ORDINARY INCOME

The phrase ordinary income derived from all sources (in ITAA97 s 6-5)
formerly read gross income derived from all sources (ITAA36 s25(1)
from which it may be concluded that the meaning of ordinary income
has the same meaning given to the words gross income [see ITAA97 s13]. Negative propositions; items that are not income by ordinary
concepts #Convertibility: In Tennant v Smith (1892) free
accommodation provided to a bank manager was held not to be ordinary
income because building could not be sub-let and the benefit thereby
converted to money. Note: Today, for employees, the benefit in Mr
Tennants case would be a housing fringe benefit, taxable to the
employer under the Fringe Benefits Tax Assessment Act. In FCT v Cooke
& Sherden (1980) an incentive prize offered by a manufacturer was not
income of the winning retailers because it was not transferable and so not
convertible into money.# 2 Capital receipts are not income
At law there is a fundamental distinction between income and capital.
From UK case law comes the California Copper principle [affirmed by
HCA in Myer Emporium case (1987)] ~ a mere realisation of an asset,
produces a capital amount. 2. From Australian case law comes the Sun
Newspapers case and the income/capital dichotomy; often called Dixons
Criteria.(dichotomy = division or classification into two [parts]).
For tax law purposes we need to distinguishing income and capital
for several reasons:
ordinary concepts notion of income does not include capital; [see
below]
general deductions [and some specific deductions, eg: repairs]
specifically excludes deductions for capital outlays
capital receipts may generate capital gains CGT; concessional
tax treatment; the gain might be discounted by 50%.
trust distribution of corpus [capital] is not assessable income.

In general terms it may be stated that capital receipts and profits

arising from the mere realisation of a capital asset are not income
but where what is done is truly the carrying on of a business, the
proceeds will be on revenue account: California Copper Syndicate
Ltd v Harris (Surveyor of Taxes) (1904) 5 TC 159; FCT v Myer
Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363.
Payments received for the loss or sterilisation of profit making
structure will be on capital account; Heavy Minerals Pty Ltd v FCT
(1966) 115 CLR 512; 10 AITR 140; but payments incidental to

operating a business are on revenue account; London Australia

Investment Co Ltd v FCT (1977) 138 CLR ; 77 ATC 4398.
An isolated transaction entered into with the intention of making
a profit will produce a revenue amount: FCT v Myer Emporium
Ltd; FCT v Whitfords Beach Pty Ltd (1982) 150 CLR 355; 82 ATC
4031. The application of the income/capital dichotomy to
employment or the provision of services or from carrying on a
business are income are considered under Propositions 9 and 10
respectively.
The Income/Capital Dichotomy Applied [ATL 3-280]
Sale of know how/licences provision of exclusive licence is capital;
simply exploiting a licence is likely to be income. The grey area is where
a person does not dispose of a patent (or other property) but grants a nonexclusive licence. The receipt is likely to be income, but the greater the
rights surrendered, the more likely the receipt is capital. [Sale of a patent
or copyright will have CGT consequences.]
Cancellation of agreements character of the payment turns on whether
there is a loss of income [process] or the loss of a right or capacity to earn
income [structure]
See Heavy Minerals Ltd v FCT (1966) - cancellation of supply agreement
ultimately forced the company into liquidation capital. [Payments
made for giving up rights will have CGT implications.]
Compensation for injury - contrast again is between loss of right or
capacity to earn income [capital] or a substitute for income [revenue]
[unliquidated damages - see ATL 6-880]. Thus payments for personal
injury are capital; payments for loss of wages are income. [Payments for
personal damages are excluded from CGT so if the amount is not income,
it is not taxable.] #3: A [mere] gift is not income This proposition is
grounded in Hayes v FCT (1956): a voluntary payment from A to B
prima facie is not income; but that presumption will not apply when the
payment is in substance a product of services provided: So, a payment
from John to Betty is not ordinary income but if John and Betty are
employer/employee or if there is a contract for the supply of goods or
services between John and Betty, that presumption is likely to be
displaced.-What about former employees? [Dixons case] -What about
gratuitous payments? [Scotts case] -What does Kellys case imply in
regard to sportsmens and womens testimonials?(Some old UK
authorities [Seymour v Reed (1927)] suggest the proceeds of a benefit
match should be characterised as personal tributes.But, Kellys case &
Stones case suggest prizes won by professional sportspersons are likely
to be income [ATL 4-046] # 4: Windfalls are not income Windfall gains
are the product of luck and usually lack that commercial dimension.
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 Punting: Martins case, a keen punter not carrying on a business

as might be the
case with an owner/breeder of racing stock and
would be for a bookmaker. So, a successful punter is not assessable
on winnings - Evans - an unsuccessful punter is not entitled to a
deduction - Brajkovich. The weight of Australian authority is
against a conclusion that punting and gambling gains are income.
But: horse racing may amount to a business activity; prizes: may
be income when they are incidental to commercial activity - Kellys
& Stones cases - but not when they are remote (eg: Pursuit of
Excellence Awards) or random, such as lotto/bingo wins. Quiz/TV
contestants judged by reference to Proposition 10. So too
hobbies.#5: Mutual receipts are not income:The essence of the
mutuality principle is that persons cannot profit through dealings
with themselves. Mutuality implies a non-profit orgainsation in
pursuit of a common objective generating funds from its members
to be applied to the common cause. Funds generated externally
(interest on deposits, dealings with the public etc) fall outside of
mutuality principle.
Positive propositions - characteristics of income
# 6: To be income, an amount must be beneficially derived.
This proposition comes from Constables case (1952). It concerned an
employers contribution to a superannuation fund for the benefit of an
employee:Constables case is also authority for saying that an amount that
would have been income had the necessary derivation existed at some
earlier period of time, does not become income at some later time when it
is derived unless in the circumstances of the later derivation it has an
income character. The employers contributions to the fund were not
allowed, given or granted to the taxpayer. When the benefits were paid
out at a later time, they were not income. An amount has to be
characterised at the point of its derivation.Income and derivation must coexist [arguably, unearned income is not income and it is not derived
either]. An amount that is not earned is not income: eg, certain
prepayments or lay-bys. However, the courts do not accept accounting
revenue recognition criteria as conclusively determining when an amount
is earned. Exactly when income is derived is to be considered later.
# 7: Income is to be judged from the character it has in the hands of
the recipient.
The decision in Just v FCT (1949) provides an insight to this proposition:
the Just brothers sold property for consideration that included a
percentage of profits for 50 yrs from the redeveloped site. Normally,
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such a sale would be a mere realisation in terms of the California

Copper principle. The HCA held the payments were income because the
payments were for an indefinite amount and took the form of an annuity.
Colonial Mutual Life Assurance Co v FCT (1953) acquired property
from the Just boys and claimed a deduction [s51(1)] for the cost,
describing it as rent. High Court classified payments as instalments of
capital and not deductible.Webb J said: The fact that these payments to
the Justs represented assessable income to them has, I think, no bearing
on the question whether such outgoings are [deductions] within s51(1).
The decisions in Hayes v FCT (1956) 6 AITR 248 and Scott v FCT
(1966) 10 AITR 367 provide authority for Proposition 7. The donors
motive may be a consideration but it is seldom decisive. The proposition
is well illustrated by the Federal Court decision in Federal Coke Co Pty
Ltd v FCT (1977) 7 ATR 519.
# 8: Income generally exhibits recurrence, regularity and periodicity.
A number of periodic payments has an income character; periodicity
suggests an income character when other elements do not point to a
different conclusion (eg; house-keeping allowance is periodical but not
income)regularity is the hallmark of wages, annuities pensions, workers
compensation
[Inksters case] etc.
But: -- just because regularity is a common feature of income, do not
conclude that an isolated or one-off receipt cannot be income: see
Coolings case. [Principle upheld by a majority of HCA in Montgomery
(1999).]Isolated transactions may generate income when they are entered
into with the intention of making a profit - Myer Emporium (1987);
California Copper (1904).

# 9: Amounts derived from employment or the provision of services

are income.A Statutory Extension ITAA36 s26(e) [ITAA97 s15-2]:
assessable income includes the value to the taxpayer of benefits, bonuses,
allowances (etc) relating directly or indirectly to employment or
provision of services...The old view was that this provision captured only
what was already income by ordinary concepts other than its nonconvertibility to money [hence value to the taxpayer - Scotts case] but
in Smiths case (1987) Brennan J considered the provision captured
capital amounts too. The decision in Smith suggests Scott was wrongly
decided: although a mere gift is not ordinary income, a connection with
employment or services will make it statutory income assessable under
s26e/15-2. The application of s26(e)/15-2 has been largely overtaken by
Fringe Benefits Tax.Refer to Rowes case (1997). A majority of the HCA
held that an ex gratia payment to a former employee was not incidental to
employment [ATL 3-400]
# 10: Amounts derived from carrying on a business are income.
Is there a business?See Fergusons case.~ has it commenced? Is it too
soon yet to say a business has started (and so the set-up costs are
structure related and capital in nature)? [Softwood Pulp & Paper case]
~ is the undertaking commercially viable? This is the principal test since
the prospect of profit is the stamp of business and what separates
businesses from charities of hobbies. Other considerations expressed in
Ferguson tend to qualify the relevance of profit.[In regard to a hobby, it
could be said that the activity does not have a profit intention, even if it
generates a surplus.]
What is the business?
~ an exact identification of the business is critical because that will
assist in characterising process [revenue] related gains from
structural [capital] related gains. For example, the sale of shares
[trading stock] by a share dealer are on revenue account whereas
the sale of shares [assets] by an investment company are likely to
be on capital account. Refer to London Australian Investment Co
for an illustration of the difficulties of these distinctions.
# 11: Amounts derived from property are income.
Property yields rent, interest, dividends and royalties.
Interest is not defined in the Act. Its ordinary meaning is the
amount generated from the use or employment by others of a
capital amount. Interest is inherently on revenue account: Steeles
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case. Rent is not defined but at common law it means a payment

received by a lessor in return for the use by a lessee of real or
personal property: Yanchep Sun City Pty Ltd v C of State Taxation
(WA) (1984) 15 ATR 1165. An annuity is a series of payments
made under a contractual obligation for a specified number of
years or for life; Edgerton-Warburton v FCT (1934) 3 ATD 40.
A royalty is an amount paid to the owner of property for the right
to use the property or to remove a substance; Stanton v FCT (1955)
92 CLR 630; 6 AITR 216. Dividends paid to a shareholder out of
profits derived by a company also sit comfortably with Proposition
11 and such payments would normally be income by ordinary
concepts. [But dividends paid in the form of bonus shares could be
seen as capital.] A separate code comprising ITAA36 s 44 - 47
covers the taxation of dividends [meaning dividends are made
statutory income and s6-25 applies (Remember?)].
#12: Amounts received as substitutes for or compensation for lost
income are themselves income.In Proposition 2 it was established that
capital does not have the character of income and that a payment made
for the loss of a right to earn income was a capital payment. Proposition
12 makes a different assertion. It states that payments in substitution of
income are themselves income. The second ground in FCT v Myer
Emporium is authority for saying compensation for the loss or assignment
of future income is itself income. As a result, social security payments
such as unemployment benefits would be income under Proposition 12.
So too would be payments made to an employee on sick leave or in
receipt of workers compensation. In Tinkler v FCT 79 ATC 4641, as the
result of a motor accident the taxpayer was unable to work and was
entitled under the Motor Accidents Act to payments for the loss of income
calculated as a proportion of average earnings. The taxpayer argued that
the payments were for the loss of earning capacity - a capital asset. The
Full Federal Court held the payments were a substitute for income. The
principle in Tinklers case, as in other compensation cases, was stated by
Brennan J as follows (at 4643):
Where a taxpayer gives up his income in exchange for other payments,
the other payments take on the character of income for which they were
exchanged (C of T (Vic) v Phillips (1936 55 CLR 144 at 157). And where
payments are made pursuant to a statute as compensation for an asset
acquired by the State or sterilised in the hands of the taxpayer in order to
serve the public interest, those payments take their character from the
character, in the taxpayers hands, of the asset acquired or sterilised (see,
for example, Newcastle Breweries Ltd v IRC Commr of Taxation v
Wade (1951) 84 CLR 105 ).

Thus in Allman v FCT 98 ATC 2142 a payment made for income lost
through wrongful dismissal was assessable income because it was a
substitute for income that would have been earned.
Compensation paid for the cancellation of business contracts or
agreements (when the profit- making structure is left intact) will be a
substitute for income: Heavy Minerals Pty Ltd v FCT (1966) 115 CLR
512; 10 AITR 140. If the profit-making structure is permanently
impaired, the compensation will be capital: Van den Bergs Ltd v Clark
(Inspector of Taxes) [1935] AC 431; Glenboig Union Fireclay & Co Ltd v
IRC (1922) 12 TC 427. Where the cancellation results in termination of
the taxpayers business, the payment will be capital (California Copper
Products Ltd (in liq) v FCT (1934) 52 CLR 28) but where a cancelled
agency or supply contract in one of many or is a comparatively minor
component of the taxpayers wider business, the general proposition
holds; the compensation is a substitute for income: Kensall Parsons &
Co v IRC (1938) 12 TC 608.

1. Div 15: Some items of assessable income

s15-20: royaltiesYour assessable income includes an amount that you
receive as or by way of royalty within the ordinary meaning of royalty
(disregarding the definition of royalty in subsection 995-1) if the amount
is not assessable as ordinary income under s 6-5.
s15-20 seems to be saying that some royalties may be income according
to ordinary concepts, assessable under s6-5. That would not include
capital payments. Payments being royalties by ordinary concepts are
assessable under s15-20, disregarding the definition in s995-1. Such
amounts could include capital. Royalties under s995-1 derived by a nonresident are subject to withholding tax
.
The assessment process may be illustrated diagrammatically:

|----> Income
|
Ordinary royalty ------ |
|
|----> Capital

s 6-5

|----> Income
|
Extended royalty --|
|
|----> Capital

s 6-5

s 15-20

Not assessable
as income maybe

CGT
2. Div 20: Amounts included to reverse the effect of past deductions
[ATH 4 180]
Div 20 is directed to recouping amounts that were formerly deductible.
The division operates independently in that there is no underlying
principle of revenue law that the recovery of an amount that was
previously deductible is, ipso facto, of a revenue nature. There is no
necessary symmetry between assessability and deductibility: FCT v Rowe
(1997) 187 CLR 266; 97 ATC 4317. Whilst a substitute for income is
itself income (FCT v Myer Emporium (1987) 163 CLR 199; 87 ATC
4363), compensation for lost income is also income (Heavy Minerals Pty
Ltd v FCT (1966) 115 CLR 512; 10 AITR 140) and amounts arising in the
course of business are income (such as the refund in H R Sinclair & Sons
Pty Ltd v FCT (1966) 114 CLR 537), the High Court in Rowes case
unanimously refused to accept that there was a more universal principle
of law.Div 20-A For Div 20-A to apply there must be an assessable
recoupment. This is:(a) any type of recoupment, reimbursement, refund, insurance, indemnity
or recovery of a loss or outgoing, however described; and
(b) a grant in respect of a loss or outgoing.
The loss or outgoing refers to any amount deductible under the Acts of
1936 or 1997.The recoupments are made assessable under s 20-20:
20-20(2) An amount you receive as recoupment of a loss or outgoing is
an
assessable recoupment if:
(a) you receive the amount by way of insurance or indemnity; and
(b) you can deduct an amount for the loss or outgoing for the current
year, or you have deducted or can deduct an amount for it for an earlier
income year, under any provision of this Act.
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Section 20-30 lists the following provisions of ITAA97 (as well as their
predecessors in ITAA36) including:- [refer ATH 4-180]
8-1 rates and taxes and bad debts
25-5 tax related expenses
25-35 bad debts
25-45 embezzlement and larceny by an employee
25-60 election expenses
25-75 rates and taxes
[plus recoupment of a range of capital write-offs, such as
depreciation]
The ITAA36 s26 framework [the remnants of s26] Employment
Termination Payments In the good old days payments made upon
termination of employment were assessable only on 5%. That meant 95%
was tax free. Obviously it was in an employees interest to accumulate
whatever bonuses and leave entitlements until resignation or retirement.
In 1978 payments in lieu of annual leave and LSL were specifically made
fully assessable (subject to a maximum tax rates). In 1983, all termination
payments were made fully assessable. From 2007/08 Pt 2-40 and Pt 3-30
cover retirement payments and superannuation.

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Derivation
The meanings of derived, residents (partly defined), source are to be
gleaned from case law relating to the former s25(1) ITAA36. Exempt
income is a kind of statutory non-income. You should read s6. It deals
with assessable income, ordinary income, statutory income and exempt
income Derived Look at s6-5(2) and s6-10(4) [above]:
When is ordinary income included in your assessable income? [When its
derived ]When is statutory income included in your assessable income
and why might the timing of its assessment be different (if it is) from
ordinary income? [Not clear need to read the particular sections. Eg: in
Div 15, most items are assessed when received.]Ordinary income is
assessable when derived. Derivation of income is about earning and
timing. The rules are a mixture of legal principles (taken from case law),
accounting & commercial practice and administrative convenience. The
ITAAs also contain deeming provisions that establish when an amount is
assessable, even if by general rules it has not been received or accrued or
derived.Court accepts the cash or accrual basis of returning for tax
but its understanding of the accrual method does not always correspond
to accounting principles. In general, in the case of an accrual base
taxpayer, the courts regard the existence of a legally enforceable debt to
be the point of derivation. But income derived is not necessarily
income receivable.

Which method is used depends upon its appropriateness to the

taxpayers activities and the type of income earned.
1. Case law: Carden (& Firstenberg & Dunn), Henderson, Arthur
Murray, J Rowe & Sons: Whitfords Beach (or Cyclone Scaffolding or
Memorex).Cardens case a taxpayer will use the method calculated to
give an appropriately correct reflex of true income.
Issue: was the income represented by the accounts receivable derived by
Dr Carden [accrual basis] or his estate [cash basis]?
[ie: if Dr Carden is on a cash basis, accounts receivable at date of death
would not have been assessed and when payment received, it would be
derived by his estate. If on an accrual basis, the accounts receivable
would have been assessed to Dr Carden and become corpus (capital) of
his estate.]Held: a sole practitioner derives amounts that are essentially
rewards for personal effort when they are received.[So, wages from
employment derived when received.]
In general:- [Dixon J.]i)Where no inventory, (ii) no natural connection
between debtors & creditors (or income and wages paid), (iii) no fund of
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circulating capital and (iv) but rather where payment is largely a reward
for services, then
cash basis is appropriate.[So, sole practitioners and small practices
providing personal services will generally return on a cash basis. It was
accepted that most manufacturing concerns and trading operations would
use an accrual basis.]
Hendersons case - held that for a large firm of accountants, accrual basis
was appropriate even though (i) [above] was not a feature of a firm of
professionals. The scale of operations, the firms accounting system, the
way the business was practiced all contrasted with Carden.
Note, the change from cash to accruals meant that closing debtors in one
year does not represent income derived because it is not received and
following the change, in the year of receipt the debtors are not income
derived because an accrual basis is now appropriate. The High Court
refused to make a one-off adjustment (but note Dormer v FCT (2002)15
ATR 353 [ATL 13-140]Arthur Murray - dance studio required advance
payment for dancing classes. In Ruling TR 96/20 the Commissioner
states that the full invoice price for a credit sale is assessable unless
the transaction offers a prompt payment discount in circumstances
on all fours with Ballarat Brewing Co Ltd.
Dividends Dividends are derived when paid. ITAA36 s 44 assesses
dividends paid and ITAA36 s 6(1) defines paid to include credited or
distributed. In Brookton Co-operative Society Ltd v FCT (1981) 11 ATR
880; 81 ATC 4346 Mason J said (at ATC 4355):
Residency .see s6(1) ITAA36; s995-1 ITAA97 definition:resident means a
person who resides in Australia... and includesa person whose domicile is in
Australia unlesspermanent place of abode is outside Australia; a person has
been in Australia more than one half of the year unless usual place of abode
outside Australia and does not intend to take up residence in Australia. There are
four dimensions to the definition:- common law test centering on ordinary
meaning of reside , a domicile test a 183 day test
Statutory Testsi) Domicile: a home each person is required to have in order to
attract legal rights and duties. Everybody has a domicile of birth or choice. The
domicile test is qualified by whether the person has a permanent place of abode
outside Australia. In this context, permanent does not mean everlasting Applegates case.ii) Physically present test: 183+ days; again subject to
qualification of intention to take up permanent residence.iii) the third statutory test
is designed to cover diplomatic staff and armed service personnel posted
overseas. It is not relevant to this course.6. Exempt income:s6-15(2)If an
amount is *exempt income, it is not assessable income.s6-20 An amount of
*ordinary income or *statutory income is exempt income if it is made exempt
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from tax by a provision of this Act.Three categories:-a) entities that are exempt:
s11-5 s50-5 to 50-45b) certain income that is exempt: s11-10 s23L ITAA36
c) certain income derived by certain entities: s11-15 (largely) former s23
ITAA36 now in ITAA97 s 51, 52.a) exempt entities: in general, charitable,
educational, religious organisations; trade unions and employer organisations,
hospitals, public educational institutions, local government etc. 50-45: exemption
for non-profit organisations conducted for the promotion of game or sport, music,
art, science or literature or community services.b) certain income: ITAA36 s23L
[s11-10]: exempts benefits within the meaning of s136 of the Fringe Benefits Tax
AssessmentsAct
So, all fringe benefits (including exempt FBs are exempt in the hands of
employees.c) certain income of certain entities:(i) s23AF &AG [s11-15]: provides
an exemption from Australian tax for certain foreign earnings of defence, aid and
charity workers working more that 91 days abroad. (ii) Miscellaneous exemptions
include maintenance payments to a spouse or former spouse; pay and
allowances to part-time members of the Defence Force Reserves; a range of
pensions (but not the age pension) [Subdiv 52-A], education allowances
scholarships etc [s51-10] [ATL 9-085 9-140].d) Non-assessable/non-exempt
income:See list s11-55. [ATL 9-005 9-015]

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