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Income according to ordinary concepts - a closer examination

When will a receipt be income according to ordinary concepts?

Possibly, when it is received on a regular basis?

Possibly, when it is a NOT voluntary payment (not paid under a contract for provision of goods or services)?

When it is NOT a receipt of capital in the hands of an individual

When it is NOT a receipt of capital in the hands of a business

If it is capital and not income, it may still be included in assessable income as a capital gain

If you have read the topic, Your income tax is based on your taxable income, so how do you calculate your taxable income? You will know that your taxable income is your assessable income less your allowable deductions.

assessable income=ordinary income + statutory income

If you have read the topic, Statutory Income - a closer examination, you should have a working knowledge of statutory income.(Don't worry if you have not read it yet! It is one of the next topics after this one in the index)

So let's look at the first constituent of assessable income: ordinary income

If you refer to section 6-1 you will see that …

Assessable income consists of *ordinary income and *statutory income.

So what is ordinary income?

You will find the answer to that question in section 6-5

6-5 Income according to ordinary concepts (ordinary income)

Your assessable income includes income according to ordinary concepts, which is called ordinary income.

So far, so good! Ordinary income is anything that the man in the street would consider to be income

Note: Some of the provisions about assessable income listed in section 10-5 may affect the treatment of ordinary income.

Is there a better definition of income that what the man in the street thinks it is?

Surprising as it may seem - no one has yet come up with a precise definition.

Anything that is income is income!

The courts usually say that receipts, which according to the ordinary concepts and usages of mankind are usually considered to be income, are income

As simple as that!

Well ... Not quite there are some attributes which if present in a receipt suggest that it may be in the nature of income.

When it is received on a regular basis

Regular payments are more likely to be income than once only payments.

However - can you think of an example of regular payments, which are not income?

What about payments of instalments of the cost of a second hand car to a friend?

Unless he is a used car dealer they would not be income - we would refer to them as payments of capital

If a payment is VOLUNTARY (not paid as part of a contract for the provision of goods or services) it may not be income

Payments made voluntarily would not usually be considered to be income.

For example - Christmas presents.

The presence of some obligation to make the payment may suggest it is income.

However see if you can think of a voluntary payment which would be in the nature of income?

What about tips paid to a waiter?

They are considered to have the nature of income.

Answer this question….

On completion of a transaction a business man who believed he had done particularly well and had achieved an ambition and made a success of things donated some shares in a public company to his former accountant, Mr Hayes.

He was disposed to give a real measure of credit for his success to advice and assistance received over the years from Mr Hayes, his business associate and personal friend.

Would the receipt of the shares be income in the hands of Mr Hayes?

Yes No

These are the facts of Hayes v FCT (1956) 6 AITR 248.

Although the decision to make a payment may have been pre-empted by rendering of some service, it is suggested that voluntary payments made as a gift or as a personal testimonial to the recipient are not income. Although the gift may have been "prompted by the remembrance of past services", this did not give the shares an income characteristic.

These are the facts of Kelly v. FCT 85 ATC 4283

In considering whether the nexus between the employment and the benefit was sufficient for it to be said that the payment was 'really incidental to the taxpayer's employment' as a footballer, his Honour referred to the joint judgment of Dixon CJ and Williams J in FCT v.Dixon (1952) 86 CLR 540 at p. 556 where it was said:

'... it is clear that if payments are really incidental to an employment, it is unimportant whether they come from the employer or from somebody else and are obtained as of right or merely as a recognised incident of the employment or work.'

Refer CCH Master Tax Guide para 10-070 for some more examples

Answer this question….

A bank made a payment of $450 to the taxpayer, one of its former employees.

The taxpayer was in receipt of a pension under the bank's superannuation scheme. The payment was expressed to be a result of the bank's realisation of the difficulties, because of high inflation, experienced by the majority of people in the superannuation scheme. The taxpayer had not received such a payment before, although he received similar payments in subsequent years. The first payment was for him an unexpected and unsolicited receipt.

Would the payment be income according to ordinary principles?

Yes No

These are the facts of FC of T v Harris 80 ATC 4238

It was held that the receipt of $450 was not produced by any current employment of the taxpayer. When it was received, it was not known by the taxpayer to be one of a series of periodical payments. The payment was a gift, which was not income in the hands of the taxpayer.

As a result of this outcome, the Income Tax Assessment Act was amended to include such amounts as assessable income. Thus an amount which was not income according to ordinary concepts was transformed into what we call statutory income.

When it is NOT a receipt of capital by an individual

Receipts, which take the place of income foregone, are income. They are often referred to as compensation payments.

But there are other forms of compensation, for the loss of earning capacity - these are in the nature of capital.

What is the difference between capital receipts and income?

The distinction between income and capital can become complicated.

The payments received for the sale of some asset are not said to be income.

They are referred to as receipts of capital. In other words they are the proceeds of the sale of an asset. The owner has given up (or lost) an asset and receives the payment in consideration of this loss.

Capital and income go together like parent and child - one is produced by the other. Think of some parallels

Income = the water: capital = the spring

Income = the fruit: capital = the tree

Picture it how you will but remember if it fits the description of capital, it won't be income.

	*Capital* Think of it as the tree which produces the fruit		*Income* Think of it as the fruit which comes from the tree
Capital can be thought of as the parent that produces children		Income can be thought of as the child produced by the parent

There is often a classification problem encountered in dealing with such receipts - are they receipts of income or receipts of capital?

Interest will always be in the nature of income

Answer this question….

Is compensation for loss of a limb in an accident at work a receipt of income?

(Once again, you will find the answer at para 10-210 CCH Master Tax Guide)

Yes No

It is capital - no one goes around earning income by chopping off limbs

The nature of the compensation payment will be the same as the nature of the receipt it replaces or the event for which it provides reparation.

If a payment is received to replace salary and wages, which would have been included in assessable income, then the compensation will be included in assessable income.

If the payment is received to offset the consequences of loss of some asset, we must then ask if the asset was part of the taxpayer's capital.

This question can get tricky, and it involves decisions about whether the payment compensates the taxpayer for the loss of the tree (capital) or the fruit produced from the tree (revenue-income)

	*Capital* Think of it as the tree which produces the fruit		*Income* Think of it as the fruit which comes from the tree
Capital can be thought of as the parent that produces children		Income can be thought of as the child produced by the parent

Answer this question….

A medical practitioner employed by a hospital took out a disability policy.

He was injured in a traffic accident and incapacitated for a period of around 5 months. During that period he received payments under the policy?

Do the payments arising from a disability insurance policy have the nature of income?

Yes No

These are the facts of FC of T v D P Smith 81 ATC 4114.

The moneys paid under the policy were paid in substitution for income and therefore took the place of a revenue receipt.

If the ability to earn is the tree, and income the fruit thereof, a policy of insurance against impairment of the fruit bearing capacity of the tree may well take the form of providing the fruit until such time as the tree recovers it proper role.

When it is NOT a receipt of capital by a business

The question to be resolved in determining whether a taxpayer has received a capital receipt often comes down to whether the business

Has parted with something ... Or

has restricted it's operations in some way ...

or whether it has merely exploited it's know-how in the course of carrying on a business.

Answer this question….

A multi national manufacturer of pharmaceutical products acceded to the request of the government of a country in which its products were sold to hand over the know-how necessary to the establishment of a nationalised industry. It thereby effectively gave up its operations in that country. It received the sum of one hundred thousand pounds sterling in consideration of its provision of the assistance.

Would this amount be a receipt of income?

Yes No

These are the facts of Evans Medical supplies case- (1957 3 All ER 718)

The provision of the 'know how' was only one element of a comprehensive arrangement by virtue of which the trader effectively gave up its business in a particular area. Thus the money paid ostensibly for the know-how ranks as a capital receipt.

Answer this question….

The Rolls Royce company entered into agreements with certain governments and businesses to supply know how based upon its own research activity in exchange for lump sum payments

Would this amount be a receipt of income?

Yes No

As we have noted, payments for know how will usually be in the nature of income unless imparting the know how results in giving up business or some other capital asset.

Special knowledge or skill can ripen into a form of property such as copyright or patent - so will the proceeds of sale of such property be capital or income? as usual, it all depends upon the facts of the case

Sale of patent rights

If the sale represents the realisation of an asset it would be capital.

If the sale were made as part of an operation of business or in carrying out a profit making scheme it would have the nature of income.

What if the inventor merely sells a licence to use his patent?

If the licence payment amounts to a royalty then the receipt will be assessed income, even if it is paid as a lump sum.

So if the consideration payable has been calculated with reference to the uses made by the user (past, present or future) it will be assessable income.

If the payment allows the licensee to use the patent as much or as little as he desires, it may well be capital, though the facts of the case may indicate that it is income

Similar considerations apply to authors in respect of copyright.

Answer this question….

A taxpayer's grazing property is damaged by a fire which started on land belonging to the Commissioner of Railways. He makes a claim for $60,480 compensation on a number of grounds, some of them capital, some of them revenue (income).

The Commissioner or railways employed a valuer to cobble together a settlement based on all the grounds put forward by the taxpayer.

The valuer produced a settlement offer of $24,700 and this settlement was offered to the taxpayer, who accepted the sum, without knowing the basis upon which the valuation of damages had been made.

When the taxpayer received his tax assessment, it included the Tax Commissioner's guess as to that part of the settlement which represented revenue - income.

Should the taxpayer have a proportion of a settlement included in his income to represent that part of the compensation for revenue-income loss?

Yes No

These are the facts of Mclaurin v FC of T 1961 104 CLR 381.

The High Court held that Commissioner of Taxation was not entitled to divide up the amount of settlement accepted by the taxpayer to bring into assessable income those amounts accepted by the valuer which were of an income nature. It makes no difference that the (taxpayer) was in a position to make a confident guess as to the amount (the valuer) had allowed for each item in making his settlement proposal. He had simply to weigh the valuer's claim against the entirety of his claim, and accept it or reject it as a whole.

, On this basis, where compensation is paid in an undissected lump sum covering income (eg wages, etc) as well as capital (loss of a limb), the whole of the amount may be accepted as capital and not included in assessable income.

If it is capital and not income,

it may still be included in assessable income

as a capital gain

The capital gains provisions of the Assessment Act can transform receipts of capital into assessable capital gains in certain circumstances. You should refer to the topics on capital gains for further information