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Section 8-1 of the ITAA 1997

1.Microhard is a computer software company. Its principal product was a database programme called Xshell.

Microhard decided to expand its products to include a word processing programme that it released under the brand name ‘WurdPherfect’.

Soon after the release a competitor [Courelle] sued Microhard for breach of copyright, claiming the name was copied from Courelle’s software package. Microhard incurred $500,000 in legal fees and eventually settled the matter on payment of $4m damages.

Required:

Advise Microhard whether the outgoings are deductible.

2.Allan and Betty were living and working in Melbourne. They decided on a ‘tree change’, sold their Melbourne home and purchased a large country house on a 10 hectare block in central Victoria. Betty works part-time as an accountant and Allan as a locum doctor. Allan is popular with the elderly patients in the town and regularly is given home-made cakes and scones, along with his fee. On one occasion he treated a local wine maker’s dog for snake bite when the vet was unavailable and was given a dozen bottles of Lonarch Brae shiraz in appreciation. The wine had a retail value of $360.

Allan and Betty enjoy gardening. They plan to establish a few hectares of grape vines and begin growing vegetables. They attend a continuing education course on organic farming and find in their second year they have a surplus of produce. Betty started making marmalade and relish using her mother’s recipes. Initially she gave them to neighbours but they became so popular that she opened a stall at the Newtown Growers Market held on the second Sunday of every month. Allan sold some of the excess to a local supermarket and now regularly supplies three retailers with sweet potatoes and pumpkin. They don’t keep records as they never intended to make a profit but estimate that in a good month gross receipts could be $500 to $600.

Their neighbours have a citrus orchard and throughout the year vegetables are swapped for oranges and mandarins. This seems like such a good idea Allan and Betty decide to set up a ‘barter’ system in the area. To join the system a person must pay an up-front, one-off fee of $50 to Allan and Betty as a charge for the keeping of administrative records. Thereafter people register their goods or services to be bartered. For example, Suzie is a retired hairdresser and will provide hairdressing services at her home. No money changes hands. Suzie would receive a credit to her account of 15 to 20 ‘barts’ that she can exchange for goods or services of equal value from other registered participants in the scheme (fruit, vegetables, child minding, lawn mowing etc.).

Required:


(a) Advise Allan of any income tax consequences of para 1, above.
(b) Citing relevant case law, explain how a hobby is to be distinguished from a business.
(c) Advise Allan and Betty of any income tax implications in paras 2 and 3 above.
(d) Advise the participants in the barter scheme of any income tax implications. 
 

Section 8-1 of the ITAA 1997

1.The present case study is based on the ascertainment of whether the legal expenses that is reported by the taxpayer would be taken into account as the permissible deductions under “section 8-1 of the ITAA 1997”. Evidently, it is noticed that Microhard occurred a legal expenses relating to the claim of copyright bought forward by one of its competitor (Tan, Braithwaite and Reinhart 2016). Eventually the claim was settled by Microhard on making a payment of $4million and incurred legal fees of $500,000 in relation to the settlement of claim.

As stated under the section 8-1 of the ITAA 1997, for the spending to form a part of allowable deductions in the form of outgoing occurred in deriving or generating the taxable income, the expenses should be related and applicable to that end. The term “incurred in producing or generating the taxable income represents in the phase of generating and making the income (Cao et al. 2015). The application of the term has been stated in the decided case of “Amalgameted Zinc v F.C of T (1935)”.

As evident under “section 8-1 of the ITAA 1997” allows the individual taxpayer to claim for an allowable deduction relating to the losses and expenses up to the extent to which such spending is occured in generating and producing the taxable income (Braithwaite 2017). However, an exception to this rule is that a deduction is not allowable if the outgoings are in the nature of capital, private or domestic in nature or it is related to the derivation of exempted income.

Evidently, Microhard is not allowed to claim an allowable deductions relating to the legal expenses of $500,000 since the outgoings are capital in nature. There are several significant court decisions have been determined for an spending to qualify for the test of “section 8-1 of the ITAA 1997”. For an expense to qualify as the deductions, it should have the necessary character of an outgoing occurred in producing the taxable income or alternatively the income generating expenditure. According to the decision of the federal law court in the case of “Lunney & Hayley v. Federal Commissioner of Taxation (1958)” for an expenditure to qualify as the allowable deductions, there must be a nexus between the outgoing and the taxable income (Miller and Oats 2016). Additionally, the outgoing forms an incidental and relevant part in deriving the assessable income. 


The law court judgement in the event of “Federal Commissioner of Taxation v Cooper (1991)” it is necessary to determine the association between the specific outgoing and the operations through which the taxpayer derives the taxable income. Similarly, in the current case of Microhard the expenditure incurred by the taxpayer is capital in nature and was not in respect of gaining the taxable income. The law court judgement in the event of “Herald and Weekly Times Ltd v. F.C of T (1932)” The legal expenditure is generally considered for deductions given they originate from the day to day activities of the tax payers business (Saad 2014).

Allowable Deductions and Taxable Income

Similarly, in the case of “F.C of T v Day (2008)” the court of law has acknowledged that the lawful expenditure that is occurred in defending the manner in which the taxpayer executed his employment duties will be considered as allowable deductions (Jones 2017). Furthermore, there was no such significance was emphasised by the court relating to the status of the taxpayers as the employee. The taxpayer in the above stated case has occurred the legal expenditure in shielding themselves against the criticism relating to the taxpayer’s work practices. The evidences that has been obtained reflects that in executing the actions that have resulted to such criticism. The taxpayer was executing not more than the employment activity and as a result of this the legal expenditure will be considered as the permissible deductions.

Similarly, in the case of Microhard, the taxpayer would be denied an allowable deduction since the legal expenditure that is occurred by the taxpayer was for claim of copyright and against the criticism of taxpayer’s work practices. The evidences obtained reflect that in executing the business activities the taxpayer faced the criticism of copyright. The taxpayer has eventually copied its competitor and was at fault that eventually led to the claim of copyright. Consequently, the legal expenditure that is occurred by the taxpayer would be considered as non-allowable deduction.   

An instance was bought forward in the case of “Ronpibon Tin NL & Tongkah Compound NL v F.C of T (1949)” where the legal expenses occurred by the taxpayer in defending the charge of victimization will not be considered as permissable deduction under “section 8-1 of the ITAA 1997”. This is because they were not occurred in generating the taxable income (Barkoczy 2014). Most importantly, in ascertaining whether the legal expenditure will be considered for allowable deduction under “section 8-1 of the ITAA 1997”, the nature of the expenditure should be considered.

Citing the reference of the federal court in the case of “Hailstorms Pty Ltd v. F.C of Taxation (1946)” the nature relating to the character of the legal expenditure monitors the benefit that is pursued to be gained in sustaining the expenditure (Blackstone and Cooley 2013). Legal expenditure is generally considered to be an allowable deduction given they originate from the day to day to activities of the taxpayer’s business. Therefore, the legal action possesses more peripheral association to the income generating activities of the taxpayer.

The taxpayer has undertaken the defamation action against the comments which were made with respect to the trust fund. Additionally, the expenditure that were not considered to be incidental in the proper execution of the office trustee but was instead occurred in maintaining the personal reputation of the taxpayer. Similarly, in the present case of Microhard the expenditure that was occurred was to gain the advantage over its competitor. The occurrence of legal fees incurred by the taxpayer will not be considered as the allowable deductions under “Section 8-1 of the ITAA 1997”.  

Court Rulings on Allowable Deductions


2.aAccording to “section 6-5 of the ITAA 1936” income that is derived from personal exertion represents the income that includes, salaries, wages, commissions, fees, bonus, retirement gratuities, allowances and gratuities that is received by in respect to the employee capacity or for any services rendered. According to the judicial perception in the case of “Federal Commissioner) of Taxation v Scott (1935),” the term income represents the receipts that are determined in respect with the ordinary concepts and practises of humankind (Cerioni 2015).

The following case study of Alan deals with the ascertainment of consequences of tax originating from the receipt of wine by Alan from one of his clients. Instances obtained from the study suggest that Alan is a practicing locum doctor and his wife Betty was an accountant and worked as the part time accountant. Alan in his town was well recognized among his elderly patients and on regular occasions received homemade cakes and scones along with the fees that was charged by him.

In accordance with the “section 6-5 of the ITAA 1936” income derived from fees by Alan constitutes income from personal exertion, which is in relation to the service rendered among his elderly patients (Coleman and Sadiq 2013). The receipt of fees have the character of income and would be considered assessable since Alan receives it in relation to the services of locum doctor rendered by Alan. However, the homemade cakes and scones that is received by Alan does not have any commercial or realisable value and these items would be included not be included in his assessable income.

Later on, evidences obtained from the case study lay down that Alan, on one occasion received a wine bottle from his client for treating a local wine maker’s dog from a snakebite. The wine bottle received by Alan carried a commercial value of $360. An item having an income character derived by the taxpayer would constitute an income for its realisable worth. To have the character of income the item should constitute as a gain by the taxpayer who derives it. As held by federal court in the case of “Hochstrasser v Mayes (1960)” for an item to qualify as income it should be beneficially gain for the taxpayer deriving the item (Gilders et al. 2014). On the other hand, as held in “Calvert v Wainwright (1947)” tips that is received by taxi driver is held as an income. Similarly, the receipt of wine bottle by Alan having a commercial value of $360 would be regarded as income and will be included in his taxable income.   

The Nature of Legal Expenditure


b.The “Taxation Ruling of TR 97/11” is associated with an individual carrying on the activities of primary producer. The ruling is helpful in the determination of whether the activities of the taxpayer constitute the business of primary producer or simply a hobby that is undertake for recreational purpose. The ruling serves as the guide in reflecting the indicators that are relevant in determining whether an individual is carrying on the business of primary production (Lasser 2014). The “Taxation ruling of TR 97/11” is applicable on the person that are carrying on the activities, which may be classified as primary production. “Subsection 6 (1) of the ITAA 1936” defines primary production as the production that is originating directly from the cultivation of land. The below stated discussion distinguishes between hobby and business. The illustration provides the summary of the primary reflectors of carrying on of the business and hobby.

  1. A business is generally considered to be having a significant commercial character or activity while hobby does not contain a significant commercial activity.
  2. Indicators suggest that a business is carried on with the purpose and intention of the taxpayer for engaging in the activity. Hobby on the other hand, lacks any purpose or intention of the taxpayer to execute the business activity.
  3. A business generally intends to make profit from the activity while hobby has no such intention of making profit from the activity.
  4. A business generally carries repetitive and regularity in character while hobby has little repetition or regularity of doings (Kenny 2013).
  5. A business is usually involves commercial selling of goods and services while in hobby sale of products occurs among relatives and friends.

The law court in the case of “Federal commissioner of Taxation v Evans (1989)” has stressed by stating that no one indicator can be considered decisive and there is regularly a substantial intersection of these indicators (Morgan, Mortimer and Pinto 2013). The law court has held that an intention of generating profit will regularly encourage an individual to execute the activity in a systematic and organized manner. This is because the cost could be lowered and production and price that is derived from the produce can be augmented.

The above stated indicators should be considered as the whole and in combination. Whether an individual is carrying on the business is depended on the big or over-all impression gained. There isn’t any fast or hard rules available for determining whether the activities of taxpayers amounts to performing the business of primary production. The intention of the taxpayer and the nature of the activity along with the method of operations assist in ascertaining whether the activity amounts to business of primary production or an act of hobby.

c.According to “section 6 of the ITAA 1936” the character of an activity especially whether the activity intends to make profit is considered to be a noteworthy factor. Nevertheless, an instant intention of making profit during the particular income or accounting year is not held as an important factor (Pinto, Kendall and Sadiq 2014). Inevitability, an assertion can be bought forward by stating that the person is carrying on the activities of business irrespective of the fact whether the profit derived by the person is big or small or where the individual is making loss. Most importantly, the repetition and regularity of the activities is regarded as an important character.

The Alan Case: Assessable Income and Taxation

As evident in the current case study of Alan and Betty, it is noticed that Betty undertakes the decision of planning few hectares of grape vines and commences growing of vegetables. They underwent an organic farming educational course and in their second year of cultivation, they witness a surplus produce. Betty began making marmalade from her mother’s recipe and gave them to her neighbours. The marmalades soon became very famous among here neighbours and Betty opened a stall which set up on every Sunday with excess produce was sold by Alan to local supplier which yielded them with an estimated profit of $500 to $600. 


Stressing on the above stated instances it can be stated that the activities of Alan and Betty was having the business character and contained a repetitive nature. Gauging into the decision of law court in the event of “Federal Commissioner of Taxation v Martin (1953)” and observing the situation of Alan and Betty it can be stressed that their activity contained a commercial flavour (Prince 2014). The taxpayer Alan and Betty does not derives all their income from the activities of primary production. Both Alan and Betty are employed in other occupations and profession. What is important is that both Alan and Betty activities of primary production amounts to carrying on of the business. Conclusively, their estimated profit of $500 to $600 will be having income tax implications.         

d.The “Taxation Ruling of IT 2668” is associated with the income tax consequences of barter and countertrade transactions. “Subsection 25-(1) of the ITAA 1936” states that the income earned by the taxpayer other than the exempted income would be liable for tax and the same will be included in the taxable income of the taxpayer (Woellner 2013). The amount to which the considerations that is received by the taxpayer from the barter or exchange transaction either in cash, credit or in kind constitutes a taxable income under the “subsection 25(1)” based on the nature on which the considerations is received in the hands of receiver.

As evident both Alan and Betty have set up a barter system. The amount to which the considerations that is received by Alan and Betty either in cash or credit constitutes a taxable income under the “subsection 25(1)”. Citing the law court verdict in the event of “Cooke & Sherden v Federal Commissioner of Taxation (1980)” considerations from the barter system received by Alan and Betty as money would be assessable under section 25-(1) and will also attract GST under the GSTR 1999 (Woellner et al. 2014). Most importantly, the setting up of barter system by Alan and Betty along with the considerations received is treated equal to cash and credit transaction. Consequently, the receipt of considerations would be liable for taxation. 

Reference List: 

Barkoczy, S. 2014. Foundations of taxation law.

Blackstone, W. and Cooley, T. 2013. Commentaries on the laws of England. Clark, N.J.: Lawbook Exchange.

Braithwaite, V. ed., 2017. Taxing democracy: Understanding tax avoidance and evasion. Routledge.

Cao, L., Hosking, A., Kouparitsas, M., Mullaly, D., Rimmer, X., Shi, Q., Stark, W. and Wende, S., 2015. Understanding the economy-wide efficiency and incidence of major Australian taxes. Canberra: Treasury working paper, 2001.

Cerioni, L. 2015. European Union and direct taxation. London: Routledge.

Coleman, C. and Sadiq, K. (n.d.). Principles of taxation law 2013.

Gilders, F., Taylor, C., Walpole, M., Burton, M. and Ciro, T. (n.d.). Understanding taxation law 2014.

J.K. Lasser's your income tax. 2013. Hoboken: Wiley.

Jones, D., 2017. Tax and accounting income-Worlds apart?. Taxation in Australia, 52(1), p.14.

Kenny, P. 2013. Australian tax 2013. Chatswood, N.S.W.: LexisNexis Butterworths.

Miller, A. and Oats, L., 2016. Principles of international taxation. Bloomsbury Publishing.

Morgan, A., Mortimer, C. and Pinto, D. 2013. A practical introduction to Australian taxation law. North Ryde [N.S.W.]: CCH Australia.

Pinto, D., Kendall, K. and Sadiq, K. 2014. Fundamental tax legislation 2014. Pyrmont, NSW: Thomson Reuters.

Prince, J. 2014. Tax for Australians for dummies.

Saad, N., 2014. Tax knowledge, tax complexity and tax compliance: Taxpayers’ view. Procedia-Social and Behavioral Sciences, 109, pp.1069-1075.

Tan, L.M., Braithwaite, V. and Reinhart, M., 2016. Why do small business taxpayers stay with their practitioners? Trust, competence and aggressive advice. International Small Business Journal, 34(3), pp.329-344.

Woellner, R. 2013. Australian taxation law 2012. North Ryde [N.S.W.]: CCH Australia.

Woellner, R., Barkoczy, S., Murphy, S., Evans, C. and Pinto, D. 2014. Australian taxation law 2014

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