GENERAL CONCEPTS OF INCOME

1
Introduction
• Assessable income is subject to income tax as it is added to
“taxable income”:

Assessable Ordinary Statutory

Income Income Income

• Focus is on the general concepts of ordinary income.

Ordinary income – general:
What is ordinary income?
• Ordinary income is “income according to ordinary concepts”
and is assessable under s 6-5 Income Tax Assessment Act
1997.
• “Income according to ordinary concepts”
– Gains that have been given characterisation by the courts
as having an income character, and thus ordinary income.
– Jordan CJ in Scott v Commissioner of Taxation (1935)
whether a gain has an income character will be determined
“… in accordance with the ordinary concepts and usages of
mankind”.
Ordinary income – general:
Commonly recognised categories of income
• Income is commonly categorised into three broad areas:

• Income from personal services and employment

1

• Income from business

2

• Income from property

3
Ordinary income – general:
Characterisation of a gain
• Central issue in the application of the Australian income tax
legislation is the characterisation of a gain as:

Gain

Not capital
Ordinary
Capital or ordinary
Income
income
Prerequisites of ordinary income
• A receipt cannot be ordinary income unless it fulfils both
prerequisites:
Prerequisites
Cash or
Real gain to of ordinary
convertible to
the taxpayer income
cash
satisfied

• Note, even if the above prerequisites are satisfied, it is not by

itself sufficient for the gain to be ordinary income (see later,
characteristics of ordinary income).
Prerequisites of ordinary income:
Cash or cash convertible
• A gain cannot be ordinary income if it is not cash or not cash
convertible.
– See, Tennant v Smith (1892); FCT v Cooke and Sherden
(1980)
• What is cash convertible?
– The item must be readily convertible to cash
– There must be no legal impediment to the sale of the non-
cash benefit : Payne v FCT (1996).
• Note statutory provisions:
o S 15-2 ITAA 1997 for treatment of non-cash benefits connected
with personal services income
o s 21A ITA 1936 for non-cash business benefits.
Prerequisites of ordinary income:
Real gain
• If a receipt is not a genuine gain (ie, the taxpayer is better off
financially), it is not ordinary income.
• More likely to apply in employment situations:
– Reimbursement of a work-related expense held not to be a
real gain: Hochstrasser v Mayes (1960).
Characteristics of ordinary income
• Provided both prerequisites of income are satisfied, a gain will
be ordinary income if it shows sufficient characteristics of
income:

• Regular / periodical receipts; or

1

• The flow concept.

2

• Note, the above characteristics are only indicia as to what

constitutes ordinary income:
– Courts can widen their views to reflect modern day
practices: for example, FCT v Myer Emporium (1987).
Characteristics of ordinary income:
Regular/periodical receipts
• A gain that is regular or periodic is more likely to be ordinary
income than a gain that is paid as a lump sum (but never
determinative – (need to consider flow principle):
– Regular receipts characterised as income nature: FCT v
Blake (1984).
– One-off receipts not ordinary income: FCT v Harris (1980).
• Lump-sum gains may also be ordinary income, for example:
– One-off receipt of interest under a loan agreement
– Contract to do a one-off job.
• Regular gain may not be ordinary income (less common):
– See, Foley v Fletcher (1843-1860) where a taxpayer
received instalments for the sale of a capital asset.
Characteristics of ordinary income:
Flow – the concept
• The flow concept is expressed in terms of “fruit” and “tree” in
Eisner v Macomber (1920) by Pitney J:

“Tree”
represents:
capital

“Fruit”
represents:
income
Characteristics of ordinary income:
Flow – important traits
• For a gain to be considered ordinary income where it is
likened to the fruit from the tree, it will have the following two
related traits:

• Nexus (a connection) with the earning source

1

• Severable from its earning source

• ie, the gain can be extracted without the affecting
2 the underlying earnings.
Characteristics of ordinary income:
Flow concept – examples
• Examples demonstrating the fruit / tree analogy:

Context “Tree” “Fruit”

Employment Taxpayer’s ability Payment for
to work / contract services
Business Goodwill of the Sales / services
business
Investment Investment Rent
property
Some gains are ordinary income despite no
earnings source
• Receipts that are regular, expected and depended upon for
support can constitute ordinary income, even if they do not
flow from an earnings source:
– Government aged pension: Keily v FCT (1983)
– Youth Allowance payments: Anstis v FCT (2010)
– “Top-up” payments offered to employees who resigned to
enlist in World War II. “Top-up” is the difference between
former salary and military salary: FCT v Dixon (1952).
Other general principles of income
• Compensation takes on the character of the loss being
compensated.
• Unrealised gains are not ordinary income.
• Legality of receipts does not affect their assessability: Minister
of Finance (Canada) v Smith (1927); Taxation Ruling TR
93/25.
• Whether a receipt is ordinary income is to be characterised in
the taxpayer’s hands: Federal Coke Co Pty Ltd v FCT (1977).
• Constructive receipt rule:
– The taxpayer who is entitled to receive the income is the
person who will be assessable on it, even if the actual gain is
directed to someone else.
Other general principles of income
• Benefit that saves taxpayer from incurring expenditure is not
ordinary income if it is not cash or cash convertible.
• “Mutuality”: if the taxpayer makes a payment to himself or
herself, there is no gain and the payment will not be income:
– Funds paid to a club/association by its members are not
assessable income of the club, as the members are the
club. Similarly, a refund of fees to a club/association’s
members also not assessable to members as no real gain:
see Bohemians Club v Acting FCT (1918).