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Ordinary Income
1. Concept of a Flow
Held:
Court used the tree and the fruit metaphor. The fruit itself is income but the tree
is capital. Court stated that T’s interest in the company had increased but no
gain in the hand of T. The position in Australia is different because statutory
provision states that a stock dividend is subject to tax. Notion that gains flowing
from an asset are income but gains to the value of the asset are not
2. Generally Re-current
Dixon v FCT
T worked for company before WW2 but decided to enlist. Employer stated that
any employee who enlisted would be topped up for any discrepancy between
military income and income that would have earned if they stayed at the
company – patriotic gesture by employer.
Held:
Since the amount was paid on a regular and periodic basis, it was deemed OI.
Other cases:
Harris case court found that a yearly supplement to a pensioner was NOT
income because not regular. In Blake’s case a fortnightly pension supplement
was held to be regular and thus income. Harris has subsequently been
overturned by legislation. Now any supplement to pension is held as income.
1
3. Must be income in the hands of tax payer
Federal Coke (FC) supplied minerals to another company (B), which then on-sold
those minerals to an overseas company (C). C broke their contract with B. B
demanded compensation from C and requested the money be paid to FC (B’s
wholly owned subsidiary). Commissioner assessed compensation receipt on FC.
Held:
Could have circumvented this situation by the deemed receipt rule s6-5(4) ITAA
97. Even if T does not receive an amount but directs that the amount be paid to
someone else, the amount will be deemed as being received by the initial T.
4. Must belong to T
Held:
Court accepted argument that mother was not beneficially entitled to the money
due to the condition enforced by the trust. Not income in the hands of the
mother.
If receipt is not cash and cannot be converted into cash, then it is not income
Tennant v Smith
2
Bank manager had to live above the bank and could not sub-let premises. Tax
office calculated an amount he would have had to pay in rent. They were trying
to impute the non-cash benefit of living rent free.
Held:
Amount was non-cash and could not be convertible since he could not sub-let –
therefore not OI.
Held:
Holiday was non-transferable and thus could not be converted into cash,
therefore not income. Court also stated if the receipt saves T from incurring
expenditure, the saving is not ordinary income because income is what ‘comes
in,’ NOT what is saved from going out.
• Amount received for giving up valuable rights may amount to a capital receipt
and NOT ordinary income.
• It needs to be:
o Generally an inducement or ‘sign-on’ fees will be assessable income:
AAT Case 822, AAT Case 7422
o Generally a restriction will be capital since T will have given up a field
of activity that would have otherwise been open to him.
a restriction/giving up of a significant right: Taxation Ruling IT
2307
restrictive covenants: Higgs v Olivier [3.140], FCT v Woite
[3.170]
o Payments for alteration of rights: CoT (Vic) v Phillips, Bennett v FCT,
AAT Case 7752 are not always capital:
Phillips: assessable income
3
Bennett: capital
AAT Case 7752: capital
T was a rugby league footballer who was approached by officials responsible for
arranging the Super League. They had a meeting with T and agreed to a three
year contract of $225,000 per year. He was also given a $50,000 payment for
signing the contract.
Held:
T was a rugby league payer who signed a lucrative contract to play rugby in
Queensland. There was a $5000 payment to ensure the player remains in
Queensland.
Held:
4
Restrictive covenants: Higgs v Olivier [3.140], FCT v Woite [3.170]
Higgs v Olivier
Olivier (T) paid 15,000 pounds for agreeing not to appear, produce or direct any
other film for another 18 months – ie. agreed to a restrictive covenant.
Held:
Court accepted the argument that T gave up valuable rights and was a restriction
on his freedom to earn income. Payment was a capital receipt.
This was followed in Woite: if the player did move to Victoria (from SA), he would
go to North Melbourne – received $10k for this agreement
Woite v FCT
T was a South Australian footballer who won Magarey medal for Best and
Fairest. North Melbourne wanted him to play with them. He received $10,000
for signing an agreement with North Melbourne that IF he moved to Victoria, he
would only play for North Melbourne. He never did move to Victoria but was still
allowed to keep $10,000.
Held:
Payments for alteration of rights: CoT (Vic) v Phillips [3.210], Bennett v FCT
[3.220], AAT Case 7752 [3.230]
Held:
5
• Amount was assessable income
o Substitution principle states that the amount is of the same character to
the payment to which it replaces
o The fact that the payment was a monthly payment was also an
important factor
Bennett v FCT
T was managing director of radio station in which he was given full control. He
entered into a new contract on similar monetary terms but he now had less
control. He was given a lump sum for the amendment of the contract.
Held:
Held:
6
• No unrealized gains are taxed
• Only situation is accrued interest earned on term deposit yet to mature
• Must be a sufficient nexus between the receipt and an income earning activity
• The court has identified the following income earning activities:
o Provision of personal services → wages or receipts by contractors (active
income)
o Business Receipts → even one-off profit making schemes (active income)
o Use of property → rent, interest, dividends, royalties (passive income)
9. Compensation Receipts
• When payment includes loss of income AND loss of asset, and the two
components are “undissected,” the full payment will be deemed as a capital
receipt (Allsop v FCT). This only applied when a case settled pre-trial. If the
dispute proceeded to trial, the judge must determine the different components
as a matter of necessity.
Statutory Income
• Receipts are deemed as income because a provision in ITAA states they are
income
• Examples include:
o Employee allowances (s 26(e) ITAA 36)
o Profits from a profit-making scheme (s 15 -15 ITAA 97)
o Dividends (s 44 ITAA 36)
Summary
7
o Must be income earning activity
o Only monetary gains or gains convertible to money (now FBT)
o Does not include capital receipts (now CGT)
Payne v FCT
Employee who worked at KPMG and was required to travel. She joined frequent
flyer program. Whenever she booked a ticket, points accrued in her name.
Eventually she had enough points to book two return tickets to London in the
name of her parents.
Commissioner argued that the frequent flyer points were earned because of the
course of her employment.
She argued that she had a contractual relationship with QANTAS and that she
had paid for membership. Also, the points were merely incidental to the course
of her employment.
Held:
There was NOT a sufficient nexus between the benefit received (ie. frequent flyer
points) and the course of her employment. The frequent flyer points arose as a
8
‘consequence’ of the employment but not ‘because’ of the employment – not
sufficient.
• Section 26(e) ITAA 1936 includes the value to T of all allowances or benefits
given in respect of employment or services
o Allowance and benefits → monetary / non-monetary; convertible / non-
convertible
o In respect of employment or services (nb Payne and cf Cooke &
Sherden)
o The value to the T is subjective
• Largely overtaken by FBT but still has some operation
• Nb s6-10(3) → also subject to deemed receipt rule
• Designed to capture those benefits which are generally not considered
ordinary income because of non-convertibility.
• S21A tries to do the same as s26(e) in terms of business tax payers→ Cooke
& Sherden
• FBT was introduced in response to the failure of s26(e). The tax now
imposed on employer and the valuation rules are now objectively assessed.
• Some gifts and other windfalls from employers are certainly NOT income, eg
o Wedding gifts
o Birthday presents
• Payment where the payer had gone above and beyond their legal obligation
may be considered to assessable. Some “gifts” are a reward for services and
therefore income, eg. tips.
9
Dixon
Held:
T worked for company managed by Richardson, but also owned a few shares
himself. Richardson wanted to acquire control of the company and thus wanted
T to sell his shares in the company. Richardson told T that he would “get it back
to him one day.” In the years following, even though T was no longer an
employee, T gave ongoing advice as a friend. Years later, the company was
listed on the share market and Richardson gifted a portion of the returns to T.
Held:
Scott
10
T was a solicitor who had acted for Mrs Freestone and her late husband and
represented her in relation to administering his estate. He charged 895 pounds.
Just before estate settled, she gave T 10,000 pounds, saying that it was in
gratitude of his friendship and assistance. Commissioner was relying on ordinary
income provisions and s26(e).
Held:
Smith
Held:
Holmes
Owner of oil tanker engaged a company to salvage the tanker which had sunk.
Owner of tanker also paid members of the crew an extra reward. Owner agreed
before-hand that if tanker salvaged, then payment (including reward) would be
paid.
Held:
11
Brown
Held:
Prizes
Kelly
T was a footballer who received match payments in SANFL during 1978 from his
football club. T won the Channel 7 Sandover medal award and received
$20,000. Commissioner argued either ordinary income or s26(e).
Held:
Stone
12
from sponsors and grants from various bodies. She accepted that appearance
fees were ordinary income. She argued that some of the prizes she had
received during the year were NOT income. Commissioner argued that
competing in events in which you receive prizes necessarily involves provision of
services
Held:
• T was not in business and therefore amounts received are not income
o Person may pursue sports as a hobby as opposed to someone who
pursues sports in the form of a business.
o NOTE: High Court allowed commissioner’s appeal finding
amounts were income.
The fact T received sponsorship funds was decisive in court
finding that she was carrying on a business
UK Cases
Seymore v Reed
Moorhouse v Dooland
13
o If you have earned it, s 654 will apply.
• Section 66(1) FBTAA 1986 states that FBT is payable by the employer.
• Deemed receipt or constructive receipt rule under the Act deemed to have
the 20k as you have directed it.
• There are tax advantages in the employer making super contribution
Step 1
Definition
• ‘Fringe Benefit’ defined in 136(1) – general definitions section
o A benefit provided to employee or associate
o Provided during the year by employer or associate / third party of
employer
o Provided in respect of employment – sufficient and material connection
between the benefit provided and employment (J&G Knowles)
Knowles v FCT
Making of an interest free loan. The recipient of benefit was both an employee of
company and a shareholder. The commissioner argued that the benefit was
made in respect of employment and therefore subject to FBT.
Held:
14
• In the case of Smith, court held that it is not enough that there is some
connection, but must be sufficient and material connection between benefit
and services provided.
• In this case, court held that benefit was provided to employee in their role as
a shareholder of the company. The loan would not have been available to an
ordinary employee.
• FBT legislation identifies 11 particular benefits and tells you how to tax them.
• If benefit does not fall within divisions 1 – 11, it will be caught as a residual
benefit (div 12).
Held:
15
• A requirement that the recipient vouches for the cost would indicate a
reimbursement.
Exemptions
• Cars
o Statutory formula x Base Value x (Days of Private Use / 365)
o Log book method
• Loans
o Any difference between interest rate provided and the statutory interest
rate
o Loan amount x (Statutory Interest Rate – Interest Rate Provided)
o Statutory interest rate at 31 March 2005 is 7.05%
16
• Expense Payments
o Taxable value will just equal the exact amount of the reimbursement
o Eg. Employer paid airline ticket for $1000. The taxable value will be
$1000
• Property Benefits
o In-house fringe benefits → taxable value is 75% of the lowest price you
would sell to the public (s42)
o External fringe benefits → taxable value is the amount paid by the
employer for the benefit (s43)
• All of the employers taxable values are added together on all employees
fringe benefits
• Total of taxable values ‘grossed up’ to represent the amount that would have
been paid if they provided an after tax cash amount.
• Employer subject to tax at 48.5% of the grossed up taxable value
• Employer entitled to deduct pre-grossed up taxable value AND actual FBT
paid.
• Thus there is no incentive two pay between salaries & wages or fringe
benefits. The only advantage to fringe benefits is the concessional rules in
which certain benefits are exempt.
INCOME FROM BUSINESS
17
Is there a “business”?
Ferguson
Held:
Walker
Held:
Hypothetical
Is T carrying on a business?
18
Start by saying that if T is in business, any income is assessable and expenses
are deductible. If hobby not assessable or deductible.
Look to TR 97/11 for list of factors to see if carrying on a business or not. No one
factor is decisive. Must look at all factors and decide on a holistic approach.
FACTORS:
o Repetition
Volume of independent sales
o Size/scale
The larger the activity the more likely carrying on a business
However, can use Walker to support assertion that just because
small in size does not mean precluded from carrying on
business. If so, need evidence of planned expansion (Ferguson
and Walker)
Must also consider whether she has started a business YET?
Softwood Pulp and Paper case identifies person undertaking
feasibility studies to see if they would start business.
o Profit Motive
T should charge more than cost price
Just because there are sales does not necessarily mean there
is a profit making intention
o Majority of income
According to Stone, Ferguson and Walker, existence of other
employment did not preclude finding that they were in business.
If you conclude that she is carrying on a business MUST SAY that receipts are
assessable and expenses are deductible.
• Proceeds from a hobby are not AI, and expenses not deductible
Stone
19
• Once T receives sponsorship, they are considered in business and therefore
prizes and grants are deemed as assessable.
• Not all sportspersons will be held to be liable for tax → must receive
sponsorship
• This case isn’t too instructive as it turns on the facts
Trautwein v FCT
T was a punter who was successful over a long period in gambling and betting
on horse races. T also engaged in other business activities such as running a
hotel. T spent a considerable amount of time betting. T also involved in
breeding horses. There was no real system of organisation as he did not keep
accounting records. In the previous year T claimed deductions for gambling (so
obviously he thought it was a business). In the current year T had more winnings
than deductions and thus claimed gambling was his hobby.
Held:
Evans v FCT
T was a punter who was successful in betting on racehorses over a five year
period. T also owned racehorses but was not profitable for T.
Held:
Note: Courts tend to regard gambling as a matter of chance and not something
business like in nature. On other hand, something taking on a more business
like nature could not be said to be a hobby. For example, an actuary engaging in
futures trading.
20
Timing
Held:
FCT v Osborne
Held:
21
T was a business financing the purchase of goods under hire purchase
agreements. T was subject to investigations and ceased to operate in 1968.
Business allowed to recommence 16 months later. There was some
reorganization of the business. T tried to claim bad debts during the intervening
period.
Held:
• T had continued to carry on the same business and thus expenses deductible
o Break in years was relatively short
o Irrelevant that company changed name and address
o Nature of the company activities were exactly the same
o A continuation of company after termination is a question of fact to be
determined on a case-by-case basis
• Statutory income
o s 15-15 ITAA97
AI includes profits arising from a profit-making undertaking or
plan
Does not include:
• Profits assessable as ordinary income. If amount could
be ordinary income and profit income under s15-15, then
tax as ordinary income.
• Profits arising from sale of property acquired after
20/9/1985
o s 21A ITAA36
Non-cash business benefit that is not convertible to cash shall
be deemed convertible and accounted for at arm’s length value
Introduced because Cooke & Sherden (soft drink suppliers
received a business holiday from supplier and held s 26(e)
because T was carrying on a business
• Profits from isolated profit making ventures can be either ordinary income or
s15-15
22
Scottish Australian Mining Co Ltd v FCT
Note: this was Australian position before Whitford’s Beach which now applies
T was a mining company which operated a coal mine on land which it owned.
When the coal was exhausted in the mid 1920s, T decided the sell-off the land.
Due to the size of the land, T carried out an extensive subdivision and
development of the land. Commissioner argued T should be assessed on the
profits on the resale of the land because T was either carrying on a business of
land dev (ordinary income principles s6-5) or alternatively, profits made from
undertaking a plan (statutory income → at the time under s 26A, now s 15-15).
Held:
Held:
23
o Mason J critical of Scottish Mining by suggesting that land
development of that scale could not possibly be mere realization.
Possibly realization if on a small parcel of land. Extensive nature of
activity enough to classify the activity as a business.
o Look through the ‘corporate veil.’ The business was a different
business after 1967. Purpose of those acquiring the company was to
begin a business venture for profit making purposes.
o Profit could have been s 15-15, but since s15-15(2) states if potentially
both, ordinary income (s6-5) takes precedence.
o Overall principle is that if a T develops land itself, it is treated as having
commenced the business of land development.
o Court also looked at the ‘net gain’ as ordinary income and NOT gross
receipts. Unfair to look at gross receipts due to huge potential capital
appreciation since property acquired in 1954 and thus huge potential
profit and tax bill. Deduct cost of development and value of land at
acquisition, ie, 1967.
T was a company that won tender to do pipe coating work with SEC of Western
Australia. Contract stipulated that T would build factory near pipeline, which
would be reimbursed by SEC, but still belong to the taxpayer. Not considered a
gift or windfall because the building would be obsolete at the end of the contract.
Contract stated SEC would pay 15% of contract price up front, ie. $4 million to
build the factory. Commissioner argued upfront receipt was assessable. T
argued it was a capital receipt because the amount was intended for the
construction of the building.
Held:
24
T was a company which hired out scaffolding to the public. The leasing
transaction with customers included a fee for damaged or non-returned
equipment. Issue was whether these fees are income or capital.
Held:
• Sale of forklifts outside the scope of T’s business thus not ordinary income
o Distinguished GKN Kwikiform on the basis that profit in present case
was not inevitable, nor did it arise from leasing transaction itself
o Sale of forklifts was a sale of the very apparatus with which T
conducted business, and not a profit from the process by which T
operated to earn regular returns.
Held:
25
o Clearly not part of firm’s legal activities BUT moving to new premises
from time to time is a part of the firm’s business.
o Payment does relate to business structure BUT the partners exploited
the business structure for a profit making purpose thus ordinary
income.
Myer Emporium lent subsidiary Myer Finance $80m at 12.5% for 7.25 years.
Three days later Myer Emporium assigned the right to receive the interest to
Citicorp. Citicorp in exchange for that right paid a lump sum of $46.3 million.
Thus, for the next 7.25 years, Myer Finance would pay interest and then at the
end of contract they would pay lump sum of $80 million to Citicorp.
Motivations
Myer wanted to borrow money externally, but was restricted by debenture trust
deed which said that it could not borrow any more externally. Hence, set up
subsidiary Myer Finance. Citicorp was prepared to lend money to the group.
Citicorp was indifferent to who it got the interest from. $46.3 million was the NPV
of the $80 million loan discounted by 12.5%. Thus, Citicorp received no real
benefit in terms of return on its investment. However, Citicorp had accumulated
tax losses to off-set the interest revenue. The period of assignment had to be
more than 7 years, because anything less would trigger anti-avoidance
measures. Market rate of interest set so as to not be accused of tax avoidance.
Entering into transaction of this nature was not really in Myer’s ordinary course of
business as Myer was primarily a retail store. Myer also argued that it was a
capital receipt for assigning its rights to the loan. The commissioner argued that
it should still be considered as a business receipt even though it was an
extraordinary receipt.
Held:
• $46.3 million was ordinary income. Court revealed two strands of reasoning:
o Proceeds of a transaction outside the ordinary course of business will
be considered income if it is entered into with a profit making purpose.
However, if you take this rule, then EVERY transaction
entered into by a business will be profit making purpose
26
Criticism of Myer
• Court ruled ordinary income, even though could have been s 15-15. In exam
question, should mention that courts have favoured ordinary income over
s15-15, even though their tax treatment is the same
Westfield v FCT
Held:
• Profit derived was of a capital nature and thus NOT ordinary income
o It does not follow from Myer that every receipt by a business is income.
o The mode of profit making must be one of the considered alternatives
at time of entering into transaction – subjective intention
o T’s profit making purpose was to develop and manage a shopping
centre NOT to sell the land at a profit
o The sale is not in the ordinary course of business nor is it incidental.
27
Compensation Receipts
Held:
Heavy Minerals
Held:
Merv Brown
28
T was wholesaler of clothing made both within Australia and also imported
garments. T had quota rights on the sale of imported clothing. T decided to sell
those quota rights which were unprofitable and focus on those quota rights that
were profitable.
Held:
Held:
AGC Investments
T sold a significant portion of its share portfolio because it thought the market
was about to crash. Issue before the court was to characterize T’s purpose in
acquiring the shares. T argued that the shares were acquired on a long term
basis and thus were only realized in these exceptional circumstances, thus
should not be assessable.
Held:
• Profits from sale of shares are capital in nature and thus NOT assessable
o T did not acquire shares with intention of realizing a profit
o Distinguished this case from banking and finance cases
Summary
29
• Receipts in the ordinary course of business or incidental to it will be ordinary
income. Issue may be whether T is carrying on business
• Receipts outside the ordinary course of business may be income if there is a
sufficient profit-making purpose (OI or s 15-15) (Myer Emporium)
• Receipts from isolated profit-making ventures may be income (OI or s 15-15)
(Whitfords Beach)
• Receipts that compensate for loss of income will be income (eg Heavy
Minerals cf Calif Oil where it was to compensate for the loss of entire
business)
• Receipts from disposing of assets will be capital unless disposal is part of
business (eg London Australia Investments cf AGC)
Royalties
McCauley v FCT
T was a dairy farmer who owned land on which tree were growing. T entered
into contract to sell the right to cut and remove the timber trees growing on his
property. Contract stipulated that T would be paid 3 shillings for every 100 feet of
timber cut. Purchaser agreed to pay in monthly instalments based on the
amount of timber cut.
Held:
30
• The agreement was a general law (ordinary) royalty because payments were
made in direct relation to the quantity of timber cut and removed
• Even though it was OR, held to be capital in nature thus assessable under s
15-20 (formerly s26(f)).
Stanton v FCT
T was a grazier who sold the rights to cut and remove a set quantity of standing
timber on his land to a sawmiller for a fixed sum. Payments were made quarterly
by sawmiller and expressly stated NOT to be related to the removal of timber.
Held:
• The amounts paid to T were NOT an ordinary royalty because it was not
related to the amount of timber cut and removed from T’s land.
Hypothetical
31
CAPITAL GAINS TAX
Introduction
• If you don’t have personal use asset just check to see if collectable
o Definition important (s 108-10(2))
o Losses from collectables are quarantined against gains from
collectables (s108-10(1))
o Gains AND losses from collectables are disregarded if CB less than
$500 (s118-10(1))
32
o Total CGT exemption for some personal use assets or collectables
(s118-5)
Includes car, motor cycle or similar vehicle
CGT Event A1
Held:
33
o Work out which of the contracts is properly seen as the source of the
obligations to effect the disposal.
o This was the first contract that gave right to the obligation (SL argued
that the 2nd one was substantially different)
McDonald v FCT
• Clear practice in NSW to enter into sale of land with a written contract.
• It was appropriate to say that there was no disposal of land until Oct written
contract.
• Require clear evidence of intention to proceed if there is only an oral contract.
FCT v Orica
T (Orica – ICI) owed money under public debenture. T entered into debt
defeasance agreement with MMBW (government agency) to transfer the
obligations in exchange for $62m (PV of $98m debenture liability over term of 10
years). Orica included a historical cost profit amount of $36m. FCT wanted to
tax that amount as AI.
Issue here is that there is no ‘receipt’ of $36m. Orica is merely better off by
$36m. Commissioner wanted to tax $36m as AI but problem because there was
no ‘flow’ of money to pay the tax.
34
Held:
• T’s contractual right when entering into agreement with MMBW is a CGT
asset.
• CGT applied – the equivalent of CGT event C 2 applied because under
the arrangement the TP remained nominally liable to each of the
debenture holders – they simply assigned the interest.
• NOTE: Problem with this case is that every time someone performs
obligations under contract should not mean a CGT event. However, not
many cases since Orica where broad approach applied.
• When contractual rights discharged may be a CGT event
Collectables
A collectable is → s 108-10(2)
• Any other CGT asset used or kept mainly for personal use or
enjoyment, except land (s 108-20(2), (3))
• Capital gains disregarded if CB less than $10,000 (s118-10(3))
• Capital losses from personal use assets are disregarded (s108-20(1))
35
CGT Exemptions
36
o If posted overseas and renting out MR for example, provided that you
do not purchase another dwelling, you can still have it as MR even if
absent for a period of up to 6 years. Entitled to another period of 6
years each time dwelling becomes and ceases to be MR.
o If you don’t rent out property and don’t purchase a second dwelling,
doesn’t matter how long you are absent for
Rollovers
• Effect of death
o Disposal on death disregarded, ie. no tax liability → s 128 -10
o Beneficiary taken to acquire asset on date of death → s 128-15
o Rule:
o if the deceased acquired asset before Sept 1985 – then B’s cost
base is the market value on the date of death (effect of this is
that any gain that accrued up to the date of death is
disregarded)
o If the deceased acquired the asset after 1985 – then beneficiary
is taken to have acquired the asset on the date of death but at
the deceased’s cost base (deferral of the gain until B disposes
of it)
o S 118 – 195: part of main residence exception – if asset that
passes to B is deceased main residence then it will be exempt
in the hands of the B if either B lives in the property or it is sold
within two years of death
37
• Same asset rollovers: Div 126
o Marriage breakdown rollover (see s 126-5)
CGT event will occur if a transfer occurs between spouses
under an order of the family court
If wife transferring half share of land to husband, then no capital
gain or loss is recorded to transferor.
If post-1985 asset, transferee deemed to acquired asset at date
of settlement
If pre-1985 asset, transferee deemed to acquired asset at
original date acquired by transferor
If post-1985 asset, transferee deemed to acquire asset for the
existing CB at the date of settlement.
If pre-1985 asset, then entitled to still be pre-CGT asset.
• There will be a capital gain if the capital proceeds > cost base of the
asset
• There will be a capital loss if the capital proceeds < cost base of the
asset
• Includes:
o Money received; and
o Market value of property received
• Includes:
1. Money paid or market value of property given to acquire asset
2. Incidental costs on acquisition and disposal → s 110-35
Legal fees
Payments to professional advisors → valuers / auctioneers /
brokers
38
Transfer costs
Stamp duty
Advertising
3. Non-capital costs (non-deductible costs) of ownership
Interest or rates
But don’t include these costs if they are deductible
4. Cost of capital improvements made to property
5. Capital expenditure in respect of title
Court costs defending title
• “Reduced cost base” used when there appears to be a capital loss → s 110-
55
1. Do NOT include non-capital costs of ownership
2. Indexation does NOT apply to a reduced cost base
• A net capital loss is not offset against other income but may be carried
forward and offset against future CGs “quarantined” (s 102-15)
o May be carried forward indefinitely until a net gain is there to offset.
o Capital losses are thus quarantined.
39
2 Methods:
1. Discount method
2. Indexation method
If a gain could be both ordinary income and also a CGT, the non-CGT provision
takes priority (s 118-20) (“anti-overlap provision”)
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• Eg a property developer who sells property (business income, and
disposal of CGT asset) – profits will be ordinary business income, not
subject to CGT
The effect of CGT concessions is that capital gains are taxed at a lower effective
rate than ordinary income gains. Meant to encourage investment. The effect of
the 12 month holding rule is to encourage longer term capital investment. Truly
rich don’t pay as much since they generate most of their profits from capital
gains. Therefore, equity implications, since tax burden shouldered more heavily
by ordinary wage earners. Skews incentive for capital investments, thus
inefficiency distortions.
DEDUCTIONS
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2. Necessarily incurred in carrying on a business
Loss or Outgoing
T was a retail department store. As was usual practice, two of T’s employees
were on their way to the bank to deposit the previous day’s takings. Employees
were held up at gunpoint and monies were stolen. T was trying to claim a
deduction for monies lost
Held:
FCT v La Rosa
T was a convicted drug dealer. He buried $220,000 proceeds from a drug deal.
Someone came to his backyard and dug up the money and stole it.
Commissioner brought the case to court to try and assess the proceeds. T was
trying to claim a deduction for the loss. Commissioner tried to argue that there
was a public policy argument to not allow deduction for illegal activity.
Held:
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NOT laws in relation to income tax. Parliament can enact legislation if
they want to amend the law.
2. Nexus
Held:
T was a company that employed a new managing director. The new managing
director was not performing to expectation, thus T asked him to resign. They
negotiated a settlement of 2500 pounds. T tried to claim a deduction for the full
amount. Commissioner argued that this was not an expense in earning AI. T
argued that they needed to re-structure to improve efficiency.
Held:
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FCT v Snowden & Wilson
T was a building contractor who built speculative homes and sold them. T was
named in a Royal Commission as engaging in questionable conduct. T took out
an advertisement to counter adverse publicity. T also engaged a lawyer and
other professional services to gain advice regarding the royal commission. T
tried to claim a deduction for all expenses.
Held:
T borrowed money at commercial rate of interest and used the money to buy
shares in its wholly owned subsidiary AND provided an interest free loan to the
same wholly owned subsidiary. Commissioner contended the interest
component on the first commercial loan which relates to the interest-free loan
was not deductible because no nexus with earning AI. T argued the loan was
made to ensure that the subsidiary became profitable and thus earned greater
dividends for T.
Held:
• T was allowed the full deduction of commercial rate of interest on the first loan
o Court agreed with T’s argument that interest free loan intended to
make subsidiary profitable and thus earn increased dividend income
for T
o Deduction was an incidental and relevant to derivation of income
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a deduction for the interest on the first loan, by contending that it was incurred in
deriving dividend income from the subsidiary.
Held:
3. Incurred
T was obliged to pay employees 2 weeks annual leave a year. T was claiming a
deduction in the accounts even though no amount had been paid.
Held:
4. Timing Issues
FCT v Maddalena
Held:
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o Expenses were incurred ‘too soon’ to be regarded as incurred in
gaining AI.
o Expenses were capital in nature as they were incurred in gaining
employment.
o A taxpayer cannot obtain a deduction for expenses of gaining
employment.
o If a taxpayer’s employment is continuous with the one employer, legal
expenses incurred in negotiating subsequent contracts WILL BE
deductible.
Steele v FCT
T acquired property with borrowed funds and incurred interest expenses. T’s
intention was to always build a motel or town-houses. In the meantime she had
just purchased some horses and used the property for agistment purposes, for
which she earned a small amount of AI. After 6 years land was still sitting idle as
she was not able to form appropriate partnership to build hotel / townhouse
venture. T tried to claim deduction for interest over 6 years. Commissioner
contended no nexus between deduction and income. Commissioner also argued
interest expenses of a capital nature.
Held:
Held:
46
o NOTE: decision in this case criticised by Barwick J in AGC (Advances)
and effectively overturned in Placer Pacific
Placer Pacific
Held:
5. Apportionment
6. Taxpayer’s Purpose
• Is it relevant under s8-1 that T has a purpose other than gaining AI?
T was a company which sold shoes. T generally acquired trading stock from
wholesaler for a certain price. T entered into new arrangement by establishing
new company (B). B purchased shoes from wholesaler for that same price but
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then sold it to T at an inflated price. T established company B so as to claim
deductions. T sought to deduct the inflated price for tax purposes.
Commissioner argued that T should be restricted to the original price it should
have paid.
Held:
FCT v Phillips
T was an accounting partnership which set up a unit trust to takeover some of the
non-professional activities of partnership, ie. ownership of furniture and other
assets of the partnership. The partnership then hired back the assets from the
unit trust at a certain markup. The purpose of this arrangement was twofold;
Firstly, to protect assets of accounting firm from potential negligence claims.
Secondly, distribute profits of partnership to family members who were
beneficiaries of unit trust. Commissioner argued partnership should not be able
to deduct full amount of the leasing costs.
Held:
Two cases which went to Privy Council in 1972 and 1976. T was a NZ company
which entered into arrangement with a US company for the supply of oil. Oil
market heavily regulated. US company forced to supply oil at ‘posted price’. T
and US company jointly set up an intermediary in Bahamas, which was a tax
haven. US company sold and then repurchased oil from intermediary at a mark-
up, earning arbitrary profits for intermediary. US company able to sell oil to T at
‘posted price’ but effectively offered a discount to T due to profits from Bahamas.
T sought to claim deduction for the full regulated price.
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Held:
• In Europa Oil (No.1) deduction reduced by the discount obtained through the
arrangement.
o Privy Council adopted a substance over form approach
• In Europa Oil (No.2) full deduction was allowed
o Privy Council read down the ratio from earlier case by stating that an
examination of the reality (substance) of the arrangement only means
examination of the legal character of the arrangement
o T successfully argued that collateral advantages of profits from
intermediary should be ignored.
o Adopted Cecil Brothers decision
Ure v FCT
Held:
Fletcher v FCT
Held:
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o If revenue derived is greater than expenditure incurred, no reason to
examine purpose of T.
o Look to T’s purpose when deductions are greater than income for a
particular activity. If on looking to T’s purpose, that T was trying to
obtain a tax benefit as well as earning AI, T only entitled to claim a
portion of deduction.
o Court mentioned that if T had allowed scheme to run its full course
without termination, the deductions may not have been limited.
Hart v FCT
Financial institution was marketing a product called a ‘split loan’. There would be
two loans, one which related to place of residence and another that related to an
investment property. Loans linked, such that all repayments made would go to
repay the home loan since no deduction for home loan repayment. That meant
that interest payable on investment property would be capitalized and therefore T
required to pay compound interest on capitalized portion and thus incurred a
greater deduction. This issue in dispute is the compound interest component of
the deduction. Federal court held compound interest component was deductible
→ not necessary to look to purpose. Commissioner appealed.
Held:
• High Court did not have to decide whether compound interest component was
deductible because applied Part IVA anti-avoidance provisions NOT s8-1.
• Note: Look at this in more detail in ‘tax avoidance’ topic.
7. Substantiation
Negative Limbs
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Capital Expenses
• Food
Cooper
Handley
T was a barrister who tried to claim a deduction for a separate room in the house
as a home-office. Separate room made up 7% of total floor space. He wanted to
claim 10% of all house expenses, including interest on mortgage, rates,
insurance, heating, cleaning, etc.
Court said there are two different types of costs; holding costs and running costs.
Can only claim running costs, ie. heating, cooling, etc. Cannot claim holding
costs, ie. interest on mortgage, rates and insurance. T entitled to claim 7% of all
running costs on the house. Note: This may restrict CGT exemption on main
residence.
• Travel
T’s were employee and dentist respectively and sought to claim deduction from
home to place of work. Court held cost of commuting between home and work
was a non-deductible expense. Court said that where you lived is a matter of
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personal choice and T should bear cost of travel. Note: cost of travel between
places of work is deductible.
Payne
Court majority rejected claim because the two places of earning income were
unconnected. Note: Legislation was then enacted to allow deduction of travel
between two unconnected places of work. See p443 textbook for specific
provisions.
Lodge
T was a law clerk and stated that child minding expense was essential in allowing
her to earn AI.
Court disallowed claim. Child minding expenses are of a private nature. Rebate
would be more appropriate because of ‘up-side-down’ effect → someone on top
marginal rate, the value of a deduction for child minding would be more valuable.
• Self-education
Finn
T was an architect who went to Europe and claimed a deduction for visiting all
architectural sites of Europe.
Hatchett
T was a teacher and undertook a higher certificate course which allowed her to
be promoted within the Department of Education. At the same time, T completed
an Arts degree at University. T sought to claim deductions for both the higher
certificate and Arts degree.
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Court held that deduction allowed for higher certificate because allowed T to be
specifically promoted and earn higher AI. Deductions relating to Arts degree
NOT allowed because more vague and personal in nature. Note: General
principle that course related study expenses will be deductible if T can show it
helped them be promoted or earn higher AI.
Studdert
Court allowed the deductions. Held there was a sufficient connection because
lessons would make T more proficient in his job as a flight engineer and increase
chances for promotion. Note: Commissioner argued subsidiary purpose of T
regarding re-training as a pilot and thus should not be deductible (Fletcher).
Court dismissed this argument.
Para 14 & 15 make the point that if you are undertaking an undergraduate
degree, there is not a sufficient link with earning income. However, if undertaking
post-graduate degree, there could be a sufficient link with greater chance of
promotion, etc.
• Clothing, cosmetics
T claimed cost of dark suits worn underneath gown as a barrister. T argued that
she would never have worn the suits in her every day life. Court did not allow the
deduction. Court held it was ordinary clothing.
Edwards
Mansfield
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Morris
10 taxpayers in this case who all claimed deduction for sun protection items such
as hats, sunglasses and sunscreen. Court allowed the deduction. There was a
sufficient nexus because all T’s required to work outdoors to earn AI.
• Repairs → s25-10
• Tax Losses → Div 36
Repairs
• What is a Repair?
Thomas
Lindsay
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• Repair v improvement
Thomas – Repair
o Held
This was clearly an improvement – new material had been used
– so not repair
Can only claim deduction for actual expenditure, not some
amount that you would have spent in repairing it – no deduction
for notional repairs
Even though can show quote of 600 – it wasn’t actual
expenditure
Expenditure was capital (have to be treated as part of cost of
that building)
• Initial Repairs
o If item requires repairs before the item can be used, the ‘initial repair’
costs become capital cost of acquisition and thus not a deduction.
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o If T has choice to either repair or replace an item and decides to
replace the item in its entirety, T is not allowed to claim a deduction for
the notional cost that would have been paid to merely repair it.
Tax Losses
Restrictions on Deductions
• If you can deduct an amount for a payment that you make to a related entity –
can only deduct so much as the commissioner considers reasonable (so can’t
pay a related entity twice what you would pay normally)
• Who is a related entity?
o Including a relative → spouses, de facto spouses, children, parents,
etc
o Corporate partnerships
• Deduction only allowed to the extent reasonable by the Commissioner
• Not a prohibition on deduction, but merely a restriction
• Market or commercial rates are generally considered ‘reasonable’
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Stewart v FCT
T was the wife of a doctor. Doctor was in a three person medical partnership.
Each partner was paying a sum of money to their wives for answering the phone
out of hours. In return for that service, they were paid $2000 per year.
Commissioner decided this was not reasonable and only allowed $1000
deduction per year. T argued that if look at commercial rates, if someone on-call
24 hours a day, then $40 per week is reasonable.
Held:
Entertainment Expenses
• Since 1985 no deduction for entertainment expense to the extent that it is for
food, drink, recreation, accommodation or travel → s 32-5
Summary
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• Loss or outgoing deductible if sufficient nexus with earning income (s8-1)
• Note: incurred, timing, apportionment, purpose
• No deduction for private/domestic expenses
• No immediate deduction for capital expenses (see week 9)
• Expense may be deductible under specific provisions
• May be a restriction on deducting certain expenses
CAPITAL EXPENSES
Held:
Application of test:
58
• Not recurrent, ie. it was a lump sum
• Chief purpose was to maintain current business structure in earning income
• Dixon J held that it was a capital expense
Held:
Held:
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T paid concession fees to state government for the right to operate the City Link
Toll Road. The payment was semi-annual for a fixed period of time. Issue more
complicated because of the structure of the payments. Fees were to be satisfied
by ‘concession notes’ which could vary. No actual payments had to be made by
T until 2034. Issue as to whether an expense was actually incurred (not dealt
with in this course). Commissioner argued that the payment was for T’s
monopoly right over particular aspect of transport system and thus should be
capital.
Held:
• Full Federal court held fees were current and thus deductible. Payments
were particularly for the right to operate the tollway and receive income from
it.
• NOTE: Case is on appeal in High Court
Held:
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Commissioner doesn’t like these kinds of products. Commissioner believes they
are not really an investment expense because investor is protected against any
downside. Therefore only a part of the expense is incurred in earning income
and part of the interest is a capital expense incurred in protecting capital.
Held:
T owned some plant and machinery. T entered into arrangement with a financier
whereby T sold the plant to financier and then leased it back. Normally lease
costs would be deductible as ongoing recurrent expense. Previously because he
owned the plant and equipment, T was only able to depreciate. Lease payments
more than depreciation deduction. The arrangement stipulated that T was
entitled to purchase back the plant and machinery at the end of the lease, ie.
standard hire purchase arrangement.
Commissioner argued that payments were partly deductible and also partly a
payment to re-acquire the plant. Commissioner also argued this was an anti-
avoidance arrangement.
Held:
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o Will the expense produce an enduring benefit (last beyond the current
year)?
o Is it an expense that is likely to be ongoing?
o Is the payment by lump sum or by regular payments?
Section 40-880
• Certain expenses can now be deductible over a 5 year period, ie. expenditure
o To establish the business structure
o To re-structure the business
o To raise equity for the business
o To defend against a takeover
o To make a takeover bid that is unsuccessful
• A successful takeover bid on another company will be capital and form part of
the CB on the company and recognised upon disposal.
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The Uniform Capital Allowance Regime
Depreciating Assets
• Asset with a limited effective life and can reasonably be expected to decline in
value: s40-30 (note: asset has ordinary meaning, ie. property)
• But not if:
o Land
o Trading stock
o Intangible assets (except as listed → can depreciate intellectual
property)
T built a special purpose factory for the woolen mill. T argued that walls were not
really ‘walls’, ceiling not really ‘ceiling’ because they had been built with
specialized equipment fitted in. They all had special purposes and therefore
‘plant and equipment.’
Held:
• Court allowed the depreciation of the walls and ceiling as ‘plant and
equipment’
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o The interior walls and ceiling were used as integral part of the
production process. Only the exterior walls were disallowed from
depreciation.
o NOTE: The facts of this case quite exceptional. Generally accepted
structures are not ‘plant’ if they merely provide shelter to workers and
machinery.
• General rule is that the legal owner of asset can claim depreciation → s 40-
40.
• Where asset is leased, the lessor is entitled to claim the deduction→ Item 10
• Where asset subject to hire-purchase arrangement, the lessee is entitled to
claim the deduction → item 5
• Where item is subject to a lease and is fixed to land, the lessor is entitled to
claim deduction where the right to recover the fixture exists → item 4
• Spreading cost
o Diminishing cost method → s 40-70
Gives rise to higher deduction initially and then lower deductions
as term of life goes on
Deduct at 150% divided by the life of asset
Eg. 100,000 x (150% / 5 years) = $30,000
70,000 x (150% / 5 years) = $21,000
Other Provisions
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o Commissioner allows everyone (business and non-business
taxpayers) to claim immediate deduction for costs less than $100
• Asset which cost less than $1000 (but more than $300) can all be added
together into low value pool and written off using diminishing value method
over 4 years (?) → Div 40-E
• S 118-24 states that capital gain or capital loss from a depreciating asset is
disregarded for CGT purposes
• S 40-25 states can deduct decline in value but only to the extent that it used
for a taxable purpose. The extent used for private purposes may be subject
to CGT
TAX AVOIDANCE
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• Tax planning is minimising tax to the extent legally possible and commercially
practical
Legitimate course action to minimize tax
• Tax avoidance is taking steps to reduce tax where the sole or dominant
purpose it to obtain a tax benefit.
o Technically correct according to tax legislation
o Not criminal but not in the spirit of the law
Duke employed a large personal staff to run country estate. He was paying them
salary and wages – purely domestic expenses thus not deductible. Entered into
arrangement with employees to pay a fixed amount for seven years in the form of
an annuity. Under UK law those payments were deductible. Inland Revenue
Commission argued that they were effectively salary and should treat them as
non-deductible.
Held:
• Court had to decide whether they were going to look to the substance of the
arrangement or alternatively the legal form of the arrangement.
• Court decided to look to the ‘form’ of the arrangement and therefore
allowed deduction
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Held:
o Where deductions from business activity > income from that business
activity deemed to be ‘non-commercial’
o Applies only to individual taxpayers who also carry on business
operations
o Can only offset expenses from business activity against income from
that activity. Cannot offset against other AI. Any excess deductions
are quarantined and can be deducted in subsequent years → s 35-
10(2)
o Quarantining provision will NOT apply if T falls into one of the
exceptions:
Other assets (apart from real property) have total value >
$100,000 → s 35-45(1)
67
• Note also cases of Ure and Fletcher where court looked to the purpose of T
and denied / apportioned deduction because of it
• Applies if:
1. Scheme entered into after 27 May 1981 (including outside Aust.) → s
177A
2. T obtained tax benefit → s 177C
3. Scheme was for the purpose of obtaining the tax benefit → s 177D
1. ‘Scheme’
o Any arrangement, scheme, plan, proposal or course of action →
s177A(1)
o Includes a unilateral scheme, plan, proposal or course of action →
s177A(3)
o Issue as to how you identify what comprises a scheme: Peabody and
Hart
o Generally not very difficult to satisfy this element. Almost anything can
be characterized as a scheme.
2. ‘Tax Benefit’
o Includes an amount not being included in AI if an amount would have
been included, or might reasonably be expected to have been
included: s177C(1)(a), also;
Reasonable expectation/hypothesis test
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Commissioner must show what would have happened if scheme
was not entered into → counter-factual difficult to prove
o Deduction being allowed → s177C(1)(b)
o Capital loss being incurred → s177C(ba)
o Franking credit trading schemes: s177EA
o Just need to identify whether there has been a gain in deduction or
reduction of AI
3. Relevant Purpose
o Did any person enter into the scheme for the purpose of enabling T to
obtain the benefit?
o Most important consideration in general anti-avoidance provision
o If more than one purpose, must be the dominant purpose →
s177A(5)
o Must be either sole or dominant purpose, determined by looking
at 8 matters in s177D → relate to ‘form and substance’ and
‘financial effect’
Financial institution was marketing a product called a ‘split loan’. There would be
two loans, one which related to place of residence and another that related to an
investment property. Loans linked, such that all repayments made would go to
repay the home loan since no deduction for home loan repayment. That meant
that interest payable on investment property would be capitalized and therefore T
required to pay compound interest on capitalized portion and thus incurred a
greater deduction. This issue in dispute is the compound interest component of
the deduction. Federal court held compound interest component was deductible
→ not necessary to look to purpose. Commissioner appealed.
Held:
• Part IVA Applied → didn’t need to consider whether deductible under s8-1
• Tax benefit obtained was the interest paid on the capitalized interest
component
• NOTE: Three different judgments in relation to what constitutes a scheme.
Gummow and Hayne JJ allowed an extremely wide interpretation, by enabling
commissioner to rely on a broad scheme OR even a narrow scheme OR both
to identify a relevant tax benefit.
o Broad scheme → all steps leading up to and implementing loan
arrangements
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o Narrow scheme → ‘wealth maximiser option’ on loan allowing
payments to be made on one of the properties thereby enabling
interest to be capitalized on the other loan
Held:
• Commissioner lost because he sued the wrong T. He should have gone after
the trust NOT the beneficiary Mrs Peabody.
• Court still discussed the issue of ‘scheme’ itself
o Extremely wide interpretation of ‘scheme’
o Commissioner is allowed to have a broad interpretation of scheme, or
in the alternative can potentially narrow the focus of the scheme, ie.
the idea of scheme within a scheme
o If scheme was just the conversion of the shares, then much easier to
say dominant purpose was tax benefit. However, looking to the
arrangement as a whole, ie. business wanting to float, had to buy
shares, required to pay tax, etc, then appears to be very much more
commercial in nature.
• Tax benefit
o Commissioner had to present ‘reasonable hypothesis test’
o Present a counter-factual such that must show what might reasonably
be expected if the scheme had not been carried out, which would give
rise to NO tax benefit
T had $40 million to invest. Chose to invest in Cook Islands. The interest rate in
Cook Islands was 4% lower than in Australia but still invested there because they
didn’t have to pay much tax in Cook Islands. Thus T obtained a tax benefit. The
main issue in this case was to determine the relevant purpose of the
transaction. Federal court held that it was a sound commercial arrangement, the
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dominant purpose of which was to maximize returns on money invested after
payment of all applicable costs and tax. Commissioner appealed to High Court.
Held:
T owned some plant and machinery. T entered into arrangement with a financier
whereby T sold the plant to financier and then leased it back. Normally lease
costs would be deductible as ongoing recurrent expense. Previously because he
owned the plant and equipment, T was only able to depreciate. Lease payments
more than depreciation deduction. The arrangement stipulated that T was
entitled to purchase back the plant and machinery at the end of the lease, ie.
standard hire purchase arrangement. Commissioner argued that payments were
partly deductible and also partly a payment to re-acquire the plant.
Commissioner also argued Part IVA.
Held:
• An individual tax payer who engages in a scheme to obtain a tax benefit may
still be subject to Part IVA even if he was unaware of the possibility of the
benefit tax, which tax advisor had made him aware of.
• Overcomes the subjective assessment of intention of T
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Consequences for Breach Part IVA
• Penalties according to s 284C Tax Administration Act 1953 (see p699 TB)
• 50% of amount of tax avoided; or
• 25% if ‘reasonably arguable position’
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