternative to taxation, but are not appropriate for “public goods” and may be considered unsuitable for certain social goods and services. For example, a user-​pays levy for healthcare may result in low-​income individuals being unable to obtain adequate healthcare services. Governments can also fund expenditure through loans from international organisations, other governments or private investors.

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However, there is a limit as to how much debt countries can enter into, and debt funding incurs interest expenses which further increase government expenditure. As such, taxation is generally the largest source of government revenue in most countries.

Power to tax [3.20]  The Commonwealth Government’s power to impose taxes stems from the Australian Constitution. Section 51(ii) of the Constitution grants the Commonwealth Parliament the power to “make laws for the peace, order and good government of the Commonwealth with respect to … taxation”. Section 51(ii) also provides the Commonwealth Government with the power to impose laws regarding the collection and administration of taxes. For the purposes of making tax laws, “taxation” is generally defined as a “compulsory exaction of money by a public authority for public purposes, enforceable by law, and is not a payment for services rendered”: Matthews v Chicory Marketing Board (1938) 60 CLR 263 at 270. It has also been said that “tax” is not a penalty and it cannot be arbitrary (ie, a tax liability must be capable of being determined in accordance with specific criteria): MacCormick v FCT (1984) 15 ATR 437 at 446.

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Section 51(ii) also specifies that any laws with respect to taxation cannot discriminate between the States or parts of States. Section 114 prevents the Commonwealth Government from imposing any tax “on property of any kind belonging to a State”. When passing taxation laws, the Commonwealth Parliament must ensure that the laws imposing taxation deal only with the imposition of taxation and deal with one subject of taxation only: s 55 of the Constitution. Any provision in an imposition Act which deals with another matter will have no effect. This explains why we have so many different Commonwealth Acts which impose different types of taxes. Taxation revenue is raised through a number of different taxes, such as income tax, fringe benefits tax, goods and services tax (GST), excise duties, customs duties, luxury car tax, wine equalisation tax and other indirect taxes, each of which is imposed in a separate Act. For each type of tax, we generally have an imposition Act (which imposes the liability for the tax), a rates Act (which specifies the applicable rate of tax) and an assessment Act (which sets out the rules for working out what is subject to tax or how to calculate the tax payable). For example, we have the Income Tax Assessment Act 1936 (Cth), the Income Tax Assessment Act 1997 (Cth), the Income Tax Rates Act 1986 (Cth) and the Income Tax Act 1986 (Cth), all of which deal with the income tax. We have the Fringe Benefits Tax Assessment Act 1986 (Cth) and the Fringe Benefits Tax Act 1986 (Cth) for the fringe benefits tax and A New Tax System (Goods and Services Tax) Act 1999 (Cth) and A New Tax System (Goods and Services Tax

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68 [3.30]  PRINCIPLES OF TAXATION LAW 2020 Imposition –​General) Act 1999 (Cth) for the goods and services tax. As required by the Constitution, the imposition Acts (eg, Income Tax Act 1986; Fringe Benefits Tax Act 1986) are relatively short and only deal with the imposition of tax and with only one type of tax. The Constitution also addresses the distribution of taxing rights between the Commonwealth and State Governments. Some taxes may be imposed at only one level of government (State or Commonwealth), while other taxes may be shared by both levels of Government. For example, s 90 of the Constitution stipulates that customs and excise duties can only be imposed by the Commonwealth Government. Income tax, on the other hand, may be shared by both levels of government and, from 1915 until 1942, both State and Commonwealth Governments imposed income tax in Australia. Prior to 1915, only State Governments imposed income tax, and since 1942, only the Commonwealth Government has imposed income tax. State Governments continue to impose a number of taxes, such as stamp duty, land tax, payroll tax and various transaction-​based taxes, but the revenue from these taxes is insufficient to fund the services provided by State Governments, such as health and education. The introduction of the GST in 2000 was, in part, an attempt to provide State Governments with a guaranteed source of funding. Although GST is imposed and collected by the Commonwealth Government, all GST revenue is distributed to State Governments under an agreement between the Commonwealth and State Governments.

Australian taxes

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[3.30]  Australia’s taxation revenue comprises a number of different taxes. Chart 3.2 illustrates the different sources of revenue in Australia.

Chart 3.2 Projected sources of revenue in Australia 2019–​2020

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69

As the Australian income tax system is the largest contributor to Australian taxation revenue, it is the primary focus of this book. The Commonwealth Government’s 2019–​2020 Budget estimates that income tax will contribute approximately 73% of total taxation revenue for the 2020 income year. We generally think of income tax as tax that we pay on common receipts, such as salary, wages, business income, interest, dividends and rent received. However, also included in the estimates of total income tax revenue is revenue collected through the taxation of capital gains. This is commonly referred to as capital gains tax, but it is important to note that, as discussed in Chapter 11, capital gains tax is not a separate tax. Rather, net capital gains form part of the taxpayer’s assessable income for the purposes of determining the taxpayer’s income tax liability.

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Related to the imposition of income tax on services income is the fringe benefits tax. As discussed in Chapter 7, this is a tax imposed on employers on the provision of benefits to employees (ie, in substitution of income). Although the fringe benefits tax only raises a small portion of total revenue, it serves an important role by ensuring that all benefits received in a services context are subject to tax. The most recent substantive change to Australia’s tax regime was the introduction of a GST in 2000. GST, as discussed in Chapter 25, is different to income tax in that it is an indirect tax. An indirect tax is one which is embedded in the price of goods or services and collected by an intermediary from the entity which ultimately bears the economic burden of the tax. In Australia, for example, GST is collected by suppliers of goods or services when they receive payment for their supplies. This aspect of the GST (and other indirect taxes) makes it attractive from an administrative perspective as it is easier to calculate and collect taxes owed, and there are fewer taxpayers to look after. Other examples of indirect taxes include customs duties (eg, on imports such as motor vehicles or clothing and footwear), excise duties (eg, on petrol, diesel, beer, tobacco and other alcoholic beverages) and agricultural levies (eg, on chicken meat).

Medicare levy [3.40]  The Australian tax system also serves as a collection mechanism for various other amounts that may be payable by Australian tax residents. In addition to the various taxes mentioned above, most Australian resident individual taxpayers with incomes above a minimum threshold are also required to pay the Medicare levy. The Medicare levy is imposed under the Medicare Levy Act 1986 (Cth) with the criteria for determining the Medicare levy liability contained in Pt VIIB of ITAA 1936.

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70 [3.50]  PRINCIPLES OF TAXATION LAW 2020 Medicare is the universal healthcare scheme that provides Australians with access to healthcare services. The tests for residency for the imposition of the Medicare levy are the same as the income tax tests for residency discussed in Chapter 4. A part-​year resident is required to pay the Medicare levy for the part of the year when they are resident. However, note that the tests for residency for the imposition of the Medicare levy are not the same as the tests for residency for the purposes of determining an individual’s entitlement to Medicare benefits: Ruling IT 2615. The entitlement to Medicare benefits is determined in accordance with ss 3(1), 10 and 21 of the Health Insurance Act 1973 (Cth). Therefore, it may be the case that individuals are required to pay the Medicare levy as they are Australian residents for tax purposes although they may not be entitled to Medicare benefits as they are not “residents” for the purposes of the Health Insurance Act 1973. This is in part addressed by the exemptions to the Medicare levy: see [3.70].

Basic levy payable [3.50]  The Medicare levy is generally calculated at a flat rate on taxable income: s 251S(1)(a) of ITAA 1936. The applicable rate is 2% from 1 July 2014 (previously 1.5%). The increase in the Medicare levy was introduced to fund the National Disability Insurance Scheme (NDIS), which provides support for people with permanent and significant disability and their families and carers.

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The Medicare levy is imposed on the whole of the individual’s taxable income, including any amount that may be subject to the tax-​free threshold. There is no maximum limit in respect of an individual’s Medicare levy. Example 3.1: Calculation of Medicare levy Elisabeth has taxable income of $50,000. The Medicare levy is calculated at 2% of Elisabeth’s taxable income. Therefore, she will be liable to a levy of $1,000.   

Example 3.2: Calculation of Medicare levy Roger has taxable income of $2 million. The Medicare levy is calculated at 2% of Roger’s taxable income. Therefore, he will be liable to a levy of $40,000.   

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Relief for low-​income earners [3.60]  A taxpayer who qualifies as a low-​income earner is either fully or partially exempted from the Medicare levy. The amount of the exemption will depend on the individual’s taxable income and whether they qualify for the seniors and pensioners tax offset (SAPTO). Individuals with taxable income equal to or less than the “threshold amount” receive a full exemption from the Medicare levy. Individuals with taxable income greater than the “threshold amount”, but less than the “phase-​in limit”, pay the Medicare levy at a rate of 10 cents on every dollar of taxable income above the “threshold amount”. Individuals with taxable income above the “phase-​in limit” are subject to the full Medicare levy, as discussed at [3.50], but may be eligible for Medicare levy reduction based on family taxable income in certain limited circumstances. The “threshold amount” and “phase-​in limit” for the 2018–​2019 income year are given in Table 3.2. TABLE 3.2 Medicare levy low-​income earner thresholds Threshold amount

Phase-​in limit

Individual entitled to the seniors and pensioners tax offset

$35,418

$44,272

All other taxpayers

$22,398

$27,997

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At the time of writing, any changes to the “threshold amount” and “phase-​in limit” for the 2019–​2020 income year were yet to be announced.

Example 3.3: Medicare levy –​low-​income earner Rupert has taxable income of $12,000. He is not entitled to the seniors and pensioners tax offset. Rupert is not required to pay the Medicare levy as his taxable income is below the “threshold amount”.   

Example 3.4: Medicare levy –​low-​income earner Jacky has taxable income of $25,000. She is not entitled to the seniors and pensioners tax offset. Jacky’s Medicare levy is calculated as ($25,000 –​$22,398) × $0.10. Therefore, Jacky will have to pay a Medicare levy of $260.20.   

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72 [3.70]  PRINCIPLES OF TAXATION LAW 2020

Exemptions [3.70]  Under ss 251T and 251U of ITAA 1936, the following individuals are exempt from the Medicare levy: • members of the Australian Defence Forces and their relatives who are entitled to free medical treatment in respect of every incapacity, disease or disabling condition; • persons entitled under the Veterans’ Entitlements Act 1986 (Cth) or the Military Rehabilitation and Compensation Act 2004 (Cth) or the Australian Participants in British Nuclear Tests and British Commonwealth Occupation Force (Treatment) Act 2006 (Cth) to full free medical treatment for all conditions; • persons who receive a sickness allowance; • persons who receive certain pensions or income support supplements in specified circumstances;



non-​residents;

• members of diplomatic missions or consular posts in Australia and members of their families who are not Australian citizens and are not ordinarily resident in Australia; and

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• any person who would not have been entitled to Medicare benefits in respect of services, treatment or care to which Medicare benefits under the Health Insurance Act 1973 relate. The individual must provide a certificate from Medicare Australia to qualify for the exemption. The Medicare levy exemption certificate can be obtained from Medicare Australia by submitting the appropriate application form. A separate application is required for each financial year. Individuals with dependants may need to satisfy additional requirements to qualify for the exemption. A partial exemption may be available where the individual satisfies one of the exemption categories for only part of the income year.

Example 3.5: Medicare levy –​exemption Yang is an international student studying at a university in Australia. She is an Australian resident for tax purposes as determined by the residency tests in s 6 of ITAA 1936 (see Chapter 4). However, under the Health Insurance Act 1973, Yang is not entitled to Medicare benefits in respect of health services provided in Australia. Yang has taxable income of $40,000. Prima facie, Yang is required to pay the Medicare levy in respect of her taxable income of $40,000 as she is a resident of Australia for tax purposes and her taxable income is above the “threshold amount” (she is not

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entitled to the seniors and pensioners tax offset). However, as she is not entitled to Medicare benefits, she can obtain a Medicare levy exemption certificate from Medicare Australia, which will exempt her from paying the Medicare levy. Yang will have to obtain a separate certificate for each financial year to obtain the Medicare levy exemption.   

Medicare levy surcharge [3.80]  In addition to the Medicare levy, a Medicare levy surcharge is payable by taxpayers, where their income is above a certain threshold and they do not have private health cover through a registered private health insurance provider for the entire income year. The Medicare levy surcharge is imposed in addition to the Medicare levy. Individuals who are exempt from the Medicare levy are also exempt from the Medicare levy surcharge (eg, foreign residents).

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Taxpayers must calculate their “income for surcharge purposes” to determine whether they have to pay the Medicare levy surcharge. “Income for surcharge purposes” includes the taxpayer’s: • taxable income (including the net amount on which family trust distribution tax has been paid); • exempt foreign employment income; • reportable fringe benefits amount; • total net investment loss (includes both net financial investment loss and net rental property loss); and • reportable super contributions (includes both reportable employer super contributions and deductible personal super contributions). Taxpayers aged between 55 and 59 years old can deduct from this amount any taxed element of a super lump sum, other than a death benefit, which they received and does not exceed the low rate cap on super lump sum benefits to determine their “income for surcharge purposes”. The “income for surcharge purposes” is only used to ascertain a taxpayer’s liability for the Medicare levy surcharge and the applicable rate. Once it is determined that the taxpayer is liable for the Medicare levy surcharge, the Medicare levy surcharge payable is calculated as follows: Taxable income (including the net amount on which family trust distribution tax has been paid and total reportable fringe benefits) × Surcharge rate

At the time of writing, the Medicare levy surcharge income thresholds and rates are as given in Table 3.3.

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74 [3.90]  PRINCIPLES OF TAXATION LAW 2020 TABLE 3.3 Medicare levy surcharge rates Income ($)

Surcharge rate (%)

Singles

Families*

0 –​90,000

0 –​180,000

90,001 –​105,000

180,001 –​210,000

1

105,001 –​140,000

210,001 –​280,000

1.25

140,000+

280,001+

1.5

0

*  For families with more than one dependent child, the relevant threshold is increased by $1,500 for each child after the first.

Example 3.6: Medicare levy surcharge Pierre is an Australian resident with taxable income of $150,000. He is single. He had private health insurance for 90 days of the income year. He did not have any reportable fringe benefits or any amounts on which family trust distribution tax has been paid. Pierre must pay the Medicare levy surcharge because his “income for surcharge purposes” exceeds the threshold and he did not have private health insurance for the entire income year. The amount of the surcharge is calculated as follows: $150,000 × 1.5% × (365 –​90)

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365

= $1,695.21

The Medicare levy surcharge in effect serves as an incentive for taxpayers to have private health insurance as the surcharge is not payable in respect of any days when a taxpayer has private health insurance. In addition, taxpayers with private health insurance receive a private health insurance tax offset as a further incentive. The amount of the offset depends on the taxpayer’s age and level of income and can be claimed as a reduction in premiums or, if the full premium amounts are paid up-​front, as a cash payment from Medicare or as an offset on the annual income tax return. See Chapter 15.

Government study and training support loans [3.90]  The government provides financial assistance in the form of loans to people undertaking higher education, trade apprenticeships and other

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training programs (eg, Higher Education Loan Program (HELP)). The Australian Taxation Office (ATO) is also responsible for the collection of these loans through the tax system. The loans must be repaid once the person’s income exceeds the repayment threshold. The compulsory repayments are collected through the tax system, but voluntary repayments can also be made to reduce the loan balance faster. Minimum repayments are required at the rates given in Table 3.4.

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TABLE 3.4 Repayment income thresholds and rates for the 2019–​2020 income year Repayment income (RI*) ($)

Repayment rate (%)

Below $45,881

Nil

$45,881 –​$52,973

1.0

$52,974 –​$56,151

2.0

$56,152 –​$59,521

2.5

$59,522 –​$ 63,092

3.0

$63,093 –​$66,877

3.5

$66,878 –​$70,890

4.0

$70,891 –​$75,144

4.5

$75,145 –​$79,652

5.0

$79,653 –​$84,432

5.5

$84,433 –​$89,498

6.0

$89,499 –​$94,868

6.5

$94,869 –​$100,560

7.0

$100,561 –​$106,593

7.5

$106,594 –​$112,989

8.0

$112,990 –​$119,769

8.5

$119,770 –​$126,955

9.0

$126,956 –​$134,572

9.5

$134,573 and above

10

*  RI is the sum of taxable income plus any total net investment loss (which includes net rental losses), total reportable fringe benefits amounts, reportable superannuation contributions and exempt foreign employment income.

From 1 July 2017, individuals with an outstanding government education loan who are living overseas are also required to make loan repayments similar to if they were living in Australia. The onus is on the person with an outstanding government education loan to provide the ATO with their overseas contact details within seven days of leaving the country if moving overseas for longer than six months.

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76 [3.100]  PRINCIPLES OF TAXATION LAW 2020

Introduction to income tax [3.100]  The rest of this chapter provides an overview of the income tax in Australia and basic information as to how income tax is imposed and calculated. Each of the elements introduced here is discussed in further detail in subsequent chapters.

Income tax burden

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[3.110]  Section 3-​5 of ITAA 1997 provides that income tax is payable for each year by each individual and company and certain other entities. In Australia, personal income tax is imposed on each individual. Some countries may impose personal income tax on a family unit or a couple, but this can sometimes prove difficult in practice as it is not easy to define the family unit or couple. For example, the family unit may encompass biological children, stepchildren, dependent children under 18, non-​dependent children under 18 and so on. Similarly, a couple could be a married couple, a de facto couple, a same-​sex couple and so on. Although personal income tax is imposed on an individual basis in Australia, family circumstances may be taken into consideration for the purposes of determining certain welfare benefits delivered through the tax system (eg, the family tax benefit). Note that partnerships and trusts are not included in s 3-​5. Although subject to the income tax system and required to lodge an annual income tax return, partnerships and trusts are not separate taxpayers. Rather, the liability to pay income tax on net gains gained or produced through partnerships and trusts is generally borne by the individuals or entities that are partners in the partnership or trustees and beneficiaries of the trust. The taxation of partners and partnerships is discussed in Chapter 19, while Chapter 20 discusses the taxation of trusts and beneficiaries. A company is treated as a separate taxpayer and pays income tax. However, company tax is in effect a prepayment of the individual income tax of the company’s shareholders. This is due to the operation of a credit arrangement known as the dividend imputation system. The imputation system and the taxation of companies and its shareholders more generally are discussed in Chapter 21. The ITAA 1997 generally uses the term “you” in referring to taxpayers. For example, s 4-​10 is in relation to “how much tax you must pay”. The meaning of “you” is stipulated in s 4-​5 which states that “you” applies to entities generally, unless its application is expressly limited. A list of “entities” is provided in s 9-​1 and includes an individual, a company, a superannuation provider, a corporate limited partnership and a trustee of a public trading trust or corporate unit trust.

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The income tax formula [3.120]  To calculate a taxpayer’s income tax liability, it is necessary to start at the basic formula in s 4-​10 of ITAA 1997. Taxpayers are required to calculate their income tax for the financial year as follows: Income Tax = (Taxable Income × Rate) –​Tax Offsets

The “financial year” is defined as the 12-​month period beginning on 1 July: ss 4-​10(1) and 995-​1 of ITAA 1997. Taxpayers with a different financial year for accounting purposes can use a “substituted accounting period” as their income year if allowed by the Commissioner: s 4-​10 Note 1 of ITAA 1997; s 18 of ITAA 1936. The Commissioner will generally grant an application for a substituted accounting period, where the taxpayer’s business needs demonstrate that 30 June is an inappropriate or impractical balance date: Practice Statement PS LA 2007/​21. For example, multinational companies may seek to utilise a substituted accounting period to align subsidiary companies’ accounting periods with that of the head company. Such taxpayers are commonly referred to as a “SAP taxpayer”.

Taxable income

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[3.130]  It can be seen from the above formula that taxable income is fundamental to the calculation of a taxpayer’s income tax liability as it is the basis upon which the amount of tax payable by a taxpayer is calculated. Taxable income is determined under s 4-​ 15 according to the following formula: Taxable Income = Assessable Income –​Deductions

The method statement in s 4-​ 15 refers the reader to Div 6 in relation to assessable income and Div 8 in relation to deductions.

Assessable income [3.140]  Assessable income consists of ordinary income and statutory income: s 6-​ 1(1) of ITAA 1997. However, some amounts of ordinary and statutory income may be categorised as “exempt income” or “non-​assessable non-​exempt” (NANE) income, in which case they are not assessable income: s 6-​ 1(2)–​ (4). As such, Assessable Income = Ordinary Income + Statutory Income, but not Exempt Income or NANE Income. Ordinary income essentially refers to amounts which have been held to be assessable by the courts because they demonstrate certain characteristics,

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78 [3.150]  PRINCIPLES OF TAXATION LAW 2020 while statutory income is those amounts that the legislature has stipulated are assessable. Exempt and NANE income are those amounts that the legislature has stipulated as not assessable. [3.150]  Ordinary income: Ordinary income is defined in s 6-​5(1) of ITAA 1997 as income according to ordinary concepts. “Ordinary concepts” is the term used to describe receipts that have an income character as set out in doctrines that have been developed in the courts. The specific provision is as follows: 6-​5 Income according to ordinary concepts (ordinary income) (1) Your assessable income includes income according to ordinary concepts, which is called ordinary income. (2) If you are an Australian resident, your assessable income includes the ordinary income you derived directly or indirectly from all sources, whether in or out of Australia, during the income year. (3) If you are a foreign resident, your assessable income includes: (a) the ordinary income you derived directly or indirectly from all Australian sources during the income year; and (b) other ordinary income that a provision includes in your assessable income for the income year on some basis other than having an Australian source. (4) In working out whether you have derived an amount of ordinary income, and (if so) when you derived it, you are taken to have received the amount as soon as it is applied or dealt with in any way on your behalf or as you direct.

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As is apparent from s 6-​5(2) and (3), the determination of a taxpayer’s ordinary income depends on whether the taxpayer is an Australian resident or a foreign resident and the source of the income. These fundamental concepts of residence and source are discussed in Chapter 4. Section 6-​ 5(4) ensures that taxpayers cannot avoid paying income tax by directing that the income be paid to a different person and not receiving the money themselves. This is known as the “constructive receipt rule”, whereby the taxpayer is deemed to have derived the income when it is dealt with per the taxpayer’s directions. Example 3.7: Constructive receipt rule Johnny provides his employer with instructions to pay half of his salary each month to his elderly parents. Johnny is deemed to have derived the salary under s 6-​5(4), even though he did not physically receive the money, as it has been dealt with per his directions.   

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The determination as to what constitutes ordinary income is a fundamental issue in tax. The legislative reference to “income according to ordinary concepts” alludes to Sir Fredrick Jordan’s statement in Scott v C of T (NSW) (1935) 3 ATD 142 at 144: 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.

Case law has developed a number of characteristics of ordinary income to assist in determining whether an amount constitutes ordinary income. Chapter 5 outlines these principles.

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[3.160]  Statutory income: Statutory income consists of amounts that are included in the taxpayer’s assessable income by a specific provision in the income tax legislation: s 6-​10(2) of ITAA 1997. The statutory income of an Australian resident includes statutory income from all sources, whether in or outside Australia, whereas the statutory income of a foreign resident only comprises statutory income from all Australian sources and any other statutory income which is assessable on some basis other than having an Australian source. As with ordinary income, there is a constructive receipt rule in s 6-​10(3) which deems that the taxpayer has derived a statutory income amount if it is dealt with as per the taxpayer’s directions. Division 10 lists the statutory income provisions contained in the income tax legislation. Most types of statutory income are amounts that the legislature wished to include in the income tax base but which fell outside the concept of ordinary income. For example, s 26(e) of ITAA 1936, which is now s 15-​2 of ITAA 1997, was introduced to capture non-​convertible benefits provided to employees. The courts had held that the value of such benefits was not ordinary income and therefore such benefits would not be subject to tax in the absence of a statutory income provision. Similarly, s 102-​5 includes net capital gains in assessable income. Capital gains would not otherwise be assessable as the courts have long accepted that capital gains are not ordinary income. However, in some cases, statutory income provisions capture amounts that would otherwise be assessable as ordinary income, but the legislature has considered it necessary to include a specific statutory income provision. For example, dividend income would likely satisfy the requirements of ordinary income, but it is also made assessable under s 44 of ITAA 1936. Where an amount of income constitutes both ordinary and statutory income, s 6-​25(1) ensures that the amount is only included in the taxpayer’s assessable

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80 [3.170]  PRINCIPLES OF TAXATION LAW 2020 income once. The amount will generally constitute statutory income unless a specific provision indicates otherwise: s 6-​ 25(2). For example, dividend income which is likely to constitute ordinary income but is also assessable under s 44 would be included in assessable income as statutory income under s 44. However, s 15-​2 of ITAA 1997, for example, which includes in assessable income allowances and other payments for services, only assesses such amounts to the extent that they are not ordinary income (ie, the section gives precedence to ordinary income): s 15-​2(3)(d). From a practical perspective, it generally does not matter whether an amount is included in a taxpayer’s assessable income as ordinary income or statutory income. In either case, the amount is assessable and subject to tax. [3.170]  Non-​assessable income: If an amount is not ordinary income and not statutory income, then it is non-​assessable income (ie, it is not subject to tax): s 6-​15(1). An amount will also be non-​assessable income if the legislation stipulates that it is “exempt income” or NANE income: ss 6-​15(2) and (3); 6-​20; 6-​23. Amounts that are classified as “exempt income” or NANE income may or may not constitute ordinary or statutory income in the first place.

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It must be noted that the term “non-​assessable non-​exempt” income is simply the name of another category of income. While NANE amounts are not assessable income, they are also not classified as “exempt income”. Although both exempt income and NANE income are not subject to tax, it is necessary to distinguish between the two categories due to other tax consequences. For example, exempt income may be taken into account in working out the amount of a tax loss under s 36-​10, whereas NANE income is not taken into account in working out the amount of a tax loss. Subdivision 11-​A lists the classes of exempt income, while subdiv 11-​B lists the particular kinds of NANE income. There are two classes of exempt income: • where the entity is exempt regardless of what type of income it has: s 11-​5 (eg, certain charitable institutions, local governments, etc); and • where the ordinary or statutory income is of a kind that is exempt: s 11-​ 15 (eg, certain education scholarships, family assistance benefits and qualifying foreign employment income). The provisions in the legislation which make an amount NANE income are listed in s 11-​55. Examples of NANE income include GST payable on a supply (s 17-​5) and the receipt of fringe benefits by employees (s 23L(1) of ITAA 1936).

Deductions [3.180]  Deductions are generally expenses which are incurred by the taxpayer in gaining or producing assessable income and therefore reduce the tax

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payable by a taxpayer on their assessable income. There are two categories of deductions: general deductions (s 8-​1) and specific deductions (s 8-​5). Where an expense is deductible as both a general deduction and a specific deduction, s 8-​10 ensures that the taxpayer can only claim the deduction once under the most specific provision. General deductions are discussed in Chapter 12, while specific deductions are discussed in Chapter 13. Some expenses that are not immediately deductible may be deductible over a number of years: see Chapter 14. The “value” of a deduction to a taxpayer depends on the taxpayer’s top marginal income tax rate. See Example 3.8 for an illustration as to the “value” of a deduction.

Income tax rates [3.190]  The applicable rate of income tax depends on the type of taxpayer and is set out in the Income Tax Rates Act 1986. The different types of taxpayers include: • individuals who are Australian residents: see [3.200]; • individuals who are foreign residents: see [3.200]; • individuals who are working holiday-​makers: see [3.200]; • companies below the turnover threshold: see [3.210]; and • companies above the turnover threshold: see [3.210].

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Individuals [3.200]  Individuals are subject to a progressive tax rate structure, whereby the taxpayer’s tax burden increases as their taxable income (a measure of the taxpayer’s ability to pay tax) increases. Under a progressive rate structure, all individuals benefit from the different tax rates for different income brackets. For example, the first $18,200 for an individual with $200,000 of taxable income is tax-​free. An individual’s tax rate generally depends on whether the individual is a resident of Australia for income tax purposes or not. Both resident and foreign resident individuals are subject to the progressive rate structure but at different rates. Tables 3.5 and 3.6 set out the applicable tax rates for Australian resident taxpayers and foreign resident taxpayers for the year ending 30 June 2020.

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82 [3.200]  PRINCIPLES OF TAXATION LAW 2020 TABLE 3.5 2019–​2020 income tax rates for Australian resident individuals Taxable income ($)

Tax on this income

0 –​18,200

Nil

18,201 –​37,000

19c for each $1 over $18,200

37,001 –​90,000

$3,572 plus 32.5c for each $1 over $37,000

90,001 –​180,000

$20,797 plus 37c for each $1 over $90,000

180,001 and over

$54,097 plus 45c for each $1 over $180,000

The above rates do not include the Medicare levy or the Medicare levy surcharge discussed earlier in the chapter.

Example 3.8: Calculating Australian resident individual income tax Jack has assessable income of $200,000 and Bobby has assessable income of $50,000. They both have deductible expenses of $10,000 and no tax offsets. They are residents of Australia for income tax purposes. Jack’s taxable income = $200,000 –​$10,000 = $190,000. Jack’s tax payable is calculated as follows: $0–​$18,200 = no tax payable $18,201–​$37,000 = $18,800 × 19% = $3,572 $37,001–​$90,000 = $53,000 × 32.5% = $17,225

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$90,001–​$180,000 = $90,000 × 37% = $33,300 $180,001–​$190,000 = $10,000 × 45% = $4,500 Therefore, Jack’s total tax payable will be $3,572 + $17,225 + $33,300 + $4,500 = $58,597. Without the deductions, Jack’s taxable income would be $200,000 and his tax payable would be $3,572 + $17,225 + $33,300 + ($20,000 × 45%) = $63,097. Therefore, the $10,000 of deductions has reduced Jack’s tax liability by $4,500, which is $10,000 × 45% (Jack’s highest marginal tax rate). Bobby’s taxable income = $50,000 –​$10,000 = $40,000 Bobby’s tax payable is calculated as follows: $0–​$18,200 = no tax payable $18,201–​$37,000 = $18,800 × 19% = $3,572 $37,001–​$40,000 = $3,000 × 32.5% = $975

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Therefore, Bobby’s total tax payable will be $3,572 + $975 = $4,547. Without the deductions, Bobby’s taxable income would be $50,000 and his tax payable would be $3,572 + ($13,000 × 32.5%) = $7,797. Therefore, the $10,000 of deductions has reduced Bobby’s tax liability by $3,250, which is $10,000 × 32.5% (Bobby’s highest marginal tax rate). As mentioned above, it is apparent from the example that the “value” of a deduction (ie, the reduction in tax payable) will depend on the individual’s highest marginal tax rate. In this case, the “value” of the deduction will be even greater as Jack would also be liable for the 2% Medicare levy and his highest marginal tax rate is effectively 47%.   

TABLE 3.6 2019–​2020 income tax rates for foreign resident individuals Taxable income ($)

Tax on this income

0 –​90,000

32.5c for each $1

90,001 –​180,000

$29,250 plus 37c for each $1 over $90,000

180,001 and over

$62,550 plus 45c for each $1 over $180,000

As discussed at [3.40], foreign residents are not required to pay the Medicare levy.

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Example 3.9: Calculating foreign resident individual income tax Pedro is a foreign resident for Australian income tax purposes. He had $100,000 of Australian sourced assessable income. He did not have any deductions or offsets. Pedro’s taxable income = $100,000. Pedro’s tax payable = ($90,000 × 32.5%) + ($10,000 × 37%) = $29,250 + $3,700 = $32,950. While foreign residents are still subject to a progressive rate structure, they do not get the benefit of the lower marginal tax rates or the tax-​free threshold.    There is a special category of individuals whose income tax obligations do not depend on their residency for tax purposes. These are “working holiday-​ makers” (ie, backpackers) who are in Australia on a “Working Holiday” or “Work and Holiday” visa. The following tax rates given in Table 3.7 apply to the Australian sourced income of working holiday-​makers regardless of their tax residency.

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84 [3.210]  PRINCIPLES OF TAXATION LAW 2020 TABLE 3.7 2019–​2020 income tax rates for working holiday-​makers Taxable income ($)

Tax on this income

0 –​37,000

15c for each $1

37,001 –​90,000

$5,550 plus 32.5c for each $1 over $37,000

90,001 –​180,000

$22,775 plus 37c for each $1 over $90,000

180,001 and over

$56,075 plus 45c for each $1 over $180,000

Other entities [3.210]  Companies are generally subject to tax at a fixed rate on their taxable income, regardless of their total amount of taxable income. This is known as a flat or proportional tax. The applicable company tax rate depends on the entity’s turnover. The corporate tax rate is being progressively reduced for companies with a turnover of less than $50 million. Table 3.8 sets out the progressive changes to the company tax rate. TABLE 3.8 Progressive changes to the company tax rate

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Income year

Turnover threshold ($m)

Company tax rate for entities under the threshold (%)

Company tax rate for entities over the threshold (%)

2019–​2020

50

27.5

30

2020–​2021

50

26.0

30

2021–​2022 and later income years

50

25.0

30

However, the lower company tax rate does not apply to a company if more than 80% of the company’s assessable income is passive income (eg, dividends, royalties and interest), even though the company’s turnover may be below the turnover threshold. Example 3.10: Company income tax Big Profits Pty Ltd had taxable income of $10 million, while Small Profits Pty Ltd had taxable income of $1 million for the 2019–​2020 income year. Assume that Big Profits Pty Ltd had an annual turnover of $100 million, while Small Profits Pty Ltd had an annual turnover of $10 million. Big Profits tax payable = $10 million × 30% = $3,000,000. Small Profits tax payable = $1 million × 27.5% = $275,000.   

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The tax rates which apply to superannuation funds and trustees are discussed in Chapters 18 and 20 respectively.

Tax offsets [3.220]  Tax offsets or rebates are deducted from income tax payable and reduce the amount of income tax which must be paid by the taxpayer. Tax offsets are not the same as deductions as tax offsets reduce income tax payable, whereas deductions reduce taxable income. Example 3.11: Tax deductions vs tax offsets Using the facts from Example 3.8, assume that, instead of having $10,000 of deductions, Jack and Bobby have $10,000 of tax offsets. Jack’s tax payable on taxable income of $200,000 = $63,097 –​$10,000 = $53,097. Bobby’s tax payable on taxable income of $50,000 = $7,797 –​$10,000 = –​ $2,203. Bobby will receive a refund of $2,203 if the tax offset is a refundable tax offset, or he will have no tax liability for the current year and tax offsets of $2,203 to be carried forward to the next year if the tax offset can be carried forward.

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The example illustrates two important points. First, both Jack and Bobby have significantly lower tax payable with tax offsets of $10,000, rather than deductions of $10,000. Second, Jack and Bobby receive equal benefit from the tax offset (reducing their tax liability by $10,000), as opposed to the deductions, where the value of the benefit corresponds with the taxpayer’s applicable marginal tax rate.    Tax offsets generally do not reduce the Medicare levy for individual taxpayers and may only be refundable in certain limited circumstances. Tax offsets are listed in s 13-​1 of ITAA 1997 and are discussed further in Chapter 15.

Questions [3.230]  3.1 What is the basic income tax payable for an Australian resident individual with taxable income for the 2019–​2020 income year of: (a) $15,000? (b) $40,000? (c) $100,000? (d) $300,000?

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86 [3.230]  PRINCIPLES OF TAXATION LAW 2020 3.2 What is the basic income tax payable for a foreign resident individual with taxable Australian income for the 2019–​2020 income year of: (a) $15,000? (b) $40,000? (c) $100,000? (d) $300,000? 3.3 Calculate the Medicare levy payable (if any) for the year ending 30 June 2020 on the following amounts for a single Australian resident taxpayer who is not entitled to the SAPTO (assume the same “threshold amount” and “phase-​in limit” as for the 2018–​2019 income year): (a) $15,000 (b) $27,000 (c) $40,000 3.4 Calculate the Medicare levy surcharge payable (if any) on the following taxable income amounts for a single Australian resident taxpayer who does not have private health insurance for the entire income year: (a) $50,000 (b) $100,000 3.5 Following on from 3.4, calculate the Medicare levy surcharge payable if the individual had private health insurance for 100 days in the income year. 3.6 Jill is an Australian resident for tax purposes. She has assessable income of $500,000. She has deductions of $100,000 and franking credit tax offsets of $30,000. What is Jill’s tax payable for the 2019–​ 2020 income year? 3.7 Acme Pty Ltd has determined that its assessable income for the year is $789,000 and it has deductions of $300,000. What is Acme’s tax payable for the 2019–​2020 income year? Assume that Acme’s turnover is in excess of $50 million. 3.8 Linley is an Australian resident for income tax purposes. She has taxable income of $277,000. She has been provided with a receipt for an expense in the amount of $10,000. This expense will constitute a deduction. How much tax will Linley save for the 2019–​2020 income year as a result of the additional deduction? 3.9 Following on from 3.8, Linley has a HELP debt of $25,000. How much of the HELP debt would she be required to repay for the 2019–​2020 income year?

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4 Residence and source

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Key points......................................................................................................  [4.00] Introduction..................................................................................................  [4.10] Legislative framework..................................................................................  [4.20] Income tax rates for individuals..................................................................  [4.30] Residence......................................................................................................  [4.40] Residence of Australia –​individuals......................................................  [4.50]

Residence according to ordinary concepts...............................................  [4.60] Domicile test.............................................................................................  [4.100] 183-​day test..............................................................................................  [4.130] Superannuation test.................................................................................  [4.140] Period of residence..................................................................................  [4.145] Temporary residents –​individuals......................................................  [4.150] Working holiday makers......................................................................  [4.155] Foreign residents –​individuals............................................................  [4.160] Residence of Australia –​companies...................................................  [4.170] Place of incorporation test.......................................................................  [4.180] Central management and control test....................................................  [4.190] Controlling shareholders test..................................................................  [4.210] Dual residency and tie breaker provisions..........................................  [4.220] Source ........................................................................................................  [4.230] Sale of goods –​trading stock..............................................................  [4.240] Sale of property other than trading stock...........................................  [4.250] Services................................................................................................  [4.260] Interest..................................................................................................  [4.270] Dividends..............................................................................................  [4.280] Royalties...............................................................................................  [4.290] Questions.....................................................................................................  [4.300]

  

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88 [4.00]  PRINCIPLES OF TAXATION LAW 2020

Key points [4.00]  • Residence and source are the bases upon which income tax is levied on taxpayers under Australian domestic tax law. • Australian residents are taxed on income from all sources. • Foreign residents are taxed on income sourced in Australia. • An individual is an Australian resident if he or she satisfies one of four tests: the ordinary concepts test, the domicile test, the 183-​day test and the superannuation test. • A company is a resident of Australia if it satisfies one of three tests: the place of incorporation test, the place of central management and control test and the controlling shareholder test. • Source requires a geographical connection with Australia. There are both statutory rules and common law rules which determine whether the geographical connection exists. • International tax treaties to which Australia is a party may override the domestic principles of source. • Determining the source of income requires the income to be categorised. • For the purposes of source, a receipt is generally considered to fall within the categories of income from the sale of goods or the sale of property other than goods, income from the provision of services, or passive income in the form of dividends, royalties or interest.

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Introduction [4.10]  This chapter introduces the two key concepts upon which income tax is imposed in Australia: residence and source. At the outset, students need to remember two broad principles: • A resident of Australia for tax purposes will be taxed on worldwide income, that is, income from all sources. • A foreign resident for tax purposes will be taxed on income sourced in Australia only. Both of these broad principles contain the concepts of residence and source. Figure 4.1 explains how these concepts fit together. It is necessary to understand what is meant by these concepts to be able to determine a taxpayer’s assessable income. Before we look at the meaning of residence and source, we need to consider the reason why they are so important in our income tax regime.

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89

Figure 4.1: Overall guide

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Legislative framework [4.20]  In order to understand the concepts of residence and source, it helps to consider the legislative framework in which they operate. Both concepts are contained in Div 6 of ITAA 1997, dealing with ordinary and statutory income. Students should revise Div 6 of ITAA 1997 as outlined in Chapter 3. It is from these provisions that we find our general principles that Australian residents are taxed on their worldwide income, while foreign residents are taxed on income sourced in Australia. This is the first reason why residency is important. There is a second reason why residency is important: where the taxpayer is an individual, the applicable tax rates depend on residency status.

Income tax rates for individuals [4.30]  The income tax rates applied to individuals are different according to whether the taxpayer is an Australian resident or a foreign resident. Students

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90 [4.40]  PRINCIPLES OF TAXATION LAW 2020 should revise the individual rates of tax set out in Chapter 3. The differences are as follows: • foreign residents do not get the benefit of the tax-​free threshold on any Australian sourced income; • the tax payable on the first bracket of income is at a higher rate; • foreign residents do not have access to many personal tax offsets; and • foreign residents are not liable for the Medicare levy. Now that we know why it is so important to establish a taxpayer’s residency and source of income at the outset, we can consider what is meant by each of these concepts.

Residence [4.40]  Section 995-​1 of ITAA 1997 provides that “Australian resident” means a person who is a resident of Australia for the purposes of the ITAA 1936. If we refer to the ITAA 1936, we find a definition of “resident” in s 6(1). Before we consider that definition, note that: • the status of an individual in migration law is not conclusive of his or her residency status for taxation purposes; • a taxpayer who does not fall within the legislative definition of “Australian resident” is automatically considered a foreign resident for taxation purposes;

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• for tax purposes, a taxpayer may be a resident of more than one country; • consistent with liability to tax being determined on a year-​ by-​ year basis, a taxpayer’s residency status is also considered yearly; and • events may be examined after year end to determine residency status.

Residence of Australia –​individuals [4.50]  The definition of “resident” in s 6(1) of ITAA 1936 contains four separate and exhaustive tests for determining whether an individual is a resident of Australia for taxation purposes. It provides that: resident or resident of Australia means: (a) a person, other than a company, who resides in Australia and includes a person: (i) whose domicile is in Australia, unless the Commissioner is satisfied that his permanent place of abode is outside Australia; (ii) who has actually been in Australia, continuously or intermittently, during more than one-​half of the year of income, unless the Commissioner

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91

is satisfied that his usual place of abode is outside Australia and he does not intend to take up residence in Australia; or (iii) who  is: (A) a member of the superannuation scheme established by deed under the Superannuation Act 1990 (Cth); or (B) an eligible spouse for the purposes of the Superannuation Act 1976 (Cth); or (C) the spouse, or a child under 16, of a person covered by sub-​ subparagraph (A) or (B).

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A taxpayer needs to satisfy only one test to be considered a resident of Australia. If a taxpayer does not satisfy any of the tests, he or she is considered a foreign resident for taxation purposes. The four tests, one common law test and three statutory tests, can be summarised as follows: • A person who resides in Australia –​This test is referred to as the ordinary concepts test and is based on the common law: see [4.60]. • The domicile test –​A person whose domicile is Australia, unless the Commissioner is satisfied that his or her permanent place of abode is outside Australia, is considered a resident of Australia: see [4.100]. • The 183-​ day test –​A person who has actually been in Australia, continuously or intermittently, during more than one-​half of the year of income, unless the Commissioner is satisfied that his or her usual place of abode is outside Australia and that he or she does not intend to take up residence in Australia, is considered a resident of Australia: see [4.130]. • The superannuation test –​A person who is a member of a superannuation scheme established by deed under the Superannuation Act 1990 (Cth) or an eligible employee for the purposes of the Superannuation Act 1976 (Cth) or the spouse, or a child under 16, of a person covered by those Acts, is considered a resident of Australia: see [4.140].

Residence according to ordinary concepts [4.60]  The primary test for determining whether an individual is a resident of Australia is the “residence according to ordinary concepts” test. It is a common law test that is somewhat circular and which requires a consideration of where a person resides. The term “resides” is not defined in the ITAA 1936 or ITAA 1997 and, as such, its ordinary meaning is ascertained from a dictionary. Two examples are the Macquarie Dictionary, which defines “reside” as “to dwell permanently or for a considerable time; have one’s abode for a time” and the Shorter Oxford English Dictionary, which defines it as “to dwell permanently or for a considerable time, to have one’s settled or usual abode, to live, in or at a particular place”:

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92 [4.70]  PRINCIPLES OF TAXATION LAW 2020 Ruling TR 98/​17, para 14. The definition clearly covers migrants but will also extend to persons dwelling in Australia for a considerable period. [4.70]  The question of whether a person resides in Australia is a question of fact and degree: Miller v FCT (1946) 73 CLR 93. The leading authorities on what constitutes ordinary residence are the UK cases of Levene v IRC [1928] AC 217 and IRC v Lysaght [1928] AC 234.

Case study 4.1: Residency –​temporary visits abroad In Levene v IRC [1928] AC 217, the taxpayer, who had always been a resident of the UK, retired from business and sold his house. For the two years following he lived at hotels in the UK. For the five years after that he lived in hotels both in the UK and abroad. During this time he spent four or five months a year in the UK to obtain medical advice, visit relatives and attend religious ceremonies. The House of Lords held that, until the taxpayer took a lease on a flat in Monte Carlo in 1925, he was a UK resident. This conclusion was based on the fact that the purposes for going abroad were nothing more than temporary. Taking into account his ties with the UK, together with the temporary nature of the time abroad, the taxpayer was a resident of the UK   for taxation purposes until 1925.

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Case study 4.2: Residency –​moved abroad IRC v Lysaght [1928] AC 234 also involved a taxpayer who spent considerable time abroad. In this case, the taxpayer partially retired and moved from England to an inherited estate in Ireland. He sold his home in England but remained a non-​ executive director of the family company. He travelled to England for approximately one week per month, staying in hotels, to attend board meetings. It was held that the taxpayer was resident and ordinarily resident in the UK. Lord Buckmaster said (at 248): “If residence be once established ordinarily resident means in my opinion no more than the residence is not casual and uncertain but that the person held to reside does so in the ordinary course of life”.  

Consistent with the UK decisions, the Administrative Appeals Tribunal (AAT) decision of Joachim v FCT (2002) 50 ATR 1072 highlights the approach adopted in Australia.

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Case study 4.3: Residency –​family home in Australia and intention to treat Australia as home In Joachim v FCT (2002) 50 ATR 1072, the taxpayer and his family had migrated to Australia in 1994. The taxpayer, a qualified master mariner, was unable to find work in Australia so he obtained employment on various Sri Lankan vessels which resulted in him being outside Australia for 316 days. His family, who had Australian permanent residency, remained in Australia during this time. The taxpayer claimed that he was not a resident of Australia as he had a permanent place of abode outside Australia. The AAT concluded that the taxpayer was a resident of Australia as he maintained a home for his family in Australia and, despite his   absence, his intention to treat Australia as his home had not changed.

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[4.80]  The cases illustrate that a broad range of factors will be considered in determining ordinary residence, with relative weight given to each. The factors considered by the courts are as follows: • Physical presence in Australia –​As a general principle, it is necessary that the taxpayer spends at least some time physically present in Australia during the year of income to be considered a resident under this test, although see Case Study [4.3]. • If the person is a visitor, the frequency, regularity and duration of visits  –​ IRC v Lysaght [1928] AC 234 is an example of a taxpayer living in one jurisdiction (Ireland) but visiting another (England) with frequency and regularity. The duration of the visits will also be considered. • The purpose of the visits to Australia and abroad –​If the person is a visitor to Australia, the purpose of the visit may be considered. Conversely, if the person is outside Australia for part of the income year in question, the purpose of the absence may also be relevant. • The maintenance of a place of abode in Australia for the taxpayer’s use –​Whether a person has a home available for use in Australia is an important factor in deciding whether he or she continues to be a resident in Australia. • The person’s family, business and social ties –​Similar to the maintenance of a place of abode, the location of a person’s family, business and social ties will provide evidence of residence: Levene v IRC [1928] AC 217. • The person’s nationality –​A person’s nationality will not normally be a relevant factor in considering residency where other factors are clearly decisive. However, if a case is borderline, nationality may be considered.

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94 [4.90]  PRINCIPLES OF TAXATION LAW 2020 [4.90]  Many of the factors above are discussed in Ruling TR 98/​17, which considers the residency status of individuals entering Australia, including migrants, academics, students studying in Australia, visitors on holiday and workers with pre-​arranged employment contracts. The Ruling discusses the facts and circumstances of an individual’s behaviour that the Commissioner considers relevant in determining whether a person is an Australian resident. While the taxpayer’s circumstances as a whole are relevant, and no single factor is decisive, the Commissioner places emphasis on: • intention or purpose of presence; • family and business or employment ties; • maintenance and location of assets; and • social and living arrangements. In addition to a person’s behaviour while in Australia, emphasis is placed on physical presence in Australia. Generally, the Commissioner considers that there must be sufficient time elapsed to demonstrate continuity, routine or habit. This is a question of fact. However, it is considered in the Ruling that a period of six months is considerable time for deciding whether an individual resides in Australia.

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Example 4.1: Residence according to ordinary concepts –​Australian resident Promising Swedish soccer player Bjorn is offered an 18-​month contract to play for a club in the National Soccer League in Australia. Bjorn lets out his house in Sweden, sells his car and redirects the mail to Australia, where he intends to remain for the full 18 months of the contract. The club provides accommodation in Australia for Bjorn and his family, his children attend school and, along with his wife, they become involved in sporting activities. However, Bjorn has trouble adapting to Australian conditions and is warned to perform “or else”. Eventually he is playing so badly that the club’s management seeks to terminate his contract on the ground of non-​performance. The contract is paid out for an agreed sum. Bjorn and his family return to Sweden four months after they arrived in Australia. Bjorn explains to the Commissioner that, although he was only in Australia for four months, he was residing here for that four months and he argues that he is entitled to be taxed as an Australian resident. The Commissioner rules that Bjorn is a resident because Bjorn established that he intended to live here for 18 months with his family and his behaviour over the four months was consistent with that intention. Source: Adapted from Example 1, Ruling TR 98/​17.   

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Example 4.2: Residence according to ordinary concepts –​foreign resident Michael, a South African diamond corporation executive, comes to Australia to participate in an intensive eight-​ month advanced management development program at a university. His wife and children don’t come with him. While he is in Australia, he stays in basic on-​campus accommodation. Michael is in Australia solely to do the course and spends his time studying or writing reports for his company. At the end of the eight-​month course, he returns to South Africa. Michael is a foreign resident because he does not exhibit behaviour that is consistent with residing in Australia. Note: Ruling TR 98/​17 only deals with the application of the residence according to ordinary concepts test. However, as Michael is in Australia for more than 183 days, we must also consider the second statutory test. The Commissioner is likely to conclude that Michael is not a resident under this test either, as Michael has a usual place of abode outside of Australia and does not intend to take up residence in Australia. Source: Adapted from Example 2, Ruling TR 98/​17.   

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Example 4.3: Residence according to ordinary concepts –​Australian resident Jane is a Professor of Biology at the University of Warsaw. She comes to Australia under a contract to work for five months on a research project. She is single. Although she intends to leave after five months, she takes on a six-​month lease for a small furnished flat near work. She also buys an old car. She spends time outside of work seeing films, attending occasional dinner parties at her colleagues’ houses, reading books and writing letters to everyone at home. Jane intends to return to Warsaw at the end of the project. The project extends and lasts for seven months, so she negotiates an extra month on her flat’s lease. Apart from depositing her salary into an Australian bank account to cover living expenses, Jane retains all assets and investments in Poland, her country of domicile. As her behaviour over the seven months in Australia is consistent with residing here, Jane is regarded as a resident from the time she arrives in Australia. Jane will be a resident for part of the year only, that is, from the time she arrives in Australia until the time she leaves Australia. Source: Adapted from Example 3, Ruling TR 98/​17.   

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Example 4.4: Residence according to ordinary concepts –​foreign resident Michelle is a viticulturist. She comes to Australia for five months to conduct research, but actually stays seven months to complete it. She stays in a hostel and uses credit cards for living expenses. Her husband and children stay in their home in Bordeaux and, from Australia, Michelle helps her husband run the family business. Michelle’s research is often interrupted because she has to frequently communicate with her husband about their emerging business problems. Eventually she needs to go home for a week to sort out a major business issue. Although Michelle is in Australia for a considerable time, the quality and character of her stay are closer to that of a visitor who is temporarily in Australia than someone residing here, so she is a foreign resident. Source: Adapted from Example 4, Ruling TR 98/​17.   

Domicile test

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[4.100]  The first statutory test, known as the domicile test, provides that a person is a resident of Australia if his or her domicile is in Australia, unless the Commissioner is satisfied that the person has a permanent place of abode outside Australia. The domicile test generally applies to outgoing individuals where that person moves overseas (usually as a work posting), but does not change his or her domicile. “Domicile” is a legal concept to be determined according to the Domicile Act 1982 (Cth) and the common law rules. It broadly means the jurisdiction with which a person has permanent legal ties. A person acquires a domicile of origin at birth (usually the place of the father’s permanent home), but may acquire a domicile of choice. Section 10 of the Domicile Act 1982 (Cth) provides that the intention that a person must have in order to acquire a domicile of choice in a country is the intention to make his home indefinitely in that country. For example, obtaining Australian permanent residency is likely to demonstrate a domicile of choice in Australia. On the other hand, a fixed period student visa or working visa would not satisfy the test for domicile of choice. As this test generally applies to individuals leaving Australia, the person will have an Australian domicile. Therefore, the individual will be a resident of Australia only if it is demonstrated that he or she does not have a “permanent place of abode outside Australia”. Consequently, cases involving this test deal

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with the question of “permanent place of abode outside Australia”, rather than domicile. Whether a person has a permanent place of abode outside Australia is a question of fact based on the individual circumstances of the case. [4.110]  The leading case on what constitutes a permanent place of abode outside Australia is FCT v Applegate (1979) 9 ATR 899.

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Case study 4.4: Permanent place of abode In FCT v Applegate (1979) 9 ATR 899, the taxpayer was a solicitor in Sydney who had been sent by his employer to Vanuatu to open and operate a branch. The taxpayer gave up the lease on his flat and, leaving no assets in Australia, left Sydney with his wife in November 1971. A lease was obtained on a house and the taxpayer, who obtained residency status, was admitted to practice in Vanuatu. In June 1973, the taxpayer became ill and returned to Sydney for medical treatment. After returning to Vanuatu for a short period, he came back to Australia in September 1973. Subsequently, the Vanuatu office was closed. It was always the intention of the taxpayer and his employer that he would return to Australia eventually. While no time frame was specified, it was intended to be substantial. The issue was whether, during his time in Vanuatu, the taxpayer had a permanent place of abode outside Australia. The Full Federal Court held that the taxpayer had a place of abode outside Australia. The question therefore, was whether it was a permanent place of abode. The Court concluded that permanent meant something less than everlasting or lasting forever, but rather took its meaning from its context, in particular by reference to a person who had retained his or her domicile. In this sense, permanent should be contrasted with temporary or transitory. As such, the Court concluded that the taxpayer had a permanent place of abode outside Australia and was not a resident.  

Case study 4.5: Permanent place of abode A similar issue arose in FCT v Jenkins (1982) 12 ATR 745, where the taxpayer, a bank employee, was transferred to Vanuatu for a fixed three-​ year period. Prior to leaving Australia, the taxpayer attempted to sell the family home but was unsuccessful. He maintained a bank account in Australia but cancelled his health insurance policy. Due to the taxpayer’s inability to efficiently perform his duties, he was repatriated back to Australia by his employer at the end of 18 months. The taxpayer claimed that he was not liable to income tax on earnings

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98 [4.120]  PRINCIPLES OF TAXATION LAW 2020

while he was in Vanuatu as it was income derived by a non-​resident from a source outside Australia. The Court, applying the decision in FCT v Applegate, concluded that the taxpayer had a permanent place of abode outside Australia during his time in Vanuatu.   [4.120]  In response to FCT v Applegate and FCT v Jenkins, the Commissioner issued Ruling IT 2650, setting out the various factors which will be taken into account in ascertaining whether a taxpayer has a permanent place of abode outside Australia. Factors considered relevant are as follows: • the intended and actual length of the taxpayer’s stay in the overseas country; • whether the taxpayer intended to stay in the overseas country only temporarily and then to move on to another country or to return to Australia at some definite point in time; • whether the taxpayer has established a home (in the sense of dwelling place; a house or other shelter that is the fixed residence of a person, a family or a household) outside Australia; • whether any residence or place of abode exists in Australia or has been abandoned because of the overseas absence;

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• the duration and continuity of the taxpayer’s presence in the overseas country; and • the durability of association that the person has with a particular place in Australia, that is, maintaining bank accounts in Australia, informing government departments such as Centrelink that he or she is leaving permanently and that family allowance payments should be stopped, place of education of the taxpayer’s children, family ties and so on. Emphasis is often placed on the length of stay overseas. To this extent, Ruling IT 2650 states that, as a broad rule of thumb, a period of two years or longer will be considered a substantial period for the purposes of a taxpayer’s stay in another country. However, a two-​year rule should not be automatically relied upon without considering the other factors.

Example 4.5: Domicile test –​Australian resident George is an Australian resident. He works for a mining company and is transferred overseas for two years for a temporary work assignment in order to gain wider work experience. He intends to return to Australia at the end of the two years. George’s wife and children go with him at first, but the children return to Australia to go back to school.

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George spends his annual holiday in Australia. While overseas he rents out his Australian home and maintains bank accounts in Australia. Except for what he spends on living expenses, George sends all his money to Australia for investment. He makes no investments overseas. George is not considered to be a resident of Australia under the ordinary meaning of “resident”, but is considered to be a resident under the extended definition of that term. That is, George is a resident of Australia under the domicile test. Source: Adapted from Ruling IT 2650, para 31.    Example 4.6: Domicile test –​foreign resident As soon as Elise finished her degree, she decided to leave Australia indefinitely. She went to work in one city in one overseas country to gain work experience. Before leaving, she closed all her bank accounts, except for a five-​year interest-​bearing deposit. She was sharing a rented house while she studied and she has no spouse or children. Elise became ill while she was overseas and had to come back to Australia within 18 months. Elise is a foreign resident as it was her original intention to remain outside Australia for an unspecified period of time and she is considered to have a permanent place of abode in the overseas country.

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Alternatively, after finishing her degree, Elise intended to spend and indeed did spend a year each in two countries and then travelled for a further year, living in youth hostels the whole time. In this case, she did not have a permanent place of abode in any of the overseas countries and continues to be a resident of Australia. Source: Adapted from Ruling IT 2650, para 32.    Example 4.7: Domicile test –​foreign resident Seth is a bank manager. He is posted to the New Hebrides for two years, where he lives with his family in a furnished house provided by the bank. He expects he will receive another overseas posting after this two-​year period, so he lets out the family home in Australia and advises Centrelink that the family is leaving Australia permanently and that Family Tax Benefit payments should cease. Seth is a foreign resident because he abandoned his place of residence in Australia and formed the intention to, and did, reside outside Australia. His place of abode in Vila was intended to be and was his home for the two years. Seth will cease being an Australian resident on the day he leaves Australia. Source: Adapted from Ruling IT 2650, para 33.   

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100 [4.125]  PRINCIPLES OF TAXATION LAW 2020 [4.125]  The Full Federal Court, in Harding v FCT [2019] FCAFC 29, decently considered what constituted a permanent place of abode outside Australia. Case study 4.6: Permanent place of abode In Harding v FCT [2019] FCAFC 29, the taxpayer had spent a considerable amount of time in Saudi Arabia as an aircraft engineer. In 2004, he acquired a house in Australia which he moved into in 2006. In 2009, he returned to Saudi Arabia to work, living in Bahrain. His wife and children remained in Australia but the taxpayer leased a two bedroom apartment for the family to visit. In the year ended 30 June 2011, the taxpayer returned to the house in Australia to visit his family for a total of 91 days. In 2011, the taxpayer’s marriage broke down and the following year he moved into a serviced apartment. The question before the court was whether the taxpayer was a resident of Australia for the 2011 income tax year. The Full Federal Court held that the taxpayer was not a resident of Australia as he had a permanent place of abode outside Australia. In coming to this conclusion, the Court found that the word “place” in the phrase “permanent place of abode” invited consideration of the town or country in which the taxpayer is physically residing “permanently”. Provided the taxpayer had permanently abandoned their residence in Australia, they were not required to be permanently located in a particular dwelling. As such, the taxpayer’s permanent place of abode in 2011 was Bahrain as that was the place where he was living.  

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183-​day  test [4.130]  The second statutory test of residence, the 183-​day test, requires physical presence in Australia for more than one-​ half of the year. Given the requirement of physical presence, this is a test that generally applies to incoming individuals. Under the test, an individual will be considered a resident of Australia where he or she is in Australia for more than 183 days, whether continuously or intermittently, unless the Commissioner is satisfied that the person’s usual place of abode is outside Australia and that he or she does not intend to take up residence in Australia. The first part of this test is purely mathematical, taking into account hours if necessary. The second part of the test provides an exception. There are two limbs to the exception –​the taxpayer has a usual place of abode outside Australia, and he or she did not intend to take up residence in Australia. Both of these limbs must be satisfied. The wording of the first limb to the exception varies from that in the first statutory test. The domicile test requires a “permanent” place of abode

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outside Australia, while the exception to the 183-​day test merely requires a “usual” place of abode outside Australia. While usual place of abode will again mean something less than everlasting, the requirement under this test will be less stringent and therefore easier to satisfy than the requirement under the domicile test. The second limb to the exception requires the Commissioner to be satisfied that the person does not intend to take up residence in Australia. This requires a consideration of the factors listed in the common law test of residence according to ordinary concepts. For the application of the 183-​day test to individuals on working holiday visas, see the AAT decision of Re Koustrup v FCT [2015] AATA 126. In that case, despite the taxpayer being in Australia for more than 183 days, she was held to have a usual place of abode outside Australia and was therefore not entitled to the tax-​free threshold under the residency tax rates. However, we now have special rules that apply to working holiday makers: see [4.155]. As Ruling TR 98/​17 (at paras 37–​38) explains, “in most cases, if individuals are not residing in Australia under ordinary concepts, their usual place of abode is outside Australia”. However, “there may be situations where an individual does not reside in Australia during a particular year but is present in Australia for more than one-​half of the income year (perhaps intermittently) and intends to take up residence in Australia”.

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Superannuation test [4.140]  The superannuation test applies to Commonwealth superannuation fund members and their families, that is, Commonwealth public servants. This test applies to relevant individuals who generally reside in Australia but leave temporarily and are not actually in Australia during the income year. In Baker v FCT [2012] AATA 168, it was held that “member of a superannuation scheme” includes an inactive member, where the taxpayer is on leave without pay.

Period of residence [4.145]  The question may arise as to whether a person is a resident of Australia for the whole year or part of the year. The Commissioner accepts that where a person is a resident under the ordinary concepts test, the person is only considered a resident from the date he or she first resides in Australia. Where a person has a permanent place of abode outside Australia under the domicile test, they are considered to be a foreign resident for the actual period they are out of Australia and a resident while in Australia. Where a person is a resident for part of the year only, the tax-​free threshold will be pro-​rated. Where a person is a resident under the 183-​day test, it has previously been understood

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102 [4.150]  PRINCIPLES OF TAXATION LAW 2020 that they are resident for the whole of the income year and therefore entitled to the full tax-​free threshold.

Temporary residents –​individuals [4.150]  The concept of “temporary resident”, contained in subdiv 768-​R of ITAA 1997, was introduced from 1 July 2006. The object of Div 768 is to provide temporary residents with tax relief on most foreign sourced income and capital gains. As such, where a taxpayer is an individual who is a resident of Australia for tax purposes but qualifies as a temporary resident, he or she generally will not pay tax on his or her foreign income. A temporary resident will pay tax at the Australian resident income tax rates. However, from 8 May 2012, temporary residents are no longer entitled to the 50% CGT discount. In the 2018–​2019 Budget, it was announced that individuals who are foreign or temporary tax residents no longer have access to the CGT main residence exemption and that existing properties held before this date would be grandfathered until 30 June 2019. However, the Bill lapsed in 2019 and has not yet been reintroduced into Parliament. Taxpayers are temporary residents if:

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• they hold a temporary visa granted under the Migration Act 1958 (Cth); • they are not Australian residents within the meaning of the Social Security Act 1991 (Cth); and • their spouse is not an Australian resident within the meaning of the Social Security Act. For the purposes of the Social Security Act, an Australian resident is generally a person who resides in Australia and is either an Australian citizen or holds a permanent resident visa. Where a resident taxpayer meets the temporary resident requirements, most foreign sourced income is not taxed in Australia. An exception to this is where the income is earned from employment performed overseas for short periods while the taxpayer is a temporary resident. Further, any capital gains or losses made by a temporary resident on the disposal of assets that do not have the necessary connection with Australia, or are not taxable Australian property, are disregarded. (Note: There are special rules for capital gains on shares and rights acquired under employee share schemes.) An ancillary object of subdiv 768-​R is to relieve the burdens associated with certain record-​keeping and interest withholding tax obligations. As such, any interest paid by a temporary resident to a foreign resident is exempt from withholding tax and the record-​ keeping obligations for controlled foreign companies and foreign investment funds are partly removed.

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Working holiday makers [4.155]  Income earned by a working holiday maker on or after 1 January 2017 is subject to a special rate of income tax. This tax is colloquially known as the “backpacker tax”. A taxpayer is defined as a working holiday maker, where they are in Australia under a 417 (working holiday) visa or a 462 (work and holiday) visa. Where this is the case, the first $37,000 is taxed at 15% with the balance taxed at ordinary rates.

Foreign residents –​individuals [4.160]  The term “foreign resident” was introduced in the ITAA 1997 and is defined as a person who is not a resident for the purposes of the ITAA 1936. Several sections in the ITAA 1936 still contain the term non-​resident and, in substance, the terms foreign resident and non-​resident mean the same thing. An individual foreign resident will be subject to income tax only on income sourced in Australia. Tax is paid at foreign resident rates.

Residence of Australia –​companies

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[4.170]  The definition of “resident” in s 6(1) of ITAA 1936 provides that a company is a resident of Australia, where it is incorporated in Australia or, not being incorporated in Australia, where it carries on business in Australia and has either its central management and control in Australia or its voting power controlled by shareholders who are residents of Australia. The three tests are known as: • the place of incorporation test: see [4.180]; • the place of central management and control test: see [4.190]; and • the controlling shareholders test: see [4.210].

Place of incorporation test [4.180]  Under the first statutory test, a company incorporated in Australia is automatically a resident of Australia regardless of any other factors. Whether a company is incorporated in Australia is a question of fact determined by reference to the Corporations Act 2001 (Cth).

Central management and control test [4.190]  Under the second statutory test, a company is a resident of Australia if it carries on business in Australia and has its central management and control

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104 [4.200]  PRINCIPLES OF TAXATION LAW 2020 in Australia. The recent High Court case of Bywater Investments Limited & Ors v Commissioner of Taxation [2016] HCA 45 clarifies the court’s position on this test. In that case, the court held that the central management and control of a foreign company is a question of fact and degree. Further, there is no general presumption that the central management and control of a company is the location of the directors or where board meetings take place. [4.200]  Previously, Taxation Ruling TR 2004/​15 set out the Commissioner’s view on how to apply the central management and control test of company residency in paragraph (b) of the definition of “resident” or “resident of Australia” in s 6(1) of ITAA 1936. TR 2004/​15 has now been replaced with TR 2018/​5 Income Tax: Central Management and Control Test of Residency. This ruling sets out the Commissioner’s revised view on how to apply the central management and control test of company residency following the High Court decision in Bywater Investments Limited & Ors v Commissioner of Taxation [2016] HCA 45. The Ruling states that four matters are relevant in determining whether a company meets the two criteria of carrying on business in Australia and having its central management and control in Australia:

(1) (2) (3) (4)

Does the company carry on business in Australia? What does central management and control mean? Who exercises central management and control? Where is central management and control exercised?

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The ruling can be summarised as follows: • First, the Ruling states that if a company has its central management and control in Australia, and it carries on business, it will carry on business in Australia within the meaning of the central management and control test of residency. Further, it is not necessary for any part of the actual trading or investment operations from which its profits are made to take place in Australia because the central management and control of a business is factually part of carrying on that business. • Second, central management and control is the control and direction of a company’s operations, and the question to be asked is the location of the making of high-​level decisions that set the company’s general policies and determine the direction of its operations and the type of transactions it will enter. This is different from the day-​to-​day conduct and management of its activities and operations. • Third, identifying who exercises central management and control is a question of fact and is not determined by identifying who has the legal power or authority to control and direct a company. Rather, the crucial question is who controls and directs a company’s operations in reality.

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• Fourth, a company will be controlled and directed where those making its decisions do so as a matter of fact and substance. It is not where decisions are merely recorded and formalised, or where the company’s constitution, by-​laws or articles of association require it be controlled and directed, if in reality it occurs elsewhere.

Controlling shareholders test [4.210]  The third statutory test provides that a company is a resident of Australia where its voting power is controlled by Australian residents, and it carries on business in Australia. As with the second statutory test, this test also contains two limbs. First, it is necessary to demonstrate that the voting power is controlled by Australian residents. The control of voting power appears to refer to the control of a majority, that is, more than 50% of the voting power at general meetings. A shareholder is a person who is entered on the company’s register or is absolutely entitled to be registered. It does not look through to the ultimate beneficial owner of the shares: Patcorp Investments Ltd v FCT (1976) 6 ATR 420. The residence of individual shareholders is determined by reference to the tests of residency as discussed at [4.50]. The second limb of this test, the company is carrying on business in Australia, is the same as it is for the central management and control test: see [4.190].

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Dual residency and tie breaker provisions [4.220]  Both an individual and a company may be a dual resident. Double tax agreements (see Chapter 22) also contain definitions of “residency” for individuals and companies, which generally provide a tie-​breaker rule, where the taxpayer is considered a resident of both jurisdictions. The most common tie-​breaker rule for individuals is the taxpayer’s permanent home or, if this does not resolve the issue, the place where the taxpayer has the personal social and economic ties. The most common tie-​breaker rule for companies is the place of effective management.

Source [4.230]  As discussed at [4.20], ss 6-​5 and 6-​10 of ITAA 1997 provide that a resident of Australia is taxed on ordinary and statutory income from all sources, while a foreign resident is taxed only on ordinary income and statutory income sourced in Australia or deemed to be assessable income on some other basis. Source rules are based on a combination of common law principles and statutory provisions. Different source rules have been adopted for different

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106 [4.230]  PRINCIPLES OF TAXATION LAW 2020 classes of income. Therefore, to determine the source of the income, it is necessary to classify the income into its relevant class.

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Figure 4.2:  Categories of income to determine source

It is often stated that the question of source is not considered a legal concept. Rather, it has been described as “something which a practical man would regard as a real source of income” and a “practical, hard matter of fact”: Nathan v FCT (1918) 25 CLR 183 at 189–​190. While this is usually suggested as the starting point for ascertaining source, it does little in the way of providing guidance as to the relevant facts to be considered. Of more practical importance is the particular class of income to which an amount will be categorised and an examination of the current source rules that apply to that particular class.

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Sale of goods –​trading stock [4.240]  The source of income from the sale of goods is generally the place, where the trading activities take place. Where the business of the taxpayer involves a number of activities situated in different locations, the income will be apportioned between the places where the activities are carried out. To determine the source and apportionment of the income from trading stock, the question that needs to be asked is whether any part of the profits were earned or produced within the jurisdiction, that is, what income arises or accrues to the taxpayer from the business operations carried on within the jurisdiction. This is a question of fact: Commissioners of Taxation v Kirk [1900] AC 588. The income allocated to a jurisdiction based on source is generally that added within the jurisdiction. Where no value is added by one jurisdiction, there will be no income allocated to that jurisdiction for the purposes of source: C of T (WA) v D & W Murray Ltd (1929) 42 CLR 332.

Sale of property other than trading stock [4.250]  The source of income derived from the sale of property will depend on the property being sold. Where the transaction involves real property, that is, land and all things attached to it, the source will be the location of the property.

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Case study 4.7: Source of income overseas In Rhodesia Metal Ltd (Liquidator) v Taxes Commr [1940] 3 All ER 422, the taxpayer was a company incorporated in England with its central management and control in England. The taxpayer was in the business of purchasing and developing immovable property in Rhodesia and the sale of that property. The taxpayer went into voluntary liquidation and sold its undertaking to another company which had also been incorporated in England. The Privy Council held that the profits were derived from sources in Rhodesia.   Case study 4.8: Source of income in Australia In Thorpe Nominees Pty Ltd v FCT (1988) 19 ATR 1834, the Full Federal Court ignored an elaborate arrangement involving various structures and contracts outside Australia to hold that the source of profits related to the sale of land located in Australia and, therefore, the profits were sourced in   Australia.

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108 [4.260]  PRINCIPLES OF TAXATION LAW 2020 Where the income is derived from the sale of tangible or intangible property, the source will be determined by reference to a number of factors, for example, the place of contract, place of negotiation and place of payment. In essence, it is always a case of being a practical hard matter of fact, where the courts generally look at the location of the economic activity giving rise to the income: Cliffs International Inc v FCT (1985) 16 ATR 601. The capital gains tax provisions also need to be considered, where there is a foreign resident holding taxable Australian property: see [22.320]–​[22.330].

Services [4.260]  Remuneration for the provision of services under an employment contract or contract for services will be in the form of salary, wages or fees. The source of that services income is generally taken to be the place of the performance of the services. Several cases are cited as authority for this general principle. Case study 4.9: Source of services income

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In FCT v French (1957) 98 CLR 398, the taxpayer was an engineer employed by an Australian company to carry out work in New Zealand. The taxpayer claimed that he was exempt from Australian income tax because the income was sourced in New Zealand. The High Court concluded that the payment was for services performed in New Zealand; as such, the source of   the payment was New Zealand.

Case study 4.10: Source of services income A similar conclusion was reached by the Full Federal Court in FCT v Efstathakis (1979) 9 ATR 867. The taxpayer, a Greek national, moved to Australia to work as a Greek Government public employee at the Press and Information Service office in Australia. The salary paid to her by cheques drawn on a Greek bank was subject to income tax in Greece. The taxpayer claimed that the salary was exempt from Australian tax under former s 23(q) of ITAA 1936 as foreign sourced income. Section 23(q) exempted residents from tax on foreign sourced income that had already been subject to tax in the source jurisdiction. The Court held that any factors supporting a finding that the income was sourced outside Australia were outweighed by the residence of the taxpayer, the performance of the   services in Australia and the receipt of payment in Australia.

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4: ResiDence anD soUrce  [4.280] 109

The general principle that the source of services income is the place of the performance of the services must be considered in the context of the possibility of other factors being relevant. For example, where services can be performed in any location, the place of contract or place of payment may be relevant: FCT v Mitchum (1965) 113 CLR 401.

Case study 4.11: Source of services income In FCT v Mitchum (1965) 113 CLR 401, the taxpayer was a well-​known US actor who entered into a contract with a Swiss company for the provision of services. The Swiss company in turn contracted with a UK subsidiary of a US film studio for the taxpayer to provide services for a movie filmed in Australia. The Commissioner assessed the taxpayer on the basis that his salary was sourced in Australia because it was paid for acting in a movie that was filmed in Australia. Although not actually reaching a decision on the source of the income, the High Court held that FCT v French did not result in the conclusion that the source of services income is always the place of performance.  

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Interest [4.270]  The source of interest income involves a consideration of a number of factors, including the place of contracting and the place where the funds are advanced: Commissioner of IR v Philips Gleilampenfabrieken [1955] NZLR 868. In the more recent case of Spotless Services v FCT (1993) 25 ATR 344, the Full Federal Court placed emphasis on the place where the contract for the loan was made and the place where the money was advanced.

Dividends [4.280]  In the case of dividends, it is s 44(1) of ITAA 1936 which provides that dividends are assessable income. It further provides the source rule for dividends as it states that the assessable income of a shareholder in a company includes: • if the shareholder is a resident, dividends that are paid to the shareholder by the company out of profits derived by it from any source; and • if the shareholder is a non-​resident, dividends paid to the shareholder by the company to the extent to which they are paid out of profits derived from sources in Australia.

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Case study 4.12: Dividends The phrase “to the extent to which they are paid out of profits derived from sources in Australia” was considered in Esquire Nominees Ltd v FCT (1973) 129 CLR 177. The taxpayer was a company incorporated in Norfolk Island and had its registered office and its central management and control located there. In the income year in question, the taxpayer, as trustee of a discretionary trust, received dividends paid on shares held in another Norfolk Island company. The dividends paid to the taxpayer were ultimately distributed after a flow of dividends through two other companies and which originated from the activities of a company resident in Australia. The Commissioner assessed the taxpayer as a non-​ resident trustee deriving Australian sourced income that had not been distributed to any beneficiaries. The High Court, in drawing a distinction between the source of the dividend and the source of the money which enables the dividend to be paid, held that the source of the dividends was the holding of the shares in the Norfolk Island company. Consequently, the non-​resident trustee was not liable to Australian tax on the dividends paid.  

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Royalties [4.290]  The common law principle in relation to royalties is that the source of the royalty is the location of the industrial or intellectual property from which the royalty flows. However, where a royalty is outgoing (ie, paid by an Australian business to a foreign entity), s 6C of ITAA 1936 deems the royalty to have an Australian source. It is also necessary to consider the interaction of double tax agreements (see Chapter 22). In Satyam Computer Services Ltd v FCT [2018] FCAFC 172, the Full Federal Court held that royalty payments made to an Indian company from Australian clients was sourced in Australia under the Australia–​India double tax agreement.

Questions [4.300]  4.1 What is the income tax payable for an Australian resident individual with taxable income for the 2019–​2020 income tax year of $120,000? 4.2 What difference does it make to Question 4.1 if the taxpayer is a foreign resident? 4.3 Fred, an executive of a British corporation specialising in management consultancy, comes to Australia to set up a branch of his company.

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Although the length of his stay is not certain, he leases a residence in Melbourne for 12 months. His wife accompanies him on the trip but his teenage sons, having just commenced college, stay in London. Fred rents out the family home. Apart from the absence of his children, Fred’s daily behaviour is relatively similar to his behaviour before entering Australia. As well as the rent on the UK property, Fred earns interest from investments he has in France. Because of ill health, Fred returns to the UK 11 months after arriving in Australia. Discuss residency and source issues.

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4.4 Jenny is an accountant who works in Hong Kong. She is single and lives in Hong Kong with her parents. Until April 2019, her work does not involve travel. At that time she accepts an offer from her employer to travel temporarily to Australia to provide business advice to large numbers of former Hong Kong residents setting up businesses in Melbourne, Sydney and Brisbane. Jenny enters Australia on 25 April 2019. She intends to spend three months travelling between the three cities, staying in various motels. Her employer asks her towards the end of her three months to take up a position in Sydney for a further nine months. In early July, she leases a serviced executive apartment for nine months near her workplace in Sydney. The apartment is her home base during her stay here. She freights more clothing and some personal effects to Australia. Her parents visit her on two occasions. Although based in Sydney, her commitments require some limited travel. On average, Jenny travels at least once a week to meet clients outside Sydney. Is Jenny a resident of Australia for tax purposes? 4.5 Ajay is a student from India who comes to Australia to study for a four-​ year bachelor degree in business. Ajay lives in rental accommodation near the university with fellow students and works part-​time at the university social club as a barman. After six months, he has to withdraw from his studies and return to India because his father is ill. Is Ajay considered a resident of Australia? 4.6 After Misha finishes her Bachelor of Commerce degree, she travels to the UK to work as an accountant for three years. During that time she rents a flat and makes many friends. Her UK salary is paid into a UK bank account. At the end of the three-​year period, she has saved enough money to travel. Misha then spends a year travelling around Europe and a year travelling around North America. At the end of the five years, she returns to Australia. Discuss the residency of Misha. 4.7 The Big Bang Company was set up by Ed, an Australian resident. It is incorporated in Singapore and has two directors who are resident in Singapore and who hold board meetings in Singapore. Each director has two shares in the Big Bang Company, which they hold on trust for Ed. The Big Bang Company owns real property, all of which is outside Australia, and makes its profits from commercial property leases on

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112 [4.300]  PRINCIPLES OF TAXATION LAW 2020 a large scale. Ed does not attend the board meetings in Singapore; however, the constitution of the Big Bang Company provides that the decisions of the directors are only effective if Ed concurs with them. The directors carry on all operational activities, such as collecting rent, paying commission, finding tenants, making minor repairs and maintaining the buildings. Is there any possible scenario in which the Big Bang Company could be considered a resident of Australia for tax purposes?

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4.8 Peter is an accountant for an international accountancy firm based in Vanuatu. He has investments in Vanuatu comprising his own home, a rental property, shares in local companies and cash deposits in high interest bearing bank accounts. On 1 February 2020, Peter was transferred to the firm’s Brisbane office on a temporary three-​month secondment. The purpose of the secondment was to establish networks with existing Australian clients that have indicated the possibility of investing in Vanuatu. During the secondment period, Peter remained an employee of the Vanuatu office and his salary was paid into his Vanuatu bank account. While Peter’s intention was to return to Vanuatu at the conclusion of his secondment, he sought and was successfully offered a permanent position in Brisbane. In early June 2020, he became an employee of the Brisbane office. His relocation involved purchasing an apartment in the Brisbane suburb of Ascot, renting out his own home in Vanuatu and transferring a sum of cash to a high interest bearing bank account in an Australian bank. Discuss residency and source issues. 4.9 Your client was born in Sydney and lived in Australia until 1 July of the current tax year. At that stage, he accepted a voluntary redundancy with Qantas. A year earlier he had separated from his wife of 20 years. A few months later he started a relationship with a resident of Singapore. Upon accepting the redundancy, he began travelling overseas to perform aircraft mechanic services at various locations within Asia. Under his contract of employment with Boeing, the taxpayer was provided with either hotel or short-​term apartment accommodation at each location he attended for work purposes. During the current income year, the taxpayer provided services in Hong Kong, Spain, Greece, Thailand and Indonesia. The longest time he stayed at any one place was 45 days in a serviced apartment in Indonesia. The taxpayer visited his two teenage children and his parents in Australia on two occasions for a total of 30 days and visited his new partner in Singapore on four occasions for a total of 50 days. During the tax year what had been the family home in Sydney was sold to complete a divorce settlement. While he no longer had any place in Australia in respect of which he could call his own, he also did not

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have ownership or leasehold in any dwelling outside Australia. Nor did he apply for a long-​term visa or residency status anywhere outside Australia. Advise your client whether he is a resident of Australia in the current tax year for income tax purposes. 4.10 Bridget and her husband are moving from London to Australia permanently under an employer-​sponsored arrangement. Bridget and her husband have a joint bank account in London which they leave open for the purposes of the rent coming from their home which they hold onto. They rent out what was the family home and the money is deposited into the London bank account. The London bank account also earns interest.

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Bridget and her husband pay tax in the UK on both the rental property income and interest income. Their UK accountant has advised them that they will not have to pay tax on the income in Australia because it is sourced in the UK. Bridget and her husband come to you to confirm whether this advice is correct. Advise your clients.

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Part 2 Income

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The first step in the taxation process is to determine assessable income. “Income” is a complex and difficult concept to understand. From an income tax perspective, assessable income is divided into income according to ordinary concepts and statutory income. Income according to ordinary concepts has been developed by the courts. A receipt is likely to be considered income when it is a product of, yet severable from, a source such as labour (or services), business or property. In addition to this basic principle, a receipt which has income characteristics, such as being periodic, expected and used for ordinary living expenses, can in some instances be considered to be ordinary income even when it is not a product of labour, business or property. Further, the courts have always held that a receipt must be a genuine gain and be money or convertible to money to be ordinary income. Many receipts will be ordinary income which is assessable income under Div 6 of Income Tax Assessment Act 1997 (Cth) (ITAA 1997). However, over the years, it became apparent that not all receipts which should be taxable were included as ordinary income. The judicial concept of income, first adopted in Australia when federal income tax was introduced in 1915, provided a narrow tax base with opportunities to shift receipts outside this judicial concept of ordinary income. Accordingly, a second category of income developed, statutory income, which shifts many types of gains and receipts into the income tax base. Assessable income (s 6-​1)

=

Ordinary income (s 6-​5)

+

Statutory income (s 6-​10)



Exempt income (s  6-​10)

Traditionally, income has been categorised according to the source to which it attaches, that is, the receipt is a product of labour, business

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116 PRINCIPLES OF TAXATION LAW 2020

or property. Because this has been the traditional approach to looking at receipts, the common law has developed along these lines with the statutory regime, then broadening the tax base of each category. However, propositions which have developed to determine whether an amount is ordinary income are not unique to income from any particular category. As such, the first chapter in Part 2, Chapter 5, is an introduction to ordinary income. It outlines the principles which apply to determine the types of gains that courts of law consider to be of an income character and, in doing so, considers the general propositions for ordinary income. Chapter 6 specifically covers income from personal services and employment. An examination of the general propositions developed by the courts, discussed in Chapter 6, demonstrates that it is easy to manipulate the ordinary income category by receiving benefits rather than salary or wages. To counter this behaviour, certain types of statutory income categories were introduced. The most significant category in relation to labour is allowances in respect of employment or services in s 15-​2 of ITAA 1997. Unfortunately, the statutory provisions have had limited success in taxing benefits received as a result of labour. Consequently, fringe benefits tax was introduced in 1986.

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Chapter 7 follows on from the discussion on income from personal services and employment to consider the fringe benefits tax regime. The key difference and unique feature of this regime, which is separate to the income tax regime, is that while the employee receives the benefit, it is the employer who pays the tax. Chapter 7 explains the operation of this regime, including a discussion of the various categories of benefits and the concessions or exemptions available for certain benefits. While the ordinary income concepts are generally no different, the source of the receipt introduces unique issues. In relation to income from business, the question that needs to be asked is: “What is a business for taxation purposes?” Chapter 8 details the indicia of a business established by the courts. A finding of the existence of a business is not sufficient to conclude that all receipts are assessable income. It is also necessary to consider whether the receipts arise as a result of activities within the scope of the business and to what extent isolated and extraordinary transactions are assessable. A third category of income, known as income from property, or passive income, also introduces unique issues. Chapter 9 details income from property, explaining the principles that apply to income from interest, dividends, leases, royalties and annuities. Taxpayers may receive various types of compensation payments. If the compensation is for loss of income, then generally the compensation

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payments themselves will be of an income character. Chapter 10 considers the different categories of compensation which may substitute for loss of income from labour, loss of income from business and loss of income from property. Although both statutory income and ordinary income are included in assessable income, the rules for some types of statutory income are concessional relative to those applying to ordinary income and it thus remains very important to determine whether a receipt is assessable as ordinary income or assessable income and, if the latter, which provision brings the receipt into assessable income. The most important statutory income measures are the “capital gains tax” rules which were adopted in 1985 to sweep up a wide range of receipts that had not been captured by the ordinary income concept or previously adopted statutory rules. Because of the broad coverage of the capital gains rules and their operation as a code within the broader income tax Act, these rules are often studied independently from other types of income which fall on either side of the ordinary income/​capital gains borderline and, accordingly, Chapter 11 looks at these rules separately.

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Amounts that do not fall within the ordinary income or statutory income provisions are either exempt income or non-​ assessable non-​ exempt income. These amounts do not form part of the taxpayer’s assessable income and are therefore not subject to tax. It is, however, necessary to distinguish between the two due to other tax consequences.

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5 Assessable income Key points......................................................................................................  [5.00] Introduction..................................................................................................  [5.10] Ordinary income –​general...........................................................................  [5.20] “In accordance with ordinary concepts and usages of mankind”.......  [5.20] Three categories of income...................................................................  [5.30] Capital gains are not ordinary income..................................................  [5.40] Prerequisites and characteristics of ordinary income...............................  [5.50] Prerequisites...........................................................................................  [5.50]

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Cash or cash convertible...........................................................................  [5.60] Real gain.....................................................................................................  [5.70] Characteristics........................................................................................  [5.80] Regular/​periodic.........................................................................................  [5.90] Flow..........................................................................................................  [5.100] Examples..................................................................................................  [5.120]

Some gains are ordinary income despite having no earnings source.......................................................................  [5.130] Other general principles.............................................................................  [5.140] Compensation takes on the character of the loss being compensated......................................................................  [5.140] Unrealised gains are not ordinary income..........................................  [5.145] Legality of receipts does not affect their assessability.......................  [5.150] Whether a receipt is ordinary income is to be characterised in the taxpayer’s hands.........................................  [5.155] Constructive receipt.............................................................................  [5.160] Benefit that saves taxpayer from incurring expenditure is not ordinary income.....................................................................  [5.165] Principle of “mutuality”........................................................................  [5.170] Questions.....................................................................................................  [5.180]   

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Key points [5.00]  • Gains that are ordinary income will be assessable income under s 6-​5 of ITAA 1997. • Gains will be ordinary income if they are the type of gains that courts of law consider to be of an income character. • For a gain to be ordinary income, it must be cash or cash convertible, as well as a genuine gain. • A gain that comes in regularly/​periodically is more likely to be ordinary income than a lump-​sum gain. • A gain that flows from an earnings source is likely to be ordinary income. • Compensation takes the form of the loss being compensated. • Whether or not a gain arises from an illegal activity does not affect whether it is ordinary income.

Introduction

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[5.10]  As discussed in Chapter 1, assessable income includes gains that are ordinary income and/​or statutory income. This means that if a gain is ordinary income it will be assessable income except if the legislation explicitly states that it is not assessable. What if a gain is not ordinary income: will it be assessable? If a gain is not ordinary income, then it will only be assessable if it is statutory income, that is only if it comes under one or more specific statutory provisions of the ITAA 1936 or ITAA 1997 and provided the legislation does not specifically state that it is not assessable. So what is ordinary income? According to s 6-​5(1) of ITAA 1997, ordinary income is “income according to ordinary concepts”. This means that a gain that is regarded by courts as being of an income character will be “ordinary income” and, as such, assessable under s 6-​5. This raises the question as to when courts will regard gains as being of an income character. To determine which gains have an income character, courts have developed a range of rules and guidelines, some of which are vague and not always consistently applied. Some gains are clearly of an income character and so will constitute ordinary income (such as a salary received by an employee). Some gains are clearly not of an income character and so will not be ordinary income (such as the capital proceeds from the sale of a milk bar that you ran for the last three years). However, given the uncertainty of

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the law, with some gains it is not possible to arrive at a definitive answer as to whether they are ordinary income –​in those cases the best we can do is make an educated guess. In this chapter, we discuss the prerequisites and characteristics of ordinary income. Chapters 6, 8 and 9 look at specific types of gains (eg, salaries, normal business profits and rents) and discuss which of those gains are or are not ordinary income. Before the ITAA 1997 was in force, the provision that was roughly equivalent to the current s 6-​5 was s 25(1) of ITAA 1936. This means that older case law that discusses the law that applied before the ITAA 1997 came into force will refer to s 25(1) of ITAA 1936 when there is an issue of whether a gain is of an income character.

Figure 5.1: Overall guide

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Ordinary income

Prerequisites

Cash or convertible to cash

Real gain

Characteristics

Regular or periodic

Flow

Other consideration

Income from property

Personal services income

Compensation

Ordinary income

Ordinary income

Illegal transactions

Statutory income

Statutory income

Business income

Ordinary income

Statutory income

Constructive receipts

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122 [5.20]  PRINCIPLES OF TAXATION LAW 2020

Ordinary income –​general “In accordance with ordinary concepts and usages of mankind” [5.20]  In discussing what gains are of an income character (and, as a consequence, are ordinary income) in Scott v Commissioner of Taxation (1935) 35 SR (NSW) 215 at 219, Jordan CJ said: 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 …

What His Honour appears to be saying is that the Court’s definition of income resembles what most ordinary people would regard as income. While this concept may have derived originally from trust law (see [1.60]), it nevertheless approximately aligns with the contemporary tax law meaning of income. For instance, most people would regard salaries and rent as income, and these gains are also recognised by courts as being of an income character. On the other hand, most people would intuitively regard a personal gift or a lottery winning as not constituting income. This conclusion is also consistent with the fact that courts do not consider such gains as being of an income character. Because the ordinary meaning of income to the layperson may change over time, the scope of ordinary income for tax purposes will also evolve, as is discussed at [5.80].

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While it is useful to keep in mind that the courts’ idea of income resembles what many people intuitively regard as income, ultimately the law as to what is ordinary income is determined by case law. As seen from Figure 5.1, income is shown to have two essential prerequisites and two characteristics (discussed later in this chapter). These four elements are key to determining whether a receipt is income or not. It is also helpful to categorise income into three broad areas as shown in Figure 5.1.

Three categories of income [5.30]  Income is commonly categorised into three broad areas: • income from personal services and employment (eg, salary): see Chapter 6; • income from business (eg, accounting firms selling accounting services): see Chapter 8; or • income from property (eg, rent and dividends): see Chapter 9. However, as discussed at [5.130], there are some relatively rare instances, where receipts will be ordinary income despite not belonging in any of these three categories.

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5: AssessaBle incoMe  [5.60] 123

Capital gains are not ordinary income [5.40]  Courts have made a distinction between gains that are capital and income (see [1.160]–​[1.170]). This means that gains that are capital will not be ordinary income and gains that are ordinary income cannot be capital. It is possible in some limited circumstances for a gain that is not capital to also not be ordinary income either. So, in this context, gains can be thought of as falling into one of three categories: • ordinary income; • capital; or • not capital and not ordinary income. The distinction between capital and income is a central issue in the application of the Australian income tax legislation as it is relevant to both the question of the assessability of receipts and the deduction of expenses (see [12.160]–​ [12.210]). In relation to assessable income, the distinction between capital and income is often considered through the application of the “flow concept”: see [5.100].

Prerequisites and characteristics of ordinary income

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Prerequisites [5.50]  For a gain to be ordinary income, it must fulfil two prerequisites (Figure 5.1). These prerequisites are necessary but not sufficient for a gain to be ordinary income. In other words, if a gain fulfils both prerequisites, then that gain might or might not be ordinary income. But if a gain does not fulfil both prerequisites, then it cannot be ordinary income. The two essential prerequisites of a receipt being ordinary income are that it is: • cash or convertible to cash; and • a real gain to the taxpayer.

Cash or cash convertible [5.60]  If a gain is cash or cash convertible, it might be ordinary income. On the other hand, if it is not cash or cash convertible, then it definitely will not be ordinary income: FCT v Cooke and Sherden (1980) 10 ATR 696. For an item to be cash convertible, it needs to be readily convertible to cash. So a new or used car, real estate or even a transferrable holiday ticket would all be regarded as cash convertible. However, the courts have indicated that if it is illegal to sell a good, then receipt of that good cannot be regarded as cash

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124 [5.70]  PRINCIPLES OF TAXATION LAW 2020 convertible:  Payne v FCT (1996) 32 ATR 516. In practical terms, this means that for most taxpayers, a receipt of cigarettes would not be regarded as cash convertible because it is illegal to sell cigarettes without a licence. Case study 5.1: Receipt of free accommodation was not income In the UK case of Tennant v Smith [1892] AC 150, the taxpayer was an agent for a bank and lived in free accommodation supplied by the bank. The taxpayer was not allowed to sublet the accommodation. The House of Lords held that the accommodation was not regarded as income as it was neither cash nor cash-​convertible.  

Case study 5.2: Receipt of non-​cash-​convertible holiday not ordinary income In the Australian case of FCT v Cooke and Sherden (1980) 10 ATR 696, a few taxpayers sold drinks “door to door”. These taxpayers received a free holiday from the soft drink manufacturer due to them selling a certain number of soft drinks. The holidays were non-​transferrable and therefore could not be sold.

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The Full Federal Court followed the principle in the case of Tennant v Smith [1892] AC 150 and held that because the holidays were not cash convertible, they were not ordinary income.   As discussed at [8.160], s 21A of ITAA 1936 deems non-​cash business benefits as being cash-​convertible. This means that for a business taxpayer benefits can be assessable income despite not being cash or cash-​convertible. Had the case of FCT v Cooke and Sherden been decided after s 21A of ITAA 1936 was introduced into the legislation, then it is very likely that the Court would have decided that the free holiday was assessable as this section would deem it to be convertible to cash. It is important to note that s 21A does not deem the non-​ cash receipt to be income, but rather it deems the benefit to have a cash value so that it satisfies the prerequisite that ordinary income must be cash or convertible to cash. This is in contrast to statutory income which specifically makes certain receipts assessable income through a provision of the Act (see [5.10]).

Real gain [5.70]  If a receipt is a genuine gain (ie, the taxpayer is better off financially), then it could be ordinary income. But if it is not a real gain, it will not be ordinary income: Hochstrasser v Mayes [1960] AC 376 (see Case Study [5.3]).

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5: AssessaBle incoMe  [5.70] 125

The principle that a receipt that is not a real gain will not be ordinary income is more likely to apply in employment situations and clubs (see [5.170]) than in other situations. In an employment situation, the courts will usually only label a receipt as not being a real gain when the receipt is related to an employment-​related expense. For instance, if an employee incurred work-​related public transport expenses and that expense is then reimbursed, this would not be regarded as a real gain because the employee has only been compensated for a work-​related expense. The employee has effectively only been reimbursed for an expense they incurred on behalf of the employer. In contrast, an employee who is reimbursed for his or her private holiday would be regarded as receiving a real gain as he or she has effectively been provided a benefit over and above their wage. It is also important to note that an employee that has been given a predetermined amount for a specific work-​related purpose and does not have to return the unspent amount will be regarded as having received an “allowance” rather than a “reimbursement”. Unlike work-​ related reimbursements, allowances will generally constitute ordinary income, though an offsetting deduction will be allowed to the extent that money has been spent for allowable income-​ producing purposes. For example, a taxpayer who receives $150 from his employer for travel purposes but ends up only spending $60 of it and is allowed to keep the rest will be assessable on the $150 allowance and will be able to deduct the $60 expenses (see Chapter 12).

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Case study 5.3: Reimbursement for work-​related loss upon moving premises not assessable In Hochstrasser v Mayes [1960] AC 376, the taxpayer’s employer required him to move cities. The taxpayer sold his house in the city he was relocating from. The house was sold by the taxpayer for less than the price for which he had purchased it. The taxpayer’s employer reimbursed him for the loss from selling his house. The House of Lords held that this payment was not assessable. One of the judges, Lord Denning, said that the payment was not assessable because it was not a real gain because the taxpayer had been compensated for a work-​ related expense. Lord Denning also mentioned that had the taxpayer been compensated for a non-​ work-​ related loss, the receipt would have been a real gain. He gave an example that if a taxpayer’s employer compensated him for share market-​related losses, then this receipt would be a real gain because in this example the taxpayer would have been compensated for a non-​work-​related loss.  

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126 [5.80]  PRINCIPLES OF TAXATION LAW 2020

Characteristics [5.80]  Provided both of the prerequisites of income are satisfied a receipt or benefit will be ordinary income if it shows sufficient of the characteristics of income (Figure 5.1). However, these characteristics are not black or white rules; they are only indicators or pointers to what constitutes ordinary income. This has increasingly been the case in recent decades as courts take a wider view of what gains are regarded as ordinary income. The widening of courts’ views has been influenced by the fact that society now regards certain gains as normal due to the fact that individuals and businesses operate differently to how they did several decades ago. For example, under the first strand in FCT v Myer Emporium Ltd (1987) 163 CLR 199 (see [8.210]–​[8.250]), a gain can be ordinary income even when it does not fulfil the characteristics described at [5.90]–​[5.110]. The characteristics of income can be grouped into two broad areas:



regular/​periodical receipts;

• the flow concept.

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Regular/​periodic [5.90]  All other things being constant, a gain that is regular or periodic is more likely to be ordinary income than a gain that is received as a once-​off lump sum amount. For instance, the cases of FCT v Blake (1984) 15 ATR 1006 and FCT v Harris (1980) 10 ATR 869 (see [6.50]) involved near identical facts –​ except that in FCT v Blake the receipt was regular while in FCT v Harris it was regarded as a one-​off receipt. Consequently, in FCT v Blake, the Court held that the receipt was of an income nature, whereas in FCT v Harris, the Court held that the one-​off receipt was not ordinary income but capital. However, the regularity of a receipt is not a determinative factor in deciding if a gain is ordinary income. For example, in Premier Automatic Ticket Issuers v FCT (1933) 50 CLR 268, a lump sum was held to be ordinary income. It is easy to think of many everyday instances of lump-​sum gains being ordinary income. For instance, a one-​off receipt of interest under a loan agreement which provides for one interest payment at the end of the loan term would be ordinary income. Another example is someone who receives one single payment under a contract to do a one-​off job. Less common but still possible is for a gain to be regular but not ordinary income, such as where a taxpayer receives instalments for the sale of a capital asset: Foley v Fletcher [1843–​1860] All ER Rep 953. For example, if the taxpayer (not a property developer) sells a block of land for $100,000 (capital sale) for

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5: AssessaBle incoMe  [5.110] 127

10 equal payments of $10,000, paid over the next 10 years, then these receipts will remain capital and not be ordinary income even though the receipts are regular. This is because each $10,000 receipt is a part payment for the sale of the capital asset.

Flow [5.100]  When courts developed the judicial concept of what is and what is not of an income character, they borrowed concepts from trust law: see [1.160]. Under trust law, trust property may have income gains or capital gains. The two were mutually exclusive; a gain could not be both an income gain and a capital gain. To decide which trust gains were income and which were capital, the courts used a “flow” concept. The courts stated that income “flowed” from the capital. For example, if the trust property was a house, the rent “flowed” from the house. This meant that for trust purposes, the rent from an investment property was considered income, and appreciation of the value of the house was regarded as capital. To use another example, if the trust property was shares, then dividends flowing from the shares were income, but profit from selling the shares was usually capital. Tax law has used the same “flow” principle as trust law. Consequently, under tax law, rent from an investment property is income, but profit from the property’s increase in value is usually capital and not ordinary income.

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This concept of “flow” is articulated in a paragraph from the US judgment Eisner v Macomber 252 US 189 (1920) by Pitney J (at 206), where the concept of flows was expressed in terms of fruit and trees. Under this analogy, the fruit was income and the tree capital: 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 an investment property, the rent is likened to the fruit and therefore considered to be ordinary income, but the sale of the property itself is likened to the sale of the tree and is capital. In an employment context, the taxpayer’s ability to work and/​or the employment contract would be regarded as the tree, which means that payment for services is akin to the fruit and is ordinary income. [5.110]  What exactly is meant by the concept that if a gain is likened to the fruit from the tree, it is likely to be considered to be ordinary income? There are a number of ways this concept can be viewed, but importantly the gain (ie, likened to the fruit) will have both of the following two related traits:

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128 [5.120]  PRINCIPLES OF TAXATION LAW 2020 1 Having a nexus (a connection) with an earning source. Specifically, having a nexus with one of the following three: (a) property (eg, rent has a nexus with property); (b) business (eg, an accounting firm’s profit has a clear nexus with the accounting business); or (c) personal services (eg, a salary has a clear nexus with an employee providing services). 2 Being severable from its earning source. Being severable means that the gain can be extracted without affecting the underlying earnings source (capital). For example, rent is clearly severable from underlying property in that rent can be obtained from a rental property without affecting the underlying property. An accounting firm’s profit can be obtained from an accounting business without damaging the underlying accounting business. Salary can be obtained without damaging the underlying work contract or the employee’s ability to work. Although the “fruit and tree” analysis distinguishes between income and capital gains, there are some receipts that are neither income nor capital gains. Personal gifts or inheritances are examples of this. Items that are neither ordinary income nor capital generally do not fit into the “fruit” or “tree” concept.

Examples

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[5.120]  Examples 5.1 and 5.2 apply the introductory principles of the prerequisites and characteristics of income. Example 5.1: Receipt of rent and proceeds of property sale A landlord owns an investment property. The rent collected from it is ordinary income as it fulfils the prerequisites of ordinary income in that it is: • cash; and • a genuine gain. Furthermore, it has the characteristics of ordinary income in that it is:

• regular (ie, rent is usually received every month);



• an amount which “flows” from the underlying property as the rent:



• has a nexus with the house; and • is severable from the house –​in that it can be extracted without effecting the value of the house.

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5: AssessaBle incoMe  [5.130] 129

On the other hand, profit from the sale of the house, although fulfilling the prerequisites, in that it is:

• cash; and



• a genuine gain;

does not have the characteristics of ordinary income as it:

• is not a regular receipt; and



• does not “flow” from any underlying source.

This is the sale of the underlying tree and so would be regarded as capital.   

Example 5.2: Business that regularly buys and sells houses Following on from Example 5.1, the profits from selling the house would be regarded as capital, but what about a business that regularly buys and sells houses? Putting aside the trading stock implications (see Chapter 17), the sale of the houses would generate ordinary income. First, the proceeds of sale would fulfil the prerequisites of ordinary income, as they are: • cash;

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• a genuine gain.

Furthermore, they have the characteristics of ordinary income as they: • would have some regularity since this business regularly sells such houses; and • can be said to be the fruit of the underlying business. The proceeds flow from the underlying business because they: •​ have a nexus with the underlying business that buys and sells properties; and •​ are severable from the underlying business, in that selling a property does not damage the underlying business.   

Some gains are ordinary income despite having no earnings source [5.130]  As discussed at [5.100], one of the major characteristics of ordinary income is that it flows from an earnings source. In other words, most gains that are ordinary income will have a nexus to and be severable from an earnings source. However, this will not always be the case. For example, if receipts are regular, expected and the taxpayer is able to depend upon them for support, this will be enough to make them ordinary income even if they do not flow from an earnings source.

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130 [5.140]  PRINCIPLES OF TAXATION LAW 2020

Case study 5.4: Government age pension constitutes ordinary income In Keily v FCT (1983) 83 SASR 494, a single judge of the Federal Court held that a government aged pension was ordinary income. This was because of the traits it had: it was regular, expected and depended upon by the taxpayer for support.   This same logic would apply to many other regular government payments, such as unemployment benefits (eg, Newstart Allowance). Specifically, in Anstis v FCT (2010) 76 ATR 735, the High Court held that Youth Allowance payments constituted ordinary income. However, this principle is not restricted to government benefits and could apply to other regular payments. Case study 5.5: Top-​up payments if employee joined the armed forces during WWII

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In FCT v Dixon (1952) 86 CLR 540, an employer offered his employees “top-​up” payments if they enlisted in the armed forces during World War II. He said to them that if they ceased working for him and signed up to be soldiers for World War II, he would pay them the difference between their former salary and their military salary. The High Court held that this “top-​up” payment was ordinary income. Two of the judges (Dixon CJ and Williams J) held that this was because of the traits that the payments had: they were regular, expected and depended upon by the taxpayer for personal living expenses. A third judge (Fullagar J) held that the payments were ordinary income due to the compensation principle discussed at [5.140]: since the payments were a compensation for lost salary, and the salary would have been ordinary income, the payments themselves were ordinary income.  

Other general principles Compensation takes on the character of the loss being compensated [5.140]  In general, compensation receipts take on the character of what they are compensating. This specifically means that compensation for loss of ordinary income is ordinary income, and compensation for loss of capital is capital. For example, salary is ordinary income, so compensation for loss of

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5: AssessaBle incoMe  [5.160] 131

salary is also ordinary income. For a manufacturing business, its factories are capital, so compensation for loss of one of its factories would be capital. Compensation receipts are discussed in more detail in Chapter 10.

Unrealised gains are not ordinary income [5.145]  An unrealised gain will not be ordinary income: Eisner v Macomber 252 US 189 (1920). This is related to the flow principle (see [5.100]) as unrealised gains are not yet regarded as a fruit flowing from a tree. For instance, if a taxpayer in the business of share trading owns shares that have appreciated in value but have yet to be sold, no ordinary income will have been generated until such time that the gain has been realised through the sale of the shares.

Legality of receipts does not affect their assessability [5.150]  The fact that a receipt is from an illegal activity does not prevent it being assessable provided it would have been assessable had the activity been legal: Minister of Finance (Canada) v Smith [1927] AC 193; Lindsay v IR Commrs (1932) 18 TC 43; Taxation Ruling TR 93/​25. This finding is reasonable as it would be rewarding illegal activities if these proceeds were not subject to tax. For instance, a taxpayer that is in the business of drug dealing is assessable on the proceeds of drug sales despite the illegality of the activities.

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Whether a receipt is ordinary income is to be characterised in the taxpayer’s hands [5.155]  Whether a receipt is ordinary income or not needs to be determined in the context of the taxpayer being assessed: Federal Coke Co Pty Ltd v FCT (1977) 7 ATR 519. For instance, if an employee receives a salary, that salary would clearly be ordinary income in the hands of the employee: see [6.30]. However, if that same employee asked their employer to have the salary paid to the employee’s spouse instead, then the salary would not be regarded as ordinary income in the hands of the spouse. This is because in the spouse’s hands the receipt does not have one of the important characteristics of ordinary income –​that is, it does not flow from their property, business or services they have provided: see [5.100]. In this situation, the salary would still be regarded as ordinary income in the hands of the employee due to the principle of a constructive receipt: see [5.160].

Constructive receipt [5.160]  The principle of a constructive receipt is that income is treated as being derived by a person when that income has been dealt with as that person

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132 [5.160]  PRINCIPLES OF TAXATION LAW 2020 directs. This means that if someone is entitled to receive income, but arranges to have someone else receive it, then the person originally entitled to receive the income has constructively received it. This means that the person originally entitled to receive the money will be assessable on it. Originally, the concept of a constructive receipt was a principle of case law, but it was later incorporated into the income tax legislation. Specifically, s 6-​5(4) of ITAA 1997 covers the principle of constructive receipt for ordinary income and s 6-​10(3) covers the principle of constructive receipt for statutory income. Example 5.3: Constructive receipt Alex works for an engineering firm. He is paid on a fortnightly basis. One fortnight he tells his employer, “for this fortnight, don’t pay me, pay my wife instead”. Although his wife receives his salary, it is still the ordinary income of Alex. This is because the salary is ordinary income and Alex has constructively received the salary, and s 6-​5(4) applies to make the salary the assessable income of Alex. The reason Alex has constructively received the salary is because he was able to receive the salary, but instead chose to have it directed to his wife.   

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Case study 5.6: ATO loses because it did not use principle of constructive receipt In Federal Coke Co Pty Ltd v FCT (1977) 7 ATR 519, Bellambi was an Australian company that owned a subsidiary, Federal Coke. Bellambi had a long-​term contract to supply mineral coke to a French company Le Nickel and the mineral coke was supplied by Bellambi’s subsidiary Federal Coke. The world price for coke had declined since the contract price was set and Le Nickel wished to be released from this contract and was willing to compensate Bellambi for cancellation of the contract. Bellambi was professionally advised that this compensation payment from Le Nickel would be treated as their assessable income. As a result of this advice, Bellambi returned the compensation payment to Le Nickel and arranged for them to make the payment to Federal Coke (subsidiary of Bellambi) instead. Bellambi hoped that the compensation would not be assessable in Federal Coke’s hands. The Commissioner argued that the compensation was assessable income of Federal Coke, but the Full Federal Court found that it was not assessable income. Specifically, the court said that the receipt was not compensation, because Le Nickel did not have any contractual or other legal obligations with Federal Coke that would have made them owe

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5: AssessaBle incoMe  [5.170] 133

Federal Coke compensation. Furthermore, the lack of dealings between Le Nickel and Federal Coke meant that it could not be argued that the receipt was ordinary income due to being the product of business activities. However, Chief Justice Bowen indicated that had the Commissioner assessed Bellambi rather than Federal Coke, then it was possible that the compensation would still have been assessable in Bellambi’s hands. This was because Bellambi may have assessable income through the principle of constructive receipt. The reasoning was that Bellambi could have received the compensation, but chose to have it redirected to Federal Coke. It could therefore be argued that they had constructively received the compensation payment and redirected it to their subsidiary Federal Coke. Constructive receipt of a payment that would have been ordinary income had it actually been received will constitute ordinary income. In other words, Bellambi’s position was similar to that of the husband in Example 5.3.  

Benefit that saves taxpayer from incurring expenditure is not ordinary income

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[5.165]  If a benefit is not received by the taxpayer, or has been received by the taxpayer but is not cash or cash convertible, then even if it saves the taxpayer from incurring expenditure, it will generally not constitute ordinary income. For instance, in the case of FCT v Cooke and Sherden (see Case Study [5.2]), the taxpayers’ receipt of a non-​cash-​convertible holiday would have made them better off in the sense that it saved them from spending their own funds on a holiday. Despite this, the receipt of the free holiday was not ordinary income. However, if the benefit that saved the taxpayer money could have been directly received by the taxpayer, but they had chosen to redirect it elsewhere, then it would be covered by the principle of constructive receipt and so would generally be ordinary income (see [5.160]).

Principle of “mutuality” [5.170]  One of the prerequisites of income is that there must be a gain to the taxpayer: see [5.50]. It therefore follows that if a taxpayer makes a payment to himself or herself, there is no gain and the payment will not be income. The principle of mutuality shows that funds given to a club/​association by its members are not assessable income of the club as the members are the club, they are one and the same. Similarly, any refund of these fees back to the members are also not assessable to the members because there is no real gain

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134 [5.170]  PRINCIPLES OF TAXATION LAW 2020 as the members are only receiving back what was their money: Bohemians Club v Acting FCT (1918) 24 CLR 334; RACV v FCT (1973) 4 ATR 567. These receipts are a type of “non-​assessable non-​exempt income” under s 6-​23 of ITAA 1997. The principle of “mutuality” will most commonly apply in situations involving non-​profit recreational clubs and Owners’ Corporations (previously known as Bodies Corporate). However, receipts of clubs and associations will not be subject to the mutuality principle if those receipts are from sources other than members, such as interest on investments, income from trading, fees collected from non-​members and other relevant external income: Carlisle & Silloth Golf Club v Smith [1912] 2 KB 177.

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Case study 5.7: Mutual receipts of a club In RACV v FCT (1973) 4 ATR 567, the Royal Automobile Club of Victoria (RACV) was a membership-​based club that provided a number of services to members and non-​members. These services included driving lessons, breakdown assistance, a journal containing commercial advertising, touring advice, vehicle testing services, insurance referral, etc. The taxpayer argued that its receipts were not assessable under the mutuality principle. The Supreme Court of Victoria held that RACV was engaged in some activities that were mutual and some that were not. The distinction between mutual and non-​mutual activities was made on the basis of whether the service was provided to members only or whether it was part of the RACV’s trading activities. The breakdown services, towing services, vehicle testing, journal and travel services relating to Australian travel were mutual services, whereas advertising in the journal, financial and insurance services, overseas travel services and driving tuition for non-​ members were non-​mutual activities.  

Example 5.4: Receipts subject to mutuality principle The following are transactions involving clubs/​associations, only some of which are subject to the mutuality principle:

• A local not-​for-​profit football club collects a $100 membership fee from each of its members. It uses these fees to organise football games that its members participate in. The collection of the fees would be subject to the mutuality principle and would not be assessable to the club.



• A football club also holds a lunch and charges its members $10 each to cover the cost of the lunch. The money collected by the club is only from members and therefore is subject to the mutuality principle and will not be assessable.

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5: AssessaBle incoMe  [5.180] 135



• A wine-​tasting club has in the past collected a total of $3,000 fees from its members. This club organises wine-​tasting tours for its members. The club has $2,000 of the $3,000 in fees collected unspent and in the bank. The club winds up and decides to refund the $2,000 back to its members. The money refunded to the members will be subject to the mutuality principle and would not be assessable income for the members.



• An Owners’ Corporation for a block of five units collects $1,200 from each of the unit owners. The $6,000 collected will be subject to the mutuality principle and will not be assessable income to the Owners’ Corporation.



• An Owners’ Corporation earns $200 in interest from the bank on fees previously collected but not yet spent. This $200 is assessable. It is not subject to the mutuality principle as the interest is not earned from its members.   

Questions [5.180]  5.1 Using the general principles discussed in this chapter, consider whether the following are likely to be ordinary income:

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(a) Salary received by an employee. (b) Compensation received by an injured worker for loss of salary because he was unable to work for four weeks. (c) A Christmas present received by a daughter from her mother. (d) Proceeds from selling the copyright to a book. The recipient was an employee accountant who wrote a novel in her spare time over a number of years. (e) Proceeds from selling the copyright to a book, where the recipient is in the business of writing books and selling his copyright. (f) Profit realised on the sale of shares that have been held for a number of years, primarily for their capital growth. (g) Unemployment benefits from the Government received by an unemployed person. 5.2 Look up some English dictionary definitions of “income”. In what respects are these definitions of income similar to what tax law regards as “ordinary income”? Why is there a similarity?

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136 [5.180]  PRINCIPLES OF TAXATION LAW 2020 5.3 Consider the following situations and discuss, giving reasons, whether any of the receipts are ordinary income. The taxpayer has operated a business of purchasing vacant land that can be subdivided into housing lots and then sell either the vacant lots or the lots with a house build on it. A site office is normally built on one of the subdivided blocks and this is staffed by a sales person. Sometimes the vacant blocks are sold directly after subdivision, but in other cases, the business arranges for the construction of a house on the subdivided block and sells the property with the completed house. On less frequent occasions, the sales are what are known as a house and land package. In these cases, the purchaser agrees on a design for the house and the business enters a contract to build the house on the block and the total sale price includes the block of land plus the construction cost of the house. In the current year, the business made the following sales: • vacant blocks of land for a total of $1,600,000; • house and land packages for a total of $2,800,000; • $250,000 for the land that the site office was located on. The site office was moved to a new subdivision; • $1,300,000 worth of farm land which the taxpayer inherited from his parents. The taxpayer had leased this land to a farmer for the past 10 years. This land was not suitable for subdivision, so he sold it to the farmer who had been leasing it. 5.4 In the High Court decision in FCT v Dixon (1952) 86 CLR 540, the taxpayer’s receipts were held to be ordinary income. However, Dixon CJ and Williams J reached this conclusion based on different reasoning from Fullagar J. In relation to this chapter’s analysis of what is ordinary income under s 6-​5 of ITAA 97, outline the reasons given for concluding that the taxpayer’s receipts were ordinary income, and discuss which you think is the most convincing, giving reasons.

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6 Income from personal services and employment Key points......................................................................................................  [6.00] Introduction..................................................................................................  [6.10] Ordinary income as a reward for services..................................................  [6.20] Does the receipt show a nexus with the service?................................  [6.30]

Salary sacrifice...........................................................................................  [6.60]

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Prizes, voluntary payments and unexpected payments......................  [6.70]

Tips ............................................................................................................  [6.80] Personal gifts and voluntary payments....................................................  [6.90] Prizes and chance winnings....................................................................  [6.110] Non-​cash benefits................................................................................  [6.130] Capital receipt or personal service......................................................  [6.140] Changes to entitlements..........................................................................  [6.150] Receipts for entering a restrictive covenant...........................................  [6.160] Sign-​on fees.............................................................................................  [6.180] Section 15-​2: Statutory income from services and employment...........  [6.190] Introduction..........................................................................................  [6.190] First requirement.....................................................................................  [6.200] Second requirement................................................................................  [6.210] Third requirement....................................................................................  [6.220] Can compensation receipts be assessable under s 15-​2?.................  [6.230] Section 15-​2’s relationship with other tax provisions........................  [6.240] Section 15-​3:  Return-​to-​work payments..................................................  [6.250] Payments upon termination of employment...........................................  [6.260] Employment termination payment –​Div 82.......................................  [6.270] When is the payment “in consequence” of termination of employment?...............................................................................  [6.290] When is there a genuine termination?....................................................  [6.310]

Genuine redundancy payments and early retirement scheme payments –​Div 83........................................................................  [6.320]

What is a genuine redundancy payment?..............................................  [6.330]

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138 [6.00]  PRINCIPLES OF TAXATION LAW 2020 What is an early retirement scheme payment?......................................  [6.340] Further conditions for redundancy payments and early retirement scheme payments.........................................................  [6.350] Threshold..................................................................................................  [6.360] Calculation of tax payable on ETP...........................................................  [6.370] Payments for unused annual and long service leave –​Div 83..........  [6.390] Questions.....................................................................................................  [6.400]

  

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Key points [6.00]  • Receipts that show a nexus with the provision of a service are ordinary income. It does not matter whether the service has been performed in the past or will be performed in the future or who makes the payment. • Unexpected or voluntary payments will be ordinary income if they are linked to personal services. However, they will not be ordinary income if they are paid for personal qualities rather than services. • Prizes are not normally ordinary income unless they are the direct result of an income-​earning activity or a reward for particular skills. • Benefits earned from personal services that are not cash or convertible to cash are not ordinary income, but may be statutory income. • Receipts paid for giving up valuable rights may be capital receipts and therefore would not be ordinary income. Capital receipts may be subject to capital gains tax. • Some employment and services gains that are not ordinary income will be assessable under s 15-​2 of ITAA 1997 if they satisfy all three of its requirements. • Payments given as an inducement for an employee to return to work will be assessable under s 15-​3 of ITAA 1997. • Payments given as a consequence of termination of employment will generally be assessable under the Eligible Termination Payment (ETP) provisions in Div 82 of ITAA 1997. The relevant tax rates that apply will depend on various factors, including the taxpayer’s age, the amount received and who received the payment. • Payments given to an employee who has been made genuinely redundant or under an early retirement scheme will generally be tax free under Div 83 of ITAA 1997 as long as they are under the relevant threshold. • Payments given to an employee upon his or her termination for unused annual leave and long service leave are assessable under Div 83 of ITAA 1997 and are generally assessable at the taxpayer’s marginal tax rates.

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6: IncoMe froM personal serVices anD eMploYMent  [6.10] 139

Introduction [6.10] Chapter 5 introduced the general concept of income under the income tax legislation and explained that income may become assessable as either “ordinary income” under s 6-​5 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) or “statutory income” under s 6-​10. Classifying how a particular receipt is identified for the purposes of income tax is extremely important as it may influence the amount that is assessable and the tax rate applicable to that amount. In addition to the classification of assessable income as ordinary and statutory income, Chapter 5 also outlined how the courts have categorised income according to how it is generated by way of: • income from personal services and employment (personal exertion); • income from business (Chapter 8); and • income from property (Chapter 9). This method of classification by the courts has partly been influenced by the income tax legislation as, over time, it has been necessary for the courts to categorise receipts in order to apply relevant legislation. For example, s 50 of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936) prior to 1 July 1987 required, in some instances, that income be identified as “income from personal exertion”, “income from property other than dividends” and “income from dividends”. Currently this categorisation is not as important for the application of the Income Tax Assessment Acts, but it remains a very useful approach for understanding how the courts have defined “ordinary income” and how statute has modified what is assessable for each of these categories.

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Figure 6.1: Overall guide

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140 [6.20]  PRINCIPLES OF TAXATION LAW 2020

Ordinary income as a reward for services [6.20]  Receipts earned from personal services and employment (also known as “personal exertion”, which encompasses both income from employment and services) may be assessable as either ordinary or statutory income. Amounts that are assessable as statutory income are discussed at [6.190]–​ [6.390]. It is also important to appreciate that non-​cash benefits received in respect of employment may also be subject to fringe benefits tax (FBT): see Chapter 7. If this is the case, these benefits are exempt from income tax for the employee (s 23L(1) of ITAA 1936) and need to be considered in relation to FBT for the employer. Amounts earned directly or indirectly by virtue of a taxpayer’s personal services will constitute ordinary income: Moorhouse v Dooland [1955] 1 All ER 93; Brown v FCT (2002) 49 ATR 301. An important factor in identifying income from personal services is the connection or “nexus” that the receipt has with the taxpayer’s personal service. The term “nexus” has been used by the courts to identify this connection with an income-​earning activity, but the term has a similar meaning as the phrase “reward for services”.

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Establishing that there is a nexus between the amount received and the work performed is an essential element for determining whether the receipt is ordinary income under s 6-​5 of ITAA 1997. This approach was followed in Scott v FCT (1966) 117 CLR 514 and Hayes v FCT (1956) 96 CLR 47 (see Case Studies [6.4] and [6.5]), where it was held that a receipt is not ordinary income if it is not a product of employment or a reward for services: see [6.90].

Does the receipt show a nexus with the service? [6.30]  Receipts in the form of wages are obviously assessable as ordinary income and provide a good example of where the nexus between the receipt and the service is clearly established. In contrast, a personal gift of cash from a friend or family member in recognition of some occasion, such as a wedding, has no nexus with any service and therefore is clearly not assessable as ordinary income. These examples illustrate two receipts that can be easily identified as either assessable or not because of the connection (or lack of a connection) with an income-​earning activity. However, there are many cases in between these two extremes where it is more difficult to determine whether or not the receipt is the result of a service. It is helpful to view this distinction as a continuum with each distinct end separated by varying degrees of uncertainty. To reduce the degree of uncertainty between the two extremes, it is necessary to consider the decided cases and to identify the factors that the courts have used to assist with this decision. Generally, the courts have used a two-​step

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6: IncoMe froM personal serVices anD eMploYMent  [6.40] 141

Figure 6.2: Income from labour viewed as a continuum

approach to determine whether an amount is ordinary income from personal services: first, identifying the activity undertaken; and second, determining whether the receipt is a reward for performing that particular activity.

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Case study 6.1: Property received as a reward for service was assessable In Brown v FCT (2002) 49 ATR 301, the taxpayer (Mr Brown) received, free of charge from a property developer, a beachfront apartment with all the costs of transfer and fitting out the apartment paid for. The total value of the property and other costs were over $1 million. Brown played an important role in the success of a major property development project by (among other things) introducing the purchaser to the property developer. The taxpayer argued that the property received was a personal gift and not ordinary income as it was given out of friendship and did not have a nexus with any work performed or service provided. The Commissioner argued that there was a benefit equal to the value of the property received and that this benefit was as a result of the services provided by Brown (the nexus). The Full Federal Court found that the value of the benefits received was ordinary income because the benefit received resulted from the activities undertaken by Brown. It was held that the benefit provided was primarily a reward to Brown for introducing the prospective buyer to the property developer, and the nexus was established because the reward would only be forthcoming if the deal was finalised.   [6.40]  Once it is shown that there is a nexus between the benefit and the activity performed, it does not matter whether the payment is made before, during or after the completion of the task: Hochstrasser v Mayes [1960] AC 376. It is also irrelevant whether the benefit is provided by the entity for which the task was performed, or by an unrelated third party –​it will still be ordinary income: Kelly v FCT (1985) 16 ATR 478: see Case Study [6.6]. Payments from a third party (an entity other than the one the taxpayer is employed by) will be ordinary income for the taxpayer if they are truly a reward for services, but it is also necessary to consider whether they are a personal gift (see [6.90]) given for some other reason: Hayes v FCT (1956) 96 CLR 47. An example

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142 [6.50]  PRINCIPLES OF TAXATION LAW 2020 of a third-​party payment would be an employee accountant who receives a voluntary payment from a client of the firm because the client is very happy with the work that the employee performed. This payment would be a third-​ party payment because the employee works for the accounting firm, rather than for the client. Furthermore, it has a strong nexus with the services that the employee performed and so would constitute ordinary income. Example 6.1: Income earned from personal services Phillip is a lawyer who runs his own business and does not have any employees. At 2.00 am one morning his friend Vincent phones and tells Phillip that he has just been questioned by police about a drug trafficking matter. Vincent informs Phillip that he has not been arrested, but he would like to retain his services as his lawyer so that he can call him any time he needs legal advice or representation. Vincent adds that he will pay Phillip $50,000 per year regardless of whether his services are needed.

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Phillip agrees and he anonymously receives $50,000 into his bank account some months after, even though Vincent has not called on him for any legal advice. The question of whether this is ordinary income under s 6-​5 of ITAA 1997 will be resolved by looking at the activity that is performed and whether the receipt is a reward for performing that activity. The service agreed to is that Phillip will be available whenever required and, even though he may not be called on, he is still being paid to be available. As a result, the nexus between the service and the receipt is established and the $50,000 per year would be ordinary income even if Phillip did not provide any legal work for Vincent. Wages, salaries, commissions, bonuses, fees for services and other payments that are an incident of employment or a reward for service are clearly ordinary income. The characterisation of these amounts as ordinary income is based on the nexus between the activity and the benefit and is not affected by whether the amount is received regularly or as a lump-​ sum payment. Similarly, it is irrelevant whether the payments are from an ongoing regular employment contract or a one-​off receipt contractually required to be paid for the performance of a given task: Brent v FCT (1971) 125 CLR 418: see Case Study [6.8].    [6.50]  Determining whether a receipt is the product of personal services may also be explored using a negative approach, by asking whether the receipt arose for some reason other than employment or the provision of a service: FCT v Harris (1980) 10 ATR 869; Laidler v Perry [1965] 2 All ER 121.

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6: IncoMe froM personal serVices anD eMploYMent  [6.60] 143

Case study 6.2: Payments to retired employee to help reduce effect of inflation on pension payments In FCT v Harris (1980) 10 ATR 869, Mr Harris, a retired bank employee, received a one-​off payment of $450 from the bank, which was described as a pension top-​up to counter the effects of increasing inflation. The Full Federal Court by majority held that the receipt was not a product of Harris’s past employment and therefore was not ordinary income. Bowen CJ conceded that Harris would not have received the payment had he not been a past employee of the bank, but went on to conclude that the payment was in no way related to the length or quality of his past service. The payment was related to his pension and was therefore not a product of his employment. The Court was influenced by the fact that the gift was one-​off rather than regular, though this factor was not determinative. Note that s 27H of ITAA 1936 was enacted to make receipts similar to that received by Harris assessable as statutory income.   Receipts arising out of employment contracts or other service agreements may also be capital in nature (see [6.140]–​[6.180]) and not assessable as ordinary income, although they may be assessable as statutory income: see [6.190]–​[6.240].

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Salary sacrifice [6.60]  Income is only assessable in the year derived (s 6-​5(2) of ITAA 1997: see Chapter 16), and employment income is normally derived when it is received and not at the time the work is performed. Consequently, if personal services income is never derived, it will never be assessable: Ruling TR 98/​1. Over the years, there have been attempts by taxpayers to redirect employment income to other family members, but these attempts have invariably failed and are now specifically covered by the personal services income anti-​avoidance legislation: see Chapter 23, Div 85 of ITAA 1997. However, employment income will not be derived if it is redirected through an effective salary sacrifice arrangement with the employer. For a salary sacrifice arrangement to be effective, employment income must be diverted before it is earned. This requires the employee to negotiate to forego future salary or wages in exchange for some other benefit, such as increased superannuation contributions by the employer. The Commissioner accepts that effective salary sacrifice arrangements divert remuneration before it is derived, and therefore it is not assessable to the employee: Ruling TR 2001/​ 10. However, any benefit accruing to the employee under the salary sacrifice

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144 [6.70]  PRINCIPLES OF TAXATION LAW 2020 arrangement will need to be considered by employers as to its possible effect on their liability to FBT: see Chapter 7. Example 6.2: Salary sacrifice Jo is aged 35 and is an employee of a large bank. His current salary is $100,000 per year. To bolster his superannuation, Jo negotiates with his employer to increase the employer superannuation contribution by $10,000 per year. Jo’s employer agrees to this on the condition that his wages are reduced to $90,000. As a result of the salary sacrifice, since Jo is on the 39% tax rate (including Medicare levy), Jo’s take-​home pay will drop by $6,000 ($10,000 –​$3,900) and his superannuation will increase by $8,500 per year ($10,000 less 15% tax of $1,500 –​employer contributions to employee superannuation are taxed at 15%: see [18.110]). Employer superannuation contributions to employee superannuation funds are exempt from FBT: see [7.80].   

Prizes, voluntary payments and unexpected payments

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[6.70]  Unexpected or voluntary payments received as a reward for service are ordinary income as the benefit is an incident of employment: Laidler v Perry [1965] 2 All ER 121. However, if the payment is made for some other reason, such as for personal qualities, then the receipt is a personal gift and will not be ordinary income as there is no connection with any personal service.

Case study 6.3: Christmas bonus was ordinary income In Laidler v Perry [1965] 2 All ER 121, a Christmas bonus was paid to all current and past employees in the form of a voucher that could be redeemed for goods. These vouchers were provided regardless of the pay rate or the personal circumstances of the employee and were accompanied by a letter expressing the board’s thanks for past services. It was held by the House of Lords that the voucher was income as it arose out of employment, even though it was a voluntary payment on behalf of the employer. Lord Reid answered the question of nexus in the negative by concluding that the benefit arose out of employment because it did not arise out of anything else. Note that benefits received in kind rather than as cash are often subject to FBT rather than income tax: see [7.10].  

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6: IncoMe froM personal serVices anD eMploYMent  [6.90] 145

Unexpected or voluntary payments may also be classified as ordinary income based on the nature of the payment (see [5.130]), rather than any nexus with employment or services: FCT v Dixon (1952) 86 CLR 540; FCT v Blake (1984) 15 ATR 1006. In FCT v Dixon, the fact that the taxpayer relied on these receipts to support himself and his family was a factor in the Court concluding that the receipts were a replacement for income and therefore assessable as ordinary income.

Tips [6.80]  Tips are an example of a third-​party gift and are voluntary payments received by waiters, taxi drivers, hotel employees and others that provide a personal service to the public. These payments are made voluntarily but are made because of the level of service provided, and not for any other reason, therefore establishing the nexus with the service and making them assessable as ordinary income: Penn v Spiers & Pond Ltd [1908] 1 KB 766 (tips received by a railway dining car waiter); Calvert v Wainwright (1947) 27 TC 475 (tips received by a taxi driver).

Personal gifts and voluntary payments

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[6.90]  In contrast to income that is earned as the product of personal services, a gift given for personal qualities is not regarded as ordinary income and would not normally be assessable to the recipient: Hayes v FCT (1956) 96 CLR 47; Scott v FCT (1966) 117 CLR 514. The treatment of personal gifts as non-​assessable income for tax purposes is based on the general meaning of “ordinary income”, which includes the notion that income “flows” from a source such as capital. In the case of personal services, the income flows from the taxpayer’s ability to work and/​or the employment contract: see [5.100]. Personal gifts therefore fall outside of this concept of income because they arise from personal qualities. However, a voluntary payment that is a reward for services will still constitute ordinary income. When distinguishing between a non-​assessable personal gift and assessable voluntary payments for service, the courts have given more weight to the nature of the receipt in the hands of the recipient, rather than the motive of the giver: Scott v FCT. Viewing the receipt from the point of view of the recipient emphasises the importance of looking for any connection the receipt may or may not have with any service provided or other income-​earning activity. The motive of the giver may be considered, but is less important. An unsolicited gift therefore does not become ordinary income only because it was prompted by gratitude for some service, as other factors must also be considered: Scott v FCT (1966) 117 CLR 514; Squatting Investment Co Ltd v FCT (1953) 86 CLR 570.

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146 [6.90]  PRINCIPLES OF TAXATION LAW 2020

Case study 6.4: Characteristics of a personal gift In Scott v FCT (1966) 117 CLR 514, the High Court held that the gift of £10,000 paid by a client (Mrs Freestone) to Mr Scott (a solicitor) was a personal gift and not ordinary income. Scott had acted as solicitor for Freestone for some years and in this case was acting as her solicitor in relation to the estate of her deceased husband. Prior to Mr Freestone’s death, he and Scott had known each other for many years and were associated in various business activities.

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On the death of her husband, Mrs Freestone engaged Scott to carry out work in relation to the administration of her husband’s deceased estate, which included the sale of a number of properties, the main one being an area of 82 acres known as “Greenacres”. Scott played an important role in the sale of the properties by successfully negotiating to have restrictions lifted which prevented the property from being subdivided. As a result of the lifting of the restrictions on the property, its value increased substantially and it was eventually sold for a considerable profit. Following the sale of “Greenacres”, Freestone was informed by letter from Scott’s firm that the bill of costs would be prepared as soon as possible, and it was later paid by Freestone. However, before the bill was rendered, Freestone told Scott that she intended to make a number of gifts from the sale of the property and this included one to him of £10,000. In reaching its conclusion that the £10,000 was not ordinary income, but rather a personal gift, the High Court emphasised a number of elements to be considered in determining the characteristics of the receipt: • The character of the £10,000 should be assessed as a receipt in the hands of the taxpayer. • The receipt must be a product of the relevant activity to be ordinary income; if it is a product of friendship or other personal characteristics, then it is a personal gift. • The fact that Scott was fully remunerated for his services separately from the payment supported the case that the £10,000 was a personal gift. • The fact that Scott did not expect the gift also supported the case that the £10,000 was a personal gift. • The personal relationship prior to the payment, as well as the fact that the donor made other gifts at the same time, also supported the argument that the £10,000 was a personal gift. • The motives of the donor do not normally determine whether the character of the receipt is ordinary income, although it might be one of the factors to consider in deciding whether the receipt is ordinary income.  

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6: IncoMe froM personal serVices anD eMploYMent  [6.100] 147

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[6.100]  The characteristics of a personal gift established in Scott v FCT (1966) 117 CLR 514 emphasise the importance of the personal relationship of the parties in distinguishing between receipts that are a product of personal services or a personal gift. In addition, where the payment is made by an entity with which the taxpayer has an employment or commercial connection, it is important to ascertain whether any service provided is separately and fully paid for. Ultimately, whether a voluntary payment is ordinary income or not will depend on whether it has sufficient nexus to the service provided. If there is sufficient nexus it will be ordinary income, but if there is not, then the voluntary payment will be a personal gift. As the case law shows, there are a number of factors that help in borderline cases to determine whether the nexus is strong enough to make a voluntary payment ordinary income. However, it must be stressed that these factors are not determinative and only assist to make this decision. The more important of these factors are: • whether the gift was expected. Expected receipts are more likely to be ordinary income: Scott v FCT (1966) 117 CLR 514; • whether the gift consists of a lump-​ sum or regular payments. If it consists of regular payments, then it is more likely to be ordinary income: FCT v Blake (1984) 15 ATR 1006; • the motive of the donor. If the donor intends the gift to be a reward for services, the gift is more likely to be ordinary income: Scott v FCT; • whether the recipient has already been remunerated for his or her services. If so, this makes the voluntary payment less likely to be ordinary income: Scott v FCT; Hayes v FCT (1956) 96 CLR 47; and • whether there was a personal relationship between the donor and recipient. The existence of a pre-​ existing personal relationship will make the voluntary payment less likely to be ordinary income: Scott v FCT; Hayes v FCT.

Case study 6.5: Characteristics of a gift In Hayes v FCT (1956) 96 CLR 47, Hayes was the supervising and general accountant for Mr Richardson’s meat and smallgoods business. Mr Richardson’s business was taken over by a company of which Hayes was a director, secretary and shareholder. Initially, Richardson did not have a controlling interest in the company but after several years gained control of the entity. Richardson persuaded Hayes to sell his shares to him but Hayes remained a director and secretary. The company became quite successful and was incorporated as a public company in which Richardson was allotted a considerable number of shares and he transferred 12,000 of these to Hayes. The Commissioner argued that the

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148 [6.100]  PRINCIPLES OF TAXATION LAW 2020

value of these shares was ordinary income or assessable under s 26(e) of ITAA 1936 (now s 15-​2 of ITAA 1997): see [6.190]. The High Court concluded that the value of the shares transferred to Hayes was a personal gift and not ordinary income. In reaching its decision, the Court noted that Hayes and Richardson had developed a personal relationship, and that for the value of the shares to be ordinary income they must be seen in the hands of the recipient as a reward from employment or other services. In this case, Hayes had been fully paid for his services and therefore the shares were not additional reward for his work. This, together with the personal relationship, was sufficient for the Court to find that the value of the shares was a personal gift and not ordinary income, or statutory income under s 26(e) of ITAA 1936.  

Example 6.3: Voluntary payments from employer

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Kim is employed in the family business, which is a medium-​ sized accounting firm. Both her parents are partners in the five-​partner firm that operates the business. Kim has been an employee for the last three years. During the current tax year, Kim received several amounts in addition to her normal wage which was equivalent to other employees with similar experience and similar qualifications. One evening during discussions over the dinner table, Kim’s father asked her whether she had any good ideas on how to improve the client base of the firm. Kim had been thinking about this for some time and she prepared a two-​page document outlining her ideas which her father presented to the other partners. One of Kim’s ideas was adopted and proved moderately successful in attracting new clients. At the end of the financial year, Kim was surprised to receive an envelope with a letter thanking her for her ideas and a cheque for $2,000. Characterising the $2,000 as ordinary income under s 6-​5 of ITAA 1997 or as a non-​assessable gift requires consideration of the elements used in Scott v FCT. First, it is important to view the receipt in Kim’s hands and give less importance to the motive of the partners for making the payment. In this example, there is a strong case to argue that the payment was a product of Kim’s suggestions to the partners and therefore is assessable as ordinary income. However, as she is fully remunerated for her work and there is a family relationship, this would support the argument that the $2,000 is a personal gift. On balance, the stronger case is that the receipt is a product of her extra effort, and the personal relationship appears to be weaker than that in Scott v FCT.

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6: IncoMe froM personal serVices anD eMploYMent  [6.110] 149

An alternative method of analysis, as used in FCT v Harris (see Case Study [6.2]), is to ask what else gave rise to this income? Using this approach, it would be difficult to argue that the $2,000 was received for her personal qualities just because Kim’s parents are partners of the firm, as they do not hold a majority. During the year Kim also announced her engagement and at her engagement party she was handed an envelope by her mother. The envelope contained a card of congratulations signed by all the partners and a cheque for $3,000 drawn on the firm’s account. Kim also received a very generous gift directly from her parents. In this case, it may be contended that Kim would not have received the cheque for $3,000 if she had not been an employee. However, that is not the test of whether the amount is a personal gift or shows a nexus with her employment. This receipt is more clearly a personal gift as it is in recognition of her engagement and is therefore paid for personal qualities and is not connected to her position as an employee of the firm.   

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Prizes and chance winnings [6.110]  An important characteristic of ordinary income is that it is earned as a result of personal services. Windfall gains in the form of chance winnings or prizes, which primarily depend on luck, are therefore not ordinary income, although they may in some cases be income from business: see [8.60]–​[8.80]. For example, winnings from gambling will be a windfall gain unless the gambler is in the business of gambling: Babka v FCT (1989) 20 ATR 1251. For prizes to be classified as ordinary income, they would have to be earned as a result of a business activity or the degree of personal services and skill would have to outweigh the element of chance. For example, an employee’s winnings from a football tipping competition organised and run by her employer are clearly not ordinary income as they depend on chance and have no connection with employment. Similarly, the winnings of a casual participant in a television game show are not normally ordinary income as the element of chance is generally far greater than any skill required: Case 37 (1966) 13 CTBR (NS) 235; Ruling IT 167. It is a question of degree as to whether the level of personal services is sufficient to turn a prize into ordinary income and, as with all questions of degree, the difficulty is to determine the level of personal service that is necessary to change the character of the receipt: Kelly v FCT (1985) 16 ATR 478.

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150 [6.120]  PRINCIPLES OF TAXATION LAW 2020

Case study 6.6: Professional sportsperson’s prize In Kelly v FCT (1985) 16 ATR 478, the taxpayer played football at the highest level in the Western Australia competition and he was paid a fixed amount for each match played. In 1978, he won a prestigious award for the “best and fairest player”, known as the Sandover Medal. Prior to the announcement of the winner of the medal, a local television station publicly broadcast that it would pay $20,000 to the winner. The Commissioner assessed Kelly on the $20,000 prize on the basis that, although unexpected, the prize directly related to his skill and performance as a professional footballer.

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Franklyn J held in the Supreme Court of Western Australia that the $20,000 was ordinary income. This was because the amount was directly related to Kelly’s employment as a footballer, even though it was unexpected and paid by an unrelated third party. First, Kelly was eligible because he was a member of the football club and, second, he was awarded the prize because of his skills and abilities.   [6.120]  Given the increased profile of professional sporting people since the decision in Kelly v FCT (1985) 16 ATR 478, it is most likely that all winnings and prizes relating to their sporting activities will be ordinary income. However, the distinction between a non-​assessable prize and a prize that is related to personal service is more difficult when the activity is not associated with employment or professional activities. Some of the factors used to make this distinction are: • the degree of professionalism; • whether the reward is for services rather than for personal qualities; • whether the reward is paid before or after service; and • whether the reward is related to the taxpayer’s contract.

Example 6.4: Prizes of a non-​professional As a young girl, Marlene had always loved dancing and she has received training in a wide range of dancing styles. Over the years she has participated in a number of local dancing competitions and she has collected quite an array of cups and trophies. At present, Marlene is employed as a full-​time lawyer and she has not danced in any competitions for the past six years. During the current tax year, Marlene decided to get back into dancing and entered a local talent competition which she won and received a cash prize of $200.

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6: IncoMe froM personal serVices anD eMploYMent  [6.130] 151

The receipt of $200 raises the issue of whether this payment is ordinary income as a reward for personal services and her skill in the performance or whether it is a non-​assessable prize that primarily depended upon luck. Marlene is clearly not a professional dancer and she has voluntarily entered the competition, rather than being engaged to dance by the co-​ordinators. In addition, there is a significant element of chance as to whether Marlene will win the prize. Considering all these factors, the $200 receipt is not ordinary income but is a non-​assessable prize.

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Later in the year Marlene responded to an advertisement to participate in a television dancing competition. There were 5,000 applicants and only 50 would be selected after the auditions and Marlene was one of the lucky few. On being selected, Marlene was required to sign a contract with the television company agreeing to quite stringent rules restricting what information could be disclosed to the public, what media outlets she could talk to, where and when she had to appear and what was required of her if she reached the final 10 and if she won the competition. Marlene was very successful and she reached the final 10, which required her to commit four days per week to the television production and, as a result, she took unpaid leave from her employment. During the final weeks of the competition, a local newspaper offered a $10,000 prize to the contestant that could record the fastest tapping in a tap dance routine. Marlene won the $10,000, but she did not go on to win the final competition. Considering the factors listed above, there is a stronger case that the $10,000 is ordinary income compared to the $200 prize. In this situation, Marlene is required to sign a contract which indicates that she is adopting a degree of professionalism. The prize was only available to those contestants that had reached the final stages of the competition and it was not paid for personal qualities but for the demonstration of a particular skill.   

Non-​cash benefits [6.130]  The general definition of “ordinary income” discussed at [5.60] identifies one of the prerequisites of ordinary income as being cash or convertible to cash. Conversely, receipts that are not convertible to cash are not ordinary income: Tennant v Smith [1892] AC 150; Payne v FCT (1996) 32 ATR 516; FCT v Cooke and Sherden (1980) 10 ATR 696. This characteristic of ordinary income is particularly relevant in relation to receipts from personal services, as payments in kind (eg, a free holiday) are quite common in employment and service arrangements. An example of the application of this characteristic of income can be seen in Payne v FCT, where the Federal Court considered whether benefits received from a customer loyalty program were, among other things, ordinary income.

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152 [6.140]  PRINCIPLES OF TAXATION LAW 2020 Customer loyalty programs typically accumulate points that can be redeemed as free travel, free accommodation, discounts on purchases or other similar rewards. Two issues arise in relation to taxation from these loyalty programs: first, whether the rewards are cash or convertible to cash and, second, whether the benefit is connected with personal service. Case study 6.7: Frequent flyer points In Payne v FCT (1996) 32 ATR 516, Janet Payne travelled regularly as a result of her employment with a large accounting firm. The flights were paid for by her employer as she was travelling for business purposes. On one of these trips Payne was offered a brochure which invited her to join the airline’s Frequent Flyer Club. She duly completed the application form and paid the $95.00 membership fee. Over the next two years, Payne accumulated sufficient points to purchase airline tickets for her parents to fly from England to Australia. The bulk of these points were accumulated through travel that was paid for by her employer, although a small percentage was from private travel (3.2%).

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Foster J of the Federal Court held that the free flights earned by Payne as a result of frequent flyer points generated through work travel were not ordinary income. The primary reason for this conclusion was that the tickets were not money or monies worth as they could only be used by the program member or his or her nominee. They could not be sold or in any way converted into money. The decision by Foster J in this case went on to consider whether these benefits were assessable under s 26(e) of ITAA 1936 (now s 15-​2 of ITAA 1997): see Case Study [6.16].   Benefits that are not cash or cash convertible cannot be ordinary income and are not assessable under s 6-​5 of ITAA 1997, but they may be assessable under s 15-​2 (see [6.190]–​[6.240]) or subject to FBT: see Chapter 7. However, if the benefit is convertible to money through sale or via some other means, then the question of the benefit’s assessability as ordinary income will rest with whether the benefit shows a nexus with personal service: see [6.30].

Capital receipt or personal service [6.140]  Capital receipts are not ordinary income under general principles: see [5.40]. As a result, it is necessary to consider whether receipts from personal services and employment are capital or not. The distinction between a receipt that is a reward for services (and is therefore ordinary income) and a receipt that is capital in nature is primarily concerned with whether the taxpayer has

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given up a valuable right. It follows that where the payment is for giving up a capital right, then the payment is most likely capital in nature and not ordinary income. Conversely, if nothing substantial of a capital nature is given up then, as discussed at [6.30ff], it is necessary to consider whether the payment shows a nexus with any service, in which case it will be ordinary income: Brent v FCT (1971) 125 CLR 418. In the case of a restraint of trade, there may be a distinction between the treatment of valuable rights depending on whether those rights are relinquished on commencement, during or at the ending of an employment contract: see [6.160]–​[6.170]. For example, if a professional sportsperson has included in her contract a clause that prevents her from playing with any other club during the term of the contract, then any payment received as a result of this agreement is an incident of the playing contract and is therefore ordinary income. Clearly, no valuable right is given up in this instance as the sportsperson is being paid to play for one club to the exclusion of the other.

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Case study 6.8: Payment for service of giving up valuable rights In Brent v FCT (1971) 125 CLR 418, Mrs Brent was the wife of the infamous criminal Ronald Biggs, who was one of the gang responsible for the UK “Great Train Robbery”. Brent was arrested in Melbourne where she had been living with Biggs following his escape from a UK gaol. After her arrest, Brent was approached by a number of newspapers with offers to publish her life’s story, and she eventually signed an agreement with The Daily Telegraph. The agreement gave the UK newspaper exclusive rights to the publication of Brent’s story. It required her to be available for interviews by newspaper staff who would then write her story for publication. The taxpayer claimed the payments were not ordinary income but that she was being paid for giving up the capital rights to her story as she signed over the exclusive rights to the newspaper. The High Court held that Brent’s earnings from this agreement were ordinary income. Brent was essentially paid for her services of telling her story and she did not give up or dispose of any property. Her secret knowledge was not property as it was not acquired through the conduct of a business and did not relate to anything to which copyright could be attached. Brent’s story was about her life and she did not write the story nor did she possess any copyright that she could assign to The Daily Telegraph. Consequently, the Court held that nothing of a capital nature was given up and therefore the payments were for the service of telling her story. The High Court also placed little importance on the so-​ called “exclusive rights” clause as this could not restrict any other author from collecting information on Brent and publishing its own version of her life’s story.  

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Changes to entitlements [6.150]  Payments for changes to entitlements under employment and service contracts may give rise to capital receipts for the giving up of valuable capital rights and therefore not fall into the category of ordinary income: Bennett v FCT (1947) 75 CLR 480. This follows the principle that compensation takes the form of what it replaces in that compensation for the loss of capital rights will be a capital receipt: see [10.20]. If no capital right is given up, as in FCT v Brent (1971) 125 CLR 418, then the receipt is more likely to be ordinary income unless it is a personal gift. Case study 6.9: Relinquishing employment rights

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In Bennett v FCT (1947) 75 CLR 480, the taxpayer was employed as the managing director of a company which he affectively controlled. His original contract was terminated and he was re-​appointed with the same remuneration but he relinquished certain rights that he previously held, including absolute control of the company. To compensate for the loss of these rights, the company agreed to pay Bennett three payments over a two-​year period. The High Court held that the payments were not for loss of income, but were capital in nature for the removal of those rights that Bennett possessed under the original agreement. Williams J applied the compensation principle finding that because the payments were not for the loss of income, they were capital payments for giving up the right to control the company.   The nature of payments for changes to existing entitlements under an employment contract was also considered by the Administrative Appeals Tribunal in AAT Case 7,752 (1992) 23 ATR 1057. In this case, employees of Shell Company Aust Ltd had their entitlements to rostered days off removed without the employees’ knowledge and it was concluded that compensation paid for the loss of these valuable rights was of a capital nature.

Receipts for entering a restrictive covenant [6.160]  A restrictive covenant or restraint of trade may be formed at the time of entering a contract, during the contract’s operation or after the completion of the service. For example, it is common for professional sportspeople to sign restrictive covenants on entering new contracts which may limit their rights to be interviewed by the media or appear on designated television shows. Similarly, professional actors and movie stars may enter agreements on the

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completion of a production to not perform in another production for a given length of time. Another example would be an employment contract entered into whereby an accounting firm requires an employee to sign a restrictive covenant preventing the employee from registering as a tax agent. Characterising receipts from entering a restrictive covenant as capital or ordinary income will depend on whether the payment is connected with the current employment agreement or whether it is a separate agreement to give up valuable rights. However, where the restrictive covenant is commonly used as part of the normal employment contract, it will be ordinary income as it is generally viewed as a payment for future services. Although the decision in Higgs v Olivier [1952] Ch 311 found the restrictive covenant to be capital, the comments in this case and in FCT v Woite (1982) 13 ATR 579 would suggest that restrictive covenant payments made as part of an ongoing contract are more likely to be income. [6.170]  Payments made at the termination of a service agreement that restricts the activities of the taxpayer are seen as capital as they do not arise out of the employment or service contract and do not show a nexus with the earning activity: Higgs v Olivier [1952] Ch 311; Hepples v FCT (1991) 22 ATR 465. Case study 6.10: Restrictive covenant –​capital

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In Higgs v Olivier [1952] Ch 311, the famous actor Sir Laurence Olivier was paid £15,000 for agreeing to not appear in or direct any film for a period of 18 months after he appeared in the film “Henry V”. The English Court of Appeal held that the receipt of £15,000 was not received as a result of his vocation as an actor and therefore was not assessable. The Court held that as the agreement to pay the £15,000 was separate to his contract to perform in the film, and was made after the completion of the film, it was not payment for his performance as an actor but   for his giving up the right to earn income which was capital in nature.

Case study 6.11: Restrictive covenant –​genuine capital payment In Hepples v FCT (1991) 22 ATR 465, the taxpayer was paid $40,000 on his retirement for agreeing not to disclose the secrets of his employer. Although this decision was mainly concerned with CGT, the High Court had no difficulty in finding that this receipt was not a substitute for income and was a capital payment for entering the restrictive covenant on   termination of employment.

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156 [6.170]  PRINCIPLES OF TAXATION LAW 2020 Capital receipts may also arise out of a restrictive covenant agreed to at the time of entering a contract, and the characterisation of these receipts will again be based on whether the payment is for giving up a valuable right or for services provided: FCT v Woite (1982) 13 ATR 579; Reuter v FCT (1993) 27 ATR 256. Case study 6.12: Restrictive covenant –​ordinary income The taxpayer in Reuter v FCT (1993) 27 ATR 256 was involved in the very famous takeover of John Fairfax Ltd. As part of the arrangements in relation to the takeover, the taxpayer was paid $8 million to agree that he would not, without prior approval, claim the success fee (normal payment for a successful takeover) for the takeover against Bond Media. Hill J in the Federal Court looked at the substance of the agreement, rather than its form, and held that the receipt of $8 million was closely connected to the services provided by the taxpayer to Rothwells Ltd and was therefore ordinary income.  

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Case study 6.13: Restrictive covenant on entering a contract In FCT v Woite (1982) 13 ATR 579, the taxpayer was a footballer who played for a South Australian team. Woite received $10,000 for entering an agreement with the North Melbourne Football Club to not play football with any Victorian club other than North Melbourne (Australian Rules Football did not have a national competition at this time). The contract did not require Woite to play for North Melbourne unless he decided to play football in the Victorian league, which he never did. The Supreme Court of South Australia held that the $10,000 was capital in nature and was not ordinary income from his profession as a footballer. Woite was contracted to the South Australian club and the payment from the North Melbourne club was not a payment for service, but a capital payment to give up the right to play for a club other than North Melbourne. It is interesting to note, although not part of the decision, that Mitchell J implied that it was highly likely that the $10,000 could be ordinary income if Woite had followed the signing of the restraint of trade by signing with the   North Melbourne Club and had subsequently played football for them.

Example 6.5: Restraint of trade payments Luke is a famous basketball player and he has been contracted to play for his club for the last five years. Currently, Luke is in negotiations with his club to renew his contract for an additional 12 months and one of the

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clauses in the contract states that he may only do media appearances with TVX, a media company that has a substantial interest in the club. Due to the inclusion of media restrictions, Luke’s agent is able to have the annual playing fee increased by $50,000. Luke signs the new contract, but halfway through the season he has a serious dispute with the club’s management as he is not being picked to play on a regular basis. Following threats of legal action by both parties, the club agrees to end Luke’s contract for no cost to Luke and also pays him $100,000 for agreeing not to disclose the reasons for the dispute with the club.

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There may be an argument that the $50,000 is payment for giving up the right to speak to any media Luke wishes, but it may also simply be part of his employment contract which requires a range of conditions. The comments in Higgs v Olivier [1952] Ch 311 and FCT v Woite (1982) 13 ATR 579 would suggest that restrictive covenant payments made as part of an ongoing contract are more likely to be income. This is not unlike an employment contract that requires certain restrictions of an employee, such as signing a secrecy agreement. In contrast, the payment of $100,000 is on termination of the contract and imposes a specific restraint on Luke and, as it is not a payment related to his playing duties, it is more likely to be capital, as in Hepples v FCT (1991) 22 ATR 465.   

Receipts that are of a capital nature are not assessable under s 6-​5(1) of ITAA 1997, but they may be statutory income under other provisions such as the CGT provisions: see Chapter 11. It is important to distinguish receipts that are ordinary income and those that are subject to CGT, as the method of determining the liability to tax differs between these two forms of income.

Sign-​on  fees [6.180]  Sign-​on payments enticing the party to enter the contract are quite common in professional sporting contracts and some higher level professional employment contracts. These receipts raise the issue of whether they are a capital payment for giving up some valuable right or whether they are ordinary income in the form of payments for future services. Case study 6.14: Sign-​on fees –​capital in nature In Jarrold v Boustead (1963) 41 TC 701, an amateur rugby player was paid a £3,000 sign-​on fee to give up his amateur status and turn professional. At this time in UK, there were some advantages in being an amateur

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and there was a chance that he could become an international player at amateur level. The Court of Appeal held that this receipt was capital in nature as it was a payment for giving up the right to play amateur football, rather than a payment for future services.   The view expressed by the Commissioner in Ruling TR 1999/​17 is that where a sign-​on fee is a normal part of the practices of attracting sportspeople and employees into a new contract, the payment is less likely to be capital and more likely to be ordinary income as a one-​off payment for future services: Pickford v FCT (1998) 40 ATR 1078. Case study 6.15: Sign-​on fees –​ordinary income In Pickford v FCT (1998) 40 ATR 1078, the taxpayer was offered a salary package to take up employment with another firm, and this package included a one-​off payment of $20,000 as compensation for given-​up share options in an employee share scheme with his current employer. The Administrative Appeals Tribunal held that the $20,000 was ordinary income because it was an incident of the taxpayer’s income-​ earning activities and employment.  

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There is very little direct Australian case authority on this issue, which could suggest that it is well settled that it is difficult to make a strong case that these receipts are not an incident of an income-​earning activity. Income from personal services may be assessable as ordinary income or statutory income. However, regardless of whether an amount is likely to be ordinary income, it is still necessary to consider whether any statutory provisions specifically apply to the receipt. The discussion at [6.190]–​[6.390] covers the most important statutory provisions that apply to receipts from employment and services.

Section 15-​2: Statutory income from services and employment Introduction [6.190]  Section 15-​2 of ITAA 1997 (previously s 26(e) of ITAA 1936) deems certain gains arising from employment and services to be assessable as

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statutory income. For the most part, s 15-​2 has the same operation as its predecessor. However, there is one major difference: s 26(e) did not have a “contrary intention”. This meant that gains that were ordinary income and covered by s 26(e) were taxed under s 26(e). However, the current s 15-​2 does have a contrary intention in s 15-​2(3)(d), which means that if a gain is ordinary income, it will not be covered by s 15-​2: see [3.80].

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Specifically, s 15-​2 covers gains from employment and services if they are not ordinary income or a fringe benefit (see Chapter 7) and if they fulfil all three of the requirements discussed at [6.200]–​[6.220]. The application of s 15-​2 is wider than ordinary income in two ways: • For employment and service gains to be ordinary income, they need to be cash or cash convertible. On the other hand, s 15-​2 covers gains that are cash, cash convertible and non-​cash convertible. • For employment and service gains to be ordinary income, there needs to be a nexus between the gain and the services required: see [6.30]. For these gains to be assessable under s 15-​2, there must also be a nexus between the gain and the services. However, case law indicates that the nexus test is easier to satisfy under s 15-​2 than it is for ordinary income. For example, in Smith v FCT (1987) 19 ATR 274 (see Case Study [6.17]), Brennan J found no reason that s 26(e) of ITAA 1936 (the predecessor of s 15-​2) should be limited to benefits that are income in ordinary concepts, with the result that s 15-​2 could potentially include capital benefits. Section 15-​ 2 potentially only applies to gains from employment or the provision of services. However, this could include services provided by a business taxpayer and also amounts received from providing services under an independent contract for services. Section 15-​2 could therefore apply to gains made by a business from providing engineering or accounting services. Conversely, s 15-​2 will not apply to gains made from holding property or from business operations that do not involve the supply of services. For instance, in FCT v Cooke and Sherden (see [5.60]), the taxpayer ran a business selling soft drinks “door to door” and subsequently received a gift from the soft drink manufacturer. In this case, the Court held that such a gift was not assessable under the predecessor of s 15-​2 because the income was sourced from a business selling goods rather than from providing a service of selling goods.

First requirement [6.200]  The first requirement for a gain to be assessable under s 15-​2 of ITAA 1997 is that there is an “allowance, gratuity, compensation, benefit, bonus or premium”. These words are very wide and will cover a range of benefits received by the taxpayer. This includes receipts that are cash, cash convertible or non-​cash convertible.

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160 [6.200]  PRINCIPLES OF TAXATION LAW 2020 Some examples of receipts that meet the first requirement are: • a cash payment for services, which is a “benefit” and so would fulfil this requirement; and • an employer giving an employee a free television or giving the employee use of a car for personal purposes. Note also that this first requirement: • is not confined to receipts that the taxpayer is entitled to receive, but can also include gifts (gratuities) that have been received by the taxpayer; and • will also be satisfied when the taxpayer receives something from an entity to which he or she has not directly provided a service. For instance, free hotel accommodation received by an employee of an accounting firm from one of the firm’s clients would satisfy this first requirement.

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An example of an item that satisfies the first requirement is an “allowance”. An allowance is a predetermined amount given to a taxpayer for a specific purpose where the taxpayer does not have to return any of the unspent amount. This is in contrast to a “reimbursement”, where a taxpayer only receives what he or she has spent. For example, a taxpayer who receives $150 from her employer for travel purposes, but ends up only spending $60 of it and is allowed to keep the rest, is in receipt of an allowance. On the other hand, a taxpayer who is reimbursed only her actual travel expenditure would not be in receipt of an allowance, but rather a reimbursement. While allowances will satisfy the first requirement of s 15-​2, whether or not a reimbursement is captured by s 15-​2 is contentious, although it is of little practical importance as, either way, it will be tax neutral. For example, where an employee purchases paper for their work’s photocopier for $50 and then is reimbursed $50, it may be argued that this is effectively not the employee’s expense but the employer’s expense and the employee is simply carrying out the purchase for the employer. If this is the case, then the employee has no benefit and no assessable income or equivalent deduction. Conversely, if s 15-​2 makes the $50 assessable, then the employee will also be entitled to a deduction (s 8-​1 of ITAA 1997) for the $50 expense incurred, which is again tax neutral. Reimbursements are also not usually ordinary income, but they may be subject to FBT: see Chapter 7. Although allowances will generally fulfil the three requirements of s 15-​2, they also will usually constitute ordinary income (see [5.70]) in which case they will be assessable as ordinary income under s 6-​5 rather than s 15-​2. This is because of the contra-​intention contained in s 15-​2(3)(d) which removes the application of s 15-​2 if the amount is also ordinary income.

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Second requirement [6.210]  The second requirement for a gain to be assessable under s 15-​2 of ITAA 1997 is that the allowance, benefit, etc is “provided to you” (ie, the taxpayer). Usually, this requirement will be relatively simple for the taxpayer to fulfil. For example, if a taxpayer has received cash, property or a benefit, like free accommodation, it will have been “provided” to the taxpayer and this second requirement will have been satisfied. Therefore, it is only in some very limited circumstances that it will be unclear whether this requirement has been met. Case study 6.16: Free ticket due to frequent flyer points earned from work-​related travel not assessable In Payne v FCT (1996) 32 ATR 516, the taxpayer worked for KPMG and undertook considerable work-​ related travel. Payne signed up for the Qantas Frequent Flyer program and accumulated a large number of points due to her work-​related travel. These points were converted to free airline tickets.

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The Court examined whether receipt of the free tickets was assessable under s 26(e) of ITAA 1936, the predecessor of s 15-​2 of ITAA 1997. The Federal Court (single judge) held that the free tickets were not assessable under s 26(e). One of the reasons for this was that the equivalent of the second requirement of s 15-​2 had not been met, because the benefit was due to a “crystallising of contractual entitlements” under the Frequent Flyer program agreement.  

Third requirement [6.220]  The third requirement for a gain to be assessable under s 15-​2 of ITAA 1997 is that what has been received by the taxpayer is “in respect of, or for or in relation directly or indirectly to, any employment of or services rendered by the taxpayer”. This requirement will be satisfied when there is a sufficient nexus between the receipt and services provided. Earlier cases, such as Scott v FCT (1966) 117 CLR 514, FCT v Dixon (1952) 86 CLR 540 and Hayes v FCT (1956) 96 CLR 47, found that the nexus test under s 15-​2’s predecessor was identical to the nexus test for determining whether a receipt is ordinary income. However, more recent case law, such as Smith v FCT (1987) 19 ATR 274, has seen courts take a different approach by indicating that the nexus test in s 15-​2 is easier to meet than the nexus test for ordinary

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162 [6.220]  PRINCIPLES OF TAXATION LAW 2020 income. Despite this, there still is a nexus requirement for this third requirement of s 15-​2. Courts have also explicitly stated that, in general, it is much easier to meet s 15-​ 2’s nexus test where the taxpayer was legally entitled to the receipt compared to when the taxpayer has received a gift: Smith v FCT (1987) 19 ATR 274; FCT v Holmes (1995) 31 ATR 71. Nevertheless, it is still possible for gifts to pass the nexus requirements of s 15-​2 under certain factual scenarios.

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Case study 6.17: Employee receipt from employer as reward for studying assessable In Smith v FCT (1987) 19 ATR 274, Westpac introduced a scheme to encourage its employees to undertake study that it considered related to banking. Under this scheme, the employer would give the employees a certain dollar amount upon successful completion of every subject of an approved degree and an extra amount upon successful completion of that approved degree. At the time there were no tertiary fees so, in effect, the employees who received this money could use it for personal purposes. Smith was an employee who undertook approved study and received money under this scheme. The issue was whether the amount received under the scheme was assessable under the predecessor to s 15-​2, s 26(e) of ITAA 1936. The High Court held that the taxpayer’s receipt was assessable. Specifically, the Court addressed the nexus issue and said that there was a sufficient nexus with employment in this case. This was due to a combination of factors, the most important being that the scheme existed to increase employee productivity by encouraging them to be more highly educated. In addition, it was also an important fact that Smith was eligible for the scheme by being employed by the donor of the gift. The Court did not consider whether the gain would have been assessable as ordinary income, although it did state that it is easier for service-​related gains to be assessable under s 15-​2’s predecessor than to constitute ordinary income.  

Case study 6.18: Receipt of free tickets due to frequent flyer points lacks sufficient nexus As discussed in Case Study [6.16], Payne v FCT (1996) 32 ATR 516 involved a taxpayer who acquired frequent flyer points through work-​related travel and used them to acquire free Qantas tickets. The Federal Court held that

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this amount was not assessable under s 15-​2’s predecessor (s 26(e) of ITAA 1936) for two reasons. First, the second requirement of s 26(e) was not satisfied: see [6.210]. Second, the Court backed up its conclusion with another, more convincing reason. It said that this third requirement of s 15-​2’s predecessor was not satisfied because there was an inadequate nexus between the receipt of the free ticket and the services provided by the employee in her capacity as a KPMG employee. It was true that, had the taxpayer not provided services for KPMG, and thus not done the amount of work-​related travel, she would not have earned enough points for a free ticket. However, the Court stated that such facts were not enough to satisfy the nexus requirements of s 15-​2’s predecessor, even if its nexus test was more lenient than required for a gain to be ordinary income. The Court said that, on the facts, the free tickets were not a reward for the taxpayer’s services to KPMG, but rather a   reward for flying with Qantas.

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Case study 6.19: Receipt of reward money for helping to prevent was assessable In FCT v Holmes (1995) 31 ATR 71, the taxpayer was an employee on a shipping vessel which happened to be near a leaking oil tanker. The leaking oil tanker was heading towards the shore; this meant that there was a risk of the oil tanker losing most of its cargo and causing an environmental disaster. The taxpayer and some of his co-​workers were able to use the vessel they were on to tow the oil tanker out of danger. As a result of his effort, the taxpayer received a payment of $23,381 “salvage reward”. The entitlement to this reward was based on a principle in the law of Admiralty (laws relating to ocean vessels) that an owner of salvaged property must pay those that saved the salvaged property. The taxpayer would not have received the reward had the efforts of towing the oil tanker to safety been unsuccessful. The Full Federal Court held that the reward money was assessable under the predecessor of s 15-​2. It stated that there was clearly a nexus between the effort of the taxpayer in saving the oil tanker and the reward money. The Court stated that the fact that the taxpayer would not have received the money had the salvage been unsuccessful only strengthened the case for there being a nexus between the reward money and the services performed. In this case, the Court did not need to consider whether the reward constituted ordinary income, because the gain was assessable under

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s 15-​2’s predecessor. The predecessor of s 15-​2 considered in this case, unlike the current s 15-​2, did not exclude amounts that were also ordinary income. If this case were decided today, the Court would first consider if the gain was ordinary income, and then only if it decided that there was a chance that it was not ordinary income, would the Court then proceed to   apply s 15-​2.

Can compensation receipts be assessable under s  15-​2? [6.230]  Compensation paid to an employee takes on the form of what the employee is being compensated for: see [10.20]. This means that compensation for loss of salary is ordinary income and compensation paid for loss of the actual job or some of the rights related to that job is generally capital. Could some compensation payments that are not ordinary income be assessable under s 15-​2 of ITAA 1997? This issue was considered in the following two cases.

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Case study 6.20: Receipt of compensation payment mandated under legislation not assessable under predecessor of s 15-​2 In FCT v Inkster (1989) 20 ATR 1516, the taxpayer received compensation from his ex-​employer due to health problems resulting from asbestos exposure that had occurred during their previous employment relationship. This compensation payment was for the taxpayer’s loss of earning ability rather than for his loss of earnings. Furthermore, the payment was mandated and calculated under legislation that applied at the time. The Court held that the compensation was not assessable under the predecessor of s 15-​2 (s 26(e) of ITAA 1936). The Court stated that this was because the compensation payment was a mandatory payment made by the ex-​ employer to compensate the taxpayer for their loss of earning ability. The Court said that in contrast, if the compensation payment had been a discretionary payment that was paid to the taxpayer as a reward for his services, then the payment would have fallen under s 15-​2’s predecessor. However, it should be noted that a discretionary reward for services would be very likely to constitute ordinary income, and so would not be covered by s 15-​2 due to it excluding amounts that are ordinary income (s 15-​2(3)(d)). It is not totally clear how the Court would have treated a discretionary payment between the parties to compensate the taxpayer for his loss

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of earning capacity; however, the Court did appear to imply that such a payment would not be assessable under s 15-​2’s predecessor. It is also unclear how the Court would have treated a mandated payment that was for compensation for loss of earnings rather than loss of earning capacity. However, such a payment would constitute ordinary income (see [10.80]) and so the current s 15-​2 could not apply to it due to s 15-​2(3)(d).  

Case study 6.21: Tribunal finds that receipt of compensation payment for loss of fortnightly rostered day off assessable under predecessor of s 15-​2 In AAT Case 7752 (1992) 23 ATR 1057, the taxpayer was compensated by his employer for losing the right to have a day off every fortnight. The employer had unilaterally terminated the taxpayer’s right to have a fortnightly day off and had compensated him with three months’ salary paid over three instalments. The Tribunal held that, while not being ordinary income, this payment was assessable under the predecessor of s 15-​ 2, as the taxpayer’s employment was the cause of the payment. However, because this is an AAT Case, it is not a binding precedent on future Court decisions.

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Given the scarcity of Court decisions on the issue, it is unclear to what extent (if any) s 15-​2 will cover compensation payments paid to employees.  

Section 15-​2’s relationship with other tax provisions [6.240]  As discussed at [6.90], s 15-​2 of ITAA 1997 will not apply to gains that are ordinary income, and it is wider than ordinary income in that it has a more lenient nexus test and also applies to non-​cash convertible items. Section 23L(1) of ITAA 1936 also states that if a gain is a fringe benefit, it will not be assessable for income tax purposes. This means that gains that are fringe benefits will not be assessable as ordinary income or under any income tax provisions, including s 15-​2, and may instead be subject to FBT (which is not income tax). The precise definition of “fringe benefits” and details about the operation of FBT are discussed in Chapter 7. Note that, in general, most non-​cash benefits provided by an employer to an employee are fringe benefits. In some limited circumstances, cash payments by an employer to an employee would also be regarded as a fringe benefit.

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Example 6.6: Examples of the application of s 15-​2

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Because s 15-​2 of ITAA 1997 only applies to gains that are not ordinary income and not fringe benefits, this leaves it with limited application. Some examples of where s 15-​2 might still operate are: • the receipt of non-​cash convertible items as a reward for volunteer work. In such an instance, the gains would not be ordinary income as they are non-​cash convertible and they would not be fringe benefits because they have not been provided by an employer to an employee; • third-​party payments for employment or services that are not cash convertible, for example, the receipt of a free non-​transferrable holiday by an employee lawyer from a client of the law firm. Such receipts would not be assessable as ordinary income because they are not cash convertible. Furthermore, they would not be regarded as fringe benefits because they are not provided by an employer to an employee (if the employer has arranged for the third party to make this contribution to the employee, then it would be regarded as a fringe benefit and would be taxed under the fringe benefits regime: see Chapter 7); and • third-​party payments that are cash or cash convertible and have some nexus with employment or services, but do not have a strong enough nexus to constitute ordinary income. These would not be ordinary income due to their insufficient nexus with the services. Furthermore, they would not be fringe benefits as they are not provided by an employer to an employee.   

Section 15-​3:  Return-​to-​work payments [6.250]  Payments made to a taxpayer as an inducement to return to work or provide services will be assessable as statutory income under s 15-​3 of ITAA 1997. Section 15-​3 does not have a contrary intention, so it will potentially apply to payments that are also ordinary income. Example 6.7: Return-​to-​work payment Nadia works as a lawyer for a big law firm. She quits because she is unhappy with the management of the firm. The firm would like to re-​ employ Nadia and offers her a one-​off payment of $20,000 on top of her salary if she agrees to be re-​employed by the firm.

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If Nadia agreed to this and received the $20,000, this money would be assessable under s 15-​3.   

Payments upon termination of employment [6.260]  The principle that compensation payments take on the character of what is being compensated for is discussed at [10.20]. However, the compensation principle does not apply to payments connected with the termination of employment. In other words, where there is a payment connected to the termination of employment that falls under one of the termination provisions of the legislation, it does not matter whether the payment is compensation for income or capital, as legislation dictates how such payments are taxed. Depending on the precise nature of the termination payment, it may be statutory income (such as an employment termination payment (ETP)) or non-​ assessable income (such as genuine redundancy payments that are below a certain threshold). The main termination payments include: • ETPs: see [6.270] (for calculations on how ETP’s are taxed, see [6.370]); • genuine redundancy payments and early retirement scheme payments: see [6.320]; and • payments for unused annual and long service leave: see [6.390].

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Employment termination payment –​ Div 82 [6.270]  In general, an ETP is a payment given by an employer to the employee upon termination. Payments can potentially be ETPs whether they are made voluntarily, under industrial relations laws, under contractual obligations or for some other reason. Payments can also be ETPs whether they are a result of the employee resigning or the employer dismissing the employee, although some redundancy payments are not regarded as ETPs: see [6.340]–​[6.380]. There are two broad sub-​types of ETPs: 1. Life benefit termination payment: an ETP paid to the ex-​employee for his or her termination of employment. 2. Death benefit termination payment: a payment made after an employee has died. This payment is usually (although not necessarily) made to a relative of the former employee. [6.280]  Specifically, under s 82-​130 of ITAA 1997, a receipt is an ETP when it is a payment made in consequence of termination of employment. In other

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168 [6.290]  PRINCIPLES OF TAXATION LAW 2020 words, for a payment to be an ETP, it must be shown that the following three requirements have been satisfied: 1. there was a payment “in consequence” of the employment termination: see [6.290]; 2. there was in fact a genuine termination of employment: see [6.310]; and 3. the payment did not fall into one of the exclusions below. The following are specifically excluded from the definition of an ETP (ss 82-​130 and 82-​135): • superannuation payments (superannuation is subject to its own taxation regime); • pensions and annuities (pensions and annuities are usually taxable as ordinary income, although annuities are also subject to statutory provisions that usually reduce the tax payable on them: see [9.120]); • genuine redundancy payments or early retirement scheme payments, but only to the extent they are not above the relevant threshold (see [6.380]); and • a restraint of trade payment that is capital in nature: see [6.140]–​[6.180].

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The following payments are examples of ETPs: • An employer voluntarily makes a payment to an employee upon retirement (a life benefit termination payment). • An employer makes a payment (required by an industrial award) as a result of dismissing an employee for his or her unsatisfactory work (a life benefit termination payment). • An employer wrongly sacks an employee. The employee receives compensation in a successful unfair dismissal claim (a life benefit termination payment). • As a result of an employee’s death, the employer makes a payment to the employee’s spouse (a death benefit termination payment).

When is the payment “in consequence” of termination of employment? [6.290]  For a payment to be regarded as an ETP, it must be paid “in consequence” of termination of employment. At first glance this would appear to mean that the payment must be due to the employment relationship ending. However, causation is never a simple matter. For example, what is the cause of the payment to an employee of 10 years who resigns and is given a termination payment of $12,000 based on the number of years of service in accordance with the relevant industrial award? The $12,000 is the result of several factors:

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• the termination of employment; • the fact that the employee worked for that employer for 10 years; and • the terms of the relevant industrial award. Termination of employment is one of the causes of the payment, but it is not the only cause and probably not even the dominant cause. Case law on the words “in consequence of termination of employment” shows that termination of employment need only be one of the causes for the payment, and it need not be the dominant cause for the payment to be an ETP: Reseck v FCT (1975) 5 ATR 538; McIntosh v FCT (1979) 20 ATR 13.

Case study 6.22: Payment in consequence of termination of employment In Reseck v FCT (1975) 5 ATR 538, a construction worker worked on one construction site between 25 November 1969 and 24 September 1971 and on a second site between 27 September 1971 and 11 February 1972. Both of these jobs were for the same employer. At the end of each of the two work periods, Reseck received a severance payment, even though the gap between the first and second period of employment was just a weekend: see [6.310].

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For technical reasons, the Court had to accept that both terminations were genuine. The main issue for the Court was whether the payments were “in consequence” of termination of employment. The legislation being considered at the time had the requirement that the payment be in “in consequence” of termination of employment, which is the same as is required by the current ETP provisions. Two out of three judges in the Full Federal Court (Gibbs and Stephens JJ) decided that the payments were in consequence of termination of employment. Although the language of these two judges was different, they were in fact saying substantially the same thing. Gibbs J stated that “in consequence” of termination means that the payment was a result of termination of employment. His Honour also stressed that the termination need not be the only or even dominant cause of the payment. Here, the payments were a result of a number of factors, including the fact that the employee’s performance had been satisfactory, the industrial agreements and the employment terminations. However, the payments were still “in consequence” of termination of employment because the terminations were one of the causes of the payments. Stephens J stated that for the payment to be “in consequence of” termination of employment, it must “follow on” from the termination. Like Gibbs J, His Honour emphasised that the termination need not be the dominant cause of the payment.  

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Case study 6.23: Conversion of pension entitlement to lump sum “in consequence” of termination In McIntosh v FCT (1979) 20 ATR 13, the taxpayer had worked for a bank for many years. In those days compulsory superannuation was still a few decades away so most workers did not have superannuation accounts. However, the employer promised a private pension to some of its employees who had met the requirement of a minimum length of service. Under the terms of this entitlement, a retiring employee could convert part of the pension to a lump sum. McIntosh retired and was entitled to the bank pension and chose to convert half of it to a lump sum. The legislation at the time, like the current ETP provisions, applied where the payment was “in consequence” of termination of employment. Under the laws of the time, if the payment was “in consequence of termination of employment” the taxpayer would have had to pay some tax on the lump sum. If it was not, then the payment would have been tax free. The taxpayer argued that the payment was not in consequence of termination of employment because it was in consequence of the taxpayer’s decision to convert his pension to a lump sum. All three judges of the Full Federal Court (Brennan, Toohey and Lockhart JJ) disagreed and decided that the lump-​sum payment was “in consequence” of termination of employment. As in Reseck v FCT (1975) 5 ATR 538, the Court emphasised that retirement need not be the dominant cause of the receipt in order for the receipt to be considered to be “in consequence” of retirement. Brennan and Toohey JJ referred to Reseck v FCT and stated that for a payment to be “in consequence” of retirement there must be some connection between the retirement and the payment, although retirement need not be the dominant cause. All three judges stated that, while it was true that one of the causes of the payment was the taxpayer’s election to convert the pension to a lump sum, the payment was still “in consequence” of retirement. This was because if the taxpayer had not retired, the taxpayer would not have been able to receive the lump sum.  

Case study 6.24: Damages for unfair dismissal payment “in consequence” of termination of employment In Le Grand v FCT (2002) 51 ATR 139, the taxpayer worked as managing director with the Business Council of Australia (BCA). BCA terminated his employment and the taxpayer claimed that he had been wrongfully dismissed. He sued BCA for loss of wages, loss of reputation and some other related grounds, including the loss of opportunity to earn money

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elsewhere. The case was settled without going to court and the taxpayer was given nearly $550,000 in compensation. Goldberg J of the Federal Court held that this payment was “in consequence” of termination of employment. This was because there was sufficient connection between the compensation payment and the taxpayer’s termination. Like many of the judges in the previous cases, Goldberg J stated that for a payment to be “in consequence” of the termination of employment, the termination need not be the dominant cause of the payment.   [6.300]  These cases (at [6.290]) clearly illustrate the point that termination of employment need not be the only reason a payment is received for the payment to be considered “in consequence” of termination of employment. However, just because a payment is given shortly after retirement does not automatically mean that it is “in consequence of termination of employment”. In other words, although termination of employment does not have to be the only or a dominant cause of the payment, it still has to be one of the causes. The fact that employment termination and the payment happen at similar times is not enough to show causation between the payment and retirement, per Brennan J in McIntosh v FCT (1979) 20 ATR 13.

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Example 6.8: Post retirement payment not “in consequence” of retirement Three months before her retirement, Linda brings a new client to the firm, which has a large impact on the firm’s profitability. The firm voluntarily gives her a substantial bonus because of this and ends up paying it to her one month after her retirement. Linda would have received this bonus even if she had continued to work for the firm. Although the payment did occur shortly after her retirement, it would not be regarded as “in consequence” of her retirement and so would not be an ETP because the payment was for introducing the new client, not because of her retirement.   

Case study 6.25: Payment due to tax minimisation scheme not “in consequence” of employment termination In Freeman v FCT (1983) 14 ATR 457, the taxpayers worked for Company A, which provided engineering consulting services. The taxpayers were also shareholders and directors of Company A. The taxpayers wanted the business transferred from Company A to Company B, as Company B

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would be run through an entity that would allow for less tax to be paid. This meant that the taxpayers would then be employed by Company B, rather than Company A. To facilitate this transaction, the taxpayers lent money to Company B. Company B used this money to pay Company A for the purchase of the engineering business and Company A then paid the taxpayers certain sums of money. In other words, the money trail followed a circle and ended up where it started. It went from the taxpayers to Company B to Company A and then to the taxpayers. The taxpayers claimed that the money they received from Company A should be concessionally taxed as it was paid “in consequence” of termination of employment. The Full Federal Court unanimously held the payment was not “in consequence of” their employment ending. The Court stated that this was partially due to the fact that the payments from Company A were made almost 12 months after the taxpayers had ceased working for Company A. The Court also appeared to be highly influenced by the fact that the whole scenario was a very contrived arrangement to reduce the amount of tax payable, rather than a genuine redundancy payment for termination of employment.

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Note: This case should not be interpreted as meaning that a payment made 12 months after retirement cannot be “in consequence” of employment terminating, although it does indicate that, all other things being constant, the longer the time lag between retirement and payment, the less likely the payment will be “in consequence” of employment terminating.  

When is there a genuine termination? [6.310]  “Termination” is defined as including cessation of employment due to retirement, as well as cessation of employment due to the taxpayer’s death: s 80-​10 of ITAA 1997. In most cases, it will be clear whether there is a termination of employment. For example, where a taxpayer receives a payment upon his or her redundancy, there will have been a termination of employment. Where a worker dies and his or her spouse receives a payment, there will have been a termination of employment. However, in a limited number of cases, it might be unclear whether there has been a genuine termination. Case study 6.26: Fixed-​term position made permanent not regarded as “termination” In Grealy v FCT (1989) 20 ATR 403, a university lecturer was on a fixed-​ term contract. Before this contract ended, it was terminated and the

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lecturer was given a permanent position by the same employer. The Court held that there had not been a “termination” of employment.   Case study 6.27: Termination and re-​employment a few days later may not be genuine In the case of Reseck v FCT (1975) 5 ATR 538, discussed in Case Study [6.18], a construction worker had his job terminated on Friday and was re-​ employed the following Monday by the same employer, but on a different construction site. For certain legal reasons, the Court had to accept that the termination was genuine. All the Court was asked to do was to decide whether the payment was “in consequence” of a termination. The Court decided that it was. However, Gibbs J did indicate that he was sceptical that there was a genuine termination, but acknowledged that, for legal reasons, he had to accept that there was a genuine termination.  

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Genuine redundancy payments and early retirement scheme payments –​ Div 83 [6.320]  To the extent that genuine redundancy payments and early retirement scheme payments do not exceed the relevant threshold, they are excluded from being ETPs and are tax free: s 83-​170 of ITAA 1997. However, to the extent that they are over the relevant threshold, they will be regarded as forming part of an ETP and will be taxed as such.

What is a genuine redundancy payment? [6.330]  Under s 83-​175 of ITAA 1997, a genuine redundancy payment is a payment made to an employee due to his or her position being genuinely made redundant. However, this is limited to the extent that the payment exceeds the amount that could be reasonably expected to be received if that employee had voluntarily terminated his or her employment. Example 6.9: Redundancy payment Jane works for a bank. Jane was paid a genuine redundancy payout of $30,000. To the extent the $30,000 is under the relevant threshold (see [6.360]), it will be tax free.   

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What is an early retirement scheme payment? [6.340]  Under s 83-​180 of ITAA 1997, an early retirement scheme is a scheme that satisfies all of the following conditions: • The scheme is open to all of the employer’s employees who are in the group that the Commissioner states are entitled to participate in the scheme. • The employer’s purpose in having the scheme is to reorganise the operations in that workplace. • The Commissioner has approved the scheme as an early retirement scheme. However, only the portion of the payment that exceeds the amount that could be reasonably expected to have been received if that employee had voluntarily terminated his or her employment is regarded as an early retirement scheme payment. Example 6.10: Early retirement scheme payment

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Neil works as a production line worker for a clothing manufacturer. The clothing manufacturer closes part of its operations due to shifting production offshore. A likely scenario would be that: • the Commissioner in writing states that this is an early retirement scheme; and • all the production line workers on that production line are considered to be a group that should be eligible for the scheme; and • the purpose of the scheme is to reorganise the workplace in question. Subsequent to the Commissioner’s written approval, the employer offers all employees on that production line $25,000 if they take a redundancy package. This would be an early retirement scheme. To the extent that the $25,000 would be under the relevant threshold (see [6.360]), it will be tax free.   

Further conditions for redundancy payments and early retirement scheme payments [6.350]  Sections 83-​175 and 83-​180 of ITAA 1997 require that, for payments to be considered redundancy payments and early retirement scheme payments, as well as fulfilling the above conditions:

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• the employee must be dismissed before he or she reaches the age of 65; • the payment must represent what would be payable under a normal commercial arrangement; and • there must be no arrangement at the time of dismissal that the employee be re-​employed by the employer.

Threshold [6.360]  Redundancy payments and early retirement scheme payments are not ETPs and are tax free to the extent they are below the relevant threshold: s 83-​170 of ITAA 1997. To the extent they are above the relevant threshold, they will usually fall into the definition of ETPs and are taxed accordingly. The formula for determining the relevant threshold for any given taxpayer is: Base amount + (Service amount × Year / s of service)

The base amount and service amount are indexed every year. For the 2018–​ 2019 financial year, the amounts are $10,638 for the base amount and $5,320 for the service amount. Example 6.11: Taxation of redundancy payments

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Katie has worked for her employer for 11 years. She is made redundant and receives a payment of $90,000 on top of any annual and long service leave entitlements. Had she not been made redundant and resigned voluntarily, she would have been paid $10,000 under the relevant workplace policies (on top of any annual and long service leave entitlements). This means that, of the $90,000:

• $10,000 is not a redundancy payment because it would have been paid had Katie voluntarily resigned. It will be taxed as an ETP.



• The remaining $80,000 ($90,000 –​$10,000) is a genuine redundancy payment. The relevant threshold for Katie would be $10,638 + ($5,320 × 11) = $69,158. This means of the $80,000 genuine redundancy payment $69,158 would be tax free and the remaining portion of the redundancy payment of $10,842 ($80,000 –​$69,158), would be taxable as an ETP. Therefore, the total amount taxable as an ETP would be $22,842 ($10,000 + $10,842).   

Calculation of tax payable on ETP [6.370]  If there is an ETP, the next step is to calculate the amount of income tax payable on the ETP. The amount of tax payable will depend on whether

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176 [6.370]  PRINCIPLES OF TAXATION LAW 2020 the ETP is a life benefit termination payment or a death benefit termination payment. The difference is that a life benefit termination payment is an ETP given to a living taxpayer whose job has been terminated, whereas a death benefit termination payment is an ETP given to someone due to the death of another person (usually a relative): see [6.270]. For example, if a taxpayer resigns and receives a payout from her former employer of $30,000, it will be classified as a life benefit termination payment. An example of a death benefit termination payment would be where a taxpayer dies and the deceased’s employer pays his spouse $100,000 because of his death. Where the ETP is taxed at concessional rates the concession is facilitated by a tax rebate (offset) which effectively lowers the rate of tax. This rebate is used to reduce the final tax liability for the employee. An important effect of applying the concession through a tax rebate is that the total amount (less any tax-​free amount) will still be included in assessable income which can influence other tax components such as the Medicare Surcharge. An ETP will be taxed as follows: • Tax-​ free component: ss 82-​ 10(1), 82-​ 65(1) and 82-​ 70(1) of ITAA 1997. The tax-​free component will include the following amounts (s 82-​140): 1 The portion of the ETP that is attributable to pre-​ 1 July 1983 employment: s 82-​155. For example, if the taxpayer has worked for his employer from July 1980 to July 2010, it might be reasonable to assume that 10% of an ETP is due to his pre-​ 1 July 1983 employment and is tax free. This is because, of his 30 years of employment, three are due to the pre-​1 July 1983 period. Copyright © 2019. Thomson Reuters. All rights reserved.

2

The portion of an ETP that is due to a taxpayer’s invalidity, referred to in the legislation as an “invalidity segment”: s 82-​150. For example, if a taxpayer becomes permanently disabled due to a work injury, an ETP received as a result will be tax free. Specifically, the portion of an ETP that constitutes an “invalidity segment” is one: (a) that is paid to a taxpayer due to the taxpayer being unable to work because of his or her ill-​health; (b) where the taxpayer’s inability to work occurred before the age of 65; and (c) where two medical doctors certify that the taxpayer is unlikely to ever be able to be employed for the position that he or she is reasonably qualified to work.

Under s 82-​150(2), the legislation puts a limit as to what portion of the ETP can constitute an invalidity segment. This cap is based on how many years of employment income the taxpayer has lost due to his or her invalidity.

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• Taxable component: Any portion of the ETP that is not a tax-​ free component will be a taxable component: s 82-​145. How the taxable component is taxed depends on whether the ETP is a life benefit termination payment or a death benefit termination payment. The taxable component of a life benefit termination payment will be taxed at the rates shown in Table 6.1: s 82-​10. TABLE 6.1  Taxable component of life benefit termination payment ETP taxable component amount

Taxpayer is at preservation age or older: see Table 18.2

Taxpayer is below preservation age: see Table 18.2

0 = threshold

Taxed at normal marginal tax rates but capped at a rate of 15% plus 2% Medicare levy

Taxed at normal marginal tax rates but capped at a rate of 30% plus 2% Medicare levy

Amounts over the threshold

Taxed at 45% plus 2% Medicare levy

Taxed at 45% plus 2% Medicare levy

The threshold applied in Table 6.1 will be the lower of the following two amounts (s 82-​10(4)): • $210,000: This figure is indexed annually and is correct for the 2019–​ 2020 financial year.

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• A $180,000 “whole-​of-​income cap” which is reduced by any non-​ETP taxable income of the taxpayer. This figure is fixed by legislation and not annually indexed. Furthermore, this amount cannot be reduced below zero. However, this threshold is unaffected by and is inapplicable to any of the following excluded amounts (s 82-​10(6)): –​ Genuine redundancy payments: see [6.330]. This includes payments that are not strictly speaking genuine redundancy payments because the taxpayer is 65 or over, but would have been genuine redundancy payments had the taxpayer been under 65. Note that this particular exclusion applies to the full genuine redundancy payment, not only the part which is under the threshold discussed in [6.360]. –​ Early retirement scheme payments: see [6.340]. This includes payments that are not strictly speaking early retirement scheme payments because the taxpayer is 65 or over, but would have been early retirement payments had the taxpayer been under 65. Note that this exclusion applies to the full early retirement scheme payment, not only the part which is under the threshold discussed in [6.360]. –​ An amount that includes an invalidity segment: see the earlier discussion in this paragraph. This includes payments that are not

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178 [6.370]  PRINCIPLES OF TAXATION LAW 2020 strictly speaking invalidity segments because the taxpayer is 65 or over, but would have been an invalidity segment had the taxpayer been under 65. –​ Compensation received due to employment disputes relating to personal injury, harassment, discrimination or unfair dismissal to the extent that such amount exceeds what the employee would have received had they voluntarily resigned in the absence of such a dispute. –​ Death benefit payments: see the earlier discussion in this paragraph. However, note that if the taxpayer receives an ETP that has both excluded and non-​ excluded components, the taxpayer is deemed to have received the excluded component first (s 82-​10(7)) and considered only against the $210,000 cap. Also, because both non-​excluded and excluded amounts have been received, it is necessary to determine whether the $210,000 or the $180,000 caps apply to the non-​excluded ETPs. Therefore, the $210,000 cap is first reduced by any excluded amount that has already been applied against this cap (s 82-​10(4)). An important effect of these rules is that the total amount of an ETP payment that is capped at the lower rate (15% or 30%, depending on age, plus Medicare levy) will not exceed $210,000: see Example 6.16. Example 6.12: ETP calculation

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Nick aged 53 (under preservation age) resigns from his work and receives a payment of $50,000. He has already earned $160,000 in salary and investment income for the financial year. The full $50,000 is regarded as an ETP. Although the $50,000 is less than the $210,000 threshold, the $180,000 “whole-​of-​income cap” must be reduced by the $160,000 taxable income (from salary and investment income) that Nick has received, meaning that the cap is in effect only $20,000 ($180,000 –​$160,000). Since this $20,000 cap is less than the $210,000 threshold, the $20,000 cap is the one that applies. This means that the first $20,000 of Nick’s ETP will be capped at the tax rate in Table 6.1 at 30% plus Medicare levy (as Nick is under preservation age). The remaining $30,000 will be taxed at 45% plus Medicare.   

Example 6.13: ETP calculation Nathan is 51 (under preservation age) and made redundant from his employment in a bank where he has been working for 11 years. He receives a redundancy payment of $159,158 in the current year on top of his annual and long service leave entitlements. Had he resigned voluntarily, he would have received only $30,000 (on top of his annual

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and long service leave entitlements), leaving the rest of the payment as a genuine redundancy payment under s 83-​175. For the financial year so far, Nathan received a salary of $250,000 and did not have any deductions. Nathan’s termination payment can be viewed as consisting of the following amounts:

• $30,000 is an ETP as he would have received this amount if he resigned and was not made redundant.



• $129,158 ($159,158 –​$30,000) balance is a genuine redundancy payment and not an ETP. As he has been working in this job for 11 years, $69,158 ($10,638 + ($5,320 × 11)) of this is tax free (see [6.360]). The remaining $60,000 ($129,158 − $69,158) is taxable as an ETP, though it is still regarded as a genuine redundancy payment.

The total amount regarded as an ETP is therefore $90,000 ($30,000 + $60,000).

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The $60,000 portion of the ETP is an excluded amount due to it being a genuine redundancy payment. Consequently, it is deemed to have been received first (s 83-​10(7)). As it is an excluded amount, the “whole-​of-​ income cap” does not apply to it, and only the $210,000 threshold will be relevant. As the $60,000 is less than the $210,000 threshold, the amount of tax on the $60,000 is capped at 30% plus Medicare levy because Nathan is under his preservation age (as, below the preservation age): see Table 6.1. In addition, the $30,000 portion of the ETP will potentially be subject to both thresholds. First, the $180,000 “whole-​of-​income cap” is reduced (but not below zero) by the $250,000 salary he received for the financial year, meaning that this cap becomes zero. Second, the $210,000 threshold will be reduced by the $60,000 portion of the ETP payment (genuine redundancy excluded amount that is not tax free) reducing it to $150,000. Since the “whole-​of-​income cap” amount of zero is the lower of the two, it will be the applicable threshold. This means that the whole $30,000 amount will have breached this threshold and so will be taxed at the rate of 45% plus Medicare levy: see Table 6.1.   

Example 6.14: ETP calculation Amelia works for a major department store and is 61 years of age (above preservation age). She resigns and receives a payout of $178,000, and she has $5,000 of salary income for the financial year. The full $178,000 is regarded as an ETP.

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180 [6.370]  PRINCIPLES OF TAXATION LAW 2020

The $180,000 “whole-​ of-​ income cap” is reduced to $175,000 as Amelia has earned other income ($5,000) for the financial year. As the $175,000 “whole-​of-​income cap” is lower than the $210,000 threshold, the $175,000 threshold will apply. This means that the first $175,000 of Amelia’s ETP is capped at 15% plus Medicare levy (as, she is over the preservation age). The remaining $3,000 is taxed at the rate of 45% plus Medicare levy: see Table 6.1.   

Example 6.15: ETP calculation William is 48 (under preservation age) and works for a car importer. He loses his job and initially receives $65,000 from his employer for ceasing employment (this did not qualify as a genuine redundancy termination payment). This $65,000 is on top of his annual and long service leave entitlements. He then sues his employer for unfair dismissal, is successful, and so receives damages of an additional $100,000. William has received other taxable income for the financial year (his salary) of $150,000. The full $165,000 ($65,000 + $100,000) is considered an ETP.

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The $100,000 is excluded from the $180,000 “whole-​of-​income cap” as it is compensation for unfair dismissal. Consequently, it is deemed to have been received first (s 83-​10(7)), and only needs to be applied against the $210,000 threshold. As the $100,000 is below the $210,000 threshold it would be capped at 30% plus Medicare levy: see Table 6.1. The $65,000 portion of the ETP will be offset against the lower of the two thresholds. First, the “whole-​of-​income cap” is reduced from $180,000 to $30,000 due to the non-​ ETP taxable income of $150,000. Second, the $210,000 threshold is reduced by $100,000 to $110,000 due to the $100,000 portion of the ETP. As the $30,000 is the lower of these two amounts, this is the threshold that would be applicable to the $65,000 portion of the ETP. This means that $30,000 of the $65,000 is capped at 30% plus Medicare levy, whereas the remaining $35,000 would be taxed at the top tax rate: see Table 6.1.   

Example 6.16: Redundancy payment Mia is 66 (above preservation age) and works for an electronic parts distributor. Due to illness, she becomes unable to work and resigns. Her work pays her $60,000 which is what she would have received had she resigned under any situation (this $60,000 is on top of her annual and long service leave entitlements), and an additional $160,000 as an invalidity

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payment. Before her illness Mia had earned taxable income of $70,000 (her salary) for the financial year. Although the full $220,000 ($160,000 + $60,000) is regarded as an ETP, the $160,000 invalidity payment is excluded from the “whole-​of-​income cap”. This is despite the fact that none of the invalidity payment is tax-​free due to Mia being 66 years old (over 65). The $160,000 excluded portion of the ETP is dealt with first as it is deemed to have been received first (s 83-​10(7)) and only needs to be tested against the $210,000 threshold. As the $160,000 is below the $210,000 threshold, it is capped at the rate of 15% plus Medicare levy: see Table 6.1. The remaining $60,000 is potentially subject to the two thresholds. First, the “whole-​of-​income cap” is reduced from $180,000 to $110,000 due to the $70,000 salary. Second, the $210,000 threshold is reduced due to the $160,000 portion of the ETP being offset against it. This will mean that the $210,000 threshold is reduced by the $160,000 to $50,000. As $50,000 is the lesser of these two thresholds, it will be the relevant amount. Consequently, $50,000 of the $60,000 will be capped at 15% plus Medicare levy, and the remaining $10,000 will be taxed at 45% plus Medicare: see Table 6.1.   

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[6.380]  Taxation of the taxable component of a death benefit termination payment depends on whether the recipient of the payment is a “dependent” of the deceased. Under s 302-​195 of ITAA 1997, the recipient will be a dependent if he or she is: • the deceased’s spouse or ex-​spouse (spouse will also include de facto and same-​sex partners in some circumstances); • the deceased’s child who is under 18; • a person who had an “interdependency relationship” with the deceased. This means someone who the deceased lived with and had a close personal relationship with. Furthermore, for someone to show he or she had a “interdependency relationship” with the deceased, it is also required that at least one of the parties involved provided financial support and at least one of the parties involved provided domestic support; or • anyone else dependent on the deceased before he or she died (this would cover financial dependence). The taxable component of a death benefit termination payment is taxed at the rates shown in Table 6.2: ss 82-​65 and 82-​70. The $210,000 threshold in Table 6.2 is indexed annually and is correct for the 2019–​2020 financial year.

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182 [6.390]  PRINCIPLES OF TAXATION LAW 2020 TABLE 6.2  Taxable component of death benefit termination payment ETP taxable component amount

Recipient is a dependent

Recipient is not a dependent

$0–​$210,000

Not taxed, except for 2% Medicare levy where applicable

Taxed at normal marginal tax rates but capped at a rate of 30% plus 2% Medicare levy

$210,000+

Taxed at 45% plus 2% Medicare levy

Taxed at 45% plus 2% Medicare levy

Payments for unused annual and long service leave –​ Div 83 [6.390]  When an employee has his or her employment terminated, it is normal for the employee to receive a lump-​ sum payment for any annual (holiday) leave and long service leave owing to the employee. These receipts are assessable as statutory income under s 83-​10 of ITAA 1997 for the annual leave payments and s 83-​80 for the long service leave payments. In many cases, these provisions provide no tax concession as the annual leave and long service leave payments are taxed at normal marginal tax rates. However, under some limited circumstances, a concession in the form of the payments being capped at the rate of 30% (plus Medicare levy) will apply. Under s 83-​ 15 of ITAA 1997 (for annual leave) and s 83-​85 of ITAA 1997 (for long service leave), this will be the case when:

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• the payment was due to annual leave or long service leave accrued due to services performed before 18 August 1993; or • the payment was in connection with a payment that consists of a genuine redundancy payment or early retirement scheme payment, or an invalidity segment of an ETP. Also, only 5% of any leave accrued prior to 16 August 1978 is subject to tax (s 83-​80). Example 6.17: Annual and long service leave payment Jack has worked for his current employee since January 2000 and he resigns voluntarily. Under the relevant industrial award, he is entitled to receive $10,000. Furthermore, he receives $12,000 in annual and long service leave owing to him. The $10,000 will be assessable as a life benefit termination payment (a type of ETP) and the $12,000 in leave entitlements will be assessable at normal marginal tax rates.   

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Example 6.18: Genuine redundancy and annual leave payment Jill has worked for her current employee for three years and is made redundant. She receives a genuine redundancy payment of $6,000, as well as an ETP of $10,000. She also receives a $9,000 payment for annual leave that is owed to her: • The $6,000 will be tax free because it is below the maximum tax free amount of $25,999 ($10,399 + ($5,200 × 3)). • The $10,000 will be taxed as a life benefit termination payment (ETP). • The $9,000 will be subject to normal marginal tax rates, but will be capped at the rate of 30% (plus Medicare levy) because it was paid in connection with a genuine redundancy payment.   

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Questions [6.400]  6.1 During the current tax year, Erin received the following amounts: • Salary and wages income of $98,000. • $4,200 interest from a bank term deposit of $50,000. • $500 per week for 50 weeks of the year from a rental property she owns. • Winnings of $10,000 on the poker machines. • $500 from selling eggs that her chickens laid to friends. • A holiday bonus of $1,000 from her employer. • A watch worth $200 from a happy client. What is Erin’s ordinary income for the current tax year? 6.2 Jane and Sally are employed school teachers who have a very wide general knowledge. Both decide to enter a television quiz program called “Lease of the Decade”. Under the rules, contestants receive $100 for each appearance, but if questions are answered correctly, they receive substantial cash prizes and other prizes, such as household items and holiday packages. The holiday packages cannot be transferred or redeemed, but the organisers of the program allow them to be converted into alternative venues and accommodation. Jane and Sally go on the show but Jane is eliminated in the first contest and receives her $100. Sally, however, makes 10 appearances. She

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184 [6.400]  PRINCIPLES OF TAXATION LAW 2020 wins cash prizes of $50,000, household appliances worth $20,000 and a trip to Europe with her family valued at $30,000. Discuss the assessability of these prizes. 6.3 Hilary is a well-​known mountain climber. The Daily Terror newspaper offers her $10,000 for her life story, if she will write it. Without the assistance of a ghost writer, she writes a story and assigns all her right, title and interest in the copyright for $10,000 to the Daily Terror. The story is published and she is paid. She has never written a story before. She also sells the manuscript to the Mitchell Library for $5,000 and several photographs that she took while mountain climbing for which she receives $2,000. Discuss whether or not the three payments are income from personal services. Would your answer differ if she wrote the story for her own satisfaction and only decided to sell it later? 6.4 George is manager of Newcastle Steel Ltd. His contract is for 10 years. In the third year, George enters into a restrictive covenant which provides that during the remainder of his contract he must not reveal to another party the confidential information of his employer. It further provides that he must not work for a competitor during the remainder of the employment agreement. Consideration for entering into the agreement is $40,000. Is this capital or income in George’s hands?

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6.5 A well-​known television personality was paid a lump sum of $400,000 to encourage her to join a new television network. She accepted the offer and received an annual salary of $100,000 in addition to the lump-​ sum payment. Discuss whether both the $400,000 and the $100,000 receipts are assessable income. 6.6 Consider the following situations and discuss whether or not they are income in ordinary concepts: • A cash prize for being the best student in income tax law received by a student who also receives a Youth Allowance from the government. • A gratuity (not being superannuation) received by a widow from her husband’s former employer in recognition of her husband’s services. • An honorarium received by a student for acting as honorary secretary of a small country town football club. • A bonus received by an employee for a suggestion adopted by the management. 6.7 Jane teaches company law at a regional university. For many years she has had a passionate interest in amateur theatricals. She has performed with several local groups. On 30 December Arthur asked

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Jane if she would be interested in performing in the next production of the group with which he performs. Jane, who has several weeks free from performing, eagerly agrees. Jane has only worked with this group once before, six years ago. After the last performance, Charles, the producer of the play, handed Jane an envelope which she assumes contains a thank-​you card for performing in the play. Jane opened the envelope late the next morning and discovered that, in addition to a thank-​you card, there is a cheque for $49.28 for participating in the production. Jane has never before been paid for appearing in any of the 60 productions in which she has been involved. Jane endorsed the cheque to her landlord as part-​payment of her rent. Advise Jane of her income tax liability with respect to $49.28. 6.8 Frederick has been out of work for the past five years, and he has been using the Findjobs Ltd employment agency for the past 12 months to find employment. In April of this year a new case manager, Albert, was given the task of finding Frederick a job. In a matter of 10 days Albert had Frederick a permanent job. In gratitude, Frederick bought a $1,000 gold watch (it was a very good job he landed) and gave it to Albert as a mark of his appreciation. Advise Albert as to whether this gift is assessable income. 6.9 Nadia is an accountant in a large accounting firm. She is on a three-​ year contract, which still has two years to go. Her official job title is “Manager” and under her contract she is entitled to her own private office. • Nadia is offered $6,000 if she changes her job title to “Senior Accountant”, with no change in pay or length of the contract. She is also offered $4,000 by her employer if she agrees to give up her private office. She agrees to this. • Advise Nadia as to her income tax liability with respect to the $6,000 and $4,000 payments. 6.10 Dan is made redundant from his job that he has been working for four years and receives $50,000 as a genuine redundancy termination payment. Before the redundancy, Dan had earned $120,000 for the tax year. Advise Dan as to the tax implication of receiving the $120,000. 6.11 Bev is dismissed from her job and receives a $80,000 redundancy amount (not a genuine redundancy termination payment). She then sues her ex-​employer for unfair dismissal and settles for $140,000. As the dismissal was early on in the tax year, she had only received $20,000 in salary for the year. Advise Bev as to the tax implications of the receipts of the $80,000 and $140,000 amounts.

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7 Fringe benefits tax

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Key points......................................................................................................  [7.00] Introduction..................................................................................................  [7.10] Definition of fringe benefit...........................................................................  [7.20] Benefit ....................................................................................................  [7.30] Provided during the year of tax.............................................................  [7.40] Employer, associate or third-​party arranger.........................................  [7.50] Employee or associate...........................................................................  [7.60] In respect of the employment of the employee...................................  [7.70] Exclusions......................................................................................................  [7.80] Categories of fringe benefits.......................................................................  [7.90] Car fringe benefits –​Div 2....................................................................  [7.100]

Exempt benefits.......................................................................................  [7.110] Taxable value...........................................................................................  [7.120] Debt waiver fringe benefits –​Div 3.....................................................  [7.150] Taxable value...........................................................................................  [7.160] Loan fringe benefits –​Div 4.................................................................  [7.170] Exempt benefits.......................................................................................  [7.180] Taxable value...........................................................................................  [7.190] Expense payment fringe benefits –​Div 5...........................................  [7.200] Exempt benefits.......................................................................................  [7.210] Taxable value...........................................................................................  [7.220] Meal entertainment fringe benefits –​Div 9A......................................  [7.230] Taxable value...........................................................................................  [7.240] Property fringe benefits –​Div 11.........................................................  [7.250] Exempt benefits.......................................................................................  [7.260] Taxable value...........................................................................................  [7.270] Residual fringe benefits –​Div 12.........................................................  [7.280] Exempt benefits.......................................................................................  [7.290] Taxable value...........................................................................................  [7.300] Exempt fringe benefits...............................................................................  [7.310] Minor benefits –​s 58P..........................................................................  [7.320] Work-​related items –​s 58X..................................................................  [7.330]

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188 [7.00]  PRINCIPLES OF TAXATION LAW 2020 Membership fees and subscriptions –​s 58Y......................................  [7.340] Single-​trip taxi travel–​s 58Z................................................................  [7.350] Reductions in taxable value.......................................................................  [7.360] In-​house fringe benefits.......................................................................  [7.370] Recipient’s contribution.......................................................................  [7.380] Otherwise deductible rule....................................................................  [7.390] Type of fringe benefit.................................................................................  [7.400] Fringe benefits taxable amount.................................................................  [7.410] FBT liability.................................................................................................  [7.420] Interaction with income tax.......................................................................  [7.430] Employer..............................................................................................  [7.430] Employee..............................................................................................  [7.440] Interaction with GST..................................................................................  [7.450] Questions.....................................................................................................  [7.460]   

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Key points [7.00]  • Fringe benefits tax is a different type of tax as it is imposed on the provision of fringe benefits, rather than the derivation of income. • Liability for fringe benefits tax is imposed on employers, not employees. • A “fringe benefit” arises where an employer provides an employee with a benefit, directly or indirectly, and the benefit is provided due to the employment relationship. • There are 13 categories of fringe benefits, and the calculation of the fringe benefits tax liability arising in relation to a particular fringe benefit will depend on its category. • A number of benefits do not attract fringe benefits tax because they are either excluded from the definition of “fringe benefit” or specifically made exempt by the fringe benefits tax legislation. • Fringe benefits tax paid by an employer and the cost of providing a fringe benefit are generally deductible to the employer for income tax purposes. • The receipt of fringe benefits by an employee is either exempt or non-​ assessable, non-​exempt income to the employee.

Introduction [7.10]  The introduction of a fringe benefits tax (FBT) was announced by then Treasurer, the Hon Paul Keating, on 19 September 1985 and came into effect on 1 July 1986. FBT was introduced to tax the provision of fringe benefits

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(ie, benefits other than salary) by employers to employees. At the time it was estimated that almost 20% of the total remuneration of senior white-​collar employees comprised benefits other than salary: Reform of the Australian Tax System, Draft White Paper (AGPS, Canberra, 1985) at 96. The introduction of s 26(e) of ITAA 1936 (now s 15-​2 of ITAA 1997) (see [6.190]–​[6.240]) was inadequate in capturing all non-​ cash benefits provided by employers to employees within the tax system. In particular, the section did not capture benefits provided to associates of employees (eg, spouses) and included in the employee’s assessable income “the value to the taxpayer” of the benefit, which is a subjective assessment. As will be seen, the FBT regime has a very wide scope and captures all benefits provided in an employment context. It is through the exclusions (see [7.80]) that some employment benefits, such as salary, are subject to income tax in the employee’s hands. There are also a number of exemptions that exclude certain employment benefits from tax altogether. FBT is a different type of tax in that it is a tax that is imposed on the provision of fringe benefits, rather than the derivation of income. As discussed in Chapter 3, separate legislation is required for the imposition of different taxes. The provisions regarding FBT are contained in the Fringe Benefits Tax Assessment Act 1986 (Cth) (FBTAA) and the Fringe Benefits Tax Act 1986 (Cth).

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A key difference between income tax and FBT is the taxpayer. FBT is imposed on the employer, not the employee: s 66(1) of FBTAA. As such, tax is imposed on the provision of fringe benefits, not on the receipt of them. The imposition of FBT on the employer rather than the employee reduces the administrative burden as there are far fewer employers than employees. A second difference between the FBT system and the income tax system is the tax year. Unlike the income tax year, which is from 1 July to 30 June, the FBT year is from 1 April to 31 March: see definition of “year of tax” in s 136(1) of FBTAA. The very first FBT year was a transitional year of only nine months for the period 1 July 1986 to 31 March 1987. The different FBT year spreads the tax compliance burden to a different time in the year, ensuring that taxpayers and tax agents are able to meet their income tax and FBT obligations in a timely manner. The FBT legislation adopts a largely prescriptive and methodical approach to determining the FBT consequences of a transaction. For example, the legislation specifies what constitutes a fringe benefit, whether or not it is subject to FBT, the value of the fringe benefit for FBT purposes and the method of calculating the FBT liability. This step-​by-​step approach should be adopted when determining the FBT consequences of a transaction. Figure 7.1 provides an overall guide to dealing with the tax consequences arising on the provision of fringe benefits.

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190 [7.10]  PRINCIPLES OF TAXATION LAW 2020

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Figure 7.1: Overall FBT guide

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Definition of fringe benefit [7.20]  The term “fringe benefit” is defined in s 136(1) of FBTAA and is central to the imposition of FBT. The first part of the definition provides that a fringe benefit exists, where there is: • a benefit: see [7.30]; • provided during the year of tax: see [7.40]; • by an employer, associate or third-​party arranger: see [7.50]; • to an employee or an associate: see [7.60]; • in respect of the employment of the employee: see [7.70]. This very broad definition of “fringe benefit” essentially captures all benefits provided by an employer to an employee, whether or not the benefits are convertible to money. Importantly, the definition then excludes a number of specific employment benefits (such as salary) from being “fringe benefits”: see [7.80]. Note that FBT only applies to benefits received in an employment context. Any benefits provided in the context of other working arrangements, such as where independent contractors are engaged or partners in a partnership, will fall outside the scope of FBT.

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Benefit [7.30]  The term “benefit” is defined in s 136(1) of FBTAA and includes any right, privilege, service or facility provided under an arrangement in relation to the performance of work. This definition is very wide and is likely to capture most benefits provided by an employer to an employee, whether of a monetary or non-​monetary nature. As we will see at [7.90], the legislation identifies a number of specific categories of fringe benefits (such as private use of an employer-​ provided car and loans) but there is an important final category, residual benefits (see [7.280]), which captures any benefits that do not fall within the specific categories and ensures the broad scope of the term “benefit”. Section 6 of FBTAA confirms this by providing that the specific categories of fringe benefits do not limit the generality of the expression “benefit”. While the scope of the term “benefit” is certainly broad, it is not unlimited. In Slade Bloodstock Pty Ltd v FCT (2007) 68 ATR 911 (see Case Study [7.4]), the Full Federal Court suggested that, where an employee makes a loan to an employer, the repayment of the loan by the employer to the employee, in whole or in part, is unlikely to constitute a “benefit” (to the employee) under

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192 [7.40]  PRINCIPLES OF TAXATION LAW 2020 the definition of “benefit” in s 136(1) which includes a right, benefit, privilege, service or facility that is provided under an arrangement for, or in relation to, the lending of money.

Provided during the year of tax [7.40]  FBT is imposed annually and tax is imposed on fringe benefits provided during, or in reference to, a particular FBT year –​that is, 1 April to 31 March. The term “provide” is defined in s 136(1) of FBTAA. In relation to benefits, it includes “allow, confer, give, grant or perform” and, in relation to property, the disposal of a beneficial interest in or legal ownership of the property. This definition is generally consistent with the common meaning of the term. A benefit may also be deemed to be provided, where the benefit is prohibited but the prohibition is not consistently enforced: s 148(3). For example, where an employee is prohibited from using an employer-​provided car for private purposes but the employer “turns a blind eye”, the private use of the car is a fringe benefit (see [7.100]) deemed to be provided by the employer per s 148(3). Section 148(4) further specifies that a benefit that is received or obtained by an employee in respect of employment is deemed to be “provided”. This ensures that fringe benefits that are supplied to an employee by a party other than the employer (see [7.55]–​[7.58]) are nonetheless “provided” by the employer.

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Case study 7.1: Meaning of “provide” In Westpac Banking Corporation v FCT (1996) 34 ATR 143, Hill J considered the meaning of “provide” in an FBT context. The taxpayer usually charged its customers a loan establishment fee when entering into a loan arrangement. However, the fee was waived in the case of loans made to employees. The taxpayer argued that the definition required a positive act for a benefit to be “provided”. The non-​imposition of a fee could not be said to be a benefit “provided” by the taxpayer. The Federal Court accepted the Commissioner’s argument that the taxpayer had “provided” its employees with a benefit –​that is, the review and assessment of the employee’s loan application for no fee.  

Employer, associate or third-​party arranger [7.50]  “Employer” is defined in s 136(1) of FBTAA as a person who pays, or is liable to pay, “salary or wages”. “Salary and wages” is discussed at [7.85]. Section 137 ensures that the FBT legislation applies in situations where there is a clear employment relationship, but the employee is remunerated with

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7: FrinGe Benefits tax  [7.55] 193

non-​cash benefits instead of salary or wages. In other words, an employer cannot escape being an “employer” under the FBT legislation by not paying an employee salary and wages but providing non-​cash benefits instead. The definition includes current, former and future employers, but excludes the Commonwealth or an authority of the Commonwealth. A “future employer” is a person who will become a current employer, while a “former employer” is a person who has been a current employer: s 136(1). The scope of past and future employment relationships is discussed further at [7.60] in the context of the definition of “employee”. [7.55]  It is important to note that a benefit does not have to be provided by an employer to an employee directly to qualify as a fringe benefit. Benefits provided by an associate of the employer may also qualify as a fringe benefit provided by the employer. The definition of “associate” in s 136(1) refers to s 318 of ITAA 1936 and s 159 of FBTAA.

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Where the employer is a “natural person”, the employer’s associates include: • relatives; • a partner of the employer and their spouse or child; • a partnership in which the employer is or was a partner; • trustees of trusts where the employer or the employer’s associates may be a beneficiary; and • companies formally or informally controlled by the employer (formal control refers to a majority voting power in the company while informal control refers to situations where the directors of a company usually act in accordance with the employer’s directions). “Relative” is defined in s 995-​1 of ITAA 1997 as a person’s spouse or that person’s parent, grandparent, sibling, uncle, aunt, nephew, niece, lineal descendant or adopted child of that person or that person’s spouse. The spouse of any of these people is also a relative. “Spouse” is defined in s 995-​1 to include de facto and same sex relationships. Where the employer is a “company”, its associates include:

• a partner (and their spouse or child if the partner is a natural person); • a partnership in which the employer is or was a partner; • companies which formally or informally control the employer; • companies which are formally or informally controlled by the employer; and

• sister companies (ie, companies with the same parent company). Section 159 specifies when authorities of the Commonwealth, a State or Territory are associates.

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194 [7.58]  PRINCIPLES OF TAXATION LAW 2020

Example 7.1: Fringe benefits from associates Company A and Company B are part of the same wholly-​owned group, that is, they are owned by the same parent company. Jack is an employee of Company A. Under the terms of his employment contract, he is entitled to a 25% discount on goods purchased from Company B. The provision of the goods at a discount by Company B qualifies as a fringe benefit provided by Jack’s employer (Company A) to Jack, as Company B is an associate of Company A under s 318 of ITAA 1936.   

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[7.58]  Fringe benefits can also be provided by an employer to an employee indirectly through third-​ party arrangements. Although the benefit is provided to the employee by a third party, it qualifies as a fringe benefit from the employer to the employee where the third party does so under an arrangement with the employer. Note that the employer must “participate in or facilitate the provision or receipt of the benefit” for the benefit to qualify as a fringe benefit: see para (ea) of the definition of “fringe benefit” in s 136(1) of FBTAA. Paragraph (ea) was introduced following Payne v FCT (1996) 32 ATR 516: see Case Studies [6.16] and [6.18]. In Ruling TR 1999/​6, the Commissioner confirms that frequent flyer points earned by an employee for work-​related travel do not constitute a fringe benefit as they have not been provided by an employer, associate of the employer or a third-​party arranger. The frequent flyer points do not arise out of an arrangement entered into by the employer with the airline, but are due to a private arrangement between the employee and the airline. Example 7.2: Fringe benefits from a third party Big Bank waives the home loan application fees for all university employees and provides them with a discount of 0.5% on the home loan rate it offers all other customers. It waives the application fee as it considers university employees “low risk” and it provides the discounted home loan rate due to an arrangement with the university whereby, in return, the university agreed to deal exclusively with Big Bank. The waiver of loan application fees does not qualify as a fringe benefit as it does not arise through an arrangement between Big Bank and the university but is a unilateral action by Big Bank. The provision of the discounted home loan rate qualifies as a fringe benefit provided by the university to its employees as it arises under an arrangement between Big Bank and the university and has therefore been facilitated by the university.   

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7: FrinGe Benefits tax  [7.65] 195

Example 7.3: Fringe benefits from third party under arrangement Jack is an employee of Company A. Under the terms of his employment contract, he is entitled to a discount for goods purchased from various retailers, such as Coles and Woolworths, pursuant to agreements in place between Company A and those retailers. The provision of goods at a discount by Coles and Woolworths qualifies as a fringe benefit provided by Jack’s employer (Company A) to Jack as the discount has been provided pursuant to an arrangement between Company A and the retailers.    As mentioned at [7.40], s 148(4) ensures that fringe benefits that are supplied by an associate of the employer or a third party are nonetheless “provided” by the employer for the purposes of the FBT legislation. In this chapter, any reference to the provision of fringe benefits by an employer is intended to also include the provision of fringe benefits by associates of the employer or third-​ party arrangers.

Employee or associate

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[7.60]  An “employee” is someone who receives salary and wages and includes current, former and future employees: s 136(1) of FBTAA. The term “salary and wages” is discussed at [7.85]. A “future employee” is a person who will become a current employee, while a “former employee” is a person who has been a current employee: s 136(1). The extension of the definition of “employee” to cover former and future employees ensures that benefits provided prior to the commencement of employment (eg, sign-​on bonuses) or provided to former employees as a result of the former employment relationship (eg, low interest loans) are captured by the FBT legislation. In Ruling MT 2016, the ATO confirms that a person will only qualify as a future employee if it can be said that the person will (not may) become an employee at the time the benefit is provided. [7.65]  A fringe benefit can also arise where the benefit is not provided to an employee directly, but to an associate of an employee. This aspect of FBT overcomes a limitation of s 15-​2 of ITAA 1997 (previously s 26(e) of ITAA 1936), which only captures the provision of benefits to an employee directly. The meaning of “associate” was discussed at [7.55]. A person will also be deemed to be an “associate” of the employee, where a benefit is provided to the person due to an arrangement between the employer and the employee: s 148(2). For example, where a benefit is provided to a friend of an employee, the friend is not an “associate” of the employee under the definition of “associate”, but is deemed to be an associate per s 148(2) of FBTAA.

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196 [7.70]  PRINCIPLES OF TAXATION LAW 2020

Example 7.4: Provision of fringe benefits to associates Simon is an employee of Company A. Under the terms of his employment agreement, he and his wife are entitled to one free interstate trip per year. The provision of the free trip to Simon’s wife qualifies as a fringe benefit as it is provided by Simon’s employer, Company A, to his associate –​his wife.    The term “recipient” is used in this chapter to refer to an employee or an associate of an employee. Note that in order to constitute a fringe benefit, the benefit provided must relate to a particular employee: Essenbourne Pty Ltd v FCT (2002) 51 ATR 629; FCT v Indooroopilly Children Services (Qld) Pty Ltd (2007) 158 FCR 325.

In respect of the employment of the employee

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[7.70]  Finally, and most importantly, the benefit must be provided in respect of the employee’s employment to qualify as a fringe benefit. As well as the exclusions and exemptions, this is one of the key features of the FBT regime, which ensures that only targeted benefits are subject to FBT. The definition of “in respect of” in s 136(1) of FBTAA specifies that, to qualify as a fringe benefit, the benefit must be provided “by reason of, by virtue of, or for or in relation directly or indirectly to, that employment”. While most benefits provided by an employer to an employee would generally be provided in respect of employment, this is not necessarily always the case and the scope of this nexus requirement has been the subject of judicial consideration. In J & G Knowles & Associates Pty Ltd v FCT (2000) 44 ATR 22, the Full Federal Court 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 … [W]‌hat 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.

Their Honours proceeded to suggest that, for the benefit to constitute a fringe benefit, there must be a “sufficient and material relationship” between the employment and the provision of the benefit. Case study 7.2: “In respect of the employment” In J & G Knowles & Associates Pty Ltd v FCT (2000) 44 ATR 22, the taxpayer, a company, was the trustee of a unit trust. The units in the unit trust

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were held by the family trusts of the four directors of the company. The company permitted the directors to write cheques for personal expenses on the company’s cheque account and the amounts were treated as loans to the directors’ family trusts. The directors were employees of the company for FBT purposes. The question arose as to whether the loans were provided to the directors in their capacity as directors and therefore in respect of their employment (making the loans fringe benefits), or whether the loans were provided because the directors were the beneficiaries of family trusts (in which case the loans would not be fringe benefits). The facts pointed in both directions. The directors drew upon the trust’s assets as these assets were ultimately held and applied for their benefit, but it was only because of their position as directors of the company that they were permitted to do so. The Court remitted the matter to the AAT to re-​examine the facts, but with the benefit of the guidance on the nexus requirement mentioned above. The AAT found that the loans were not made to the directors in their capacity as directors but because they were the “ultimate owners of the business and its assets” and, as such, the loans were not fringe benefits: Re J & G Knowles (2000) 45 ATR 1101.  

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Case study 7.3: Loan to company directors and shareholders not “in respect of employment” In Starrim Pty Ltd v FCT (2000) 44 ATR 487, the taxpayer was a company owned by a husband and wife who were the only shareholders and directors of the company. The company lent the husband and wife money to purchase a block of land. The block of land was the site of a business which had just been purchased by the company and it was therefore in the company’s interests for the transaction to take place. Lindgren J concurred with the AAT’s conclusion that the taxpayer had made the loan because the husband and wife were the purchasers of the property and  not in respect of their employment.

Case study 7.4: Repayments of loans not fringe benefits In Slade Bloodstock Pty Ltd v FCT (2007) 68 ATR 911, the taxpayer company provided loans to Mr and Mrs Slade, who were its sole shareholders. The Slades made a series of loans to the taxpayer on the basis that the taxpayer would repay any amounts owing at call and that the taxpayer would direct the payments to any parties nominated by the Slades. The loans represented the taxpayer’s only source of working capital and, over

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198 [7.75]  PRINCIPLES OF TAXATION LAW 2020

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time, the taxpayer paid a number of the Slades’ private expenses such as children’s school fees or private credit card balances. These payments were set off against the amounts owing to the Slades. The Commissioner assessed the taxpayer for FBT on the basis that the payments of the Slades’ private expenses (ie, the loan repayments) constituted fringe benefits. At issue was whether the payments had been made “in respect of the employment of an employee”. The Slades accepted that through their actions they were employees of the company, but contended that the payments were made as a consequence of their being creditors of the company and not because of the employment relationship. The AAT found in favour of the taxpayer but a single judge of the Federal Court, Heerey J, found in favour of the Commissioner. By the time the case reached the Full Federal Court, the Commissioner had conceded that the payments were not in respect of the Slades’ employment as “there was no material relationship” between the employment and the payments. In doing so, the Commissioner accepted that the repayment of a loan owed by an employer to an employee is not a benefit that is provided in respect of employment, at least where there is a binding obligation to repay the loan under the loan agreement and the obligation is imposed without reference to the employment of the lender. In such cases, the repayments are a product or incident of the creditor/​debtor relationship. The Full Federal Court noted that this position is consistent with the policy of the FBT legislation, which is to capture benefits that would have been income if provided as cash to the employee.   [7.75]  The scope of the requirement that the benefit be provided in respect of the employment of the employee is potentially widened by s 148(1) of FBTAA, which states that a benefit is provided in respect of the employment of the employee regardless of whether the benefit: • is also provided in respect of another matter or thing; • relates to past, current or future employment; • is surplus to the needs or wants of the recipient; • is also provided to another person; • is offset by any inconvenience or disadvantage; • is provided or used in connection with the employment; • is in the nature of income; and • is a reward for services rendered or to be rendered by the employee. In Rulings MT 2016 and MT 2019, the ATO suggests that s 148(1) should not be read as broadening the scope of FBT beyond the targeted benefits. In Ruling MT 2016, the ATO states:

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7: FrinGe Benefits tax  [7.75] 199 Sub-​section 148(1) seeks to anticipate arguments that might otherwise be put so as to narrow the defined meaning of “fringe benefit”. The subsection is based in part on experiences of difficulties with the practical application of para 26(e) of the Income Tax Assessment Act 1936 [now section 15-​2 of ITAA 1997]. 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.

In Ruling MT 2019, the ATO suggests that a benefit provided to an employee who is also a shareholder will not constitute a fringe benefit if it is provided to the person solely because they are a shareholder. This is despite the fact that s 148(1) deems the benefit to be provided in respect of employment.

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Despite the ATO’s guidance, the application of s 148(1) remains uncertain. In FCT v Slade Bloodstock Pty Ltd (2007) 68 ATR 911 (see Case Study [7.4]), Heerey J found that payments by an employer to its employees, which were loan repayments arising out of the debtor/​creditor relationship, were nonetheless fringe benefits due to the operation of s 148(1). By the time the case reached the Full Federal Court, however, the ATO conceded that the payments were not fringe benefits. Therefore, the operation of s 148(1) was not fully considered by the Full Federal Court. It is particularly important to ascertain whether a benefit is provided “in respect of employment”, where there is another relationship between the employer and the employee since that other relationship may be the reason for the provision of the benefit. Essentially, for a benefit to be in respect of the employee’s employment, the benefit must be provided to the person because he or she is an employee and not for some other reason. The ATO’s Fringe Benefits Tax: Guide for Employers (NAT 1054) suggests (at s 1.1) that a useful question to ask when determining whether a fringe benefit is provided “in respect of employment” is whether the person would have received the benefit if he or she were not an employee. Where there is an employment relationship as well as a family relationship, it is necessary to consider whether the benefits are provided in an ordinary family setting and would have been a normal incidence of family relationships.

Example 7.5: Benefit not provided in respect of employment Kim works in the family business owned by his parents, which imports furniture from overseas. For his birthday, Kim’s parents gave him an expensive piece of furniture from the shop. Although Kim is an employee who has received a benefit from his employer, the benefit does not qualify as a fringe benefit as Kim did not receive the benefit in respect of his employment. The benefit was

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200 [7.80]  PRINCIPLES OF TAXATION LAW 2020

received by him due to the private, family relationship between him and his employer. Source: Adapted from Example 2 (1.1 What is a fringe benefit?) in the ATO’s Fringe Benefits Tax: Guide for Employers (NAT 1054).   

Example 7.6: Benefit not provided in respect of employment Nora is an employee of Company X. She also owns shares in Company X, which she purchased because all shareholders are entitled to a 10% discount on goods sold by Company X. Nora purchases goods from Company X at a 10% discount. Although Nora is an employee who has received a benefit from her employer, the benefit does not qualify as a fringe benefit as Nora did not receive the benefit in respect of her employment. Rather, the benefit was received by her in her capacity as a shareholder.   

Example 7.7: Benefit provided in respect of employment

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Janet is an electrician. She is employed under the terms of a particular industrial award. The award requires Janet’s employer to reimburse her for all travel expenses. Janet’s employer reimburses her for her travel expenses in accordance with the terms of the award. Although the employer provided the reimbursement due to the terms of the award, the reimbursement of the travel expenses is a benefit received in respect of Janet’s employment. The reimbursement would not have been made if Janet was not an employee. Source: Adapted from Example 1 (1.1 What is a fringe benefit?) in the ATO’s Fringe Benefits Tax: Guide for Employers (NAT 1054) (original document).   

Exclusions [7.80]  The definition of “fringe benefit” in s 136(1) of FBTAA specifically excludes certain items from being a fringe benefit, including: • salary or wages (as defined by reference to Sch 1 of the Taxation Administration Act 1953 (Cth), in particular, s 12-​35 of that Schedule); • superannuation contributions; • payments from superannuation funds;

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7: FrinGe Benefits tax  [7.85] 201

• benefits under an employee share scheme; and • payments on termination of employment. These items are excluded from the definition of “fringe benefit” as they are dealt with under the income tax system. [7.85]  “Salary or wages” comprises payments (including commissions, bonuses or allowances) to employees, company directors and office holders; Commonwealth education or training payments; and compensation, sickness or accident payments. These amounts are subject to the PAYG withholding provisions in Sch 1 of the Taxation Administration Act 1953.

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It has been said that the definition of “salary and wages” is “deliberately wide” (Hill J in Roads & Traffic Authority of NSW v FCT (1993) 26 ATR 76 at 82) and a wide approach was adopted by the majority of the Full High Court in Murdoch v Commr of Pay-​roll Tax (Vic) (1980) 143 CLR 629. Essentially, “salary and wages” comprise all amounts paid as a reward for services rendered by an employee:  FCT v J Walter Thompson (Australia) Pty Ltd (1944) 69 CLR 227. The description of the payment is not determinative, and it is necessary to look at the substance of the payment to determine its character: Roads and Traffic Authority of New South Wales v FCT (1993) 26 ATR 76; Ruling TR 92/​15. One issue that often arises in an FBT context is whether a payment to an employee constitutes an allowance (which is “salary and wages”) or a reimbursement (which is not “salary and wages”). The term “reimburse” is defined in s 136(1) of FBTAA as “any act having the effect or result, direct or indirect, of a reimbursement”. The scope of the term “reimburse” was considered by Hill J in Roads & Traffic Authority of NSW v FCT (1993) 26 ATR 76. His Honour said that “the concept of reimbursement requires that the payment in question be made by reference to actual cost … [T]‌here would need to be some correspondence between the payment and the expenditure incurred”. As a general rule, an amount will constitute an allowance, where it is a predetermined amount to cover an estimated expense, while a reimbursement is a payment made in respect of the taxpayer’s actual expenditure: Roads and Traffic Authority of New South Wales v FCT (1993) 26 ATR 76; Ruling TR 92/​15. Example 7.8: Allowance versus reimbursement Zhou and Beatrice are both employed by the same company. Under the terms of his employment agreement, Zhou receives $500 per month to cover the costs of entertaining clients. Under an industrial award, Zhou also receives $50 per fortnight to cover his medical insurance premiums. Zhou is required to provide a letter from the health fund certifying that he is a member of the health fund, but is not required to provide any further evidence in relation to the payments.

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202 [7.90]  PRINCIPLES OF TAXATION LAW 2020

Under the terms of her employment agreement, Beatrice is entitled to a payment for her medical insurance premiums up to a limit of $500 per year. In order to claim the payment, Beatrice is required to provide the employer with her insurance premium statements verifying the actual amount incurred by her in relation to the premiums. The payments made to Zhou for entertaining clients and his medical insurance premiums are allowances. He receives the amounts regardless of his actual expenditure. The payments made to Beatrice are reimbursements –​that is, she is compensated for the actual amount of her medical insurance and cannot make a claim for payment without documentary evidence. The upper limit of $500 per year does not alter the character of the payment as it is based on the precise accounting of actual expenditure. Source: Adapted from the Example in Ruling TR 92/​15.    Allowances are classified as “salary and wages” and are excluded from the definition of “fringe benefit”; on the other hand, reimbursements are not excluded from the definition of “fringe benefit”.

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Categories of fringe benefits [7.90]  There are 13 categories of fringe benefits in the legislation, and it is important to determine the appropriate category a fringe benefit falls into as the FBT consequences arising differ between each category. Each category of fringe benefit is dealt with by a separate Division in the FBTAA. Each Division describes when the fringe benefit arises, any exemptions applicable to that particular category of fringe benefit and the taxable value of the fringe benefit. Remember that the benefit must constitute a “fringe benefit” as discussed at [7.20]. In particular, the benefit must be attributable to the employment relationship. The following categories of fringe benefits are discussed in detail in this chapter: • car fringe benefits: see [7.100]; • debt waiver fringe benefits: see [7.150]; • loan fringe benefits: see [7.170]; • expense payment fringe benefits: see [7.200]; • meal entertainment fringe benefits: see [7.230]; • property fringe benefits: see [7.250]; and • residual fringe benefits: see [7.280].

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7: FrinGe Benefits tax  [7.100] 203

The other categories of fringe benefits in the legislation which are less common and are not discussed in further detail in this chapter are: • housing fringe benefits: Div 6; • living-​away-​from-​home allowance fringe benefits: Div 7; • airline transport fringe benefits: Div 8; • board fringe benefits: Div 9; • tax-​exempt body entertainment fringe benefits: Div 10; and • car parking fringe benefits: Div 10A.

Car fringe benefits –​ Div 2

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[7.100]  One of the most common types of fringe benefits provided by employers to employees is a car fringe benefit. A car fringe benefit arises where an employer provides a car for an employee’s private use: s 7(1) of FBTAA. A “car” is defined in s 136(1) (by reference to s 995-​1 of ITAA 1997) as a motor vehicle designed to carry a load of less than 1 tonne or fewer than nine passengers. “Motor vehicle” is defined as any motor-​powered road vehicle, including a four-​wheel drive vehicle. “Private use” is defined in s 136(1) as any use of a car by an employee or associate that is not exclusively in the course of producing assessable income. As a general rule, travel between home and work is not considered to be in the course of producing assessable income and would constitute private use: see [12.390]; Ruling MT 2027. It is important to note that it does not matter whether the employee actually uses the car for private purposes; a fringe benefit arises as long as the car is available for private use: s 7(1). This is relevant where the statutory formula method (see [7.130]) is used to calculate the taxable value of the car as the formula refers to the number of days the car was provided as a fringe benefit. For example, a car fringe benefit will arise where the car is garaged at or near the residence of an employee or an associate of the employee: s 7(2). In AAT Case 9824 (1994) 29 ATR 1246, the AAT found that a car that was used solely in a business run from a home was a car fringe benefit under s 7(2) as the car was garaged at the home. In Determination TD 94/​16, the Commissioner suggests that a car fringe benefit will arise even where the employee is overseas if the car is garaged at or near the employee’s home during this time. There is an exception in s 7(2A) for ambulances, fire fighting vehicles and police cars that are garaged at the employee’s home. A car fringe benefit will also arise where an employee or an associate of the employee has custody and control over the car and it is not being used for employment purposes at the time: s 7(3). Finally, a car fringe benefit can still arise where the employer prohibits the private use of a car if the prohibition is not strictly enforced: s 7(4). In Determination TD 94/​16, the Commissioner

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204 [7.110]  PRINCIPLES OF TAXATION LAW 2020 suggests that the prohibition against private use must be made in clear and unequivocal terms and a general instruction or understanding between the employer and employee would be insufficient. The prohibition should be enforced through disciplinary measures and consistent enforcement such as checks of odometer readings. Example 7.9: Car available for private use John is provided with a car by his employer. John leaves the car in an airport car park while travelling overseas for work purposes. The car cannot be left at the employer’s premises as there are no car parking facilities available there. The airport car park is not in the vicinity of John’s residence. If John retains the keys to the car while he is overseas, a car fringe benefit will arise as he has custody and control over the car. However, if John’s employer removes control and custody of the car from John (eg, by taking the car keys) and enforces a prohibition on the private use of the car by John or his associates, a car fringe benefit will not arise. Source: Adapted from the Example in Determination TD 94/​16.   

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Exempt benefits [7.110]  A car fringe benefit will be an exempt benefit, where the car provided by an employer to an employee is only used for work-​related travel and any private use by the employee or an associate of the employee is minor, infrequent and irregular: s 8(2) of FBTAA. Note that, to be exempt, the car must be a taxi, panel van, utility truck or other road vehicle not designed for the principal purpose of carrying passengers: s 8(2)(a). A car fringe benefit will also be exempt where the benefit arises in relation to an unregistered car: s 8(3). Any fringe benefits that may arise in relation to the provision of a car fringe benefit are treated as exempt benefits under s 53. For example, payments for fuel or repairs by the employer could be considered expense payment fringe benefits, but are exempt due to the operation of s 53.

Taxable value [7.120]  There are two methods prescribed by the FBTAA for calculating the taxable value of a car fringe benefit: • statutory formula method (s 9): see [7.130]; and • cost basis (s 10): see [7.140].

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7: FrinGe Benefits tax  [7.130] 205

The statutory formula method applies automatically unless an employer elects to use the cost basis: s 10(1). An employer can choose either method for each car that gives rise to a car fringe benefit. An employer’s election to use the cost basis is automatically disregarded if the statutory formula method results in a lower taxable value: s 10(5). [7.130]  Statutory formula method (s 9 of FBTAA). The taxable value of a car fringe benefit under this method is the amount calculated in accordance with the following formula:      Base value  0.2 × × of the car      

Number of days during   that year of tax Amount  on whiichthe car fringebenefits  if any ) ( were provided by the provider  − of the Number of daays  recipient’s  inthat year of tax  payment   

Broadly, the base value of the car will be either its cost (if the car was purchased by the provider) or the leased car value at the earliest time the provider started to hold the car (if the car is leased). In either case, the amount is reduced by one-​third if the relevant FBT year commences at least four years after the provider first started holding the car: s 9(2)(a).

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In Taxation Ruling TR 2011/​3, the ATO suggests that, in addition to the purchase price, the “cost” of a car would include any other amounts that are directly attributable to the acquisition or delivery of the car. For example, dealer delivery charges would be included in the “cost” of a car, but insurance costs and extended car warranties would not be included in “cost”. The recipient’s payment includes amounts paid directly by the employee to the employer in relation to the car and amounts paid by the employee to a third party, such as petrol costs, for which the employee was not reimbursed by the employer. Example 7.10: Taxable value of car fringe benefit –​statutory formula method Raj is a troubleshooter for his employer. He visits the company’s various premises to deal with any problems that may arise. He is provided with a car for his work travel. The contract for the provision of the car was entered into on 1 January 2019. Raj is permitted to take the car home at the end of the day and there is no restriction on his use of the car for non-​ work purposes. The car was originally leased by Raj’s employer on 1 July

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206 [7.140]  PRINCIPLES OF TAXATION LAW 2020

2013. The leased car value at that time was $45,000. For the current FBT year, the following expenses were incurred by the company in relation to the car: Petrol and oil

$3,000

Repairs and maintenance

$500

Registration

$1,000

Insurance

$900

Lease payments

$6,000

Raj is required to contribute $50 per month towards the car expenses. He has determined that the total kilometres travelled by the car for the year 1 April 2019 to 31 March 2020 is 50,000 km (30,000 km related to business travel). Note that the payment of the car expenses does not give rise to a separate fringe benefit: s 53 of FBTAA. Statutory formula method: Taxable value = 0.2 × $30, 000 ×

366 − $600 = $5, 400; 366

where:

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Base value = leased car value = $45,000, which is reduced by one-​third as the car has been held by Raj’s employer for more than four years. Number of days in the FBT year when the car is provided as a fringe benefit. There is no restriction on Raj’s private use of the car and he takes the car home at the end of the day, which is deemed private use under s 7(2). As such, it appears that the car fringe benefit was provided for the entire FBT year. Number of days in the FBT year. As it is a leap year, the total number of days is 366. Recipient’s contribution = $50 × 12 = $600.    [7.140]  Cost basis (s 10 of FBTAA). The taxable value of a car fringe benefit using the cost basis is determined as follows: Taxable value = [C × (100% − BP)] − R

where: C is the operating cost of the car during the holding period; BP is the business use percentage of the car during the holding period; and R is the amount of the recipient’s payment (if any).

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The operating cost of the car consists of any expenses relating to the car incurred by the provider or any other person during the holding period. Examples of such expenses include repairs and maintenance, registration and insurance attributable to the holding period. Where the car is owned by the provider, an amount for deemed depreciation and deemed interest is also included in operating cost (s 11 of FBTAA describes how deemed depreciation and interest are calculated). Where the car is leased by the provider, the leasing costs attributable to the holding period are included in operating cost: s 10(3)(a)(v). The “business use percentage” is the percentage of the business kilometres travelled by the car out of the total kilometres travelled by the car during the holding period. Business kilometres refers to the number of kilometres on a “business journey”, which is defined in s 136(1) as any use of the car other than private use by an employee or associate. The cost basis may provide a lower taxable value than the statutory formula method, where the business use percentage of the car during the year is high. However, log book records and odometer records must be maintained when using the operating cost method, which increases the compliance burden: ss 10A and 10B.

Example 7.11: Taxable value of car fringe benefit Assume the same facts as Example 7.10 and that Raj has maintained the necessary log book and odometer records. Cost basis:

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Taxable value = (C ) $11, 400 × (100% − (BP ) 60% ) − (R ) $600 = $3, 960;

where: C = operating cost = $3,000 + $500 + $1,000 + $900 + $6,000 = $11,400; BP = business use percentage = (30,000/​50,000) × 100% = 60%; R = recipient’s contribution = $50 × 12 = $600. Comparing Examples 7.10 and 7.11, Raj’s employer should use the cost basis to determine the taxable value of the car fringe benefit since it results in a lower taxable value.   

Debt waiver fringe benefits –​ Div 3 [7.150]  A debt waiver fringe benefit arises where an employee (or associate) owes an amount to an employer and the employee (or associate) is released from his or her obligation to repay all or some of that amount: s 14 of FBTAA.

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208 [7.160]  PRINCIPLES OF TAXATION LAW 2020 The debt must be waived due to the employment relationship and not for some other reason (eg, because it is irrecoverable) to constitute a debt waiver fringe benefit.

Taxable value [7.160]  The taxable value of a debt waiver fringe benefit is the amount of the loan that no longer needs to be repaid: s 15 of FBTAA. Example 7.12: Debt waiver fringe benefit Due to unexpected personal misfortune, Miles was forced to borrow $30,000 from his employer on 1 September. On 1 January, his employer informed him that he was only required to repay $20,000 of the loan. The debt was waived because the employer values Miles as an employee and wants to reward him for his loyalty. A debt waiver fringe benefit arises as Miles has been released from his obligation to repay an amount that is owed to his employer and the waiver was due to the employment relationship. The taxable value of the debt waiver fringe benefit is $10,000, being the amount that Miles no longer has to repay.   

Loan fringe benefits –​ Div 4

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[7.170]  A loan fringe benefit arises in each year when an employer provides an employee (or associate) with a loan: s 16 of FBTAA.

Exempt benefits [7.180]  A loan fringe benefit will be an exempt benefit where the loan is provided by a person who provides loans to the general public in the ordinary course of his or her business, and the loan to the employee is provided at an interest rate at least equal to the interest rate prevailing at that time on similar loans to the public (eg, a home loan to a bank employee at standard commercial terms): s 17(1) and (2) of FBTAA. A loan fringe benefit will also be an exempt benefit where the loan is essentially an advance to the employee so that the employee can meet expenses that are reasonably expected to be incurred by the employee in the next six months in the course of performing his or her duties of employment: s 17(3) of FBTAA.

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Finally, a loan fringe benefit will also be exempt where the loan is provided to enable the employee to pay a rental bond, security deposit in respect of gas, electricity or telephone services or any similar amount. The employee must be required to repay the loan amount within 12 months, and the loan must be provided in conjunction with certain other fringe benefits to be exempt: s 17(4) of FBTAA.

Taxable value [7.190]  The taxable value of a loan fringe benefit is determined as follows (s 18 of FBTAA): Loan amount × [Statutory interest rate − Actual interest rate ] ×

No of days loan provided during the year T year No of days in FBT

The statutory interest rate is published by the ATO at the start of each FBT year. For the FBT year commencing on 1 April 2019, the applicable statutory interest rate is 5.37% per annum: Determination TD 2019/​6. Essentially, the fringe benefit represented by the taxable value is the interest “saved” by the employee in obtaining a loan through the employer, rather than at commercial market rates. Where the loan is provided at an interest rate which is equal to or higher than the statutory interest rate, no FBT liability arises as the taxable value is nil.

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Where the loan is provided for only a portion of the FBT year, it is necessary to adjust the taxable value for the loan period. Example 7.13: Loan fringe benefit Company Z provides its employee, Robyn, with a loan of $10,000 on 1 December 2019 at no interest. Robyn has not repaid any amount of the loan at 31 March 2020. A loan fringe benefit arises as Company Z has provided one of its employees with a loan. The taxable value of the loan fringe benefit = $10, 000 × [5.37% − 0%] ×

122 = $179 366

Therefore, Robyn has “saved” $179 in interest by obtaining a loan from her employer rather than at commercial rates.   

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210 [7.200]  PRINCIPLES OF TAXATION LAW 2020

Expense payment fringe benefits –​ Div 5 [7.200]  An expense payment fringe benefit arises, where: • an employer pays an expense incurred by the employee; or • an employer reimburses an employee for expenditure incurred by the employee: s 20 of FBTAA. To constitute an expense payment fringe benefit, the expense must be “incurred” by the employee. Broadly, an expense is incurred by an employee when the employee is definitely committed to the expense. Some other category of fringe benefit (eg, residual fringe benefits) may arise where an employer pays an expense which is not incurred by the employee. Example 7.14: Expense incurred by employee Stefan’s employer pays for his mobile phone bills. His employer also pays for him to go to a physiotherapist once a month as Stefan often works long hours in front of his computer. Stefan would not otherwise go to the physiotherapist.

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The payment of Stefan’s mobile phone bills by his employer is an expense payment fringe benefit as Stefan’s employer has paid an expense incurred by Stefan (he is definitely committed to the expense). The payment of the physiotherapist’s cost is not an expense payment fringe benefit as Stefan has not incurred the expense. However, it may constitute a residual fringe benefit.    Where an employer pays an amount to an employee in relation to expenditure incurred by the employee, it is necessary to consider whether the payment is a “reimbursement” or an “allowance”. The distinction gives rise to very different tax consequences. “Reimbursements” are treated as expense payment fringe benefits and taxed to the employer under the FBT regime, while “allowances” constitute “salary and wages” (see [7.85]) and are taxed to the employee under the income tax.

Exempt benefits [7.210]  An employer can make a “no-​private-​use declaration” in respect of all of the employer’s expense payment fringe benefits, which means that the employer will only pay or reimburse so much of an expense as would result in a taxable value of nil (reductions in taxable value are discussed at [7.360]). An expense payment fringe benefit covered by such a declaration is an exempt benefit: s 20A of FBTAA. Certain accommodation expense payment benefits where the employee is required to live away from his or her usual place of residence due to employment

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reasons and certain car expense payment benefits are also treated as exempt benefits: ss 21 and 22 of FBTAA.

Taxable value [7.220]  The taxable value of an expense payment fringe benefit depends on whether the fringe benefit is an in-​house expense payment fringe benefit or an external expense payment fringe benefit. An expense payment fringe benefit is an in-​house expense payment fringe benefit, where the expense relates to goods or services provided by the employer or an associate of the employer to outsiders in the ordinary course of their business: definition of “in-​house expense payment fringe benefit” in s 136(1) of FBTAA. For example, an employee purchases a laptop computer from their employer who is a computer retailer. The employer reimburses the employee for the cost of the computer. The reimbursement is an expense payment fringe benefit, which is an in-​house expense payment fringe benefit since it relates to property that is sold by the employer in the ordinary course of its business.

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An expense payment fringe benefit is an external expense payment fringe benefit if it is not an in-​house expense payment fringe benefit: definition of “external expense payment fringe benefit” in s 136(1). An employer reimburses an employee for the employee’s children’s school fees. The reimbursement is an external expense payment fringe benefit (assuming the employer is not the school). Broadly, the taxable value of an in-​house expense payment fringe benefit is the taxable value of the fringe benefit as if it was a property or residual fringe benefit (ie, assume the employer did not reimburse the employee but provided the property or services directly): s 22A. The taxable value of an external expense payment fringe benefit is the amount of the expense or reimbursement incurred by the employer: s 23. Example 7.15: Expense payment fringe benefit Joe pays his telephone bill of $200 for which he is later reimbursed by his employer, an accounting firm. The employer also pays $3,000 in fees directly to the university for a further study course he is undertaking. There are two expense payment fringe benefits arising as Joe’s employer has reimbursed him for the telephone bill and paid for his university fees. Both expenses were incurred by Joe as he is definitely committed to them.

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212 [7.230]  PRINCIPLES OF TAXATION LAW 2020

Both expenses are external expense payment fringe benefits as the benefits are not provided by Joe’s employer in the ordinary course of its business. The taxable values of both benefits are $200 and $3,000, respectively, being the amount paid by the employer in relation to them. Depending on the facts, the “otherwise deductible” rule (see [7.390]) may apply to reduce the taxable value of both fringe benefits under s 24 of FBTAA.   

Meal entertainment fringe benefits –​ Div 9A [7.230]  Meal entertainment fringe benefits can be captured by a number of categories, such as expense payment fringe benefits, property fringe benefits and, of course, meal entertainment fringe benefits. Generally, the most specific category is the relevant category for a fringe benefit. However, in the case of meal entertainment, an employer can elect for Div 9A of FBTAA to apply to the provision of meal entertainment fringe benefits for a particular FBT year, in which case the relevant fringe benefits will be taxed under this Division and not another: ss 37AA and 37AF. A meal entertainment fringe benefit arises where an employer provides its employees with: • entertainment by way of food or drink;

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• accommodation or travel in connection with entertainment by way of food or drink; or • a reimbursement of expenses incurred by an employee in relation to the above. A meal entertainment fringe benefit arises regardless of whether or not the meal entertainment relates to business purposes. Determining whether food or drink is provided as “entertainment” will be a question of fact. In Ruling TR 97/​17, the ATO suggests that the following factors are relevant in answering that question: • why the food or drink is provided: the ATO suggests that food or drink provided as refreshment (eg, morning tea for employees) will not be entertainment, but food or drink provided in a social situation (eg, lunch at a restaurant) will be classified as entertainment; • what type of food or drink is provided: for example, morning or afternoon tea, sandwiches or light meals are unlikely to constitute entertainment, while a three-​course meal will constitute entertainment; • when the food or drink is provided: food or drink provided during work hours, during overtime or while an employee is travelling for work purposes is less likely to be entertainment; and

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• where the food or drink is provided: food or drink provided at the employer’s premises is less likely to be entertainment but food or drink provided at a hotel, restaurant or café is more likely to be classified as entertainment. Although no single factor is determinative, the ATO suggests that the first two factors will be the most important in determining whether food or drink is provided as entertainment.

Taxable value

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[7.240]  There are two methods for calculating the taxable value of meal entertainment fringe benefits: • 50/​50 split method; and • 12-​week register method. The 50/​50 split method will apply automatically unless the employer elects for the 12-​week register method to apply: s 37B of FBTAA. Under the 50/​50 split method, the taxable value of meal entertainment fringe benefits is half of the expenses incurred by the employer during the FBT year in providing meal entertainment: s 37BA. Alternatively, the employer can elect to calculate the taxable value of meal entertainment fringe benefits under the 12-​week register method: s 37CA. In this case, the employer must maintain a register of all meal entertainment expenditure over a representative 12-​week period and determine the percentage of that expenditure which relates to the provision of meal entertainment as fringe benefits (ie, meal entertainment provided to employees or their associates and not to others, such as clients): s 37CB. The percentage of total meal entertainment expenditure which constitutes meal entertainment fringe benefits (ie, meal entertainment provided to employees and their associates) is known as the “register percentage”: s 37CB. The 12-​week period chosen should be representative of the first FBT year in which the register method is to be used for the register to be valid: s 37CC. The register is valid for the FBT year in which it is first used and the four FBT years following that year: s 37CD. Where the 12-​week period spans more than one FBT year, the register can only be used for the first time in the FBT year in which the 12-​week period ends: s 37CD(2). A register ceases to be valid for a particular FBT year, where the total meal entertainment expenditure in that year exceeds the total meal entertainment expenditure in the year the register was first used by more than 20%: s 37CD(3). The taxable value of meal entertainment fringe benefits under the register method is calculated using the following formula (s 37CB): Total meal entertainment expenditure incurred in the FBT ye ear × Register percentage

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214 [7.250]  PRINCIPLES OF TAXATION LAW 2020

Example 7.16: Meal entertainment fringe benefit Company A incurred $5,000 in expenditure on meal entertainment for the year. Assume Company A elects to apply Div 9A and treat the expenses as meal entertainment fringe benefits. Company A has maintained a register of all meal entertainment expenditure for a period of 12 weeks, in accordance with the above requirements. The register information indicates that 70% of the meal entertainment expenditure was on clients (ie, not fringe benefits) while 30% related to employees and their associates (ie, fringe benefits). Therefore, Company A’s register percentage is 30%. Under the 50/​50 split method, the taxable value of the meal entertainment fringe benefits is $2,500, being half the expenditure on providing meal entertainment. Alternatively, if Company A elected to use the 12-​week register method, the taxable value of the meal entertainment fringe benefits is $1,500, being $5,000 × 30%. Therefore, in this case, it would be better for Company A to elect to use the register method in calculating its FBT liability in relation to the provision of meal entertainment fringe benefits.    The register method will generally provide a lower taxable value (and therefore a lower fringe benefits tax liability), where less than 50% of meal entertainment expenditure is provided as fringe benefits (ie, to employees and their associates).

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Property fringe benefits –​ Div 11 [7.250]  A property fringe benefit arises where an employer provides an employee (or associate) with property: s 40 of FBTAA. Note that a fringe benefit only arises where the employer gives the employee the property, not just the use of the property. The use of property may be captured by another category such as residual benefits. “Property” is defined in s 136(1) as tangible and intangible property. “Tangible property” is defined to mean goods, and the definition specifies that this includes animals, fish, gas and electricity. “Intangible property” is defined as real property (ie, land and buildings), a chose in action (ie, a right to sue) and any other kind of property that is not tangible property. However, rights arising under a contract of insurance or a lease or licence in respect of real or tangible property are specifically excluded.

Exempt benefits [7.260]  A property fringe benefit will be an exempt benefit where the property is provided to a current employee and the property is provided to and

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consumed by the employee on a working day and on the business premises of the employer or a related company: s 41 of FBTAA. For example, biscuits or fruits provided to employees to be consumed on work premises would be exempt property fringe benefits.

Taxable value [7.270]  The taxable value of a property fringe benefit depends on whether the property fringe benefit is an in-​house property fringe benefit or an external property fringe benefit. Broadly, a property fringe benefit is an in-​house property fringe benefit, where the property is provided by the employer or an associate of the employer to outsiders in the ordinary course of their business: s 136(1) of FBTAA. A property fringe benefit is an external property fringe benefit if it is not an in-​ house property fringe benefit: s 136(1). The taxable value of an in-​house property fringe benefit is determined under s 42 and is broadly as follows:

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1. Where the property is manufactured, produced, processed or treated by the provider and: (a) is sold in the ordinary course of business to manufacturers, wholesalers or retailers –​the taxable value is the lowest price at which the property was sold; or (b) is sold in the ordinary course of business to members of the public –​the taxable value is equal to 75% of the lowest price at which property was sold to a member of the public; or (c) in any other case –​the taxable value is 75% of the amount that could reasonably be paid to acquire the property from the provider in an arm’s length transaction. 2. Where (1) does not apply and the property is acquired by the provider, the taxable value is the lesser of: (a) the cost of the property if acquired in an arm’s length transaction; or (b) the amount that could reasonably be paid to acquire the property from the provider in an arm’s length transaction. 3. In any other case, the taxable value is 75% of the amount that could reasonably be paid to acquire the property from the provider in an arm’s length transaction. The determination of the taxable value of in-​house property fringe benefits essentially depends on whether the employer is a manufacturer or reseller and whether the employer operates in the wholesale or retail market. Employers can still provide employees with in-​house property fringe benefits without incurring FBT, where the employee pays the wholesale price of the property.

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216 [7.270]  PRINCIPLES OF TAXATION LAW 2020 As we will see at [7.380], the taxable value of a fringe benefit is reduced by the amount of the recipient’s contribution, if any. Both employers and employees benefit in this case as the employer does not incur FBT, and the employee pays the wholesale, rather than retail, price of the goods. Example 7.17: In-​house property fringe benefit Ratna works at a second-​hand computer shop. Her employer provided her with a computer which cost the employer $1,000 to acquire and is for sale to the public for $1,500. The provision of the computer is an in-​house property fringe benefit as Ratna’s employer provides computers to outsiders in the ordinary course of its business. The taxable value of the fringe benefit is the lesser of: • the cost of the property –​$1,000; or • the amount that could reasonably be paid to acquire the property from Ratna’s employer –​$1,500. Therefore, the taxable value is $1,000.

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Note that if Ratna paid her employer $1,000 for the computer, the taxable value would be nil as the recipient’s contribution is deducted from taxable value: see [7.380]. Both the employer and Ratna benefit in this situation as the employer does not incur FBT and Ratna has paid $1,000, rather than    the retail price of $1,500, to acquire the computer. Broadly, the taxable value of an external property fringe benefit is the cost to the employer, or expenditure incurred by the employer to provide the property: s 43. Where the employer can acquire the property for less than the employee could (eg, due to the employer’s purchasing power or because it can purchase the property at wholesale prices) and the employee reimburses the employer for the cost of acquiring the property, a win-​win situation arises since the employer has no FBT liability and the employee has acquired the property for less than the retail price. Example 7.18: External property fringe benefit Following on from Example 7.17, Ratna’s employer also gave her a brand new plasma television, which was acquired from a television wholesaler for $2,000. The provision of the plasma television is an external property fringe benefit since Ratna’s employer does not provide plasma televisions to outsiders as part of its business.

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The taxable value of the fringe benefit is the cost to Ratna’s employer in acquiring the property, which is $2,000. If Ratna paid her employer $2,000 for the television, the taxable value is reduced to nil as the recipient’s contribution is deducted from taxable value: see [7.380]. Both the employer and Ratna benefit in this situation as the employer does not incur FBT and Ratna has paid the wholesale price of $2,000 for the television, rather than the retail price which is likely to    be higher.

Residual fringe benefits –​ Div 12 [7.280]  The last category of fringe benefits is residual fringe benefits, which is a catch-​all category to capture any benefits that do not fall into any of the other categories of fringe benefits: s 45 of FBTAA. Examples of residual benefits include the provision of services for free or at a discount; the provision of caravans at work sites for the accommodation of employees (Roads and Traffic Authority of NSW v FCT (1993) 26 ATR 76) and waivers of loan establishment fees:  Westpac Banking Corporation v FCT (1996) 34 ATR 143. Note that a residual benefit can arise in conjunction with another fringe benefit, but not if the benefit is fully captured by another category: Westpac Banking Corporation v FCT (1996) 34 ATR 143.

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Case study 7.5: Residual fringe benefits Following on from Case Study [7.1], in Westpac Banking Corporation v FCT (1996) 34 ATR 143, the taxpayer sought to argue that the waiver of the loan establishment fee was not a residual benefit as the waiver was integrally related to the making of the loan to the employee, and therefore there was only one benefit –​that is, the making of the loan. As such, the fringe benefits tax consequences were to be determined solely in accordance with Div 4 regarding loan fringe benefits. Hill J found that Div 4 was not an exclusive code for all benefits relating to loans. In this case, there were two separate benefits –​the loan that is dealt with under Div 4 and the fee waiver that is captured as a residual fringe benefit.  

Exempt benefits [7.290]  As the scope of residual fringe benefits is unlimited, there are a number of residual benefits that are made exempt in s 47 of FBTAA. For example, “business operation facilities”, such as toilets, bathroom facilities, food or drink vending machines, tea-​or coffee-​making facilities, water dispensers and other

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218 [7.300]  PRINCIPLES OF TAXATION LAW 2020 such amenities, are exempt benefits under s 47(4). Recreational or child care facilities located on the employer’s premises are exempt under s 47(2). Ruling TR 2000/​4 discusses the meaning of “business premises” in the context of the s 47(2) exemption. Section 47(3) also provides an important exemption for any private use of property located on the employer’s premises, where the property is wholly or principally in connection with the operation of the business. This exempts from FBT private phone calls or personal printing at the employer’s premises.

Taxable value [7.300]  Similar to property fringe benefits (see [7.270]), the taxable value of a residual fringe benefit depends on whether the residual fringe benefit is an in-​house residual fringe benefit or an external residual fringe benefit. Broadly, the taxable value of an in-​house residual fringe benefit under ss 48 and 49 of FBTAA is: • 75% of the lowest price at which an identical benefit is sold to a member of the public under an arm’s length transaction; or • in any other case, 75% of the amount that could reasonably be paid to acquire the property from the provider in an arm’s length transaction. The taxable value of an external residual fringe benefit is, broadly, the cost to the employer or expenditure incurred by the employer in providing the benefit: ss 50 and 51.

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Example 7.19: In-​house residual fringe benefit Imogen works at a second-​hand computer shop. She has had problems with her computer and her employer services her computer for free. The employer would normally charge customers $60 for the service. The servicing of the computer would constitute an in-​ house residual fringe benefit as the benefit does not fall within any of the other categories of fringe benefits and as Imogen’s employer services computers in the ordinary course of its business. The taxable value of the fringe benefit is 75% of the lowest price charged to members of the public in an arm’s length transaction, which would be 75%    × $60 = $45.

Example 7.20: External residual fringe benefit Following on from Example 7.19, Imogen’s employer also gave her two tickets to an upcoming classical music concert by an international artist. The tickets cost $250 each.

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7: FrinGe Benefits tax  [7.320] 219

The provision of the tickets would constitute an external residual fringe benefit as they do not fall within any of the other categories of fringe benefits and Imogen’s employer does not provide concert tickets in the ordinary course of its business. Note that the payment for the tickets does not constitute an expense payment fringe benefit as Imogen has not “incurred” the expense. The taxable value of the fringe benefit is the expenditure incurred by Imogen’s employer in providing the benefit, which is $500.   

Exempt fringe benefits

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[7.310]  There are a number of benefits that are exempt from FBT. No FBT liability arises in relation to an exempt fringe benefit. The exemptions can apply to a particular category of fringe benefit or fall within Div 13 of FBTAA, which covers “miscellaneous exempt benefits”. The category-​based exemptions were discussed under the relevant categories at [7.100]–​[7.300]. There are a number of exempt benefits in Div 13, such as: • reimbursements for the costs of travelling to an interview or selection test in connection with an application for employment with a new employer, or a promotion or transfer with an existing employer (s 58A); • various job relocation expenses (ss 58AA, 58B, 58C, 58D, 58E and 58F); • certain medical benefits (ss 58K, 58L and 58M); and • the cost of providing newspapers and periodicals to employees for business purposes: s 58H. The following common exemptions are discussed in detail: • minor benefits: see [7.320]; • work-​related items: see [7.330]; • membership fees and subscriptions: see [7.340]; and • single-​trip taxi travel: see [7.350].

Minor benefits –​ s 58P [7.320]  Broadly, a benefit will be exempt as a minor benefit, where the notional taxable value of the benefit is less than $300. “Notional taxable value” is defined in s 136(1). It is the taxable value of the fringe benefit as determined for each category of fringe benefit taking into account any reduction for recipient’s contribution but not any reduction of taxable value due to the application of the otherwise deductible rule (see [7.360]). In the case of a car fringe benefit,

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220 [7.320]  PRINCIPLES OF TAXATION LAW 2020 the notional taxable value is the taxable value determined as if the car benefit was a residual benefit. The $300 limit is applied to each benefit and is not a cumulative exemption. However, to be treated as a minor benefit, the frequency and regularity of the minor benefit (and similar or connected benefits) must be taken into consideration, and it must be concluded that it would be unreasonable to treat the minor benefit as a fringe benefit: s 58P(f) of FBTAA; Ruling TR 2007/​12. The exemption does not apply to in-​house fringe benefits which are subject to a $1,000 reduction in taxable value for each employee: see [7.370]. The exemption is also not available for meal entertainment fringe benefits if the employer uses the 50/​50 split method (see [7.240]) to calculate the taxable value of the meal entertainment: s 37BA; Ruling TR 2007/​12. Example 7.21: Infrequent but regular benefits qualify as minor benefits Joe provides each of his employees with a bottle of wine every Christmas. The cost of each bottle is less than $300 and satisfies the taxable value limit for minor benefits. The gifts are provided infrequently (once a year) but regularly (every Christmas). There are no similar or connected benefits. Upon evaluation of these criteria, it can be concluded that the provision of the bottle of wine is a minor benefit as it would be unreasonable to treat it as a fringe benefit. Source: Adapted from Example 1 in Ruling TR 2007/​12.   

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Example 7.22 Infrequent but regular benefits qualify as minor benefits Each year Nicholas provides all of his employees and their families with an end of financial year dinner at a local restaurant. The total value of the fringe benefit for each employee is less than $300. The benefit is provided infrequently (once a year) but regularly (every year). As the total value of the benefit and all connected benefits is less than $300, and taking into account the other factors, it can be concluded that the provision of the fringe benefit is a minor benefit as it would be unreasonable to treat it as a fringe benefit. Source: Adapted from Example 2 in Ruling TR 2007/​12.   

Example 7.23 Frequent and regular benefits not treated as minor benefits Big Firm provides its employees with a fine dining meal voucher whenever they have to work late. The value of each voucher is less than $300.

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However, employees generally work late at least once a month. Although each benefit is less than $300, it would not be reasonable to treat the meal vouchers as a minor benefit, taking into consideration the frequency and regularity with which they are provided and the fact that their cumulative value for each employee is likely to exceed $300.   

Work-​related items –​ s 58X [7.330]  The following work-​related items are treated as exempt fringe benefits: • a portable electronic device; • an item of computer software; • an item of protective clothing; • a briefcase; and • a tool of trade: s 58X(2) of FBTAA.

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These items will only be eligible for the exemption, where they are primarily for use in the employee’s employment. In ATO ID 2008/​127, the ATO suggests that the provision of a laptop computer to an employee who regularly visits clients is primarily for use in the employee’s employment. Further, the exemption is limited to one item of each type per employee per FBT year unless the item is a replacement item: s 58X(3) and (4) of FBTAA. The limitation does not apply if the work-​related item is a “portable electronic device” and the employer is a “small business entity”. In this context, a “small business entity” is a sole trader, partnership, company or trust that operates a business for all or part of the income year and has an aggregated turnover of less than $10 million. Broadly, “aggregated turnover” is the entity’s turnover plus the annual turnover of any business that is connected or affiliated to the entity. Note that employees are not entitled to depreciation deductions (see Chapter 14) in relation to these items. The legislation does not specify what is a “portable electronic device”, and in ATO ID 2008/​133, the ATO suggests that it should therefore take on its ordinary meaning. The ATO further suggests that a portable electronic device would be one which is: • easily portable and designed for use away from an office environment; • small and light; • able to operate without an external power supply; and • designed as a complete unit. This includes mobile phones, laptop computers, GPS navigation receivers, personal digital assistants and so on.

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222 [7.340]  PRINCIPLES OF TAXATION LAW 2020

Membership fees and subscriptions–​ s 58Y [7.340]  The following benefits are exempt benefits whether paid for directly by the employer or by way of a reimbursement: • subscription to a trade or professional journal; • entitlement to use a corporate credit card; and • entitlement to use an airport lounge membership.

Single-​trip taxi travel –​ s 58Z [7.350]  The provision of a single taxi trip beginning or ending at the employee’s place of work is an exempt benefit. ATO guidance indicates that the exemption is limited to travel undertaken in a vehicle that is licensed to operate as a taxi by the relevant State or Territory and does not extend to travel undertaken in a ride-​sourcing vehicle or other vehicle for hire that does not hold a taxi license.

Reductions in taxable value [7.360]  Having determined the taxable value of a fringe benefit, it is then necessary to determine whether the taxable value can be reduced because:

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• it is an in-​house fringe benefit: see [7.370]; • there is a recipient’s contribution: see [7.380]; or • the otherwise deductible rule applies: see [7.390]. All of these reductions can apply individually or in conjunction with the others.

In-​house fringe benefits [7.370]  Under s 62 of FBTAA, the taxable value of all in-​house (expense, property or residual) fringe benefits for each particular employee is reduced by $1,000. Where the taxable value of all in-​house fringe benefits to a particular employee is less than $1,000, the taxable value is reduced to nil, and there is effectively no FBT payable on the provision of the in-​house fringe benefits to that employee. Note that the reduction relates to the particular employee and cannot be done on an aggregate basis. Example 7.24: Reduction in taxable value for in-​house property fringe benefits Company Y provides its employees Leonie and James with in-​house property fringe benefits. The taxable value of Leonie’s in-​house fringe

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benefits is $2,000 and the taxable value of James’ in-​house fringe benefits is $300. Applying s 62 of FBTAA, the taxable value of Leonie’s in-​house fringe benefits is reduced to $1,000 and the taxable value of James’ in-​house fringe benefits is reduced to nil. The reduction relates to the particular employee and cannot be done on an aggregate basis. The unutilised $700 exemption in relation to James cannot be applied to reduce Leonie’s liability.   

Recipient’s contribution [7.380]  The definition of “taxable value” for most fringe benefits reduces the taxable value of the fringe benefit by the amount of the recipient’s contribution (if any). Of the categories of fringe benefits discussed in detail at [7.100]–​[7.300], this step is not required for car fringe benefits, debt waiver fringe benefits and loan fringe benefits, as it is either not applicable or has been incorporated into the determination of taxable value at first instance. Where the fringe benefit is an expense payment fringe benefit that arises because of a reimbursement, the amount of the employee’s expenditure is not considered the recipient’s contribution: ss 22A(4) and 23 (as the employee has been reimbursed for the expense). In all other cases, reduce the taxable value by the amount of the recipient’s contribution (if any).

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Example 7.25: Reducing taxable value for recipient’s contribution Belinda is a lawyer at a small law firm specialising in conveyancing. She recently purchased her first home for $500,000. The firm provided her with conveyancing services at a 50% discount. The standard fee for conveyancing services on properties similar to Belinda’s would be $2,000. The provision of conveyancing services constitutes an in-​house residual fringe benefit as the services are provided to outsiders in the ordinary course of the employer’s business. The taxable value of the fringe benefit is 75% of the lowest price charged to customers, which would be 75% × $2,000 = $1,500. The services were provided to Belinda at a 50% discount, which means that she paid $1,000 towards the conveyancing fees. The taxable value is therefore reduced for recipient’s contribution to $500. (Note: The taxable value may be further reduced to nil by applying the $1,000 reduction for in-​house benefits, depending on whether Belinda received any other in-​house benefits during the FBT year: s 62 of FBTAA.)   

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224 [7.390]  PRINCIPLES OF TAXATION LAW 2020

Otherwise deductible rule [7.390]  Most categories of fringe benefits also include the “otherwise deductible rule” to reduce the taxable value of a fringe benefit. Of the categories of fringe benefits discussed in detail at [7.100]–​[7.300], the otherwise deductible rule is not applicable to car fringe benefits and debt waiver fringe benefits. Under the otherwise deductible rule, the taxable value of a fringe benefit is reduced by the amount which would have been deductible to the employee had the employee incurred an expense directly rather than received a fringe benefit. It is important to note that the otherwise deductible rule only applies in relation to the employee and not associates of the employee (ie, the expense must have been deductible to the employee). It is also important to note that the expense must give rise to a one-​time-​only deduction to the employee for the otherwise deductible rule to apply. An expense which would be deductible to the employee over a number of years (eg, depreciation) would not qualify as an otherwise deductible expense. In such cases, it may be preferable for the employee to incur the expense themselves as the amount is excluded from the employee’s income (as deductions), albeit over a period of years, rather than receive a benefit that is fully taxable to the employer under FBT.

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Example 7.26: Otherwise deductible rule On 1 April 2019, Ali received a loan of $20,000 from his employer at an interest rate of 2.37%. Ali used $10,000 to purchase shares, $5,000 to pay his personal credit card debt and the remaining $5,000 to purchase shares in his wife’s name. The $20,000 provided by the employer to Ali is a loan fringe benefit. The taxable value of the benefit is $20,000 × (5.37% –​2.37%) = $600. The loan is provided for the entire FBT year, so there is no need to adjust for the loan period. The $600 represents interest that Ali has “saved” by obtaining a loan from his employer, rather than at commercial rates. The relevant question when applying the otherwise deductible rule is whether Ali would have been entitled to a deduction for some or all of the $600 had he incurred the interest expense directly by obtaining a loan at commercial interest rates instead of receiving the fringe benefit. Half of the loan amount was used to purchase shares and, as discussed in Chapter 12, interest incurred in acquiring an income-​producing asset is deductible for tax purposes. Therefore, the interest expense which relates to that portion of the loan (50% × $600 = $300) would have been “otherwise deductible”.

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Interest relating to the portion of the loan used to pay the credit card debt would not be deductible as it is a private expense. The interest relating to the purchase of shares in the wife’s name is also not otherwise deductible as the interest expense is not deductible to Ali, but to his wife. Therefore, the taxable value of the loan fringe benefit is reduced from $600 to $300 by applying the otherwise deductible rule.   

Example 7.27: Otherwise deductible rule Under the terms of his employment agreement, Jerry’s employer has agreed to pay his tax agent’s fees of $550 for the preparation of Jerry’s personal income tax return. The payment of the tax agent’s fees by the employer constitutes an external expense payment fringe benefit. The taxable value of the fringe benefit is the amount of the expense, being $550. The cost of managing one’s tax affairs is deductible under s 25-​5 of ITAA 1997: see Chapter 13. Therefore, if Jerry had paid the tax agent’s fees himself, he would have been entitled to a deduction for the fees. Applying the otherwise deductible rule, the taxable value of the expense payment fringe benefit would be reduced to nil as the $550 would have been fully deductible had it been incurred by Jerry.   

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Example 7.28: Otherwise deductible rule Under the terms of her employment agreement, Jade’s employer has agreed to pay her home phone bills totalling $2,200 for the year. Only 20% of her calls were for work purposes. The payment of the phone bills by the employer constitutes an expense payment fringe benefit. The taxable value of the fringe benefit is the amount of the expense, being $2,200. Twenty per cent of Jade’s calls are for work purposes and it is likely that, had she paid the phone bills herself, she would have been entitled to a deduction for 20% of the cost, being $440 (see Chapter 12). Therefore, applying the otherwise deductible rule, the taxable value of the expense payment fringe benefit would be reduced by $440 to $1,760.   

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226 [7.390]  PRINCIPLES OF TAXATION LAW 2020 Where a benefit is provided to an employee and their associate jointly, the otherwise deductible rule is to be applied on a proportionate basis. The otherwise deductible rule for loan fringe benefits, expense payment fringe benefits, property fringe benefits and residual fringe benefits was amended by Sch 4 of the Tax Laws Amendment (2008 Measures No 5) Act 2008 (Cth) to ensure that the rule operated as such. The amendments were necessary due to s 138(3), which deems a benefit jointly provided to an employee and their associate to be provided solely to the employee. In National Australia Bank v FCT (1993) 26 ATR 503, the Federal Court held that the taxable value of a loan fringe benefit provided to an employee and his spouse was reduced to nil under the otherwise deductible rule. This was due to the operation of s 138(3), which deemed the benefit to be provided solely to the employee. The following examples from Sch 4 of Tax Laws Amendment (2008 Measures No 5) Act 2008 illustrate the application of the law following the amendments. Example 7.29: Benefit provided to employee and associate

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Francisca and her husband Peter receive a joint interest-​ free loan of $50,000 from Peter’s employer. Assume that the taxable value of the loan fringe benefit is $10,000. Francisca and Peter use the loan to purchase $50,000 of shares which they will hold jointly with a 50% interest each. Francisca and Peter return 50% of the dividends derived from the shares as assessable income in each of their income tax returns. Under the previous law (and as a result of the NAB case), the otherwise deductible rule would apply to reduce the taxable value of the loan fringe benefit ($10,000) (ie, in respect of both Francisca and Peter’s share of the benefit) to nil and consequently the employer would have no FBT liability. As a result of new paragraph 19(1)(i) and new subsection 19(5), the notional deduction of $10,000 is reduced by Peter’s percentage of interest in the shares –​that is, 50% so that the taxable value of the loan fringe benefit of $10,000 is reduced by $5,000. The employer has an FBT liability on $5,000, which reflects the share of the loan fringe benefit that was provided to Francisca. Source: Adapted from Example 4.2 in Explanatory Memorandum to Tax Laws Amendment (2008 Measures No 5) Act 2008.   

Example 7.30: Benefit provided to employee and associate Assume Francisca and Peter only use 50% of the $50,000 loan for acquiring shares. They use the other 50% ($25,000) for a private overseas holiday. The taxable value of the loan fringe benefit that relates to that

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7: FrinGe Benefits tax  [7.400] 227

part of the loan used for private purposes ($5,000) is not deductible to either Francisca or Peter, so the otherwise deductible rule does not apply to reduce that part of the loan fringe benefit. The taxable value of the loan fringe benefit that arises on the part of the loan that is used for acquiring shares can be reduced by Peter’s share of the benefit (ie, $2,500). The employer can reduce the taxable value of the loan fringe benefit ($10,000) by $2,500. The taxable value of the loan fringe benefit provided to Francisca and Peter that will be subject to FBT is therefore $7,500 ($10,000 –​$2,500) which represents the portion of the loan used for the private holiday and the portion for Francisca’s ownership of the shares. Source: Adapted from Example 4.3 in Explanatory Memorandum to Tax Laws Amendment (2008 Measures No 5) Act 2008.   

Type of fringe benefit [7.400]  Having determined the taxable value of each fringe benefit, it is then necessary to determine whether the fringe benefit is a Type 1 fringe benefit or a Type 2 fringe benefit.

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A Type 1 fringe benefit exists where the employer is entitled to input tax credits (ie, a refund of GST paid) in relation to the provision of a fringe benefit: ss 5C(3) and 149A of FBTAA. See Chapter 25 for when a taxpayer is entitled to input tax credits. A Type 2 fringe benefit is any fringe benefit which is not a Type 1 fringe benefit: s 5C(4). For example, where an employer did not pay GST in relation to the provision of the fringe benefit, the fringe benefit will be a Type 2 fringe benefit as the employer is not entitled to input tax credits in relation to that fringe benefit. Debt waiver fringe benefits and loan fringe benefits are always Type 2 fringe benefits as GST is not applicable to them. The separation of fringe benefits into two types is necessary following the introduction of the GST on 1 July 2000. As we will see in Chapter 25, GST is borne by private consumers and not businesses. Where a fringe benefit is provided by an employer, there is an additional benefit to the employee in the GST that has not been paid –​that is, if the employee had acquired the benefit themselves they would have paid an additional 10% in GST, and the GST “saved” is an additional benefit of receiving a fringe benefit. The gross-​up mechanism discussed at [7.410] adds the GST that has not been paid back into the FBT base.

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228 [7.410]  PRINCIPLES OF TAXATION LAW 2020

Fringe benefits taxable amount [7.410]  The next step is to calculate the “fringe benefits taxable amount” as prescribed by s 5B of FBTAA. The fringe benefits taxable amount is calculated by “grossing-​up” the taxable value of the fringe benefit by the appropriate rate. As mentioned at [7.400], the “gross-​up” takes into account the fact that the employee has received an additional benefit in the form of the “GST saved” on receiving a benefit. The “gross-​up” also adds the FBT payable on the fringe benefit back into the tax base. Where an employee receives salary, the tax on the salary is paid by the employee. However, where the employee receives a fringe benefit, the tax on the fringe benefit (FBT) is paid by the employer. As such, the employee has received an additional benefit since tax is paid by the employer rather than the employee.

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Example 7.31: Fringe benefits taxable amount Ivo’s employer provides him with a mobile phone. The provision of the mobile phone is a fringe benefit and the taxable value of the fringe benefit is determined by the method discussed earlier. The taxable value only relates to the provision of the mobile phone. In addition, Ivo has also received a benefit in that he has not had to pay GST on the acquisition of the phone. The “GST saved” is also a benefit to Ivo and FBT is payable on that benefit. Ivo receives a further benefit in that he does not pay income tax on the receipt of these benefits. The “income tax saved” is also a benefit received by Ivo, and FBT is payable on that benefit. The “gross-​up” adds the GST saved and the income tax saved by Ivo into the tax base –​ that is, the amount upon which the FBT liability is ultimately calculated.    Many students, and even some tax professionals, often find it difficult to understand the reasoning behind the “gross-​ up”. It is not essential in determining the FBT consequences to understand the reasoning behind this and the fringe benefits taxable amount can simply be calculated in accordance with the following formulae: For a Type 1 fringe benefit, the fringe benefits taxable amount equals: Total taxable value of all Type 1 fringe benefits ×

FBT rate + GST rate

[1 – FBT rate] × [1+ GST rate] × FBT rate

With the current (ie, for the year ending 31 March 2020) FBT rate of 47% and GST rate of 10%, the fringe benefits taxable amount for Type 1 fringe benefits equals: Total taxable value of all Type 1 fringe benefits × 2.0802

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For a Type 2 fringe benefit, the fringe benefits taxable amount equals: Total taxable value of all Type 2 fringe benefits ×

1 1− FBT rate

With the current (ie, for the year ending 31 March 2020) FBT rate of 47%, the fringe benefits taxable amount for Type 2 fringe benefits equals: Total taxable value of all Type 2 fringe benefits × 1.8868

FBT liability [7.420]  The final step is to determine the employer’s FBT liability, which is calculated as: ( Type 1 fringe benefits taxable amount ) + ( Type 2 fringe benefits taxable amount ) × FBT rate

See ss 5B(1A) and 66 of FBTAA. The “FBT rate” is equal to the highest marginal tax rate plus the Medicare levy. For the FBT year ending 31 March 2020, the FBT rate is 47%.

Interaction with income tax

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Employer [7.430]  From an employer’s perspective, any FBT liability incurred in relation to the provision of fringe benefits and the cost of providing the fringe benefit are generally deductible as ordinary business expenses under s 8-​1 of ITAA 1997: see also Ruling TR 95/​24. The FBT liability is generally deductible as an expense incurred in gaining or producing assessable income that is not capital or capital in nature; private or domestic in nature; incurred in gaining or producing exempt or non-​assessable non-​exempt income; or a denied deduction: see Chapter 12. It should also be noted that the deductibility of the FBT liability for income tax purposes does not impact on an employer’s FBT liability. For example, an employer’s FBT liability is not reduced because the employer chooses not to claim a deduction for the FBT liability: Determination TD 94/​42. The cost of providing a fringe benefit is also generally deductible under s 8-​1 of ITAA 1997 as an ordinary business expense: see Chapter 12. Broadly, the mechanism for calculating FBT and the fact that both the cost of providing a fringe benefit and FBT are deductible to an employer mean that, from a tax perspective, employers are generally indifferent in respect of providing

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230 [7.430]  PRINCIPLES OF TAXATION LAW 2020 employees with salary or fringe benefits. The fact that a benefit is an exempt benefit or that the taxable value of a benefit is reduced for any of the reasons discussed at [7.360]–​[7.390] generally does not affect the employer’s entitlement to a deduction for the cost of providing the fringe benefit. There is an important interaction between FBT and the deductibility of expenses which is worth noting. Certain expenses that are generally denied deductions (see [12.240]–​[12.260]) are deductible if incurred in the provision of a fringe benefit. For example, entertainment expenses are generally not deductible under s 32-​5 of ITAA 1997 but are deductible under s 32-​30, where the entertainment expenses are incurred in the provision of a fringe benefit. The amount of the deduction will depend on the treatment of the entertainment expenses for FBT purposes. For example, where the 50/​50 split method is used for calculating the taxable value of meal entertainment fringe benefits, only half the meal entertainment expenses will be deductible for income tax purposes as only half the meal entertainment expenses have been treated as a fringe benefit (see also s 51AEA of ITAA 1936).

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Other expenses that are generally not deductible for income tax purposes, but which are deductible when provided as a fringe benefit, include: • higher education contribution payments: s 26-​20(2); • a relative’s travel expenses: s 26-​30(3); • recreational club expenses: s 26-​45(3); and • leisure facility expenses: s 26-​50(8). These generally denied deductions are only deductible when provided as a fringe benefit. If the benefit is an “exempt benefit”, a deduction is not allowed as exempt benefits are not “fringe benefits”: see definition of “fringe benefit” in s 136(1). Example 7.32: Denied deductions and exempt fringe benefits Following on from Example 7.22, the cost of the end of financial year dinner is potentially deductible due to s 32-​20 of ITAA 1997 as the cost of providing entertainment by way of providing a fringe benefit. However, as discussed in Example 7.22, the provision of the dinner would qualify as a “minor benefit” and thus be an “exempt benefit” under s 58P. Exempt benefits are not fringe benefits per the definition of “fringe benefit” in s 136(1) and therefore, the cost of the dinner is not deductible.    Finally, note that any amounts received directly by an employer from an employee in respect of a fringe benefit (recipient’s contribution) may constitute assessable income of the employer.

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Employee [7.440]  For an employee, fringe benefits constitute non-​assessable, non-​ exempt income of the employee: s 23L(1) of ITAA 1936; s 15-​2 of ITAA 1997. This is the case even where little or no FBT has been paid in relation to the fringe benefit because of a reduction to the taxable value of the fringe benefit. Exempt fringe benefits are treated as exempt income of the employee: s 23L(1A) of ITAA 1936; s 15-​2 of ITAA 1997. Where the taxable value of an employee’s fringe benefits exceeds $2,000, the employer is required to report the fringe benefits on the employee’s Payment Summary (subject to certain exceptions), and the employee is required to report these fringe benefits on his or her income tax return. These “reportable fringe benefits” do not affect the employee’s income tax liability, but do affect the calculation of certain amounts, such as the Medicare levy surcharge or Higher Education Loan Program (HELP) repayments.

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Interaction with GST [7.450]  As discussed at [7.410], the fact that an employer may be entitled to a refund of GST paid on the acquisition of a fringe benefit, while an employee would generally not be entitled to a refund, is taken into account in determining the FBT liability through the grossing-​up mechanism. As such, the cost of a fringe benefit in determining taxable value is the GST-​inclusive cost: Ruling TR 2001/​2. Where the fringe benefit relates to a reimbursement, s 111-​5 of A New Tax System (Goods and Services Tax) Act 1999 (Cth) deems the acquisition to have been made by the employer for GST purposes. This provision enables the employer to obtain GST input tax credits in relation to the acquisition (if entitled) even though the acquisition was actually made by the employee and the employer only reimbursed the employee. As will be seen in Chapter 25, the provision of employee services and the receipt of fringe benefits may be considered a barter transaction that gives rise to GST consequences. However, s 9-​75(3) of A New Tax System (Goods and Services Tax) Act 1999 provides that such transactions will not give rise to a GST liability unless the recipient makes a contribution for the benefit. Where the employee makes a contribution towards the benefit, the employer is registered for GST purposes and the benefit is not GST-​free or input-​taxed, the employer will have to remit one-​eleventh of the recipient’s contribution in GST to the ATO in respect of the supply of the fringe benefit.

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232 [7.460]  PRINCIPLES OF TAXATION LAW 2020

Questions [7.460]  7.1 Determine whether the following benefits are fringe benefits or exempt fringe benefits and, where applicable, the relevant category of fringe benefit. Provide reasons for your answer: (a) Payment to employee for the estimated cost of the employee’s home phone bill as the employee sometimes has to use the home phone for work purposes.

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(b) Provision of accommodation at the family home to a child who is over 21 and works in the family business. (c) Payment of employee’s superannuation contribution by the employer to a complying superannuation fund. (d) Loan by Company X to one of its directors, Rupert, who is also a shareholder in the company. The company’s rules do not permit loans to directors. (e) Payment of taxi fare by employer for employee to travel home after working late. (f) Flowers sent to a sick employee. The flowers cost $75. (g) Provision of a car for an employee’s private use, including payment of all fuel costs by the employer. (h) Provision of sandwiches at a lunchtime seminar held at the employer’s premises. (i) Provision of an all-​expenses-​paid holiday to an employee who has had to work every weekend for the last six months. (j) Provision of two laptop computers to an employee who regularly attends clients’ premises. 7.2 Jenny is an employee of the university. She is provided with 10 gift vouchers worth $50 each for use at the local supermarket as a Christmas gift. Advise Jenny and the university of the tax consequences of this transaction. 7.3 Loo is an employee at a large real estate agency. He has negotiated the following benefits with his employer: • Provision of a car for work and personal use. Loo was provided with the car for the period 1 April 2019 to 31 March 2020. The leased car value was $22,000 at 1 April 2019, and the car had only been leased for a year at that time. Loo is required to pay for any petrol costs which he has determined to be $1,300 for the period 1 April 2019 to 31 March 2020. • Provision of the latest model smart phone on 1 April each year as Loo is usually “on the street” and needs a good phone to do his

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7: FrinGe Benefits tax  [7.460] 233

job. Loo estimates that he uses the phone 70% for work purposes. The phone was purchased new on 1 April 2019 for $1,100 (including GST). Advise Loo’s employer as to the FBT consequences (including calculation of any FBT liability) arising out of the above information. You may assume that any benefits are Type 1 fringe benefits. 7.4 Jasmine borrowed $15,000 from her employer on 1 February 2020 to pay for her wedding. The loan was provided at an interest rate of 2%. The wedding was on 29 February 2020 and on that day, Jasmine’s employer informed her that she only needed to repay $10,000 of the loan. Advise Jasmine’s employer as to the FBT consequences (including calculation of any FBT liability) arising out of the above information. You may assume that wedding costs are not a deductible expense for tax purposes. You may also assume that any benefits are Type 2 benefits. 7.5 Rita’s employer sells furniture. On 17 January 2020, Rita purchased a table from her employer for $1,000. The table would usually be sold for $3,000 and cost the employer $500 to purchase. The employer decided to give Rita a tablecloth for the table as a “free gift” for the purchase of the table. The tablecloth would usually be sold for $150 and cost the employer $50 to purchase. Rita’s employer also decided to host a “leap year party” on 29 February 2020 for all employees and their partners. In total, there were 20 attendees (10 employees and 10 partners) and the party cost $3,300 (including GST). The party was held at a local Mexican restaurant. Advise Rita’s employer as to the FBT consequences (including calculation of any FBT liability) arising out of the above information. You may assume that any benefits are Type 1 benefits. You may also assume that Rita’s employer has no other meal entertainment expenditure for the year, elects for Div 9A to apply to the provision of meal entertainment fringe benefits and determines the taxable value of meal entertainment fringe benefits using the 50/​50 split method.

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8 Income from business

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Key points......................................................................................................  [8.00] Introduction..................................................................................................  [8.10] Step 1: Carrying on a business...................................................................  [8.20] Indicators of a business activity............................................................  [8.30]

Gambling....................................................................................................  [8.60] Sportspeople..............................................................................................  [8.80] Investment activities..................................................................................  [8.90] Land sales.................................................................................................  [8.100] Sharing economy.................................................................................  [8.105] Crowdfunding activities.......................................................................  [8.107] Commencement and termination of business...................................  [8.110] Step 2: Normal proceeds of a business....................................................  [8.130] Nature of the business –​broad or narrow approach?........................  [8.140] Nexus of receipt with business...........................................................  [8.150] Non-​cash business benefits.................................................................  [8.160] Extraordinary and isolated transactions..................................................  [8.170] Introduction..........................................................................................  [8.170]

Transaction forms a business in itself under the principle in FCT v Whitfords Beach..............................................  [8.180]

Principle applied to isolated transactions...............................................  [8.180] Principle applied to extraordinary transactions......................................  [8.190] Calculating ordinary income under the principle in FCT v Whitfords Beach...............................................................................  [8.200] Two strands of Myer............................................................................  [8.210] First strand of Myer..................................................................................  [8.220] Second strand of Myer............................................................................  [8.260]

Statutory provisions that may apply to extraordinary and isolated transactions...................................................................................  [8.265]

Capital gains tax.......................................................................................  [8.270] Section 15-​10: Bounties and subsidies...................................................  [8.280]

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236 [8.00]  PRINCIPLES OF TAXATION LAW 2020 Section 15-​15: Profit-​making undertaking or plan.................................  [8.290] Section 25A: Profit from sale of asset acquired with the purpose of resale...............................................................  [8.300] Questions.....................................................................................................  [8.310]

  

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Key points [8.00]  • Business income is ordinary income under s 6-​5 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997). • Whether a business is being carried on or not will be determined by weighing up whether sufficient characteristics of a business are present. • No one of the indicators of a business is decisive in classifying an activity as a business. • Some activities are by nature more likely to be pursued as a hobby or for recreational purposes and are therefore less likely to be classified as a business. • As well as identifying the business, it is also necessary to decide when the business commences and ends as receipts not associated with the operation of the business are not business income. • Receipts that are not the normal proceeds of the business are not assessable as business income but may be assessable under one of the other principles of ordinary income or statutory income. • Non-​cash business benefits are deemed to be convertible to cash by s 21A of ITAA 1936 and, provided they are income of the business, they are assessable and valued at an arm’s length value. • One-​off transactions undertaken by taxpayers who are not running a continuous business are called isolated transactions. • Transactions undertaken by taxpayers that are running a continuing business but that are not within the scope of that business are called extraordinary transactions. • Isolated and extraordinary transactions usually only generate ordinary income if they fulfil the requirement of one or more of the following three: • the principle in FCT v Whitfords Beach; • the first strand of FCT v Myer Emporium; or • the second strand of FCT v Myer Emporium. • The principle in FCT v Whitfords Beach is likely to be satisfied if the isolated/​ extraordinary transaction has sufficient characteristics of a business.

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• The first strand of FCT v Myer Emporium will be satisfied if there is a business/​ commercial transaction, a profit-​ making intention upon entering the transaction and consistency between the way the profit is made and the original intention. • The second strand of FCT v Myer Emporium will be satisfied where a taxpayer sells the right to income but retains ownership of the underlying asset that is the source of the that income. • Profits from isolated and extraordinary transactions will often be taxable under capital gains tax.

Introduction [8.10]  Income earned from carrying on a business is ordinary income under s 6-​5 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) following the general concepts of income outlined in Chapter 5. This is in contrast to non-​ business activities, such as hobby or pleasure activities, which do not generate ordinary income and therefore are not assessable under s 6-​5. Characterising receipts as ordinary income from a business activity is a two-​ step process that requires: 1. determine whether the taxpayer is carrying on a business; and

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2. consider whether the particular receipts are in fact the normal proceeds of carrying on that business. This two-​step process removes from assessable income activities that are undertaken as a hobby or recreational pursuit and receipts that are not the normal proceeds of the business because they are outside the scope of the business activity. However, receipts that are not the normal proceeds of the business may still be assessable as ordinary or statutory income. This will be the case if they are characterised as ordinary income by one of the other general concepts of income (see [8.170]–​[8.300]) or if they are specifically made assessable by the legislation.

Step 1: Carrying on a business [8.20]  Disputes relating to whether or not a business is carried on often arise because a taxpayer wishes to take advantage of concessions offered to certain types of businesses, such as farming or the lower tax rates available for some companies (see Chapter 21). Similarly, the taxpayer may wish to use the losses from non-​profitable activities, such as share trading, against other taxable income. In contrast, the Commissioner may seek to classify an activity as a business to collect tax on the profits realised, even though the taxpayer is treating it as a hobby.

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238 [8.30]  PRINCIPLES OF TAXATION LAW 2020 The term “business” is used throughout the legislation, and the definition in s 995-​1(1) of ITAA 1997 “includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee”. This definition is of little assistance as it only adds to the general meaning of “business” by including any profession, trade, etc, and leaves open the question of what is a business in the ordinary meaning of the word. As a result, it is necessary to look at the decided cases to determine the factors that have been used by the courts in making this decision: Ferguson v FCT (1979) 9 ATR 873: see Case Study [8.1]. It is significant that the definition of “business” in s 995-​1(1) states that it does not include income from an “occupation as an employee”. This means that in most cases, employment income will not be business income. However, in some cases, an employee contract may not be solely a contract of employment: Spriggs v FCT; Riddell v FCT (2009) 72 ATR 148: see [8.80].

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While income from personal services and business income are both generally assessable under s 6-​5 as ordinary income, there are certain consequences that follow depending on how the income is categorised. For instance, gains that are business income can be subject to certain types of deductions that are not available for income that is purely income from personal services: see [8.80]. When considering if a business is being carried on, the courts have made a distinction between activities that are conducted in a commercial-​like manner and activities that are pursued as a hobby or recreational activity. As with other characteristics of ordinary income, this distinction is quite clear at the extreme ends of the spectrum. However, it is difficult to identify the point at which a hobby becomes a business, or the point at which activities first undertaken for pleasure show sufficient characteristics of a commercial approach to be later classified as a business.

Indicators of a business activity [8.30]  Over the years, the courts have identified a number of characteristics of a business, and the presence, or lack, of these characteristics has been used to classify the activity as a business or a hobby. However, this is a very imprecise process, and it is extremely important to appreciate that the characteristics used by the courts are not necessarily exhaustive and no one characteristic alone is a single indicator of a business. To ascertain whether a business exists, the courts use an accumulative approach of weighing up the characteristics of a business that are present and comparing them to those that are absent. On balance, a decision is then reached as to whether the activity possesses sufficient of the characteristics

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to be classified as a business. This approach involves a question of degree (weighing up the facts toward a possible conclusion) and, like all other questions of degree, it is difficult to draw a precise line between activities that are a business and those that are not. It is also important to recognise that the courts may place varying degrees of importance on particular characteristics for different types of activities. For example, the courts tend to look for a higher level of certainty that a business exists for activities such as gambling: Evans v FCT (1989) 20 ATR 922; Brajkovich v FCT (1989) 20 ATR 1570.

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[8.40]  Although it is not possible to create an exhaustive list of the characteristics of a business, the following are the most common factors that have been considered by the courts (Ferguson v FCT (1979) 9 ATR 873: see Case Study [8.1]; FCT v JR Walker (1985) 16 ATR 331: see Case Study [8.2]): • Whether there is a profit-​making intent. A profit-​making intention is a strong, though not determinative indication that there is a business. In addition, a lack of profit-​making intention does not necessarily preclude there being a business, especially if the operation has sufficient other characteristics of a business: Stone v FCT (2005) 59 ATR 50: see Case Study [8.8]. Furthermore, it is not necessary to show the existence of an actual profit to show a profit-​making intent. • The scale of activities, including the nature and type of capital and the level of turnover. For example, the larger the business turnover, the more likely it would be held to be a business, but this does not exclude small activities from being held to be a business: FCT v JR Walker (1985) 16 ATR 331: see Case Study [8.2]. • Whether a commercial approach is taken. For example, whether professional advice has been sought before and during the operation, whether markets for produce have been explored and whether the produce is more than that needed for domestic purposes. • System and organisation employed. For example, the degree of planning involved, the amount of time devoted to the activity and whether records are kept. Generally, the courts have been willing to accept that taxpayers may delegate many of the business-​like activities to a manager yet still be considered to be running a business: Ferguson v FCT (1979) 9 ATR 873; FCT v JR Walker (1985) 16 ATR 331. • Methods characteristic of the particular line of business. For example, using methods similar to those used in a similar commercial business, such as a dairy farmer using planned breeding programs to increase milk production. • Sustained and frequent activity. For example, occasionally selling pups from your pet dogs is not the same as regularly breeding a particular type of dog and aiming to sell the offspring.

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240 [8.40]  PRINCIPLES OF TAXATION LAW 2020 • The type of activity and the type of taxpayer. For example, a business of trading in stamps would have to be much more than the traditional pastime of a hobbyist collecting stamps and occasionally selling some duplicates.

Case study 8.1: Indicators of a business

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In Ferguson v FCT (1979) 9 ATR 873, the taxpayer (Ferguson) planned to purchase rural land on which he intended to establish a full-​scale cattle production business for his retirement in two to three years’ time. To begin building up his planned herd of 200 Charolais cattle, Ferguson leased five females for four years and bred them to a stud bull in order to establish his purebred herd. Ferguson also entered into a management agreement with a rural management firm for a period of 10 years for the purpose of managing the leased cattle and their calves. The management agreement required the manager to find suitable grazing for the cattle and to manage their breeding. All resulting offspring became the property of the taxpayer. The taxpayer contended that these activities constituted a business, but the Commissioner argued that this was only preparation for a future business. The Full Federal Court held that Ferguson was carrying on a business, even though it was small and even though it was preliminary to his intended future business. Central to the conclusion reached by the Court was the question of whether the taxpayer was conducting this breeding program in a commercial manner albeit carried out by a manager. In its decision, the Court considered the following factors:







• A purpose of profit-​making may be important but not essential. • Repetition and regularity are considerations, but a business could involve a single transaction and every business must commence with a single transaction. • Organisation and a business-​ like approach with appropriate record keeping, etc, is an indication of a business activity. • Having other sources of income did not preclude this activity from being a business. In other words, the fact that the taxpayer had a full-​time job was not inconsistent with him carrying on a business. • The size of the operation and the amount of capital are relevant, but must be looked at in the context of the type of activity. For example, a recreational pursuit may have considerable effort and resources contributed to it and still not be a business. • These activities were more than preparation to begin a future business.

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[8.50]  When using these factors to characterise an activity as a business or not, the courts will weigh up the factors present in the context of the type of activity, but there is no single determinative factor that is a reliable indicator of a business. However, the courts may place a relatively higher degree of importance on whether the taxpayer is taking a commercial approach, by conducting the activity in a manner similar to that used in situations that are clearly conducting a business: Thomas v FCT (1972) 3 ATR 165; Ferguson v FCT (1979) 9 ATR 873; FCT v JR Walker (1985) 16 ATR 331.

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Case study 8.2: Small-​scale goat-​breeding operation a business In FCT v JR Walker (1985) 16 ATR 331, the taxpayer was a real estate agent who was interested in breeding Angora goats. He purchased one female Angora goat for $3,000, and then paid another $2,000 to have the goat impregnated. The breeding process undertaken by the taxpayer involved substantial assistance by a veterinary surgeon called Dr Corbett, who undertook many of the actions and decisions of the goat-​ breeding operation since the taxpayer lived over 3,000 km away and so could not be directly involved in its everyday running. The breeding eventually led to the birth of four more goats, though the original goat and one of its offspring prematurely died. Although the taxpayer stated that he intended to profit from the breeding operation, in fact it only produced losses. Consequently, after a few years the taxpayer quit the goat-​ breeding operation. However, while the goat-​ breeding venture was running, the taxpayer relied upon Dr Corbett for advice, joined the Angora Breeding Society, read that society’s journals and kept detailed books of accounts. Justice Ryan of the Supreme Court of Queensland held that the taxpayer had been running a business rather than a hobby. His Honour applied the criteria outlined in Ferguson v FCT for deciding if there was a business. Specifically, the conclusion that there was a business was partially supported by the fact that the taxpayer had a profit-​making intention. It was also supported by the fact that there was repetition and regularity in the breeding activities in that the breeding process was undertaken repeatedly for a number of years. The conclusion was also highly influenced by the fact that the taxpayer conducted the operations in a business-​like manner, as evidenced by his keeping of accounts, joining the Angora Breeding Society, reading the relevant journal and generally keeping himself informed about the Angora goat-​breeding market. While many of the actions and decisions were deferred to Dr Corbett, this was understandable given the fact that the taxpayer lived some distance from the operation and that Dr Corbett had much more expertise and knowledge on the subject of breeding Angora goats.  

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242 [8.50]  PRINCIPLES OF TAXATION LAW 2020 The finding in FCT v JR Walker that the taxpayer was running a business was despite the fact that the operation was small even though size was mentioned in Ferguson v FCT as relevant in determining the existence of a business. Therefore, although volume of operations is a factor in deciding whether there is a business, a small operation can still constitute a business if there are sufficient other business-​like characteristics. Case study 8.3: A small business or a hobby

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In Thomas v FCT (1972) 3 ATR 165, the taxpayer (Thomas) was a barrister who purchased 7.5 acres (3.04 ha) of land where he constructed a private home and planted several varieties of trees for timber, macadamia nut and avocado production, some of which were irrigated. For the relevant period no income had been produced and some of the trees had been destroyed by fire and there had been some replanting. Thomas contended that he was carrying on a business, but the Commissioner argued that this was a hobby because it was not likely that there would be any significant income and this type of agriculture was not common in this area. The High Court held that there was a business of primary production and that a business may exist even though it is conducted on a small scale and has little or no short-​term prospect of making a profit. It was not significant that the taxpayer’s main income was earned from his profession as a barrister or that only a small amount of time was devoted to the farming activity. What was important was that the tree planting was much greater than what would be needed for domestic purposes and the activity was more than a recreational pursuit or hobby. Walsh J was not swayed by evidence that the business was conducted rather inefficiently, and his Honour concluded that it is reasonable to accept that mistakes will be made and the taxpayer did seek technical advice to assist with management decisions.   Distinction between a business and hobby in Thomas v FCT centred on the issue of whether the farming undertaken was more than a recreational activity pursued for mainly leisure purposes. Example 8.1: Degree of commercial approach A taxpayer who plants vegetable and fruit trees in his own backyard and uses the produce for his own personal consumption is clearly not conducting a business. This would still be the case even if small amounts of excess produce are sold to neighbours, as this is unlikely to be enough to cross the border between a hobby and business.

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Establishment of a business for income tax purposes requires some degree of commerciality, which would be indicated by production being more than required for domestic consumption and a more systematic and organised approach to the vegetable and fruit production: Ferguson v FCT (1979) 9 ATR 873. Facts such as using land other than the backyard, selling produce on a regular basis at the local markets, seeking professional advice on production techniques, planning production to meet demand and keeping appropriate records would all help to indicate that a commercial approach is being employed.    As previously mentioned, there is no exact formula for identifying the dividing line between a business and a recreational activity or hobby. Each case must be considered on its facts and decided in the light of the factors that the courts have considered relevant in the decided cases. Some examples to assist in narrowing the degree of uncertainty in this decision include: • gambling: see [8.60]; • sportspeople’s earnings: see [8.80]; • investment activities: see [8.90]; and • land sales: see [8.100].

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Gambling [8.60]  Taxpayers such as professional bookmakers and casino operators are clearly running a business because they take a commercial approach in that they operate on such a large scale that they can reasonably manage the odds of winning and predict their likely profit. On the other hand, an individual who gambles is very unlikely to be considered to be in the business of gambling because such activities are inherently recreational in nature. For instance, a person who regularly bets on horse races or at the casino is normally undertaking a recreational pursuit and is not considered to be in the business of gambling. For an individual to be found to be carrying on a business of gambling, there would need to be a significant level of commercial activity, such as regular and systematic betting, large amounts of money wagered and possibly integration with other business activities like horse racing and horse breeding: Trautwein v FCT (1936) 56 CLR 196; Prince v FCT (1959) 7 AITR 505. Gambling on horse racing is more likely to be a business if the gambler is associated with other related activities, such as owning horses, training horses or operating as a bookmaker: Income Tax ruling IT 2655.

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244 [8.70]  PRINCIPLES OF TAXATION LAW 2020

Case study 8.4: Gambling part of business of horse racing In Trautwein v FCT (1936) 56 CLR 196, the taxpayer had for a number of years been interested in horse racing with a view to making a profit. He devoted a substantial amount of time and money to the sport and established a farm for breeding racehorses. Trautwein raced his own horses as well as others that had been leased to him. The taxpayer was also involved in frequent and systematic betting on horse races wagering large amounts of money and using an agent to place bets and collect winnings. He also regularly attended race meetings throughout the year.

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The High Court held that the taxpayer’s gambling activities were part of his racehorse business, and therefore his earnings were ordinary income. Influential to the Court’s decision was the fact that the taxpayer’s gambling was closely associated and integrated with his horse-​racing business. Other factors considered relevant were:

• the size of the bets;



• the systematic and organised approach;



• commitment of substantial amounts of money and time to betting; and



• employment of other people to place bets and collect winnings.

[8.70]  In Australia, the courts have generally concluded that gambling does not constitute a business if it is not conducted on a large scale and is not connected to another business: Martin v FCT (1953) 90 CLR 470; Evans v FCT (1989) 20 ATR 922; Brajkovich v FCT (1989) 20 ATR 1570. As a result of the more recent decisions in Martin v FCT and Evans v FCT, it may be suggested that if facts similar to Trautwein v FCT were considered by the courts today, the same conclusion may not be reached. Case study 8.5: Gambling not a business even though associated with horse breeding In Martin v FCT (1953) 90 CLR 470, the taxpayer owned and bred race horses and had previously carried on business as a hotelier and then as a farmer. Over the years, he regularly engaged in betting on horse races in a systematic manner and his accountant kept the records of his expenses and winnings from gambling. The High Court held that the taxpayer was not conducting a business, but pursuing a recreational pastime despite the facts that there were a large number of bets, he employed a system in his betting and he had other interests in horse racing.  

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Case study 8.6: Gambling not a business due to lack of systematic approach In Evans v FCT (1989) 20 ATR 922, the taxpayer earned over $800,000 from betting on horse racing over a five-​year period. The Federal Court held that Evans was a lucky gambler and was not conducting a business because of the lack of a systematic approach. The Court relied on the fact that he did not place his bets with a bookmaker and he often wagered on long-​ odds  bets.  

Case study 8.7: Gambling with no other source of income was not a business

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In Babka v FCT (1989) 20 ATR 1251, on retiring at the age of 51, the taxpayer had commenced spending a large amount of time gambling. The gambling was predominantly concentrated on horse racing, although it included other activities such as card games and casinos. The taxpayer did not have employees or an office. The Commissioner claimed that the taxpayer was in the business of gambling due to the fact that they had no other income, kept detailed records of previous bets and utilised a betting system. Justice Hill of the Federal Court held that Babka was not in the business of gambling. His Honour stated that the fact that a taxpayer devotes a large amount of time to their gambling activities, uses a betting system and keeps detailed betting records does not necessarily mean that they are in  the business of gambling.

Sportspeople [8.80]  Some sporting activities involve a high degree of professionalism to the extent that participants are fully occupied by their sporting pursuits. Also, there may be significant amounts of money involved, extensive use of managers and agents to negotiate individual contracts and significant involvement of the media and advertising industries. In these circumstances, it is relatively clear that the participants are carrying on a business of earning income or at least earning income from personal services: see [6.30]. In contrast, sporting activities that are undertaken as a recreation pursuit will not constitute the carrying on of a business although there may still be income from personal services: see [6.30]. Identifying the receipts of a professional sportsperson as income from a business or income from personal services (see [6.10]–​[6.30]) is important.

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246 [8.80]  PRINCIPLES OF TAXATION LAW 2020

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This is because it may influence how they are treated for tax purposes as a team-​based professional sports person paid as an employee may have limited tax deductions compared to a professional sports person judged to be operating a business: Stone v FCT (2005) 59 ATR 50; Spriggs v FCT; Riddell v FCT (2009) 72 ATR 148: see Case Studies [8.8] and [8.9]. The tax consequences of a professional sportsperson’s activities constituting a business, or not, include: • Any fees paid by the club that the professional sportsperson is playing for will be ordinary income regardless of whether the taxpayer’s sporting activities are regarded as a business. For example, club payments to a professional footballer who is in the business of playing football could be ordinary income from business, but if he is not in the business of playing football, then the payments would be ordinary income from personal services. • Prizes for sporting achievements (see [6.110]) received by a sportsperson whose sporting activities constitute a business will be ordinary income from that business: Stone v FCT: see Case Study [8.8]. On the other hand, if the sporting activities do not constitute a business, prizes received for sporting achievement may still be regarded as ordinary income from personal services: Kelly v FCT (1985) 16 ATR 478: see Case Study [6.6]. However, in the case of sportspeople whose sporting activities constitute a business, there may still be instances where sporting prizes may not be regarded as ordinary income if the prize is awarded for the personal qualities of the taxpayer: Stone v FCT. • There could be a broader range of deductions available if the taxpayer’s sporting activities are regarded as a business. For example, if a professional football player is regarded as being in the business of playing football, then any fees paid to a manager to enter into a contract with a new team would be deductible: Spriggs v FCT; Riddell v FCT. However, such fees would not be deductible if the football player’s sporting activities are not regarded as being a business. This is because the first limb of s 8-​1 ITAA 1997 (only available to employees) requires that the expense is incurred in the course of earning the income, but agents fees are incurred before the income is earned. In recent years, the courts have been more likely to label professional sportspeople as being in business. This has been the case for sportspeople that regularly play team sports at a high level: Spriggs v FCT; Riddell v FCT. It has also been the case for taxpayers that compete in non-​team sports at high levels of competitions, especially if the sportsperson also undertakes related commercial activities, such as seeking corporate sponsorship: Stone v FCT.

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Case study 8.8: Javelin thrower was carrying on a business In Stone v FCT (2005) 59 ATR 50, the taxpayer (Stone) was a world-​class javelin thrower and was also a full-​time employee in the Queensland Police Force. As well as performing her duties as a police officer, Stone competed successfully in national and international competitions, including being selected for the Australian Olympic squad and winning the women’s javelin event in the 1998 World Cup. During the tax year ending 30 June 1999, Stone earned $136,448 from her sporting pursuits. This sum consisted of prize money, grants from the Queensland Sports Academy, appearance fees and sponsorship fees. The sponsorship fees were paid for her wearing clothing of certain brands, as well as her agreeing to have advertising material on her sporting clothes and the motor vehicle that was provided to her. The taxpayer also employed a manager for a short time to manage her sponsorships and appearances.

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The High Court held that Stone was carrying on a business in relation to her sporting activities and that all cash receipts from this business were ordinary income under s 6-​5 of ITAA 1997. The Court stated that although Stone lacked a clear profit motive, an examination of the relevant activities indicated that she was carrying on a business. In reaching this decision, the Court was particularly influenced by the fact that Stone had entered into sponsorship deals. The Court also mentioned that although the presence of a profit motive is a strong, though not conclusive, indication that the taxpayer is running a business, an operation can still be a business despite the taxpayer lacking a profit motive.  

Case study 8.9: Professional team sportspeople are carrying on a business In Spriggs v FCT; Riddell v FCT (2009) 72 ATR 148, both taxpayers played football in their respective football leagues and arranged for their managers to negotiate new player contracts upon them changing clubs. Following the completion of the negotiations of the player contracts, the managers charged their clients a fee, which Spriggs and Riddell claimed as a tax deduction. One issue considered by the High Court was whether Spriggs and Riddell were carrying on a business and, if so, the extent of their business activities. Due to the rules of deductibility, management fees relating to entering contracts with new clubs would only have been deductible if the sport-​playing activities were business activities: see [12.340]–​[12.350]. It was accepted by all parties that activities outside their playing duties

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248 [8.90]  PRINCIPLES OF TAXATION LAW 2020

(eg, endorsement and media engagements) were business activities. However, the Commissioner contended that the older decision in Maddalena v FCT (1971) 2 ATR 541 should be followed. In Maddalena v FCT, the Court had held that professional football playing activities were employment activities and not business activities. The High Court found that Maddalena v FCT did not apply to the facts in Spriggs and Riddell and held that the taxpayers’ sports-​playing activities were business activities. The Court distinguished Maddalena v FCT on the basis that in Maddalena v FCT the taxpayer played rugby part time and had no manager. In contrast, the taxpayers in Spriggs and Riddell played football full time and had managers. Furthermore, the Court was influenced by the fact that modern-​day football had changed since the case of Maddalena v FCT in that changing clubs was easier and more structured than had previously been the case.  

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Investment activities [8.90]  Investment income will normally be characterised as income from property (see Chapter 9) because it is inherently passive in nature and is earned without showing sufficient of the elements of a business: FCT v Radnor Pty Ltd (1991) 22 ATR 344. However, whether investment income is property or business income can be an important distinction as it will affect the tax treatment of the transactions. Where investment income is classified as property income, the acquisition of the underlying investments, such as shares and rental property, will be treated as capital and the sale will not be ordinary income: Greig v FCT [2018] FCA 1084. Conversely, if the investment activity is classified as a business, the underlying investment, such as the shares, will be regarded as trading stock (see Chapter 17) and treated on revenue account as ordinary income, rather than as capital. Identifying investment activities as a business is a question of degree which will be determined from the facts, taking into account the previously identified indicators of a business: see [8.30]–​[8.50]. For example, large superannuation funds and listed investment trusts are commonly in the business of investment. However, there has to be something more than a profit-​making intention and frequent transactions to show that the taxpayer is carrying on a business of investing. In London Australia Investment Co Ltd v FCT (1977) 7 ATR 757, the High Court held that a business of investment was being carried on due to the high degree of activity in investing and reinvesting in shares to maintain a minimum dividend yield. In contrast, a business that invests for long-​term growth, rather than

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speculative investment, will normally be classified as earning property income and not income from a business: AGC (Investments) Ltd v FCT (1992) 23 ATR 287; Smith and Commissioner of Taxation [2010] AATA 576. For example, a taxpayer who purchases a portfolio of shares as a long-​term investment for capital growth, but occasionally sells some of the shares to restructure the portfolio, is not conducting a business of selling shares. This is illustrated by the Commissioner’s view that a self-​managed superannuation fund that holds shares and/​or rental property to earn passive income is not carrying on a business: Self-​Managed Superannuation Fund Ruling 2009/​1. Whereas a bank that holds a large portfolio of shares and regularly speculates on movements in the share market and trades in these shares to maintain liquidity is in the business of buying and selling shares. In Taxation Ruling 2019/​ 1, the Commissioner expresses the view that a company can be taken to be carrying on a business even if the activities are quite limited. This would be the case even if the company’s income consists mainly of passive income such as rent or interest. Nevertheless, the statement in the draft ruling is qualified with the comment that each case has to be determined on the facts.

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Case study 8.10: Holding shares for long-​term growth not carrying on an investment business In AGC (Investments) Ltd v FCT (1992) 23 ATR 287, the taxpayer (AGC (Investments)) was a subsidiary of an insurance company and was set up to earn dividend income and maximise long-​term capital growth for the parent company. The share portfolio was professionally managed and the parent company treated the value as a capital reserve in its balance sheet. In 1987, the taxpayer decided to sell over 50% of its share portfolio, realising almost $80 million and a significant profit. AGC (Investments) then reinvested the proceeds into fixed interest securities. The Full Federal Court held that AGC (Investments) was not carrying on an investment business but was holding the shares for long-​term capital growth. The key facts in reaching this decision were that there was clear evidence that the investments were undertaken for long-​term growth rather than speculative returns. In addition, the shares were not bought and sold to maintain liquidity for the parent company. Under current legislation, the sale of these shares would be subject to capital gains tax: see Chapter 11.   Most cases concerning the business status of share trading activities have involved facts relating to larger financial institutions. Even so, it is still possible

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250 [8.100]  PRINCIPLES OF TAXATION LAW 2020 for an individual to be conducting a business of share trading. This is a question of fact as it is with all other decisions as to whether an activity is a business for tax purposes. For instance, in AAT Case 4083 [2011] AATA 545, it was held that an individual taxpayer trading shares in his own name was in the business of share trading for income tax purposes. The primary reasons for reaching this conclusion, despite the small number of sales in the year, were that the taxpayer operated on a large scale (millions of dollars), he normally traded regularly, he followed a systematic approach even though he did not have clear goals and he was often seeking volatile shares.

Land sales

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[8.100]  As with other decisions as to whether a business is being carried on, it is difficult to draw a clear line between the sale of land that is capital as a “mere realisation” (disposal of an asset that is no longer required) of an asset and the business of property development. Where the firm’s primary activity is purchasing, developing and selling land, it is clearly undertaking an ongoing business of selling land: FCT v St Hubert’s Island Pty Ltd (1978) 8 ATR 452. Conversely, a firm that sells a factory and accompanying land because the property is no longer required is clearly not in the business of selling land, even though it may conduct some other business in the factory. However, if the land could potentially be rezoned as residential and the firm decides to undertake extensive development activities, the question arises as to whether the firm has entered a new business of property development: see [8.170]–​[8.200]. Whether the sale of land is part of an ongoing business activity will be resolved by considering the extent to which the elements of a business are present. However, land may also be sold as an isolated transaction, which may be classified as ordinary income: see [8.170].

Sharing economy [8.105]  In recent years, there has been a rapid increase in the “sharing economy”, as it has become known. The concept of the sharing economy is that the Internet is used to connect a client with a service provider. Some of the more common examples are the renting accommodation space (rooms or whole houses) through such sites as Air BNB, Stayz and Booking.com, ride-​ sourcing through Uber, DiDi, Ola and GoCatch; providing personal services through Airtasker or Oneflare; retail activities operated through eBay; and renting parking space through Parkhound. All of these activities allow providers to make their services or product available to a wide range of potential clients without the usual infrastructure such as websites and advertising that businesses normally require to access their markets.

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The sharing economy has come under scrutiny by the Australian Taxation Office’s (ATO) Black Economy Taskforce as there is some concern that some operators in the sharing economy are treating receipts as cash and not considering whether they are assessable income. Providers operating in the sharing economy need to be aware of the possible income tax obligations that arise from providing services via these websites. These obligations will primarily depend on whether they have earned income from personal services (see Chapter 6) or whether they are conducting a business. There could also be other taxation implications such as liability to GST (see Chapter 25) and effects on CGT main residence concessions if part of your main residence is available to the public for accommodation: see later in this chapter.

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Earlier in this chapter, the characteristics of a business were discussed in detail, and this will be an important consideration as to whether the receipts from these activities are assessable or not as ordinary income under s 6-​5 ITAA 1997. The primary distinction to be made is whether the activities are undertaken for recreational purposes as a hobby (not ordinary income) or conducted in a business-​like manner to earn assessable income. Where these services are provided through a facilitating website, such as Uber or Air BNB, it will be very difficult to make the case that this is a private recreational activity (hobby) as there are significant characteristics of a business present: see [8.40]. For example: • pricing of the services on offer would indicate an intention to profit; • the scale of the operation may be small, but this does not exclude the activity from being a business if it is conducted in a business-​like manner. Conducting the activity through a sharing economy website would be evidence of a business-​like approach; • a commercial approach is evident as the sharing economy websites require a level of detail and professionalism in the offering of the service. For example, Air BNB requires details of the facilities offered in the accommodation, and they require a certain level of standard; • the provider is required to be organised and satisfy the requirement of the sharing economy website. For example, an Uber driver is required to meet certain requirements including a vehicle inspection; • there may or may not be sustained and frequent activities, but when these activities are undertaken, they show many of the characteristics of a business. Note: The Commissioner of Taxation considers income earned from the sharing economy to be assessable income. If it is established that operating in the sharing economy is a business activity, then the normal requirements of the income tax legislation will need to be

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252 [8.107]  PRINCIPLES OF TAXATION LAW 2020 satisfied. Income will be assessable, and deductions can be used to reduce the taxable amount. There will also be the normal record-​keeping requirements. Some of the tax implications of operating in the sharing economy include: • income is assessable income; • liability to GST if the turnover is $75,000 or greater; • interest relating to property, vehicles or other assets may be deductible in part or in full based on the degree to which the assets are used to earn assessable income; • possible depreciation deductions for depreciating assets or Div 43 write-​off of buildings; • partial or complete loss of CGT main residence concessions through renting out part of a home that is designated as a main residence or making paid parking space available on private property; • requirements to register an Australian Business Number (ABN); and • requirements to keep records for tax purposes.

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Crowdfunding activities [8.107]  The concept of raising funds from the public for many and varied purposes is by no means a new idea. In 1700s, Jonathon Swift established a process whereby wealthier citizens (the crowd) could provide funds to be lent to the poor in Dublin. However, the development of the Internet has facilitated the rapid growth of this form of fund raising where a project is funded by raising small contributions from a large number of people (contributor –​the crowd). The process begins with the initiator (recipient) proposing to raise funds for a specific purpose (eg, to develop a new product). They then engage an Internet-​based crowdfunding platforms (intermediary’s such as Mycause and GoFundMe) to promote and collect contributions, and then for a fee or commission pass the collected funds onto the initiator or recipient of the project. Crowdfunding has been used for a number of purposes including raising funds for bushfire and drought relief, business start-​ups, technology development and recently, due to changes in government legislation (Corporations Amendment (Crowd-​ sourced Funding for Proprietary Companies) Act 2018), making it possible for proprietary companies to use crowdfunding for equity raising. The income tax impact on funds raised through crowdfunding will depend on the purpose the funds are raised for and the circumstances of the taxpayer(s) involved. Generally, crowdfunding will either be: • a donation (eg, drought relief); • reward-​based (contributor receives goods or services based on the level of contribution); and

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• equity-​based (the contributor obtains an interest in a project with rights to returns). For tax purposes, this means that the three parties involved in crowdfunding need to consider the tax implications of their transactions: • Initiator or recipient: Is this part of a business activity or not? • Crowdfunding platform (intermediary): Is this activity a business or are they operating as an agent? • Contributor: Are contributions a tax deduction and any return assessable? Initiator (recipient): Receipts from crowdfunding will be assessable if they are connected to carrying on a business (see [8.20]), or the receipts are an extraordinary or isolated transaction entered into with the intention of making a profit (see [8.170]). However, it is also necessary to consider whether or not the business has commenced at the time the crowdfunding arrangements begins (see [8.110]). If the business has not commenced at this stage, then the receipts will not be ordinary income under s 6-​5 of ITAA 1997 unless it is an extraordinary or isolated transaction. Similarly, if the business has not commenced, then any expenses will not be deductible under s 8-​1 of ITAA 1997, but it may be possible to obtain a specific deduction under s 40-​880 (see [12.130]).

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Consideration also needs to be given to whether the project is of a capital nature as capital receipts are not ordinary income but potentially subject to CGT (see Chapter 11). Capital expenses are also not a general deduction, but some specific deductions may be available (see Chapter 14). Intermediary: If the intermediary is in the business of sourcing crowdfunding projects, promoting the scheme and collecting and distributing funds, then their receipts will be ordinary income from business and expenses will be deductible based on the normal tax deduction provisions (see Chapters 12–​ 14). Distributions to the initiator of the project will also be deductible as these are an expense (not capital) in carrying on the business (s 8-​1 of ITAA 1997). However, if the intermediary acts as an agent (acts on behalf of the initiator) so that the funds received are not the income of the intermediary but simply passed to the initiator, then these funds are not ordinary income as they are not derived by the taxpayer. In this case, the only assessable income would be any commission received for acting as an agent. If the intermediary is a tax-​ deductible charity, then these receipts will be tax exempt (Div 50 of ITAA 1997) provided the charity does not breach its not-​for-​profit  rules. Contributor: Contributions that are made as a donation to a tax-​deductible charity will be tax deductible for amounts of $2 or more (see [13.130]). As

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254 [8.110]  PRINCIPLES OF TAXATION LAW 2020 this is a donation, there will no right to receive any return and therefore there cannot be any assessable income. Some crowdfunding projects provide the promise of a return to the contributor depending on the level of contribution. For example, the initiator has designed a new wine preservation device and seeks funds to put the product into production. For a contribution of $100, the contributor is promised one free wine preservation unit (retail value $150) if the crowdfunding is successful and the product is manufactured. If the contributor is a private person, then this arrangement is private in nature and the cost of $100 is not deductible and the receipt of the free product is not assessable. However, if the contribution is entered in the course of the taxpayer’s business, the cost will be deductible and any goods or services provided in return will be assessable as ordinary income. Example 8.2: Taxation of a crowdfunded donation

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A tax-​deductible charity raises funds for donation to drought-​stricken farmers. The taxpayer making the donation will be entitled to a tax deduction for contributions of $2 or more (see [13.130]). Provided the charity does not breach its not-​for-​profit rules then the receipt of these donations will not be taxable income of the charity as they are exempt income. If the funds distributed are used for business purposes such as the purchase of farm supplies, stock feed and other deductible expenses, then the receipt will be assessable as ordinary income under the compensation principle (see Chapter 10). However, the use of these funds will also result in an equivalent deduction. The ATO has indicated the where these funds are spent on tax deductible expenses (eg, stock feed), then there will be no net taxable income as the assessable receipt will be offset by the equivalent deduction. If the funds are used for private purposes (eg, food and clothing), then they are not ordinary income as they are a non-​assessable gift (see [6.90]).   

Crowdfunding used to raise equity would be treated in the same manner as similar financial dealings that are currently undertaken.

Commencement and termination of business [8.110]  Once it has been established that there is a business, it may also be necessary to determine whether a business is being “carried on” during the relevant tax period. This makes it necessary to identify the times when the

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business starts and when it ends. Transactions that occur before the business commences or after it has ceased are treated differently for tax purposes to those that occur during the business operation. For example, expenses incurred before the business starts, or after it ends, may not be deductible under the general deduction provision and may only be deductible under a specific provision: see [12.130]–​[12.140]. Example 8.3: Preliminary expenses A taxpayer intending to start a new business may incur preliminary costs to explore whether the proposed enterprise has a reasonable chance of success. These costs may include professional advice, market research, feasibility studies, product testing, pilot production research, etc. If the business has not commenced, these expenses will not be deductible under s 8-​1 of ITAA 1997, although it may be possible to obtain a deduction under statutory provisions such as s 40-​880: see [12.130].   

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Ascertaining the time of commencement of a business is a question of fact primarily based on the intention of the taxpayer at the relevant point in time:  Softwood Pulp and Paper Ltd v FCT (1976) 7 ATR 101. For example, product market testing may be undertaken before the start of operation, but it may also be an ongoing activity of the business once it has commenced trading. If product testing is conducted to determine whether there is sufficient demand to warrant commencing a new business, then this would be a preliminary expense and not within the scope of the business. Product testing of a new product line for a firm that already has 50 existing lines would be within the scope of the continuing business. A key question which the courts have used in drawing this line between preliminary expenses and operating expenses is: Has the taxpayer “committed” to commencing the business or merely deciding whether or not to go ahead? Softwood Pulp and Paper Ltd v FCT; Goodman Fielder Wattie Ltd v FCT (1991) 22 ATR 26. Case study 8.11: Feasibility study not a commitment to commence business In Softwood Pulp and Paper Ltd v FCT (1976) 7 ATR 101, the taxpayer company was incorporated to establish a paper mill for a Canadian company. Following incorporation, Softwood Pulp undertook a feasibility study to ascertain whether the proposed mill would be viable. However, the project never proceeded due to a lack of funds, and the company never made any substantial income.

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256 [8.120]  PRINCIPLES OF TAXATION LAW 2020

The Supreme Court of Victoria found that no business was “carried on” as these expenses were to determine whether the mill was viable and, at this point, there had been no commitment to commence operations. These expenses were incurred before the income-​ earning activities commenced, and therefore they were not deductible under the law at the time.  

Case study 8.12: Business had already commenced while land was being prepared for chestnut farming In FCT v Osborne (1990) 21 ATR 888, the taxpayer leased land for the purpose of planting and growing chestnuts. The taxpayer subsequently entered into a contract to buy chestnut plants and seedlings and also fertilised the soil due to the land having a nitrogen deficiency. However, after a year the taxpayer decided to abandon the chestnut venture because it was not economically feasible. The venture was abandoned before the taxpayer had planted chestnut seedlings or plants. The taxpayer wished to deduct the cost of leasing the land, depreciation on equipment and paying for labour.

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The Full Federal Court held that a business had already commenced when the taxpayer had taken steps to fertilise the land. However, the costs were not deductible for a separate reason in that they were of a capital nature: see Chapter 12 for a discussion on deductibility of capital  expenses.

[8.120]  Issues regarding the deductibility of preliminary expenses have been the main area of dispute that the courts have considered in relation to the commencement and ending of a business. Nevertheless, the same principle would reasonably apply to income earned prior to commencement, provided that the income did not fall into another category of ordinary or statutory income. Similar principles also apply when businesses cease to operate and are wound-​up.

Example 8.4: Commencement of business Michelle has for many years been a very keen seamstress, and she made many of her children’s clothes when they were young. Occasionally Michelle has also made clothes for friends for special events, such as weddings and other formal functions. Twice her friends insisted on

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8: IncoMe froM BUsiness  [8.130] 257

paying her amounts of about $300 for the clothes even though she never asked for any money. Now that that the family has grown up and left home, Michelle decided to look into renting a small shop and offer her services to do clothing repairs and alterations, as well as make garments to order for special occasions. Michelle’s first step prior to renting a shop was to talk to her accountant to see whether she thought this could be a viable enterprise. She also travelled to the nearest major town to investigate whether there were any other businesses offering similar services. On 1 January, Michelle entered a lease for a small shop and spent money on signs for the window, advertising in the local paper, additional stocks of supplies, a new sewing machine and computer to keep records and help with the design of the garments. On 4 March, Michelle received her first order and business has been quite good ever since.

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Prior to renting the shop, Michelle is clearly not carrying on a business as her sewing is mainly domestic and the small amount of income would be income from a hobby and not ordinary income under s 6-​ 5 of ITAA 1997. The costs of seeking advice from her accountant and exploring the availability of sewing services are most likely preliminary to commencement of the business as there is no commitment at this point to commence operations: Softwood Pulp and Paper Ltd v FCT (1976) 7 ATR 101: see Case Study [8.11]. Entering the lease agreement is a clear indication that Michelle has made a commitment to start her income-​ earning activity and is a strong indicator of the commencement of her business, even though no income is derived until some months later.   

Step 2: Normal proceeds of a business [8.130]  Identifying the factors that distinguish a business from a hobby or recreational activity is the first step in characterising business income as ordinary income under s 6-​5 of ITAA 1997. The second step is to determine which receipts are the normal proceeds of the business and which are not. If a receipt is not earned from “carrying on” the usual business of the taxpayer, then it is not within the “normal proceeds” of the business, although it may still be assessable for other reasons: see [8.170]–​[8.300]; Californian Copper Syndicate v Harris (1904) 5 TC 159. Characterising a receipt as part of the normal proceeds of the business requires: • an investigation of the nature of the business; and • an assessment as to whether the receipt shows a nexus with the identified business activity.

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258 [8.140]  PRINCIPLES OF TAXATION LAW 2020

Example 8.5: Are receipts normal proceeds of the business? Continuing Example 8.4, the nature of Michelle’s business is her activity as a seamstress, and therefore the normal proceeds of this business will be the earnings related to her seamstress activities. However, if Michelle had negotiated a two-​year contract to repair uniforms for a local supermarket, but could not cope with the work and sold the contract to another business, then this receipt is not within the normal proceeds of her business. The nature of Michelle’s business does not include arranging and selling contracts, and therefore the money received from the disposal of this contract does not have a nexus with normal business activity. Consequently, the sale proceeds do not constitute the “normal proceeds” of the business. Although the sale of the contract is not the “normal” proceeds of the business, it may be assessable under other general concepts (FCT v Myer Emporium Ltd (1987) 163 CLR 199: see Case Studies [8.23] and [8.24]) or statutory provisions, such as capital gains tax: see [8.270].   

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Nature of the business –​broad or narrow approach? [8.140]  The question of whether a receipt is the normal proceeds of the business is influenced by whether the court adopts a broad or narrow view of what activities make up the business. If a broad view of the business activities is adopted, it is more likely that unusual receipts could still be treated as business income: Memorex Pty Ltd v FCT (1987) 19 ATR 553; see Case Study [8.15]; GP International Pipecoaters Pty Ltd v FCT (1990) 21 ATR 1; see Case Study [8.14]. Conversely, if a narrower view is taken of the nature or the business, it will be less likely that an unusual transaction will be held to be normal proceeds of the business: Scottish Australian Mining Co Ltd v FCT (1950) 81 CLR 188 (see Case Study [8.16]); FCT v Merv Brown Pty Ltd (1985) 16 ATR 218 (see Case Study [8.13]). Example 8.6: Narrow or broad identification of the nature of the business A narrow approach to the identification of the nature of the business may be to say that a scaffolding hire business is not in the business of selling scaffolding equipment. Therefore, any income from charges made because scaffolding had not been returned is not within the normal proceeds of the business as it is effectively a receipt for the sale of equipment. The narrow approach would be to look at the primary purpose of the business (hiring scaffolding equipment) and conclude that the receipts from the

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8: IncoMe froM BUsiness  [8.140] 259

disposal of equipment are not from hiring and therefore are not within the scope of this business. Conversely, a broad approach to the identification of the nature of the business could be to say that income from charges made because scaffolding had not been returned is a normal and regular component of the hiring business. Therefore, any receipts resulting from the failure to return equipment would be within the normal proceeds of the business activity.   

Australian courts do not explicitly express whether a narrow or broad approach is adopted when establishing the nature of the business. However, case authority suggests that a broader approach is more common, but if a broad approach is used, the courts then require a strong connection between the taxpayer’s core business and the unusual activity to show a nexus with the core business: Memorex Pty Ltd v FCT.

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Case study 8.13: Sale of unwanted import quotas not proceeds of business (narrow approach) In FCT v Merv Brown Pty Ltd (1985) 16 ATR 218, the taxpayer was a clothing importer, but changes to government policy reduced the profitability of some imported lines. As a result, the taxpayer decided to sell the import quotas for these less profitable items. The quotas sold only represented a small percentage of the total number of import quotas held by the taxpayer. The Full Federal Court held that the sale of the quotas was of a capital nature and not within the “normal proceeds” of the business. The majority identified the taxpayer’s business as the purchase and sale of clothing and material (narrow approach), and therefore the sale of the import quotas was not the normal proceeds of this business activity. This decision relied on the fact that the taxpayer did not normally sell quotas and that these sales were a reorganisation of the taxpayer’s business as a  result of changes to government policy.

Case study 8.14: Receipts from contract within scope of business (broad approach) In GP International Pipecoaters Pty Ltd v FCT (1990) 21 ATR 1, two companies successfully tendered to coat pipes that were to be supplied to the State Electricity Commission of Western Australia (SECWA) for the construction of a natural gas pipeline. A requirement of the tender was

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260 [8.150]  PRINCIPLES OF TAXATION LAW 2020

that the pipes be coated in Australia, which necessitated constructing a pipe coating factory. The taxpayer (GP Inter-​national Pipecoaters Pty Ltd) was incorporated by the successful tender companies to construct the pipe coating facility and carry out the pipe coating required. SECWA paid the taxpayer a sum of over $5 million to cover some of the cost of constructing the pipe coating factory, and the taxpayer argued that the receipt of the money was capital and not within the scope of the business. The High Court held that the receipt was within the normal proceeds of the business because the money was received as a result of work which was required to be carried out due to successfully winning the tender to coat pipes. A broad approach was used to identify the scope of the business arising out of the successful tender, holding that the business included both the construction of the plant and the coating of the pipes.  

Nexus of receipt with business

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[8.150]  Having established the nature of the business, the second step is to ascertain whether the receipts in question have a nexus to the business activity and so are the normal proceeds of that business. Case law such as FCT v Hyteco Hiring Pty Ltd (1992) 24 ATR 218 and Westfield Ltd v FCT (1991) 21 ATR 1398 (see Case Study [8.22]) indicates that receipts will be normal business proceeds when they are a product of: • a transaction that is part of the ordinary business activity, such as a share trader’s receipts from the sale of shares; or • a transaction that is an ordinary incident of the business activities –​for example, the sale of ex-​lease goods by a leasing company would in some circumstances be business income: see Case Study [8.15]. Some court decisions suggest that an important consideration in this second step is the frequency and magnitude of the activity that generated the receipt: Memorex Pty Ltd v FCT (1987) 19 ATR 553 (see Case Study [8.15]). However, each of the steps in this process is to some degree interrelated. For example, in FCT v Merv Brown Pty Ltd (1985) 16 ATR 218 (see Case Study [8.13]), the sale of the import quotas was held to be outside the normal proceeds of the business. This was because the nature of the business was limited to the sale of imported clothing and material, and the sale of quotas was infrequent and therefore not part of that business. On the other hand, if the sale of quotas was a regular activity, then it may have been included in the nature of the business.

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Case study 8.15: Sale of leased equipment was within the scope of the business

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In Memorex Pty Ltd v FCT (1987) 19 ATR 553, the taxpayer operated a business of selling and leasing computer equipment, as well as providing advice on the design of computer systems. The commercial life of the computer equipment was about five years. Due to the rapid development of the technology, some customers preferred to lease the equipment rather than purchase it outright. Typical lease agreements were two to four years, and at the end of the lease the equipment was either re-​leased to the customer, returned or sold to the lessee. Receipts from the sale of the leased equipment were not a major component of the taxpayer’s business, and the taxpayer argued that they were capital in nature and not the normal proceeds of the business. The Full Federal Court held that receipts from the sale of the leased equipment were part of the normal proceeds of the business and were not capital in nature. In reaching this conclusion, the Court identified the nature of the business as selling and leasing of computer equipment and that the receipts from the sale of leased equipment showed a nexus with this core business activity. The nexus was established on the basis that, although these sales were not a major component of the business, they were of sufficient magnitude, frequency and regularity to be judged as a normal incident of the business operations.  

Receipts that are the normal proceeds of a business are ordinary income under s 6-​5 of ITAA 1997. However, if the receipt is not a normal proceed of the business, it may still be ordinary income as an isolated business transaction (see [8.210]): FCT v Myer Emporium Ltd (1987) 163 CLR 199 (see Case Studies [8.23] and [8.24]).

Non-​cash business benefits [8.160]  Under general principles, ordinary income does not include receipts that are not cash or convertible to cash: see [5.60]. Consequently, business income will also not include amounts that are non-​cash business benefits: FCT v Cooke and Sherden (1980) 10 ATR 696 (see Case Study [5.2]). Following the decision in FCT v Cooke and Sherden, s 21A of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936) was enacted with the aim of bringing these non-​ cash business benefits into the meaning or ordinary income by deeming the benefits as being convertible to cash. Section 21A of ITAA 1936 only applies to non-​cash business benefits and not to other categories of income, such as property income or income from personal

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262 [8.160]  PRINCIPLES OF TAXATION LAW 2020 services. Section 21A also does not deem non-​cash business benefits to be ordinary income for tax purposes; it merely deems non-​cash business receipts to be cash convertible and then prescribes a method of valuing the non-​cash benefit. The result is that business receipts that are not ordinary income only because they lack cash convertibility are deemed to be cash convertible and therefore will constitute ordinary income. Therefore, before s 21A is applied, it is first necessary to determine if the benefit is truly income in nature as a benefit derived from carrying on a business, disregarding whether it is cash or convertible to cash. Provided the non-​cash business benefit has the character of income, then s 21A(1) treats it as convertible to cash and s 21A(2) requires the benefit to be brought to account at its arm’s length value, less any amount that the taxpayer contributed to acquiring the benefit or to the extent that the recipient could have obtained a tax deduction if they had paid for the benefit themselves. To avoid double taxation, s 21A does not apply to non-​cash business benefits that are non-​deductible for the provider of the benefit (eg, entertainment expenses): s 21A(4). Also, to avoid dealing with very small amounts, s 23L(2) of ITAA 1936 exempts the application of s 21A if the total amount applicable for the tax year is $300 or less.

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Example 8.7: Non-​cash business benefit Tan owns and operates a thriving mobile phone business located in a large city shopping centre. To promote its product, one of the mobile phone companies provides Tan with two new top-​of-​the-​range mobiles each year. During the current tax year, Tan received two free mobile phones, each valued at $900. Both of these phones were locked, so that they could only be used on Tan’s account and the SIM cards were also locked so the phone could not be used with a different phone number. Tan kept one phone for his personal use and gave the other to his wife. As the phones cannot be used by anyone else, they cannot be converted to cash and therefore are not ordinary income under s 6-​ 5 of ITAA 1997: FCT v Cooke and Sherden (1980) 10 ATR 696. However, the benefit is received as an incident of carrying on the business and would be income of the business except for the fact that the phones are not convertible to cash. This satisfies the first requirement of s 21A(2) and (5) and, as a result, s 21A(1) deems the benefit be treated as if it is convertible to cash. Section 21A(2)(a) then brings the benefit to account at its “arm’s length value”, which is defined in s 21A(5) as the amount the taxpayer would have reasonably expected to pay had he or she been dealing at arm’s length. In this example, the arm’s length value will be the usual price of $900 each.

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The next step is to determine whether any of the value is excluded from the application of s 21A. Of the exclusions possible the only one that is relevant is whether Tan could have claimed a deduction had he paid for the phones. Clearly this would not be the case for the phone given to his wife, but Tan may be able to argue that the cost of the phone he used for work could be deductible. If Tan is successful in arguing that the phone he kept would have been deductible, if he acquired it, then he will have assessable income of $900 for his wife’s phone less any cost he may have contributed to the acquisition of the phone provided to his wife.   

Extraordinary and isolated transactions Introduction

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[8.170]  As discussed at [8.130]–​[8.150], receipts of a business that are the normal proceeds of the business will be ordinary income. Transactions that are not within the normal proceeds of the business have generally been labelled by the courts as “extraordinary transactions”: FCT v Myer Emporium Ltd (1987) 163 CLR 199 (see Case Studies [8.23] and [8.24]); Westfield Ltd v FCT (1991) 21 ATR 1398 (see Case Study [8.22]). Extraordinary transactions may give rise to ordinary income or capital, and the remainder of this chapter discusses how the courts have attempted to make this distinction. Courts have also labelled transactions that are one-​ off in nature and not undertaken by an existing business operation as “isolated transactions”: FCT v Whitfords Beach Pty Ltd (1982) 12 ATR 692 (see Case Study [8.17]). Isolated transactions may also give rise, in some instances, to ordinary income and at other times will constitute capital.

Example 8.8: Extraordinary and isolated transactions A bed manufacturer owned five factories and decided to close one of its factories. It arranged to demolish the factory, then extensively developed the land and sold it. This would be an extraordinary transaction because when the taxpayer sells the land, it is in a continuing business of bed manufacturing. Since the proceeds from the development and sale of land are not the normal proceeds of the business, it is an extraordinary transaction. An example of an isolated transaction would be where an employee accountant owns a holiday house in the country on a large piece of land.

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He knocks down the house, extensively develops the land, builds multiple residential units and then sells them. This is an isolated transaction because it is not associated with an existing business.    The case law discussed below indicates that proceeds from isolated and extraordinary transactions can generate ordinary income if they fall into at least one of three categories, where the transaction: • forms a business in itself: see [8.180]–​[8.200]; • falls under the first strand of FCT v Myer Emporium: see [8.220]–​[8.250]; or • falls under the second strand of FCT v Myer Emporium: see [8.260]. These categories are not mutually exclusive, so it is possible for a transaction to fall into more than one category. Taxation Ruling TR 92/​3 gives the ATO’s view on this issue, but a tribunal decision held that parts of this ruling are “wrong and should be rewritten”: Case [1999] AATA 66; Case 1/​99 (1999) 41 ATR 1117.

Transaction forms a business in itself under the principle in FCT v Whitfords Beach

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Principle applied to isolated transactions [8.180]  Case law indicates that if an isolated transaction has sufficient indicators of a business (see [8.20]–​[8.100]), then it will generate ordinary income even though it is a one-​off transaction. In other words, if an isolated transaction exhibits sufficient characteristics of a business, then profit from it will be considered a form of business income and so will constitute ordinary income. This is more likely to be the case if an isolated transaction involves a sufficient amount of effort, capital and planning. The leading case on this issue is FCT v Whitfords Beach Pty Ltd (1982) 12 ATR 692 (see Case Study [8.17]), where the Full High Court held as ordinary income the profits from an extensive land development project undertaken by a company that previously had no other business activities. The difference between an isolated transaction that does or does not produce ordinary income under this principle was described in the English case Californian Copper Syndicate v Harris (1904) 5 TC 159, where the Court made a distinction between: • a “mere realisation” of a capital good made by enhancing its value is characterised as a capital gain; and • a gain made from carrying on a business is characterised as ordinary income.

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Example 8.9: Extensiveness of isolated transaction influences whether it generates ordinary income Jake had been a farmer for many years and retired from farming two years ago, and his land has been unused since his retirement. He has now decided to develop and sell his farm land, so that it can be used for residential purposes. The development was a very minor one and just involved clearing and subdividing the land. This is clearly an isolated transaction as it is a one-​off event not undertaken by a continuing business. As the development of the land is relatively minor, the sale will not generate ordinary income. This is because the process of developing and selling the land did not involve much capital and/​or effort and could not be said to have sufficient of the characteristics of a business. This will come under the first category of Californian Copper Syndicate v Harris (1904) 5 TC 159 and will constitute a “mere realisation” which is capital in nature.

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Sean is also farmer who, like Jake, became tired of farming. He gave up farming for a few years and left his land unused. He then decided to develop and sell his farm land, so that it can be used for residential purposes. Sean was directly involved in the development and sale of the land. The development was extensive and involved subdividing the land and arranging to have electricity, gas and sewerage supplied to each subdivided lot. It also involved Sean arranging to have roads built on the land. In other words, he developed the land so that each subdivided lot was ready to have a house built on it. Like Jake’s development and sale, this is an isolated transaction. However, since Sean has extensively developed the land before selling it, there is a strong argument that the isolated transaction has generated ordinary income. This is very much influenced by the fact that the development was extensive and required considerable effort and capital. Although the transaction was a one-​ off isolated transaction, it had enough characteristics of a business to conclude that the profits are ordinary income. This will come under the second category of Californian Copper Syndicate v Harris.   

Case study 8.16: Isolated transaction –​Proceeds held not to be ordinary income In Scottish Australian Mining Co Ltd v FCT (1950) 81 CLR 188, the taxpayer was originally a mining company which subsequently stopped operating as a miner. The taxpayer then extensively developed one of the pieces of land it had previously used for mining purposes and sold it. The

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development was very extensive and included laying roads and building a railway station. This case was heard in front of a single judge of the High Court, where Williams J held that the proceeds of sale were not ordinary income. Williams J stated that, since the taxpayer was not in the business of land sale, proceeds from the sale were not ordinary income. In the later High Court case FCT v Whitfords Beach Pty Ltd (1982) 12 ATR 692, at least two of the three judges that commented on Scottish Australian Mining Co Ltd v FCT (Mason and Wilson JJ) stated or implied that they believed that Scottish Australian Mining Co Ltd v FCT had been wrongly decided. Their reasoning was that, since the development of land was so extensive, it could be argued that the development activities had the characteristics of a business, so that its proceeds would have generated ordinary income. Given what the judges in FCT v Whitfords Beach said about Scottish Australian Mining Co Ltd v FCT, it could be argued that if Scottish Australian Mining Co Ltd v FCT were to be decided today, then the   Court would find that the taxpayer generated ordinary income.

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Case study 8.17: Isolated transaction –​Proceeds held to be ordinary income In FCT v Whitfords Beach Pty Ltd (1982) 12 ATR 692, the taxpayer (Whitfords Beach Pty Ltd) was a company that owned beachfront land. The company’s shareholders were fishermen who had formed the company, so that they could use the company’s land to access their fishing shacks. In other words, the taxpayer company originally owned the land, so that its shareholders could use it for recreational, rather than commercial, purposes. Several years later, the shares in Whitfords Beach Pty Ltd were sold to a property developer. It is important to note that Whitfords Beach Pty Ltd remained the owner of the land, as only the shares in the company were sold to the developer, not the land. The new shareholders changed the Articles of the taxpayer to state that the company’s purpose was to develop land (the Articles of a company were documents of a company that, among other things, stated the purpose of the company –​companies incorporated nowadays would have a constitution instead). The taxpayer then extensively developed the land and sold it at a substantial profit. The Full High Court held that the profit from the developed land was ordinary income. Of the three judges who held that the profit only (not the gross receipts) was ordinary income, one (Gibbs CJ) stated that, had the development and sale been undertaken when the company was owned by its original shareholders (who were using the land for recreational

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purposes), the proceeds of the sale would not have generated ordinary income. The other two judges (Mason and Wilson JJ), who held that the sale had generated ordinary income, appeared to have relied on different reasoning to support their finding. Their conclusion was highly influenced by the fact that the development and sale was so extensive that it had the characteristics of a business. Both Mason and Wilson JJ implied that had the development and sale of the land been undertaken by the original shareholders, then the sale would still have generated ordinary income. However, they both indicated that the fact that the company had been bought by developers who changed its Articles strengthened the argument that the sale proceeds generated ordinary income. Given the majority opinion of Mason and Wilson JJ, there is a strong argument that their approach is the one that has set the law.  

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Case study 8.18: Farmer who developed and sold farm land did not generate ordinary income In Statham v FCT (1988) 20 ATR 228, the deceased (the taxpayer was the trustee of the deceased’s estate) owned a piece of land on which he both lived and operated a farming business. Because the farm was financially unsuccessful, he had ceased farming and arranged for the local city council to develop the land. This included connecting the land to the electricity grid and constructing roads. The land was also subdivided and finally sold piece by piece through a real estate agent. The Full Federal Court held that the gain was not ordinary income but a “mere realisation”. The Court was influenced by the fact that the deceased had arranged for the council to develop the land, rather than arranging to do so himself. The Court was also influenced by the fact that the deceased used a real estate agent to sell the land and was not in any way directly involved in the sales process. The Court indicated that, had the deceased arranged to develop the land himself (rather than through the council), it would be more likely that the sale would have generated ordinary income.  

Case study 8.19: Ex-​farmer who extensively developed and sold land generated ordinary income In Stevenson v FCT (1991) 22 ATR 56, the taxpayer was a farmer who had owned land that he had used as a farm for many years. He gave up farming and had the land subdivided and extensively developed. Stevenson was

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in charge of the development and subsequent sale process and the sale of the land took place over a number of years. The Administrative Appeals Tribunal (AAT) held that the sale did generate ordinary income and was not a “mere realisation”. On appeal to the Federal Court (single judge), it was held that the AAT had not made an error in its decision. The Court was influenced by the fact that the taxpayer was the sole decision maker regarding the development process, that he had sought finance for the development and that he had controlled the marketing of the blocks.  

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Case study 8.20: Ex-​farmer developed land only to extent necessary to gain subdivision Casimaty v FCT (1997) 37 ATR 358 involved a taxpayer who had originally used land for farming, ceased farming and then followed on by subdividing, developing and selling the land. The development mostly consisted of constructing roads, providing water and sewerage facilities to the land and constructing external fencing. The taxpayer had only developed the land to the extent necessary to gain approval to have the land subdivided. The Federal Court (single judge) held that the taxpayer’s sale had amounted to a “mere realisation” and was not ordinary income. However, the Court did say that, had the taxpayer gone further in his development, such as building internal fences or units, then the Court would have been more inclined to find that the taxpayer had generated ordinary income. In other words, the Court’s finding that the profit was capital was influenced by the fact that the taxpayer had not done anything more than the minimum required to get subdivision approval. The Court also stated that it would have been more inclined to find that the taxpayer generated ordinary income had he participated more actively in the selling off the land, rather than leaving the whole sale process up to a   real estate agent.

FCT v Whitfords Beach (see Case Study [8.17]) and later cases on the same issue show that there are no strict rules, only guidelines, in deciding whether an isolated transaction has amounted to a “mere realisation” or generates ordinary income. This means that, although in some cases it might be easy to distinguish between a “mere realisation” and a transaction that produces ordinary income, in more borderline cases it is difficult to predict what a court may decide should the case be disputed. However, Case Studies [8.16]–​ [8.19] do indicate that, at least in the case of land development, a taxpayer who is actively involved in the development and sales process (as opposed

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to delegating those activities) is more likely to fall under the principle in FCT v Whitfords Beach.

Principle applied to extraordinary transactions [8.190]  Although the principle in FCT v Whitfords Beach Pty Ltd (1982) 12 ATR 692 has only been applied to isolated transactions, there is an argument that it could also apply to extraordinary transactions. However, this issue has not been tested in court.

Example 8.10: How the principle in FCT v Whitfords Beach might apply to extraordinary transactions

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Bed Pty Ltd is a bed manufacturer that has four factories. It decides to close one of its factories and sell off the associated land. To do this, the company arranges to demolish the factory, subdivide the land and have gas, electricity and sewerage supplied to each piece of subdivided land. This is an extraordinary transaction because proceeds from developing and selling land are not the normal proceeds of a bed manufacturer. However, there is a convincing argument that since the process of developing and selling land was so extensive, Bed Pty Ltd was for that time not only a bed manufacturer, but also a land developer. This analysis leads to the conclusion that the profits from land sale would generate ordinary income. Pillow Pty Ltd also has four factories that it uses to manufacture pillows and it decides to close one of its factories. The company then arranges to demolish the factory, remove the concrete from the factory’s car park and sell the land without further development. This is an extraordinary transaction because the proceeds of selling land are not the normal proceeds of a pillow manufacturer, but this transaction would still not generate ordinary income. This is because developing the land for sale did not have sufficient characteristics of a business to be classed a business in itself.   

Calculating ordinary income under the principle in FCT v Whitfords Beach [8.200]  For most taxpayers, gross revenue will form assessable income, and deductions will be taken away from this to give taxable income. However, it was mentioned in FCT v Whitfords Beach Pty Ltd (1982) 12 ATR 692 (see Case Study [8.17]) that for an isolated transaction that falls under the principle of that

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270 [8.210]  PRINCIPLES OF TAXATION LAW 2020 case, it is the profit (not the total sales proceeds) that is assessable as ordinary income. This profit is calculated as the sales proceeds less the value of the land at the time the isolated transaction commenced and the costs of developing the land. Example 8.11: Calculation of profit from proceeds of an extraordinary transaction that falls under the principle in FCT v Whitfords Beach Nathan has been a farmer for 20 years. Two years ago his farm was worth $2 million, and at that time he ceased farming and undertook extensive redevelopment of the land. This development cost $4 million and when it was completed he sold the land piece by piece for a total of $11 million. Assuming that this transaction is covered by the principle in FCT v Whitfords Beach Pty Ltd (1982) 12 ATR 692, Nathan’s assessable income from the development and sale of the land is the profit of $5 million ($11 million –​($2 million + $4 million)).   

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Two strands of Myer [8.210]  The important High Court case of FCT v Myer Emporium Ltd (1987) 163 CLR 199 (see Case Studies [8.23] and [8.24]) shows that the proceeds of an isolated or extraordinary transaction will be ordinary income if the conditions of one of the two approaches followed in the decision are satisfied. The two approaches applied in FCT v Myer Emporium have become known as the “first strand of Myer” and the “second strand of Myer”. These two strands are independent principles relied on by the Court in FCT v Myer Emporium in arriving at its conclusion that the taxpayer had generated ordinary income. For further discussion of: • the first strand of Myer: see [8.220]–​[8.250]; • the second strand of Myer: see [8.260]; and • the facts of the case: see Case Studies [8.21] and [8.23].

Case study 8.21: FCT v Myer Emporium In FCT v Myer Emporium Ltd (1987) 163 CLR 199, the taxpayer (Myer) lent $80 million to its subsidiary, Myer Finance. Interest was chargeable on this loan at a commercial interest rate of 12.5% pa. At the time the loan was made, Myer intended to sell the “right to interest” on this loan

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to Citicorp. As planned, three days after Myer lent the money to Myer Finance, Myer sold the “right to interest” on this loan to Citicorp in exchange for Myer receiving a lump sum of approximately $45 million. This meant that Myer was still entitled to be repaid the principal of $80 million from Myer Finance. However, the interest on this loan was now to be paid by Myer Finance to Citicorp. The issue that the Full High Court had to decide was whether the $45 million received by Myer was ordinary income. The Full High Court decided that the proceeds were ordinary income. The reasoning of the Court is not particularly clear, but subsequent cases (see later discussion in this chapter) have interpreted the decision in FCT v Myer Emporium as meaning that the proceeds from an extraordinary or isolated transaction will be ordinary income if it satisfies the requirements of either what have now become known as the first strand or second strand of Myer. In this case, both the first strand of Myer (see Case Study [8.23]) and second strand of Myer (see Case Study [8.26]) were fulfilled, although fulfilling one of them would  have been sufficient.

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First strand of Myer [8.220]  The first strand of Myer expresses the principle that extraordinary or isolated transactions that satisfy three particular requirements will be ordinary income. The first two requirements originate from the case of FCT v Myer Emporium Ltd (1987) 163 CLR 199. The third requirement, although originally implied in FCT v Myer Emporium, was stated more explicitly in the case of Westfield Ltd v FCT (1991) 21 ATR 1398 (see Case Study [8.22]). The three requirements are: 1 There was a business operation or commercial transaction: see [8.230]. 2 There was a profit-​making intention upon entering the transaction: see [8.240]. 3 The profit was made by means consistent with the original intention: see [8.250]. [8.230]  Profit resulted from “business operation or commercial transaction”. If the relevant transaction is an extraordinary transaction, then the first requirement will be automatically fulfilled. As explained at [8.130]–​[8.150], an extraordinary transaction occurs when a business undertakes a transaction that generates proceeds which are not the normal proceeds of that business. As an extraordinary transaction is undertaken by a business, the first requirement of a “business operation or commercial transaction” will always be satisfied.

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272 [8.240]  PRINCIPLES OF TAXATION LAW 2020 With an isolated transaction, the first requirement of there being a “business operation or commercial transaction” will not automatically be satisfied. An isolated transaction occurs where there is a one-​off transaction without a continuing business operation: see [8.180]. This means that an isolated transaction will only fulfil the first requirement if there is a “commercial transaction”. Unfortunately, there is little case law that explains what exactly is meant by the term “commercial transaction”. However, Ruling TR 92/​3 gives a few examples of what the Commissioner believes is a “commercial transaction”, though it does not mention what case law the examples are based on. According to the ruling, a taxpayer who buys and resells $100,000 of gold bars in a short time is undertaking a commercial transaction. On the other hand, the ruling states that a taxpayer who purchases an investment property to earn rent and later sells it is not regarded as undertaking a commercial transaction.

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Although there is limited guidance as to when an isolated transaction will be considered a “commercial transaction”, this condition is more likely to be satisfied when the transaction concerned is entrepreneurial in nature, but it is less likely to be fulfilled if the transaction is of the type that a typical salary earner might enter into. Greig v FCT [2018] FCA 1084 (subject to appeal to the full Federal Court) highlights the uncertainty regarding whether the first strand of Myer requires that the taxpayer is carrying on a business. Although the Myer decision has primarily been applied to income, in this case the taxpayer argued that it applies to deductions. The taxpayer claimed a tax deduction under s 8-​1(1)(b) for losses of $11.85 million realised on the sale of shares rather than treating the losses as a capital loss for CGT. He argued that the losses were revenue losses on the basis that they were incurred as a commercial transaction as was the case in Myer. Justice Thawley disagreed and held that the taxpayer was not in the business of dealing in shares and that the hope of a profit was not sufficient to make it a business or commercial transaction for the purposes of Myer. Depending on the appeal, this decision gives stronger authority that for Myer to apply the taxpayer must be in business. [8.240]  Profit-​making intention upon entering the transaction. The second requirement of the first strand of Myer is that the taxpayer had a profit-​making intention upon “entering the transaction”. This profit-​making intention need not be the taxpayer’s sole or dominant intention: FCT v Cooling (1990) 21 ATR 13 (see Case Study [8.24]). Many extraordinary or isolated transactions involve selling assets and, where a profit is realised, the time of “entering the transaction” will be when the asset was purchased. In other words, if the taxpayer did not have a profit-​making intention when buying the asset, but had a profit-​making intention only when selling it, the second requirement of the first strand of Myer would not be

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satisfied. In reality, there will often be a lack of clear evidence as to what a taxpayer’s intention was at the time of entering into the transaction. In August v FCT [2013] FCAFC 85, the Full Federal Court dismissed the taxpayer’s appeal from a single judge of the Federal Court and confirmed the decision that the gains made following the purchase, leasing and sale of several commercial shopping centres were ordinary income. This was despite the fact that these properties had been owned and leased for up to seven years. Central to this decision was that the facts showed there was an initial intention to purchase, develop, lease and then sell the shopping centres as long-​term tenanted properties. The initial intention to profit via sale was critical to this decision even though the properties were leased to earn income for some time before sale. [8.250]  Profit made by means consistent with original intention. For the first strand of Myer to be fulfilled, the way the profit is eventually made must be consistent with the original profit-​making intention of the taxpayer upon entering the transaction: Westfield Ltd v FCT (1991) 21 ATR 1398. If the taxpayer has more than one intention upon entering the transaction, the way the profit was made need only be consistent with one of those intentions: August v FCT [2013] FCAFC 85.

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Case study 8.22: First strand of Myer not satisfied as the profit realised was inconsistent with the original intention In Westfield Ltd v FCT (1991) 21 ATR 1398, the taxpayer (Westfield) was in the business of designing, constructing and operating shopping centres. Westfield purchased a piece of land with the intention of jointly developing a shopping centre on the land with Australian Mutual Provident (AMP) Society. At the time of purchase, the taxpayer knew there was a possibility that it might end up selling the land to AMP Society rather than developing a shopping centre, but selling it was not its original intention. Eventually the taxpayer did sell the land to AMP Society rather than developing a shopping centre. The Full Federal Court held that the proceeds from sale were not ordinary income. It found that the transaction was an extraordinary transaction as the proceeds of the sale were not the normal proceeds of the taxpayer’s business, and these proceeds would be ordinary income if the requirements of the first strand of Myer were satisfied. However, the way the taxpayer made the profit (resale) was not consistent with the original profit-​making intention (developing a shopping centre with AMP Society). The fact that at the time of purchase the taxpayer knew of the possibility of resale was not the same as the taxpayer having an intention to profit from resale. As a result, the first strand of Myer did not apply, and the sale proceeds were not ordinary income.  

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Case study 8.23: The case of Myer The facts of FCT v Myer Emporium Ltd (1987) 163 CLR 199 are described in Case Study [8.21]. As discussed in Case Study [8.21], both the first and second strands of Myer were satisfied on the facts of this case. Specifically, the first strand of Myer was fulfilled because the taxpayer was running a business operation, had a profit-​making intention upon entering the transaction (when it lent the money it intended to sell the right to interest a few days later) and the profit was eventually realised as initially intended.  

Case study 8.24: Lease incentive falls under the first strand of Myer

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In FCT v Cooling (1990) 21 ATR 13, the taxpayer was a partner in a Brisbane law firm which wished to move premises. Upon signing the lease for the new premises, the landlord paid a lease incentive of which Cooling received a share. A lease incentive is when the landlord gives the lessee money as an inducement to enter into the lease. At that time it was common in Brisbane for lease incentives to be paid upon a commercial lessee entering into a long-​term commercial lease because there was an excess of office space available for lease and it was difficult for landlords to attract a tenant. The Full Federal Court held that the lease incentive was ordinary income. The Court appeared to be of the view that the incentive was ordinary income because moving premises from time to time was in the ordinary course of the taxpayer’s business, which meant that the proceeds were the normal proceeds of the taxpayer’s business. In addition, the Court went on to say that, even if the proceeds of the transaction were not considered to be the normal proceeds, they would still be ordinary income due to the satisfaction of the requirements of the first strand of Myer. The Court noted that one of the purposes that the taxpayer had when entering the new lease was to make a profit from receiving the lease incentive. Although this was not its dominant intention, it was still one of its   “not insignificant” purposes of entering into the lease.

Example 8.12: First strand of Myer applies to extraordinary transaction A television manufacturer owned three factories, and it purchased a vacant piece of land because it believed that the land would rise in value and could be sold in the future for a profit. Three years later, it sold the land at a profit without using the land in the meantime.

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This is likely to be considered an extraordinary transaction as income from speculating in real estate does not constitute the normal proceeds for a television manufacturer. Although it is an extraordinary transaction, it will be ordinary income as it satisfies the first strand of Myer. This is because:

• there was a business operation: the taxpayer is in the business of manufacturing TVs;



• there was a profit-​ making intention at the time the land was purchased: the land was purchased because the taxpayer believed it could later be sold for a profit; and • the way the profit was eventually realised was through selling the land. This is consistent with how the taxpayer intended to profit when entering the transaction, that is, when the taxpayer purchased the land.   

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Case study 8.25: First strand of Myer applied to an Isolated Transaction In McCurry v FCT (1998) 39 ATR 121, the taxpayers were two brothers who in 1986 purchased a block of land with a run-​down house on it. They obtained permission for and built three townhouses on the land. During May 1987, the taxpayers advertised the townhouses for sale but were unable to sell them. Subsequently, in June 1987, attempts to sell were put on hold, and the brothers and their families used two of the townhouses as their private residence as their family had purchased a nearby news agency. The third townhouse was also used by them for private purposes. After living in the townhouses for some time, they were again advertised for sale in July 1988 and subsequently sold in December 1988 for a substantial profit. Justice Davies from the Federal Court held that the profit was assessable as ordinary income. In substance he applied the principle in the first strand of Myer. One of the requirements for the first strand of Myer was that the profit must have resulted from either a business or a commercial transaction. As the taxpayers had no continuing business, the issue was whether the activity was commercial in nature. His Honour found that the venture, which involved purchasing the house and land, demolishing the house and building three townhouses, combined with the profit-​making purpose, was commercial in character. However, his Honour did not appear to find that all the characteristics of the venture needed to be commercial, but

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rather that their presence in some aspects of this case clearly showed that it was a commercial activity. Furthermore, his Honour found that the taxpayers had an intention to profit from building and selling the townhouses when they initially purchased the land. This decision was reached despite the fact that the taxpayers claimed that at the time of purchase, they were unsure whether they intended to rent or sell the new townhouses. However, the Court found that this claim was not supported by the evidence. For instance, the evidence indicated that the brothers had never made inquiries as to how much rent they could collect on the townhouses. Consequently, the Court concluded that while the possibility of renting the townhouses did enter the minds of the brothers at the time of purchase, their dominant intention at this time had been to profit from selling the townhouses. Justice Davies also found the profit was made in a manner that was consistent with the taxpayers’ original intention when purchasing the land. This was despite the fact that the taxpayers had argued that the original profit-​making venture was abandoned. The taxpayers’ argument was based on the fact that their first attempt to sell the properties failed, so they used them for private purposes, and only then re-​advertised and sold them over a year later. However, his Honour found that the facts did not support the finding that the taxpayers’ original profit-​making plan was abandoned. Rather, their initial plans had been temporarily interrupted.  

Second strand of Myer [8.260]  The Court in FCT v Myer Emporium Ltd (1987) 163 CLR 199 established that one of the reasons the proceeds in that case were ordinary income was due to what is now known as the “first strand of Myer”: see [8.220]–​[8.250]. However, the Court also identified a second reason for the proceeds being ordinary income. This second reason has become known as the “second strand of Myer”. The second strand of Myer expresses the principle that the proceeds from a transaction will be ordinary income if the taxpayer sells the right to income from an asset without selling the underlying asset. This is an application of the compensation principle, where compensation for loss of income is deemed to be ordinary income: see [10.20]. Unlike the principle in FCT v Whitfords Beach Pty Ltd (1982) 12 ATR 692 (see Case Study [8.17]) and the first strand of Myer, the second strand of Myer potentially only applies to a very narrow set of circumstances.

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Case study 8.26: Second strand of Myer The facts of FCT v Myer Emporium Ltd (1987) 163 CLR 199 are described in Case Study [8.21]. The second reason the Court held that the sale of the right to interest was ordinary income has become known as the “second strand of Myer”. The taxpayer sold the right to income while keeping ownership of the underlying property. Specifically, Myer sold the right to interest on the loan (the right to receive income that would have been ordinary income) and retained the underlying property (the right to be repaid). If Myer had continued to receive the interest from its loan, it would have clearly been ordinary income: see [9.20]. Therefore, by applying the second strand of Myer, the Court concluded that selling the right to receive an income stream for a lump sum will not change its nature as ordinary income. Even though the right to interest was received as a lump sum, it was still ordinary income as the payment was compensation for  the loss of an income stream (the interest).

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Case study 8.27: Application of second strand of Myer In Henry Jones (IXL) Ltd v FCT (1991) 22 ATR 328, the taxpayer owned trademarks of certain brands of canned fruits. The taxpayer’s subsidiary manufactured and sold canned fruits, using the trademarks owned by the taxpayer. The taxpayer decided that the canned fruit business run by its subsidiary was not meeting profit targets and decided to sell the whole canned fruit business. However, the taxpayer did not proceed with the sale, but rather entered into an agreement with two other canned fruit producers (SPC and Ardmona) which gave them exclusive use of the taxpayer’s trademarks for ten years (the trademarks themselves were not transferred). In exchange, SPC and Ardmona were to pay the taxpayer royalties of 5% of the net sales of products that used the trademarks in question (subject to a minimum payment). A few months later, the taxpayer sold the right to these royalties to a third party in exchange for a lump sum of approximately $7.5 million. When the taxpayer entered into its initial royalty agreement with SPC and Ardmona, it had intended to sell the royalty agreement for a lump sum of $7.5 million. The Full Federal Court held that the first strand of Myer did not apply, but the second strand of Myer did and, as a result, the $7.5 million was found to be ordinary income. The Court based its reasoning on the view that the taxpayer did not have a profit-​making intention of selling the rights to the royalties at the time of entering into the royalty contract. While it was true

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that at the time of entering the royalty agreement the taxpayer intended to sell rights under the agreement for $7.5 million, on the current facts, this did not constitute a profit-​ making intention. The Court appeared to state that this was because the intention of the taxpayer in entering this agreement was to dispose of its canned fruit business in the form of getting of a lump sum receipt and therefore the first strand of Myer did not apply. However, the second strand of Myer did apply because the taxpayer sold the right to what would be ordinary income for a lump sum, while retaining the underlying property. Henry Jones (IXL) disposed of its right to income (the royalties), but kept the underlying property (the trademark) and therefore the proceeds from the sale constituted ordinary income.  

Statutory provisions that may apply to extraordinary and isolated transactions

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[8.265]  Income from business activities may be assessable as ordinary income under s 6-​5 of ITAA 1997 or as statutory income via s 6-​10 of ITAA 1997. However, regardless of whether an amount is likely to be ordinary income, it is still necessary to consider whether any statutory provisions specifically apply to the receipt. This is important because some statutory provisions apply different tax rates, as is the case with capital gains which are taxed differently to ordinary income. If a receipt is both ordinary and statutory income under the Act, s 6-​2 5 of ITAA 1997 states that it is included in assessable income only once and it will normally be taxed under the statutory provision rather than as ordinary income. The exception to this rule occurs if the statutory provision states that it only applies if the amount is not ordinary income: see [3.80]. For example, s 15-​20 deems certain royalties to be assessable income but also states that the section does not apply if the royalty is ordinary income under s 6-​5: s 15-​20(2). The following discussion covers some of the more common statutory provisions that apply to receipts from business activities.

Capital gains tax [8.270]  Extraordinary and isolated transactions that do not produce ordinary income and involve an asset acquired after 19 September 1985 will often be subject to capital gains tax (CGT). As explained in Chapter 11, gains that are

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subject to CGT may incur less tax than gains that are taxed under s 6-​5 of ITAA 1997 as ordinary income. Consequently, it is important to be able to ascertain whether or not gains from extraordinary/​isolated transactions are ordinary income or capital.

Section 15-​10: Bounties and subsidies [8.280]  Section 15-​ 10 of ITAA 1997 states that bounties and subsidies received in relation to carrying on a business are assessable as statutory income. A bounty or subsidy is a payment from the government in order to assist the recipient in carrying on its business. However, s 15-​10 does not apply to gains that are ordinary income: s 15-​10(b).

Example 8.13: Government subsidy –​Assessability as statutory income A car manufacturer receives a government subsidy for every car it makes. These payments are ordinary income as they would be regarded as normal proceeds of the business. As the receipts are ordinary income, they would not be assessable under s 15-​10 of ITAA 1997.

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Another car manufacturer receives a government subsidy to purchase new machinery for its existing factory. This receipt is not ordinary income as it would not be regarded as normal proceeds of the business and is not covered by the principal in FCT v Whitfords Beach Pty Ltd (1982) 12 ATR 692 or either of the strands of Myer. However, this receipt would be assessable under s 15-​10 as being a bounty or subsidy received in relation to the business.   

Section 15-​15: Profit-​making undertaking or plan [8.290]  Section 15-​15 of ITAA 1997 states that the profits from a profit-​making undertaking or plan are assessable and so will constitute statutory income. However, s 15-​15 does not apply to: • gains that are ordinary income (s 15-​15(2)(a)); or • gains that involve assets purchased on or after 20 September 1985 (s 15-​15(2)(b)). A profit-​making undertaking or plan for the purposes of s 15-​15 is a course of conduct that produces a profit and involves something more complex than the taxpayer simply buying and then selling property or outlaying money in the hope of making a return: Steinberg v FCT (1975) 5 ATR 565; Clowes v FCT (1954) 91 CLR 209.

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280 [8.300]  PRINCIPLES OF TAXATION LAW 2020 In practical terms, s 15-​15 will seldom apply because transactions that potentially are a profit-​making undertaking or plan will often be ordinary income due to FCT v Whitfords Beach Pty Ltd (1982) 12 ATR 692 and so will not be covered by s 15-​15. The section also has limited application since it only applies to assets purchased before the introduction of CGT. Example 8.14: Section 15-​15 –​Difficulty of application In 1984, Jell Pty Ltd, a manufacturer of doors, purchased vacant land as an investment which it sells in the current tax year. This would not be assessable under s 15-​15 of ITAA 1997 because it is a mere “buy and sell” and so would not constitute a profit-​making undertaking or plan. Jack farms land that he purchased in 1983. He is tired of farming, so he subdivides the farm land, installs amenities on it and then builds roads and townhouses on the subdivided land. Jack then sells the subdivided lots one by one. Although this is a profit-​making undertaking or plan, it is unlikely to be assessable under s 15-​15. This is because the profit from this transaction is likely to be ordinary income under the principle in FCT v Whitfords Beach Pty Ltd (1982) 12 ATR 692 and s 15-​15 does not apply to gains that are ordinary income.   

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Section 25A: Profit from sale of asset acquired with the purpose of resale [8.300]  Section 25A of ITAA 1936 makes assessable certain profits from selling an asset that was initially acquired for the purpose of resale. However, s 25A will seldom apply because of the following limitations: • it only applies to assets purchased prior to 20 September 1985 (s 25(1A)); and • it only applies where the intention to profit by resale that existed at the time of purchase was the sole or dominant purpose of the taxpayer: Eisner v FCT (1971) 2 ATR 3.

Example 8.15: Profit from asset acquired with purpose of resale and subsequently assessable under s 25A Alan purchased vacant land in 1983 with the sole purpose of reselling it at a profit. He sells it in the current tax year and realises a profit of $500,000. This profit will be assessable under s 25A of ITAA 1936 because

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it was made from selling an asset that was purchased with the purpose of making a profit by reselling it. For property purchased before 20 September 1985, it will become more and more difficult to establish that there was, at the time of the purchase, a profit-​making intent through resale. This is because, as time passes, it will become more difficult to elicit evidence and also the longer property is held, the more likely it was held for some other purpose than simply resale at a profit.   

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Questions [8.310] 8.1 After entering into a management agreement two years ago for the purpose of starting a business in cattle breeding next year, Georgina paid $5,250 by cheque to ACM, whose business was transferring embryos from stud cows to ordinary breeding cows. Under the agreement she was guaranteed six calves in the next two years. If the venture failed, ACM remained liable to supply the calves from another source. Having paid her fees for Year 2, she did not receive any subsequent notification that the implants in her recipient cows were successful. She did not follow up after the implantation notices to find out whether any of her cows were pregnant. Nor did she enquire whether her cows had been implanted a second time as contemplated by the terms of the Management Agreement, which provided that each recipient cow would be implanted once in each of the 12-​month contractual periods. She said that she had spoken to her accountant who told her things were progressing, but slower than anticipated. After paying her Year 2 Fees in June, Georgina heard nothing specific from ACM except by way of newsletters containing general information. She made no attempt to contact ACM in the current year about extending the lease on her recipient cows. She said she was going through a very difficult time. Her 12-​month-​old child had contracted a serious illness and she had to focus on looking after him. Is Georgina carrying on business? 8.2 Axis Holdings Ltd was founded eight years ago by Lucas and Tait, who were the initial shareholders and directors. Lucas and Tait had for many years been involved in property development. Seven years ago, Axis purchased two properties in an area where there was extensive real estate development. For six years, the properties were used for cattle breeding and the properties were improved for that purpose.

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282 [8.310]  PRINCIPLES OF TAXATION LAW 2020 Owing to unforeseen circumstances, the cattle breeding proved to be unprofitable and there was an imminent zoning change whereby the properties could only be disposed of in 100-​hectare lots instead of 25-​hectare lots. Axis therefore arranged to subdivide the land up into 25-​hectare blocks and sold the whole property to one purchaser. The Commissioner assessed Axis on the gross receipts in s 6-​5 of ITAA 1997. Discuss. 8.3 Peter is a farmer with 15 hectares of land on which he has grown oranges since 1970. He inherited the land from his father in that year. The farm has gradually been surrounded by urban development and, three years ago, following complaints from neighbours about pesticides, he decided to sell the land. Two years ago, Peter contracted with a consulting engineer and surveyor who prepared a subdivision plan and who applied to the local council for rezoning. Peter was not directly involved in the plan or the rezoning, which was granted by the council later that year. Nearly all expenses were paid by Peter, although he had to borrow $120,000 to cover some incidental expenses. Following completion of the development, the land went on sale through a real estate firm and to date 150 of the 200 blocks have now been sold for residential housing. Blocks sell for an average of $150,000 each.

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Advise Peter as to his tax liability, if any. 8.4 Five years ago, Bruce purchases 10 hectares of land for $1 million in an area that was ripe for subdivision. At the time of purchase he intended to get planning permission from the local council to develop the land by subdivision and then resell it at a profit, but instead he leased it for grazing horses. Three years ago, Bruce attempted to get planning permission to subdivide his 10 hectares, but it proved very difficult, and finally in March of the current tax year the local council refused permission to subdivide. Bruce reluctantly sold the land in May for $3 million. What are the tax consequences of Bruce’s sale? 8.5 Two years ago, Peta purchased a house in Kew. This house had two old tennis courts down the back which were in poor condition. She purchased the property for two reasons: • so that she and her family could live in the house; and • so that she could build three units on the tennis courts and sell them at a profit. In the current tax year, the tennis club next door offered to buy the old tennis courts, but only if Peta first restored them to good condition.

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Peta decided to accept the club’s offer instead of going ahead with her plan to build and sell units. Peta spent $100,000 on preparing the tennis courts for sale. This involved a great deal of work. Peta had to resurface the tennis courts and build new fences around them. She then sold the tennis courts in the current tax year to the tennis club for $600,000. Ignoring capital gains tax, discuss whether the receipt of $600,000 is ordinary income under s 6-​5. 8.6 Mrs Jones is the owner of a large racehorse stud and horse training business. She employs eight staff and holds a training licence. Mrs Jones’ involvement in the racing business is her full-​time occupation and she attends as many race meetings as possible (over one per week). Mrs Jones is also a very keen punter, betting on both her own and other horses, and during the last year she had several very big wins which netted her $120,000 in winnings for the year. Discuss whether the receipt of $120,000 is ordinary income under s 6-​5. 8.7 Pierre has operated his market garden business in Queensland for the last 25 years. During recent flooding, his total crop was destroyed along with most of his buildings, irrigation equipment and fencing. As a result of this flood, Pierre received a payment from the Government of $300,000 to purchase new green houses for raising seedlings so he can get back into business more quickly. He also received a payment from the Government of $50,000 to dispose of damaged crops. 8.8 New Coal Pty Ltd (New Coal) is a large coal mining company with several large coal mines in Australia. During the current tax year, New Coal employed a consulting firm to investigate the feasibility of the company constructing and operating a coal fired power station. New Coal has never operated a power station in the past. Discuss whether the proposal to investigate the viability of the power station is a separate business for tax purposes or would it be within the scope of the existing coal mining business? 8.9 Kerryn works full time as an employee accountant. She loves to sing and regularly records songs she wrote herself and posts them on YouTube. For the last three years she would on average spend approximately 20 hours a week on this activity. Because her cousin Joel owned a recording studio, she was able to use his recording facilities for free. Occasionally Kerryn would dream that one day she would be discovered as a star and could make enough money to retire from her job, though in reality Kerryn told herself that this was unlikely to happen. On average, Kerryn would post a new song on YouTube every two weeks.

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Since Kerryn found quite a following (some of her songs had over 100,000 hits), in an attempt to profit from her new found fame, she auctioned some of her old clothes and jewellery online (that she had bought many years ago) and manages to sell them for $8,000. Advise Kerryn on whether the $8,000 would constitute ordinary income.

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9 Income from property

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Key points......................................................................................................  [9.00] Introduction..................................................................................................  [9.10] Interest���������������������������������������������������������������������������������������������������������  [9.20] Discounts and premiums.......................................................................  [9.30] Timing of interest receipts.........................................................................  [9.50] Division 16E, s 26BB and s 70B of ITAA 1936...........................................  [9.60] Taxation of financial arrangements –​Div 230 of ITAA 1997.......................................................................................  [9.70] Interest and compensation....................................................................  [9.80] Interest relating to compensation for damages for property.........................................................................................  [9.90] Interest relating to compensation for damages for personal injury............................................................................  [9.100] Section 51-​57: Exemption of post-​judgment interest on personal injury compensation....................................................  [9.110] Interest compensation and CGT..............................................................  [9.120] Section 15-​35: Interest on overpayment and early payment of tax..................................................................................  [9.130] Interest portion of instalment payments.............................................  [9.140] Dividends.....................................................................................................  [9.150] Rental and lease income............................................................................  [9.160] Rent.......................................................................................................  [9.160] Lease premiums...................................................................................  [9.170]

Section 15-​25 –​Amount received for lease obligation to repair.........................................................................................  [9.180] Royalties......................................................................................................  [9.190] Introduction..........................................................................................  [9.190] Assessability of royalties.....................................................................  [9.200] Annuities.....................................................................................................  [9.210] Questions.....................................................................................................  [9.220]   

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Key points [9.00]  • Property income is an application of the “flow” concept of ordinary income. • Interest is usually ordinary income as it flows from the lending/​ investment of capital. • Payments on loans to compensate for increased risk of non-​repayment may not be interest. • Loan discounts and premiums may alter the timing of taxable income. • The timing for tax purposes of gains on financial instruments is subject to legislation under Div 16E, s 26BB and s 70B of ITAA 1936 and Div 230 of ITAA 1997. • Interest paid as a part of compensation payments is treated differently for taxation purposes depending on whether it is paid for the loss of property or as damages for personal injury. • In Australia, the courts have been reluctant to carve out interest from capital payments unless it is clearly identifiable. • Dividends are ordinary income, but they are specifically made assessable as statutory income under s 44 of ITAA 1936. • Division 974 of ITAA 1997 provides rules for distinguishing payments of dividends from payments of interest. • Rent is ordinary income even when received as a one-​off lump sum. • Lease premiums are capital unless the taxpayer is in the business of receiving premiums or the premium is a substitute for rent. • Royalties include payments that are calculated based on the usage of intellectual property. Royalties can also be payments based on the quantity/​value resources taken from a taxpayer. • Most royalties are ordinary income and those that are not are assessable under s 15-​20 of ITAA 1997.

Introduction [9.10] Chapter 5 outlined the essential characteristics of income that have been developed by the courts, one of which is the notion that income “flows” from capital. As a result, receipts such as interest, rent, royalties and dividends that “flow” from the passive ownership of capital investments will be ordinary income under s 6-​5 of ITAA 1997. Following the “fruit and tree” analysis (see [5.10]), these receipts are generated from capital without the capital being diminished in any way. For example, interest flows from fixed-​ term investments, rent flows from the ownership of property, dividends flow from investments in shares and royalties flow from intellectual property, such as copyright.

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Income earned from the passive ownership of capital is generally known as property income, but this is not to be confused with the gains realised on the sale of the property itself. Taxation of the gains from the sale of the property itself may be assessable as business income, subject to capital gains tax or other relevant statutory provisions. Property income is a class of ordinary income, but certain forms of property income may also be specifically deemed assessable as statutory income. It is important to distinguish whether property income is ordinary or statutory income because this may influence the amount that is assessable and/​or the tax due. If a receipt is both ordinary and statutory income under the Act, s 6-​25 of ITAA 1997 states that it is included in assessable income only once and it will normally be taxed under the statutory provision rather than as ordinary income. The exception to this rule occurs if the statutory provision states that it only applies if the amount is not ordinary income: see [3.80]. For example, s 15-​20 deems certain royalties to be assessable income but also states (s 15-​20(2)) that the section does not apply if the royalty is ordinary income under s 6-​5. In this chapter, the main areas of property income are discussed as ordinary or statutory income under the following headings: • interest: see [9.20]–​[9.140]; • dividends: see [9.150]; • rental and lease income: see [9.160]–​[9.180]; • royalties: see [9.190]–​[9.200];

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• annuities: see [9.210]. Figure 9.1: Overall guide Income from property

Interest

Dividends

Rent and lease income

Royalties

Annuities

s 6–5

s 6–5

s 6–5

s 6–5

s 6–5

Div 16E, s 26BB, s 70B ITAA 36

s 44 ITAA 36

S 15–25 ITAA 97

S 15–20 ITAA 97

s 27H ITAA 36

Div 230, s 15–35, s 51–57 ITAA 97

Div 974 ITAA 97

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Interest [9.20]  Most people understand the common use of the term “interest” to mean the cost of borrowed funds or the return from fixed-​term investments, such as bank term deposits or debentures. In this form, receipts of interest provide a clear example of income from property which is therefore ordinary income and assessable under s 6-​5 of ITAA 1997: Lomax v Peter Dixon & Son Ltd [1943] 1 KB 671 (see Case Study [9.1]). However, the term “interest” is not specifically defined in the tax legislation and therefore it is necessary to rely on case authority for a definition. In Riches v Westminster Bank Ltd [1947] AC 390 at 400, interest is described as “a payment which becomes due because the creditor has not had his money at the due date”. Interest therefore is the return that flows from the lending of money and is the compensation for the loss of use of that money. The capital sum lent is not affected by the payment of interest providing a clear application of the “flow” concept of income. Although interest in its normal form is ordinary income, there are some specific statutory provisions which impact on the taxation of interest. In addition, there are issues relating to the timing of its assessability and whether it may in some circumstances be treated as capital.

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Discounts and premiums [9.30]  Commercial rates of interest are relatively easy to establish for various types of lending, but these rates are substantially influenced by the degree of risk associated with the debt. Lenders may increase the standard interest rate to account for the increased risk of non-​repayment or they may retain the standard rate of interest and negotiate a discount or premium on the debt. A discounted loan is one where the amount provided to the borrower is less than the amount of the loan. A loan premium is one where the borrower has to repay more than the amount advanced by the lender. Example 9.1: Loan discounts and premiums Loan discount XYZ Pty Ltd arranges a loan of $1 million (notional principal) for one year to finance the development of a new production process. This loan is an interest-​only loan and the interest rate is well below that expected for similar loans. The principal of $1 million is to be repaid in full at the end of the one-​year term. However, the lender advances only $900,000 to XYZ Pty Ltd, not the full $1 million, but the loan agreement states that the full $1 million has to be repaid. The $100,000 difference between the amount advanced and the amount repaid is known as the “discount”.

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Note that interest will still be paid on the $1 million even though only $900,000 is advanced to the borrower. Loan premium ABC Pty Ltd arranges a loan of $900,000 (notional principal) for one year to finance the development of a new production process. This is an interest-​only loan and the interest rate is well below the rate that might be expected for similar loans. However, at the end of the loan, ABC Pty Ltd is required to repay $1 million, consisting of the $900,000 debt plus a “premium” of $100,000. In this case, the annual interest will still be based on the $900,000 borrowed.

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Difference between discounts and premiums The difference between a loan discount and premium is very subtle and may best be understood by comparing the two notional principals for each of the arrangements above. With the discount arrangement, the notional principal is $1 million with a discount of $100,000, which means that only $900,000 is received by the borrower. On the other hand, with the loan premium, the notional principal is $900,000 and the borrower has to pay an additional premium of $100,000 on maturity of the debt giving a total repayment of $1 million. The other important difference is that for the loan discount, interest is levied on the principal of $1 million, but on the loan premium, the interest is only charged on the $900,000 advance.   

It may appear from Example 9.1 that loan premiums and discounts are no more than different terms for the same arrangement, that is, paying back a larger amount than the amount received. In addition, the discount or premium could be simply seen as a substitute for interest. However, these types of financial arrangements have also been developed to alter the timing of assessable income and as an attempt to characterise the discount or premium as capital rather than ordinary income: Lomax v Peter Dixon & Son Ltd [1943] 1 KB 671.

Case study 9.1: Interest or compensation for risk In Lomax v Peter Dixon & Son Ltd [1943] 1 KB 671 (an English case), the English taxpayer lent money to an associated Finnish company just before the outbreak of World War II. The taxpayer was not in the business of lending money, but determined that there was a high level of risk associated with this loan. As a result, the taxpayer required a much higher rate of return than would normally be accepted, but this was not achieved by charging a higher-​than-​usual interest rate. In fact, the stated interest rate was comparable to normal commercial lending. The additional risk

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of non-​repayment was catered for by the borrower being required to pay both a premium and a discount on the debt. The House of Lords accepted the argument by the taxpayer that the benefits received as a result of the discount and premium were capital in nature and not interest. The Court appears to have taken into account in this decision the facts that a commercial rate of interest was charged and that the taxpayer was not in the business of lending money.   [9.40]  The importance of the decision in Lomax v Peter Dixon & Son Ltd [1943] 1 KB 671 is that it shows that there is a distinction between interest which is ordinary income and a capital return that results from an allowance for risk. However, this case is also important as it is often cited as authority for the principle that if the discount is simply a replacement for interest, then it will be ordinary income. This same conclusion would be reached via the application of the first strand of Myer: see [8.220].

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Case study 9.2: Gain on a discounted security was ordinary income In FCT v Hurley Holdings (NSW) Pty Ltd (1989) 20 ATR 1293, the taxpayer’s main business was investing in the hotel industry. The company had realised some of its investments so that they could be held in a more liquid form until the managing director’s son took control of the company. As part of this process, the taxpayer purchased a discounted bill for $442,200 with a face value of $500,000 and a maturity date of just over one year. No actual interest was paid on this investment, but on maturity, the value of the investment had increased by $57,800, which is a notional return of 13% on the original investment of $442,200. The Commissioner assessed the $57,800 as ordinary income, but the taxpayer argued that it was capital. The Federal Court held that the gain made on the realisation of the investment was ordinary income. In reaching this conclusion, Gummow J distinguished the facts in this case from Lomax v Peter Dixon & Son Ltd [1943] 1 KB 671. The basis of this distinction was because Hurley Holdings did not receive interest and the discount was more akin to a substitute for interest and not simply an increase in capital value. This same conclusion was reached through the application of the first strand  of Myer: see [8.220]. With the increased complexity and sophistication of financial markets, and the application of the first strand of Myer, the courts may be more inclined in today’s financial climate to view premiums and discounts as ordinary income.

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Nevertheless, the decision in Lomax v Peter Dixon and Son Ltd is good authority and it is still conceivable that a genuine discount or premium could be held to be capital if: • interest was payable on the loan; • the interest and the terms of the loan were commercially justifiable; and • the discount took into account the risk of non-​repayment.

Timing of interest receipts [9.50]  Even though discounts or premiums will generally be ordinary income, deferring the receipt of the gain to when the debt is redeemed may delay the time when the gain is assessable as interest is normally derived and assessable on a cash basis. For example, if interest is paid on an annual basis, the interest will be derived and assessable under s 6-​ 5(2) of ITAA 1997 in that year. However, to the extent that the gain is realised via a discount or premium at the end of the loan, it will not be derived and assessable under s 6-​5(2) until that later date: FCT v AGC (1984) 15 ATR 982.

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Deferral of the taxation of interest earned by way of a discount or premium may cause an imbalance in the taxation system. This happens if the borrower can claim a deduction on a yearly basis, but the lender only has assessable income when the loan is repaid. As a result of this potential imbalance, a range of legislation was introduced to counter the possible deferral of tax through discount and premium arrangements.

Division 16E, s 26BB and s 70B of ITAA 1936 [9.60]  Division 16E of ITAA 1936 deals with the timing of assessable income and deductions relating to discount and deferred interest payments on “qualifying securities”. Division 16E only affects the timing of assessable income and deduction and does not determine whether or not these payments are assessable. This means that the first step when presented with a premium or discount on a qualifying security is to determine whether the discount or premium is ordinary income. If it is ordinary income, then the second step is to apply Div 16E. The effect of Div 16E is that the gains made on these securities are included in assessable income of the lender annually over the life of the loan. This will be the case even though the actual receipt of these monies may not occur until the end of the loan. Under this Division, the borrower is also entitled to a deduction on an annual basis, regardless of when the discount or deferred interest is paid.

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292 [9.60]  PRINCIPLES OF TAXATION LAW 2020 Sections 26BB and 70B of ITAA 1936 apply to “traditional securities” acquired after 10 May 1989. These provisions deem premiums and discounts to be assessable income to the recipient and deductible for the payer, even when they are capital in nature. Traditional securities are taxed on realisation and are not taxed on an annual basis like those subject to Div 16E. The distinction between “qualifying securities” and “traditional securities” is based on the amount of the premium/​discount. Traditional securities have a return (other than periodic interest) equal to or less than 1.5% pa and qualifying securities have a return (other than periodic interest) of greater than 1.5% pa, or where the return cannot be determined at the time of issue. Example 9.2: Difference between qualifying and traditional securities Two 10-​year loans are available, both with a repayable face value of $1,000. The first is issued at $750 and the second is issued at $900. The benchmark amount for differentiating between the qualified and traditional security is $150 (1.5% × 10 years × $1,000). The first loan’s return is $250 ($1,000 –​$750), which is greater than the $150 benchmark and so would be a qualifying security. The second loan’s return is $100 ($1,000 –​$900), which is less than the $150 benchmark and so would be a traditional security.   

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Example 9.3: Illustration of Div 16E –​Qualifying security Kathie lends money under a four-​year loan with a repayable face value of $20,000. However, the loan is subject to a discount and is issued at $17,000. This is a qualifying security because the return due to the discount is greater than 1.5% pa: ($20,000 –​$17,000) = $3,000 which is a return of $750 pa ($3,000/​4 years) or 3.75% pa ($750/​$20,000) of the $20,000 loan. The first step is to decide whether the discount of $3,000 is income or capital. This will depend on the individual facts of the case, such as what (if any) interest rate is charged in addition to the discount. If the $3,000 is ordinary income, then, under Div 16E, its assessability will be apportioned over four years (the life of the loan). On the other hand, if it is capital, Div 16E will not apply, but Kathie will almost definitely be subject to capital gains tax upon repayment of the loan: see Chapter 11. Furthermore, any actual interest payable during the term of the loan will be    Kathie’s ordinary income.

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Example 9.4: Illustration of s 26BB –​Traditional security Cindy lends money under a four-​year loan agreement. The terms are that the repayable face value is $20,000, but the loan is subject to a discount so that the loan is issued at $19,000. This is a traditional security because the return due to the discount is less than 1.5% pa: ($20,000 –​ $19,000) = $1,000 which is a return of $250 pa or 1.25% pa of the $20,000 loan. The $1,000 gain will be Cindy’s statutory income under s 26BB at the end of the term of the loan. Any interest payable during the term of the loan will be Cindy’s ordinary income.   

Taxation of financial arrangements (TOFA) –​Div 230 of ITAA 1997

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[9.70]  Division 230 of ITAA 1997 was introduced into the ITAA 1997 because the previous timing provisions for financial instruments did not adequately cater for some of the more complex and newer financial arrangements. It was also justified on the basis that the previous provision did not take into account the time value of money, that is, because of inflation and lost interest earning capacity, $1 earned today is more valuable than $1 earned in one year’s time. These rules apply to financial instruments acquired on or after 1 July 2010, but a taxpayer may also elect to apply these rules from 1 July 2009. The primary aim of the Taxation of Financial Arrangements (TOFA) provisions is to reduce the mismatch between the timing of the deductions for payments on financial instruments and the timing of the assessability of those payments. This will effectively reduce the opportunity for deferral of the income from these arrangements and will treat all the gains as income, rather than capital. The TOFA rules are very complex and have been subject to frequent amendment. However, these rules do not apply to individuals and therefore only apply to a limited number of taxpayers such as those dealing with bonds, promissory notes, debentures and risk shifting arrangements. Taxpayers not subject to the TOFA provisions will still be taxed under Div 16E, s 26BB and s 70B of ITAA 1936.

Interest and compensation [9.80]  Interest is normally the return to the lender/​investor for the loss of the use of funds: see [9.20]. However, interest may also be paid on damages and compensation payments to compensate for the time lag between the loss and the receipt of the compensation. For example, a person injured in a car

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294 [9.90]  PRINCIPLES OF TAXATION LAW 2020 accident who receives $100,000 compensation, but has to wait 12 months for the final decision and receipt of payment, may be entitled to interest on the $100,000 because of the delay. If the compensation itself is ordinary income, any interest paid on the compensation will also be ordinary income under the compensation principle: see [10.20]. However, if the compensation itself is not ordinary income, the question arises as to the tax treatment of the interest component of the compensation payments: Federal Wharf Co Ltd v DCT (1930) 44 CLR 24 (see Case Study [9.3]). These interest payments may be: • ordinary income; • capital because it cannot be separated from compensation of a capital nature (this may be subject to capital gains tax, although some capital compensation is exempt from CGT: see [11.290]); • capital for other reasons, such as being pre-​ judgment interest on personal injury payments: see [9.100]; or • specifically made exempt by the ITAA 1997: see [3.90]. Before considering the impact of the specific statutory provisions on interest relating to compensation for loss of capital, it is first necessary to understand how these receipts have been categorised by the courts. Case law shows that different approaches may be used for compensation for the loss of property and compensation for personal injury: Federal Wharf Co Ltd v DCT (1930) 44 CLR 24; Whitaker v FCT (1998) 38 ATR 219.

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Interest relating to compensation for damages for property [9.90]  The decision in Federal Wharf Co Ltd v DCT (1930) 44 CLR 24 illustrates that interest compensation relating to property will be ordinary income where the interest component of the compensation is a clearly identifiable amount. This is effectively an application of the compensation principle. However, if the capital and interest components are undissected (the components of the compensation cannot be ascertained), then the court is more likely to treat the total compensation as capital, even though it may include some component of income, such as interest: see [10.240]. Case study 9.3: Interest on capital compensation is ordinary income In Federal Wharf Co Ltd v DCT (1930) 44 CLR 24, the taxpayer’s property was compulsorily acquired under legislation and the relevant Act allowed for interest at the rate of 4% pa to be paid on the amount owing from the time of acquisition to the time the compensation was paid. The compensation for the loss of property was clearly capital, but Federal

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Wharf argued that the 4% pa (interest) component formed part of the compensation for resumption of the land and was also capital. The High Court held that the interest component of the compensation was ordinary income because it was paid to account for the fact that the taxpayer had been deprived of the use of the funds that it was due. Rich J followed the analogy that if the funds were received immediately, they could have been invested and any interest received would be ordinary income.   In Federal Wharf Co Ltd v DCT, the interest component of the compensation was clearly identifiable. As a result, it was possible for the Court to separate the capital component for the resumption of the land from the income component in the form of interest.

Interest relating to compensation for damages for personal injury [9.100]  Interest paid as part of compensation for personal injury can be separated into pre-​ judgment and post-​ judgment interest. Pre-​ judgment interest is interest accumulated between the time of the event giving rise to the compensation and the time of the judgment; post-​judgment interest is the interest accrued between the time of the judgment and the time of receipt of the compensation.

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Case study 9.4: Pre-​judgment and post-​judgment interest In Whitaker v FCT (1998) 38 ATR 219, the taxpayer was awarded compensation of about $808,000 following surgery which left her blind. The sum awarded included pre-​judgment interest of $65,000. Whitaker also received approximately $288,000 in post-​judgment interest because the compensation remained unpaid for over two years due to the case being appealed. The Commissioner included both the post-​and pre-​ judgment interest in the taxpayer’s assessable income. On appeal to the Full Federal Court, it was held that the pre-​judgment interest was capital in nature and not ordinary income, but the post-​ judgment interest was ordinary income and therefore assessable. The Court had little difficulty in concluding that the post-​judgment interest was ordinary income because it was paid to compensate for the delay in the payment of the compensation. This interest had nothing to do with the damages awarded for the injury. However, pre-​judgment interest was seen as part of the compensation awarded for the injury suffered and therefore was capital in nature.

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Although the judgment was unanimous, the reasoning varied but generally related to the fact that although the pre-​judgment interest is compensation for being deprived of the money, the amount is not certain until the award is made and it is just one component of the compensation for the loss suffered. It was also suggested that it could not reasonably be assumed that these funds would have been available for investment as they did not crystallise until the judgment was made. Note that the decision in this case relating to post-​judgment interest has been made redundant due to the enactment of s 51-​57: see [9.110].  

Section 51-​57: Exemption of post-​judgment interest on personal injury compensation [9.110]  The decision in Whitaker v FCT (1998) 38 ATR 219 generated considerable media interest and political debate regarding the issue of whether it was fair and equitable to tax post-​judgment interest from personal injury compensation. Consequently, retrospective legislation was introduced, effective from the 1992–​ 1993 tax year, to exempt post-​judgment interest from assessable income.

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Under s 51-​57 of ITAA 1997, the interest is exempt if it relates to damages for personal injury and is in respect of the period between the original judgment and the ending of any appeal process or the time of any out-​of-​court settlement. Any interest arising between settlement and the date of receipt of the compensation is not covered by the s 51-​57 exemption. This interest would be subject to the decision in Whitaker v FCT and would be categorised as ordinary income.

Interest compensation and CGT [9.120]  Compensation of a capital nature may be subject to CGT provided it is not exempted by s 118-​37 of ITAA 1997: see Chapters 10 and 11. As a result, any interest component that cannot be clearly identified may be included in the amount subject to CGT. For example, where the compensation is for a capital loss and in the form of an undissected amount (see [10.240]), then the total amount of compensation will be treated as capital. This will be the case even if the final amount was determined after consideration of compensation for the loss of use of funds (ie, interest).

Section 15-​35: Interest on overpayment and early payment of tax [9.130]  Where a taxpayer has paid his or her tax but has disputed the assessment and is successful in having the tax assessment reduced, the

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taxpayer is entitled to be paid interest on the overpaid tax: Taxation (Interest on Overpayments and Early Payments) Act 1983 (Cth). The refund of the tax already paid will therefore include compensation in the form of interest to account for the fact that the tax had previously been overpaid. This compensation, paid in the form of interest, is specifically deemed to be assessable under s 15-​35 of ITAA 1997. Although such payments will also constitute ordinary income, they will be assessable only under s 15-​35, as gains that are both ordinary and statutory income are taxed under the statutory provision (s 6-​25) unless the specific provision requires otherwise: see [3.80].

Interest portion of instalment payments [9.140]  Interest could also be imputed into periodic payments for capital items. For example, on the sale of a retail business, the vendor may agree that the purchaser can pay for the business with equal quarterly payments over a three-​year period. This type of arrangement is commonly known as a “term sale” or “vendor financing” and may occur where purchasers cannot obtain their own finance.

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If this type of arrangement states a specific interest rate to be charged on the outstanding balance, then that interest will clearly be ordinary income. However, if no explicit interest rate is included in the agreement, the issue arises as to whether there is an implied interest included in the periodic payments. Australian courts have generally been reluctant to impute an interest component into periodic capital payments and are more inclined to treat the total amount as capital if there is no identifiable amount of interest: Californian Oil Products Ltd (in liq) v FCT (1934) 52 CLR 28. However, these amounts may be subject to the CGT provisions: see Chapter 11. Example 9.5: Interest component of periodic capital payments Mr Gan wishes to sell his gardening and home maintenance business as a going concern, and he has a willing purchaser. Mr Gan has advertised the business (equipment, customer lists and forward bookings) for $160,000, but he would sell it for $150,000. The potential purchaser is very keen to buy the business, but she cannot obtain the finance for the purchase. As a result, Mr Gan agrees to sell the business for 10 quarterly payments of $16,000 each and secures the payments by taking a mortgage over the purchaser’s private home. There is no mention of interest in the agreement. As there is no mention of interest in this contract, the full payment will most likely be treated as capital. However, provided CGT is applicable,

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Mr Gan will have realised a capital gain for tax purposes on the date of the agreement to sell. As a result, he will be subject to tax on the gain in the year of the sale, regardless of the fact that he will not be paid in full until over two years later.   

Dividends

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[9.150]  Dividends are paid to company shareholders as their share of company profits. It therefore follows that dividends flow from the ownership of shares and are ordinary income under s 6-​5 of ITAA 1997. However, dividends are also specifically made assessable as statutory income under s 44 of ITAA 1936 and because of s 6-​25 of ITAA 1997, this specific provision has precedence over the general provision, s 6-​5: see [3.80]. Consequently, dividends are brought to assessable income via s 44 rather than s 6-​5: see [21.40]. Section 6(1) of ITAA 1936 defines a “dividend” as including: • any distribution in the form of money or property that a company makes to its shareholders; and • any amount credited by the company to any of its shareholders as shareholders. The meaning of “dividend” for tax purposes is discussed in detail at [21.130], but in most situations, it will be clear what a dividend is. However, over the years, many complex financial instruments have been developed in an attempt to alter the tax effect of benefits paid to shareholders. This has created some confusion as to whether the payments are interest on debt, dividends or of a capital nature. Of particular concern is whether the payments by a company are dividends paid to the holder of shares (equity) or interest paid on debt. This distinction is important as it alters the tax treatment for both the company and the investor. Example 9.6: Company payment on debt Rupert has lent (debt) $50,000 to his family private company, of which he is a shareholder, and the agreement is that the company pays Rupert 8% pa interest and the debt is to be repaid at the end of three years. In this case, the company will have a tax deduction for the interest payment and Rupert will be assessable on the interest receipt as ordinary income. The repayment of the loan at the end of three years is capital in nature with no income tax implications for either the company or Rupert. The important characteristics of Rupert’s investment are that there is a known fixed amount of return and the repayment of the capital is also agreed to.   

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Example 9.7: Company payment on equity Gertrude purchases $50,000 of shares (equity) in a private company. Gertrude will only receive a dividend from her investment if the company makes a profit and decides it can afford to distribute a dividend to its shareholders. If the company does pay a dividend to Gertrude, the company will not be able to claim the payment as a deduction because it is not an expense, but a distribution of profits. Gertrude will have assessable income under s 44 of ITAA 1936, but may be entitled to a rebate via the dividend imputation system to account for the tax the company has already paid on its profits before paying the dividend: see [21.420]. The only means for Gertrude to realise the capital value of her shares is to sell them or for the company to buy them back, both which could give rise to CGT: see Chapter 11.

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The important characteristics of Gertrude’s investment in equity are that the returns are not certain and the capital value can only be realised through sale.    The main differences between investments in debt and equity are: • the different level of risk borne by the investor, in that lenders are exposed to less risk than shareholders; and • the different tax treatments. Given the different tax treatment of investments in debt and equity, companies have devised securities which blur the boundary between payments of interest and dividends. This has been done to alter the tax situation for both the company and investor. As a result, Div 974 of ITAA 1997 was enacted to provide a clearer definition of debt and equity investments. These rules are very complex, but in essence, the distinction between debt and equity is made on the basis of the certainty of the return and the level of risk to which the investor is exposed.

Rental and lease income Rent [9.160]  Rent is a payment by one party in exchange for the exclusive possession of the other party’s property for an agreed amount of time. The receipt of rent by a lessor clearly constitutes ordinary income as it is income from property. Under the flow concept, rent is income that flows from an investment in property: see [5.100]. Although rent receipts are usually periodical in nature, rent will still constitute ordinary income when it is paid as a lump sum.

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Lease premiums [9.170]  A lease premium is a payment by a potential lessee to induce a lessor to enter a lease agreement with the lessee. Receipt of a lease premium by a lessor is normally treated as capital because it is regarded as a receipt for realising an interest in the asset. Lease premiums that are capital will usually be assessable under the CGT provisions: see Chapter 11. However, lease premiums will constitute ordinary income in either of the two following situations: • where the taxpayer is in the business of receiving lease premiums: Kosciusko Thredbo Pty Ltd v FCT (1983) 15 ATR 165 (see Case Study [9.5]). This is usually only the case if the taxpayer regularly receives lease premiums; and • where the lease premium is in reality a substitute for rent: Dickenson v FCT (1958) 98 CLR 460.

Example 9.8: Lease premium –​Capital

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Pete owns a rental property and wants to find a tenant to enter a one-​ year rental agreement. He believes he can charge rent of $1,500 per month, but at this rate, he receives far more prospective tenants than he expected. One particular applicant, Alex, offers to pay Pete a one-​off premium of $1,200 on top of the rent if he is chosen as the tenant, and Pete accepts this offer. The rent of $1,500 will be ordinary income, but the lease premium of $1,200 will be capital and subject to CGT.   

Example 9.9: Lease premium –​Business income Build Pty Ltd builds and rents out office buildings. It regularly enters into three-​year leases with its tenants. Every time it finds a new tenant, it charges the tenant a one-​off lease premium on top of the monthly rent. Because it owns many offices, Build Pty Ltd regularly receives lease premiums. In this instance, receipt of the lease premiums would constitute ordinary income and would be assessable under s 6-​5 of ITAA 1997. The receipt of the lease premiums is regarded as normal proceeds of Build Pty Ltd’s business because it receives them on a regular basis as part of its business activities.   

Example 9.10: Lease premium –​Substitute for rent Jemima owns a rental property and wants to charge $1,800 rent per calendar month. However, a friend of hers told her that lease premiums

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are not ordinary income. As a result, she enters into a lease agreement with a tenant where she is paid $1,000 per month rent and $800 per month “premium”. The $1,000 per month rent would be ordinary income and assessable under s 6-​5. The $800 per month “premium” would also be ordinary income in this situation as it is clearly a substitute for rent.   

Case study 9.5: Taxpayer in business of receiving lease premiums In Kosciusko Thredbo Pty Ltd v FCT (1983) 15 ATR 165, the taxpayer, in its capacity as a tenant, entered into a 45-​year lease of a State park. The taxpayer then proceeded to develop the land, which included building facilities and apartments. The taxpayer subsequently sublet the apartments and other facilities to various tenants and received lease premiums upon granting some of these leases. The Court held that the lease premiums constituted ordinary income as they were part of the normal proceeds of the taxpayer’s business. This was because the receipt of lease premiums was repetitive and an essential ingredient of the taxpayer’s business. Consequently, the scope of   the taxpayer’s business included receiving lease premiums.

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Section 15-​25 –​Amount received for lease obligation to repair [9.180]  Section 15-​25 of ITAA 1997 states that amounts received by a lessor from a lessee due to the lessee failing to comply with a lease obligation to repair the premises are assessable income. However, s 15-​25 will only apply where: • the lessee has used the premises for producing assessable income; and • the payment is not ordinary income. Example 9.11: Amount assessable under s 15-​25 Alice owns an office that she leases to Bob. Bob runs a consulting business from the leased premises. There is a condition in the lease agreement that Bob must make any necessary repairs to the office and that if he fails to do so, he must pay a contractual penalty to Alice. The office requires repairs and Bob fails to carry them out. As a result, Bob pays Alice money as determined under the lease agreement. This amount is assessable under s 15-​25. Note that there is an equivalent deduction under s 25-​15 for expenses incurred in carrying out these repairs.   

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Royalties Introduction

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[9.190]  A royalty is a payment that is calculated based on the usage of intellectual property or the quantity/​value of a substance taken, such as coal taken from a mine. The following would be royalties: • When a taxpayer is paid for use of his or her intellectual property. For example, Simone wrote a book and, as a result, owns the copyright to it. A publisher then enters into an agreement with Simone to publish and sell her book in exchange for giving her $2 per sale. This payment constitutes a royalty because it is calculated based on the usage of the copyright. • When the owner of intellectual property agrees to sell his or her intellectual property for an amount based on its usage. For instance, Steve writes a book and owns the copyright to it. A publisher who wishes to publish and sell Steve’s book offers to give him $2 per sale in consideration for Steve selling the copyright to the publisher. The amount received by Steve will constitute a royalty. This differs from the first example because in the first example, the author retains ownership of the copyright, but in this example, the copyright is being sold. Nevertheless, in both cases, the payments constitute royalties as the amounts are calculated on the usage of intellectual property. • Where someone is paid to produce intellectual property and the payment is based on its subsequent usage. For instance, Christie agrees with a publisher to write a book for them in exchange for a payment of $2 per book sold. The copyright in this example will always have been owned by the publisher because, under copyright law, if a writer enters a contract to write a piece for someone (such as a publisher), the copyright usually rests with the party that is paying. However, despite the fact that Christie never owned the copyright, the payment will still be a royalty because it is calculated according to the usage of intellectual property. • Where a taxpayer is paid for his or her physical resources based on the quantity of resources taken. For example, Alexia owns land that has oil reserves. A mining company pays her $20 for every barrel of oil that it extracts from her land. This amount will constitute a royalty.

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Case study 9.6: Taxpayer paid for timber taken from his land in receipt of royalty In McCauley v FCT (1944) 69 CLR 235, the taxpayer was a dairy farmer who owned land with trees on it. The taxpayer entered into an agreement with Laver, where Laver would cut and take the trees from the taxpayer’s land. The agreement stated that Laver would pay the taxpayer an amount based on the quantity of timber that had been cut and removed from the land. The High Court held by a 2:1 majority that the payment received by the taxpayer was a royalty as it was a payment made in relation to the amount of   timber removed.

Assessability of royalties

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[9.200]  Section 15-​ 20 of ITAA 1997 deems royalties to be assessable as statutory income. However, s 15-​20 does not apply to royalties that are ordinary income under s 6-​5 of ITAA 1997. This means that royalties that are ordinary income will be assessable under s 6-​5 and those that are not ordinary income will be assessable under s 15-​20. This raises the issue of which royalties are ordinary income. Royalties that are a product of exploiting intellectual property (such as the first three points in the list at [9.190]) will constitute ordinary income. In the case of Stanton v FCT (1955) 92 CLR 630 (see Case Study [9.7]), the majority arguably implied that payments for physical resources (such as the last of the points at [9.190]) will be capital royalties. However, the case law on what constitutes a capital royalty is unclear, and it is also arguable that royalty payments for physical resources are ordinary income.

Case study 9.7: Farmer’s receipt from a sawmiller for right to take timber was not a royalty In Stanton v FCT (1955) 92 CLR 630, the taxpayer was a farmer who granted a sawmiller the right to come on to his land and remove timber in exchange for a predetermined sum to be paid quarterly. The agreement also prescribed a maximum amount of timber that could be removed and gave a proportionate reduction of the payment if less than this maximum was removed. For instance, if only half the timber was removed, then the taxpayer would end up receiving only half the pre-​agreed amount.

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304 [9.210]  PRINCIPLES OF TAXATION LAW 2020

The High Court held that the payments received by the farmer were not royalties and were capital in nature. Consequently, the payment was not assessable as it was not ordinary income and s 15-​20’s predecessor did not apply as the payment was not a royalty. The Court stated that the taxpayer’s receipt was not a royalty because the agreement expressed the payment as a predetermined amount. This was despite the fact the agreed pro-​rata reduction of the predetermined payment meant that, in substance, the amount paid was linked to the amount of timber removed. In other words, the Court appeared to define royalty by its form rather than its substance. If this case was decided today, it is likely that the Court would still find that the payment was not a royalty. However, it is likely that a modern court would find that the payment was ordinary income under other grounds. For instance, it is possible that the court would find the payment is ordinary income as the normal proceeds of the taxpayer’s farming business. This is likely because courts may now take a wider view of what are normal business proceeds: see [8.130]–​[8.160]. Furthermore, even if modern courts decided that the payment did not constitute normal business proceeds, they are likely to find that the payment was ordinary income due to satisfying the first strand of Myer: see [8.220]–​[8.250]. Finally, if a court held that such a payment was not ordinary income, it would be assessable under the CGT provisions: see Chapter 11.  

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Annuities [9.210]  An annuity is a stream of payments that occur at regular intervals (eg, monthly or quarterly), and this may be for a fixed length of time or for the life of an individual. Where the annuity is purchased, it is known as a “purchased annuity”, which occurs where the taxpayer pays an entity, such as an insurance company, a lump sum in exchange for that entity paying the taxpayer a regular income stream. The main two types of annuities are fixed-​term and life annuities. A fixed-​ term annuity is where the payments are made by the annuity provider for a predetermined amount of time. A life annuity occurs when the terms of the annuity contract state that annuity payments are to be made for the rest of the recipient’s life. At the end of the annuity period, the original purchase price of the annuity will usually have been totally consumed and the recipient will not be entitled to any final capital payment. In effect, the provider of the annuity has repaid over the life of the annuity the purchase price plus any interest earned during the annuity period. However, in some limited cases, the

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taxpayer will be entitled to receive part of the purchase price of the annuity at the end of the annuity period, but this ultimately depends on the term of the annuity agreement. Example 9.12: Fixed-​term and life annuities A taxpayer purchases an annuity from an insurance company for $100,000 in exchange for a 10-​year annuity. The terms of this particular annuity provide the taxpayer with regular payments for the next 10 years that amount to $14,500 pa. This is an example of a fixed-​term annuity. Another taxpayer pays an annuity provider $60,000 in exchange for the taxpayer receiving regular payments of $7,000 pa for the rest of his life. This    is an example of a life annuity. Under case law, the full amount of the regular annuity payments is regarded as ordinary income: Egerton-​Warburton v DCT (1934) 51 CLR 568. This is an unjust outcome because only part of the annuity payment is a real gain, whereas the rest is a return of the taxpayer’s purchase price, which is capital: see [5.70]. As a result, the Government enacted s 27H of ITAA 1936, which makes the return of the annuity’s capital component tax free. Section 27H only applies to non-​superannuation annuities as superannuation annuities are subject to other legislative provisions: see Chapter 18.

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Example 9.13: Section 27H of ITAA 1936 reduces assessable component of annuity Stan pays $80,000 in exchange for an eight-​ year annuity that pays $13,000 pa. Under the terms of the agreement, Stan is not entitled to have any of the purchase price returned at the end of the eight years. Stan’s purchase price of $80,000 apportioned over the term of the annuity amounts to $10,000 per year. This means that, due to s 27H, $10,000 of the yearly annuity income is tax free. The other $3,000 will be assessable as ordinary income.   

Questions [9.220]  9.1 Your client has invested $10,000 in a savings bond that matures in five years’ time and pays interest at 8% pa, but the interest is paid as a lump sum on the redemption of the bond in five years’ time. How will the interest be treated for income tax purposes?

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306 [9.220]  PRINCIPLES OF TAXATION LAW 2020 9.2 Your client has purchased an investment apartment that has a rent guarantee from the developer of 5% pa for a period of four years. During the current financial year, your client has been unable to rent the apartment, so is relying on the rent guarantee payment to compensate her for not being able to find a tenant. The developer is due to pay the amount as a lump sum and your client is not sure whether the amount is income. Advise her. 9.3 Your client was injured in a work-​related accident and has received damages of $300,000 for the loss of his ability to work. In the final judgment, the Court awarded $12,000 in pre-​judgment interest and $5,000 in post-​judgment interest. Which amounts, if any, are assessable income? 9.4 Your client makes most of her income from writing hit songs for various performing artists and receives a large amount of royalties from overseas record companies. Is this assessable income and how will it be taxed? 9.5 Your client has just written his first book of his experience as a hostage of a terrorist group. He spent the last two years writing the book and he has received two offers from a publishing company that wished to publish his book. The first offer is to purchase the copyright for a lump sum payment of $10,000 provided your client gives up future claims to the copyright and royalties. The second offer is to pay 10% of the sale price of each book sold provided your client agrees to assign the copyright in the book to the publisher for 10 years. Discuss the effect on assessable income of each of the two offers. 9.6 Your client is a parent who lent $40,000 to her son to provide a short-​ term housing loan. The agreement is that the son will repay $50,000 at the end of five years. Reconsider this question in light of the following facts. The loan was made to the son without any formal agreement and without any security provided for the sum lent. In addition, the client (the mother) has informed you that she told her son that he need not pay interest. However, the son repaid the full amount after two years and included in his payment an additional amount which was equal to 5% pa on the amount borrowed. Only one cheque was presented for the total amount. Discuss the effect on the assessable income of the parent. 9.7 Helen is 68 years old and single. Three years ago (when she was 65) she purchased a lifetime annuity for a lump sum of $1 million (not through her superannuation) that will give her an income of $60,000 a year for the rest of her life. The annuity has no guaranteed minimum annuity period and no amount payable to her estate upon her death. Assume

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that according to the government actuarial tables, a 65-​year-​old female has a life expectancy of 89. How would Helen’s $60,000 receipt be treated for income tax purposes? 9.8 Ms Kim works as a nurse at the local private hospital and in addition to her private home, she owns a commercial property which she rents to a tenant who operates a retail business from the property. As part of the rental agreement Ms Kim requires a bond of $2,000 to be paid on signing of the rental agreement, and the tenant also agrees to rectify any damage to the property caused by the tenant. During the current tax year, the tenant stopped paying rent and on inspection of the property Ms Kim found the tenant had vacated and there was $3,000 worth of damage caused by the tenant. As a result, she retained the full $2,000 bond and used it to repair the damage caused by the tenants.

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How will Ms Kim’s retention of the $2,000 bond be treated for income tax purposes?

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10

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Principles of compensation Key points....................................................................................................  [10.00] Introduction................................................................................................  [10.10] Compensation for losses incurred by individuals....................................  [10.40] Compensation for loss of salary or wages..........................................  [10.60] Loss of earnings vs loss of earning capacity......................................  [10.80] Compensation received by way of insurance or indemnity..............  [10.90] Compensation for loss of physical abilities......................................   [10.100] Compensation for pain, suffering or medical expenses..................   [10.110] Compensation under anti-​discrimination legislation........................   [10.120] Compensation paid by financial institutions.....................................   [10.130] Structured settlements......................................................................   [10.140] Compensation for business losses..........................................................   [10.150] Compensation for breach of contract –​ordinary trading contracts.........................................................................   [10.170] Compensation for breach of contract going to fundamental structure of business..................................................................   [10.190] Compensation for loss of asset –​depreciable assets......................   [10.200] Compensation for loss of asset –​capital assets...............................   [10.210] Compensation for loss of asset –​trading stock................................   [10.220] Compensation by way of insurance proceeds.................................   [10.230] Composite claims.....................................................................................   [10.240] Reimbursement of previously deducted expenses................................   [10.260] Questions...................................................................................................   [10.300]   

Key points [10.00]  • Generally, a compensation receipt or damages award takes on the character of the item it replaces. This is known as the “replacement principle”.

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310 [10.10]  PRINCIPLES OF TAXATION LAW 2020 • The common law “replacement principle” may be supplemented or overridden by statutory provisions of the ITAA 1936 or ITAA 1997. • Compensation for loss of salary or wages will generally be assessed as ordinary income. • Compensation for loss of physical abilities, pain, suffering or medical expenses will generally be a capital receipt and exempt from income tax consequences. • Compensation under anti-​discrimination legislation may be assessable income depending on the circumstances. • Division 54 of ITAA 1997 provides that certain annuities and lump sums provided under structured settlements and structured orders to persons who have suffered personal injury are exempt from income tax. • Compensation payments or damages received for breach of an ordinary trading contract will be assessed as ordinary income. • Compensation payments or damages received for a breach of contract going to the fundamental structure of the business will be assessed as a capital gain. • The taxation consequences of compensation received for the loss of an asset depends on the type of underlying asset; depreciable assets will be dealt with under the depreciation provisions, trading stock will be dealt with under the trading stock provisions and capital assets will be subject to common law principles. • Compensation received under an insurance or indemnity policy may be assessable under s 15-​30 of ITAA 1997. • Where a composite claim cannot be dissected into its component parts, the whole amount will be treated as capital and assessed as such. • The “replacement principle” does not apply to the reimbursement of previously deducted expenses. Rather, the reimbursement itself is considered to determine whether the receipt is income or capital.

Introduction [10.10]  Compensation or damages may be received by a taxpayer for a variety of reasons. This chapter divides compensation and damages receipts into two categories: compensation or damages received by individual taxpayers outside the ordinary course of a business and compensation or damages received by taxpayers during the ordinary course of a business. The first category includes compensation or damages received by an employee, as well as those received in a private or personal capacity. Compensation or damages may be received from an employer, through workers’ compensation or a private insurance policy, or directly from another party. The second category includes compensation or damages received by a business for some type of loss or injury to that business. The loss may be in

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10: Principles of coMpensation  [10.20] 311

the form of a reduction in profits, temporary cessation or reduction in business or damage to the asset structure of the business. Again, the compensation or damages may be received through an insurance policy or from another party. [10.20]  As a general principle, a compensation receipt or damages award takes on the character of the item it replaces: FCT v Dixon (1952) 86 CLR 540. Consequently, where the indicia of ordinary income are present for the amount being replaced, any compensation received in lieu of that amount will itself be considered ordinary income and assessable under s 6-​5 of ITAA 1997. Alternatively, a compensation receipt or damages award in lieu of capital or a capital item will be capital in nature and subject to the capital gains tax provisions of the ITAA 1997. This is known as the “replacement principle” and applies to all compensation receipts unless it is overridden by a statutory provision of the Income Tax Assessment Acts. Often compensation or damages that replace income will be in the form of a lump-​sum payment. The fact that the compensation is paid as a lump sum will not alter its character where the substituted item is income in nature.

Figure 10.1: Overall guide

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Is an amount received compensation, damages or a reimbursement of previously deducted expenses?

Compensation or damages are received

Compensation or damages for loss incurred by an individual

Compensation or damages for loss incurred by a business

See [10.40]

See [10.150]

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A reimbursement for a previously deducted expense is received

See [10.260]

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312 [10.30]  PRINCIPLES OF TAXATION LAW 2020 Prima facie, the replacement principle applies to all compensation or damages receipts. However, this principle is not extended to apply to the reimbursement or refund of previously deducted expenses, as a receipt to compensate or reimburse deductible outgoings is not characterised as income simply because it is a reimbursement of expenses previously deducted. Where a taxpayer receives a reimbursement of previously deducted expenses, the taxation consequences of that receipt are determined by reference to the character of the receipt itself, rather than the item it replaces. [10.30]  The following guide considers the individual types of compensation or damages receipts within specific categories. While the replacement principle generally applies to these categories, there are circumstances where specific rules have been developed and statutory provisions need to be considered. The categories below make it possible to consider the common law application of the principles and specific statutory provisions which supplement or override the replacement principle.

Compensation for losses incurred by individuals

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[10.40]  Compensation or damages received by a taxpayer not carrying on a business will relate to either income-​producing circumstances or personal circumstances. In Chapter 6, the concept of income from personal services and employment is discussed. The doctrines set out in that chapter are the fundamental principles to be applied to determine the consequences of a compensation or damages payment received by an individual taxpayer. Students should review these concepts. “Income from personal exertion” is income consisting of earnings, salaries, wages, commissions, fees, bonuses, pensions, superannuation allowances and retiring gratuities, allowances and gratuities received in the capacity of employee or in relation to any services rendered. These amounts are assessable as ordinary income under s 6-​5 of ITAA 1997. To determine whether an amount is income from personal exertion, the courts have established certain indicia. Amounts that do not satisfy the indicia of income from personal exertion are generally considered non-​assessable, non-​exempt income, that is, the amounts are not subject to income tax. Of course, there may be statutory income provisions that override the common law and include an amount as assessable income. [10.50]  Compensation or damages received by an individual will generally fall into one of five categories. With the underlying principles of income in mind, the consequences of the following compensation or damages receipts received by an individual are set out in Figure 10.2

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10: Principles of coMpensation  [10.70] 313

Figure 10.2: Compensation received by an individual What type of loss has the taxpayer suffered?

Compensation for loss of salary or wages

Compensation for loss of physical abilities

Compensation for pain, suffering or medical expenses

Compensation under anti-discrimination legislation

Structured settlements

See [10.60]

See [10.100]

See [10.110]

See [10.120]

See [10.140]

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Compensation for loss of salary or wages [10.60]  In Chapter 6, it was established that salary and wages are ordinary income and assessable under s 6-​5 of ITAA 1997. Applying the replacement principle, compensation or damages that replace salary or wages will also be assessed as ordinary income. Compensation for loss of salary or wages often results as a consequence of a policy of insurance held by an employer, such as a workers’ compensation policy (or other statutory injury compensation payment) or a policy of insurance taken out by the individual being compensated. The taxation consequences of a payment which substitutes lost salary or wages under either type of insurance policy are straightforward and will be assessable as ordinary income under the replacement principle. [10.70]  There are circumstances, however, where a payment is made directly by the taxpayer’s employer to a current or past employee. In these situations, if there is no reference to lost wages, it may not be so obvious as to what the payment is for. Case study 10.1: Compensation payment held to be ordinary income In FCT v Dixon (1952) 86 CLR 540, the employer made payments to its employees who enlisted in the armed forces during World War II. The payment, which was the difference between the salary paid by the employer and the salary paid by the armed forces, was made voluntarily and without any conditions attached. The Commissioner assessed the taxpayer on the payments on the basis that they constituted ordinary income. The High Court held that the receipts

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314 [10.80]  PRINCIPLES OF TAXATION LAW 2020

were assessable as ordinary income. In particular, Fullager J concluded that the amounts were ordinary income as they were compensation for wages (and periodical payments) that would have otherwise been received.  

Case study 10.2: Compensation payment held to be ordinary income In C of T (Victoria) v Phillips (1936) CLR 144, the taxpayer, a director of a company, entered into a contract in which he agreed to serve as managing director for 10 years. In the sixth year, the contract was terminated by the employer and the taxpayer was compensated with monthly payments corresponding to the amounts the taxpayer would have received under the contract. The Court held that the new payments were in the nature of income as they were of the same nature as those they replaced.   In both FCT v Dixon and C of T (Victoria) v Phillips, the payments were periodical. However, the receipt of compensation or damages as a lump sum will not alter its assessability where the lump-​sum payment is for loss of income only or a portion of the lump-​sum payment is identifiable and quantifiable as income: Determination TD 93/​58.

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Example 10.1: Lump-​sum compensation Adele manages Belinda’s business. Adele’s contract provides that Belinda is required to pay her a 5% share of the profits from the business. Adele calculates that Belinda has only been paying her 4% of the profits of the business due to an error in the figures. Belinda agrees to pay Adele $50,000 to make up for the mistake. The $50,000 is assessable income in the hands of Adele as it is compensation for losses of an income nature: see Determination TD 93/​58. It is irrelevant that the compensation is paid as a lump sum. The receipt is income only, as there is no capital component. It is also not relevant that the basis of the calculation of the lump sum cannot be determined.   

Loss of earnings vs loss of earning capacity [10.80]  Where compensation is awarded, it is necessary to ensure that any compensation is received for lost earnings as opposed to a payment for the loss of earning capacity. Although this can be difficult to do, this is demonstrated by the different results in Sommer v FCT (2002) 51 ATR 102 as compared to Coward v FCT (1999) 41 ATR 1138.

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Case study 10.3: Compensation receipt held to be ordinary income In Sommer v FCT (2002) 51 ATR 102, the taxpayer was a medical practitioner specialising in stress management. He became unable to work and claimed compensation under a Professional Income Replacement Policy. Ultimately the taxpayer was paid a lump sum of $140,000 as consideration for the cancellation of the policy. The taxpayer claimed that the lump sum was a capital amount and therefore not assessable as ordinary income. The Court, in finding for the Commissioner, held that the sum was ordinary income as the purpose of the insurance was to replace a revenue receipt.  

Case study 10.4: Compensation receipt held to be capital Sommer v FCT can be contrasted with Coward v FCT (1999) 41 ATR 1138, where the taxpayer, having reached 65 years of age, converted weekly personal injury compensation payments to a lump sum. The AAT held that, while the weekly payments replaced lost wages, the lump sum was capital in character as it related to a loss of earning capacity.  

Example 10.2: Loss of salary or wages Jamie, an apprentice chef, slices his index finger off during work. Jamie is paid $5,000 in workers’ compensation for lost wages.

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The $5,000 which replaces lost income is assessable as ordinary income.   

Compensation received by way of insurance or indemnity [10.90]  Compensation received by way of insurance or indemnity which is not assessable as ordinary income may still be assessable under s 15-​30 of ITAA 1997. Section 15-​30 provides that a taxpayer’s assessable income includes an amount received by way of insurance or indemnity for the loss of an amount if the lost amount would have been included in assessable income, and it is not assessable as ordinary income under s 6-​5.

Compensation for loss of physical abilities [10.100]  A compensation or damages payment for the loss of a physical ability, such as the loss of a limb, eye or finger, is a capital receipt. Further, the

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316 [10.110]  PRINCIPLES OF TAXATION LAW 2020 compensation or damages payment relating to the taxpayer personally or the taxpayer’s occupation will be exempt from capital gains tax implications under s 118-​37 of ITAA 1997. Section 118-​37(1)(a)(i) exempts from capital gains tax consequences any gain or loss made from a CGT event relating directly to compensation or damages received by the taxpayer for any wrong or injury suffered in the taxpayer’s occupation. Section 118-​37(1)(a)(ii) exempts from capital gains tax consequences any gain or loss made from a CGT event relating directly to compensation or damages received by the taxpayer for any wrong, injury or illness the taxpayer or a relative suffers personally. Section 118-​37(1)(b) exempts compensation or damages received by a trustee for the same reasons as s 118-​37(1)(a) of ITAA 1997. Section 118-​37(1)(ba) goes on to exempt from capital gains tax consequences a CGT asset that is received by a beneficiary of a trust to the extent that the CGT asset is attributable to compensation or damages that the trustee receives in relation to a wrong or injury to a beneficiary or a wrong, injury or illness suffered personally by a relative. Any post-​judgment interest received on a personal injury compensation payment is also exempt from tax under s 51-​57. This will cover interest accrued from the time the original judgment is made to the time when the judgment is finalised, for example, when the period for lodging an appeal ends.

Example 10.3: Loss of physical ability

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Jamie, an apprentice chef, slices his index finger off during work. In addition to the $5,000 Jamie is paid in workers’ compensation for lost wages, he is awarded $10,000 for the loss of the finger. The $10,000 is considered a capital receipt. In addition, the amount will be exempt from capital gains tax under s 118-​37 of ITAA 1997, which exempts from CGT any sum received by way of compensation or damages for any injury suffered by Jamie either to his person or in his vocation.   

Compensation for pain, suffering or medical expenses [10.110]  Any compensation or damages received for pain, suffering or medical expenses is replacing lost capital and therefore will be a capital receipt.

Example 10.4: Award of medical expenses Jamie, an apprentice chef, slices his index finger off during work. In addition to the $5,000 Jamie is paid in workers’ compensation for lost wages and the $10,000 he is awarded for the loss of the finger, Jamie is awarded $6,000 to cover his out-​of-​pocket medical expenses.

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The $6,000 is considered a capital receipt. In addition, the amount will be exempt from capital gains tax under s 118-​37 of ITAA 1997, which exempts from CGT any sum received by way of compensation or damages for any injury suffered by Jamie to his person or in his vocation.   

Compensation under anti-​discrimination legislation [10.120] Compensation paid because of claims made under the Commonwealth or State anti-​discrimination legislation, for example, the Sex Discrimination Act 1984 (Cth), may be assessable income depending on the circumstances of the payment. To illustrate the operation of the income tax law in relation to these types of compensation payments, in Ruling IT 2424, the Commissioner provides common examples which serve as a guide. However, it is stressed in the Ruling that the determination of the character of a compensation payment and, in particular, whether it is liable to tax in the hands of an employee depends upon the nature of the payment.

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As with other types of payments, the broad principle is that a compensation payment in substitution of lost earnings or for income which would otherwise have been earned is in the nature of income and is subject to income tax. On the other hand, compensation payments for psychological and emotional injury, such as injury to feelings, humiliation, embarrassment, depression and anxiety, are capital in nature. Such an amount will be exempt from capital gains tax by virtue of s 118-​37(1) of ITAA 1997: see [11.290]. [10.125]  The Commissioner offers the following examples of compensation awarded under anti-​ discrimination legislation, along with the likely tax consequences: • Hiring practice –​Compensation for failure to offer employment would normally make up for lost wages and therefore be ordinary income. Any part of the compensation payment that relates to psychological or emotional injury would be capital in nature and not subject to income tax. • Sexual harassment –​Compensation paid for sexual harassment will generally be a payment made for psychological and emotional injury, injury to feelings, humiliation and embarrassment, loss of self-​esteem, anxiety or distress, or loss of enjoyment of life. Any of these payments will be capital in nature and not subject to income tax. • Terms and conditions of employment –​An employee may be compensated where the terms of employment discriminate on the basis of sex, marital status or pregnancy. For example, an employee may receive less salary than a peer or have less flexibility in working hours. Compensation paid for these types of claims may be made

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318 [10.125]  PRINCIPLES OF TAXATION LAW 2020 up of both assessable and non-​ assessable receipts. A payment will generally make up for lost wages, salary or bonus and will be considered income in nature. Further, compensation may be paid for psychological and emotional injury, such as frustration, and is capital in nature. • Opportunities for promotion –​Any payment made for loss of a higher salary, due to discrimination in relation to promotion, is considered income and therefore subject to income tax. Payment compensating for impairment to prospects for future promotion or future earning capacity, as well as payment for psychological and emotional injury, is capital in nature. • Dismissal –​A compensation payment received because of unlawful dismissal is considered to be made “in consequence of the termination of any employment of the taxpayer”. Therefore, the payment is considered an employment termination payment and is subject to income tax in accordance with the employment termination payment provisions. See [6.260] onwards for a discussion of employment termination payments.

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Example 10.5: Compensation paid under anti-​discrimination legislation Jane applies for a position at her local supermarket. She is awarded the position and starts work four days per week. A month after starting work Jane has an appraisal where her employer states that they are very happy with her work. At the same appraisal, Jane notifies her employer that she is pregnant. Two days later Jane is advised that her employer is no longer satisfied with her work and that her employment is being terminated. Jane lodges a complaint with the Human Rights and Equal Opportunity Commission seeking appropriate redress and compensation from the employer. She requests that her employment be reinstated and that the employer make up lost wages during the intervening period and that compensation be paid for injury to feelings, loss of self-​esteem and humiliation. Jane is ultimately successful in receiving $2,000 in lost wages and $10,000 for injury to feelings. A compensation payment paid to Jane to make up for lost earnings is considered to be income according to ordinary concepts. The whole of the payment is included in Jane’s assessable income in the year it is received. A payment to compensate for damages for injury to feelings is a   payment of a capital nature and is not liable to tax.

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Compensation paid by financial institutions [10.130]  The recent inquiry into banking practices has resulted in bank customers receiving compensation. This compensation is generally for loss of an investment, refund or reimbursement of fees, or interest. Where the compensation is for the loss of an investment which the taxpayer has already disposed of, the compensation will be treated as additional capital proceeds from the disposal. If the investment is still held by the taxpayer, the cost base of the asset will need to be adjusted by the amount of compensation. Where compensation is in the form of a refund of fees paid for financial advice, the tax consequences will depend on whether the original payment was claimed as a deduction or whether it was part of the cost base of an asset. If no deduction was claimed, the reimbursement will not be included in assessable income. If, however, an amount was included in an asset’s cost base, an adjustment will need to be made. Where compensation is in the form of interest, that amount will be assessable as ordinary income.

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Structured settlements [10.140]  Division 54 of ITAA 1997, which applies from 26 September 2001, provides that certain annuities (periodic payments) and lump sums provided under structured settlements and structured orders to persons who have suffered personal injury are exempt from income tax. Division 54 applies to compensation or damages paid other than compensation paid by an employer or under a workers’ compensation claim. A “structured settlement” is defined as an agreed settlement in writing of a claim that is for compensation or damages for personal injury where at least part of the payment is in the form of an annuity. A “structured order” is defined as an order by the court in respect of a claim for compensation or damages for personal injury where at least part of the payment is in the form of an annuity. Division 54 does not prevent part of the compensation being in the form of a lump sum; however, there must be at least one annuity purchased out of the compensation or damages receipt. Without Div 54, any annuity would be assessable under s 27H of ITAA 1936. Despite perceived benefits, structured settlements have not generally been taken up. In 2007, the income tax exemption for structured settlement payments underwent a review. The principal recommendation of the review was to retain Div 54 in its current form without any extension. On 20 March 2008, the Federal Government responded to the recommendations of the review, agreeing to retain Div 54 and commenting that “structured settlements may be adopted in the future”. However, there has been no other progress.

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320 [10.150]  PRINCIPLES OF TAXATION LAW 2020

Compensation for business losses [10.150]  As with compensation received by an individual, compensation received by a business will be subject to taxation consequences in accordance with the replacement principle. Compensation or damages received by a taxpayer carrying on a business will either replace an amount that otherwise would have been received from transactions carried out in the ordinary course of business or compensate for the loss of capital or a capital item. Income from business is considered in Chapter 8. The doctrines set out in that chapter are the fundamental principles to be applied to determine the consequences of a compensation or damages payment received by a business. Students should review these concepts. Once the existence of a business is established, it is necessary to determine the scope of the business as not all receipts of the business are assessable as income. Receipts within the scope of the business will constitute assessable income, as will some receipts which have been considered to fall outside the ordinary scope of the business: see FCT v Myer Emporium Ltd (1987) 163 CLR 199 and FCT v Whitfords Beach Ltd (1982) 12 ATR 692. On the other hand, receipts of capital are subject to the capital gains tax provisions of the ITAA 1997.

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In addition to the income taxation consequences of a compensation receipt, the GST consequences also need to be considered. The GST consequences will depend on whether the payment constitutes consideration for a supply and whether that supply is a taxable supply. Students should review the concepts discussed in Chapter 25. The Australian Taxation Office (ATO) approach to GST on compensation payments is set out in GST Ruling GSTR 2001/​4. [10.160]  With these principles in mind, the consequences of the following types of compensation or damages received by a business are set out in Figure 10.3.

Compensation for breach of contract –​ordinary trading contracts [10.170]  Applying the replacement principle, compensation payments or damages received for breach of an ordinary trading contract will generally be assessed as ordinary income. Compensation or damages for loss of anticipated profits will fall within this category, as will a breach of contract for the sale of goods. The courts have consistently found that such compensation or damages are assessable as income.

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Figure 10.3: Compensation received by a business Ordinary trading contract See [10.170] Compensation for breach of contract Going to the fundamental structure of the business See [10.190]

What type of compensation has the business received?

Asset is a depreciable asset See [10.200] Compensation for loss of an asset of the business Asset is a capital asset See [10.210] Compensation by way of insurance proceeds where the amount is not assessable as ordinary income See [10.230]

Asset is trading stock See [10.220]

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Case study 10.5: Compensation for breach of ordinary trading contract In Heavy Minerals Pty Ltd v FCT (1966) 115 CLR 512, the taxpayer had entered into four forward selling contracts with American and German customers for the sale of rutile. Subsequent to the contracts, the market for rutile collapsed and the price fell. Following this turn of events, the contracts were cancelled and the taxpayer received compensation by way of lump sums. The Commissioner assessed the taxpayer on the lump-​sum compensation payments. The High Court held that the payments were ordinary income in the hands of the taxpayer despite the fact that the contracts in question ensured a regular market for the taxpayer’s goods. It was concluded that the mining operations had been abandoned not because of the cancellation of the contracts, but rather because of the collapse of the market in general.   [10.180]  A similar result was reached in Allied Mills Industries Pty Ltd v FCT (1989) 20 ATR 457.

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322 [10.190]  PRINCIPLES OF TAXATION LAW 2020

Case study 10.6: Compensation for breach of ordinary trading contract In Allied Mills Industries Pty Ltd v FCT (1989) 20 ATR 457, the taxpayer had an agreement to be the sole distributor of Peek Frean Australia’s biscuits, which included Vita-​Weat biscuits. The taxpayer became the sole selling and distribution agent for Peek Frean biscuit products in Australia, Papua New Guinea and Fiji. The agreement could be terminated on six months’ notice, but the taxpayer was to be offered the right to manufacture and sell Vita-​Weat for a minimum of 10 years. Instead of this original agreement being followed, the parties agreed to terminate the distribution agreement in return for a lump-​sum payment of $372,700. The Commissioner included this amount in the taxpayer’s assessable income. The Full Federal Court held that the amount was assessable as ordinary income. In coming to this conclusion, the Court held that the taxpayer was not parting with a substantial part of its business, ceasing  to carry on business or disposing of the fixed framework of its business.

Example 10.6: Compensation for breach of ordinary trading contract

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A tenant fails to vacate a commercial property at the end of the lease. The landlord sues and is awarded damages in the amount of the difference between rent paid by the tenant and rent which is obtainable on the open market. The damages awarded are ordinary income in the hands of the landlord: see Raja’s Commercial College v Gian Singh & Co Ltd [1976] 2 All ER 801.   

Compensation for breach of contract going to fundamental structure of business [10.190]  Compensation for breach of contract may go further than a payment to compensate for loss of trading income. In this case, the amount may be considered capital. An amount may be considered a capital sum where the payment is for a breach of contract that goes to the fundamental structure of the business. Usually the termination of the contract results in the cessation of the business as a whole. One such example is Californian Oil Products Ltd (in liq) v FCT (1934) 52 CLR 28, where the Full High Court held that compensation amounts paid as a result of the termination of a contract were capital receipts because the termination led to the cessation of the taxpayer’s business.

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Case study 10.7: Compensation for breach of contract going to fundamental structure of business In Californian Oil Products Ltd (in liq) v FCT (1934) 52 CLR 28, the taxpayer was the exclusive distributor in Australia of the products of an American company. This was the taxpayer’s only business. The American company subsequently decided to have a local subsidiary distribute the products and terminated the contract, which led to the closure of the taxpayer’s business. Despite the fact that the termination agreement provided for semi-​annual payments over the same period as the original contract, the payments were held to be capital receipts because the termination of the contract resulted in the cessation of the taxpayer’s business.  

Example 10.7: Compensation for breach of contract going to fundamental structure of business

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Betty has a contract with a UK company to act as the sole distributor of Ester’s Exquisite Jewellery range. There is such a demand for Ester’s Exquisite Jewellery in Australia that Betty does not distribute any other products. The contract, which is for a period of five years, is terminated by Ester after two years. Betty and Ester come to an agreement regarding compensation for the early termination of the contract. Based on estimated earnings, Betty is to receive $20,000 per year for the next three years. The compensation paid to Betty is capital in nature and will not be ordinary income, despite being calculated by reference to the lost income and paid over the same period as the terminated contract. However, Betty will need to consider the capital gains tax consequences of the receipts: see Ruling TR 95/​35.   

Compensation for loss of asset –​depreciable assets [10.200]  Any compensation received for the loss or damage to a depreciable asset will be dealt with under the depreciation provisions. Where the compensation relates to the disposal of the asset, it is necessary to make any required balancing adjustments under Div 40 of ITAA 1997.

Compensation for loss of asset –​capital assets [10.210]  Compensation in relation to capital assets depends on whether the asset has been rendered permanently destroyed or disabled or merely

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324 [10.210]  PRINCIPLES OF TAXATION LAW 2020 temporarily disabled. Generally, an amount that relates to the permanent disablement of the asset is considered capital in nature. Case study 10.8: Compensation for loss of capital asset In Glenboig Union Fireclay Co Ltd v IR Commissioner of Inland Revenue [1922] SLT 182, the taxpayer, the lessee of land which contained fireclay, was in the business of mining clay deposits. A railway company had tracks running over part of the land. It exercised certain statutory powers preventing the taxpayer from working parts of the land. The taxpayer was paid compensation calculated by reference to the profits that would have been earned from the unworked part of the land. Despite the method of calculating the compensation payment, the House of Lords held that the amount was capital in nature as part of the taxpayer’s company was “sterilised” and destroyed by the exercise of   the statutory power. In contrast to Glenboig Union Fireclay v IR Commissioner, compensation paid in relation to an asset that has been rendered temporarily disabled will generally be considered income in nature: see Ensign Shipping Co Ltd v IR Commissioner of Inland Revenue (1928) 12 TC 1169 and Burmah Steamship Co Ltd v IR Commissioner of Inland Revenue (1931) 16 TC 67.

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An amount that compensates for temporary disablement will need to be assessed on the facts: see, for example, Sydney Refractive Surgery Centre Pty Ltd v FCT (2008) 73 ATR 28. Case study 10.9: Damages for defamation In Sydney Refractive Surgery Centre Pty Ltd v FCT (2008) 73 ATR 28, the taxpayer carried on business, which included performing laser eye surgery. The taxpayer successfully sued for damages for defamation and was awarded $844,624. The question before Sackville J was whether $812,726 actually received after allowing for $31,898 in costs was “income according to ordinary concepts”. The taxpayer claimed damages on two alternative bases: the loss it sustained by the reduction in the value of its business attributable to the defamatory publications or the loss of profits sustained during a closed period by reason of the reduction in the number of laser procedures attributable to the defamatory publications. The second basis was accepted by the Supreme Court. However, in deciding the assessability of the damages, Sackville J held that the damages were to compensate the taxpayer

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for the injury to its reputation in the way of business. His Honour went on to state that the fact that the award was calculated by reference to loss of profits did not alter the character of the payment. It was compensation for injury to a capital asset and thus the payment was not income according to ordinary concepts.  

Compensation for loss of asset –​trading stock [10.220]  Section 70-​115 of ITAA 1997 provides that a taxpayer’s assessable income includes an amount received by way of insurance or indemnity for a loss of trading stock as long as that amount is not assessable as ordinary income under s 6-​5. Consequently, it is necessary to consider whether an amount received for loss of trading stock is ordinary income under the common law principle. This issue was considered by the High Court in FCT v Wade (1951) 84 CLR 105, where it was held that a lump-​sum compensation payment paid to a taxpayer who carried on the business of dairy farming was income. The compensation was paid for the loss of dairy cows which were condemned and destroyed.

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Given that receipts from the sale of trading stock are ordinary income under s 6-​5, an amount received to replace lost trading stock will be ordinary income. Therefore, it is difficult to see when s 70-​115 would be applied. However, it may be argued that s 70-​115 extends beyond the common law proposition with the use of the words “by way of … indemnity” to capture a statutory right to compensation not caught by the common law principle. Example 10.8: Compensation for loss of trading stock Bob is a poultry farmer who breeds chickens to sell for meat. Due to excessive amounts of pesticides in chicken food obtained from Barry, a local wheat farmer and poultry food producer, Bob suffers the loss of 80% of his chickens. Barry is found liable to compensate Bob for the losses suffered. As Bob is being compensated for loss of trading stock, the compensation will be ordinary income under s 6-​5 (or, alternatively, assessable under s 70-​115):  see Gill v The Australian Wheat Board [1980] 2 NSWLR 795.   

Compensation by way of insurance proceeds [10.230]  Section 15-​30 of ITAA 1997 provides that a taxpayer’s assessable income includes an amount received by way of insurance or indemnity for

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326 [10.240]  PRINCIPLES OF TAXATION LAW 2020 the loss of an amount if that amount would have been included in assessable income, and the amount was not assessable as ordinary income under s 6-​5. Where an amount may be assessable as ordinary income and statutory income under s 15-​30, the ordinary income provisions will prevail. It may also be necessary to consider whether the right under the insurance policy is an asset for capital gains tax purposes where the payment of a claim gives rise to a capital gain. There are specific provisions dealing with the recovery of losses under insurance policies where the loss relates to livestock and timber. Section 385-​130 provides that where the livestock is an asset of a primary production business, the insurance payout may be included in assessable income in equal instalments over a five-​year period. A similar provision applies for the loss of trees on land held for the purposes of manufacture or sale in the course of carrying on a business.

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Composite claims [10.240]  The above discussion assumes that a compensation or damages payment is easily identifiable as a substitute for income or capital. Often, however, taxpayers receive an undissected lump-​sum payment representing compensation for both a loss of income and a loss of capital or capital assets. This will be common where there is an out-​of-​court compromise settlement. Where the compensation or settlement payment received is for unliquidated damages, the courts have been reluctant to apportion the sum received into income and capital components. Instead, the whole amount is treated as capital. If, however, there is a portion of the lump-​sum payment that is identifiable and quantifiable as income, the Commissioner considers that part of the compensation will be assessable as ordinary income: Determination TD  93/​58.

Example 10.9: Composite claim Charles, the owner of land, agrees to accept a payment of $100,000 in compensation for its compulsory resumption. In addition, interest of 10% on the principal sum is to be paid. The compensation paid to Charles under the settlement includes an amount of $20,000 for interest. The $20,000 is assessable income under s 6-​5 of ITAA 1997 as it can be identified and quantified by the parties.   

[10.250]  The question as to the assessability of a lump-​sum payment arose in McLaurin v FCT (1961) 104 CLR 381.

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Case study 10.10: Composite claim In McLaurin v FCT (1961) 104 CLR 381, the taxpayer’s grazing property was damaged by a fire that started on NSW Railway land. Compensation of £12,350 was paid to the taxpayer by NSW Railways in full settlement of a claim for damages. The claim was for a sum of £30,240 under a number of heads of damage, including damages to pastures, loss of livestock, damage to wool and loss of fencing. The settlement amount was computed by reference to the various items; however, the taxpayer was not aware of the calculations. The Commissioner included a portion of the settlement payment in the taxpayer’s assessable income. The High Court held that no part of the lump sum was assessable as ordinary income. In coming to this conclusion, the Court made it clear that where the payment is in respect of a claim of unliquidated damages and is made or accepted under a compromise which treats the settlement as a single undissected amount, the amount is to be considered as a whole. A similar conclusion was reached in Allsop v FCT (1965) 113 CLR 341: see Case Study [10.11].  

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Given that an undissected amount of compensation or damages is treated as capital, it may be subject to the capital gains tax regime. The capital gains tax consequences of a capital receipt are considered by the Commissioner in Ruling TR 95/​35. Where it is possible to attribute the capital receipt to an underlying asset, the cost base of that underlying asset will attach to the compensation or damages receipt. Where there is no underlying asset, CGT events H2 (see [11.120]) and C2 (see [11.70]) should be considered.

Reimbursement of previously deducted expenses [10.260]  Compensation that replaces lost income is in itself considered income and assessable to the recipient. A logical expansion of this principle would provide that a reimbursement of a previously deducted expense (a revenue expense) would be assessable income. However, as a common law proposition, the courts have not adopted this principle. Case study 10.11: Reimbursement of previously deducted expense In FCT v Rowe (1997) 187 CLR 266, the High Court rejected the notion that, as a general principle of law, an amount paid as compensation for or reimbursement of a deductible expense is income within ordinary

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328 [10.270]  PRINCIPLES OF TAXATION LAW 2020

concepts. In that case, the taxpayer had been allowed a deduction for legal expenses incurred in relation to his suspension from a Queensland Shire Council. After being cleared of all wrongdoing, the Queensland Government made an ex gratia payment in the equivalent amount of the expenditure incurred. The High Court concluded that it was necessary to determine whether the receipt was income according to ordinary concepts and, in this case, it   was not. The High Court in FCT v Rowe clearly rejected the notion that a reimbursement of a previously deducted expense is itself income. Rather, the courts have adopted the approach that the assessability of a reimbursement of a previously deducted expense is determined by reference to the receipt itself and the ordinary concepts of income, which are discussed in Chapter 5. Several cases have discussed the application of the common law concepts where a taxpayer has received a reimbursement of a previously deducted expense. The cases generally centre on the question of whether the reimbursement can be considered as received in the ordinary course of carrying on a business.

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[10.270]  The cases of Allsop v FCT (1965) 113 CLR 341, HR Sinclair & Son Pty Ltd v FCT (1966) 114 CLR 537 and Warner Music Australia Pty Ltd v FCT (1996) 34 ATR 171 all demonstrate the application of the common law principle of income according to ordinary concepts to reimbursements of previously deducted expenses. Case study 10.12: Reimbursement of capital receipt In Allsop v FCT (1965) 113 CLR 341, the taxpayer, Allsop, was an interstate carrier who paid fees for haulage permits. The fees were subsequently held to be unconstitutional and the taxpayer sued to recover the fees. The claim was settled prior to the trial and, upon the execution of a deed of release, Allsop was paid £37,500. The Commissioner assessed the taxpayer on the basis that the amount recovered was assessable income. The Court concluded that the sum received was not a reimbursement of fees paid, but rather a payment for settlement of a claim. That being the case, the sum was not assessable as ordinary income, but rather a capital receipt.   [10.280]  A year later, the High Court was again faced with a similar issue.

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Case study 10.13: Reimbursement received in ordinary course of business In HR Sinclair & Son Pty Ltd v FCT (1966) 114 CLR 537, the taxpayer had paid, for a period of four years, royalties under protest to the Forests Commission of Victoria. The taxpayer, who had been claiming the royalties as a deduction for taxation purposes, eventually convinced the Commission that the royalties had been miscalculated and a refund was voluntarily paid to the taxpayer. The Commissioner included in the taxpayer’s assessable income the amount of the refund. The High Court concluded that the refund did not acquire the character of income because it was made as payment for previously deducted expenses. However, the ordinary concepts of income were applied to conclude that the payment was income to the taxpayer as the   refund was received in the course of the taxpayer’s business.

Case study 10.14: Reimbursement an incident of business

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Also supporting the notion that a reimbursement may be assessable income is the Federal Court decision in Warner Music Australia Pty Ltd v FCT (1996) 34 ATR 171. In that case, Hill J held the reduction in sales tax liability that had previously been allowed as a deduction was “so intimately connected with Warner’s business of selling records, cassettes and the like, that it must be treated as being an incident of that business, even if not an ordinary incident of that business” (at 182). Consequently, based on the tests in FCT v Myer Emporium Ltd (1987) 163 CLR 199, the gain was “stamped” with the character of income.   [10.290]  So far, the common law position in relation to the reimbursement of previously deducted expenses has been considered. It is also necessary to consider the statutory provisions of the ITAA 1997 which affect the common law position. Division 20 includes amounts in a taxpayer’s assessable income to reverse the affect of certain kinds of deductions. In particular, it includes in a taxpayer’s assessable income amounts received, either by the taxpayer or another entity, by way of insurance, indemnity or other recoupment if it is for a deductible expense and it is not otherwise assessable income. Division 20 divides amounts received into two categories: an amount received by way of insurance or indemnity (s 20-​20(2)) and other recoupments (s 20-​20(3)). Other recoupments must be of an amount deducted under one of the specific provisions listed in s 20-​30, which include bad debts, rates or taxes, tax-​related

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330 [10.300]  PRINCIPLES OF TAXATION LAW 2020 expenses, embezzlement or larceny by an employee, capital allowances and foreign exchange losses. The first category of reimbursements in s 20-​20, an amount received by way of insurance or indemnity, was previously found in s 26(j) of ITAA 1936. The meaning in s 26(j) of “indemnity or recoupment” has been considered by the courts. Case study 10.15: Meaning of “indemnity or recoupment” In FCT v CSR Ltd (2000) 45 ATR 559, the taxpayer received a lump-​ sum settlement from an insurer who had previously refused to pay an indemnification. The Commissioner assessed the settlement payment as an indemnity to reimburse the taxpayer for a previously deducted outgoing. The Full Federal Court held that as the payment was an undissected lump sum in settlement of all claims against another party, it could not be said to be a reimbursement of a previously deducted outgoing. A similar conclusion was reached in the case of Allsop v FCT (1965) 113 CLR 341: see Case Study [10.11].  

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Questions [10.300]  10.1 David disturbed two prison escapees who were attempting to break into his car. He suffered serious head injuries as a result of being bashed by the men and spent three months recuperating in hospital. The escapees were later recaptured, found guilty of the assault and sentenced to an additional two years in jail. David applied for and was awarded $30,000 compensation under the Victims Compensation Act 1987 (NSW) for his pain and suffering resulting from the assault. Marina, David’s wife also received $20,000 compensation under this Act. She was able to establish that the fear she now had of driving a car alone was attributable to the assault on her husband and she was therefore entitled to compensation for the loss of enjoyment of life. What are the tax consequences of the compensation receipts? 10.2 While cycling home from work, Mark is hit by a car and seriously injured. He spends the next three months in hospital. Due to the severity of his injuries, at the end of the three months, Mark is declared unable to work again. After protracted legal proceedings, Mark receives the following sums of money: • $500,000 from the insurer of the driver who hit Mark; • $15,000 in lost wages through a workers’ compensation payment; and

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10: Principles of coMpensation  [10.300] 331

• $100,000 for the permanent loss of the sight in one eye. How is each of these amounts assessed? 10.3 Alice, an employee of Acme Co, is sexually harassed by a workmate. Alice complains to the company and seeks compensation for the humiliation and indignity she has suffered. In return for signing an agreement in which she surrenders any rights she may have against the company, Alice receives from the company an amount of $35,000 and resigns from the company. The payment is calculated on the basis of six months’ salary, including long service and annual leave entitlements. What are the tax consequences of the compensation receipt? 10.4 Jenny and Mark have their own business producing furniture for both wholesale and retail clients. Unfortunately, their factory was burned to the ground because of an electrical fault. Jenny and Mark lost everything. They had various insurance policies which provided for the following amounts of compensation: • $1 million for the loss of the factory; • $500,000 for the loss of machinery and other depreciable assets; • $200,000 for loss of trading stock; and • $50,000 each to Jenny and Mark for loss of income while the business was not operating. What are the tax consequences of each of these amounts? 10.5 At the start of the current tax year, Colin installs a water tank at his rental property for $3,000. Colin claims a deduction for the decline in value of the water tank under Div 40 of ITAA 1997 using the prime cost method and an effective life of 10 years. Colin also applies for and receives a Queensland State Government rebate of $1,000 as a recoupment of his expenditure on the water tank. Is the $1,000 assessable in the hands of Colin? 10.6 Hospitality Pty Ltd (“Hospitality”) carries on a business of providing catering services for corporate events. Their major client is an Australian airline. Hospitality is contracted to run the airline’s airport premium customer lounges across Australia, providing the food and beverage as well as service staff in each lounge. The duration of the contract is five years, with an annual charge of $5 million payable in monthly instalments. This represents approximately 80% of Hospitality’s annual revenue. Recently, the airline reviewed its operations and decided to terminate the contract one year early, that is, at the end of the fourth year. The airline agreed to pay Hospitality the balance of the contract of $5 million, but sought to mitigate the amount payable by claiming that the work performed by Hospitality was of a poor standard. After lengthy negotiations, Hospitality and the airline agreed to settle their

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332 [10.300]  PRINCIPLES OF TAXATION LAW 2020

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claims for a final amount of $4.7 million. Is the $4.7 million ordinary income in the hands of Hospitality? 10.7 Felicity sought financial advice from Makemoneyfast Bank in 2015. She paid $5,000 for advice which involved advising her to invest $500,000 into one of their managed funds. It was a fund which was labelled high-​ risk, high-​return. The fund performed badly, and Felicity disposed of her investment for $250,000 in the current tax year. In the same year, Makemoneyfast Bank reviewed the advice given to Felicity and determined that, based on her instructions that she wanted to ensure the money was “safe”, the advice should have been to invest in a conservative “low-​risk” fund. As a consequence, the Bank paid Felicity $200,000 in compensation, including a refund of $5,000 on the fee for the original financial advice and $50,000 in lost interest. Felicity had claimed a tax deduction for the fee. Advise Felicity of the tax consequences. 10.8 Ozzie Bank has agreed to pay thousands of its customers compensation for charging interest above the agreed rate, failing to activate offset accounts and failing to switch customers from an interest-​only loan to a principle and interest loan. Compensation is in the form of damages for poor advice, additional interest charges and lost opportunity. Advise the recipients of the compensation of their tax liability. Would it make any difference if the loan related to their main residence or a rental property?

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11 Capital gains tax

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Key points....................................................................................................  [11.00] Introduction................................................................................................  [11.10] Step 1 –​Have you made a capital gain or a capital loss?.......................  [11.30] Question 1: Has a CGT event happened to the taxpayer?.................  [11.40]

Subdivision 104-​A: Disposals..................................................................  [11.50] Subdivision 104-​B: Use and enjoyment before title passes..................  [11.60] Subdivision 104-​C: End of a CGT asset...................................................  [11.70] Subdivision 104-​D: Bringing into existence a CGT asset.......................  [11.80] Subdivision 104-​E: Trusts........................................................................  [11.90] Subdivision 104-​F: Leases.....................................................................  [11.100] Subdivision 104-​G: Shares....................................................................  [11.110] Subdivision 104-​H: Special capital receipts.........................................  [11.120] Subdivision 104-​I: Australian residency ends......................................  [11.130] Subdivision 104-​J: CGT events relating to rollovers............................  [11.140] Subdivision 104-​K: Other CGT events...................................................  [11.150] Subdivision 104-​L: Consolidated groups and multiple entry consolidated groups......................................................................  [11.160] Question 2: Is the asset a CGT asset?...............................................   [11.170] Collectables............................................................................................  [11.180] Personal use assets................................................................................  [11.190] Separate CGT assets..............................................................................  [11.200] Time of acquisition of CGT asset...........................................................  [11.210] Question 3: Does an exception or exemption apply?......................   [11.220] Disregarded capital gains and losses on certain assets......................  [11.230] Exempt or loss denying transactions....................................................  [11.280] Anti-​overlap provisions..........................................................................  [11.310] Small business relief..............................................................................  [11.320] Main residence exemption....................................................................  [11.380] Death.......................................................................................................  [11.425] Question 4: Can there be a roll-​over?...............................................   [11.430]

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334 [11.00]  PRINCIPLES OF TAXATION LAW 2020 Step 2 –​Work out amount of capital gain or loss.................................   [11.440] What is a capital gain or loss?...........................................................   [11.450] What factors come into calculating a capital gain or loss?..............   [11.460]

Capital proceeds.....................................................................................  [11.470] Cost base................................................................................................  [11.480] Reduced cost base.................................................................................  [11.500]

Step 3 –​Work out your net capital gain or loss for the income year............................................................................  [11.510] Calculation 1.......................................................................................   [11.520] Calculation 2.......................................................................................   [11.530] Calculation 3.......................................................................................   [11.540] Calculation 4.......................................................................................   [11.550] Calculation 5.......................................................................................   [11.560]

Capital losses..........................................................................................  [11.570]

Indexation figures..............................................................................   [11.580]

Current index reference base................................................................  [11.580]

Questions...................................................................................................   [11.590]   

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Key points [11.00]  • CGT affects a taxpayer’s income because assessable income includes the net capital gain for the income year. As such, there is no such thing as a separate capital gains tax. Rather, capital gains are taxed as statutory income under ITAA 1997. • A taxpayer’s net capital gain for an income year is the total of the capital gains for the income year minus certain capital losses for the income year. • Capital losses cannot be deducted from assessable income. This is known as quarantining. However, capital losses may be carried forward to be offset against capital gains in future income years. • A taxpayer makes a capital gain or a capital loss only if a CGT event happens, that is, CGT applies only to realised gains. • Most CGT events involve a CGT asset. • There are certain exemptions or exceptions that reduce the capital gain or loss or allow the taxpayer to disregard it altogether. • Gains and losses made on assets acquired before 20 September 1985 are generally exempt from CGT. • There are certain rollovers which allow a taxpayer to defer a capital gain or loss from a CGT event. • A taxpayer generally makes a capital gain if he or she receives capital amounts (known as capital proceeds) which exceed the total costs (known as the cost base) associated with the CGT event.

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• A taxpayer generally makes a capital loss if he or she receives capital amounts (known as capital proceeds) which are less than the total costs (known as the reduced cost base) associated with the CGT event. • In certain circumstances, a taxpayer may be able to take into account inflation or apply a general discount to a capital gain.

Introduction [11.10]  The topics covered so far have considered whether a receipt is income or capital and whether that receipt is ordinary or statutory income. The focus has then been on the tax consequences of a receipt of income. This chapter considers the consequences of a receipt of capital or, more specifically, capital gains tax. Gains that are assessable under the CGT regime are a form of statutory income. The capital gains and capital losses provisions (commonly referred to as capital gains tax or CGT) are contained in Pts 3-​1 and 3-​3 of Ch 3 of ITAA 1997. Part 3-​ 1 deals with capital gains and losses general topics, while Pt 3-​3 deals with special topics, such as rollovers and small business concessions.

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A taxpayer’s income tax liability is affected by CGT because assessable income includes the net capital gain for the income year (s 102-​5(1)), where net capital gains consist of the total capital gains for the year reduced by certain capital losses. A taxpayer cannot deduct a net capital loss. However, a loss may be carried forward to be offset against gains in future years. The starting point for considering the application of the capital gains tax provisions is generally Div 104 which contains all of the CGT events. Once it has been established that there is a CGT event, it is possible to consider the other Divisions of the CGT Parts of the Act. For example, it will be necessary to consider Div 108 which provides a definition of a CGT asset, Div 110 which provides the rules relating to the cost base of the asset, Div 116 which provides the rules relating to the capital proceeds from the event and Div 118 which provides many of the exemptions available. [11.15]  One of the most important aspects of calculating a taxpayer’s net capital gain is determining whether the general discount percentage applies. The general discount percentage is applied at the third step outlined below after determining whether there is a gain or loss and the amount of that gain or loss. However, because it ultimately reduces the net capital gain to be included in assessable income, it is worth noting at the outset. A 50% general discount applies to qualifying capital gains: s 115-​5. To qualify, the asset must be acquired at least 12 months before the CGT event giving rise to the gain. The general discount percentage is discussed further in [11.540]. [11.20]  Taxpayers need to be aware of the types of situations where a capital gain or loss may arise. Most taxpayers will be aware that a gain or

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336 [11.30]  PRINCIPLES OF TAXATION LAW 2020 loss may arise where there is the disposal of a CGT asset. However, while most CGT events involve a CGT asset, the trigger for a gain or loss is a CGT event. Examples of CGT events include leases, inheritance, subdividing land, goodwill, contracts, options, a company liquidation, leaving Australia, marriage breakdown, working from home, shares, a civil court case, trusts, bankruptcy and incorporating a company: s 100-​10(3) of ITAA 1997. To determine whether a taxpayer is affected by the CGT provisions, it is necessary to follow a three-​step process described in Div 100 of ITAA 1997. Within each of these three steps, we ask a series of questions to ultimately determine the affect of the CGT provisions on a taxpayer’s liability to pay income tax. Figure 11.1: Determining CGT effects on taxpayer

Step 1

Step 2

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Step 3

Have you made a capital gain or loss? See [11.30]

Work out the amount of capital gain or loss See [11.440]

Work out the net capital gain or loss for the income year See [11.510]

Step 1 –​Have you made a capital gain or a capital loss? [11.30]  The first step is to determine whether the taxpayer has made a capital gain or loss. To help us determine whether there is a capital gain or loss in the current income year, we ask four questions.

Question 1: Has a CGT event happened to the taxpayer? [11.40]  A taxpayer makes a capital gain or loss if, and only if, a CGT event happens: s 102-​20 of ITAA 1997. Therefore, the first step in the CGT process is to determine whether a CGT event happens to the taxpayer’s situation. If more than one CGT event happens, subject to certain exceptions, you use the one

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that is the most specific to the situation: s 102-​25(1). The capital gain or loss will be taken into account in the tax year in which the CGT event happens. Figure 11.2: Capital gain or loss?

Question 1

Question 2

Question 3

Question 4

Has a CGT event happened to the taxpayer? See [11.40]

Is the asset a CGT asset? See [11.170]

Does an exception or exemption apply? See [11.220]

Can there be a roll-over? See [11.430]

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Division 104 sets out all of the CGT events for which a taxpayer can make a capital gain or loss. Division 104 also tells you how to work out whether the taxpayer has made a gain or loss from the CGT event and the time of the CGT event. The Division also contains some exceptions for gains and losses, as well as some of the cost base adjustment rules. A summary of CGT events is contained in s 104-​5. There are 12 major categories of CGT events: • 104-​A  –​ disposals; • 104-​B –​use and enjoyment before title passes; • 104-​C –​end of a CGT asset; • 104-​D –​bringing into existence a CGT asset; • 104-​E  –​ trusts; • 104-​F  –​ leases; • 104-​G  –​ shares; • 104-​H –​special capital receipts; • 104-​I –​Australian residency ends; • 104-​J –​CGT event relating to rollovers; • 104-​K –​other CGT events; • 104-​L –​consolidated groups and MEC groups.

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338 [11.50]  PRINCIPLES OF TAXATION LAW 2020

Subdivision 104-​A: Disposals [11.50]  CGT event A1 is the most common CGT event. CGT event A1 happens if a taxpayer disposes of a CGT asset: s 104-​10(1) of ITAA 1997. A disposal occurs where there is a change in ownership because of some act or event or by operation of law. However, a change of ownership does not occur if the taxpayer stops being the legal owner, but continues to be the beneficial owner, or merely because of a change of trustee: s 104-​10(2).

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The time of CGT event A1 is when the taxpayer enters into the contract or, if there is no contract, when the change of ownership occurs: s 104-​10(3). Where there is more than one contract –​for example, an original contract and a subsequent contract varying the terms –​the date of disposal will be determined by reference to the contract which gives rise to the obligation to sell or transfer the asset: FCT v Sara Lee Household & Body Care (Australia) Pty Ltd (2000) 44 ATR 370. Further, in the context of an acquisition, the court has held that an oral contract, whether enforceable or not, will determine the date of acquisition: McDonald v FCT (1998) 38 ATR 563. However, where the contract is preliminary and not the actual contract for acquisition, the date of acquisition will be the latter contract: Elmslie v FCT (1993) 26 ATR 611. Where there is no contract, the time of the event will be the time of the change of ownership to be determined on the facts –​for example, the provision of access to the property, such as the handing over of the keys. Where CGT event A1 occurs, you make a capital gain if the capital proceeds from the disposal are more than the asset’s cost base and you make a capital loss if those proceeds are less than the asset’s reduced cost base: s 104-​10(4). The cost base is generally the total costs associated with the CGT event (see [11.480]), while the capital proceeds are generally the amount the taxpayer receives, or is entitled to receive, from the CGT event: see [11.470]. Example 11.1: Event A1 In June 2019, Kylie enters into a contract to sell land. The contract is settled in October 2019. Kylie makes a capital gain of $50,000. The $50,000 gain is made in the 2018–​2019 income year, that is, the year in which the contract is entered into, and not the 2019–​2020 income year. Source: Adapted from s 104-​10 of ITAA 1997.   

Case study 11.1: Time of disposal In FCT v Sara Lee Household & Body Care (Australia) Pty Ltd (2000) 44 ATR 370, the taxpayer was a subsidiary of a US company involved in the pharmaceuticals and healthcare product market. On 31 May 1991,

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the taxpayer entered into a contract with Roche to sell its business. On 30 August 1991, a number of amendments were made to the original agreement, including an adjustment to the purchase price and the name of the purchaser. The issue before the High Court was whether the relevant date of the contract for CGT purposes was 31 May 1991 or 30 August 1991. The High Court held that it is a question as to which contract gave rise to the obligation to effect the disposal. In this case, although the terms of the original agreement were varied in August, the obligation established on 31 May 1991 did not change. Therefore, the date of disposal for CGT purposes was 31 May 1991.  

Subdivision 104-​B: Use and enjoyment before title passes [11.60]  CGT event B1 happens if a taxpayer enters into an agreement under which the right to the use and the enjoyment of a CGT asset owned by the taxpayer passes to another entity and title in the asset will or may pass to that entity before the end of the agreement: s 104-​15(1) of ITAA 1997. The time of the event is when the other entity first obtains the use and enjoyment of the asset: s 104-​15(2).

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Example 11.2: Event B1 Mark agrees to rent an investment property to John for a period of two years. The agreement entered into by the parties provides that at any time during the two-​year period John has the right to purchase the property from Mark. Event B1 occurs when Mark starts renting the property.   

Subdivision 104-​C: End of a CGT asset [11.70]  Category C, dealing with the end of a CGT asset, contains three separate events. CGT event C1, the loss or destruction of a CGT asset, happens if a CGT asset that the taxpayer owns is lost or destroyed: s 104-​20(1) of ITAA 1997. The time of CGT event C1 is when the taxpayer first receives compensation for the loss or destruction or, if no compensation is received, when the loss is discovered or the destruction occurred: s 104-​20(2).

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Example 11.3: Event C1 Erin owns a factory that burns down. She has insurance which compensates her for the loss. CGT event C1 happens when the factory is destroyed, and the time of the event is when she receives the insurance payment.    CGT event C2, covering cancellation, surrender and similar endings, happens where the taxpayer’s ownership of an intangible asset ends by the asset: • being redeemed or cancelled; or • being released, discharged or satisfied; or • expiring; or • being abandoned, surrendered or forfeited; or • if the asset is an option –​being exercised; or • if the asset is a convertible interest –​being converted: s 104-​25(1). The time of CGT event C2 is when the taxpayer enters into the contract that results in the asset ending or, if there is no contract, when the asset ends: s 104-​25(2).

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Example 11.4: Event C2 Tim has a contract with Acme Co to be the exclusive supplier of their widgets for the next 10 years. Acme Co terminates the agreement with Tim after five years. Tim is paid $5,000 as compensation for the early termination of the contract. CGT event C2 happens as Tim’s intangible asset, that is, his rights under the agreement, have come to an end. Later we will see that the capital gain will be the $5,000 less any costs associated with the event (eg, legal fees).   

CGT event C3, the end of an option to acquire shares, happens if an option that a company or trustee of a unit trust granted to an entity to acquire a CGT asset, which is shares in the company (or units in the unit trust or debentures in the company or unit trust), ends because it is not exercised by the latest time for its exercise, is cancelled, released or abandoned: s 104-​30(1). Event C3 only deals with company issued options. All other options are dealt with as a D2 event, with the difference being the time of the event. The time of event C3 is when the option ends: s 104-​30(2).

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Example 11.5: Event C3 On 1 January 2019, Gina pays Acme Co $100 for the right to acquire 10,000 shares in the company for $1 per share. The option to acquire shares must be exercised within 12 months of entering into the option. Gina decides not to exercise the option. As a result, the option expires and CGT event C3 happens on 1 January 2020. Acme Co makes a capital gain of $100 (less any associated expenses) on 1 January 2020.   

Subdivision 104-​D: Bringing into existence a CGT asset [11.80]  Category D, bringing into existence a CGT asset, has four separate events. CGT event D1 happens where a taxpayer creates a contractual or other legal right in another entity: s 104-​35(1). The bringing into existence of an asset which triggers a CGT event D1 often leads to a CGT event C2 when the asset created comes to an end.

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Example 11.6: Event D1 Bart sells his business to Lucy. As part of the agreement, Bart agrees not to operate a similar business within a 5-​km radius for the next two years. Lucy pays $10,000 for Bart to agree to this restraint of trade. A contractual right in favour of Lucy has been created. If Bart breaches the contract, Lucy can enforce that right. CGT event D1 happens when the contract for the restraint of trade is entered into and Bart will have a capital gain. At the end of the two-​ year period, CGT event C2 will happen and Lucy will have a capital loss. Source: Adapted from s 104-​35 of ITAA 1997.   

CGT event D2 happens if a taxpayer grants an option to an entity or extends an option already granted: s 104-​40(1). Event D2 does not happen if CGT event C3 applies to the situation, that is, the option is for the acquisition of shares in a company.

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Example 11.7: Event D2 Ben pays Sara $5,000 for an option to purchase her business. The one-​ month option is granted on 1 January 2020. Ben decides not to exercise the option. CGT event D2 happens on 1 January 2020 and Sara has a capital gain of $5,000 less any associated expenses. If Ben exercises the option, CGT event D2 is ignored and CGT event A1 happens: see [11.50].    CGT event D3 happens if a taxpayer who owns a prospecting entitlement or mining entitlement grants the right to receive income from the operation of the entitlement: s 104-​45(1). CGT event D4 happens if a taxpayer enters into a conservation covenant over land that he or she owns: s 104-​47(1).

Subdivision 104-​E: Trusts [11.90]  There are ten CGT events relating to trusts listed in subdiv 104-​E of ITAA 1997: • creating a trust over a CGT asset –​CGT event E1; • transferring a CGT asset to a trust –​CGT event E2; • converting a trust to a unit trust –​CGT event E3; Copyright © 2019. Thomson Reuters. All rights reserved.

• capital payment for trust interest –​CGT event E4; • beneficiary becoming entitled to a trust asset –​CGT event E5; • disposal to beneficiary to end income right –​CGT event E6; • disposal to beneficiary to end capital interest –​CGT event E7; • disposal by beneficiary of capital interest –​CGT event E8; • creating a trust over future property –​CGT event E9; • annual cost base reduction exceeds cost base of interest in AMIT –​CGT event E10.

Subdivision 104-​F: Leases [11.100]  There are five CGT events relating to leases listed in subdiv 104-​F of ITAA 1997: • granting a lease –​CGT event F1; • granting a long-​term lease –​CGT event F2;

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• lessor pays lessee to get lease changed –​CGT event F3; • lessee receives payment for changing lease –​CGT event F4; • lessor receives payment for changing lease –​CGT event F5. Example 11.8: Event F4 On 1 January 2020, Jake (the lessee) enters into a lease. On 1 May 2020, Jake agrees to waive a term. Eastfield (the lessor) pays Jake $1,000 for this. If Jake’s cost base at the time of the waiver is $2,500, it is reduced from $2,500 to $1,500. On 1 September 2020, Jake agrees to waive another term. Eastfield pays Jake $2,000 for this. If Jake’s cost base at the time of the waiver is $1,500, Jake makes a capital gain of $500 and the cost base is reduced to nil. Source: Adapted from s 104-​125 of ITAA 1997.   

Example 11.9: Event F5 Eastfield owns a shopping centre. Con (the lessee of a shop in the centre) pays Eastfield $10,000 for agreeing to change the terms of its lease. Eastfield incurs expenses of $1,000 for a solicitor and $500 for a valuer. Eastfield makes a capital gain of $8,500. Source: Adapted from s 104-​130 of ITAA 1997.   

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Subdivision 104-​G: Shares [11.110]  There are two CGT events relating to shares listed in subdiv 104-​G of ITAA 1997. CGT event G1 happens if a company makes a payment to a taxpayer in respect of shares the taxpayer owns in the company and the payment is not a dividend: s 104-​135(1). CGT event G3 happens if a taxpayer owns shares in a company and a liquidator or administrator declares the shares worthless: s 104-​145(1).

Subdivision 104-​H: Special capital receipts [11.120]  There are two CGT events relating to special capital receipts listed in subdiv 104-​H of ITAA 1997. CGT event H1 happens if a deposit paid to a taxpayer is forfeited because a prospective sale or other transaction does not proceed: s 104-​150(1).

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Example 11.10: Event H1 Barry decides to sell land to Judy. A contract of sale for $120,000 is entered into, and Judy pays Barry a 10% deposit. Judy fails to complete the contract, and the deposit is forfeited. CGT event H1 happens, and Barry has a capital gain of $12,000 less any costs associated with the failed transaction.    CGT event H2 happens if an act, transaction or event occurs in relation to a CGT asset that the taxpayer owns, and the act, transaction or event does not result in an adjustment being made to the asset’s cost base or reduced cost base: s 104-​155(1). Example 11.11: Event H2 Max owns land on which he intends to construct a manufacturing facility. A business promotion organisation pays Max $50,000 as an inducement to start work early. No contractual rights or obligations are created by the arrangement. The payment is made because of an event (the inducement to start construction early) in relation to Max’s land, so a CGT event H2 happens and Max has a capital gain of $50,000 (less any costs associated with starting early).

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Source: Adapted from s 104-​155 of ITAA 1997.   

Subdivision 104-​I: Australian residency ends [11.130]  There are two CGT events relating to the ending of Australian residency listed in subdiv 104-​I of ITAA 1997. CGT event I1 happens when a taxpayer stops being an Australian resident: s 104-​160(1). However, an Australian resident individual may choose to disregard making a capital gain or capital loss, in which case the assets will be deemed to be taxable Australian property until a CGT event happens to those assets or the taxpayer becomes an Australian resident again. CGT event I2 happens if a trust stops being a resident trust for CGT purposes: s 104-​170(1).

Subdivision 104-​J: CGT events relating to rollovers [11.140]  There are five CGT events relating to rollovers listed in subdiv 104-​J of ITAA 1997 (note that CGT event J3 has been repealed):

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• company ceasing to be a member of wholly owned group after rollover –​CGT event J1; • change of status of replacement asset for a rollover under subdiv 152-​ E –​CGT event J2; • trust failing to cease to exist after rollover under subdiv 124-​N –​CGT event J4; • failure to acquire replacement asset and to incur fourth element expenditure after a rollover under subdiv 152-​E –​CGT event J5; • cost of acquisition of replacement asset or amount of fourth element expenditure, or both, not sufficient to cover disregarded capital gain –​ CGT event J6.

Subdivision 104-​K: Other CGT events [11.150]  There are 12 CGT events listed in subdiv 104-​K of ITAA 1997. They are as follows: • incoming international transfer of emissions unit –​CGT event K1; • bankrupt pays amount in relation to debt –​CGT event K2; • asset passing to tax-​advantaged entity –​CGT event K3; • CGT asset starts being trading stock –​CGT event K4; • special collectable losses –​CGT event K5; • pre-​CGT shares or trust interest –​CGT event K6;

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• balancing adjustment events for depreciating assets and s 73BA depreciating assets –​CGT event K7; • direct value shifts –​CGT event K8; • carried interests –​CGT event K9; • certain short-​term forex realisation gains –​CGT event K10; • certain short-​term forex realisation losses –​CGT event K11; • foreign hybrids –​CGT event K12.

Subdivision 104-​L: Consolidated groups and multiple entry consolidated groups [11.160]  There are seven CGT events relating to consolidated groups and multiple entry consolidated (MEC) groups listed in subdiv 104-​L of ITAA 1997: • loss of pre-​CGT status of membership interests in entity becoming subsidiary member –​CGT event L1; • where pre-​formation intragroup rollover reduction results in negative allocable cost amount –​CGT event L2;

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346 [11.170]  PRINCIPLES OF TAXATION LAW 2020 • where tax cost setting amounts for retained cost base assets exceeds joining allocable cost amount –​CGT event L3; • where no reset cost base assets and excess of net allocable cost amount on joining –​CGT event L4; • where amount remaining after step 4 of leaving allocable cost amount is negative –​CGT event L5; • error in calculation of tax cost setting amount for joining entity’s assets –​CGT event L6; • where reduction in tax cost setting amounts for reset cost base assets cannot be allocated –​CGT event L8.

Question 2: Is the asset a CGT asset?

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[11.170]  Most CGT events involve a CGT asset. Division 108 of ITAA 1997 defines the various categories of assets that are relevant to working out a taxpayer’s capital gains and losses. A “CGT asset” is defined as any kind of property or a legal or equitable right that is not property: s 108-​5(1). The definition includes part of, or an interest in, an asset as defined, goodwill or an interest in it, and an interest in an asset of a partnership. Division 108 also sets out when land, buildings and capital improvements are taken to be separate CGT assets. The first part of the definition contained in s 108-​5(1)(a) provides that a CGT asset is any type of property, including both tangible property, such as land and buildings, as well as intangible property, such as copyright and patents. The second part of the definition contained in s 108-​5(1)(b) provides that a CGT asset is a legal or equitable right that is not property. This category includes those assets which are not transferable, such as the right to sue, and rights under an insurance contract. Examples of CGT assets from s 108-​5 include the following: • land and buildings; • shares in a company; • units in a unit trust; • options; • debts owed to you; • a right to enforce a contractual obligation; and • foreign currency. While the definition of “CGT asset” is very broad, there are certain things that are not considered CGT assets. Generally, a right which is not property must be enforceable by legal or equitable proceedings. For example, general freedoms, such as the right to work, are not CGT assets nor are the right of a landlord to enter into a lease and the right to a refund. Although, the Commissioner of Taxation has recently expressed the view that bitcoin is a CGT asset.

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It is important to classify CGT assets into their relevant categories as special rules apply to each. The relevant categories of assets in Div 108 are as follows: • CGT assets; • collectables: see [11.180]; and • personal use assets: see [11.190]. Each CGT asset needs to be classified into one of the three categories as there are special rules that apply to collectables and personal use assets. An item not considered to fall within the subcategories collectables or personal use assets is a general CGT asset.

Collectables [11.180]  “Collectable” is defined in s 108-​10(2) of ITAA 1997 as: • artwork, jewellery, an antique or a coin or medallion; or • a rare folio, manuscript or book; or • a postage stamp or first day cover, that is used or kept mainly for personal use or enjoyment.

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It is important to remember that there are two limbs to this definition. First, the item must be one of the kind listed. For example, the Commissioner considers that an antique is an “object of artistic or historical significance that is of an age exceeding 100 years”: Determination TD 1999/​40. Second, the asset must be used or kept mainly for personal use or enjoyment. This means that artwork that is purchased as an investment rather than to enjoy will not be considered a collectable. Where an item is defined as a collectable, there are four specific rules that  apply: 1. Capital gains and capital losses made from collectables are disregarded where the first element of the asset’s cost base is $500 or less. 2. When working out the cost base of a collectable, disregard the third element (non-​capital costs of ownership). 3. Capital losses from collectables can only be used to reduce capital gains from collectables. This is known as a quarantining rule. Any losses not used in the current tax year can be carried forward to be offset against gains from collectables in future years. Note, however, that the quarantining rule only applies one way –​that is, you are able to offset losses from the sale of ordinary CGT assets against gains from collectables.

Example 11.12: Losses from collectables Bridgette has a capital gain from collectables of $200 and capital losses from collectables of $400. She has other capital gains of $500. She has a net capital gain of $500 and a net capital loss of $200.

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The $200 loss can be carried forward to be offset against any capital gain from collectables she has in future tax years. However, it cannot be used to reduce the $500 capital gain. Source: Adapted from s 108-​10 of ITAA 1997.   

Example 11.13: Gains from collectables but losses from ordinary CGT assets Brodie has a capital gain from collectables of $200 and capital losses from ordinary CGT assets of $600. She has other capital gains of $500. She has a net capital gain of $100, as the losses can be used to reduce both the $200 capital gain and the $500 capital gain.   

4. If you own collectables that are part of a set, then that set of collectables is treated as a single collectable.

Example 11.14: Sets Lily buys a set of three books for $900. If the books are of equal value, she has acquired the books for $300 each. However, the books are taken to be a single collectable. Lily will not get the exemption in s 118-​10 because she acquired the set for more than $500.

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Source: Adapted from s 108-​15 of ITAA 1997.   

Personal use assets [11.190]  “Personal use asset” is defined in s 108-​20(2) of ITAA 1997 as a CGT asset (other than a collectable) that is used or kept mainly for personal use or enjoyment. Where an item is defined as a “personal use asset”, there are four specific rules that apply: 1. Capital gains made from personal use assets are disregarded where the first element of the asset’s cost base is $10,000 or less. 2. When working out the cost base of a personal use asset, disregard the third element (non-​capital costs of ownership). 3. A capital loss made from a personal use asset is disregarded. 4. If you own personal use assets that are part of a set, then that set of personal use assets is treated as a single personal use asset.

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Examples of personal use assets include: • a television at home; • mobile telephone for private use; • a bicycle; • a yacht owned for personal use and enjoyment. Section 108-​20(3) provides that a personal use asset does not include a land or a building. Further, if an asset is considered a collectable, it will not be treated as a personal use asset. Given that a gain made from a personal use asset acquired for $10,000 or less is disregarded, it is difficult to think of many personal use assets which would be subject to tax on any gains. Examples commonly cited are yachts and racehorses.

Separate CGT assets [11.200]  Subdivision 108-​D of ITAA 1997 provides special rules for separate CGT assets. In particular, it provides an exception to the common law principle that what is attached to the land is part of the land, special rules about buildings and adjacent land and rules about when a capital improvement to a CGT asset is treated as a separate asset.

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The following specific rules are provided: • If land is acquired on or after 20 September 1985, a building or structure on the land is taken to be a separate asset if the depreciating asset or research and development balancing adjustment provisions apply.

Example 11.15: Separate CGT assets Mills Pty Ltd constructs a timber mill on land it already owns. The building is subject to a balancing adjustment on disposal, loss or destruction. The timber mill is considered a separate CGT asset. Source: Adapted from s 108-​55(1) of ITAA 1997.   

• If land was acquired before 20 September 1985, a building or structure constructed on the land is taken to be a separate CGT asset if the contract for construction was entered into on or after that day or, if there is no contract, the construction started on or after that day.

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Example 11.16: Separate CGT assets Acme Co purchases a block of land with a building on it on 1 January 1980. On 1 January 2010, Acme Co enters a contract to have another building erected on the land. The second building is taken to be a separate CGT asset. Source: Adapted from s 108-​55(2) of ITAA 1997.    A depreciating asset that is part of a building is a separate CGT asset. Example 11.17: Separate CGT assets Acme Co carries on a business of producing widgets from its factory. It installs new bathrooms for the employees. The plumbing fixtures and fittings are depreciable assets. They are separate CGT assets to the factory. The factory will be subject to the CGT provisions, but the depreciable assets will be disregarded for CGT purposes. Source: Adapted from s 108-​60 of ITAA 1997.    Land acquired on or after 20 September 1985 that is adjacent to land already owned is taken to be a separate CGT asset if the two parcels of land are combined into the one title.

Copyright © 2019. Thomson Reuters. All rights reserved.

Example 11.18: Separate CGT assets In 1980, David purchased a block of land. In 1990, David purchased the adjacent block of land and amalgamated the two titles into one. The second block is a separate CGT asset. A capital gain will be made on the second block when the land is disposed of. Source: Adapted from s 108-​65 of ITAA 1997.    A capital improvement is a separate CGT asset to the land if: • a balancing adjustment provision applies to the land; • the cost base of the capital improvement to an asset acquired before 20 September 1985 is more than the improvement threshold for the relevant income year and more than 5% of the capital proceeds from the event; or • the total cost base of related capital improvements to an asset acquired before 20 September 1985 is more than the improvement threshold

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for the relevant income year and more than 5% of the capital proceeds from the event. The improvement threshold is $50,000 indexed from 1985. For the year ended 30 June 2018, it is $147,582 (TD 2017/​16); for the year ended 30 June 2019, it is $150,386 (TD 2018/​8) and for the year ended 30 June 2020, it is $153,093. Example 11.19: Improvements to CGT assets In 1980, William purchased a boat. In 1991, he installed a new mast for $30,000. He sold the boat in 2019–​2020 for $150,000. Assuming the cost base of the improvement in the year of sale is $41