Income: According To Ordinary Concepts and Statutory Income. Income According

Part
2
Income
The first step in the taxation process is to determine assessable income.

“Income” is a complex and difficult concept to understand. From an
income tax perspective, assessable income is divided into income
according to ordinary concepts and statutory income. Income according
to ordinary concepts has been developed by the courts. A receipt is likely
to be considered income when it is a product of, yet severable from, a
source such as labour (or services), business or property. In addition to
this basic principle, a receipt which has income characteristics, such as
being periodic, expected and used for ordinary living expenses, can in
some instances be considered to be ordinary income even when it is not
Copyright © 2020. Thomson Reuters (Professional) Australia Pty Limited. All rights reserved.
a product of labour, business or property. Further, the courts have always

held that a receipt must be a genuine gain and be money or convertible to
money to be ordinary income.
Many receipts will be ordinary income which is assessable income under

Div 6 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997). However,
over the years, it became apparent that not all receipts which should be
taxable were included as ordinary income. The judicial concept of income,
first adopted in Australia when federal income tax was introduced in 1915,
provided a narrow tax base with opportunities to shift receipts outside
this judicial concept of ordinary income. Accordingly, a second category
of income developed, statutory income, which shifts many types of gains
and receipts into the income tax base.
Assessable Ordinary Statutory Exempt

income = income + income − income
(s  6-1) (s  6-5) (s  6-10) (s  6-10)
Sadiq, E. A. (2020). Principles of taxation law 2021. ProQuest Ebook Central <a
onclick=window.open('http://ebookcentral.proquest.com','_blank') href='http://ebookcentral.proquest.com' target='_blank' style='cursor: pointer;'>http://ebookcentral.pro
Created from unimelb on 2021-07-18 00:03:47.
112 PRINCIPLES OF TAXATION LAW 2021
Traditionally, income has been categorised according to the source to

which it attaches, that is, the receipt is a product of labour, business
or property. Because this has been the traditional approach to looking
at receipts, the common law has developed along these lines with
the statutory regime, then broadening the tax base of each category.
However, propositions which have developed to determine whether an
amount is ordinary income are not unique to income from any particular
category. As such, the first chapter in Part 2, Chapter 5, is an introduction
to ordinary income. It outlines the principles which apply to determine the
types of gains that courts of law consider to be of an income character
and, in doing so, considers the general propositions for ordinary income.
Chapter 6 specifically covers income from personal services and

employment. An examination of the general propositions developed by the
courts, discussed in Chapter 6, demonstrates that it is easy to manipulate
the ordinary income category by receiving benefits rather than salary
or wages. To counter this behaviour, certain types of statutory income
categories were introduced. The most significant category in relation to
labour is allowances in respect of employment or services in s 15-2 of
the ITAA 1997. Unfortunately, the statutory provisions have had limited
success in taxing benefits received as a result of labour. Consequently,
fringe benefits tax was introduced in 1986.
Chapter 7 follows on from the discussion on income from personal

services and employment to consider the fringe benefits tax regime. The
key difference and unique feature of this regime, which is separate to the
income tax regime, is that while the employee receives the benefit, it is
the employer who pays the tax. Chapter 7 explains the operation of this
regime, including a discussion of the various categories of benefits and
the concessions or exemptions available for certain benefits.
While the ordinary income concepts are generally no different, the

source of the receipt introduces unique issues. In relation to income from
business, the question that needs to be asked is: “What is a business for
taxation purposes?” Chapter 8 details the indicia of a business established
by the courts. A finding of the existence of a business is not sufficient to
conclude that all receipts are assessable income. It is also necessary to
consider whether the receipts arise as a result of activities within the scope
of the business and to what extent isolated and extraordinary transactions
are assessable. A third category of income, known as income from
property, or passive income, also introduces unique issues. Chapter 9
details income from property, explaining the principles that apply to
income from interest, dividends, leases, royalties and annuities.
Part 2: Income 113
Taxpayers may receive various types of compensation payments. If the

compensation is for loss of income, then generally the compensation
payments themselves will be of an income character. Chapter 10
considers the different categories of compensation which may substitute
for loss of income from labour, loss of income from business and loss of
income from property.
Although both statutory income and ordinary income are included in

assessable income, the rules for some types of statutory income are
concessional relative to those applying to ordinary income and it thus
remains very important to determine whether a receipt is assessable as
ordinary income or statutory income and, if the latter, which provision
brings the receipt into assessable income. The most important statutory
income measures are the “capital gains tax” rules which were adopted
in 1985 to sweep up a wide range of receipts that had not been captured
by the ordinary income concept or previously adopted statutory rules.
Because of the broad coverage of the capital gains rules and their operation
as a code within the broader income tax Act, these rules are often studied
independently from other types of income which fall on either side of
the ordinary income/capital gains borderline and, accordingly, Chapter 11
looks at these rules separately.
Amounts that do not fall within the ordinary income or statutory income
provisions are either exempt income or non- assessable non-
exempt
income. These amounts do not form part of the taxpayer’s assessable
income and are therefore not subject to tax. It is, however, necessary to
distinguish between the two due to other tax consequences.
5
Assessable income
Key points...................................................................................................... [5.00]
Introduction.................................................................................................. [5.10]
Ordinary income –general........................................................................... [5.20]
“In accordance with ordinary concepts and usages of mankind”....... [5.20]
Three categories of income................................................................... [5.30]
Capital gains are not ordinary income.................................................. [5.40]
Prerequisites and characteristics of ordinary income............................... [5.50]
Prerequisites........................................................................................... [5.50]
Cash or cash convertible........................................................................... [5.60]
Real gain..................................................................................................... [5.70]
Characteristics........................................................................................ [5.80]
Regular/periodic......................................................................................... [5.90]
Flow.......................................................................................................... [5.100]
Examples.................................................................................................. [5.120]
Some gains are ordinary income despite having no
earnings source............................................................................ [5.130]
Other general principles............................................................................. [5.140]
Compensation takes on the character of the loss being
compensated................................................................................ [5.140]
Unrealised gains are not ordinary income.......................................... [5.145]
Legality of receipts does not affect their assessability....................... [5.150]
Whether a receipt is ordinary income is to be characterised in the
taxpayer’s hands........................................................................... [5.155]
Constructive receipt............................................................................. [5.160]
Benefit that saves taxpayer from incurring expenditure is not
ordinary income............................................................................ [5.165]
Principle of “mutuality”........................................................................ [5.170]
Questions..................................................................................................... [5.180]

116 [5.00] PRINCIPLES OF TAXATION LAW 2021
Key points
[5.00]
• Gains that are ordinary income will be assessable income under s 6-5
of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997).
• Gains will be ordinary income if they are the type of gains that courts
of law consider to be of an income character.
• For a gain to be ordinary income, it must be cash or cash convertible,
as well as a genuine gain.
• A gain that comes in regularly/periodically is more likely to be ordinary
income than a lump-sum gain.
• A gain that flows from an earnings source is likely to be ordinary
income.
• Compensation takes the form of the loss being compensated.
• Whether or not a gain arises from an illegal activity does not affect
whether it is ordinary income.
Introduction
[5.10] As discussed in Chapter 1, assessable income includes gains that are
ordinary income and/or statutory income. This means that if a gain is ordinary
income it will be assessable income except if the legislation explicitly states
that it is not assessable.
What if a gain is not ordinary income: will it be assessable? If a gain is not

ordinary income, then it will only be assessable if it is statutory income, that is

only if it comes under one or more specific statutory provisions of the Income
Tax Assessment Act 1997 (Cth) (ITAA 1997) or the Income Tax Assessment Act
1936 (Cth) (ITAA 1936) and provided the legislation does not specifically state
that it is not assessable.
So what is ordinary income? According to s 6-5(1) of the ITAA 1997, ordinary

income is “income according to ordinary concepts”. This means that a gain
that is regarded by courts as being of an income character will be “ordinary
income” and, as such, assessable under s 6-5.
This raises the question as to when courts will regard gains as being of an
income character. To determine which gains have an income character, courts
have developed a range of rules and guidelines, some of which are vague
and not always consistently applied. Some gains are clearly of an income
character and so will constitute ordinary income (such as a salary received by
an employee). Some gains are clearly not of an income character and so will
not be ordinary income (such as the capital proceeds from the sale of a milk
Ordinary income –general
“In accordance with ordinary concepts and usages of
mankind”
[5.20] In discussing what gains are of an income character (and, as a
consequence, are ordinary income) in Scott v Commissioner of Taxation (1935)
35 SR (NSW) 215 at 219; 52 WN (NSW) 44; 3 ATD 142, Jordan CJ said:
The word “income” is not a term of art, and what forms of receipts are comprehended
within it, and what principles are to be applied to ascertain how much of those
receipts ought to be treated as income, must be determined in accordance with the
ordinary concepts and usages of mankind …
What his Honour appears to be saying is that the Court’s definition of income
resembles what most ordinary people would regard as income. While this
concept may have derived originally from trust law (see [1.160]), it nevertheless
approximately aligns with the contemporary tax law meaning of income. For
instance, most people would regard salaries and rent as income, and these gains
are also recognised by courts as being of an income character. On the other
hand, most people would intuitively regard a personal gift or a lottery winning
as not constituting income. This conclusion is also consistent with the fact that
courts do not consider such gains as being of an income character. Because the
ordinary meaning of income to the layperson may change over time, the scope
of ordinary income for tax purposes will also evolve, as is discussed at [5.80].
While it is useful to keep in mind that the courts’ idea of income resembles
what many people intuitively regard as income, ultimately the law as to what is
ordinary income is determined by case law.
As seen from Figure 5.1, income is shown to have two essential prerequisites

and two characteristics (discussed later in this chapter). These four elements
are key to determining whether a receipt is income or not. It is also helpful to
categorise income into three broad areas as shown in Figure 5.1.
Three categories of income

[5.30] Income is commonly categorised into three broad areas:
• income from personal services and employment (eg, salary): see
Chapter 6;
• income from business (eg, accounting firms selling accounting
services): see Chapter 8; or
• income from property (eg, rent and dividends): see Chapter 9.
However, as discussed at [5.130], there are some relatively rare instances,
where receipts will be ordinary income despite not belonging in any of these
three categories.
5: Assessable income [5.60] 119
Capital gains are not ordinary income

[5.40] Courts have made a distinction between gains that are capital and
income (see [1.160]–[1.170]). This means that gains that are capital will not
be ordinary income and gains that are ordinary income cannot be capital. It is
possible in some limited circumstances for a gain that is not capital to also not
be ordinary income either. So, in this context, gains can be thought of as falling
into one of three categories:
• ordinary income;
• capital; or
• not capital and not ordinary income.
The distinction between capital and income is a central issue in the application
of the Australian income tax legislation as it is relevant to both the question
of the assessability of receipts and the deduction of expenses (see [12.160]–
[12.210]). In relation to assessable income, the distinction between capital and
income is often considered through the application of the “flow concept”: see
[5.100].
Prerequisites and characteristics of

ordinary income
Prerequisites
[5.50] For a gain to be ordinary income, it must fulfil two prerequisites

(Figure 5.1). These prerequisites are necessary but not sufficient for a gain
to be ordinary income. In other words, if a gain fulfils both prerequisites,
then that gain might or might not be ordinary income. But if a gain does not
fulfil both prerequisites, then it cannot be ordinary income. The two essential
prerequisites of a receipt being ordinary income are that it is:
• cash or convertible to cash; and
• a real gain to the taxpayer.
Cash or cash convertible

[5.60] If a gain is cash or cash convertible, it might be ordinary income. On
the other hand, if it is not cash or cash convertible, then it definitely will not be
ordinary income: FCT v Cooke and Sherden (1980) 10 ATR 696.
For an item to be cash convertible, it needs to be readily convertible to cash.

So a new or used car, real estate or even a transferrable holiday ticket would
all be regarded as cash convertible. However, the courts have indicated that if
it is illegal to sell a good, then receipt of that good cannot be regarded as cash
convertible: Payne v FCT (1996) 32 ATR 516. In practical terms, this means
that for most taxpayers, a receipt of cigarettes would not be regarded as cash
convertible because it is illegal to sell cigarettes without a licence.
Case study 5.1: Receipt of free accommodation was not income

In the UK case of Tennant v Smith [1892] AC 150, the taxpayer was an
agent for a bank and lived in free accommodation supplied by the bank.
The taxpayer was not allowed to sublet the accommodation.
The House of Lords held that the accommodation was not regarded as
income
as it was neither cash nor cash-convertible.
Case study 5.2: Receipt of non-cash-convertible holiday was not

ordinary income
In the Australian case of FCT v Cooke and Sherden (1980) 10 ATR 696,
a few taxpayers sold drinks “door to door”. These taxpayers received a
free holiday from the soft drink manufacturer due to them selling a certain
number of soft drinks. The holidays were non-transferrable and therefore
could not be sold.
The Full Federal Court followed the principle in the case of Tennant v
Smith [1892] AC 150 and held that because the holidays were not cash
convertible,
they were not ordinary income.
As discussed at [8.160], s 21A of the ITAA 1936 deems non-cash business

benefits as being cash-convertible. This means that for a business taxpayer
benefits can be assessable income despite not being cash or cash-convertible.
Had the case of FCT v Cooke and Sherden been decided after s 21A of the
ITAA 1936 was introduced into the legislation, then it is very likely that the
Court would have decided that the free holiday was assessable as this section
would deem it to be convertible to cash. It is important to note that s 21A does
not deem the non-cash receipt to be income, but rather it deems the benefit to
have a cash value so that it satisfies the prerequisite that ordinary income must
be cash or convertible to cash. This is in contrast to statutory income which
specifically makes certain receipts assessable income through a provision of
the Act (see [5.10]).
Real gain
[5.70] If a receipt is a genuine gain (ie, the taxpayer is better off financially),
then it could be ordinary income. But if it is not a real gain, it will not be
ordinary income: Hochstrasser v Mayes [1960] AC 376 (see Case Study [5.3]).
The principle that a receipt that is not a real gain will not be ordinary income is
more likely to apply in employment situations and clubs (see [5.170]) than in
other situations.
In an employment situation, the courts will usually only label a receipt as not
being a real gain when the receipt is related to an employment-related expense.
For instance, if an employee incurred work-related public transport expenses
and that expense is then reimbursed, this would not be regarded as a real
gain because the employee has only been compensated for a work-related
expense. The employee has effectively only been reimbursed for an expense
they incurred on behalf of the employer. In contrast, an employee who is
reimbursed for his or her private holiday would be regarded as receiving a
real gain as he or she has effectively been provided a benefit over and above
their wage.
It is also important to note that an employee that has been given a predetermined
amount for a specific work-related purpose and does not have to return the
unspent amount will be regarded as having received an “allowance” rather
than a “reimbursement”. Unlike work- related reimbursements, allowances
will generally constitute ordinary income, though an offsetting deduction will
be allowed to the extent that money has been spent for allowable income-
producing purposes. For example, a taxpayer who receives $150 from his
employer for travel purposes but ends up only spending $60 of it and is allowed
to keep the rest will be assessable on the $150 allowance and will be able to
deduct the $60 expenses (see Chapter 12).
Case study 5.3: Reimbursement for work-related loss upon moving

premises was not assessable
In Hochstrasser v Mayes [1960] AC 376, the taxpayer’s employer required
him to move cities. The taxpayer sold his house in the city he was
relocating from. The house was sold by the taxpayer for less than the
price for which he had purchased it. The taxpayer’s employer reimbursed
him for the loss from selling his house.
The House of Lords held that this payment was not assessable. One of the
judges, Lord Denning, said that the payment was not assessable because
it was not a real gain because the taxpayer had been compensated for
a work- related expense. Lord Denning also mentioned that had the
taxpayer been compensated for a non- work-
related loss, the receipt
would have been a real gain. He gave an example that if a taxpayer’s
employer compensated him for share market-related losses, then this
receipt would be a real gain because in this example the taxpayer would
have
been compensated for a non-work-related loss.
Characteristics
[5.80] Provided both of the prerequisites of income are satisfied, a receipt or
benefit will be ordinary income if it also shows sufficient of the characteristics
of income (Figure 5.1). However, these characteristics are not black or white
rules; they are only indicators or pointers to what constitutes ordinary income.
This has increasingly been the case in recent decades as courts take a wider
view of what gains are regarded as ordinary income. The widening of courts’
views has been influenced by the fact that society now regards certain gains
as normal due to the fact that individuals and businesses operate differently
to how they did several decades ago. For example, under the first strand in
FCT v Myer Emporium Ltd (1987) 163 CLR 199 (see [8.210]–[8.250]), a gain can
be ordinary income even when it does not fulfil the characteristics described
at [5.90]–[5.110]. The characteristics of income can be grouped into two
broad areas:
• regular/periodical receipts; or
• the flow concept.
Regular/periodic
[5.90] All other things being constant, a gain that is regular or periodic is
more likely to be ordinary income than a gain that is received as a once-off
lump sum amount. For instance, the cases of FCT v Blake (1984) 15 ATR 1006
and FCT v Harris (1980) 10 ATR 869 (see [6.50]) involved near identical facts –
except that in FCT v Blake the receipt was regular while in FCT v Harris it was
regarded as a one-off receipt. Consequently, in FCT v Blake, the Court held that
the receipt was of an income nature, whereas in FCT v Harris, the Court held
that the one-off receipt was not ordinary income but capital.
However, the regularity of a receipt is not a determinative factor in deciding if

a gain is ordinary income. For example, in Premier Automatic Ticket Issuers
v FCT (1933) 50 CLR 268, a lump sum was held to be ordinary income. It is
easy to think of many everyday instances of lump-sum gains being ordinary
income. For instance, a one-off receipt of interest under a loan agreement
which provides for one interest payment at the end of the loan term would
be ordinary income. Another example is someone who receives one single
payment under a contract to do a one-off job.
Less common but still possible is for a gain to be regular but not ordinary
income, such as where a taxpayer receives instalments for the sale of a capital
asset: Foley v Fletcher [1843–1860] All ER Rep 953. For example, if the taxpayer
(not a property developer) sells a block of land for $200,000 (capital sale) for
10 equal payments of $20,000, paid over the next 10 years, then these receipts
will remain capital and not be ordinary income even though the receipts are
regular. This is because each $20,000 receipt is a part payment for the sale of
the capital asset.
Flow
[5.100] When courts developed the judicial concept of what is and what is not
of an income character, they borrowed concepts from trust law: see [1.160].
Under trust law, trust property may have income gains or capital gains. The
two were mutually exclusive; a gain could not be both an income gain and a
capital gain. To decide which trust gains were income and which were capital,
the courts used a “flow” concept. The courts stated that income “flowed” from
the capital. For example, if the trust property was a house, the rent “flowed”
from the house. This meant that for trust purposes, the rent from an investment
property was considered income, and appreciation of the value of the house
was regarded as capital. To use another example, if the trust property was
shares, then dividends flowing from the shares were income, but profit from
selling the shares was usually capital.
Tax law has used the same “flow” principle as trust law. Consequently, under
tax law, rent from an investment property is income, but profit from the
property’s increase in value is usually capital and not ordinary income.
This concept of “flow” is articulated in a paragraph from the US judgment

Eisner v Macomber 252 US 189 (1920) by Pitney J (at 206), where the concept
of flows was expressed in terms of fruit and trees. Under this analogy, the fruit
was income and the tree capital:
The fundamental relation of “capital” to “income” has been much discussed by

economists, the former being likened to the tree or the land, the latter to the fruit or
the crop; the former depicted as a reservoir supplied from springs, the latter as the
outlet stream, to be measured by its flow during a period of time.
For an investment property, the rent is likened to the fruit and therefore
considered to be ordinary income, but the sale of the property itself is likened
to the sale of the tree and is capital. In an employment context, the taxpayer’s
ability to work and/or the employment contract would be regarded as the
tree, which means that payment for services is akin to the fruit and is ordinary
income.
[5.110] What exactly is meant by the concept that if a gain is likened to the
fruit from the tree, it is likely to be considered to be ordinary income? There
are a number of ways this concept can be viewed, but importantly the gain (ie,
likened to the fruit) will have both of the following two related traits:
1. Having a nexus (a connection) with an earning source. Specifically,
having a nexus with one of the following three:
(a) property (eg, rent has a nexus with property);
(b) business (eg, an accounting firm’s profit has a clear nexus with the
accounting business); or
(c) personal services (eg, a salary has a clear nexus with an employee
providing services).
2. Being severable from its earning source. Being severable means that
the gain can be extracted without affecting the underlying earnings
source (capital). For example, rent is clearly severable from underlying
property in that rent can be obtained from a rental property without
affecting the underlying property. An accounting firm’s profit can be
obtained from an accounting business without damaging the underlying
accounting business. Salary can be obtained without damaging the
underlying work contract or the employee’s ability to work.
Although the “fruit and tree” analysis distinguishes between income and
capital gains, there are some receipts that are neither income nor capital
gains. Personal gifts or inheritances are examples of this. Items that are
neither ordinary income nor capital generally do not fit into the “fruit” or “tree”
concept.
Examples
[5.120] Examples 5.1 and 5.2 apply the introductory principles of the
prerequisites and characteristics of income.
Example 5.1: Receipt of rent and proceeds of property sale

A landlord owns an investment property. The rent collected from it is
ordinary income as it fulfils the prerequisites of ordinary income in
that it is:
• cash; and
• a genuine gain.
Furthermore, it has the characteristics of ordinary income in that it is:
• regular (ie, rent is usually received every month);
• an amount which “flows” from the underlying property as the rent:
– has a nexus with the house; and
– is severable from the house –in that it can be extracted
without effecting the value of the house.
On the other hand, profit from the sale of the house, although fulfilling the
prerequisites, in that it is:
• cash; and
• a genuine gain;
does not have the characteristics of ordinary income as it:

• is not a regular receipt; and
• does not “flow” from any underlying source.
This is the sale of the underlying tree and so would be regarded as capital.

Example 5.2: Business that regularly buys and sells houses

Following on from Example 5.1, the profits from selling the house would
be regarded as capital, but what about a business that regularly buys and
sells houses? Putting aside the trading stock implications (see Chapter
17), the sale of the houses would generate ordinary income. First, the
proceeds of sale would fulfil the prerequisites of ordinary income, as
they are:
• cash;
• a genuine gain.
Furthermore, they have the characteristics of ordinary income as they:
• would have some regularity since this business regularly sells
such houses; and
• can be said to be the fruit of the underlying business. The proceeds
flow from the underlying business because they:
– have a nexus with the underlying business that buys and

sells properties; and
– are severable from the underlying business, in that selling a
property does not damage the underlying business.
Some gains are ordinary income despite having no

earnings source
[5.130] As discussed at [5.100], one of the major characteristics of ordinary
income is that it flows from an earnings source. In other words, most gains that
are ordinary income will have a nexus to and be severable from an earnings
source. However, this will not always be the case. For example, if receipts are
regular, expected and the taxpayer is able to depend upon them for support,
this will be enough to make them ordinary income even if they do not flow
from an earnings source.
Case study 5.4: Government age pension constitutes ordinary income

In Keily v FCT (1983) 83 SASR 494, a single judge of the Federal Court held
that a government aged pension was ordinary income. This was because
of the traits it had: it was regular, expected and depended upon by the
taxpayer
for support.
This same logic would apply to many other regular government payments,
such as unemployment benefits (eg, Newstart Allowance). Specifically, in
Anstis v FCT (2010) 76 ATR 735, the High Court held that Youth Allowance
payments constituted ordinary income. However, this principle is not restricted
to government benefits and could apply to other regular payments.
Case study 5.5: Top-up payments if employee joined the armed forces

during World War II
In FCT v Dixon (1952) 86 CLR 540, an employer offered his employees
“top-up” payments if they enlisted in the armed forces during World War II.
He said to them that if they ceased working for him and signed up to be
soldiers for World War II, he would pay them the difference between their
former salary and their military salary.
The High Court held that this “top-up” payment was ordinary income. Two
of the judges (Dixon CJ and Williams J) held that this was because of the
traits that the payments had: they were regular, expected and depended
upon by the taxpayer for personal living expenses. A third judge (Fullagar J)
held that the payments were ordinary income due to the compensation
principle discussed at [5.140]: since the payments were a compensation
for lost salary, and the salary would have been ordinary income, the
payments
themselves were ordinary income.
Other general principles

Compensation takes on the character of the loss being
compensated
[5.140] In general, compensation receipts take on the character of what
they are compensating. This specifically means that compensation for loss of
ordinary income is ordinary income, and compensation for loss of capital is
capital. For example, salary is ordinary income, so compensation for loss of
salary is also ordinary income. For a manufacturing business, its factories are
capital, so compensation for loss of one of its factories would be capital.
Compensation receipts are discussed in more detail in Chapter 10.
Unrealised gains are not ordinary income

[5.145] An unrealised gain will not be ordinary income: Eisner v Macomber
252 US 189 (1920). This is related to the flow principle (see [5.100]) as
unrealised gains are not yet regarded as a fruit flowing from a tree. For
instance, if a taxpayer in the business of share trading owns shares that have
appreciated in value but have yet to be sold, no ordinary income will have
been generated until such time that the gain has been realised through the
sale of the shares.
Legality of receipts does not affect their assessability

[5.150] The fact that a receipt is from an illegal activity does not prevent it
being assessable provided it would have been assessable had the activity
been legal: Minister of Finance (Canada) v Smith [1927] AC 193; Lindsay
v IR Commrs (1932) 18 TC 43; Taxation Ruling TR 93/25. This finding is
reasonable as it would be rewarding illegal activities if these proceeds were
not subject to tax. For instance, a taxpayer that is in the business of drug
dealing is assessable on the proceeds of drug sales despite the illegality of
the activities.
Whether a receipt is ordinary income is to be

characterised in the taxpayer’s hands

[5.155] Whether a receipt is ordinary income or not needs to be determined
in the context of the taxpayer being assessed: Federal Coke Co Pty Ltd v FCT
(1977) 7 ATR 519. For instance, if an employee receives a salary, that salary
would clearly be ordinary income in the hands of the employee: see [6.30].
However, if that same employee asked their employer to have the salary paid
to the employee’s spouse instead, then the salary would not be regarded as
ordinary income in the hands of the spouse. This is because in the spouse’s
hands the receipt does not have one of the important characteristics of ordinary
income –that is, it does not flow from their property, business or services they
have provided: see [5.100]. In this situation, the salary would still be regarded
as ordinary income in the hands of the employee due to the principle of a
constructive receipt: see [5.160].
Constructive receipt
[5.160] The principle of a constructive receipt is that income is treated as
being derived by a person when that income has been dealt with as that person
directs. This means that if someone is entitled to receive income, but arranges
to have someone else receive it, then the person originally entitled to receive
the income has constructively received it. This means that the person originally
entitled to receive the money will be assessable on it.
Originally, the concept of a constructive receipt was a principle of case law, but
it was later incorporated into the income tax legislation. Specifically, s 6-5(4) of
the ITAA 1997 covers the principle of constructive receipt for ordinary income
and s 6-10(3) covers the principle of constructive receipt for statutory income.
Example 5.3: Constructive receipt
Alex works for an engineering firm. He is paid on a fortnightly basis. One
fortnight he tells his employer, “for this fortnight, don’t pay me, pay my
wife instead”. Although his wife receives his salary, it is still the ordinary
income of Alex. This is because the salary is ordinary income and Alex
has constructively received the salary, and s 6-5(4) applies to make the
salary the assessable income of Alex. The reason Alex has constructively
received the salary is because he was able to receive the salary, but
instead chose to have it directed to his wife.

Case study 5.6: ATO loses because it did not use principle of

constructive receipt
In Federal Coke Co Pty Ltd v FCT (1977) 7 ATR 519, Bellambi was an
Australian company that owned a subsidiary, Federal Coke. Bellambi
had a long-term contract to supply mineral coke to a French company

Le Nickel and the mineral coke was supplied by Bellambi’s subsidiary
Federal Coke.
The world price for coke had declined since the contract price was set
and Le Nickel wished to be released from this contract and was willing
to compensate Bellambi for cancellation of the contract. Bellambi was
professionally advised that this compensation payment from Le Nickel
would be treated as their assessable income. As a result of this advice,
Bellambi returned the compensation payment to Le Nickel and arranged
for them to make the payment to Federal Coke (subsidiary of Bellambi)
instead. Bellambi hoped that the compensation would not be assessable
in Federal Coke’s hands.
The Commissioner argued that the compensation was assessable
income of Federal Coke, but the Full Federal Court found that it was not
assessable income. Specifically, the Court said that the receipt was not
compensation, because Le Nickel did not have any contractual or other
legal obligations with Federal Coke that would have made them owe
Federal Coke compensation. Furthermore, the lack of dealings between Le
Nickel and Federal Coke meant that it could not be argued that the receipt
was ordinary income due to being the product of business activities.
However, Chief Justice Bowen indicated that had the Commissioner
assessed Bellambi rather than Federal Coke, then it was possible that the
compensation would still have been assessable in Bellambi’s hands. This
was because Bellambi may have assessable income through the principle
of constructive receipt. The reasoning was that Bellambi could have
received the compensation, but chose to have it redirected to Federal
Coke. It could therefore be argued that they had constructively received
the compensation payment and redirected it to their subsidiary Federal
Coke. Constructive receipt of a payment that would have been ordinary
income had it actually been received will constitute ordinary income. In
other words, Bellambi’s position was similar to that of the husband in
Example 5.3.

Benefit that saves taxpayer from incurring expenditure

is not ordinary income
[5.165] If a benefit is not received by the taxpayer, or has been received by the
taxpayer but is not cash or cash convertible, then even if it saves the taxpayer
from incurring expenditure, it will generally not constitute ordinary income. For
instance, in the case of FCT v Cooke and Sherden (see Case Study [5.2]), the
taxpayers’ receipt of a non-cash-convertible holiday would have made them

better off in the sense that it saved them from spending their own funds on a
holiday. Despite this, the receipt of the free holiday was not ordinary income.
However, if the benefit that saved the taxpayer money could have been
directly received by the taxpayer, but they had chosen to redirect it elsewhere,
then it would be covered by the principle of constructive receipt and so would
generally be ordinary income (see [5.160]).
Principle of “mutuality”
[5.170] One of the prerequisites of income is that there must be a gain to the
taxpayer: see [5.50]. It therefore follows that if a taxpayer makes a payment to
himself or herself, there is no gain and the payment will not be income.
The principle of mutuality shows that funds given to a club/association by its

members are not assessable income of the club as the members are the club,
they are one and the same. Similarly, any refund of these fees back to the
members are also not assessable to the members because there is no real gain
as the members are only receiving back what was their money: Bohemians
Club v Acting FCT (1918) 24 CLR 334; RACV v FCT (1973) 4 ATR 567. These
receipts are a type of “non-assessable non-exempt income” under s 6-23 of the
ITAA 1997. The principle of “mutuality” will most commonly apply in situations
involving non-profit recreational clubs and Owners’ Corporations (previously
known as Bodies Corporate).
However, receipts of clubs and associations will not be subject to the mutuality
principle if those receipts are from sources other than members, such as interest
on investments, income from trading, fees collected from non-members and
other relevant external income: Carlisle & Silloth Golf Club v Smith [1912] 2
KB 177.
Case study 5.7: Mutual receipts of a club

In RACV v FCT (1973) 4 ATR 567, the Royal Automobile Club of Victoria
(RACV) was a membership-based club that provided a number of services
to members and non-members. These services included driving lessons,
breakdown assistance, a journal containing commercial advertising,
touring advice, vehicle testing services, insurance referral, etc. The
taxpayer argued that its receipts were not assessable under the mutuality
principle.
The Supreme Court of Victoria held that RACV was engaged in some
activities that were mutual and some that were not. The distinction
between mutual and non-mutual activities was made on the basis of
whether the service was provided to members only or whether it was
part of the RACV’s trading activities. The breakdown services, towing

services, vehicle testing, journal and travel services relating to Australian
travel were mutual services, whereas advertising in the journal, financial
and insurance services, overseas travel services and driving tuition for
non-
members were non-mutual activities.
Example 5.4: Receipts subject to mutuality principle

The following are transactions involving clubs/associations, only some of
which are subject to the mutuality principle:
• A local not-for-profit football club collects a $100 membership fee
from each of its members. It uses these fees to organise football
games that its members participate in. The collection of the fees
would be subject to the mutuality principle and would not be
assessable to the club.
• A football club also holds a lunch and charges its members $10
each to cover the cost of the lunch. The money collected by
the club is only from members and therefore is subject to the

mutuality principle and will not be assessable.
• A wine-tasting club has in the past collected a total of $3,000 fees
from its members. This club organises wine-tasting tours for its
members. The club has $2,000 of the $3,000 in fees collected
unspent and in the bank. The club winds up and decides to refund
the $2,000 back to its members. The money refunded to the
members will be subject to the mutuality principle and would not
be assessable income for the members.
• An Owners’ Corporation for a block of five units collects $1,200
from each of the unit owners. The $6,000 collected will be subject
to the mutuality principle and will not be assessable income to the
Owners’ Corporation.
• An Owners’ Corporation earns $200 in interest from the bank on
fees previously collected but not yet spent. This $200 is assessable.
It is not subject to the mutuality principle as the interest is not
earned from its members.
Questions
[5.180]
5.1 Using the general principles discussed in this chapter, consider whether
the following are likely to be ordinary income:
(a) Salary received by an employee.
(b) Compensation received by an injured worker for loss of salary
because he was unable to work for four weeks.
(c) A Christmas present received by a daughter from her mother.
(d) Proceeds from selling the copyright to a book. The recipient was
an employee accountant who wrote a novel in her spare time over
a number of years.
(e) Proceeds from selling the copyright to a book, where the recipient
is in the business of writing books and selling his copyright.
(f) Profit realised on the sale of shares that have been held for a
number of years, primarily for their capital growth.
(g) Unemployment benefits from the government received by an
unemployed person.
5.2 Look up some English dictionary definitions of “income”. In what

respects are these definitions of income similar to what tax law regards
as “ordinary income”? Why is there a similarity?
5.3 Consider the following situations and discuss, giving reasons, whether
any of the receipts are ordinary income.
The taxpayer has operated a business of purchasing vacant land that
can be subdivided into housing lots and then sell either the vacant lots
or the lots with a house build on it. A site office is normally built on one
of the subdivided blocks and this is staffed by a sales person.
Sometimes the vacant blocks are sold directly after subdivision, but in
other cases, the business arranges for the construction of a house on
the subdivided block and sells the property with the completed house.
On less frequent occasions, the sales are what are known as a house
and land package. In these cases, the purchaser agrees on a design
for the house and the business enters a contract to build the house on
the block and the total sale price includes the block of land plus the
construction cost of the house.
In the current year, the business made the following sales:
• vacant blocks of land for a total of $1,600,000;
• house and land packages for a total of $2,800,000;
• $250,000 for the land that the site office was located on. The site
office was moved to a new subdivision;
• $1,300,000 worth of farm land which the taxpayer inherited from his
parents. The taxpayer had leased this land to a farmer for the past
10 years. This land was not suitable for subdivision, so he sold it to

the farmer who had been leasing it.
5.4 In the High Court decision in FCT v Dixon (1952) 86 CLR 540, the
taxpayer’s receipts were held to be ordinary income. However, Dixon CJ
and Williams J reached this conclusion based on different reasoning
from Fullagar J. In relation to this chapter’s analysis of what is ordinary
income under s 6-5 of the ITAA 1997, outline the reasons given for
concluding that the taxpayer’s receipts were ordinary income, and
discuss which you think is the most convincing, giving reasons.
5.5 Ten employees agree to each contribute $5 per week to a fund that is
used to purchase a weekly lottery ticket. During the year there have
been sufficient winnings to pay for an end of year dinner ($100 per
person) for the 10 members of the group. There was also sufficient
money left over to refund $200 to each contributor.
Using Figure 5.1 as a guide, which elements of the figure are relevant to
determining whether any of the benefits received are ordinary income
under s 6-5 of the ITAA 1997?
6
Income from personal services
and employment
Key points...................................................................................................... [6.00]
Introduction.................................................................................................. [6.10]
Ordinary income as a reward for services.................................................. [6.20]
Does the receipt show a nexus with the service?................................ [6.30]
Salary sacrifice........................................................................................... [6.60]
Prizes, voluntary payments and unexpected payments...................... [6.70]
Tips�� [6.80]
Personal gifts and voluntary payments.................................................... [6.90]
Prizes and chance winnings.................................................................... [6.110]
Non-cash benefits....................................................................................... [6.130]

Capital receipt or personal service............................................................. [6.140]
Changes to entitlements.......................................................................... [6.150]
Receipts for entering a restrictive covenant........................................... [6.160]
Sign-on fees............................................................................................. [6.180]
Section 15-2: Statutory income from services and employment........... [6.190]
Introduction.......................................................................................... [6.190]
First requirement..................................................................................... [6.200]
Second requirement................................................................................ [6.210]
Third requirement.................................................................................... [6.220]
Can compensation receipts be assessable under s 15-2?................. [6.230]
Section 15-2’s relationship with other tax provisions........................ [6.240]
Section 15-3: Return-to-work payments.................................................. [6.250]
Payments upon termination of employment........................................... [6.260]
Employment termination payment –Div 82....................................... [6.270]
When is the payment “in consequence” of termination of
employment?.................................................................................... [6.290]
When is there a genuine termination?.................................................... [6.310]
Genuine redundancy payments and early retirement scheme
payments –Div 83........................................................................ [6.320]
What is a genuine redundancy payment?.............................................. [6.330]
What is an early retirement scheme payment?...................................... [6.340]

Further conditions for redundancy payments and early retirement
scheme payments............................................................................ [6.350]
Threshold.................................................................................................. [6.360]
Calculation of tax payable on ETP........................................................... [6.370]
Payments for unused annual and long service leave –Div 83.......... [6.390]
Questions..................................................................................................... [6.400]

Key points
[6.00]
• Receipts that show a nexus with the provision of a service are ordinary
income. It does not matter whether the service has been performed in
the past or will be performed in the future or who makes the payment.
• Unexpected or voluntary payments will be ordinary income if they are
linked to personal services. However, they will not be ordinary income
if they are paid for personal qualities rather than services.
• Prizes are not normally ordinary income unless they are the direct
result of an income-earning activity or a reward for particular skills.
• Benefits earned from personal services that are not cash or convertible
to cash are not ordinary income, but may be statutory income.
• Receipts paid for giving up valuable rights may be capital receipts
and therefore would not be ordinary income. Capital receipts may be
subject to capital gains tax.
• Some employment and services gains that are not ordinary income
will be assessable under s 15-2 of the Income Tax Assessment Act
1997 (Cth) (ITAA 1997) if they satisfy all three of its requirements.
• Payments given as an inducement for an employee to return to work
will be assessable under s 15-3 of the ITAA 1997.
• Payments given as a consequence of termination of employment will
generally be assessable under the employment termination payment
(ETP) provisions in Div 82 of the ITAA 1997. The relevant tax rates that
apply will depend on various factors, including the taxpayer’s age, the
amount received and who received the payment.
• Payments given to an employee who has been made genuinely
redundant or under an early retirement scheme will generally be
tax free under Div 83 of the ITAA 1997 as long as they are under the
relevant threshold.
• Payments given to an employee upon his or her termination for unused
annual leave and long service leave are assessable under Div 83 of
the ITAA 1997 and are generally assessable at the taxpayer’s marginal
tax rates.
Ordinary income as a reward for services

[6.20] Receipts earned from personal services and employment (also known
as “personal exertion”, which encompasses both income from employment
and services) may be assessable as either ordinary or statutory income.
Amounts that are assessable as statutory income are discussed at [6.190]–
[6.390]. It is also important to appreciate that non-cash benefits received in
respect of employment may also be subject to fringe benefits tax (FBT): see
Chapter 7. If this is the case, these benefits are exempt from income tax for the
employee (s 23L(1) of the ITAA 1936) and need to be considered in relation to
FBT for the employer.
Amounts earned directly or indirectly by virtue of a taxpayer’s personal

services will constitute ordinary income: Moorhouse v Dooland [1955] 1 All ER
93; Brown v FCT (2002) 49 ATR 301. An important factor in identifying income
from personal services is the connection or “nexus” that the receipt has with
the taxpayer’s personal service. The term “nexus” has been used by the courts
to identify this connection with an income-earning activity, but the term has a
similar meaning as the phrase “reward for services”.
Establishing that there is a nexus between the amount received and the work
performed is an essential element for determining whether the receipt is
ordinary income under s 6-5 of the ITAA 1997. This approach was followed
in Scott v FCT (1966) 117 CLR 514 and Hayes v FCT (1956) 96 CLR 47 (see
Case Studies [6.4] and [6.5]), where it was held that a receipt is not ordinary
income if it is not a product of employment or a reward for services:
see [6.90].
Does the receipt show a nexus with the service?

[6.30] Receipts in the form of wages are obviously assessable as ordinary
income and provide a good example of where the nexus between the receipt
and the service is clearly established. In contrast, a personal gift of cash from a
friend or family member in recognition of some occasion, such as a wedding,
has no nexus with any service and therefore is clearly not assessable as
ordinary income. These examples illustrate two receipts that can be easily
identified as either assessable or not because of the connection (or lack of a
connection) with an income-earning activity. However, there are many cases
in between these two extremes where it is more difficult to determine whether
or not the receipt is the result of a service. It is helpful to view this distinction
as a continuum with each distinct end separated by varying degrees of
uncertainty.
income: Kelly v FCT (1985) 16 ATR 478: see Case Study [6.6]. Payments from
a third party (an entity other than the one the taxpayer is employed by) will
be ordinary income for the taxpayer if they are truly a reward for services, but
it is also necessary to consider whether they are a personal gift (see [6.90])
given for some other reason: Hayes v FCT (1956) 96 CLR 47. An example
of a third-party payment would be an employee accountant who receives a
voluntary payment from a client of the firm because the client is very happy
with the work that the employee performed. This payment would be a third-
party payment because the employee works for the accounting firm, rather
than for the client. Furthermore, it has a strong nexus with the services that the
employee performed and so would constitute ordinary income.
Example 6.1: Income earned from personal services

Phillip is a lawyer who runs his own business and does not have any
employees. At 2.00 am one morning his friend Vincent phones and tells
Phillip that he has just been questioned by police about a drug trafficking
matter. Vincent informs Phillip that he has not been arrested, but he would
like to retain his services as his lawyer so that he can call him any time he
needs legal advice or representation. Vincent adds that he will pay Phillip
$50,000 per year regardless of whether his services are needed.
Phillip agrees and he anonymously receives $50,000 into his bank account
some months after, even though Vincent has not called on him for any
legal advice.
The question of whether this is ordinary income under s 6-5 of the ITAA
1997 will be resolved by looking at the activity that is performed and

whether the receipt is a reward for performing that activity. The service
agreed to is that Phillip will be available whenever required and, even
though he may not be called on, he is still being paid to be available. As
a result, the nexus between the service and the receipt is established and
the $50,000 per year would be ordinary income even if Phillip did not
provide any legal work for Vincent.
Wages, salaries, commissions, bonuses, fees for services and other
payments that are an incident of employment or a reward for service are
clearly ordinary income. The characterisation of these amounts as ordinary
income is based on the nexus between the activity and the benefit and
is not affected by whether the amount is received regularly or as a lump-
sum payment. Similarly, it is irrelevant whether the payments are from an
ongoing regular employment contract or a one-off receipt contractually
required to be paid for the performance of a given task: Brent v FCT (1971)
125 CLR 418: see Case Study [6.8].

6: Income from personal services and employment [6.60] 139
[6.50] Determining whether a receipt is the product of personal services may

also be explored using a negative approach, by asking whether the receipt arose
for some reason other than employment or the provision of a service: FCT v
Harris (1980) 10 ATR 869; Laidler v Perry [1965] 2 All ER 121.
Case study 6.2: Payments to retired employee to help reduce effect of

inflation on pension payments
In FCT v Harris (1980) 10 ATR 869, Mr Harris, a retired bank employee,
received a one-off payment of $450 from the bank, which was described
as a pension top-up to counter the effects of increasing inflation.
The Full Federal Court by majority held that the receipt was not a product
of Harris’s past employment and therefore was not ordinary income.
Bowen CJ conceded that Harris would not have received the payment
had he not been a past employee of the bank, but went on to conclude
that the payment was in no way related to the length or quality of his
past service. The payment was related to his pension and was therefore
not a product of his employment. The Court was influenced by the fact
that the gift was one-off rather than regular, though this factor was not
determinative.
Note that s 27H of the ITAA 1936 was enacted to make receipts similar to
that
received by Harris assessable as statutory income.
Receipts arising out of employment contracts or other service agreements

may also be capital in nature (see [6.140]–[6.180]) and not assessable as

ordinary income, although they may be assessable as statutory income: see
[6.190]–[6.240].
Salary sacrifice
[6.60] Income is only assessable in the year derived (s 6-5(2) of the ITAA
1997: see Chapter 16), and employment income is normally derived when it is
received and not at the time the work is performed. Consequently, if personal
services income is never derived, it will never be assessable: Ruling TR 98/1.
Over the years, there have been attempts by taxpayers to redirect employment
income to other family members, but these attempts have invariably failed and
are now specifically covered by the personal services income anti-avoidance
legislation: see Chapter 23, Div 85 of the ITAA 1997. However, employment
income will not be derived if it is redirected through an effective salary sacrifice
arrangement with the employer.
For a salary sacrifice arrangement to be effective, employment income must

be diverted before it is earned. This requires the employee to negotiate to
forego future salary or wages in exchange for some other benefit, such as
increased superannuation contributions by the employer. The Commissioner
accepts that effective salary sacrifice arrangements divert remuneration before
it is derived, and therefore it is not assessable to the employee: Ruling TR 2001/
10. However, any benefit accruing to the employee under the salary sacrifice
arrangement will need to be considered by employers as to its possible effect
on their liability to FBT: see Chapter 7.
Example 6.2: Salary sacrifice
Jo is aged 35 and is an employee of a large bank. His current salary is
$100,000 per year. To bolster his superannuation, Jo negotiates with
his employer to increase the employer superannuation contribution by
$10,000 per year. Jo’s employer agrees to this on the condition that his
wages are reduced to $90,000. As a result of the salary sacrifice, since Jo
is on the 39% tax rate (including Medicare levy), Jo’s take-home pay will
drop by $6,000 ($10,000 − $3,900) and his superannuation will increase by
$8,500 per year ($10,000 less 15% tax of $1,500 –employer contributions
to employee superannuation are taxed at 15%: see [18.110]). Employer
superannuation contributions to employee superannuation funds are
exempt from FBT: see [7.80].

Prizes, voluntary payments and unexpected payments

[6.70] Unexpected or voluntary payments received as a reward for service
are ordinary income as the benefit is an incident of employment: Laidler v
Perry [1965] 2 All ER 121. However, if the payment is made for some other
reason, such as for personal qualities, then the receipt is a personal gift and will
not be ordinary income as there is no connection with any personal service.
Case study 6.3: Christmas bonus was ordinary income

In Laidler v Perry [1965] 2 All ER 121, a Christmas bonus was paid to
all current and past employees in the form of a voucher that could be
redeemed for goods. These vouchers were provided regardless of
the pay rate or the personal circumstances of the employee and were
accompanied by a letter expressing the board’s thanks for past services.
It was held by the House of Lords that the voucher was income as it arose
out of employment, even though it was a voluntary payment on behalf of
the employer. Lord Reid answered the question of nexus in the negative
by concluding that the benefit arose out of employment because it did not
arise out of anything else.
Note that benefits received in kind rather than as cash are often subject to
FBT
rather than income tax: see [7.10].
Unexpected or voluntary payments may also be classified as ordinary income

based on the nature of the payment (see [5.130]), rather than any nexus with
employment or services: FCT v Dixon (1952) 86 CLR 540; FCT v Blake (1984)
15 ATR 1006. In FCT v Dixon, the fact that the taxpayer relied on these receipts
to support himself and his family was a factor in the Court concluding that the
receipts were a replacement for income and therefore assessable as ordinary
income.
Tips
[6.80] Tips are an example of a third-party gift and are voluntary payments
received by waiters, taxi drivers, hotel employees and others that provide a
personal service to the public. These payments are made voluntarily but are
made because of the level of service provided, and not for any other reason,
therefore establishing the nexus with the service and making them assessable
as ordinary income: Penn v Spiers & Pond Ltd [1908] 1 KB 766 (tips received
by a railway dining car waiter); Calvert v Wainwright (1947) 27 TC 475 (tips
received by a taxi driver).
Personal gifts and voluntary payments

[6.90] In contrast to income that is earned as the product of personal services,
a gift given for personal qualities is not regarded as ordinary income and would
not normally be assessable to the recipient: Hayes v FCT (1956) 96 CLR 47;
Scott v FCT (1966) 117 CLR 514.
The treatment of personal gifts as non-assessable income for tax purposes

is based on the general meaning of “ordinary income”, which includes the
notion that income “flows” from a source such as capital. In the case of
personal services, the income flows from the taxpayer’s ability to work and/or
the employment contract: see [5.100]. Personal gifts therefore fall outside of
this concept of income because they arise from personal qualities. However,
a voluntary payment that is a reward for services will still constitute ordinary
income.
When distinguishing between a non-assessable personal gift and assessable

voluntary payments for service, the courts have given more weight to the
nature of the receipt in the hands of the recipient, rather than the motive of the
giver: Scott v FCT. Viewing the receipt from the point of view of the recipient
emphasises the importance of looking for any connection the receipt may or
may not have with any service provided or other income-earning activity. The
motive of the giver may be considered, but is less important. An unsolicited gift
therefore does not become ordinary income only because it was prompted by
gratitude for some service, as other factors must also be considered: Scott v
FCT (1966) 117 CLR 514; Squatting Investment Co Ltd v FCT (1953) 86 CLR 570.
Case study 6.4: Characteristics of a personal gift

In Scott v FCT (1966) 117 CLR 514, the High Court held that the gift of
£10,000 paid by a client (Mrs Freestone) to Mr Scott (a solicitor) was a
personal gift and not ordinary income.
Scott had acted as solicitor for Freestone for some years and in this
case was acting as her solicitor in relation to the estate of her deceased
husband. Prior to Mr Freestone’s death, he and Scott had known each
other for many years and were associated in various business activities.
On the death of her husband, Mrs Freestone engaged Scott to carry out
work in relation to the administration of her husband’s deceased estate,
which included the sale of a number of properties, the main one being an
area of 82 acres known as “Greenacres”. Scott played an important role in
the sale of the properties by successfully negotiating to have restrictions
lifted which prevented the property from being subdivided. As a result
of the lifting of the restrictions on the property, its value increased
substantially and it was eventually sold for a considerable profit.

Following the sale of “Greenacres”, Freestone was informed by letter from
Scott’s firm that the bill of costs would be prepared as soon as possible,
and it was later paid by Freestone. However, before the bill was rendered,
Freestone told Scott that she intended to make a number of gifts from the
sale of the property and this included one to him of £10,000.
In reaching its conclusion that the £10,000 was not ordinary income, but
rather a personal gift, the High Court emphasised a number of elements
to be considered in determining the characteristics of the receipt:
• The character of the £10,000 should be assessed as a receipt in
the hands of the taxpayer.
• The receipt must be a product of the relevant activity to be
ordinary income; if it is a product of friendship or other personal
characteristics, then it is a personal gift.
• The fact that Scott was fully remunerated for his services
separately from the payment supported the case that the £10,000
was a personal gift.
• The fact that Scott did not expect the gift also supported the case
that the £10,000 was a personal gift.
• The personal relationship prior to the payment, as well as the fact
that the donor made other gifts at the same time, also supported
the argument that the £10,000 was a personal gift.
• The motives of the donor do not normally determine whether the
character of the receipt is ordinary income, although it might be
one of the factors to consider in deciding whether the receipt is
ordinary income.

[6.100] The characteristics of a personal gift established in Scott v FCT

(1966) 117 CLR 514 emphasise the importance of the personal relationship of
the parties in distinguishing between receipts that are a product of personal
services or a personal gift. In addition, where the payment is made by an entity
with which the taxpayer has an employment or commercial connection, it is
important to ascertain whether any service provided is separately and fully
paid for.
Ultimately, whether a voluntary payment is ordinary income or not will depend

on whether it has sufficient nexus to the service provided. If there is sufficient
nexus it will be ordinary income, but if there is not, then the voluntary payment
will be a personal gift. As the case law shows, there are a number of factors
that help in borderline cases to determine whether the nexus is strong enough
to make a voluntary payment ordinary income. However, it must be stressed

that these factors are not determinative and only assist to make this decision.
The more important of these factors are:
• whether the gift was expected. Expected receipts are more likely to be
ordinary income: Scott v FCT (1966) 117 CLR 514;
• whether the gift consists of a lump- sum or regular payments. If it
consists of regular payments, then it is more likely to be ordinary
income: FCT v Blake (1984) 15 ATR 1006;
• the motive of the donor. If the donor intends the gift to be a reward for
services, the gift is more likely to be ordinary income: Scott v FCT;
• whether the recipient has already been remunerated for his or her
services. If so, this makes the voluntary payment less likely to be
ordinary income: Scott v FCT; Hayes v FCT (1956) 96 CLR 47; and
• whether there was a personal relationship between the donor and
recipient. The existence of a pre- existing personal relationship will
make the voluntary payment less likely to be ordinary income: Scott v
FCT; Hayes v FCT.
Case study 6.5: Characteristics of a gift

In Hayes v FCT (1956) 96 CLR 47, Hayes was the supervising and
general accountant for Mr Richardson’s meat and smallgoods business.
Mr Richardson’s business was taken over by a company of which Hayes
was a director, secretary and shareholder. Initially, Richardson did not
have a controlling interest in the company but after several years gained
control of the entity. Richardson persuaded Hayes to sell his shares
to him but Hayes remained a director and secretary. The company
became quite successful and was incorporated as a public company in
which Richardson was allotted a considerable number of shares and he
transferred 12,000 of these to Hayes. The Commissioner argued that the
value of these shares was ordinary income or assessable under s 26(e) of
the ITAA 1936 (now s 15-2 of the ITAA 1997): see [6.190].
The High Court concluded that the value of the shares transferred
to Hayes was a personal gift and not ordinary income. In reaching its
decision, the Court noted that Hayes and Richardson had developed a
personal relationship, and that for the value of the shares to be ordinary
income they must be seen in the hands of the recipient as a reward from
employment or other services. In this case, Hayes had been fully paid
for his services and therefore the shares were not additional reward for
his work. This, together with the personal relationship, was sufficient for
the Court to find that the value of the shares was a personal gift and not
ordinary
income, or statutory income under s 26(e) of the ITAA 1936.
Example 6.3: Voluntary payments from employer

Kim is employed in the family business, which is a medium- sized
accounting firm. Both her parents are partners in the five-partner firm that
operates the business. Kim has been an employee for the last three years.
During the current tax year, Kim received several amounts in addition to
her normal wage which was equivalent to other employees with similar
experience and similar qualifications.
One evening during discussions over the dinner table, Kim’s father
asked her whether she had any good ideas on how to improve the client
base of the firm. Kim had been thinking about this for some time and
she prepared a two-page document outlining her ideas which her father
presented to the other partners. One of Kim’s ideas was adopted and
proved moderately successful in attracting new clients. At the end of
the financial year, Kim was surprised to receive an envelope with a letter
thanking her for her ideas and a cheque for $2,000.
Characterising the $2,000 as ordinary income under s 6-5 of the ITAA 1997
or as a non-assessable gift requires consideration of the elements used
in Scott v FCT. First, it is important to view the receipt in Kim’s hands and
give less importance to the motive of the partners for making the payment.
In this example, there is a strong case to argue that the payment was a
product of Kim’s suggestions to the partners and therefore is assessable
as ordinary income. However, as she is fully remunerated for her work
and there is a family relationship, this would support the argument that
the $2,000 is a personal gift. On balance, the stronger case is that the
receipt is a product of her extra effort, and the personal relationship
appears to be weaker than that in Scott v FCT.
An alternative method of analysis, as used in FCT v Harris (see Case
Study [6.2]), is to ask what else gave rise to this income? Using this
approach, it would be difficult to argue that the $2,000 was received for
her personal qualities just because Kim’s parents are partners of the firm,
as they do not hold a majority.
During the year Kim also announced her engagement and at her
engagement party she was handed an envelope by her mother. The
envelope contained a card of congratulations signed by all the partners
and a cheque for $3,000 drawn on the firm’s account. Kim also received a
very generous gift directly from her parents.
In this case, it may be contended that Kim would not have received the
cheque for $3,000 if she had not been an employee. However, that is not
the test of whether the amount is a personal gift or shows a nexus with
her employment. This receipt is more clearly a personal gift as it is in

recognition of her engagement and is therefore paid for personal qualities
and is not connected to her position as an employee of the firm.

Prizes and chance winnings

[6.110] An important characteristic of ordinary income is that it is earned as
a result of personal services. Windfall gains in the form of chance winnings
or prizes, which primarily depend on luck, are therefore not ordinary income,
although they may in some cases be income from business: see [8.60]–[8.80].
For example, winnings from gambling will be a windfall gain unless the gambler
is in the business of gambling: Babka v FCT (1989) 20 ATR 1251.
For prizes to be classified as ordinary income, they would have to be earned as

a result of a business activity or the degree of personal services and skill would
have to outweigh the element of chance. For example, an employee’s winnings
from a football tipping competition organised and run by her employer are
clearly not ordinary income as they depend on chance and have no connection
with employment. Similarly, the winnings of a casual participant in a television

game show are not normally ordinary income as the element of chance is
generally far greater than any skill required: Case 37 (1966) 13 CTBR (NS) 235;
Ruling IT 167.
It is a question of degree as to whether the level of personal services is sufficient

to turn a prize into ordinary income and, as with all questions of degree, the
difficulty is to determine the level of personal service that is necessary to
change the character of the receipt: Kelly v FCT (1985) 16 ATR 478.
Case study 6.6: Professional sportsperson’s prize

In Kelly v FCT (1985) 16 ATR 478, the taxpayer played football at the
highest level in the Western Australia competition and he was paid a
fixed amount for each match played. In 1978, he won a prestigious award
for the “best and fairest player”, known as the Sandover Medal. Prior to
the announcement of the winner of the medal, a local television station
publicly broadcast that it would pay $20,000 to the winner.
The Commissioner assessed Kelly on the $20,000 prize on the basis that,
although unexpected, the prize directly related to his skill and performance
as a professional footballer.
Franklyn J held in the Supreme Court of Western Australia that the $20,000
was ordinary income. This was because the amount was directly related
to Kelly’s employment as a footballer, even though it was unexpected
and paid by an unrelated third party. First, Kelly was eligible because he
was a member of the football club and, second, he was awarded the prize
because
of his skills and abilities.
[6.120] Given the increased profile of professional sporting people since the
decision in Kelly v FCT (1985) 16 ATR 478, it is most likely that all winnings and
prizes relating to their sporting activities will be ordinary income. However,
the distinction between a non-assessable prize and a prize that is related to
personal service is more difficult when the activity is not associated with
employment or professional activities. Some of the factors used to make this
distinction are:
• the degree of professionalism;
• whether the reward is for services rather than for personal qualities;
• whether the reward is paid before or after service; and
• whether the reward is related to the taxpayer’s contract.
Example 6.4: Prizes of a non-professional
As a young girl, Marlene had always loved dancing and she has
received training in a wide range of dancing styles. Over the years she
has participated in a number of local dancing competitions and she has
collected quite an array of cups and trophies. At present, Marlene is
employed as a full-time lawyer and she has not danced in any competitions
for the past six years. During the current tax year, Marlene decided to get
back into dancing and entered a local talent competition which she won
and received a cash prize of $200.
The receipt of $200 raises the issue of whether this payment is ordinary
income as a reward for personal services and her skill in the performance
or whether it is a non-assessable prize that primarily depended upon
luck. Marlene is clearly not a professional dancer and she has voluntarily
entered the competition, rather than being engaged to dance by the
co-ordinators. In addition, there is a significant element of chance as to
whether Marlene will win the prize. Considering all these factors, the $200
receipt is not ordinary income but is a non-assessable prize.
Later in the year Marlene responded to an advertisement to participate
in a television dancing competition. There were 5,000 applicants and
only 50 would be selected after the auditions and Marlene was one of
the lucky few. On being selected, Marlene was required to sign a contract
with the television company agreeing to quite stringent rules restricting
what information could be disclosed to the public, what media outlets she
could talk to, where and when she had to appear and what was required
of her if she reached the final 10 and if she won the competition. Marlene
was very successful and she reached the final 10, which required her to
commit four days per week to the television production and, as a result,
she took unpaid leave from her employment. During the final weeks of the
competition, a local newspaper offered a $10,000 prize to the contestant
that could record the fastest tapping in a tap dance routine. Marlene won
the $10,000, but she did not go on to win the final competition.
Considering the factors listed above, there is a stronger case that the
$10,000 is ordinary income compared to the $200 prize. In this situation,
Marlene is required to sign a contract which indicates that she is
adopting a degree of professionalism. The prize was only available to
those contestants that had reached the final stages of the competition
and it was not paid for personal qualities but for the demonstration of a
particular skill.

Non-cash benefits
[6.130] The general definition of “ordinary income” discussed at [5.60]
identifies one of the prerequisites of ordinary income as being cash or
convertible to cash. Conversely, receipts that are not convertible to cash are
not ordinary income: Tennant v Smith [1892] AC 150; Payne v FCT (1996) 32
ATR 516; FCT v Cooke and Sherden (1980) 10 ATR 696. This characteristic of
ordinary income is particularly relevant in relation to receipts from personal
services, as payments in kind (eg, a free holiday) are quite common in
employment and service arrangements.
An example of the application of this characteristic of income can be seen in

Payne v FCT, where the Federal Court considered whether benefits received
from a customer loyalty program were, among other things, ordinary income.
Customer loyalty programs typically accumulate points that can be redeemed
as free travel, free accommodation, discounts on purchases or other similar
rewards.
Two issues arise in relation to taxation from these loyalty programs: first,

whether the rewards are cash or convertible to cash and, second, whether the
benefit is connected with personal service.
Case study 6.7: Frequent flyer points

In Payne v FCT (1996) 32 ATR 516, Janet Payne travelled regularly as a
result of her employment with a large accounting firm. The flights were
paid for by her employer as she was travelling for business purposes.
On one of these trips Payne was offered a brochure which invited her to
join the airline’s Frequent Flyer Club. She duly completed the application
form and paid the $95.00 membership fee. Over the next two years,
Payne accumulated sufficient points to purchase airline tickets for her
parents to fly from England to Australia. The bulk of these points were
accumulated through travel that was paid for by her employer, although
a small percentage was from private travel (3.2%).
Foster J of the Federal Court held that the free flights earned by Payne
as a result of frequent flyer points generated through work travel were
not ordinary income. The primary reason for this conclusion was that the
tickets were not money or monies worth as they could only be used by
the program member or his or her nominee. They could not be sold or in
any way converted into money.
The decision by Foster J in this case went on to consider whether these
benefits were assessable under s 26(e) of the ITAA 1936 (now s 15-2 of
ITAA 1997): see Case Study [6.16].
the
Benefits that are not cash or cash convertible cannot be ordinary income and
are not assessable under s 6-5 of the ITAA 1997, but they may be assessable
under s 15-2 (see [6.190]–[6.240]) or subject to FBT: see Chapter 7. However,
if the benefit is convertible to money through sale or via some other means,
then the question of the benefit’s assessability as ordinary income will rest with
whether the benefit shows a nexus with personal service: see [6.30].
Capital receipt or personal service

[6.140] Capital receipts are not ordinary income under general principles: see
[5.40]. As a result, it is necessary to consider whether receipts from personal
services and employment are capital or not. The distinction between a receipt
that is a reward for services (and is therefore ordinary income) and a receipt
that is capital in nature is primarily concerned with whether the taxpayer has
given up a valuable right. It follows that where the payment is for giving up a
capital right, then the payment is most likely capital in nature and not ordinary
income. Conversely, if nothing substantial of a capital nature is given up then,
as discussed at [6.30], it is necessary to consider whether the payment shows
a nexus with any service, in which case it will be ordinary income: Brent v FCT
(1971) 125 CLR 418.
In the case of a restraint of trade, there may be a distinction between the

treatment of valuable rights depending on whether those rights are relinquished
on commencement, during or at the ending of an employment contract: see
[6.160]–[6.170]. For example, if a professional sportsperson has included in her
contract a clause that prevents her from playing with any other club during the
term of the contract, then any payment received as a result of this agreement
is an incident of the playing contract and is therefore ordinary income. Clearly,
no valuable right is given up in this instance as the sportsperson is being paid
to play for one club to the exclusion of the other.
Case study 6.8: Payment for service of giving up valuable rights

In Brent v FCT (1971) 125 CLR 418, Mrs Brent was the wife of the infamous
criminal Ronald Biggs, who was one of the gang responsible for the UK
“Great Train Robbery”. Brent was arrested in Melbourne where she had
been living with Biggs following his escape from a UK gaol. After her arrest,
Brent was approached by a number of newspapers with offers to publish
her life’s story, and she eventually signed an agreement with The Daily
Telegraph. The agreement gave the UK newspaper exclusive rights to the
publication of Brent’s story. It required her to be available for interviews
by newspaper staff who would then write her story for publication. The
taxpayer claimed the payments were not ordinary income but that she
was being paid for giving up the capital rights to her story as she signed
over the exclusive rights to the newspaper.
The High Court held that Brent’s earnings from this agreement were ordinary
income. Brent was essentially paid for her services of telling her story and
she did not give up or dispose of any property. Her secret knowledge was
not property as it was not acquired through the conduct of a business and
did not relate to anything to which copyright could be attached. Brent’s
story was about her life and she did not write the story nor did she possess
any copyright that she could assign to The Daily Telegraph. Consequently,
the Court held that nothing of a capital nature was given up and therefore
the payments were for the service of telling her story. The High Court also
placed little importance on the so-called “exclusive rights” clause as this
could not restrict any other author from collecting information on Brent
and
publishing its own version of her life’s story.
Changes to entitlements
[6.150] Payments for changes to entitlements under employment and service
contracts may give rise to capital receipts for the giving up of valuable capital
rights and therefore not fall into the category of ordinary income: Bennett v
FCT (1947) 75 CLR 480. This follows the principle that compensation takes the
form of what it replaces in that compensation for the loss of capital rights will
be a capital receipt: see [10.20]. If no capital right is given up, as in FCT v
Brent (1971) 125 CLR 418, then the receipt is more likely to be ordinary income
unless it is a personal gift.
Case study 6.9: Relinquishing employment rights

In Bennett v FCT (1947) 75 CLR 480, the taxpayer was employed as the
managing director of a company which he affectively controlled. His
original contract was terminated and he was re-appointed with the same
remuneration but he relinquished certain rights that he previously held,
including absolute control of the company. To compensate for the loss of
these rights, the company agreed to pay Bennett three payments over a
two-year period.
The High Court held that the payments were not for loss of income,
but were capital in nature for the removal of those rights that Bennett
possessed under the original agreement. Williams J applied the
compensation principle finding that because the payments were not for
the loss of income, they were capital payments for giving up the right to
control
the company.
The nature of payments for changes to existing entitlements under an

employment contract was also considered by the Administrative Appeals
Tribunal in AAT Case 7,752 (1992) 23 ATR 1057. In this case, employees of
Shell Company Aust Ltd had their entitlements to rostered days off removed
without the employees’ knowledge and it was concluded that compensation
paid for the loss of these valuable rights was of a capital nature.
Receipts for entering a restrictive covenant

[6.160] A restrictive covenant or restraint of trade may be formed at the time
of entering a contract, during the contract’s operation or after the completion
of the service. For example, it is common for professional sportspeople to sign
restrictive covenants on entering new contracts which may limit their rights
to be interviewed by the media or appear on designated television shows.
Similarly, professional actors and movie stars may enter agreements on the
completion of a production to not perform in another production for a given
length of time. Another example would be an employment contract entered
into whereby an accounting firm requires an employee to sign a restrictive
covenant preventing the employee from registering as a tax agent.
Characterising receipts from entering a restrictive covenant as capital or

ordinary income will depend on whether the payment is connected with the
current employment agreement or whether it is a separate agreement to give
up valuable rights. However, where the restrictive covenant is commonly used
as part of the normal employment contract, it will be ordinary income as it is
generally viewed as a payment for future services. Although the decision in

Higgs v Olivier [1952] Ch 311 found the restrictive covenant to be capital, the
comments in this case and in FCT v Woite (1982) 13 ATR 579 would suggest
that restrictive covenant payments made as part of an ongoing contract are
more likely to be income.
[6.170] Payments made at the termination of a service agreement that restricts

the activities of the taxpayer are seen as capital as they do not arise out of the
employment or service contract and do not show a nexus with the earning
activity: Higgs v Olivier [1952] Ch 311; Hepples v FCT (1991) 22 ATR 465.
Case study 6.10: Restrictive covenant –capital

In Higgs v Olivier [1952] Ch 311, the famous actor Sir Laurence Olivier
was paid £15,000 for agreeing to not appear in or direct any film for a
period of 18 months after he appeared in the film “Henry V”.
The English Court of Appeal held that the receipt of £15,000 was not
received as a result of his vocation as an actor and therefore was not
assessable. The Court held that as the agreement to pay the £15,000 was
separate to his contract to perform in the film, and was made after the
completion of the film, it was not payment for his performance as an actor
but for his giving up the right to earn income which was capital in nature.
Case study 6.11: Restrictive covenant –genuine capital payment

In Hepples v FCT (1991) 22 ATR 465, the taxpayer was paid $40,000 on his
retirement for agreeing not to disclose the secrets of his employer.
Although this decision was mainly concerned with CGT, the High Court
had no difficulty in finding that this receipt was not a substitute for
income and was a capital payment for entering the restrictive covenant
on
termination of employment.
Capital receipts may also arise out of a restrictive covenant agreed to at the time
of entering a contract, and the characterisation of these receipts will again be
based on whether the payment is for giving up a valuable right or for services
provided: FCT v Woite (1982) 13 ATR 579; Reuter v FCT (1993) 27 ATR 256.
Case study 6.12: Restrictive covenant –ordinary income

The taxpayer in Reuter v FCT (1993) 27 ATR 256 was involved in the
very famous takeover of John Fairfax Ltd. As part of the arrangements in
relation to the takeover, the taxpayer was paid $8 million to agree that he
would not, without prior approval, claim the success fee (normal payment
for a successful takeover) for the takeover against Bond Media.
Hill J in the Federal Court looked at the substance of the agreement,
rather than its form, and held that the receipt of $8 million was closely
connected to the services provided by the taxpayer to Rothwells Ltd and
was
therefore ordinary income.
Case study 6.13: Restrictive covenant on entering a contract

In FCT v Woite (1982) 13 ATR 579, the taxpayer was a footballer who
played for a South Australian team. Woite received $10,000 for entering
an agreement with the North Melbourne Football Club to not play football
with any Victorian club other than North Melbourne (Australian Rules
Football did not have a national competition at this time). The contract
did not require Woite to play for North Melbourne unless he decided to
play football in the Victorian league, which he never did.
The Supreme Court of South Australia held that the $10,000 was capital in
nature and was not ordinary income from his profession as a footballer.
Woite was contracted to the South Australian club and the payment from
the North Melbourne club was not a payment for service, but a capital
payment to give up the right to play for a club other than North Melbourne.
It is interesting to note, although not part of the decision, that Mitchell J
implied that it was highly likely that the $10,000 could be ordinary income
if Woite had followed the signing of the restraint of trade by signing with
the
North Melbourne Club and had subsequently played football for them.
Example 6.5: Restraint of trade payments

Luke is a famous basketball player and he has been contracted to play
for his club for the last five years. Currently, Luke is in negotiations with
his club to renew his contract for an additional 12 months and one of the
clauses in the contract states that he may only do media appearances
with TVX, a media company that has a substantial interest in the club.
Due to the inclusion of media restrictions, Luke’s agent is able to have the
annual playing fee increased by $50,000.

Luke signs the new contract, but halfway through the season he has a
serious dispute with the club’s management as he is not being picked to
play on a regular basis. Following threats of legal action by both parties,
the club agrees to end Luke’s contract for no cost to Luke and also pays
him $100,000 for agreeing not to disclose the reasons for the dispute with
the club.
There may be an argument that the $50,000 is payment for giving up the
right to speak to any media Luke wishes, but it may also simply be part
of his employment contract which requires a range of conditions. The
comments in Higgs v Olivier [1952] Ch 311 and FCT v Woite (1982) 13
ATR 579 would suggest that restrictive covenant payments made as part
of an ongoing contract are more likely to be income. This is not unlike an
employment contract that requires certain restrictions of an employee,
such as signing a secrecy agreement. In contrast, the payment of $100,000
is on termination of the contract and imposes a specific restraint on Luke
and, as it is not a payment related to his playing duties, it is more likely to
be capital, as in Hepples v FCT (1991) 22 ATR 465.

Receipts that are of a capital nature are not assessable under s 6-5(1) of the
ITAA 1997, but they may be statutory income under other provisions such
as the CGT provisions: see Chapter 11. It is important to distinguish receipts
that are ordinary income and those that are subject to CGT, as the method of
determining the liability to tax differs between these two forms of income.
Sign-on  fees
[6.180] Sign-on payments enticing the party to enter the contract are quite
common in professional sporting contracts and some higher level professional
employment contracts. These receipts raise the issue of whether they are a
capital payment for giving up some valuable right or whether they are ordinary
income in the form of payments for future services.
Case study 6.14: Sign-on fees –capital in nature

In Jarrold v Boustead (1963) 41 TC 701, an amateur rugby player was paid
a £3,000 sign-on fee to give up his amateur status and turn professional.
At this time in UK, there were some advantages in being an amateur
and there was a chance that he could become an international player at
amateur level.
The Court of Appeal held that this receipt was capital in nature as it was
a payment for giving up the right to play amateur football, rather than a
payment
for future services.
The view expressed by the Commissioner in Ruling TR 1999/17 is that where

a sign-on fee is a normal part of the practices of attracting sportspeople and
employees into a new contract, the payment is less likely to be capital and more
likely to be ordinary income as a one-off payment for future services: Pickford v
FCT (1998) 40 ATR 1078.
Case study 6.15: Sign-on fees –ordinary income

In Pickford v FCT (1998) 40 ATR 1078, the taxpayer was offered a salary
package to take up employment with another firm, and this package
included a one-off payment of $20,000 as compensation for given-up
share options in an employee share scheme with his current employer.
The Administrative Appeals Tribunal held that the $20,000 was ordinary
income because it was an incident of the taxpayer’s income- earning
activities
and employment.
There is very little direct Australian case authority on this issue, which could
suggest that it is well settled that it is difficult to make a strong case that these
receipts are not an incident of an income-earning activity.
Income from personal services may be assessable as ordinary income or

statutory income. However, regardless of whether an amount is likely to
be ordinary income, it is still necessary to consider whether any statutory
provisions specifically apply to the receipt.
The discussion at [6.190]–[6.390] covers the most important statutory

provisions that apply to receipts from employment and services.
Section 15-2: Statutory income from services

and employment
Introduction
[6.190] Section 15-2 of the ITAA 1997 (previously s 26(e) of the ITAA 1936)
deems certain gains arising from employment and services to be assessable
as statutory income. For the most part, s 15-2 has the same operation as its
predecessor. However, there is one major difference: s 26(e) did not have a
“contrary intention”. This meant that gains that were ordinary income and
covered by s 26(e) were taxed under s 26(e). However, the current s 15-2 does
have a contrary intention in s 15-2(3)(d), which means that if a gain is ordinary
income, it will not be covered by s 15-2: see [3.80].
Specifically, s 15-2 covers gains from employment and services if they are not
ordinary income or a fringe benefit (see Chapter 7) and if they fulfil all three
of the requirements discussed at [6.200]–[6.220]. The application of s 15-2 is
wider than ordinary income in two ways:
• For employment and service gains to be ordinary income, they need
to be cash or cash convertible. On the other hand, s 15-2 covers gains
that are cash, cash convertible and non-cash convertible.
• For employment and service gains to be ordinary income, there needs
to be a nexus between the gain and the services required: see [6.30].
For these gains to be assessable under s 15-2, there must also be a
nexus between the gain and the services. However, case law indicates
that the nexus test is easier to satisfy under s 15-2 than it is for ordinary
income. For example, in Smith v FCT (1987) 19 ATR 274 (see Case Study
[6.17]), Brennan J found no reason that s 26(e) of the ITAA 1936 (the
predecessor of s 15-2) should be limited to benefits that are income in
ordinary concepts, with the result that s 15-2 could potentially include
capital benefits.
Section 15- 2 potentially only applies to gains from employment or the

provision of services. However, this could include services provided by a
business taxpayer and also amounts received from providing services under
an independent contract for services. Section 15-2 could therefore apply to
gains made by a business from providing engineering or accounting services.
Conversely, s 15-2 will not apply to gains made from holding property or from
business operations that do not involve the supply of services. For instance,
in FCT v Cooke and Sherden (see [5.60]), the taxpayer ran a business selling
soft drinks “door to door” and subsequently received a gift from the soft drink
manufacturer. In this case, the Court held that such a gift was not assessable
under the predecessor of s 15-2 because the income was sourced from a
business selling goods rather than from providing a service of selling goods.
First requirement
[6.200] The first requirement for a gain to be assessable under s 15-2 of the
ITAA 1997 is that there is an “allowance, gratuity, compensation, benefit, bonus
or premium”. These words are very wide and will cover a range of benefits
received by the taxpayer. This includes receipts that are cash, cash convertible
or non-cash convertible.
Some examples of receipts that meet the first requirement are:

• a cash payment for services, which is a “benefit” and so would fulfil this
requirement; and
• an employer giving an employee a free television or giving the
employee use of a car for personal purposes.

Note also that this first requirement:
• is not confined to receipts that the taxpayer is entitled to receive,
but can also include gifts (gratuities) that have been received by the
taxpayer; and
• will also be satisfied when the taxpayer receives something from
an entity to which he or she has not directly provided a service. For
instance, free hotel accommodation received by an employee of an
accounting firm from one of the firm’s clients would satisfy this first
requirement.
An example of an item that satisfies the first requirement is an “allowance”. An
allowance is a predetermined amount given to a taxpayer for a specific purpose
where the taxpayer does not have to return any of the unspent amount. This is
in contrast to a “reimbursement”, where a taxpayer only receives what he or
she has spent. For example, a taxpayer who receives $150 from her employer
for travel purposes, but ends up only spending $60 of it and is allowed to keep
the rest, is in receipt of an allowance. On the other hand, a taxpayer who is
reimbursed only her actual travel expenditure would not be in receipt of an
allowance, but rather a reimbursement.
While allowances will satisfy the first requirement of s 15-2, whether or not
a reimbursement is captured by s 15-2 is contentious, although it is of little
practical importance as, either way, it will be tax neutral. For example, where
an employee purchases paper for their work’s photocopier for $50 and then
is reimbursed $50, it may be argued that this is effectively not the employee’s
expense but the employer’s expense and the employee is simply carrying
out the purchase for the employer. If this is the case, then the employee has
no benefit and no assessable income or equivalent deduction. Conversely, if
s 15-2 makes the $50 assessable, then the employee will also be entitled to a
deduction (s 8-1 of the ITAA 1997) for the $50 expense incurred, which is again
tax neutral. Reimbursements are also not usually ordinary income, but they
may be subject to FBT: see Chapter 7.
Although allowances will generally fulfil the three requirements of s 15-2, they
also will usually constitute ordinary income (see [5.70]) in which case they
will be assessable as ordinary income under s 6-5 rather than s 15-2. This is
because of the contra-intention contained in s 15-2(3)(d) which removes the
application of s 15-2 if the amount is also ordinary income.
Second requirement
[6.210] The second requirement for a gain to be assessable under s 15-2 of
the ITAA 1997 is that the allowance, benefit, etc is “provided to you” (ie, the
taxpayer).
Usually, this requirement will be relatively simple for the taxpayer to fulfil.
For example, if a taxpayer has received cash, property or a benefit, like free
accommodation, it will have been “provided” to the taxpayer and this second
requirement will have been satisfied. Therefore, it is only in some very limited
circumstances that it will be unclear whether this requirement has been met.
Case study 6.16: Free ticket due to frequent flyer points earned from
work-related travel not assessable
In Payne v FCT (1996) 32 ATR 516, the taxpayer worked for KPMG and
undertook considerable work- related travel. Payne signed up for the
Qantas Frequent Flyer program and accumulated a large number of
points due to her work-related travel. These points were converted to
free airline tickets.
The Court examined whether receipt of the free tickets was assessable
under s 26(e) of the ITAA 1936, the predecessor of s 15-2 of the ITAA
1997. The Federal Court (single judge) held that the free tickets were
not assessable under s 26(e). One of the reasons for this was that the
equivalent of the second requirement of s 15-2 had not been met, because
the benefit was due to a “crystallising of contractual entitlements” under
the
Frequent Flyer program agreement.
Third requirement
[6.220] The third requirement for a gain to be assessable under s 15-2 of
the ITAA 1997 is that what has been received by the taxpayer is “in respect
of, or for or in relation directly or indirectly to, any employment of or services
rendered by the taxpayer”. This requirement will be satisfied when there is a
sufficient nexus between the receipt and services provided.
Earlier cases, such as Scott v FCT (1966) 117 CLR 514, FCT v Dixon (1952) 86
CLR 540 and Hayes v FCT (1956) 96 CLR 47, found that the nexus test under
s 15-2’s predecessor was identical to the nexus test for determining whether
a receipt is ordinary income. However, more recent case law, such as Smith v
FCT (1987) 19 ATR 274, has seen courts take a different approach by indicating
that the nexus test in s 15-2 is easier to meet than the nexus test for ordinary
income. Despite this, there still is a nexus requirement for this third requirement
of s 15-2.
Courts have also explicitly stated that, in general, it is much easier to meet
s 15-
2’s nexus test where the taxpayer was legally entitled to the receipt
compared to when the taxpayer has received a gift: Smith v FCT (1987) 19 ATR
274; FCT v Holmes (1995) 31 ATR 71. Nevertheless, it is still possible for gifts to
pass the nexus requirements of s 15-2 under certain factual scenarios.
Case study 6.17: Employee receipt from employer as reward for

studying assessable
In Smith v FCT (1987) 19 ATR 274, Westpac introduced a scheme to
encourage its employees to undertake study that it considered related
to banking. Under this scheme, the employer would give the employees
a certain dollar amount upon successful completion of every subject of
an approved degree and an extra amount upon successful completion
of that approved degree. At the time there were no tertiary fees so, in
effect, the employees who received this money could use it for personal
purposes.
Smith was an employee who undertook approved study and received
money under this scheme. The issue was whether the amount received
under the scheme was assessable under the predecessor to s 15- 2,
s 26(e) of the ITAA 1936.
The High Court held that the taxpayer’s receipt was assessable. Specifically,
the Court addressed the nexus issue and said that there was a sufficient
nexus with employment in this case. This was due to a combination of
factors, the most important being that the scheme existed to increase
employee productivity by encouraging them to be more highly educated.
In addition, it was also an important fact that Smith was eligible for the
scheme by being employed by the donor of the gift.
The Court did not consider whether the gain would have been assessable
as ordinary income, although it did state that it is easier for service-related
gains to be assessable under s 15-2’s predecessor than to constitute
ordinary
income.
Case study 6.18: Receipt of free tickets due to frequent flyer points

lacks sufficient nexus
As discussed in Case Study [6.16], Payne v FCT (1996) 32 ATR 516 involved
a taxpayer who acquired frequent flyer points through work-related travel
and used them to acquire free Qantas tickets. The Federal Court held that
this amount was not assessable under s 15-2’s predecessor (s 26(e) of the
ITAA 1936) for two reasons.
First, the second requirement of s 26(e) was not satisfied: see [6.210].
Second, the Court backed up its conclusion with another, more convincing
reason. It said that this third requirement of s 15-2’s predecessor was not
satisfied because there was an inadequate nexus between the receipt of
the free ticket and the services provided by the employee in her capacity
as a KPMG employee.
It was true that, had the taxpayer not provided services for KPMG, and
thus not done the amount of work-related travel, she would not have
earned enough points for a free ticket. However, the Court stated that
such facts were not enough to satisfy the nexus requirements of s 15-2’s
predecessor, even if its nexus test was more lenient than required for
a gain to be ordinary income. The Court said that, on the facts, the free
tickets were not a reward for the taxpayer’s services to KPMG, but rather
a
reward for flying with Qantas.
Case study 6.19: Receipt of reward money for helping to prevent an

environmental disaster was assessable
In FCT v Holmes (1995) 31 ATR 71, the taxpayer was an employee on a
shipping vessel which happened to be near a leaking oil tanker. The leaking
oil tanker was heading towards the shore; this meant that there was a risk
of the oil tanker losing most of its cargo and causing an environmental
disaster. The taxpayer and some of his co-workers were able to use the
vessel they were on to tow the oil tanker out of danger. As a result of his
effort, the taxpayer received a payment of $23,381 “salvage reward”. The
entitlement to this reward was based on a principle in the law of Admiralty
(laws relating to ocean vessels) that an owner of salvaged property must
pay those that saved the salvaged property. The taxpayer would not have
received the reward had the efforts of towing the oil tanker to safety been
unsuccessful.
The Full Federal Court held that the reward money was assessable under
the predecessor of s 15-2. It stated that there was clearly a nexus between
the effort of the taxpayer in saving the oil tanker and the reward money.
The Court stated that the fact that the taxpayer would not have received
the money had the salvage been unsuccessful only strengthened the
case for there being a nexus between the reward money and the services
performed.
In this case, the Court did not need to consider whether the reward
constituted ordinary income, because the gain was assessable under
s 15-2’s predecessor. The predecessor of s 15-2 considered in this case,
unlike the current s 15-2, did not exclude amounts that were also ordinary
income. If this case were decided today, the Court would first consider if
the gain was ordinary income, and then only if it decided that there was
a chance that it was not ordinary income, would the Court then proceed
to
apply s 15-2.
Can compensation receipts be assessable under s 15-2?

[6.230] Compensation paid to an employee takes on the form of what the
employee is being compensated for: see [10.20]. This means that compensation
for loss of salary is ordinary income and compensation paid for loss of the
actual job or some of the rights related to that job is generally capital. Could
some compensation payments that are not ordinary income be assessable
under s 15-2 of the ITAA 1997?
This issue was considered in the following two cases.
Case study 6.20: Receipt of compensation payment mandated under

legislation not assessable under predecessor of s 15-2
In FCT v Inkster (1989) 20 ATR 1516, the taxpayer received compensation
from his ex-employer due to health problems resulting from asbestos
exposure that had occurred during their previous employment
relationship. This compensation payment was for the taxpayer’s loss
of earning ability rather than for his loss of earnings. Furthermore, the
payment was mandated and calculated under legislation that applied at
the time.
The Court held that the compensation was not assessable under the
predecessor of s 15-2 (s 26(e) of the ITAA 1936). The Court stated that
this was because the compensation payment was a mandatory payment
made by the ex- employer to compensate the taxpayer for their loss
of earning ability. The Court said that in contrast, if the compensation
payment had been a discretionary payment that was paid to the taxpayer
as a reward for his services, then the payment would have fallen under
s 15-2’s predecessor. However, it should be noted that a discretionary
reward for services would be very likely to constitute ordinary income,
and so would not be covered by s 15-2 due to it excluding amounts that
are ordinary income (s 15-2(3)(d)).
It is not totally clear how the Court would have treated a discretionary
payment between the parties to compensate the taxpayer for his loss
of earning capacity; however, the Court did appear to imply that such a
payment would not be assessable under s 15-2’s predecessor. It is also
unclear how the Court would have treated a mandated payment that was
for compensation for loss of earnings rather than loss of earning capacity.
However, such a payment would constitute ordinary income (see [10.80])
and
so the current s 15-2 could not apply to it due to s 15-2(3)(d).
Case study 6.21: Tribunal finds that receipt of compensation payment

for loss of fortnightly rostered day off assessable under predecessor
of s 15-2
In AAT Case 7752 (1992) 23 ATR 1057, the taxpayer was compensated
by his employer for losing the right to have a day off every fortnight.
The employer had unilaterally terminated the taxpayer’s right to have a
fortnightly day off and had compensated him with three months’ salary
paid over three instalments.
The Tribunal held that, while not being ordinary income, this payment
was assessable under the predecessor of s 15- 2, as the taxpayer’s
employment was the cause of the payment. However, because this is an

AAT Case, it is not a binding precedent on future court decisions.
Given the scarcity of court decisions on the issue, it is unclear to what
extent
(if any) s 15-2 will cover compensation payments paid to employees.
Section 15-2’s relationship with other tax provisions

[6.240] As discussed at [6.90], s 15-2 of the ITAA 1997 will not apply to gains
that are ordinary income, and it is wider than ordinary income in that it has a
more lenient nexus test and also applies to non-cash convertible items. Section
23L(1) of the ITAA 1936 also states that if a gain is a fringe benefit, it will not
be assessable for income tax purposes. This means that gains that are fringe
benefits will not be assessable as ordinary income or under any income tax
provisions, including s 15-2, and may instead be subject to FBT (which is not
income tax). The precise definition of “fringe benefits” and details about the
operation of FBT are discussed in Chapter 7.
Note that, in general, most non-cash benefits provided by an employer to an

employee are fringe benefits. In some limited circumstances, cash payments
by an employer to an employee would also be regarded as a fringe benefit.
Example 6.6: Examples of the application of s 15-2

Because s 15-2 of the ITAA 1997 only applies to gains that are not ordinary
income and not fringe benefits, this leaves it with limited application.
Some examples of where s 15-2 might still operate are:
• the receipt of non-cash convertible items as a reward for volunteer
work. In such an instance, the gains would not be ordinary income
as they are non-cash convertible and they would not be fringe
benefits because they have not been provided by an employer to
an employee;
• third-party payments for employment or services that are not cash
convertible, for example, the receipt of a free non-transferrable
holiday by an employee lawyer from a client of the law firm. Such
receipts would not be assessable as ordinary income because
they are not cash convertible. Furthermore, they would not be
regarded as fringe benefits because they are not provided by
an employer to an employee (if the employer has arranged for
the third party to make this contribution to the employee, then it
would be regarded as a fringe benefit and would be taxed under
the fringe benefits regime: see Chapter 7); and
• third-party payments that are cash or cash convertible and have

some nexus with employment or services, but do not have a
strong enough nexus to constitute ordinary income. These would
not be ordinary income due to their insufficient nexus with the
services. Furthermore, they would not be fringe benefits as they
are not provided by an employer to an employee.
Section 15-3: Return-to-work payments

[6.250] Payments made to a taxpayer as an inducement to return to work or
provide services will be assessable as statutory income under s 15-3 of the
ITAA 1997. Section 15-3 does not have a contrary intention, so it will potentially
apply to payments that are also ordinary income.
Example 6.7: Return-to-work payment
Nadia works as a lawyer for a big law firm. She quits because she is
unhappy with the management of the firm. The firm would like to re-
employ Nadia and offers her a one-off payment of $20,000 on top of her
salary if she agrees to be re-employed by the firm.
If Nadia agreed to this and received the $20,000, this money would be
assessable under s 15-3.

Payments upon termination of employment

[6.260] The principle that compensation payments take on the character of what
is being compensated for is discussed at [10.20]. However, the compensation
principle does not apply to payments connected with the termination of
employment. In other words, where there is a payment connected to the
termination of employment that falls under one of the termination provisions
of the legislation, it does not matter whether the payment is compensation for
income or capital, as legislation dictates how such payments are taxed.
Depending on the precise nature of the termination payment, it may be

statutory income (such as an employment termination payment (ETP)) or non-
assessable income (such as genuine redundancy payments that are below a
certain threshold). The main termination payments include:
• ETPs: see [6.270] (for calculations on how ETP’s are taxed, see [6.370]);
• genuine redundancy payments and early retirement scheme payments:

see [6.320]; and
• payments for unused annual and long service leave: see [6.390].
Employment termination payment – Div 82

[6.270] In general, an ETP is a payment given by an employer to the employee
upon termination. Payments can potentially be ETPs whether they are made
voluntarily, under industrial relations laws, under contractual obligations or for
some other reason. Payments can also be ETPs whether they are a result of the
employee resigning or the employer dismissing the employee, although some
redundancy payments are not regarded as ETPs: see [6.340]–[6.380].
There are two broad sub-types of ETPs:

1. Life benefit termination payment: an ETP paid to the ex-employee for
his or her termination of employment.
2. Death benefit termination payment: a payment made after an employee
has died. This payment is usually (although not necessarily) made to a
relative of the former employee.
[6.280] Specifically, under s 82-130 of the ITAA 1997, a receipt is an ETP when
it is a payment made in consequence of termination of employment. In other
words, for a payment to be an ETP, it must be shown that the following three
requirements have been satisfied:
1. there was a payment “in consequence” of the employment termination:
see [6.290];
2. there was in fact a genuine termination of employment: see [6.310]; and
3. the payment did not fall into one of the exclusions below.
The following are specifically excluded from the definition of an ETP (ss 82-130
and 82-135):
• superannuation payments (superannuation is subject to its own
taxation regime);
• pensions and annuities (pensions and annuities are usually taxable
as ordinary income, although annuities are also subject to statutory
provisions that usually reduce the tax payable on them: see [9.120]);
• genuine redundancy payments or early retirement scheme payments,
but only to the extent they are not above the relevant threshold (see
[6.380]); and
• a restraint of trade payment that is capital in nature: see [6.140]–[6.180].
The following payments are examples of ETPs:
• An employer voluntarily makes a payment to an employee upon
retirement (a life benefit termination payment).
• An employer makes a payment (required by an industrial award) as a

result of dismissing an employee for his or her unsatisfactory work (a
life benefit termination payment).
• An employer wrongly sacks an employee. The employee receives
compensation in a successful unfair dismissal claim (a life benefit
termination payment).
• As a result of an employee’s death, the employer makes a payment to
the employee’s spouse (a death benefit termination payment).
When is the payment “in consequence” of termination of

employment?
[6.290] For a payment to be regarded as an ETP, it must be paid “in
consequence” of termination of employment. At first glance this would appear
to mean that the payment must be due to the employment relationship ending.
However, causation is never a simple matter. For example, what is the cause of
the payment to an employee of 10 years who resigns and is given a termination
payment of $12,000 based on the number of years of service in accordance
with the relevant industrial award? The $12,000 is the result of several factors:
• the termination of employment;
• the fact that the employee worked for that employer for 10 years; and
• the terms of the relevant industrial award.
Termination of employment is one of the causes of the payment, but it is not
the only cause and probably not even the dominant cause. Case law on the
words “in consequence of termination of employment” shows that termination

of employment need only be one of the causes for the payment, and it need
not be the dominant cause for the payment to be an ETP: Reseck v FCT (1975)
5 ATR 538; McIntosh v FCT (1979) 20 ATR 13.
Case study 6.22: Payment in consequence of termination of

employment
In Reseck v FCT (1975) 5 ATR 538, a construction worker worked on one
construction site between 25 November 1969 and 24 September 1971
and on a second site between 27 September 1971 and 11 February 1972.
Both of these jobs were for the same employer. At the end of each of the
two work periods, Reseck received a severance payment, even though
the gap between the first and second period of employment was just a
weekend: see [6.310].
For technical reasons, the Court had to accept that both terminations
were genuine. The main issue for the Court was whether the payments
were “in consequence” of termination of employment.
The legislation being considered at the time had the requirement that the
payment be in “in consequence” of termination of employment, which is
the same as is required by the current ETP provisions.
Two out of three judges in the Full Federal Court (Gibbs and Stephens JJ)
decided that the payments were in consequence of termination of
employment. Although the language of these two judges was different,
they were in fact saying substantially the same thing. Gibbs J stated that
“in consequence” of termination means that the payment was a result of
termination of employment. His Honour also stressed that the termination
need not be the only or even dominant cause of the payment. Here, the
payments were a result of a number of factors, including the fact that the
employee’s performance had been satisfactory, the industrial agreements
and the employment terminations. However, the payments were still “in
consequence” of termination of employment because the terminations
were one of the causes of the payments. Stephens J stated that for the
payment to be “in consequence of” termination of employment, it must
“follow on” from the termination. Like Gibbs J, his Honour emphasised
that the termination need not be the dominant cause of the payment.
Case study 6.23: Conversion of pension entitlement to lump sum “in

consequence” of termination
In McIntosh v FCT (1979) 20 ATR 13, the taxpayer had worked for a bank
for many years. In those days compulsory superannuation was still a few
decades away, so most workers did not have superannuation accounts.
However, the employer promised a private pension to some of its
employees who had met the requirement of a minimum length of service.
Under the terms of this entitlement, a retiring employee could convert
part of the pension to a lump sum. McIntosh retired and was entitled to
the bank pension and chose to convert half of it to a lump sum.
The legislation at the time, like the current ETP provisions, applied where
the payment was “in consequence” of termination of employment. Under
the laws of the time, if the payment was “in consequence of termination
of employment” the taxpayer would have had to pay some tax on the
lump sum. If it was not, then the payment would have been tax free. The
taxpayer argued that the payment was not in consequence of termination
of employment because it was in consequence of the taxpayer’s decision
to convert his pension to a lump sum.
All three judges of the Full Federal Court (Brennan, Toohey and
Lockhart JJ) disagreed and decided that the lump-sum payment was
“in consequence” of termination of employment. As in Reseck v FCT
(1975) 5 ATR 538, the Court emphasised that retirement need not be the
dominant cause of the receipt in order for the receipt to be considered
to be “in consequence” of retirement. Brennan and Toohey JJ referred
to Reseck v FCT and stated that for a payment to be “in consequence” of
retirement there must be some connection between the retirement and
the payment, although retirement need not be the dominant cause.
All three judges stated that, while it was true that one of the causes of the
payment was the taxpayer’s election to convert the pension to a lump
sum, the payment was still “in consequence” of retirement. This was
because if the taxpayer had not retired, the taxpayer would not have been
able
to receive the lump sum.
Case study 6.24: Damages for unfair dismissal payment “in

consequence” of termination of employment
In Le Grand v FCT (2002) 51 ATR 139, the taxpayer worked as managing
director with the Business Council of Australia (BCA). BCA terminated
his employment and the taxpayer claimed that he had been wrongfully
dismissed. He sued BCA for loss of wages, loss of reputation and some
other related grounds, including the loss of opportunity to earn money
elsewhere. The case was settled without going to court and the taxpayer
was given nearly $550,000 in compensation.
Goldberg J of the Federal Court held that this payment was “in
consequence” of termination of employment. This was because there
was sufficient connection between the compensation payment and the
taxpayer’s termination. Like many of the judges in the previous cases,
Goldberg J stated that for a payment to be “in consequence” of the
termination of employment, the termination need not be the dominant
cause
of the payment.
[6.300] These cases (at [6.290]) clearly illustrate the point that termination
of employment need not be the only reason a payment is received for the
payment to be considered “in consequence” of termination of employment.
However, just because a payment is given shortly after retirement does not
automatically mean that it is “in consequence of termination of employment”.
In other words, although termination of employment does not have to be the
only or a dominant cause of the payment, it still has to be one of the causes.
The fact that employment termination and the payment happen at similar times
is not enough to show causation between the payment and retirement, per
Brennan J in McIntosh v FCT (1979) 20 ATR 13.
Example 6.8: Post retirement payment not “in consequence” of

retirement
Three months before her retirement, Linda brings a new client to the firm,
which has a large impact on the firm’s profitability. The firm voluntarily
gives her a substantial bonus because of this and ends up paying it to her
one month after her retirement. Linda would have received this bonus
even if she had continued to work for the firm.
Although the payment did occur shortly after her retirement, it would
not be regarded as “in consequence” of her retirement and so would not
be an ETP because the payment was for introducing the new client, not
because of her retirement.

Case study 6.25: Payment due to tax minimisation scheme not “in

consequence” of employment termination
In Freeman v FCT (1983) 14 ATR 457, the taxpayers worked for Company
A, which provided engineering consulting services. The taxpayers were
also shareholders and directors of Company A. The taxpayers wanted
the business transferred from Company A to Company B, as Company B
would be run through an entity that would allow for less tax to be paid.
This meant that the taxpayers would then be employed by Company B,
rather than Company A.
To facilitate this transaction, the taxpayers lent money to Company

B. Company B used this money to pay Company A for the purchase of
the engineering business and Company A then paid the taxpayers certain
sums of money. In other words, the money trail followed a circle and
ended up where it started. It went from the taxpayers to Company B to
Company A and then to the taxpayers. The taxpayers claimed that the
money they received from Company A should be concessionally taxed as
it was paid “in consequence” of termination of employment.
The Full Federal Court unanimously held the payment was not “in
consequence of” their employment ending. The Court stated that this was
partially due to the fact that the payments from Company A were made
almost 12 months after the taxpayers had ceased working for Company
A. The Court also appeared to be highly influenced by the fact that the
whole scenario was a very contrived arrangement to reduce the amount
of tax payable, rather than a genuine redundancy payment for termination
of employment.
Note: This case should not be interpreted as meaning that a payment made
12 months after retirement cannot be “in consequence” of employment
terminating, although it does indicate that, all other things being constant,
the longer the time lag between retirement and payment, the less likely
the payment will be “in consequence” of employment terminating.
When is there a genuine termination?

[6.310] “Termination” is defined as including cessation of employment due
to retirement, as well as cessation of employment due to the taxpayer’s death:
s 80-10 of the ITAA 1997. In most cases, it will be clear whether there is a
termination of employment. For example, where a taxpayer receives a payment
upon his or her redundancy, there will have been a termination of employment.
Where a worker dies and his or her spouse receives a payment, there will have
been a termination of employment. However, in a limited number of cases, it
might be unclear whether there has been a genuine termination.
Case study 6.26: Fixed-term position made permanent not regarded as

“termination”
In Grealy v FCT (1989) 20 ATR 403, a university lecturer was on a fixed-
term contract. Before this contract ended, it was terminated and the
lecturer was given a permanent position by the same employer. The
Court
held that there had not been a “termination” of employment.
Case study 6.27: Termination and re-employment a few days later may

not be genuine
In the case of Reseck v FCT (1975) 5 ATR 538, discussed in Case Study
[6.18], a construction worker had his job terminated on Friday and was re-
employed the following Monday by the same employer, but on a different
construction site.
For certain legal reasons, the Court had to accept that the termination
was genuine. All the Court was asked to do was to decide whether the
payment was “in consequence” of a termination. The Court decided that
it was. However, Gibbs J did indicate that he was sceptical that there was
a genuine termination, but acknowledged that, for legal reasons, he had
to
accept that there was a genuine termination.
Genuine redundancy payments and early retirement

scheme payments – Div 83
[6.320] To the extent that genuine redundancy payments and early retirement
scheme payments do not exceed the relevant threshold, they are excluded
from being ETPs and are tax free: s 83-170 of the ITAA 1997. However, to
the extent that they are over the relevant threshold, they will be regarded as
forming part of an ETP and will be taxed as such.
What is a genuine redundancy payment?

[6.330] Under s 83-175 of the ITAA 1997, a genuine redundancy payment is a
payment made to an employee due to his or her position being genuinely made
redundant. However, this is limited to the extent that the payment exceeds the
amount that could be reasonably expected to be received if that employee had
voluntarily terminated his or her employment.
Example 6.9: Redundancy payment
Jane works for a bank. Jane was paid a genuine redundancy payout of
$30,000. To the extent the $30,000 is under the relevant threshold (see
[6.360]), it will be tax free.

What is an early retirement scheme payment?

[6.340] Under s 83-180 of the ITAA 1997, an early retirement scheme is a
scheme that satisfies all of the following conditions:
• The scheme is open to all of the employer’s employees who are in the
group that the Commissioner states are entitled to participate in the
scheme.
• The employer’s purpose in having the scheme is to reorganise the
operations in that workplace.
• The Commissioner has approved the scheme as an early retirement
scheme.
However, only the portion of the payment that exceeds the amount that could
be reasonably expected to have been received if that employee had voluntarily
terminated his or her employment is regarded as an early retirement scheme
payment.
Example 6.10: Early retirement scheme payment

Neil works as a production line worker for a clothing manufacturer.
The clothing manufacturer closes part of its operations due to shifting
production offshore.
A likely scenario would be that:
• the Commissioner in writing states that this is an early retirement
scheme; and
• all the production line workers on that production line are
considered to be a group that should be eligible for the
scheme; and
• the purpose of the scheme is to reorganise the workplace in
question.
Subsequent to the Commissioner’s written approval, the employer offers
all employees on that production line $25,000 if they take a redundancy
package. This would be an early retirement scheme. To the extent that
the $25,000 would be under the relevant threshold (see [6.360]), it will be
tax free.

Further conditions for redundancy payments and early

retirement scheme payments
[6.350] Sections 83-175 and 83- 180 of the ITAA 1997 require that, for
payments to be considered redundancy payments and early retirement scheme
payments, as well as fulfilling the above conditions:
• the employee must be dismissed before he or she reaches the
age of 65;
• the payment must represent what would be payable under a normal
commercial arrangement; and
• there must be no arrangement at the time of dismissal that the employee
be re-employed by the employer.
Threshold
[6.360] Redundancy payments and early retirement scheme payments are
not ETPs and are tax free to the extent they are below the relevant threshold:
s 83-170 of the ITAA 1997. To the extent they are above the relevant threshold,
they will usually fall into the definition of ETPs and are taxed accordingly.
The formula for determining the relevant threshold for any given taxpayer is:
Base amount + (Service amount × Year / s of service)
The base amount and service amount are indexed every year. For the 2020–
2021 financial year, the amounts are $10,989 for the base amount and $5,496
for the service amount.
Example 6.11: Taxation of redundancy payments

Katie has worked for her employer for 11 years. She is made redundant
and receives a payment of $80,000 on top of any annual and long service
leave entitlements.
This means that, of the $80,000 genuine redundancy payment:
• The relevant threshold for Katie would be $10,989 + ($5,496 ×
11) = $71,445. This means of the $80,000 genuine redundancy
payment, $71,445 would be tax free and the remaining portion of
the redundancy payment of $8,555 ($80,000 − $71,445) would be
taxable as an ETP.
Calculation of tax payable on ETP

[6.370] If there is an ETP, the next step is to calculate the amount of income
tax payable on the ETP. The amount of tax payable will depend on whether
the ETP is a life benefit termination payment or a death benefit termination
payment. The difference is that a life benefit termination payment is an ETP
given to a living taxpayer whose job has been terminated, whereas a death
benefit termination payment is an ETP given to someone due to the death
of another person (usually a relative): see [6.270]. For example, if a taxpayer
resigns and receives a payout from her former employer of $30,000, it will be
classified as a life benefit termination payment. An example of a death benefit
termination payment would be where a taxpayer dies and the deceased’s
employer pays his spouse $100,000 because of his death.
Where the ETP is taxed at concessional rates the concession is facilitated by a

tax rebate (offset) which effectively lowers the rate of tax. This rebate is used
to reduce the final tax liability for the employee. An important effect of applying
the concession through a tax rebate is that the total amount (less any tax-free
amount) will still be included in assessable income which can influence other
tax components such as the Medicare Surcharge.
An ETP will be taxed as follows:

• Tax-free component: ss 82-10(1), 82-65(1) and 82-70(1) of the ITAA
1997. The tax- free component will include the following amounts
(s 82-140):
1. The portion of the ETP that is attributable to pre-
1 July 1983
employment: s 82-155. For example, if the taxpayer has worked for
his employer from July 1979 to July 2019, it might be reasonable to
assume that 10% of an ETP is due to his pre-1 July 1983 employment
and is tax free. This is because, of his 40 years of employment, four
are due to the pre-1 July 1983 period.
2. The portion of an ETP that is due to a taxpayer’s invalidity, referred to
in the legislation as an “invalidity segment”: s 82-150. For example,
if a taxpayer becomes permanently disabled due to a work injury,
an ETP received as a result will be tax free. Specifically, the portion
of an ETP that constitutes an “invalidity segment” is one:
(a) that is paid to a taxpayer due to the taxpayer being unable to
work because of his or her ill-health;
(b) where the taxpayer’s inability to work occurred before the age
of 65; and
(c) where two medical doctors certify that the taxpayer is unlikely
to ever be able to be employed for the position that he or she
is reasonably qualified to work.
Under s 82-150(2), the legislation puts a limit as to what portion
of the ETP can constitute an invalidity segment. This cap is
based on how many years of employment income the taxpayer

has lost due to his or her invalidity.
• Taxable component: Any portion of the ETP that is not a tax- free
component will be a taxable component: s 82-145. How the taxable
component is taxed depends on whether the ETP is a life benefit
termination payment or a death benefit termination payment. The
taxable component of a life benefit termination payment will be taxed
at the rates shown in Table 6.1: s 82-10.
Table 6.1 Taxable component of life benefit termination payment
ETP taxable
Taxpayer is at preservation Taxpayer is below preservation
component
age or older: see Table 18.2 age: see Table 18.2
amount
Taxed at normal marginal tax Taxed at normal marginal tax
0 = threshold rates but capped at a rate of rates but capped at a rate of 30%
15% plus 2% Medicare levy plus 2% Medicare levy
Amounts over Taxed at 45% plus 2% Taxed at 45% plus 2% Medicare
the threshold Medicare levy levy
The threshold applied in Table 6.1 will be the lower of the following two
amounts (s 82-10(4)):
• $215,000: This figure is indexed annually and is correct for the 2020–
2021 financial year.
• A $180,000 “whole-of-income cap” which is reduced by any non-ETP
taxable income of the taxpayer. This figure is fixed by legislation and
not annually indexed. Furthermore, this amount cannot be reduced
below zero. However, this threshold is unaffected by and is inapplicable
to any of the following excluded amounts (s 82-10(6)):
– Genuine redundancy payments: see [6.330]. This includes payments
that are not strictly speaking genuine redundancy payments because
the taxpayer is 65 or older, but would have been genuine redundancy
payments had the taxpayer been under 65. Note that this particular
exclusion applies to the full genuine redundancy payment, not only
the part which is under the threshold discussed in [6.360].
– Early retirement scheme payments: see [6.340]. This includes

payments that are not strictly speaking early retirement scheme
payments because the taxpayer is 65 or older, but would have been
early retirement payments had the taxpayer been under 65. Note that
this exclusion applies to the full early retirement scheme payment,
not only the part which is under the threshold discussed in [6.360].
– An amount that includes an invalidity segment: see the earlier

discussion in this paragraph. This includes payments that are not
strictly speaking invalidity segments because the taxpayer is 65 or
older, but would have been an invalidity segment had the taxpayer
been under 65.
– Compensation received due to employment disputes relating to
personal injury, harassment, discrimination or unfair dismissal to
the extent that such amount exceeds what the employee would
have received had they voluntarily resigned in the absence of such
a dispute.
– Death benefit payments: see the earlier discussion in this paragraph.
However, note that if the taxpayer receives an ETP that has both excluded
and non- excluded components, the taxpayer is deemed to have received
the excluded component first (s 82-10(7)) and considered only against the
$215,000 cap. Also, because both non-excluded and excluded amounts have
been received, it is necessary to determine whether the $215,000 or the
$180,000 caps apply to the non-excluded ETPs. Therefore, the $215,000 cap
is first reduced by any excluded amount that has already been applied against
this cap (s 82-10(4)). An important effect of these rules is that the total amount
of an ETP payment that is capped at the lower rate (15% or 30%, depending on
age, plus Medicare levy) will not exceed $215,000: see Example 6.16.
Example 6.12: ETP calculation
Nick aged 53 (under preservation age) resigns from his work and receives
a payment of $50,000. He has already earned $160,000 in salary and
investment income for the financial year.
The full $50,000 is regarded as an ETP. Although the $50,000 is less than
the $215,000 threshold, the $180,000 “whole-of-income cap” must be
reduced by the $160,000 taxable income (from salary and investment
income) that Nick has received, meaning that the cap is in effect only
$20,000 ($180,000 − $160,000). Since this $20,000 cap is less than the
$215,000 threshold, the $20,000 cap is the one that applies. This means
that the first $20,000 of Nick’s ETP will be capped at the tax rate in
Table 6.1 at 30% plus Medicare levy (as Nick is under preservation age).
The remaining $30,000 will be taxed at 45% plus Medicare.

Nathan is aged 51 (under preservation age) and made redundant from
his employment in a bank where he has been working for 11 years. He
receives a genuine redundancy payment under s 83-175 of $161,445 in
the current year on top of his annual and long service leave entitlements.
Had he resigned voluntarily, he would have received only $30,000 (on
top of his annual and long service leave entitlements), leaving the rest of
the payment as a genuine redundancy payment under s 83-175. For the

financial year so far, Nathan received a salary of $250,000 and did not
have any deductions.
Nathan’s termination payment can be viewed as consisting of the
following amounts:
• $30,000 is an ETP as he would have received this amount if he
resigned and was not made redundant.
• $131,445 ($161,445 − $30,000) balance is a genuine redundancy
payment and not an ETP. As Nathan has been working in this
job for 11 years, $71,445 ($10,989 + ($5,496 × 11)) of this is tax
free (see [6.360]). The remaining $60,000 ($131,445 − $71,445)
is taxable as an ETP, though it is still regarded as a genuine
redundancy payment.
The total amount regarded as an ETP is therefore $90,000 ($30,000 +
$60,000).
The $60,000 portion of the ETP is an excluded amount due to it being a
genuine redundancy payment. Consequently, it is deemed to have been
received first (s 83-10(7)). As it is an excluded amount, the “whole-of-

income cap” does not apply to it, and only the $215,000 threshold will be
relevant. As the $60,000 is less than the $215,000 threshold, the amount
of tax on the $60,000 is capped at 30% plus Medicare levy because
Nathan is under his preservation age (as, below the preservation age): see
Table 6.1.
In addition, the $30,000 portion of the ETP will potentially be subject to
both thresholds. First, the $180,000 “whole-of-income cap” is reduced
(but not below zero) by the $250,000 salary he received for the financial
year, meaning that this cap becomes zero. Second, the $215,000
threshold will be reduced by the $60,000 portion of the ETP payment
(genuine redundancy excluded amount that is not tax free) reducing it to
$155,000. Since the “whole-of-income cap” amount of zero is the lower
of the two, it will be the applicable threshold. This means that the whole
$30,000 amount will have breached this threshold and so will be taxed at
the rate of 45% plus Medicare levy: see Table 6.1.

Amelia works for a major department store and is 61 years of age (above
preservation age). She resigns and receives a payout of $178,000, and
she has $5,000 of salary income for the financial year.
The full $178,000 is regarded as an ETP.

The $180,000 “whole- of-
income cap” is reduced to $175,000 as
Amelia has earned other income ($5,000) for the financial year. As the
$175,000 “whole-of-income cap” is lower than the $215,000 threshold,
the $175,000 threshold will apply. This means that the first $175,000 of
Amelia’s ETP is capped at 15% plus Medicare levy (as, she is over the
preservation age). The remaining $3,000 is taxed at the rate of 45% plus
Medicare levy: see Table 6.1.

William is aged 48 (under preservation age) and works for a car importer.
He loses his job and initially receives $65,000 from his employer for
ceasing employment (this did not qualify as a genuine redundancy
termination payment). This $65,000 is on top of his annual and long
service leave entitlements. He then sues his employer for unfair dismissal,
is successful, and so receives damages of an additional $100,000. William

has received other taxable income for the financial year (his salary) of
$150,000.
The full $165,000 ($65,000 + $100,000) is considered an ETP.
The $100,000 is excluded from the $180,000 “whole-of-income cap” as it
is compensation for unfair dismissal. Consequently, it is deemed to have
been received first (s 83-10(7)), and only needs to be applied against the
$215,000 threshold. As the $100,000 is below the $215,000 threshold it
would be capped at 30% plus Medicare levy: see Table 6.1.
The $65,000 portion of the ETP will be offset against the lower of the two
thresholds. First, the “whole-of-income cap” is reduced from $180,000
to $30,000 due to the non- ETP taxable income of $150,000. Second,
the $215,000 threshold is reduced by $100,000 to $115,000 due to the
$100,000 portion of the ETP. As the $30,000 is the lower of these two
amounts, this is the threshold that would be applicable to the $65,000
portion of the ETP. This means that $30,000 of the $65,000 is capped at
30% plus Medicare levy, whereas the remaining $35,000 would be taxed
at the top tax rate: see Table 6.1.

Example 6.16: Redundancy payment
Mia is aged 66 (above preservation age) and works for an electronic parts
distributor. Due to illness, she becomes unable to work and resigns. Her
work pays her $60,000 which is what she would have received had she
resigned under any situation (this $60,000 is on top of her annual and long
service leave entitlements), and an additional $160,000 as an invalidity
payment. Before her illness Mia had earned taxable income of $70,000
(her salary) for the financial year.
Although the full $220,000 ($160,000 + $60,000) is regarded as an ETP,
the $160,000 invalidity payment is excluded from the “whole-of-income
cap”. This is despite the fact that none of the invalidity payment is tax-free
due to Mia being 66 years old (over 65).
The $160,000 excluded portion of the ETP is dealt with first as it is deemed
to have been received first (s 83-10(7)) and only needs to be tested against
the $215,000 threshold. As the $160,000 is below the $215,000 threshold,
it is capped at the rate of 15% plus Medicare levy: see Table 6.1.
The remaining $60,000 is potentially subject to the two thresholds. First,
the “whole-of-income cap” is reduced from $180,000 to $110,000 due
to the $70,000 salary. Second, the $215,000 threshold is reduced due to
the $160,000 portion of the ETP being offset against it. This will mean
that the $215,000 threshold is reduced by the $160,000 to $55,000.

As $55,000 is the lesser of these two thresholds, it will be the relevant
amount. Consequently, $55,000 of the $60,000 will be capped at 15%
plus Medicare levy, and the remaining $5,000 will be taxed at 45% plus
Medicare: see Table 6.1.

[6.380] Taxation of the taxable component of a death benefit termination

payment depends on whether the recipient of the payment is a “dependent”
of the deceased. Under s 302-195 of the ITAA 1997, the recipient will be a
dependent if he or she is:
• the deceased’s spouse or ex-spouse (spouse will also include de facto
and same-sex partners in some circumstances);
• the deceased’s child who is under 18;
• a person who had an “interdependency relationship” with the deceased.
This means someone who the deceased lived with and had a close
personal relationship with. Furthermore, for someone to show he or
she had a “interdependency relationship” with the deceased, it is also
required that at least one of the parties involved provided financial
support and at least one of the parties involved provided domestic
support; or
• anyone else dependent on the deceased before he or she died (this
would cover financial dependence).
The taxable component of a death benefit termination payment is taxed at the
rates shown in Table 6.2: ss 82-65 and 82-70.
Table 6.2 Taxable component of death benefit termination payment

ETP taxable
component Recipient is a dependent Recipient is not a dependent
amount
Taxed at normal marginal tax
Not taxed, except for 2%
$0–$215,000 rates but capped at a rate of
Medicare levy where applicable
30% plus 2% Medicare levy
Taxed at 45% plus 2% Medicare Taxed at 45% plus 2%
$215,000+
levy Medicare levy
The $215,000 threshold in Table 6.2 is indexed annually and is correct for the
2020–2021 financial year.
Payments for unused annual and long service leave – Div 83

[6.390] When an employee has his or her employment terminated, it is normal
for the employee to receive a lump-sum payment for any annual (holiday)
leave and long service leave owing to the employee. These receipts are
assessable as statutory income under s 83-10 of the ITAA 1997 for the annual
leave payments and s 83-80 for the long service leave payments. In many
cases, these provisions provide no tax concession as the annual leave and
long service leave payments are taxed at normal marginal tax rates. However,
under some limited circumstances, a concession in the form of the payments
being capped at the rate of 30% (plus Medicare levy) will apply. Under s 83-15
of the ITAA 1997 (for annual leave) and s 83-85 of the ITAA 1997 (for long
service leave), this will be the case when:
• the payment was due to annual leave or long service leave accrued due
to services performed before 18 August 1993; or
• the payment was in connection with a payment that consists of a
genuine redundancy payment or early retirement scheme payment, or
an invalidity segment of an ETP.
Also, only 5% of any leave accrued prior to 16 August 1978 is subject to tax
(s 83-80).
Example 6.17: Annual and long service leave payment

Jack has worked for his current employee since January 2000 and he
resigns voluntarily. Under the relevant industrial award, he is entitled to
receive $10,000. Furthermore, he receives $12,000 in annual and long
service leave owing to him.
The $10,000 will be assessable as a life benefit termination payment (a
type of ETP) and the $12,000 in leave entitlements will be assessable at

normal marginal tax rates.

Example 6.18: Genuine redundancy and annual leave payment

Jill has worked for her current employee for three years and is made
redundant. She receives a genuine redundancy payment of $6,000, as
well as an ETP of $10,000. She also receives a $9,000 payment for annual
leave that is owed to her:
• The $6,000 will be tax free because it is below the maximum tax
free amount of $25,999 ($10,399 + ($5,200 × 3)).
• The $10,000 will be taxed as a life benefit termination
payment (ETP).
• The $9,000 will be subject to normal marginal tax rates, but will
be capped at the rate of 30% (plus Medicare levy) because it was
paid in connection with a genuine redundancy payment.
Questions
[6.400]
6.1 During the current tax year, Erin received the following amounts:
• Salary and wages income of $98,000.
• $4,200 interest from a bank term deposit of $50,000.
• $500 per week for 50 weeks of the year from a rental property
she owns.
• Winnings of $10,000 on the poker machines.
• $500 from selling eggs that her chickens laid to friends.
• A holiday bonus of $1,000 from her employer.
• A watch worth $200 from a happy client.
What is Erin’s ordinary income for the current tax year?
6.2 Jane and Sally are employed school teachers who have a very wide
general knowledge. Both decide to enter a television quiz program
called “Lease of the Decade”. Under the rules, contestants receive $100
for each appearance, but if questions are answered correctly, they
receive substantial cash prizes and other prizes, such as household
items and holiday packages. The holiday packages cannot be
transferred or redeemed, but the organisers of the program allow them
to be converted into alternative venues and accommodation.
Jane and Sally go on the show but Jane is eliminated in the first contest
and receives her $100. Sally, however, makes 10 appearances. She

wins cash prizes of $50,000, household appliances worth $20,000 and
a trip to Europe with her family valued at $30,000.
Discuss the assessability of these prizes.
6.3 Hilary is a well-known mountain climber. The Daily Terror newspaper
offers her $10,000 for her life story, if she will write it. Without the
assistance of a ghost writer, she writes a story and assigns all her right,
title and interest in the copyright for $10,000 to the Daily Terror. The
story is published and she is paid. She has never written a story before.
She also sells the manuscript to the Mitchell Library for $5,000 and
several photographs that she took while mountain climbing for which
she receives $2,000.
Discuss whether or not the three payments are income from personal
services. Would your answer differ if she wrote the story for her own
satisfaction and only decided to sell it later?
6.4 George is manager of Newcastle Steel Ltd. His contract is for 10 years. In
the third year, George enters into a restrictive covenant which provides
that during the remainder of his contract he must not reveal to another
party the confidential information of his employer. It further provides
that he must not work for a competitor during the remainder of the
employment agreement. Consideration for entering into the agreement
is $40,000. Is this capital or income in George’s hands?
6.5 A well-known television personality was paid a lump sum of $400,000
to encourage her to join a new television network. She accepted the
offer and received an annual salary of $100,000 in addition to the lump-
sum payment.
Discuss whether both the $400,000 and the $100,000 receipts are
assessable income.
6.6 Consider the following situations and discuss whether or not they are
income in ordinary concepts:
• A cash prize for being the best student in income tax law received by
a student who also receives a Youth Allowance from the government.
• A gratuity (not being superannuation) received by a widow from
her husband’s former employer in recognition of her husband’s
services.
• An honorarium received by a student for acting as honorary
secretary of a small country town football club.
• A bonus received by an employee for a suggestion adopted by the
management.
6.7 Jane teaches company law at a regional university. For many years
she has had a passionate interest in amateur theatricals. She has
performed with several local groups. On 30 December Arthur asked
Jane if she would be interested in performing in the next production
of the group with which he performs. Jane, who has several weeks
free from performing, eagerly agrees. Jane has only worked with this
group once before, six years ago. After the last performance, Charles,
the producer of the play, handed Jane an envelope which she assumes
contains a thank-you card for performing in the play. Jane opened the
envelope late the next morning and discovered that, in addition to a
thank-you card, there is a cheque for $49.28 for participating in the
production. Jane has never before been paid for appearing in any of
the 60 productions in which she has been involved. Jane endorsed the
cheque to her landlord as part-payment of her rent. Advise Jane of her
income tax liability with respect to $49.28.
6.8 Frederick has been out of work for the past five years, and he has been
using the Findjobs Ltd employment agency for the past 12 months to
find employment. In April of this year a new case manager, Albert, was
given the task of finding Frederick a job. In a matter of 10 days Albert
had Frederick a permanent job. In gratitude, Frederick bought a $1,000
gold watch (it was a very good job he landed) and gave it to Albert as a
mark of his appreciation.
Advise Albert as to whether this gift is assessable income.
6.9 Nadia is an accountant in a large accounting firm. She is on a three-

year contract, which still has two years to go. Her official job title is
“Manager” and under her contract she is entitled to her own private
office.
• Nadia is offered $6,000 if she changes her job title to “Senior
Accountant”, with no change in pay or length of the contract. She
is also offered $4,000 by her employer if she agrees to give up her
private office. She agrees to this.
• Advise Nadia as to her income tax liability with respect to the $6,000
and $4,000 payments.
6.10 Dan is made redundant from his job that he has been working for
four years and receives $50,000 as a genuine redundancy termination
payment. Before the redundancy, Dan had earned $120,000 for the
tax year.
Advise Dan as to the tax implication of receiving the $120,000.
6.11 Bev is dismissed from her job and receives a $80,000 redundancy
amount (not a genuine redundancy termination payment). She then
sues her ex-employer for unfair dismissal and settles for $140,000.
As the dismissal was early on in the tax year, she had only received
$20,000 in salary for the year.
Advise Bev as to the tax implications of the receipts of the $80,000 and
$140,000 amounts.
6.12 Karen has been working in the same place for 15 years and made
redundant. She receives a genuine redundancy payment of $200,000,
after earning a salary of $90,000 in the current year. Upon her

redundancy, she also receives accrued unpaid leave of $80,000.
Advise Karen as to the tax implications of the $200,000 and $80,000
amounts.
7
Fringe benefits tax
Key points...................................................................................................... [7.00]
Introduction.................................................................................................. [7.10]
Definition of fringe benefit........................................................................... [7.20]
Benefit..................................................................................................... [7.30]
Provided during the year of tax............................................................. [7.40]
Employer, associate or third-party arranger......................................... [7.50]
Employee or associate........................................................................... [7.60]
In respect of the employment of the employee................................... [7.70]
Exclusions...................................................................................................... [7.80]
Categories of fringe benefits....................................................................... [7.90]
Car fringe benefits –Div 2.................................................................... [7.100]
Exempt benefits....................................................................................... [7.110]
Taxable value........................................................................................... [7.120]

Debt waiver fringe benefits –Div 3..................................................... [7.150]
Taxable value........................................................................................... [7.160]
Loan fringe benefits –Div 4................................................................. [7.170]
Exempt benefits....................................................................................... [7.180]
Taxable value........................................................................................... [7.190]
Expense payment fringe benefits –Div 5........................................... [7.200]
Exempt benefits....................................................................................... [7.210]
Taxable value........................................................................................... [7.220]
Meal entertainment fringe benefits –Div 9A...................................... [7.230]
Taxable value........................................................................................... [7.240]
Property fringe benefits –Div 11......................................................... [7.250]
Exempt benefits....................................................................................... [7.260]
Taxable value........................................................................................... [7.270]
Residual fringe benefits –Div 12......................................................... [7.280]
Exempt benefits....................................................................................... [7.290]
Taxable value........................................................................................... [7.300]
Exempt fringe benefits............................................................................... [7.310]
Minor benefits –s 58P.......................................................................... [7.320]
Work-related items –s 58X.................................................................. [7.330]
Membership fees and subscriptions –s 58Y...................................... [7.340]
Single-trip taxi travel –s 58Z............................................................... [7.350]
Reductions in taxable value....................................................................... [7.360]

In-house fringe benefits....................................................................... [7.370]
Recipient’s contribution....................................................................... [7.380]
Otherwise deductible rule.................................................................... [7.390]
Type of fringe benefit................................................................................. [7.400]
Fringe benefits taxable amount................................................................. [7.410]
FBT liability................................................................................................. [7.420]
Interaction with income tax....................................................................... [7.430]
Employer.............................................................................................. [7.430]
Employee.............................................................................................. [7.440]
Interaction with GST.................................................................................. [7.450]
Questions..................................................................................................... [7.460]

Key points
[7.00]
• Fringe benefits tax is a different type of tax as it is imposed on the
provision of fringe benefits, rather than the derivation of income.
• Liability for fringe benefits tax is imposed on employers, not employees.
• A “fringe benefit” arises where an employer provides an employee
with a benefit, directly or indirectly, and the benefit is provided due to
the employment relationship.
• There are 13 categories of fringe benefits, and the calculation of the
fringe benefits tax liability arising in relation to a particular fringe benefit
will depend on its category.

• A number of benefits do not attract fringe benefits tax because they
are either excluded from the definition of “fringe benefit” or specifically
made exempt by the fringe benefits tax legislation.
• Fringe benefits tax paid by an employer and the cost of providing a
fringe benefit are generally deductible to the employer for income tax
purposes.
• The receipt of fringe benefits by an employee is either exempt or non-
assessable, non-exempt income to the employee.
Introduction
[7.10] The introduction of a fringe benefits tax (FBT) was announced by then
Treasurer, the Hon Paul Keating, on 19 September 1985 and came into effect
on 1 July 1986. FBT was introduced to tax the provision of fringe benefits (ie,
benefits other than salary) by employers to employees. At the time it was
estimated that almost 20% of the total remuneration of senior white-collar
7: Fringe benefits tax [7.10] 185
employees comprised benefits other than salary: Reform of the Australian Tax

System, Draft White Paper (AGPS, Canberra, 1985) at 96. The introduction of
s 26(e) of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936) (now s 15-2
of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997)) (see [6.190]–[6.240])
was inadequate in capturing all non-cash benefits provided by employers to
employees within the tax system. In particular, the section did not capture
benefits provided to associates of employees (eg, spouses) and included in
the employee’s assessable income “the value to the taxpayer” of the benefit,
which is a subjective assessment. As will be seen, the FBT regime has a very
wide scope and captures all benefits provided in an employment context. It
is through the exclusions (see [7.80]) that some employment benefits, such
as salary, are subject to income tax in the employee’s hands. There are also
a number of exemptions that exclude certain employment benefits from tax
altogether.
FBT is a different type of tax in that it is a tax that is imposed on the provision of
fringe benefits, rather than the derivation of income. As discussed in Chapter
3, separate legislation is required for the imposition of different taxes. The
provisions regarding FBT are contained in the Fringe Benefits Tax Assessment
Act 1986 (Cth) (FBTAA) and the Fringe Benefits Tax Act 1986 (Cth).
A key difference between income tax and FBT is the taxpayer. FBT is imposed
on the employer, not the employee: s 66(1) of the FBTAA. As such, tax is
imposed on the provision of fringe benefits, not on the receipt of them. The
imposition of FBT on the employer rather than the employee reduces the
administrative burden as there are far fewer employers than employees.
A second difference between the FBT system and the income tax system is the
tax year. Unlike the income tax year, which is from 1 July to 30 June, the FBT
year is from 1 April to 31 March: see definition of “year of tax” in s 136(1) of the
FBTAA. The very first FBT year was a transitional year of only nine months for
the period 1 July 1986 to 31 March 1987. The different FBT year spreads the
tax compliance burden to a different time in the year, ensuring that taxpayers
and tax agents are able to meet their income tax and FBT obligations in a timely
manner.
The FBT legislation adopts a largely prescriptive and methodical approach

to determining the FBT consequences of a transaction. For example, the
legislation specifies what constitutes a fringe benefit, whether or not it is
subject to FBT, the value of the fringe benefit for FBT purposes and the method
of calculating the FBT liability. This step-by-step approach should be adopted
when determining the FBT consequences of a transaction. Figure 7.1 provides
an overall guide to dealing with the tax consequences arising on the provision
of fringe benefits.
Definition of fringe benefit

[7.20] The term “fringe benefit” is defined in s 136(1) of the FBTAA and is
central to the imposition of FBT.
The first part of the definition provides that a fringe benefit exists, where
there is:
• a benefit: see [7.30];
• provided during the year of tax: see [7.40];
• by an employer, associate or third-party arranger: see [7.50];
• to an employee or an associate: see [7.60];
• in respect of the employment of the employee: see [7.70].
This very broad definition of “fringe benefit” essentially captures all benefits
provided by an employer to an employee, whether or not the benefits are
convertible to money. Importantly, the definition then excludes a number of
specific employment benefits (such as salary) from being “fringe benefits”: see
[7.80]. Note that FBT only applies to benefits received in an employment context.
Any benefits provided in the context of other working arrangements, such as
where independent contractors are engaged or partners in a partnership, will
fall outside the scope of FBT.
Benefit
[7.30] The term “benefit” is defined in s 136(1) of the FBTAA and includes any
right, privilege, service or facility provided under an arrangement in relation to
the performance of work. This definition is very wide and is likely to capture
most benefits provided by an employer to an employee, whether of a monetary
or non-monetary nature.
As we will see at [7.90], the legislation identifies a number of specific categories

of fringe benefits (such as private use of an employer-provided car and loans)
but there is an important final category, residual benefits (see [7.280]), which
captures any benefits that do not fall within the specific categories and ensures
the broad scope of the term “benefit”. Section 6 of the FBTAA confirms this
by providing that the specific categories of fringe benefits do not limit the
generality of the expression “benefit”.
While the scope of the term “benefit” is certainly broad, it is not unlimited.
In Slade Bloodstock Pty Ltd v FCT (2007) 68 ATR 911 (see Case Study [7.4]),
the Full Federal Court suggested that, where an employee makes a loan to
an employer, the repayment of the loan by the employer to the employee, in
whole or in part, is unlikely to constitute a “benefit” (to the employee) under
the definition of “benefit” in s 136(1) which includes a right, benefit, privilege,
service or facility that is provided under an arrangement for, or in relation to,

the lending of money.
Provided during the year of tax

[7.40] FBT is imposed annually and tax is imposed on fringe benefits provided
during, or in reference to, a particular FBT year –that is, 1 April to 31 March.
The term “provide” is defined in s 136(1) of the FBTAA. In relation to benefits,

it includes “allow, confer, give, grant or perform” and, in relation to property,
the disposal of a beneficial interest in or legal ownership of the property.
This definition is generally consistent with the common meaning of the term.
A benefit may also be deemed to be provided, where the benefit is prohibited
but the prohibition is not consistently enforced: s 148(3). For example, where
an employee is prohibited from using an employer-provided car for private
purposes but the employer “turns a blind eye”, the private use of the car is a
fringe benefit (see [7.100]) deemed to be provided by the employer per s 148(3).
Section 148(4) further specifies that a benefit that is received or obtained by an
employee in respect of employment is deemed to be “provided”. This ensures
that fringe benefits that are supplied to an employee by a party other than the
employer (see [7.55]–[7.58]) are nonetheless “provided” by the employer.
Case study 7.1: Meaning of “provide”

In Westpac Banking Corporation v FCT (1996) 34 ATR 143, Hill J considered
the meaning of “provide” in an FBT context. The taxpayer usually

charged its customers a loan establishment fee when entering into a loan
arrangement. However, the fee was waived in the case of loans made to
employees. The taxpayer argued that the definition required a positive
act for a benefit to be “provided”. The non-imposition of a fee could not
be said to be a benefit “provided” by the taxpayer. The Federal Court
accepted the Commissioner’s argument that the taxpayer had “provided”
its employees with a benefit –that is, the review and assessment of the
employee’s
loan application for no fee.
Employer, associate or third-party arranger

[7.50] “Employer” is defined in s 136(1) of the FBTAA as a person who pays,
or is liable to pay, “salary or wages”. “Salary and wages” is discussed at [7.85].
Section 137 ensures that the FBT legislation applies in situations where there
is a clear employment relationship, but the employee is remunerated with
non-cash benefits instead of salary or wages. In other words, an employer

cannot escape being an “employer” under the FBT legislation by not paying an
employee salary and wages but providing non-cash benefits instead.
The definition includes current, former and future employers, but excludes the
Commonwealth or an authority of the Commonwealth. A “future employer” is
a person who will become a current employer, while a “former employer” is
a person who has been a current employer: s 136(1). The scope of past and
future employment relationships is discussed further at [7.60] in the context of
the definition of “employee”.
[7.55] It is important to note that a benefit does not have to be provided by

an employer to an employee directly to qualify as a fringe benefit. Benefits
provided by an associate of the employer may also qualify as a fringe benefit
provided by the employer. The definition of “associate” in s 136(1) refers to
s 318 of the ITAA 1936 and s 159 of the FBTAA.
Where the employer is a “natural person”, the employer’s associates include:

• relatives;
• a partner of the employer and their spouse or child;
• a partnership in which the employer is or was a partner;
• trustees of trusts where the employer or the employer’s associates
may be a beneficiary; and
• companies formally or informally controlled by the employer (formal
control refers to a majority voting power in the company while informal
control refers to situations where the directors of a company usually

act in accordance with the employer’s directions).
“Relative” is defined in s 995-1 of the ITAA 1997 as a person’s spouse or
that person’s parent, grandparent, sibling, uncle, aunt, nephew, niece, lineal
descendant or adopted child of that person or that person’s spouse. The
spouse of any of these people is also a relative. “Spouse” is defined in s 995-1
to include de facto and same sex relationships.
Where the employer is a “company”, its associates include:

• a partner (and their spouse or child if the partner is a natural person);
• a partnership in which the employer is or was a partner;
• companies which formally or informally control the employer;
• companies which are formally or informally controlled by the
employer; and
• sister companies (ie, companies with the same parent company).
Section 159 specifies when authorities of the Commonwealth, a State or
Territory are associates.
Example 7.1: Fringe benefits from associates

Company A and Company B are part of the same wholly-owned group,
that is, they are owned by the same parent company. Jack is an employee
of Company A. Under the terms of his employment contract, he is entitled
to a 25% discount on goods purchased from Company B.
The provision of the goods at a discount by Company B qualifies as a
fringe benefit provided by Jack’s employer (Company A) to Jack, as
Company B is an associate of Company A under s 318 of the ITAA 1936.

[7.58] Fringe benefits can also be provided by an employer to an employee

indirectly through third-party arrangements. Although the benefit is provided
to the employee by a third party, it qualifies as a fringe benefit from the
employer to the employee where the third party does so under an arrangement
with the employer. Note that the employer must “participate in or facilitate
the provision or receipt of the benefit” for the benefit to qualify as a fringe
benefit: see para (ea) of the definition of “fringe benefit” in s 136(1) of the
FBTAA. Paragraph (ea) was introduced following Payne v FCT (1996) 32 ATR
516: see Case Studies [6.16] and [6.18]. In Ruling TR 1999/6, the Commissioner
confirms that frequent flyer points earned by an employee for work-related
travel do not constitute a fringe benefit as they have not been provided by an
employer, associate of the employer or a third-party arranger. The frequent
flyer points do not arise out of an arrangement entered into by the employer
with the airline, but are due to a private arrangement between the employee
and the airline.
Example 7.2: Fringe benefits from a third party

Big Bank waives the home loan application fees for all university employees
and provides them with a discount of 0.5% on the home loan rate it offers
all other customers. It waives the application fee as it considers university
employees “low risk” and it provides the discounted home loan rate due
to an arrangement with the university whereby, in return, the university
agreed to deal exclusively with Big Bank.
The waiver of loan application fees does not qualify as a fringe benefit
as it does not arise through an arrangement between Big Bank and the
university but is a unilateral action by Big Bank. The provision of the
discounted home loan rate qualifies as a fringe benefit provided by
the university to its employees as it arises under an arrangement between
Big Bank and the university and has therefore been facilitated by the
university.

Example 7.3: Fringe benefits from third party under arrangement

Jack is an employee of Company A. Under the terms of his employment
contract, he is entitled to a discount for goods purchased from various
retailers, such as Coles and Woolworths, pursuant to agreements in place
between Company A and those retailers.
The provision of goods at a discount by Coles and Woolworths qualifies
as a fringe benefit provided by Jack’s employer (Company A) to Jack
as the discount has been provided pursuant to an arrangement between
Company A and the retailers.

As mentioned at [7.40], s 148(4) ensures that fringe benefits that are supplied
by an associate of the employer or a third party are nonetheless “provided”
by the employer for the purposes of the FBT legislation. In this chapter, any
reference to the provision of fringe benefits by an employer is intended to also
include the provision of fringe benefits by associates of the employer or third-
party arrangers.
Employee or associate
[7.60] An “employee” is someone who receives salary and wages and
includes current, former and future employees: s 136(1) of the FBTAA. The
term “salary and wages” is discussed at [7.85].
A “future employee” is a person who will become a current employee, while

a “former employee” is a person who has been a current employee: s 136(1).
The extension of the definition of “employee” to cover former and future
employees ensures that benefits provided prior to the commencement of
employment (eg, sign-on bonuses) or provided to former employees as a result
of the former employment relationship (eg, low interest loans) are captured by
the FBT legislation. In Ruling MT 2016, the ATO confirms that a person will
only qualify as a future employee if it can be said that the person will (not may)
become an employee at the time the benefit is provided.
[7.65] A fringe benefit can also arise where the benefit is not provided to
an employee directly, but to an associate of an employee. This aspect of FBT
overcomes a limitation of s 15-2 of the ITAA 1997 (previously s 26(e) of the
ITAA 1936), which only captures the provision of benefits to an employee
directly. The meaning of “associate” was discussed at [7.55]. A person will
also be deemed to be an “associate” of the employee, where a benefit is
provided to the person due to an arrangement between the employer and
the employee: s 148(2). For example, where a benefit is provided to a friend
of an employee, the friend is not an “associate” of the employee under the

definition of “associate”, but is deemed to be an associate per s 148(2) of
the FBTAA.
Example 7.4: Provision of fringe benefits to associates

Simon is an employee of Company A. Under the terms of his employment
agreement, he and his wife are entitled to one free interstate trip per year.
The provision of the free trip to Simon’s wife qualifies as a fringe benefit as
it is provided by Simon’s employer, Company A, to his associate –his wife.

The term “recipient” is used in this chapter to refer to an employee or an

associate of an employee. Note that in order to constitute a fringe benefit, the
benefit provided must relate to a particular employee: Essenbourne Pty Ltd
v FCT (2002) 51 ATR 629; FCT v Indooroopilly Children Services (Qld) Pty Ltd
(2007) 158 FCR 325.
In respect of the employment of the employee

[7.70] Finally, and most importantly, the benefit must be provided in respect
of the employee’s employment to qualify as a fringe benefit. As well as the
exclusions and exemptions, this is one of the key features of the FBT regime,
which ensures that only targeted benefits are subject to FBT. The definition
of “in respect of” in s 136(1) of the FBTAA specifies that, to qualify as a fringe
benefit, the benefit must be provided “by reason of, by virtue of, or for or in
relation directly or indirectly to, that employment”.
While most benefits provided by an employer to an employee would generally

be provided in respect of employment, this is not necessarily always the
case and the scope of this nexus requirement has been the subject of judicial
consideration. In J & G Knowles & Associates Pty Ltd v FCT (2000) 44 ATR 22,
the Full Federal Court said:
The words “in respect of” have no fixed meaning. They are capable of having a very
wide meaning denoting a relationship or connection between 2 things or subject
matters. However, the words must, as with any other statutory expression, be given
a meaning that depends on the context in which the words are found … [W]‌hat is
required is a sufficient link for the purposes of the particular legislation. It cannot
be said that any causal relationship between the benefit and the employment is a
sufficient link so as to result in a taxable transaction.
Their Honours proceeded to suggest that, for the benefit to constitute a fringe
benefit, there must be a “sufficient and material relationship” between the
employment and the provision of the benefit.
Case study 7.2: “In respect of the employment”

In J & G Knowles & Associates Pty Ltd v FCT (2000) 44 ATR 22, the taxpayer,
a company, was the trustee of a unit trust. The units in the unit trust
were held by the family trusts of the four directors of the company. The
company permitted the directors to write cheques for personal expenses
on the company’s cheque account and the amounts were treated as
loans to the directors’ family trusts. The directors were employees of the
company for FBT purposes.
The question arose as to whether the loans were provided to the directors
in their capacity as directors and therefore in respect of their employment
(making the loans fringe benefits), or whether the loans were provided
because the directors were the beneficiaries of family trusts (in which case
the loans would not be fringe benefits). The facts pointed in both directions.
The directors drew upon the trust’s assets as these assets were ultimately
held and applied for their benefit, but it was only because of their position
as directors of the company that they were permitted to do so.
The Court remitted the matter to the AAT to re-examine the facts, but
with the benefit of the guidance on the nexus requirement mentioned
above. The AAT found that the loans were not made to the directors in
their capacity as directors but because they were the “ultimate owners
of the business and its assets” and, as such, the loans were not fringe
benefits: Re
J & G Knowles (2000) 45 ATR 1101.
Case study 7.3: Loan to company directors and shareholders not “in

respect of employment”
In Starrim Pty Ltd v FCT (2000) 44 ATR 487, the taxpayer was a company
owned by a husband and wife who were the only shareholders and
directors of the company. The company lent the husband and wife money
to purchase a block of land. The block of land was the site of a business
which had just been purchased by the company and it was therefore
in the company’s interests for the transaction to take place. Lindgren J
concurred with the AAT’s conclusion that the taxpayer had made the loan
because the husband and wife were the purchasers of the property and
not in respect of their employment.
Case study 7.4: Repayments of loans not fringe benefits

In Slade Bloodstock Pty Ltd v FCT (2007) 68 ATR 911, the taxpayer company
provided loans to Mr and Mrs Slade, who were its sole shareholders.
The Slades made a series of loans to the taxpayer on the basis that the
taxpayer would repay any amounts owing at call and that the taxpayer
would direct the payments to any parties nominated by the Slades. The
loans represented the taxpayer’s only source of working capital and, over
time, the taxpayer paid a number of the Slades’ private expenses such as
children’s school fees or private credit card balances. These payments
were set off against the amounts owing to the Slades.
The Commissioner assessed the taxpayer for FBT on the basis that the
payments of the Slades’ private expenses (ie, the loan repayments)
constituted fringe benefits. At issue was whether the payments had
been made “in respect of the employment of an employee”. The Slades
accepted that through their actions they were employees of the company,
but contended that the payments were made as a consequence of their
being creditors of the company and not because of the employment
relationship.
The AAT found in favour of the taxpayer but a single judge of the Federal
Court, Heerey J, found in favour of the Commissioner. By the time the case
reached the Full Federal Court, the Commissioner had conceded that the
payments were not in respect of the Slades’ employment as “there was
no material relationship” between the employment and the payments.
In doing so, the Commissioner accepted that the repayment of a loan
owed by an employer to an employee is not a benefit that is provided
in respect of employment, at least where there is a binding obligation to
repay the loan under the loan agreement and the obligation is imposed
without reference to the employment of the lender. In such cases, the
repayments are a product or incident of the creditor/debtor relationship.
The Full Federal Court noted that this position is consistent with the policy
of the FBT legislation, which is to capture benefits that would have been
income
if provided as cash to the employee.
[7.75] The scope of the requirement that the benefit be provided in respect
of the employment of the employee is potentially widened by s 148(1) of the
FBTAA, which states that a benefit is provided in respect of the employment of
the employee regardless of whether the benefit:
• is also provided in respect of another matter or thing;
• relates to past, current or future employment;
• is surplus to the needs or wants of the recipient;
• is also provided to another person;
• is offset by any inconvenience or disadvantage;
• is provided or used in connection with the employment;
• is in the nature of income; and
• is a reward for services rendered or to be rendered by the employee.
In Rulings MT 2016 and MT 2019, the ATO suggests that s 148(1) should not be
read as broadening the scope of FBT beyond the targeted benefits. In Ruling
MT 2016, the ATO states:
Sub-section 148(1) seeks to anticipate arguments that might otherwise be put so
as to narrow the defined meaning of “fringe benefit”. The subsection is based in
part on experiences of difficulties with the practical application of para 26(e) of the
Income Tax Assessment Act 1936 [now section 15-2 of ITAA 1997]. Sub-section
148(1) does not remove in any circumstances, the fundamental requirement that,
before there can be a tax liability, the benefit under consideration has to be provided
in respect of the employment of the employee.
In Ruling MT 2019, the ATO suggests that a benefit provided to an employee
who is also a shareholder will not constitute a fringe benefit if it is provided to
the person solely because they are a shareholder. This is despite the fact that
s 148(1) deems the benefit to be provided in respect of employment.
Despite the ATO’s guidance, the application of s 148(1) remains uncertain. In

FCT v Slade Bloodstock Pty Ltd (2007) 68 ATR 911 (see Case Study [7.4]), Heerey J
found that payments by an employer to its employees, which were loan
repayments arising out of the debtor/creditor relationship, were nonetheless
fringe benefits due to the operation of s 148(1). By the time the case reached
the Full Federal Court, however, the ATO conceded that the payments were not
fringe benefits. Therefore, the operation of s 148(1) was not fully considered by
the Full Federal Court.
It is particularly important to ascertain whether a benefit is provided “in respect

of employment”, where there is another relationship between the employer and
the employee since that other relationship may be the reason for the provision
of the benefit. Essentially, for a benefit to be in respect of the employee’s
employment, the benefit must be provided to the person because he or she
is an employee and not for some other reason. The ATO’s Fringe Benefits
Tax: Guide for Employers (NAT 1054) suggests (at s 1.1) that a useful question
to ask when determining whether a fringe benefit is provided “in respect of
employment” is whether the person would have received the benefit if he or
she were not an employee. Where there is an employment relationship as well
as a family relationship, it is necessary to consider whether the benefits are
provided in an ordinary family setting and would have been a normal incidence
of family relationships.
Example 7.5: Benefit not provided in respect of employment

Kim works in the family business owned by his parents, which imports
furniture from overseas. For his birthday, Kim’s parents gave him an
expensive piece of furniture from the shop.
Although Kim is an employee who has received a benefit from his

employer, the benefit does not qualify as a fringe benefit as Kim did
not receive the benefit in respect of his employment. The benefit was
received by him due to the private, family relationship between him and
his employer.
Source: Adapted from Example 2 (1.1 What is a fringe benefit?) in the
ATO’s Fringe Benefits Tax: Guide for Employers (NAT 1054).

Example 7.6: Benefit not provided in respect of employment

Nora is an employee of Company X. She also owns shares in Company
X, which she purchased because all shareholders are entitled to a 10%
discount on goods sold by Company X. Nora purchases goods from
Company X at a 10% discount.
Although Nora is an employee who has received a benefit from her
employer, the benefit does not qualify as a fringe benefit as Nora did not
receive the benefit in respect of her employment. Rather, the benefit was
received by her in her capacity as a shareholder.

Example 7.7: Benefit provided in respect of employment

Janet is an electrician. She is employed under the terms of a particular
industrial award. The award requires Janet’s employer to reimburse her
for all travel expenses. Janet’s employer reimburses her for her travel
expenses in accordance with the terms of the award.
Although the employer provided the reimbursement due to the terms of
the award, the reimbursement of the travel expenses is a benefit received
in respect of Janet’s employment. The reimbursement would not have
been made if Janet was not an employee.
Source: Adapted from Example 1 (1.1 What is a fringe benefit?) in the
ATO’s Fringe Benefits Tax: Guide for Employers (NAT 1054) (original
document).

Exclusions
[7.80] The definition of “fringe benefit” in s 136(1) of the FBTAA specifically
excludes certain items from being a fringe benefit, including:
• salary or wages (as defined by reference to Sch 1 of the Taxation
Administration Act 1953 (Cth), in particular, s 12-35 of that Schedule);
• superannuation contributions;
• payments from superannuation funds;
• benefits under an employee share scheme; and
• payments on termination of employment.
These items are excluded from the definition of “fringe benefit” as they are
dealt with under the income tax system.
[7.85] “Salary or wages” comprises payments (including commissions,

bonuses or allowances) to employees, company directors and office holders;
Commonwealth education or training payments; and compensation, sickness
or accident payments. These amounts are subject to the PAYG withholding
provisions in Sch 1 of the Taxation Administration Act 1953.
It has been said that the definition of “salary and wages” is “deliberately wide”
(Hill J in Roads & Traffic Authority of NSW v FCT (1993) 26 ATR 76 at 82) and a
wide approach was adopted by the majority of the Full High Court in Murdoch
v Commr of Pay-roll Tax (Vic) (1980) 143 CLR 629. Essentially, “salary and
wages” comprise all amounts paid as a reward for services rendered by an
employee: FCT v J Walter Thompson (Australia) Pty Ltd (1944) 69 CLR 227.
The description of the payment is not determinative, and it is necessary to look
at the substance of the payment to determine its character: Roads and Traffic
Authority of New South Wales v FCT (1993) 26 ATR 76; Ruling TR 92/15.
One issue that often arises in an FBT context is whether a payment to an employee
constitutes an allowance (which is “salary and wages”) or a reimbursement
(which is not “salary and wages”). The term “reimburse” is defined in s 136(1)
of the FBTAA as “any act having the effect or result, direct or indirect, of a
reimbursement”. The scope of the term “reimburse” was considered by Hill J in
Roads & Traffic Authority of NSW v FCT (1993) 26 ATR 76. His Honour said that
“the concept of reimbursement requires that the payment in question be made
by reference to actual cost … [T]‌here would need to be some correspondence
between the payment and the expenditure incurred”. As a general rule, an
amount will constitute an allowance, where it is a predetermined amount to
cover an estimated expense, while a reimbursement is a payment made in
respect of the taxpayer’s actual expenditure: Roads and Traffic Authority of
New South Wales v FCT (1993) 26 ATR 76; Ruling TR 92/15.
Example 7.8: Allowance versus reimbursement

Zhou and Beatrice are both employed by the same company. Under the
terms of his employment agreement, Zhou receives $500 per month to
cover the costs of entertaining clients. Under an industrial award, Zhou
also receives $50 per fortnight to cover his medical insurance premiums.
Zhou is required to provide a letter from the health fund certifying that he
is a member of the health fund, but is not required to provide any further
evidence in relation to the payments.
Under the terms of her employment agreement, Beatrice is entitled to a
payment for her medical insurance premiums up to a limit of $500 per
year. In order to claim the payment, Beatrice is required to provide the
employer with her insurance premium statements verifying the actual
amount incurred by her in relation to the premiums.
The payments made to Zhou for entertaining clients and his medical
insurance premiums are allowances. He receives the amounts
regardless of his actual expenditure. The payments made to Beatrice
are reimbursements –that is, she is compensated for the actual amount
of her medical insurance and cannot make a claim for payment without
documentary evidence. The upper limit of $500 per year does not alter
the character of the payment as it is based on the precise accounting of
actual expenditure.
Source: Adapted from the Example in Ruling TR 92/15.

Allowances are classified as “salary and wages” and are excluded from the
definition of “fringe benefit”; on the other hand, reimbursements are not
excluded from the definition of “fringe benefit”.
Categories of fringe benefits

[7.90] There are 13 categories of fringe benefits in the legislation, and it is

important to determine the appropriate category a fringe benefit falls into as
the FBT consequences arising differ between each category. Each category of
fringe benefit is dealt with by a separate Division in the FBTAA. Each Division
describes when the fringe benefit arises, any exemptions applicable to that
particular category of fringe benefit and the taxable value of the fringe benefit.
Remember that the benefit must constitute a “fringe benefit” as discussed
at [7.20]. In particular, the benefit must be attributable to the employment
relationship.
The following categories of fringe benefits are discussed in detail in this

chapter:
• car fringe benefits: see [7.100];
• debt waiver fringe benefits: see [7.150];
• loan fringe benefits: see [7.170];
• expense payment fringe benefits: see [7.200];
• meal entertainment fringe benefits: see [7.230];
• property fringe benefits: see [7.250]; and

• residual fringe benefits: see [7.280].
The other categories of fringe benefits in the legislation which are less common
and are not discussed in further detail in this chapter are:
• housing fringe benefits: Div 6;
• living-away-from-home allowance fringe benefits: Div 7;
• airline transport fringe benefits: Div 8;
• board fringe benefits: Div 9;
• tax-exempt body entertainment fringe benefits: Div 10; and
• car parking fringe benefits: Div 10A.
Car fringe benefits – Div 2

[7.100] One of the most common types of fringe benefits provided by
employers to employees is a car fringe benefit. A car fringe benefit arises where
an employer provides a car for an employee’s private use: s 7(1) of the FBTAA.
A “car” is defined in s 136(1) (by reference to s 995-1 of the ITAA 1997) as a
motor vehicle designed to carry a load of less than 1 tonne or fewer than nine
passengers. “Motor vehicle” is defined as any motor-powered road vehicle,
including a four-wheel drive vehicle. “Private use” is defined in s 136(1) as any
use of a car by an employee or associate that is not exclusively in the course
of producing assessable income. As a general rule, travel between home and
work is not considered to be in the course of producing assessable income and
would constitute private use: see [12.390]; Ruling MT 2027.
It is important to note that it does not matter whether the employee actually
uses the car for private purposes; a fringe benefit arises as long as the car is
available for private use: s 7(1). This is relevant where the statutory formula
method (see [7.130]) is used to calculate the taxable value of the car as the
formula refers to the number of days the car was provided as a fringe benefit.
For example, a car fringe benefit will arise where the car is garaged at or near
the residence of an employee or an associate of the employee: s 7(2). In AAT
Case 9824 (1994) 29 ATR 1246, the AAT found that a car that was used solely in
a business run from a home was a car fringe benefit under s 7(2) as the car was
garaged at the home. In Determination TD 94/16, the Commissioner suggests
that a car fringe benefit will arise even where the employee is overseas if the
car is garaged at or near the employee’s home during this time. There is an
exception in s 7(2A) for ambulances, fire fighting vehicles and police cars that
are garaged at the employee’s home.
A car fringe benefit will also arise where an employee or an associate of the
employee has custody and control over the car and it is not being used for
employment purposes at the time: s 7(3). Finally, a car fringe benefit can still
arise where the employer prohibits the private use of a car if the prohibition
is not strictly enforced: s 7(4). In Determination TD 94/16, the Commissioner
suggests that the prohibition against private use must be made in clear and
unequivocal terms and a general instruction or understanding between the
employer and employee would be insufficient. The prohibition should be
enforced through disciplinary measures and consistent enforcement such as
checks of odometer readings.
Example 7.9: Car available for private use

John is provided with a car by his employer. John leaves the car in an
airport car park while travelling overseas for work purposes. The car
cannot be left at the employer’s premises as there are no car parking
facilities available there. The airport car park is not in the vicinity of John’s
residence.
If John retains the keys to the car while he is overseas, a car fringe
benefit will arise as he has custody and control over the car. However,
if John’s employer removes control and custody of the car from John
(eg, by taking the car keys) and enforces a prohibition on the private
use of the car by John or his associates, a car fringe benefit will
not arise.
Source: Adapted from the Example in Determination TD 94/16.

Exempt benefits
[7.110] A car fringe benefit will be an exempt benefit, where the car provided
by an employer to an employee is only used for work-related travel and
any private use by the employee or an associate of the employee is minor,
infrequent and irregular: s 8(2) of the FBTAA. Note that, to be exempt, the car
must be a taxi, panel van, utility truck or other road vehicle not designed for
the principal purpose of carrying passengers: s 8(2)(a). A car fringe benefit
will also be exempt where the benefit arises in relation to an unregistered
car: s 8(3).
Any fringe benefits that may arise in relation to the provision of a car fringe
benefit are treated as exempt benefits under s 53. For example, payments for
fuel or repairs by the employer could be considered expense payment fringe
benefits, but are exempt due to the operation of s 53.
Taxable value
[7.120] There are two methods prescribed by the FBTAA for calculating the
taxable value of a car fringe benefit:
• statutory formula method (s 9): see [7.130]; and
• cost basis (s 10): see [7.140].
The statutory formula method applies automatically unless an employer elects
to use the cost basis: s 10(1). An employer can choose either method for each
car that gives rise to a car fringe benefit. An employer’s election to use the cost
basis is automatically disregarded if the statutory formula method results in a
lower taxable value: s 10(5).
[7.130] Statutory formula method (s 9 of the FBTAA). The taxable value of

a car fringe benefit under this method is the amount calculated in accordance
with the following formula:
 Number of days during 

 that year of tax 
  Amount
 on whichthe car fringebenefits 
 (if any )
Base value were provided by the provider 
 0.2 × × − of the
 of the car Number of daays 
  recipient’s
 inthat year of tax  payment
 
 
 

Broadly, the base value of the car will be either its cost (if the car was purchased
by the provider) or the leased car value at the earliest time the provider started
to hold the car (if the car is leased). In either case, the amount is reduced
by one-third if the relevant FBT year commences at least four years after the
provider first started holding the car: s 9(2)(a).
In Taxation Ruling TR 2011/3, the ATO suggests that, in addition to the purchase
price, the “cost” of a car would include any other amounts that are directly
attributable to the acquisition or delivery of the car. For example, dealer
delivery charges would be included in the “cost” of a car, but insurance costs
and extended car warranties would not be included in “cost”.
The recipient’s payment includes amounts paid directly by the employee to the
employer in relation to the car and amounts paid by the employee to a third
party, such as petrol costs, for which the employee was not reimbursed by the
employer.
Example 7.10: Taxable value of car fringe benefit –statutory

formula method
Raj is a troubleshooter for his employer. He visits the company’s various
premises to deal with any problems that may arise. He is provided with
a car for his work travel. The contract for the provision of the car was
entered into on 1 January 2020. Raj is permitted to take the car home at
the end of the day and there is no restriction on his use of the car for non-
work purposes. The car was originally leased by Raj’s employer on 1 July
2014. The leased car value at that time was $45,000. For the current FBT
year, the following expenses were incurred by the company in relation to
the car:
Petrol and oil $3,000

Repairs and maintenance $500
Registration $1,000
Insurance $900
Lease payments $6,000
Raj is required to contribute $50 per month towards the car expenses. He
has determined that the total kilometres travelled by the car for the year
1 April 2020 to 31 March 2021 is 50,000 km (30,000 km related to business
travel).
Note that the payment of the car expenses does not give rise to a separate
fringe benefit: s 53 of the FBTAA.

Statutory formula method:
365
Taxable value = 0.2 × $30,000 × − $600 = $5,400;
365

where:
Base value = leased car value = $45,000, which is reduced by one-third
as the car has been held by Raj’s employer for more than four years.
Number of days in the FBT year when the car is provided as a fringe
benefit. There is no restriction on Raj’s private use of the car and he takes
the car home at the end of the day, which is deemed private use under
s 7(2). As such, it appears that the car fringe benefit was provided for the
entire FBT year.
Number of days in the FBT year. As it is not a leap year, the total number
of days is 365.
Recipient’s contribution = $50 × 12 = $600.

[7.140] Cost basis (s 10 of the FBTAA). The taxable value of a car fringe
benefit using the cost basis is determined as follows:
Taxable value = C × (100% − BP ) − R
where:
C is the operating cost of the car during the holding period;

BP is the business use percentage of the car during the holding period; and
R is the amount of the recipient’s payment (if any).
The operating cost of the car consists of any expenses relating to the car
incurred by the provider or any other person during the holding period.
Examples of such expenses include repairs and maintenance, registration
and insurance attributable to the holding period. Where the car is owned by
the provider, an amount for deemed depreciation and deemed interest is
also included in operating cost (s 11 of the FBTAA describes how deemed
depreciation and interest are calculated). Where the car is leased by the
provider, the leasing costs attributable to the holding period are included in
operating cost: s 10(3)(a)(v).
The “business use percentage” is the percentage of the business kilometres

travelled by the car out of the total kilometres travelled by the car during the
holding period. Business kilometres refers to the number of kilometres on a
“business journey”, which is defined in s 136(1) as any use of the car other than
private use by an employee or associate.
The cost basis may provide a lower taxable value than the statutory formula
method, where the business use percentage of the car during the year is high.
However, log book records and odometer records must be maintained when
using the operating cost method, which increases the compliance burden:
ss 10A and 10B.
Example 7.11: Taxable value of car fringe benefit

Assume the same facts as Example 7.10 and that Raj has maintained the
necessary log book and odometer records.
Cost basis:
Taxable value = (C) $11,400 × (100% − (BP) 60%) − R $600 = $3,960
where:
C = operating cost = $3,000 + $500 + $1,000 + $900 + $6,000 = $11,400;
BP = business use percentage = (30,000/50,000) × 100% = 60%;

R = recipient’s contribution = $50 × 12 = $600.
Comparing Examples 7.10 and 7.11, Raj’s employer should use the cost
basis to determine the taxable value of the car fringe benefit since it
results in a lower taxable value.

Debt waiver fringe benefits – Div 3

[7.150] A debt waiver fringe benefit arises where an employee (or associate)
owes an amount to an employer and the employee (or associate) is released
from his or her obligation to repay all or some of that amount: s 14 of the
FBTAA. The debt must be waived due to the employment relationship and
not for some other reason (eg, because it is irrecoverable) to constitute a debt
waiver fringe benefit.
Taxable value
[7.160] The taxable value of a debt waiver fringe benefit is the amount of the
loan that no longer needs to be repaid: s 15 of the FBTAA.
Example 7.12: Debt waiver fringe benefit

Due to unexpected personal misfortune, Miles was forced to borrow
$30,000 from his employer on 1 September. On 1 January, his employer
informed him that he was only required to repay $20,000 of the loan. The
debt was waived because the employer values Miles as an employee and
wants to reward him for his loyalty.
A debt waiver fringe benefit arises as Miles has been released from his
obligation to repay an amount that is owed to his employer and the waiver
was due to the employment relationship. The taxable value of the debt
waiver fringe benefit is $10,000, being the amount that Miles no longer
has to repay.

Loan fringe benefits – Div 4

[7.170] A loan fringe benefit arises in each year when an employer provides
an employee (or associate) with a loan: s 16 of the FBTAA.
Exempt benefits
[7.180] A loan fringe benefit will be an exempt benefit where the loan is
provided by a person who provides loans to the general public in the ordinary
course of his or her business, and the loan to the employee is provided at
an interest rate at least equal to the interest rate prevailing at that time on
similar loans to the public (eg, a home loan to a bank employee at standard
commercial terms): s 17(1) and (2) of the FBTAA.
A loan fringe benefit will also be an exempt benefit where the loan is essentially
an advance to the employee so that the employee can meet expenses that
are reasonably expected to be incurred by the employee in the next six
months in the course of performing his or her duties of employment: s 17(3)
of the FBTAA.
Finally, a loan fringe benefit will also be exempt where the loan is provided to
enable the employee to pay a rental bond, security deposit in respect of gas,
electricity or telephone services or any similar amount. The employee must
be required to repay the loan amount within 12 months, and the loan must be
provided in conjunction with certain other fringe benefits to be exempt: s 17(4)
of the FBTAA.
Taxable value
[7.190] The taxable value of a loan fringe benefit is determined as follows
(s 18 of the FBTAA):
No of days loan provided during the year

Loan amount × [Statutory interest rate − Actual interest rate ] ×
No of days in FBT year
The statutory interest rate is published by the ATO at the start of each FBT year.
For the FBT year commencing on 1 April 2020, the applicable statutory interest
rate is 4.80% per annum.
Essentially, the fringe benefit represented by the taxable value is the interest
“saved” by the employee in obtaining a loan through the employer, rather
than at commercial market rates. Where the loan is provided at an interest
rate which is equal to or higher than the statutory interest rate, no FBT liability
arises as the taxable value is nil.
Where the loan is provided for only a portion of the FBT year, it is necessary to
adjust the taxable value for the loan period.
Example 7.13: Loan fringe benefit

Company Z provides its employee, Robyn, with a loan of $10,000 on
1 December 2020 at no interest. Robyn has not repaid any amount of
the loan at 31 March 2021.
A loan fringe benefit arises as Company Z has provided one of its
employees with a loan.
The taxable value of the loan fringe benefit =
121
$10, 000 × [4.80% − 0% ] ×
365
= $159

Therefore, Robyn has “saved” $159 in interest by obtaining a loan from
her employer rather than at commercial rates.

Expense payment fringe benefits – Div 5

[7.200] An expense payment fringe benefit arises, where:
• an employer pays an expense incurred by the employee; or
• an employer reimburses an employee for expenditure incurred by the
employee: s 20 of the FBTAA.
To constitute an expense payment fringe benefit, the expense must be
“incurred” by the employee. Broadly, an expense is incurred by an employee

when the employee is definitely committed to the expense. Some other
category of fringe benefit (eg, residual fringe benefits) may arise where an
employer pays an expense which is not incurred by the employee.
Example 7.14: Expense incurred by employee

Stefan’s employer pays for his mobile phone bills. His employer also pays
for him to go to a physiotherapist once a month as Stefan often works
long hours in front of his computer. Stefan would not otherwise go to the
physiotherapist.
The payment of Stefan’s mobile phone bills by his employer is an expense
payment fringe benefit as Stefan’s employer has paid an expense incurred
by Stefan (he is definitely committed to the expense). The payment of the
physiotherapist’s cost is not an expense payment fringe benefit as Stefan
has not incurred the expense. However, it may constitute a residual fringe
benefit.

Where an employer pays an amount to an employee in relation to expenditure

incurred by the employee, it is necessary to consider whether the payment is a
“reimbursement” or an “allowance”. The distinction gives rise to very different
tax consequences. “Reimbursements” are treated as expense payment fringe
benefits and taxed to the employer under the FBT regime, while “allowances”
constitute “salary and wages” (see [7.85]) and are taxed to the employee under
the income tax.
Exempt benefits
[7.210] An employer can make a “no-private-use declaration” in respect of
all of the employer’s expense payment fringe benefits, which means that the
employer will only pay or reimburse so much of an expense as would result in
a taxable value of nil (reductions in taxable value are discussed at [7.360]). An
expense payment fringe benefit covered by such a declaration is an exempt
benefit: s 20A of the FBTAA.
Certain accommodation expense payment benefits where the employee is

required to live away from his or her usual place of residence due to employment
reasons and certain car expense payment benefits are also treated as exempt
benefits: ss 21 and 22 of the FBTAA.
Taxable value
[7.220] The taxable value of an expense payment fringe benefit depends on
whether the fringe benefit is an in-house expense payment fringe benefit or an

external expense payment fringe benefit.
An expense payment fringe benefit is an in-house expense payment fringe

benefit, where the expense relates to goods or services provided by the
employer or an associate of the employer to outsiders in the ordinary course
of their business: definition of “in-house expense payment fringe benefit” in
s 136(1) of the FBTAA. For example, an employee purchases a laptop computer
from their employer who is a computer retailer. The employer reimburses the
employee for the cost of the computer. The reimbursement is an expense
payment fringe benefit, which is an in-house expense payment fringe benefit
since it relates to property that is sold by the employer in the ordinary course
of its business.
An expense payment fringe benefit is an external expense payment fringe

benefit if it is not an in-house expense payment fringe benefit: definition of
“external expense payment fringe benefit” in s 136(1). An employer reimburses
an employee for the employee’s children’s school fees. The reimbursement is
an external expense payment fringe benefit (assuming the employer is not the
school).
Broadly, the taxable value of an in-house expense payment fringe benefit is

the taxable value of the fringe benefit as if it was a property or residual fringe
benefit (ie, assume the employer did not reimburse the employee but provided
the property or services directly): s 22A.
The taxable value of an external expense payment fringe benefit is the amount
of the expense or reimbursement incurred by the employer: s 23.
Example 7.15: Expense payment fringe benefit

Joe pays his telephone bill of $200 for which he is later reimbursed by
his employer, an accounting firm. The employer also pays $3,000 in fees
directly to the university for a further study course he is undertaking.
There are two expense payment fringe benefits arising as Joe’s employer
has reimbursed him for the telephone bill and paid for his university
fees. Both expenses were incurred by Joe as he is definitely committed
to them.
Both expenses are external expense payment fringe benefits as the
benefits are not provided by Joe’s employer in the ordinary course of
its business. The taxable values of both benefits are $200 and $3,000,
respectively, being the amount paid by the employer in relation to them.
Depending on the facts, the “otherwise deductible” rule (see [7.390]) may
apply to reduce the taxable value of both fringe benefits under s 24 of

the FBTAA.

Meal entertainment fringe benefits – Div 9A

[7.230] Meal entertainment fringe benefits can be captured by a number of
categories, such as expense payment fringe benefits, property fringe benefits
and, of course, meal entertainment fringe benefits. Generally, the most specific
category is the relevant category for a fringe benefit. However, in the case of
meal entertainment, an employer can elect for Div 9A of the FBTAA to apply
to the provision of meal entertainment fringe benefits for a particular FBT year,
in which case the relevant fringe benefits will be taxed under this Division and
not another: ss 37AA and 37AF.
A meal entertainment fringe benefit arises where an employer provides its

employees with:
• entertainment by way of food or drink;

• accommodation or travel in connection with entertainment by way of
food or drink; or
• a reimbursement of expenses incurred by an employee in relation to
the above.
A meal entertainment fringe benefit arises regardless of whether or not the
meal entertainment relates to business purposes. Determining whether food
or drink is provided as “entertainment” will be a question of fact. In Ruling TR
97/17, the ATO suggests that the following factors are relevant in answering
that question:
• why the food or drink is provided: the ATO suggests that food or drink
provided as refreshment (eg, morning tea for employees) will not be
entertainment, but food or drink provided in a social situation (eg, lunch
at a restaurant) will be classified as entertainment;
• what type of food or drink is provided: for example, morning or
afternoon tea, sandwiches or light meals are unlikely to constitute
entertainment, while a three-course meal will constitute entertainment;
• when the food or drink is provided: food or drink provided during work
hours, during overtime or while an employee is travelling for work
purposes is less likely to be entertainment; and
• where the food or drink is provided: food or drink provided at the
employer’s premises is less likely to be entertainment but food or drink
provided at a hotel, restaurant or café is more likely to be classified as
entertainment.
Although no single factor is determinative, the ATO suggests that the first
two factors will be the most important in determining whether food or drink is
provided as entertainment.
Taxable value
[7.240] There are two methods for calculating the taxable value of meal
entertainment fringe benefits:
• 50/50 split method; and
• 12-week register method.
The 50/50 split method will apply automatically unless the employer elects for
the 12-week register method to apply: s 37B of the FBTAA. Under the 50/50
split method, the taxable value of meal entertainment fringe benefits is half of
the expenses incurred by the employer during the FBT year in providing meal
entertainment: s 37BA.
Alternatively, the employer can elect to calculate the taxable value of meal
entertainment fringe benefits under the 12-week register method: s 37CA.
In this case, the employer must maintain a register of all meal entertainment
expenditure over a representative 12-week period and determine the percentage
of that expenditure which relates to the provision of meal entertainment
as fringe benefits (ie, meal entertainment provided to employees or their
associates and not to others, such as clients): s 37CB. The percentage of total
meal entertainment expenditure which constitutes meal entertainment fringe
benefits (ie, meal entertainment provided to employees and their associates) is
known as the “register percentage”: s 37CB.
The 12-week period chosen should be representative of the first FBT year in
which the register method is to be used for the register to be valid: s 37CC.
The register is valid for the FBT year in which it is first used and the four FBT
years following that year: s 37CD. Where the 12-week period spans more than
one FBT year, the register can only be used for the first time in the FBT year
in which the 12-week period ends: s 37CD(2). A register ceases to be valid for
a particular FBT year, where the total meal entertainment expenditure in that
year exceeds the total meal entertainment expenditure in the year the register
was first used by more than 20%: s 37CD(3).
The taxable value of meal entertainment fringe benefits under the register
method is calculated using the following formula (s 37CB):
Total meal entertainment expenditure incurred in the FBT year × Register percentage
Example 7.16: Meal entertainment fringe benefit

Company A incurred $5,000 in expenditure on meal entertainment for the

year. Assume Company A elects to apply Div 9A and treat the expenses
as meal entertainment fringe benefits.
Company A has maintained a register of all meal entertainment expenditure
for a period of 12 weeks, in accordance with the above requirements.
The register information indicates that 70% of the meal entertainment
expenditure was on clients (ie, not fringe benefits) while 30% related to
employees and their associates (ie, fringe benefits). Therefore, Company
A’s register percentage is 30%.
Under the 50/50 split method, the taxable value of the meal entertainment
fringe benefits is $2,500, being half the expenditure on providing meal
entertainment. Alternatively, if Company A elected to use the 12-week
register method, the taxable value of the meal entertainment fringe
benefits is $1,500, being $5,000 × 30%.
Therefore, in this case, it would be better for Company A to elect to
use the register method in calculating its FBT liability in relation to the
provision of meal entertainment fringe benefits.

The register method will generally provide a lower taxable value (and therefore
a lower FBT liability), where less than 50% of meal entertainment expenditure
is provided as fringe benefits (ie, to employees and their associates).
Property fringe benefits – Div 11

[7.250] A property fringe benefit arises where an employer provides an
employee (or associate) with property: s 40 of the FBTAA. Note that a fringe
benefit only arises where the employer gives the employee the property, not
just the use of the property. The use of property may be captured by another
category such as residual benefits.
“Property” is defined in s 136(1) as tangible and intangible property. “Tangible

property” is defined to mean goods, and the definition specifies that this
includes animals, fish, gas and electricity. “Intangible property” is defined as
real property (ie, land and buildings), a chose in action (ie, a right to sue) and
any other kind of property that is not tangible property. However, rights arising
under a contract of insurance or a lease or licence in respect of real or tangible
property are specifically excluded.
Exempt benefits
[7.260] A property fringe benefit will be an exempt benefit where the
property is provided to a current employee and the property is provided to and
consumed by the employee on a working day and on the business premises of
the employer or a related company: s 41 of the FBTAA. For example, biscuits

or fruits provided to employees to be consumed on work premises would be
exempt property fringe benefits.
Taxable value
[7.270] The taxable value of a property fringe benefit depends on whether
the property fringe benefit is an in-house property fringe benefit or an external
property fringe benefit.
Broadly, a property fringe benefit is an in-house property fringe benefit, where

the property is provided by the employer or an associate of the employer
to outsiders in the ordinary course of their business: s 136(1) of the FBTAA.
A property fringe benefit is an external property fringe benefit if it is not an in-
house property fringe benefit: s 136(1).
The taxable value of an in-house property fringe benefit is determined under

s 42 and is broadly as follows:
1. Where the property is manufactured, produced, processed or treated

by the provider and:
(a) is sold in the ordinary course of business to manufacturers,

wholesalers or retailers –the taxable value is the lowest price at
which the property was sold; or
(b) is sold in the ordinary course of business to members of the

public –the taxable value is equal to 75% of the lowest price at
which property was sold to a member of the public; or
(c) in any other case –the taxable value is 75% of the amount that
could reasonably be paid to acquire the property from the provider
in an arm’s length transaction.
2. Where (1) does not apply and the property is acquired by the provider,
the taxable value is the lesser of:
(a) the cost of the property if acquired in an arm’s length transaction; or
(b) the amount that could reasonably be paid to acquire the property
from the provider in an arm’s length transaction.
3. In any other case, the taxable value is 75% of the amount that could
reasonably be paid to acquire the property from the provider in an
arm’s length transaction.
The determination of the taxable value of in-house property fringe benefits
essentially depends on whether the employer is a manufacturer or reseller and
whether the employer operates in the wholesale or retail market. Employers
can still provide employees with in-house property fringe benefits without
incurring FBT, where the employee pays the wholesale price of the property.
As we will see at [7.380], the taxable value of a fringe benefit is reduced by the
amount of the recipient’s contribution, if any. Both employers and employees
benefit in this case as the employer does not incur FBT, and the employee pays
the wholesale, rather than retail, price of the goods.
Example 7.17: In-house property fringe benefit

Ratna works at a second-hand computer shop. Her employer provided
her with a computer which cost the employer $1,000 to acquire and is for
sale to the public for $1,500.
The provision of the computer is an in-house property fringe benefit as
Ratna’s employer provides computers to outsiders in the ordinary course
of its business.
The taxable value of the fringe benefit is the lesser of:
• the cost of the property –$1,000; or
• the amount that could reasonably be paid to acquire the property
from Ratna’s employer –$1,500.
Therefore, the taxable value is $1,000.

Note that if Ratna paid her employer $1,000 for the computer, the taxable
value would be nil as the recipient’s contribution is deducted from taxable
value: see [7.380]. Both the employer and Ratna benefit in this situation
as the employer does not incur FBT and Ratna has paid $1,000, rather
than
the retail price of $1,500, to acquire the computer.
Broadly, the taxable value of an external property fringe benefit is the cost
to the employer, or expenditure incurred by the employer to provide the
property: s 43. Where the employer can acquire the property for less than the
employee could (eg, due to the employer’s purchasing power or because it can
purchase the property at wholesale prices) and the employee reimburses the
employer for the cost of acquiring the property, a win-win situation arises since
the employer has no FBT liability and the employee has acquired the property
for less than the retail price.
Example 7.18: External property fringe benefit

Following on from Example 7.17, Ratna’s employer also gave her a brand
new plasma television, which was acquired from a television wholesaler
for $2,000.
The provision of the plasma television is an external property fringe
benefit since Ratna’s employer does not provide plasma televisions to
outsiders as part of its business.

The taxable value of the fringe benefit is the cost to Ratna’s employer in
acquiring the property, which is $2,000.
If Ratna paid her employer $2,000 for the television, the taxable value is
reduced to nil as the recipient’s contribution is deducted from taxable
value: see [7.380]. Both the employer and Ratna benefit in this situation
as the employer does not incur FBT and Ratna has paid the wholesale
price of $2,000 for the television, rather than the retail price which is likely
to
be higher.
Residual fringe benefits – Div 12

[7.280] The last category of fringe benefits is residual fringe benefits, which is
a catch-all category to capture any benefits that do not fall into any of the other
categories of fringe benefits: s 45 of the FBTAA. Examples of residual benefits
include the provision of services for free or at a discount; the provision of
caravans at work sites for the accommodation of employees (Roads and Traffic
Authority of NSW v FCT (1993) 26 ATR 76) and waivers of loan establishment
fees: Westpac Banking Corporation v FCT (1996) 34 ATR 143. Note that a
residual benefit can arise in conjunction with another fringe benefit, but not if
the benefit is fully captured by another category: Westpac Banking Corporation
v FCT (1996) 34 ATR 143.
Case study 7.5: Residual fringe benefits

Following on from Case Study [7.1], in Westpac Banking Corporation v
FCT (1996) 34 ATR 143, the taxpayer sought to argue that the waiver of
the loan establishment fee was not a residual benefit as the waiver was
integrally related to the making of the loan to the employee, and therefore
there was only one benefit –that is, the making of the loan. As such,
the FBT consequences were to be determined solely in accordance with
Div 4 regarding loan fringe benefits. Hill J found that Div 4 was not an
exclusive code for all benefits relating to loans. In this case, there were
two separate benefits –the loan that is dealt with under Div 4 and the fee
waiver
that is captured as a residual fringe benefit.
Exempt benefits
[7.290] As the scope of residual fringe benefits is unlimited, there are a number
of residual benefits that are made exempt in s 47 of the FBTAA. For example,
“business operation facilities”, such as toilets, bathroom facilities, food or drink
vending machines, tea-or coffee-making facilities, water dispensers and other
such amenities, are exempt benefits under s 47(4). Recreational or child care
facilities located on the employer’s premises are exempt under s 47(2). Ruling
TR 2000/4 discusses the meaning of “business premises” in the context of
the s 47(2) exemption. Section 47(3) also provides an important exemption
for any private use of property located on the employer’s premises, where
the property is wholly or principally in connection with the operation of the
business. This exempts from FBT private phone calls or personal printing at
the employer’s premises.
Taxable value
[7.300] Similar to property fringe benefits (see [7.270]), the taxable value of
a residual fringe benefit depends on whether the residual fringe benefit is an
in-house residual fringe benefit or an external residual fringe benefit.
Broadly, the taxable value of an in-house residual fringe benefit under ss 48

and 49 of the FBTAA is:
• 75% of the lowest price at which an identical benefit is sold to a member
of the public under an arm’s length transaction; or
• in any other case, 75% of the amount that could reasonably be
paid to acquire the property from the provider in an arm’s length
transaction.
The taxable value of an external residual fringe benefit is, broadly, the cost
to the employer or expenditure incurred by the employer in providing the
benefit: ss 50 and 51.
Example 7.19: In-house residual fringe benefit

Imogen works at a second-hand computer shop. She has had problems
with her computer and her employer services her computer for free. The
employer would normally charge customers $60 for the service.
The servicing of the computer would constitute an in- house residual
fringe benefit as the benefit does not fall within any of the other categories
of fringe benefits and as Imogen’s employer services computers in the
ordinary course of its business.
The taxable value of the fringe benefit is 75% of the lowest price charged
to members of the public in an arm’s length transaction, which would be
75% × $60 = $45.

Example 7.20: External residual fringe benefit

Following on from Example 7.19, Imogen’s employer also gave her two
tickets to an upcoming classical music concert by an international artist.
The tickets cost $250 each.
The provision of the tickets would constitute an external residual fringe
benefit as they do not fall within any of the other categories of fringe
benefits and Imogen’s employer does not provide concert tickets in the
ordinary course of its business. Note that the payment for the tickets
does not constitute an expense payment fringe benefit as Imogen has not
“incurred” the expense.
The taxable value of the fringe benefit is the expenditure incurred by
Imogen’s employer in providing the benefit, which is $500.

Exempt fringe benefits

[7.310] There are a number of benefits that are exempt from FBT. No FBT
liability arises in relation to an exempt fringe benefit.
The exemptions can apply to a particular category of fringe benefit or fall

within Div 13 of the FBTAA, which covers “miscellaneous exempt benefits”.
The category-based exemptions were discussed under the relevant categories
at [7.100]–[7.300]. There are a number of exempt benefits in Div 13, such as:
• reimbursements for the costs of travelling to an interview or selection
test in connection with an application for employment with a new
employer, or a promotion or transfer with an existing employer (s 58A);
• various job relocation expenses (ss 58AA, 58B, 58C, 58D, 58E and 58F);
• certain medical benefits (ss 58K, 58L and 58M); and
• the cost of providing newspapers and periodicals to employees for
business purposes: s 58H.
The following common exemptions are discussed in detail:
• minor benefits: see [7.320];
• work-related items: see [7.330];
• membership fees and subscriptions: see [7.340]; and
• single-trip taxi travel: see [7.350].
Minor benefits – s 58P
[7.320] Broadly, a benefit will be exempt as a minor benefit, where the

notional taxable value of the benefit is less than $300. “Notional taxable value” is
defined in s 136(1). It is the taxable value of the fringe benefit as determined for
each category of fringe benefit taking into account any reduction for recipient’s
contribution but not any reduction of taxable value due to the application of
the otherwise deductible rule (see [7.360]). In the case of a car fringe benefit,
the notional taxable value is the taxable value determined as if the car benefit
was a residual benefit.
The $300 limit is applied to each benefit and is not a cumulative exemption.
However, to be treated as a minor benefit, the frequency and regularity of
the minor benefit (and similar or connected benefits) must be taken into
consideration, and it must be concluded that it would be unreasonable to treat
the minor benefit as a fringe benefit: s 58P(f) of the FBTAA; Ruling TR 2007/12.
The exemption does not apply to in-house fringe benefits which are subject
to a $1,000 reduction in taxable value for each employee: see [7.370]. The
exemption is also not available for meal entertainment fringe benefits if the
employer uses the 50/50 split method (see [7.240]) to calculate the taxable
value of the meal entertainment: s 37BA; Ruling TR 2007/12.
Example 7.21: Infrequent but regular benefits qualify as minor benefits

Joe provides each of his employees with a bottle of wine every Christmas.
The cost of each bottle is less than $300 and satisfies the taxable value limit
for minor benefits. The gifts are provided infrequently (once a year) but
regularly (every Christmas). There are no similar or connected benefits.
Upon evaluation of these criteria, it can be concluded that the provision of
the bottle of wine is a minor benefit as it would be unreasonable to treat
it as a fringe benefit.
Source: Adapted from Example 1 in Ruling TR 2007/12.

Example 7.22: Infrequent but regular benefits qualify as minor benefits

Each year Nicholas provides all of his employees and their families with
an end of financial year dinner at a local restaurant. The total value of the
fringe benefit for each employee is less than $300. The benefit is provided
infrequently (once a year) but regularly (every year). As the total value of
the benefit and all connected benefits is less than $300, and taking into
account the other factors, it can be concluded that the provision of the
fringe benefit is a minor benefit as it would be unreasonable to treat it as
a fringe benefit.
Source: Adapted from Example 2 in Ruling TR 2007/12.

Example 7.23: Frequent and regular benefits not treated as minor

benefits
Big Firm provides its employees with a fine dining meal voucher whenever
they have to work late. The value of each voucher is less than $300.
However, employees generally work late at least once a month. Although
each benefit is less than $300, it would not be reasonable to treat the meal
vouchers as a minor benefit, taking into consideration the frequency and
regularity with which they are provided and the fact that their cumulative
value for each employee is likely to exceed $300.

Work-related items – s 58X
[7.330] The following work-related items are treated as exempt fringe benefits:
• a portable electronic device;
• an item of computer software;
• an item of protective clothing;

• a briefcase; and
• a tool of trade: s 58X(2) of the FBTAA.
These items will only be eligible for the exemption, where they are primarily
for use in the employee’s employment. In ATO ID 2008/127, the ATO suggests
that the provision of a laptop computer to an employee who regularly visits
clients is primarily for use in the employee’s employment.
Further, the exemption is limited to one item of each type per employee per
FBT year unless the item is a replacement item: s 58X(3) and (4) of the FBTAA.
The limitation does not apply if the work-related item is a “portable electronic
device” and the employer is a “small business entity”. In this context, a “small
business entity” is a sole trader, partnership, company or trust that operates a
business for all or part of the income year and has an aggregated turnover of
less than $10 million. In the 2020 Federal Budget, it was announced that the
exemption on multiple work-related portable devices would be extended to
businesses with an aggregated annual turnover of less than $50 million from
1 April 2021. Broadly, “aggregated turnover” is the entity’s turnover plus the
annual turnover of any business that is connected or affiliated to the entity.
Note that employees are not entitled to depreciation deductions (see Chapter
14) in relation to these items.
The legislation does not specify what is a “portable electronic device”, and in
ATO ID 2008/133, the ATO suggests that it should therefore take on its ordinary
meaning. The ATO further suggests that a portable electronic device would be
one which is:
• easily portable and designed for use away from an office environment;
• small and light;
• able to operate without an external power supply; and
• designed as a complete unit.
This includes mobile phones, laptop computers, GPS navigation receivers,
personal digital assistants and so on.
Membership fees and subscriptions – s 58Y

[7.340] The following benefits are exempt benefits whether paid for directly
by the employer or by way of a reimbursement:
• subscription to a trade or professional journal;
• entitlement to use a corporate credit card; and
• entitlement to use an airport lounge membership.
Single-trip taxi travel – s 58Z

[7.350] The provision of a single taxi trip beginning or ending at the employee’s
place of work is an exempt benefit. The definition of “taxi” was amended in
2020 to ensure that the FBT exemption extends to services obtained through
ride-sourcing platforms (eg, Uber).
Reductions in taxable value
[7.360] Having determined the taxable value of a fringe benefit, it is then
necessary to determine whether the taxable value can be reduced because:
• it is an in-house fringe benefit: see [7.370];
• there is a recipient’s contribution: see [7.380]; or
• the otherwise deductible rule applies: see [7.390].
All of these reductions can apply individually or in conjunction with the others.
In-house fringe benefits

[7.370] Under s 62 of the FBTAA, the taxable value of all in-house (expense,
property or residual) fringe benefits for each particular employee is reduced by
$1,000. Where the taxable value of all in-house fringe benefits to a particular
employee is less than $1,000, the taxable value is reduced to nil, and there is
effectively no FBT payable on the provision of the in-house fringe benefits to
that employee. Note that the reduction relates to the particular employee and
cannot be done on an aggregate basis.
Example 7.24: Reduction in taxable value for in-house property fringe

benefits
Company Y provides its employees Leonie and James with in-house
property fringe benefits. The taxable value of Leonie’s in-house fringe
benefits is $2,000 and the taxable value of James’ in-house fringe benefits
is $300.
Applying s 62 of the FBTAA, the taxable value of Leonie’s in-house fringe
benefits is reduced to $1,000 and the taxable value of James’ in-house
fringe benefits is reduced to nil. The reduction relates to the particular
employee and cannot be done on an aggregate basis. The unutilised
$700 exemption in relation to James cannot be applied to reduce Leonie’s
liability.

Recipient’s contribution
[7.380] The definition of “taxable value” for most fringe benefits reduces the
taxable value of the fringe benefit by the amount of the recipient’s contribution
(if any). Of the categories of fringe benefits discussed in detail at [7.100]–[7.300],
this step is not required for car fringe benefits, debt waiver fringe benefits and
loan fringe benefits, as it is either not applicable or has been incorporated into
the determination of taxable value at first instance. Where the fringe benefit is
an expense payment fringe benefit that arises because of a reimbursement,
the amount of the employee’s expenditure is not considered the recipient’s
contribution: ss 22A(4) and 23 (as the employee has been reimbursed for the
expense).
In all other cases, reduce the taxable value by the amount of the recipient’s
contribution (if any).
Example 7.25: Reducing taxable value for recipient’s contribution

Belinda is a lawyer at a small law firm specialising in conveyancing. She
recently purchased her first home for $500,000. The firm provided her
with conveyancing services at a 50% discount. The standard fee for
conveyancing services on properties similar to Belinda’s would be $2,000.
The provision of conveyancing services constitutes an in-house residual
fringe benefit as the services are provided to outsiders in the ordinary
course of the employer’s business.
The taxable value of the fringe benefit is 75% of the lowest price charged
to customers, which would be 75% × $2,000 = $1,500.
The services were provided to Belinda at a 50% discount, which means
that she paid $1,000 towards the conveyancing fees.
The taxable value is therefore reduced for recipient’s contribution to
$500. (Note: The taxable value may be further reduced to nil by applying
the $1,000 reduction for in-house benefits, depending on whether Belinda
received any other in-house benefits during the FBT year: s 62 of the
FBTAA.)

Otherwise deductible rule
[7.390] Most categories of fringe benefits also include the “otherwise
deductible rule” to reduce the taxable value of a fringe benefit. Of the categories
of fringe benefits discussed in detail at [7.100]–[7.300], the otherwise deductible
rule is not applicable to car fringe benefits and debt waiver fringe benefits.
Under the otherwise deductible rule, the taxable value of a fringe benefit is
reduced by the amount which would have been deductible to the employee
had the employee incurred an expense directly rather than received a fringe
benefit. It is important to note that the otherwise deductible rule only applies in
relation to the employee and not associates of the employee (ie, the expense
must have been deductible to the employee).
It is also important to note that the expense must give rise to a one-time-only
deduction to the employee for the otherwise deductible rule to apply. An
expense which would be deductible to the employee over a number of years
(eg, depreciation) would not qualify as an otherwise deductible expense. In such
cases, it may be preferable for the employee to incur the expense themselves
as the amount is excluded from the employee’s income (as deductions), albeit
over a period of years, rather than receive a benefit that is fully taxable to the
employer under FBT.
Example 7.26: Otherwise deductible rule
On 1 April 2020, Ali received a loan of $20,000 from his employer at an
interest rate of 1.80%. Ali used $10,000 to purchase shares, $5,000 to
pay his personal credit card debt and the remaining $5,000 to purchase
shares in his wife’s name.
The $20,000 provided by the employer to Ali is a loan fringe benefit. The
taxable value of the benefit is $20,000 × (4.80% − 1.80%) = $600. The
loan is provided for the entire FBT year, so there is no need to adjust
for the loan period. The $600 represents interest that Ali has “saved” by
obtaining a loan from his employer, rather than at commercial rates.
The relevant question when applying the otherwise deductible rule is
whether Ali would have been entitled to a deduction for some or all of the
$600 had he incurred the interest expense directly by obtaining a loan at
commercial interest rates instead of receiving the fringe benefit.
Half of the loan amount was used to purchase shares and, as discussed
in Chapter 12, interest incurred in acquiring an income-producing asset
is deductible for tax purposes. Therefore, the interest expense which
relates to that portion of the loan (50% × $600 = $300) would have been
“otherwise deductible”.
Interest relating to the portion of the loan used to pay the credit card debt
would not be deductible as it is a private expense. The interest relating to
the purchase of shares in the wife’s name is also not otherwise deductible
as the interest expense is not deductible to Ali, but to his wife.
Therefore, the taxable value of the loan fringe benefit is reduced from
$600 to $300 by applying the otherwise deductible rule.

Under the terms of his employment agreement, Jerry’s employer has
agreed to pay his tax agent’s fees of $550 for the preparation of Jerry’s
personal income tax return.
The payment of the tax agent’s fees by the employer constitutes an
external expense payment fringe benefit. The taxable value of the fringe
benefit is the amount of the expense, being $550.
The cost of managing one’s tax affairs is deductible under s 25-5 of the
ITAA 1997: see Chapter 13. Therefore, if Jerry had paid the tax agent’s
fees himself, he would have been entitled to a deduction for the fees.
Applying the otherwise deductible rule, the taxable value of the expense
payment fringe benefit would be reduced to nil as the $550 would have
been fully deductible had it been incurred by Jerry.

Under the terms of her employment agreement, Jade’s employer has
agreed to pay her home phone bills totalling $2,200 for the year. Only
20% of her calls were for work purposes.
The payment of the phone bills by the employer constitutes an expense
payment fringe benefit.
The taxable value of the fringe benefit is the amount of the expense,
being $2,200.
Twenty per cent of Jade’s calls are for work purposes and it is likely that,
had she paid the phone bills herself, she would have been entitled to a
deduction for 20% of the cost, being $440 (see Chapter 12).
Therefore, applying the otherwise deductible rule, the taxable value of
the
expense payment fringe benefit would be reduced by $440 to $1,760.
Where a benefit is provided to an employee and their associate jointly, the

otherwise deductible rule is to be applied on a proportionate basis. The
otherwise deductible rule for loan fringe benefits, expense payment fringe
benefits, property fringe benefits and residual fringe benefits was amended
by Sch 4 of the Tax Laws Amendment (2008 Measures No 5) Act 2008 (Cth) to
ensure that the rule operated as such. The amendments were necessary due
to s 138(3), which deems a benefit jointly provided to an employee and their
associate to be provided solely to the employee.
In National Australia Bank v FCT (1993) 26 ATR 503, the Federal Court held
that the taxable value of a loan fringe benefit provided to an employee and
his spouse was reduced to nil under the otherwise deductible rule. This was
due to the operation of s 138(3), which deemed the benefit to be provided
solely to the employee. The following examples from Sch 4 of the Tax Laws
Amendment (2008 Measures No 5) Act 2008 illustrate the application of the
law following the amendments.
Example 7.29: Benefit provided to employee and associate

Francisca and her husband Peter receive a joint interest- free loan of
$50,000 from Peter’s employer. Assume that the taxable value of the loan
fringe benefit is $10,000. Francisca and Peter use the loan to purchase
$50,000 of shares which they will hold jointly with a 50% interest each.
Francisca and Peter return 50% of the dividends derived from the shares
as assessable income in each of their income tax returns.
Under the previous law (and as a result of the NAB case), the otherwise
deductible rule would apply to reduce the taxable value of the loan fringe
benefit ($10,000) (ie, in respect of both Francisca and Peter’s share of the
benefit) to nil and consequently the employer would have no FBT liability.
As a result of new paragraph 19(1)(i) and new subs 19(5), the notional
deduction of $10,000 is reduced by Peter’s percentage of interest in the
shares –that is, 50% so that the taxable value of the loan fringe benefit of
$10,000 is reduced by $5,000. The employer has an FBT liability on $5,000,
which reflects the share of the loan fringe benefit that was provided to
Francisca.
Source: Adapted from Example 4.2 in Explanatory Memorandum to the

Tax Laws Amendment (2008 Measures No 5) Act 2008.

Example 7.30: Benefit provided to employee and associate

Assume Francisca and Peter only use 50% of the $50,000 loan for
acquiring shares. They use the other 50% ($25,000) for a private overseas
holiday. The taxable value of the loan fringe benefit that relates to that
part of the loan used for private purposes ($5,000) is not deductible to
either Francisca or Peter, so the otherwise deductible rule does not apply
to reduce that part of the loan fringe benefit.
The taxable value of the loan fringe benefit that arises on the part of the
loan that is used for acquiring shares can be reduced by Peter’s share
of the benefit (ie, $2,500). The employer can reduce the taxable value
of the loan fringe benefit ($10,000) by $2,500. The taxable value of the
loan fringe benefit provided to Francisca and Peter that will be subject to
FBT is therefore $7,500 ($10,000 − $2,500) which represents the portion
of the loan used for the private holiday and the portion for Francisca’s
ownership of the shares.
Source: Adapted from Example 4.3 in Explanatory Memorandum to the
Tax Laws Amendment (2008 Measures No 5) Act 2008.

Type of fringe benefit

[7.400] Having determined the taxable value of each fringe benefit, it is then
necessary to determine whether the fringe benefit is a Type 1 fringe benefit or
a Type 2 fringe benefit.
A Type 1 fringe benefit exists where the employer is entitled to input tax credits
(ie, a refund of GST paid) in relation to the provision of a fringe benefit: ss 5C(3)
and 149A of the FBTAA. See Chapter 25 for when a taxpayer is entitled to input
tax credits.
A Type 2 fringe benefit is any fringe benefit which is not a Type 1 fringe
benefit: s 5C(4). For example, where an employer did not pay GST in relation
to the provision of the fringe benefit, the fringe benefit will be a Type 2 fringe
benefit as the employer is not entitled to input tax credits in relation to that
fringe benefit. Debt waiver fringe benefits and loan fringe benefits are always
Type 2 fringe benefits as GST is not applicable to them.
The separation of fringe benefits into two types is necessary following the
introduction of the GST on 1 July 2000. As we will see in Chapter 25, GST
is borne by private consumers and not businesses. Where a fringe benefit is
provided by an employer, there is an additional benefit to the employee in
the GST that has not been paid –that is, if the employee had acquired the
benefit themselves they would have paid an additional 10% in GST, and the
GST “saved” is an additional benefit of receiving a fringe benefit. The gross-up
mechanism discussed at [7.410] adds the GST that has not been paid back into
the FBT base.
Fringe benefits taxable amount

[7.410] The next step is to calculate the “fringe benefits taxable amount”
as prescribed by s 5B of the FBTAA. The fringe benefits taxable amount is
calculated by “grossing-
up” the taxable value of the fringe benefit by the
appropriate rate.
As mentioned at [7.400], the “gross-up” takes into account the fact that the
employee has received an additional benefit in the form of the “GST saved”
on receiving a benefit. The “gross-up” also adds the FBT payable on the fringe
benefit back into the tax base. Where an employee receives salary, the tax on
the salary is paid by the employee. However, where the employee receives a
fringe benefit, the tax on the fringe benefit (FBT) is paid by the employer. As
such, the employee has received an additional benefit since tax is paid by the
employer rather than the employee.
Example 7.31: Fringe benefits taxable amount

Ivo’s employer provides him with a mobile phone. The provision of the
mobile phone is a fringe benefit and the taxable value of the fringe benefit
is determined by the method discussed earlier. The taxable value only
relates to the provision of the mobile phone. In addition, Ivo has also
received a benefit in that he has not had to pay GST on the acquisition of
the phone. The “GST saved” is also a benefit to Ivo and FBT is payable on
that benefit. Ivo receives a further benefit in that he does not pay income
tax on the receipt of these benefits. The “income tax saved” is also a
benefit received by Ivo, and FBT is payable on that benefit. The “gross-up”
adds the GST saved and the income tax saved by Ivo into the tax base –
that is, the amount upon which the FBT liability is ultimately calculated.

Many students, and even some tax professionals, often find it difficult
to understand the reasoning behind the “gross- up”. It is not essential in
determining the FBT consequences to understand the reasoning behind this
and the fringe benefits taxable amount can simply be calculated in accordance
with the following formulae:
For a Type 1 fringe benefit, the fringe benefits taxable amount equals:
FBT rate + GST rate

Total taxable value of all Type1 fringe benefits ×
1 − FBT rate ] × [ 1 + GST rate × FBT rate
With the current (ie, for the year ending 31 March 2021) FBT rate of 47% and
GST rate of 10%, the fringe benefits taxable amount for Type 1 fringe benefits
equals:
Total taxable value of all Type 1 fringe benefits × 2.0802
For a Type 2 fringe benefit, the fringe benefits taxable amount equals:
1
Total taxable value of all Type 2 fringe benefits ×
1 − FBT rate
With the current (ie, for the year ending 31 March 2021) FBT rate of 47%, the
fringe benefits taxable amount for Type 2 fringe benefits equals:
Total taxable value of all Type 2 fringe benefits × 1.8868
FBT liability
[7.420] The final step is to determine the employer’s FBT liability, which is
calculated as:
( Type 1 fringe benefits taxable amount ) + ( Type 2 fringe benefits taxable amount ) × FBT rate
See ss 5B(1A) and 66 of the FBTAA. The “FBT rate” is equal to the highest
marginal tax rate plus the Medicare levy. For the FBT year ending 31 March
2021, the FBT rate is 47%.
Interaction with income tax

Employer
[7.430] From an employer’s perspective, any FBT liability incurred in relation
to the provision of fringe benefits and the cost of providing the fringe benefit
are generally deductible as ordinary business expenses under s 8-1 of the ITAA
1997: see also Ruling TR 95/24.
The FBT liability is generally deductible as an expense incurred in gaining or

producing assessable income that is not capital or capital in nature; private or
domestic in nature; incurred in gaining or producing exempt or non-assessable
non-exempt income; or a denied deduction: see Chapter 12. It should also be
noted that the deductibility of the FBT liability for income tax purposes does
not impact on an employer’s FBT liability. For example, an employer’s FBT
liability is not reduced because the employer chooses not to claim a deduction
for the FBT liability: Determination TD 94/42.
The cost of providing a fringe benefit is also generally deductible under

s 8-1 of the ITAA 1997 as an ordinary business expense: see Chapter 12.
Broadly, the mechanism for calculating FBT and the fact that both the cost
of providing a fringe benefit and FBT are deductible to an employer mean
that, from a tax perspective, employers are generally indifferent in respect of
providing employees with salary or fringe benefits. The fact that a benefit is an
exempt benefit or that the taxable value of a benefit is reduced for any of the
reasons discussed at [7.360]–[7.390] generally does not affect the employer’s
entitlement to a deduction for the cost of providing the fringe benefit.
There is an important interaction between FBT and the deductibility of expenses

which is worth noting. Certain expenses that are generally denied deductions
(see [12.240]–[12.260]) are deductible if incurred in the provision of a fringe
benefit. For example, entertainment expenses are generally not deductible
under s 32-5 of the ITAA 1997 but are deductible under s 32-30, where the
entertainment expenses are incurred in the provision of a fringe benefit. The
amount of the deduction will depend on the treatment of the entertainment
expenses for FBT purposes. For example, where the 50/50 split method is used
for calculating the taxable value of meal entertainment fringe benefits, only half
the meal entertainment expenses will be deductible for income tax purposes
as only half the meal entertainment expenses have been treated as a fringe
benefit (see also s 51AEA of the ITAA 1936).
Other expenses that are generally not deductible for income tax purposes, but
which are deductible when provided as a fringe benefit, include:
• higher education contribution payments: s 26-20(2);
• a relative’s travel expenses: s 26-30(3);
• recreational club expenses: s 26-45(3); and
• leisure facility expenses: s 26-50(8).
These generally denied deductions are only deductible when provided as a
fringe benefit. If the benefit is an “exempt benefit”, a deduction is not allowed
as exempt benefits are not “fringe benefits”: see definition of “fringe benefit”

in s 136(1).
Example 7.32: Denied deductions and exempt fringe benefits

Following on from Example 7.22, the cost of the end of financial year
dinner is potentially deductible due to s 32-20 of the ITAA 1997 as the cost
of providing entertainment by way of providing a fringe benefit. However,
as discussed in Example 7.22, the provision of the dinner would qualify as
a “minor benefit” and thus be an “exempt benefit” under s 58P. Exempt
benefits are not fringe benefits per the definition of “fringe benefit” in
s 136(1) and therefore, the cost of the dinner is not deductible.

Finally, note that any amounts received directly by an employer from an

employee in respect of a fringe benefit (recipient’s contribution) may constitute
assessable income of the employer.
Employee
[7.440] For an employee, fringe benefits constitute non- assessable, non-
exempt income of the employee: s 23L(1) of the ITAA 1936; s 15-2 of the ITAA
1997. This is the case even where little or no FBT has been paid in relation
to the fringe benefit because of a reduction to the taxable value of the fringe
benefit.
Exempt fringe benefits are treated as exempt income of the employee:

s 23L(1A) of the ITAA 1936; s 15-2 of the ITAA 1997.
Where the taxable value of an employee’s fringe benefits exceeds $2,000, the
employer is required to report the fringe benefits on the employee’s Payment
Summary (subject to certain exceptions), and the employee is required to
report these fringe benefits on his or her income tax return. These “reportable
fringe benefits” do not affect the employee’s income tax liability, but do affect
the calculation of certain amounts, such as the Medicare levy surcharge or
Higher Education Loan Program (HELP) repayments.
Interaction with GST
[7.450] As discussed at [7.410], the fact that an employer may be entitled to
a refund of GST paid on the acquisition of a fringe benefit, while an employee
would generally not be entitled to a refund, is taken into account in determining
the FBT liability through the grossing-up mechanism. As such, the cost of a
fringe benefit in determining taxable value is the GST-inclusive cost: Ruling TR

2001/2. Where the fringe benefit relates to a reimbursement, s 111-5 of the A
New Tax System (Goods and Services Tax) Act 1999 (Cth) deems the acquisition
to have been made by the employer for GST purposes. This provision enables
the employer to obtain GST input tax credits in relation to the acquisition (if
entitled) even though the acquisition was actually made by the employee and
the employer only reimbursed the employee.
As will be seen in Chapter 25, the provision of employee services and the
receipt of fringe benefits may be considered a barter transaction that gives rise
to GST consequences. However, s 9-75(3) of the A New Tax System (Goods
and Services Tax) Act 1999 provides that such transactions will not give rise
to a GST liability unless the recipient makes a contribution for the benefit.
Where the employee makes a contribution towards the benefit, the employer
is registered for GST purposes and the benefit is not GST-free or input-taxed,
the employer will have to remit one-eleventh of the recipient’s contribution in
GST to the ATO in respect of the supply of the fringe benefit.
Questions
[7.460]
7.1 Determine whether the following benefits are fringe benefits or exempt
fringe benefits and, where applicable, the relevant category of fringe
benefit. Provide reasons for your answer:
(a) Payment to employee for the estimated cost of the employee’s
home phone bill as the employee sometimes has to use the home
phone for work purposes.
(b) Provision of accommodation at the family home to a child who is
over 21 and works in the family business.
(c) Payment of employee’s superannuation contribution by the
employer to a complying superannuation fund.
(d) Loan by Company X to one of its directors, Rupert, who is also a
shareholder in the company. The company’s rules do not permit
loans to directors.
(e) Payment of taxi fare by employer for employee to travel home
after working late.
(f) Flowers sent to a sick employee. The flowers cost $75.
(g) Provision of a car for an employee’s private use, including payment
of all fuel costs by the employer.
(h) Provision of sandwiches at a lunchtime seminar held at the
employer’s premises.
(i) Provision of an all-expenses-paid holiday to an employee who has

had to work every weekend for the last six months.
(j) Provision of two laptop computers to an employee who regularly
attends clients’ premises.
7.2 Jill is a scientist at a research laboratory. Her employer provides her
with a protective coat to use while working. She is also reimbursed
for any travel expenses incurred for travel from home to work after
hours. Jill sometimes has to work late if the experiments take longer
than expected. Jill usually uses a ride-sourcing service rather than a
taxi as it is cheaper.
Advise Jill and her employer as to the tax consequences arising out of
the above information.
7.3 Loo is an employee at a large real estate agency. He has negotiated the
following benefits with his employer:
• Provision of a car for work and personal use. Loo was provided with
the car for the period 1 April 2020 to 31 March 2021. The leased car
value was $22,000 at 1 April 2020, and the car had only been leased
for a year at that time. Loo is required to pay for any petrol costs
which he has determined to be $1,300 for the period 1 April 2020 to
31 March 2021.
• Provision of the latest model smart phone on 1 April each year as Loo
is usually “on the street” and needs a good phone to do his job. Loo
estimates that he uses the phone 70% for work purposes. The phone
was purchased new on 1 April 2020 for $1,100 (including GST).
Advise Loo’s employer as to the FBT consequences (including
calculation of any FBT liability) arising out of the above information.
You may assume that any benefits are Type 1 fringe benefits.
7.4 Shah is an engineer. His employer provides interest-free loans to its
employees as one of its employment benefits. At 31 March 2021,
Shah had an outstanding loan of $3,000 with his employer. Shah had
borrowed the money on 1 December 2020 to pay for some emergency
renovations at home. The employer has also agreed to reimburse Shah
for the cost of his children’s school fees. Shah received a payment of
$30,000 from the employer on 27 February 2021 in relation to this.
Advise Shah’s employer as to the FBT consequences (including
You may assume that home renovations and children’s school fees are
not deductible expenses for tax purposes. You may also assume that
any benefits are Type 2 benefits.
7.5 Rita’s employer sells furniture. On 17 January 2021, Rita purchased a
table from her employer for $1,000. The table would usually be sold for
$3,000 and cost the employer $500 to purchase. The employer decided
to give Rita a tablecloth for the table as a “free gift” for the purchase
of the table. The tablecloth would usually be sold for $150 and cost
the employer $50 to purchase. Rita’s employer also decided to host a
party on 28 February 2021 for all employees and their partners. In total,
there were 20 attendees (10 employees and 10 partners) and the party
cost $3,300 (including GST). The party was held at a local Mexican
restaurant.
Advise Rita’s employer as to the FBT consequences (including
You may assume that any benefits are Type 1 benefits. You may also
assume that Rita’s employer has not provided Rita with any other
benefits and that Rita’s employer has no other meal entertainment
expenditure for the year, elects for Div 9A to apply to the provision of
meal entertainment fringe benefits and determines the taxable value of
meal entertainment fringe benefits using the 50/50 split method.
8
Income from business
Key points...................................................................................................... [8.00]
Introduction.................................................................................................. [8.10]
Step 1: Carrying on a business................................................................... [8.20]
Indicators of a business activity............................................................ [8.30]
Gambling.................................................................................................... [8.60]
Sportspeople.............................................................................................. [8.80]
Investment activities.................................................................................. [8.90]
Land sales................................................................................................. [8.100]
Sharing economy................................................................................. [8.105]
Crowdfunding activities....................................................................... [8.107]
Commencement and termination of business................................... [8.110]
Step 2: Normal proceeds of a business.................................................... [8.130]
Nature of the business –broad or narrow approach?........................ [8.140]

Nexus of receipt with business........................................................... [8.150]
Non-cash business benefits................................................................. [8.160]
Extraordinary and isolated transactions.................................................. [8.170]
Introduction.......................................................................................... [8.170]
Transaction forms a business in itself under the principle in
FCT v Whitfords Beach................................................................. [8.180]
Principle applied to isolated transactions............................................... [8.180]
Principle applied to extraordinary transactions...................................... [8.190]
Calculating ordinary income under the principle in
FCT v Whitfords Beach..................................................................... [8.200]
Two strands of Myer............................................................................ [8.210]
First strand of Myer.................................................................................. [8.220]
Second strand of Myer............................................................................ [8.260]
Statutory provisions that may apply to extraordinary and
isolated transactions..................................................................... [8.265]
Capital gains tax....................................................................................... [8.270]
Section 15-10: Bounties and subsidies................................................... [8.280]
Section 15-15: Profit-making undertaking or plan................................. [8.290]

Section 25A: Profit from sale of asset acquired with the purpose
of resale............................................................................................ [8.300]
Questions..................................................................................................... [8.310]

Key points
[8.00]
• Business income is ordinary income under s 6-5 of the Income Tax
Assessment Act 1997 (Cth).
• Whether a business is being carried on or not will be determined
by weighing up whether sufficient characteristics of a business are
present.
• No one of the indicators of a business is decisive in classifying an
activity as a business.
• Some activities are by nature more likely to be pursued as a hobby or
for recreational purposes and are therefore less likely to be classified
as a business.
• As well as identifying the business, it is also necessary to decide when
the business commences and ends as receipts not associated with the
operation of the business are not business income.
• Receipts that are not the normal proceeds of the business are not
assessable as business income but may be assessable under one of
the other principles of ordinary income or statutory income.
• Non-cash business benefits are deemed to be convertible to cash by

s 21A of the Income Tax Assessment Act 1936 (Cth) and, provided they
are income of the business, they are assessable and valued at an arm’s
length value.
• One-off transactions undertaken by taxpayers who are not running a
continuous business are called isolated transactions.
• Transactions undertaken by taxpayers that are running a continuing
business but that are not within the scope of that business are called
extraordinary transactions.
• Isolated and extraordinary transactions usually only generate
ordinary income if they fulfil the requirement of one or more of the
following three:
• the principle in FCT v Whitfords Beach;
• the first strand of FCT v Myer Emporium; or
• the second strand of FCT v Myer Emporium.
•
The principle in FCT v Whitfords Beach is likely to be satisfied if the
isolated/
extraordinary transaction has sufficient characteristics of a
business.
8: Income from business [8.20] 233
•
The first strand of FCT v Myer Emporium will be satisfied if there is
a business/ commercial transaction, a profit- making intention upon
entering the transaction and consistency between the way the profit is
made and the original intention.
•
The second strand of FCT v Myer Emporium will be satisfied where
a taxpayer sells the right to income but retains ownership of the
underlying asset that is the source of the that income.
•
Profits from isolated and extraordinary transactions will often be
taxable under capital gains tax.
Introduction
[8.10] Income earned from carrying on a business is ordinary income under
s 6-5 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) following the
general concepts of income outlined in Chapter 5. This is in contrast to non-
business activities, such as hobby or pleasure activities, which do not generate
ordinary income and therefore are not assessable under s 6-5.
Characterising receipts as ordinary income from a business activity is a two-

step process that requires:
1. determine whether the taxpayer is carrying on a business; and
2. consider whether the particular receipts are in fact the normal proceeds
of carrying on that business.
This two- step process removes from assessable income activities that
are undertaken as a hobby or recreational pursuit and receipts that are not
the normal proceeds of the business because they are outside the scope of the
business activity. However, receipts that are not the normal proceeds of the
business may still be assessable as ordinary or statutory income. This will
be the case if they are characterised as ordinary income by one of the other
general concepts of income (see [8.170]–[8.300]) or if they are specifically
made assessable by the legislation.
Step 1: Carrying on a business

[8.20] Disputes relating to whether or not a business is carried on often
arise because a taxpayer wishes to take advantage of concessions offered to
certain types of businesses, such as farming or the lower tax rates available
for some companies (see Chapter 21). Similarly, the taxpayer may wish to use
the losses from non-profitable activities, such as share trading, against other
taxable income. In contrast, the Commissioner may seek to classify an activity
as a business to collect tax on the profits realised, even though the taxpayer is
treating it as a hobby.
The term “business” is used throughout the legislation, and the definition in
s 995-1(1) of the ITAA 1997 “includes any profession, trade, employment,
vocation or calling, but does not include occupation as an employee”. This
definition is of little assistance as it only adds to the general meaning of
“business” by including any profession, trade, etc, and leaves open the question
of what is a business in the ordinary meaning of the word. As a result, it is
necessary to look at the decided cases to determine the factors that have been
used by the courts in making this decision: Ferguson v FCT (1979) 9 ATR 873:
see Case Study [8.1].
It is significant that the definition of “business” in s 995-1(1) states that it does

not include income from an “occupation as an employee”. This means that
in most cases, employment income will not be business income. However,
in some cases, an employee contract may not be solely a contract of
employment: Spriggs v FCT; Riddell v FCT (2009) 72 ATR 148: see [8.80].
While income from personal services and business income are both generally
assessable under s 6-5 as ordinary income, there are certain consequences
that follow depending on how the income is categorised. For instance, gains
that are business income can be subject to certain types of deductions that
are not available for income that is purely income from personal services: see
[8.80].
When considering if a business is being carried on, the courts have made a
distinction between activities that are conducted in a commercial-like manner
and activities that are pursued as a hobby or recreational activity. As with other
characteristics of ordinary income, this distinction is quite clear at the extreme
ends of the spectrum. However, it is difficult to identify the point at which a

hobby becomes a business, or the point at which activities first undertaken for
pleasure show sufficient characteristics of a commercial approach to be later
classified as a business.
Indicators of a business activity

[8.30] Over the years, the courts have identified a number of characteristics of
a business, and the presence, or lack, of these characteristics has been used to
classify the activity as a business or a hobby. However, this is a very imprecise
process, and it is extremely important to appreciate that the characteristics
used by the courts are not necessarily exhaustive and no one characteristic
alone is a single indicator of a business.
To ascertain whether a business exists, the courts use an accumulative

approach of weighing up the characteristics of a business that are present
and comparing them to those that are absent. On balance, a decision is then
reached as to whether the activity possesses sufficient of the characteristics
to be classified as a business. This approach involves a question of degree

(weighing up the facts toward a possible conclusion) and, like all other
questions of degree, it is difficult to draw a precise line between activities that
are a business and those that are not. It is also important to recognise that the
courts may place varying degrees of importance on particular characteristics
for different types of activities. For example, the courts tend to look for a higher
level of certainty that a business exists for activities such as gambling: Evans v
FCT (1989) 20 ATR 922; Brajkovich v FCT (1989) 20 ATR 1570.
[8.40] Although it is not possible to create an exhaustive list of the

characteristics of a business, the following are the most common factors that
have been considered by the courts (Ferguson v FCT (1979) 9 ATR 873: see
Case Study [8.1]; FCT v JR Walker (1985) 16 ATR 331: see Case Study [8.2]):
• Whether there is a profit-making intent. A profit-making intention is a

strong, though not determinative indication that there is a business. In
addition, a lack of profit-making intention does not necessarily preclude
there being a business, especially if the operation has sufficient other
characteristics of a business: Stone v FCT (2005) 59 ATR 50: see Case
Study [8.8]. Furthermore, it is not necessary to show the existence of
an actual profit to show a profit-making intent.
• The scale of activities, including the nature and type of capital and
the level of turnover. For example, the larger the business turnover,
the more likely it would be held to be a business, but this does not
exclude small activities from being held to be a business: FCT v JR
Walker (1985) 16 ATR 331: see Case Study [8.2].
• Whether a commercial approach is taken. For example, whether

professional advice has been sought before and during the operation,
whether markets for produce have been explored and whether the
produce is more than that needed for domestic purposes.
• System and organisation employed. For example, the degree of
planning involved, the amount of time devoted to the activity and
whether records are kept. Generally, the courts have been willing to
accept that taxpayers may delegate many of the businesslike activities
to a manager yet still be considered to be running a business: Ferguson
v FCT (1979) 9 ATR 873; FCT v JR Walker (1985) 16 ATR 331.
• Methods characteristic of the particular line of business. For example,
using methods similar to those used in a similar commercial business,
such as a dairy farmer using planned breeding programs to increase
milk production.
• Sustained and frequent activity. For example, occasionally selling pups
from your pet dogs is not the same as regularly breeding a particular
type of dog and aiming to sell the offspring.
• The type of activity and the type of taxpayer. For example, a business
of trading in stamps would have to be much more than the traditional
pastime of a hobbyist collecting stamps and occasionally selling some
duplicates.
Case study 8.1: Indicators of a business

In Ferguson v FCT (1979) 9 ATR 873, the taxpayer (Ferguson) planned to
purchase rural land on which he intended to establish a full-scale cattle
production business for his retirement in two to three years’ time. To
begin building up his planned herd of 200 Charolais cattle, Ferguson
leased five females for four years and bred them to a stud bull in order to
establish his purebred herd. Ferguson also entered into a management
agreement with a rural management firm for a period of 10 years for the
purpose of managing the leased cattle and their calves. The management
agreement required the manager to find suitable grazing for the cattle and
to manage their breeding. All resulting offspring became the property of
the taxpayer. The taxpayer contended that these activities constituted a
business, but the Commissioner argued that this was only preparation for
a future business.
The Full Federal Court held that Ferguson was carrying on a business,
even though it was small and even though it was preliminary to his
intended future business. Central to the conclusion reached by the Court
was the question of whether the taxpayer was conducting this breeding
program in a commercial manner albeit carried out by a manager. In its
decision, the Court considered the following factors:

• A purpose of profit-making may be important but not essential.
• Repetition and regularity are considerations, but a business could
involve a single transaction and every business must commence
with a single transaction.
• Organisation and a businesslike approach with appropriate record
keeping, etc, is an indication of a business activity.
• Having other sources of income did not preclude this activity
from being a business. In other words, the fact that the taxpayer
had a full-time job was not inconsistent with him carrying on a
business.
• The size of the operation and the amount of capital are relevant,
but must be looked at in the context of the type of activity. For
example, a recreational pursuit may have considerable effort and
resources contributed to it and still not be a business.
• These activities were more than preparation to begin a future
business.

[8.50] When using these factors to characterise an activity as a business or

not, the courts will weigh up the factors present in the context of the type of
activity, but there is no single determinative factor that is a reliable indicator
of a business. However, the courts may place a relatively higher degree of
importance on whether the taxpayer is taking a commercial approach, by
conducting the activity in a manner similar to that used in situations that are
clearly conducting a business: Thomas v FCT (1972) 3 ATR 165; Ferguson v
FCT (1979) 9 ATR 873; FCT v JR Walker (1985) 16 ATR 331.
Case study 8.2: A small-scale goat-breeding operation was a business

In FCT v JR Walker (1985) 16 ATR 331, the taxpayer was a real estate agent
who was interested in breeding Angora goats. He purchased one female
Angora goat for $3,000, and then paid another $2,000 to have the goat
impregnated. The breeding process undertaken by the taxpayer involved
substantial assistance by a veterinary surgeon called Dr Corbett, who
undertook many of the actions and decisions of the goat- breeding
operation since the taxpayer lived over 3,000 km away and so could not
be directly involved in its everyday running. The breeding eventually led
to the birth of four more goats, though the original goat and one of its
offspring prematurely died. Although the taxpayer stated that he intended
to profit from the breeding operation, in fact it only produced losses.
Consequently, after a few years the taxpayer quit the goat- breeding
operation. However, while the goat-breeding venture was running, the
taxpayer relied upon Dr Corbett for advice, joined the Angora Breeding
Society, read that society’s journals and kept detailed books of accounts.
Justice Ryan of the Supreme Court of Queensland held that the taxpayer
had been running a business rather than a hobby. His Honour applied the
criteria outlined in Ferguson v FCT for deciding if there was a business.
Specifically, the conclusion that there was a business was partially
supported by the fact that the taxpayer had a profit-making intention. It
was also supported by the fact that there was repetition and regularity
in the breeding activities in that the breeding process was undertaken
repeatedly for a number of years. The conclusion was also highly
influenced by the fact that the taxpayer conducted the operations in a
businesslike manner, as evidenced by his keeping of accounts, joining
the Angora Breeding Society, reading the relevant journal and generally
keeping himself informed about the Angora goat-breeding market. While
many of the actions and decisions were deferred to Dr Corbett, this was
understandable given the fact that the taxpayer lived some distance
from the operation and that Dr Corbett had much more expertise and
knowledge
on the subject of breeding Angora goats.
The finding in FCT v JR Walker that the taxpayer was running a business was
despite the fact that the operation was small even though size was mentioned
in Ferguson v FCT as relevant in determining the existence of a business.
Therefore, although volume of operations is a factor in deciding whether
there is a business, a small operation can still constitute a business if there are
sufficient other businesslike characteristics.
Case study 8.3: A small business or a hobby

In Thomas v FCT (1972) 3 ATR 165, the taxpayer (Thomas) was a barrister
who purchased 7.5 acres (3.04 ha) of land where he constructed a private
home and planted several varieties of trees for timber, macadamia nut
and avocado production, some of which were irrigated. For the relevant
period no income had been produced and some of the trees had been
destroyed by fire and there had been some replanting. Thomas contended
that he was carrying on a business, but the Commissioner argued that this
was a hobby because it was not likely that there would be any significant
income and this type of agriculture was not common in this area.
The High Court held that there was a business of primary production
and that a business may exist even though it is conducted on a small
scale and has little or no short-term prospect of making a profit. It was
not significant that the taxpayer’s main income was earned from his
profession as a barrister or that only a small amount of time was devoted
to the farming activity. What was important was that the tree planting was
much greater than what would be needed for domestic purposes and the
activity was more than a recreational pursuit or hobby. Walsh J was not
swayed by evidence that the business was conducted rather inefficiently,
and his Honour concluded that it is reasonable to accept that mistakes
will be made and the taxpayer did seek technical advice to assist with
management
decisions.
Distinction between a business and hobby in Thomas v FCT centred on the

issue of whether the farming undertaken was more than a recreational activity
pursued for mainly leisure purposes.
Example 8.1: Degree of commercial approach

A taxpayer who plants vegetable and fruit trees in his own backyard
and uses the produce for his own personal consumption is clearly not
conducting a business. This would still be the case even if small amounts
of excess produce are sold to neighbours, as this is unlikely to be enough
to cross the border between a hobby and business.
Establishment of a business for income tax purposes requires some

degree of commerciality, which would be indicated by production being
more than required for domestic consumption and a more systematic
and organised approach to the vegetable and fruit production: Ferguson
v FCT (1979) 9 ATR 873. Facts such as using land other than the
backyard, selling produce on a regular basis at the local markets, seeking
professional advice on production techniques, planning production to
meet demand and keeping appropriate records would all help to indicate
that a commercial approach is being employed.

As previously mentioned, there is no exact formula for identifying the dividing

line between a business and a recreational activity or hobby. Each case must
be considered on its facts and decided in the light of the factors that the courts
have considered relevant in the decided cases. Some examples to assist in
narrowing the degree of uncertainty in this decision include:
• gambling: see [8.60];
• sportspeople’s earnings: see [8.80];
• investment activities: see [8.90]; and
• land sales: see [8.100].
Gambling
[8.60] Taxpayers such as professional bookmakers and casino operators are

clearly running a business because they take a commercial approach in that
they operate on such a large scale that they can reasonably manage the odds
of winning and predict their likely profit.
On the other hand, an individual who gambles is very unlikely to be considered

to be in the business of gambling because such activities are inherently
recreational in nature. For instance, a person who regularly bets on horse
races or at the casino is normally undertaking a recreational pursuit and is not
considered to be in the business of gambling.
For an individual to be found to be carrying on a business of gambling, there

would need to be a significant level of commercial activity, such as regular and
systematic betting, large amounts of money wagered and possibly integration
with other business activities like horse racing and horse breeding: Trautwein v
FCT (1936) 56 CLR 196; Prince v FCT (1959) 7 AITR 505. Gambling on horse
racing is more likely to be a business if the gambler is associated with other
related activities, such as owning horses, training horses or operating as a
bookmaker: Income Tax ruling IT 2655.
Case study 8.4: Gambling was part of business of horse racing

In Trautwein v FCT (1936) 56 CLR 196, the taxpayer had for a number
of years been interested in horse racing with a view to making a profit.
He devoted a substantial amount of time and money to the sport and
established a farm for breeding racehorses. Trautwein raced his own
horses as well as others that had been leased to him. The taxpayer was
also involved in frequent and systematic betting on horse races wagering
large amounts of money and using an agent to place bets and collect
winnings. He also regularly attended race meetings throughout the year.
The High Court held that the taxpayer’s gambling activities were part of
his racehorse business, and therefore his earnings were ordinary income.
Influential to the Court’s decision was the fact that the taxpayer’s gambling
was closely associated and integrated with his horse-racing business.
Other factors considered relevant were:
• the size of the bets;
• the systematic and organised approach;
• commitment of substantial amounts of money and time to
betting; and
• employment of other people to place bets and collect winnings.

[8.70] In Australia, the courts have generally concluded that gambling does
not constitute a business if it is not conducted on a large scale and is not
connected to another business: Martin v FCT (1953) 90 CLR 470; Evans v FCT

(1989) 20 ATR 922; Brajkovich v FCT (1989) 20 ATR 1570. As a result of the
more recent decisions in Martin v FCT and Evans v FCT, it may be suggested
that if facts similar to Trautwein v FCT were considered by the courts today, the
same conclusion may not be reached.
Case study 8.5: Gambling was not a business even though associated

with horse breeding
In Martin v FCT (1953) 90 CLR 470, the taxpayer owned and bred race
horses and had previously carried on business as a hotelier and then as a
farmer. Over the years, he regularly engaged in betting on horse races in
a systematic manner and his accountant kept the records of his expenses
and winnings from gambling.
The High Court held that the taxpayer was not conducting a business, but
pursuing a recreational pastime despite the facts that there were a large
number of bets, he employed a system in his betting and he had other
interests
in horse racing.
Case study 8.6: Gambling was not a business due to lack of systematic

approach
In Evans v FCT (1989) 20 ATR 922, the taxpayer earned over $800,000
from betting on horse racing over a five-year period. The Federal Court
held that Evans was a lucky gambler and was not conducting a business
because of the lack of a systematic approach. The Court relied on the fact
that he did not place his bets with a bookmaker and he often wagered on
long-
odds  bets.
Case study 8.7: Gambling with no other source of income was not a

business
In Babka v FCT (1989) 20 ATR 1251, on retiring at the age of 51, the
taxpayer had commenced spending a large amount of time gambling.
The gambling was predominantly concentrated on horse racing, although
it included other activities such as card games and casinos. The taxpayer
did not have employees or an office. The Commissioner claimed that the
taxpayer was in the business of gambling due to the fact that they had no
other income, kept detailed records of previous bets and utilised a betting
system.
Justice Hill of the Federal Court held that Babka was not in the business of
gambling. His Honour stated that the fact that a taxpayer devotes a large
amount of time to their gambling activities, uses a betting system and
keeps detailed betting records does not necessarily mean that they are in
the
business of gambling.
Sportspeople
[8.80] Some sporting activities involve a high degree of professionalism to the
extent that participants are fully occupied by their sporting pursuits. Also, there
may be significant amounts of money involved, extensive use of managers
and agents to negotiate individual contracts and significant involvement of
the media and advertising industries. In these circumstances, it is relatively
clear that the participants are carrying on a business of earning income or at
least earning income from personal services: see [6.30]. In contrast, sporting
activities that are undertaken as a recreation pursuit will not constitute the
carrying on of a business although there may still be income from personal
services: see [6.30].
Identifying the receipts of a professional sportsperson as income from a

business or income from personal services (see [6.10]–[6.30]) is important. This
is because it may influence how they are treated for tax purposes as a team-
based professional sports person paid as an employee may have limited tax
deductions compared to a professional sports person judged to be operating
a business: Stone v FCT (2005) 59 ATR 50; Spriggs v FCT; Riddell v FCT (2009)
72 ATR 148: see Case Studies [8.8] and [8.9]. The tax consequences of a
professional sportsperson’s activities constituting a business, or not, include
the following:
• Any fees paid by the club that the professional sportsperson is playing
for will be ordinary income regardless of whether the taxpayer’s sporting
activities are regarded as a business. For example, club payments to a
professional footballer who is in the business of playing football could
be ordinary income from business, but if he is not in the business of
playing football, then the payments would be ordinary income from
personal services.
• Prizes for sporting achievements (see [6.110]) received by a sportsperson
whose sporting activities constitute a business will be ordinary income
from that business: Stone v FCT: see Case Study [8.8]. On the other
hand, if the sporting activities do not constitute a business, prizes
received for sporting achievement may still be regarded as ordinary
income from personal services: Kelly v FCT (1985) 16 ATR 478: see
Case Study [6.6]. However, in the case of sportspeople whose sporting
activities constitute a business, there may still be instances where
sporting prizes may not be regarded as ordinary income if the prize is
awarded for the personal qualities of the taxpayer: Stone v FCT.

• There could be a broader range of deductions available if the
taxpayer’s sporting activities are regarded as a business. For example,
if a professional football player is regarded as being in the business
of playing football, then any fees paid to a manager to enter into a
contract with a new team would be deductible: Spriggs v FCT; Riddell
v FCT. However, such fees would not be deductible if the football
player’s sporting activities are not regarded as being a business. This
is because the first limb of s 8-1 of the ITAA 1997 (only available to
employees) requires that the expense is incurred in the course of
earning the income, but agents fees are incurred before the income is
earned.
In recent years, the courts have been more likely to label professional
sportspeople as being in business. This has been the case for sportspeople
that regularly play team sports at a high level: Spriggs v FCT; Riddell v FCT. It
has also been the case for taxpayers that compete in non-team sports at high
levels of competitions, especially if the sportsperson also undertakes related
commercial activities, such as seeking corporate sponsorship: Stone v FCT.
Case study 8.8: Javelin thrower was carrying on a business

In Stone v FCT (2005) 59 ATR 50, the taxpayer (Stone) was a world-class
javelin thrower and was also a full-time employee in the Queensland
Police Force. As well as performing her duties as a police officer, Stone
competed successfully in national and international competitions,
including being selected for the Australian Olympic squad and winning
the women’s javelin event in the 1998 World Cup.
During the tax year ending 30 June 1999, Stone earned $136,448 from
her sporting pursuits. This sum consisted of prize money, grants from the
Queensland Sports Academy, appearance fees and sponsorship fees. The
sponsorship fees were paid for her wearing clothing of certain brands,
as well as her agreeing to have advertising material on her sporting
clothes and the motor vehicle that was provided to her. The taxpayer also
employed a manager for a short time to manage her sponsorships and
appearances.
The High Court held that Stone was carrying on a business in relation
to her sporting activities and that all cash receipts from this business
were ordinary income under s 6-5 of the ITAA 1997. The Court stated that
although Stone lacked a clear profit motive, an examination of the relevant
activities indicated that she was carrying on a business. In reaching this
decision, the Court was particularly influenced by the fact that Stone had
entered into sponsorship deals. The Court also mentioned that although
the presence of a profit motive is a strong, though not conclusive,
indication that the taxpayer is running a business, an operation can still
be
a business despite the taxpayer lacking a profit motive.
Case study 8.9: Professional team sportspeople are carrying on

a business
In Spriggs v FCT; Riddell v FCT (2009) 72 ATR 148, both taxpayers
played football in their respective football leagues and arranged for their
managers to negotiate new player contracts upon them changing clubs.
Following the completion of the negotiations of the player contracts, the
managers charged their clients a fee, which Spriggs and Riddell claimed
as a tax deduction.
One issue considered by the High Court was whether Spriggs and Riddell
were carrying on a business and, if so, the extent of their business
activities. Due to the rules of deductibility, management fees relating to
entering contracts with new clubs would only have been deductible if
the sport-playing activities were business activities: see [12.340]–[12.350].
It was accepted by all parties that activities outside their playing duties
(eg, endorsement and media engagements) were business activities.
However, the Commissioner contended that the older decision in
Maddalena v FCT (1971) 2 ATR 541 should be followed. In Maddalena v
FCT, the Court had held that professional football playing activities were
employment activities and not business activities.
The High Court found that Maddalena v FCT did not apply to the facts in
Spriggs and Riddell and held that the taxpayers’ sports-playing activities
were business activities. The Court distinguished Maddalena v FCT on
the basis that in Maddalena v FCT the taxpayer played rugby part time
and had no manager. In contrast, the taxpayers in Spriggs and Riddell
played football full time and had managers. Furthermore, the Court was
influenced by the fact that modern-day football had changed since the
case of Maddalena v FCT in that changing clubs was easier and more
structured
than had previously been the case.
Investment activities
[8.90] Investment income will normally be characterised as income from
property (see Chapter 9) because it is inherently passive in nature and is earned
without showing sufficient of the elements of a business: FCT v Radnor Pty Ltd
(1991) 22 ATR 344. However, whether investment income is property or business
income can be an important distinction as it will affect the tax treatment of the
transactions. Where investment income is classified as property income, the
acquisition of the underlying investments, such as shares and rental property,

will be treated as capital and the sale will not be ordinary income. Conversely,
if the investment activity is classified as a business, the underlying investment,
such as the shares, will be regarded as trading stock (see Chapter 17) and
treated on revenue account as ordinary income, rather than as capital.
Identifying investment activities as a business is a question of degree which

will be determined from the facts, taking into account the previously identified
indicators of a business: see [8.30]–[8.50]. For example, large superannuation
funds and listed investment trusts are commonly in the business of investment.
However, there has to be something more than a profit-making intention and
frequent transactions to show that the taxpayer is carrying on a business of
investing.
In London Australia Investment Co Ltd v FCT (1977) 7 ATR 757, the High
Court held that a business of investment was being carried on due to the
high degree of activity in investing and reinvesting in shares to maintain a
minimum dividend yield. In contrast, a business that invests for long-term
growth, rather than speculative investment, will normally be classified as
earning property income and not income from a business: AGC (Investments)
Ltd v FCT (1992) 23 ATR 287; Smith v FCT [2010] AATA 576. For example, a
taxpayer who purchases a portfolio of shares as a long-term investment for
capital growth, but occasionally sells some of the shares to restructure the
portfolio, is not conducting a business of selling shares. This is illustrated by
the Commissioner’s view that a self-managed superannuation fund that holds
shares and/or rental property to earn passive income is not carrying on a
business: Self-Managed Superannuation Fund Ruling 2009/1. Whereas a bank
that holds a large portfolio of shares and regularly speculates on movements
in the share market and trades in these shares to maintain liquidity is in the
business of buying and selling shares.
In Taxation Ruling TR 2019/1, the Commissioner expresses the view that a

company, that is a small business entity for tax purposes, can be taken to be
carrying on a business even if the activities are quite limited. This would be the
case even if the company’s income consists mainly of passive income such as
rent or interest. Nevertheless, the statement in the draft ruling is qualified with
the comment that each case has to be determined on the facts.
Case study 8.10: Holding shares for long-term growth was not

carrying on an investment business
In AGC (Investments) Ltd v FCT (1992) 23 ATR 287, the taxpayer (AGC
(Investments)) was a subsidiary of an insurance company and was set up
to earn dividend income and maximise long-term capital growth for the
parent company. The share portfolio was professionally managed and
the parent company treated the value as a capital reserve in its balance
sheet. In 1987, the taxpayer decided to sell over 50% of its share portfolio,
realising almost $80 million and a significant profit. AGC (Investments)
then reinvested the proceeds into fixed interest securities.
The Full Federal Court held that AGC (Investments) was not carrying on
an investment business but was holding the shares for long-term capital
growth. The key facts in reaching this decision were that there was clear
evidence that the investments were undertaken for long-term growth
rather than speculative returns. In addition, the shares were not bought
and sold to maintain liquidity for the parent company.
Under current legislation, the sale of these shares would be subject to
capital
gains tax: see Chapter 11.
Most cases concerning the business status of share trading activities have
involved facts relating to larger financial institutions. Even so, it is still possible
for an individual to be conducting a business of share trading. This is a question
of fact as it is with all other decisions as to whether an activity is a business
for tax purposes. For instance, in AAT Case 4083 [2011] AATA 545, it was held
that an individual taxpayer trading shares in his own name was in the business
of share trading for income tax purposes. The primary reasons for reaching
this conclusion, despite the small number of sales in the year, were that the
taxpayer operated on a large scale (millions of dollars), he normally traded
regularly, he followed a systematic approach even though he did not have
clear goals and he was often seeking volatile shares.
Land sales
[8.100] As with other decisions as to whether a business is being carried on,
it is difficult to draw a clear line between the sale of land that is capital as a
“mere realisation” (disposal of an asset that is no longer required) of an asset
and the business of property development. Where the firm’s primary activity
is purchasing, developing and selling land, it is clearly undertaking an ongoing
business of selling land: FCT v St Hubert’s Island Pty Ltd (1978) 8 ATR 452.
Conversely, a firm that sells a factory and accompanying land because the
property is no longer required is clearly not in the business of selling land, even
though it may conduct some other business in the factory. However, if the land
could potentially be rezoned as residential and the firm decides to undertake
extensive development activities, the question arises as to whether the firm
has entered a new business of property development: see [8.170]–[8.200].
Whether the sale of land is part of an ongoing business activity will be resolved
by considering the extent to which the elements of a business are present.
However, land may also be sold as an isolated transaction, which may be
classified as ordinary income: see [8.170].
Sharing economy
[8.105] In recent years, there has been a rapid increase in the “sharing
economy”, as it has become known. The concept of the sharing economy is
that the Internet is used to connect a client with a service provider. Some of
the more common examples are the renting accommodation space (rooms or
whole houses) through such sites as Air BNB, Stayz and Booking.com; ride-
sourcing through Uber, DiDi, Ola and GoCatch; providing personal services
through Airtasker or Oneflare; retail activities operated through eBay; and
renting parking space through Parkhound. All of these activities allow providers
to make their services or product available to a wide range of potential
clients without the usual infrastructure such as websites and advertising that
businesses normally require to access their markets.
The sharing economy has come under scrutiny by the Australian Taxation
Office’s (ATO) Black Economy Taskforce as there is some concern that some
operators in the sharing economy are treating receipts as cash and not
considering whether they are assessable income.
Providers operating in the sharing economy need to be aware of the possible

income tax obligations that arise from providing services via these websites.
These obligations will primarily depend on whether they have earned income
from personal services (see Chapter 6) or whether they are conducting a
business. There could also be other taxation implications such as liability to
GST (see Chapter 25) and effects on CGT main residence concessions if part
of your main residence is available to the public for accommodation: see later
in this chapter.
Earlier in this chapter, the characteristics of a business were discussed in

detail, and this will be an important consideration as to whether the receipts
from these activities are assessable or not as ordinary income under s 6-5 of
the ITAA 1997. The primary distinction to be made is whether the activities
are undertaken for recreational purposes as a hobby (not ordinary income) or
conducted in a businesslike manner to earn assessable income. Where these
services are provided through a facilitating website, such as Uber or Air BNB, it
will be very difficult to make the case that this is a private recreational activity
(hobby) as there are significant characteristics of a business present: see [8.40].
For example:
• pricing of the services on offer would indicate an intention to profit;
• the scale of the operation may be small, but this does not exclude
the activity from being a business if it is conducted in a businesslike
manner. Conducting the activity through a sharing economy website
would be evidence of a businesslike approach;

• a commercial approach is evident as the sharing economy websites
require a level of detail and professionalism in the offering of the
service. For example, Air BNB requires details of the facilities offered in
the accommodation, and they require a certain level of standard;
• the provider is required to be organised and satisfy the requirement of
the sharing economy website. For example, an Uber driver is required
to meet certain requirements including a vehicle inspection;
• there may or may not be sustained and frequent activities, but when
these activities are undertaken, they show many of the characteristics
of a business.
Note: The Commissioner of Taxation considers income earned from the
sharing economy to be assessable income.
If it is established that operating in the sharing economy is a business activity,

then the normal requirements of the income tax legislation will need to be
satisfied. Income will be assessable, and deductions can be used to reduce the
taxable amount. There will also be the normal record-keeping requirements.

Some of the tax implications of operating in the sharing economy include:
• income is assessable income;
• liability to GST if the turnover is $75,000 or greater;
• interest relating to property, vehicles or other assets may be deductible
in part or in full based on the degree to which the assets are used to
earn assessable income;
• possible depreciation deductions for depreciating assets or Div 43
write-off of buildings;
• partial or complete loss of CGT main residence concessions through
renting out part of a home that is designated as a main residence or
making paid parking space available on private property;
• requirements to register an Australian Business Number (ABN); and
• requirements to keep records for tax purposes.
Crowdfunding activities
[8.107] The concept of raising funds from the public for many and varied
purposes is by no means a new idea. In 1700s, Jonathon Swift established a
process whereby wealthier citizens (the crowd) could provide funds to be lent
to the poor in Dublin. However, the development of the Internet has facilitated
the rapid growth of this form of fund raising where a project is funded by raising
small contributions from a large number of people (contributor –the crowd).
The process begins with the initiator (recipient) proposing to raise funds for a
specific purpose (eg, to develop a new product). They then engage an Internet-
based crowdfunding platform (intermediary’s such as Mycause and GoFundMe)
to promote and collect contributions, and then for a fee or commission, pass
the collected funds onto the initiator or recipient of the project.
Crowdfunding has been used for a number of purposes including raising funds
for bushfire and drought relief, business start-ups, technology development and
recently, due to changes in government legislation (the Corporations Amendment
(Crowd-sourced Funding for Proprietary Companies) Act 2018), making it possible
for proprietary companies to use crowdfunding for equity raising.
The income tax impact on funds raised through crowdfunding will depend on
the purpose the funds are raised for and the circumstances of the taxpayer(s)
involved. Generally, crowdfunding will either be:
• a donation (eg, drought relief);
• reward-based (contributor receives goods or services based on the
level of contribution); and
• equity-based (the contributor obtains an interest in a project with rights
to returns).
For tax purposes, this means that the three parties involved in crowdfunding
need to consider the tax implications of their transactions:
• Initiator or recipient: Is this part of a business activity or not?
• Crowdfunding platform (intermediary): Is this activity a business or are
they operating as an agent?
• Contributor: Are contributions a tax deduction and any return
assessable?
Initiator (recipient): Receipts from crowdfunding will be assessable if they

are connected to carrying on a business (see [8.20]), or the receipts are an
extraordinary or isolated transaction entered into with the intention of making
a profit (see [8.170]). However, it is also necessary to consider whether or not
the business has commenced at the time the crowdfunding arrangements
begin (see [8.110]). If the business has not commenced at this stage, then the
receipts will not be ordinary income under s 6-5 of the ITAA 1997 unless it
is an extraordinary or isolated transaction. Similarly, if the business has not
commenced, then any expenses will not be deductible under s 8-1 of the ITAA
1997, but it may be possible to obtain a specific deduction under s 40-880 (see
[12.130]).
Consideration also needs to be given to whether the project is of a capital

nature as capital receipts are not ordinary income but potentially subject to CGT
(see Chapter 11). Capital expenses are also not a general deduction, but some
specific deductions, such as depreciation, may be available (see Chapter 14).
Intermediary: If the intermediary is in the business of sourcing crowdfunding

projects, promoting the scheme and collecting and distributing funds, then
their receipts will be ordinary income from business and expenses will be
deductible based on the normal tax deduction provisions (see Chapters 12–14).
Distributions to the initiator of the project will also be deductible as these are
an expense (not capital) in carrying on the business (s 8-1 of the ITAA 1997).
However, if the intermediary acts as an agent (acts on behalf of the initiator)

so that the funds received are not the income of the intermediary but simply
passed to the initiator, then these funds are not ordinary income as they are
not derived by the taxpayer. In this case, the only assessable income would be
any commission received for acting as an agent.
If the intermediary is a tax-deductible charity, then these receipts will be tax

exempt (Div 50 of the ITAA 1997) provided the charity does not breach its
not-for-profit  rules.
Contributor: Contributions that are made as a donation to a tax-deductible

charity will be tax deductible for amounts of $2 or more (see [13.130]). As
this is a donation, there will no right to receive any return and therefore there
cannot be any assessable income for the contributor.
Some crowdfunding projects provide the promise of a return to the contributor

depending on the level of contribution. For example, the initiator has designed
a new wine preservation device and seeks funds to put the product into
production. For a contribution of $100, the contributor is promised one free
wine preservation unit (retail value $150) if the crowdfunding is successful and
the product is manufactured. If the contributor is a private person, then this
arrangement is private in nature and the cost of $100 is not deductible and
the receipt of the free product is not assessable. However, if the contribution
is entered in the course of the taxpayer’s business, the cost will be deductible
and any goods or services provided in return will be assessable as ordinary
income.
Example 8.2: Taxation of a crowdfunded donation

A tax-deductible charity raises funds for donation to drought-stricken
farmers. The taxpayer making the donation will be entitled to a tax
deduction for contributions of $2 or more (see [13.130]). Provided the
charity does not breach its not-for-profit rules, then the receipt of these
donations will not be taxable income of the charity as they are exempt
income.
If the funds distributed are used for business purposes such as the
purchase of farm supplies, stock feed and other deductible expenses,
then the receipt will be assessable to the recipient as ordinary income
under the compensation principle (see Chapter 10). However, the use of
these funds to purchase stock feed etc. will also result in an equivalent
deduction. The ATO has indicated that where these funds are spent
on tax-deductible expenses (eg, stock feed), then there will be no net
taxable income as the assessable receipt will be offset by the equivalent
deduction.
If the funds are used for private purposes (eg, food and clothing), then
they are not ordinary income as they are a non-assessable gift (see [6.90]).

Crowdfunding used to raise equity would be treated in the same manner as

similar financial dealings that are currently undertaken.
Commencement and termination of business

[8.110] Once it has been established that there is a business, it may also
be necessary to determine whether a business is being “carried on” during
the relevant tax period. This makes it necessary to identify the times when the
business starts and when it ends. Transactions that occur before the business
commences or after it has ceased are treated differently for tax purposes
to those that occur during the business operation. For example, expenses
incurred before the business starts, or after it ends, may not be deductible
under the general deduction provision and may only be deductible under a
specific provision: see [12.130]–[12.140].
Example 8.3: Preliminary expenses
A taxpayer intending to start a new business may incur preliminary costs
to explore whether the proposed enterprise has a reasonable chance of
success. These costs may include professional advice, market research,
feasibility studies, product testing, pilot production research, etc. If the
business has not commenced, these expenses will not be deductible
under s 8-1 of the ITAA 1997, although it may be possible to obtain a
deduction under statutory provisions such as s 40-880: see [12.130].

Ascertaining the time of commencement of a business is a question of fact

primarily based on the intention of the taxpayer at the relevant point in
time: Softwood Pulp and Paper Ltd v FCT (1976) 7 ATR 101. For example,
product market testing may be undertaken before the start of operation, but it
may also be an ongoing activity of the business once it has commenced trading.
If product testing is conducted to determine whether there is sufficient demand
to warrant commencing a new business, then this would be a preliminary
expense and not within the scope of the business. Product testing of a new
product line for a firm that already has 50 existing lines would be within the
scope of the continuing business.
A key question which the courts have used in drawing this line between
preliminary expenses and operating expenses is: Has the taxpayer “committed”
to commencing the business or merely deciding whether or not to go ahead?
Softwood Pulp and Paper Ltd v FCT; Goodman Fielder Wattie Ltd v FCT (1991)
22 ATR 26.
Case study 8.11: Feasibility study was not a commitment to

commence business
In Softwood Pulp and Paper Ltd v FCT (1976) 7 ATR 101, the taxpayer
company was incorporated to establish a paper mill for a Canadian
company. Following incorporation, Softwood Pulp undertook a feasibility
study to ascertain whether the proposed mill would be viable. However,
the project never proceeded due to a lack of funds, and the company
never made any substantial income.
The Supreme Court of Victoria found that no business was “carried on”
as these expenses were to determine whether the mill was viable and,
at this point, there had been no commitment to commence operations.

These expenses were incurred before the income- earning activities
commenced, and therefore they were not deductible under the law at
the time.

Case study 8.12: A business had already commenced while land was
being prepared for chestnut farming
In FCT v Osborne (1990) 21 ATR 888, the taxpayer leased land for the
purpose of planting and growing chestnuts. The taxpayer subsequently
entered into a contract to buy chestnut plants and seedlings and also
fertilised the soil due to the land having a nitrogen deficiency. However,
after a year the taxpayer decided to abandon the chestnut venture because
it was not economically feasible. The venture was abandoned before the
taxpayer had planted chestnut seedlings or plants. The taxpayer wished
to deduct the cost of leasing the land, depreciation on equipment and
paying for labour.
The Full Federal Court held that a business had already commenced
when the taxpayer had taken steps to fertilise the land. However, the
costs were not deductible for a separate reason in that they were of a
capital nature: see Chapter 12 for a discussion on deductibility of capital
expenses.
[8.120] Issues regarding the deductibility of preliminary expenses have been

the main area of dispute that the courts have considered in relation to the
commencement and ending of a business. Nevertheless, the same test as to
whether a business is carried on would reasonably apply to income earned
prior to commencement, provided that the income did not fall into another
category of ordinary or statutory income. Similar principles also apply when
businesses cease to operate and are wound-up.
Example 8.4: Commencement of business
Michelle has for many years been a very keen seamstress, and she made
many of her children’s clothes when they were young. Occasionally
Michelle has also made clothes for friends for special events, such as
weddings and other formal functions. Twice her friends insisted on
paying her amounts of about $300 for the clothes even though she never
asked for any money.
Now that that the family has grown up and left home, Michelle decided to
look into renting a small shop and offer her services to do clothing repairs
and alterations, as well as make garments to order for special occasions.
Michelle’s first step prior to renting a shop was to talk to her accountant
to see whether she thought this could be a viable enterprise. She also
travelled to the nearest major town to investigate whether there were any
other businesses offering similar services.
On 1 January, Michelle entered a lease for a small shop and spent money
on signs for the window, advertising in the local paper, additional stocks
of supplies, a new sewing machine and computer to keep records and
help with the design of the garments. On 4 March, Michelle received her
first order and business has been quite good ever since.
Prior to renting the shop, Michelle is clearly not carrying on a business
as her sewing is mainly domestic and the small amount of income
would be income from a hobby and not ordinary income under s 6-5
of the ITAA 1997. The costs of seeking advice from her accountant and
exploring the availability of sewing services are most likely preliminary to
commencement of the business as there is no commitment at this point
to commence operations: Softwood Pulp and Paper Ltd v FCT (1976) 7
ATR 101: see Case Study [8.11]. Entering the lease agreement is a clear
indication that Michelle has made a commitment to start her income-
earning activity and is a strong indicator of the commencement of her
business, even though no income is derived until some months later.

Step 2: Normal proceeds of a business

[8.130] Identifying the factors that distinguish a business from a hobby or
recreational activity is the first step in characterising business income as
ordinary income under s 6-5 of the ITAA 1997. The second step is to determine
which receipts are the normal proceeds of the business and which are not. If
a receipt is not earned from “carrying on” the usual business of the taxpayer,
then it is not within the “normal proceeds” of the business, although it may
still be assessable for other reasons: see [8.170]–[8.300]; Californian Copper
Syndicate v Harris (1904) 5 TC 159.
Characterising a receipt as part of the normal proceeds of the business requires:

• an investigation of the nature of the business; and
• an assessment as to whether the receipt shows a nexus with the
identified business activity.
Example 8.5: Are receipts normal proceeds of the business?

Continuing Example 8.4, the nature of Michelle’s business is her activity
as a seamstress, and therefore the normal proceeds of this business will
be the earnings related to her seamstress activities.
However, if Michelle had negotiated a two-year contract to repair uniforms
for a local supermarket, but could not cope with the work and sold the
contract to another business, then this receipt is not within the normal
proceeds of her business. The nature of Michelle’s business does not
include arranging and selling contracts, and therefore the money received
from the disposal of this contract does not have a nexus with normal
business activity. Consequently, the sale proceeds do not constitute the
“normal proceeds” of the business.
Although the sale of the contract is not the “normal” proceeds of the
business, it may be assessable under other general concepts (FCT v Myer
Emporium Ltd (1987) 163 CLR 199: see Case Studies [8.23] and [8.24]) or
statutory provisions, such as capital gains tax: see [8.270].

Nature of the business –broad or narrow approach?

[8.140] The question of whether a receipt is the normal proceeds of the
business is influenced by whether the court adopts a broad or narrow view of
what activities make up the business. If a broad view of the business activities is
adopted, it is more likely that unusual receipts could still be treated as business
income: Memorex Pty Ltd v FCT (1987) 19 ATR 553; see Case Study [8.15]; GP
International Pipecoaters Pty Ltd v FCT (1990) 21 ATR 1; see Case Study [8.14].
Conversely, if a narrower view is taken of the nature or the business, it will
be less likely that an unusual transaction will be held to be normal proceeds
of the business: Scottish Australian Mining Co Ltd v FCT (1950) 81 CLR 188
(see Case Study [8.16]); FCT v Merv Brown Pty Ltd (1985) 16 ATR 218 (see
Case Study [8.13]).
Example 8.6: Narrow or broad identification of the nature of the

business
A narrow approach to the identification of the nature of the business may
be to say that a scaffolding hire business is not in the business of selling
scaffolding equipment. Therefore, any income from charges made because
scaffolding had not been returned is not within the normal proceeds of
the business as it is effectively a receipt for the sale of equipment. The
narrow approach would be to look at the primary purpose of the business
(hiring scaffolding equipment) and conclude that the receipts from the
disposal of equipment are not from hiring and therefore are not within the
scope of this business.
Conversely, a broad approach to the identification of the nature of the
business could be to say that income from charges made because
scaffolding had not been returned is a normal and regular component of
the hiring business. Therefore, any receipts resulting from the failure to
return equipment would be within the normal proceeds of the business
activity.

Australian courts do not explicitly express whether a narrow or broad approach

is adopted when establishing the nature of the business. However, case
authority suggests that a broader approach is more common, but if a broad
approach is used, the courts then require a strong connection between the
taxpayer’s core business and the unusual activity to show a nexus with the
core business: Memorex Pty Ltd v FCT.
Case study 8.13: Sale of unwanted import quotas were not proceeds

of the business (narrow approach)
In FCT v Merv Brown Pty Ltd (1985) 16 ATR 218, the taxpayer was
a clothing importer, but changes to government policy reduced the
profitability of some imported lines. As a result, the taxpayer decided to
sell the import quotas for these less profitable items. The quotas sold only
represented a small percentage of the total number of import quotas held
by the taxpayer.
The Full Federal Court held that the sale of the quotas was of a capital
nature and not within the “normal proceeds” of the business. The
majority identified the taxpayer’s business as the purchase and sale of
clothing and material (narrow approach), and therefore the sale of the
import quotas was not the normal proceeds of this business activity. This
decision relied on the fact that the taxpayer did not normally sell quotas
and that these sales were a reorganisation of the taxpayer’s business as a
result
of changes to government policy.
Case study 8.14: Receipts from a contract were within the scope of

business (broad approach)
In GP International Pipecoaters Pty Ltd v FCT (1990) 21 ATR 1, two
companies successfully tendered to coat pipes that were to be supplied
to the State Electricity Commission of Western Australia (SECWA) for the

construction of a natural gas pipeline. A requirement of the tender was
that the pipes be coated in Australia, which necessitated constructing
a pipe coating factory. The taxpayer (GP Inter-national Pipecoaters Pty
Ltd) was incorporated by the successful tender companies to construct
the pipe coating facility and carry out the pipe coating required. SECWA
paid the taxpayer a sum of over $5 million to cover some of the cost of
constructing the pipe coating factory, and the taxpayer argued that the
receipt of the money was capital and not within the scope of the business.
The High Court held that the receipt was within the normal proceeds of
the business because the money was received as a result of work which
was required to be carried out due to successfully winning the tender
to coat pipes. A broad approach was used to identify the scope of the
business arising out of the successful tender, holding that the business
included
both the construction of the plant and the coating of the pipes.
Nexus of receipt with business

[8.150] Having established the nature of the business, the second step is
to ascertain whether the receipts in question have a nexus to the business
activity and so are the normal proceeds of that business. Case law such as
FCT v Hyteco Hiring Pty Ltd (1992) 24 ATR 218 and Westfield Ltd v FCT (1991)
21 ATR 1398 (see Case Study [8.22]) indicates that receipts will be normal
business proceeds when they are a product of:

• a transaction that is part of the ordinary business activity, such as a
share trader’s receipts from the sale of shares; or
• a transaction that is an ordinary incident of the business activities –for
example, the sale of ex-lease goods by a leasing company would in
some circumstances be business income: see Case Study [8.15].
Some court decisions suggest that an important consideration in this second
step is the frequency and magnitude of the activity that generated the
receipt: Memorex Pty Ltd v FCT (1987) 19 ATR 553 (see Case Study [8.15]).
However, each of the steps in this process is to some degree interrelated.
For example, in FCT v Merv Brown Pty Ltd (1985) 16 ATR 218 (see Case
Study [8.13]), the sale of the import quotas was held to be outside the normal
proceeds of the business. This was because the nature of the business was
limited to the sale of imported clothing and material, and the sale of quotas
was infrequent and therefore not part of that business. On the other hand, if
the sale of quotas was a regular activity, then it may have been included in the
nature of the business.
Case study 8.15: Sale of leased equipment was within the scope of the
business
In Memorex Pty Ltd v FCT (1987) 19 ATR 553, the taxpayer operated a
business of selling and leasing computer equipment, as well as providing
advice on the design of computer systems. The commercial life of the
computer equipment was about five years. Due to the rapid development
of the technology, some customers preferred to lease the equipment
rather than purchase it outright. Typical lease agreements were two to
four years, and at the end of the lease the equipment was either re-leased
to the customer, returned or sold to the lessee. Receipts from the sale
of the leased equipment were not a major component of the taxpayer’s
business, and the taxpayer argued that they were capital in nature and
not the normal proceeds of the business.
The Full Federal Court held that receipts from the sale of the leased
equipment were part of the normal proceeds of the business and were
not capital in nature. In reaching this conclusion, the Court identified the
nature of the business as selling and leasing of computer equipment and
that the receipts from the sale of leased equipment showed a nexus with
this core business activity. The nexus was established on the basis that,
although these sales were not a major component of the business, they
were of sufficient magnitude, frequency and regularity to be judged as a
normal
incident of the business operations.
Receipts that are the normal proceeds of a business are ordinary income under
s 6-5 of the ITAA 1997. However, if the receipt is not a normal proceed of the
business, it may still be ordinary income as an isolated business transaction
(see [8.210]): FCT v Myer Emporium Ltd (1987) 163 CLR 199 (see Case Studies
[8.23] and [8.24]).
Non-cash business benefits

[8.160] Under general principles, ordinary income does not include receipts
that are not cash or convertible to cash: see [5.60]. Consequently, business
income will also not include amounts that are non-cash business benefits: FCT
v Cooke and Sherden (1980) 10 ATR 696 (see Case Study [5.2]). Following the
decision in FCT v Cooke and Sherden, s 21A of the Income Tax Assessment
Act 1936 (Cth) (ITAA 1936) was enacted with the aim of bringing these non-
cash business benefits into the meaning or ordinary income by deeming the
benefits as being convertible to cash.
Section 21A of the ITAA 1936 only applies to non-cash business benefits and
not to other categories of income, such as property income or income from
personal services. Section 21A also does not deem non-cash business benefits
to be ordinary income for tax purposes; it merely deems non-cash business
receipts to be cash convertible and then prescribes a method of valuing the
non-cash benefit. The result is that business receipts that are not ordinary
income only because they lack cash convertibility are deemed to be cash
convertible and therefore will constitute ordinary income. Therefore, before
s 21A is applied, it is first necessary to determine if the benefit is truly income in
nature as a benefit derived from carrying on a business, disregarding whether
it is cash or convertible to cash.
Provided the non-cash business benefit has the character of income, then
s 21A(1) treats it as convertible to cash and s 21A(2) requires the benefit to be
brought to account at its arm’s length value, less any amount that the taxpayer
contributed to acquiring the benefit or to the extent that the recipient could
have obtained a tax deduction if they had paid for the benefit themselves. To
avoid double taxation, s 21A does not apply to non-cash business benefits that
are non-deductible for the provider of the benefit (eg, entertainment expenses):
s 21A(4). Also, to avoid dealing with very small amounts, s 23L(2) of the ITAA
1936 exempts the application of s 21A if the total amount applicable for the tax
year is $300 or less.
Example 8.7: Non-cash business benefit

Tan owns and operates a thriving mobile phone business located in a
large city shopping centre. To promote its product, one of the mobile
phone companies provides Tan with two new top-of-the-range mobiles
each year. During the current tax year, Tan received two free mobile
phones, each valued at $900. Both of these phones were locked, so that
they could only be used on Tan’s account and the SIM cards were also
locked so the phone could not be used with a different phone number.
Tan kept one phone for his personal use and gave the other to his wife.
As the phones cannot be used by anyone else, they cannot be converted
to cash and therefore are not ordinary income under s 6-5 of the ITAA
1997: FCT v Cooke and Sherden (1980) 10 ATR 696. However, the benefit
is received as an incident of carrying on the business and would be income
of the business except for the fact that the phones are not convertible to
cash. This satisfies the first requirement of s 21A(2) and (5) and, as a
result, s 21A(1) deems the benefit be treated as if it is convertible to cash.
Section 21A(2)(a) then brings the benefit to account at its “arm’s length
value”, which is defined in s 21A(5) as the amount the taxpayer would
have reasonably expected to pay had he or she been dealing at arm’s
length. In this example, the arm’s length value will be the usual price of
$900 each.
The next step is to determine whether any of the value is excluded from
the application of s 21A. Of the exclusions possible the only one that
is relevant is whether Tan could have claimed a deduction had he paid
for the phones. Clearly this would not be the case for the phone given
to his wife, but Tan may be able to argue that the cost of the phone he
used for work could be deductible. If Tan is successful in arguing that the
phone he kept would have been deductible, if he acquired it, then he will
have assessable income of $900 for his wife’s phone less any cost he may
have contributed to the acquisition of the phone provided to his wife.

Extraordinary and isolated transactions

Introduction
[8.170] As discussed at [8.130]–[8.150], receipts of a business that are the
normal proceeds of the business will be ordinary income. Transactions that are
not within the normal proceeds of the business have generally been labelled
by the courts as “extraordinary transactions”: FCT v Myer Emporium Ltd (1987)
163 CLR 199 (see Case Studies [8.23] and [8.24]); Westfield Ltd v FCT (1991)
21 ATR 1398 (see Case Study [8.22]). Extraordinary transactions may give rise
to ordinary income or capital, and the remainder of this chapter discusses how
the courts have attempted to make this distinction.
Courts have also labelled transactions that are one- off in nature and not
undertaken by an existing business operation as “isolated transactions”: FCT v
Whitfords Beach Pty Ltd (1982) 12 ATR 692 (see Case Study [8.17]). Isolated
transactions may also give rise, in some instances, to ordinary income and at
other times will constitute capital.
Example 8.8: Extraordinary and isolated transactions

A bed manufacturer owned five factories and decided to close one of its
factories. It arranged to demolish the factory, then extensively developed
the land and sold it. This would be an extraordinary transaction because
when the taxpayer sells the land, it is in a continuing business of bed
manufacturing. Since the proceeds from the development and sale of
land are not the normal proceeds of the business, it is an extraordinary
transaction.
An example of an isolated transaction would be where an employee
accountant owns a holiday house in the country on a large piece of land.
He knocks down the house, extensively develops the land, builds multiple
residential units and then sells them. This is an isolated transaction
because it is not associated with an existing business.

The case law discussed below indicates that proceeds from isolated and
extraordinary transactions can generate ordinary income if they fall into at least
one of three categories, where the transaction:
• forms a business in itself: see [8.180]–[8.200];
• falls under the first strand of FCT v Myer Emporium: see
[8.220]–[8.250]; or
• falls under the second strand of FCT v Myer Emporium: see [8.260].
These categories are not mutually exclusive, so it is possible for a transaction to
fall into more than one category. Taxation Ruling TR 92/3 gives the ATO’s view
on this issue, but a tribunal decision held that parts of this ruling are “wrong
and should be rewritten”: Case [1999] AATA 66; Case 1/99 (1999) 41 ATR 1117.
Transaction forms a business in itself under the

principle in FCT v Whitfords Beach
Principle applied to isolated transactions
[8.180] Case law indicates that if an isolated transaction has sufficient
indicators of a business (see [8.20]–[8.100]), then it will generate ordinary

income even though it is a one-off transaction. In other words, if an isolated
transaction exhibits sufficient characteristics of a business, then profit from it
will be considered a form of business income and so will constitute ordinary
income. This is more likely to be the case if an isolated transaction involves
a sufficient amount of effort, capital and planning. The leading case on this
issue is FCT v Whitfords Beach Pty Ltd (1982) 12 ATR 692 (see Case Study
[8.17]), where the Full High Court held as ordinary income the profits from an
extensive land development project undertaken by a company that previously
had no other business activities.
The difference between an isolated transaction that does or does not produce
ordinary income under this principle was described in the English case
Californian Copper Syndicate v Harris (1904) 5 TC 159, where the Court made
a distinction between:
• a “mere realisation” of a capital good made by enhancing its value is
characterised as a capital gain; and
• a gain made from carrying on a business is characterised as ordinary
income.
Example 8.9: Extensiveness of isolated transaction influences whether

it generates ordinary income
Jake had been a farmer for many years and retired from farming two
years ago, and his land has been unused since his retirement. He has
now decided to develop and sell his farm land, so that it can be used for
residential purposes. The development was a very minor one and just
involved clearing and subdividing the land. This is clearly an isolated
transaction as it is a one-off event not undertaken by a continuing business.
As the development of the land is relatively minor, the sale will not
generate ordinary income. This is because the process of developing and
selling the land did not involve much capital and/or effort and could not
be said to have sufficient of the characteristics of a business. This will
come under the first category of Californian Copper Syndicate v Harris
(1904) 5 TC 159 and will constitute a “mere realisation” which is capital
in nature.
Sean is also farmer who, like Jake, became tired of farming. He gave
up farming for a few years and left his land unused. He then decided
to develop and sell his farm land, so that it can be used for residential
purposes. Sean was directly involved in the development and sale of the
land. The development was extensive and involved subdividing the land
and arranging to have electricity, gas and sewerage supplied to each
subdivided lot. It also involved Sean arranging to have roads built on the
land. In other words, he developed the land so that each subdivided lot
was ready to have a house built on it.
Like Jake’s development and sale, this is an isolated transaction. However,

since Sean has extensively developed the land before selling it, there is
a strong argument that the isolated transaction has generated ordinary
income. This is very much influenced by the fact that the development
was extensive and required considerable effort and capital. Although
the transaction was a one- off isolated transaction, it had enough
characteristics of a business to conclude that the profits are ordinary
income. This will come under the second category of Californian Copper
Syndicate v Harris.

Case study 8.16: Isolated transaction –proceeds were held not to

be ordinary income
In Scottish Australian Mining Co Ltd v FCT (1950) 81 CLR 188, the
taxpayer was originally a mining company which subsequently stopped
operating as a miner. The taxpayer then extensively developed one of the
pieces of land it had previously used for mining purposes and sold it. The
development was very extensive and included laying roads and building
a railway station.
This case was heard in front of a single judge of the High Court, where
Williams J held that the proceeds of sale were not ordinary income.
Williams J stated that, since the taxpayer was not in the business of land
sale, proceeds from the sale were not ordinary income.
In the later High Court case FCT v Whitfords Beach Pty Ltd (1982) 12 ATR
692, at least two of the three judges that commented on Scottish Australian
Mining Co Ltd v FCT (Mason and Wilson JJ) stated or implied that they
believed that Scottish Australian Mining Co Ltd v FCT had been wrongly
decided. Their reasoning was that, since the development of land was
so extensive, it could be argued that the development activities had the
characteristics of a business, so that its proceeds would have generated
ordinary income. Given what the judges in FCT v Whitfords Beach said
about Scottish Australian Mining Co Ltd v FCT, it could be argued that if
Scottish Australian Mining Co Ltd v FCT were to be decided today, then
the
Court would find that the taxpayer generated ordinary income.
Case study 8.17: Isolated transaction –proceeds were held to be

ordinary income
In FCT v Whitfords Beach Pty Ltd (1982) 12 ATR 692, the taxpayer
(Whitfords Beach Pty Ltd) was a company that owned beachfront land. The
company’s shareholders were fishermen who had formed the company,
so that they could use the company’s land to access their fishing shacks.
In other words, the taxpayer company originally owned the land, so that
its shareholders could use it for recreational, rather than commercial,
purposes. Several years later, the shares in Whitfords Beach Pty Ltd were
sold to a property developer. It is important to note that Whitfords Beach
Pty Ltd remained the owner of the land, as only the shares in the company
were sold to the developer, not the land.
The new shareholders changed the Articles of the taxpayer to state that
the company’s purpose was to develop land (the Articles of a company
were documents of a company that, among other things, stated the
purpose of the company –companies incorporated nowadays would
have a constitution instead). The taxpayer then extensively developed
the land and sold it at a substantial profit.
The Full High Court held that the profit from the developed land was
ordinary income. Of the three judges who held that the profit only (not the
gross receipts) was ordinary income, one (Gibbs CJ) stated that, had the
development and sale been undertaken when the company was owned
by its original shareholders (who were using the land for recreational
purposes), the proceeds of the sale would not have generated ordinary
income.
The other two judges (Mason and Wilson JJ), who held that the sale
had generated ordinary income, appeared to have relied on different
reasoning to support their finding. Their conclusion was highly influenced
by the fact that the development and sale was so extensive that it had
the characteristics of a business. Both Mason and Wilson JJ implied
that had the development and sale of the land been undertaken by the
original shareholders, then the sale would still have generated ordinary
income. However, they both indicated that the fact that the company had
been bought by developers who changed its Articles strengthened the
argument that the sale proceeds generated ordinary income.
Given the majority opinion of Mason and Wilson JJ, there is a strong
argument
that their approach is the one that has set the law.
Case study 8.18: Farmer who developed and sold farm land did not
generate ordinary income
In Statham v FCT (1988) 20 ATR 228, the deceased (the taxpayer was
the trustee of the deceased’s estate) owned a piece of land on which

he both lived and operated a farming business. Because the farm was
financially unsuccessful, he had ceased farming and arranged for the
local city council to develop the land. This included connecting the land to
the electricity grid and constructing roads. The land was also subdivided
and finally sold piece by piece through a real estate agent.
The Full Federal Court held that the gain was not ordinary income but
a “mere realisation”. The Court was influenced by the fact that the
deceased had arranged for the council to develop the land, rather than
arranging to do so himself. The Court was also influenced by the fact that
the deceased used a real estate agent to sell the land and was not in any
way directly involved in the sales process. The Court indicated that, had
the deceased arranged to develop the land himself (rather than through
the council), it would be more likely that the sale would have generated
ordinary
income.
Case study 8.19: Ex-farmer who extensively developed and sold land

generated ordinary income
In Stevenson v FCT (1991) 22 ATR 56, the taxpayer was a farmer who had
owned land that he had used as a farm for many years. He gave up farming
and had the land subdivided and extensively developed. Stevenson was
in charge of the development and subsequent sale process and the sale
of the land took place over a number of years.
The Administrative Appeals Tribunal (AAT) held that the sale did generate
ordinary income and was not a “mere realisation”. On appeal to the
Federal Court (single judge), it was held that the AAT had not made an
error in its decision. The Court was influenced by the fact that the taxpayer
was the sole decision-maker regarding the development process, that he
had sought finance for the development and that he had controlled the
marketing
of the blocks.
Case study 8.20: Ex-farmer did not generate ordinary income by only

developing land to the extent necessary to gain subdivision
Casimaty v FCT (1997) 37 ATR 358 involved a taxpayer who had originally
used land for farming, ceased farming and then followed on by subdividing,
developing and selling the land. The development mostly consisted of
constructing roads, providing water and sewerage facilities to the land
and constructing external fencing. The taxpayer had only developed the
land to the extent necessary to gain approval to have the land subdivided.
The Federal Court (single judge) held that the taxpayer’s sale had amounted
to a “mere realisation” and was not ordinary income. However, the Court
did say that, had the taxpayer gone further in his development, such as
building internal fences or units, then the Court would have been more
inclined to find that the taxpayer had generated ordinary income. In other
words, the Court’s finding that the profit was capital was influenced by
the fact that the taxpayer had not done anything more than the minimum
required to get subdivision approval.
The Court also stated that it would have been more inclined to find that the
taxpayer generated ordinary income had he participated more actively in
the selling off the land, rather than leaving the whole sale process up to
a
real estate agent.
FCT v Whitfords Beach (see Case Study [8.17]) and later cases on the
same issue show that there are no strict rules, only guidelines, in deciding
whether an isolated transaction has amounted to a “mere realisation” or

generates ordinary income. This means that, although in some cases it
might be easy to distinguish between a “mere realisation” and a transaction
that produces ordinary income, in more borderline cases it is difficult to
predict what a court may decide should the case be disputed. However,
Case Studies [8.16]–[8.19] do indicate that, at least in the case of land
development, a taxpayer who is actively involved in the development and
sales process (as opposed to delegating those activities) is more likely to fall
under the principle in FCT v Whitfords Beach.
Principle applied to extraordinary transactions

[8.190] Although the principle in FCT v Whitfords Beach Pty Ltd (1982) 12 ATR
692 has only been applied to isolated transactions, there is an argument that
it could also apply to extraordinary transactions. However, this issue has not
been tested in court.
Example 8.10: How the principle in FCT v Whitfords Beach may apply

to extraordinary transactions
Bed Pty Ltd is a bed manufacturer that has four factories. It decides to
close one of its factories and sell off the associated land. To do this, the
company arranges to demolish the factory, subdivide the land and have
gas, electricity and sewerage supplied to each piece of subdivided land.
This is an extraordinary transaction because proceeds from developing
and selling land are not the normal proceeds of a bed manufacturer.
However, there is a convincing argument that since the process of
developing and selling land was so extensive, Bed Pty Ltd was for that
time not only a bed manufacturer, but also a land developer. This analysis
leads to the conclusion that the profits from land sale would generate
ordinary income.
Pillow Pty Ltd also has four factories that it uses to manufacture pillows
and it decides to close one of its factories. The company then arranges
to demolish the factory, remove the concrete from the factory’s car park
and sell the land without further development. This is an extraordinary
transaction because the proceeds of selling land are not the normal
proceeds of a pillow manufacturer, but this transaction would still not
generate ordinary income. This is because developing the land for sale
did not have sufficient characteristics of a business to be classed a
business
in itself.
Calculating ordinary income under the principle in FCT v

Whitfords Beach
[8.200] For most taxpayers, gross revenue will form assessable income, and
deductions will be taken away from this to give taxable income. However,
it was mentioned in FCT v Whitfords Beach Pty Ltd (1982) 12 ATR 692 (see
Case Study [8.17]) that for an isolated transaction that falls under the principle
of that case, it is the profit (not the total sales proceeds) that is assessable as
ordinary income.
This profit is calculated as the sales proceeds less the value of the land at the
time the isolated transaction commenced and the costs of developing the land.
Example 8.11: Calculation of profit from proceeds of an extraordinary

transaction that falls under the principle in FCT v Whitfords Beach
Nathan has been a farmer for 20 years. Two years ago his farm was worth
$2 million, and at that time he ceased farming and undertook extensive
redevelopment of the land. This development cost $4 million and when it
was completed he sold the land piece by piece for a total of $11 million.
Assuming that this transaction is covered by the principle in FCT v
Whitfords Beach Pty Ltd (1982) 12 ATR 692, Nathan’s assessable income
from the development and sale of the land is the profit of $5 million
($11 million − ($2 million + $4 million)).

Two strands of Myer

[8.210] The important High Court case of FCT v Myer Emporium Ltd (1987)
163 CLR 199 (see Case Studies [8.23] and [8.24]) shows that the proceeds of an
isolated or extraordinary transaction will be ordinary income if the conditions
of one of the two approaches followed in the decision are satisfied. The two
approaches applied in FCT v Myer Emporium have become known as the
“first strand of Myer” and the “second strand of Myer”. These two strands
are independent principles relied on by the Court in FCT v Myer Emporium in
arriving at its conclusion that the taxpayer had generated ordinary income. For
further discussion of:
• the first strand of Myer: see [8.220]–[8.250];
• the second strand of Myer: see [8.260]; and
• the facts of the case: see Case Studies [8.21] and [8.23].
Case study 8.21: FCT v Myer Emporium

In FCT v Myer Emporium Ltd (1987) 163 CLR 199, the taxpayer (Myer) lent
$80 million to its subsidiary, Myer Finance. Interest was chargeable on this
loan at a commercial interest rate of 12.5% pa. At the time the loan was
made, Myer intended to sell the “right to interest” on this loan to Citicorp.
As planned, three days after Myer lent the money to Myer Finance, Myer
sold the “right to interest” on this loan to Citicorp in exchange for Myer
receiving a lump sum of approximately $45 million. This meant that
Myer was still entitled to be repaid the principal of $80 million from Myer
Finance. However, the interest on this loan was now to be paid by Myer
Finance to Citicorp. The issue that the Full High Court had to decide was
whether the $45 million received by Myer was ordinary income.
The Full High Court decided that the proceeds were ordinary income. The
reasoning of the Court is not particularly clear, but subsequent cases (see
later discussion in this chapter) have interpreted the decision in FCT v
Myer Emporium as meaning that the proceeds from an extraordinary or
isolated transaction will be ordinary income if it satisfies the requirements
of either what have now become known as the first strand or second
strand of Myer. In this case, both the first strand of Myer (see Case Study
[8.23]) and second strand of Myer (see Case Study [8.26]) were fulfilled,
although
fulfilling one of them would have been sufficient.
First strand of Myer

[8.220] The first strand of Myer expresses the principle that extraordinary or
isolated transactions that satisfy three particular requirements will be ordinary
income. The first two requirements originate from the case of FCT v Myer
Emporium Ltd (1987) 163 CLR 199. The third requirement, although originally
implied in FCT v Myer Emporium, was stated more explicitly in the case of
Westfield Ltd v FCT (1991) 21 ATR 1398 (see Case Study [8.22]). The three
requirements are as follows:
1. There was a business operation or commercial transaction: see [8.230].
2. There was a profit-making intention upon entering the transaction: see
[8.240].
3. The profit was made by means consistent with the original intention: see
[8.250].
[8.230] Profit resulted from “business operation or commercial transaction”.
If the relevant transaction is an extraordinary transaction, then the first
requirement will be automatically fulfilled. As explained at [8.130]–[8.150], an
extraordinary transaction occurs when a business undertakes a transaction that

generates proceeds which are not the normal proceeds of that business. As an
extraordinary transaction is undertaken by a business, the first requirement of
a “business operation or commercial transaction” will always be satisfied.
With an isolated transaction, the first requirement of there being a “business

operation or commercial transaction” will not automatically be satisfied.
An isolated transaction occurs where there is a one-off transaction without
a continuing business operation: see [8.180]. This means that an isolated
transaction will only fulfil the first requirement if there is a “commercial
transaction”. Unfortunately, there is little case law that explains what exactly
is meant by the term “commercial transaction”. However, Ruling TR 92/ 3
gives a few examples of what the Commissioner believes is a “commercial
transaction”, though it does not mention what case law the examples are based
on. According to the ruling, a taxpayer who buys and resells $100,000 of gold
bars in a short time is undertaking a commercial transaction. On the other hand,
the ruling states that a taxpayer who purchases an investment property to earn
rent and later sells it is not regarded as undertaking a commercial transaction.
Although there is limited guidance as to when an isolated transaction will be

considered a “commercial transaction”, this condition is more likely to be
satisfied when the transaction concerned is entrepreneurial in nature, but it
is less likely to be fulfilled if the transaction is of the type that a typical salary
earner might enter into.
Greig v FCT [2020] FCAFC 25 considered the issue of whether the first strand
of Myer requires that the taxpayer must be carrying on a business for the Myer
principle to apply. Although the Myer decision has primarily been applied to
income, in this case the taxpayer argued that it applied to deductions. The
taxpayer claimed a tax deduction under s 8-1 of the ITAA 1997 for losses of
$11.85 million realised on the sale of shares. The taxpayer argued that the losses
were revenue losses on the basis that they were incurred as a “commercial
transaction” as was the case in Myer. The majority of the Full Federal Court
allowed the deduction. They agreed that even though the taxpayer was not
in the business of share trading, the large scale of the share dealings and the
commercial steps undertaken were sufficient to show a profit-making intention
(although a loss was realised) which was then sufficient to make it a business
or commercial transaction for the purposes of Myer. The decision gives further
weight to the argument that the Myer principle can still apply even when the
activities under consideration are not held to be a business for tax purposes.
[8.240] Profit-making intention upon entering the transaction. The second

requirement of the first strand of Myer is that the taxpayer had a profit-making
intention upon “entering the transaction”. This profit-making intention need
not be the taxpayer’s sole or dominant intention: FCT v Cooling (1990) 21 ATR
13 (see Case Study [8.24]).
Many extraordinary or isolated transactions involve selling assets and, where

a profit is realised, the time of “entering the transaction” will be when the asset
was purchased. In other words, if the taxpayer did not have a profit-making
intention when buying the asset, but had a profit-making intention only when
selling it, the second requirement of the first strand of Myer would not be
satisfied. In reality, there will often be a lack of clear evidence as to what a
taxpayer’s intention was at the time of entering into the transaction.
In August v FCT [2013] FCAFC 85, the Full Federal Court dismissed the
taxpayer’s appeal from a single judge of the Federal Court and confirmed
the decision that the gains made following the purchase, leasing and sale of
several commercial shopping centres were ordinary income. This was despite
the fact that these properties had been owned and leased for up to seven
years. Central to this decision was that the facts showed there was an initial
intention to purchase, develop, lease and then sell the shopping centres as
long-term tenanted properties. The initial intention to profit via sale was critical
to this decision even though the properties were leased to earn income for
some time before sale.
[8.250] Profit made by means consistent with original intention. For the
first strand of Myer to be fulfilled, the way the profit is eventually made must
be consistent with the original profit-making intention of the taxpayer upon
entering the transaction: Westfield Ltd v FCT (1991) 21 ATR 1398. If the taxpayer
has more than one intention upon entering the transaction, the way the profit
was made need only be consistent with one of those intentions: August v FCT
[2013] FCAFC 85.
Case study 8.22: First strand of Myer was not satisfied as the profit
realised was inconsistent with the original intention
In Westfield Ltd v FCT (1991) 21 ATR 1398, the taxpayer (Westfield) was in
the business of designing, constructing and operating shopping centres.
Westfield purchased a piece of land with the intention of jointly developing
a shopping centre on the land with Australian Mutual Provident (AMP)
Society. At the time of purchase, the taxpayer knew there was a possibility
that it might end up selling the land to AMP Society rather than developing
a shopping centre, but selling it was not its original intention. Eventually
the taxpayer did sell the land to AMP Society rather than developing a
shopping centre.
The Full Federal Court held that the proceeds from sale were not ordinary
income. It found that the transaction was an extraordinary transaction
as the proceeds of the sale were not the normal proceeds of the
taxpayer’s business, and these proceeds would be ordinary income if the
requirements of the first strand of Myer were satisfied. However, the way
the taxpayer made the profit (resale) was not consistent with the original
profit-making intention (developing a shopping centre with AMP Society).
The fact that at the time of purchase the taxpayer knew of the possibility
of resale was not the same as the taxpayer having an intention to profit
from resale. As a result, the first strand of Myer did not apply, and the sale
proceeds
were not ordinary income.
Case study 8.23: Summary of the decision in Myer

The facts of FCT v Myer Emporium Ltd (1987) 163 CLR 199 are described
in Case Study [8.21].
As discussed in Case Study [8.21], both the first and second strands of
Myer were satisfied on the facts of this case. Specifically, the first strand
of Myer was fulfilled because the taxpayer was running a business
operation, had a profit-making intention upon entering the transaction
(when it lent the money it intended to sell the right to interest a few days
later)
and the profit was eventually realised as initially intended.
Case study 8.24: Lease incentive falls under the first strand of Myer
In FCT v Cooling (1990) 21 ATR 13, the taxpayer was a partner in a

Brisbane law firm which wished to move premises. Upon signing the
lease for the new premises, the landlord paid a lease incentive of which
Cooling received a share. A lease incentive is when the landlord gives the
lessee money as an inducement to enter into the lease. At that time it was
common in Brisbane for lease incentives to be paid upon a commercial
lessee entering into a long-term commercial lease because there was an
excess of office space available for lease and it was difficult for landlords
to attract a tenant.
The Full Federal Court held that the lease incentive was ordinary income.
The Court appeared to be of the view that the incentive was ordinary
income because moving premises from time to time was in the ordinary
course of the taxpayer’s business, which meant that the proceeds were
the normal proceeds of the taxpayer’s business. In addition, the Court
went on to say that, even if the proceeds of the transaction were not
considered to be the normal proceeds, they would still be ordinary income
due to the satisfaction of the requirements of the first strand of Myer.
The Court noted that one of the purposes that the taxpayer had when
entering the new lease was to make a profit from receiving the lease
incentive. Although this was not its dominant intention, it was still one of
its
“not insignificant” purposes of entering into the lease.
Example 8.12: First strand of Myer applies to extraordinary transaction

A television manufacturer owned three factories, and it purchased a
vacant piece of land because it believed that the land would rise in value
and could be sold in the future for a profit. Three years later, it sold the
land at a profit without using the land in the meantime.
This is likely to be considered an extraordinary transaction as income
from speculating in real estate does not constitute the normal proceeds
for a television manufacturer. Although it is an extraordinary transaction,
it will be ordinary income as it satisfies the first strand of Myer. This is
because:
• there was a business operation: the taxpayer is in the business of
manufacturing TVs;
• there was a profit- making intention at the time the land was
purchased: the land was purchased because the taxpayer believed
it could later be sold for a profit; and
• the way the profit was eventually realised was through selling
the land. This is consistent with how the taxpayer intended to
profit when entering the transaction, that is, when the taxpayer
purchased the land.
Case study 8.25: First strand of Myer applied to an isolated transaction

In McCurry v FCT (1998) 39 ATR 121, the taxpayers were two brothers
who in 1986 purchased a block of land with a run-down house on it.
They obtained permission for and built three townhouses on the land.
During May 1987, the taxpayers advertised the townhouses for sale but
were unable to sell them. Subsequently, in June 1987, attempts to sell
were put on hold, and the brothers and their families used two of the
townhouses as their private residence as their family had purchased a
nearby news agency. The third townhouse was also used by them for
private purposes. After living in the townhouses for some time, they were
again advertised for sale in July 1988 and subsequently sold in December
1988 for a substantial profit.
Justice Davies from the Federal Court held that the profit was assessable
as ordinary income. In substance he applied the principle in the first
strand of Myer.
One of the requirements for the first strand of Myer was that the profit
must have resulted from either a business or a commercial transaction.
As the taxpayers had no continuing business, the issue was whether the
activity was commercial in nature. His Honour found that the venture,
which involved purchasing the house and land, demolishing the house
and building three townhouses, combined with the profit-making purpose,
was commercial in character. However, his Honour did not appear to find
that all the characteristics of the venture needed to be commercial, but
rather that their presence in some aspects of this case clearly showed that
it was a commercial activity.
Furthermore, his Honour found that the taxpayers had an intention to
profit from building and selling the townhouses when they initially
purchased the land. This decision was reached despite the fact that the
taxpayers claimed that at the time of purchase, they were unsure whether
they intended to rent or sell the new townhouses. However, the Court
found that this claim was not supported by the evidence. For instance,
the evidence indicated that the brothers had never made inquiries as to
how much rent they could collect on the townhouses. Consequently, the
Court concluded that while the possibility of renting the townhouses did
enter the minds of the brothers at the time of purchase, their dominant
intention at this time had been to profit from selling the townhouses.
Justice Davies also found the profit was made in a manner that was
consistent with the taxpayers’ original intention when purchasing the
land. This was despite the fact that the taxpayers had argued that the
original profit-making venture was abandoned. The taxpayers’ argument
was based on the fact that their first attempt to sell the properties failed,
so they used them for private purposes, and only then re-advertised and
sold them over a year later. However, his Honour found that the facts did
not support the finding that the taxpayers’ original profit-making plan was
abandoned.
Rather, their initial plans had been temporarily interrupted.
Second strand of Myer

[8.260] The Court in FCT v Myer Emporium Ltd (1987) 163 CLR 199 established
that one of the reasons the proceeds in that case were ordinary income was
due to what is now known as the “first strand of Myer”: see [8.220]–[8.250].
However, the Court also identified a second reason for the proceeds being
ordinary income. This second reason has become known as the “second
strand of Myer”.
The second strand of Myer expresses the principle that the proceeds from a
transaction will be ordinary income if the taxpayer sells the right to income
from an asset without selling the underlying asset. This is an application of the
compensation principle, where compensation for loss of income is deemed
to be ordinary income: see [10.20]. Unlike the principle in FCT v Whitfords
Beach Pty Ltd (1982) 12 ATR 692 (see Case Study [8.17]) and the first strand of
Myer, the second strand of Myer potentially only applies to a very narrow set
of circumstances.
Case study 8.26: Second strand of Myer

The facts of FCT v Myer Emporium Ltd (1987) 163 CLR 199 are described
in Case Study [8.21].
The second reason the Court held that the sale of the right to interest
was ordinary income has become known as the “second strand of Myer”.
The taxpayer sold the right to income while keeping ownership of the
underlying property. Specifically, Myer sold the right to interest on the
loan (the right to receive income that would have been ordinary income)
and retained the underlying property (the right to be repaid).
If Myer had continued to receive the interest from its loan, it would
have clearly been ordinary income: see [9.20]. Therefore, by applying
the second strand of Myer, the Court concluded that selling the right to
receive an income stream for a lump sum will not change its nature as
ordinary income. Even though the right to interest was received as a lump
sum, it was still ordinary income as the payment was compensation for
the loss of an income stream (the interest).
Case study 8.27: Application of the second strand of Myer

In Henry Jones (IXL) Ltd v FCT (1991) 22 ATR 328, the taxpayer owned
trademarks of certain brands of canned fruits. The taxpayer’s subsidiary
manufactured and sold canned fruits, using the trademarks owned by
the taxpayer. The taxpayer decided that the canned fruit business run
by its subsidiary was not meeting profit targets and decided to sell the
whole canned fruit business. However, the taxpayer did not proceed with
the sale, but rather entered into an agreement with two other canned
fruit producers (SPC and Ardmona) which gave them exclusive use of the
taxpayer’s trademarks for 10 years (the trademarks themselves were not
transferred). In exchange, SPC and Ardmona were to pay the taxpayer

royalties of 5% of the net sales of products that used the trademarks in
question (subject to a minimum payment).
A few months later, the taxpayer sold the right to these royalties to a
third party in exchange for a lump sum of approximately $7.5 million.
When the taxpayer entered into its initial royalty agreement with SPC and
Ardmona, it had intended to sell the royalty agreement for a lump sum of
$7.5 million.
The Full Federal Court held that the first strand of Myer did not apply, but
the second strand of Myer did and, as a result, the $7.5 million was found
to be ordinary income. The Court based its reasoning on the view that the
taxpayer did not have a profit-making intention of selling the rights to the
royalties at the time of entering into the royalty contract. While it was true
that at the time of entering the royalty agreement the taxpayer intended to
sell rights under the agreement for $7.5 million, on the current facts, this did
not constitute a profit-making intention. The Court appeared to state that
this was because the intention of the taxpayer in entering this agreement
was to dispose of its canned fruit business in the form of getting of a lump
sum receipt and therefore the first strand of Myer did not apply. However,
the second strand of Myer did apply because the taxpayer sold the right
to what would be ordinary income for a lump sum, while retaining the
underlying property. Henry Jones (IXL) disposed of its right to income (the
royalties), but kept the underlying property (the trademark) and therefore
the
proceeds from the sale constituted ordinary income.
Statutory provisions that may apply to extraordinary

and isolated transactions
[8.265] Income from business activities may be assessable as ordinary income
under s 6-5 of the ITAA 1997 or as statutory income via s 6-10 of the ITAA 1997.
However, regardless of whether an amount is likely to be ordinary income,
it is still necessary to consider whether any statutory provisions specifically
apply to the receipt. This is important because some statutory provisions apply
different tax rates, as is the case with capital gains which are taxed differently
to ordinary income.
If a receipt is both ordinary and statutory income under the Act, s 6-25 of
the ITAA 1997 states that it is included in assessable income only once and
it will normally be taxed under the statutory provision rather than as ordinary
income. The exception to this rule occurs if the statutory provision states
that it only applies if the amount is not ordinary income: see [3.80]. For example,
s 15-20 deems certain royalties to be assessable income but also states that the
section does not apply if the royalty is ordinary income under s 6-5: s 15-20(2).
The following discussion covers some of the more common statutory

provisions that apply to receipts from business activities.
Capital gains tax
[8.270] Extraordinary and isolated transactions that do not produce ordinary
income and involve an asset acquired after 19 September 1985 will often be
subject to capital gains tax (CGT). As explained in Chapter 11, gains that are
subject to CGT may incur less tax than gains that are taxed under s 6-5 of
the ITAA 1997 as ordinary income. Consequently, it is important to be able
to ascertain whether or not gains from extraordinary/isolated transactions are
ordinary income or capital.
Section 15-10: Bounties and subsidies

[8.280] Section 15-10 of the ITAA 1997 states that bounties and subsidies
received in relation to carrying on a business are assessable as statutory
income. A bounty or subsidy is a payment from the government in order to
assist the recipient in carrying on its business. However, s 15-10 does not apply
to gains that are ordinary income: s 15-10(b).
Example 8.13: Government subsidy –assessability as statutory income

A car manufacturer receives a government subsidy for every car it makes.
These payments are ordinary income as they would be regarded as
normal proceeds of the business. As the receipts are ordinary income,

they would not be assessable under s 15-10 of the ITAA 1997.
Another car manufacturer receives a government subsidy to purchase
new machinery for its existing factory. This receipt is not ordinary income
as it would not be regarded as normal proceeds of the business and is
not covered by the principal in FCT v Whitfords Beach Pty Ltd (1982)
12 ATR 692 or either of the strands of Myer. However, this receipt would
be assessable under s 15-10 as being a bounty or subsidy received in
relation to the business.

Section 15-15: Profit-making undertaking or plan

[8.290] Section 15-15 of the ITAA 1997 states that the profits from a profit-
making undertaking or plan are assessable and so will constitute statutory
income. However, s 15-15 does not apply to:
• gains that are ordinary income (s 15-15(2)(a)); or
• gains that involve assets purchased on or after 20 September 1985
(s 15-15(2)(b)).
A profit-making undertaking or plan for the purposes of s 15-15 is a course of

conduct that produces a profit and involves something more complex than
the taxpayer simply buying and then selling property or outlaying money in
the hope of making a return: Steinberg v FCT (1975) 5 ATR 565; Clowes v FCT
(1954) 91 CLR 209.
In practical terms, s 15-15 will seldom apply because transactions that potentially
are a profit-making undertaking or plan will often be ordinary income due to
FCT v Whitfords Beach Pty Ltd (1982) 12 ATR 692 and so will not be covered by
s 15-15. The section also has limited application since it only applies to assets
purchased before the introduction of CGT.
Example 8.14: Section 15-15 –difficulty of application

In 1984, Jell Pty Ltd, a manufacturer of doors, purchased vacant land as
an investment which it sells in the current tax year. This would not be
assessable under s 15-15 of the ITAA 1997 because it is a mere “buy and
sell” and so would not constitute a profit-making undertaking or plan.
Jack farms land that he purchased in 1983. He is tired of farming, so he
subdivides the farm land, installs amenities on it and then builds roads
and townhouses on the subdivided land. Jack then sells the subdivided
lots one by one. Although this is a profit-making undertaking or plan,
it is unlikely to be assessable under s 15-15. This is because the profit
from this transaction is likely to be ordinary income under the principle
in FCT v Whitfords Beach Pty Ltd (1982) 12 ATR 692 and s 15-15 does not
apply to gains that are ordinary income.

Section 25A: Profit from sale of asset acquired with the

purpose of resale
[8.300] Section 25A of the ITAA 1936 makes assessable certain profits from
selling an asset that was initially acquired for the purpose of resale. However,
s 25A will seldom apply because of the following limitations:
• it only applies to assets purchased prior to 20 September 1985
(s 25(1A)); and
• it only applies where the intention to profit by resale that existed
at the time of purchase was the sole or dominant purpose of the
taxpayer: Eisner v FCT (1971) 2 ATR 3.
Example 8.15: Profit from asset acquired with purpose of resale and

subsequently assessable under s 25A
Alan purchased vacant land in 1983 with the sole purpose of reselling it at
a profit. He sells it in the current tax year and realises a profit of $500,000.
This profit will be assessable under s 25A of the ITAA 1936 because it
was made from selling an asset that was purchased with the purpose of
making a profit by reselling it.
For property purchased before 20 September 1985, it will become more
and more difficult to establish that there was, at the time of the purchase,
a profit-making intent through resale. This is because, as time passes, it
will become more difficult to elicit evidence and also the longer property
is held, the more likely it was held for some other purpose than simply
resale at a profit.

Questions
[8.310]
8.1 After entering into a management agreement two years ago for the
purpose of starting a business in cattle breeding next year, Georgina
paid $5,250 by cheque to ACM, whose business was transferring
embryos from stud cows to ordinary breeding cows. Under the
agreement she was guaranteed six calves in the next two years.
If the venture failed, ACM remained liable to supply the calves from
another source. Having paid her fees for Year 2, she did not receive
any subsequent notification that the implants in her recipient cows
were successful. She did not follow up after the implantation notices to
find out whether any of her cows were pregnant. Nor did she enquire
whether her cows had been implanted a second time as contemplated
by the terms of the Management Agreement, which provided that
each recipient cow would be implanted once in each of the 12-month
contractual periods. She said that she had spoken to her accountant
who told her things were progressing, but slower than anticipated.
After paying her Year 2 Fees in June, Georgina heard nothing specific
from ACM except by way of newsletters containing general information.
She made no attempt to contact ACM in the current year about
extending the lease on her recipient cows. She said she was going
through a very difficult time. Her 12-month-old child had contracted a
serious illness and she had to focus on looking after him.
Is Georgina carrying on business?
8.2 Axis Holdings Ltd was founded eight years ago by Lucas and Tait, who
were the initial shareholders and directors. Lucas and Tait had for many
years been involved in property development. Seven years ago, Axis
purchased two properties in an area where there was extensive real
estate development. For six years, the properties were used for cattle
breeding and the properties were improved for that purpose.
Owing to unforeseen circumstances, the cattle breeding proved to
be unprofitable and there was an imminent zoning change whereby
the properties could only be disposed of in 100-hectare lots instead
of 25-hectare lots. Axis therefore arranged to subdivide the land up
into 25-hectare blocks and sold the whole property to one purchaser.
The Commissioner assessed Axis on the gross receipts in s 6-5 of the
ITAA 1997.
Discuss.
8.3 Peter is a farmer with 15 hectares of land on which he has grown
oranges since 1970. He inherited the land from his father in that year.
The farm has gradually been surrounded by urban development
and, three years ago, following complaints from neighbours about
pesticides, he decided to sell the land.
Two years ago, Peter contracted with a consulting engineer and
surveyor who prepared a subdivision plan and who applied to the local
council for rezoning. Peter was not directly involved in the plan or the
rezoning, which was granted by the council later that year. Nearly all
expenses were paid by Peter, although he had to borrow $120,000 to
cover some incidental expenses.
Following completion of the development, the land went on sale through

a real estate firm and to date 150 of the 200 blocks have now been sold
for residential housing. Blocks sell for an average of $150,000 each.
Advise Peter as to his tax liability, if any.
8.4 Five years ago, Bruce purchases 10 hectares of land for $1 million in an
area that was ripe for subdivision. At the time of purchase he intended
to get planning permission from the local council to develop the land
by subdivision and then resell it at a profit, but instead he leased it
for grazing horses. Three years ago, Bruce attempted to get planning
permission to subdivide his 10 hectares, but it proved very difficult,
and finally in March of the current tax year the local council refused
permission to subdivide. Bruce reluctantly sold the land in May for
$3 million.
What are the tax consequences of Bruce’s sale?
8.5 Two years ago, Peta purchased a house in Kew. This house had two
old tennis courts down the back which were in poor condition. She
purchased the property for two reasons:
• so that she and her family could live in the house; and

• so that she could build three units on the tennis courts and sell them
at a profit.
In the current tax year, the tennis club next door offered to buy the old
tennis courts, but only if Peta first restored them to good condition.
Peta decided to accept the club’s offer instead of going ahead with her
plan to build and sell units.
Peta spent $100,000 on preparing the tennis courts for sale. This
involved a great deal of work. Peta had to resurface the tennis courts
and build new fences around them.
She then sold the tennis courts in the current tax year to the tennis club
for $600,000.
Ignoring capital gains tax, discuss whether the receipt of $600,000 is
ordinary income under s 6-5.
8.6 Mrs Jones is the owner of a large racehorse stud and horse training
business. She employs eight staff and holds a training licence.
Mrs Jones’ involvement in the racing business is her full- time
occupation and she attends as many race meetings as possible (over
one per week). Mrs Jones is also a very keen punter, betting on both
her own and other horses, and during the last year she had several very
big wins which netted her $120,000 in winnings for the year.
Discuss whether the receipt of $120,000 is ordinary income under s 6-5.
8.7 Pierre has operated his market garden business in Queensland for
the last 25 years. During recent flooding, his total crop was destroyed
along with most of his buildings, irrigation equipment and fencing. As

a result of this flood, Pierre received a payment from the government
of $300,000 to purchase new green houses for raising seedlings so he
can get back into business more quickly. He also received a payment
from the government of $50,000 to dispose of damaged crops.
Discuss whether the receipt is ordinary or statutory income.
8.8 New Coal Pty Ltd (New Coal) is a large coal mining company with
several large coal mines in Australia. During the current tax year, New
Coal employed a consulting firm to investigate the feasibility of the
company constructing and operating a coal fired power station. New
Coal has never operated a power station in the past.
Discuss whether the proposal to investigate the viability of the power
station is a separate business for tax purposes or would it be within the
scope of the existing coal mining business?
8.9 Kerryn works full time as an employee accountant. She loves to
sing and regularly records songs she wrote herself and posts them
on YouTube. For the last three years she would on average spend
approximately 20 hours a week on this activity. Because her cousin

Joel owned a recording studio, she was able to use his recording
facilities for free. Occasionally Kerryn would dream that one day she
would be discovered as a star and could make enough money to retire
from her job, though in reality Kerryn told herself that this was unlikely
to happen. On average, Kerryn would post a new song on YouTube
every two weeks.
Since Kerryn found quite a following (some of her songs had over
100,000 hits), in an attempt to profit from her new found fame, she
auctioned some of her old clothes and jewellery online (that she had
bought many years ago) and manages to sell them for $8,000.
Advise Kerryn on whether the $8,000 would constitute ordinary income.
8.10 Zoe Barker has lived in her current home for the past 20 years. Three
years ago, she converted the garage (separate from her house) into
a luxurious single bedroom apartment at a cost of $110,000. Zoe
advertises her apartment for short-term accommodation via several
online accommodation booking platforms and earns about $5,000 per
month. Her costs are mainly contract cleaners, property costs (eg, rates
and power) and commission paid to the online booking platforms.
One very satisfied customer (James) enjoyed the accommodation so
much that he offered Zoe the opportunity to stay at his holiday apartment
for two weeks free of charge, which would normally have cost $3,500.
Also, during the year, the government severely restricted travel within
the state which reduced Zoe’s income to only $1,000 per month. As a
result of the restrictions, Zoe received a monthly government subsidy
of $3,000 to help cover her fixed costs.

Advise Zoe on the assessability of her receipts and benefits.
9
Income from property
Key points...................................................................................................... [9.00]
Introduction.................................................................................................. [9.10]
Interest .......................................................................................................... [9.20]
Discounts and premiums....................................................................... [9.30]
Timing of interest receipts......................................................................... [9.50]
Division 16E, s 26BB and s 70B of the Income Tax Assessment
Act 1936 (Cth)..................................................................................... [9.60]
Taxation of financial arrangements (TOFA) –Div 230 of the ITAA 1997....... [9.70]
Interest and compensation.................................................................... [9.80]
Interest relating to compensation for damages for property.................. [9.90]
Interest relating to compensation for damages for personal injury...... [9.100]
Section 51-57: Exemption of post-judgment interest on personal
injury compensation........................................................................ [9.110]

Interest compensation and CGT.............................................................. [9.120]
Section 15-35: Interest on overpayment and early payment of tax...... [9.130]
Interest portion of instalment payments............................................. [9.140]
Dividends..................................................................................................... [9.150]
Rental and lease income............................................................................ [9.160]
Rent....................................................................................................... [9.160]
Lease premiums................................................................................... [9.170]
Section 15-25 –Amount received for lease obligation to repair....... [9.180]
Royalties...................................................................................................... [9.190]
Introduction.......................................................................................... [9.190]
Assessability of royalties..................................................................... [9.200]
Annuities..................................................................................................... [9.210]
Questions..................................................................................................... [9.220]

Key points
[9.00]
• Property income is an application of the “flow” concept of ordinary
income.
•
Interest is usually ordinary income as it flows from the lending/
investment of capital.
•
Payments on loans to compensate for increased risk of non-repayment
may not be interest.
•
Loan discounts and premiums may alter the timing of taxable income.
•
The timing for tax purposes of gains on financial instruments is subject
to legislation under Div 16E, s 26BB and s 70B of the Income Tax
Assessment Act 1936 (Cth) (ITAA 1936) and Div 230 of the Income Tax
Assessment Act 1997 (Cth) (ITAA 1997).
•
Interest paid as a part of compensation payments is treated differently
for taxation purposes depending on whether it is paid for the loss of
property or as damages for personal injury.
•
In Australia, the courts have been reluctant to carve out interest from
capital payments unless it is clearly identifiable.
•
Dividends are ordinary income, but they are specifically made
assessable as statutory income under s 44 of the ITAA 1936.
•
Division 974 of the ITAA 1997 provides rules for distinguishing
payments of dividends from payments of interest.
•
Rent is ordinary income even when received as a one-off lump sum.
•
Lease premiums are capital unless the taxpayer is in the business of
receiving premiums or the premium is a substitute for rent.
•
Royalties include payments that are calculated based on the usage
of intellectual property. Royalties can also be payments based on the
quantity/value resources taken from a taxpayer.
•
Most royalties are ordinary income and those that are not are assessable
under s 15-20 of the ITAA 1997.
Introduction
[9.10] Chapter 5 outlined the essential characteristics of income that have
been developed by the courts, one of which is the notion that income “flows”
from capital. As a result, receipts such as interest, rent, royalties and dividends
that “flow” from the passive ownership of capital investments will be ordinary
income under s 6-5 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997).
Following the “fruit and tree” analysis (see [5.100]), these receipts are generated
from capital without the capital being diminished in any way. For example,
interest flows from fixed-term investments, rent flows from the ownership of
property, dividends flow from investments in shares and royalties flow from
intellectual property, such as copyright.
Income earned from the passive ownership of capital is generally known as

property income, but this is not to be confused with the gains realised on the
Interest
[9.20] Most people understand the common use of the term “interest” to mean
the cost of borrowed funds or the return from fixed-term investments, such as
bank term deposits or debentures. In this form, receipts of interest provide a
clear example of income from property which is therefore ordinary income
and assessable under s 6-5 of the ITAA 1997: Lomax v Peter Dixon & Son Ltd
[1943] 1 KB 671 (see Case Study [9.1]). However, the term “interest” is not
specifically defined in the tax legislation and therefore it is necessary to rely on
case authority for a definition. In Riches v Westminster Bank Ltd [1947] AC 390
at 400, interest is described as “a payment which becomes due because the
creditor has not had his money at the due date”. Interest therefore is the return
that flows from the lending of money and is the compensation for the loss
of use of that money. The capital sum lent is not affected by the payment of
interest providing a clear application of the “flow” concept of income.
Although interest in its normal form is ordinary income, there are some specific
statutory provisions which impact on the taxation of interest. In addition, there
are issues relating to the timing of its assessability and whether it may in some
circumstances be treated as capital.
Discounts and premiums

[9.30] Commercial rates of interest are relatively easy to establish for various
types of lending, but these rates are substantially influenced by the degree
of risk associated with the debt. Lenders may increase the standard interest
rate to account for the increased risk of non-repayment or they may retain the
standard rate of interest and negotiate a discount or premium on the debt.
A discounted loan is one where the amount provided to the borrower is less
than the amount of the loan. A loan premium is one where the borrower has to
repay more than the amount advanced by the lender.
Example 9.1: Loan discounts and premiums

Loan discount
XYZ Pty Ltd arranges a loan of $1 million (notional principal) for one year
to finance the development of a new production process. This loan is an
interest-only loan and the interest rate is well below that expected for
similar loans. The principal of $1 million is to be repaid in full at the end of
the one-year term. However, the lender advances only $900,000 to XYZ
Pty Ltd, not the full $1 million, but the loan agreement states that the full
$1 million has to be repaid. The $100,000 difference between the amount
advanced and the amount repaid is known as the “discount”.
9: INCOME FROM PROPERTY [9.30] 285
Note that interest will still be paid on the $1 million even though only
$900,000 is advanced to the borrower.
Loan premium
ABC Pty Ltd arranges a loan of $900,000 (notional principal) for one year
to finance the development of a new production process. This is an
interest-only loan and the interest rate is well below the rate that might
be expected for similar loans. However, at the end of the loan, ABC Pty
Ltd is required to repay $1 million, consisting of the $900,000 debt plus a
“premium” of $100,000. In this case, the annual interest will still be based
on the $900,000 borrowed.
Difference between discounts and premiums
The difference between a loan discount and premium is very subtle and
may best be understood by comparing the two notional principals for
each of the arrangements above. With the discount arrangement, the
notional principal is $1 million with a discount of $100,000, which means
that only $900,000 is received by the borrower. On the other hand, with
the loan premium, the notional principal is $900,000 and the borrower has
to pay an additional premium of $100,000 on maturity of the debt giving
a total repayment of $1 million. The other important difference is that for
the loan discount, interest is levied on the principal of $1 million, but on
the loan premium, the interest is only charged on the $900,000 advance.

It may appear from Example 9.1 that loan premiums and discounts are no more
than different terms for the same arrangement, that is, paying back a larger
amount than the amount received. In addition, the discount or premium could
be simply seen as a substitute for interest. However, these types of financial
arrangements have also been developed to alter the timing of assessable
income and as an attempt to characterise the discount or premium as capital
rather than ordinary income: Lomax v Peter Dixon & Son Ltd [1943] 1 KB 671.
Case study 9.1: Interest or compensation for risk

In Lomax v Peter Dixon & Son Ltd [1943] 1 KB 671 (an English case),
the English taxpayer lent money to an associated Finnish company just
before the outbreak of World War II. The taxpayer was not in the business
of lending money, but determined that there was a high level of risk
associated with this loan. As a result, the taxpayer required a much higher
rate of return than would normally be accepted, but this was not achieved
by charging a higher-than-usual interest rate. In fact, the stated interest
rate was comparable to normal commercial lending. The additional risk
of non-repayment was catered for by the borrower being required to pay
both a premium and a discount on the debt.
The House of Lords accepted the argument by the taxpayer that the
benefits received as a result of the discount and premium were capital in
nature and not interest. The Court appears to have taken into account in
this decision the facts that a commercial rate of interest was charged and
that
the taxpayer was not in the business of lending money.
[9.40] The importance of the decision in Lomax v Peter Dixon & Son Ltd
[1943] 1 KB 671 is that it shows that there is a distinction between interest
which is ordinary income and a capital return that results from an allowance for
risk. However, this case is also important as it is often cited as authority for the
principle that if the discount is simply a replacement for interest, then it will be
ordinary income. This same conclusion would be reached via the application
of the first strand of Myer: see [8.220].
Case study 9.2: Gain on a discounted security was ordinary income

In FCT v Hurley Holdings (NSW) Pty Ltd (1989) 20 ATR 1293, the taxpayer’s
main business was investing in the hotel industry. The company had
realised some of its investments so that they could be held in a more
liquid form until the managing director’s son took control of the company.
As part of this process, the taxpayer purchased a discounted bill for
$442,200 with a face value of $500,000 and a maturity date of just over
one year. No actual interest was paid on this investment, but on maturity,
the value of the investment had increased by $57,800, which is a notional

return of 13% on the original investment of $442,200. The Commissioner
assessed the $57,800 as ordinary income, but the taxpayer argued that it
was capital.
The Federal Court held that the gain made on the realisation of the
investment was ordinary income. In reaching this conclusion, Gummow J
distinguished the facts in this case from Lomax v Peter Dixon & Son
Ltd [1943] 1 KB 671. The basis of this distinction was because Hurley
Holdings did not receive interest and the discount was more akin to a
substitute for interest and not simply an increase in capital value. This
same conclusion was reached through the application of the first strand
Myer: see [8.220].
of
With the increased complexity and sophistication of financial markets, and

the application of the first strand of Myer, the courts may be more inclined in
today’s financial climate to view premiums and discounts as ordinary income.
Nevertheless, the decision in Lomax v Peter Dixon and Son Ltd is good
authority and it is still conceivable that a genuine discount or premium could

be held to be capital if:
• interest was payable on the loan;
• the interest and the terms of the loan were commercially justifiable; and
• the discount took into account the risk of non-repayment.
Timing of interest receipts

[9.50] Even though discounts or premiums will generally be ordinary income,
deferring the receipt of the gain to when the debt is redeemed may delay the
time when the gain is assessable as interest is normally derived and assessable
on a cash basis. For example, if interest is paid on an annual basis, the interest
will be derived and assessable under s 6-5(2) of the ITAA 1997 in that year.
However, to the extent that the gain is realised via a discount or premium at the
end of the loan, it will not be derived and assessable under s 6-5(2) until that
later date: FCT v AGC (1984) 15 ATR 982.
Deferral of the taxation of interest earned by way of a discount or premium

may cause an imbalance in the taxation system. This happens if the borrower
can claim a deduction on a yearly basis, but the lender only has assessable
income when the loan is repaid. As a result of this potential imbalance, a range
of legislation was introduced to counter the possible deferral of tax through
discount and premium arrangements.
Division 16E, s 26BB and s 70B of the Income Tax

Assessment Act 1936 (Cth)
[9.60] Division 16E of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936)
deals with the timing of assessable income and deductions relating to discount
and deferred interest payments on “qualifying securities”. Division 16E only
affects the timing of assessable income and deduction and does not determine
whether or not these payments are assessable. This means that the first step
when presented with a premium or discount on a qualifying security is to
determine whether the discount or premium is ordinary income. If it is ordinary
income, then the second step is to apply Div 16E.
The effect of Div 16E is that the gains made on these securities are included
in assessable income of the lender annually over the life of the loan. This will
be the case even though the actual receipt of these monies may not occur
until the end of the loan. Under this Division, the borrower is also entitled to
a deduction on an annual basis, regardless of when the discount or deferred
interest is paid.
Sections 26BB and 70B of the ITAA 1936 apply to “traditional securities”
acquired after 10 May 1989. These provisions deem premiums and discounts
to be assessable income to the recipient and deductible for the payer, even
when they are capital in nature. Traditional securities are taxed on realisation
and are not taxed on an annual basis like those subject to Div 16E.
The distinction between “qualifying securities” and “traditional securities” is

based on the amount of the premium/discount. Traditional securities have a
return (other than periodic interest) equal to or less than 1.5% pa and qualifying
securities have a return (other than periodic interest) of greater than 1.5% pa,
or where the return cannot be determined at the time of issue.
Example 9.2: Difference between qualifying and traditional securities

Two 10-year loans are available, both with a repayable face value of
$1,000. The first is issued at $750 and the second is issued at $900.
The benchmark amount for differentiating between the qualified and
traditional security is $150 (1.5% × 10 years × $1,000).
The first loan’s return is $250 ($1,000 − $750), which is greater than the
$150 benchmark and so would be a qualifying security.
The second loan’s return is $100 ($1,000 − $900), which is less than the
$150 benchmark and so would be a traditional security.

Example 9.3: Illustration of Div 16E –Qualifying security

Kathie lends money under a four-year loan with a repayable face value
of $20,000. However, the loan is subject to a discount and is issued
at $17,000. This is a qualifying security because the return due to the
discount is greater than 1.5% pa: ($20,000 − $17,000) = $3,000 which
is a return of $750 pa ($3,000/4 years) or 3.75% pa ($750/$20,000) of the
$20,000 loan. The first step is to decide whether the discount of $3,000
is income or capital. This will depend on the individual facts of the case,
such as what (if any) interest rate is charged in addition to the discount.
If the $3,000 is ordinary income, then, under Div 16E, its assessability will
be apportioned over four years (the life of the loan). On the other hand,
if it is capital, Div 16E will not apply, but Kathie will almost definitely be
subject to capital gains tax upon repayment of the loan: see Chapter 11.
Furthermore, any actual interest payable during the term of the loan will
be Kathie’s ordinary income.

Example 9.4: Illustration of s 26BB –Traditional security

Cindy lends money under a four-year loan agreement. The terms are
that the repayable face value is $20,000, but the loan is subject to a
discount so that the loan is issued at $19,000. This is a traditional security
because the return due to the discount is less than 1.5% pa: ($20,000
− $19,000) = $1,000 which is a return of $250 pa or 1.25% pa ($250/
$20,000) of the $20,000 loan. The $1,000 gain will be Cindy’s statutory
income under s 26BB at the end of the term of the loan. Any interest
payable during the term of the loan will be Cindy’s ordinary income.

Taxation of financial arrangements (TOFA) –Div 230 of the

ITAA 1997
[9.70] Division 230 of the ITAA 1997 was introduced into the ITAA 1997 because
the previous timing provisions for financial instruments did not adequately
cater for some of the more complex and newer financial arrangements. It was
also justified on the basis that the previous provision did not take into account
the time value of money, that is, because of inflation and lost interest earning
capacity; for example, $1 earned today is more valuable than $1 earned in one
year’s time. These rules apply to financial instruments acquired on or after 1
July 2010, but a taxpayer may also elect to apply these rules from 1 July 2009.
The primary aim of the Taxation of Financial Arrangements (TOFA) provisions

is to reduce the mismatch between the timing of the deductions for payments
on financial instruments and the timing of the assessability of those payments.
This will effectively reduce the opportunity for deferral of the income from
these arrangements and will treat all the gains as income, rather than capital.
The TOFA rules are very complex and have been subject to frequent
amendment. However, these rules do not apply to individuals and therefore
only apply to a limited number of taxpayers such as those dealing with bonds,
promissory notes, debentures and risk shifting arrangements. Taxpayers not
subject to the TOFA provisions will still be taxed under Div 16E, s 26BB and
s 70B of the ITAA 1936.
Interest and compensation

[9.80] Interest is normally the return to the lender/investor for the loss of
the use of funds: see [9.20]. However, interest may also be paid on damages
and compensation payments to compensate for the time lag between the loss
and the receipt of the compensation. For example, a person injured in a car
accident who receives $100,000 compensation, but has to wait 12 months for
the final decision and receipt of payment, may be entitled to interest on the
$100,000 because of the delay.
If the compensation itself is ordinary income, any interest paid on the

compensation will also be ordinary income under the compensation
principle: see [10.20]. However, if the compensation itself is not ordinary
income, the question arises as to the tax treatment of the interest component
of the compensation payments: Federal Wharf Co Ltd v DCT (1930) 44 CLR 24
(see Case Study [9.3]). These interest payments may be:
• ordinary income;
• capital because it cannot be separated from compensation of a capital
nature (this may be subject to capital gains tax, although some capital
compensation is exempt from CGT: see [11.290]);
• capital for other reasons, such as being pre- judgment interest on
personal injury payments: see [9.100]; or
• specifically made exempt by the ITAA 1997: see [3.90].
Before considering the impact of the specific statutory provisions on interest
relating to compensation for loss of capital, it is first necessary to understand
how these receipts have been categorised by the courts. Case law shows that
different approaches may be used for compensation for the loss of property
and compensation for personal injury: Federal Wharf Co Ltd v DCT (1930) 44
CLR 24; Whitaker v FCT (1998) 38 ATR 219.
Interest relating to compensation for damages for property

[9.90] The decision in Federal Wharf Co Ltd v DCT (1930) 44 CLR 24 illustrates
that interest compensation relating to property will be ordinary income where
the interest component of the compensation is a clearly identifiable amount.
This is effectively an application of the compensation principle. However, if
the capital and interest components are undissected (the components of the
compensation cannot be ascertained), then the court is more likely to treat the
total compensation as capital, even though it may include some component of
income, such as interest: see [10.240].
Case study 9.3: Interest on capital compensation is ordinary income

In Federal Wharf Co Ltd v DCT (1930) 44 CLR 24, the taxpayer’s property
was compulsorily acquired under legislation and the relevant Act
allowed for interest at the rate of 4% pa to be paid on the amount owing
from the time of acquisition to the time the compensation was paid.
The compensation for the loss of property was clearly capital, but Federal
Wharf argued that the 4% pa (interest) component formed part of the
compensation for resumption of the land and was also capital.
The High Court held that the interest component of the compensation
was ordinary income because it was paid to account for the fact that the
taxpayer had been deprived of the use of the funds that it was due. Rich J
followed the analogy that if the funds were received immediately, they
could have been invested and any interest received would be ordinary
income.

In Federal Wharf Co Ltd v DCT, the interest component of the compensation

was clearly identifiable. As a result, it was possible for the Court to separate the
capital component for the resumption of the land from the income component
in the form of interest.
Interest relating to compensation for damages for

personal injury
[9.100] Interest paid as part of compensation for personal injury can be
separated into pre- judgment and post- judgment interest. Pre-judgment
interest is interest accumulated between the time of the event giving rise to
the compensation and the time of the judgment; post-judgment interest is the
interest accrued between the time of the judgment and the time of receipt of
the compensation.
Case study 9.4: Pre-judgment and post-judgment interest

In Whitaker v FCT (1998) 38 ATR 219, the taxpayer was awarded
compensation of about $808,000 following surgery which left her blind.
The sum awarded included pre-judgment interest of $65,000. Whitaker
also received approximately $288,000 in post-judgment interest because
the compensation remained unpaid for over two years due to the case
being appealed. The Commissioner included both the post-and pre-
judgment interest in the taxpayer’s assessable income.
On appeal to the Full Federal Court, it was held that the pre-judgment
interest was capital in nature and not ordinary income, but the post-
judgment interest was ordinary income and therefore assessable. The
Court had little difficulty in concluding that the post-judgment interest
was ordinary income because it was paid to compensate for the delay in
the payment of the compensation. This interest had nothing to do with
the damages awarded for the injury. However, pre-judgment interest was
seen as part of the compensation awarded for the injury suffered and
therefore was capital in nature.
Although the judgment was unanimous, the reasoning varied but
generally related to the fact that although the pre-judgment interest is
compensation for being deprived of the money, the amount is not certain
until the award is made and it is just one component of the compensation
for the loss suffered. It was also suggested that it could not reasonably be
assumed that these funds would have been available for investment as
they did not crystallise until the judgment was made.
Note that the decision in this case relating to post-judgment interest has
been made redundant due to the enactment of s 51-57 of the ITAA 1997:
see [9.110].
Section 51-57: Exemption of post-judgment interest on

personal injury compensation
[9.110] The decision in Whitaker v FCT (1998) 38 ATR 219 generated
considerable media interest and political debate regarding the issue of
whether it was fair and equitable to tax post-judgment interest from personal
injury compensation. Consequently, retrospective legislation was introduced,
effective from the 1992–1993 tax year, to exempt post-judgment interest from
assessable income.
Under s 51-57 of the ITAA 1997, the interest is exempt if it relates to damages
for personal injury and is in respect of the period between the original
judgment and the ending of any appeal process or the time of any out-of-court
settlement. Any interest arising between settlement and the date of receipt
of the compensation is not covered by the s 51-57 exemption. This interest
would be subject to the decision in Whitaker v FCT and would be categorised
as ordinary income.
Interest compensation and CGT

[9.120] Compensation of a capital nature may be subject to CGT provided it is
not exempted by s 118-37 of the ITAA 1997: see Chapters 10 and 11. As a result,
any interest component that cannot be clearly identified may be included in the
amount subject to CGT. For example, where the compensation is for a capital
loss and in the form of an undissected amount (see [10.240]), then the total
amount of compensation will be treated as capital. This will be the case even if
the final amount was determined after consideration of compensation for the
loss of use of funds (ie, interest).
Section 15-35: Interest on overpayment and early

payment of tax
[9.130] Where a taxpayer has paid his or her tax but has disputed the
assessment and is successful in having the tax assessment reduced, the
taxpayer is entitled to be paid interest on the overpaid tax: Taxation (Interest
on Overpayments and Early Payments) Act 1983 (Cth). The refund of the tax
already paid will therefore include compensation in the form of interest to
account for the fact that the tax had previously been overpaid.
This compensation, paid in the form of interest, is specifically deemed to be

assessable under s 15-35 of the ITAA 1997. Although such payments will also
constitute ordinary income, they will be assessable only under s 15-35, as
gains that are both ordinary and statutory income are taxed under the statutory
provision (s 6-25 of the ITAA 1997) unless the specific provision requires
otherwise: see [3.80].
Interest portion of instalment payments

[9.140] Interest could also be imputed into periodic payments for capital
items. For example, on the sale of a retail business, the vendor may agree that
the purchaser can pay for the business with equal quarterly payments over a
three-year period. This type of arrangement is commonly known as a “term
sale” or “vendor financing” and may occur where purchasers cannot obtain
their own finance.
If this type of arrangement states a specific interest rate to be charged on the

outstanding balance, then that interest will clearly be ordinary income. However,
if no explicit interest rate is included in the agreement, the issue arises as to
whether there is an implied interest included in the periodic payments.
Australian courts have generally been reluctant to impute an interest component

into periodic capital payments and are more inclined to treat the total amount
as capital if there is no identifiable amount of interest: Californian Oil Products
Ltd (in liq) v FCT (1934) 52 CLR 28. However, these amounts may be subject to
the CGT provisions: see Chapter 11.
Example 9.5: Interest component of periodic capital payments

Mr Gan wishes to sell his gardening and home maintenance business as a
going concern, and he has a willing purchaser. Mr Gan has advertised the
business (equipment, customer lists and forward bookings) for $160,000,
but he would sell it for $150,000. The potential purchaser is very keen
to buy the business, but she cannot obtain the finance for the purchase.
As a result, Mr Gan agrees to sell the business for 10 quarterly payments

of $16,000 each and secures the payments by taking a mortgage over
the purchaser’s private home. There is no mention of interest in the
agreement.
As there is no mention of interest in this contract, the full payment will
most likely be treated as capital. However, provided CGT is applicable,
Mr Gan will have realised a capital gain for tax purposes on the date of the
agreement to sell. As a result, he will be subject to tax on the gain in the
year of the sale, regardless of the fact that he will not be paid in full until
over two years later.

Dividends
[9.150] Dividends are paid to company shareholders as their share of company
profits. It therefore follows that dividends flow from the ownership of shares and
are ordinary income under s 6-5 of the ITAA 1997. However, dividends are also
specifically made assessable as statutory income under s 44 of the ITAA 1936
and because of s 6-25 of the ITAA 1997, this specific provision has precedence
over the general provision, s 6-5: see [3.80]. Consequently, dividends are
brought to assessable income via s 44 rather than s 6-5: see [21.40].
Section 6(1) of the ITAA 1936 defines a “dividend” as including:

• any distribution in the form of money or property that a company
makes to its shareholders; and

• any amount credited by the company to any of its shareholders as
shareholders.
The meaning of “dividend” for tax purposes is discussed in detail at [21.130],
but in most situations, it will be clear what a dividend is. However, over the
years, many complex financial instruments have been developed in an attempt
to alter the tax effect of benefits paid to shareholders. This has created some
confusion as to whether the payments are interest on debt, dividends or of a
capital nature. Of particular concern is whether the payments by a company
are dividends paid to the holder of shares (equity) or interest paid on debt. This
distinction is important as it alters the tax treatment for both the company and
the investor.
Example 9.6: Company payment on debt

Rupert has lent (debt) $50,000 to his family private company, of which he
is a shareholder, and the agreement is that the company pays Rupert 8%
pa interest and the debt is to be repaid at the end of three years. In this
case, the company will have a tax deduction for the interest payment and
Rupert will be assessable on the interest receipt as ordinary income. The
repayment of the loan at the end of three years is capital in nature with no
income tax implications for either the company or Rupert.
The important characteristics of Rupert’s investment are that there is a
known fixed amount of return and the repayment of the capital is also
agreed to.

Example 9.7: Company payment on equity

Gertrude purchases $50,000 of shares (equity) in a private company.
Gertrude will only receive a dividend from her investment if the company
makes a profit and decides it can afford to distribute a dividend to its
shareholders. If the company does pay a dividend to Gertrude, the
company will not be able to claim the payment as a deduction because
it is not an expense, but a distribution of profits. Gertrude will have
assessable income under s 44 of the ITAA 1936, but may be entitled to
a rebate via the dividend imputation system to account for the tax the
company has already paid on its profits before paying the dividend: see
[21.420]. The only means for Gertrude to realise the capital value of her
shares is to sell them or for the company to buy them back, both which
could give rise to CGT: see Chapter 11.
The important characteristics of Gertrude’s investment in equity are that

the returns are not certain and the capital value can only be realised
through sale.

The main differences between investments in debt and equity are:

• the different level of risk borne by the investor, in that lenders are
exposed to less risk than shareholders; and
• the different tax treatments.
Given the different tax treatment of investments in debt and equity, companies
have devised securities which blur the boundary between payments of
interest and dividends. This has been done to alter the tax situation for both
the company and investor. As a result, Div 974 of the ITAA 1997 was enacted
to provide a clearer definition of debt and equity investments. These rules are
very complex, but in essence, the distinction between debt and equity is made
on the basis of the certainty, or otherwise, of the return and the level of risk to
which the investor is exposed.
Rental and lease income

Rent
[9.160] Rent is a payment by one party in exchange for the exclusive
possession of the other party’s property for an agreed amount of time. The
receipt of rent by a lessor clearly constitutes ordinary income as it is income from
property. Under the flow concept, rent is income that flows from an investment
in property: see [5.100]. Although rent receipts are usually periodical in nature,
rent will still constitute ordinary income when it is paid as a lump sum.
Lease premiums
[9.170] A lease premium is a payment by a potential lessee to induce a lessor
to enter a lease agreement.
Receipt of a lease premium by a lessor is normally treated as capital because

it is regarded as a receipt for realising an interest in the asset. Lease premiums
that are capital will usually be assessable under the CGT provisions: see
Chapter 11. However, lease premiums will constitute ordinary income in either
of the two following situations:
• where the taxpayer is in the business of receiving lease
premiums: Kosciusko Thredbo Pty Ltd v FCT (1983) 15 ATR 165 (see
Case Study [9.5]). This is usually only the case if the taxpayer regularly
receives lease premiums; and

• where the lease premium is in reality a substitute for rent: Dickenson v
FCT (1958) 98 CLR 460.
Example 9.8: Lease premium –Capital
Pete owns a rental property and wants to find a tenant to enter a one-
year rental agreement. He believes he can charge rent of $1,500 per
month, but at this rate, he receives far more prospective tenants than
he expected. One particular applicant, Alex, offers to pay Pete a one-off
premium of $1,200 on top of the rent if he is chosen as the tenant, and
Pete accepts this offer. The rent of $1,500 will be ordinary income, but the
lease premium of $1,200 will be capital and subject to CGT.

Example 9.9: Lease premium –Business income
Build Pty Ltd builds and rents out office buildings. It regularly enters into
three-year leases with its tenants. Every time it finds a new tenant, it
charges the tenant a one-off lease premium on top of the monthly rent.
Because it owns many offices, Build Pty Ltd regularly receives lease
premiums. In this instance, receipt of the lease premiums would constitute
ordinary income and would be assessable under s 6-5 of the ITAA 1997.
The receipt of the lease premiums is regarded as normal proceeds of
Build Pty Ltd’s business because it receives them on a regular basis as
part
of its business activities.
Example 9.10: Lease premium –Substitute for rent

Jemima owns a rental property and wants to charge $1,800 rent per
calendar month. However, a friend of hers told her that lease premiums
are not ordinary income. As a result, she enters into a lease agreement
with a tenant where she is paid $1,000 per month rent and $800 per
month “premium”. The $1,000 per month rent would be ordinary income
and assessable under s 6-5. The $800 per month “premium” would also
be ordinary income in this situation as it is clearly a substitute for rent.

Case study 9.5: Taxpayer in business of receiving lease premiums

In Kosciusko Thredbo Pty Ltd v FCT (1983) 15 ATR 165, the taxpayer,
in its capacity as a tenant, entered into a 45-year lease of a State park.
The taxpayer then proceeded to develop the land, which included
building facilities and apartments. The taxpayer subsequently sublet
the apartments and other facilities to various tenants and received lease
premiums upon granting some of these leases.
The Court held that the lease premiums constituted ordinary income
as they were part of the normal proceeds of the taxpayer’s business.
This was because the receipt of lease premiums was repetitive and an
essential ingredient of the taxpayer’s business. Consequently, the scope
of
the taxpayer’s business included receiving lease premiums.
Section 15-25 –Amount received for lease obligation

to repair
[9.180] Section 15-25 of the ITAA 1997 states that amounts received by a
lessor from a lessee due to the lessee failing to comply with a lease obligation
to repair the premises are assessable income. However, s 15-25 will only
apply where:
• the lessee has used the premises for producing assessable income; and
• the payment is not ordinary income.
Example 9.11: Amount assessable under s 15-25

Alice owns an office that she leases to Bob. Bob runs a consulting business
from the leased premises. There is a condition in the lease agreement that
Bob must make any necessary repairs to the office and that if he fails to
do so, he must pay a contractual penalty to Alice.
The office requires repairs and Bob fails to carry them out. As a result, Bob
pays Alice money as determined under the lease agreement. This amount
is assessable under s 15-25. Note that there is an equivalent deduction
under s 25-15 of the ITAA 1997 for expenses incurred in carrying out
these
repairs.
Royalties
Introduction
[9.190] A royalty is a payment that is calculated based on the usage of
intellectual property or the quantity/value of a substance taken, such as coal
taken from a mine. The following would be royalties:
• When a taxpayer is paid for use of his or her intellectual property. For
example, Simone wrote a book and, as a result, owns the copyright to
it. A publisher then enters into an agreement with Simone to publish
and sell her book in exchange for giving her $2 per sale. This payment
constitutes a royalty because it is calculated based on the usage of the
copyright.
• When the owner of intellectual property agrees to sell his or her
intellectual property for an amount based on its usage. For instance,
Steve writes a book and owns the copyright to it. A publisher who
wishes to publish and sell Steve’s book offers to give him $2 per sale
in consideration for Steve selling the copyright to the publisher. The

amount received by Steve will constitute a royalty. This differs from
the first example because in the first example, the author retains
ownership of the copyright, but in this example, the copyright is being
sold. Nevertheless, in both cases, the payments constitute royalties as
the amounts are calculated on the usage of intellectual property.
• Where someone is paid to produce intellectual property and the
payment is based on its subsequent usage. For instance, Christie
agrees with a publisher to write a book for them in exchange for a
payment of $2 per book sold. The copyright in this example will always
have been owned by the publisher because, under copyright law,
if a writer enters a contract to write a piece for someone (such as a
publisher), the copyright usually rests with the party that is paying.
However, despite the fact that Christie never owned the copyright, the
payment will still be a royalty because it is calculated according to the
usage of intellectual property.
• Where a taxpayer is paid for his or her physical resources based on the
quantity of resources taken. For example, Alexia owns land that has oil
reserves. A mining company pays her $20 for every barrel of oil that it
extracts from her land. This amount will constitute a royalty.
Case study 9.6: Taxpayer paid for timber taken from his land in receipt
of royalty
In McCauley v FCT (1944) 69 CLR 235, the taxpayer was a dairy farmer
who owned land with trees on it. The taxpayer entered into an agreement
with Laver, where Laver would cut and take the trees from the taxpayer’s
land. The agreement stated that Laver would pay the taxpayer an amount
based on the quantity of timber that had been cut and removed from
the land.
The High Court held by a 2:1 majority that the payment received by the
taxpayer was a royalty as it was a payment made in relation to the amount
of
timber removed.
Assessability of royalties
[9.200] Section 15-20 of the ITAA 1997 deems royalties to be assessable as
statutory income. However, s 15-20 does not apply to royalties that are ordinary
income under s 6-5 of the ITAA 1997. This means that royalties that are ordinary
income will be assessable under s 6-5 and those that are not ordinary income
will be assessable under s 15-20. This raises the issue of which royalties are
ordinary income.
Royalties that are a product of exploiting intellectual property (such as the first
three points in the list at [9.190]) will constitute ordinary income. In the case of
Stanton v FCT (1955) 92 CLR 630 (see Case Study [9.7]), the majority arguably
implied that payments for physical resources (such as the last of the points at
[9.190]) will be capital royalties. However, the case law on what constitutes
a capital royalty is unclear, and it is also arguable that royalty payments for
physical resources are ordinary income.
Case study 9.7: Farmer’s receipt from a sawmiller for right to take

timber was not a royalty
In Stanton v FCT (1955) 92 CLR 630, the taxpayer was a farmer who
granted a sawmiller the right to come on to his land and remove
timber in exchange for a predetermined sum to be paid quarterly. The
agreement also prescribed a maximum amount of timber that could be
removed and gave a proportionate reduction of the payment if less than
this maximum was removed. For instance, if only half the timber was
removed, then the taxpayer would end up receiving only half the pre-
agreed amount.
The High Court held that the payments received by the farmer were not
royalties and were capital in nature. Consequently, the payment was not
assessable as it was not ordinary income and s 15-20’s predecessor did
not apply as the payment was not a royalty.
The Court stated that the taxpayer’s receipt was not a royalty because
the agreement expressed the payment as a predetermined amount. This
was despite the fact the agreed pro-rata reduction of the predetermined
payment meant that, in substance, the amount paid was linked to the
amount of timber removed. In other words, the Court appeared to define
royalty by its form rather than its substance.
If this case was decided today, it is likely that the Court would still
find that the payment was not a royalty. However, it is likely that a
modern court would find that the payment was ordinary income under
other grounds. For instance, it is possible that the court would find the
payment is ordinary income as the normal proceeds of the taxpayer’s
farming business. This is likely because courts may now take a wider
view of what are normal business proceeds: see [8.130]–[8.160].
Furthermore, even if modern courts decided that the payment did
not constitute normal business proceeds, they are likely to find that
the payment was ordinary income due to satisfying the first strand of
Myer: see [8.220]–[8.250]. Finally, if a court held that such a payment
was not ordinary income, it would be assessable under the CGT
provisions: see
Chapter 11.
Annuities
[9.210] An annuity is a stream of payments that occur at regular intervals (eg,
monthly or quarterly), and this may be for a fixed length of time or for the life
of an individual. Where the annuity is purchased, it is known as a “purchased
annuity”, which occurs where the taxpayer pays an entity, such as an insurance
company, a lump sum in exchange for that entity paying the taxpayer a regular
income stream.
The main two types of annuities are fixed-term and life annuities. A fixed-
term annuity is where the payments are made by the annuity provider for a
predetermined amount of time. A life annuity occurs when the terms of the
annuity contract state that annuity payments are to be made for the rest of
the recipient’s life. At the end of the annuity period, the original purchase
price of the annuity will usually have been totally consumed and the recipient
will not be entitled to any final capital payment. In effect, the provider of the
annuity has repaid over the life of the annuity the purchase price plus any
interest earned during the annuity period. However, in some limited cases, the
taxpayer will be entitled to receive part of the purchase price of the annuity at
the end of the annuity period, but this ultimately depends on the term of the
annuity agreement.
Example 9.12: Fixed-term and life annuities

A taxpayer purchases an annuity from an insurance company for $100,000
in exchange for a 10-year annuity. The terms of this particular annuity

provide the taxpayer with regular payments for the next 10 years that
amount to $14,500 pa. This is an example of a fixed-term annuity.
Another taxpayer pays an annuity provider $60,000 in exchange for the
taxpayer receiving regular payments of $7,000 pa for the rest of his life.
This
is an example of a life annuity.
Under case law, the full amount of the regular annuity payments is regarded as
ordinary income because it is a regular payment in the form of income: Egerton-
Warburton v DCT (1934) 51 CLR 568. This is an unjust outcome because
only part of the annuity payment is a real gain, whereas the rest is a return
of the taxpayer’s purchase price, which is capital: see [5.70]. As a result,
the Government enacted s 27H of the ITAA 1936, which makes the return of
the annuity’s capital component tax free. Section 27H only applies to non-
superannuation annuities as superannuation annuities are subject to other
legislative provisions: see Chapter 18.
Example 9.13: Section 27H of the ITAA 1936 reduces assessable

component of annuity
Stan pays $80,000 in exchange for an eight-year annuity that pays $13,000
pa. Under the terms of the agreement, Stan is not entitled to have any of
the purchase price returned at the end of the eight years. Stan’s purchase
price of $80,000 apportioned over the term of the annuity amounts to
$10,000 per year. This means that, due to s 27H, $10,000 of the yearly
annuity receipt is tax free. The other $3,000 will be assessable as ordinary
income.

Questions
[9.220]
9.1 Your client has invested $10,000 in a savings bond that matures in five
years’ time and pays interest at 8% pa, but the interest is paid as a lump
sum on the redemption of the bond in five years’ time.
How will the interest be treated for income tax purposes?
9.2 Your client has purchased an investment apartment that has a rent
guarantee from the developer of 5% pa for a period of four years.
During the current financial year, your client has been unable to rent the
apartment, so is relying on the rent guarantee payment to compensate
her for not being able to find a tenant. The developer is due to pay the
amount as a lump sum and your client is not sure whether the amount
is income. Advise her.
9.3 Your client was injured in a work-related accident and has received
damages of $300,000 for the loss of his ability to work. In the final
judgment, the Court awarded $12,000 in pre-judgment interest and
$5,000 in post-judgment interest. Which amounts, if any, are assessable
income?
9.4 Your client makes most of her income from writing hit songs for
various performing artists and receives a large amount of royalties
from overseas record companies.
Is this assessable income and how will it be taxed?
9.5 Your client has just written his first book of his experience as a hostage
of a terrorist group. He spent the last two years writing the book and
he has received two offers from a publishing company that wished to
publish his book. The first offer is to purchase the copyright for a lump
sum payment of $10,000 provided your client gives up future claims
to the copyright and royalties. The second offer is to pay 10% of the
sale price of each book sold provided your client agrees to assign the
copyright in the book to the publisher for 10 years.
Discuss the effect on assessable income of each of the two offers.
9.6 Your client is a parent who lent $40,000 to her son to provide a short-
term housing loan. The agreement is that the son will repay $50,000 at
the end of five years.
Reconsider this question in light of the following facts. The loan was
made to the son without any formal agreement and without any
security provided for the sum lent. In addition, the client (the mother)
has informed you that she told her son that he need not pay interest.
However, the son repaid the full amount after two years and included
in his payment an additional amount which was equal to 5% pa on
the amount borrowed. Only one cheque was presented for the total
amount.
Discuss the effect on the assessable income of the parent.
9.7 Helen is 68 years old and single. Three years ago (when she was 65) she
purchased a lifetime annuity for a lump sum of $1 million (not through
her superannuation) that will give her an income of $60,000 a year for
the rest of her life. The annuity has no guaranteed minimum annuity
period and no amount payable to her estate upon her death. Assume
that according to the government actuarial tables, a 65-year-old female
has a life expectancy of 89.
How would Helen’s $60,000 receipt be treated for income tax purposes?
9.8 Ms Kim works as a nurse at the local private hospital and in addition to
her private home, she owns a commercial property which she rents to
a tenant who operates a retail business from the property. As part of
the rental agreement Ms Kim requires a bond of $2,000 to be paid on
signing of the rental agreement, and the tenant also agrees to rectify
any damage to the property caused by the tenant. During the current
tax year, the tenant stopped paying rent and on inspection of the
property Ms Kim found the tenant had vacated and there was $3,000
worth of damage caused by the tenant. As a result, she retained the full
$2,000 bond and used it to repair the damage caused by the tenants.
How will Ms Kim’s retention of the $2,000 bond be treated for income
tax purposes?
9.9 Trevor lends money under a five-year loan agreement. The terms of the
loan are that $60,000 is to be repaid at the end of the five-year period,
but the loan is subject to a discount so that the borrower receives only
$55,000. The agreement also states that the borrower pays 2% per
annum in interest.
What ordinary and/or statutory income, if any, will Trevor be assessable
on under this arrangement?

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Part

The first step in the taxation process is to determine assessable income.

a product of labour, business or property. Further, the courts have always

Many receipts will be ordinary income which is assessable income under

Assessable Ordinary Statutory Exempt

Traditionally, income has been categorised according to the source to

Chapter 6 specifically covers income from personal services and

Chapter 7 follows on from the discussion on income from personal

While the ordinary income concepts are generally no different, the

Taxpayers may receive various types of compensation payments. If the

Although both statutory income and ordinary income are included in

distinguish between the two due to other tax consequences.

What if a gain is not ordinary income: will it be assessable? If a gain is not

ordinary income, then it will only be assessable if it is statutory income, that is

So what is ordinary income? According to s 6-​5(1) of the ITAA 1997, ordinary

As seen from Figure 5.1, income is shown to have two essential prerequisites

Three categories of income

Capital gains are not ordinary income

Prerequisites and characteristics of

[5.50] For a gain to be ordinary income, it must fulfil two prerequisites

Cash or cash convertible

For an item to be cash convertible, it needs to be readily convertible to cash.

Case study 5.1: Receipt of free accommodation was not income

Case study 5.2: Receipt of non-​cash-​convertible holiday was not

As discussed at [8.160], s 21A of the ITAA 1936 deems non-​cash business

Case study 5.3: Reimbursement for work-​related loss upon moving

However, the regularity of a receipt is not a determinative factor in deciding if

This concept of “flow” is articulated in a paragraph from the US judgment

The fundamental relation of “capital” to “income” has been much discussed by

Example 5.1: Receipt of rent and proceeds of property sale

does not have the characteristics of ordinary income as it:

Example 5.2: Business that regularly buys and sells houses

–​ have a nexus with the underlying business that buys and

Some gains are ordinary income despite having no

Case study 5.4: Government age pension constitutes ordinary income

Case study 5.5: Top-​up payments if employee joined the armed forces

Other general principles

Compensation receipts are discussed in more detail in Chapter 10.

Unrealised gains are not ordinary income

Legality of receipts does not affect their assessability

Whether a receipt is ordinary income is to be

characterised in the taxpayer’s hands

Case study 5.6: ATO loses because it did not use principle of

had a long-​term contract to supply mineral coke to a French company

Benefit that saves taxpayer from incurring expenditure

taxpayers’ receipt of a non-​cash-​convertible holiday would have made them

The principle of mutuality shows that funds given to a club/​association by its

Case study 5.7: Mutual receipts of a club

part of the RACV’s trading activities. The breakdown services, towing

Example 5.4: Receipts subject to mutuality principle

the club is only from members and therefore is subject to the

5.2 Look up some English dictionary definitions of “income”. In what

10 years. This land was not suitable for subdivision, so he sold it to

Non-​cash benefits....................................................................................... [6.130]

What is an early retirement scheme payment?...................................... [6.340]

Ordinary income as a reward for services

Amounts earned directly or indirectly by virtue of a taxpayer’s personal

Does the receipt show a nexus with the service?

So what is ordinary income? According to s 6-5(1) of the ITAA 1997, ordinary

Three categories of income

Capital gains are not ordinary income

Case study 5.1: Receipt of free accommodation was not income

Case study 5.2: Receipt of non-cash-convertible holiday was not

As discussed at [8.160], s 21A of the ITAA 1936 deems non-cash business

Case study 5.3: Reimbursement for work-related loss upon moving

Example 5.1: Receipt of rent and proceeds of property sale

does not have the characteristics of ordinary income as it:

Example 5.2: Business that regularly buys and sells houses

– have a nexus with the underlying business that buys and

Case study 5.4: Government age pension constitutes ordinary income

Case study 5.5: Top-up payments if employee joined the armed forces

Compensation receipts are discussed in more detail in Chapter 10.

Unrealised gains are not ordinary income

characterised in the taxpayer’s hands

had a long-term contract to supply mineral coke to a French company

taxpayers’ receipt of a non-cash-convertible holiday would have made them

The principle of mutuality shows that funds given to a club/association by its

Case study 5.7: Mutual receipts of a club

Non-cash benefits....................................................................................... [6.130]

may also be capital in nature (see [6.140]–[6.180]) and not assessable as

Case study 6.3: Christmas bonus was ordinary income

The treatment of personal gifts as non-assessable income for tax purposes

When distinguishing between a non-assessable personal gift and assessable

Case study 6.4: Characteristics of a personal gift

Case study 6.5: Characteristics of a gift

Case study 6.6: Professional sportsperson’s prize

Case study 6.7: Frequent flyer points

Case study 6.8: Payment for service of giving up valuable rights

Case study 6.9: Relinquishing employment rights

Case study 6.10: Restrictive covenant –capital

Case study 6.11: Restrictive covenant –genuine capital payment

Case study 6.12: Restrictive covenant –ordinary income

Case study 6.14: Sign-on fees –capital in nature

The view expressed by the Commissioner in Ruling TR 1999/17 is that where

Case study 6.15: Sign-on fees –ordinary income

The discussion at [6.190]–[6.390] covers the most important statutory

Section 15-2: Statutory income from services

income, it will not be covered by s 15-2: see [3.80].

Section 15- 2 potentially only applies to gains from employment or the

Some examples of receipts that meet the first requirement are:

Can compensation receipts be assessable under s 15-2?

This issue was considered in the following two cases.

Section 15-2’s relationship with other tax provisions

Note that, in general, most non-cash benefits provided by an employer to an

Example 6.6: Examples of the application of s 15-2

• third-party payments that are cash or cash convertible and have

Section 15-3: Return-to-work payments

assessable under s 15-3.