Topic 1 Flashcards
Quiz 1: Payment for Personal Services
+Are tips received by an employee taxi driver from a customer ordinary income or a mere personal gift?
+ If the taxi driver received a gift of a new jacket from a customer, would the value be ordinary income?
+ Gifts of natural love and affection are not ordinary income (Scott v FC of T). However, the motive of donor is not decisive. From the from the recipient’s viewpoint the gift arose as an incident of rendering services for reward and is ordinary income under s. 6-5 (Calvert v Wainwright).
+Non-cash non-convertible benefits are not ordinary income (Cooke & Sherden). However, the value of such benefits in respect of services rendered is brought to account as statutory income under s.15-2.
Quiz 2: Business v Hobby
A suburban resident sells occasionally sells tomatoes at a casual Sunday market stall. They represent the surplus in excess of his own requirements grown in his garden.
Is the Resident carrying on a business ?
Proceeds of a hobby or pastime are not ordinary income (Martin v FC of T). The lack of profit motive by growing primarily for own requirements in a suburban environment suggests that a business does not exist and the arrangement appears to be small scale and non-commercial (TR 97/11).
Quiz 3: Asset Disposal a mere Capital Receipt?
A car dealer decides to move his business to a newlocation. He sells the old block of land for $1m that hepreviously used to display his stock of cars. The blockoriginally cost $250,000 and there was minimal improvements made to the land to get a better sale price.
Is the $750,000 gain ordinary income or a mere capital receipt?
The land was acquired and used as a capital asset of the business, being the premises within which that business was being conducted. There was nothing exceptional about the manner in which the asset was disposed that suggested the asset had changed its
nature to trading stock in a land development business or a commercial profit making transaction. This is a mere disposal of a capital asset and the $1m is a capital receipt (Casimaty v FC of T). The $750,000 gain may give rise to statutory income under the CGT regime.
Quiz 4: Voluntary Payment
A local amateur athletics club pays an honorarium to the honorary club treasurer each month.
The modest amount is paid in recognition of both time and expense the treasurer incurs in carrying out duties of holding that position.
Is the honorarium assessable as ordinary income?
An honorarium falls into one of two categories of payment”
- An honorary reward for a voluntary service; or
- A fee for professional services voluntarily rendered
Provided the individual’s profession is not related to the task, e.g not an accountant, etc. then item 2 will not apply.
Applying ordinary principles to item 1, the payments seem partially related to services rendered by recognising the time expended. Also, the payments seem regular and expected and are related to the rendering of services. The receipts are ordinary income (FC of T v Dixon, Brent v FC of T). Had the amounts only been reimbursements for vouched expenses, or token amounts that were not automatically paid, such as each amount requiring approval by the committee then they may not have been ordinary income.
Quiz 5: Compensation Receipt
A farmer receives $1m in full settlement concerning a claim for damages against a neighbour. The neighbour negligently started a fire which destroyed some of the farmer’s property. The heads of damages agreed to were:
Barn $300,000
Fences $200,000
Livestock $500,000
$1,000000
How much of the above is ordinary income to the farmer?
How much is on his capital account?
Compensation generally takes the form of what it replaces. Consequently, we must examine if the destroyed assets were on the capital or revenue account.
Barn Capital asset
Fences Capital asset
Livestock Trading stock
The $500,000 compensation for loss of livestock will be ordinary income (FCT v Wade).
The balance may be subject to the capital gains tax provisions discussed in topic 5.
To what extent are the following assessable income:
(i) A $5,000 prize won by an author from a literary competition.
A $5,000 prize won by an author from a literary competition.
Answer: Prizes and windfall gains are not ordinary income (Evans v FCof T). However, exploiting the literary skill as an author removes the element of chance. This receipt appears to be related to an income source either of carrying on a business of writing or otherwise rendering a service as a skilled author which would be ordinary income under s. 6-5 (C of T v Stone).
To what extent are the following assessable income:
Tips received by a waitress. Would your answer be different if the tips were given in kind rather than cash?
Tips received by a waitress. Would your answer be different if the tips were given in kind rather than cash?
Answer: Gifts of natural love and affection are not ordinary income (Scott v FC of T). However, the motive of donor is not decisive. From the from the recipient’s viewpoint the gift arose as an incident of rendering services for reward and is ordinary income under s. 6-5 (Brent v FC of T).
To what extent are the following assessable income:
Shift allowance received by a salary and wages employee.
Shift allowance received by a salary and wages employee.
Answer: Incentives paid to render services, such as working unfavourable shift hours, are ordinary income under s. 6-5. The shift allowance is regular, expected and paid to employees at the same time as the basic salary as part of the working conditions.
To what extent are the following assessable income:
Proceeds from the sale of tomatoes grown by a suburban resident. The tomatoes are in excess of his own requirements.
Proceeds from the sale of tomatoes grown by a suburban resident. The tomatoes are in excess of his own requirements.
Answer: Proceeds of a hobby or pastime are not ordinary income (Martin v FC of T). The lack of profit motive by planting primarily for own requirements in a suburban environment suggests that a business does not exist and the arrangement appears non-commercial.
To what extent are the following assessable income:
Cash received by a student from part-time baby-sitting.
Cash received by a student from part-time baby-sitting.
Answer: Rendering services for reward is ordinary income under s. 6-5 (Brent v FC of T).
QUESTION 3
Christopher Skate had owned a farm for 20 years. On 1 July 2015 he sold the farm and retired to the north coast of New South Wales. On 1 March 2016 he purchased two acres of land on the waterfront for $600,000. In order to provide funds for his retirement and by way of investment, Skate commissioned a builder to design and build eight (8) townhouses at a cost of $130,000 each. Skate also consulted his accountant and asked him to provide details of the expected return from the leasing out of seven (7) of the townhouses.
The townhouses were completed in August 2016. One of the townhouses was retained by Skate and used as his principal residence. The others were leased out on a short term basis. In January 2017 Skate successfully applied to have the townhouses separated by means of strata titles and in March 2017 four (4) of the townhouses had been sold for $300,000 each. With the proceeds Skate purchased an adjoining block of land for $700,000 with the intention of building more townhouses.
Required:
Advise Skate of the income tax implications of the above transactions.
Answer:
Issue: Whether the proceeds of disposal are income or capital receipts.
Relevant Law: Ordinary income is income under ordinary concepts and is assessable under s. 6-5, usually on a gross basis. Capital receipts are not ordinary income and may be subject to capital gains tax on a net basis under s. 102-5. The capital gains discount could apply to the land. (Students note that CGT is covered in topic 5).
Arguments for ordinary income (these would be submitted by the ATO)
+ Skate has purchased land for resale at a profit as a real estate speculator so the proceeds are ordinary income (Californian Copper Syndicate v Harris).
+ The short term renting followed by sale and purchase of more land to develop is inconsistent with the activity of being a landlord. Skate appears to be carrying on a business of developing land for which the proceeds are ordinary income under s. 6-5.
+ Even if Skate initially acquired the land as a capital asset to earn rent from the townhouses, the extensive activity of legal subdivision by strata title to enhance the sale value indicates more than a mere sale of investment. Rather, a change has occurred and the properties have been ventured into a new business of development and sale of real estate and the proceeds are ordinary income under s. 6-5 (FC of T v Whitfords Beach Pty Ltd).
+ Even if a business does not exist, the nature and scale of the activity is commercial such that any novel or once-off transaction for profit is ordinary income (FC of T v The Myer Emporium).
Arguments for capital receipts
+ Skate purchased the land to earn rental income. The land is held as a capital asset such that any gain on disposal of the investment is not profit (Californian Copper Syndicate v Harris).
+ The legal subdivision and sale at enhanced value is merely the disposal of a capital asset to its best advantage (Scottish Australian Mining Company v FC of T).
+ Even if the nature and scale of activities are commercial, Skate originally purchased the land and built the townhouses as an investment. The original arrangement was not entered into for a profit motive and so the gain should be of a capital nature (Westfield Ltd v FC of T).
Conclusion
The evidence of only short term rental contracts, the effort at enhancing sales value by subdivision and the subsequent purchase of further land to develop suggests that the receipts are ordinary income as opposed to a mere disposal of a capital asset.
QUESTION 4
Stage 1: Lien completed a pottery course at a local college in December 2016. She had originally enrolled in the course for something to do while her children were at school. She enjoyed the course and found she had a talent for it. Friends began asking her to make them dinner sets and by February 2017 she had made six sets, but only charged sufficient to cover her costs.
Stage 2: By April 2017 Lien was so busy making dinner sets for friends and acquaintances that she was working nights and week-ends. In June 2017 she began charging a 25% mark-up (the industry average was 60%).
Stage 3: As the orders and work load increased, Lien in July 2017 registered a business name, placed advertisements in the local newspaper and began charging a 60% mark-up.
- Is Lien conducting a business in each income year?
- Why?
- If so, at what point did the money she received from the pottery become assessable income?
Answer: Businesses often start on a small scale and conversely sometimes hobbies can become very consuming. If a hobby makes a transition to a business, the timing may be unclear.
ATO Tax Ruling 97/11 provides a useful summary of business indicators. Of particular relevance is the commercial nature of the transactions and the profit motive. However, scale and repetition may be relevant.
Stage 1: Lien has enrolled on the pottery course as a pastime. Whilst she has charged for six sets of pottery, she has only sold a small quantity to friends and the amount is only to cover costs. The small scale, non-commercial nature suggests that the receipts a merely proceeds of a hobby and are not ordinary income.
Stage 2: Lien is devoting considerable spare time as her turnover is increasing. She is charging a markup on cost, however this is still well below the industry average. It is unclear whether Lien is really making a profit with such a low mark-up just because she has low overheads working from home or whether she is not aware of indirect costs etc. It is possible that she is conducting a business on a small scale in its early stages (FC of T v Walker, Ferguson v FC of T). However, the non-commercial mark-up combined with activity being constrained to spare time in the evenings and weekends might suggest that she is vigorously pursuing a hobby (Martin v FC of T).
Stage 3: Even without registering a business name, Lien is advertising to the public and charges a commercial mark-up which suggests that she is carrying on a business.
Explain whether and to what extent the following receipts are assessable income.
(i) A landscape gardener is injured in a car accident and sues the other driver for lost wages of $10,000 whilst they rehabilitate. The court awarded an additional sum of $500,000 in respect of lost earning capacity because the injury prevents the individual from being able to perform physical gardening work again.
(ii) An advertising Agency Ltd receives $20,000 as compensation for cancellation of an agency contract. The loss of the agency caused the company some loss of prestige but there was little change in the company’s operations. The company has 20 other major clients.
(iii) A dentist sells his business in Hawthorn to another dentist. A condition of the sale is that the vendor signs an agreement that he will not practice dentistry within 15km of Hawthorn for a period of five years. The dentist was paid $10,000 for undertaking this agreement not to compete with the purchaser.
