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The issue is whether the amount received as compensation for the cancellation of
an agreement is ordinary income or capital income. under ITAA97 s 6-5, A
compensation is deemed to be ordinary if it arise from loss of income or simply
put the amount if earned would have been included in assessable income for the
purpose of taxation. On the other hand, under ITAA97 section 6-10 and section
15-30, an ordinary income or the compensation payment would be assessed as
statutory income if it arise from losing the right to earn profit and is not assessable
under ordinary income.
In order to determine whether the compensation amount is ordinary assessable
income or Capital income some rules established by case law need to be
examined. The general rule that has been established by case law is:
1. Compensation paid for cancelation or variation of a commercial
contract :
When Tax payers suffer losses be it commercial or other kinds, they will
be compensated. The tax treatment of compensation amount depends on
what the compensation is received for. Based on Allmans principles
compensation payment for income lost was a replacement for income that
would have been earned. It is reasonable to assume that Ajax Ltd has paid
the amount $ 100000 as compensation for cancellation of contract. Given
that Ajax Ltd ended 16 years of professional relationship and cancelled a
contract which still had four years to run indicates that the amount paid
can only be compensation as a result of contract termination.

2. Compensation is paid in the ordinary case of the business:
Edwards Jones & Associatess is an accounting organization with number
of business contracts and Ajax ltd is one of its contract that is cancelled. It
is reasonable to assume that in that contract there was a clause that said
that says that the party that cancels has to pay other party compensation.
3. The loss does not conduct the structure of the tax payers business:
The termination of contract did not destroy the structure and earning
capacity of Edwards Jones & Associates. According to the principle of
Heavy Minerals case, the compensation made for termination of contract
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will be a substitute for income, where the profit making structure of the
business is intact. If the businesss profit making structure is permanently
terminated, the income will be of capital nature (Glenboig case). Where
the cancelled contract does not terminate profit making of the business
permanently, or is one of many profit making components of the business,
the compensation will be substitute for income. Although the contract
provides 40% of Edwards Jones & Associates income it does not restrict
them from entering into other contracts. However, the cancellation of
contract has created a hole in profit and has temporarily impaired
income earning on Edwards Jones & Associates. According to Allied
mills (1986) case principle, compensation of agency contract not affecting
profit making structure of a firm is income in nature.
Taking the above factors into consideration it can be concluded that the
compensation amount is ordinary income in nature. This is illustrated in Phillips
principle which states that payments received as compensation must be regarded
as of the same nature as the payments which they replace. The cancellation of
contract has affected future profit of Edwards Jones & Associates which they
would have earned had the contract not been cancelled. Following the principles
of Liftronic Pty Ltd v FC of T 96 ATC 4425, a hole in profit is income in nature.
The structure of the business is unaffected. Hence, the compensation will be
assessable ordinary income.








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References
Barkoczy, S. 2014. Foundation Of Taxation Law, 6
th
edn, cch Australia
Limited, Australia.
Barkoczy, S. 2014. Core Tax Legislation and Study Guide, 17
th
edn, cch
Australia limited, Australia.
Allman vs FC of T 98 ATC 2142, Paragraph: 12.8
Allied Mills Industries pty Ltd FC of T 89 ATC 4345, Paragraph: 12.8, 12.9
Glenboig Union Fireclay Co Ltd v IRC (1922) 12 TC 427, Paragraph: 12.8, 12.9
Liftronic pty Ltd v FC of T 96 ATC 4425, Paragraph: 12.8
Phillips; C of T (Vic) v (1936) 55 CLR 144, Paragraph: 12.8
Heavy Minerals pty Ltd v FC of T (1966) 115 CLR 512, Paragraph: 12.8, 12.9