Module 6 - Income from services

Main provisions in the context of income from services

Section 15-2 ITAA97, S 23L ITAA36, FBTAA

What is section 15-2 ITAA97 include?

Allowances and other things provided in respect of employment or services

Section 15-2 (1)

Your assessable income includes the value to you of all allowances, gratuities, compensation, benefits, bonuses and premiums *provided to you in respect of, or for or in relation directly or indirectly to, any employment of or services rendered by you (including any service as a member of the Dedence Force).

Section 15-2 (2)

This is so whether the things were *provided in money or in any other form.

Section 15-2 (3)

However, the value of the following are not included in your assessable income under this section:

a) a superannuation lump sum or an employment termination payment

b) an unused annual leave payment or an unused long service leave payment

c) a dividend or non-share dividend

d) an amount that is assessable as ordinary income under section 6-5

e) ESS interests to which Subdivision 83 A-B or 83A-C (about employee share schemes) applies

what does s 23L ITAA36 tell us?

Certain benefits in the nature of income not assessable

Stipulates that a fringe benefit is NANE income. As such, if a payment or benefit constitutes a ‘fringe benefit’, it is taxable to the employer under the fringe benefits tax regime and is not assessable income for the employee.

S 23L ITAA 36 (1) - Fringe Benefits

Income derived by a taxpayer by way of the provision of a fringe benefit is not assessable income and is not exempt income of the taxpayer

S 23L ITAA 36 (1A) - Provision of benefits

Income derived by a taxpayer by way of the provision of a benefit (other than a benefit to which section 15-70 of ITAA97 applies) that, but for paragraph (g) of the definition of fringe benefit in subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986, would be a fringe benefit is exempt income of the taxpayer.

S 23L ITAA 36 (2) - Non-cash business benefits Where:

a) In a year of income, a taxpayer derives income consisting of one or more non-cash business benefits (within the meaning of section 21A); and

b) The total amount that is applicable under section 21A in respect of those benefits does not exceed $300;

The income is exempt income.

In determining the tax consequences of cash or non-cash benefits received in a service it is necessary to consider the following..?

• Is it a fringe benefit? (if there is an employment relationship)

• Is the amount ordinary income (s 6-5)?

• Is the amount caught by s 15-2 or CGT Event D1?

What are salary and wages considered?

A classic form of ordinary income and is assessable income under s 6-5.

• excluded from the definition of fringe benefit in s 136(1) FBTAA

What are allowances?

Allowances are predetermined amount made to cover an estimated expense and paid regardless of whether the expense is incurred.

• assessable income under either s 6-5 or s 15-2

Tax consequences for allowances and relevant case law?

Depend on whether it is an allowance or reimbursement.

Case Law: Roads and Traffic Authority of New South Wales v FCT (1993) 93 ATC 4508

Roads and Traffic Authority of New South Wales v FCT (1993) 93 ATC 4508

The court stated that an ‘allowance’ is a predetermined amount made to cover an estimated expense and is paid regardless of whether the expense is incurred whereas a ‘reimbursement’ is compensation for the actual amount of expenses incurred by the taxpayer. The Commissioner adopts the same position in TR 92/15.

Reimbursement

Compensation for the actual amount of expenses incurred

Reimbursement tax consequence

Treated as a ‘fringe benefit’ and is subject to the fringe benefits tax

In TR 92/15 how is an allowance defined?

 A definite, predetermined amount of money paid to an employee to cover estimated expenses. It is paid regardless of whether the employee actually incurs or spends the money, and the employee has full discretion over how to use it.

In TR 92/15 how is a reimbursement defined?

A payment that compensates an employee precisely for an expense they have already incurred (or will incur on behalf of the employer). The employee must account for the exact amount and often provide receipts or vouchers.

Voluntary Payments vs Gifts

Voluntary payments are employment/services being the sole and motivating cause of the benefit (even if the amount is gratuitous) it may be income, whereas gifts are personal/other characteristics of the recipient being the sole and motivating cause of the benefit.

FCT v Holmes (1995) 31 ATR 71 - Facts

Receipt of reward money for helping to prevent an environmental disaster was assessable.

Taxpayer was an employee on a shipping vessel near a leaking oil tanker.

Leaking oil tanker was heading towards the shore, risking losing most of its cargo and causing an environmental disaster.

• Taxpayer and coworkers were able to use the vessel they were on to tow the oil tanker out of danger

• As a result of his effort the TP received a payment of $23,381 “Salvage Reward”

• The entitlement to this reward was based on a principle in the law of Admiralty (laws relating to ocean vessels) that an owner of salvaged property must pay those that saved the salvaged property

• TP would not have received the money if he failed to to tow the oil tanker safely

FCT v Holmes (1995) 31 ATR 71 - Outcome

Full Federal Court held that the reward money was assessable under the predecessor of s15-2.

• Stating that there was clearly a nexus between the effort of the TP in saving the oil tanker and the reward money

• Court stated the fact that that the TP would not have received the money had the salvage been unsuccessful strengthened the case for there being a nexus between the reward money and the services performed

In this case, the court did not need to consider whether the reward constituted ordinary income, because the gain was assessable under s 15-2’s predecessor.

NOTE

• The predecessor of s 15-2 considered in this case, unlike the current s 15-2, did not exclude amounts that were also ordinary income.

• If the case was decided today, the Court would first consider if the gain was ordinary income, and then only if it decided that there was a chance that it was not ordinary income, would the Court then proceed to apply s 15-2.

What cases assist in determining whether an amount/benefit is income or a gift?

1. Scott v FCT (1966) 117 CLR 514 [CS 6.4]

2. Brown v FCT (2002) 49 ATR 301 [CS 6.1]

3. Laidler v Perry [1965] 2 All ER 121 [CS 6.3]

4. Hayes v FCT(1956) 96 CLR 47 [CS 6.5]

Scott v FCT (1966) 117 CLR 514 [CS 6.4] - Whether the TP has been otherwise adequately remunerated for their services, whether there was another relationship between the taxpayer and the provider, whether the benefit was solicited, whether the benefit is of a kind which is a common incident of the recipient’s occupation - FACTS

Characteristics of a personal gift

High Court held that the gift of 10,000 euros paid by a client to Mr Scott was a personal gift and not ordinary income.

Scott had acted as solicitor for Freestone for some years and in this case was acting as her solicitor in relation to the estate of her deceased husband.

• Prior to Mr Freestone’s death, he and Scott had known each other for many years and were associated in various business activities

• On the death of her husband, Mrs Freestone engaged Scott to carry out work in relation to the administration of her husband’s deceased estate, which included the sale of a number of properties, the main one being an area of 82 acres known as “Greenacres”

• Scott played an important role increasing the value of the property thus was sold for a considerable profit

• Following the sale of “Greenacres” Mrs Freestone was informed by Scott that the bill of costs would be prepared and later paid by Freestone.

• Before the bill was rendered Mrs Freestone told Scott she intended to make  a number of gifts from the sale of the property and this included one to him of 10,000 euros

Scott v FCT (1966) 117 CLR 514 [CS 6.4] - Whether the TP has been otherwise adequately remunerated for their services, whether there was another relationship between the taxpayer and the provider, whether the benefit was solicited, whether the benefit is of a kind which is a common incident of the recipient’s occupation - OUTCOME

High Court reasons to why it was not ordinary income:

• Character of 10,000 should be assessed as a receipt in the hands of the taxpayer

• Receipt must be a product of the relevant activity to be ordinary income; if it is a product of friendship or other personal characteristics, then it is a personal gift

• The fact that Scott was fully remunerated for his services separately from the payment

• The fact that Scott did not expect the gift

• Personal relationship prior to the payment as well as the fact that the donor made other gifts at the same time

• Motives of the donor do not normally determine whether the character of the receipt is ordinary income

Brown v FCT (2002) 49 ATR 301 [CS 6.1] - Whether the TP has been otherwise adequately remunerated for their services, Whether there was another relationship between the taxpayer and the provider, whether the benefit is traceable to some activity by the recipient for which the provider is grateful - FACTS

Property received as a reward for service was assessable

Brown received free of charge from the property developer a beachfront apartment with all the costs of transfer and fitting out the apartment paid for. The total value of the property and other costs were over $1mill.

Brown played an important role in the success of a major property development project by (among other things) introducing the purchaser to the property developer.

TP argued that the property received was a personal gift and not ordinary income as it was given out of friendship and did not have a nexus with any work performed or service provided.

The commissioner argued that there was a benefit equal to the value of the property received and that this benefit was as a result of the services provided by Brown.

Brown v FCT (2002) 49 ATR 301 [CS 6.1] - Whether the TP has been otherwise adequately remunerated for their services, Whether there was another relationship between the taxpayer and the provider, whether the benefit is traceable to some activity by the recipient for which the provider is grateful - OUTCOME

The Full Federal Court found that the value of the benefits received was ordinary income because the benefit received resulted from the activities undertaken by Brown.

• It was held that the benefit provided was primarily a reward to Brown for introducing the prospective buyer to the property developer, and the nexus was established because the reward would only be forthcoming if the deal was finalised.

Laidler v Perry [1965] 2 All ER 121 [CS 6.3] - Whether there was another relationship between the taxpayer and the provider - FACTS

Christmas Bonus was Ordinary Income

A Christmas bonus was paid to all current and past employees in the form of a voucher that could be redeemed for goods. 

• Vouchers were provided regardless of the pay rate or the personal circumstances of the employee and were accompanied by a letter expressing the boards thanks

Laidler v Perry [1965] 2 All ER 121 [CS 6.3] - Whether there was another relationship between the taxpayer and the provider - OUTCOME

It was held by the House of Lords that the voucher was income as it arose out of employment, even though it was a voluntary payment on behalf of the employer.

Hayes v FCT(1956) 96 CLR 47 [CS 6.5] - Whether the benefit was solicited, whether the benefit is traceable to some activity by the recipient for which the provider is grateful - FACTS

Characteristics of a gift

Hayes was the supervising and general accountant for Mr Richardon’s meat and smallgoods business.

• Richardson’s business was taken over by  company of which Hayes was a director, secretary and shareholder

• Initially, Richardson did not have a controlling interest in the company but after several years gained control of the entity

• Richardson persuaded Hayes to sell his shares to him but Hayes remained a director and secretary

• Company became quite successful and was incorporated as a public company in which Richardson was allotted a considerable number of shares and he transferred 12,000 of these to Hayes

The commissioner argued that the value of these shares was ordinary income or assessable under s 26(e) of the ITAA36 = s 15-2 97.

Hayes v FCT(1956) 96 CLR 47 [CS 6.5] - Whether the benefit was solicited, whether the benefit is traceable to some activity by the recipient for which the provider is grateful - OUTCOME

The High Court concluded that the value of the shares transferred to Hayes was a personal gift and not ordinary income

• Court noted that Hayes and Richardson had developed a personal relationship, and that for the value of the shares to be ordinary income they must be seen in the hands of the recipient as a reward from employment or other services

• In this case, Hayes had been fully paid for his services and therefore the shares were not additional reward for his work

Penn v Spiers & Pond Ltd [1908] 1 KB 76 - Whether the benefit is of a kind which is a common incident of the recipient’s occupation - FACTS & OUTCOME

Tips received by a railway dining car waiter

• Made because of the level of service provided making them assessable as ordinary income

Great Western Railway Co v Helps [1918] AC 141 - Whether the benefit is of a kind which is a common incident of the recipient’s occupation - FACTS & OUTCOME

Made because of the level of service provided making them assessable as ordinary income

Calvert v Wainwright (1947) 27 TC 475 - Whether the benefit is of a kind which is a common incident of the recipient’s occupation - FACTS & OUTCOME

Tips received by a taxi driver

• Made because of the level of service provided making them assessable as ordinary income

General rule for competition prizes

Competition prizes are not considered income as they are a windfall gain.

3 exceptions to that general rule for competition prizes

1. Where the taxpayer is carrying on a business

2. Where the prize is directly related to the taxpayer’s income earning activity: Kelly v FCT (1985) 16 ATR 478 [CS 6.6]; IT 167. If the prize is indirectly related to the taxpayer’s income earning activity, it is necessary to consider the gift v income factors discussed earlier

3. Where the competition involves extensive personal exertion and skill

Kelly v FCT (1985) 16 ATR 478 [CS 6.6]; IT 167 - FACTS

Professional sportsperson’s prize

TP played football at the highest level in the WA competition and he was paid a fixed amount for each match played.

In 1978, he won a prestigious award for the “best and fairest player”, known as the Sandover Medal.

• Prior to the announcement of the winner of the medal, a local television station publicly broadcast that it would pay $20,000 to the winner

• The Commissioner assessed Kelly on the $20,000 prize on the basis that although unexpected, the prize directly related to his skill and performance as a professional footballer

Kelly v FCT (1985) 16 ATR 478 [CS 6.6]; IT 167 - OUTCOME

Franklyn J held that in the Supreme Court of WA that the $20,00 was ordinary income. This was because the amount was directly related to Kelly’s employment as a footballer, even though it was unexpected and paid by an unrelated third party.

1. Kelly was eligible because was a member of the football club

2. He was awarded the prize because of his skills and abilities

Superannuation in relation to fringe benefit (or not)

Superannuation is not a fringe benefit as it is excluded from the definition of ‘fringe benefit’: s 136(1)(j) FBTAA.

The amount is not assessable income when paid into the superannuation fund and instead, the tax consequences arise when the employee withdraws an amount from the superannuation fund.

Frequent Flyer Points on Work-Related Travel

In Payne v FCT (1996), 32 ATR 516 [CS 6.7 and CS 6.18], the High Court held that the value of frequent flyer points earned on work-related travel is not assessable income. They are not considered a ‘fringe benefit’ as the employer does not arrange for them to be provided.

Payne v FCT (1996), 32 ATR 516 [CS 6.7 and CS 6.18] - FACTS

Frequent Flyer Points

Payne travelled regularly for her work. She joined the airline’s Frequent Flyer Club. Over the next two years she accumulated sufficient points to purchase airline tickets for her parents to fly from England to Australia.

• Bulk of these points were accumulated through travel for work

Payne v FCT (1996), 32 ATR 516 [CS 6.7 and CS 6.18] - OUTCOME

The Federal Court held that the free flights earned by Pane as a result of frequent flyer points generated through work travel were not ordinary income.

• Primary reason for this conclusion was that the tickets were not money nor monies worth as they could only be useful by the program member or his or her nominee

• They could not be sold or in anyway converted into money

Provision of knowledge relevant case law in determining tax consequence

Brent v FCT (1971) 125 CLR 418 [CS 6.8], the High Court held that amounts received for the provision of information through interviews, etc were payments for the provision of services (income) and not payments for the provision of knowledge (capital).

Brent v FCT (1971) 125 CLR 418 [CS 6.8] - FACTS

Payment for service of giving up valuable rights

Brent was the wife of an infamous criminal. After her arrest Brent was approached by a number of newspapers with offers to publish her story. 

• Required her to be available for interviews

TP claimed the payments were not ordinary income but that she was being paid for giving up the capital rights to her story as she signed over the exclusive rights to the newspaper.

Brent v FCT (1971) 125 CLR 418 [CS 6.8] - OUTCOME

High Court held that Brent’s earnings were ordinary income.

• Essentially paid for her services of telling her story

• Her knowledge was not property it was about her life and she did not write up the story nor did she possess any copyright that she could assign to newspaper

Court held that nothing of a capital nature was given up and therefore the payments were for the service of telling her story.

Compensation Payments & relevant case law

Compensation payments are the total monetary and non-monetary value an individual receives in exchange for work performed, or money awarded as a financial settlement to cover loss, injury, or damage. take on the character of what they are replacing and it does not matter how they are calculated: C of T (Victoria) v Phillips (1936) CLR 144 [CS 10.2]; Bennett v FCT (1947) 75 CLR 480 [CS 6.9].

C of T (Victoria) v Phillips (1936) CLR 144 [CS 10.2] - FACTS

Compensation Payment held to be ordinary income

The taxpayer, a director of a company, entered into a contract in which he agreed to serve as managing director for 10 years.

In the sixth year, the contract was terminated by the employer and the TP was compensated with monthly payments corresponding to the amounts the taxpayer would have received under the contract.

C of T (Victoria) v Phillips (1936) CLR 144 [CS 10.2] - OUTCOME

Court held that the new payments were in the nature of income as they were of the same nature as those they replaced.

Bennett v FCT (1947) 75 CLR 480 [CS 6.9] - FACTS

Relinquishing employment rights

TP was employed as the managing director of a company which he effectively controlled. 

• Original contract was terminated and he lost rights that he previously held

• To compensate for the loss of these rights, the company agreed to pay Bennett three payments over a two-year period

Bennett v FCT (1947) 75 CLR 480 [CS 6.9] - OUTCOME

The High Court held that the payments were not for loss of income, but were capital in nature for the removal of those rights that Bennett possessed under the original agreement.

• Applied the compensation principle finding that because the payments were not for the loss of income, they were capital payments for giving up the right to control the company

Restrictive Covenants

Restrictive Covenants are payments for someone agreeing not to do something.

What section captures restrictive covenant payments?

CGT Event D1

Case Law for restrictive covenants

Higgs v Olivier [1952] Ch 311 [CS 6.10] and FCT v Woite (1982) 13 ATR 579 [CS 6.13], the courts held that payments for the taxpayers entering into restrictive covenants were capital gains as the taxpayers were giving up their right to practice their vocation which is capital assets

Higgs v Olivier [1952] Ch 311 - FACTS

Restrictive covenant - capital

The actor (Olivier) was paid 15,000 euros for agreeing to not appear in or direct any film for a period of 18 months.

The English Court of Appeal held that the receipt of 15,000 was not received as a result of his vocation as an actor and therefore was not assessable.

Higgs v Olivier [1952] Ch 311 - OUTCOME

Court held that as the agreement to pay 15,000 was separate to his contract to perform in the film, and was made after the completion of the film, it was not payment for his performance as an actor but for his giving up the right to earn income which was capital in nature.

 FCT v Woite (1982) 13 ATR 579 - FACTS

Restricted Covenant on entering a contract

TP played for South Australian team entered into a contract for $10,000 to not play any football with any Victorian Club apart from North Melbourne.

He never played in the Victorian League.

 FCT v Woite (1982) 13 ATR 579 - OUTCOME

The Supreme court held that the $10,000 was capital in nature and was not ordinary income from his profession as a footballer.

Capital Amounts

A capital amount refers to a receipt tied to the structure, framework, or sale of a profit-yielding asset or structural capacity (the "tree"), rather than the regular earnings produced by it (the "fruit").

• Any amounts received in a services context which are considered capital amounts are not ordinary income under s 6-5.

When received in a services context, a capital amount is a lump sum or payment related to your capacity to provide services, a restrictive covenant, or the surrender of a service contract—rather than regular salary, wages, or fees earned directly for performing day-to-day work

Capital Amounts tax consequence

Capital amounts received in a services context could be assessable income under s 15-2 (see AAT Case 7752 (1992) 23 ATR 1057) but this provision is rarely used to capture capital amounts from income from service. 

Such amounts are usually considered assessable income as a capital gain under s 102-5. Specifically, these amounts are usually captured by CGT Event D1 which produces the same outcome as s 15-2. 

Examples of Capital Amounts

Entering into a restrictive covenant (such as agreeing not to compete).

Granting an easement or a license over land or an asset.

Creating a right to use intellectual property or a trademark

AAT Case 7752 (1992) 23 ATR 1057 - Facts

TPs were compensated by his employer for losing the right to have a day off every fortnight. The employer had unilaterally terminated the Tps right to have a fortnightly day off and had compensated him with three months’ salary paid over 3 installments.

AAT Case 7752 (1992) 23 ATR 1057 - OUTCOME

The tribunal held that, while not being ordinary income, this payment was assessable under the predecessor of s 15-2, as the TPs employment was the cause of the payment. However, because this is an AAT case it is not a binding precedent on future court decisions.

Given the scarcity of court decisions on the issue, it is unclear to what extent (if any) s 15-2 will cover compensation payments paid to employees.

s 102-5

Assessable income includes net capital gain

CGT Event D1

• Happens when you create a contractual right or other legal or equitable right in another entity. It brings a new capital gains tax (CGT) asset into existence rather than disposing of an existing one.

• Event occurs when the contract is entered into or the right is created

Gain/Loss: A capital gain arises if proceeds exceed incidental costs; a capital loss occurs if incidental costs exceed proceeds. Standard cost bases, pre-CGT exemptions, and the CGT discount do not apply