Assessability of Income - Essay Example

Running header: Assessability of income Assessability of income Author’s Name Institutional Affiliation Date of submission Introduction Every year, Megan is involved in a number of activities that generate money for her with the major portion being the money derived from her mining activities. Her mining activities are mostly carried on outside Australia during a given year given that she spends nearly 8 months outside Australia. She has also received an amount of $75,000 for her not to work for any other mining company. She has also derived some money from designing a mining equipment which she sells together with the copyright thereof. She also carries out some freelance activities and other activities not related to mining that she considers hobby. In addition, she received Christmas gifts that are of substantial amounts. The differing kinds of receipts that Megan receives raise an issue of whether they are all assessable for tax purposes in Australia or not. The assessability or not of her earnings in Australia will depend on a number of factors including whether the money derived from her activities amount to income or not. We also need to consider whether she is an Australian resident for tax purposes given the amount of time she spends outside Australia. As such, this paper is aimed at advising Megan on the assessability or non-assessability of the income she earns from the various activities she involved in during the year. Below is a detailed explanation of the various issues raised regarding her various income generating activities. To determine whether the $180,000 salary Megan earns from her employment by the Australian mining company is assessable, the issue to be determined is whether she is an Australian resident for tax purposes. It is worth noting that she spends almost eight months outside Australia in earning this salary. However, it is also worth noting that she also sacrifices $20,000 salary to superannuation. The ruling in IT 2650 provides four tests of tax residency1. These tests include the residence according to ordinary concepts test in which we consider whether the amount of time she spends in Australia is reasonable enough for her to be considered an Australian resident for tax purposes. Given that she spends most of her time outside Australia during the year, the time spent in Australia is not a considerable amount of time for her to be considered an Australian resident. Another test of residency is the domicile test. Though no information is availed regarding her domicile, it can be assumed that Megan’s domicile is in Australia given that most of her activities are carried out in Australia with the exception of her employment which partly happens outside Australia. In other words, based on her conduct, it cannot be concluded that she has a permanent place of abode outside Australia as was held in FCT v Applegate2. Thus based on the domicile test, it can be concluded that Megan is an Australian resident for tax purposes. Megan does not fulfil the 183 day test given that she spends more than a half of the income year outside Australia. However, it is to be noted that Megan sacrifices $20,000 of her income for a superannuation fund. Under superannuation test, one is recorded an Australian resident for tax purposes if they are a member of a commonwealth superannuation fund. Thus, in this regard, Megan will be considered an Australian resident for tax purposes. In TR 98/17, it was held that if one satisfies one of the four tests outlined above, then he/she will be considered an Australian resident for tax purposes3. In this regard therefore, the $180,000 she receives from her employment by the Australian mining company will be assessable for tax purposes in Australia although she spends almost eight months outside Australia. However, the $20,000 salary sacrifice to a superannuation fund is an allowable deduction. Another issue to be determined is whether the $75,000 one off payment is of income nature and hence assessable income or of capital nature and hence not assessable income. In this regard, this payment is aimed at compensating Megan for the salary she would have earned if she is to perform mining services for another mining company next year. In other words, it does not affected his ability to perform mining services but it has been restricted. In this regard therefore, it can be concluded that the compensation replaces salary and not capital. In FCT v Dixon, it was held that such a compensation should take on the character of what it is meant to replace4. Further, s6-5 of income tax assessment act states that when the characteristics of ordinary income are evident for the amount that is being replaced, then the compensation ought to be considered ordinary income5. It does not matter whether the compensation is a one off payment or periodic payments. In this regard therefore, the $75,000 should be considered part of Megan’s assessable income since it replaces the salary or the income she would have made had she continued to offer mining services to other companies. Another issue to be considered is whether the freelance services she offers to other companies can be considered business and hence assessable or otherwise and hence non-assessable. In this regard, the freelance mining activities can be considered business for Megan since she regularly does them whenever approached and has already acquired an ABN for this purpose and she has received tax invoices. Furthermore, the $121,000 she earned from the freelance activities is substantial and consistent with amounts earned in the industry. It is obvious that she engages in the freelance mining activities to enhance her income and hence for profit purposes. As such, the freelance mining activities should be considered business and hence add up to her assessable income. Anther issue that arises is whether the Christmas gifts of $5,000 cash and the cash of vintage champagne valued at $1,800 are mere gifts and hence un-assessable or fridge benefits or income and hence assessable. In MT 2042, it was held that relatively expensive Christmas gifts such as the champagne would be subject to fridge benefits tax with section 58P of the fridge benefits tax assessment act providing exemption for minor benefits which are infrequently provided6. The limit is set at $300. Based on Laidler v Perry (1965), unexpected or voluntary payments received as incidence of employment contribute to ordinary income7. Hence, the $5,000 is ordinary income and hence assessable since it is voluntary unexpected payment. On the other hand, the $1,800 would be considered fridge benefit and hence assessable attracting fridge benefit tax since it is greater than $300. Another issue to be determined is whether the $220,000 earned from selling the design of the new equipment together with all the rights to the equipment including its intellectual property is ordinary income and hence assessable or capital and hence not assessable income. Income is characterized by regular receipts as held in FCT v Blake (1984) with one of receipts not considered as ordinary income as held in FCT v Harris8. Income also has to fulfill the flow concept as is the case of fruit and tree as held in Eisner v MA comber9. This means income must be connected with its earning source and it must also be extractable without affecting future earnings. In this case, the $220,000 is a one-off payment. The fact that all the rights including intellectual property are sold together with the machine means that her ability to earn from the machine in future has been affected since she cannot design or sell similar machines in future. Thus, the $220,000 should not be considered income but rather capital and hence not assessable income. The final issue of determination is whether her landscape painting activities are a hobby or a business and hence the income therefrom is assessable or not. It is to be noted that landscape painting is something she enjoys and hence the prizes are not chance winnings but something that is regular. Furthermore, she expends a degree of skill in her paintings and hence this is more of personal exertion than luck as held in Kelly v FCT10. She has also put some effort in taking her paintings to the exhibition. The fact that she did not earn this from her employer does not make the prizes luck or hobby. Furthermore, she has earned a substantial amount of money from the paintings. Thus, the characteristics of her painting activities imply that the money earned should be treated as income and hence added to her assessable income. Conclusion This paper has used various legislations and case laws in analyzing the various activities Megan is engaged in with an aim of establishing their assessability or non-assessability for tax purposes. Various issues have been determined based on the relevant laws and hence various conclusions have been made. The issues of determination included factors that determine tax residency of an individual. The essay has also sought to differentiate mere gifts from income and fridge benefits and whether payments arising from restrictive covenants should be considered income. The essay also sought to establish whether freelance activities should be considered hobby or a business. Another issue of determination was whether money obtained from selling the equipment design together with the rights thereof regards to capital or income. Finally, the essay sought to know whether prizes arising from activities that require skills can be considered as income from business or from a hobby. Arising from the discussion above therefore, the essay concludes that all of the income generating activities that Megan was involved in are taxable with the exception of the sale of the mining equipment design together with the rights thereof for $220,000 which was considered un-assessable since this transaction involved sale of capital and hence it should be established whether a capital gain has been made and the relevant capital gains tax paid. Read More