(1) Income according to ordinary concepts
ITAA97 s6-5
The general principle here is that a gain from a person’s labour, in employment or for personal services, is income under ordinary concepts. Incomes from personal services generally have the following indicia:
1. Payment is linked to the provision of employment or services;
2. The payment is often recurrent
3. Services are provided for the purposes of obtaining a gain.
The nature of those types of payments will be income under s6-5.
An amount is ordinary income and included under s6-5, if there is sufficient nexus between the amount and an earning activity. Where the earning activity is employment or the rendering of services, the nexus test is satisfied if the amount is characterised as a “product or incident of employment or reward for services rendered” this is the “income from personal exertion” principle. An amount may satisfy the nexus test even though it is consideration for past or future services, is paid by a third party, or is the product of an isolated act of service.
In characterizing an amount, the court will not confine itself to the form of the supporting documentation, but rather will look at the whole of the circumstances surrounding the receipt.
The fact that an amount is voluntary (i.e. not earned, given for free) will not necessarily preclude it from being ordinary income. If the amount is a product or incident of employment or a reward for services rendered, it is ordinary income. An amount must be characterized objectively in the hands of the donee. You have to determine exactly what it was given for and the motive is relevant but not decisive. Often the goodwill is generated by the relationship. If it was not for the services, the goodwill would never have been granted. It is important to look at the nature of the payment.
- If payment is as a consequence of goodwill - it will not be assessable.
- If it is a result of the services - it is income.
A true gift is not assessable even if the gift was given as a result of the services; it is not given for the services.
FCT v Dixon (1952)
Facts: the taxpayer’s employer had sent a circular to staff during World War II advising that it would endeavour to pay to staff who enlisted amounts to “make up the difference between their present rate of wages and the amounts they will receive from the naval or military authorities.” The taxpayer subsequently enlisted and received a series of such payments from his former employer.
Held: The High Court in a 3:2 decision held it to be income – two said it was a true gift.
DIXON, WILLIAMS & FULLAGER said it was income.
FULLAGER said it was income because the payments were periodical. The payments were substituted for or added to what was income and therefore took the character of income.
DIXON and WILLIAMS said They were periodical receipts and the taxpayer depended on it for his and his dependants’ maintenance (on that basis, if you were rich and did not depend on it, it would not be income? This argument has been confused in later cases. This analysis is looking at what it is being used for, not what it is being received for.
The better reason, the payments were incidental to the taxpayer’s employment as a soldier, it being unimportant whether the payment came from the employer or from someone else, and was obtained as of right or merely as a recognised incident of employment or work.
Hayes v FCT (1956)
Facts: the taxpayer had formed a company, the management of which was taken over by Richardson. Richardson made several large gifts of shares in the public company, including 12,000 shares to the taxpayer. It was held that the taxpayer had been fully remunerated for the work done while in Richardson’s direct employ and while employed by the companies controlled by him. The shares were a mere gift. The taxpayer was an accountant and financial adviser to Mr Richardson, and had worked for Richardson for a number of years. Richardson floated the company, made heaps, and gives the taxpayer some shares in the company. Shares can be sold. The Commissioner sought to include the value of the shares as the income of the employee.
Held: High Court, single judge Fullager, said that an employer/employee relationship the presumption is that it is generally income, unless you can show otherwise. Stating point is that employers do not give gifts. The Court said that although the services rendered in the past may have given rise to goodwill and generous feelings towards the taxpayer, it was only the generosity that had given rise to the shares. The Court said the shares were not in any sense a product of the labour or services provided.
The facts which led the court to its conclusion:
They said the motive of the employer is important but not decisive - the taxpayer might not have been adequately rewarded in the past, and this could be a type of “catch-up” payment. On the facts here, the Court said the taxpayer had been fully remunerated in the past, no suggestion of a “catch-up” payment.
Facts showed that Richardson had done particularly well out of the float, and had made gifts to a number of institutions and other persons other than the taxpayer. He had a habit of giving, and not necessarily only to employees.
Scott v FCT (1966)
Facts: Taxpayer was a solicitor. He performed professional services for a widow, whose husband had been killed in the war. Scott assisted her in realising a block of land for a greatly enhanced value in his professional capacity. He had also assisted her in creating a monument for her husband (in Longueville Park). He had been paid fully for his professional services. At the end of it all he was given an unsolicited amount of £10,000 by the widow.
Issue: What was the nature of the receipt?
Held: High Court held it was not income, it was an unsolicited gift. Court said an unsolicited gift does not become part of the income of recipient, merely because generosity was inspired by goodwill, and goodwill can be traced to gratitude engendered by some service rendered. The money was not given for the services; it was a product of the goodwill.
The facts that led the court to the conclusion that the payment was not for services:
- The solicitor had been fully remunerated for his professional services
- The widow had made cash gifts to other friends and relatives
- Also relevant but court did not mention, the sheer size of the payment. It was way in excess of the value of the services.
The above cases are where the payment was received from the employer, and where it was received from the client. In both situations the recipient had provided services to the giver. What if payment was received from a third party? Is this payment assessable?
E.g. a waiter who gets a tip – it is not money given to the waiter by his employer; a footballer who wins the “best and fairest” award in a match, wins a car.
Where the receipt is incidental to an activity carried on for gain, i.e. it is the sort of receipt you could expect for carrying on that activity, it will be classed as income.
E.g. a footballer who receives a prize of most valued player. A professional is playing for gain. An amateur does not.
In Kelly v FCT the taxpayer was a professional footballer who got a prize for best and fairest. He was assessed. Income from personal services is distinguished from capital receipts. Distinguished between ordinary income in the context of ordinary income compared to capital.
Similarly in personal injury cases, damages are also calculated by reference to what you would have earned if you had not been injured. It is where you are paid for loss of future income, it would take the nature of or character of the income it replaced, and would be taxable BUT it is in fact paid for loss of income earning capacity, not loss of income itself, and is therefore a capital receipt. But if you settled eg on basis of loss of future income, you run the risk of it being taxed. Have to be very careful how you describe what the money is paid for.
(2) Relevant statutory provisions
ITAA97, s10-5, 15-2, Div 82-83 - refer to these statutory provisions
Elements of s 15-2
Section 15-2 was introduced in 2006 when s26 was repealed replacing para 26(e) and 26(ea).
Section 15-2 differs from former provisions in the following significant ways:
• Whereas both s26(e) and (ea) excluded fringe benefits and exempt fringe benefits from their ambit, s 15-2 does not, on the basis that any fringe benefits that s 15-2 covers would be exempt income or non-assessable non-exempt income under s23L ITAA36.
• S15-2 excludes an amount that is assessable as ordinary income under s6-5 ITAA97; in contrast, ordinary income was not excluded under s26(e) and, in the absence of the contrary intention, an amount that was both ordinary income and statutory income by the operation of s26(e) was treated as statutory income.
• Whereas s 15-2 applies to allowances “provided”, s26(e) applied to allowances “allowed, given or granted”, and s26(ea) applied to allowances “given or granted”. Despite this difference in terminology, it appears that there is not intended to be a legal difference, as ”provide” is defined in s995-1(1) ITAA97, in relation to providing a fringe benefit or an economic benefit, as including allowing, conferring, giving, granting or performing the benefit.
Despite the differences, the intent of and wording of s 15-2 and the former provisions is very similar. For that reason, judicial analysis of former 26(e) is generally applicable also to s 15-2.
There must be a “benefit”
The first requirement is that there must be an allowance, gratuity, compensation, benefit, bonus or premium. These words must be construed in their context, but are clearly intended to cover a broad area.
Allowance
An “allowance” is a predetermined amount to coven an estimated expense which is paid regardless of whether the recipient incurs the expense or the anticipated amount of the expense. A reimbursement of expense is not an allowance. If a payment is a reimbursement of expense (rather than an allowance), then it may be an expense payment fringe benefit.
Nexus with employment or services rendered
However, it was found in Cooke and Sherdan that the former section 26(e) was not applicable. There was no relevant “employment” as the relationship between the taxpayers was that of vendor and purchaser and not of employer and employee. Moreover, there had been no “rendering of services” by the retailers to the manufacturer, they were providing services to the public. The holiday which was given could not be converted to cash, and therefore was not ordinary income and was not part of any contractual relationship for services rendered.
The nexus test in the section requires the benefit to be allowed, given or granted to the taxpayer “in respect of, or for or in relation directly or indirectly to, any employment of or services rendered by” the taxpayer. There must therefore be an employment or services relationship.
Smith v FCT (1988) - “consequence” of employment/services may be sufficient
Principle: HC Held that there is a sufficient nexus if the benefit is a product, incident or consequence of employment.
This formulation gives the section a potentially wider operation than s 6-5(1) ITAA97 and was accepted by Haggarty v FCT.
The HC is Smith’s case said it might go a bit further than things as ordinary income, it may go as far as to catch a benefit that was a product, incident or consequence of the employment of services. Any “consequence” – this is wider than “product or “incident”, which was previously thought to be the limit.
The section is not limited to employer/employee relationships. It also covered the situation where services are rendered – “any employment of or services rendered”.
Valuation rule
The amount included in assessable income under the section is the value to the taxpayer of the benefit. This is a subjective test that requires the commissioner to examine separately the circumstances of each individual taxpayer receiving benefits, in order to establish the value of the benefit to that taxpayer.
Problems in applying the valuation rule
It refers to “the value to the taxpayer” of the benefit. It does not refer to market value, it is subjective valuation. You have to look at the taxpayer’s particular circumstances, and ask what is the value of the benefit to him. If you get something that is not convertible to cash, what is the benefit to him eg private school fees. \A trip to Singapore is of no use if you have just come back from there (and hated it). The value to you might be dramatically less than the value of the ticket. But, administratively it is a nightmare to the Commissioner.
Reconciliation rules
If an amount is included in assessable income by s 15-2 ITAA97 and is also included in assessable income as ordinary income r as statutory income, or is a fringe benefit under FBTAA, it is necessary to reconcile the different bases upon which the amount may be included to determine which applies.
Section 15-2 has been reconciled with s 6-5(1). Where an amount is included in assessable income and is also ordinary income, the intention is that, unless the contrary intention appears, priority is given to treatment if the amount as statutory income: s 6-25(2). This problem cannot arise where an amount is included as assessable income by s15-2, because ordinary income is specifically excluded. An amount that is assessable as ordinary income under s 6-5 ITAA97 would be treated as ordinary income.
Section 15-2 does not exclude fringe benefits or exempt fringe benefits from its scope, on the basis that a fringe benefit is non-assessable non-exempt income (s23L(1)) and an exempt benefit covered by para (g) of 136(1) FBTAA is exempt income (s23L(1A)).
Employment termination payments
Lump sum payments that relate to the termination of a person’s employment are statutory income from personal exertion.
The taxation of an eligible termination payment involved 4 steps:
1. Determining whether the payment was an eligible termination payment within the definition in s 27A(1).
2. if the payment was an eligible termination payment, identifying the “components” of the payment.
3. Determining whether any of the payments were rolled over to a superannuation fund, which had the effect of deferring liability to tax, and
4. determining the tax treatment of the various components which had not been rolled over.
An employment termination payment (ETP) is a payment received by a person on or after 1 July 2007:
• In consequence of the termination of that person’s employment; or
• After another person’s death, in consequence of the termination of the other person’s employment (s82-130 ITAA97).
To be an ETP, a payment must generally be received no later tan 12 months after the termination, unless the Commissioner considers that a later time is reasonable. If it falls within the 12 months test than it is assessable income (s 83-295).
ETP’s cannot be rolled into a superannuation fund, but must instead be taken in cash. Unless transitional termination payment which the employer directs to be paid to a superannuation fund.
Two types of ETP’s, each with their own taxing rules:
• Lump sum received by a person in consequence of the termination of that person’s employment – a “life benefit termination payment”.
• A lump sum received by a person after another person’s death causes the termination of employment – a “death benefit termination payment”.
Reseck v FCT (1975)
Facts: Taxpayer was employed by the same company for two periods. Only a weekend separated the two periods. The termination on each occasion was due to a lack of work in the area. At the end of each period the taxpayer received severance pay in accordance with an agreement between the employer and the union. It was argued that “in consequence of” required that the termination be the dominant cause of the payment. In this case, it was argued, the dominant cause of the payment, was the agreement between the employer and the union.
Held: The High Court said the expression “in consequence of” means where the payment follows as an effect or result of the termination. In the case at hand, the payment was made in consequence of a number of circumstances including the industrial agreement, but none the less it was still paid in consequence of the termination of employment.
Principle: In Reseck, the ruling states that a payment is made in consequence of the termination of the taxpayer’s employment if the payment “follows as an effect or result of” the termination. According to the ruling, the phrase requires a “casual connection between the termination and the payment, although the termination need not be the dominant cause of the payment”. The question whether a taxpayer has terminated employment is a factual question and is not based on any special legal concepts under the tax law.
McIntosh v FCT (1979)
Facts: A taxpayer elected (in accordance with the terms of a pension fund) seven days after his retirement to commute 50% of his pension entitlement to a lump sum of $27,000. The taxpayer argued that the payment was not received in consequence of retirement, but in consequence of the decision to commute – a decision made after and separate from, the retirement.
Held: All three judges of the Full Federal Court rejected this argument and held that the amount was assessable under s26(d). Brennan J stated that, for a payment to be in consequence of the termination of employment, there must be more than a mere temporal link between the termination and the payment, although termination need not be the direct (i.e. “immediate”) or dominant cause of the payment. At least where there is an entitlement to the payment, the termination must be “the occasion of, and a condition of, entitlement to the payment”.
(3) Fringe Benefits Tax Assessment Act
The central provisions of the FBTAA are found in Pt III. Divisions 2 to 12 currently identify 13 categories of fringe benefit. The first 12 of these relate to specific fringe benefits, while the final category is a general one designed to catch any remaining benefits. The respective categories are:
• car fringe benefits (Div 2, s7 to 13)
• debt waiver fringe benefits (Div 3, s14; 15)
• loan fringe benefits (Div 4, s16 to 19)
• expense payment fringe benefits (Div 5, s20 to 24)
• housing fringe benefits (Div 6, s25 to 29A)
• living-away-from-home allowance fringe benefits (Div 7, s30; 31)
• airline transport fringe benefits (Div 8, s32 to 34)
• board fringe benefits (Div 9, s35 to 37)
• meal entertainment fringe benefits (Div 9A, s37A to 37CF)
• tax-exempt body entertainment fringe benefits (Div 10, s38; 39)
• car parking fringe benefits (Div 10A, s39A to 39E)
• property fringe benefits (Div 11, s40 to 44), and
• residual fringe benefits (Div 12, s45 to 52)
Each Division in the FBTAA is divided into two or more Subdivisions. Subdivision A defines the benefit to which the Division applies. In most cases it is defined in broad terms without any particular reference to the employment relationship. If that benefit is a fringe benefit, the its taxable value is determined by Subdiv B (as well as Subdiv C in the case of Div 9A and Subdiv C and D in the case of Div 10A).
The structure may be illustrated by examining Div 3, which deals with “debt waiver fringe benefits”. Subdivision A (s14) defined the benefit as follows:
“Where at a particular time, a person (…the ‘provider’) waives the obligation of another person (…the ‘recipient’) to pay or repay the provider an amount, the waiver shall be taken to constitute a benefit provided at that time by the provider to the recipient…”
As can be seen, the definition of the benefit does not contain any reference to the employment relationship. The definition of “fringe benefit” provides the necessary link with the employment relationship. There are two requirements of a debt waiver it must be a debt waiver AND it must also be a fringe benefit.
Section 66(1) – Subject to the Act, tax imposed in respect of the fringe benefits taxable amount of an employer of a year of tax is payable by the employer.
Definition of “fringe benefit”
Step one - Is there a fringe benefit?
To come within the definition of “fringe benefits” in s136(1), there must be:
1. a benefit;
2. provided during the year of tax or in respect of the year of tax;
3. by an employer, associate, third party arranger or other relevant person;
4. to an employee or an associate, third party arranger or relevant person; this includes a current, future or former employer other than the Commonwealth or its exempt authorities.
5. in respect of the employment of the employee.
Benefit
“Benefit” is defined in broad terms in s136(1) and includes “any right (including a right in relation to, and an interest in, real or personal property), privilege, service or facility”.
Not all benefits are subject to FBT. Some benefits are treated as “exempt benefits” and as such are excluded from the definition of “fringe benefit” under para (g) of the definition of “fringe benefit”.
Benefit must be provided in respect of the employment of the employee
A nexus between the provision of the benefit and employment must exist for there to be a fringe benefit. The nexus required is set out in the definition of “in respect of” in 136(1). According to that definition the benefit must be provided “by reason of, by virtue of, or for or in relation directly or indirectly to” the employment.
In J&G Knowles & Associates Pty Ltd v FC of T has indicated that there must be “some discernible and rational link between the benefit and employment”. The court emphasized that what was required was a “sufficient” or “material” casual connection or relationship between the benefit and the employment. Where the link between the benefit and employment is insufficient, no fringe benefit can arise.
Inter-relationship between Fringe Benefits Tax Assessment Act and Income Tax Assessment Act
By way of reconciliation with the income tax law, s136(1) expressly excludes a number of different benefits from the definition of “fringe benefit”, including the following:
• salary or wages (para (f))
• the acquisition of shares or rights under employee share schemes to which 26AAC ITAA36 or Div 13A applies (para (h), (ha)).
• The payment of money to a superannuation fund that the person making the contribution had reasonable grounds for believing was a complying superannuation fund (para (j))
• ETP’s (para(k)).
• Consideration of a capital nature for, or in respect of, a legally enforceable contract in restraint of trade or personal injury to a person (para (m)).
• The payment of an amount deemed to be a dividend under ITAA36, (para(r)); and
• A loan that would give rise to a deemed dividend under s109D ITAA36, were it not for the loan meeting the requirements of s 109N ITAA36 (para (s)).
As previously mentioned, the definition of “fringe benefit” also excludes an “exempt benefit” (para (g)). Such a benefit will therefore not fall within the FBT regime. Importantly, such a benefit will also not constitute assessable income under the income tax law by virtue of s 23L (1A) ITAA36. This means that an exempt benefit will not be taxed in either the hands of the employer or employee.
Step Two - What is the taxable value of the fringe benefit?
Recipient’s contribution
The taxable value of the fringe benefit is reduced by any contribution to the cost of the benefit made by the recipient of the benefit (reduced by any reimbursement paid to the recipient). This ensures that only the “net benefit” is taxable.
Under s51AJ ITAA36 a deduction is not allowed to the employee to the extent that the contribution is made towards the private component of a fringe benefit.
The “otherwise deductible” rule
The taxable value of a loan, expense payment, airline transport, board, property or residual fringe benefit may in certain cases be reduced by the “otherwise deductable rule”. The rule is designed to overcome the inequity that would otherwise arise where an employer is required to pay FBT on a fringe benefit and an employee would not be entitled to claim a deduction as he or she had not incurred the relevant expenditure.
The otherwise deductable rule prevents what is effectively a form of “double taxation” by reducing the taxable value of a fringe benefit to the extent that the employee has “lost” a deduction by reason of the provision of the fringe benefit. The taxable value of the fringe benefit is reduced by a “notional deduction” calculated in accordance with formulas found in the relevant provisions.
The FBTAA contains its own substantiation provisions which only allow employers the benefit of the otherwise deductible rule where they have obtained declarations and certain documentary evidence from their employees specifying the extent to which the expenditure would otherwise have been deductable.
Miscellaneous reduction amounts
Div 14 provides for concessional reductions in the taxable value of specific fringe benefits.
Step Three - Calculation of FBT liability
Section 66 is the FBTAA’s charging provision and imposes FBT on employees in respect of their “fringe benefits taxable amount” for a year of tax.