BULAW 5916 Taxation Law and Practice Assignment Sample
The taxpayer, Components R Us Pty. Ltd., manufactures and sells car components. In 2016 it entered into a ten-year market sharing contract with XYZ, a company in China, whereby Components R Us agreed not to distribute its products in China and XYZ agreed not to distribute its products in Australia.
In January 2021 XYZ Ltd. paid Components R Us $20 million to terminate the 2016 contract. In return for receiving the $20 million, Components R Us agreed to give up its exclusive distribution rights in Australia. The $20 million was based on the estimation of the profit that Components R Us thought it would lose by allowing XYZ to compete with it in the Australian market.
Advise Components R Us as to whether the amount it has received as compensation constitutes assessable income. Refer to case law and statutory provisions in your answer. 15 marks
Hardeep is a professional basketball player. On 1 January 2021, he entered into an eight year contract to play basketball for the Adelaide All Stars. Under the contract, Hardeep agrees to play in all of the club’s matches, provided that the coach selects him and he is fit to play. After signing the contract the All Stars pay Hardeep $300,000. The All Stars also agree to pay Hardeep $4,000 each month for his living costs. There is no requirement for Hardeep to repay any of the $300,000 if he fails to play because he is not selected or he is not fit to play.
Advise Hardeep whether he has to include the full amount of the contract monies received in advance in his assessable income for the 2020/2021 income year. Refer to case law, statutory provisions and tax rulings in your answer. 15 marks
Criteria Used to Grade This Assessment
In marking your assignment, your lecturer will place emphasis on whether you have demonstrated an ability to:
• Identify and appropriately explain the range of tax issues connected with the fact scenarios posed in the questions
• Apply case law, legislation, and tax rulings (where appropriate) to the fact scenarios posed in the questions
• Communicate in clear written English
• Format your assignment appropriately
The prevailing case analysis reflects about the issue based on the concept of assessable income. It is required to determine whether or not compensation receipt received by the business for breach of contract would form part of assessable income of assesse.
As per section 6-1 of the ITAA 1997, assessable income is computed by considering ordinary income and statuary income (Awasthi & Engelschalk, 2018). There are mainly two prerequisites of income such as profit must be either is in cash or eligible for converted into cash, and there should be real gain that is also explained in the case of Hochstrasser v Mayes. In the legal case, Federal Coke Co Pty Ltd v FCT, it was contended by the court that, amount that could not be covered into cash by assesse, is not considered as income from ordinary sources.
In the case of compensation receipt, whether or not it is included in the assessable income would be based on the nature of compensation (Abramowicz & Blair-Stanek, 2019). In the context of payment received or compensation obtained due to cancellation of trading contracts it is treated as income and included in assessable income. If there is a breach of any ordinary trading contract, loss of predicted profits, or contract for the sale of goods, then in such case, compensation receipts are considered as ordinary income and therefore included in the assessable income of the person (Hasseldine & Fatemi, 2019). In case of, Heavy Minerals Pty Ltd v FCof T (1966), taxpayer has formed forward contract for sale of goods to its consumers, but because of collapse of market, consumers want to breach this contract. In this, consumer has provided some sum to taxpayer for agreeing to cancel contract and court treated this compensation as income of taxpayer. However, if breach of contract creates impact on fundamental structure of business, then in such case, compensation receipt are considered as capital in nature and same would not be included in the assessable income (Ford & Dibden, 2019). An example of this can be observed in the case of California Oil Products Ltd v FCT, termination of contract assists towards cessation of business, and therefore it is in capital nature. However, if cancelled contract is connectively minor element of the wider business of taxpayer, then compensation is considered as a substitution of income as explained in case of Kelsall Parsons & Co v IRC. Moreover, compensation received would be considered as capital nature if there is cancellation of structural contract, which is an integral element of running business activities of taxpayer as seen in case of Glenboig Union Fireclay & Co Ltd v IRC (Barkoczy, 2018).
In the legal case, Burmah Steamship Co v IRC, it was held by the court that, payment for the losses of capital assets are normally capital in nature and therefore it does not fall in ordinary income. It should be noted that, if the amount of compensation receipt received by assesse replaces the capital assets then it is considered as capital assets. Conversely, if the amount received by assesse leads towards replacement of income then it falls in assessable income (Compensation: CGT and the Replacement principle, 2021). The same aspect has been applied by the court in the legal case, FCT v Dixon; it was held that, compensation receipt takes on the nature of item that is replaced by it.
Apart from this, undissected lump sum amount consists of compensation received for loss of income and loss of capital assets. Where assesse received payment with respect to unliquidated damages, then in such case, courts are averse to apportion receipt into income and capital, and therefore whole sum is considered as capital receipt (Sadiq et al., 2020). In the legal case, Mc Laurin v FCT, property of assesse has been damaged because of fire and compensation has been received for damages. In the cited case, it was held by the court that, not any part of income was considered as ordinary income. Payment has been made for claiming of unliquidated damages and it is accepted by person under compromise, and therefore it is considered as single undissected amount (Taxation Ruling, 2021).
By considering the given case scenario, it has been noticed that the compensation received by R Us of $20 million from the XYZ Ltd. This compensation has been received because of breach of contract as earlier both entities has been entered into contract for non-distribution of their goods in particular area. By this contract, R Us agreed not to sale its goods in China, and XYZ agrees not to sale its goods in Australia. However, by making payment of $20 million, XYZ limited has terminated contract and can sale goods in Australia. By applying the judgment given in the case of FCT v Dixon, compensation receipts treated as an item that is replaced by it. Since, in the given case, compensation is mainly for the loss of business profit of the R Us company and therefore such amount replaces its ordinary income. Further, by application of provisions of undissected lump sum receipts, it can be said that, compensation received by R Us is only for loss of income and not comprised with loss of capital assets. Therefore, $20million is not considered as undissected lump sum receipt, and therefore this amount is not considered as capital nature receipt of assesse. It has been given that; amount of compensation was based on anticipated loss of business profit of R Us, and does not create impact on fundamental business structure of an entity. All these aspects suggest that, $20 million replaces what will have been profit, and therefore it would be assessable as income.
On the basis of the afore-mentioned analysis, it can be concluded that, $20million received by R Us from XYZ Company would be included in the assessable income of taxpayer. It is because, $20million received by R Us for breach of contract or it can be said that, it is compensation for business losses of R Us, which would be suffered by it because of giving up of exclusive right of selling of goods in Australia.
Prevailing case scenario contained issue of analysis of ordinary income of assesse and whether it would be included in the assessable income of taxpayer or not. With this aspect, by application of rules of ITAA 1997, it is required to provide advice to Hardeep, whether above mentioned sum would be included in assessable income.
According to section 6-5(1) of the ITAA 1997, assessable income of the taxpayer comprises with income as per ordinary sources. Therefore, ordinary income can be explained as income generated by person as per usual concept. There are several case laws that reflected income for the purpose of tax its general meaning, and it does not comply with any particular definition. In order to assess income as ordinary income, it is essential that there must be existence of prerequisites of income and characteristics (Stantcheva et al., 2020).
Following are the prerequisites of income:
• The profit should be received in cash or can be convertible into cash.
• Real gain should be availed by taxpayer (Lewis et al., 2019).
In the case of FCT v Cooker & Sherden, free holiday has been received by taxpayer from the company for selling of particular number of soft drinks. In the cited case, court held that, receipt from holiday would not be regarded as ordinary income as it was non-cash convertible.
Further, characteristics of income has been explained as follows:
• The profit should be regular or received in a periodic manner. It can be said that a profit that is received on regular basis is more probably considered as ordinary income as compared to lump sum amount (Plakhtii, Fedoryshyna, & Tomchuk, 2019).
• If anything ‘flows’, then it is more probable to consider as ordinary income.
• Ordinary income should be received by recipient (Bailey & Hagan, 2016). In this aspect, an amount is considered as ordinary income if it comes to the person in that specific income year. It has been stated under Section 6-5, if the amount is derived by entity, then it is considered as amount has come into entity. Due to this, unrealized amount could not be regarded as ordinary income for that specific income year.
It should be noted that, extraordinary and isolated transactions may leads towards capital nature, however it may be considered as ordinary income if it forms a business itself, and satisfy first and second criteria explained in case of FCT v Myer. In the context of forms of business itself, it is required to make difference between mere realization of a capital goods assisting towards capital gain, and profit made because of carrying business activities, assisting towards ordinary income (Taylor, Walpole, & Burton, 2020). Further, first strand of Myer reflects that, extraordinary and isolated transactions would be considered as ordinary income if there is commercial activity, profit generating intention at the time of entering into transactions, and it was generated by the way of consistent with original purpose (Managing employee relocation costs in a tax effective manner, 2021). Further, second strands of Myer reflects that, receipts from transactions would be considered as ordinary income if assesse sells the right of income from asset without selling of the underlying assets.
Further, it should be noted that, Section 15-2 states that, assessable income of person comprised with the amount of all allowance, compensation, benefits, bonus amount, premium that has been offered in relation to employment of or services provided in direct manner or in indirect way (Income tax assessment Act 1997, 2021). As per TR92/15, payment is considered as an allowance in which person has been paid a particular amount for covering of predicted expenses. It is paid notwithstanding of whether or not expenses has been incurred by assesse, and it is on the discretion of recipient whether to spend allowance (Burton, 2018).
By considering the given case analysis, $4000 is definitely included in the assessable income of the taxpayer as it is generated from ordinary sources. There is clear connection between the services provided by Hardeep and this receipt, which reflects a number of indicators of income, consisting of regularity, connected with personal services, and some others. Therefore, there is not any doubt about inclusion of $4000 in the assessable income of person. Further, it has been identified that, All Star also paid $300000 to Hardeep for signing of the contract. Above analysis reflects that, it is not always essential that lump sum payment is in capital nature and therefore it does not included in the assessable income. Sometimes, extra ordinary and isolated transactions would also consider as ordinary income if profit has been made by carrying business activities. further, by considering the two characteristics of income, it can be said that $300000 is not regular or periodic gain of Hardeep, but it is just an indicator and only on the basis of this, it cannot be said that, cited amount is not ordinary income. Another characteristic is based on flow, which reflects that if something flows, then it is more probably considered as ordinary income. Further, by applying section 15-2, any allowance or benefits that have been offered in connection with employment would be included in the assessable income. Therefore, by application of statuary provision, it can be said that, $300000 has been provided to taxpayer directly in connection with services provided by him, and therefore it will be included in the assessable income.
On the basis of afore-mentioned analysis, it can be said that, $4000 would definitely include in the assessable income of Hardeep as it is considered as ordinary income as per section 6 of the ITAA 1997. Further, in the context of $300000, it is also considered as assessable income by application of section 15-2 of the ITAA 1997, which reflects that any amount or benefit received in relation to employment and personal services would be included in the assessable income. Overall, it can be said that, it is required by Hardeep to include $300000 and $4000 as contract money received from All Star in the assessable income of 2020-2021 income year.