Income from Business, Income from Property and Compensation
Topic 3 –Income from Business,
Income from Property and
Hobby or business, profit making scheme,
Mutuality, Interest, Rent, Dividends and
Intellectual property, Compensation for
loss of salary, pain and suffering
Chapters 6,7and 8
Income Tax Formula – s 4-10, s 4-15
Assessable Income (s 6-5 and s 6-10
Less: Allowable Deductions (s 8-1 & Div 25)
= Taxable Income x Tax rate + Medicare
levy (1.5%) + (surcharge 1% if applicable)
= Tax payable - Less: tax offsets + rebates =
Tax refund or payment to ATO
Income from Property
• S 6(1) ITAA 36: income from property or
income derived from property means all
income not being income from personal
• definition circular – Income means ‘income
• Definition used when a scheduler system in
Australia – up until 1953 and then again in
1974-75 – tax was higher than income from
Principle of Mutuality
• Income has certain characteristics – provision of
labour or services, regularity, sale of goods,
interest or rent.
• If member of an association are payments to that
association income? Payment to yourself?
Bohemians Club v Acting FCT
• RACV v FCT – membership payments not income
except other receipts – rent.
• It does not matter if the association is a company
Income v Capital
• Distinction very important prior to the
introduction of CGT – 20 September 1985.
Now important with discount method to
reduce the amount of CGT – 22 Sept 1999
• Eisner v Macomber 252 US 189 (1920),
Putney J – “capital likened to the tree or
land and income likened to the fruit or the
Business or Hobby
• Business activity denotes the derivation of
assessable income whereas a hobby produces non-
assessable income. ATO tends to regard income of
less than $20,000 per annum as a hobby. (note
Non-commercial loss provisions).
• These cases revolve around the deductibility of
expenses but are relevant to determine if engaged
in a business.
What constitutes a business?
• Leading case: Ferguson v FC of T:
• 4 tests made by the Court
• A profit making motive is necessary, although the
amount of profit or even a loss does not mean that
a business is not being carried on.
• Regularity or repetition of activities is important.
However, a business has to begin and even
isolated activities may be held to be the start of the
• There is a need to have organised activities in a
business-like manner such as keeping books of
account and records
• The amount of capital employed in the business
and volume of operations may be significant.
• Mr Ferguson was in the Navy and leased 5 cows
for breeding. The Full Bench of the Federal Court
held that the activities were in the nature of a
FCT v Stone (2005)
• (page 655) Ms. Stone an Olympic athlete, received
sponsorship money, prize money and worked as a
police officer in Queensland.
• $93,429 winnings assessed as income. Needed to
show that taxpayer engaged in a business and not
a hobby. Sport or business, prize or gift.
• High Court – a business, therefore assessable
income, but able to claim expenses as a deduction.
The fact that she was not motivated to make
money but represent her country did not change
the fact that she carried on a business.
Gambling – Hobby or business
• Brajkovich v FC of T – (page 659) taxpayer
wanted to claim as a tax deduction for his
gambling losses. In order to do this he had to
convince the Federal Court that the gambling was
in the nature of a business.
• The Court held that the following six tests must be
– The betting is conducted in a systematic, organised and
– The size and extent of betting wins and losses
Brajkovich v FC of T
– Whether betting activities related to other
business-like activities, i.e. horse breeding
– taxpayer’s objective for activities for pleasure
– Whether system rewards skill and judgement or
just pure luck
– Whether activities considered a mere hobby or
Evans v FC of T
• Between 1972 and 1979 the taxpayer operated a number of
businesses declaring not more than $7,500 p.a. and in
some years losses.
• Over the same period he bet between $400,000 and
$1,000,000 p.a. winning $91,295 in 1978, $135,752 in
1979, $427,935 in 1980 and $351,948 in 1981.
• He clearly financed his lifestyle out of his gambling wins.
• He did not extensively study form, nor use a computer to
store or analyse race-related information.
• He did not utilise any betting system but used a mixture of
intuition and judgement for his bets.
• He bet mostly on the TAB or on course and mainly on
"higher risk" exotic type of betting such as trifectas.
Evans v FC of T
• Taxpayer derived substantial income from
gambling. ATO assessed the taxpayer on
the income on the basis that it was a
• Federal Court said no, not assessable as the
taxpayer did not have a betting system, kept
no records and simply relied on luck. He
did not satisfy the tests for a gambling
Income from Isolated
• The most recent case FC of T v Montgomery
(1999) provides an up-to-date summary of the
attitude of the High Court to one-off and isolated
• High Court held that a lease incentive payment
was assessable income and not a capital receipt,
even though it was a one-off and isolated
• The decision was based on previous cases such as
Myer Emporium, Cooling and Westfield Ltd.
FCT v Montgomery
• High Court – 4-3 majority that the sum of $26.3
million was income and not capital. Federal Court
held that it was a capital receipt, not income.
• Derived from wider business activities and would
not have been paid except for the size and
reputation of the law firm. The Law firm exploited
its capital – its attractiveness as a tenant – a single
and extraordinary transaction.
• Section 15-15(1) Your assessable income includes
profit arising from the carrying on or carrying out
of a profit-making undertaking or plan.
• Section 15-15(2) This section does not apply to a
– (a) is assessable as ordinary income under section 6-5;
– (b) arises in respect of the sale of property acquired on
or after 20 September 1985.
• The section only applies to property acquired prior
to the introduction of capital gains tax – 20
September 1985. After that date the taxpayer will
pay CGT on any capital gain
• The original section, s 26(a) ITAA 36 was
designed to tax profits on property that was
acquired for the purpose of profit making or
engaged in the carrying on of a profit making
undertaking or scheme. Section 25A replaced s
26(a). Then in 1997, s 15-15 introduced.
Profit-making scheme (cont)
• Bernard Elsey Pty Ltd v FC of T, High Court
The taxpayer had 4 blocks of land and built shops
on the land and then sold them. He spent money
on construction, interest expense, marketing,
• The High Court held that the building of the shops
was a profit making undertaking or scheme and
therefore the profit was assessable income, s 25A ,
s 26(a), now s 15-15 and not a capital receipt.
• The sale was pre-CGT and a profit making
FC of T v Whitfords Beach Pty Ltd
• A further example of the application of s 25A / s
26(a) [ now s 15-15] although the High Court
applied s 25(1) [now s 6-5] to make the profit
• The basis for taxing the profit as assessable
income was that the beach front land was
developed, subdivided and sold off at a substantial
profit. Originally the land was purchased merely
for recreational purposes with no profit making
motive in mind.
FCT v Myer Emporium
• Myer Emporium lent Myer Finance $80m at
12.5% interest. Myer Emporium assigned the
receipt of the interest to Citicorp for $45.370m.
The interest cash flow was discounted at 16% to
give the above amount.
• Citicorp had accumulated tax losses, so no income
tax on the interest and Myer Emporium argued
that the $45m was a capital receipt.
FCT v Myer Emporium
• Myer Emporium would still receive the $80m
principal from Myer Finance.
• High Court – amount of $45.370 was income and
taxable s 6-5 and s15-15. Isolated transaction,
Myer involved in retail operations, but still
assessable. Myer would not have entered into the
loan if Citicorp had not been prepared to take the
interest income. The two transactions were part of
a profit making scheme.
Westfield v FCT
• Sale of land, pre CGT originally purchased to
build a shopping centre.
• Land subsequently sold at a profit of $267,906.
Was it income or capital gain?
• Full Bench of Federal Court held capital gain and
no income tax payable. Myer case distinguished.
• Taxpayer had no profit motive at time of purchase
and not part of the normal business activity.
Stratham v FCT
• Land that was acquired in 1970 subsequently sold
after it was subdivided.
• Full Federal Court held that not income as no
business activity involved, no profit making
scheme or undertaking.
• Could not sell the land as a single piece, no money
borrowed, no business organisation to market the
blocks and the council did most of the work.
Income from Property
• Property consists of money, real property, shares,
capital equipment and Intellectual property.
• Passive or active investor – negative gearing and
non-commercial loss provisions – Division 35 :
four tests; real property $500,000, depreciating
assets $100,000, assessable income more than
$20,000 and profits test – 3 out of last 5 years.
• Does not apply to passive investments, primary
production $40,000 or artist.
• Debentures offered to the public, fixed interest, 20
years but could be redeemed at end of 5 years.
AGC claimed a deduction for interest but interest
not paid until after 5 years as a lump sum.
• Mismatch of income and deductions.
• Federal Court held interest deductible even though
• Government introduced Division 16E, ITAA 36
taxes on an accruals basis even if no interest paid.
Taxation of Derivatives
• Either on revenue account or capital
account. If on capital account then CGT
• If part of the business then on revenue
account, similar to shares/equities/
• Used to manage risk – interest rate risk,
currency risk or a commodity risk.
Taxation of Financial Arrangements
• New law found in Division 230. Applies on
or after 1 July 2009, or can elect to use after
1 July 2008.
• Does not apply to individuals, ADI’s with
turnover less than $20m, entities with
turnover less than $100m.
• Referred to as ‘TOFA’
Real Property – negative gearing
• Negative gearing, passive investment, not
caught by Division 35.
• Designed to provide large tax deduction to
be used to offset assessable income from
• Need to obtain a capital gain to compensate
Taxation of Dividends
• Dividends assessable income – s 44(1),
• Ordinary and preference shares, convertible
• Dividend imputation – franking credits,
imputation credits – tax offsets.
• Dividend x t/1 – t = 30/70 (t = company tax
Taxation of Leases
• Lease and Hire-purchase distinction –
ownership of asset being leased.
• Division 40 – capital allowance /
True operating lease – no option to
purchase. Depreciation claimed by financier
and total of lease payment income.
• Does not include goodwill but goodwill a
• Royalties ordinary income, s 6-5, but if a
capital receipt then s 15-20 deems the
amount to be statutory income.
• No overlap with s 6-5 and CGT by virtue of
s 118-20 – no double taxation
Principles of Compensation
• Compensation takes the character of what it
replaces – the ‘replacement principle’
• Compensation for loss of wages or salary –
ordinary income, s 6-5, FCT v Dixon
• The payment may be periodic payments or a lump
sum – still income.
• Compensation still assessable under s 15-30 if
received by way of insurance or indemnity – if the
amount ordinary income or not income under s 6-5
• Loss of a finger – lump sum ordinary income.
Loss of physical abilities
• Compensation for loss of an eye or limb a capital
receipt and exempt from CGT under s 118-37(1)
including post-judgment interest.
• Pain and suffering and medical expenses a capital
receipt – exempt s 118-37(1)
• Anti-discrimination – either capital or income,
depression, sexual harassment - capital, loss of
promotion on the basis of sex or race income.
Dismissal an ETP.
Division 54 Settlements
• The compensation for personal injury is
structured as an annuity and or a lump sum
– exempt from tax. Without this provision
an annuity would be income.
• Designed to prevent a lump sum from being
spent and not used to replace loss of
Compensation for business losses
• Compensation for breach of contract – income –
Heavy Minerals v FCT
• If compensation is for loss of the structure of the
business then capital – Californian Oil Products v
• Loss of a depreciable asset – Division 40 –
• Loss of a capital asset – if permanently destroyed
then a capital receipt.
• Compensation for loss of trading stock – income, s
6-5, by virtue of s 70-115.
• Insurance proceeds – s 15-30, statutory income,
considers any amount paid by way of insurance or
indemnity for loss of an amount that would have
been income – loss of profit – is assessable
• Special arrangement for livestock and timber – s
385-130 – income spread over 5 years.
• Composite claims – if for unliquidated damages
and not capable of being dissected – capital –
McLaurin v FCT
• Division 20 – assessable recoupments – where an
amount has been claimed as a deduction and later
an amount is paid as reimbursement, then income,
s 20-30 – bad debts, larceny.
• Or insurance s 20-20, income.