Taxation law notes – Winson Edition 2010

Income from business

The main issues that arise from income from business:

1. Is a business being carried on?
Ferguson v FCT
-
FCT v Walker
-
Ruling TR 97/11
-
Ruling TR 2007/8
-
1.1 hobby or business
- Evans v FCT—gambling
- FCT v Stone—sportman and sponsorship
1.2 Share trading
- Shields v Deputy Commissioner of Taxation

2. Is income or capital nature?

2.1 scope of business
- Californian Copper Syndicate v Harris
- Western Goldmines (NL) v DCL (WA)
- Scottish Australian Mining Co Ltd v FCT
2.2 profit making scheme
- FCT v Whitfords Beach Pty Ltd
- FCT v Myer Emporium Ltd
- Westfield Ltd v FCT
- FCT v Cooling
- FCT v Montgomer
2.3 Intellectual information
- Evans Medical Supplies Ltd v Moriarty
- Rolls-Royce Ltd v Jeffrey
2.4 Use of business receipt to acquire capital assets
- G P International Pipecoaters Pty Ltd v FCT
2.5 Property development and land dealing
- Statham v FCT
- Moana Sand Pty Ltd v FCT
2.6 Trusts and Investment Companies
- Charles v FCT (fiduciary duty)
- London Australia Investment Co Ltd v FCT (investment, carry on
business)
2.7 Gift
- Federal Coke Co Pty Ltd v FCT
2.8 Debt defeasance is not ordinarily income
- FCT v Orica

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 The proceeds of a business, provided that they are derived from within the scope of
the business, are income on ordinary concepts: Myer Emporium
 Income may arise from an isolated profit-making scheme outside the scope of the
business or even where no business exists. The tp acquires an asset intending at the
time of acquisition to resell it for a profit and carries out that intention. The tp’s profit-
making intention must exist at the time of entry into the scheme and the profit must be
made in the vey way intended at the time of entry: Westfield Ltd

Business: it includes any profession, trade, employment, vocation or calling but does not
include occupation as an employee.
An isolated transaction occurs when there is a one-off transaction without a continuing
business operation.

1. Is a business being carried on?

The relevant factors identified by the courts are as follows:
 System and organization: this can change what would have been a hobby into a
business, for example gambling or a hobby farm.
 The profit motive: a business may exist without this motive, but a business will be
found often to exist where the motive is present, even though there may not be
objective evidence that it can make a profit: Ferguson v FCT
 Size or scale of activity: despite this factor, a business may be carried on in a
small way: Thomas v FCT
 Frequency of transaction: whist frequency is one indication of business, a business
venture can be confined to an isolated transaction: FCT v Whitfords Beach Pty Ltd
(that case involved a profit-making scheme rather than a business)
 Period of ownership: a quick resale of property tends to indicate a business activity:
Turner v FCT
 Nature of property: property that gives no inherent pride of ownership is more likely
to have been acquired for business purposes: Rutledge v IRC
 Supplementary work done on the property: FCT v Whitfords Beach Pty Ltd
 Circumstances responsible for the realization: the taxpayer may be able to point to
non-business reasons for selling. An asset may have been acquired for the purpose of
using it as part of the capital structure in a business, and then been sold where the
business venture has collapsed
 A business can be carried on even though the activities are illegal: FCT v La Rosa

Ferguson v FCT
 Taxpayer wished to establish a business of primary production; he carried on activities
such as reading periodicals, maintaining a system and a ledger. An overall loss was
made on his transactions.
 Issue: was the taxpayer carrying on a business of cattle production

 The taxpayer carried on activities such as reading periodicals, maintaining a card

index system where he recorded particulars as to date of birth, type, sire and dam,
and the date of artificial insemination.
 He also maintained a ledger as a record of his receipts and payments.
 The activities were conducted on a commercial basis and were part of a mass
marketed scheme, which explains the business-like approach of the venture.

FCT v Walker

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 He had a profit-making purpose, there was repetition and regularity in his activities and
his activities were concluded in a businesslike way.
 The small scale of his activities did not precluded them from constituting the carrying
on of a business

Is it a business of primary production?

Ruling TR 97/11
The courts have held that the following indicators are relevant:
 Whether the activity has a significant commercial purpose or character;
 Whether the taxpayer has a purpose of profit as well as a prospect of profit from the
activity
 Whether there is repetition and regularity of the activity
 Whether the activity is of the same kind and carried on in a similar manner to that
of the ordinary trade in that line of business
 Whether the activity is planned, organized and carried on in a businesslike
manner such that it is directed at making a profit
 The size, scale and permanency of the activity; and
 Whether the activity is better described as a hobby, a form of recreation or a
sporting activity.
No one indicator is decisive.

Ruling TR 2007/8
There must be a business of afforestation and that business must be the business of the
investor

Hobby or business
Evans v FCT
 Was the taxpayer engaged in the business of gambling?
 What was lacking to characterize his gambling as a vocation or business was the
element of system or organization (no tipping or information service, no attempt to
work out combinations of bets designed to give him a positive result or limit his
exposure to risk, no use of technology, not in accordance with a preformulated plan).
 What the court regarded as of considerable significance in this case is that the odds
given are unknown at the time the bet is placed and the dividend will be unable
to be precisely calculated until it is announced 10 minutes or so after the race is
concluded.
 It seems quite inconsistent with the money-making systematic, business-like
character which is an essential ingredient in the carrying of a business.

FCT v Stone
 Stone was a world-class javelin thrower and earned prize money, grants from QSA,
appearance fees and sponsorship.
 Issue: was the taxpayer carrying on a business?

 Held: Stone was carrying on business in relation to her sporting activities and that all
cash receipts from this business were ordinary income under s6-5 of ITAA 1997
 The taxpayer’s subjective intention of pursuing excellence rather than money
did not prevent her from carrying on a business.
 She had turned her skills to account by sponsoring commercial products, and
the rest of her services were therefore business
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 The prizes were clearly part of the business and the AOC grants, although gratuitous,
formed part of the proceeds of a business.
 The sponsorship agreements cannot be put into a separate category marked
“business”, with other receipts being put into a category marked “sport”. Nor
can some receipts be distinguished from others on the basis that the activity producing
a receipt was not an activity in the course of carrying on what otherwise was to be
identified as a business.

professional sportsperson seeking employment

Although the definition of carrying on business expressly excludes being an employee, it
seems that where a professional sportperson such as a football player enters into a
number of contracts with different clubs and endorses products and gets money for
appearance fees, such person will be carrying on a business: Spriggs v FCT and
Riddell v FCT

2. Is income or capital nature?

Scope of the business
 Once it has been decided that there is a business, it then becomes necessary to
decide what is the scope of the business, since not all profits made by a business are
assessable income. For example, if a grocer were to sell his premises, any profit
realized would not normally be assessable income
 Those profits that are within the scope of the business are assessable income,
and some profits that are outside the scope of the business are also assessable
where they result from entry into a profit-making scheme.

Californian Copper Syndicate v Harris

 Taxpayer was incorporated for the purpose of mining and it acquired certain mines.
Instead of working them, the mine was sold for profit.
 Was the taxpayer assessable on the profits arising from the sale of the land?

 Held: the profit was assessable income. The taxpayer intended at the time of
acquisition (at the time of entry into the scheme) to resell the mine at a profit rather
than work the mine for trading receipt. It carried on a business by selling an asset. The
profit is a gain made in an operation of business in carrying out a scheme for profit
making.
 The difference btw an isolated transaction that does or does not produce OI
 A “mere realization” of a capital good made by enhancing the value – this
will result in a capital gain
 A gain made carrying on a business – this will generate OI
 This was that the turning of investment to account was not to be merely
incidental, but was the essential feature of the business, speculation being
among the appointed means of the company’s gain.

Western Goldmines (NL) v DCL (WA)

 The taxpayer acquired mines for the purpose of working them. The taxpayer had not
intended to resell the mine at the time of its acquisition. But it was forced to do so
owing to changing circumstances. The resultant profit was held not to be assessable
income

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 Held: the profit was not assessable income. There was no intention to sell it when
acquired. The sale was for the purpose of securing to itself a share, which is a
change of a form of investment but not for making a profit in a commercial
transaction.

 Where taxpayer acquires land by purchase, and subsequently subdivides and sells,
there will be little problem in characterizing the proceeds as income.
 Where the taxpayer acquired the land for a purpose other than resale and then, many
years later, decides to subdivide and sell. It is a question of mixed fact and law
whether the taxpayer is carrying on a business.

Scottish Australian Mining Co Ltd v FCT—the land not acquired with a

profit-making intention by resale

 Taxpayer purchased land for the purpose of mining coal. Then it sold the land in
subdivision and granted to schools and churches.

 Held: the profit from sale was not income. The land which was acquired and used
for different purpose is no longer a business-like carry out (not within scope).
As the company is not formed for dealing in land, all the company did was to
take steps to realize the land to the best advantage. This does not convert the
transaction into a business.
 If it is advantageous to the sale of the land as a whole to set aside part of the
land for parks and other amenities, this does not convert the transaction from
one of mere realization into a business. It is simply part of the process of
realizing a capital asset.

Profit-making scheme
The proceeds of an isolated or extraordinary transaction will be OI if they fall into at
least one of three categories, where the transaction:
 Forms a business in itself
 Falls under the first strand of FCT v Myer Emporium
 Falls under the second strand of FCT v Myer Emporium
These categories are not mutually exclusive, so it is possible for a transaction to fall
into more one category.

Transaction forms a business in itself under the principle in FCT v

Whitfords Beach
Principle applied to isolated transactions
Case law indicates that if an isolated transaction has sufficient indicators of a business,
then it will generate OI even though it is a one-off transaction.
 It an isolated transaction exhibits sufficient characteristics of a business, then
profit from it will be considered a form of business income and so will constitute
OI.
 Leading case: FCT v Whitfords Beach
 The difference btw an isolated transaction that does or does not produce OI
(Californian Copper Syndicate v Harris)
 A “mere realization” of a capital good made by enhancing the value – this will
result in a capital gain

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 A gain made carrying on a business – this will generate OI

This is highly influenced by the fact that the development was extensive and required
considerable effort and capital. Although the transaction was a one-off isolated
transaction, it had enough characteristics of a business to conclude that the
proceeds are OI.

FCT v Whitfords Beach Pty Ltd

 At the beginning, the purpose of the company is to acquire land. Later the company
was taken over by three shareholders who caused the company to change to enable
land development, and then sold the land.
 Issue: was the taxpayer assessable on the profit on the sale of the subdivided land
under either s25(1) or 26(a) or was the taxpayer merely realising a capital asset?

 Held: the profit was income. The taxpayer was transformed from a company which
held land for the domestic purposes of its shareholders to a company whose
purpose was to engage in a commercial venture with a view to profit.
 The extensive work of development and subdivision is seen to be more than the
mere realization of an existing asset and to be work done in the course of what
was truly a business venture.

FCT v Myer Emporium Ltd

 Myer lend 80million to associate, and then assigned the right to receive the interest
income to Citibank for 45million.
 Issue: was the receipt by taxpayer assessable under s25(1) as an income receipt or
under the second limb of s 26(a) as a profit from a profit-making undertaking or
scheme?

 Held: 45million was assessable income. Myer’s business is retailer and property
developer, so this transaction is outside the scope of the business. However, the two
transactions were an overall profit-making scheme, as the taxpayer intended to sell the
right to receive interest.
 Profit made on a realization or change of investments may constitute income if
the investments were initially acquired as part of a business with the intention or
purpose that they be realized subsequently in order to capture the arising from
they expected increase in value.
 The assignment was not unrelated to and independent of the loan agreement. The
two transactions were interdependent in the sense that Myer would not have entered
into the loan agreement unless it knew that Citicorp would shortly thereafter take an
assignment of the moneys due or to become due for a sum approximating the amount
payable in the consideration of the assignment. The two transactions were essential
and integral elements in an overall scheme, that being scheme a profit-making
scheme.
 The scheme may be a profit-making scheme notwithstanding that neither the
sole nor the dominant purpose of entering into it was the making of the profit.

Post-myer developments
FCT v Cooling
 Taxpayer was a partner in a firm that was considering moving premises. The lease was
held by a service company B. The lessor promised to pay money to partner if B would
become the tenant of lessor.

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 Issue: was the lease incentive payment assessable under s 25(1)

 Held: the payment is assessable income. As the transaction entered into by the firm
was a commercial transaction and it formed part of the business activity and obtained a
commercial profit by way of incentive payment.
 The firm was reluctant to move. But the firm did commit itself to the move and it
was an integral part of this commitment that it receives the incentive payment
which is properly a profit of the partnership.
 The transaction entered into by the firm was a commercial transaction; it formed part
of the business activity of the firm and a not insignificant purpose of it was the obtaining
of a commercial profit by way of the incentive payment.

Westfield Ltd v FCT

 Taxpayer carried on business of designing, constructing, leasing and manage shopping
centre. It acquired land for developing it to shopping center, but later sold it for a profit.
 Issue: was the profit on the sale of the land assessable according to the principle in
Myer’s case

 Held: the profit is not assessable. The transaction is outside the scope of ordinary
business activities, and the intention of the taxpayer at the time of acquisition
was to employ it in business and receive ordinary trading receipt. So there was
no profit-making scheme.
 Where a transaction occurs outside the taxpayer’s ordinary business activities,
in order for the profit to be assessable in accordance with the principle in Myer’s
case, the transaction was entered into there must be a purpose of profit making
by the very means which give rise to the profit actually made.

FCT v Montgomer –lease incentives

 The taxpayer was a partner of company. The firmed wanted to move premises and
received premises from lessor, as it was regarded as a particularly attractive tenancy
target.
 Issue: was the incentive payment according to ordinary concepts?

 Held: the payment was on revenue account. The firm got the inducement offer to
take premises as it was attractive, which means it used its capital in course of
carrying on its business. The receipts were an ordinary incident of part of the
firm’s business activity even though they were an extraordinary and unusual part
of that business activity. So the amount received by a lessee on agreeing to take
a lease is not capital account.
 If a lessee pays premium to obtain advantage of the lease and that lease may well form
part of the profit-yielding structure of the lessee’s business. The premium is outlaid on
capital account.
 However, the inducement paid by the lessor could be seen as an income for the lessee
because the lessee used of exploited its capital ( in this case carrying on business) to
derive/ receive for separate use, benefit and disposal and it does not necessarily form
part of profit- yielding structure.

Is the receipt capital or income?

 It is clear from Myer, Cooling and Westfield that certain profits are not income as they
neither within the scope of the business, nor the product of a profit-making scheme.
 Eg. The sale of the head office of a trading or financial corporation will give rise to a

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capital receipt.
 Sale of the profit-making structure for a lump sum will give rise to a capital
receipt. The profit-making structure is not confined to property; it may extend
to assets such as know-how and confidential information which belong to a
business.
 If there is no business and the tp supplies confidential information for a
fee, there is no disposal of an asset, but simply provision of services for
a fee: Brent v FCT
 Where there is a business, the supply of confidential information and know-
how can be on capital account in exceptional circumstances.

Evans Medical Supplies Ltd v Moriarty

 Taxpayer carried on business as a manufacturer and wholesaler of drugs. Its agency
closed and sold certain confidential information for fee.
 Issue: was the 100000 sum received from the Burmese government as consideration
fort the supply of secret processes and ancillary know-how a receipt of the taxpayer’s
trade liable to income tax or was it a non-taxable receipt.

 Held: this payment is capital as the effective disposal of business asset. The agency is
closed so that the company had in substance parted with a part of its income-producing
property for a purchase price, which is a capital asset and received for it a capital sum.
 The lump sum was received in an isolated transaction as consideration for
communication of secret processes with a resulting total loss of the company’s
Burmese trade.
 The company had sold to the Burmese government a secret process on which
the success of its business in Burma had to depend and it had disposed
altogether of its Burmese trade.

The exceptional nature of Evans Medical Supplies Ltd v Moriarty was explained by the
House of Lords in Rolls-Royce Ltd v Jeffrey

Facts: taxpayer carries out a business and sells out its confidential information. The
payment is regarded capital in nature because of effective disposal of business asset.
( Brent’s case !)
 The company has parted with an asset which was once the source of its profit.

Rolls-Royce Ltd v Jeffrey

 Taxpayer entered agreement to supply technical information necessary to manufacture
such engines. It chose to do it because it was unable to sell its engines in this country.
 Issue: was the lump sums received under the license agreements of an income or
capital nature

 Held: the lump sums were income. They has no business, and turn the “know-how” to
account by reward it to others in order to bring about alternative form of
manufacture, there was no disposal of asset, but only provision for services for a fee.
So it cannot be account to capital.
 The taxpayer was not disposing of a capital asset under the licence agreements
but was exploiting its know-how in the best way possible in countries where it
could not directly manufacture or sell engines. The supply of know-how under the
licence agreements was undertaken by the taxpayer on a regular and systematic basis
over a period of years and was properly regarded as either being a trading activity in

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itself or else as a mere extension of its principal trade of designing and manufacturing
engines.
 Know-how has the peculiar quality that it can be communicated to or shared with
others outside the manufacturer’s own business, without in any sense destroying its
value to him.

2. Use of business receipt to acquire capital assets

 Whether a receipt is income or capital depends on its objective character in the hands
of the recipient.
 That character is not affected by the recipient’s decision to acquire capital assets with
the money

G P International Pipecoaters Pty Ltd v FCT

 Taxpayer entered into contract to supply coatings for pipes for SECWA. Part of the
contract price was agreed to be used to build the plant.
 Issue: were the amounts received by the taxpayer in respect of the construction of the
pipe coating plant of an income or capital nature?

 Held: the contract price was income being a trading receipt. The relevant question is
whether the receipt of the establishment cost was income in the taxpayer’s hand, it was
not affected by the fact as it was been used to construct the plant. The activity of the
taxpayer corresponds to the contract and receives under the contract for its
performance, so that it was received as income rather than received in exchange for an
item of capital.
 The relevant question is whether the receipt of the establishment costs was
income in the tp’s hands. When money is received for the purpose of its being
expended by the recipient, the character of the receipt is necessarily determined
by the character of its proposed expenditure by the recipient.
 The establishment costs were received by the tp under the k, as part of the monetary
consideration payable for the tp’s agreement to perform, or its performance of, the
entire k.
 The establishment costs were not received under a severable part of the k relating to
the construction of the plant. By constructing the plant and coating the pipe the tp
performed the obligations in consideration for which it was entitled to be paid
the establishment costs and other moneys payable under the k.

Generally speaking, whether a receipt is income or capital depends on the character in the
hands of the recipient. But in this case the character does not affect the substance of the
payment.
Facts: portion of investment spent on building a plant for construction only ( no use after
performance of the contract) was income.
 Capital : sth is built to generate assessable income and can be depreciated
under s 54 of ITAA 1936

Sale of depreciable plant

Property development and land dealing

Statham v FCT
 It was held that the receipts were on capital account because the trustees were not

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carrying on a biz of subdivision.

A reverse list to Ferguson’s case
Owner were at first content to sell the land as one parcel but was unable to do
so
No money borrowed
Limited clearing work was involved
Owners rely upon others to carry out roadworks, kerbing, electricity and
severage works, which are required to be done
No erect buildings
No business organization, no manager, no office , no secretary and no
letterhead
Owner has retained his own career
No advertisement of the land for sale
No engagement of other contractors
Bookkeeping of sale of land was done by the owner personally
Land was sold by listing it with real estate agents

Moana Sand Pty Ltd v FCT

 The intention was that the land should be used for estracting sand and subdivided for
sale. However, the land were compulsorily resumed by a government department for
370000

 It was held assessable income either as proceeds of business or as a profit-making

scheme. A scheme can be a profit- making scheme even though the dominant
purpose is not profit-making.

Share trading: carrying on business vs hobby

Shields v Deputy Commissioner of Taxation
 Taxpayer is a finance staff, he buy shares after declaration of franked dividend and
sold before the market price changed. His strategy leaded to loss.
 Issue: was the taxpayer carrying on a business

 Held: taxpayer carried on a business because of his extensive commercial knowledge

and his strategy. Also, his trading was regular and purpose for profit-making is
undoubted. So his operation was businesslike.
o Degree of repetition
o Turnover is substantial in relation to the applicant
o Sufficient accounting records
o The applicant used the office of his employer and needed no other
o The applicant has counted in a manner considered adequate (yrs of
experience and skills and care)

Insurance companies, banks, finance companies and the

doctrine of switching
Australian Catholic Assurance Co Ltd v FCT
 Taxpayer is an insurance company, which purchased blocks of flat as long-term
investment and hoped to hold 30 years. However, during the war taxpayer cannot
afford maintenance and expenditure, so the flat was been sold for profit.
 Was the receipt assessable as income

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 Held: the profit was assessable income. As part of their investment business, bought
real estate at high return and sold it profitably before it became bad investment, which
was what they intended from the very first. So the income is according to the ordinary
concept.

Capital gains made on purchase and sale of securities by insurance companies,

banks, finance companies and the doctrine of switching are assessable income. The
reason is that investment for capital gain is within the scope of the business of
taxpayers and it is necessary for these taxpayers to generate a certain yield to meet
clients’ claim and that the realization of capital gains is an inevitable consequence
of the pursuit of high yields through switching.

Trusts and investment companies: scale, frequency and

intention of fund managers determines whether trusts and
investment companies are carrying on business to pursue capital
increments or maintaining fiduciary duties?
Charles v FCT (fiduciary duty)
 Taxpayer was a trustee whose managers were closely informed of market trends and
who sold shares that were likely to fall in the value.

 Held: the profit was not assessable income but a capital receipt. The deed gave a wide
power to vary investment, so the manager can request trustee to sell investment and
re-investment. The money arose here was not from transactions in the conduct of
business or a profit-making scheme, but from transactions effected in the course
of performing a fiduciary duty to preserve for beneficiaries as far as practicable
the assets comprising the trust fund and any increments in the value of those
assets which might appear from time to time to be in jeopardy.

London Australia Investment Co Ltd v FCT (investment, carry on

business)
 Taxpayer’s principal object was to invest in Australian securities to produce dividend
income. Its policy is to produce 4 percent return. Direct meetings were held to decide
sell or buy securities and later it made gain from disposal shares.
 Issue: was the taxpayer assessable under s 25(1) on the surplus arising from the sale
of its shares

 Held: the profit was assessable income under s25-1936. The shares were not bought
for the purpose of selling them at profit, which is not part of profit-making activities so
that the s15-2 cannot be applied. However, although business was to invest shares
and get dividend, the conduct of the investment business required the share portfolio
should be given regular consideration and that shares should frequently be sold when
the dividend yield dropped, so the income is within the ordinary concept. Also, the
large-scale of activity in the buying and selling shares could be another determined
reason.

Gifts
Federal Coke Co Pty Ltd v FCT

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 B was the holding company while F is its subsidiary. B has a contract to supply coke to
LN. Then, LN wants to cancel the contract and agree to pay compensation to B. But B
gave the money to F related to closure of F.
 Issue: was the compensation payment of an income or capital nature

 Held: the money to F is not assessable income. For F, the payment was unexpected
and its business is produce coke, which has been ceased when payment received and
it did not perform any financial work for B. And also, the money is compensation to B
but not to F. It is income in B’s hand but did not necessary to be income in F’s hand.

Debt defeasance is not ordinarily income

FCT v Orica
 Taxpayer wanted to raise new funds for expansion and entered into assumption
agreement with MMBW, which would receive a payment in consideration of its
agreement to pay the principal sums. MMBW need to made series payment to
taxpayer, while in 1987 the money MMBW paid to taxpayer is over the present value
under the assumption agreement.

 Held: the difference between present value and the amount payable on maturity was
not assessable income. As at the time of agreement, the taxpayer only received
MMBW’s promise which is not income. It was a benefit constituted by the discharging
of that capital obligation. There was no income according to ordinary concept or profit-
making scheme.

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