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GENERAL CONCEPT OF INCOME

Statutory Provisions - ss. 6(1) & s.26(e)ITAA36.


1.2 Income According to Ordinary Concepts and Usages
S6-5 - general provision capturing assessable income
Employs the general common law concept of income, income according to ordinary concepts based
on cases.
Assessable income of a taxpayer includes where the taxpayer is a:
(a) Resident -

gross income derived from all sources in or out of Australia

(b) Non resident - gross income derived from all sources in Australia
There is no general definition of "income" contained in the ITAA nor in any of the cases.
The courts tend to classify certain gains as income by employing various categories of income and
have developed numerous tests to determine whether the gain in question comes within one of those
categories of income.

income from employment or rendering services,


income from carrying on a business,
income from carrying on a profit-making scheme,
income from property, such as interest, dividends, rent, royalty

But there is no single test for the meaning of "income" under the common law.
S. 6(1), ITAA36 - provides circular definitions of different types of income but never actually defines
income as a whole. S. 6(1) merely distinguishes between different aspects of an undefined whole.
S. 6(1) distinguishes between
(1) Income from personal exertion which means
"income consisting of - earnings, salaries, wages, commissions, fees, bonuses, pensions, allowances
and gratuities received in the capacity of employee or in relation to services rendered",
"income consisting of -the proceeds of any business carried on by the taxpayer",
"income consisting of -any profit arising from the sale by the taxpayer of any property acquired by
him for the purpose of profit-making by sale or from the carrying on or carrying out of any profitmaking undertaking or scheme"
(2) Income from property which means "all income which is not income from personal exertion."

Note - These definitions are all circular - the word income appears on both sides of the equation, for
example,
Income from personal exertion means - "income consisting of......
This part of s. 6(1) in effect states that "income" means "income". It then goes on to include a
number of gains that are of an income nature - "wages, salary, commissions, fees, ..... received in the
capacity of employee or in relation to services rendered" but s.6(1) never in fact defines income.
These definitions merely differentiate between different aspects on an undivided whole, that is,
income from employment,
income from rendering personal services,
income from carrying on a business,
income from carrying out a profit-making scheme,
income from property acquired for profit-making purposes,
income from property.
But - the definitions in s. 6(1) are an aid to strengthen a conclusion independently reached that a
particular gain is income. In any individual case it is still necessary to show that a particular gain is of
an income nature.
Many tests provided by the cases are used by courts to distinguish income from a number of
non-income gains such as:

Capital,
windfall gains, such as gambling, lottery winnings
gifts,
legacies;

A useful analogy to distinguish income from capital Capital is the tree, the structure of the business, etc.
Income is the fruit, which is severed from the tree, the product of operations - (such as business
profits, salary, rent, interest, dividends, etc) which is yielded by the operation of the business
structure.

Useful tests for characterising a gain as income:


(i) Convertibility into money
Tennant v Smith The provision of rent free accommodation by an employer to employee was not cash or convertible
into cash and so not income.
Income is that which comes in, rather than that which is saved from going out,
It is something that a person becomes possessed of and can be disposed of by the possessor.

FCT v Cooke & Sherden 2.

The provision of a free holiday by a distributor of goods to a retailer was not convertible to cash and
therefore not income.
ThereceiptoftheholidaywasnotcaughtbyS.26(e),ITAA36(nows.152,ITAA97)norbyFBTasit
wasnotreceivedinanemploymentrelationship.Itwouldbecaughtbys.21A,ITTA36asaproductofa
businessrelationship.

Non-cash benefits otherwise of an income nature (apart from the fact that they are not
cash or convertible to cash) are taxable (a)ifreceivedinconnectionwithemployment - s. 15-2, ITAA97 (employee taxable) and Fringe
Benefits Tax Assessment Act (FBTAA) (employer taxable). Double taxation is prevented under
S. 23L(1), ITAA36 a fringe benefit is not assessable and not exempt income in regard to the
employee.
(b) if received in connection with a business relationship are taxed in the hands of the recipient under
s.21(A), ITAA.

(ii) Periodicity, recurrence, regularity


Salaries, wages, government sickness and unemployment benefits, pensions, rent, interest,
royalties, dividends, business profits, etc tend to be paid periodically, regularly, etc.
These gains do not cease to be income just because they are paid in lump sum.

(iii) Regular means of support


Salaries, wages, government sickness and unemployment benefits, pensions, holiday pay, longservice leave are all regular means of support.

(iv) Substitute for income


Government sickness and unemployment benefits, pensions, holiday pay, long-service leave are
all substitutes for income and therefore are also considered to be income.

(v) Income is the normal proceeds of:


personal exertion - salaries, wages, commissions,bonuses,etc
property - rent, interest, dividends, royalties
business - business profits.

(vi) Sufficient nexus with an earning activity


A gain is ordinary income if it has its source in an earning activity, for example, personal
services, carrying on a business or a form of investment. Gains such as pensions,
unemployment benefits, etc, do not have the necessary nexus with an earning activity but are
ordinary income because of other income related characteristics. Pure gifts, windfall gains and
bequests do not have the necessary nexus with an earning activity and do not exhibit other
income related characteristics.

3.

(vii) An amount must be characterized as ordinary income in the hands of the


person who derived it
The character of a receipt is determined by reference to the person who derives the gain and not
by the character of the expenditure that produced the gain.
Federal Coke Co Pty Ltd v FCT 77 ATC 4255
L agreed to pay B an amount in consideration for B releasing L from a long-term supply
contract. The compensation was paid by L to FC, a wholly-owned subsidiary of B, as
compensation for FC closing down its coking works as a result of the supply contract being
cancelled. There had never been a prior legal relationship between L and FC. The commissioner
argued that if the amount had been derived by B it would have had the character of income.
Held the amount had to be characterized in the hands of the person who derived it. In this
case, it was a capital sum derived by FC for agreeing to closing down its coking works.

(viii) Compensation takes the character of what it replaces


Compensation will be of an income nature if it replaces an income item. Compensation for the
loss of earnings will generally be ordinary income while compensation for the loss, surrender or
substantial impairment of a capital asset will generally be characterized as capital.

(ix) Illegality and immorality will not prevent a gain being characterized as
ordinary income
This principle is based on social policy that illegal activities should be taxable in the same way
as legal activities provided that the gains are a product of an income earning activity.
1.5 Distinction between "Income" and "Capital"
Though capital gains are not assessable as income under common law, they are now defined as assessable
income Division 100 - capitalgains

(2) Income from Personal Services


All receipts which are the product of taxpayers labour, employment or services are income at
common law - provided received as cash or are convertible to cash.

Area of difficulty Gratuitous payments where the donor is under no legal obligation to make the payment.

The key issue Whether the receipt represents income from employment or rendering services or is a non-taxable
gift?
The motive of the donor is not decisive.

The key legal principle

4.

An unsolicited gift does not become income merely because it can be traced to gratitude engendered
by some service rendered.
In distinguishing between a taxable and a non-taxable gift, the relevant question is whether the gift
was in a relevant sense, a product of the recipient's personal services
or on the other hand,
an exceptional payment due to the recipient's personal qualities, basedonlove,affection,respect,
admiration,etc

Examples Herbert v McQuade 4 TC 489


Annual payments by a congregation to a clergyman to supplement his income were held to be
income. The payments were received because the clergyman held an office that was inadequately
provided for. Had the gift been exceptional due to the personal qualities of the taxpayer, the payment
might have been a gift.
Annual payments by a congregation to a clergyman to supplement his income were held to be
income.
The payments were received because the clergyman held an office that was inadequately provided
for.
Had the gift been exceptional due to the personal qualities of the taxpayer, the payment might have
been a gift.

WrightvBoyce38TC160
ItwasthecustomtomakeChristmaspresentsofcashtothepersonwhoforthetimebeingheldthe
officeofemploymentofhuntsman.
Held assessable as the huntsman was the object of the custom by virtue of his office or
employment.Therewasnoquestionofhistestimonialorofadmiration,respectorregardforthe
outstandingpersonalqualitiesofthetaxpayer.

Seymour v Reed A professional cricketer was given a benefit after a long period of service on the eve of his
retirement -

Held - gift, tribute to his personal qualities rather than cricketing prowess.
Moorhouse v Dooland
A professional cricketer was entitled by his contract to a collection whenever he played particularly
well -

Held - the payment was a product of rendering services.


Moore v Griffiths

5.

The 1966 English Football Association made a once only, unexpected gift to all members of its
successful World Cup team including the captain - taxpayer.
The payment was not provided for in his contract.
The team's reserves received the same sum even if they never entered on the field - so there was no
relationship between the payment and the quality of services.
The Football Association claimed that it paid the bonus to promote football, as a personal tribute to
show their esteem for all the players, rather than to reward services.

Held - non-taxable gift provided as a mark of esteem as a result of the joy felt as England winning
the 1966 World Cup
It is doubtful that this case would apply in the current era of complete professionalism - such gains
would probably be seen as an inherent part of a professional sport.

Scott v FCT
A woman gave an unsolicited $10,000 to her solicitor who was:
(a) her professional advisor and whose services merited proper reward and also
(b) her friend whose personal qualities merited appreciation
She had always paid him his proper fees.
She claimed payment was due to "personal friendship, not because of anything he had done for me."
She also made similar payments to relatives that she had never met

Held - the payment was not income but a non-taxable gift.


There was ample evidence of the taxpayer's desire to express appreciation of the taxpayer's personal
qualities as well as showing appreciation of certain relatives.
anexceptionalpaymentduetotherecipient'spersonalqualitiesbasedonlove,affection,respect,
admiration,etc.

Principle of Scott's case


An unsolicited gift does not become income merely because it can be traced to gratitude engendered
by some service rendered. In distinguishing between a taxable and a non-taxable gift, the
relevant question is whether the gift was in a relevant sense, a product of the recipient's
personal services or on the other hand, an exceptional payment due to the recipient's personal
qualities.

V135 88 ATC 85, WVB 7-046


Accommodation, meals and a research allowance was received by a visiting Australian academic
from an overseas university.

6.

Held
The benefits were non-assessable gratuities as the benefits were conferred on her by reason of of her
personal qualities as a scholar and her commitment to research and not because of any services
rendered to the overseas university.
The commissioner has stated that he considers that the decision is wrong and does not intend to
follow it.
It is arguable that the benefits were received as ordinary incidents in the course of an academic's
employment.

FCT v Dixon (1952)


In 1939 an employer offered to pay staff who enlisted in the army an amount to make up difference
between their former salary and their army pay.
The employer had no obligation to make the payment.
The employee had no obligation to rejoin his former employer after the war.

Held - income.
the ex- employee could rely on the payments as a regular incident of his employment in the army.
the payments were received regularly and periodically.
the payments were a substitute for salary which acquired the character of that for which they were
substituted.

Hayes v FCT
H, a former employee of R and also his friend, often gave him informal advice.
In 1942 H worked for the company that took over R's business.
The company's business deteriorated and so R took over business on condition that all shares be
transferred to him.
H reluctantly agreed to transfer his shares to R at what he considered an undervalue.
R promised to make it up to H at some time in future.
In 1950 a public company took over the company and R received shares in the public company.
R gave some of his public shares to H.

Held
The receipt of the shares was not related to any income producing activity by H.
Though gratitude for past services played a role in R's decision, the shares were still a mere gift.
H was not employed by R, he merely provided a favour to R,
Many years later, R felt obliged to return the favour out of a sense of friendship rather than in
exchange for services rendered.

7.

Conclusion
If a receipt is unrelated to any personal exertion it is not assessable except possibly where it is part
of a series of recurring payment which replace and come to be relied upon as a replacement for
former income as in Dixon's case.

FCT v Harris
The taxpayer received a pension from his employer.
The trustee of the pension fund was empowered to adjust the pension in accordance with upward
movements of the trust deed index.
As a result of a high inflation period, the former employer considered certain employee's pensions
inadequate.
The ex-employer made a gift of $450 on the understanding that there was no further commitment to
make further gratuitous payments.
Over the next 3 years, the ex-employer made similar payments.

Held - gift though some periodicity was later exhibited.


From the ex-employer's point of view The former employer's motive was not to reward pensioners for previous faithful service.
The former employer desired to mitigate the impact of inflation and wanted to seen to be fair to
former employees.
Perhaps the former employer's motive was to improve the staff morale of existing employees.

From the former employees point of view The payment was not a pension, nor a pension supplement, it was not intended to bring his pension
up to certain figure.
The payment was not relied upon for regular expenses.
Each payment was separate, arbitrary and without assurance of continuation.

FCT v Blake Similar circumstances to Harris' case except that a regular subsidy was paid with each pension
payment to counter the effects of inflation.

Held - income.
Unlike Harris' case, the payments in this case were received regularly with each pension payment.
The payments were held to be of a regular means of support and compensation for the loss of
purchasing power of the pension.
Both Harris and Blake have been superceded by s. 27H, ITAA36 but were included for the purpose
of illustrating the concept of common law income.

8.

2.3 Compensation Payments


Such payments generally takes the same character as the item they replace.
If the payment is compensation for a revenue asset or loss of income then it is of an income nature.
If the payment is compensation for the loss, surrender or impairment of a capital asset, then it is
generally of a capital nature.

RestrictiveCovenants
HiggsvOlivier

33TC136

Theactor,LaurenceOlivierhadbeenengagedbyafilmcompanyunderanagreementtoproduce,
directandactinthefilmHenryV.ThecompletedfilmhadbeenshowninLondonandNewYork
sinceDecember1944buthadnotbeenverypopular.Itwasagreedthatthebestwaytopromoting
interestinthefilmwouldbeforthetaxpayertorefrainfromappearingin,directingorproducing
anyotherfilmforaperiodof18monthsotherthanforthefilmcompanyforwhichhereceived
15,000pounds.Therewasnoobligationforthefilmcompanytoemployhimanditdidnotdoso
duringtheperiod.

Heldcapitalreceipt.
Hadtherebeenevidencethatthe1945agreementwasadevicewherebythetaxpayerobtaineda
furtherrewardorplayinginandproducingHenryV,thesumreceivedwouldhavebeentaxable.
Thetaxpayerhadperformedallhisobligationsunderthe1943agreementbeforetherestrictive
covenantcameintobeing.The15,000poundsreceivedbyhimcouldnotberegardedasfurther
remunerationforhisservicesunderthe1943agreement.Thesumwaspaidtothetaxpayerfor
givinguptherighttoearnincomeasan
actorduringthespecifiedperiodandnotfromtheexerciseofhisvocation.

FCT v Woite 82 ATC 4578, FTR 11.792


A professional footballer during his current contract to play football in South Australia, received
$10,000 from a club in the Victorian Football League to sign a form which restricted him from
playing in Victoria with any other club other than the club that paid him the $10,000.
He never committed himself to play in Victoria.

Held
The payment was compensation for giving up a capital right - the right to hire out his services to
other club.
If the signing of the form had been followed by a contract to play with that Victorian club the lump
sum probably would have been regarded as income as a sum received to play for
the particular club.

9.

Case A14 A professional rugby footballer contracted with a club to play for 3 years and further agreed not to
play with any other club in that metropolitan area for another 3 years.
The Contract stated that the taxpayer would receive;
(1) $5,400 as a signing on fee and
(2) $4,600 for entering into a restrictive covenant.
The club secretary stated in court that the club did not want him to play against the club in the
future.
The club competed in the only major professional league in Australia so as a result of the restraint
clause, if he did not play for the club he would not be able to play professionally elsewhere.

Held The restrictive covenant was regarded as interdependent with the signing-on fee.
The majority took the view that the payment of $4,600 was simply another incentive to play football
with that club.
The majority took the view that the purpose of the restraint clause was to ensure that the player
continued with the club at the end of three year period rather than simply to prevent him to play for
another club.
In substance the $10,000 was negotiated as the consideration for agreeing to play for the club.

InducementPayments
JarroldvBoustead41TC701
Anamateurrugbyfootballplayerreceivedapaymentforrelinquishinghisamateurstatusforlifeon
becomingaprofessionalrugbyleagueplayer.Atthetimeonceapersonjoinedarugbyleagueclub,
hewasbarredfromeveragainplayingfororvisitingarugbyunionclubandfromcompetingasan
amateur.
Heldthesigningonfeewascompensationforthelossofhisamateurstatusandthe
varioussocialandrecreationalactivitiesthatamateurstatusentailed.

D38 72 ATC 211


Apart from entering a standard player's agreement to play professional rugby an amateur footballer
agreed to give up his amateur status for a lump sum.
The agreement stated that the club was anxious that he give up his amateur status.

Held
Each agreement would not have been signed without the other.
He was being paid for playing football for 3 years - not just for giving up his amateur status.
The loss of amateur status was the result of entering into the agreement but it was not the reason for
entering into the agreement. The decision may have been different had the player also been an
amateur athlete for whom the acceptance of money would have made him ineligible to compete as an
Olympic athlete. In such circumstances, the loss of his amateur athletic status may have represented
the loss of a genuine right or "asset" separate from his amateur football status and therefore of a
capital nature.

10.

RileyvCoghlan44TC481
AnamateurfootballersignedanagreementwithaRugbyLeaguefootballclubforpaymentsper
match.Healsoreceivedafurther500poundsforagreeingtoservetheclubfortherestofhiscareer
or12years,whicheverwaslonger.Ifhewasinjuredandcouldnolongerplayhehadtopaybacka
proportionateamount.
Held
Remunerationforfutureservices.Thepaymentwasseenasarunningpayment
coveringthewholeperiodofpayment.

PritchardvArundale47TC680
The taxpayer was a senior partner in a firm of chartered accountants. One of his clients offered him a
senior management position which he was reluctant to accept because it would mean giving up his
established position in private practice. Eventually the client arranged for the taxpayer to be issued
shares in a related company six months before he commenced work for the company as an
inducement to accept the offer.

Held
The shares were an inducement to take the risks involved in taking up the employment and
compensationforthelossofstatusinvolvedingivingup hispositioninprivatepractice.The
taxpayergaveupasecurelivelihoodtoservethecompany.Hisemploymentwasnottocommence
for6monthsandhemighthavediedbeforeanyserviceswererenderedbuttherewasnoprovision
forareturnoftheconsideration.Theshareswerenotarewardforfutureservices.Theinducement
didnotflowfromtheofficeoremploymentbutwasforundertakingtheoffice.

VaughanNeilvIRC(1979)STC644
Apracticingbarristerofhighstandingenteredintoadeedunderwhichwithamajorconstruction
groupofferedhim40,000poundsasaninducementtogiveuphisstatusasapracticingbarrister
withtheconsequentsocialandprofessionallossofhisestablishedpositionandprospectsoffurther
distinctionarisingfromhispracticeattheplanningbar.Sixmonthslaterheretiredfromthebarand
joinedthecompany.
Held
Nottaxableasthepaymentwasnotinrespectoftheholdingofanofficeoremploymentbutwasan
inducement to accept the professional and social consequences of the loss of his established
positionandprospectsoffurtherdistinctionarisingfromhispracticeattheplanningbarwhich
flowedfromhistakinguptheemployment.

GlantreEngineeringLtdvGoodhand(1983)STC1
A chartered accountant was offered immediate employment as a financial director by an
internationalfirmofaccountants.Hewaspaid10,000poundsstatedtobeascompensationfor
11.

sacrificinghisprofessionalstatusasacharteredaccountantinaleadinginternationalaccountancy
firm,forthelossofpartnershipprospectsandtheuncertaintyofsecurityinthefuturebecause
althoughthenewemployerwassuccessfulatthetime,ithadonlybeenrunningfor3yearsand
couldoffernolongtermsecurity.
Held
Taxable as the taxpayer had sought the additional money more as protection against the risks
involvedinthemoveratherthanascompensationforthelossofanyadvantages,professionalstatus
orprospectsinhispreviousemployment.
UnlikePritchardvArundalewhichinvolvedachangefromseniorpartnerinafirmofchartered
accountants,thetaxpayerwasmerelychangingfromoneemploymenttoanother.Hehadnotup
any substantial rights. Furthermore, Pritchard v Arundale was not a case of a payment by the
employer but a transfer of shares by a third party.

PickfordvFCT98ATC2268;40 ATR 1078


Under an employee acquisition scheme, the taxpayer acquired options to purchase shares in the
company that employed him. The options would lapse if the taxpayer ceased to be an employee of
the company. The taxpayer commenced employment with a new employer whereby he received a
remuneration package, which apart from salary, superannuation and a vehicle, included a payment of
$20,000 as compensation the gain that might have arisen under the scheme if he had remained an
employee of his previous employer. The taxpayer argued that the payment was a capital gain taxable
under 160M(3)(b), ITAA36. On the other hand, the Commissioner argued that the payment was
ordinary income as it was an inducement to secure services of the taxpayer and the existence of the
potential capital gain merely provided the means to quantify the incentive payment forming part of
the overall employment package.
Held the payment was an integral part of the offer made to and accepted by the taxpayer. It was
one of the main attractions of the overall package, which was a single bundle of entitlements offered
as an inducement to enter the new employment. The source of the payment was the service to be
rendered by the taxpayer that is, a benefit received in respect of future services to be rendered.
Section26(e)ITAA36assessesallbenefitsreceivedfororinrelationdirectlyorindirectlytoany
employmentoforservicesrenderedbythetaxpayer.Apaymenttoapersonabouttobecomean
employeeorperformserviceswhichiscompensationfornecessaryabandonmentofastatuswillbe
attheveryleast,indirectlyrelatedtotheemploymentorservices.

Motor Accident Compensation


Before 1979 compensation being paid under Motor Accident Act 1973 (Victoria) was expressed to
be for the loss of earnings and was calculated by reference to the recipient's pre-accident earnings.
Compensation was viewed as statutory substitute for salary lost - taxable.
In 1979 the Victorian legislation was altered so that compensation was paid for the loss of
recipient's income earning capacity with the taxpayer's income level prior to the accident only one
of the matters to be considered in determining damages.
Parliamentary speeches at the time indicated that a major problem to be overcome by the amendment
was the attraction of tax to such benefits.

FCT v Slaven 12.

The taxpayer received 5 regular installments closely approximating his pre-accident earnings.
The Act expressed payment as being compensation for the deprivation or impairment of earning
capacity

Held The compensation was paid in respect of the taxpayer's loss of income earning capacity - capital.
Although the Victorian parliament could not determine the capital/income status of a receipt under
Federal Government legislation, the terms of the Victorian legislation were a guide for the court in
determining the payments capital/income status under the ITAA.

General accident insurance policy payments for injury follows the same general principles in distinguishing capital and income payments.

13.