(1) Legislative framework

The Income Tax Assessment Act (ITAA) 1936 was very complicated, unwieldy, without much internal integrity, due to the numerous amendments. The Tax Simplification Committee decided to slowly introduce a new Act, while at the same time leaving the old act operating.

The new ITAA came into effect in 1997 and its purpose was to make the Act simpler and easier to follow, in plain English, rather than to change the law.

The Commonwealth does not have the exclusive power to impose taxes. The states have the concurrent power to tax, subject to the constraints of provisions such as s90 and 109 of the Constitution.

The Commonwealth’s power is contained in s51(ii), which provides that the Parliament shall have power to make laws with respect to (ii) Taxation; but not so as to discriminate between States or parts of States.

Structure of the ITAA 1997 and relationship to the ITAA 1936• Section 2-1 is the design. It is a guide. It is only used for limited purposes.
• S2-5, general to particular – pyramid shape.
• Division 4 starts the core provisions. They are operative provisions. 4-1 says who pays income tax  It is payable by each individual and company and some other entities.
S4-10 pay tax on 30 June.
S4-10(3) how to calculate tax which is:

Taxable income x rates – tax offsets = income tax

S4-15 how to calculate taxable income which is:

Taxable income (net profit) = assessable income (sales) – deductions (expenses)

This is variable for a variety of reasons such as depreciation, research and development expenses and the like.

• Div 6-1 assessable income is calculated:

Assessable income = ordinary income (s6-5) and statutory income (s6-10)

S6-15 If it’s not ordinary income and not statutory income (specifically listed in s10-5), it is not assessable income (so you do not have to pay income tax on it).

• Deductions is the amount you can deduct
s8-1 (general deductions)
s8-5 (specific deductions)

e.g.: ‘you’ – a company that manufactures goods and sells them to public – what type of things would be assessable income of the company? Sale proceeds, interest on excess cash etc.
Deductions: wages, costs of materials, rates, electricity, and depreciation. If you buy a capital item, you get depreciation because in earning your assessable income you have bought a machine for say $100,000, which might have a useful life of 10 years. The value of the equipment might drop by $10,000 each year and this is your depreciation. 

The whole process is comparable to working out profit. A company has a profit and loss statement – Revenue less operating expenses, gives your net profit. Tax act works the same principle. It is designed to work out how much better off you are at the end of the year, at least in a realized sense, and the government taking a share of it.

Direct versus indirect tax

Direct tax – Where the economic burden of the tax is borne by the person who pays the tax.
Indirect tax – Where the person who pays the tax is able to pass on the economic burden of the tax to third parties.

E.g. The cost of income tax is borne by the person who earns the income and it is, therefore, described as direct tax. In contrast, the cost of GST, while generally paid by the supplier of goods or services, is ultimately borne by the consumer through the increase price charged for those goods or services by the supplier. Ultimately, however, the cost of all tax is passed on in one way or another.

(2) Concept of income

ITAA 1997, Div 6 & ITAA 1936 ss 6, 21, 21A, 26(e)
Section 6-5 deals with ordinary income. No definition of income in the Act.

Ordinary income falls into 1 of 3 categories:
1. income from personal exertion – salary, wages
2. income from property – e.g. rent
3. income from carrying on a business – sales proceeds

S6-10(1) your assessable income also includes some amounts which are not ordinary income – statutory income.
S6-10(2) Amounts which are not ordinary income but which are included in your assessable income by provisions about assessable income, are called statutory income (note refers us to 10-5).

6-25 the amount can be ordinary or statutory income but not caught twice. Specific provisions.

The concepts of capital and income are mutually exclusive. Capital is the tree or land. The income is the fruit or the crop. One can’t say that the sale of a building is capital. Look at the nature of the receipt in terms of tax payer.

Amounts that are included in assessable income but which are not “ordinary income” are referred to as “statutory income” (s6-10(2) ITAA97). A checklist of the many different statutory income provisions that are contained in the tax laws located in Div 10 ITAA97. 

Some important statutory income provisions include ITAA36, s26(e), which relates to allowances in relation to employment. Prior to the introduction of the FBT, s26(3) ITAA36 was the main provision aimed at taxing employment allowances and benefits.  The provision includes in the assessable income of a taxpayer, the “value to the taxpayer” of all allowances, gratuities, compensations, benefits, bonuses and premiums allowed, given or granted to the taxpayer in respect of, of for or in relation directly or indirectly to, any employment of or services rendered by the taxpayer.  

S6 of the ITAA36 provides a definition of income from personal exertion or income derived from personal exertion.

Common law concept of income

Assessable income = ordinary income + statutory income (s6-1 ITAA97)

An amount may be brought into assessable income either as:
• “ordinary income” (s6-5), or
• “Statutory income” (i.e. amounts specifically included in assessable income by particular provisions of ITAA36 or ITAA97).

These terms are not defined although descriptions have been provided.
“Ordinary income” is interpreted in s6-5 as “income according to ordinary concepts”  For an amount to be ordinary income, it must have its source in an earning activity.

Statutory income is the label given to gains that are included in assessable income by specific sections. The most important type of capital income is capital gains. Fringe benefits are not included in statutory income.

The judicial notion of income is income according to the ordinary concepts and usages of mankind. There is no single rule in determining whether a particular receipt is income according to ordinary concepts. “Income” is a form of financial “gain”.

Need to distinguish between income and capital.
Capital – the tree or the land
Income – the fruit or the crop
The character of the receipt depends upon the nature of the receipt in the hand of the particular taxpayer.

E.g. In a business, capital tends to be the structure itself within which you generate this regular income. If you sell the factory, it tends to be a capital receipt. The proceeds of the manufactured goods are income. But it all depends on the facts – a person selling 10 factories in a year might have proceeds assessed as income – he is carrying a business of buying and selling factories.

Receipt of money or money’s worth

The benefit you receive back has to be income or something that can be converted to money.

Tennant v Smith [1892]

Facts: A bank manager was provided with rent-free accommodation by his bank. The manager was forbidden from assigning leasing or sub-letting premises, i.e. he could not convert the benefit to cash.

Held: House of Lords said, that simply saving someone from incurring expenditure does not mean that what has been provided is income. The receipt by the taxpayer must be something that the taxpayer can convert into cash or otherwise dispose for his advantage.

Principle: Valuation rule: that a benefit which cannot be turned into cash is (or is not) income with a zero value. It is not assessable, it is not ordinary income – must be able to convert it to benefit you.

FCT v Cooke and Sherden (1980)

Facts: Deals with a business context.
A husband and wife carried on a soft drink business, selling soft drinks from a truck. The cordial manufacturers provided prizes to the retailer who bought the most cordials in a month. The couple were given a free holiday to Singapore. The terms of the holiday were that I could not be cashed in or transferred to anyone else.

Held: Brennan, Deane & Toohey said that it was not ordinary income because the benefit could not be converted to cash. The Full Federal Court said that although it had all the characteristics of income, quoting Tennant v Smith, as it cold not be converted into cash, it was not income.

“If a taxpayer receives a benefit which cannot be turned to pecuniary account, he has not received income as that term is understood according to ordinary concepts and usages…[though] it is not necessary that the pecuniary alternative be available by way of direct conversion of the benefit received.”

This decision has been overcome by s21A.

Compensation for loss of earnings or other income flows will generally be characterized as ordinary income, while compensation for loss, surrender or substantial impairment of a capital asset will generally be characterized as capital.

The characteristics of periodicity, recurrence and regularity are often seen as prima facie indicators that an amount has the character of ordinary income.

(3) Residence

ITAA97, s995-1 & ITAA36, s6(1)

INCOME TAX ASSESSMENT ACT 1997 - SECT 6.5
Income according to ordinary concepts (ordinary income)
             (1)  Your assessable income includes income according to ordinary concepts, which is called ordinary income .
Note:          Some of the provisions about assessable income listed in section 10 5 may affect the treatment of 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 behalf or as you direct.

Non-residents are only taxed on Australian sourced income, ordinary or statutory.
Is a person a resident or non-resident?
What is the source of income?
Derived- when is it taxed i.e. looks at “timing”.

INCOME TAX ASSESSMENT ACT 1936 - SECT 6
"resident or resident of Australia" means:
                     (a)  a person, other than a company, who resides in Australia and includes a person:
                              (i)  whose domicile is in Australia, unless the Commissioner is satisfied that his permanent place of abode is outside Australia;
                             (ii)  who has actually been in Australia, continuously or intermittently, during more than one half of the year of income, unless the Commissioner is satisfied that his usual place of abode is outside Australia and that he does not intend to take up residence in Australia; or
                            (iii)  who is:
                                        (A)  a member of the superannuation scheme established by deed under the Superannuation Act 1990 ; or
                                        (B)  an eligible employee for the purposes of the   Superannuation Act 1976 ; or
                                        (C)  the spouse, or a child under 16, of a person covered by sub-subparagraph (A) or (B); and
                     (b)  a company which is incorporated in Australia, or which, not being incorporated in Australia, carries on business in Australia, and has either its central management and control in Australia, or its voting power controlled by shareholders who are residents of Australia.

Below cases rely in the dictionary definition of “reside” which means “to dwell permanently or for a considerable time, to have ones settled or usual abode, to live in or at a particular place”.
 
Individuals

Ordinary meaning of “resident”

IRC v Lysaght [1936]

Facts: A person shifted his permanent home to Ireland where he lived with his family. Once a month he would stay in England for a week at a hotel. He came for business reasons.

Issue: Was he rising in England, even though he was only there one week in four.

Held: House of Lords said that he was a resident of England.
“A man might well be compelled to reside here (England) completely against his will. The necessities of business often, in a practical sense, forbid the choice of residence and although the person may make his home elsewhere….if the periods for which and the conditions under which he stayed are such that they may be regarded as constituting residence, it is open to find that he does so reside.

Principle: Where someone resides is descriptive of their character rather then their property.
E.g. A person in gaol in Thailand for 10 years is a Thai resident, despite being an Australian citizen with property, family etc in Australia.

Gregory v DFCT (1937)

Facts: Taxpayer had a peal fishing business in WA. He had a home in WA which eh owned, and where he resided from time to time. He then commenced a business in Darwin, a fishing business, rented a house in Darwin, social life based in Darwin. He lived part of the year in each state and travelled the rest of the time. States had own tax laws. Did he reside in WA or NT – a lot of evidence each way.

Held: HC said he resided in both places. Although he had not ceased to be a resident of Darwin, NT. He still kept a strong presence in Broome.

Principal: With unusual circumstances, you can reside in more than one place.

Extended definition of “resident”

Test 1 – Where do you actually reside?
Test 2 – A person is a resident if you are domiciled in Australia, unless the Commissioner is satisfied his permanent place of abode is outside Australia.
(ITAA36 s6)
Test 3 – Whether the person has been in Australia continuously or intermittently for more than one half of the year of income.

Domicile does not mean citizenship or nationality.

Domicile test: Domicile is a legal relationship between a person and a state by which a person invokes the state’s legal system as his or her personal law. At birth, every person is attributed a domicile of origin and that domicile is retained until changed by choice. A domicile of choice is acquired where a person demonstrates an intention to fix a permanent residence in a new country. 

So if you are born in Australia, in order to be treated as non-domiciled, you would have to demonstrate that your permanent place of abode is outside Australia. The courts have held that the word “permanent” is not used in the sense of everlasting but is used to mean something more than merely temporary or transitory  - authority is: