LWB364INTRODUCTION TO TAXATION LAW

SEMESTER 1, 2011

LINA TERRESA BUI

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RESIDENCE

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STATE THE ISSUE

The issue which arises on the facts is whether the [taxpayer] is a resident for tax purposes.

BACKGROUND

The general jurisdictional rules provide:

Residents are assessed on their ordinary income and statutory income from all sources (ss 6-5(2), 6-10(4) ITAA97) Foreign residents are assessed on their ordinary income and statutory income from Australian sources (ss 6-5(3)(a), 6-

10(5)(a) ITAA97).

AUSTRALIAN RESIDENTS

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

Assessable income also includes statutory income (ITAA s 6-10).

Therefore, if [person] is a resident taxpayer of Australia, they will be assessed on all sources, whether in Australia or elsewhere (ITAA 97 s 6-5(2)).

NON-RESIDENT AUSTRALIANS

A non-Australian resident is taxed on:

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

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

having an Australian source (ITAA 1997 s 6-10(5)(b)).

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IS THE TAXPAYER AN AUSTRALIAN RESIDENT?

The residence of a taxpayer is determined from year to tear (s 4-10 ITAA97).

Australian resident means a person who is an Australian resident under the ITAA 1936 (ITAA97 s 995).

A resident or resident of Australia is a person, other than a company, who resides in Australia (s 6(1) ITAA36).

TESTS FOR DETERMINING RESIDENCY

The four tests of residence are alternatives and only one need to be satisfied to be a resident. The tests are:

(a) Common Law Test/Residence According to Ordinary Concepts(b) The domicile Test(c) The 183-day test(d) The superannuation fund test

These tests determine whether a person is an Australian resident – if they do not meet at least one test they are a foreign resident.

WHEN TO APPLY THE TESTS

IF the taxpayer was once a resident now a non-resident:

Common Law Test Domicile Test Superannuation Test

Here, the issue is whether the [taxpayer] has ceased to be a resident. Therefore, we must satisfy either the common law test or the domicile test.

IF the taxpayer was a non-resident now a resident:

Common Law Test 183 Day Rule

Here, the issue is whether the [taxpayer] has become a resident. Therefore, we must satisfy either the common law test of the 183 day rule.

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COMMON LAW TEST

The common law test of residence relies on the ordinary meaning of ‘reside’ to determine residency.

The [taxpayer] will be a resident of Australia if they are a person who ordinarily resides in Australia.

Residency is a question of fact and degree (FCT v Miller).

TR 98/17 at [14] adopts the dictionary definition of reside, being to dwell permanently or for a considerable time, or to be settled, or have ones usual place of abode in a particular place.

IF some influential events have taken place after the financial year:

Events after the financial year may assist in determining residency status (FC of T v Applegate).

The Commissioner considers 6 months to be a considerable amount of time for the purposes of this test, but this is not determinative (TR 98/17 at [22]).

Residence is determined on the basis of a number of factors which must be considered, and the fact that a person is a resident of another country does not preclude a finding that they are also a resident of Australia (Gregory v FCT).

FACTORS TO TAKE INTO ACCOUNT

PHYSICAL PRESENCE IN AUSTRALIA

Generally, some physical presence in Australia is necessary (Case 28) unless the person has no place of abode elsewhere during the year of income (Rogers v Inland).

Residence is often described as the place a person ‘eats and sleeps’ (Cesna Sulphur Co Ltd v Nicholson).

IF physically present in Australia:

Here, the [taxpayer] is physically present in Australia. Physical presence is one of the factors which points towards residency (Case 28) unless the [taxpayer] has no place of abode elsewhere during the year of income (Rogers v Inland).

IF not physical presence in Australia:

Here, the [taxpayer] is not physically present in Australia. Generally, some physical presence in Australia is necessary to be a resident (Case 28).

FREQUENCY, REGULARITY AND DURATION OF VISITS

The frequency, regularity and duration of the [taxpayer’s] visits will be relevant in determining whether they are a resident.

IF previously a resident:

Here, the [taxpayer] was previously a resident. Therefore, frequency and duration need not be substantial.

Generally the purpose is not an important factor and in particular, it is not relevant that the visits were involuntary but necessitated by business or some other reason (Lysaght).

IF not previously a resident:

Here, the [taxpayer] has never been a resident of Australia and their visits are short and temporary.

Short and temporary visits are not likely to result in residency, the “quality and character” of an individual’s behaviour is to be assessed. If behaviour over the period of physical presence reflected a degree of “continuity, routine or habit that is consistent with residing” then usually regarded as a resident.

IF taxpayer is here on business:

Here, the [taxpayer] is in Australia for business. The purpose of the visit is generally irrelevant to deciding residency (IRC v Lysaght).

MAINTENANCE OF A HOME IN AUSTRALIA DURING ABSENCES

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The maintenance of a home in Australia while the [taxpayer] is absent is relevant to the issue of residency.

It will be important where the [taxpayer] has no place of abode outside Australia during absences (Rogers v Inland Revenue).

Must consider whether the [taxpayer] is staying in a house or a hotel.

IF a property is available upon return:

Here, the [taxpayer] has a property which is available for their use when they return from absences. This is indicative of a resident (Cooper v Cadwalader).

FAMILY AND BUSINESS TIES

Whether the [taxpayer] has family and business ties in Australia will be a significant factor.

Greater weight is likely to be given to this factor in determining whether a person who was previously a resident has ceased to be a resident (Levene).

If the [taxpayer’s] family is living with him or her in Australia or the [taxpayer] has his or her business or employment in Australia, this supports the inference that the [taxpayer] resides in Australia.

Here, the [taxpayer] has his or her family living with them while they are [in or outside Australia]. This supports the inference that the [taxpayer] resides in Australia.

IF there is family in another country:

Here, the [taxpayer] has family in [the country other than Australia]. Therefore, it is unlikely that the [taxpayer] will be a resident of Australia (Levene).

IF there is no family in another country:

Here, the [taxpayer] has no immediate family in [the country other than Australia].

This lack of family in another country supports the inference that the [taxpayer] is a resident of Australia (Levene).

PRESENT HABITS AND MODE OF LIFE

The [taxpayer’s] present habits and way of life are important factors in determining whether a person ceases to be a resident.

IF mode of life is similar before and after:

IF the taxpayer’s mode of life is similar before and after the alleged change in residence, then this may indicate that there has been no change.

IF taxpayer travels around:

Here, the taxpayer travels around and does not have a permanent place of abode outside of Australia. This may be indicative of a change in residence. The courts are looking for a break in habits to find a change in residence (Levene).

NATIONALITY

The nationality of the taxpayer is unlikely to be a very important factor except in borderline cases (Levene).

CASES

Levene v IRC

UK subject, who had always lived in London, left England to live abroad on medical advice. The taxpayer surrendered the lease on his house and, between 1919 to 1925, had no fixed abode, living in hotels in

Monaco and France. During this period, he also returned to England for around five months each year (again living in hotels) to obtain

medical advice, visit family and attend to various business and religious matters. The HOL confirmed that it was open to the IRC to conclude that the taxpayer was an ‘ordinary resident’ of the UK for the

relevant period based on his ‘habits of life’, the regularity of his visits, his ties with England and the freedom of his attachment abroad.

IRC v Lysaght

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Taxpayer who had retired as MD of an English company and moved with his family from England to Ireland to live on a large acreage

The taxpayer was subsequently appointed as an advisory direction of the English company and was required to visit England for approximately one week every month.

When in England, the taxpayer stayed in hotels or at his brother’s house. HELD that it was open to the IRC to treat the taxpayer as an ‘ordinary resident’ of the UK. The fact that taxpayer had a home in Ireland and no established home in England was not incompatible with him being a

resident of the UK if there was other sufficient evidence to support this conclusion.

Cooper & Cadwalader (1904) 5 Tax Cases 101

US Barrister retained a property in Scotland (hunting lodge) He spent 2 months per year at his property in Scotland which was always operated by 2 servants who kept it ready for

him all the time In his absence, the property was occupied by the two servants Property was ALWAYS available for his use HELD that he was a UK resident especially because the property was always available for him

TR 97/17 Example

Jane Cierpinski is single and is a Professor of Biology at the University of Warsaw. She comes to Australia to work on a research project. She is contracted to do the research in Australia for five months. A six month lease of a small furnished unit near her work is such an attractive proposition that she enters into the lease

despite intending to leave after five months. She also buys an old car. She relaxes at the end of her long days by going to the movies, occasionally attending dinner parties hosted by her

colleagues, reading novels or writing letters to her friends and parents. Jane intends to return to Warsaw at the end of the project that actually lasts for seven months. She negotiates an extra month on the lease of her unit. Apart from depositing her salary into an Australian bank account to cover normal living expenses, Jane retains all assets

and investments in Poland, her country of domicile. Jane’s behaviour over the seven months in Australia is consistent with residing here. She is regarded as a resident from her arrival.

TR 98/17 Example

Michael Desmond is a South African diamond corporation executive. He takes the opportunity to participate in an intensive eight month advanced management development program at an

Australian university. Michael's wife and children do not accompany him to Australia and while here he stays in basic accommodation on

campus. He spends his time studying or writing reports for his company. He is in Australia solely to do the course and at the end of eight months he returns home. Michael does not exhibit behaviour that is consistent with residing here. All of the facts lead to a conclusion that he is a non-resident (a foreign resident).

DOMICILE TEST

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The taxpayer will be a resident of Australia if their domicile is in Australia, unless the Commissioner is satisfied that their permanent place of abode is outside of Australia.

DOMICILE IN AUSTRALIA

Domicile is a legal relationship between a person and a state by which the person invokes the state’s legal system as his or her personal law.

There are three categories of domicile:

(a) Domicile of origin – domicile of their father at date of the birth(b) Domicile of choice(c) Domicile by operation of the law

ABODE OUTSIDE AUSTRALIA

The taxpayer will not be a resident if the Commissioner is satisfied that they have a permanent place of abode outside Australia.

The ordinary meaning of abode is a person’s home or residence.

This does not require an intention to move forever, however it must not be transitory (Applegate).

One can have a permanent place of abode outside Australia even if there is an intention to return at a specified time (Jenkins v FCT).

Some factors relevant to determining whether a person’s permanent place of abode is outside of Australia include (IT 2560):

Intention as to length of stay; Actual length of stay; Abandonment of place of abode in Australia; Acquisition of place of abode outside Australia; Intention to make place of abode 'home'; Nature and quality of use made of place of abode; Duration and continuity of presence in place; and Durability of association (ties) with place (e.g. family, bank accounts, member of golf club etc)

IF more than two years in another country:

The fact that the taxpayer has stayed in another country for more than two years is substantial and supports the inference that their domicile is in that country.

In other words, if the taxpayer remains in the foreign country for less than two years, it is likely that they are still an Australian resident. This operates as a result of thumb - it is not decisive.

Applegate v FCT 79 ATC 4307

Sydney solicitor opened new firm in Vila – he always intended to come back to Aust though Gave up lease of flat in Australia & sold assets – surrendered most of his links with Australia Retained membership with Australian house fund, his wife came back to Australia to give birth to their child and she

claimed child endowment Had hospital cover & life insurance in Australia Was coming back to Australia some time in the future (time not set) Rented house in Vila with his wife, got resident status, was admitted to practise as a solicitor in Vila Had a number of holidays in Australia Wife gave birth in Australia Returned to Australia earlier than planned – ill health Issue was whether he had a permanent place of abode in Vila Court interpreted place of abode as a home outside of Australia HELD that the man did have a home outside of Australia Was it a permanent place of abode? Permanent is something more than temporary but less than forever – less than everlasting Permanent place of abode is a question of fact and degree The fact that the man went to Vila indefinitely to set up a branch meant that he had a permanent place of abode outside

Australia. Therefore, the man won in this case (not subject to Australian Tax)

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Jenkins v FCT 82 ATC 4098

Bank officer went to Vila for 3 years (set time) with a possibility of that time period being extended Couldn’t sell house so bank rented it from him Furniture stored in Australia Returned after 18 months due to illness The fact that he was only to stay at Vila for a fixed time did not mean that it was temporary 3 years was significant, so the man had a permanent abode outside of Australia.

183 DAYS TEST

The 183 days rule provides that if a person is in Australia for more than half of the year, they are prima facie a resident of Australia, unless the Commissioner is satisfied that:

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(a) their usual place of abode is not Australia; and (b) that the person does not intend to take up residence.

This test only applies to people coming into Australia – it is only used to determine whether a person has commenced to reside in Australia, not whether they cease to reside. Therefore, it does not apply to people who leave Australia after being present in Australia for 183 days.

The 183 days must be in the income or financial year. However, there is no requirement that the person is present in Australia for 183 days straight.

USUAL PLACE OF ABODE

‘Usual place of abode’ means a home outside of Australia which is less than permanent. Therefore, it is not as stringent as the ‘permanent place of abode’ requirement.

Relevant factors include (IT 2650):

Intended and actual length of stay Abandonment of place of abode in Australia Acquisition of place of abode outside Australia Intention to make place of abode 'home' Nature and quality of use made of place of abode Duration and continuity of presence in place Durability of association (ties) with place

Example

Bill is an intending migrant who comes to Australia with a view to settling here, but subsequently changes his intention. Bill arrives in Australia, having broken all connections with his former country of residence on 1 July 1992, and leaves

after seven months. After leaving, Bill travels the world (for the final five months of the year) without establishing any further place of

residence. Bill is a resident under the ordinary concepts test only in respect of the seven-month period spent in Australia and,

therefore, the 183 day test needs to be considered in respect of the other part of the year (i.e. the final five month period).

The precondition for the test is satisfied (i.e. being in Australia for more than one half of the year). Although Bill does not have an intention during the five-month period of residing in Australia, he does not have a usual

place of abode outside Australia during the period and, consequently, he has not met both the conditions required to satisfy the specified exception to the 183 day test.

Accordingly, the 183 day test will deem Bill to be a resident for the whole year and not only the original 7 month period (slide said: final 5 month period).

SUPERANNUATION TEST

A person who is a member of a superannuation scheme established by deed under the Superannuation Act 1990, an eligible employee for the purposes of the Superannuation Act 1976, or a spouse or child of such person is a resident of Australia.

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This test is concerned only with a specific category of taxpayer. The following persons are resident of Australia:

1. A person who is a member of a superannuation scheme established by deed under the Superannuation Act 1990 (Cth) 2. An eligible employee for the purposes of the Superannuation Act 1976; or3. The spouse or child under 16 covered by points 1 and 2 above.

Generally, this covers Australian Embassy staff overseas only e.g. an Australian Ambassador for the United States.

Therefore, if the person is not a Commonwealth public servant, or their spouse or child under 16 then they are not covered by this test.

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SOURCE

OF INCOME

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INTRODUCTION

The source of income is a question of fact, determined by practical concepts of the meaning of source (Nathan v FC of T).

Ordinary income or statutory income has an Australian source if, and only if, it is derived from a source in Australia for the purposes of the Income Tax Assessment Act 1936 (s 995-1 ITAA97).

Nathan v FCT (1918) 25 CLR 183

“The Legislature in using the word ‘source’ meant, not a legal concept, but something which a practical man would regard as a real source of income. Legal concepts, of course, enter into the question when we have to consider to whom a given source belongs. But the ascertainment of the actual source of a given income is a practical, hard matter of fact.”

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REMUNERATION FOR SERVICES RENDERED

Some of the factors which may affect the source include:

Where the contract of employment is made Where the services are performed Where you are paid the money

The source of salary and wages will usually be where the service was performed (FC of T v French).

If, however, creative powers or special knowledge is involved to such a high degree that the place where those powers or knowledge are utilised is relatively unimportant, the dominant source may be the place where the contract was made (FCT v Mitchum).

CT (NSW) v Cam and Sons (1936) 36 SR (NSW) 544

Men employed on fishing trawlers On the morning of the trip, they would engage fishermen on the wharfs of NSW The trawling was done in the open sea off the coast of NZ and Vic so they would sail out side of Australian territorial

waters Employment engagement was entered into in NSW Some work performed outside NSW territorial waters Payment was made once trawler returned to port (NSW) (this case was not a tax case, but still dealt with the issue of the source of income w.r.t. another piece of NSW

legislation) Issue – what is the source of this income? Court decided that the wages paid to the employees was derived partly from sources in NSW and partly from sources

outside NSW Therefore, the wages were apportioned based on where the work was performed – this was the all important factor The performance of the worker was the most important factor and apportionment is to be made according to where the

work was performed.

FCT v French (1957) 98 CLR 398

The taxpayer, an engineer, was sent by his employer for 2-3 weeks each year to New Zealand. He claimed the money earned in NZ was exempt under s 23(q) being an overseas source. Emphasized that ‘special circumstances’ may exist which makes another factor the most important one HELD that source in NZ, where the personal exertion took place (As the then s 23(q) exempted such foreign sourced

income)

FCT v Mitchum (1965) 113 CLR 401

Taxpayer was a non-resident actor Entered into a contract with a Swiss company To act and provide consultancy services to a film being partially produced in Australia Therefore, he had to be at the company’s disposal and if they didn’t use him then that was ok Swiss company lent him to Warner bros who were making a film in Australia Came to Australia for 11 weeks, during which time he did some acting and carried out some consulting services Contract negotiated and signed outside Australia (Swiss income) Payment made in the United States Board of review found that the taxpayers income was derived from any source in Australia and therefore was exempt

from aust tax Commissioner appealed to the High court Commissioner argued that the test as used in FCT v French was that the source is where the performance of the

contract was rendered (i.e. Australia) unless special circumstances HELD that no such test existed – it was a question of fact and must consider the factors HC decided that the board of review’s decision should be affirmed Court was trying to say that the contract was not a simple one for his acting – it was a contract for a range of artistic

services which could have been performed anywhere in the world, and it just so happened that a portion of this was performed in Australia

Therefore, the place where contract was made and where payment was made was given more weight agreement was to provide services in 2 films to be made at unspecified locations

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Evans v FCT 81 ATC 4512

Involved an academic research in Switzerland He continued to have his salary paid into an Australian bank account Even though the taxpayer performed his research outside Australia, his income was derived from an Australian source,

mainly because of the place of payment.

FINANCIAL TRANSACTIONS

When the income is derived from transactions purely financial in nature the source is determined on a case by case basis.

The source of financial transactions are the place where the services are performed (Tariff Reinsurances Ltd v CT (Vic)).

Courts have also determined source based on the substance of the transaction, not the form (Thorpe Nominees Pty Ltd v FCT).

Tariff Reinsurances Ltd v CT (Vic) (1938) 59 CLR 194

Taxpayer carried on the business in the UK The business was reinsurance – where company own the rights of the insurance policies of other insurance companies Reinsurance business based in the UK Provided reinsurance for a Victorian insurance company Payment for insurance policy was made to the Australian bank account Argument of cmr was look at place where the income arose – where did the contract have more of a connection –

performance of the contract gave rise to the profits and the contract was completely carried out in Aust Taxpayer argued that the business of a reinsurer is to make contracts, and the source of profits is where the contract is

made. The real business is the selection of risks and entering into some contracts HELD that look at things like where the contract was entered into, where the payment is made Said in this case, the profits of the reinsurance contract were derived from that contract, and not the insurance

operations which were carried on in Victoria Nor did the fact that the payments for reinsurance were received in Victoria mean that there was a source in Victoria.

The source of the transaction was the UK Dixon J at 217 said that nothing in the present case was done in Victoria or done on its behalf, except for the receipt of

the money, paid into its account The transaction out of the receipt of income arose was the acceptance in London of a reinsurance treaty, negotiated in

London.

Thorpe Nominees Pty Ltd v FCT 88 ATC 4886

Here the courts looked to see where the economic activity giving rise to the income had occurred. Taxpayer wanted to shift part of its income to shore to Switzerland because there is a lower rate of tax in Switzerland There was a tax avoidance scheme Court looked at the substance of the transaction, not its form The scheme was arranged in Australia and concerned a disposal of land in Australia by Australian residents to

Australian residents Therefore, the source of the income was in Australia Court looked at where the economic activity giving rise to the income occurred

BUSINESS INCOME

The source of business income will generally be determined where the trading activities took place (C of T (WA) v D & W Murray).

The income may be apportioned between multiple sources (FCT v Lewis Berger & Sons (Australia) Ltd).

SALE OF REAL ESTATE

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Where property is sold, the income will generally be sourced from the place the contract was entered into, except for certain types of property.

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

Rhodesia Metals Ltd (in liq) v C of T [1940] 3 All ER 422

Taxpayer was in business of acquisition for the development and fail of mining claims in southern Rhodesia Taxpayer purchased mining claims in Rhodesia for 5000 pounds Spent $2000 in developing the claims Went into liquidation (months later) and sold claims by entering into contract in England for a profit of 146,000 pounds Contracts for claims made in England. Evidence suggested to the court that the money claims were being acquired for resale at a profit Court held that the profit was subject to pay Rhodesian tax Company appealed against the assessment and argued that the profit wasn’t assessable because it was of a capital

nature, rather than an income nature, and in any event, the profit was derived from sources in England Issues of source (was the profit derived from the UK or Rhodesian sources), and of capital vs income nature of the

profits Court held that it was of a profit nature derived from Rhodesian source Normally, the sale of an entire company’s undertaking is a matter of capital but in this case, the company bought the

money claims as part of a profit making scheme which is being affected by the sale of the claims pursuant to liquidation giving the profits of the sale the character of income

They also said there was no legal concept that something which a practical man would regard as real source of income (quoted Nathan case again) but the case today is one where the sole business operation was a purchase if immovable property in southern Rhodesia and its development there, for the purposes of transferring profit

The court said that the hard matter of fact is that the company received the sum in question from the territory – in Rhodesia.

INTEREST

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

Where interest arises from a mortgage over property in Australia, the source will be Australia.

FCT v Spotless Services Ltd 95 ATC 4775

Interest paid to an Australian resident company by a Cook Islands bank On funds deposited against a certificate of deposit issued by Cook Islands bank However the deposit was dependent on security being obtained for a deposit in a bank in Australia in the form of an

irrevocable letter of credit Commissioner argued that the interest had source in Australia – said that that’s where all the dealings with the party

originated and the contract letter was made HELD that the certificate was a crucial document and that the income had its source in the cook islands Commissioner took to high court and found that it was a tax avoidance scheme.

DIVIDENDS

The source of dividends are the place from which the profits of the company are sourced (ITAA 1936 s 44 (1)).

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The source of the company’s profits are a question of fact (Esquire Nominees Ltd v FCT).

Esquire Nominees v FCT (1973) 129 CLR 204

EQ, a Norfolk Island company EQ received dividends from a shareholding in another Norfolk Island Company, Mitchell Credits which ultimately flowed from a shareholding in an Australian company cmr argued that the divs had an Australian source court held some source. The source had to be determined by the source of the profits of the company that paid the divs

i.e. in Norfolk island 2 companies, not the Australian company. The source of the divs is not the location of the share register, but where the company paying the div made the profit out

of which the div was paid.

DIVIDEND PAID BY AUSTRALIAN COMPANY TO NON-RESIDENT

Withholding tax may apply where a resident company pays dividends to a non-resident (TAA schl 1 s 12-210). Withholding will only apply when the dividend is unfranked.

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ORDINARY

INCOME

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INTRODUCTION

An entity’s taxation income for an income year is calculated according to s 4-15 as follows:

Taxable Income = Assessable Income - Deductions

A person’s assessable income is comprised of ordinary and statutory income (s 6-1 ITAA97).

‘Ordinary income’ is not defined in the legislation and therefore takes on its common law meaning.

Section 6-5 operates subject to the other provisions in the legislation.

Therefore, ordinary income that is ‘exempt income’ or ‘non-assessable non-exempt’ income is not included in assessable income.

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CHARACTERISING INCOME

Instead of providing a comprehensive judicial definition of the term ‘income’, the courts have instead traditionally adopted a process of ‘characterization’ in which they weigh up various factors to determine whether an amount constitutes income.

Scott v Commissioner of Taxation

Jordan CJ held that ‘“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 an intention to the contrary…’

In examining whether an amount is income according to ordinary concepts, the courts have weighed up factors. All factors must be considered, and no one factor is conclusive – must do a balancing act:

Nexus with earning activity It comes in to the recipient beneficially Characterised in the hands of the recipient It is money or money's worth It must be 'received' as income It will often exhibit periodicity, recurrence and regularity The normal proceeds of personal exertion, property or business are income Compensation receipts may be income if they replace a revenue loss Illegal, immoral or ultra vires receipts do not affect character of receipt Capital gains are not income at common law "Mutual" receipts are not income

NEXUS WITH EARNING ACTIVITY

An receipt will usually be ordinary income if it has a nexus with an earning activity.

IF windfall gain or gift:

As such, windfall gains and gifts will not have a sufficient nexus.

IF expectation of receipt:

An expectation of receipt may aid in establishing the nexus.

COMES TO THE TAXPAYER BENEFICIALLY

The receipt must ‘come in’ to the taxpayer beneficially (Tennant v Smith).

IF savings:

Savings will not constitute an incoming receipt (Tennant v Smith).

Tennant v Smith

In this case, the taxpayer’s employer rented an apartment, which the taxpayer lived in. He used it after hours for the bank, but was entitled to live there. HELD that this constituted a saving, and did not constitute a flow that comes in to the taxpayer. Income is not something that is being ‘saved’, it is ‘what comes into the pocket’.

Further, a saved outgoing cannot be income according to ordinary concepts.

FC of T v Cooke & Sherden 80 ATC 4140

Sellers of soft drinks were awarded a free holiday by their supplier. HELD that the fact that the taxpayers would have to expend money had they wished to provide the holiday themselves,

it did not mean that the holiday or benefit was income. Nothing had come in, and the holiday couldn’t be converted into money. Therefore, the people got a tax free holiday.

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IF reduction in liability:

A reduction in liability does not constitute ordinary income as it does not come in to the taxpayer (International Nickel Australia Ltd v FC of T).

IF amount is subject to a contingency:

Amounts subject to a contingency do not come into the taxpayer beneficially (Case R107).

IF in the course of business:

In the course of business, saved expenditure may constitute income (FCT v Unilever Australia Securities Ltd).

IF subject to terms of a trust:

Where the income is received under a trust and it is subject to a condition, the taxpayer may not be beneficially entitled to it (Countess of Bective v FCT).

Countess of Bective v FCT

According to terms of trust, money was going to be paid to the mother on condition that it goes to maintenance of the daughter.

Court accepted argument that mother was not beneficially entitled to the money due to the condition enforced by the trust.

Not income in the hands of the mother.

MONEY OR MONEY’S WORTH

Under the common law the receipt must be money or money’s worth (Tennant v Smith).

Therefore, income must be money or capable of being converted to money (FCT v Cooke and Sherden).

Tennant v Smith

The accommodation provided by an employer was not convertible into money because the taxpayer could not sell or convert the benefit into money, given that he was prohibited from sub-letting the premises.

FCT v Cooke and Sherden

A soft drink manufacturer gave away a holiday to encourage businesses to sell more soft drink. Because the tickets were not transferable, the tickets could not be converted into money and the tickets were therefore

not money’s worth.

Payne v FCT

Employee of an accounting firm travelled all around the country for work purposes, and she joined a frequent flyer program – she paid the membership fee herself

Work related travel so her employer paid for all the tickets Frequent flyer program - tickets not transferable (tickets could only be used by the taxpayer or by her permitted nominee

– ticket subject to cancellation if sold) In 1993, she accumulated points and she bought tickets for her parents to travel out from England to visit her Commissioner assessed her on the market value of the tickets HELD that it was not income because it was not money and it could not be turned to pecuniary account

STATUTORY MODIFICATION

Section 21 ITAA36 deems non-cash benefits to be convertible into cash, at the value of the consideration provided.

Section 21A ITAA36 deems non-cash business benefits to be convertible into cash, at its arm’s length value.

Section 15-2 ITAA97 makes the value of benefits in respect of employment assessable income regardless of whether they are convertible into money.

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RECEIVED AS INCOME

The receipt is characterised as ordinary income at the moment of derivation, and is characterised objectively and from the perspective of the person deriving the income.

PERIODICITY, RECURRENCE AND REGULARITY

Ordinary income will ordinarily exhibit periodicity, recurrence and regularity (FCT v Dixon).

FCT v Dixon

The taxpayer’s employer agreed to pay staff the difference between what their normal wage and what they earned in the armed forces.

The payment was voluntary on the part of the employer. HELD that the payments were ordinary income because they were regular, periodic and the taxpayer relied upon them

for his livelihood.

However, regularity alone is not decisive (Kelley v FCT).

Kelley v FCT

The taxpayer received a prize for best and fairest. Despite being irregular, the court held that the income was ordinary income because the taxpayer was contractually

obliged to pay his best at all times and this gave it a clear nexus with his employment.

If one-off lump sum from profit making scheme:

One-off lump sums from profit making schemes have been held to be income (FCT v The Myer Emporium Ltd).

IF periodic payment representing payment for purchase price of capital:

Conversely, periodic payments representing payment for the purchase price of capital have been held to be capital in nature (Foley Fletcher).

CHARACTERIZED IN HANDS OF RECIPIENT

The receipt must be characterised in the hands of the taxpayer, not by reference to another person or the expenditure that produced the receipt (Federal Coke Co Pty Ltd v FCT).

Federal Coke v FCT

Federal Coke (FC) supplied minerals to another company (B), which then on-sold those minerals to an overseas company (C).

C broke their contract with B. B demanded compensation from C and requested the money be paid to FC (B’s wholly owned subsidiary). Commissioner assessed compensation receipt on FC. HELD that if amount is to compensate for loss of income, then receipt is of an income character. Court held than amount was income in nature but from FC’s perspective it was a windfall gain such that they provided

no consideration for the receipt – capital in nature. If assessed on B, would have been income. Could have circumvented this situation by the deemed receipt rule s 6-5(4) ITAA 97. Even if T does not receive an amount but directs that the amount be paid to someone else, the amount will be deemed

as being received by the initial T.

The relevant time to assess the character is at the time it is received (Constable v FCT).

ILLEGAL, IMMORAL AND ULTRA VIRES RECEIPTS

Whether an amount is received illegally or immorally is irrelevant to the determination of whether it is assessable income (Partridge v Mallandaine).

FCT v La Rosa (2003)

Taxpayer caught for drug dealing. He hadn’t filed tax returns for 7 years.

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Commissioner assessed him on drug payments for 7 years. He argued that if this was to be done, then should be allowed to claim $200,000 of stolen moneys as a deduction. Based on Charles Moore: said stolen monies are deductable. The Court allowed the deductions. However, there was public outcry, and now s 26-54 states that deductions cannot be claimed for the proceeds of

indictable offences.

The following are examples of illegal activities giving rise to assessable income:

(a) Partridge v Mallandaine (business of burglary)(b) Minister of Finance (Canada) v Smith (illegal bookmaker)(c) Lindsay v IR Commissioners (whisky smuggler)(d) No 275 v MNR (prostitution)(e) England v Webb (ultra vires activities of company)

Section 26-24 denies deductions for illegal or immoral activities (FCT v La Rosa).

MEASURED ON GROSS BASIS

The income is the gross receipt (ss 6-5, 6-10 and 6-15 ITAA97 and FCT v James Flood Pty Ltd).

MUTUAL RECEIPTS

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

The Bohemians Club v FCT

High Court HELD that an unincorporated association that operated as a social club was not assessable on subscriptions received from its members that were unexpended at the end of the year.

Griffith CJ stated that ‘Contributions made by a person for expenditure in his business or otherwise for his own benefit cannot be regarded as his income.’

APPLICATION

The mutuality principle will only apply if there is ‘complete identity’ between the contributors and participants (Municipal Mutual Insurance v Hills).

In other words, all the contributors to the common fund must be entitled to participate in the surplus and all participators in the surplus must be contributors to the common fund.

IF members are prohibited from participating in the surplus:

Where members are prohibited from participating in the surplus, the mutuality principle cannot apply (Coleambally Irrigation Mutual Co-operative).

Coleambally Irrigation Mutual Co-operative

Concerned non-trading co-operative that was established to provide irrigation infrastructure for its members. The taxpayer’s activities were funded by ‘sinking fun’ contributions paid by its members. The Co-Operatives Act 1992 (NSW), however, prohibited the taxpayer from giving returns or distributing any surplus to

members on winding up. HELD that the mutuality principle did not apply because the sinking fund contributions no longer belonged to the

members who paid them, as it was clear that they could not get their payments back.

Following this decision, s 59-35 ITAA97 was enacted to allow non-profit entities whose constituent documents prevent them from making distributions to their members /to treat certain income from their members as non-assessable non-exempt income.

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INCOME FROM PROPERTY

Income from holding property will often come within the concept of ordinary income.

INTEREST

Interest is compensation to an owner or the lost opportunity to use an asset.

According to ordinary concepts, interest is compensation for what could have been obtained from using the capital asset and consists of periodic and regular payments (Riches v Westminster Bank Ltd).

Interest will be sourced at the place where the contract is made or the money advanced.

RENT

Rent is a payment received from a lessee for the use of real or personal property. According to ordinary concepts rent is assessable income (Adelaide Fruit).

Rent is generally periodic and regular and the manner of the payment is usually irrelevant.

Rent will be sourced where the property is located.

IF lease premium:

Lease premiums are generally considered capital in nature.

DIVIDENDS

Dividends are profits of an entity provided to owners of the entity.

IF resident shareholder:

Here, the taxpayer is a resident shareholder and has received dividends. Therefore, they will be assessed on dividends derived out of profits from any source (s 44 ITAA36).

IF non-resident shareholder:

Here, the taxpayer is a non-resident shareholder and has received dividends. Therefore, they will be assessed on dividends derived out of profits sourced in Australia (s 44 ITAA36).

ROYALTY

A royalty arises where a person has a right to use someone else’s property, and the obligation to pay occurs if and only if the right is exercised and the payment is proportional to the extent of the users.

A royalty is not assessable under s 6-5 ITAA97. However, it is assessable income by way of s 15-20 ITAA97.

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COMPENSATION AND REIMBURSEMENTS

Character of a compensation receipt usually depends on what the amount is received for.

LOSS OF TRADING STOCK

Compensation payments for loss of trading stock are treated as income (FCT v Wade).

INSURANCE POLICIES

Amounts received under a personal disability insurance policy are of an income nature (FCT v Smith).

CANCELLATION OF EMPLOYMENT CONTRACTS

Amounts received for the loss of salary due to the cancellation of employment contracts are treated as income (C of T v Phillips).

C of T v Phillips

MD of a theatre company, who was required to retire before the end of his contract, was paid by way of compensation the same amounts at the same times that he would have otherwise been entitled to receive as salary if he had not retired.

HELD that the payments he received must be regarded as of the same nature as they payments which they replace. As the payments replaced salary, they were of an income nature.

CLOSING DOWN OF STERILISATION OF CAPITAL ASSET

Compensation amounts received for the closing down or the sterilization of profit-yielding assets are treated as capital (Glenboig Union Fireclay).

Glenboig Union Fireclay v IRC

Taxpayer carried on a business of mining and selling raw fireclay. The company held leases over land containing deposits of fireclay, with railway lines running over part of the land. The railway company exercised its statutory right to require the fireclay to be left unworked (for the stability of the railway

lines) and paid an amount to the taxpayer as compensation. HELD to be capital because the taxpayer was permanently deprived of the opportunity to carry on its business in

relation to the fixed asset (fireclay). The payment took the same character as the asset which it replaced.

TRADING CONTRACTS

Amounts received for the loss of business profits due to the cancellation of trading contracts are usually treated as income (Heavy Minerals).

CANCELLATION OF STUCTURAL CONTRACTS

Compensation amounts received in respect of the cancellation of structural contracts that are integral to the way that the taxpayer conducts its business operations are usually of a capital nature (Van den Berghs).

Van den Berghs v Clark

Two margarine companies worked in “friendly allegiance” in relation to share profits and losses, allocate territories and deal with various ancillary matters. The parties fell out, and Van den Berghs was paid £450,000 in consideration of its release from the agreement.

The compensation payment was characterized as capital for the following reasons per Lord MacMillan: By accepting the payment, Van den Berghs gave up their rights under the agreement The agreements were not ordinary commercial contracts but related to the basic structure of the company and affected

the whole conduct of the business The agreements formed the fixed framework in which the company’s capital circulated. The agreements provided a

means of making profits but did not themselves yield profits (margarine manufacture yielded profits).

CANCELLATION OF AGENCY AGREEMENTS

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Amounts received for the cancellation of agency agreements have been treated as capital receipts where the agency agreements are fundamental and necessary to the continued operation of the taxpayer’s business (Californian Oil Products).

UNDISSECTED LUMP SUMS

Courts are generally prepared to apportion compensation receipts where it is possible to dissect them into distinct income and capital components (Federal Wharf).

NOT POSSIBLE TO DISSECT

Where it is not possible to apportion the receipt, the entire amount will be treated as a capital receipt (McLaurin).

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STATUTORY

INCOME

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INTRODUCTION

A taxpayer’s assessable income includes amounts that are not ordinary income (s 6-10 ITAA97). These amounts are called statutory income and are contained in Div 15 ITAA97.

TYPES OF STATUTORY INCOME

Allowances and other things provided in respect of employment or services (s 15-2 ITAA97). Return to work payments (s 15-3 ITAA97). Accrued leave transfer payments (s 15-5 ITAA97). Bounties and subsidies (s 15-10 ITAA97). Profit-making undertaking or plan (s 15-15 ITAA97). Royalties (s 15-20 ITAA97). Payments made to members of a copyright collecting society (s 15-22 ITAA97). Amount received for lease obligation to repair (s 15-25 ITAA97). Insurance or indemnity for loss of assessable income (s 15-30 ITAA97). Interest on overpayments and early payments of tax (s 15-35 ITAA97). Providing mining, quarrying or prospecting information (s 15-40 ITAA97). Amounts paid under forestry agreements (s 15-45 ITAA97). Amounts paid under forestry managed investment schemes (s 15-46 ITAA97). Work in progress amounts (s 15-50 ITAA97). Certain amounts paid under funeral policy (s 15-55 ITAA97). Certain amounts paid under scholarship plan (s 15-60 ITAA97). Sugar industry exit grants (s 15-65 ITAA97). Reimbursed car expenses (s 15-70 ITAA97). Bonuses (s 15-75 ITAA97). Employer FHSA contributions etc (s 15-80 ITAA97).

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INCOME FROM

BUSINESS

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INTRODUCTION

Gains flowing from ‘trading’ transactions, or that represent the ‘ordinary proceeds’ or ‘ordinary incidents’ of a business, are income in nature.

IDENTIFY THE ISSUE

Here, the taxpayer is engaged in [the business, hobby or pastime]. If this activity is found to amount to a business, then the receipts received through this enterprise may be considered income.

Therefore, the issue is whether the taxpayer is carrying on a business.

WHAT INCOME IS ASSESSED?

Income from business is income not from personal exertion, not income from property – it is income derived from carrying on a business.

Generally, most receipts you will be getting in from carrying on your business will be income according to ordinary concepts.

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DOES A BUSINESS EXIST?

Whether a business is being carried on is a question of fact and degree (Evans v FCT).

A multitude of factors must be weighed and assessed to determine whether a taxpayer is carrying on a business (FCT v Radnor).

A business includes any “profession, trade, employment, vocation or calling”, but is not occupation as an employee (ITAA97 s 995-1).

The courts consider a broad range of factors to determine whether or not the taxpayer is carrying on a business, including:

System and organisation Scale of activities Sustained, regular and frequent transactions Turning talent to account for profit Profit motive Commercial character of transactions Characteristics or quantities of property Inherent characteristics of the taxpayer

SYSTEM AND ORGANISATION

An activity that is a business will generally be organised and have a system associated with it (Ferguson v FCT).

Ferguson v FCT

Taxpayer was naval officer, due for retirement and wanted to go into cattle farming. He leased five cows for four years and used a management company to breed these cows with artificial insemination. He wanted to build he herd up to 200 cattle – here, the court held he was in the preliminary business of primary

production. He wanted to argue he was carrying on a business was because he had losses which he could offset against his naval

salary. HELD to be in the business of primary production, because venture had a ‘commercial flavour’. Held that you can have a business of a limited nature in anticipation of a larger business in the future. The appointment of a management company was an important consideration.

A system may be shown by:

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

FCT v Walker 85 ATC 4179

Taxpayer bought one female Angora goat (Geraldine) Held to be in the business of goat breeding (this is strange, as you need at least 2 goats to breed?) Court was satisfied that the taxpayer was conducting his activities in a business like manner Goat was kept at a stud farm Cared for by experts Used as the basis of a breeding program, including the transportation of live embryos Walker was a member of the Angora Breed Society and read its journals Kept detailed books of account HELD to be in the business, even though the venture was not particularly successful The presence of system and organization was a factor which contributed to the finding that Walker was in a business of

primary production (even though he made no profit for over 14 years) This was a win for the taxpayer as he would get all the concessions and could deduct losses

Brajkovich v FCT 89 ATC 5227

Taxpayer retired at 36 having accumulated wealth in his previous occupation as a life insurance salesman, real estate agent and property developer producer

Gambled heavily – e.g. horse races, card games, “two-up”, football bets etc

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Evidence indicated that he did not maintain records The taxpayer claimed deductions for his quite considerable losses – he claimed that the losses were incurred in the

carrying on of the business of a gambler Commissioner did not allow the deductions HELD that on the evidence, the taxpayer was not carrying on the business of gambling, and therefore not entitled to

claim the deductions There was evidence that he was a passionate gambler from a young age But held – not business activity Court stated that – in the norm, gambling activities are purely random and the odds are heavily against the punter – and

would not of themselves, constitute the carrying on of the business, no matter how avidly they are pursued by the taxpayer

Martin v FCT (1953) 90 CLR 470

Taxpayer ran hotel and farming businesses which occupied most of his time He also placed a large number of bets and he derived substantial winnings He won a lot of money in the course of his gambling activity (c.f. Brajkovich v FCT) Kept records of betting activities He made systematic bets – generally placed them himself, he raced and bred his own horses and employed the

services of trainers Commissioner wanted to tax the man for his gambling winnings, alleging that he was in fact carrying on a business in

gambling Taxpayer maintained that he wasn’t carrying on a business – gambling was merely a hobby/pastime, such that his

winnings did not constitute assessable income HELD that the taxpayer was not carrying on the business of gambling – winnings were not assessable as income In order to carry on a business, you have to more involved than merely vigorously pursuing a hobby or pastime. Must establish a systematic and organized approach towards gambling with a clear profit making purpose and a design

to eliminate the element of chance

SCALE OF ACTIVITIES

A business generally operates on a scale beyond that of ordinary domestic needs (Rutledge v IRC).

Rutledge v IRC

Taxpayer bought a large quantity of toilet paper, which he immediately sold at a profits. HELD to be a business because the toilet paper was of a quantity that would not be purchased for ordinary domestic

needs, contrary to the argument of the taxpayer.

However, the scale of the business is not decisive, and a person may conduct it on a small scale (FCT v Walker).

FCT v Walker

The taxpayer wanted to go into the goat business. The taxpayer had a female goat, but was not good at breeding and many goats ended up dying, so that at any one time

there was only ever 3 goats alive. The taxpayer earned some income, but lost much more, claiming these deductions. HELD that the Taxpayer was in the business of breeding goats because it was carried on in a business like way

through, inter alia, agreements with vets, reading journals and joining of a goat society.

Thomas v FCT 72 ATC 4094

Taxpayer was a barrister. Had 30 avocado trees, 75 macadamia nut trees and 1,800 pine trees on family property He claimed a deduction for his expenses – claiming that he was carrying on a business of primary production No income received in the year which the deduction was claimed – 7 years before they would bear fruit Once the fruit matured, there was an expected profit No other growers around that area – wrong zone Trees destroyed due to frost and fires Installed irrigation system but didn’t water as much as he should have Commissioner argued that he was not a primary producer and that the planting of the trees was just a hobby – so that

his expenses cannot be deductible

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Commissioner relied on expert evidence that showed that the taxpayer failed to achieve in several respects, a standard of competency and good husbandry (farming) that might have been expected of a man that set out to grow trees for a business venture

HELD that the taxpayer was entitled to claim a deduction – he was not just involved in a hobby, but was involved in a business of primary production

It was decided that in planting the trees, set out to grow them on a scale that was much greater than was required to satisfy his own domestic needs, and expected upon reasonable grounds that there produce would have a ready market once the trees became established, and a financial return which would be a significant amount, was relatively smaller and the return would continue for a very long time

The mere fact that the taxpayer was naïve or a poor businessman (e.g. not watering trees enough) does not necessarily mean that they are not carrying on a business – can have incompetent people running a business

It is also clear that the courts are influenced by the size and scale of the taxpayer’s activities – generally the smaller the scale, the more likely the courts will find that it is a hobby or pastime, rather than business.

SUSTAINED, REGULAR, FREQUENT TRANSACTIONS

A business is usually expected to have regular transactions over a lengthy period of time.

However, the courts recognise that a business may go through ordinary periods of quiet.

A sufficiently large one-off transaction will be sufficient (FCT v Shield). Therefore, even activities undertaken for only a short period of time, while a taxpayer is otherwise gainfully employed, can constitute a business.

FCT v Shield

Taxpayer was a full-time employee of a finance company who, for a period of two months, bought shares in Australian banks that were about to pay franked dividends at ‘cum dividend’ prices.

The taxpayer than sold the shares after the bank paid the dividends at ex dividend prices. The spread between the cum and ex dividend prices gave rise to arbitrage opportunities, which the taxpayer sough to

exploit. Administrative Appeals Tribunal concluded that the careful and systematic way in which the taxpayer bought and sold

shares, and the degree of repetition and substantial turnover involved in the transactions, point to the fact that he was carrying on a business.

PROFIT MOTIVE

Business is usually motivated by a profit motive, however the fact that a profit is or is not made is not decisive (Thomas v FCT).

Thomas v FCT

A barrister who worked full time planted fruit and nut producing trees. This was a long-term project because Avocado and Macadamia trees take a long time to produce fruit or nuts. The trees ended up being planted on unproductive land and no income was ever possible. The commissioner argued that it was only a hobby and the taxpayer could not claim the losses. HELD that it wasn’t a hobby, partly because the amount of fruit could not be used for domestic use. The fact that no profit was in fact available, did not prevent it from being a business.

The absence of a profit motive is not decisive (FCT v Stone).

However, it was held in TR 97/11 that, subject to all the circumstances of a case, where an overall profit motive appears absent and the activity does not look like it will ever produce a profit, it is unlikely that the activity will amount to a business.

In Brackavich, the court held that the taxpayer was not in the business of gambling, and therefore not able to claim losses, despite having a profit motive, because inter alia, there were no records. The court found it irrelevant that the taxpayer had purchased a horse, because it believed that this was only to obtain inside information.

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

COMMERCIAL CHARACTER OF TRANSACTIONS

A business will usually trade on the open market, on terms and conditions similar to other businesses.

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CHARACTERISTICS OF PROPERTY OR GOODS

There will not be a business where the goods (or quantity thereof) are inherently unsuited to domestic use (Rutledge v IRC).

Taxpayer bought 1 million rolls of toilet paper.

Rutledge v IRC

Stuck them in a warehouse and on-sold them. Attempted to argue that he purchased the toilet paper for personal use. He was found to be carrying on a business – despite toilet paper being something one can use for personal

consumption; What can be a business purchase in the hands of one person, can be a domestic purchase in the hands of another

person.

Property which does not provide income or personal enjoyment by ownership itself is more likely to be accepted as being acquired for the purpose of business dealings.

CHARACTERISTICS OF TAXPAYER

Usually in the past where you have a business activity conducted by companies rather than an individual, it suggests that those activities are a business activity.

For instance, a company may not engage in a hobby.

OTHER FACTORS

ILLEGALITY

The fact that activities may be illegal does not prevent them from constituting a business (La Rosa).

FC of T v La Rosa

Taxpayer was involved in an illegal drug dealing business. As a consequence, the taxpayer was allowed deductions for money that had been robbed from him during an attempted

drug deal. Full Federal Court made the point that the purpose of the tax laws was to tax taxable income, not to punish wrongdoing.

OTHER EMPLOYMENT

Being employed does not prevent you from carrying on a business in another area (Ferguson).

LENGTH OF TIME

The length of time the activities are carried on may be relevant.

TALENT USED TO ACCOUNT FOR PROFIT

Athletic pursuits undertaken by a person who is otherwise gainfully employed may constitute a business (Stone).

FC of T v Stone

Javelin thrower for Qld – went to Olympics and world cup. She was also a constable in Qld Police full-time. For 1999, earned $136 000 from the sport, from prize money ($93 000), govt grants ($28 000), sponsorship ($12 000)

and appearances ($2700). Commissioner assessed her on this , and she claimed it was a hobby and only declared her $39 000 from the police

force. HC said it was a business and all was assessable. The key was the sponsorship, as it required her to undertake activities and obligations. Said if the sponsorship funds were assessable, then everything was – she couldn’t get the sponsorship without

everything else. Couldn’t put some into a category of business and some into a category of hobby. She had turned her talent to account for money – appearance fees. Also, the amounts were more than trivial, and the money was paid in exchange for her undertaking obligations.

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Once this is found to be assessable income – you are showing the taxpayer was using her ability to derive money – therefore, she was carrying on a business and all of her receipts became assessable (full $136,000);

Therefore, as she had turned her ability into a profit making venture, she was conducting a business.

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GAMBLING

A business should be distinguished from a hobby or pastime. The distinction is not always clear cut and depends on the particular facts of each case.

BUSINESS PRESENT

In Trautwein, the taxpayer was held to be in the business of gambling because he owned a number of horses and kept very clear records.

Trautwein v FC of T

The taxpayer was involved in the hotel industry and had a keen interest in horse racing. He devoted a substantial proportion of time and effort to extracting the maximum results from his betting activities. He established a horse breeding and stud farm and expended considerable money racing his own horses and horses

under lease. He also frequently attended races and regularly and systematically placed large bets on carefully selected horses after

making extensive enquiries from trainers and others in the industry. He also employed others to place and settle his bets. HELD that, having regard to the system, extent, frequency, continuity and volume of the betting transactions, the

taxpayer’s activities were part and parcel of the carrying on of a horse-racing business.

Similarly, in Prince v FCT, a retired book-maker who gambled heavily was held to be in business.

Prince v FCT

Retired bookmaker who maintained a horse training establishment and gambled heavily and systematically. Menzies J concluded that the taxpayer had applied his wide and extensive knowledge of the horse racing industry,

which had been derived from his previous vocation as a bookmaker, for the purpose of maximizing his profits. The extent, system and organization of the taxpayer’s gambling activities went beyond the vigorous pursuit of a hobby or

pastime. He carried on his gambling activities for the purposes of profit, rather than for pleasure or the satisfaction of addiction.

HOBBY OR PASTIME

In Martin v FCT, the taxpayer was held not to be carrying on a business because his betting activities were primarily carried on pleasure.

Martin v FCT

Taxpayer ran hotel and farming businesses that occupied most of his time. He also placed a considerable number of bets on horse races, from which he derived substantial winnings. The taxpayer usually attended only one racecourse and usually placed no more than one bet on each race. He also raced and bred his own horses, employed trainers and kept records of his betting activities. HELD by High Court that, despite these factors, it could not be concluded that the taxpayer’s betting activities

constituted any more than the normal activities of a person who derived pleasure from the pursuit of horse racing. To constitute income from carrying on a business, it must be established that the taxpayer was more involved than a

person merely vigorously pursuing a hobby or pastime. The evidence must establish a systematic and organized approach towards gambling with a clear profit-making purpose

and a design to eliminate the element of chance.

Babka v FCT

Retired public servant spent considerable time on betting activities. He had no business premises, did not employ any assistants, had never owned a racehorse, did not subscribe to any

betting information service, and did not maintain a line of credit with any bookmaker. He also did not maintain any accounting records. HELD that the taxpayer was not engaged in the business of gambling, but he was merely a keen follower of the turf.

In Brajkovich v FCT, the court held that the taxpayer was not in the business of gambling, and therefore not able to claim losses, despite having a profit motive, because inter alia, there were no records. The court found it irrelevant that the taxpayer had purchased a horse, because it believed that this was only to obtain inside information.

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

is it conducted in a systematic, organised and businesslike way its scale (ie size of wins and losses) whether the betting is related to other business-like activities (ie breeding horses) a pleasure or profit motive whether the form of betting involves skill and judgment or purely chance whether the gambling activity in question is of a kind ordinarily thought of as a pastime or hobby.

IS THE RECEIPT BUSINESS INCOME?

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

Gains that relate directly to the business activity will be income according to the Californian Copper Syndicate Case.

GAINS FROM ISOLATED AND EXTRAORDINARY TRANSACTIONS

TRADITIONAL APPROACH

Traditionally, the mere realisation of an asset is capital in nature, however where the sale occurs in the carrying out of the business and there is a sufficient nexus, the receipt will be income (Californian Copper Sundicate v Harris).

Californian Copper Syndicate (1904) TC 159

Taxpayer acquired copper bearing land, but didn’t have enough capital or money to work the mines They sold the land in shares for substantial profit The court held that the profit was income The taxpayer endeavored to make a profit in selling the land Thus the taxpayer made a gain in the operation of the business in carrying out a scheme for profit making.

This was adopted in the following case.

Scottish Australian Mining v FCT (1950) 81 CLR 188

HELD that a mining company’s income was not assessable where a large profit is made when it sold subdivided allotments of land

Taxpayer was a company incorporated in 1859 as a mining company, and had as its principle object, the carrying out of mining operations

Purchased land 1860’s & carried on a mining business Mined on land until 1924 Company decided to sell land: built roads, railways, set aside land for parks, churches and schools Large profits received Assessed on profits on the basis they were the proceeds of a business of selling land (remember that they were a

mining company) Court held that the profits were not income according to ordinary concepts – the land was acquired to mine The taxpayer’s subdividing activities did not constitute a land developing business – the taxpayer merely realised, to its

best advantage, land which had been acquired for mining coal, not real estate dealings Establishes the principle that a landowner may develop and realise his land, without making a profit which partakes as

the character of income. Even though he goes about the realisation in an enterprising sort of way, so that he can secure the best price.

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

1. What is the exact nature and scope of the business?2. Is there a nexus between the business and the receipt?

Proceeds from large-scale sub-division and development constitute income (FCT v Whitfords Beach Pty Ltd).

FCT v Whitfords Beach (1982) 150 CLR 355

Group of fishermen formed company called Whitfords in 1934 to acquire land to ensure beach access 1967 – some 13 years later, three development companies wanted to acquire the land for subdivision sale

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Developers realised that if they simply bought the land from Whitfords and sold it for profit, the income would be assessable (under s 25A – section now repealed)

Developers thought they would try to get around this by buying the shares in Whitfords. Then once they got control of Whitfords, they were going to have the company subdivide and sell the land – to try to show that the land was not acquired for profit making purposes (so that it could fall within mere realisation exception)

sold land by selling shares in the company to developers Developers changed articles of association They had Whitfords arrange the re-zoning of the land in June 1969, improvements done and land sold as subdivided

residential lots HELD that the profit made by Whitfords on the sale of subdivided lots was assessable as ordinary income Gibbs took the view that the mere realisation doctrine in Scottish Australian Mining Company would have applied if the

takeover by the developers had not happened. The takeover mean that Whitfords was transformed to a company which held land for domestic purposes, that its shareholders into the company whose purpose was to engage in a commercial venture with a view to gain profit. This transformed a mere realisation to a business venture

Mason and Wilson – the subdivision and development activities in themselves constituted business activities and suggested that the Scottish Australian Mining case might have been wrongly decided

Mason disagreed with the suggestion that subdivided land is necessarily no more than a realisation of an asset in an enterprising way – the improvement to the land was done on such a massive scale (involved layout of roads, construction of parklands) such that you cannot say that it was a mere realisation of a capital asset

Wilson – act of steps taken to alter the existing land zoning and subdivision were very significant – it is a business and you intend to make profit, not a mere realisation

Murphy – profit was taxable income from a one off business transaction. High court was unanimous in holding Whitfords assessable on the profit made from those land sales.

The court looks at the substance of the transaction and business, so that the sale of shares in the company, rather than the asset itself will not prevent the sale from constituting income if that was its true purpose (FCT v Whitfords Beach Pty Ltd).

NEW APPROACH

However, the Californian Copper principle has potentially been broadened by Myer Emporium Ltd v FCT.

Under this test, profits or gain realised in the ordinary course of business are income, in addition to certain receipts through extraordinary transaction (Myer Emporium v FCT).

Myer Emporium v FCT (1987) 163 CLR 199

High court had to decide whether a lump sum received outside the ordinary course of business was income or capital Taxpayer (Myer) was a business and decided to diversify – retailer and property development It needed to resort to external funding for finance Its ability to borrow was limited by its credential trustee Transactions entered into to borrow funds needed for diversification – it decided to enter into a complex financial

arrangement to borrow funds 6 March 1981 – Myer lent $80 million to a finance subsidiary company - Myer Finance Ltd (a shelf company acquired on

the 20th February 1981 (2 weeks earlier)) at the commercial rate of 12.5% per annum payable to Myer Myer Finance was required to repay the loan on, but not prior to, 30 June 1988 (7 years and 3 months later) Interest totalling $72M was to be paid over the period of the loan 3 days later on 9 March 1981, Myer assigned right to interest under the loan to Citicorp for $45.37M (for 7 years and 3

months) Citicorp was an unrelated finance company which had large tax losses Myer remained entitled to the principal ($80 million) from the Finance subsidiary In return, Citicorp paid Myer a lump sum of $45.37 million in consideration for the assignment of the interest These transactions were interrelated and the taxpayer would not have made the loan to Myer Finance unless Citicorp

agreed in advance to pay for the assigned interest Citicorp had losses available to wipe out any tax liability on the interest payment of Myer Finance (benefited all parties

involved) Commissioner treated the $45.37 million as an income receipt, assessable income. Taxpayer argued that it was merely realising a capital asset and it had received money from Citicorp in an isolated

transaction outside the ordinary course of its retail trading and property development business – therefore the payment was a non-assessable capital receipt

Myer argued that it made no profit, as $45.37M = present value of future interest payments of $72M Victorian Supreme Court and Full Fed court held that the lump sum was a capital receipt. However, the full high court decided that the $45.37 million received was assessable as an income receipt, endorsing

the basic principle in Californian Copper as interpreted in Whitford Beach

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However, such a wide discrimen has been criticised given the capital / income distinction in the tax acts (FCT v Spedley Securities Ltd).

FCT v Spedley Securities Ltd 88 ATC 4126

Taxpayer a merchant bank Engaged Santos to secure a $65M loan in return for 1.25% commission Santos terminated agreement with the taxpayer after the taxpayer had already done most of the work to try and get the

loan Cancellation of the agreement might have made it seem to the outside world that Santos was not satisfied with the

Bank’s services – reputation of bank on the line In the agreement of discharge, Santos paid taxpayer $200,000 – loss of reputation and loss of commission (did not

specify how much would be for loss of rep and how much for loss of commission Commissioner assessed the whole $200,000 as income – assessed it on the loss of commission, not the loss of

reputation According to principle in Myer, the receipt was income as it was received in the course of the taxpayer’s business and

the transaction was undertaken to make a profit Taxpayer argued that in part the lump sum was received as compensation for damage to taxpayer’s reputation and good

will – so that the amount would be of a non-assessable capital nature. They argued that even part of the compensation was received as a loss of taxpayer’s commission (which would be income in taxpayer’s hands – as it substituted income), such an amount could not be separately identified, so the whole amount should be treated as a capital receipt

HELD that there was sufficient evidence to treat the $200,000 lump sum as having being received as compensation for loss of commission in part, and compensation for loss of reputation and goodwill

On this basis, the whole amount should be treated as non-assessable capital nature Court went on to say that the Commissioner’s argument that the $200,000 was assessable because it was received in

course of taxpayer’s business operations, were incorrect – it the Commissioner’s argument was correct, it would mean that any receipt in a business would necessarily be of an income nature and this would be contrary to authority, and contrary to the basic principle distinguishing capital and income (can’t use Myer as authority for declaring everything as assessable income – some things still remain to be capital).

EXTRAORDINARY TRANSACTIONS

Relevant factors in determining whether the transaction is a business one are:

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

Where a not-insignificant purpose of the transaction is making a profit, it is likely to be income (FCT v Cooling).

The actual method the profit was made must relate to the profit making purpose contemplated when assets were purchased (Westfield Ltd v FCT).

FCT v Cooling 90 ATC 4472

Taxpayer = partner in a legal firm of Brisbane solicitors Received a proposal from AMP to relocate to new lease premises in Comalco House (owned by AMP) AMP induce tenants to Comalco House by offering the legal firm a cash incentive of $162,000 to enter into new

premises Agreement provided for a lump sum lease incentive payment to be paid to the firm to induce the firm’s service company

to accept a lease, and to guarantee the company’s obligations under the lease Common practice at the time for landlords to offer incentives to new tenants – ordinary incident to receive such incentive

payments Firm had not previously received payment of this type Payment was a one-off lump sum payment NOT connected to services rendered (the firm was solicitors, not property

dealers), and NOT received in the ordinary course of business Commissioner argued that the incentive was assessable income relying on Myer Emporium

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Argued that it arose on the basis of business and commercial transactions entered into the course of carrying on the partnership business with a profit element in mind

Taxpayer also relied on Myer – argued that the incentive payment was not assessable in accordance with the decision in Myer, on the basis that the partnership business was the performance of professional services, not for the receipt of incentive payments – they were not in the business of receiving incentive payments

At first instance, the fed court held that the incentive payment was for the firm to move into the premises, rather than a payment for services to be rendered by the firm, and the payment was a non-assessable capital receipt

The full court of fed court – held that the lump sum payment was assessable income. It was ordinary income as it was received in the ordinary course of the taxpayer’s business

At page 4484 – where a taxpayer operates to lease premises, the move from one premises to another and the leasing of the premises occupied are acts of the taxpayer in the course of business activities, just as much as the trading activities give rise more directly to taxpayer’s assessable income. (finding a place to set up your offices is part of your business activities)

Westfield Ltd v FCT 91 ATC 4234

Taxpayer (Westfield) was in the business of constructing, designing, letting and managing shopping centres Taxpayer acquired land for $450,000 – after previously taking up options – originally taking an option for the purposes of

itself establishing a shopping centre in Mt Gravatt. After the option had lapsed, they took out another option in order block development on the site by a rival

Taxpayer sold land to AMP for $735,000, on the basis that AMP would employ the taxpayer to design and construct shopping centre which AMP proposed to build on the site

Commissioner included profit on sale of land as income, conceding that the taxpayer not in the business of selling land However, he argued that the profit on the sale of the land was nonetheless assessable as the profit was of an income

nature (based on Myer Emporium) Argued that the High court held in Myer that a profit made by a taxpayer otherwise in the ordinary course of carrying on

its business, which arises from an isolated one off commercial transaction entered into by the taxpayer with the intention of making a profit may be of an income nature

Taxpayer argued Myer did not apply because although at the time, the land was acquired, a possibility opened for taxpayers to sell the land to AMP, the taxpayer preferred to develop the land and therefore, it could not be said that the land was acquired with the purpose of making a profit

HELD that the profit on the sale of the land was not income but a non-assessable capital receipt. Judgment of Justice Hill – explained the decision in Myer Emporium did not mean that every profit made by a taxpayer

in the course of carrying on its business must be of an income nature. Such a view would distort the long established distinction between capital and income.

In this case, the profits received by the taxpayer were not received as a result of the taxpayer’s ordinary business activities, they were outside the taxpayer’s ordinary business activities – they weren’t in the business of selling land – they were in the business of developing shopping centres

Where a transaction occurs outside the taxpayer’s ordinary business activities, in order for the profits to be assessable in accordance with the principle in Myer, the transaction that generates the profit must be a commercial transaction, and at the time the transaction was entered into, there must be a purpose of profit making, by the very need which gives rise to the profit actually made.

Court was trying to narrow down the decision in Myer Here, although at the time the land was acquired, the possibility of selling the land was open, but the taxpayer decided

to develop the land – so it can not be said that the land was originally acquired with the purpose of making profit by resale.

As the taxpayer lacked that necessary purpose, at the time of acquisition of the land, Myer didn’t apply here.

TRADING STOCK

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

With regard to trading stock there are numerous issues which need to be considered, including:

1. Is the party carrying on a business (s 70-35 ITAA97).2. What is trading stock?3. What does on-hand mean?4. How do we value trading stock?5. How does trading stock impact taxable income?

IS A BUSINESS CARRIED ON

Above.

TRADING STOCK

Trading stock is defined as live stock, or “anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business” (ITAA97 s 70-10).

Trading stock includes livestock (s 70-10(b)).

Trading stock may include:

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

Trading stock does not include:

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

LAND

St Hubert's Island (1978) 8 ATR 459

Land development company developing land in two islands north of Sydney The company went into liquidation and the developer made a contribution to the shareholders – distributed the land to

the shareholders in the company The Commissioner tried to assess the company on disposal of trading stock outside the ordinary course of the business

– Commissioner arguing that the land of the developing company was trading stock The taxpayer argued that it wasn’t trading stock because trading stock refers to stuff that is on hand which relates to

chattels and not real property; and the trading stock provisions referred to had been replaced and became obsolete Shepard J said that land can be trading stock – looked at the definition of ‘trading stock’ as an inclusive definition (not

exhaustive) and Stephens J said that trading stock would be looking at a true reflex of taxpayer’s income, and to remove one type of stock (i.e. land) would lead to anomalous results

Mason J looked at it from a commercial perspectives and said that accountants recognised land as trading stock so it is inevitable that the meaning of ‘trading stock’ at common law would also include land.

SHARES FOR SHARE TRADER

Investment and Merchant Finance Corporation Ltd v FCT

If an ordinary individual held a parcel of shares this would not be trading stock because that person is not trading them and they are not part of that person’s business

Only if the person engages in the business of share trading, will shares become their trading stock

SPARE PARTS

Guinea Airways Ltd v FCT

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Business of selling air conditioning units, and also service the machines. If a compression valve which is used to service air conditioners, breaks down on a regular basis the compression valves

are not part of the trading business – the business person uses them to repair, and the spare parts would not be considered trading stock, as they do not buy and sell them as part of their business (they do buy them for purpose of repair, but don’t sell them).

GOODS FOR HIRE

Cyclone Scaffolding Pty Ltd v FCT

Not trading stock because the business is providing customers with the right to use the goods, and the business is not trading in the goods – the goods are coming back.

ON HAND

Trading stock is on hand if the taxpayer has the legal power to dispose of the goods (Farnsworth v FCT).

Farnsworth v FCT

Taxpayer was fruit grower who was part of the fruit growing association and participated in a pooled marketing scheme Fruit sent to a packing house on the ground that it could not be withdrawn When it was sent there, the fruit was intermixed with other farmers fruit Once it was sent there, could not distinguish any individual farmers fruit End of year packing house sent a statement setting out what was left and estimated proceeds Commissioner argued that whether the goods were trading stock depended on whether the taxpayer had rights to the

property, rather than physical possession In this case, it was held that it was no longer on hand, because even though the farmers were still the legal owners of

the fruit, they had no dispositive power and therefore it was no longer trading stock Therefore, the fruit was no longer ‘on hand’ once delivered to the packing house – could not restore it meant there was a

loss of dispositive power.

OWNERSHIP

A lack of ownership does not preclude the trading stock from being on hand (FCT v Suttons Motors (Chullora) Wholesale Pty Ltd).

FCT v Suttons Motors (Chullora) Wholesale Pty Ltd

Taxpayer member of motor vehicle retailing group (Suttons Motors) Taxpayer took delivery and obtained possession of motor vehicles through a finance company (bailor) The cars were put in retailers (Suttons) showroom Suttons entered into contract to purchase the vehicles at the time the retail company sold them Taxpayer acquired title at the time when the retailer sold a car The reason for this arrangement was so that retailer had cars to sell, but retail company wouldn’t have to pay wholesale

price, nor do they have to pay sales tax until the vehicles are sold Commissioner argued that for the taxpayer (bailee), the cars were not trading stock because the taxpayer did not own

the vehicles, they did not have possession of the vehicles and they made no payments in relation to the vehicles Vehicles were trading stock ‘on hand’ – the wholesale company had dispositive power to sell the vehicles or dispose of

them Even though they weren’t the legal owner, it was trading stock.

LACK OF PHYSICAL POSSESSION

A lack of physical possession is not decisive (All States Frozen Foods Pty Ltd v FCT).

All States Frozen Foods

Wholesaler of frozen foods Under a CIF contract (cost insurance and freight) – when contractual documents handed over, property in the goods

passed – so at the time of the contract, the buyer acquired ownership At 30 June 1985 frozen foods were on ships on their way to Australia Contracts – CIF (Taxpayer had legal ownership of goods) The fact that All States Frozen Foods could on-sell the frozen goods at any time meant that those goods were trading

stock Frozen foods were ‘on hand’ at the end of the income year

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VALUING TRADING STOCK

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

Cost; Market selling value; Replacement value.

The taxpayer can elect which method they use, and switch between income years, provided that the value of an item at the end of one income year is the same as its value at the start of the next income year (ITAA97 s 70-40).

The Taxpayer may also elect to use a lower, reasonable value if the stock has become obsolete, or for some other special reason (ITAA97 s 70-50).

If the asset is disposed outside the ordinary course of business, then the relevant value is its market value (ITAA97 s 70-90).

COST BASIS OF VALUATION

The cost basis of valuation includes all amounts incurred in acquiring the item or brining it into existence (Philip Morris Ltd v FCT).

This is not available where the transaction is not at arms length and the taxpayer pays above market value at the time (ITAA97 s 70-20).

You can elect between FIFO and weighted cost (IT2350).

MARKET SELLING VALUE

The market selling value is the amount it could be sold for in the taxpayer’s ordinary course of business (Austalasian Jam Co Pty Ltd v FCT).

Australasian Jam Co Pty Ltd

Taxpayer trading in jams and tinned fruit Used a ‘fixed’ valuation of stock for a number of years (argued this was correct under the Act) If using market selling price – look at what they would get if they sold ALL their stock as at 30 June Market selling looks at the sale price in the ordinary course of the taxpayers business Market value price is not the value of the goods if every unit is sold – so if markdowns are made to get rid of stock

(supply and demand) it doesn’t matter – it is calculated by reference to the price that would be realised in the ordinary course of the business.

REPLACEMENT VALUE

Value at which the taxpayer can replace the goods on the last day of the year of income.

Replacement goods must be available and substantially the same.

Price for that particular taxpayer (not the price that the person next door would pay) (i.e. Price that taxpayer would pay to replace the good).

OUTCOME

ValueEnd > ValueStart Assessable income includes the costs of goods that were purchases but not soled

ValueStart > ValueEnd Allowable deduction provides a deduction for the cost of goods purchased in prior years that were sold in this income year.

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DERIVATION

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INTRODUCTION

Section 6-5 requires taxpayers to include in assessable income for an income year the ordinary income derived during the income year.

The term ‘derived’ is not defined in tax legislation. Therefore derivation of income is determined by the application of ordinary business and commercial principles (Brent v FCT).

COMMISSIONER’S VIEW

In TR 98/1, the Commissioner expresses the view that:

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

o producing activities involve the sale of trading stock

o outgoings directly relate to the income derived

o relies on circulating capital or consumables to produce income

o rely on staff or equipment to produce income.

METHODS OF DERIVATION

There are two methods of accounting for income:

1. Cash receipts method – income is derived when it is received2. Accruals basis – income is derived as it is earned.

The taxpayer must uses the one that substantially reflects the taxpayer’s true income (Carden’s Case).

INCOME FROM EMPLOYEES AND TRADING

Employment income and income derived by individuals who conduct business as sole traders is derived on a cash basis (Carden’s case).

Carden’s Case (1938) 63 CLR 108

Taxpayer was the executor of Carden’s estate Dr Carden practiced medicine in WA He died on 15 Nov 1935 Up till 1929, he was operating on the accruals basis Prior to his death (until financial year 30 June 1935) Dr Carden operated on the cash basis (the great depression in

1929 – better to work on a cash basis) The cash basis would mean outstanding debts weren’t taxed At the time of the decision, the executive estate would have received fees earned by the doctor from 1 July 1935 to 15

Nov 1935 (date of death) – wouldn’t have been liable for tax assessment Commissioner issued an assessment based on the accruals method and sought to change previous financial year’s

assessment method to accrual method as well. HELD that Dr Carden didn’t derive his income until he received it – cash basis was most appropriate Influenced by factors including, the fact that there was no trading stock There was no fund from circulating capital And the fees he received were in effect a fee for personal skills and knowledge and training as a doctor So the Commissioner had no grounds to change the assessment method.

Caden’s was followed in FCT v Firstenberg which concerned the income of a sole practising solicitor who employed a secretary.

FCT v Firstenberg 76 ATC 4049

Sole practitioner – one employee (secretary) paid secretary 60 per week

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Operated on the cash basis. Commissioner assessed on the accruals basis Court held cash basis most appropriate – taxpayer was a professional and according to Carden’s case, it was more

appropriate to use the cash receipts method Taxpayer conducted a one-man practice by his professional skill and experience. The source of income arised from his

personal exertion Accrual basis for sole practitioner would be burdensome on the taxpayer Distinguished from Henderson

Brent v FCT (1971) 125 CLR 418

Taxpayer (Brent) was the wife of Ronald Biggs (Great Train Robbery) In Oct 1969 she was arrested in Melbourne where she was living with Biggs under another name Media hype about her life story with Biggs She accepted one of these offers and entered into an agreement that she would be paid $62,250 Sold rights to her life story Work completed by 1969 Payment of $ 62,250 Only received $10,000 – the rest of the money was still owing to her Her tax assessment notice came home, and it stated that her assessable income was $62,250 (even though she only

received 10,000 of it) The balance of the money was still only owing to Mrs Brent The only sum derived by the taxpayer was the $10,000 that she received Pointed out that there was no commercial practice or principle of accountancy which required the whole amount to be

assessed in that year in question Court referred to Cardin’s case and said that the taxpayer didn’t carry on business or profession, and had no stock in

trade What she received was a reward for personal services.

INCOME OF PROFESSIONAL PARTNERSHIP

The accruals basis is appropriate for the income of professional partnerships (Henderson).

Henderson v FCT

Accountancy firm that had 19 partners and employed 295 staff. Up until 1964, the firm had lodged its accounts on a cash basis. In subsequent years, the firm swapped to an accruals basis. The Commissioner, however, refused to accept the change of accounting method. HELD that the accruals basis was the appropriate method of accounting for the firm’s income in the income years

ending 1965. HC considered that the size, structure and method of operation of the firm were all relevant factors it could take into

account.

Accruals basis has also been applied to a pathology partnership consisting of five partners in Barratt & Ors. Just because legislation may prevent recovery action from being instituted until a certain period of time has lapsed, this does not necessarily mean that income has not been earned until the end of that period.

INCOME OF TRADING BUSINESSES

The accruals basis has been applied to taxpayers that carry on trading businesses (J Rowe & Son).

INCOME ARISING FROM CONDITIONAL CONTRACTS

Under an executor contract for the sale of land, unpaid purchase money does not become a debt until the contract has been completed by the execution and acceptance of a conveyance (Gasparin v FCT).

INCOME FROM ADVANCE PAYMENTS

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In most situations where a taxpayer receives an up-front payment for services, the taxpayer is treated as having derived the income at the time of recept.

However, this will not always be the case.

Arthur Murray (NSW) v FC of T (1965) 114 CLR 314

Taxpayer provided dance lessons for fees of various amounts Received payments in advance – placed in ‘untaught lessons account’ Once she gave the lesson/tuition, the money for that lesson was transferred to another account (distinguishing between

money earned and money not yet earned) Option to pay upfront or in instalments, and a discount was available for those who paid upfront If a student didn’t complete the course, there was no right to a contractual refund No refund policy (but in practice were sometimes given) Fees received in advance only became income when earned by the actual giving of the lessons Commissioner sought to tax on the basis of receipt (i.e. all the money in the “untaught lessons account”, even if the

taxpayer didn’t yet “earn” that income – as they had not yet provided the tuition yet) Full high court held that the taxpayer derived the prepaid tuition fees in the year in which the tuition was provided, rather

than the year that they received the money Taxpayer won again.

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GENERAL DEDUCTIONS

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INTRODUCTION

An allowable deduction is a general deduction or specific deduction.

Deductions are the counter of ordinary income and statutory income. There are two main types of deductions:

(a) Ordinary deductions; and(b) General deductions

Expenses incurred by taxpayers in earning assessable income may be deducted against that income to reduce the taxpayer’s final tax liability.

Expenses may be immediately deductible under the general deduction provision in s 8-1 of ITAA 1997 or under a specific deduction provision. Expenses that are not immediately deductible may be deducted over a number of years in certain circumstances.

STATE THE ISSUE

The issue here is whether the taxpayer can claim a general deductions for the [expenses] under s 8-1 ITAA97.

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FIRST POSITIVE LIMB - SECTION 8-1(1)(a)

The first positive limb of allowable deductions requires that there be:

1. Loss or outgoing2. To the extent that3. Incurred4. Sufficient nexus between deduction and income.

LOSS OR OUTGOING

The taxpayer must have incurred a loss or outgoing to claim a deduction under s 8-1.

LOSS

A loss arises where the taxpayer’s financial resources have been diminished.

The following are examples of a loss:

Where the taxpayer’s money has been stolen (Charles Moore); or Where bills and notes are issued at a discount to the face value for which they are required to be redeemed (Coles Myer

Finance). Bad debts (AGC (Advance) v FCT)

There must be an obligation to pay the amount OR there was no choice whether to pay the amount.

Charles Moore & Co

Store staff would deposit previous days takings in the bank (which was close to the store) Staff were robbed of 3031 pounds on the way to the bank Taxpayer did not have insurance Was the stolen money a loss? Loss was deductible because it was an outflow – it was not voluntary, the taxpayer had no choice in it happening, but

the reasoning of why it was deductible was because going to the bank the next day was just as much a part of the business itself, so the taxpayer was entitled to the deduction.

FCT v La Rosa

T was a convicted drug dealer. He buried $220,000 proceeds from a drug deal. Someone came to his backyard and dug up the money and stole it. Commissioner brought the case to court to try and assess the proceeds. T was trying to claim a deduction for the loss. Commissioner tried to argue that there was a public policy argument to not allow deduction for illegal activity. HELD that the $220,000 was a loss and therefore deductible

o Court applied the Charles Moore conception of ‘loss’

o Rejected Commissioner’s policy arguments by stating that punishment

o of those engaged in unlawful activities will be punished by criminal law

OUTGOING

An outgoing involves some form of payment, outlay or expenditure and includes:

payment of interest under a loan (Fletcher) payment of a premium under an insurance policy (FCT v Smith).

TO THE EXTENT THAT

The term ‘to the extent that’ indicates the concept of apportionment (Ronpibon Tin NL v FCT).

Apportionment is appropriate where the costs can be clearly distinguished, or where there is a lump sum that serves multiple purposes (Ronpibon Tin NL v FCT).

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IF non-arms length transaction:

Apportionment rules are likely to apply when the transaction is not at arms length (Ure v FCT).

Ure v FCT

Bank/finance company, solicitor and associate (i.e. family) Associate wanted a house Both borrowed money to finance the house – not for business and couldn’t be claimed as a deduction as there was no

nexus between the house and the business Taxpayer (solicitor) borrowed money at 12.5% interest He on lent to associates (family) at 1% interest Incurred 12.5% interest and generated income at 1% Used money for private purposes (residential property) Apportion to extent of income producing purpose – 1% allowed as a deduction Court looked at “to the extent that” – said that the extent that the 12.5% was incurred as generic income was 1% - the

other 11.5% had no relationship to the company as it was for a purely private purpose.

INCURRED

There must be a definite liability to pay, not merely an impeding, threatened or expected loss or outgoing.

A loss may be incurred even if it is unpaid, if the taxpayer has completely subjected themselves to the liability (Commonwealth Aluminium Corporation Ltd).

Provisions for losses or outgoings (such as provisions for bad and doubtful debts, and employment leave) are not incurred.

In some cases, subjecting yourself to the liability will not mean the outgoing is deductible in that year, and it may be apportioned (Coles Myer Finance).

Coles Myer Finance Ltd 93 ATC 4214

In-house finance to Coles Myer Group Drew bills of exchange and promissory notes (Coles Myer will pay $500,000 in 18 months’ time, if you give us $400,000

now) Meant legally obliged to pay amounts in future income years The court apportioned the deductions over the period of the contract Court came to this decision because there was a tax avoidance attempt by Coles Myer, so the court looked at the

subjective purpose Two issues –

1. When was the liability for the bills incurred?2. What period was the liability properly referable to?

Coles Myer Finance claimed that they incurred $500,000 today because as of today, they had an obligation to repay that money in the future and they were under a liability from that point in time (wanted a deduction sooner in this year, rather than needing to wait for it) – as soon as they drew that bill to the bank, the liability was incurred

Cmr argued that no liability arose until the due date – therefore, don’t incur it until you have to pay it Court held –

o In relation to the incurred issue – the relevance of the present existence of a legal liability on the part of a taxpayer

to meet the bills at a future date is that it establishes that a taxpayer has incurred, in the year of income, an obligation to repay that amount – so the court held that on the word “incurred”, the expenses were incurred in that particular income year but then said that what’s been incurred is not payable until the next year, and the outgoing relates to multiple income years. Therefore, the deduction should be apportioned over the 2 years. In short, yes the taxpayer has incurred an expense in a particular year, but still need to look at the extent of that that relates to income producing in a particular year

o Discounts on bills of exchange and promissory notes were partly deductible as the loss was of a revenue character,

it was incurred as a presently existing liability and properly referable to the income year.

FCT v James Flood P/L (1953) 88 CLR 492

Employer set aside amounts for employees holiday entitlements There were a number of conditions that could invalidate their entitlement The employer physically put money aside in a separate account – actual dollars were separated out Did not have to pay out money until holidays were taken Employer argued that they were entitled to a deduction because they physically put the money aside and incurred the

expense as the money is no longer circulating in the business

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Cmr said that it was not incurred because all the taxpayer did was put the money aside in a separate account – under no obligation to pay all of those monies; the taxpayer would only be under an obligation because they had completely subjected themselves to liability and there were conditions attached to employee’s entitlement to get paid. Because those conditions may not be satisfied, the employer would not have to pay and they did not completely subject themselves to liability

Therefore, no deduction.

NEXUS BETWEEN DEDUCTION AND INCOME

The loss or outgoing must be incurred in gaining or producing the taxpayer’s assessable income (ITAA97 s 8-1(1)(a)).

The court will be lenient with regards to the deductibility of outgoings incurred for subsidiary companies (FCT v Total Holdings (Australia) Pty Ltd).

This nexus can be demonstrated by showing that the outgoing:

was incidental and relevant to the production of income; or had the essential characteristic of being related to gaining assessable income; or taxpayer’s subjective purpose indicates so.

IN THE COURSE OF / INCIDENTAL AND RELEVANT TESTS

To establish the relevant nexus, the expenditure must be incidental and relevant to the production of assessable income (Ronpibon Tin NL v FCT).

This involves a comparison of the scope of the income producing activities and the relevance of the expenditure to the scope, rather than the purpose of the expenditure in itself (Herald Weekly Times).

There must be something more than a causal connection (Payne). In this case, the court held that travel between work as a pilot and deer farm business was incidental and relevant.

IF legal expenses and payments to settle a claim:

Here, the taxpayer has incurred Legal expenses and payments to settle a legal claim. These expenses are deductible (Herald and Weekly Times).

IF loss incurred terminating an employment contract prematurely:

Here, the taxpayer has incurred a loss in terminating an employment contract prematurely. These expenses will be deductible (W Nevill & Tin NL v FCT).

IF mines:

Here, the taxpayer is a mining company which owns mines. Mines were held to be capital expenditure and not deductible (Ronpibon Tin NL v FCT).

IF business ceases and paying premiums for workers compensation:

Here, the taxpayer’s business has ceased its operations and administrative functions and paid premiums for workers compensation. These expenses are not deductible (Amalgamated Zinc).

Herald and Weekly Times (1932) 48 CLR 113

Taxpayer was a newspaper publisher Incurred expenses for legal fees and payment to settle a defamation claim – in relation to an article that it published Cmr argued that the legal expenses weren’t in relation to the production of income because it wasn’t related to the sale

of newspapers (didn’t depend itself on the existence of a defamation action) – trying to argue that this expense was not deductible

Taxpayer argued that it was part of the business of publishing newspapers as you put articles in the newspaper, and by putting articles in the newspaper, you expose yourself to liability in defamation – so they argued that it was incidentally relevant to publishing newspapers, that you may have to defend yourself in a defamation action

Nexus existed between expense and income The liability to damages was incurred ‘because of the very act of publishing the newspaper’ Therefore, taxpayer was entitled to claim the deduction

Amalgamated Zinc (de Bavay’s) (1935) 54 CLR 295

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Taxpayer was a mining company and had ceased all mining operations in 1924 and administrative functions by 1929 for the Broken Hill area

Taxpayer continued an investment business Taxpayer remained liable to pay workers compensation premiums under state legislation after 1929 Taxpayer’s miners hadn’t worked since 1924 so cut down income related activities Taxpayer claimed a deduction for the premiums for its workers a number of years ago Nexus was NOT sufficient Cmr argued that the act of not mining was relevant – how can there be a nexus or relationship if there is no mining or

income produced? Mining stocks stopped 5 years prior The court acknowledged that Herald and Weekly Times case, but they distinguished this case because of the basis that

in Herald, there was a continuing business (the taxpayer in Herald was still publishing newspapers) whereas in this case, the company ceased to produce business – ceased the income producing activity.

W Nevill & Tin NL v FCT (1937) 56 CLR 290

Company had single management and decided to change over to joint management (put another manager on for a 5 year period)

Arrangements did not work and they wanted to pay out a director part way through a five year contract Contract terminated before the period expired Taxpayer argued that the loss incurred of paying out the director was deductible Cmr argued that it wasn’t deductible because the payment was for a future outgoing, and not producing income – it was

production of a future outgoing Nexus held to exist between payment and assessable income The payments in question were bona fide in the course of business in the interests of the efficiency of the business …

The expenditure was made for the purpose of increasing the efficiency of the company and increasing its income producing capacity

Ronpibon Tin NL v FCT (1949) 78 CLR 47

Tin mining operations carried on in countries occupied by Japan Had to cease activities (for a period) because of war During this time, they still had income from investment activities and the company continued these activities the whole

time Maintained administrative functions for period so they could resume mining after the war Taxpayer argued that expenses were incurred as a deduction for the successful income Cmr argued that because only a small amount of those expenses related to the income producing of the company, that

there should be some apportionment Argument was that income producing was investments, the mines which were just sitting there were not producing any

income at all, but even though there were some costs in relation to them, the court said that there had to be some apportionment.

Court looked at what was ‘incidental and relevant’ and said that the expenses were deductible and they were incidental and relevant to the extent that they were related back to the investment income of the company

Remitted the matter back for a determination of proper apportionment In this case, the mining company, or the mines, if it was not deductible expenditure, what is it? Non-deductible because

it was capital (no income producing from capital at that point in time) – so it was a capital expense.

ESSENTIAL CHARACTER OF INCOME PRODUCING EXPENSE

The court will look to the essential characteristic and nature of the outgoing to determine whether it is productive of assessable income (Charles More & Co (WA) Pty Ltd v FCT).

The mere fact that the expenditure is a pre-requisite to deriving income is not sufficient (Lunney and Hayley v FCT).

A requirement by an employer to incur an expense does not automatically make it a deduction (FCT v Cooper ).

IF travel expenses to and from work:

Here, the taxpayer is claiming expenses relating to travel to and from work. These expenses are not deductible as the essential character of using expenses to get you in a position to produce or gain income is a private expense, and is not connected to the production of income itself ( Lumney & Hayley).

IF childcare expenses claimed:

Here, the taxpayer is claiming expenses relating to childcare. These expenses are not deductible are they are not connected to the production of income itself (Lodge v FCT).

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Charles Moore & Co (1956) 11 ATD 147

Business takings stolen on the way to the bank Nexus looks at things ‘in the course of gaining or producing assessable income’ The loss has the ‘essential character’ of a business expense – the loss represented a natural or recognized incident of

the business operations The banking and income had an essential nature and character of being an activity relating to the business which is

income producing; and the fact that the loss was incurred in that activity, established a nexus Court allowed the deduction and that the banking of money is something to be done in the course of gaining or

producing assessable income So the banking is as much a part of the business as is putting goods on the shelves and selling them

Lunney & Hayley 100 CLR 478

Taxpayers claimed a deduction for bus/train travel from home to work There was no place of business at home Expenditure must be ‘incidental and relevant’ and whether it is so characterised depends on the ‘essential character’ Expenses were NOT deductible – the rationale was that if they allowed this for every time a commuter used public

transport, it would extend to every other expense they had Also, travelling to work is not incurred, in gaining or producing assessable income; the cost of travel is to get yourself in

a position where you can gain or produce income Note – you can claim deductions when you travel while you are at work – travel while working – because in this

instance, you are gaining or producing income while travelling (e.g. sales representative – part of their job is not only selling goods, but also travelling around to make sales)

The essential nature and character of using expenses to get yourself in a position to produce or gain income is a private expense, therefore not deductible as it does not have the relationship of producing income

PURPOSE TEST

The court will generally examine the outgoing objectively (Cecil Bros Pty Ltd v FCT). In this case, the High Court allowed deductions for a shoe retailer, even though it was overpriced.

The courts will generally leave it to the taxpayer to determine how they run their business, and will not inquire into the price paid, unless it is grossly excessive (FCT v Phillips).

FCT v Phillips

The taxpayer was a group of accountants who set up a services company to deal with the secretarial and other expenses.

The service company charged the partnership commercial rates for the services. The high court HELD that because this was commercially realistic, and not grossly excessive, the expense was

deductible.

However, in certain circumstances the court will go behind the objective circumstances to determine the taxpayer’s true purpose for incurring the expenditure (Magna Alloys & Research Pty Ltd v FCT). This will arise particularly where the deduction is greater than the income (Fletcher).

Magna Alloys & Research (1980) 11 ATR 276

This case concerned the 2nd positive limb of s 8-1 Taxpayer company directors convicted of criminal charges The criminal charges were related to the marketing strategies that the company adopted Charges related to gifts given to company customers – in short, they were offering bribes to their customers Taxpayer Company paid legal costs of directors who unsuccessfully defended the charges The subjective purpose is a relevant test to use where the taxpayer incurs expenditure particularly firstly where there is

no obligation to do so; and secondly, the expenditure is not to be found in whatever is deducted as assessable income The second part is relevant to this case – the company makes its income via sales of goods; defending the director of

the company does not generate income for the company – it is the director’s private affair, so paying for the directors’ legal fees isn’t what the company’s activities relate to – no direct relationship between generation of income and the expenses occurred

However, the court in looking at the subjective purpose test, and whether the amounts were deductible, the courts looked at 2 aspects – (a) Objectively, were the outgoings seen as reasonably desirable or appropriate to pursue the business ends of the

business?

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(b) Having established objectively whether it was desirable or reasonable, subjectively, did the person carrying on the business so see it? – was the company doing so to pursue their business ends?

The court looked at the outgoing, which was cost of defending legal charges and said that objectively, it was appropriate to pursue this business end or the business needs of the company because directors make decisions which generate the profit of the company so while they are still the separate entity, they are still part of the business ends or business needs of the company

Subjectively, that was what the company was doing – it was pursuing their business end Amounts were deductible

Ure v FCT

Bank/finance company, solicitor and associate (i.e. family) Both borrowed money to finance a house for the associate – not for business and couldn’t be claimed as a deduction as

there was no nexus between the house and the business Taxpayer (solicitor) borrowed money at 12.5% interest He on lent to associates (family) at 1% interest Incurred 12.5% interest and generated income at 1% Used money for private purposes (residential property) Apportion to extent of income producing purpose – 1% allowed as a deduction Court looked at “to the extent that” – said that the extent that the 12.5% was incurred as generic income was 1% - the

other 11.5% had no relationship to the company as it was for a purely private purpose In working out the apportionment, the courts looked at the subjective purpose test – looked at reasons of borrowing

money at high interest rate and on-lending at a low interest rate and the use that the money was being put to (one aspect was to buy a family home)

Objectively, as a third party looking at that, it appeared that the taxpayer was incurring the higher rate of interest for 2 purposes –1. to get the money to on-lend2. to get a family home (private purpose)

Subjectively, that is what the taxpayer did – they were intending to do this Therefore, there was apportionment of the deduction for the interest on the loan

FCT v Phillips (1978) 36 FLR 399

Taxpayer was a partner in a partnership and the partnership established a unit trust Accounting firm transferred clerical services to a unit trust Unit trust provided services back to the firm/partnership (clerical staff, office equipment, furniture etc) Unit trust charged the partnership a fee for services – the fee was a mark up on the original cost for the services to be

provided to the partnership (at commercial rates) Units in the trust issued to partners and family members – the unit holders in the unit trust were also the partners in the

partnership and members of the family What they were trying to do was to set up the unit trust which provided services to the partnership, the partnership

provided money back to the unit trust for the services but the services were marked up – so that by increasing the wages (expenditure to the unit trust) the income of the partnership will decrease and they would be liable to pay less tax

Commissioner tried to argue that because of the mark up, that part of the purpose was to save tax – tried to argue that, objectively, a business needs secretary and staff etc, but the other purpose was to split income with spouse and/or children

And Commissioner argued that subjectively this is what the taxpayer was trying to do Taxpayer applied the legal rights test – argument was that he provided accountancy services; as part of his business, he

needed clerical staff, furniture etc. The partnership got the deduction because the court didn’t see that there was an actual advantage outside of getting the

secretarial or admin services, so basically, the business needed services as part of their business and how they selected to get these services and furniture

Court also kept emphasizing that the payments being made were commercially realistic because the Cmr tried to argue that the mark ups were not commercially realistic. The court said that the amounts were commercially realistic because as a partnership, you are paying salaries and wages to an employee with a whole heap of other obligations (e.g. sick leave, workers comp, training costs etc).

The court did note that if the payments were commercially unrealistic, there would be a dual purpose and apportionment would be required

FCT v Fletcher (1992) 22 ATR 613

Partner in a partnership that entered into a complex annuity investment scheme – basically, for a small outlay (about 50,000 entered into the scheme and could get substantial deductions up front for the first 5 years, and for the next 5 years the deductions would decrease and the last 5 years there would be large amounts of income)

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Substantial tax deductions first 5 years; small deductions next 5 years and large income last 5 years Could pull out before last 5 years Cmr argued that you would only be entitled to the deductions to the extent that it didn’t exceed the assessable income –

Cmr trying to limit the deduction in the partnership HELD deductible in full IF the scheme ran for the full 15 years Whether or not the scheme ran for the full 15 years is a question of fact When looking at the subjective purpose test, the courts look at –

1. If outgoing gives rise to a greater amount of income, there is no real need to refer the taxpayer to the subjective purpose test to claim the deduction

2. If there is no identifiable income or a large disproportion between the outgoing and the income, it may be necessary to look at the subjective intention

In looking at the subjective intention of the taxpayer, need to look at the direct and indirect purposes behind incurring the expenditure and then make a common sense weighing of the factors

Once the court is satisfied that the nexus exists between the loss or outgoing, it is not for the court or Cmr to tell the taxpayer how to spend their money

SECOND POSITIVE LIMB - SECTION 8-1(1)(b)

Section 8-1(1)(b) only applies where the taxpayer is carrying on a business.

The elements are as per the first limb, plus:

1. ‘necessarily incurred’

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2. ‘in carrying on a business for the purpose’

NECESSARILY INCURRED

Necessarily incurred means that it is “clearly appropriate and adapted” (Ronpibon Tin NL).

The court will examine the business ends to which it is directed and often use a reasonable business person as a benchmark (FCT v Snowden & Wilson Pty Ltd).

The loss will not be necessarily incurred in carrying on the business where it would be instinctive for any person to defend and protect themselves against negative claims made against it (Snowden).

FCT v Snowden & Willson (1958) 11 ATD 463

This case didn’t satisfy the first limb as the loss or outgoing was held not to be necessarily incurred in carrying on the business

Taxpayer builder was a building company in SA Incurred expenses in responding to adverse (negative) publicity it received in relation to its activities It placed newspaper advertisements Incurred legal costs for representation at a ‘royal commission’ Taxpayer argued that it had necessarily incurred these expenses in carrying on the business and if they did not incur

these amounts, there would be a direct impact on their business The impact would be damage to goodwill of the business – taxpayers and the media ‘Royal commission’ engaged in

shonky activities and needed to defend itself from those activities otherwise the business would be destroyed Court said that it would be instinctive for any man to defend and protect himself against such claims It would naturally be seen as essential to the directors to protect the integrity of the company and repel or defend the

claims made against them No defence would be successful without the expenditure of money.

CARRYING ON A BUSINESS

There must be a nexus between the outgoing and the business, which may require a temporal connection (Steele v FCT).

EXPENSES DEDUCTIBLE

BEFORE BUSINESS

Outgoings that are preliminary to the commencement of business are not deductable (Softwood Pulp and Paper Ltd v FCT).

Softwood Pulp & Paper v FCT

Softwood was a company incorporated for the purpose of establishing a paper mill The taxpayer undertook feasibility studies to work out whether it was realistic to open a paper mill in Australia The funding from the backer was from Canada but never came through The company did not go ahead with the mill but it wanted to claim the deduction for accountancy and legal

expenses incurred in making the decision of whether to establish the company or not The Cmr argued that the expenses were incurred at a point too soon; when the expenses were incurred, the

taxpayer had not yet commenced carrying on the business – they were only in the investigatory stages of the business

HELD not to be deductible There was no relationship or connection with the generation of income and going back to s 8-1, there is no business

so there will be no relationship with the loss or outgoing with generation of income Also the 2nd limb only applies for the taxpayer carrying on the business – and the taxpayer was not carrying in a

business yet, so therefore, not deductible The lack of commitment to the project/establishment of the business was also a deciding factor The expenses were incurred to determine whether assessable income would or could be generated – point too

soon.

AFTER CESSATION OF BUSINESS

It has been traditionally believed that deductions were not available after the cessation of business (Amalgamated Zinc (De Bavay’s) Ltd v FCT).

However, the better view is that a cessation in business will not prevent deductibility (AGC (Advances) v FCT).

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A practical approach is taken to assess deductibility after the cessation of business (FCT v Brown).

Costs involved in selling a business are not deductible (Peyton v FCT).

Steele v FCT 99 ATC 4242

Taxpayer purchase land which was being used for agistment at a racing track Borrowed money to acquire the land Intention was to carry out a hotel development Taxpayer had every intention of developing a hotel on the land and there was evidence of architects being paid and

applications made to the council – intention to produce income and evidence to support the intention Ultimately, the taxpayer was unsuccessful in gaining local council approval to construct the hotel Land eventually sold without carrying out the hotel development The whole time, the taxpayer had finance and was incurring interest on a loan Taxpayer’s business was for hotel development Issue – could the taxpayer claim a deduction on the interest incurred even thought the hotel was never built Taxpayer argued that they could claim the deduction Cmr argued that it was a point too soon – nothing had been approved, nothing had been built The court held that the taxpayer could claim the deduction Whether the taxpayer’s activities is a question of fact and here, the court was satisfied that the taxpayer always had the

intention to develop the hotel – applied for council approval, receipts, architects etc Distinguished Softwood pulp – there was no commitment to establishing the business in that case, but in this case there

was a commitment to developing the hotel.

Placer Pacific v FCT 95 ATC 4459

Taxpayer company manufactured conveyor belts Business ‘sold’ the conveyer belt business in part in July 1981 Taxpayer remained liable for any claim arising from the conduct before the sale Legal action commenced for a faulty belt in August 1981 By July 1984 total conveyor business sold After 31/12/87 activity was invest & manage Claim settled in 1989 and deduction claimed Part of the settlement – there were damages and legal expenses incurred in taking the claim the whole way through The question was whether Placer Pacific was entitled to deductions from 1989 in relation to defective conveyer belts

from August 1981 (when the company had only conducted an investment management business) Deduction was allowed – the reason is because the occasion for the loss or outgoing was the sale of conveyor belts and

the sale of conveyor belts was part of their business The court provided that the occasion of the business outgoing is to be found in the business operations directed towards

the gaining or producing assessable income (income producing activity), the fact that the outgoing was incurred a year later does not determine the issue of deductibility

FCT v Brown 99 ATC 4600

November 1998 taxpayer & wife borrowed $105,000 to purchase a deli business It was unsuccessful so in March 1990 sold the deli for $65,000 $42,174 outstanding on the loan after selling They probably could have paid out the full loan at the time if they wanted to, but they chose not to and they decided to

continue to make interest payments on the loan in relation to the business that had already closed down Payments of interest & principal continued until 1995 when loan was extinguished Cmr argued that once the business ceased, the occasion for the loss or outgoing was in connection with carrying on the

business, but in the decision of the husband and wife not paying the loan – so argued that they only incurred the expense was because they chose not to pay out the loan

Taxpayer argued that the nexus or relationship between the business and the interest liability was not severed – it was for the sale of the business and it continued to be deductible

Court held that it was deductible because, although the business did cease, it did not break the nexus The court looked back to the occasion and the court said that the occasion for the loss or outgoing was to get the

finance to start the business, therefore, as the occasion was for generating assessable income, the interest on the loan was still deductible

Warning by the court – there may be a cut-off point in time where the loss or outgoing concerned is too far away from the time that the business ceased – there may a point in time where the income generation and the deduction is too far

Jone’s Case

Taxpayer husband and wife were in a partnership for a trucking business

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The partnership obtained a loan to buy a truck The husband drives the truck, husband dies Still outstanding amount from the loan for the truck Wife is elderly and has to go back to work as a nurse to pay the loan Wife refinances the loan so that she could get a cheaper interest rate to pay off the loan Cmr argued that the fact that she refinanced the loan has broken the nexus between incurring the deductible expense

(the interest) and the generation of income from the truck driving business – and so she cannot claim the deduction HELD that it was deductible even though it had been refinanced and a whole new loan that had nothing to do with the

business had been made BUT the occasion for the original loss or outgoing was the business of driving trucks therefore the nexus was still

present and it was deductible

FOUR NEGATIVE LIMBS - SECTION 8-1(2)

Even where a loss or outgoing satisfies the positive limb(s) of s 8-1, it will not be deductible where –

1. It is capital or capital in nature2. It is private or domestic in nature3. It is incurred in gaining or producing exempt income4. Provision of the Act prevents the amount being deductible.

CAPITAL OR CAPITAL IN NATURE

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Losses and outgoings are not deductible to the extent that they are capital in nature (ITAA97 s 8-1(2)(a)).

There are a number of different tests to determine whether an outgoing is capital in nature. The leading test is the business entity test.

ONCE AND FOR ALL TEST

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

ENDURING BENEFIT TEST

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

British Insulated & Helsby Cables v Atherton (1926) 10 TC 155

Taxpayer contributed $31,784 to a staff pension fund Purpose was to retain good staff Held that the money that was put into the fund was capital because it divided an enduring benefit – the enduring benefit

being the amount being paid into the fund to retain good staff (Note – this was back in the time when there was no such thing as superannuation therefore this is NOT authority that

superannuation is capital) Sometimes, superannuation can be paid quarterly so it can take on the form of income – as it is periodic, recurrent and

regular Not deductible bought into existence an asset with ‘enduring benefit’.

FIXED OR CIRCULATING CAPITAL TEST

An expense related to fixed capital will be capital, whereas outgoings related to circulating capital will not be capital in nature

Where the expense is related to circulating capital, it is of revenue character and is deductible (John Smith & Son v Moore). A circulating capital is that which comes back in your trading operations (e.g. trading stock, wages) (BP Australia v FCT).

BUSINESS ENTITY TEST

The focus of this test is to look at the profit making structure, as opposed to the process of operating the structure. If the expense went to the structure of the business operations, it will not be deductible.

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

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

Sun Newspapers (1938) 61 CLR 337

Newspaper company paid a competitor a lump sum (instalments over three years) NOT to produce a newspaper within 300 miles of Sydney

The rival went out of business Issue – were the payments that Sun Newspapers made capital or not capital? Capital in nature and NOT deductible under s 8-1

o The payment to another business from operating went to the structure of the business operations (i.e. to make your

competition go away) which is distinct from the process of operating the structure (e.g. paper, ink etc) Dixon – Three relevant factors

1. Does expenditure relate to business structure (not deductible) or the process of operating it (deductible)2. Nature of the asset or advantage sought – advantage sought here was to protect the business structure3. Degree of recurrence of the expenditure – if it is expenditure that occurs on a monthly basis, it would be not capital

and deductible

Mount Isa Mines v FCT 92 ATC 4755

Mining company claimed a deduction for cooling and roasting plant towers Towers demolished for employee safety Was this a capital expenditure or a deductible expenditure? The Commissioner argued that it was related to the business structure and capital nature therefore not deductible

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The taxpayer argued that it was incurred for the maintenance and upkeep for the business operations (the destruction of the towers was for the upkeep and maintenance; he was done for employee safety and rapid technological advances meant that this expense was normal

HELD to be capital because the expenditure was for the demolition of the towers itself which was capital – it was a once and for all expense as well

Therefore, capital expense and NOT deductible

PRIVATE OR DOMESTIC IN NATURE

Losses and outgoings are not deductible to the extent that they are private or domestic in nature (ITAA97 s 8-1(2)(b)).

Private expenses relate to a person as an individual, while domestic expenses relate to a person’s house or family organisation.

Some situations of private or domestic deductions include:

1. Home Study/Office2. Childcare Expenses3. Clothing4. Self Education Expenses.

HOME OFFICE EXPENSES

There are two different types of expenses that may be claimed:

occupancy expenses; and home study expenses (TR 93/30).

Occupancy expenses

Occupancy expenses (which include rates, repairs & interest on mortgages) are only deductible if the premises is a place of business (Swinford). It is not sufficient that the place is used as a matter of convenience (Handley).

Home study expenses

Home study expenses (ie lighting, depreciation on computer, etc) will be deductible if there is a sufficient nexus with income. Unlike occupancy expenses, these can be deducted even if the study is only used as a matter of convenience (Handley).

Apportionment may be required, which is usually done on a time and floor area basis.

The following factors will assist wither determining whether something is a place of business or not (TR 93/30):

Area is clearly identified as a place of business Area is not readily adaptable or suitable for private use Area used exclusively or almost exclusively for income producing Area is visited by clients

FCT v Forsyth (1981) 148 CLR 203

Barrister had city chambers Agreement with a family trust that the taxpayer would pay for the use of a study in the family home The barrister was trying to shift income from his business (himself) to the beneficiaries in the family trust (income

splitting arrangement) HELD not to be deductible – was a family home with the office being integrated into the house The home was not a place of business – the place of business was in his chambers in the city The study he was using at home was actually being used as a dressing room – so there were clearly private purposes;

no clients visiting there, not clearly identified as place of business etc

FCT v Faichney 72 ATC 4245

Taxpayer was a scientist with CSIRO Employer provided laboratory BUT limited reading area Part of job required him to publish and read colleagues work – journals and articles Claimed deductions for interest expense (for the home loan); proportion of electricity expenses and depreciation for

carpet, curtains & desk Question – was this or convenience or was it a place of business?

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The employer provided the taxpayer with premises with which to work from, but the taxpayer just didn’t like reading there, so working from home was for the taxpayer’s convenience

Therefore he could not claim the occupancy expenses – interest expense NOT deductible But he was able to claim the running expenses (proportion of electricity expenses and depreciation for carpet, curtains

and desk) – remainder of expenses were deductible

CLOTHING

The general principle is that clothing is not deductible as it is of a private nature, but there are very limited circumstances where deductions can be claimed.

Clothing may fall into one of 5 categories:

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

Conventional clothing

Conventional clothing is not generally deductible. However, in certain circumstances it will be deductible (FCT v Edwards).

In FCT v Edwards, the taxpayer was the private secretary to the governor, and had to have significantly expensive formal gowns to attend balls. The court allowed these as deductions for a number of reasons, including that she had to change multiple times throughout the day.

FCT v Edwards 94 ATC 4255

Private Secretary to governor She had to attend lots of parties and it was not uncommon for her to go through 3 or 4 outfits in the day (conventional

clothing but clothing that she would not normally wear everywhere) The court held that she was entitled to a deduction for the excess that she would normally require as part of her

conventional clothing She kept records of how her costs have increased since working for the governor 2/3 deduction for conventional clothing worn in course of duty SPECIAL CASE – deductible as had to wear a number of formal outfits in a single day.

Items of clothing to protect against harsh working conditions may be deductible (Mansfield v FCT).

Mansfield v FCT 96 ATC 4001

Flight attendant claimed panty hose, body moisturizer, hair moisturizer and shoes Reason she claimed the moisturizer was because of the abnormal conditions she worked in – pressurized cabin that

had a dehydrating effect on her skin She claimed the shoes because they were half a size bigger than what she normally wore (harsh working conditions

required this) The airline had a strict uniform policy and failure to comply with the policy could result in dismissal (strictly enforced) DEDUCTIBLE – working conditions on aircraft Pantyhose deductible because part of uniform; shoes deductible because of harsh working environment meant that she

needed shoes that were half a size bigger; moisturizer deductible because of the harsh working environment; hair moisturizer was deductible because of harsh working environment.

Compulsory uniforms

A compulsory uniform is not private or domestic in nature if it creates a distinctive image – a requirement to wear a particular colour, brand or style is not sufficient (TR 96/16).

It includes a collection of inter-related items of clothing and accessories that is distinctive to a particular organisation is also deductible (TR 97/12).

Non-compulsory uniforms

Deduction for a non-compulsory uniform (s 34-15 definition) is available where –

You can deduct under another provision of the ITAA97; and

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Design is registered (s 34-10).

Example of criteria for design to be registered:

Company logo 1cm x 1cm and identifiable from 2 meters Not more than 8 separate colours

Protective clothing

Protective clothing is not private or domestic in nature, even if it could be classified as conventional clothing, provided in the circumstances it is used as protective clothing (TR 2003/16 ).

For example, sun protection items are not private in nature and are deductible (Morris v FCT).

Occupation specific clothing

Occupational specific clothing is generally deductible (s 34-20(1)). It includes clothing that identifies you as belonging to a particular trade, vocation, occupation or calling.

TRAVEL

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

Exceptions include:

commencing work at home prior to travelling to work an itinerant worker whose home is their base of operations where there is a need to transport heavy or bulky material (FCT v Vogt).

The cost of travel between unrelated workplaces are deductible under ITAA97 s 25-100 ).

Capital expenditure cannot be deducted (s 25-100(5)).

You cannot deduct the cost of an accompanying relative, if their presence is not related to producing assessable income (ITAA97 s 26-30).

CHILD CARE

Child care is not deductible because it is private or domestic in nature (Lodge v FCT).

SELF EDUCATION

Self-education expenses are generally deductible because there is usually a nexus to assessable income.

A deduction will not be allowable for an initial qualification because this is capital in nature (FCT v Finn).

Self-education expenses will be deductible where they improve or maintain the taxpayer’s skills, or objectively is likely to lead to an increase in income from the taxpayer’s current income producing activities.

This will be satisfied where:

it leads to a promotion (FCT v Hatchett) it improves earnings (FCT v Highfield).

Hatchet’s case

Hatchet was a teacher with 2 years training Claimed deduction for a fee to submit a thesis and an Arts degree which was necessary for promotion The thesis fees were deductible

The Arts degree was not deductible – because there was no connection with his production of income, apart from the fact that he was a teacher

In Anstis v FCT, the court held that various university expenses were deductible because they related to the youth-allowance, which was assessable income and conditional upon passing, and therefore met the deductibility requirements.

Deductions will be available even if the training involves an overseas trip (ie to go to a conference) (FCT v Finn).

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A deduction is not available for HECS or HELP (ITAA97 s 26-20).

Section 82A ITAA36 limitation

Section 82A ITAA36 renders the first $250 of self-education expenses from prescribed education courses non-deductible.

The first $250 in relation to the self-education expense is not deductible. Any amount in excess of $250 will be deductible.

A deduction is only available for a prescribed education course (e.g. school, college, university) where the course is undertaken to gain qualifications for use in carrying on of a profession, business, trade or employment.

LEGAL EXPENSES

Legal expenses are generally of a revenue nature and therefore not deductible (Hallstroms).

Some legal expenses are clearly of a capital nature – e.g. conveyancing costs in connection with the purchase of real estate, legal fees in connection with the purchase or establishment of a business or other capital asset for use in a business.

Deductible

The following are examples of deductible legal expenses:

(a) costs of defending proceedings for the unauthorized use of a trademark;(b) costs of patent infringement action;(c) costs of defending an employee against corruption charges and assault charges;(d) costs incurred by an employee to prevent defamatory statements being made by a colleague;(e) damages paid in settlement of a misrepresentation claim against an estate agent;(f) costs and damages of an employer in an employee's personal injuries claim against the employer;(g) costs of a landlord in ejectment proceedings against a rent-defaulting tenant;(h) damages and costs of a newspaper in defending a libel action – see Herald and Weekly Times (1932) 48 CLR 113;(i) costs incurred by a company in supporting an application by an ex-director for leave to resume his activities as a director

notwithstanding a prior conviction – Magna Alloys & Research 80 ATC 4542); and(j) costs of defending an action for wrongful dismissal brought by a former director.

Non-revenue legal expenses

The following are non-revenue legal expenses:

(a) costs of settlement of breach of contract action, the result being that the taxpayer was free to reorganize its trading structure and method;

(b) costs of defending the legal validity of a contract on the basis of which the viability of the taxpayer's business depended;(c) costs of defending a driving charge where the taxpayer's employment was conditional on holding a driver's licence;(d) trustee's expenses of opposition to an action for the trustee's removal;(e) publisher's costs of defence to criminal libel prosecution;(f) costs of eviction proceedings against a tenant whose term had expired;(g) costs of action for damage done to a rent-producing property;(h) costs of a public servant's defence in inquiry on charges of failure to obey an order;(i) legal expenses incurred in seeking to regain employment by a policeman who was dismissed following a Police Integrity

Commission inquiry;(j) costs of a company in resisting winding-up action by a dissident shareholder;(k) costs of preparing a contract for performance of services and payment of royalties;(l) costs of resisting land resumption and disputing the compensation amount; and(m) payments made by a solicitor suspended from practice to cover legal and investigation costs incurred by the Law

Society where the payment was a prerequisite to resumption of practice.

INTEREST EXPENSES

Interest expenditure is one of the most common forms of outgoing for which deductions are regularly sought under the general deduction provision.

Interest represents the cost of borrowing money and it includes ‘compound interest’ (Hart & Anor).

Character of interest ordinarily depends on the use of the borrowed funds

The deductibility of the interest payable on a loan will usually depend upon the objective use to which the borrowed funds are applied (Munro).

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IF used to acquire income-producing asset:

If the taxpayer borrows the money for the purpose of using it to acquire an income-producing asset, they would ordinarily be entitled to claim a deduction for the interest payable on the loan (Munro).

IF used for non-income producing purposes:

If the taxpayer uses the borrowed funds for non-income producing purposes, the interest payable on the loan will not bedeductible (Munro). This is the case even though the borrowings enable the taxpayer to retain income-producing assetswhich the taxpayer might otherwise have had to sell.

RENT AND LICENCE FEE EXPENSES

Rental payments

Taxpayers are generally not entitled to deduct rent paid to lease their office premises because the cost of acquiring the asset is generally capital in nature as it provides an enduring benefit.

As a general rule, deductions are allowed for the payment of rent provided the only immediate advantage secured by the taxpayer from making the payment is the use of an income-producing asset over the term of the lease (South Australian Battery Makers).

Licence fees

Licence fees paid for the right to exploit income-producing assets over a period of time will usually be deductible revenue outgoings provided the taxpayer does not obtain any permanent ownership rights in relation to those assets (Citylink Melbourne).

Payments to secure a licence or lease

Payments that are made for the purposes of securing a licence are likely to be capital in nature (Star City v FCT).

INCURRED IN PRODUCING EXEMPT OR NON-ASSESSABLE NON-EXEMPT INCOME

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

PROVISION PREVENTS THE DEDUCTION

An outgoing is not deductible if a specific provision denies it (ITAA97 s 8-1(2)(d)).

Penalties (s 26-5) Higher education contributions (s26-20) Family maintenance payments (s26-40) Entertainment expenses (s32-5) Recreational club expenses (s26-45) Non-compulsory uniforms (Div 34) Car packaging expenses (s 51AGA) First $250 of certain self education expenses (s 82A).

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SPECIFIC DEDUCTIONS

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INTRODUCTION

The tax law contains a number of specific deduction provisions. A list of these provisions is contained in Division 12 ITAA97.

The specific deduction provisions provide deductions for particular kinds of expenditure that might not be deductible under the general deduction provision in s 8-1.

STATE THE ISSUE

The issue here is whether the taxpayer can claim a deduction for the [expenses] under one of the specific deduction provisions.

OVERVIEW OF SPECIFIC DEDUCIONS

Some of the areas include:

Repairs: s 25-10 ITAA97. Uniform Capital Allowance Regime (Depreciation): s 40 ITAA97. Tax related expenses: s 25-5 ITAA97. Bad Debts: s 25-35 ITAA97. Loss by Theft: s 25-45 ITAA97. Council Rates: s 25-75 ITAA97. Travel Expenses Car Expenses: Div 28 ITAA97. Gifts and Donations: Div 30 ITAA97. Prior Year Losses: s 36-15 ITAA97.

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REPAIRS - SECTION 25-10

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

WAS EXPENDITURE INCURRED?

An expenditure must occur – a saving is not sufficient.

WHAT IS A REPAIR?

‘Repair’ is not defined in the Act. According to the common law, what is a repair is a question of fact and degree and depends on the individual case

MINOR IMPROVEMENT

There are some circumstances where a minor improvement is okay, as long as there is no significant increase in the functionality, in which case it would be an improvement rather than a repair and will not be deductible under s 25-10.

MAINTENANCE

Repair needs to be contrasted from maintenance. In a legal sense, there is a difference between the two. Maintenance would be deductible under s 8-1 as a ‘loss or outgoing in order to produce income’, whereas a repair is deductible under s 25-10.

Costs that are incurred to bring an asset into a workable are not repairs, but rather form the cost of the acquisition (W Thomas & Co v FCT).

REQUIREMENTS OF A REPAIR

In order to be considered a repair, there are a number of requirements which must be satisfied:

1. Item must be in need of repair2. Repair restores item to its previous condition3. Repair replaces PART of an item, not the whole item4. Notional repairs are not deductible5. Capital repairs are not deductible

ITEM IN NEED OF REPAIR

The item must have needed repair or restoration (Case J47).

RESTORATION TO PREVIOUS CONDITION

The repair must be for the purposes of restoring the item (W Thomas & Co v FCT).

To be a repair, the expenditure cannot lead to a functional improvement in the quality of the asset (FCT v Western Suburbs Cinemas).

However, more modern materials may be used without it being considered an improvement (Wates v Rowland). It is a question of the function of the repair, not its material per se (W Thomas & Co).

ENTIRETY NOT PART

A repair is not a reconstruction of the entirety (Lurcott v Wakely and Wheeler).

Whether it constitutes a part or the entirety is a question of fact (TR 97/23).

To determine this, the court looks at whether the item is a subsidiary of an other item, or an entirety in itself. The courts have applied a test as to whether it is a ‘physically, commercially or functionally’ inseparable part of a large unit, or a unit in itself (Lindsay v FCT).

IF bake furnace:

In Alcoa of Australia Ltd, a bake furnace was held to be the entirety, despite it’s two main components (brickwork and a waste gas duct) being listed separately in the company’s books.

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IF railway track system:

In Rhodesia, the whole railway track system was held to be the entirety.

W Thomas & Co v FCT (1965) 115 CLR 58

Taxpayer purchased new business premises and incurred a number of expenses in the new premises There were 2 types of expenses – those that related to fixing up the premises and the construction of lunchrooms etc Premises were previously used to manufacture spices so they had to be “sanitised” so not to contaminate the taxpayer’s

products (fixing up) Taxpayer argued that the cost of fixing up was deductible and that the other costs were not Deductions claimed for:

o Roof and guttering and basement floor repairs (fixing up – repair)

o Repairs to walls and painting (fixing up – repair)

o Alteration and enlargement of office (not deductible as repair)

o Installation of lunch room and other amenities (not deductible – capital)

o Repairs to a wooden floor (fixing up – repair)

The building was the entirety Judge made a number of comments – repairs to a whole are often made by the replacement of worn out parts On the facts here, the building was the whole part (or the entirety) and could be repaired by replacing parts such as

roofing and guttering Repair involves restoration of a thing to a condition it formerly had, without changing its character Restoration of efficiency and function is the thing that’s important – not necessarily exact replication Any expense incurred in rendering it as suitable for use, should be considered capital, not a repair, and therefore not

allowable as a deduction Taxpayer argued that it was all deductible because it was related to fixing up the premises HELD that while they were fixing up the premises, the expenses were incurred for making the premises suitable for use,

therefore, it was not deductible If you are repairing something, you are remedying a defect, but when you buy something to fix, you can’t claim

deduction because you didn’t buy it to produce income – anything that wasn’t used to generate income... On the facts, no deduction available for any of the items claimed by the taxpayer – because can’t repair the property for

income producing purposes unless the property was already an income producing asset At the point when the property was purchased, the expenses were made in order to get the premises up and running

Lindsay v FCT (1961) 106 377

Taxpayer repaired ships at business premises Premises included two slipways Timber slipway replaced with a concrete slipway because no timber was available Evidence suggested that the concrete and timber were about the same price and there were no real advantages of

timber New slipway was longer but the length did not create any greater efficiency Taxpayer didn’t claim a deduction for the extended part – only claimed deduction for the extent (length) that the old one

was (i.e. only claimed deduction for 30m rather than 40m because the timber slipway was 30m) Taxpayer argued that it was deductible as a repair because the slipway formed part of their business operations –

needed slipway to get ships out on the river Cmr argued that the slipway was an entirety Slipway was an entirety – replacement of an entirety could not be claimed as a deduction under s 25-10

NOT NOTIONAL OR CAPITAL REPAIR

Notional repair

Notional repairs are not deductible as the taxpayer must carry out the repairs and they must incur an expense: Cmr v Western Suburbs Cinema. Therefore, a taxpayer cannot claim a deduction on what they would have been able to claim had they repaired the item, rather than restoring it.

Commissioner v Western Suburbs Cinema (1952) 86 CLR 102

Had two choices to make – 1 repair the hole in the ceiling which would cost 600 pounds or 2 replace the entire ceiling at a cost of 3000 pounds

It was impracticable to repair the ceiling because of new and improved products Taxpayer decided to replace the ceiling and paid 3000 and claimed the deduction for the 600 pounds – he was saying

that he should have received the deduction because if he repaired it, he would have been able to get a deduction

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HELD that they could not claim the 600 pounds in repairs Cannot carry out capital repairs and then claim any savings in any deductible repairs.

Capital repair

Capital repairs are not deductible (s 25-10(3)).

Three types of capital repairs:

1. Additions and alterations – Additions and alterations to a capital asset will not be deductible2. Improvements – Repairs restore an item to their former position while an improvement makes them functionally better3. Initial repairs – Expenses incurred to repair an item to make it suitable for use (e.g. in W Thomas & Co case) is not

deductible. Can’t repair the property for income producing purposes unless the property was already an income producing asset.

IF item used partly for income producing purpose:

Apportionment on a reasonable basis of repairs to an asset used partly for income-producing purposes and partly private purposes (s 25-10(2)).

What is reasonable is a question of fact.

Commissionerr v Western Suburbs Cinemas (1952) 86 CLR 102

Taxpayer owned a cinema Replaced a tin ceiling with a fibro ceiling Fibro sheeting had some advantages over tin Considered to be an improvement because replacing the tin with fibro would significantly reduce future repairs Therefore, could not claim a deduction under repairs

Law Shipping Co v IRC (1924) 12 TC 621

Taxpayer purchased a ship for 97,000 pounds Ship needed work (required a lot of repairs) before it could sail with freight Were allowed to do one journey under the contract 51,558 pounds spent to get the ship seaworthy (over half the purchase price) Tried to claim a deduction Held to be not deductible because they were capital expenditure

Odeon Associated Theatres Ltd v Jones (1972) 1 All ER 681

Taxpayer acquired theatres after WW2 Theatres in poor condition because of war time restrictions – could not repair the theatres during time of war (rationing

materials for war effort) Repairs were completed over a 10 year period They were held to be able to claim a deduction The dilapidation did not affect the price paid, the repairs were not an immediate remedy for public safety and the initial

owners could not repair because of the wartime restrictions Expenses were held to be deductible

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DEPRECIATING ASSET

A taxpayer may deduct the decline in value of a depreciating asset held during the income year (ITAA97 s 40-25 (1)).

The deduction must be apportioned to the extent that the asset is not used for a taxable purpose (ITAA97 s 40-25(2)).

Five Steps to consider in working out UCA regime

1. Must have a depreciating asset: s 40-302. Must have a holder of the depreciating asset: s 40-403. The depreciating asset must have a taxable purpose: s 40-25(7)4. Calculate the depreciation for the income tax year: s 40-70; 40-72; 40-755. Calculate the tax consequences of any balancing adjustment events (evens out the adjustments).

IS THERE A DEPRECIATING ASSET?

A depreciating asset is (s 40-30(1)):

An asset Of limited effective life That is reasonably expected to decline in value

IF trading stock:

Trading stock is excluded from being a depreciating asset (s 40-30(1)(a)).

IF land:

Land is excluded from being a depreciating asset (s 40-30(1)(a)).

Other exclusions

Does not apply to an eligible work related item for the purposes of section 58X of the FBTAA (ITAA97 s 40-45).

where Division 43 (Capital works regime) (ITAA97 s 40-45).

Where the special rules regards Australian films apply (ITAA97 s 40-45).

Where it is deducted under another sub-division (ITAA97 s 40-50).

For a car, where you use the cents per kilometre or 12% of original value method (ITAA97 s 40-55).

DOES TAXPAYER HOLD THE ASSET?

The taxpayer must hold the asset (ITAA97 s 40-25).

Section 40-40 sets out a table of who holds the asset in certain circumstances.

Generally, the legal owner will be the holder.

TAXABLE PURPOSE?

The depreciating asset must be held for a taxable purpose.

A taxable purpose is (s 40-25(7)):

(a) the purpose of producing assessable income;(b) the purpose of exploration or prospecting; (c) the purpose of mining site rehabilitation; or(d) environmental protection activities.

DECLINE IN VALUE?

In calculating the income tax year there are a number of steps which must be followed:

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1. When do you start depreciating the asset (s 40-60 ITAA97).2. Two methods for decline in value (s 40-65 ITAA97).

(a) Prime Cost method (s 40-75 ITAA97).(b) Diminishing value (s 40-70/72 ITAA97).

STARTING TIME

A depreciating asset starts to decline in value from its ‘start time’ (s 40-60(1)) being the time at which the entity first uses the asset or has it installed ready for use for any purpose.

STARTING VALUE

The starting value of the asset is:

the amount paid for it (s 40-180); plus the cost to bring the asset into its present condition and location (s 40-190).

The starting value is reduced by the amount of Input Tax Credits {GST} available to the entity (s 27-80).

Cars that are over a certain limit (2007-08 = $57,123; 2008-09 = $57,180) are limited to that amount (s 40-230).

EFFECTIVE LIFE

Pursuant to s 40-95, the taxpayer may choose to:

adopt the Commissioner’s effective life published in tax rulings (s 40-100); or calculate their own effective life (s 40-105). If this method is adopted, it must be calculated in accordance with

reasonable wear and tear, or how long the entity expects until it will scrap the asset (s 40-105(2)).

CALCULATION

The taxpayer may choose between the diminishing value or prime cost method (ITAA97 s 40-65(1)).

Diminishing Value: post 9-May 2006 assets

Decline in value =Base Value ´Days held365

´200 %Asset©s Effective Life

Diminishing Value: pre 10-May 2006 assets

Decline in value =Base Value ´Days held365

´150 %Asset©s Effective Life

Prime cost

Decline in value =Base Value ´Days held365

´100 %Asset©s Effective Life

Base value

The base value is (s 40-85):

the cost value in the first year; or the opening adjustable value of the asset, which is the cost of the asset plus any capital improvements to the asset,

less the decline in value

Balancing adjustments

When a taxpayer ceases to hold an asset it must make a balancing adjustment (s 40-285).

Where the asset was worth less than anticipated – i.e. the termination value is less than the adjustable value – this difference is deductible (s 40-285).

Where the asset was worth more than anticipated – i.e. the termination value is more than the adjustable value – this difference becomes income (s 40-285).

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IMMEDIATE DEDUCTION

You can immediately deduct depreciating assets that are predominantly used to produce assessable income that is not income from carrying on a business, if the cost does not exceed $300 (ITAA97 s 40-80).

When you are not in business, and you acquire a capital asset for less than $300, you can claim a deduction for the $300 upfront (even though it is capital and non-deductible under s 8-1). This provision does not apply to people who are carrying on a business – only applies to salary and wage earners.

LOW COST PLANT

Assets that cost less than $1,000 or have an opening adjusting value of less that $1,000 may be placed in a low-value pool (s 40-425).

The asset must be a depreciating asset used for a taxable purpose (ITAA97 s 40-425(2)).

Once the asset is put in the pool, it must remain in there (s 40-439).

If you choose to have a low-value pool, you must put all low-value assets in the poo (s 40-430). This does not apply to plant acquired prior to 1 July 2000, where it can be allocated on an item by item basis.

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TAX RELATED EXPENSES - SECTION 25-5

Tax expenses are deductible (ITAA97 s 25-5).

Tax affairs is defined in s 995-1 and it restricts to income tax (excludes GST, Fringe benefits tax – which may still be deductible under s 8-1).

Some of the things included that you can deduct under s 25-5 are –

Preparation of tax return Tax audit fees Tax planning advice

BAD DEBTS - SECTION 25-35

Section 25-35 allows taxpayers to deduct a debt written off as bad in an income year if:

(a) It was included in the taxpayer’s assessable income for the income year or an earlier income year, or(b) It is in respect of money lent by the taxpayer in the ordinary course of the taxpayer’s business of moneylending.

There are four elements:

1. Debt must exist Money presently entitled to receive

2. Debt must be bad (refers back to commercial basis) Reasonably and commercially show the debt is bad through the age of the debt, recovery action / payment

arrangements – would reasonable person in commercial context consider the debt ‘bad’3. Debt must be written off

Written details to show the debt is bad4. Debt included in income in a prior year

If you claim a deduction because of a bad debt and then subsequently receive payment of that debt, you have to put it back into income as assessable income (ss 20-35, 20-40).

LOSS BY THEFT - SECTION 25-45

A deduction is allowable where (s 25-45):

the taxpayer discovered the loss in the income year; there was loss caused by theft, stealing, embezzlement, larceny, defalcation or misappropriation by your employee or

agent; and the money was assessable income in an earlier income year.

Section 25-45 applies where there has been a loss by an employee or agent but only if the loss was included as income in the earlier year.

Again, if the money is subsequently recovered, then you have to claim that amount as assessable income.

COUNCIL RATES - SECTION 25-75

Council rates may be deductible under s 25-75. The same principles apply as under s 8-1.

Can claim a deduction for:

Rates which are annually assessed Land tax imposed under a State or Territory law.

TRAVEL EXPENSES74

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Travel expenses are covered by section 8-1, however there are some statutory provisions:

The cost of travel between unrelated workplaces are deductible under ITAA97 s 25-100. Capital expenditure cannot be deducted (s 25-100(5)).

You cannot deduct the cost of an accompanying relative, if their presence is not related to producing assessable income (ITAA97 s 26-30).

TRAVEL OVERSEAS FOR WORK

Section 8-1 principles apply:

If purpose is to expand business structure (e.g. travel for the purpose of deciding whether to change income producing activity, that is, a business totally different to what your income producing activity is now) – NOT deductible

If purpose is to keep aware of new developments in your field, to expand your knowledge so that you can increase your income (e.g. attend conferences etc ) – deductible.

TRAVEL BETWEEN HOME AND WORK

Section 8-1 principles apply:

Generally not deductible No nexus with producing income; or Private or domestic expense

There is an exception where the taxpayer is required to carry bulky equipment to work and there is no place to secure the equipment at the work place.

TRAVEL BETWEEN TWO PLACES OF WORK - SECTION 25-100

Only applies to expenses incurred from 1 July 2001 – as a result of Payne’s case

Therefore, the current position is that if you go from one income producing activity to another, you can claim a deduction for your travel expenses. This provision also applies if you catch public transport to travel between workplaces.

Transport expenses to the extent it is incurred in travel between two workplaces No deduction if one place is the place where you reside – s 25-100(3) Cannot deduct amounts of capital expenditure – s 25-100(5).

CAR EXPENSES - DIVISION 28

Div 28 provides for the deduction of car expenses by individuals (or partnership consisting of an individual) (s 28-10).

For each income year, the taxpayer may chose one of the 4 methods to calculate car expenses (ITAA97 s 28-15 & 28-20).

CENTS PER KILOMETRE - SECTION 28-25

Section 28-25 only applies for 0 - 5,000 km and no substantiation is required.

Under the cents per kilometre method, you multiply the number of business kilometres by the number of cents based on the car’s engine capacity (s 28-25(1)).

The business kilometres are capped at 5,000 km (s 28-25(2)).

Business kilometres are those the car travelled in the course of producing assessable income or for travel between workplaces (s 28-25(3)).

12% OF ORIGINAL VALUE - SECTION 28-45

Section 28-45 only applies if the business kilometers exceeds 5,000 km.

If you have travelled more than 5,000 km (28-50).

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This method allows you to deduct 12% of the acquisition cost or if the car is being leased, the market value of the car when the lease began (s 28-45).

This value of the car is capped at the car limit (57,180 in 08/09) (ss 28-45(2) & 40-230).

Business kilometres are those the car travelled in the course of producing assessable income or for travel between workplaces (s 28-25(3)).

No substantiation is required (s 28-60).

ONE THIRD ACTUAL EXPENSES - SECTION 28-70

A person may use the one third of actual expenses approach if they have used the car for more than 5,000 business kilometres (s 28-75).

Business kilometres are those the car travelled in the course of producing assessable income or for travel between workplaces (s 28-25(3)).

This method allows you to deduct a third of deductible expenses used in relation to the car (s 28-70).

Thus, these expenses such as registration, petrol, depreciation & interest will be deductible, but outgoings such as tolls & fines will not be included. Expenses that are capital in nature are not included (s 28-13).

LOG BOOK METHOD - SECTION 28-90

You must hold the car to use the log book method (s 28-95).

Under this method you can deduct car expenses to the extent of your business use percentage (ie the percentage you use the car for business purposes) (s 28-90).

Thus, these expenses such as registration, petrol, depreciation & interest will be deductible, but outgoings such as tolls & fines will not be included. Expenses that are capital in nature are not included (s 28-13).

You must substantiate expenses and keep a log book for all journeys in the car for a continuous period of 12 weeks in the income year (ss 28-100, s28-110 & 28-120).

You can use the same log book statistics for the next 4 income years (s 28-115).

GIFTS AND DONATIONS - DIVISION 30

There is a separate division for gifts and donations because the test in s 8-1 requires that the loss or outgoing have a nexus with generation of income, and gifts and donations have no such nexus.

Gifts are voluntary transfers of property with no strings attached, or benefit conferred (FCT v McPhail).

A gift is deductible where it is provided to Deductible Gift Recipients (s 30-15). DGRs are listed in Div 30 and it includes public hospitals and public universities.

The gift must be over $2, and may be in money or property, provided that the property was purchased within the previous 12 months.

The gift cannot be a testamentary gift.

PRIOR YEAR LOSSES - SECTION 36-15

The taxpayer may deduct previous year losses (ITAA97 s 36-10).

When calculating your loss, you must deduct exempt income and any other losses (s36-10).

Losses incurred after 1 July 1989 can be carried forward indefinitely, however those before that date were limited to 7 years.

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CAPITAL

GAINS TAX

EXAM SUMMARY

1. Determine whether there is a CGT event2. Determine whether a capital gain or a capital loss arises under the CGT event3. Determine whether the capital gain or capital loss is disregarded

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INTRODUCTION

The CGT was a Labor government initiative that was introduced in Australia on 20 September 1985.

Before this time, gains that were not of an income nature usually escaped tax unless one of a limited number of statutory income provisions applied.

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IS THERE A CGT EVENT?

A capital gain or capital loss only arises if there is a CGT event (s 102-20).

Section 104-5 sets out the CGT events.

If more than one exception arises, you generally use the most specific event (s 102-25).

CGT assets are broken up into 3 categories, and depending on what category the asset falls into, certain rules will apply.

For each CGT event the section:

Describes how the gain (loss) arises Identify when the gain (loss) arises Specifies how to calculate the gain (loss) Identifies specific exceptions that may apply.

LIST OF SELECTED EVENTS

Here, there is a CGT event:

A1 because there was a disposal of a CGT asset (s 104-10) B1 because the use and enjoyment of the CGT asset passed before title (s 104-15) C1 because a CGT asset was lost or destroyed (s 104-20) D1 because there was a creation of contractual or other rights (s 104-35) E1 because a trust was created over a CGT asset (s 104-55) E2 because a CGT asset was transferred into a trust (s104-60) F1 because a lease was granted (s 104-110) F2 because a long-term lease was granted (s104-115) I2 because the taxpayer stopped being an Australian resident (s 104-170)

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IS THERE A CGT ASSET?

CGT assets are defined broadly as any kind of property or a legal or equitable right that is not property (s 108-5(1)).

A proprietary right must be capable in its nature of assumption by third parties (The Queen v Toohey).

IF legal or equitable right that is not property:

Rights are that legal or equitable in nature can constitute a CGT asset. While they are not proprietary in nature, they are still enforceable in court.

It will include the right of a patient to sue a doctor for negligence, and the right of a beneficiary to sue a trustee for breach of trust.

COLLECTABLE ASSET

Section 108-10(2) provides that a collectable is:

(a) Artwork, jewellery, an antique, or a coin or medallion; or(b) A rare folio, manuscript or book; or(c) A postage stamp or first day cover

that is used or kept mainly for your (or your associate’s) personal use or enjoyment and includes any interest, debt arising from, or option to acquire any of those things (s 108-10(3)).

CALCULATING CAPITAL GAINS AND LOSSES

Capital gains on assets with a cost base of $500 or less are disregarded (s 118-10(1)). However, s 108-15 applies to prevent individual components of sets being sold for under this amount to gain the advantage of this threshold.

The third element of the cost base is not available for collectable assets (s 108-17).

EFFECT ON CAPITAL GAINS AND LOSSES

Capital losses from collectables can only be offset against capital gains on other collectables (s 108-10(1)).

Losses may be applied against future net capital gains from collectables (s 108-10(4)).

PERSONAL USE ASSETS

Section 108-20(2) provides that a personal use asset is:

(a) A CGT asset (except a collectable) that is used or kept mainly for you personal use or enjoyment; or(b) An option or right to acquire a CGT asset of that kind; or(c) A debt arising from a CGT event in which the CGT asset the subject of the event was one covered by paragraph

(a); or (d) A debt arising other than:

(i) In the course of gaining or producing your assessable income; or(ii) From the course of carrying on your business.

Personal use assets do not include land or buildings (s 108-20(3)).

EFFECT OF BEING A PERSONAL ASSET

Capital losses are disregarded (s 108-20(1)).

Capital gains on assets with a cost base of $10,000 or less are disregarded (s 118-10(3)). However, s 108-25 applies to prevent individual components of sets being sold for under this amount to gain the advantage of this threshold.

The third element of the cost base is not available for personal use assets (s 108-30).

DEEMED SEPARATE ASSETS

The ITAA97 deems assets that would be considered one asset at general law, to be separate assets for the purpose of CGT (s 108-50).

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These include:

A building or structure on land that the taxpayer acquired on or after 20 September 1985 if the building or structure is a depreciating asset or for research and development (s 108-55(1)).

A building or structure constructed on land that you acquired before 20 September 1985 where the contract for construction was entered into, or if there was no contract, construction began, on or after 20 September 1985 (s 108-55(2)).

A depreciating asset that is part of a building or structure (s 108-60). Adjacent land that has been amalgamated into one title where once lot was acquired prior to 20 September 1985 and

another acquired after 20 September 1985 (s 108-65). Where you make a capital improvement to an asset acquired before 20 September 1985, and the cost base of that asset

is more than:o the improvement threshold ($112,512 in 06/07; $116,337 in 07/08; $119,594 in 08/09); and

o more than 5% of the capital proceeds of the event (s 108-70(2)).

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A1 EVENT

The most common CGT is the CGT event A1 which accounts for 90% of cases.

It arises where a taxpayer ‘disposes’ of a CGT asset. (s 104-10(1)).

Disposal occurs where the ownership of an asset changes (but not where the beneficial ownership remains identical) (s 104-10(2)).

IF splitting or merger of an asset:

The splitting or merger of an asset does not result in a change in beneficial ownership, only a change in the form of the original asset (TD 2000/10).

TIMING

The event occurs on the date of contract, or if there is no contract, the date ownership transfers (s104-10(3)).

CT v Sara Lee HBC Aust Ltd

T was a US company (Sara Lee) sold pharmaceutical subsidiary business operating in Australia and other countries. They signed a global contract on 1 May 1991. They then sat down and negotiated the terms of the contract and made amendments. They increased purchase price for $1 million and substituted a different company as the purchaser. This amendment agreement was signed in August 1991. T argued that the time of disposal was the August 1991. T’s motivation was to utilize capital losses in the 91/92 financial year to offset the capital gains of this disposal. They did not have capital losses in 90/91 to offset these amounts. HELD that the contract was entered in May 1991. When there are two or more contracts, you must determine which of the two contracts creates an obligation to dispose:

o Work out which of the contracts is properly seen as the source of the obligations to effect the disposal.

o This was the first contract that gave right to the obligation (SL argued that the 2nd one was substantially different)

CAPITAL GAIN OR LOSS

A capital gain (loss) occurs when the capital proceeds are more (less) than the cost base of the asset (s 104-10(4)).

SPECIFIC EXEMPTIONS

Specific exemptions:

The capital gain (loss) is disregarded if it was acquired before 20 September 1985 (ITAA97 s 104-10(5)). The capital gain (loss) is disregarded if the lease was granted, extended or renewed before 20 September 1985 (s 104-

10(5)). An A1 event does not occur where the disposal was to provide or redeem a security (s 104-10(7)).

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B1 EVENT

The CGT event B1 deals with the use and enjoyment of a CGT asset before title passes.

It occurs if a taxpayer enters into an agreement with another entity under which:

(a) The right to the use and enjoyment of a CGT asset you own passes to the other entity; and(b) Title in the asset will or may pass to the other entity at or before the end of the agreement.

Examples are hire purchase agreements and a terms contract for the sale of land.

TIMING

The time of the event is when the other entity first obtains the use and enjoyment of the asset (s 104-15(2)).

CAPITAL GAIN OR LOSS

You make a capital gain if the *capital proceeds from the agreement are more than the asset's *cost base.

You make a capital loss if those *capital proceeds are less than the asset's *reduced cost base.

SPECIFIC EXEMPTION

Under s 103-15(4), a capital gain or capital loss you make is disregarded if:

(a) Title in the asset does not pass to the other entity at or before the end of the agreement; or(b) You acquired the asset before 20 September 1985.

EXAMPLE OF A B1 EVENT

On 1 August 2007, Graham Smith entered into a contract with Stephanie Miles which gave him the use and enjoyment of her holiday house in Port Stephens, for a period of nine months in order for him to decide if he wanted to buy the holiday house. Thereafter, on 30 April 2008, a contract was entered into for Graham to buy the holiday house from Stephanie for $500,000.

In this example, CGT event B1 would happen on 1 August 2007 as Graham had use and enjoyment of the holiday house before title to the property passed, rather than CGT event A1, which does not take place until 30 April 2008 when Graham signed the contract to actually buy the house from Stephanie.

Therefore, the significant question is: when does use and enjoyment pass – this is the CGT event.

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C1 EVENT

A C1 event occurs if a CGT asset the taxpayer owns is lost or destroyed (s 104-20(1)).

It includes involuntary actions and voluntary destruction by the owner e.g. demolition. Loss of an asset includes an involuntary event which deprives the owner of the asset e.g. theft.

TIMING

The time of the event is (s 104-20):

if you receive compensation, when you first receive compensation; or when the loss is discovered or the destruction occurred.

CAPITAL GAIN OR LOSS

A capital gain (loss) occurs when the capital proceeds are more (less) than the cost base of the asset (s 104-20(3)).

The capital gain (loss) is disregarded if it was acquired before 20 September 1985 (ITAA97 s 104-10(5)).

SPECIFIC EXEMPTIONS

Under s 104-20(4), a capital gain or capital loss you make is disregarded if:

the CGT asset was acquired before 20 September 1985.

EXAMPLE OF C1 EVENT

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.

C2 EVENT

A C2 event happens if a taxpayer’s ownership of an intangible CGT asset ends by the asset (s 104-25(1)):

being redeemed or cancelled; or being released, discharged or satisfied; or expiring; being abandoned, surrendered or forfeited; if the asset is an option - being exercised; if the asset is a convertible interest – being converted.

Examples are a share being redeemed, a debt being discharged, or a contract expiring.

TIMING

The time of the event is:

(a) When you enter into the contract; or(b) If there is no contract, when the asset ends.

CAPITAL GAIN OR LOSS?

Capital gain made if the capital proceeds from the ending of the asset are more than the asset’s cost base (s 104-25(3)).

Capital loss if capital proceeds are less than the asset’s reduced cost base (s 104-25(3)).

SPECIFIC EXEMPTIONS

A capital loss/gain will be disregarded where:

(a) You acquired the asset before 20 September 1985; or(b) For a lease where:

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(i) It was granted before 20 September 1985; or(ii) If it has been renewed or extended – the start of the last renewal or extension occurred before 20 September 1985.

EXAMPLE OF C2 EVENT

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 $5000 as compensation for the early termination of the contract. CGT event C2 happens as Tim’s intangible asset, i.e. the right to enforce the agreement, has come to an end. The capital proceeds will be the $5000 less any costs associated with the event (e.g. legal fees).

C3 EVENT - END OF OPTION TO ACQUIRE SHARES OR UNITS

CGT event C3 deals with the end of an option to acquire shares, units or debentures.

This event occurs if an entity is granted an option by a company or the trustee of a unit trust to acquire shares or debenture of the company or units or debentures of the unit trust and the option ends in one of the following ways:

(a) it is not exercised (by the latest time for its exercise);(b) it is cancelled; or(c) it is released or abandoned (s 104-30(1)).

TIMING

The time of the event is when the option ends (s 104-30(2).

CAPITAL GAIN OR LOSS?

A capital gain is where the capital proceeds form the grant of the option are more than the expenditure incurred in granting it and a capital loss is where the capital proceeds from the option are less (s 104-30(3)).

SPECIFIC EXEMPTION

A capital gain or loss is disregarded if the option was acquired prior to 20 September 1985 (s 104-30(5)).

EXAMPLE

On 1 January 2008 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 2009. Acme Co makes a capital gain of $100

(less any associated expenses).

D1 EVENT - CREATING CONTRACTUAL OR OTHER RIGHTS

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D1 occurs if a taxpayer creates a contractual right or some other legal or equitable right in another entity (s 104-35(1)).

An example is entering into a restrictive covenant or exclusive trade ties.

This is only applied if no other CGT events occur (s 102-25).

TIMING

A D1 event occurs when the taxpayer enters into the contract or creates another right (s 104-35).

CAPITAL GAIN OR LOSS?

A capital gain (loss) occurs where the capital proceeds are more (less) than the incidental costs incurred in relation to that event (s 104-35(3)).

The costs can include giving property (s 104-35(4)).

Incidental costs include:

remuneration of a surveyor, valuer, auctioneer, accountant, broker, agent, consultant or legal advisor (s 110-35(2)) costs of transfer (s 110-35(3) stamp duty or similar (s 110-35(4)) cost of advertising or marketing (s 110-35(5)) costs of making valuation or apportionment under Part 3-1 or 3-3 (s 110-35(6)) search fees (s 110-35(7)) conveyancing kit (s 110-35(8)) borrowing expenses such as loan application fees and mortgage discharge fees (s 110-35(9)) expenditure made by related parties in the corporate group on the CGT asset (s 104-10(10)).

SPECIFIC EXCEPTIONS

This event does not happen if:

(a) you created the right by borrowing money or obtaining credit from another entity;(b) the right requires you to do something that is another CGT event that happens to you;(c) a company issues or allots equity interests or non-equity shares in the company;(d) the trustee of a unit trust issues units in the trust;(e) a company grants an option to acquire equity interests, non-equity shares or(f) debentures in the company; or(g) the trustee of a unit trust grants an option to acquire units or debentures in the trust.

EXAMPLE OF D1 EVENT

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. 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 is entered into and Bart will have a capital gain (of $10,000). At the end of the two-year period CGT event C2 will happen and Lucy will have a capital loss (i.e. of $10,000).

D2 EVENT - GRANTING OF AN OPTION

D2 occurs if a taxpayer grants an option, or renews or extends an option the taxpayer had granted (s 104-40(1)).

It does not apply to options granted, renewed or extended by a company or the trustee of a unit trust to acquire shares in the company or units in the unit trust or debentures of the company or unit trust (s 104-40(6)).

It does not apply to options relating to personal use assets or collectables (s 104-40(7)).

TIMING

The time of the event is when you grant, renew or extend the option (s 104-40(2)).

CAPITAL GAIN OR LOSS?

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There will be a capital gain if the proceeds from the granting of the option are more than the expenditure you incurred to grant and vice versa for a capital loss (s 104-40(3)).

SPECIFIC EXCEPTIONS

The event D2 does not apply to an option granted by a company or the trustee of a unit trust to acquire an asset that is:

(a) shares in the company or units in the unit trust (see Event C3); and(b) debentures in the company or unity trust (see Event C3).

EXAMPLE OF D2 EVENT

Ben pays Sara $5000 for an option to purchase her business. The one-month option is granted on 1 January 2009. Ben decides not to exercise the option. CGT Event D2 happens on 1 January 2009 and Sara has a capital gain of $5000 less any associated expenses (e.g.

legal expenses). If Ben exercises the option, CGT event D2 is ignored and CGT event A1 happens.

F1 EVENT - GRANT OF LEASE

CGT event F1 occurs (104-110):

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when the contract for the lease is entered into; if there is no contract, the start of the lease; or for renewal or extension – at the start of the renewal or extension

The F1 event does not occur if the grant, extension or renewal is over 50 yeas, this is a F2 event.

TIMING

The time of a F1 event is when the contract for the lease is entered into or, if there is no contract, at the start of the lease.

Where a lease is renewed or extended, the time of this CGT event is the start of the renewal or extension (s 104-110(2)).

CAPITAL GAIN OR LOSS?

The capital gain (loss) occurs where the capital proceeds are more (less) than the expenditure in relation to the grant, extension or renewal (s 104-110(3)).

F4 EVENT - LESSEE INCURS EXPENDITURE TO VARY LEASE

CGT event F4 happens if a lessee receives a payment from the lessor for agreeing to vary or waive a term of the lease (s 104-125(1)).

TIMING

The time of the event is when the term is varied or waived (s 104-125(2)).

CAPITAL GAIN OR LOSS?

The lessee makes a capital gain if the capital proceeds from the event are more than the lease’s cost base (at the time of the event). If the lessee makes a capital gain, the lease’s cost base is also reduced to nil (s 104-125(3)).

If the lessee’s proceeds are less, the lease’s cost base is reduced by that amount at the time of the event (s 104-125(4)).

SPECIFIC EXCEPTIONS

A capital gain the lessee makes is disregarded if (s 104-125(5)):

(a) The lease was granted before 20 September 1985; or(b) For a lease that has been renewed or extended prior to 20 September 1985.

EXAMPLE OF F4 EVENT

On 1 January 2009 Jake (the lessee) enters a lease. On 1 May 2009 Jake agrees to waive a term. Eastfield (the lessor) pays Jake $1000 for this. If Jake’s cost base at the time of the waiver is $2500, it is reduced from $2500 to $1500. On 1 September 2009 Jake agrees to waive another term. Eastfield pays Jake $2000 for this. If Jake’s cost base at the time of the waiver is $1500, Jake makes a capital gain of $500 and the cost base is reduced to

nil.

EXEMPTIONS

Not all capital gains and capital losses made in respect of CGT assets fall within the CGT regime.

There are a number of exemptions which are discussed below.

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CERTAIN ASSETS

Several exempt assets include:

Pre 20 September 1985 Assets Passenger motor vehicles or motorbikes (s 118-5(a)), which are defined as those that can hold 9 or less passengers, or

loads of less than 1 tonne (s 995). Depreciating assets (s 118-24) Trading stock (s118-25) Compensation for personal injury or workers compensation (s 118-37) Gambling, game or competition with prizes (s 118-37(c)) Decoration awarded for velour or brave conduct (unless you paid for it) (s 118-5(b)) CGT asset used to produce exempt income (s 118-12(1)) Collectable if 1st element of cost base is less than $500 (s 118-10(1)) Personal use asset if the 1st element of the cost base is less than $1,000 (s 118-10(3)).

MAIN RESIDENCE EXEMPTION

The main residence exemption found is found in Subdiv 118-B.

Policy reasons behind main residence exemption

Policy reasons behind exempting main residence: home ownership valued & encouraged, affect mobility of workforce, cost-base calculations impossible, illusory gains (used usually to buy another home, which will also have significantly increased in value

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since the original purchase of the home that was just sold). The exemption was originally called the ‘principal place of residence’ exemption.

Map of the main residence exemption

BASIC CASE - SECTIONS 118-100 - 118-130

Section 118-110 states that a capital gain or capital loss relating to an ‘ownership interest’ in a ‘dwelling’ that is the taxpayer’s main residence is disregarded.

In other words, capital gains and losses from a CGT asset that is a dwelling, or your ownership interest in the dwelling, are disregarded if:

you are an individual; the dwelling was your main residence throughout your ownership period; and the interest did not pass from the estate of a deceased person

DWELLING

A dwelling includes (s 118-115(1)):

a unit of accommodation that is a building or contained in a building that consists wholly or mainly of residential accommodation; or

a unit of accommodation that is a caravan, houseboat or other mobile home

IF land immediate under unit of accommodation:

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The dwelling contains the land immediately under the unit of accommodation (s 118-115(1)(c)).

IF adjacent land:

The dwelling includes adjacent land that is used predominantly for a private purpose and does not exceed 2 hectares (s 118-120). Adjacent does not mean touching, but must be sufficiently close (TD 1999/68).

IF land by itself:

Land by itself will never be a main residence (TD 1999/73).

IF structures associated with the dwelling:

Structures associated with the dwelling, and forms part of the CGT event, that is used primarily for private or domestic purposes are treated as part of the dwelling (s 118-120(3). It includes sheds (Re Summer v FCT).

Whether the primary purpose of the land or structure was private or domestic is a question of fact an degree.

MAIN RESIDENCE

Whether the dwelling is a person’s main residence is a question of fact. It will depend on factors such as:

the length of time the taxpayer lived in the dwelling the place of residence of the taxpayer’s family where the taxpayer’s personal belongings are kept the taxpayer’s intention to occupy, although this is not sufficient per se (Erdelyi v Commissioner of Taxation) the taxpayer’s address for mail and on the electoral roll the connection of services such as phone, gas & electricity.

OWNERSHIP INTEREST

The taxpayer has an ownership interest in the asset because (s 118-130(1)):

they had a legal or equitable interest in it, or a right to occupy it; or for a dwelling that is not a flat or home unit, you have a legal or equitable interest in the land on which it is erected, or a

licence or right to occupy it; or for a flat or home unit, you have:

o a legal or equitable interest in it; or

o a licence or right to occupy it; or

o a share in a company that owns a legal or equitable interest in the land on which the flat or home unit is erected and

gives you a right to occupy it

Where you acquire the dwelling through a contract, you have an ownership interest in it from (s 118-130(2)):

the time when you obtain legal ownership {is this registration under LTA?}; or if the contract gives you a right to occupy the dwelling prior to obtaining legal ownership, from that point

The ownership interests ends when your legal ownership ends (s 118-130(3)).

IF dwelling was used as taxpayer’s main residence throughout the period of ownership:

Here, the dwelling was used as taxpayer’s main residence throughout the period of ownership. Therefore, they will be entitled to the main residence exemption.

IF the dwelling was not used as taxpayer’s main residence throughout the period of ownership:

Here, the dwelling was not used as taxpayer’s main residence throughout the period of ownership. Therefore, the taxpayer will have to rely on one of the extension provisions which allows for a partial exemption.

EXTENSION OF EXEMPTION - SECTIONS 118-135 - 118-160

EXTENSION OF THE EXEMPTION TO LAND - SECTION 118-120

Where the same CGT event happens to an adjacent piece of land as the main residence house, the main residence exemption can extend to exempt the gain or loss from the piece of land.

Adjacent land does not have to be connected with the block of land that the main residence exception is being claimed over.

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There can be a distance between the adjacent land and the land on which the main residence is located.

Conditions

The same CGT event must happen to the land (s 118-120(1)).

Extent land must be held for private or domestic purpose (s 118-120(1)).

Maximum area is 2 hectares (s 118-120(2)).

CHANGING MAIN RESIDENCE - SECTION 118-140

Section 118-140 allows the taxpayer to have 2 main residences for a maximum time period of 6 months.

This enables them to acquire an interest in a new main residence.

Conditions

To take advantage of this:

the existing main resident must have been the taxpayer’s main residence for a continuous periods of at least 3 months in the 12 months ending when the ownership interest ends; and

the existing main residence was not used for the purpose of producing assessable income in any part of the 12 month period when it was not your main residence

ABSENCES - SECTION 118-145

A taxpayer may be entitled to treat a dwelling as his or her main residence during a period of absence (s 118-145).

Conditions

You may do this indefinitely if you do not use the dwelling to produce assessable income (s 118-145(3)).

If you use the dwelling to produce assessable income, then you can only treat it as your main residence for up to 6 years, resetting each time it becomes and ceases to be your main residence (s 118-145(3)).

BUILD, REPAIR OR RENOVATE - SECTION 118-150

The dwelling can be treated as your main residence for a period of up to 4 years where you build a dwelling on the land, or repair renovate or finish a building on the land, provided that (s 118-150):

it becomes your main residence as soon as practicable after the work is finished; and it continues to be your main residence for at least 3 months no other dwelling can be treated as your main residence

Section 118-155 deals with what happens if the taxpayer dies any time before the dwelling has become their main residence for the required 3 months after the work.

Example

Two people are living in a house and they decide to renovate their second property They are living in their original property and they buy that second property They have 6 months in which they can sell their original property and can still claim the main residency exemption on it If they sell their original property within 6 months and move into a rental property after the 6 month period, they have 4

years to renovate the second property that they have purchased

DESTRUCTION: SALE OF LAND - SECTION 118-160

If the dwelling that is your main residence is accidentally destroyed, provided that you do not erect another dwelling, the land can be treated as if the dwelling had not been destroyed, and it was you main residence (s 118-160).

The exemption is not available where you have another main residence (s 118-160(3)).

RULES LIMITING THE EXEMPTION

SPOUSE HAVING DIFFERENT MAIN RESIDENCE

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If, during a period, a dwelling is the taxpayer’s main residence and another dwelling is the main residence of the taxpayer’s spouse, the taxpayer and the spouse can (s 118-170):

choose one of the dwellings as your main residence; or nominate the different dwellings, and apportion them (apportionment: if you have an interest of less than 50% in your

main residence, it is your main residence for the whole period, otherwise it will be your main residence for half the period. Applies similarly with the spouse).

If the main residence of your child who is under 18 and is dependant, you must choose one of them as the main residence for you both (s 118-175).

SEPARATE CGT EVENT - SECTION 118-165

The exemption does not occur where the CGT event relates to land or other structures, but not the dwelling (s 118-165).

NON-MAIN RESIDENCE PERIOD

Where you would be entitled to the exemption, except that the dwelling was not your main residence for the whole of the ownership period, then you will be eligible for a partial exemption (s 118-185(1)).

Your capital gain (loss) is multiplied by the percentage of non-main residence days (non-main residence days ÷ days in your ownership period) (s 118-185(2)).

Example

Someone buys house and uses it as rental property for 5 years and then at the end of the 5 years they decide to move into the property for the next 10 years

1/3 of the time (5 out of 15 years), the property had been used for income producing purpose Only 1/3 of the capital gain would be included in their income (the other 2/3 is exempt)

DWELLING USED TO PRODUCE ASSESSABLE INCOME

In this case, we must distinguish between 3 situations –

1. House used as a main residence and to produce assessable income; Apportionment

2. House used as a main residence and work at home as a place of convenience If place of business, rather than place of convenience, can claim running costs and occupancy costs

No apportionment because there is no business or income producing activity

3. Sole use of property is for generating assessable income e.g. rental property No apportionment because 100% of the capital gain would be included

Where conversion from entirely residential to income producing

If the asset was initially used solely as your main residence, and you began using the asset to produce assessable income after 7.30 pm on 20 August 1996, and you would otherwise be entitled to a partial exemption, you are deemed to have acquired the dwelling, or your interest therein, on the day you first started using it to produce assessable income (s 118-192).

Where also used to produce assessable income

Only a partial exemption is available where the dwelling was used for producing assessable income for all or part of the period and interest would have been deductible (s 118-190).

It is permissible to ignore the asset’s use to produce assessable income if falls within s 118-145 (s 118-190(3)).

The capital gain (loss) is increased by an amount reasonable having regard to the extent to which you would have been able to deduct interest (s 118-190(2)).

IF taxpayer used the dwelling out of convenience:

Here, interest would not be deductible because the taxpayer used the dwelling out of convenience (ITAA97 s 8-1 and Handley).

IF use of residence amounted to carrying on of a business:

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Here, the interest would be deductible because the use of the residence was not merely out of convenience, but amounted to carrying on a business (ITAA97 s 8-1 and Swinford).

DWELLING ACQUIRED THROUGH DECEASED ESTATE

Section 118-195 provides that a capital gain or capital loss from a CGT event that happens in relation to a dwelling may be ignored if the taxpayer is an individual who acquired the ownership interest in the dwelling as a beneficiary, or as a trustee, of a deceased estate.

There are two main requirements that must be fulfilled for this exemption to apply.

First requirement

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The first requirement is that:

The deceased acquired the ownership interest before 20 September 1985; or The deceased acquired the ownership interest on or after 20 September 1985 and the dwelling was the deceased’s

main residence just before death and was not being used for income producing purposes.

Second requirement

The second requirement is that:

The taxpayer must have disposed of his or her ownership interest within 2 years of deceased’s death; or The dwelling was, from the deceased’s death until your ownership interest ends, the main residence of one or more of:

(a) The spouse of deceased immediately before death (except for spouse living permanently separately and apart from deceased); or

(b) An individual who had a right to occupy the dwelling under the deceased’s will; or(c) The taxpayer.

DECEASED ESTATES

Upon death, any capital gains or losses are disregarded (s 128-10). So the person who dies will never have a capital gain or a capital loss in relation to the asset that they held. However, the beneficiaries under the will may incur that capital gain.

When someone dies, the personal representative will take the asset. That personal representative then passes the asset onto the beneficiary and any loss or gain that the personal representative makes will also be disregarded.

WHERE THE ASSET PASSES TO A BENEFICIARY

The general rule is that any capital gain or loss the personal representative makes is disregarded if the asset ‘passes to a beneficiary’ (s 128-15(3)).

A CGT asset passes to a beneficiary if the beneficiary becomes an owner (s 128-20):

under the will (or as varied by the court) by operation of an intestacy law it is appropriated to the beneficiary by the legal representative under a deed of arrangement

An asset does not pass to a beneficiary if it is sold by the legal representative to the beneficiary or a third party (s 128-20(2)).

DATE OF ACQUISITION

The date of acquisition is the date of death (s 128-15(2)).

COST BASE

The first element of the beneficiary’s (or legal personal representative’s) cost base is (s 128-15(4)):

the cost base of the deceased on the day they died, because they acquired it on or after 20 September 1985 and it was not their main residence;

the market value of the asset on the day <deceased> died, because it was acquired by them before 20 September 1985;

the market value of the dwelling on the date of death, because the dwelling was <deceased>’s main residence just before their death;

The cost base also includes any expenditure that the legal personal representative would have been able to include, as of the day it was incurred by the personal representative (s 128-15(5)).

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CALCULATING THE GAIN OR LOSS

There are four steps to calculating the capital gain or loss on disposal:

1. What are the capital proceeds?2. What is the cost base or reduced cost base?

If have capital gain, use cost base, if capital loss, use reduced cost base In reduced cost base, element 3 is left out and it is used where we have a capital loss

3. What is the indexed cost base? Can only index assets acquired before the 21 Sep 1999

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4. What is the capital gain or loss? Work out what the capital gain is by calculating the proceeds of cost base.

CAPITAL PROCEEDS

Capital proceeds is comprised of (s 116-20(1)):

the money received, or entitled to receive, in respect of the event; or the market value of any property received or entitled to receive.

IF F1 event:

The capital proceeds of an F1 event are defined as any premium paid or payable to you for the grant, renewal or extension (s 116-20(2)).

MODIFICATION

Market value substitution rule

The market value substitution rule applies where:

no capital proceeds were received (s 116-30(1)) some or all of the capital proceeds cannot be valued (s 116-30(2)(a)) the capital proceeds are more or less than the market value and (i) it was not an arms length transaction, or (ii) it is a C2

event (s 116-20(2)(b)).

This rule does not apply to D1 events (s 116-30).

The market value is calculated at the time of the CGT event (s 116-30).

Apportionment rule

Where a transaction relates to more than one CGT event, the capital proceeds must be apportioned between the events (s 116-40).

Non-receipt rule

The capital proceeds are reduced by the amount you are unlikely to receive, provided you took all reasonable steps to obtain the amount and it is not because of anything the taxpayer did (s 116-45).

Repaid rule

The capital proceeds are reduced by the amount you repay, or any compensation you pay that may be reasonably regarded as a repayment of them (s 116-50). This can include giving property back (s 116-50).

Another entity assumed liability

The capital proceeds are increased if another entity acquires the asset subject to a liability (such as a mortgage or other security) over the asset, by an amount equal to the liability (s 116-55).

Misappropriation rule

The capital proceeds are reduced by any amount misappropriated by an agent or employee (s 116-20).

COST BASE

The cost base based is used when determining the capital gain.

The cost base must be net of input tax credits on those expenditures (s 103-30).

The asset’s cost base consists of 5 elements (s 110-25(1)):

E1 – s 110-25(2) Cost of acquisition E2 – s 110-25(3) Incidental Costs E3 – s 110-25(4) Non capital costs of ownership E4 – s 110-25(5) Capital expenditure to increase / preserve value E5 – s 110-25(6) Capital expenditure to establish title etc

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If the taxpayer can claim input tax credits, these must be removed from the cost base.

Some CGT events do not have CGT events, including D1 & F1 (s 110-10).

ELEMENT 1 - MONEY PAID OR PROPERTY GIVEN

The first element of the cost base includes all money, or the market value of any property, you have or are required to provide (s 110-25(2)).

Modifications

Here, because the taxpayer :

did not incur expenditure to acquire the asset some or all of their expenditure cannot be valued (only substituted if more than the market value) did not deal at arm’s length with the other entity in connection with the acquisition (only substituted if more than the

market value)

then the market value at the time of acquisition forms this cost base (s 112-20).

ELEMENT 2 - INCIDENTAL COSTS

The second element of the cost base is incidental costs incurred (which can include giving property) (s 110-25(3)).

Incidental costs include:

remuneration of a surveyor, valuer, auctioneer, accountant, broker, agent, consultant or legal advisor (s 110-35(2)) costs of transfer (s 110-35(3) stamp duty or similar (s 110-35(4)) cost of advertising or marketing (s 110-35(5)) costs of making valuation or apportionment under Part 3-1 or 3-3 (s 110-35(6)) search fees (s 110-35(7)) conveyancing kit (s 110-35(8)) borrowing expenses such as loan application fees and mortgage discharge fees (s 110-35(9))

Expenditure does not form part of the cost base to the extent that you have or can deduct it (s 110-40(2) {pre 7.30pm on 14 May 1997}; s 110-45(1B) {post 7.30pm on 14 May 1997}).

ELEMENT 3 - NON-CAPITAL COSTS OF OWNERSHIP

The third element of the cost base includes:

interest on money borrowed to acquire the asset costs of maintaining, repairing or insuring the asset rates or land tax, if the asset is land interest on money you borrowed to refinance the money you borrowed to acquire the asset interest on money you borrowed to finance the capital expenditure you incurred to increase the asset’s value.

Limitation

Here, we cannot include element 3 of the cost base because:

the asset was acquired on or before 20 August 1991 (s 110-25(4)) the asset is a collectable (s 108-17) the asset is a personal use asset (s 108-30)

ELEMENT 4 - CAPITAL EXPENDITURE TO INCREASE TO PRESERVE VALUE

For CGT events on or after 1 July 2005, the fourth element of the cost base includes capital expenditure that relates to installing or moving the asset, or whose purpose or expected effect was to increase or preserve the asset’s value (s 110-25(5)).

Expenditure on good will is not included (s 110-25(5A)).

Initial repairs are included in this (TD98/19).

ELEMENT 5 - CAPITAL EXPENDITURE TO ESTABLISH TITLE

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The fifth element of the cost base is capital expenditure you incurred to establish, preserve or defend your title or right in the asset (s 110-25(6)).

This can only apply to acts done after the CGT asset has been acquired.

REDUCED COST BASE

The reduced cost base is used where the cost base exceeds capital proceeds.

The reduced cost base does not include the 3rd element, it is replaced with any balancing adjustments made for the asset that increases your assessable income (because it will not include amounts that are deductible.) (s 110-55).

INDEXED COST BASE

The elements (other than the 3rd element) of the cost base of a CGT asset acquired on or before 11:45am on 21 September 1999 may be indexed for inflation, provided the asset has been held for more than 12 months and a choice to index has been made (s 110-36).

Here, the taxpayer can (cannot) use indexation because:

the asset was acquired before (after) 21 September 1999 (s 114-1); and the asset was acquired more (less) than 12 months before the CGT event (s 114-10).

Calculation

Indexation is calculated by multiplying the relevant element of the cost base by the ‘indexation factor’ (s 960-270).

This is a number that is, generally, calculated by dividing the CPI index number for the quarter in which the relevant CGT event occurred by the CPI index number for the quarter in which the relevant expenditure was incurred (s 960-275(2)).

Indexation table

Year Jan – March April – June July – September October – December

1985 -- -- 72.7 71.3

1986 74.4 75.6 77.6 79.8

1987 81.4 82.6 84.0 85.5

1988 87.0 88.5 90.2 92.0

1989 92.9 95.2 97.4 99.2

1990 100.9 102.5 103.3 106.0

1991 105.8 106.0 106.6 107.6

1992 107.6 107.3 107.4 107.9

1993 108.9 109.3 109.8 110.0

1994 110.4 111.2 111.9 112.8

1995 114.7 116.2 117.6 118.5

1996 119.0 119.8 120.1 120.3

1997 120.5 120.2 119.7 120.0

1998 120.3 121.0 121.3 121.9

1999 121.8 122.3 123.4

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CALCULATING THE NET GAIN OR LOSS

1. Work out all capital gains & losses for all CGT events for the year Reduce capital gains by capital losses Capital losses are quarantined to capital gains, if you make a capital loss, you can’t use it to offset against

ordinary income – can only be offset against capital gains2. Apply any previously unapplied net capital losses

If one year you have a capital loss but you can’t do anything with it (no more capital gains to offset against, so that amount just sits there), if you make a capital gain the following year, you can offset unapplied net capital losses in the following year.

3. Reduce by the discount percentage.

DISCOUNT CAPITAL GAINS

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A taxpayer’s net capital gain is reduced under Step 3 in s 102-5 by the discount percentage of any discount capital gains remaining after Step 2.

DISCOUNT CAPITAL GAIN

A discount capital gain is a capital gain that satisfies the following requirements (s 115-5):

The capital gain must be made by an individual, complying superannuation entity or trust (s 115-10) The capital gain must result from a CGT event happening after 21 Sept 1999 (s 115-15) The capital gain must have been calculated without taking indexation into account (s 115-20); and The capital gain must result from a CGT event happening to a CGT asset acquired at least 12 months before the CGT

event.

DISCOUNT PERCENTAGE

IF individual or trust:

The discount percentage is 50% for individuals and trusts (s 115-100).

IF complying superannuation entity:

The discount percentage is 33 and a half % for superannuation entities (s 115-100).

GOODS101

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SERVICES

TAX

INTRODUCTION

GST is a broad based indirect tax which replaced the wholesale sales tax system and should eventually replace a number of state indirect taxes.

The GST applies at a flat rate of 10% on the supply of most goods and services and is collected by the seller or supplier, if the business is registered for GST purposes.

There are 6 requirements for the application of GST:

1. Is there a ‘taxable supply?2. Is there consideration?3. Is the supply made by an enterprise?

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4. Is the supply connected with Australia?5. Is the supplier registered for GST?6. Are the supplies GST-free or input taxed.

STATE THE ISSUE

The issue is whether the [taxpayer] is subject to GST for expenditure.

IS THE TAXPAYER REGISTERED OR REQUIRED TO BE?

An entity is required to be registered for GST if (GSTA s 23-5):

they are carryon on an enterprise; and its GST turnover meets the registration turnover threshold.

The registration turnover threshold is $75,000 (s 23-5 GSTA).

IF a non-profit body:

The registration turnover threshold is $150,000 for non-profit bodies (s 23-15).

An entity may be registered if it is carrying on an enterprise (s 23-10).

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SPECIAL RULES

The following entities must register, irrespective of their GST turnover:

Taxi drivers (s 144-5) Representatives of incapacitated entities that are registered or required to be registered (s 147-5) Resident agents acting for non-residents that are registered or required to be registered (s 57-20).

CARRYING ON AN ENTERPRISE

An enterprise is an activity, or series of activities, including (GSTA s 9-20):

a business (including any profession, trade, employment, vocation or calling) adventure or concern in the nature of a trade leasing, licensing or granting, an interest in property on a regular or continuous basis Deductible gift recipients under the ITAA 1997 complying superannuation fund charities and religious institutions

Definition extends to activities done ‘on a regular or continuous basis, in the form of a lease, licence or other grant of an interest in property’ (s 9-20(1)(c)).

It also encompasses activities done by trustees of superannuation funds, charitable institutions, religious funds, and by the Commonwealth, a State or a Territory (s 9-20(1)(d)-(h)).

“Carrying on” includes commencement and termination activities (GSTA s 195-1).

The activity is not in carrying on enterprise if it is done:

as an employee or PAYG earner as a private recreational pursuit or hobby (s 9-20(2)) by an individual or partnership of individuals without reasonable expectation of profit or gain as a member of a local government body.

TURNOVER THRESHOLD

An entity is above the turnover threshold if their current GST turnover or projected GST turnover is above the threshold (GSTA s 188-10).

The threshold is $75,000 (or $150,000 for not-for-profits).

CURRENT GST TURNOVER

The entity’s current GST turnover is the values of the supplies (that are for consideration, in the course of the enterprise and not input taxed) it has made during the 12 months ending at the end of that month (GSTA s 188-15).

PROJECTED GST TURNOVER

The entity’s projected GST turnover is the values of the supplies (that are for consideration, in the course of the enterprise and not input taxed) it has made, or is likely to make during that month, and the next 11 months (GSTA s 188-15).

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IS THERE A TAXABLE SUPPLY?

GST is payable on taxable supplies (GSTA s 7-1(1)).

The taxpayer makes a taxable supply if (s 9-5):

they make a supply for consideration the supply is made in the course or furtherance of an enterprise that they carry on the supply is connected with Australia the taxpayer is registered or required to be registered the supply is not GST free or input taxed.

DID THE TAXPAYER MAKE A SUPPLY?

There must have been a supply (GSTA s 9-5).

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Supply is defined broadly in GSTA s 9-10 as any supply whatsoever, including:

a supply of goods (which includes any tangible property: GSTA s 195-1). a supply of services provision of advice or information a grant, assignment or surrender of real property a creation, grant, transfer, assignment or surrender of any right a financial supply an entry into, or release from, an obligation to do anything to refrain from an act to tolerate an act or situation.

LAWFULNESS

Lawfulness is irrelevant (GSTA s 9-10(3)).

SUPPLY OF MONEY

A supply does not include a supply of money unless the money is provided as consideration for a supply that is a supply of money (GSTA s 9-10(4)).

Term money includes currency, promissory notes, bills of exchange, negotiable instruments, postal notes, money orders, payments by credit card or debit card, credit or debit to an account or creation or transfer of a debt (s 195-1).

COURT ORDERS AND OUT OF COURT SETTLEMENT

A court order for the payment of damages in negligence does not involve the creation, grant, transfer, assignment or surrender of any right or the entry into, or release from, an obligation within the meaning of s 9-10(2) (Interchase Corporation).

To make a taxable supply, there must be some voluntary action. Release of an obligation to pay judgment sum by payment of that sum occurs regardless of whether the judgment creditor makes, or does, any act at all (Shaw).

IS THERE CONSIDERATION?

Consideration must have been provided (GSTA s 9-5).

Consideration includes any payment, or act of forbearance, in connection with a supply (GSTA s 9-15).

Consideration need not be voluntary, nor provided by the recipient of the supply (GSTA s 9-15(2)).

Consideration is received (GSTR 2003/12):

in the case of cash, when tendered in the case of credit cards, upon signature of the cardholder in the case of EFTPOS, when accepted

Consideration can also include barter transactions and anything having value in the eye of contract law (Chappel & Co Ltd v Nestle Co Lt).

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GIFTS, PRIZES AND GRANTS

Gifts are not taxable supplies. A gift arises where something is transferred voluntarily without any material benefit to the donor (FCT v McPhail).

Prize may constitute consideration for a supply (GST Ruling GSTR 2002/3).

Grant will constitute consideration for supply where it is made on the condition that the grantee must do something in return for receiving the grant.

DEPOSITS

A deposit is not consideration unless and until it is forfeited (Reliance Carpet).

TAXES, FEES AND CHARGES

The payment of any Australian tax, fee or charge is treated as the provision of consideration, unless it has been exempted by the Treasurer (s 81-5).

IS THE SUPPLY MADE BY AN ENTERPRISE?

The supply must have been made in the furtherance of an enterprise the taxpayer carries on (GSTA s 9-5).

An enterprise is an activity, or series of activities, including (GSTA s 9-20):

a business (including any profession, trade, employment, vocation or calling) adventure or concern in the nature of a trade leasing, licensing or granting, an interest in property on a regular or continuous basis Deductible gift recipients under the ITAA 1997 complying superannuation fund charities and religious institutions

The activity is not in carrying on enterprise because it is done:

as an employee or PAYG earner as a private recreational pursuit or hobby (s 9-20(2)) by an individual or partnership of individuals without reasonable expectation of profit or gain as a member of a local government body.

CARRYING ON OF AN ENTERPRISE

“Carrying on” includes commencement and termination activities (GSTA s 195-1).

IS THE SUPPLY CONNECTED WITH AUSTRALIA?

The supply must be connected to Australia (GSTA s 9-5).

Here, the supply is connected to Australia, because:

the goods were delivered or made available in Australia (s 9-25(1)) the goods were removed from Australia (GSTA s 9-25(2)) the goods were imported to, or assembled in Australia (GSTA s 9-25(3)) the real property is in Australia (GSTA s 9-25) the supply of services (or anything except goods or real property) is done in Australia or makes a supply through an

enterprise the supplier carries on in Australia (GSTA s 9-25(5)).

ARE THE SUPPLIES GST-FREE OR INPUT TAXED?

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The supply cannot be GST-free or input taxed (GSTA s 9-5).

GST-FREE GOODS

A supply is GST-free if (GSTA s 9-30(1)):

it is so under Division 38, or another provision of another Act; or is a right to receive such a supply

Categories of GST-free items include:

Food (s 38-2). Education (s 38-85). Health (s 38-7). Child Care (s 38-140). Religious services (s 38-220). Charities (s 38-250). Water (s 38-285). Going concern (s 38-325). Transport (s 38-355).

FOOD

Food is defined in GSTA s 38-4(1) as food or beverages for human consumption (and their ingredients), goods to be mixed with food for human consumption, and fats & oils marketed for culinary purposes.

Food is not defined as live animals (other than crustaceans or molluscs), unprocessed cows milk, grain, cereal or sugar cane not subject to any process, and plants under cultivation (GSTA s 38-4(1).

The following are exceptions to the food exemption

food consumed on premises (GSTA s 38-5), hot takeaway food, prepared meals and food (Schl 1), confectionary, savoury snacks, icecream and biscuits (Schl 1), bakery goods (Schl 1), caviar, and water that is carbonated or has other additives.

HEALTH

Supplies of certain medical, health, hospital and residential and community care services, supplies of certain medical aids, appliances, drugs and medicinal products, and supplies of private health insurance are GST free (Subdiv 38-B).

EDUCATION

Supplies of education courses, excursions, course materials and leases of curriculum related goods are GST free (Subdiv 38-C).

An education course is defined exhaustively in s 195-1 and covers a range of specifically defined courses.

INPUT TAXED GOODS

Goods which are input-taxed goods have no GST payable and no entitlement to input tax credits.

A supply is input taxed if(GSTA s 9-30(2)):

it is so under Division 40 or under a provision of Another Act it is a right to receive such a supply

Division 40 includes:

Financial supplies: GSTA s 40-5 Residential rent: GSTA s 4-35 Residential premises: GSTA s 4-65 precious metals: GSTA s 40-100 School tuckshops: GSTA s 40-130

A supply is not input taxed, where it is GST-free (GSTA s 9-30).

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GST PAYABLE

GST is payable on 10% (or 1/11th of the purchase price) of the value of the taxable supply (ss 9-40, 9-70 & 9-75).

IS IT A CREDITABLE ACQUISITION?

Input tax credits are available for creditable acquisitions (GSTA ss 7-1(2) & 11-20).

A registered entity is entitled to an input tax credit for creditable acquisitions they make (GSTA s 11-20).

You make a creditable acquisition where (GSTA s 11-5):

you acquire something solely or partly for a creditable purpose the supply of the thing to you is a taxable supply you provide, or are liable to provide consideration of the supply.

ACQUISITION

Acquisition is broadly defined in GSTA s 11-10, including:

an acquisition of goods or services a receipt of advice or information; an acceptance of a grant, assignment or surrender of real property; an acceptance of a grant , transfer, assignment or surrender of any right; an acquisition a financial supply; an acquisition of a right to require another person:

o to do anything; or

o to refrain from an act; or

o to tolerate an act or situation;

any combination of any of the above.

CREDITABLE PURPOSE

You acquire a thing for a creditable purpose to the extent that you acquire it in carrying on your enterprise (GSTA s 11-15(1)).

However, it is not a creditable purpose if (GSTA s 11-15(2)):

the acquisition relates to supplies that are input taxed; or the acquisition is of a private or domestic nature

PARTLY CREDITABLE

Because the acquisition is only partly creditable, it must be apportioned as follows:

Full input tax credit ´ extent of creditable purpose ´ Extent of consideration

Where extent of consideration is how much you provide (GSTA s 11-30).

TAXABLE SUPPLY

The taxpayer makes a taxable supply if (s 9-5):

they make a supply for consideration the supply is made in the course or furtherance of an enterprise that they carry on the supply is connected with Australia the taxpayer is registered or required to be registered the supply is not GST free or input taxed.

SUPPLY

There must have been a supply (GSTA s 9-5).

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Supply is defined broadly in GSTA s 9-10 as any supply whatsoever, including:

a supply of goods (which includes any tangible property: GSTA s 195-1). a supply of services provision of advice or information a grant, assignment or surrender of real property a creation, grant, transfer, assignment or surrender of any right a financial supply an entry into, or release from, an obligation to do anything to refrain from an act to tolerate an act or situation.

CONSIDERATION PROVIDED

Consideration must have been provided (GSTA s 9-5).

Consideration includes any payment, or act of forbearance, in connection with a supply (GSTA s 9-15).

Consideration need not be voluntary, nor provided by the recipient of the supply (GSTA s 9-15(2)).

Consideration is received (GSTR 2003/12):

in the case of cash, when tendered in the case of credit cards, upon signature of the cardholder in the case of EFTPOS, when accepted

INPUT TAX CREDITS

The quantum of the input tax credit is the amount of GST payable on the supply (GSTA s 11-25). Thus, the input tax credit will be 1/11th of the purchase price (GSTA ss 9-40, 9-70 & 9-75).

You cannot claim an input tax credit without a Tax invoice at the time of lodging the GST return, except for small value supplies (GSTA s 29-80).

TOTAL GST LIABILITY

The taxpayer’s net GST liability is the GST collected less input tax credits (GSTA s 7-5).

The tax period is generally every 3 months unless a monthly period selected (GSTA ss 27-5 & 27-10).

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FRINGE BENEFITS

TAX

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INTRODUCTION

A fringe benefit is a benefit received by an employee which is not salary and wages but which results from the relationship of employment.

FBT is deductible under s 8-1. Type 1 benefits claim input tax credits, and type 2 benefits doe not claim input tax credits. The deductible amount is the cost of the benefit.

STATE THE ISSUE

The issue here is whether the [taxpayer] has received a fringe benefit.

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IS THERE A FRINGE BENEFIT?

A fringe benefit is defined as a benefit provided to an employee (or an associate) during the FBT year by their employer (or associate, or 3rd party arranger), in respect of the employment (FBTAA s 136).

BENEFIT

Benefit is broadly defined in FBTAA s 136 to include any right, privilege, service or facility.

A fringe benefit can include:

Usage Ownership Enjoyment of a privilege or facility The provision of a service.

EXCLUDED BENEFITS

Fringe benefits do not include:

salary & wages (s136(1)(f)). Payments to a complying super fund (s 136(1)(j)). Employment Termination Payments (s136(1)(lc)) or genuine redundancy payment (s136(1)(lb).

However, there are also benefits which are exempt from FBT. These include:

Recreational and childcare facilities located at an employer’s business premises: s 47(2) Relocation and recruitment expenses: s 58B. Laptop computers, briefcases, calculators, electronic diaries and personal organisers where primarily used for work

purposes: s 58X. Use of motor vehicle for work purposes: s 53(1) A single taxi trip beginning or ending at the employees place of work: s 58Z Minor benefits which are infrequent and less than $300: s 58P Value of meals and accommodation provided in the family home for children who are also employees and the family

conduct a business of primary production from the same location: s 58ZD Housing provided to employees in remote locations: s 58ZC The first $1000 of the aggregate of any in-house fringe benefit and airline transport fringe benefits provided to an

employee in any given year: s 62

DURING THE YEAR

The benefit must be provided during the year of tax.

Provide is defined in the FBTAA s 136 to include:

for a benefit - allowing, conferring, giving, granting or performing for property – disposing by sale, gift or declaration

A provision will occur by the employer ‘turning a blind eye’ to the provision, such as where an employee is not given the use of a work car, but is not prevented from using it on the weekend (FBTAA s 148(3)).

PROVIDED BY EMPLOYER, ASSOCIATE OR THIRD PARTY

Benefit must be provided by the employer, associate, or third party.

Employer is defined as a current, future or former employer other than the Commonwealth (FBTAA s 136(1)).

Associate is defined as a relative or partner of an individual, or a company that is sufficiently influenced by the individual, or whom the person holds a majority voting interest in the company (FBTAA s 159 & TIAA36 s 318).

RECEIVED BY EMPLOYEE, ASSOCIATE OR THIRD PARTIE

Benefit must be received by the employee, associate or third party.

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An employee is defined as a current, future or former employee (FBTAA s 136).

Associate is defined as a relative or partner of an individual, or a company that is sufficiently influenced by the individual, or whom the person holds a majority voting interest in the company (FBTAA s 159 & TIAA36 s 318).

A person is deemed to be an associate if the 3rd party receives a benefit under an arrangement between the employee and employer (FBTAA s 148(2); ATO ID 2003/7).

The employee or associate must be identifiable.

It does not matter that a person has a dual capacity {ie employee and member} (FBTAA s 148(1)(a)).

IN RESPECT OF EMPLOYMENT

The benefit must be provided in respect of employment means by reason of, or virtue of, directly or indirectly, employment (FBTAA s 136(1)).

FBTAA s 148(1)(f) provides that benefits may still be in the course of employment even if it is not used in respect of employment.

Gifts will generally not be in respect of employment.

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TAXABLE VALUE OF THE FRINGE BENEFIT

The taxable value is used to determine the FBT payable. Need to establish the employer’s aggregate fringe benefits amount according to the type of benefit and its costs.

CAR FRINGE BENEFIT

There are 2 methods of calculating the taxable value of car fringe benefits:

Statutory formula method Operating cost method

If there is no election then the statutory formula applies (s 10(1)). However, if the taxpayer chooses operating costs and the statutory formula is less than the statutory formula applies (s 10(5)).

STATUTORY FORMULA METHOD

Section 9 provides that the calculation of the taxable value will be in accordance with the formula:

Taxable value = (ABC) less E

D

Where:

A = the base value of the car

B = the statutory fraction

C = number of days the benefit was provided

D = number of days in the FBT year

E = the amount of any contribution by recipients

Base value

The base value is the cost price of the car (s 9(2)(a)).

It is reduced to 2/3 if provider holds for more than 4 years at beginning of FBT.

If the car is leased, the base value is the value when it was first leased (s 9(2)(a)).

The base price excludes registration and tax on transfer costs, but includes delivery costs (s 163(1)).

Statutory fraction

The statutory fraction is found in s 9(2)(c)(ii) and depends on the total number of kilometres travelled during the year

Total kilometres travelled during the year Taxable value as a percentage of base value

Less than 15 000 0.26

15 000 to 24 999 0.20

25 000 to 40 000 0.11

Greater than 40 000 0.07

Number of days benefit was provided

Day on which the conditions for a car benefit were satisfied.

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Number of days in the FBT year

Number of days in the year concerned, including leap years.

Amount of contribution by recipients

Includes:

Payment to employer for consideration for the car benefit (s 9(2)(e)). Must actually make the payment Must provide documentary evidence No documentary evidence for fuel and oil

OPERATING COST METHOD

The formula for valuing the car fringe benefit is:

C X (100% - BP) – R

Where:

C = the operating cost of the car during the holding period;

BP = the business percentage applicable to the car which is based on the maintenance of a log book; and

R = the amount of any payments by recipients.

Operating costs

The operating costs includes:

Car expenses such as fuel, repairs, maintenance (s 163(1)) Registration (apportioned by days) Insurance (apportioned by days)

If owned car, must take into account depreciation and imputed interest costs.

If car is leased, must take into account lease costs.

Depreciation costs

The depreciation cost is calculated according to s 11(1) as follows:

ABC / D

Where:

A = Depreciated value

B = depreciation rate (.225 car acquired < 1/7/02 or .1875 car acquired > 1/7/02)

C = Days car was held

D = number of days in the year

DEBT WAIVER FRINGE BENEFIT

A debt waiver fringe benefit arises where an obligation to pay or repay an amount to the provider arises (ss 14, 15).

The taxable value is the amount of payment or repayment which is waived. The waiver must be in connection with the employment of the employee for a benefit to arise. If the debt is waived for some other reason, such as bankruptcy then no benefit arises.

LOAN FRINGE BENEFIT

A loan fringe benefit is deemed to arise where an employer makes a loan to an employee in respect of the employee’s employment (ss 16, 17, 18).

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This occurs where:

The recipient is under an obligation to repay a loan (FBTAA s 16(1)) The employer lets a debt run past it’s due date (FBTA s 16(2)) A loan on which interest accrues but is not payable at least every 6 months (FBTAA s 16(3)).

A loan includes an advance of money or the provision of credit.

The value of the benefit is the difference between the notional interest rate specified under the act (FBTAA s 18) and the actual interest charged.

It does not include loans from a bank to a staff member on commercial terms (FBTAA s 17(1)&(2)), current employee employment related expenses incurred within 6 months (FBTAA s 17(3)), or a temporary advance to pay security deposits (FBTAA s 17(4)).

EXPENSE FRINGE BENEFIT

An expense payment fringe benefit arises where obligations of the employee or associate of the employee are met by the employer. These expenses may be private expenses of the employee or associate of the employee (ss 20 to 24).

The taxable value is the actual payment or reimbursement to the employee or associate of the employee reduced by any employee contributions.

EXEMPTIONS

There are specific exemptions to this, including:

a no private use declaration (FBTAA s 20A); accommodation expenses incurred because they are required to live away from their usual residence because of

employment (FBTA s 21); car expenses where the reimbursement is calculated according to the distance travelled (FBTA s 22).

HOUSING FRINGE BENEFIT

A housing fringe benefit arises where an employee, including a member of their family, is given the right to accommodation as their usual place of residence by the employer (ss 25-29).

The value of the benefit will be the market value of the right to occupy reduced by any employee contributions. Different valuation methods apply depending on whether the accommodation is outside or within Australia.

LIVING AWAY FROM HOME ALLOWANCE

A living away from home allowance fringe benefit arises where any allowance is paid to an employee to compensate for additional expenses incurred in living away from home allowance the amount must be paid to the employee (ss 30, 31).

The taxable value of the living away from home allowance is the amount of the allowance reduced by either or both of:

so much of the allowance as is reasonable compensation for the cost of accommodation of the employee; and so much of the allowance as is reasonable compensation for increased expenditure on food.

MEAL ENTERTAINMENT FRINGE BENEFIT

Meal Entertainment Fringe Benefits arise where an employer provides a meal which is considered to be entertainment to their employee or associates of employees.

There are two methods of calculating the taxable value of the benefit:

50/50 split method (s 37BA); and 12 week register method: s 37CB

50/50 SPLIT METHOD

Under the 50/50 split method, the taxable value is 50% of the value of expenses (s 37BA).

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12 WEEK REGISTER METHOD

The 12 week register method is calculated according to the following method:

Register percentage

The register percentage is calculated according to the following method:

“Total value of meal entertainment fringe benefits" means the total value of meal entertainment fringe benefits that are provided by the employer in the 12 week period covered by the employer's register.

"Total value of meal entertainment" means the total value of meal entertainment provided by the employer during the 12 week period covered by the register.

The “total meal entertainment expenditure” is the total of expenses incurred by the employer in providing meal entertainment for the FBT year.

PROPERTY FRINGE BENEFIT

A property fringe benefit will arise where a person provides property to another person (s 40).

Property is defined in s 135(1) to include all goods, real property and legal property is provided to persons. Goods supplied on working days and consumed on the employer’s premises will not attract FBT.

The taxable value will depend on whether the property is “in-house” or “external”. Valuation of the benefit takes place in accordance with ss 42 and 43 respectively.

IN HOUSE BENEFIT

In house benefits are those kinds of benefits which the provider also provides in the ordinary course of business to outsiders.

An example is floor stock by a furniture retailer to an employee.

EXTERNAL BENEFIT

External benefits are other kinds of benefits

An example is the provision of a plasma television by a law firm to an employee.

RESIDUAL FRINGE BENEFIT

A residual benefit will arise in a situation where there is a benefit but the other specific benefit provisions do not apply (s 45).

Generally, the types of benefits which fall for consideration under this division are services. Valuation depends on whether the benefit is “in-house” or “external”.

REDUCTIONS

The taxable value is reduced by:

the recipient’s contribution the extent that the recipient could have claimed a deduction if they had paid for it themselves. {does not apply to

associates}o The benefit must be a loan, expense payment, airline transport, board, property or residual benefit.

o The recipient must be the employee.

o It does not apply where the deduction is for depreciation.

miscellaneous reduction amounts.

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FBT LIABILITY

An employer pays FBT on the fringe benefits taxable amount. The FBT taxable amount is calculated by reference to ‘grossing up’ the employer aggregate fringe benefits based on the type of benefit.

FRINGE BENEFITS PROVIDED

Here, the total benefits provided:

for which the employer can claim GST input tax credits (Type 1) (FBTAA s 5B(1B)). for which no input tax credits are claimable (Type 2) (FBTAA s 5B(1C)).

GROSSING UP

The taxable benefit must be grossed up under FBTAA s 136AA, so that the aggregate taxable benefit for:

type 1 benefits is multiplied by 2.0647; and type 2 benefits is multiplied by 1.8962.

TOTAL FBT LIABILITY

The grossed up benefits are multiplied by FBT rate.

The FBT rate is taxed at the top marginal tax rate plus the Medicare levy.

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PARTNER

SHIPS

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INTRODUCTION

The tax law contain special rules that deal with partnerships. The general partnership taxation rules are contained in Div 5 of Part III ITAA36.

Division 5 ensures that while partnership income and losses are calculated at the ‘partnership entity level’, a partnership does not actually pay the tax.

STATE THE ISSUE

The issue is here is how much the taxable income of the [partnership] is.

DOES A PARTNERSHIP EXIST?

Under the Partnership Act 1891 (Qld) s 5(1), a partnership is defined as a group of people carrying on a business in common with a view of profit. This is expanded by ITAA97 s 995-1, to include an association of persons in receipt of income jointly.

PARTNERSHIP AT LAW

A partnership is the relation which subsists between persons carrying on a business in common with a view of profit (s 5(1) Partnership Act 1891).

PARTNERSHIP FOR TAX PURPOSES

For tax purposes a partnership is an association of persons carrying on a business as partners or in receipt of ordinary income or statutory income jointly (s 995-1 ITAA97).

The consequences of finding a partnership for tax purposes allow for deductions to be claimed (FCT v McDonald).

FCT v McDonald

Taxpayer and spouse purchased rental property as joint tenants Written agreement – taxpayer 25%/spouse 75% Taxpayer to pay all losses Several years of losses for which taxpayer claimed deductions Commissioner argued that it was not a partnership at general law as the agreement could not define the allocation of

income and losses, and the taxpayer was not entitled to a deduction HELD that the commissioner was correct and the basis for allocation is interest in jointly held property.

EXISTENCE OF A PARTNERSHIP

Whether a business is carried on as a partnership (including husband and wife) is determined by examining (TR 94/8):

mutual assent and intention joint ownership of business assets registration of business name joint business account and power to operate account extent to which parties are involved in the business extent of capital contributions entitlement to a share of net profits business records trading in joint names and public recognition of partnership.

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DETERMINE THE TAX LIABILITY

Under the general partnership taxation rules, partnerships are required to lodge returns, but are not liable to pay tax (s 91).

Instead, it is the partners who account for their respective shares in the income or loss of the partnership (s 92).

DETERMINE NET PARTNERSHIP INCOME

The net income of a partnership (NIP) is its assessable income less allowable deductions.

This is calculated in as with the income of an individual, except certain deductions are excluded:

Personal contributions to a superannuation fund (ITAA97 s 290-150). Losses from previous years are not deductible for the partnership (ITAA97 Div 36).

ADJUSTMENTS

Adjustments are made for:

Partnership salaries – because a partnership cannot employ a partner, any salaries represent a distribution of partnership income. A partner salary cannot be distributed unless there is money to be distributed. If a salary exceeds the partnership income, the entitlement to the salary is carried forward to later years (TR 2005/7).

Drawings – these are not deductions, they are treated as prepayments of the distribution of profits. Loans by a partner to the partnership Interest on capital accounts Partnership borrowing to reduce capital accounts.

DISTRIBUTE NET INCOME OR LOSS

The share of the profits (loss) is included in the partners’ individual tax returns (ITAA36 s 92).

This occurs regardless of whether the individual has received the amounts (Rose v FCT).

IF resident partner:

A resident partner is assessable on income attributable to all sources (ITAA36 ss 92(1)(a)&(2)(a)).

IF non-resident partner:

A non-resident partner is assessable on their share of partnership income attributable to Australian sources only (ITAA36 ss 92(1)(b)&(2)(b)).

PARTNERS SALARY

A partner cannot make a contract with themselves, nor can a partnership employ one of its partners (Ellis v Joseph Ellis).

Any salary drawn represents an additional distribution of the partnership income.

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TRUSTS

EXAM SUMMARY

1. Calculate the "net income of the trust estate".2. Identify the beneficiaries who are presently entitled to a share of the income of the trust estate.

Present entitlement may arise:(a) under s 95A(2);(b) under s 101; or(c) because the circumstances are such that the beneficiary is "presently entitled to a share in the

income of the trust estate".3. Where a beneficiary is presently entitled and is not under a legal disability, the beneficiary (and not

the trustee) will be assessed upon his/her share of the net income, ie his/her assessable income will include his/her share; s 97(1)(a).

4. Where a beneficiary is presently entitled and is under a legal disability, then:(a) the trustee pays tax upon that share of the net income as if it were the income of an individual;

s 98(1); and(b) the beneficiary may, in some circumstances, be assessed on the same income by virtue of s

100(1), though he/she will obtain, pursuant to s 100(2), a credit for any tax paid by the trustee under s 98(1).

5. Where there is a part of the net income to which no beneficiary is presently entitled, the trustee is assessed to tax upon that share under either ss 99 or 99A.

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INTRODUCTION

Division 6 of Pt III ITAA36 contains special rules for dealing with the taxation of trust estates.

Trust estates are not treated as separate entities and trust income is taxed on a ‘flow through’ basis.

Trust income is assessed at the hands of either the trustee or the beneficiaries of the estate.

Trust losses are locked in the trust estate and carried forward until such time as they can be utilized to be offset against trust income in future years.

STATE THE ISSUE

The issue here is whether the [trustee] or the [beneficiary] under the [relevant trust] will be taxed, and the amount.

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TYPES OF TRUSTS

TYPES

The following are the types of trusts:

Express trust Implied and constructive trusts Bare or simple trust Fixed trust Discretionary trust Unit trust Family trust

EXPRESS TRUSTS

An express trust arises where there is an express intention to create a trust.

In the simplest case, an express trust arises where a person declares that they hold property on trust for the benefit of another person.

An express trust can also arise where a court orders money to be held on trust as security for costs (Dwight) or pending the outcome of a dispute (Harmer & Co).

IMPLIED AND CONSTRUCTIVE TRUSTS

Implied and constructive trusts arise where there is no express declaration of trust, but it is nevertheless appropriate that a trust be implied or construed.

Where an employee misappropriates an employer’s funds, the employee would hold the funds and any earnings from them on a constructive trust for the benefit of the employer (Zobory).

FIXED TRUSTS

A fixed trust is a trust under which the beneficiaries’ entitlements to income and capital are fixed.

A beneficiary of a fixed trust has an equitable interest in the property that is held on trust (Baker v Archer-Shee).

DISCRETIONARY TRUSTS

A discretionary trust is a trust under which the trustee has a discretion as to how to distribute the trust income and capital.

The only right that a beneficiary of a discretionary trust usually possesses is the equitable right to demand that the trustee properly administer the trust.

CREATION

A trust may be created inter vivos, by will, or by operation of law.

BENEFICIARY

Beneficiaries of fixed or unit trusts have a proprietary interest in all the property the subject of the trust (Charles v FCT).

A beneficiary of a discretionary trust has no interest in the trust property until the trustee exercises a discretion in their favour (CSD v Livingston). Their only right is to have the trust duly administered, and the trustee to comply with their duties (CSD v Livingston).

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NET INCOME OF TRUST ESTATE

GENERAL RULE

The net income of the trust is determined as if it were a resident taxpayer, meaning its taxable income is its assessable income less allowable deductions (ITAA36 s 95).

The allowable deductions exclude:

Income equalisation deposits In respect of life tenants and income only beneficiaries, previous years losses are required to be met out of corpus.

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TAX INCOME OF TRUST ESTATE

The trustee is not liable to pay tax unless required to by the Act (ITAA36 s 96).

There is no requirement that the person receives a distribution.

PRESENT ENTITLEMENT

A present entitlement is a legal right to demand immediate payment (FCT v Whiting).

FCT v Whiting

The taxpayer was the executors and trustees of a deceased estate. The will provided the residue was to be provided to his widow and children as an annuity. 10 years after the death, the liabilities had not been finalized, however there were credits in the books of account income

for the benefit of the beneficiaries. HELD that the beneficiaries were not presently entitled because they could not get the residue paid to them because the

liabilities of the estate had not been paid. The court determined that a vested right that may never eventuate is not sufficient.

In Taylor & Anor v FCT, the court held presently entitled to include where:

The beneficiary had an absolute and indefeasible interest vested in possession. Income is available for distribution and immediate payment could be demanded. But for the disability, the beneficiary would have been able to demand payment of the income. It is only the disability that prevents entitlement, the person is presently entitled.

RIGHT IS CONTINGENT

There is no present entitlement if the right is contingent.

DEEMED PRESENT ENTITLEMENT

A person has a deemed present entitlement under ITAA36 s 101 where:

There is a discretionary trust The trustee exercises its discretion The discretion is exercised in favour of the beneficiary.

A person has a deemed present entitlement under ITAA36 s 95A(2) where the entitlement is:

Vested; and Indefeasible.

RESIDENT

The relevant date of residency is the end of the year of income.

LEGAL DISABILITY

A person is under a legal disability if they cannot give a valid discharge for a payment made to them (FCT v Taylor). This includes:

A bankrupt A person under a mental disability Minors.

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APPLICATION

PRESENTLY ENTITLED - NO LEGAL DISABILITY - SECTION 97

Because the [beneficiary] is presently entitled, an Australian resident and not under a legal disability, then the beneficiary is taxed on the distribution (ITAA36 s 97).

This includes those who are deemed to be presently entitled under s 101 {discretionary trust}, but not s 95A(2) (ITAA36 s 97(2)(a)).

The taxable amount is the share of the income of:

Whole trust estate, while they are an Australian resident (s 97(1)(a)(i)). The trust estate sourced in Australia for the period the person was a non-resident (s 97(1)(a)(ii)).

PRESENTLY ENTITLED - LEGAL DISABILITY - SECTION 98(1)

Because the [beneficiary] is a presently entitled resident, but under a legal disability, the trustee is taxed at the beneficiary’s marginal tax rate (ITAA36 s 98(1)).

The taxable amount is the share of the income of:

Whole trust estate, while they are an Australian resident (s 98(1)(a)). The trust estate sourced in Australia for the period the person was a non-resident (s 98(1)(b))).

BENEFICIARY’S TAX RETURN

If the beneficiary has no other income, they do not need to lodge a tax return.

If the beneficiary has other income, they must lodge a tax return that includes the income from the trust, and are entitled to a credit for the tax already paid by the trustee (ITAA36 ss 98 & 100).

DEEMED TO BE PRESENTLY ENTITLED - SECTION 95A(2)

Because the beneficiary is deemed to be presently entitled under ITAA36 s 95A and is a resident, the trustee is taxed at the beneficiary’s marginal tax rate (ITAA36 s 98(2)).

If the beneficiary has other income, they must lodge a tax return that includes the income from the trust, and they are entitled to a credit for the tax already paid by the trustee (ITAA36 ss 98 & 100).

PRESENTLY ENTITLED - NON RESIDENT - SECTIONS 98(2A), (3)

Because the beneficiary is a presently entitled non-resident, the trustee is liable to pay tax (ITAA36 s 98(2A) & (3)).

The income is taxed as if it is income of an individual not subject to any deduction.

The taxable income is the beneficiary’s:

Share of the estate when they are a resident (ITAA36 s 98(2A)(c)). Share of the income of the estate for a period they were a non-resident that was sourced in Australia (ITAA36 s 98(2A)

(d)).

NO BENEFICIARY PRESENTLY ENTITLED - SECTIONS 99, 99A

Where there is no beneficiary presently entitled (ie because it does not fall within ss 97 & 98, and is not income that a non-resident in presently entitled to which is sourced outside of Australia), the trustee must pay tax on the income at the top marginal tax rate as if it were a resident (ITAA36 ss 99 & 99A).

The marginal tax rate (rather than the top marginal tax rate) will apply if section 99A (2) applies, which includes:

A trust that results from a will, codicil or intestacy (ITAA36 s 99A(2)(a)). A trust that results from bankruptcy (ITAA36 s 99A(2)(b)&(c)). The Commissioner exercising a discretion that it is unreasonable to apply s 99A.

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TRANSFER OF LOSSES

Trust losses remain within the trust and cannot be distributed.

Trust losses can be carried forward to off-set future income of the trust (ss 265-8 & 272-140).

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STATE TAXES

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INTRODUCTION

There are approximately 125 taxes which are levied on Australians, and the majority of those taxes are imposed by the Commonwealth.

The reduction of various state taxes was considered as part of the reforms which saw the introduction of the GST in 2000.

However, States continue to impose several key taxes of which a tax advisor should be aware, particularly in relation to stamp duty and land tax.

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LAND TAX

Land tax is primarily imposed by the States and the ACT on the value of land.

In Queensland, the relevant legislation is the Land Tax Act 2010 (Qld).

WHO IS LIABLE TO PAY LAND TAX?

Liability for land tax vests with the owner of the land at a particular point in time.

Owner is defined in s 3LTMA as including every person who, jointly and severally, whether at law or in equity, is entitled to any estate of freehold in possession in land.

The Act also expressly includes:

any person whom holds land under a lease from the Crown in perpetuity (s 21) any person in whom land is vested as a trustee (s 24) any purchase of land who has obtained possession (s 26(1)(a)) any person receiving the income of a business carried on the land by another person who is the legal owner (s 30).

The rate of land tax is different for individuals and companies or trustees.

CALCULATION OF TAX

Tax is payable on the taxable value of land owned on 30 June before the year for which the tax is levied.

The actual rates of tax payable are set out in the LTA. In order to determine the amount of an owner’s tax liability, it is necessary to identify:

Which land is owned by a taxpayer; Which land if exempt from tax; That taxable value of the land which is not exempt; The rate of tax applicable.

EXEMPT LAND

The exemptions fall broadly into five main categories:

1. Land owned by, or held in trust for, prescribed bodies, regardless of the use to which the land is put (Chief Commissioner of State Revenue v Darling Harbour Authority). This includes:

a) Friendly societies (Evatt v Chief Commissioner of Land Tax)b) Local councils (s 52)

2. Land owned by, or held in trust for, bodies carried on for certain purposes, and not used for pecuniary profit. This includes:

a) Charitable societies (s 46)b) Educational societies (s 47)c) Religious societies (s 48)

3. Land used or occupied by the owner for a certain purpose (Evatt v Chief Commissioner of Taxation).4. Land and strata lots used as the taxpayer’s principle place of residence.

TAXABLE VALUE

Land tax is payable in the taxable value of non-exempt land.

The taxable value of the land owned is the total sum of the average land values of each parcel of non-exempt land that the person owns.

RATES OF TAX

Land tax is calculated by applying the appropriate rate of land tax to the taxable value of the land.

0 - 599,999 Nil600,00 - 999,999 500 + 1.0% of the excess over 600,00

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1,000,000 - 2,999,999 4,500 + 1.65% of the excess over 1,000,0003,000,000 - 4,999,999 37,500 + 1.25% of the excess over 3,000,000

5,000,000 or more 62,500 + 1.75% of the excess over 5,000,000

The following rates apply for companies, absentees and trustees for the 2010/11 year.

0 - 349,999 Nil350,000 - 2,249,999 1,450 + 1.7% of the excess of 350,000

2,250,000 - 4,999,999 33750 + 1.5% of the excess over 2,250,0005,000,000 or more 75,000 + 2.0% of the excess over 5,000,000

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STAMP DUTY

Stamp duty is a tax imposed separately by each of the States and Territories either a fixed rate or at an ad valorem rate which increase with the value of a transaction.

LIABILITY FOR STAMP DUTY

TRANSFERS AND OTHER TRANSACTIONS CONCERNING DUTIABLE PROPERTY

Chapter 2 of the Duties Act deals not only with transfers of dutiable property, but also with dutiable transactions, including:

Agreements for sale or transfer and declarations of trust over such property (Commissioner of State Revenue v Lam & Kym)

Foreclosure of a mortgage of dutiable property A vesting of dutiable property as a consequence of a statute or court order (s 9).

Dutiable property

Dutiable property generally covers the following:

Land (Tighe v Commissioner of State Revenue) Certain transferable floor space Goodwill (Tourism Holdings Australia) A business asset

EXEMPTIONS FROM DUTY AND CONCESSIONAL RATES

There are generally specific exemptions contained in various provisions, such as for:

Stock in trade, materials held for use in manufacture, goods under manufacture, goods for primary production, live stock, a registered motor vehicle, or a ship or vessel

Marketable securities Transfers to married couples and de facto partners, and on break up of marriages and domestic relationships and

transfers without consideration by a trustee to a beneficiary.

RATES OF DUTY

0 - 5,000 Nil5,001 - 75,000 1.50 for every 100 in excess of 5,000

75,001 - 540,000 1,050 + 3.50 for every 100 in excess of 75,000540,001 - 980,000 17,325 + 4.50 for every 100 in excess of 540,000980,001 or more 37,125 + 5.25 for every 100 in excess of 980,000

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