Question 27

Michelle is your client. She provides you with the following information:
Michelle’s Activities in 2021-22
Michelle has been painting for several years. She is employed full-time as a public servant, but works
on her art in her spare time - on average 12 to 15 hours a week outside normal work hours.
Michelle uses a spare room in her home as a painting studio and to store materials. She is a member
of a local landscape-painting club which regularly arranges painting trips to sites in the area and once
a year to
the Western Australia. Her club participation involves attending club meetings once a month and
showing her work to gain feedback from the other club members. She engages in her art activity with
a great deal of enthusiasm and commitment.
Michelle sells artwork to family and friends, at prices that just cover the cost of the materials used.
Jennifer sold two of her art works to friends for a total of $800 and she spent $5,000 to create several
other works of art. Michelle has not keep receipts for all of her expenses.

Michelle’s Activities in the 2022-23 income year

Michelle decides to work part-time at her job in the public service so that she can devote more time to
her art and make a name for herself as a landscape artist. Michelle also becomes a member of two
professional art associations. For the first time, she engages an agent to assist with the exhibitions she
has planned for 2022 and with marketing her work more generally. In consultation with her
accountant and her agent, she develops a business plan.

Michelle’s business plan involves renting of a small studio to conduct her painting and store her
materials. She exhibits her works at various local galleries as part of group exhibitions and sells a
number of paintings for a total of $13,700. She keeps detailed records of her income and expenses.
Her art expenses for 2022-23 are $15,700, comprised of the following:

Type of expense Amount

Materials $4,750
Rent $6,000
Gallery commission (40% of total sales) $4,250
Membership fees in professional arts associations $200
Journal subscription fees $500

In 2022-23, Michelle returned a net loss of $2,000 from her art activity. She spends considerable time
painting, to build up a body of work so that she can participate in exhibitions (local and interstate) she
has planned for the next year. She is also setting up a website of her works for greater exposure. She
intends to ultimately resign from her full-time job and spend more time marketing and producing her
art, if that is sustainable.

Required: Using case law to substantiate your answer, is Michelle carrying on a business and if so,
when did her business commence? What are the tax consequences?

Michelle Activities in 2021-22

Issues:
Whether Michelle is carrying on a business?
Whether her $800 is ordinary income and deductible expenses?

Rules and application:

Profit-making intention is a strong indicator of carrying on a business. In this case, Michelle
seems lacking in profit-making intention. Michelle did not undertake any activities to increase
her profit, and her painting activities are more likely to be a hobby unlike the Stone case.
The scale of business is very small since she only works on her art in her spare time which
is 12 to 15 hours a week. Moreover, the turnover rate of her business is low since she
invested $5000 to create her artwork and her revenue is only $800. She did not spend most
of her time and invested a large amount of money in painting activities unlike the Walker
(1985) case.
The case also demonstrated that there is less degree of planning and amount of time
invested. Michelle did not hire anyone to assist her business and she did not delegate her
duty to anyone unlike the Ferguson case. Although she gets some advice from club
members, there is no expert assistance unlike the Walker case. She did not take any action
to try to expand her painting business.
In addition, Michelle sells her artwork to friends only, there is no exploration of the market for
sale opportunities. The painting activity is more likely to be a recreational activity since there
is no commercial approach taken as in Thomas case. She did not adopt any marketing and
promoting strategy to try to boost her sales. Last, Michelle only works in her spare room and
there is no official painting studio for her to store paintings and materials which also differs
from Ferguson case.

In conclusion, Michelle's activities in 2021-22 are more likely to be a hobby and she did not
carry on a business. Therefore, an $800 receipt is not an ordinary income and there is no
deductible expense.

Michelle's Activities in 2022-23

Issues:
Whether she is carrying on business
If yes, whether and why the commencement date matters
Whether carrying on a business for GST purpose

Rules and application

Courts use various indicators/characteristics that indicate the presence of a business. First,
the profit-making intention is a strong indicator of carrying on a business. In this case,
Michelle rented a small studio to conduct her painting and store her material. She also
exhibits her painting in galleries and sells several paintings for a total of $13700 as in Stone
case, it seems that Michelle treats her painting business seriously. She rented a studio
which is her official working place and her high revenue of $13700 also indicates that she
has an intention to sell her painting to generate a higher profit.
Michelle also undertook a commercial approach which is also a strong indicator. She
engages agents to assist with the exhibition and marketing of her artwork. She also consults
her accountant and agent and develops a business plan as in Ferguson case. She hires
people and delegates many job descriptions to the employee which is the delegation of
duties. She also joined the professional art association and named herself as an artist which
represents her engagement in the art business as in Thomas case. Michelle’s job is still a
public servant but she intends to resign and the commercial approach taken in her art
business shows that she is carrying on a business.
For the scale of activities, Michelle invested a large amount of money in the painting
business, her total expense is $15700. She recorded her expenses and revenue which
indicates that she has profit-making intentions as in Walker case. Even though Michelle’s
business is not a very big operation, there are sufficient characteristics to show that the
business exists. Her business plan is also budgeting for her business operation. She also set
up a website for her work to generate greater exposure which is a marketing and promotion
technique and it is a profit-making intention.
The degree of planning of the business is high since Michelle hired an accountant to record
her revenue and also an agent to assist her exhibition as in Ferguson case, it is a delegation
of duties. She spent a considerable time on her artwork and intends to resign from her
current job which indicates she spent a large amount of time on her art business.

Since Michelle fulfilled many characteristics of carrying on a business, therefore her painting
is a business rather than a mere hobby.

Commencement date
The commencement time is important because the receipts before or at the end of a
business that is not associated with the operation of the business, are not business income
and because the expenses before or at the end of a business that is not associated with the
business may not be deductible
Michelle’s business commenced in 2022-23 since Michelle fulfilled many characteristics of
carrying on a business in 2022-23 so the expense in 2022-23 is deductible. In contrast,
Michelle did not carry on a business in 2021-22 so the expenses are not deductible.
Therefore, her taxable income for Michelle is $13700 and expenses are deductible.

GST consequence
For the GST, there is no sufficient information to determine whether Michelle registered for
GST. If she registered for the GST s 23-5 GST Act since artwork is a taxable supply so she
can claim the input tax credit. If she did not register, she cannot charge GST on sales but
cannot claim input tax credits on acquisitions
Question 28

Sunrise Manufacturing Pty Ltd (“Sunrise”) is an Australian company that carries out the manufacture
and assembly of conveyor belts and other equipment used by the construction industry. In 2022-23,
Sunrise received $1,500,000 (incl GST) for the sale of its conveyor belts. Sunrise also receives
royalties of $50,000 from a number of other manufacturers who manufacture conveyor belts using
Sunrise’s design.
Sunrise has existing contracts in place with various retailers both in Australia and overseas. One
particular contract with a company in the UK, had been in existence since 1990 but the UK Company
cancelled the contract due to undisclosed reasons in 2022-23. Sunrise received $800,000 as
compensation in connection with the cancellation. The contract would have taken up 15% of Sunrise
Manufacturing capacity for the next two years and provided it with revenue of over $185,000 over
that period.
In the same year (2022-23), Sunrise had a fire in one of its factories. The factory was completely
destroyed, including all the equipment inside. Sunrise received $5 million in insurance.

Required: Citing all relevant legislation and case law, Sunrise Manufacturing Pty Ltd wants advice
on which amounts it receives are ordinary income under s. 6-5 ITAA97. Advise Lanes, include
reasons for your conclusions.

Proceed of sale of conveyor belts

Sunrise is a company that manufactures conveyor belts so it is their normal business

procedure. $150000 is the revenue from the sale activities of Sunrise. A receipt from the
normal proceeds of a business constitutes ordinary income (s. 6-5 ITAA97). Therefore, the
receipt of $1500000 x 10/11 = 1363636 is an ordinary income.

Proceed of royalty

A royalty payment is a payment that is calculated based on the usage of intellectual property
or the quantity/value of a substance taken. In this case, Sunrise received royalties of $50000
from other manufacturers who manufacture conveyor belts using Sunrise’s design which is
intellectual property. It is a sale of rights for other companies to manufacture as in
McCauley's case. Therefore, receipt of a royalty of $50000 is ordinary income.

Proceeds from cancellation of contract = $800000

As outlined in s 6-5 ITAA97, where compensation replaces ordinary income then it is

ordinary income. In this case, the compensation is for the loss of an ordinary trading contract
since the UK company breached the contract due to undisclosed reasons. They cancelled
the transaction so the transaction cannot be continued and Sunrise cannot receive an
ordinary income. Here, the compensation is to replace the ordinary income as in the Heavy
Minerals case. Therefore, the $800000 compensation is an ordinary income

Proceeds from insurance = $5 million

As outlined in s 6-5 ITAA97, where compensation replaces capital or something of a capital
nature is capital rather than ordinary income. In this case, Sunrise had a fire in one of his
factories and it was completely destroyed which indicates that the factory is permanently
destroyed as in the Glenboig Union Fireclay case. It is also a breach of contract that goes to
the fundamental structure of the business since the factory is the main asset of the company
as in the California Oil Products Ltd case. Therefore, the compensation of insurance is not
an ordinary income, it is a capital. For the composition claims, since Sunrise’s factory was
damage from fire so whole sum treated as capital: McLaurin v FCT (1961)
Question 29

Rebecca Tan and Peter Green are keen property enthusiasts and have invested in commercial
properties over the years. In 2007, Rebecca and Peter acquired a deteriorating commercial building in
King Street, Melbourne for $1,700,000. At the time of purchase, the couple envisaged that the price
of the building was below value and there would be a substantial increase in property prices in this
area over a ten-year period.
Their business plan involved using the building to run a hotel business. They charge $350 per room
per night and also run a restaurant and day spa in the hotel.

In 2022-23, Rebecca and Peter decided to sell the King Street building as they had planned fifteen
years ago. This was an opportune time as property prices were trending upwards. However, before the
property went to market, the couple received a letter from the State Government advising that the
building would be demolished to make way for a new railway station to service a fast rail link to
Melbourne airport. Consequently, the Government proceeded to compulsorily acquire the property,
and provided compensation of $22 million dollars to the couple.

Required: Using legislation and case law to support your answer, characterise the receipts (for tax
purposes) from the hotel business and the $22 million.

Receipt from business.

Rebecca and Peter were running a hotel business. The charges of room and services for
$350 is the normal business procedure as in Memorex's case. Providing room service,
restaurant, and spa are their regular business activities and the receipt of $350 is their
revenue from ordinary business activities. A receipt from the normal proceeds of a business
constitutes ordinary income (s. 6-5 ITAA97). Therefore, room charges and proceeds from
the restaurant and spa of $350 is an ordinary income.

Compensation from Government

As outlined in s 6-5 ITAA97, where compensation replaces capital or something of a capital

nature is capital rather than ordinary income. In this case, the government proceeded to
compulsorily acquire the property. The building is a capital asset to Rebecca and Peter’s
hotel business and the government needs to acquire the building. As a result, they received
compensation for the loss of their capital asset; therefore the compensation will be
considered as a capital gain as in the California Oil Products Ltd case.