Selected Answer Guides topic 2 SG question 2.4 (a) Issue: Is the lump sum income or a capital receipt? If the lump sum is a receipt for the disposal of a capital asset s. 6-5 of the ITAA should not apply as it is not ordinary income. The lump sum will be income under s. 6-5 if the disposal of the property can be viewed as occurring in the ordinary course of the taxpayer’s business or income earning activities. To determine whether the proceeds are income, as distinct from a capital receipt, regard should be had to all of the facts of the particular case, since no one fact is likely to be conclusive. In particular, the following facts need to be considered: 1. The business or profession of the taxpayer. If his or her business or profession is such that such disposals are reasonably incidental to the conduct of such a business or profession, the lump sum is more likely to be viewed as income; the periodicity, regularity and repetition of such contracts. If contracts for the disposal of copyright are frequently entered into, it is more likely that the payment is income and not the mere realisation of a capital asset; and the existence of a profit motive. If the taxpayer’s substantial or dominant purpose in disposing of the copyright was to derive a profit, the receipt is more likely to be income. However, if the taxpayer is carrying on a business, and the receipt is extraordinary when judged in relation to the ordinary course of that business, the receipt may still be income if the principle in Federal Commissioner of Taxation v. Myer Emporium Ltd 87 ATC 4363 applies. 2. The receipt may constitute income even though it arises from an isolated business transaction, if the taxpayer is already conducting a business and the taxpayer’s intention or purpose in entering the transaction was to make a profit or gain by the means giving rise to the profit. Therefore, if the taxpayer was in the business of writing and selling copyright then the receipt is ordinary income under s 6-5 as business income. In contrast, if the normal income is royalties which flow from the copyright then the sale of the copyright is the sale of capital (the tree) and not ordinary income. (b) Issue: As the taxpayer is in business of a property developer, what is the scope of the business and therefore what is ordinary income under s 6-5? Also is it possible for taxpayer is this business to have a mere realisation of assets? The sale of the subdivided lots and the house and land package are clearly within the scope of the business and are ordinary income in the form of circulating capital.

Sale of the office block appears to be a mere realisation (Westfield) as it indicates that it was no longer suitable for the purpose acquired. However, the nature of the taxpayer’s business needs to be considered (eg display houses used as business offices and then sold). This issue needs to be considered in relation to the original intention at the time of purchase and the manner in which it is sold (Whitford’s Beach) as the land does not appear to have become part of the property development business assests. Sale of the inherited land is a mere realisation (Westfield) because there could be no intention of acquisition as it was a gift and it has not been introduced into the scope of the business as it has not been developed in anyway. Coleman 6.2 In Tax Ruling IT 167, the ATO is of the view that prizes won from casually appearing on a game show will not constitute ordinary income. Consequently, it is unlikely that Sally’s prizes will constitute ordinary income. However, there is an argument that the fact that Sally appeared on 10 shows indicates sufficient regularity and skill for the cash and household appliance prizes to be classified as ordinary income: see [6.110]–[6.120]. The overseas trip is not cash convertible and so would not be ordinary income: FCT v Cooke & Sherden (1980) 10 ATR 696; see [6.130]. None of the prizes would be assessable under capital gains tax under any circumstances because of s 118-37(1)(c) of ITAA 1997: see Chapter 11. It is possible that s 15-2 of ITAA 1997 would apply to the prizes if they were not ordinary income. However, the application of s 15-2 in situations analogous to this remains untested by case law: see [6.190]–[6.220]. The $100 appearance money for both Jan and Sally is likely to be regarded as ordinary income due to being a reward for services: see [6.30]. Coleman 6.4 The amount of $40,000 is likely to be considered ordinary income rather than capital. In cases such as FCT v Woite (1982) 13 ATR 579 and Higgs v Olivier [1952] Ch 311, the court indicated that restraint of trade payments that occur during the length of the employment contract are typically ordinary income: see [6.160]–[6.170]. In cases such as FCT v Woite (1982) 13 ATR 579 and Higgs v Olivier [1952] Ch 311 the court indicated that restraint of trade payments that occur during the length of the employment contract are typically ordinary income. However, in Bennett v FCT (1947) a payment to reduce the directors powers was held to be capital for the given up of a valuable right. The amount of $40,000 is paid during the course of the employment contract and does not extend beyond it. As a result Woite, Hepples and Higgs v Olivier are not good authority and so the question still remains does this payment show a

nexus for the services provided or has the taxpayer given up a valuable right/s. In Bennett the valuable right was identified as the loss of certain powers within the entity but in this case the agreement is more a requirement to not do certain things which is the provision of a service, and the obiter in Woite could be used to support the case that this is ordinary income. In reality the employee has just amended their employment contract and not given up anything of value – it is just an additional terms that has been added to the employment contract. Coleman 9.5 First offer – $10,000 to give up all rights to the book: it is unlikely that this receipt is income from the business of being an author as this is the first book written and it is based on a one-off experience. There is no indication of an intention to enter a new business of writing books. Further, since the client wrote the book and is now selling the rights to publish the book, it is not income from personal exertion as he was not contracted by the publisher to write the book: Brent v FCT (1971) 125 CLR 418. For the receipt to be ordinary income under the first strand of Myer, the client would have had to enter this transaction with an intention to profit and would have undertaken it in a business-like manner. This could be argued either way as the facts do not give sufficient detail. This leaves the question of whether it is property income in the form of a royalty. The client has sold all the rights to the book and therefore has disposed of the source of income rather than the income itself, making the $10,000 capital in nature. Capital royalties can be assessable income under s 15-20, but for this section to apply, the amount must be a royalty. For the receipt to be a royalty the payment must be related to the quantity sold, which it is not in this case: see [9.190]–[9.200]. Therefore, the first strand of Myer may be applied to include the $10,000 as ordinary income, but if this is not the case, then the $10,000 would be subject to CGT. Second offer – 10% of the sale price of each book: in this case the client has used the capital of the book to earn income as a royalty, which will be ordinary income under s 65. Section 15-20 will not apply because of the contra indication in s 15-20(2). Coleman 6.5 The main issue is whether the receipts show a nexus to work performed and are therefore ordinary income under s 6-5 of ITAA 1997 or whether any part of the receipts is capital for giving up the right to income as in FCT v Woite (1982) 13 ATR 579. The annual salary of $100,000 is clearly assessable as ordinary income as there is a clear nexus with the services provided and this receipt shows many of the indicia of income – ie regular, relied on, nexus with personal services etc: see [6.30].

The $400,000 receipt is not as obvious and should be compared with decisions such as Woite and Jarrold v Boustead (1963) 41 TC 701. If there is a nexus with some service, then it is ordinary income as in Brent v FCT (1971) 125 CLR 418. However, if the payment is to give up the right to income then it is capital, as in Woite. The conclusion therefore depends on the facts but it appears that the taxpayer is paid as an inducement to enter a contract. As a result, they are being paid to provide a service in the future, thus establishing the nexus and making it ordinary income: see [6.30]. The taxpayer has not given up any valuable right by accepting this contract and therefore it is likely they have been paid to do something which is ordinary income under s 6-5: see [6.180]. Section 15-2 is also relevant if there are sufficient facts to deny the $400,000 being ordinary income. The $400,000 receipts will be statutory income under s 15-2 if they constitute a benefit etc, provided it is in respect of employment or services. From Smith v FCT (1987) 19 ATR 274 there is the suggestion that the nexus test required for s 15-2 is easier to meet than for s 6-5, and the fact that this payment is an inducement to enter an employment contract would show it as arising out of future services: see [6.220]. Coleman 6.6 • When considering whether the prize is ordinary income (s 6-5 of ITAA 1997) the first step must be to ascertain if there is a nexus with any service provided. The prize is a reward for being the top student but is it a reward for personal exertion? The nexus with personal exertion may not exist as the student does not provide a service to the donor of the award, the prize is not relied on and the level of chance is high, which makes for a stronger case that it is not ordinary income: see [6.110]. However, in Kelly v FCT (1985) 16 ATR 478 a prize paid for the best performance was held to be ordinary income on the basis that is was a direct result of the taxpayer’s skill, even though the reward was paid by a third party. Nevertheless, Kelly was a professional footballer and this case may be distinguished on the basis that the student’s prize did not arise out of an income earning activity: see [6.120]. The fact that the student receives government assistance raises the issue of whether this prize relates to this assistance. It clearly does not so this fact does not alter the nature of the prize for tax purposes. • If the gratuity is a gift, it is not income in ordinary concepts under s 6-5 but the payment will be income if it is a payment for services rendered by the taxpayer. The taxpayer in this case is the widow (not the deceased spouse) since she receives the benefit of the payment and the provider of the services was her deceased husband. Since the taxpayer did not render any services to her deceased husband’s employer, the gratuity is not ordinary income: see [6.20]–[6.30]. In addition, s 15-2 would not apply as the payment is not related to any service provided. If the payment was

made to the deceased estate of the spouse, it may be ordinary income under s 6-5 if it relates to past services. • The honorarium will be ordinary income (s 6-5) if it is a direct payment for services rendered to the club: see [6.90]–[6.100]. If it is a gift, it will not be ordinary income.

In this case the honorarium will be a gift if there is no nexus with any service provided: Scott v FCT (1966) 117 CLR 514; Hayes v FCT (1956) 96 CLR 47. From the facts it appears that the payment is unexpected, its amount is independent of the quantity of work performed, and it appears to be paid infrequently. On the other hand, the amount is ordinary income if it is paid for services provided. In this case it would be difficult to argue that the honorarium is paid for any other reason other than for the work done for the football club: Laidler v Perry [1965] 2 All ER 121. There is no indication of any personal relationship as in Scott or special event for which the amount is paid, and therefore it is more likely to be ordinary income under s 6-5. However, in Case Z16 (1992) 92 ATC 183 (not binding authority), the tribunal found that an honorarium of $100 was not ordinary income because it depended on the goodwill of the organisation making the payment. Even if there is some case for the honorarium not being ordinary income, it is still necessary to consider whether it is statutory income under s 15-2. From Smith v FCT (1987) 19 ATR 274 there is the suggestion that the nexus test required for s 15-2 is easier to meet than for s 6-5. The fact that this payment is from an organisation for which the taxpayer provided services and that there is no other reason for the payment would strongly indicate that the honorarium is in respect of the service provided and therefore subject to s 15-2: see [6.220]. If the amount is ordinary income under s 6-5, then s 15-2 will not apply. • The bonus will be ordinary income (s 6-5) if it is a direct or indirect product of services rendered by the employee in developing the suggestion. It will not be ordinary income if it is unrelated to the employee’s services, but is regarded as the result of luck or chance. Various factors need to be considered in deciding whether the bonus is income. These include the following:     Is the payment a payment for services? Did management have an established practice of rewarding employees for their suggestions and were such payments frequently paid, i.e. was the reward expected? Has the employee already been adequately rewarded for the services rendered by him? Did the employee rely on the payment as part of the receipts on which he supports himself and any dependants?

From Laidler v Perry [1965] 2 All ER 121 there is no indication that this amount was paid for any reason other than the contribution of the idea. There is no indication of any personal relationship, as in Scott, or special event (eg birthday) for which the amount is paid, and therefore it is more likely to be ordinary income under s 6-5. Even if there is a case that the amount was not ordinary income, it is still necessary to consider whether it is statutory income under s 15-2. From Smith v FCT (1987) 19 ATR 274 there is the suggestion that the nexus test required for s 15-2 is easier to meet than for s 6-5. The fact that this payment is from an employer for whom the taxpayer worked, and that there is no other reason for the payment, would strongly indicate that the bonus is in respect of providing the suggestion and therefore subject to s 15-2: see [6.220]. If the amount is ordinary income under s 6-5, then s 15-2 will not apply. Coleman 8.1 To determine whether Georgina is in business or only conducting activities that are preliminary to a business, it is necessary to apply the indicia of a business used by the courts. In Ferguson v FCT (1979) 9 ATR 873, the main criteria used were that: • • a purpose of profit-making may be important but not essential; repetition and regularity are considerations, but a business could involve a single transaction and every business must commence with a single transaction; organisation and a businesslike approach with appropriate record-keeping etc are indications of a business activity; having other sources of income did not preclude this activity from being a business; the size of the operation and the amount of capital are relevant, but must be looked at in the context of the type of activity, eg a recreational pursuit may have considerable effort and resources contributed to it and not be a business.

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The fact that Georgina conducts the activity through an agent will not in itself show that she is not in business as the court will consider a number of factors and weigh these up to form a conclusion. The facts given for Georgina do not have some of the key elements that were present in Ferguson v FCT. For example, there is no clear indication of a longer term plan to develop the herd, there is no real personal involvement in the planning and operation of the breeding program, the size of the transaction was rather small and there is no capital involved.

On the other hand, a business may exist even though it is small (Thomas v FCT) or conducted inefficiently. If Georgina could show that this breeding program is part of a plan to build a larger herd of stud cattle and that she was undertaking this in a businesslike manner, there would be a reasonable case to argue that she is in business. However, on the facts presented, it would be difficult to justify that her activities are a business. SG question 2.13 (a) (d) a) Issue: whether the one-off transaction constituted a business venture with an intention to profit and therefore ordinary income under s. 6-5 or is it simply a mere realisation of an asset and therefore capital. The taxpayer purchased the land with the intention of building a shopping complex on it and presumably deriving profit from the use of the property rather than from its sale. However, this plan was never pursued as in Westfield so it needs to be considered whether the sale is a mere realisation of a failed plan or a commercial transaction with an intention to profit as in Myer. To apply Myer both the commercial transaction and the intention to profit must be proved. The fact that the taxpayer ‘believed she could do better by developing the land herself’, may indicates that she had the intention of making a profit rather than just realising an existing asset. Her level of activity and the fact that she refused a previous offer all point to the conclusion that there is both the commercial approach and the intention to profit but the intention to profit from sale may not have existed at the start as required for Myer to apply. As a result Whitfords Beach will be more relevant if you conclude that she has now entered this asset into a new business. Applying the tests of a business (Ferguson) there is quite a deal of facts supporting the commencement of a business of property development – seeking advice, size of the operation, the nature of the activity and assets. d) Issue: Is the taxpayer carrying on a business making the gain ordinary income under s. 6-5 or is it a hobby? Does the illegal nature of the activities effect assessability? The fact that the taxpayer’s activities are illegal, is irrelevant (Partridge v Mallandaine). Activities may still be considered to be carrying on a business as defined in sec. 9951(1). If the taxpayer was considered to be carrying on a business, then the proceeds of his activities $10,000 would be income in ordinary concepts and assessable under s. 65(1); Partridge v Mallandaine. Also TR 93/25. Applying the indicia of a business (commercial approach etc) shows clearly that this is a business activity. It is not appropriate to argue that the income would not be detectible by the ATO or that he would not declare it, the question must be answered on the basis of the law.

Coleman 8.2 The first issue raised in the question is whether the sale is an isolated transaction that is ordinary income following the decision in FCT v Whitfords Beach Pty Ltd (1982)12 ATR 692, or whether it is a mere realisation of a capital asset. Axis Holdings is carrying on a farming business and whether this is an extraordinary or isolated transaction will depend on whether the current business is still in operation: see [8.170]. As the property is developed for resale it could be argued that the business of farming has ceased and the sale is an isolated transaction. On this basis, the principles in FCT v Whitfords can be applied to help determine whether this sale is ordinary income or a mere realisation. From the cases following Whitfords Beach it appears that there are only guidelines and no strict rules on how a mere realisation can be separated from a sale undertaken in a business manner. However, the businesslike approach to the disposal is an important distinguishing factor. This is seen in cases such as Casimaty v FCT (1997) 37 ATR 358 where the development was not taken to the final stage of selling individual blocks. In this case, Axis Holdings has sold the area as one parcel of land and this fact would help the argument that it is a mere realisation, as in Scottish Australian Mining Co Ltd v FCT (1950) 81 CLR 188. These facts also need to be considered in relation to the possible application of the first strand of FCT v Myer Emporium Ltd (1987) 163 CLR 199. The first strand of Myer will apply if there is a commercial transaction entered into with an intention to profit and the profit ultimately realised arises from the initial intention. For the first strand of Myer to apply, it would be necessary to show that the property was purchased with the intention to sell it at a profit. The facts give some indication of this intention in that the shareholders of the company have been involved in property development and the purchase is in an area of extensive real estate development. However, the company appears to have been established to operate a farming business. The other factor that may be used to argue against the application of Myer is that the property was not developed as might be expected from a property developer, but was sold rather quickly because of imminent changes to zoning. The decision in Westfield Ltd v FCT (1991) 21 ATR 1398, where it was shown that the intention to sell the property must clearly exist at the time of the purchase, may also be used to support the case that this is a mere realisation. It could be reasonable to argue that this is ordinary income from an extraordinary transaction provided it is assumed that the development is continuing, but if the sale is not ordinary income it may be subject to CGT. Coleman 8.5 Issue: Consider the ‘first limb of Myers’, if a commercial transaction has a profit making purpose, then the proceeds will be ordinary income under s. 6-5. However, for the ‘first

limb of Myers’ to apply, the profit making purpose on acquiring the asset must be consistent with the way the profit was eventually made (Westfield) - Is there sufficient similarity between the purpose and the way the profit was actually made? For the sale to be ordinary income under Myer both the commercial transaction and the intention to profit must be shown, and as Peta does not appear to be in business the intention must be present at the time of acquisition. In this case the facts indicate that Peta had an intention of profit through the development and sale of part of the property so it could be argued that the intention existed. However, the original plan was not proceeded with and for Myer to apply it would be necessary to show that the intention of profit survived the change in plan. In contrast it could be argued that the original intention was abandoned and that this is a mere realization at the best possible price as in Westfield. The fact that some time has passed and that she was approached by the tennis club supports the view that this is a change in plan, and it could be argued that the original intention has been abandoned. Also consider that this could be an isolated transaction under Whitford, ie, that Peta is in the business of reconditioning tennis courts. In Whitford’s case, it was either suggested by the judges that a simple subdivision and sale of land would not be ordinary income (a mere realization) . However, an extensive development of land (which includes not only a subdivision, but also constructing roads, etc) would constitute a business and so would be ordinary income. Applying this principle to Peta requires a determination of whether what she has done is ‘thorough’ enough to show a business or commercial intent, this is a question of fact. The Commissioner may disagree with this and argues that an amount will be assessable if the taxpayer acquires property with the a purpose of making a profit by whichever means prove most suitable and a profit is later obtained by any means which implements the initial profit-making purpose; acquires property contemplating a number of different methods of making a profit and uses one of those methods in making a profit; or enters into a transaction with the purpose of making a profit by one particular means but actually obtains the profit by a different means. TR 92/3 para 5558. In Case 1 of 1999 (99 ATC 101), the AAT stated that these paragraphs of TR 92/3 were “wrong and should be rewritten”. So what did the High court mean in Myer? Case 1 of 1999 involved an intention to make a profit but the actual profit was made in a different way. The courts said non-assessable. The appeal, FC of T v Haass 99 ATC 4814 held that the amount was assessable because the way in which the profit was made was only slightly different to the way in which it was originally intended. However, if the taxpayer intended to make a profit by any number of alternatives, even though the actual method had not been determined initially, the profit may still be assessable. That is, intended to sell at a profit but the

profit was made in a way that was not specifically set out at the time the acquisition was made. SG question 2.16 (c) c) Issue: Assessability of compensation under s.6-5 depends on what the compensation is replacing; C of T (NSW) v Meeks. The compensation takes on the same character as that which it replaces. Also, is the compensation capital or income. Ordinary income will often exhibit periodicity, recurrence and regularity; FC of T v Harris. Whether the business structure was fundamentally destroyed and therefore the compensation payment is capital, or simply a cancellation of a business contract. Compensation received for damage to the fundamental structure of the business is considered capital; Van den Berghs, Federal Coke. However, compensation for cancellation of business contracts is generally income as it represents lost profits: Short Bros Ltd v IRC. As the loss only represented 10% of the taxpayer’s business, and she was able to enter a similar agency agreement and suffer little or no loss, the payment would be considered to be income; Heavy Minerals Pty Ltd. SG question 2.18 (a) (c) a) The importance of this question of to apply the correct section of the ITAAs and to explore whether s 6-5 or s 15-2 is the most appropriate section to apply. All except the reimbufarsement are clearly ordinary income but the 3 allowances are also assessable under s 15-2 and because of the operation of s 15-2 in conjunction with s 6-25 it is necessary to first apply s 6-5 and if this makes it assessable the amount will be assessed as ordinary income. If s 6-5 does not apply then see if s 15-2 will apply which arguable has a lower standard of nexus test and therefore is easier to satisfy . The reimbursement is not ordinary income but is assessable under s 15-2 as it is compensation for employee expenses. c)  Christmas bonus would be income, as it is a product or incident of employment; Hochstrasser v Mayes, there is sufficient nexus with employment. However, it is also assessable under s.15-2 and as this section is more specific it must be applied in preference to s.6-5. The special bonus would could be treated the same as the Christmas bonus but it may also be an ETP under s.27A. I do not expect you to study ETPs in detail but you should be aware of their existence.

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Annual and long service leave would be assessable under ss. 26AC (depending on the reason for leaving and the date re after Aug 1993 will be taxed at ordinary rates if resigned) and 26AD respectfully.