sample essay of taxation law

taxation law is a hard unit, but i think it is fun...
there were two parts of the assignment, but we did not the answers to these two question...the following anwsers were made by me.

QUESTION:
PART A

Michael Rage was a train driver. However, his real passion was photography. Michael owned an SLR digital camera and lenses worth $12,000. He spent a lot of his spare time looking for and taking exciting and unusual photographs. He particularly enjoyed taking photographs of people, and the night skies. He also owned a $5,000 telescope for the purpose of photographing the night sky.

Michael had set up a web page on which he placed some of his most spectacular photos. Michael was approached by NASA after having seen his web site. NASA asked Michael to join a team of other amateur photographers to photograph designated portions of the night sky. NASA agreed to contribute $3,000 per annum to the maintenance of his photographic equipment.

A regular science programme on TV did a special feature of Michael as a result of his invitation to be amongst a select few to help NASA. Also, Michael had established a strong following as a result of his web site. Because of these two factors request were often made of Michael by other photographers to teach them better photographic techniques generally and of astronomical bodies in particular. Michael was also often approached by people who wanted to take up photographer to teach them the basics of photography.

As a result of these requests Michael began running small classes for basic and advanced photography. Michael would run these classes once every month for beginners over 2 days, and once every month over 2 evenings, for 4 hours each evening, for those wishing to learn the technique of night sky photography. In fact Michael simply incorporated these classes into his usual photographic routine. Thus, on most Friday and Saturday evenings Michael would take photos of the evening sky. Now, every fourth Friday and Saturday he would also teach the art of photography. To help in his lessons Michael bought two new telescopes each worth $3,000, an overhead projector worth $3,500 and a computer worth $1,800 to help in the lessons he gave.

Michael charged the people who attended his classes $175. Each class was restricted to six people. He held ten classes a year for beginners and six classes a year for those wishing to learn how to photograph the night sky. In total Michael received $16,800 in fees.

The salary from train driving is clearly income. However, are the other amounts Michael received assessable income?

PART B

Bill & Ben Reticulation Pty Ltd had a entered into a contract worth $15,000 with the Port Cricket Club to replace the drainage system on the playing surface of the club’s sporting ground. Shortly after entering into the contract, and before Bill and Ben had done any work under the contract, Port Cricket Club decided it would sell its current sports ground and buy better grounds and facilities. It therefore negotiated with Bill & Ben Reticulation Pty Ltd to be released from the contract. Bill & Ben Reticulation Pty Ltd. agreed to this if they were paid the sum of $6,000. Port Cricket Club agreed to this and duly paid the sum.

Will the $15,000 received by Bill and Ben Reticulation Pty Ltd be taxed and if so why?

ANSWERS

Part A


In the scenario, there are two receipts related to Michael’s income besides the salary from train driving. The first one is $3,000 which is given by NASA to maintain his photographic equipment. The other one is $16,800 which he receives from his class. These two amounts have different natures, so they should be considered separately.

-$3,000 from NASA

To decide whether this part of received amount should be treated as assessable income, one important thing to do is whether should consider this receipt is ordinary income or not.

There is a large amount of case laws dealing with the issue of whether a receipt is ordinary income. From this case law it is possible to identify a number of factors that will determine if a receipt is income according to ordinary concepts. The most basic list that can be identified from these cases is

 Whether the amount has the characteristics of periodicity, recurrence or regularity;

 whether it is convertible into money, or money’s worth

 Whether it is associated with business activities or services rendered, as distinct from the mere sale of property

In the question, obviously, the $3,000 is cash, and NASA pays him every year. But the receipt is not from business or person services. The reasons are listed below.

1. The amounts are not from business.

The ITAA 1997 defines a “business” includes “any profession, trade, employment, vocation or calling, but does not include occupation as an employee”. In Tax Ruling 1997/11, it lists several indicators to define the activity whether it is carrying on a business or not:

- Whether the activity has a significant commercial purpose or character; this indicator comprises many aspects of the other indicators.

- The size, scale and permanency of the activity

- Whether the activity is planned, organized and carried on in a businesslike manner such that it is directed at making a profit.

In the question, Michael is keen on photography, but neither indication shows that he is doing photography to make profit. The receipt is from NASA after he set up a website. That’s to say, before he started the photography or set up the website, he didn’t know he could earn money from this. If he wants to make money form the photography, he should approach to NASA and sold his photos. But in fact, NASA approached him, and wanted him to join a team, after that, gave him some money to the maintenance of his photographic equipment. What is more, the photos are just shown on the website, rather than sold to the NASA or someone else. It should be noticed that the money is given to maintain the photographic equipment, which doesn’t come from selling photos.

From the analysis above, the money is not from business. Michael’s behavior is just a kind of hobby.

2. The receipt is not from personal service.

Although not every payment received by an employee will be income, the courts have established the following factors in determining whether gains from person services or gift are ordinary. (Kenny, 2008)

 Degree of connection to employment or services rendered. The $3000 is nothing to do with his job or service rendered. In the question, NASA asked Michael to join a team of other amateur photographers to photograph designated portions of the night sky. But the payment is to maintenance of his photographic equipment. The degree of connection to employment or services rendered is almost zero.

 Reasonable expectation payment would be made. As mentioned above, he didn’t know NASA would give him money after he set up the website.

 Dependence upon payment to meet usual living expenses. $3000 in Australia is not a big amount, his life can’t rely on this.

 Payment replaces income. Comparing his salary from train driver, these receipts can’t replace his income.

 Motive of the payer or donor, i.e. commercial considerations or personal reasons for making payment. NASA as a non-profit organisation, it gave Michael money can’t be for commercial considerations.

So the receipt is not from personal service.

In conclusion, the money is not from the business or personal service, and the activity is better described as a hobby, and that should be non-assessable income.

-$16800- received from taking the classes

To decide this amount is assessable or not assessable, first thing to do is determine whether this receipt is ordinary income. If it is ordinary income, it is clearly that it should be taxed. Income tax laws failed to define income, so it leaves that task to the courts. And the courts have developed other principles for ordinary income resulting in the following categorization of income by principles:

 Must be derived;

 Must be convertible into money;

 Periodical and regular gains usually have the character of income

 Gains from the carrying on of a business have the character of income (Kenny,2008)

Next, the essay will consider these principles one by one:

Must be derived

Subsections 6-5(2) and (3) require that you include your ordinary income derived directly or indirectly during the income year. According to the fact of the question, it satisfies this principle clearly.

Must be convertible into money obviously

A cash payment of income will have a readily ascertainable income value. Also in this question, the people who attend Michael’s class directly pay him money, but not other type of payment.

Periodical and regular gains usually have the character of income

In the question, Michael received the money regularly, because he took the classes periodically. In the case- FCT v Dixon (1952) 86 CLR 540, a clerk enlisted for military service during World War II. His wartime pay was less than his pay from his form his former job and so his former employer paid him the amount of the difference. The periodic payments received by him during the income year totaled $104. The Commissioner assessed the payments as ordinary income. The full high court held that payments were income. The total amount received was income as it was periodical, expected and a substitute for wages. In the question, Michael received the money, which is very similar to that Dixon received it from his former employer, it is periodical, expected.

Gains from the carrying on of a business have the character of income

Carrying on a business is not defined, so the courts have developed a number of relevant characteristics for a business activity. In the case- Ferguson v FCT (1979) 9 ATR 873 the taxpayer was a member of the Australian Navy who wished to establish a primary production business after he retired. Before retirement, he leased five cows for a period of four years. He intended to breed these cattle by artificial insemination and established a herd of about 200 cows. In the years ended 30 June 1973 and 30 June 1974 expenses totaling $2370 and $1258 respectively were incurred by Ferguson, who sought to deduct these amounts against his salary. The natural increase over these years was two bulls and three heifers in 1974, for bulls in 1975 and two heifers in the eight month to 28 February 1977. Two bulls were sold in the year ended 30 June 1976 and four in the eight month to 28 February 1977. An overall loss was made on these transactions. The Full Federal Court held that taxpayer was carrying on a business through a manager and that expenditures were deductible. The Court said that a purpose of profit-making may be important, repetition and regularity were relevant and organisation along business lines was important. Other relevant factors were the volume if operation and the amount of capital were employed by the taxpayer. In the question, Michael’s behavior is similar to Ferguson’s. The reason is as follows:

1. Profit motive: In this question, the profit motive or profit-making intention is very clear. He charged the people who attended his classes $175. In objective, if he doesn’t have the profit-making intention, he should not charge the money.

2. Volume of operations-size or scale activity. He held ten classes a year for beginners and six classes a year for those wishing to learn how to photograph the night sky. It’s a heavy work for just one person to carry on that numbers of classes.

3. Organization of activities in business- like manner- keeping of records, use of a system- he held the class once every month for beginners over 2 days, and one every month over 2 evening, for 4 hours each evening, for those wishing to learn the technique of night sky photography. He already makes himself like a tutor, and makes his classes running regularly.

4. Time engaged in activities- once he starts his classes, first, he should spend some time to prepare the class, i.e. how to teach the “students”. Second, it takes him 4 hours for each class. That means during this 4 hours, he can’t do anything but just teach the “students”. Third, after class, he also needs to answer the questions from the “student”. In a word, it will cost him a lot of his spare time to hold a class.

5. Amount of capital used. To help in his lessons, Michael bought two new telescopes each worth $3000, and some other equipments, totally costs him $10300. That’s to say, besides the time he put into the class, he invest a lot of money on the class.

6. Profit is made from activities. Obviously, to charge the people who attend the class, this activity makes Michael can get profit. Although he must buy some equipment to start his class, but the money which he gets from the class is more than the money which he spent on the equipment. In total Michael received $16,800 in fees, but his expense is $11,300. And his investment is fixed, however as he continues his class, his profit will grow up.

To sum up, the 16800 is the receipts from carrying on the business, which belongs to the ordinary income. According to the ITAA 1997 6-5, the assessable income includes income according to ordinary concepts. Hence, the amount should be treated as assessable income.

In conclusion, the $3000 is from Michael’s hobby, and should not be ordinary income. But the $16800 is the receipt from the business, and it should be assessable income.

Part B

In the question, obviously, $6,000 received by Bill and Ben Reticulation Pty Ltd is one kind of payments for cancellation of business contracts. This is one kind of compensation or damages received by taxpayers during the ordinary course of a business. This category includes compensation or damages received by a business for some type of loss or injury to that business. The loss may be in the form of a reduction in profits, temporary cessation or reduction in business or damage to the asset structure of the business. (Coleman, 2008) But whether the $6,000 should be taxed, it depends on which kind of compensation it is.

Generally, the various types of payments can be classified into three types. First one is “Ordinary Trading Contracts”. Second type is “Contracts relating to the structure of a business”. The last one is “Contracts relating to business agencies”. (Kenny, 2008)

In this question, there is nothing to do with the agency, so the third type of compensation can be ignored firstly. So just consider the first two kinds, which is enough to answer this question.

The difference between “Ordinary trading contracts” and “Contracts relating to the structure of a business” is whether the compensation affects the structure of business. Next, it will discuss whether the receipt affects the structure of the company.

A mounts received for the cancellation of ordinary trading contracts are generally income. On the other hand, cancellation substantially affects the structure of a business and is not a normal incident of the business, it is generally a capital. In another word, compensation for a structure contract is generally a capital concept. If trading contract is cancelled, the compensation payment is treated as assessable income. So, determining whether the act relates to the structure of company is the key point to judge the nature of the compensation.

Go back to the question. In the scenario, there is no evidence to indicate the act of cancelling the contract affect the structure of the business. Firstly, the contract is only worth $15,000. For a company, $15,000 is not a big amount. The assets and capital of a reticulation company is far more than $15,000. Even if, there is no compensation, the company can also afford the loss of cancellation. Secondly, before Bill and Ben had done any work under the contract, Port Cricket Club decides to cancel the contract. In a word, so far, Bill and Ben has spend $0 on the contract. So, it is impossible that the cancellation of the contract affect the structure of company. Thirdly, even if Ben and Bill bought some new equipments and assets for the new contract, but it’s a reticulation company. Its capital assets are just like the tools or equipment to replace the drainage. After the contracts are cancelled it is still had there. It’s free to find the next customer. For example, the club will sell the sporting ground, but the sporting ground is still there, the drainage system still needs to be fixed. Ben and Bill have the tools and equipments to deal with it. They can make a new contract with the next owner. They were not put out of business by the cancellation of the club. Fourthly, in the question, it doesn’t show the main source of income for the Bill and Ben Company is dealing the business with the Club. So the California Oil Products Ltd v FCT case can’t be used in this situation. In that case, the cancellation of the agreements resulted in the taxpayer abandoning its only business. The payments were installments of a capital sum. But the situation of the Bill and Ben is totally different, they still have the power and opportunity to do business with other companies. And even the contract which made between the Bill & Ben and Club is not cancelled, the company can’t rely on this single contract. As it was said, the contract was only worth $15,000. In a word, the income from the contract was not the only source of the company. Fifthly, the question is very similar to Heavy Minerals Pty Ltd v FCT. In that case, the taxpayer was a rutile miner who entered into forward sales contracts with USA and German customers. However, the price of rutile collapsed. Accordingly, the contracts were cancelled and the taxpayer received $220,000. In the question, the Bill and Ben have the same situation as the Heavy Minerals Pty Ltd. The other party cancels the contract before they do and work under the contract. Then they received the compensation. In Heavy Minerals Pty Ltd case the High Court held that the amount which received by the taxpayer is income, not capital. It was not the cancellation of contracts that put the taxpayer out of business, but the collapse of rutile prices. The taxpayer still retained its capital assets, plant and the mine. Similarly, Bill and Ben can continue the business, and still hold its capital assets, plant and the equipment. Its capability to do the business is not changed evidently. Consequently, according to this case, the compensation received by Bill and Ben also should be treated as income.

To sum up, based on the situation of Bill and Ben and case- Heavy mineral Pty Ltd, the $6,000 received by Bill and Ben Reticulation Pty Ltd has nothing to do with the structure of company, and it’s just a compensation for cancellation of an ordinary trading contract. So it should be classified into income. As a general principle, a compensation receipt or damages award takes on the character of the item it replaces: FCT v Dixon (1952) 86 CLR 540. (Coleman, 2008) Consequently, where the indicia of ordinary income are present for the amount being replaced, and compensation received in lieu of that amount will itself be considered ordinary income and assessable under s 6-5 of ITAA- (1) your assessable income includes income according to ordinary concepts which is called ordinary income. (Coleman, 2008)

In conclusion, Bill and Ben need to pay the tax for $6,000 which was received from the Club because it is assessable income.


Reference

Coleman C, Hart G, Jogarajan S, Krever R, Mclaren J, Sadiq K, Principles of Taxation Law, 2008, Thomson Legal & Regulatory Limited

Deutsch L, Fundamental Tax Legislation, 2008, Professor R L Deutsch BEc, LLB (Hons) LLM (Cantab), Thomson Legal & Regulatory Limited

Kenny P, Concise Tax Legislation 2008, 2008, Butterworths

Kenny P, Australian Tax 2008, 2008, Butterworths

California Oil Products Ltd v FCT (1934) 52 CLR 28

FCT v Dixon (1952) 86 CLR 540

Heavy Minerals Pty Ltd v FCT (1966) 115 CLR 512

Tax Ruling 97/11