Ordinary income Tennant v Smith, (money or convertible into money) An employee was given accommodation rent free by his employer. Was this ordinary income? • The employee could not sublet the accommodation to anyone else, therefore could not turn this accommodation into cash. • The Court said it was not ordinary income under s. 25(1) (now s. 6-5) since the accommodation was not convertible into money. • Not ordinary income under s. 6-5. FCT v Cooke & Sherden. (money or convertible into money) Soft drink retailers were given holidays by wholesalers/manufacturers for selling a certain number of soft drinks.
Was this ordinary income? The holidays could not be cashed in or transferred to anyone else. The holidays were not convertible into cash, therefore the first characteristic was not met, and therefore the holidays were not ordinary income under s. 25(1). There is a further principle from this case. If the holidays were a substitute for income, rather than a voluntary reward, then the holiday would assume the character of the income it replaced. Not a binding principle from this case (Obiter Dicta).
FCT v Dixon, Periodicity, recurrence and regularity/substitution principal Taxpayer left his job to enlist in the armed forces, but the army did not pay as much as his old job. Former employer topped up his pay on a regular basis to make up the difference. 2 of the 5 judges said the payments were judged to be incidental to the army service. Therefore ordinary income. 1 judge said that the payments were a substitute for salary from the taxpayer’s former employment, therefore were ordinary income. The other two judges said there was no connection to an earning activity and concluded that it was not ordinary income.
But the case was decided on a 3-2 majority of the High Court that the receipt was ordinary income. FCT v Harris, Periodicity, recurrence and regularity Ex-gratia payment (voluntary) made to a retired bank manager to offset the effects of inflation on his pension. One payment only was originally intended but others were made later. This case considered the first payment only. The majority of judges agreed the payments were not ordinary income because the payments were not a product of past services. However one judge disagreed saying that the past employment was the cause of the payments.
He was in the minority so the payments were judged to not be ordinary income. Regularity and periodicity is relevant, though not generally decisive. The decisions in Harris and Dixon turned on whether the payment had a connection to any earning activity. FCT v Blake. Periodicity, recurrence and regularity Similar to Harris, but regular supplementary payments were made and considered in the case. Held to be income (contrast with Harris). The judge in Blake agreed with the minority judge in Harris that the payments were ‘caused’ by the previous employment.
Commentators favour the approach in Blake therefore Blake’s reasoning is preferred. Myer Emporium capital v income The case involved assignment of an income stream on a loan (ie interest) to a third party. Myer received a lump sum for that assignment. High Court held that the receipt was ordinary income. Refer back to FCT v Harris & periodicity not being a decisive characteristic. Mclaurin v FCT, Allsop v FCT. (capital) Where a lump sum is made up of both income and capital, but we don’t know how much of each, then the whole amount is capital Scott v FCT.
If there is an employment/services relationship only, you can argue strongly that there is a sufficient nexus between the voluntary payment and an earning activity, therefore it is ordinary income under s. 6-5(1). If there is an employment/services relationship and a personal relationship it is assumed that there is sufficient nexus unless the taxpayer can prove the gift was personal. Gambling Cases: Jones v FCT. Jones was a grazier who betted heavily and lost lots of money. High Court held the taxpayer was not carrying on a business. High level of betting not nough to constitute a business. The taxpayer had a bad habit that he was in a special position to be able to gratify Trautwein v FCT. Contrast with Jones’ case. • Conducted a horse racing business and the betting systematic and organised. Therefore the betting was seen as small part of that large business. The winnings were held to be income under s. 6-5(1) and the losses deductible. Martin v FCT. A case between the extremes of Jones and Trautwein. Taxpayer owned and raced horses as a part-time activity. He employed trainers to train them and also bet on them using a betting system.
High Court decided the activities were not enough to constitute carrying on a business General deduction cases Charles moore Employees were robbed whilst going to the bank to deposit the day’s takings. Banking daily takings is a necessary part of business operations (High Court). Therefore the loss was necessarily incurred in carrying on a business for producing assessable income. The loss by robbery was ‘incidental and relevant’ to the business. ACG This case involved a finance company which traded unprofitably.
Trading ceased for one year and then the company was taken over by AGC Ltd whereupon trading recommenced. Deductions were sought for losses incurred in relation to debts from the old business that was taken over. The Commissioner denied the deductions using Amalgamated Zinc as an authority, i. e. The expenditure had to be incurred at the same time as producing the assessable income. But the Court decided that it is enough that the cause of the outgoing can be found in the carrying on of a business for the production of assessable income, even though the income was produced in a previous year.
Placer Pacific Management Pty Ltd v FCT The taxpayer manufactured conveyer belts. In 1981 it sold its business, except for some uncompleted contracts, to a new company. The taxpayer was liable to complete these contracts at its own risk and loss. A prior customer sued claiming a conveyer belt was defective. The matter was settled 8 years later in 1989 (well after business had ceased) and the taxpayer claimed a deduction for the settlement amount and legal fees. The Commissioner denied the deduction since the taxpayer’s business was sold 8 years before.
But the court held that the taxpayer was entitled to the deductions. This is because the business operations were the cause of the settlement and legal expenses. “Provided the occasion for the loss or outgoing is to be found in the business operations directed to gaining or producing assessable income, that loss will be deductible unless it is of a capital nature. ” Lunney v FCT; Hayley v FCT Two taxpayers’ claims for travel costs from home to work were denied. The judge said that you cannot argue that the travel costs were deductible because the expenditure was necessary to derive income.
This means that you ignore the purpose of the expenditure. Instead you consider the expenditure’s essential character. Ure v FCT The taxpayer borrowed some money from a bank at commercial interest rates of up to 12. 5% and on-lent that money at 1% interest rate. He returned the interest earned at 1% as assessable income and claimed deduction for full amount of interest paid to the bank. The court looked at the subjective purpose of borrowing the money, which was private, and only allowed a deduction up to the level of the 1% interest earned
Specific deductions Western suburb cinemas A cinema’s ceiling was made from ‘Tin Test’ with lattice panels. Replaced by fibro sheeting. The new ceiling had a number of advantages (including reducing repair bills) and so was judged to be a non-deductible improvement Lindsay v. FCT (1961) Expenditure on a slipway, which involved the demolition of the old slipway and the reconstruction of a new one, was found to amount to expenditure on an entirety. It was found that the slipway was separately identifiable as a principal item of capital equipment.
Accordingly, it was to be regarded as an entirety by itself and not as a subsidiary part of anything else, such as of the ship-yard. Hence, the work was of a non-deductible capital nature. W G Thomas & Co Pty Ltd v. FCT Also, the question of what constituted an entirety was considered. The company taxpayer claimed a deduction for general repairs to a building, including roof and guttering repairs, repairs to walls and the basement floor, painting, and alterations to an office. In this case, the building itself was held to be the entirety for the purpose of determining whether work done was a revenue repair or capital in nature.
As a consequence, what could be classed as a replacement of a part of the building, eg roof and guttering replacement, would be a deductible repair, rather than the replacement or renewal of an entirety which would be capital. Law Shipping Co. Ltd v. CIR Where, a ship was bought in a state that required significant repairs to pass survey for it to continue at sea. In fact, at the time of purchase the ship was at sea and the survey was undertaken on its return. Repairs amounting to 51,558 pounds were required and of this amount only an amount of 12,000 pounds was allowed as a deduction.
This lesser amount was held to be applicable to repairs whose need arose during the period of new ownership Carden’s case,which method Henderson v FCT, accrual Large chartered accounting firm. Accruals basis because: The firm had 19 partners and 295 employees including 150 qualified accountants, and The income was not the result of one person’s work alone, but many accountants. Not personal services income FCT v Firstenberg, cash Contrasting decision to Henderson. • A solicitor in sole practice with one secretary. • The income was derived due to the efforts of one person alone.
Secretary only provided support. Only the solicitor does billable work. Therefore is personal services income. • Cash basis appropriate. Arthur Murray (NSW) Pty Ltd v FCT. Cash received in advanced Dancing school, offered lifetime courses, 3,000 pounds paid up front for 1,200 hours of lessons. The fees are clearly ordinary income under s. 6-5(1) as it is income from a business. Accruals basis seen as appropriate for a large dancing school with many staff. No obligation to repay the fees for non-completion (although sometimes refunds were given). Used an ‘unearned income’ account to record the fees. Money was transferred to an income account when the lessons were taught. • Since accruals basis was appropriate, the issue was when was the money earned? Was money earned when it was paid by customers or when the lessons had been provided? The possibility that Arthur Murray would give money back to customers for lessons not taught meant that the money could not be earned until the lessons were completed. • Once the lessons were completed the customer could not ask for a refund and had no claim on the money paid. The case confirmed the business accounting method as the correct method of derivation for tax.