Taxation - Income From Personal Exertion And Assessable Income

Question 1 (Hilary- Income From Personal Exertion)

Hilary is a well-known mountain climber and she has been offered by Daily Terror newspaper an amount of $ 10,000 for writing a life story. She writes a story without taking assistance from a ghost writer and assigns all her rights, interest and title to Daily Terror in the copyright for $ 10,000. She had never written any story before this. She also had send a manuscript to Mitchell Library $ 5,000 and her mountain climbing photographs for $ 2,000

• Whether the three payments are categorized as Income from personal Exertion
• If the story was written for personal satisfaction and later on sold, then also the income from sale proceeds would be income from personal exertion or not?

Definitions of Income Tax Assessment Act 1936- Sec 6

As per the definition provided by ITAA 1936, “income from personal exertion or income derived from personal exertion" means income consisting of earnings, salaries, wages, commissions, fees, bonuses, pensions, superannuation allowances, retiring allowances and retiring gratuities, allowances and gratuities received in the capacity of employee or in relation to any services rendered, the proceeds of any business carried on by the taxpayer either alone or as a partner with any other person, any amount received as a bounty or subsidy in carrying on a business, any amount that is included in the assessable income of the taxpayer by reason of section 393-10 of the Income Tax Assessment Act 1997 , the income from any property where that income forms part of the emoluments of any office or employment of profit held by the taxpayer, and any profit arising from the sale by the taxpayer of any property acquired by the taxpayer for the purpose of profit-making by sale or from the carrying on or carrying out of any profit-making undertaking or scheme, but does not include:

1. Interest, unless the taxpayer's principal business consists of the lending of money, or unless the interest is received in respect of a debt due to the taxpayer for goods supplied or services rendered by the taxpayer in the course of the taxpayer's business; or
2. Rents, dividends or non-share dividends.”

(Source: https://www.austlii.edu.au/au/legis/cth/consol_act/itaa1936240/s6.html)

• Section 84.5 of the Income Tax Assessment Act 1997 provides the meaning of personal service Income. The section provides that both ordinary or statutory income can be a personal service income if the same is received as a reward in lieu of  efforts and skills
• Section 85.30 of the Income Tax Assessment Act 1997 states that any amount, payment or contribution will not be a personal service income when the same involves business of personal services.
• Brent v FCT (1971) 125 CLR 418, at p 429
• Brent v FCT (1971) 125 CLR 418, at p 430. This was cited from Commissioner of Taxes (S.A.) v. Executor, Trustee and Agency Co. of South Australia Ltd. (Carden's Case) (1938) 63 C.L.R.108, at pp. 152-154.
• Taxation Ruling No. IT 2639, Income Tax: Personal Service Income

On the basis of the above provisions of tax, the income from personal exertion is the one which an individual earns  in the form of reward for one’s personal efforts. Such efforts involve providing services, exercising skills and applying labour. Few examples of income from personal exertion includes, salaries and wages, professional income, income under a contract, and any income of a professional entertainer or sportsperson from exercise of any particular skill. Let us take each any every case separately:

In Brent case a life story was written by a wife of a train robber and sold the same for exclusive publication for $ 65,250. In the year 1970, she received an amount of $ 10,000 and the remaining was paid in later years on signing of the manuscripts. As per the court, she was held to have derived assessable income of $ 62,250. It was concluded that the income so derived is income from personal services as no commercial practice involved and hence, the income will be recognised in the years of receipt. The first payment is received by Hilary for writing a story. The Daily Newspaper had offered her $ 10,000 for the same. Hilary has written the complete story without any assistance and transferred the copyright to Daily Terror Newspaper. So on the basis of the case and the and provisions involved, it can be said that the income derived of $ 10,000 is an income from personal exertion as the service involved were Hilary’s own skills and labour and there was no intention of personal service business.

• Selling Manuscripts and photographs to Mitchell Library:

Question 2 (Short-term Housing Loan - Assessable Income)

In context to section 85.30, the selling of the manuscripts and photographs involves commercial practice and will be considered as a business income and not income from personal exertion. Hence, the income of $ 7,000 is business income.

• Story written for own satisfaction and further sold:

Initially, when the story was written, Hilary had no intention of selling the same. However, later on she decided to sell the same and earn money through the same. This involves commercial practice and will be regarded as personal service business. As per section 85.30 of the Income Tax Assessment Act, the income so derived is an exception to income from personal exertion and hence, it will be treated as  a business income.

Conclusion:

Hence, $ 10,000 from Daily Terror is treated as  income from personal exertion, while $ 7,000 is business income. However, if Hilary had written the story for her own satisfaction and later made the sale of the same, the would not have an income from personal exertion rather would be a business income, as at the time of writing the story there was no contract or was prepared out of her own personal interest not for providing any personal services.

References:

Definition of Income Tax Assessment Act,1936 (Section 6), “Income from personal exertion or income derived from personal exertion”; Available at:

https://www.austlii.edu.au/au/legis/cth/consol_act/itaa1936240/s6.html

Ranjana Gupta, 2009, “Receipts from Personal Exertion: Mere gifts or gross income”; Available at:

 https://aut.researchgateway.ac.nz/bitstream/handle/10292/735/GuptaR.pdf?sequence=5

Tom Delany, 2012, “Personal Services Income: Where to from here?”; Available at:

https://epublications.bond.edu.au/cgi/viewcontent.cgi?article=1220&context=rlj

Section 84.5 of ITAA 1997, Available at: https://www.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s84.5.html

Section 85.30 of ITAA Act, Available at: https://www.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s85.30.html

In the given case, a loan was made to son of $ 40,000 to provide for short-term housing loan. As per the agreement, as amount of $ 50,000 was receivable from son at the end of five years. There did not exist any formal agreement and was made without any security. The assessee said that, she told her son to not to pay interest on the sum lent. Though, the son paid full amount after two years inclusive of interest payment of 5% p.a. on the amount borrowed.

Effect on assessable income of the parent, whether the interest will form part of assessable income?

• Subsection 995-1(1) of the Income Tax Assessment Act 1997
• Section 6.5: Income According to the Ordinary concepts (Ordinary income) of the Income Tax Assessment Act 1997
• Section 6.10: Other Assessable Income (Statutory Income) of the Income Tax Assessment Act, 1997
• Section 6.15: What is not Assessable Income, of the Income Tax Assessment Act, 1997

As per the definition of Assessable income, assessable income includes interest income but does not include principal repayments on loans made. In the given case, a loan of $ 40,000 has been provided by a mother to his son as a short-term housing loan.

In the given case, there is no formal agreement but the son has taken the loan and paid interest of $ 4000 ($ 40000 x 5% x 2 years) at the time of repayment of loan. As per the provisions of the sections referred above, the loan repayment of principle amount is not included in the assessable income of the mother but in case any interest received, will form part of assessable income of the parent. No legal agreement or mother’s claim of telling the son to not to pay interest will not be considered as interest has been paid by the son and the loan is not an interest-free. So it will be taxable.

Conclusion

The interest part of $ 4,000 will be included in the assessable income of mother.

Reference:

Virginia Wallis, 2013, “Does a property loan to my son attract tax?”; Available at:

https://www.theguardian.com/money/2013/may/01/property-loan-son-attract-tax

Division 6 of the ITAA 1997, “Assessable Income and Exempt Income”

Australian Taxation Office, 2015, “What to include in your assessable income Available at:

https://www.ato.gov.au/Business/Income-and-deductions-for-business/Working-out-your-assessable-income/What-to-include-in-your-assessable-income/

Scott an accountant has purchased a vacant block of land in Brisbane on October 1, 1980. On September 1, 1986 he had built a house on that land. The land valued at $ 90,000 and construction cost involved was of $ 60,000. The property was sold at an Auction for $ 800,000.

• Calculation of net capital gain or loss for the year ended 30 June of the current tax year
• Capital gain on property sold for a consideration lower than the fair value or market price
• Capital Gain calculation consequences in case the owner of the property was a company and not an individual

• Division 100 – A guide to Capital Gains and losses of the ITAA 1997
• Section 115.25: Discount Capital Gain must be on asset acquired at least 12 months before of the Income Tax Assessment Act, 1997
• Section 960.275: Indexation Factor of the Income Tax Assessment Act 1997

Part a)

As per the provisions for calculation of Capital Gain or loss, for CGT assets acquired before 21 September 1999, the assessee can choose any of the following methods whichever is more saving:

Indexation Method: Using the indexation method, the capital gain has been calculated as under:

Particulars	Amount
Sale Proceeds	800,000
Less:
Cost of Land	90,000
Cost of Construction	60,000
Total Cost	150,000
Indexation Factor	2.488
Indexed Cost	373264
Taxable Capital Gain	426736

 Indexation factor = ______CPI for Quarter ending 30 June_________

CPI for quarter in which expenditure was incurred

= 107.5 / 43.2

= 2.488

1. Discount Method: Using the discount method, the capital gain tax can be calculated as under:

Particulars	Amount
Sale Proceeds	800,000
Less:
Cost of Land	90,000
Cost of Construction	60,000
Total Cost	150,000
Capital Gain	650000
Reduction in capital gain (50%)	325000
Taxable Capital Gain	325000

Hence, it is more beneficial for Scott to use Discount Method for capital gain calculation as it will lead to lower capital gain tax liability.

As per the provisions of Capital Gain Tax, if a property is sold to a family member at a price lower than the market value or fair value, the capital proceeds will be assumed to be the market value and accordingly the capital gain will be calculated. Hence, in this case, even if Scott has sold the property to daughter for $ 200,000, the capital proceeds will be $ 800,000 only and the capital gain on the transaction will be $ 325000 as calculated above using the discount method.

Yes, it would make a difference as company claims depreciation on the property owned. For calculation of capital gain the written down value of the property after depreciation will be the cost basis and accordingly capital gain will be calculated.

Conclusion

Capital Gain on sale of property by Scott = $ 325,000 in part 1 and 2. Capital gain calculation will be different if the sale is made by a company instead of an individual.

References:

Australian Taxation Office, 2015, “Capital Gains Tax”; Available at: https://www.ato.gov.au/General/Capital-gains-tax/

Australian Taxation Office, 2015, “Capital Gains Tax: Selling your rental property”; Available at:

https://www.ato.gov.au/General/Capital-gains-tax/Your-home-and-other-real-estate/Selling-your-rental-property/

Australian Taxation Office, 2015, “Capital Gains Tax: Transferring real estate to family and friends”; Available at:

https://www.ato.gov.au/General/Capital-gains-tax/In-detail/Real-estate/Transferring-real-estate-to-family-or-friends/?page=3

Division 100 – A guide to Capital Gains and losses of the ITAA 1997; Available at:

https://www.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/

Section 115.25: Discount Capital Gain must be on asset acquired at least 12 months before of the Income Tax Assessment Act, 1997;

Available at: https://www.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s115.25.html

Section 960.275: Indexation Factor of the Income Tax Assessment Act 1997; Available at:

https://www.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s115.25.html

Australian Taxation Office, 2015, “Working out your Capital Gain”; Available at:

https://www.ato.gov.au/General/capital-gains-tax/working-out-your-capital-gain-or-loss/working-out-your-capital-gain/

Australian Taxation Office, 2015, “The indexation method of calculating your capital gain”; Available

at:https://www.ato.gov.au/Individuals/Ind/The-indexation-method-of-calculating-your-capital-gain/

Australian Taxation Office, 2015, “The discount method of calculating your capital gain”; Available

at:https://www.ato.gov.au/General/Capital-gains-tax/In-detail/Calculating-a-capital-gain-or-loss/The-discount-method-of-calculating-your-capital-gain/