1. ORDINARY INCOME

2. Section 6-5
Section 6-5 ITAA97 includes ordinary income in assessable income
Residents include ordinary income derived directly or indirectly from all sources in assessable income
Foreign residents include ordinary income derived directly or indirectly from Australian sources in assessable income
Ordinary income is not defined in legislation and takes on common law meaning

3. Gain Concept Income = a form of financial “gain”
Under tax law, not all realised financial gains will be treated as income – courts distinguish between gains that are income in nature vs capital in nature

4. Tree
(Capital asset)
Fruit
ie, returns from
capital asset
(Income)

5. “Come in” and “conversion into cash”
Generally for an amount to be income, it must:
“Come in” to a taxpayer rather than merely save expenditure
Be received as cash or in a form that is convertible into cash (Tennant v Smith)
Mere saving of expenditure is not ordinarily income

6. Assessable Income 6-1(1) Assessable income consists of
Ordinary income and
statutory income .
Two Step Process
Is the Payment income according to ordinary concepts?
Is the answer to (a) affected by statute?

7. ORDINARY INCOME Section 6-5 only makes ordinary income assessable
DEFINITION
Scott v Commissioner of Tax
determined in accordance with the ordinary concepts and usages of mankind

8. Common examples of ordinary income
Rent from a lease
Interest from a loan
Royalties from a licence
Dividends from shares
Salary and wages
Whether or not an amount is income “depends upon its quality in the hands of the recipient,

9. Categories of income Ordinary Income Income from personal exertion
Rewards for
services and
payments incidental
to employment,
but not gifts or
payments for
relinquishing
or restricting rights
Income from
business
The ordinary
proceeds of a
business and profits
from trading
transactions, but
not gains from the
mere realisation of
capital assets
Income from profit-
making schemes
Profits from isolated
commercial
transactions
entered into with
the purpose of
making a profit
Income from
Property
Flows from the use
of capital assets
but not gains
accruing to capital
Assets
Foundations of Taxation Law

10. Relevant factors * Now irrelevant due to FBT and S. 21A
Recurrence, regularity and periodicity (Keily)
Continuing expectation of receipt / reliance (Dixon)
Cash / convertible to cash* (Tennant v Smith)/ (Cooke n Sherden v FCT)
* Now irrelevant due to FBT and S. 21A

11. Nexus Should be a nexus between payment and income producing activity
However;
Periodicity; and
Reliance on Receipt
without appropriate nexus (i.e. it being a receipt from personal services, business or property) can give rise to assessable income. see
FCT v Dixon
FCT v Blake

12. FCT V DIXON
Mr Dixon had been employed as a clerk for a shipping agent. In 1940 he voluntarily enlisted for service in the Australian Imperial Forces and he continued to serve in the armed forces until his discharge in In 1946 he returned to work for his former employer.
During the period of the taxpayer's war service, the former employer continued to pay him a sum of money equal to the difference between the rate of his military pay and the rate of pay he had received at the time of his enlistment in

13. The High Court held that the voluntary payments were income in the ordinary sense of the word.
The 'circumstances' in which Mr Dixon entered the war service, as outlined above, were such that he was able to rely with confidence on receiving the periodic payments from his former employer.
(i)   the payments were regular and periodical;
(ii) the payments arose out of circumstances attending Mr Dixon's war service;
(iii)   the payments formed part of the receipts that Mr Dixon depended upon for regular expenditure for himself and his dependants; and
(iv)   the payments were made for that purpose.

14. Substitution of ordinary income
Fullagar J also held that the payments were income, on the basis of the expected regularity of the receipts and the fact that the payments were made in substitution for the salary and wages Mr Dixon would have earned had he not enlisted. The payment accordingly acquired the characteristics of the payment for which it was substituted.

15. FCT v BLAKE
This case considered the issue of ordinary income and whether or not regular payments made as a supplement to an ex-employees pension entitlement was assessable as ordinary income.
Held : It was ordinary income as it was cash, regular, recurrent and periodical
Contrast with FCT v Harris (same facts but payment was in one lump sum hence not ordinary income)

16. Rewards for services & payments incidental to employment
Rewards for services are generally income:
Payment for granting interviews (Brent)
Voluntary payments related to professional activities may be income:
Collections received from the crowd by a professional cricketer for “meritorious performances” (Moorhouse v Dooland)
Payments made by third parties that are “incidental” to employment may be income:
Cash award for “best and fairest” player (Kelly)
Tips (Calvert v Wainwright)

17. Brent v FCT
Wife of Great Train Robber received payments by media co for exclusive right to publish her story.
Held : Income in nature since payment was for services rendered i.e for giving interviews. She was not disposing of copyright or asset.

18. Moorhouse v Dooland
Profesional cricketeer received collections for meritorious performance.
Held : payment was connected to his professional activities i.e. to services rendered hence ordinary income

19. Kelly v FCT
Prof football player received $20,000 from TV Channel for being awarded “best and fairest player”
Held : sufficient nexus between receipt of payment and TP’s employment to be ordinary income. Payment was made in the TP’s pursuit of career.

20. Calvert v Wainwright
Tips received by taxi driver was held to be income in nature as they were clearly remuneration for services rendered.
Therefore, if payment received is incidental to employment it will be considered ordinary income for personal services.

21. Personal Gifts
If there is no nexus between the payment and the services provided (eg: payments by ex employers) then that payment would be characterised as personal gifts rather than remuneration for services (since the services are no longer performed)
Payments that can be traced to some personal relationship that exists between the payer and the recipient will generally not be income:
FCT v Hayes

22. FCT v HAYES
Accountant received shares in a co owned by former employer who had since become a close friend.
Held : Could not relate receipt of shares to any income producing activity on his part. Hence not income in nature (shares were held to be a capital receipt)
Also see : Scott v FCT (solicitor’s gift of personal relationship)

23. Payments for relinquishing rights
Are capital in nature since it means the recipient is surrendering a right
Jarrold v Boustead : payment received by rugby player for giving up amatuer status was held to be a capital (not income) receipt.
Also see : Pritchard v Arundale : shares given to accountatnt to induce him to work for a co was held to be capital since he did not work for it.

24. Income from Business
Gains flowing from trading transactions or that represent the ordinary proceeds or ordinary incidents of a business activity are income.
Whether a business is being carried on depends on “question of fact and degree”

25. Is there a Business?
Factors courts consider when determining whether or not a taxpayer is carrying on a business include:
Profit motive
System and organisation
Regularity of activity
Business records
Ferguson v FCT (preparatory to retirement);
FCT v Walker (purchase of 1 goat)

26. What constitutes a business
A business can exist even where:
Small scale activities (eg Walker: artificial insemination of one goatwas considered a biz due to depth of study)
Short term activities (eg Shields: full time e’yee of finance co bought and sold dividends over 2 mths)
Athletic pursuits (eg Stone: prize money, appearance fees and grants received by police officer who took part in athletics)
Illegal activities (eg La Rosa : TP was allowed to deduct losses from attempted drug deal)

27. hobby A business needs to be distinguished from other activities:
Hobby or pastime
Depends on the facts of each case.
Hobbies may become a biz in the long run.
See : Trautwein v FCT
Contrast with Martin v FCT
Also see : TR 1999/17 ; TR 97/11
Gambling (Babka v FCT 89 ATC 4963)

28. gambling
Although mere punting, especially with the aid of computers, can now be so systematic and dedicated to profit making that it may constitute a business, the intrusion of chance into the activity as a predominant ingredient will usually preclude such a finding.

29. If taxpayer is carrying on a business, then the entire “ordinary proceeds of the business” are assessable even if such amounts are applied for capital purposes
GP International Pipecoaters):co entered into a contract to coat pipes. They used the payment to build a factory to carry out the contract. Payment was income not capital in nature
Profits arising from the restructure of a taxpayer’s business are not generally ordinary proceeds of the business and are usually capital receipts (eg Merv Brown)

30. Capital or Income? How do you distinguish one from the other?
Gains flowing from trading transactions or that represent the ordinary proceeds or ordinary incidents of a business activity are income.
See California Copper

31. California Copper v Harris
1 company sold its copper bearing land and received shares in another company as payment. The company claimed that they should not be taxed on the profit gained as they had substituted one asset (land) for another asset (shares)
Held : sale of the land was a trading transaction since they did not mine the land

32. Importance Gains arising from realisation of an asset is CAPITAL
Gains arising from trading transaction and profit making schemes are INCOME

33. Extraordinary transactions
6/3/1981 : TP lent $80 Million to Myer Finance (shelf co acquired 1 week b4)
MF agreed to pay the $80 plus interest of 12.5% p.a by 30/6/1988 (total $72M)
9/3/1981: TP assigned the $72M to Citicorp for an immediate payment of $45 M

34. Isolated & extraordinary transactions
First strand of Myer:
Gains made from extraordinary transactions may be income where they arise from commercial transactions entered into by taxpayers with the intention of making a profit
Second strand of Myer:
Where a future right to interest is converted into a present lump sum amount, the present lump sum amount will be income as it replaces the future interest which would have been treated as income

35. Income from property
Amounts that “flow” from the exploitation or use of a property (capital asset) are usually income.
Eg : Rent received under a lease of property (Adelaide Fruit & Produce Exchange Co Ltd v DFCT)
However, gains from the sale of capital assets are not ordinarily income in nature :
Foley v Fletcher
Ruhamah Property Co Ltd v FCT (1928)
Scottish Australian Mining Co Ltd v FCT

36. Foley v Fletcher
Vendors sold their land. The Agreement was that the Buyer will pay £768 every 6 months for 30 years.
Even though it looks like ordinary income, it was in reality realisation of capital asset since the Vendors parted with a capital asset in order to gain that income.
The gain was capital NOT income in nature.

37. Ruhamah property v fct
Family owned company sold some properties that had been gifted to the company by the head of the family. The company had held the properties for 9 years and derived rental from them.
The courts held that the sale was of a capital nature and NOT a profit making scheme.

38. Scottish australia mining co V fct
the taxpayer acquired 1771 acres of land between 1863 and 1865 which it used for the purpose of coal mining until the coal was exhausted in It then commenced to progressively subdivide and sell the land.
The taxpayer constructed roads, built a railway station, gave land to institutions, such as schools and churches, and set aside land for parks.

39. Scottish australia mining co V fct
The High Court considered that the mere extensiveness of the organisation set up to realise the land did not cause the realisation to become a business.
They had merely taken the necessary steps to realise the land to its best advantage.
From the above cases we can see that where the asset has been used for some purpose before its sale, the courts will consider it realisation as capital asset.

40. Venturing asset into trading
However, the line that separates it is not always clear.
FCT v WHITFORDS BEACH PTY LTD
In fishermen who wanted access to the beach , formed a company and bought the land leading to the sea and built some fishing shacks on it.
In investors bought the majority shares in the company (and as a result control over the land).
The new shareholders changed the company’s constitution to allow for development of the land.
Issue : is the gain income or capital in nature?

41. Fct v whitfords beach pty ltd
Held : The gain was ordinary income.
It would have been Capital in nature if the 3 fishermen had sold it.
When the 3 new shareholders took over the company, the land was no longer used to access the beach. It was used for development i.e it was a business.

42. Compensation amounts-Income
Payments that replace, substitute or compensate a taxpayer for revenue items or amounts that would have been received on revenue account are generally income:
Loss of trading stock (FCT v Wade)
Loss of income under insurance policy (DP Smith)
Cancellation of employment contracts (Phillips)
Cancellation of trading contracts (Heavy Minerals Pty Ltd, Liftronic Pty Ltd)

43. Compensation amounts – capital (cancellation of contracts)
Payments that replace, substitute or compensate a taxpayer for the loss or destruction of a capital asset are generally capital:
Closing down or sterilisation of a capital asset (Glenboig Union Fireclay Co Ltd v IRC)
Cancellation of structural contracts (Van den Berghs Ltd v Clark)
Cancellation of agency agreements (where it results in the termination of the taxpayer’s business) (Californian Oil Products Ltd)

44. Glenboig Union Fireclay Co Ltd v irc
TP carried on biz of mining and selling raw clay. The Co. held leases over the land containing the clay. Railway lines ran over parts of the land. The Railway co exercised their statutory right to stop the company from mining near the railway lines and paid compensation to the TP.
Held : the amount was capital in nature as the company was permanently deprived of the opportunity to mine that area.
The payment took the same character as the asset it replaced.

45. Van den berghs v clark
2 margarine companies worked in “friendly allegiance”. The parties fell out and Van den Berghs was paid $450,000 as compensation to terminate the agreement.
Held : payment was capital in nature b’coz :
VDB had to surrender their rights under the contract to obtain that payment;
The agreement was not a commercial contract as it affected the manner in which the biz was carried out;
The profit came from the margarine biz not the allegiance agreement.

46. Payment vs premium
Payment (rent) for the use of the property is income in nature. However, a lease premium is usually capital in nature unless it is in reality substitute for rent.
Lease premiums are the payment made in order to secure a lease. Once secured, the payment that follows is rent.

47. Royalty payment Royalty payments can arise from
a) The use of an IP (Book publishing)
b) The Quantity / value of a (physical) substance (eg. Oil extracted off a reserve)
In McCauley v FCT, a dairy farmer sold the trees on his land and was paid an amount based on the quantity of trees cut & removed.
Held : Payment was royalty

48. However, contrast with Stanton v FCT
The TP was a farmer who gave a 3rd party right to remove timber from his land for a predetermined sum to be paid quarterly.
Held : Payment not royalty but capital in nature since the payment sum was predetermined.