INCOME A. BASIC PRINCIPLES 1. WHAT IS TAXABLE INCOME - the ...
INCOME A. BASIC PRINCIPLES 1. WHAT IS TAXABLE INCOME - the taxation equation Annual gross income [s BC2] - Annual allowable deductions [s BC 3] = Taxable income 2. ANNUAL GROSS INCOME Legislation BD1: An amount is income of a person if it is their income under a provision in Part C (Income). CA 1 Amounts that are income 1) an amount is income of a person if it is income under a provision in this part. 2) an amount is also income of a person if it is their income under ordinary concepts.
3. THE CONCEPT OF DERIVATION AND RECOGNITION “Derived means more than received… . it means flowing, springing, emanating from or…. Arising from or accruing” 1. WHEN was the income derived for income tax purposes? Legislation BD 3 Allocation of Income to Particular Income Years (2) “An amount of income is allocated to the income year in which the amount is derived” [unless a provision in Parts C or E to I provides for allocation on another basis” (3) When the time of derivation of an amount of income is being determined, regard must be had to case law, which— (a) requires some people to recognise income on an accrual basis; and (b) requires other people to recognise income on a cash basis; and (c) more generally, defines the concept of derivation. (4) This includes income that is credited in a persons account or dealt with in a person’s interest or on their behalf. Judicial principles - The concept of derived The accrual basis [pay tax on the money you receive] is the norm except for a few exceptions
Approach: 1. “the calculation of profits for tax purposes must be founded on legal reality and proper weight must be given to ascertainable facts.” (FTC) 2. ask: what is the nature of this set of arrangements? (Arthur Murray) EXAMPLES CIR v FTC - income earning process is complete when the fridge was exchanged for a debt. - debt is a revenue asset received in exchange for goods in the course of the income earning process. It is cash convertible either through being paid or by selling the debt. CIR v National Bank - Bank did not treat interest incurred on loans to “C” class customers as “income.” EG if “C” class customer owes 10,800 [800 of which is interest] it ignores the $800 as income for tax purposes. - good accounting practice Held: - ‘got’ the $800 when they approved loan and received interest. - different if National Bank wrote the debt off as a bed debt. - Act requires a true view of the taxpayer’s annual income. The annual income cannot be ascertained with reasonable accuracy without taking this debt into account. - therefore, the interest is derived in the year in which it is debited to the customer and so becomes due. Arthur Murray - Ballet school. Customer pays for 10 lessons in advance. Ballet school did not treat as income, put it in a suspense account until class given and then count it as income - amount for fees is received subject to the contingency that a service is performed. The possibility of having to make such a payment back is an inherent characteristic of the receipt itself. - therefore it is not consistent with reality to hold that the amount received has the quality of income derived by the company - distinguishing National Bank: in National Bank, the doing of the “thing” to “get” the income [lending the money] had been done. All that was left to do was collect the money. Here the “doing” of the “thing” had not been done. 4. SOURCE AND RESIDENCE Source Philips Was the interest on a loan “derived” from New Zealand? Court asks - what was the source or derivation of a given income as a practical, hard matter of fact?
To examine the source of the income one must look at the originating cause of the obligation to make the payment of income? Not concerned with where the money came from. That is not the “source” of the income. Here: - Debt payable in Holland - Paid debt by borrowing $$ from England - Proceeds of loan never came to NZ. - Cheque came to NZ, but cheque drawn on bank in London. - TDC owns no property in NZ, and has done nothing in NZ. Concluded: the source of the income was a business transaction [the drawing of the loan] which occurred in the Netherlands. Residence 1. A person who is resident (need to work out what this means) is liable for tax on all income derived from NZ or elsewhere, whether or not it is remitted to NZ 2. Person who is not resident in NZ is liable to income tax on income that has a source in NZ. The Residence Test
Individuals – s YD 1 - Residence of natural persons: Permanent place of abode in New Zealand
(1)
A company is a New Zealand resident for the purposes of this Act if— (a) it is incorporated in New Zealand: (b) its head office is in New Zealand: (c) its centre of management is in New Zealand [textual] (d) its directors, in their capacity as directors, exercise control of the company in NZ, even if the directors’ decision-making also occurs outside New Zealand.
5. REVENUE/CAPITAL General - item coming in? taxpayer wants it to be capital and therefore not assessable. - item going out? Taxpayer wants to be revenue because it can be deducted. Capital payments cannot be deducted - revenue is fruit of the tree and capital is the tree – helpful on one level. APPROACH” BP Australia - no rigid test, look at all the circumstances and ask what the expenditure was calculated to effect from a practical and business point of view. What is really going on? - the result is not determined by the economic consequences for the taxpayers of the receipt – it depends on the commercial effect produced by the transaction. Look at the legal relations actually created. Principles/factors to look for: Capital
Revenue
1. Part of the business structure [eg machine that makes the widget]
Part of the money earning process [workers in factory producing the widget]
- continuity - durability of association - whether you have availability of a dwelling - whether continue to have family and social ties in place - whether you have personal property in place - whether you have business and economic ties in a place
2. Fixed capital [money put into the business to fund a building/factory/machinery]
Circulating [money going round that is generated from the business]
3. Enduring benefit [once and for all] 4. Length of time of the arrangement. One off
Short term benefit/will have to pay again soon Long period of time
Companies – YD 2 – 3
McKenzies
(2)
A person is a New Zealand resident if they have a permanent place of abode in New Zealand, even if they also have a permanent place of abode elsewhere.
What factors are relevant to establish what a “permanent place of abode” means?
Also consider: 5. the need or occasion for the transaction. What was the character of the advantage sought? 6. the usual accounting treatment – while accounting principles do not provide the answer, an accounting perspective of the situation will be another factor in the mix.
Taxpayer was a retail COY. After its takeover it continued to manage its freehold and leasehold properties that it had subleased. Taxpayer paid lessor of a property a lump sum payment in consideration for the surrender of the lease it was paying rent on. The taxpayer claimed a deduction on the sum, arguing that it was rent. Court applied the predominant test. Is this part of the business structure or is it part of the money earning process. Court looked at the real effect of the transaction – what is really going on? While the transaction looked like rent. The expenditure could not be described as a commutation of 38 payments for the lease because M gave up the ability to use the property. The consideration for the payment was the surrender of the interest in the lease not the ability to use the property M was actually paying to get rid of the lease which was part of the structure of the business and therefore a capital asset. = capital payment [not deductible] Note if the transaction involves the acquisition by the firm of an asset it is important to examine the nature of the asset in relation to the business. In this case the lease was part of the profit making structure of the business. However, it would have been a revenue asset if the taxpayer traded in leases – it would be part of trading stock/circulating capital. B: SOME SPECIFIC ITEMS 1. BUSINESS Open to interpretation: 1. what does/does not constitute a business? 2. what is a profession, trade or undertaking carried on for profit? A: Taxpayers Intention – is it a business? Legislation CB 1 Amounts derived from business: (1) an amount that a person derives from a business is income of the person (2) subsection 1 does not apply to an amount that is of a capital nature Business is defined as: (a) includes any profession, trade, or undertaking carried on for profit: (b) includes the activities of— (i) a statutory producer board: (ii) an airport operator: (c) is further defined in section DD 11 (Some definitions) for the purposes of subpart DD (Entertainment expenditure)
If a hobby income not taxable but no deductions. If a business income is taxable but can deduct loss YA 1: Includes any profession trade or undertaking carried on for a profit. Plus some specific inclusions. Whether carried on for profit is a factual question by reference to subjective intention and other expenditure. Grieve - M and Mrs G purchase farm and Mr G works to develop it over two years – clearing gorse, rubbish and weeds and building fences. Start a Stud which runs at a loss. Taxpayers want to offset the losses from the farm activity against their other incomes – including Dr G’s income as a GP Issue: is this a business [and therefore a taxable entity]? Or is it a hobby [private, non-taxable] CA: interprets “business” literally, plain meaning. Two stage TEST: Step 1: the nature of the activities carried on in an organised an coherent way directed to an end result Step 2: the intention of the taxpayer in engaging in those activities The question is not whether it is possible/realistic to make a profit from an enterprise. The question is whether there is an objectively evidenced intention [look at conduct] by the taxpayer to make a profit. Examine: - nature of activity - period over which it is engaged in - the scale of operations - the volume of transactions, - the commitment of time, money and effort - the pattern of activity, - the financial results. - are the operations of the same kind and carried on in the same way as a business in that trade would conduct the venture Reasoning: it is not for the Act to dictate to taxpayers what business they should go about. Applied to the facts here: - significant piece of land - 13 years activity - organised development work - consistent pattern of activity - Mr G committed a lot of time to the exercise Conclusion – it was a “business” - Even though chances of making a profit were slim, objectively the Grieves had an intention to do so – manifested in the activities they, particularly Mr Grieves undertook. B Illegal activities
3. THE CONCEPT OF DERIVATION AND RECOGNITION “Derived means more than received… . it means flowing, springing, emanating from or…. Arising from or accruing” 1. WHEN was the income derived for income tax purposes? Legislation BD 3 Allocation of Income to Particular Income Years (2) “An amount of income is allocated to the income year in which the amount is derived” [unless a provision in Parts C or E to I provides for allocation on another basis” (3) When the time of derivation of an amount of income is being determined, regard must be had to case law, which— (a) requires some people to recognise income on an accrual basis; and (b) requires other people to recognise income on a cash basis; and (c) more generally, defines the concept of derivation. (4) This includes income that is credited in a persons account or dealt with in a person’s interest or on their behalf. Judicial principles - The concept of derived The accrual basis [pay tax on the money you receive] is the norm except for a few exceptions
Approach: 1. “the calculation of profits for tax purposes must be founded on legal reality and proper weight must be given to ascertainable facts.” (FTC) 2. ask: what is the nature of this set of arrangements? (Arthur Murray) EXAMPLES CIR v FTC - income earning process is complete when the fridge was exchanged for a debt. - debt is a revenue asset received in exchange for goods in the course of the income earning process. It is cash convertible either through being paid or by selling the debt. CIR v National Bank - Bank did not treat interest incurred on loans to “C” class customers as “income.” EG if “C” class customer owes 10,800 [800 of which is interest] it ignores the $800 as income for tax purposes. - good accounting practice Held: - ‘got’ the $800 when they approved loan and received interest. - different if National Bank wrote the debt off as a bed debt. - Act requires a true view of the taxpayer’s annual income. The annual income cannot be ascertained with reasonable accuracy without taking this debt into account. - therefore, the interest is derived in the year in which it is debited to the customer and so becomes due. Arthur Murray - Ballet school. Customer pays for 10 lessons in advance. Ballet school did not treat as income, put it in a suspense account until class given and then count it as income - amount for fees is received subject to the contingency that a service is performed. The possibility of having to make such a payment back is an inherent characteristic of the receipt itself. - therefore it is not consistent with reality to hold that the amount received has the quality of income derived by the company - distinguishing National Bank: in National Bank, the doing of the “thing” to “get” the income [lending the money] had been done. All that was left to do was collect the money. Here the “doing” of the “thing” had not been done. 4. SOURCE AND RESIDENCE Source Philips Was the interest on a loan “derived” from New Zealand? Court asks - what was the source or derivation of a given income as a practical, hard matter of fact?
To examine the source of the income one must look at the originating cause of the obligation to make the payment of income? Not concerned with where the money came from. That is not the “source” of the income. Here: - Debt payable in Holland - Paid debt by borrowing $$ from England - Proceeds of loan never came to NZ. - Cheque came to NZ, but cheque drawn on bank in London. - TDC owns no property in NZ, and has done nothing in NZ. Concluded: the source of the income was a business transaction [the drawing of the loan] which occurred in the Netherlands. Residence 1. A person who is resident (need to work out what this means) is liable for tax on all income derived from NZ or elsewhere, whether or not it is remitted to NZ 2. Person who is not resident in NZ is liable to income tax on income that has a source in NZ. The Residence Test
Individuals – s YD 1 - Residence of natural persons: Permanent place of abode in New Zealand
(1)
A company is a New Zealand resident for the purposes of this Act if— (a) it is incorporated in New Zealand: (b) its head office is in New Zealand: (c) its centre of management is in New Zealand [textual] (d) its directors, in their capacity as directors, exercise control of the company in NZ, even if the directors’ decision-making also occurs outside New Zealand.
5. REVENUE/CAPITAL General - item coming in? taxpayer wants it to be capital and therefore not assessable. - item going out? Taxpayer wants to be revenue because it can be deducted. Capital payments cannot be deducted - revenue is fruit of the tree and capital is the tree – helpful on one level. APPROACH” BP Australia - no rigid test, look at all the circumstances and ask what the expenditure was calculated to effect from a practical and business point of view. What is really going on? - the result is not determined by the economic consequences for the taxpayers of the receipt – it depends on the commercial effect produced by the transaction. Look at the legal relations actually created. Principles/factors to look for: Capital
Revenue
1. Part of the business structure [eg machine that makes the widget]
Part of the money earning process [workers in factory producing the widget]
- continuity - durability of association - whether you have availability of a dwelling - whether continue to have family and social ties in place - whether you have personal property in place - whether you have business and economic ties in a place
2. Fixed capital [money put into the business to fund a building/factory/machinery]
Circulating [money going round that is generated from the business]
3. Enduring benefit [once and for all] 4. Length of time of the arrangement. One off
Short term benefit/will have to pay again soon Long period of time
Companies – YD 2 – 3
McKenzies
(2)
A person is a New Zealand resident if they have a permanent place of abode in New Zealand, even if they also have a permanent place of abode elsewhere.
What factors are relevant to establish what a “permanent place of abode” means?
Also consider: 5. the need or occasion for the transaction. What was the character of the advantage sought? 6. the usual accounting treatment – while accounting principles do not provide the answer, an accounting perspective of the situation will be another factor in the mix.
Taxpayer was a retail COY. After its takeover it continued to manage its freehold and leasehold properties that it had subleased. Taxpayer paid lessor of a property a lump sum payment in consideration for the surrender of the lease it was paying rent on. The taxpayer claimed a deduction on the sum, arguing that it was rent. Court applied the predominant test. Is this part of the business structure or is it part of the money earning process. Court looked at the real effect of the transaction – what is really going on? While the transaction looked like rent. The expenditure could not be described as a commutation of 38 payments for the lease because M gave up the ability to use the property. The consideration for the payment was the surrender of the interest in the lease not the ability to use the property M was actually paying to get rid of the lease which was part of the structure of the business and therefore a capital asset. = capital payment [not deductible] Note if the transaction involves the acquisition by the firm of an asset it is important to examine the nature of the asset in relation to the business. In this case the lease was part of the profit making structure of the business. However, it would have been a revenue asset if the taxpayer traded in leases – it would be part of trading stock/circulating capital. B: SOME SPECIFIC ITEMS 1. BUSINESS Open to interpretation: 1. what does/does not constitute a business? 2. what is a profession, trade or undertaking carried on for profit? A: Taxpayers Intention – is it a business? Legislation CB 1 Amounts derived from business: (1) an amount that a person derives from a business is income of the person (2) subsection 1 does not apply to an amount that is of a capital nature Business is defined as: (a) includes any profession, trade, or undertaking carried on for profit: (b) includes the activities of— (i) a statutory producer board: (ii) an airport operator: (c) is further defined in section DD 11 (Some definitions) for the purposes of subpart DD (Entertainment expenditure)
If a hobby income not taxable but no deductions. If a business income is taxable but can deduct loss YA 1: Includes any profession trade or undertaking carried on for a profit. Plus some specific inclusions. Whether carried on for profit is a factual question by reference to subjective intention and other expenditure. Grieve - M and Mrs G purchase farm and Mr G works to develop it over two years – clearing gorse, rubbish and weeds and building fences. Start a Stud which runs at a loss. Taxpayers want to offset the losses from the farm activity against their other incomes – including Dr G’s income as a GP Issue: is this a business [and therefore a taxable entity]? Or is it a hobby [private, non-taxable] CA: interprets “business” literally, plain meaning. Two stage TEST: Step 1: the nature of the activities carried on in an organised an coherent way directed to an end result Step 2: the intention of the taxpayer in engaging in those activities The question is not whether it is possible/realistic to make a profit from an enterprise. The question is whether there is an objectively evidenced intention [look at conduct] by the taxpayer to make a profit. Examine: - nature of activity - period over which it is engaged in - the scale of operations - the volume of transactions, - the commitment of time, money and effort - the pattern of activity, - the financial results. - are the operations of the same kind and carried on in the same way as a business in that trade would conduct the venture Reasoning: it is not for the Act to dictate to taxpayers what business they should go about. Applied to the facts here: - significant piece of land - 13 years activity - organised development work - consistent pattern of activity - Mr G committed a lot of time to the exercise Conclusion – it was a “business” - Even though chances of making a profit were slim, objectively the Grieves had an intention to do so – manifested in the activities they, particularly Mr Grieves undertook. B Illegal activities
