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.
Judicial Principles – what is income under ordinary concepts? Reid: The answer “must be derived from a consideration of all the circumstances, some of which may point in one direction, some in another.” Factors to consider 1. Something that comes in - is it capable of being turned into money? Here – free TV rental instead of interest payments – not income. (Dawson) - disregard prudent accounting practice 2. Periodicity, recurrence, regularity - Scott: part of the receipts upon which the recipient may depend for his living expenses? CF - CIR v City Motors: Mobil paid for outfitting premises in exchange for promise that City Motors will only supply Mobil Oil. This was a one-off payment. No recurrence. - Reid: sums were regular periodical payments made to alleviate expenses while training.
3. Dependant on the quality in the recipients’ hands Reid: 1) Look at the relationship between the payer and the payee and the purpose of the payment to determine the quality of the payment in the hands of the payee. 2) Does it add more to the notion of $$ coming in? 3) Does it transform the payment of $$ from a gift into income? Here: the nature of the bargain was more like a scholarship: Money only given with promise of reid to work as teacher after qualified - Taxpayer did not do anything more than a prospective teacher would be expected to do in exchange for the allowance. A Taxpayer: - stolen money is not income derived because it is not property in the recipients’ hands. The taxpayer had an obligation to pay the money back. (Changed now – statute provides for stolen money being assessable now) 3. IN WHAT PERIOD WAS IT DERIVED? Income must be allocated to an income year under this section. “Derived means more than received… . it means flowing, springing, emanating from or…. Arising from 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. or accruing” 1. When was the income derived for income tax purposes? Judicial principles - The concept of derived The accrual basis [derived when obligation incurred/debt goes on books] is the norm except for a few exceptions
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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)
Concluded: the source of the income was a business transaction [the drawing of the loan] which occurred in the Netherlands.
CIR v FTC Debt is an asset – once you get it, income is deemed received - cannot ignore existence of the asset of debt received on revenue account in exchange for the goods. The debt is cash convertible either through being paid or by selling the debt. - income earning process is complete when the fridge was exchanged for a debt.
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.
CIR v National Bank Once the “doing of the thing” to “get” the asset is done, it is income - 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: - Interest ‘got’ (and hence derived in year) the $800 when they approved loan and received interest. - different if National Bank wrote the debt off as a bed debt. - Must be consistent with the reality of the taxpayer’s annual income. When interest is earned and charged, the business has acquired an asset. Arthur Murray If deeming something income is still contingent on something further happening, then you can’t recognize income until that thing is done. Possibility of not receiving it is an inherent characteristic of the income itself - 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 - 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.
Residence
Individuals – s YD 1 - Residence of natural persons: Permanent place of abode in New Zealand (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? - 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
The Residence Test
4. SOURCE AND RESIDENCE Was the source in NZ? Philips Was the originating cause of obligation from in NZ? Where the payment came from doesn’t matter. 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? 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.
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3. Enduring benefit [once and for all] 4. Length of time of the arrangement. One off
Companies – YD 2 – 3 (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 New Zealand, even if the directors’ decision-making also occurs outside New Zealand [textual]
5. REVENUE/CAPITAL Income is the fruit not the tree 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 BP Australia - no rigid test or description - answer derived from many aspects of the whole set of circumstances some of which may point in one direction, some in the other - Hallstrom test: weigh and balance all of the factors. What was the expenditure calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process. - 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]
2. Fixed capital [money put into the business to fund a building/factory/machinery]
Circulating [money going round that is generated from the business]
Short term benefit/will have to pay again soon Long period of time
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. McKenzies 1) Was the transaction going to affecting structure of the business, or more related to income earning? 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. The taxpayer claimed a deduction on the sum, arguing that it was rent. 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. 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] B: SOME SPECIFIC ITEMS 1. BUSINESS An amount derived from a business is income of the person 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)
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A: Taxpayers Intention Grieve - a secretary [Mr G] and a GP [Dr G] purchase a run down farm and Mr G works to develop it over two years – clearing gorse, rubbish and weeds and building new fences. Start a Hereford Stud. Stud 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] Two stage TEST: 1. Was the nature of the activities carried on in an organised an coherent way directed to an end result? 2. What was the objective intention of the taxpayer in engaging in those activities? (Irrelevant whether possible/realistic to make a profit from enterprise – not for Act to dictate how TP’s should go about business 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 te venture Applied to the facts here: - significant piece of land - 13 years continuous activity - development work took place in organized way - 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 CB 32 Property obtained by theft Income (1) (2) (3)
If a person obtains possession or control of property without claim of right, an amount equal to the market value of the property is income of the person. The income is allocated to the income year in which the person obtains possession or control of the property. Subsection (1) applies whether or not the person holds the property as a trustee under a constructive trust.
2. LAND 1. is it land? Definition – broad (a) (b) (c) (d) (e) (f)
includes any estate or interest in land: includes an option to acquire land or an estate or interest in land: does not include a mortgage: is defined in section CB 19(3) (Business exclusion from sections CB 6 to CB 11) for the purposes of that section: is defined in section IZ 1(12) (Use of specified activity net losses) for the purposes of that section: in the definitions of permit area, petroleum mining asset, prospecting expenditure, and residual expenditure,— (i) (ii) (iii) (iv)
means all land within the territorial limits of New Zealand; and includes land below the territorial sea of New Zealand or any other waters within the territorial limits of New Zealand; and includes the continental shelf; and includes the seabed and subsoil below any sea that is beyond the territorial sea of New Zealand but that, by New Zealand legislation and under international law, has been or may be designated as an area in which the rights of New Zealand relating to natural resources may be exercised
Cost of acquiring land may be deductable BD2 – If meet a section in D, deductable., DB23 – Deductable for expenditure incurred as revenue account property YA1 – Revenue Account Property: trading stock of person, is disposed of for valuable consideration and - sale price 250,000 - cost of land 100,000 - taxable gain 150,000 is what is taxable. Categories A: Is it acquired for the purpose/intention of sale? S CB 6: CM9 A: The rule: $$ derived from disposing of land is income if land was acquired:
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Judicial Principles – what is income under ordinary concepts? Reid: The answer “must be derived from a consideration of all the circumstances, some of which may point in one direction, some in another.” Factors to consider 1. Something that comes in - is it capable of being turned into money? Here – free TV rental instead of interest payments – not income. (Dawson) - disregard prudent accounting practice 2. Periodicity, recurrence, regularity - Scott: part of the receipts upon which the recipient may depend for his living expenses? CF - CIR v City Motors: Mobil paid for outfitting premises in exchange for promise that City Motors will only supply Mobil Oil. This was a one-off payment. No recurrence. - Reid: sums were regular periodical payments made to alleviate expenses while training.
3. Dependant on the quality in the recipients’ hands Reid: 1) Look at the relationship between the payer and the payee and the purpose of the payment to determine the quality of the payment in the hands of the payee. 2) Does it add more to the notion of $$ coming in? 3) Does it transform the payment of $$ from a gift into income? Here: the nature of the bargain was more like a scholarship: Money only given with promise of reid to work as teacher after qualified - Taxpayer did not do anything more than a prospective teacher would be expected to do in exchange for the allowance. A Taxpayer: - stolen money is not income derived because it is not property in the recipients’ hands. The taxpayer had an obligation to pay the money back. (Changed now – statute provides for stolen money being assessable now) 3. IN WHAT PERIOD WAS IT DERIVED? Income must be allocated to an income year under this section. “Derived means more than received… . it means flowing, springing, emanating from or…. Arising from 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. or accruing” 1. When was the income derived for income tax purposes? Judicial principles - The concept of derived The accrual basis [derived when obligation incurred/debt goes on books] is the norm except for a few exceptions
1
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)
Concluded: the source of the income was a business transaction [the drawing of the loan] which occurred in the Netherlands.
CIR v FTC Debt is an asset – once you get it, income is deemed received - cannot ignore existence of the asset of debt received on revenue account in exchange for the goods. The debt is cash convertible either through being paid or by selling the debt. - income earning process is complete when the fridge was exchanged for a debt.
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.
CIR v National Bank Once the “doing of the thing” to “get” the asset is done, it is income - 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: - Interest ‘got’ (and hence derived in year) the $800 when they approved loan and received interest. - different if National Bank wrote the debt off as a bed debt. - Must be consistent with the reality of the taxpayer’s annual income. When interest is earned and charged, the business has acquired an asset. Arthur Murray If deeming something income is still contingent on something further happening, then you can’t recognize income until that thing is done. Possibility of not receiving it is an inherent characteristic of the income itself - 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 - 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.
Residence
Individuals – s YD 1 - Residence of natural persons: Permanent place of abode in New Zealand (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? - 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
The Residence Test
4. SOURCE AND RESIDENCE Was the source in NZ? Philips Was the originating cause of obligation from in NZ? Where the payment came from doesn’t matter. 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? 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.
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3. Enduring benefit [once and for all] 4. Length of time of the arrangement. One off
Companies – YD 2 – 3 (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 New Zealand, even if the directors’ decision-making also occurs outside New Zealand [textual]
5. REVENUE/CAPITAL Income is the fruit not the tree 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 BP Australia - no rigid test or description - answer derived from many aspects of the whole set of circumstances some of which may point in one direction, some in the other - Hallstrom test: weigh and balance all of the factors. What was the expenditure calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process. - 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]
2. Fixed capital [money put into the business to fund a building/factory/machinery]
Circulating [money going round that is generated from the business]
Short term benefit/will have to pay again soon Long period of time
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. McKenzies 1) Was the transaction going to affecting structure of the business, or more related to income earning? 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. The taxpayer claimed a deduction on the sum, arguing that it was rent. 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. 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] B: SOME SPECIFIC ITEMS 1. BUSINESS An amount derived from a business is income of the person 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)
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A: Taxpayers Intention Grieve - a secretary [Mr G] and a GP [Dr G] purchase a run down farm and Mr G works to develop it over two years – clearing gorse, rubbish and weeds and building new fences. Start a Hereford Stud. Stud 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] Two stage TEST: 1. Was the nature of the activities carried on in an organised an coherent way directed to an end result? 2. What was the objective intention of the taxpayer in engaging in those activities? (Irrelevant whether possible/realistic to make a profit from enterprise – not for Act to dictate how TP’s should go about business 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 te venture Applied to the facts here: - significant piece of land - 13 years continuous activity - development work took place in organized way - 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 CB 32 Property obtained by theft Income (1) (2) (3)
If a person obtains possession or control of property without claim of right, an amount equal to the market value of the property is income of the person. The income is allocated to the income year in which the person obtains possession or control of the property. Subsection (1) applies whether or not the person holds the property as a trustee under a constructive trust.
2. LAND 1. is it land? Definition – broad (a) (b) (c) (d) (e) (f)
includes any estate or interest in land: includes an option to acquire land or an estate or interest in land: does not include a mortgage: is defined in section CB 19(3) (Business exclusion from sections CB 6 to CB 11) for the purposes of that section: is defined in section IZ 1(12) (Use of specified activity net losses) for the purposes of that section: in the definitions of permit area, petroleum mining asset, prospecting expenditure, and residual expenditure,— (i) (ii) (iii) (iv)
means all land within the territorial limits of New Zealand; and includes land below the territorial sea of New Zealand or any other waters within the territorial limits of New Zealand; and includes the continental shelf; and includes the seabed and subsoil below any sea that is beyond the territorial sea of New Zealand but that, by New Zealand legislation and under international law, has been or may be designated as an area in which the rights of New Zealand relating to natural resources may be exercised
Cost of acquiring land may be deductable BD2 – If meet a section in D, deductable., DB23 – Deductable for expenditure incurred as revenue account property YA1 – Revenue Account Property: trading stock of person, is disposed of for valuable consideration and - sale price 250,000 - cost of land 100,000 - taxable gain 150,000 is what is taxable. Categories A: Is it acquired for the purpose/intention of sale? S CB 6: CM9 A: The rule: $$ derived from disposing of land is income if land was acquired:
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