Income Tax Law Essay Example

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    Law
  • Document type:
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  • Level:
    Undergraduate
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INCOME TAX LAW

Question 1: Why payment in FCT v Dixon was assessable income but Payment in Scott was not

Income has not been defined by statute; however, the Macquire Dictionary defines it as ‘the returns gained periodically in particular annually from a person’s work, property, revenue from business or a receipt.’(Macquire Dictionary). Tax on income is important and according to Camad Investments PtyLtd v FCT (1983) 158 CLR 622 it is a compulsory payment purposely for the government and it is not imposed based on the services rendered, a penalty, arbitrary and incontestable. The two cases Commissioner of Taxation v Dixon (1952) 86 CLR 540 (‘Dixon’s case’) and Scott v FCT (1966) 117 CLR 514 (‘Scotts Case’) presents a dilemma on what is to be considered as income or not.

The issues to be determined by the courts were:

  1. Whether the income is assessable from the character it has in the hands of the recipient

  2. Whether voluntary payment made by the former employer income in the hands of the former employee

  3. Whether the amounts derived from employment or the provision of services are income.

  4. Whether the £10,000 received by the taxpayer assessable income under ITAA 36 section 25 (1) or section 26(e)

The case of Dixon involved a taxpayer who had enlisted in the AIF and served until discharged in 1945. Prior to his enlistment his employer sought to distinguish Army and usual salary to differentiate amongst those who enlisted. This was not a peculiar arrangement, after the end of the war he returned to his former employment but there was no obligation to return existed between him and his former employer. In that year he received £104 and the Commissioner accepted it as ordinary income. The court held that the amount received was assessable income. The court created an assumption that if in reality a payment is income it does not matter the person who pays it.

On the other hand, in Scott’s case t v FCT the taxpayer practiced as a solicitor having performed legal services for Mrs. Freestone because of the death of her husband. Mrs. Freestone gave Mr. Scott a gift of $10,000. The reason for the gift was that Scott was her professional advisor; the services merited a proper award, her friend whose services merited appreciation. Mrs. Freestone specifically indicated that the payment was due to personal friendship and not because of anything he had done. The Court held that the £10 000 was gift, gratuitous in nature it was not made in discharge of an obligation and not taken by the recipient as discharging an obligation and not income by ordinary concepts. The payment was one-off.

The determination of whether or not receipt of money is income or capital is determinable by the character and nature of the receipt by the taxpayer. The case of Scott created a principle that ‘an unsolicited gift does not become income merely because it can be traced to gratitude endangered by some service rendered’. According to Winder J in Scott, the court has to assess the nexus between the gift and relevance to the recipient personal services or on the other hand, an exceptional payment due to the recipient’s personal qualities.

Section 6-1(1) of ITAA 97 states that assessable income consists of ordinary income and statutory income. Section 6-5(1) ITAA97 states that assessable income includes income according to ordinary concepts which is considered as ordinary income. In Leary v FCT (1980) 32 ALR 221 a gratuitous is valid if there was an intention to transfer, no obligation to return the material and there was no obligation on the donor to transfer the gift. The amount assessable as income must correlate with the services offered. In a similar case FCT v Harris (1980) 43 FLR 36 the issue was whether the $450 lump sum payment income or capital in nature. The court held that the receipt was not a product of the past services of the taxpayer because the services given previously were paid.

In Dixon’s case the military salary was well below the civilian salary. The applicable section then was section 25(1) ITAA36 currently section 6-5 ITAA 97. Section 26e according to Dixon JC and Webb JJ was not applicable in this situation since it was because of the employment relationship no services provided. The principle set in this case was that as long as there was services rendered, the payment given was directly or indirectly linked to any employment or services rendered then it would be assessable income.

The decision in Dixon applied in Reuter v FCT (1993) 27 ATR 256 that even though Bond Media Ltd the court found a nexus between the $8m and services provided by the taxpayer to Rothwells arranged the $8m stamped it as income by ordinary concepts. The critical elements are the periodicity, not incidental to an employment and not relied upon for regular expenditure.

The two cases demonstrates what constitutes ordinary income, that is salaries, wages and fees that are connected or linked with the employment or provision of services. The case clearly outlines the necessity to create a nexus between the amounts earned and the earning activity. In general, gifts that are unrelated to employment, services or business do not possess the character of an income and therefore not assessable. In Scott the payment or gift is transferable from employer to the employee in circumstances that are unrelated to employment or services rendered, that is the employee-employer relationship is coincidental. There needs to be no obligation on the part of the donor to give the gift to the employee and no obligation on the done to return the gift. In Dixon the principle set by the court was that it was possible to show that even if the payment is voluntary and driven by the most honourable of motives it may yet become income in the hands of the recipient if there is a sufficient employment services connection. Distinguishing between assessable income and non-assessable income, the circumstances and nature of the gift are important to determine whether it is taxable income.

Question 2

Section 995-1 defines a deduction an amount that is deductible, not subject to taxation. The deduction is allowable if one incurs it in gaining or producing assessable income or in carrying on a business for gaining or producing your assessable income. In deductions, the expense costs must be incidental and relevant to the earning or production of income and must be an earning expense. The case scenario presented highlights the situation of Nigel a professional percussionist performing of bands and orchestras.

The issues raised are whether he is entitled to claim tax deductions for all the costs together with the depreciation on the room and equipment. This arises since he set aside a special room in his house that is soundproof with a variety of electronic equipment used for practice or performance. He pays council rates, interest on house mortgage, repairs and maintenance, electricity and telephone expenses in connection with the house.

Sections 8-1 (1) of ITAA97 states that a person can deduct from assessable income any loss or outgoing to the extent that; it is incurred in gaining or producing assessable income or it is necessarily incurred in carrying on the business for the purpose of gaining or producing the assessable income. The house in which Nigel has set up his special room is a working place or ‘office’ since it is his source of income. In Lodge v FCT the taxpayer claimed deductions since she worked at home and had sent the children to a nursery school, so she can have a quiet environment. The court held that this was not deductible since the nursery fees was a personal or a living expenses and it failed to have the character of a business expenses since it was not a prerequisite for derivation of income. It is important to note the expenses incurred are not only relevant and personal to Nigel but connected with the derivation of income from his business as a percussionist.

In Taxation Ruling TR 93/30 the Commissioner ruled that if, a home is the place of business a proportion of occupancy and running expenses may be deductible in respect of the home office. However, the home office is merely used in connection with the taxpayers earning activities and is not a place of business only a proportion of the running expenses may be deductible. In Swinford v FCT the taxpayer was a self-employed scriptwriter working from home, separate room to do the writing in except for a wardrobe in the room. The taxpayer claimed deductions in work in respect of rent in the proportion to which the room represented part of the house. The court held that it was deductible since there was no alternative place to work.

Section 25-10 of ITAA 97 specifically states that a person can deduct the amount spent on repairs. This is in relation to premises or depreciable assets used solely for producing assessable income. It is important to note that for a repair to be deductible, it is of restoration or replacement of subsidiary parts of the whole as held in Lurcott v Wakely & Wheeler [1911] 1 KB. The repairs done by Nigel must be substantial to warrant deductions.

Section 25-30 of ITAA 97 states that expenses of discharging a mortgage is also deductible. Nigel has an interest on the house mortgage and this is deductible since it links with his ability to obtain his income. Section 25-75 of ITAA 97 allows for the deduction on rates and land rates on premises used to produce mutual receipts. Nigel pays council rates in relation to obtaining his assessable income.

Section 40-30(1) of ITAA 97 defines a depreciating asset as an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used. ITAA97 specifically states that land, an item of trading stock or an intangible asset such as good will are not deductible. Some of the items that are deductible include mining, quarry, in-house software, spectrum license. The amount one can claim as allowable deduction is ‘amount equal to the decline in the value of depreciating asset (Barckozy, 2013)’. In the case of Yarmouth v France [1987] QBD 646 stated that a depreciating asset includes ‘all goods, chattels, fixed or moveable which one keeps for permanent employment in his business.’ The room and equipment are all depreciating assets linked to his business and therefore a tax deduction is allowable.

In order to determine whether a tool is entitled to deduction, it must be a tool of trade playing a crucial role in the derivation of income. In the case of Jarrold v John Good & Sons Ltd 40 TC 681 it was held that moveable office partitions were held to be plant on the basis that they provided flexibility of accommodation which was a commercial necessity for the taxpayer. In Wangarratta Woollen Mills v FCT the courts used the functionality test to determine the essence of the asset and the nature of the business. In the case, the dye house was a tool of trade and played a major role in the production process. Division 43 of ITAA97 allows for Capital works depreciation deduction for income producing buildings. Section 43-20 of ITAA97 states that ‘capital works’ is an umbrella term that covers structures, extensions, alteration and an improvement to such structures, the special room is an improvement to the house. These include buildings, structural improvements and environment protection earthworks.

In conclusion, Nigel is entitled to tax deductions related to the nature of conducting his business from his house. However, the extent of his deductions commensurate to the expenses that are incurred; not personal in nature but those that are linked to his derivation of income. ITAA97 allows for deductions on repairs, mortgages, interests and land rates associated with the derivation of income. This can either be capital outgoing or capital expenses and this is not taxable.

References

Australian Legal Dictionary (1997) . Sydney, Butterworths p. 524

ed. Sydney:CCH Australia.th5Foundations of Taxation Law. Barkoczy, S. (2013).

Camad Investments PtyLtd v FCT (1983) 158 CLR 622

FCT v Dixon (1952) 86 CLR 540

Income Tax Asssessment Act 1936 (Cth)

Income Tax Assessment Act 1997 (Cth)

Jarrold v John Good & Sons Ltd 40 TC 681

Lurcott v Wakely & Wheeler [1911] 1 KB.

Macquire Dictionary

Reuter v FCT (1993) 27 ATR 256

Scott v FCT (1966) 117 CLR 514

Yarmouth v France [1987] QBD 646