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