Module 5 - Assessable Income

Assessable income formula

Assessable income (s 6-1) = Ordinary income (s 6-5) + Statutory income (s 6-10) - Exempt income (s6-10)

Section 6-1

1. Assessable Income costs of ordinary income and statutory income

2. Some ordinary income and some statutory income is exempt income

3. Exempt income is not assessable income

4. Some ordinary income and some statutory income is neither assessable income or exempt income

5. An amount of ordinary income or statutory income can have only one status (that is, assessable income, exempt income or non-assessable non-exempt income) in the hands of a particular entity

Ordinary Income

Earnings from workings, business activities or property (salary, wages, business profits) based on everyday concepts of income

Section 6-5 Income according to ordinary concepts (ordinary income)

1) Your assessable income includes income according to ordinary concepts, which is called ordinary income.

2) If you are an Australian resident, your assessable income includes the ordinary income you derived directly or indirectly from all sources, whether in or out of Australia, during the income year

3) If you are a foreign resident, your assessable income includes:

a) the ordinary income you derived directly or indirectly from all Australian sources during the income year; and

b) other ordinary income that a provision includes in your assessable income for the income year on some basis other than having an Australian source

4) In working out whether you have derived an amount of ordinary income, and (if so) when you derived it, you are taken to have received the amount as soon as it is applied or dealt with in any way on your behald or as you direct

What is the case law as to what the legislative references to “income according to ordinary concepts”?

Scott v Commissioner of Taxation (1935) 35 SR (NSW) 215 at 219

Scott v Commissioner of Taxation (1935) 35 SR (NSW) 215 at 219

The word “income” is not a term of art, and what forms of receipts are comprehended within it, and what principles are to be applied to ascertain how much of those receipts ought to be treated as income, must be determined in accordance with the ordinary concepts and usages of mankind.

Features of Ordinary Income

1. For an amount to constitute ordinary income, it would generally have a sufficient nexus to one of three income-earning activities:

• the provision of services

• the carrying on of a business, or

• the ownership of property

One exception to this general rule, government payments may constitute ordinary income even though they don’t have a connection to an income-earning activity

2. Not a capital gain

Case Law where government payments may constitue as ordinary income

Keily v FCT (1983) 83 SASR 494 [CS 5.4]; FCT v Anstis (2010) 76 ATR 735.

Keily v FCT (1983) 83 SASR 494 [CS 5.4]

Government age pension constitutes ordinary income.

• Because of the traits it had (regular, expected and depended upon by the taxpayer for support)

Anstis v FCT (2010) 76 ATR 735.

Same logic applies to many other government payments, such as unemployment benefits (eg, jobseeker payment)
The High Court held that Youth Allowance payments constituted ordinary income.

This principle is not restricted to government benefits and could apply to other regular payments.

Case Law of “not a capital gain”

Eisner v Macomber 252 US 189 (1920)

Eisner v Macomber 252 US 189 (1920)

The concept of “flow” is articulated in this case, where the concept of flows was expressed in terms of fruit and trees. The fruit was income and the tree capital.

“The fundamental relation of “capital” to “income” has been much discussed by economists, the former being likened to the tree or the land, the latter to the fruit or the crop; the former depicted as a reservoir supplied from springs, the latter as the outlet stream, to be measured by its flow during a period of time.”

In an employment context, the taxpayer’s ability to work and/or the employment contract would be regarded as the tree, which means that payment for services is akin to the fruit and is ordinary income.

What about unrealised gains?

An unrealised gain will not be ordinary income.

This is related to the flow principle as unrealised gains are not yet regarded as a fruit flowing from a tree. For instance, if a taxpayer in the business of share trading owns shares that have appreciated in value but have yet to be sold, no ordinary income will have been generated until such time that the gain has been realised through the sale of the shares.

Prerequisites of Ordinary Income

1. An amount must be money or convertible to money to constitute ordinary income.

2. An amount must be realised gain to constitute ordinary income

3. An amount must be a real gain to the taxpayer to constitute ordinary income

4. Note constructive receipt rule subsection 6-5(4)

1. An amount must be money or convertible to money to constitute ordinary income.

Relevant Case Law and Legislation

Tenant v Smith [1892] AC 150 [CS 5.1]; FCT v Cooke and Sherden (1980) 10 ATR 696 [CS 5.2]. However, note that s 21A ITAA36 deems any non-cash benefits received in a business context to be convertible.

Tennant v Smith [1892] AC 150 [CS 5.1]

Receipt of free accommodation was not income

The taxpayer was an agent for a bank and lived in free accommodation supplied by the bank. The taxpayer was not allowed to rent out the accommodation.

The House of Lords held that the accommodation was not regarded as income as it was neither cash nor cash-convertible.

FCT v Cooke and Sherden (1980) 10 ATR 696 [CS 5.2

Receipt of non-cash-convertible holiday was not ordinary income

A few taxpayers sold drinks “door to door”. These taxpayers received a free holiday from the soft drink manufacturer due to them selling a certain number of soft drinks. The holidays were non-transferrable and therefore could not be sold.

The Full Federal Court followed the principle in the case of Tennant v Smith and held that because the holidays were not cash-convertible, they were not ordinary income.

However, if the benefit that saved the Taxpayer money could have been directly received by the taxpayer, but they had chosen to redirect it elsewhere, then it would be covered by the principle of constructive receipt and so would generally be considered ordinary income.

s 21A ITAA36

Deems non-cash business benefits as being cash convertible

• business taxpayers can be potentially assessable as ordinarily income despite not being cash or cash-convertible

2. An amount must be realised gain to constitute ordinary income

Relevant case law

Eisner v Macomber

3. An amount must be a real gain to the taxpayer to constitute ordinary income

Relevant Case Law

Countess of Bective v FCT [1932] HCA 22; Hochstrasser v Mayes [1960] AC 376 [CS 5.4]. For example, if an amount is a reimbursement for an expense incurred by the taxpayer, there is no real gain to the taxpayer and the amount does not constitute ordinary income. 

Countess of Bective v FCT [1932] HCA 22

FCT added 633 euros paid to the Countess by trust trustees into her assessable income for 1930.

Established by her late husband for their infant daughter, requiring trustees to pay the net income to the Countess until the child turned 15 for her maintenance, education, and support. 

Whether trust distribution paid to a parent/guardian for the purpose of maintaining a child constitutes assessable income of the parent. To resolve this, the court had to determine if the Countess had a beneficial interest in the funds, meaning they “came in” to her as a real financial gain.

Decision: High court ruled in favour of the Countess. The trust income was not her beneficial income. Because the trust instrument legally mandated that the money be applied to the child’s maintenance, education and support, the Countess received the funds as a fiduciary or guardian subject to an obligation - not as personal wealth. Therefore, money could not be taxed as her ordinary individual income.

Hochstrasser v Mayes [1960] AC 376 [CS 5.4]

Reimbursement for work-related loss upon moving premises was not assessable.

The taxpayer’s employer required him to move cities. 

• Taxpayer sold his house in the city he was relocating from

• House was sold for less than the price for which he purchased it

• Taxpayer’s employer reimbursed him for the loss from selling his house

The House of Lords held that this payment was not assessable.

1. Because it was not a real gain but a compensation for a work-related expense

If the taxpayer had been compensated for a non-work related loss, the receipt would have been a real gain. 

E.g. if a taxpayer’s employer compensated him for share market-related losses, then this receipt would be a real gain because in this example the taxpayer would have been compensated for a non-work-related loss.

4. Also note the constructive receipt rule in subsection 6-5(4).

‘In working out whether you have derived an amount of ordinary income, and (if so) when you derived it, you are taken to have received the amount as soon as it is applied or dealt with in any way on your behalf or as you direct.

• Means you cannot avoid paying tax - or delay the timing of your tax liability by asking someone to pay your income to a third party, bank account, or bill instead of giving it to you directly in cash.

1. You cannot redirect your income to escape tax “applied on your behalf or as you direct” → law treats it as if it hit your own bank account first

2. Locks in the Timing “when you derived it” → prevents taxpayers from manipulating the FY in which they pay tax

Principle of Constructive receipt is that income is treated as being derived by a person when that income has been dealt with as that person directs.

General characteristic of ordinary income?

Periodic, recurrent and regular

• not always the case and a lump-sum amount may constitute ordinary income in certain circumstances

Relevant case law in determining general characteristics of ordinary income

FCT v Blake (1984) 15 ATR 1006, FCT v Harris (1980) 10 ATR 869

FCT v Blake (1984) 15 ATR 1006,

All other things being constant, a gain that is regular or periodic, is more likely to be ordinary income than again that is received as a once-off lump-sum amount

The receipt was regular, the court held that the receipt was of an income nature.

FCT v Harris (1980) 10 ATR 869

One-off receipt

The court held that the one-off receipt was not ordinary income but capital.

When determining whether an amount constitutes ordinary income, it is characterised in the hands of the taxpayer - Federal Coke Co Pty Ltd v FCT (1977) 7 ATR 519 [CS 5.6]

Whether or not the amount would be ordinary income for anyone else is irrelevant.

Whether a receipt is ordinary income or not needs to be determined in the context of the taxpayer.

ATO loses because it did not use the principle of constructive receipt. Section 6-5(4)

Bellambi was an Australian company that owned a subsidiary, Federal Coke. Bellambi had a long-term contract to supply mineral coke to a French company Le Nickel and the mineral coke was supplied by Bellambi’s subsidiary Federal Coke. 

World price of coke declined since the contract price was set and Le Nickel wished to be released from the contract and was willing to compensate Bellambi for cancellation of the contract.

Bellambi professionally advised the compensation payment to Le Nickel and arranged for them to make the payment to Federal Coke. Bellambi hoped that the compensation would not be assessable in Federal Coke’s hands.

Commissioner argued that the income was assessable income of Federal Coke, Full Federal Court found that it was not assessable income.

Court said the receipt was not compensation, because Le Nickel did not have any contractual or other legal obligations with Federal Coke that would have made them owe Federal Coke compensation.

Furthermore, the lack of dealings between Le Nickel and Federal Coke meant that it could not be argued that the receipt was ordinary income due to being the product of business activities.

However, Chief Bowed indicated that had the Commissioner assessed Bellambi rather than Federal Coke, then it was possible that the compensation would still have been assessable in Bellambi’s hands → as Bellambi may have assessable income through the principle of constructive receipt.

The legality of receipts does not affect whether or not an amount constitutues ordinary income - FCT v La Rosa (2003) 53 ATR 1

The court affirmed that the Income Tax legislation does not distinguish between lawful and unlawful business activities for the purpose of ordinary income or standard deductions.

The purpose of income tax laws is to tax taxable income rather than punish moral wrongdoing, which is the proper domain of criminal law.

Because the operation met the definition of a business (repetition, organisation, profit-making intent), the stolen cash represented a loss incurred in purchasing trading stock.

Following on from the pre-requisite that there must be a real gain for an amount to constitute ordinary income, the ‘principle of mutuality’ applies so that payments by members to a club/association is not assessable income to the club - RACV v FCT (1973)

Principle of Mutuality

• One of the prerequisites of income is that there must be a gain to the taxpayer. 

• Therefore follows that if a taxpayer makes a payment to himself or herself, there is no gain and the payment will not be income

Shows that funds given to a club/association by its members are not assessable income of the club as the members are the club, they are one and the same.
Similarly, any refund of these fees back to the members are also not assessable to the members because there is no real gain as the members are only receiving back what was their money.

Taxpayer (RACV) argued that its receipts were not assessable under the mutuality principle.

The Supreme Court of Victoria held that RACV was engaged in some activities that were mutual and some that were not. 

• Distinction between mutual and non-mutual activities was made on the basis of whether the service was provided to members only or whether it was part of the RACV’s trading activities

Compensation payments take on the character of what they are replacing - FCT v Dixon (1952)

Employers offered his employees top up payments if they enlisted in the armed forces during World War II. He said to them that if they ceased working for him and signed up to be soldiers for World War II, he would pay them the difference between their former salary and their military salary.

The High Court held that this “top-up” payment was ordinary income.

• Two judges held that this was because of the traits of the payment (regular, expected and depended upon by the taxpayer for personal living expenses)

• 3rd judge held that the payments were ordinary income due to the compensation principle: since the payments were a compensation for lost salary, and the salary would have been ordinary income, the payment themselves were ordinary income

Statutory Income

Any money/financial gain that is not earned or “ordinary” income, but is still treated as taxable income.

Statutory Income consists of amounts that are included in assessable income by specific provisions of the income tax legislation: s 6-10(2). 

s 6-10

1. Your assessable income also includes some amounts that are not* ordinary income (section 10-5 for a summary of provisions)

2. Amounts that are not* ordinary income, but are included in your assessable income by provisions about assessable income, are called statutory income

3. If an amount would be statutory income apart from the fact that you have not received it, it becomes statutory income as soon as it is applied or dealt with in any way on your behalf or as you direct,

4. If you are an Australian resident, your assessable income includes your statutory income from all sources, whether in or out of Australia

5. If you are a foreign resident, your assessable income includes:

1. Your statutory income from all Australia sources; and

2. Other statutory income that a provision includes in your assessable income on some basis other than have an Australian source

Examples of ordinary income

• Royalties

• Dividends

• Allowances, etc

• Net Capital Gains

Royalties s 15-20

Royalty is a compensation paid to the owner of an asset, such as intellectual property or natural resources, for the right to use that asset.

Dividends: s 44(1)

A portion of the company’s profits paid out to its shareholders.

Allowances, etc: s 15-2;

A fixed amount of money, time, or other resources given regularly for a specific purpose or person

Net capital gains: s 102-5

The final profit you report on your tax return after you add up your capital gains, subtract losses, and apply any eligible discounts

What happens if an amount constitutes both ordinary income and statutory income?

The amount will only be included in assessable income once: s 6-25(1). Generally, statutory income prevails: s 6-25(2). However, this is not always the case and it is necessary to look at the particular statutory income provision. 

Constructive receipt rule for assessable income legislation

s 6-10(3)

Non-Assessable Income (Two types)

• Exempt income (s 6-20)

• Non-assessable-non-exempt income (NANE) (s 6-23)

Even though exempt income and NANE income are both not subject to tax why is it important to know whether an amount is exempt income or NANE?

Due to other consequences such as in the utilisation of losses s 36-10. Exempt income is not taxed, but it may still be counted by the Australian Taxation Office (ATO) to calculate losses or test eligibility for other benefits, whereas NANE (Non-Assessable, Non-Exempt) income is completely ignored for tax calculations and does not affect tax losses.

s 6-20 Exempt Income

1. An amount of ordinary income or statutory income is exempt income if it is made exempt from income tax by a provision of this Act or another Commonwealth law

Summary lists of provisions about exempt income, see section 11-5 and 11-15

2. Ordinary income is also exempt income to the extent that this Act excludes it (expressly or by implication) from being assessable income

3. By contrast, an amount of statutory income is exempt income only if it is made exempt from income tax provision of this Act outside this Division or another Commonwealth law

4. If an amount of ordinary income or statutory income is non-assessable non-exempt income, it is not exempt income

Two classes of exempt income

• Where the entity is exempt regardless of what type of income it has; s 11-5

E.g. certain charitable institutions and local governments

• Where the ordinary or statutory income is of a kind that is exempt: s11-15

E.g. certain education scholarships, qualifying foreign employment income

s 6-23 NANE Income

An amount of ordinary income or statutory income is non-assessable non-exempt income if a provision of this Act or of another Commonwealth law states that it is not assessable income and is not exempt income.

List of provisions about non-assessable non-exempt income, see Subdivision 11-B.

Examples of NANE income

• GST payable on a supply s 17-5

• Receipt of fringe benefits by employees (s 23L(1))

4 Categories of non-assessable income

1. Where the entity is exempt no matter what kind of income it has (s 11-5). For example, certain charitable institutions, local governments, etc are exempt from the income tax.

S 11-5 entities that are exempt, no matter what kind of ordinary or statutory income they have.

2. Where the particular income is ‘exempt income (s 11-15). For example, certain education scholarships (s 51-10) and foreign employment income (s 23AG).

S 11-15 Ordinary or statutory income which is exempt

3. Where the particular income is ‘NANE income’ (s 11-55). For example, fringe benefits (s 23L(1)) and foreign branch income (s 23AH).

S 11-55 List of non-assessable non-exempt income provisions

4. Miscellaneous amounts. For example, exempt fringe benefits (s 23L(1A)) and non-cash business benefits < $300 (s 23L(2))