Chapter 4
[4.1] In dealing with the contribution to the meaning of income for purposes of the Assessment Act that is made by the ordinary usage meaning of income, attention was at all times drawn to the possibility that the contribution that might otherwise have been made by the ordinary usage meaning has been denied, or been limited or modified, by some specific provision of the Act. A possible operation of a specific provision in this way is an aspect of the analysis, referred to in [1.30]ff. as the central provision analysis, which asserts that any item which enters “assessable income”, in the sense of an amount from which allowable deductions are subtracted to bring out an amount of income on which tax is levied, must have entered through the word “income” in the phrase “gross income” in s. 25(1). And it is an aspect of the analysis, referred to as the single meaning analysis, which asserts that the word “income” as used in the Assessment Act has only one meaning, a meaning to be drawn from all the provisions of the Act.
[4.2] It was noted that the analyses, referred to as the parallel provisions and two meanings analyses, which are given some recognition in judicial decisions, must reject the possibility that the contribution of the ordinary usage meaning can be denied, limited or modified by some specific provision of the Act which purports to give meaning to the word income. Dixon C.J. in W. E. Fuller Pty Ltd (1959) 101 C.L.R. 403, Windeyer J. in Gibb (1966) 118 C.L.R. 628, and Stephen J. in Reseck (1975) 133 C.L.R. 45 would insist that the ordinary usage meaning of income is adopted by s. 25(1) in the phrase “gross income”. Any item that is income by ordinary usage, which is not expressly excepted from the operation of s. 25(1), is thus necessarily income for purposes of the Assessment Act and, subject to the tests of jurisdiction and exemption embodied in s. 25, is carried to assessable income. None of the judges referred to directs attention to the possibility that the Act might, in some specific provision, have qualified the operation of s. 25(1) by expressly providing that some item is not income. A provision which may qualify the operation of s. 25(1) in this way is s. 23E, relating to Special Bonds defined in s. 23E(3). It reads, in subs. (1): “Subject to sub-section (2), no part of the amount received by a person upon the redemption of a Special Bond, other than a part of that amount paid as accrued interest, shall, for any purpose of this Act, be taken to be income derived by that person.” Nor does any of those judges direct attention to the possibility that the Act might, in some particular respect, have expanded the operation of s. 25(1) by deeming an item to be income by ordinary usage. Harrowell (1967) 116 C.L.R. 607 may be explained on the basis that the item in question was deemed by s. 47 to be income by ordinary usage. In Rutherford (1976) 76 A.T.C. 4304 the Commissioner argued, though unsuccessfully, that s. 108 which deems certain receipts to be dividends, had the effect of making those receipts income by ordinary usage and thus income by force of s. 25(1).
[4.3] These possibilities could be accommodated within the parallel provisions and two meanings analyses. But the possibiity that a specific provision, by saying that an item is not assessable income or by omitting an item in saying that a class of items is assessable income, has qualified the operation of s. 25(1), cannot be accommodated. This is evident in the judgment of Stephen J. in Reseck. The fact that s. 26(d) dealt only with 5 per cent of the amount of a retiring allowance which is income by ordinary usage, did not qualify the meaning of income in s. 25(1). If it was to be taken to express an intention that the other 95 per cent was not assessable income—which Stephen J. thought was not the case—the most that it could have done was to make that 95 per cent exempt income. It would have been exempt income, presumably because of the definition of exempt income in s. 6, which refers to “income which is not assessable income”.
[4.4] It is true that Gibbs J. in Reseck held that a “contrariety” between s. 25(1) and s. 26(d) required a conclusion that s. 25(1) did not make the 95 per cent income. And Jacobs J. reached the same conclusion by reasoning that the “special provision in s. 26(d) must be given its effect in preference to the general provision in s. 25(1)” (at 57). It is true also that they reached the conclusion after verbal reference to the parallel provisions and two meanings analyses. The conclusion is, none the less, a rejection of those analyses. The analyses would assert that the operation of s. 25(1), in carrying items to assessable income, is quite independent of the operation of any specific provision, so that “contrariety” or a relationship of general and special cannot arise. The conclusions reached by Gibbs and Jacobs JJ. can only be explained on the basis that the Act has only one meaning for the word income.
[4.5] Reference has already been made in [1.39], [2.223] and [2.369] above to the apparent endorsement of the parallel provisions and two meanings analyses of the structure of the Assessment Act, reflected in the words added to s. 25(1) in 1984. The words are: “[which is not] … an amount to which s. 26AC or s. 26AD applies or an eligible termination payment within the meaning of Subdivision AA [of Division 2 of Part III].” The words let in all the unacceptable consequences of the parallel provisions and two meanings analyses, both those that flow from the dissenting judgment of Stephen J. in Reseck (1975) 133 C.L.R. 45 and those that will leave the Assessment Act without coherent bases of jurisdiction. And the words added to s. 25(1) do more than this. At least the view adopted by Stephen J. could resolve a conflict between s. 25(1) and a specific provision where the ordinary usage notion of income had a wider operation than a specific provision that shows a clear intention to exclude from assessable income some item of what is income by ordinary usage. The Stephen J. resolution—that the item of ordinary usage is made exempt income—may draw no support from the policy of the Assessment Act, but it is at least a resolution. That resolution is no longer possible. The words added carry an inescapable implication that the only manner in which an item of ordinary usage income can be denied entry to assessable income is by an express provision in s. 25(1), the section that otherwise carries all items of ordinary usage income to assessable income. Thus, despite the clear intention of s. 27H that an annuity receipt should not be assessable income to the extent of the amount excluded by that section, the whole amount of the annuity will be carried to assessable income by s. 25(1). Avoiding consequences of this kind is probably beyond judicial interpretation of the Assessment Act, though Cooper Brookes (Wollongong) Pty Ltd (1981) 147 C.L.R. 297 and the provisions of ss 15AA and 15AB of the Acts Interpretation Act might encourage a court to try. More appropriately, the Assessment Act should be amended to remove the words added in 1984 to s. 25(1) and to add words to ss 26AC, 26AD, 27B and 27C so that, within their fields of operation, they exclusively determine what is assessable income for purposes of the Assessment Act. The opportunity might be taken to ensure, where this is the intention of the Act, that other specific provisions operate as codes, though it might be preferable to leave the question whether other specific provisions are codes to judicial determination. The way will be left for judicial determination if the words by which ss 26AC, 26AD, 27B and 27C are made codes are expressed to be without prejudice to the possible exclusive operation of other specific provisions.
[4.6] In what follows in this chapter the central provision and single meaning analyses are maintained. The word “income” in s. 25(1), and anywhere else in the Act, has a meaning which is drawn from all the provisions of the Act. It is the meaning of ordinary usage, confirmed, extended, limited or modified by specific provisions. The parallel provisions and two meanings analyses, taken with the words added to s. 25(1), produce chaos that awaits legislative action.
[4.7] Some income is exempt, and does not enter assessable income because its entry is denied by s. 25(1). Income will be exempt where the Act expressly says that it is exempt. And the Act may impliedly make it exempt by saying that it is “not assessable”: at least this appears to be the assumption of the definition of exempt income in s. 6. The reference to income that is not assessable income in the definition could be explained as a reference to items of income which fail to enter assessable income because they are outside the jurisdiction asserted by s. 25(1), being foreign source income of a non-resident. It is so explained by Barwick C.J., McTiernan and Taylor JJ. in Gibb (1966) 118 C.L.R. 628 at 633–634:
“Nor do we think that on the taxpayer’s reading of the definition of exempt income ‘the second part of it would add nothing and would be altogether otiose’. It is sufficient to point out that the assessable income of a non-resident taxpayer is limited to his ‘gross income derived directly or indirectly from all sources in Australia’. His ex-Australian income is not assessable income for the purposes of the Act though s. 23(r) goes on to exempt from income tax income derived by such a taxpayer from sources wholly out of Australia. However, the dividend income of a non-resident taxpayer paid out of profits derived partly in Australia and partly outside Australia is not the subject of an express exemption, but it is clear that his assessable income for purposes of the Act includes only those dividends to the extent to which they are paid out of profits derived by the company from sources in Australia (s. 44(1)(b)). The remainder of his dividend income is, therefore, income which is not ‘assessable income’ but it is ‘exempt income’ pursuant to the second part of the definition of that term for the purposes of the Act including s. 80.”
However, the reference to income that is not assessable income in the definition of exempt income in s. 6 does, it seems, extend to income expressly made not assessable by s. 128D (income subject to withholding tax). There is an assumption that it does, in s. 80(3)(b) in defining “net exempt income” in relation to loss carry forward. It might be thought that the definition should also extend to income in the form of film and video tape royalties derived by a non-resident, to which Div. 13A of Pt III applies. It is expressly provided in s. 136A(4) that such income “shall not be included in the assessable income of a person”. One would have expected s. 80(3)(b) to contain a reference to s. 136A(4), as well as to s. 128D.
[4.8] The central provision and single meaning analyses do not exclude the possibility that a specific provision such as s. 44(2), with which W. E. Fuller Pty Ltd (1959) 101 C.L.R. 403 and Gibb (1966) 118 C.L.R. 628 were concerned, may, in the use of a phrase such as “not assessable income”, make some item of income exempt. The specific provision can of course have this effect only where the item is one that is within the Assessment Act’s concept of income. The question of construction in Fuller and Gibb was whether the words “the assessable income shall not include” in s. 44(2) had the effect of making the item—bonus shares—in any respect exempt income. There were in effect two questions: whether the item was in any respect income, either by virtue of the ordinary usage meaning of income or by the specific provisions of s. 44, and whether the words operated to exempt that income. Dixon C.J. concluded that the item was not income. The majority in Fuller (Fullagar and Menzies JJ.) concluded that it was, and that the words used made this income exempt. Gibb by majority, overruled Fuller on the question whether the item was income. The possible operation of the words of s. 44(2) to bring about an exemption did not arise.
[4.9] While it is thus a possible operation of words which refer to an item as “not assessable income”, in the course of some specific provision giving meaning to the Assessment Act’s concept of income, that they make income exempt, it is not an operation that ought readily to be given to the words. An operation of the words “not assessable income” in this way assumes that the specific provision has confirmed some aspect of the ordinary usage meaning, or has extended the ordinary usage meaning, and has then by a choice of the words used in the s. 6 definition attributed exemption to it. The more likely construction is that the words used simply limit the confirmation or extension of the ordinary usage meaning. A failure to confirm on the central provision and single meaning analyses may, in this context, simply carry the implication that the item not confirmed is not income for the purposes of the Assessment Act. It is an implication which is directed by the use of the words “not assessable income”. Indeed any other implication would seem to be perverse. It is a most unlikely legislative intention that the specific provision confirms the ordinary usage meaning in respect of some item, or extends it in respect of some item, and then by the use of the words “not assessable income” makes that item exempt income.
[4.10] Where a specific provision in confirming an aspect of the ordinary usage meaning does so in a way that requires an inference that it is intended to be a code dealing with this and related aspects, it will have excluded those related aspects of ordinary usage from the Act’s concept of income. This was the construction given to s. 26(d) by the majority in Reseck (1975) 133 C.L.R. 45. In this case, items within those related aspects are not income within the Assessment Act’s meaning. There is no basis for saying that the items are within the Assessment Act’s meaning, but have been made impliedly “not assessable income” so as to be exempt by virtue of the definition in s. 6. On the central provision and single meaning analyses, the conclusion contemplated though not in fact drawn by Stephen J. in Reseck, could not be drawn. If he had thought that s. 26(d) was intended as a code dealing with lump sum allowances paid in consequence of retirement from, or termination of office or employment, he would have held that the 95 per cent of the allowance received in Reseck that was not made income by the code, was exempt income. The prospect of such a conclusion must condemn the analyses that make it possible.
[4.11] Chapter 3 above has been devoted to a survey of two specific statutory provisions, s. 25A and s. 26AAA, which bear on the meaning of income for purposes of the Assessment Act. The survey that follows of other specific statutory provisions which bear on the meaning of income in the Assessment Act, is arranged by reference to the propositions as to the ordinary usage meaning of income in Chapter 2 above. In some instances a provision will need to be considered more than once. Where the provision has already been considered in Chapter 2 or 3 above, the present treatment is very little more than a cross-reference. Where the provision is the subject of extended treatment in later chapters, only an outline is given in the present treatment, and a cross-reference is given to the later chapter. Under each heading specific provisions are dealt with in the order of their appearance in the Assessment Act.
[4.12] The view taken in this Volume is that derivation is an aspect of income. The income quality of an item must be assessed in the hands of the person who has derived it. It follows that a delay in derivation may have the consequence that an item never comes to be the income of any person, because at the time of derivation the circumstances do not give the item an income character, though circumstances of an earlier time might have given that character had derivation been at the earlier time. Constable (1952) 86 C.L.R. 402 referred to in [2.17]–[2.19] and [2.22] illustrates this consequence. And it follows, at least in theory, that derivation may come too soon. The derivation may be at a time when the circumstances which would give the item an income character do not yet obtain. Problems of derivation are problems of tax accounting, and are dealt with in Chapters 11–14 below. For the present it is sufficient to observe only briefly on specific provisions more closely considered in those chapters.
[4.13] Section 6C(1) does not directly bear on the issue of derivation. The history of the section does, however, show how the separation of the moment of derivation from another moment when an item comes to have a quality necessary for its inclusion in assessable income, will preclude any inclusion. At the time of the facts of the Aktiebolaget Volvo (1978) 78 A.T.C. 4316, s. 6C of the Act gave a source in Australia to royalties “paid” by an Australian resident to a non-resident. The definition of royalty extended to certain amounts “paid”. Jenkinson J. in Volvo observed that if an amount became payable to a taxpayer in one year so as to be derived by him in that year, an accruals basis of accounting being applicable, but the amount was not paid to him in that year, the amount would not be given an Australian source. Indeed it would be more correct to say that if there was a moment of derivation in advance of the moment of payment, even though both moments occur in the same year of income, the amount derived would not be given an Australian source by s. 6C.
[4.14] Following the Volvo decision, the definition in s. 6 was amended by Act No. 24 of 1980 so that it now covers amounts “paid or credited”. Some weeks after this amendment, it being considered that the amendment to s. 6 was insufficient to cover the weakness exposed in the Volvo judgment, s. 6C was also amended so that it now covers amounts “paid or credited”. The assumption of both amendments seems to have been that “crediting” by a debtor involves a derivation by an accruals basis taxpayer in whose favour the item is credited. There is no basis for such an assumption. The accrual is complete when a non contingent right of the taxpayer to receive an ascertained amount arises—crediting merely records that right of the taxpayer in the books of the debtor. The weakness exposed by the Volvo decision still remains. If it is correct that royalties in the circumstances of Volvo are to be accounted for on an accruals basis, an amount will not have an Australian source, so that it might enter assessable income under s. 25, if a right to receive arises and its source in Australia depends on s. 6C. It may come to have an Australian source when an entry is made in the debtor’s books or it is paid to the creditor, but this does not assist the entry into assessable income. The item must have an Australian source at the time of derivation. Both in the s. 6 definition and in s. 6C the word “derived” should replace “paid or credited”.
[4.15] Section 19 may do no more than confirm a principle of constructive receipt as an aspect of the notion of derivation by a taxpayer who is on a cash basis of accounting. The section has been the subject of interpretation in a number of cases including Permanent Trustee Co. of N.S.W. (1940) 6 A.T.D. 5, Gair (1944) 71 C.L.R. 388, Brent (1971) 125 C.L.R. 418 and Poole & Dight (1970) 122 C.L.R. 427. This interpretation is considered in Chapter 11 below. The importance of s. 19, and the principle of constructive receipt, for the rational operation of the Assessment Act, cannot be overemphasised. The function of the section, and of the principle, is to bring about a derivation at a time when the circumstances of the derivation may still give an income character to the item. If a cash basis taxpayer assigns a debt due to him, for example, a debt for professional services rendered, s. 19 or the principle may treat the assignment as a derivation. If it does not, the item may never be income derived by anyone. It will not be income of the assignor because he has not derived it. It will not be income of the assignee because the circumstances of any derivation by him—the receipt of payment—will not give the item an income character: Federal Coke Co. Pty Ltd (1977) 77 A.T.C. 4255. If a cash basis taxpayer, being entitled to an amount for professional services, agrees that the amount to which he is entitled should be lent to the debtor, s. 19 or the principle may treat his agreement as a derivation. If it does not, the item may escape ever being treated as income derived. When the taxpayer receives payment he receives repayment of a loan, and this circumstance will not give the item an income character.
[4.16] The present concern is whether the ordinary usage notion of derivation, otherwise adopted by s. 25, is displaced by any of these provisions.
[4.17] Clearly there is no displacing when the relevant provision itself uses the word “derive”. Thus, s. 26(b) refers to “beneficial interests in income derived”. Sections 25A and 26AAA, in their reference to “profit arising”, should not be held to have displaced the ordinary usage notion of derivation in relation to a profit. Where the word used is “received”—it is used in paras (f), (g), (h), (i), (j), (ja) and (l)—it is arguable that the effect is to put all taxpayers on a cash basis of accounting in relation to the relevant item, though it is more likely that the word received will be read as equivalent to “derived” and the general principles of tax accounting remain unaffected.
[4.18] Paragraphs (e) and (ea) of s. 26 give rise to more difficulty. The words “allowed given or granted” are explained in Constable (1952) 86 C.L.R. 402 and Dixon (1952) 86 C.L.R. 540 in ways which suggest that they have a meaning which displaces the general principles of tax accounting. The benefit must have been allowed given or granted “to the taxpayer”. If s. 26(e) is a code, a possibility canvassed in [2.367]–[2.373] above and [4.42] below, those words may exclude the operation of the constructive receipt principles of ordinary usage derivation.
[4.19] Paragraph (eb) of s. 26 refers to any amount “paid to the taxpayer”. Paragraph (jb) refers to an amount “paid to the taxpayer or applied by the Commissioner in discharge or partial discharge of a liability of the taxpayer to the Commonwealth”. The significance of the use of the words “paid to the taxpayer” is examined in Chapter 11 below. The express provision in para. (jb) referring to an amount “applied by the Commissioner” may have a bearing on the construction of s. 19, and on the scope of the ordinary usage principle of constructive receipt. It strengthens an argument that moneys “are not dealt with on [the taxpayer’s] behalf or as he directs”, nor are they constructively received, when the creditor applies an amount owed to him by the taxpayer in satisfaction of an amount owed by the taxpayer to the creditor. Issues of this kind are considered in Chapter 11 below.
[4.20 Reference was made above in [2.25]–[2.26] and [2.35] to the specific provisions of s. 26AAC which provide tests of derivation where the item is a right to a share, or a share in a company, made available to an employee. There is a derivation when a share is acquired, and that acquisition is deemed to occur when the right of the taxpayer to dispose of the share ceases to be restricted in the ways referred to in the section, or when he ceases to be liable to be divested of his ownership of the share, or the time “immediately before the taxpayer disposes of the share”, whichever first happens (subss (5) and (15) of s. 26AAC). There is a derivation when a right to a share is acquired and the taxpayer disposes of the right to a person who is not an associate of the taxpayer (s. 26AAC(8)). Problems of double taxation that may result from the derivations thus arising under s. 26AAC, and the derivations that may arise under other provisions, are dealt with in subss (11) and (12) of s. 26AAC, and are considered in [2.25]–[2.26] above, and in [12.165]–[12.180] below.
[4.21] An attempt is made in s. 26AAC to displace ordinary usage derivation within principles determined by Abbott v. Philbin [1961] A.C. 352 and Donaldson (1974) 74 A.T.C. 4192, and thus avoid yet another prospect of two derivations and the double inclusion of an item in assessable income. Section 26AAC(10) displaces the operation of s. 26(e). But it does not expressly displace derivation of ordinary usage income. The inference may be that s. 26(e) is a code which has, in its turn, displaced ordinary usage derivation, though that inference seems hardly consistent with judicial observations in Dixon (1952) 86 C.L.R. 540, Hayes (1956) 96 C.L.R. 47 and Scott (1966) 117 C.L.R. 514. And the point has already been made in [4.5] above that so long as the words added in 1984 to s. 25(1) remain, it is impossible to treat any specific provision as a code save those mentioned in those added words.
[4.22] Section 26BA displaces the ordinary usage principles of derivation, by deeming income derived by ordinary usage in one year, to be derived in a later year. The purpose of the section is to overcome the bunching of income in one year. A number of other sections, including s. 26B, which also operate to bring about deemed derivations, have the same purpose.
[4.23] Sections 27B and 27C of Subdiv. AA of Div. 2 of Pt III will include, in whole or in part, an eligible termination payment “made in relation to a taxpayer”, in the assessable income of the taxpayer. “Eligible termination payment” is defined so that it means a payment of specified kinds “made in respect of the taxpayer”, and s. 27A(3) defines the latter words so that they are a reference to a payment made:
The “taxpayer” for purposes of an “eligible termination payment” within para. (a) of the definition of eligible termination payment in s. 27A(1), is the person whose employment is terminated. The consequence of this drafting is to include in the assessable income of the taxpayer an amount that might not have been regarded as derived by him if only ordinary usage principles of derivation were applicable. The possibility that the amount might, in the particular circumstances, be income of the dependant or other person or trustee of the taxpayer’s estate, and the prospect of double taxation, are handled by an involved drafting device in s. 27A(5). If the amount is income of the dependant, other person or trustee, it will be taken out of the definition of eligible termination payment and thus out of the operation of s. 27B or s. 27C in relation to the taxpayer. The prospect remains that the taxpayer might derive income other than by virtue of s. 27B or 27C. He might be held to have constructively received what has been paid to the dependant, other person or trustee, and the amount is in other respects his income as a reward for services. Double taxation in that event could only be avoided if the ordinary usage principles of constructive receipt, and indeed s. 19, are held inapplicable on the ground that s. 27A(3) is a code in this regard.
[4.24] Section 44(1) provides that the assessable income of a shareholder includes dividends paid to him by the company. In this and other contexts discussed in [11.163]ff. below the Assessment Act appears to make derivation by a taxpayer depend exclusively on action taken by another.
[4.25] The operation of ordinary usage principles of derivation in relation to income moving to partners through a partnership, would pose awkward problems, more especially where the entitlements of partners to share in profits are complex. And there would be problems in regard to the availability of deductions. These problems are avoided by Div. 5 which makes the partnership a tax accounting entity, in a manner which has its parallel in the provisions of Div. 6 in relation to trusts considered below. Section 90 provides for a calculation of a notional income for a year of income, of a hypothetical entity—the partnership as a taxpayer. Section 92 imputes a derivation of income by each partner, being a share of that notional income. The imputation depends on a specific provision in s. 92, which applies to the notional income the individual interest of each partner in the income of the partnership according to partnership law. The imputation cannot occur until the notional income of the hypothetical entity for the year of income becomes calculable, which will be at the last moment of the year of income. It follows that derivation by a partner of income moving to him through the partnership cannot occur until the last moment of the year of income. It is this that makes possible the transfer of income by the assignment of a share in a partnership, recognised in Everett (1980) 143 C.L.R. 440 and Galland (1984) 84 A.T.C. 4053.
[4.26] Division 6 displaces the operation of the ordinary usage principle expressed in Proposition 4—to have the character of income an item must be a gain by the taxpayer who derived it. And it displaces the principle expressed in Proposition 3 that the character of an item as income must be judged in the circumstances of its derivation by the taxpayer: a beneficiary in whose favour the trustee of a discretionary trust exercises his discretion will derive income by force of ss 101 and 97, though the quality as income will have been determined by reference to the circumstances of a derivation by the hypothetical taxpayer referred to in s. 95.
[4.27] The present concern is to note the specific provisions which govern derivation by a beneficiary, and displace the ordinary usage principles of derivation. Sections 97 and 98 substitute “present entitlement” and “vested and indefeasible interest” as the tests of derivation. And s. 101 deems a present entitlement when a trustee exercises his discretion “to pay or apply income … for the benefit of” a beneficiary. These tests of derivation operate in a special fashion. They are strictly tests of derivation of trust law income by the beneficiary. From that derivation a derivation of income for purposes of the income tax is imputed. The derivation imputed is a derivation of a share of the income for purposes of the income tax, derived by the hypothetical taxpayer referred to in s. 95—the share being the same as the beneficiary’s share of trust law income.
[4.28] There are no specific provisions concerned specially with the derivation of notional income by the hypothetical taxpayer in s. 95. The ordinary usage principles will apply, affected by other specific provisions now considered. Thus, where a trustee is a partner, the provisions of Div. 5 will apply. And where the trustee is a beneficiary in another trust, Div. 6 will apply.
[4.29] Sections 99 and 99A displace the ordinary usage principles of derivation: they impute a derivation by the trustee in relation to such of the income derived by the hypothetical taxpayer referred to in s. 95, as is not the subject of an imputed derivation by a beneficiary by force of ss 97, 98 and 101.
[4.30] Section 99B displaces the ordinary usage principles of derivation where property of a trust estate is paid to or applied for the benefit of a beneficiary. The derivation in this instance operates directly. It completes the income quality in the hands of the beneficiary of the property paid to or applied for his benefit.
[4.31] Division 6A is directed against income splitting by transfer of income for short periods. The intention of the Division, expressed in s. 102B(1) is to impute a derivation by the transferor of income which, if it is in fact derived as income, will be derived by the transferee. The expression of that intention raises awkward problems of interpretation. Section 102B(1) provides:
“any income derived from the property that is paid to, or applied or accumulated for the benefit of the [transferee] by reason of the transfer, being income that, but for the transfer, would have been included in the assessable income of the transferor, shall be treated for purposes of this Act as if the transfer had not been made.”
[4.32] There may be some doubt about the sufficiency of the deeming. The income is to be treated “as if the transfer had not been made”. One would have expected the deeming clause to add “and the income had been derived by the transferor”.
[4.33] Section 128D provides, in general, that income upon which withholding tax is payable “shall not be included in the assessable income of a person”. Reference has been made in [4.7] above to the likely construction of this provision that it makes income exempt income by making it not assessable. There is another possible construction which would treat s. 128D as having simply denied the element of derivation which is a condition of income being subject to tax by assessment. Other provisions of Div. 11A—in particular s. 128B—provide a notion of derivation in terms of “paid to” a person, specifically for purposes of withholding tax. On this analysis items subject to withholding tax are not income for purposes of tax by assessment.
[4.34] Sections 20 and 21 express the general usage principle that an item of an income character that has been derived will be income in the amount of its realisable value. An item of foreign currency is income in the amount of its market equivalent in Australian currency. Where the item is not currency, the money value of the item will be the amount of income. Section 21 is expressed in a way that might be thought to confine its operation to the determination of the amount of an outgoing. It is, however, applicable to any movement of consideration, and by requiring that the money value be treated as “paid or given”, it prescribes an amount for purposes of tax accounting whether the accounting is for an outgoing or an item of income, or for the determination of a loss which is deductible or a profit which is income.
[4.35] There is a question of the precise effect of s. 21 on the matter of derivation of an item of profit which is income or of a loss which is deductible. The principle expressed in Proposition 4 that an item to be income must be a gain, refers to a realised gain. There is a realised gain when an asset is disposed of for an amount of money greater than its money cost, and there is a realised loss when it is disposed of for an amount of money less than its money cost. Whatever be the consequences of the ordinary usage meaning of income, s. 21 ensures that an exchange of assets neither of which is currency will be treated as the realisation of an asset for an amount of money which may include a profit or demonstrate a loss. And the section ensures that the exchange will be treated as the acquisition of an asset for a money cost, so that a profit or loss may arise when the asset is disposed of.
[4.36] The view is taken in this Volume that the outlay of currency for an asset is, generally, not an event which calls for recognition in a present tax account. There is no outgoing which is deductible unless there are express statutory provisions which require that the currency outlaid must be treated as an outgoing: there are such provisions in ss 28ff. and s. 51(2), concerned with trading stock as defined in s. 6. Section 21 does not challenge that view. Where, however, an asset which is not currency is exchanged for another asset which is not currency, the exchange may involve the realisation of a profit or loss in relation to the asset disposed of. And it will be the occasion of establishing a cost of the asset acquired, as much as would be the outlay of cash for the asset acquired. In these situations s. 21 has an operation: Executor Trustee & Agency Company of S.A. Ltd (Bristowe’s case) (1962) 36 A.L.J.R. 271, Varty v. British South Africa Co. [1966] A.C. 381. These matters are considered in [5.23]–[5.26] and in Chapter 12 below.
[4.37] Section 21 is expressed in very wide terms—it deems the money value to have been paid or given “for purposes of [the] Act”. It should have the effect of requiring that a disposition of an asset which is not currency be treated as a payment for purposes of a provision of the Act whose operation depends on an item having been “paid”, or a “payment” having been made. Thus s. 27A(8), deeming a transfer of property to be a payment of an amount equal to the value of the property before the transfer, is unnecessary. The deeming is for purposes of Subdiv. AA of Div. 2 of Pt III referred to in [2.386]–[2.387] above and again in [2.419] and [4.183]ff. below.
[4.38] Section 26(e) displaces the ordinary usage principle that an item is income in the amount of its realisable value, in the context of items which are derived “in respect of, or for or in relation directly or indirectly to, any employment of or services rendered by [the taxpayer]”. The section goes some way to defeating tax planning which depends on the giving of benefits other than money as rewards for services. The operation of s. 26(e) in relation to such “fringe benefits” has been the subject of comment in [1.81]–[1.84] above and [4.38]–[4.83] below. Its effect is to substitute “value to the taxpayer” for realisable value as the measure of the amount in which an item is income.
[4.39] The meaning given to the phrase “value to the taxpayer” by Bowen C.J. in Eq. in Donaldson (1974) 74 A.T.C. 4192 at 4207 is “what a prudent person in [the taxpayer’s] position would be willing to give for [the item] rather than fail to obtain [it]”. The fact that a benefit is subject to a restriction affecting the power of the taxpayer to transfer it to another may have a significantly depressing effect on its realisable value, but not on the amount a person in the position of the taxpayer would pay for the item. A benefit in the form of use of a motor vehicle, the taxpayer being forbidden to allow any other person to use the vehicle, has no realisable value, but a person “in the [taxpayer’s] position”—a person who would therefore be entitled to use the vehicle—may be prepared to pay a substantial amount for the benefit. Which is not to say that a person in the position of the taxpayer would not pay more for the benefit if it were a benefit he could transfer to another.
[4.40] The meaning given by Bowen C.J. in Eq. to the phrase “value to [the taxpayer]” leaves open a question whether the hypothetical person in the position of the taxpayer must be taken to have the tastes and financial resources of the taxpayer. The question is starkly raised where the taxpayer asserts that he would never have chosen to acquire the item provided for him by the employer, had it been offered to him at the price others would have asked him to pay for it. If the tastes and financial resources of the taxpayer are to be imputed to the hypothetical buyer, the operation of s. 26(e) must become utterly unpredictable. The point is made below in dealing with subsidised housing that to allow the financial circumstances of the taxpayer to affect the value to the taxpayer is to invite a conclusion that luxury has no value to a taxpayer who cannot afford it if he must buy it for himself.
[4.41] There is a question whether the prudent person in the position of the taxpayer must be taken to have the special knowledge which the taxpayer has. It may be difficult to assert at once that the taxpayer’s tastes and financial circumstances are irrelevant, and that his special knowledge is relevant. If his special knowledge is relevant it would follow, in an Abbott v. Philbin [1961] A.C. 352 or Donaldson (1974) 74 A.T.C. 4192 situation, that the value to the taxpayer may be higher or lower because of the special knowledge the taxpayer had, special knowledge indicating a prospect of an increase or a decrease in the value of the company’s shares.
[4.42] If tastes, financial circumstances and inside knowledge of the taxpayer are relevant, they may cause the value to the taxpayer to be less than the realisable value. The question would then arise whether there is none the less a derivation of income in the amount of the realisable value. The answer would depend on whether s. 26(e) is a code covering the particular context. The question whether s. 26(e) is a code is now inextricably linked with the effect of the words added in 1984 to s. 25(1) in ways that have been explained in [4.5], [2.367]–[2.373] above. It might be thought a strange outcome of a conclusion that it is a code that a teetotal taxpayer who has accepted a gift of expensive liquor has derived a valueless item, and there is no amount of income, even though he can sell the item for a substantial sum.
[4.43] The exclusion by s. 26(e) of the principle in Tennant v. Smith [1892] A.C. 150 gives rise to a question of characterisation which cannot arise when ordinary usage principles are alone applicable. Where the item allowed, given or granted is neither money nor capable of being turned into money there is room for argument, in some circumstances, that it is not a product of his employment, which would make it income, but rather a “condition” of his employment. Thus the flat which a caretaker occupies in his employer’s building, the cabin occupied by a sailor on his ship and the room occupied by a doctor who is required to be on immediate call at a hospital, may not be “benefits” under s. 26(e).
[4.44] In some situations accommodation provided for an employee may be in part a “condition” of employment and in part a “benefit” to the employee. Thus he may be called on to entertain in his employer’s interests, and the house provided for him has space and facilities for this purpose. He may use a company car on the company’s business and for private purposes. There is a question whether an apportionment is proper in such a case. Hayes (1956) 96 C.L.R. 47 may indicate that an apportionment is not proper and that the dominant purpose governs. The application of the phrase “benefits in kind” in United Kingdom legislation in the Court of Appeal decision in Westcott v. Bryan [1969] 2 Ch. 324 on the other hand would support the view than an apportionment is proper.
[4.45] The value to the taxpayer of a benefit ought not to be less than the amount that he might obtain by surrendering the benefit. In Heaton v. Bell [1970] A.C. 728 the provision of a car by his employer involved a subtraction from his salary. A surrender of the car would have restored his salary to its previous amount. In this instance the amount of income will not differ whether s. 26(e) or ordinary usage principles are applicable, save where the amount obtainable by surrendering has been set at a low figure, in order to limit its realisable value.
[4.46] The operation of s. 26(e) in circumstances where the immediate recipient of a benefit provided by the employer is not the taxpayer but a third person, who may be a relative of the taxpayer, is less than clear. The phrase “value to [the taxpayer]” might appear to deny that the taxpayer has derived any amount of income beyond the value to him of any benefit that he may derive indirectly, for example by relief from some legal or moral obligation binding him to provide for the relative the direct benefit provided by the employer. The employer might have paid the school fees of the taxpayer’s child. Ordinary usage derivation might be even more limiting on the amount that could be regarded as income. There will be circumstances in which the taxpayer might be taken to have received constructively the amount expended by the employer in providing the benefit to the relative. Constructive receipt principles are examined in [11.122]ff. and [13.66]ff. below where the view is expressed that a stipulation in a contract of service that a payment be made to another will not at any time give rise to a constructive receipt by the person who makes the stipulation. The circumstances do not involve an assignment of income which could give rise to a derivation by the person who makes the stipulation.
[4.47] Where there is no stipulation express or implied in the service agreement, the possibility of ordinary usage derivation is even more remote. The provision of a benefit to the relative may take the form of funding a scholarship scheme for children of employees. The taxpayer employee was held to have derived income in these circumstances in Wicks v. Firth [1983] 1 All E.R. 151, but the decision involved the application of special provisions of the United Kingdom law. In Australia, ordinary usage derivation would be confined to the realisable value of the indirect benefit to the taxpayer employee, and there would appear to be no realisable value. In any event Constable (1952) 86 C.L.R. 402, discussed in [2.17] and [2.22] above, may stand in the way of a conclusion that the benefit to the taxpayer is a reward for services.
[4.48] Section 26(e) uses a number of words to identify the item that is income—allowances, gratuities, compensations, benefits, bonuses and premiums. Where the item is not money, there are problems in isolating the item that is income where the taxpayer has obligations to the person providing the item in regard to its use, and where the taxpayer’s use of that item is in some degree inherent in performing the services for which it is a reward. An obligation to maintain a motor vehicle, and to keep it in a parking space, will limit the benefit provided in the form of use of the vehicle. Where the motor vehicle is used by the taxpayer in performing services for his employer, the use of the vehicle is not in this respect an income item. The use is not a benefit from the employment: it is a condition of employment, no different from the office space, light and heating provided for an employee engaged in office work.
[4.49] Isolating the income item that may be involved in the use of a motor vehicle becomes a subtle, and in terms of demands on the administration of the income tax, a costly exercise. A principle, discussed in [8.57]–[8.82] below, that the costs of travel to and from work are not a deductible outgoing, suggests that the use of a car provided by an employer to travel to and from work should be regarded as an income item. But the employee may argue that the use of the car in this way is simply inherent in performing his services: it is inherent in carrying out his obligation to maintain and keep the car safe, and to have it available at all times to travel on some duty away from his normal place of work.
[4.50] In 1974 provisions were inserted in the Assessment Act—a former s. 26AAB—which sought to avoid these subtleties, by providing that a “standby value” of a vehicle provided by an employer would be an income item of an employee, wherever there was any private use of the vehicle by the employee. The provisions deemed use for travel to and from work to be private use. The provisions were repealed, with retrospective effect, in 1975. The reason given for the repeal was the serious effect on the motor vehicle manufacturing industry, and employment in that industry, that would result from what was seen as a tax disincentive to employees using vehicles provided by their employers. An inequity in the income tax which is sufficiently entrenched, may be beyond any action to redress it.
[4.51] Isolating the item that is income when free or subsidised housing is provided by an employer is also a subtle exercise. An obligation on the employee to use the house to entertain clients of the employer must limit the benefit provided, and where the employee has some caretaking function to perform—the housing may be in a building where the employer’s business is conducted—there is room for an argument that, at least in part, the taxpayer’s use of the housing is inherent in performing the services. It is a condition of service, and is not a reward for service.
[4.52] The fact that there is an obligation on the employee to use the house to entertain clients may not only limit the benefit, but also require that some of the apparent benefit that remains should be treated as inherent in performing the services. It may be argued that the enjoyment of “prestige” housing provided by the employer is a condition of employment. The employer’s “image” is furthered by the quality of the housing provided for the employee, in the same way as that image is furthered by the luxury of the motor vehicle provided for the employee.
[4.53] The method of valuation contemplated by s. 26(e) is qualified by ss 26AAAA and 26AAAB. These provisions were inserted in the Act in 1980 and 1981 respectively, following industrial action by employees working in more remote parts of Queensland. The action was in protest against the Commissioner’s intention to use s. 26(e) to tax some part of the value to the employees of subsidised housing provided by their employers. Sections 26AAAA and 26AAAB qualify the operation of s. 26(e) in relation to subsidised housing where a taxpayer who is an employee receives a benefit “in respect of or in relation to his employment … by way of the grant of a lease or licence in respect of … residential accommodation … occupied by the taxpayer or by the taxpayer and his family”. This wording does not cover all forms of subsidised housing. It does not cover circumstances where the benefit relates not to employment but to services rendered. It will not cover a rent allowance. Nor will it cover a direct payment of rent by the employer.
[4.54] On its face s. 26AAAA does not change the law expressed in s. 26(e): it merely requires the Commissioner, in determining the value to the taxpayer of the subsidised housing, to have regard to all relevant matters, and to take certain specific matters into account. So far, however, as the specific matters are not relevant to the isolation of the income item or its valuation within the principles just explained, s. 26AAAA must be regarded as having effected changes in the law. Thus the Commissioner is required by para. (b) to take into account the fact that the provision of subsidised housing is customary in the industry concerned. The intention is, apparently, that a fringe benefit which has been enjoyed tax free for a time must continue to be tax free. The difficulty of redressing an inequity in which a substantial number of taxpayers have acquired a vested interest, has already been noted.
[4.55] Requiring the Commissioner to take into account the matter specified in para. (d) may have effected a change in the law. It might have been considered that, save where it is a proper conclusion that the enjoyment of high standard or spacious accommodation is a condition of employment, the valuation of that accommodation would not be affected by the fact that the taxpayer was persuaded to enjoy luxury by the circumstance that the employer subsidised its cost. Paragraph (d) would appear to make an assumption about the meaning of the phrase “value to [the taxpayer]” in s. 26(e), which would assert that luxury has no value to a person who cannot afford it if he must buy it for himself.
[4.56] Paragraph (d) of s. 26AAAA may, however, be read as a matter related to those included in paras (a) and (c). So read, it may not have effected a change in the law. Paragraph (d) requires the Commissioner to take into account the fact that the residential accommodation is of a higher standard than could reasonably be expected to be provided for the taxpayer, or is of a larger size than is necessary to accommodate the taxpayer or the taxpayer and his family. Paragraphs (a) and (c) require the Commissioner to take into account, severally, the fact that the residential accommodation is in a remote area, and the fact that suitable alternative accommodation on reasonable terms and conditions are not available within reasonable distance from the place of employment. Where some of the costs of residential accommodation would be seen as expenses incurred in serving the interests of the employer there is room for treating relief from those expenses as a contribution to capital by the employer. There is no gain by the employee. The relevant principle is that a contribution to capital is not income—Proposition 7. Hochstrasser v. Mayes [1960] A.C. 376 is the case in point.
[4.57] Section 26AAAA(e) does not effect any change in the law. The existence of onerous conditions is clearly relevant to the identifying of the benefit which must be valued.
[4.58] The application of s. 26AAAA is excluded if s. 26AAAB applies: s. 26AAAB(9). Section 26AAAB provides that, in certain circumstances, the amount to be included in assessable income by virtue of s. 26(e) is to be 10 per cent of the annual rental value less any rent paid by the employee. An employee must satisfy one of two sets of conditions in order to enjoy the limitation on the amount to be included in assessable income. The first set of conditions relates to geographic remoteness (subs. (1)(a)), and the second relates to the extent to which an employee is required to live in close proximity to his place of work (subs. (1)(b)). While the provision of residential accommodation in the conditions specified might to a degree be explained as a contribution to capital, it is unlikely to extend to 90 per cent of the value of the accommodation. Section 26AAAB thus, at least substantially, gives privileged treatment to certain employees.
[4.59] Under s. 26AAAB(1)(a), the section will cover the provision of housing where all the following conditions are met:
It will be noted that the matters of remoteness, custom, an arm’s length relationship and absence of an agreement to obtain a benefit are matters of fact. Necessity is a matter of the Commissioner’s opinion.
[4.60] In contrast with s. 26AAAA, s. 26AAAB(1)(a) closely defines, in s. 26AAAB(10), the areas that will meet a condition of remoteness. Remoteness for purposes of s. 26AAAA is not defined in terms of areas: it is enough that the housing “is situated in a place that is remote from a major centre of population” (s. 26AAAA(a)).
[4.61] With respect to s. 26AAAB(1)(a)(iv)(c) it is hard to see how the fact that subsidised accommodation is “customary” can ever necessitate its provision. Perhaps industrial action by the employee taxpayers in support of the custom may make such provision necessary, though it would be odd if tax consequences depended on the propensity to strike. And the fact that a taxpayer employee has demanded the provision of subsidised housing—as opposed to, say, a rent allowance—may raise the inference that the employer and the taxpayer were not dealing with one another “at arm’s length” and that the provision of subsidised housing was made “in pursuance of an agreement that was entered into … for the purpose, or for purposes that included the purpose, of obtaining for the taxpayer the benefit of the application of [s. 26AAAB]”, in which events s. 26AAAB(1)(a)(v) may operate to deny the limitation on the amount to be included in assessable income otherwise set by s. 26AAAB.
[4.62] The other set of conditions which, if satisfied, will attract the operation of s. 26AAAB to limit the amount to be included in assessable income in respect of housing provided by the taxpayer’s employer, are set out in s. 26AAAB(1)(b). The conditions, all of which must be satisfied are:
It will be noted that the existence of a custom, the provision of accommodation for not fewer than five other employees, an arm’s length relationship and the absence of an agreement to obtain a benefit are matters of fact. The other conditions involve the formation of an opinion by the Commissioner. Again there is an anti-avoidance provision which might be thought to be attracted where there has been industrial action in support of the custom.
[4.63] The possibility was explored, in [2.15]-[2.16] above, that a right to buy goods or services at a discount might be treated as itself an item of income, as the share options were treated in Abbott v. Philbin [1961] A.C. 352 and Donaldson (1974) 74 A.T.C. 4192. It is not easy to see why a right to shares is different from a right to goods or services, unless the right to shares gives an interest in the shares. Abbott v. Philbin did not, however, insist that the options should give such an interest, if they are to be regarded as an income item. Where the right is to goods or services, the analysis relied on by Lord Denning (dissenting) in Abbott v. Philbin is, presumably, appropriate, and there will be a derivation of income at the time of the exercise of the right. That analysis would say that the employee has a contractual right that the employer will maintain an offer to sell to the employee at the promised discount. Such a contractual right is different from the right expressed in an option. The contractual right to buy goods or services at a discount has its parallel in a contractual right that the employer will keep standing an offer to grant options over shares.
[4.64] On this analysis of the employee’s right to acquire goods or services at a discount, there can, consistent with Abbott and Donaldson, be a derivation of income at the time of exercise by the employee of his contractual right. The item of income will be the goods or services obtained by the taxpayer, so far as they represent a gain. They will represent a gain, and will be income, in the amount of the difference between the value of them to the taxpayer, and the amount he outlaid in buying them. If the discount given by the employer is no more than the discount that the taxpayer might have obtained outside the employment relationship, there will be no gain and thus no income.
[4.65] The approach taken above, in terms of Lord Denning’s analysis in Abbott v. Philbin, obviates problems that would arise if the approach adopted were to treat as income the right to the supply of goods or services. However, treating the actual supply of goods or services as the derivation by the employee, must create great difficulties of administration and compliance. Records of the use made of the staff canteen by a particular employee will not be kept, though some record might be available of the use of the executive dining room. Detailed records of “in-house” discounts received by employees of a retail store, are unlikely to be kept. Perhaps, in this case, the discount does not amount to a benefit because like discounts may be available to the employee elsewhere. At some point, however, the equity of the income tax is seriously impaired if discount privileges are ignored. The subsidised travel available to employees in the travel industry may involve substantial benefits. Industrial action is sometimes directed to securing that employees are able to obtain supplies at levels of discount which involve substantial benefits. The assumption is that the availability of such benefits offers an opportunity for tax evasion that will not be challenged.
[4.66] Cooke and Sherden (1980) 80 A.T.C. 4140 involved an attempt by the Commissioner to bring to tax the value to the taxpayer of a holiday provided without cost. The attempt failed because s. 26(e) was held not to be applicable. The case at once emphasises the inequity that arises from the sole operation of the ordinary usage principle of realisable value and illustrates the need to give s. 26(e) a wider operation.
[4.67] The low interest loan is a widely available fringe benefit to employees. It may also be a benefit given in a business situation where, as in Cooke and Sherden, the benefit is not a reward for services. In the latter situation the benefit will go untaxed, assuming that it is not possible for the taxpayer to make the loan available to another person. Where the loan is provided as a reward for services, s. 26(e) is available to the Commissioner, though fixing the manner of operation of the provision may involve difficulties of analysis.
[4.68] Where the loan is for a fixed term and at a fixed rate of interest, it could be argued that there is a derivation of a benefit at the time of the granting of the loan, the amount of income being the present value of the savings of interest apparent on a comparison of the interest charges with those that would have been made for an arm’s length loan. If this is the correct operation of s. 26(e) in the fixed-term fixed-interest loan situation, there will be an unacceptable bunching effect. An operation for s. 26(e) which treats the saving of interest as it occurs as the income derived is more convenient. At least in the case of a loan where the lender may vary the interest rate, it is probably the correct operation.
[4.69] There is a question of how the saving of interest is to be determined. The fixed-term fixed-interest loan may have been made at a commercial rate. There should not be held to be any benefit in the saving of interest, should the prevailing commercial rate for such a loan increase. Where a fixed-term fixed-interest loan has been made at a rate less than the prevailing commercial rate, there is a benefit by way of saving of interest. But that saving should not be regarded as any more than what may appear from a comparison of the rate set by the loan, and the prevailing commercial rate for such a loan at the time the loan was granted. In such a case there will be some testing of the principle adopted, if the prevailing commercial rate falls below the rate at the time the loan was granted.
[4.70] Where the lender has power to vary the interest rate, the interest saving may fairly be regarded as the difference between the rate in fact charged in the year in question by the lender, and the prevailing commercial rate.
[4.71] There are evident problems in fixing the relevant prevailing commercial rate. This and the other difficulties adverted to above may indicate that s. 26(e) is not adequate to deal with fringe benefits in the form of interest savings. The difficulties will be multiplied if the financial circumstances of the taxpayer are held relevant to the determination of the “value to the taxpayer”. A taxpayer may assert that he would never have borrowed as much as he did if the low rate of interest had not been offered to him. It may be that there is need of specific provisions to deal with interest savings, provisions that must be arbitrary to a degree.
[4.72] An employer may meet directly the expenses of education of an employee’s children. There is a benefit derived by the children, but the circumstances will not give the benefit an income quality in their hands. There may be a benefit to the employee in the form of meeting of expenses which he would otherwise have met himself.
[4.73] In some circumstances it will be arguable that there is no income because there is no gain to the employee. The apparent benefit did no more than spare the employee an outgoing he would have incurred in furthering the interests of the employer. The circumstances envisaged would involve the acceptance of employment in a remote place where adequate schooling is not available, on condition that the employer will meet the expenses of boarding the employee’s children at school. Any benefit received by the employee could be seen as a contribution to capital within Proposition 7. The relevant authority is Hochstrasser v. Mayes [1960] A.C. 376.
[4.74] The same analysis might be applied to the direct provision of fares by an employer, where the employee and his family go on home leave from some remote place of employment. It is assumed that there is an agreement with the employee that fares will be provided in this way. A prior agreement assists the characterisation as a contribution to capital, though it may not be essential.
[4.75] An employer may meet directly the expenses of the employee’s own education, for example in a trade or professional course. Again it is arguable that there is no gain to the employee and the payment by the employer is a contribution to capital. This may involve treating the advantage of education in the way in which the value of a meal is treated where the employee entertains a client of his employer. Any benefit to the employee is seen as a condition of his employment and not a gain recognised by the income tax. The contribution to capital principle has an operation independent of the availability of a deduction to the employee, had he met the expense himself. A want of correlation between a non-income conclusion in regard to the benefit, and deductibility had the employee met the expense himself, suggests tax planning to ensure that the education is paid for by the employer. Section 82A, it will be seen in [8.52] upsets correlation in regard to expenses of an employee’s education by requiring that the first $250 of “self education” expenses must be treated as rebatable expenditure (which may not give rise to any tax relief), and is not deductible under s. 51.
[4.76] Where the education of the employee furthers not the employer’s purpose but the purpose of the employee, there will be income to the employee by the operation of s. 26(e). Where there is only an incidental element of employee’s purpose, the predominant purpose of the payment should govern, in line with the view that the characterising of a benefit as a product of employment should follow its predominant purpose. Section 82A aside, correlation with the treatment of expenses incurred by the employee himself is probably preserved by a principle whereby the whole of self-education expenses must be subject to a single characterisation as deductible or not deductible, and, despite the words “to the extent to which” in s. 51, no apportionment is proper. That principle excludes an apportionment where there are two purposes served by an expense and a distinct payment could not have been made to serve each purpose. It is considered in [6.28], [8.16], [8.51], [8.85] and [9.11] below.
[4.77] An employer may meet directly the travel and entertainment expenses of his employee. The appropriate treatment of any benefit to the employee would follow the analysis just attempted in regard to self-education expenses. The benefit of travel or entertainment may be a condition of employment.
[4.78] Section 51AB was added to the Assessment Act in 1974. Its effect is to deny a deduction to the employer, of expenses to secure or maintain the membership of a club for an employee, and of some like expenses. The section will deny a deduction by the employee where he meets the expenses himself. The operation of the section where the employer meets the expenses may be to deny a deduction to the employer, and yet leave the employee subject to tax on the ground that there is a benefit to him which is income under s. 26(e).
[4.79] Where money is made available to an employee on condition that he vouch his expenses and return any surplus, the money should be treated in the same manner as the direct provision of travel and entertainment would be treated. Where the travel and entertainment are predominantly in serving the employer’s purposes, there is no gain to the employee: the money is a contribution to capital. A reimbursement of such expenses would be treated in the same manner. It may be argued that the money is an “allowance”, and is made income by s. 26(e). The argument in reply is that the word should be given the meaning that it has in the context of the other associated words in s. 26(e)—“gratuities, compensations, benefits, bonuses and premiums” (Mutual Acceptance Co. Ltd (1944) 69 C.L.R. 389, per Dixon J. at 402–403). In that context money provided subject to obligations to vouch, and if necessary refund, is not an allowance. The expenses of the employee in these circumstances will not be outgoings within s. 51(1) and no question of deductibility will arise.
[4.80] Where money is given, but vouching and return of surplus are not required, the money is an allowance that is income. The employee may be entitled to deductions which will produce the same result, in terms of taxable income, as in the cases of an allowance subject to vouching and return of surplus, and direct provision of travel and entertainment.
[4.81] Section 26(ea) has provisions, relating to a member of the Defence Force, which parallel some of the provisions of s. 26(e). It would appear to be a survival in part of an earlier provision that included a proviso by which a money limit was imposed on the value of allowances in kind “that would be income”. As it now stands, s. 26(ea) has no function that is not performed by s. 26(e), unless it is construed to extend in its operation to amounts excluded from the operation of s. 26(e) by subparas (i) and (ii) of s. 26(e). Section 26(ea) does not, in terms, except an eligible termination payment within the meaning of Subdiv. AA of Div. 2 of Pt III, or an amount to which s. 26AC or s. 26AD applies. There is left a question of the correlation between s. 26(ea) and those provisions. A correlation might be achieved by limiting the meaning of “allowances” in s. 26(ea), but the meaning for the word that would achieve this result is not evident. Another correlation would involve treating Subdiv. AA and ss 26AC and 26AD as codes that displace s. 26(ea).
[4.82] Section 26AAC has already been the subject of comment in [2.25], [2.35], [4.20]–[4.21] above. Where the section applies, s. 26(e) is excluded. The section concerns rewards for services, but it does not adopt the test of “value to the taxpayer” provided for in s. 26(e).
[4.83] There are some consequences. Where an option is acquired, under a scheme of the kind with which the section is concerned, and it is disposed of to a person who is not an associate of the taxpayer, there is an item of income derived by the taxpayer in the amount of the consideration received, less the amount paid or payable by the taxpayer as consideration for the right. If s. 26AAC had not been applicable, the value to the taxpayer of the option at the time of the grant of the option would have been income. The amount may have been more than the amount realised on the disposition of the option. Where the employee has acquired shares under the scheme, their “value”, less the costs of the taxpayer’s acquisition of the shares, will be income. This value will be determined at the time the shares cease to be subject to restrictions or are disposed of by the taxpayer. “Value” for this purpose may differ from “value to the taxpayer” under s. 26(e), for reasons not concerned with the differences in times of derivation. How much the difference in value may be, in each of the circumstances referred to, will depend on the extent of the restrictions affecting the options or continuing to affect the shares at the time of disposition. It will also depend on the taste and economic circumstances of the taxpayer, and any special knowledge [?] have, if those factors are relevant in fixing a “value to the taxpayer”.
[4.84] From the discussion of s. 26(e) above, it will be evident that s. 26(e) does not depart from the principle that the character of an item as income must be judged in the hands of the person who derived it. Section 26AAC(1)(b) does depart from the principle. More important are the departures from the principle made in Div. 6 (Trusts) and Div. 9B (Superannuation funds) of Pt III.
[4.85] Section 26AAC applies in relation to the acquisition of a right to shares, or to the acquisition of shares, by a person under a scheme for the acquisition of shares by employees. The person who acquires may derive income, notwithstanding he is not the employee who has furnished the consideration by rendering services. By section 26AAC(1)(b), it is enough that a relative of the person who acquired the right or the shares performed the services.
[4.86] The operation of Div. 6 in applying special notions of derivation has already been explained in [4.26]–[4.30] above. The income quality of what is imputed as derived by a beneficiary, because of his “present entitlement” to what is income by trust law, or the income quality of what is imputed as derived by the trustee because of the want of derivations by beneficiaries, is determined by reference to the circumstances of the hypothetical taxpayer referred to in s. 95—the trustee “as if he were a taxpayer”. The definition of “net income” in s. 95 calls for a calculation of income and the subtraction of deductions, made on the assumption that the trustee is a taxpayer. Sections 97–99A provide for the imputing of derivations of that net income by beneficiaries in proportions determined by their interests in trust law income, and, as to any surplus, the imputing of derivation by the trustee in his capacity as trustee. The income quality of what is imputed as derived by beneficiaries and trustee is determined by the circumstances of the person who is the trustee “as if [he] were a taxpayer”. The hypothesis might have been expressed in the words “as if [he] had derived beneficially”. The hypothesis thus supplies the element of gain that is identified in Proposition 4 as a necessary requirement for an item to be income. Section 95 does not, however, attribute to the hypothetical person the qualities the trustee has in his own right. Thus it will be seen in [13.74]ff. below that where the trustee of a share in a partnership is in his own right a partner but not a trustee, the character of partner is not attributed to the hypothetical person.
[4.87] The circumstances of derivation by the beneficiary under s. 97 or s. 98, or by the trustee under ss 99 or 99A, need not be examined for aspects which would give what is derived the character of income in his hands. Those circumstances might in fact give an income quality, for example, to interest or rents to which the beneficiary has an immediate beneficial entitlement, or to a receipt by a beneficiary under an annuity which the trustee is bound to pay. But they would not in general give an income quality to a distribution made by the trustee to a beneficiary in the exercise of a discretion given to the trustee.
[4.88] Where the circumstances of derivation by the beneficiary would not give an income quality to what is derived, or where there is no derivation by a beneficiary, Div. 6 has the effect of bringing to tax gains which would otherwise go untaxed. Div. 6 should therefore not be given a narrow operation. Some observations in the Federal Court in Everett (1978) 78 A.T.C. 4595 may suggest that the words “trust estate” in s. 95 require that there should be property vested in the trustee from which the gains are derived, if they are to be brought to tax under the Division. The view was expressed above in [2.233] that the reference to “trust estate” should be regarded as a reference to a tax accounting entity which transcends the person who may be trustee for the time being. The word “estate” is not used in any sense which requires that property be vested in the trustee. But the gains derived by the trustee must be derived in circumstances which would give them an income character if they were derived by the trustee beneficially. Under an assignment of a mere expectancy, if it is effective, the assignor becomes trustee of the item assigned when it comes into existence. The assignment may be of future salary. The assignor becomes trustee of a present right to receive salary when that right comes into existence. He is trustee for the assignee. The arising of the trust is a constructive receipt, within ordinary usage notions of derivation, or s. 19, by the assignor, so that the salary is at that moment his income. But the salary will not be income of the hypothetical person—the trustee, in this case the assignor, as if he were a taxpayer—about whom the s. 95 calculation is made. The assignor has not, as trustee, performed services which would give an income quality to his receipt as trustee. His receipt as trustee is a receipt of corpus. The matter is further considered in [13.9]ff. below.
[4.89] On the other hand, services performed by a trustee as trustee, for example in carrying on a business included in the estate of a deceased person, will give an income character to a receipt which is a reward for those services when the calculation required by s. 95 is made.
[4.90] Section 101A, in the special circumstances of a receipt by a trustee of the estate of a deceased person of “any amount which would have been assessable income in the hands of the deceased person if it had been received by him during his lifetime”, requires that the amount be treated as income derived by the hypothetical person about whom the s. 95 calculation is made. The amount will fall to be taxed under s. 99 or s. 99A.
[4.91] The combined operations of s. 101A and s. 95, in relation to the requirement that income quality must be judged in the hands of the person who derives, become complex. Section 95, for purposes of the calculation required by that section, supplies the element of beneficial derivation. Section 101A supplies other elements which may give the character of income to the receipt, by imputing to the trustee’s derivation the circumstances that would have attended a derivation by the deceased. The extent of this imputation remains a matter of some doubt. Where the deceased had at the time of his death taken all the action that would have brought about an income derivation by him had the final element of derivation been satisfied, s. 101A must operate to impute all that action to the trustee. But where some action is taken by the trustee or by other persons—for example, the partners of the deceased as in Single (1964) 110 C.L.R. 177—there is a question whether that action may be added to the action imputed to the trustee. Where the action taken by the trustee is itself enough to supply circumstances which will give an income quality to the receipt by the hypothetical person in s. 95, there will be income for purposes of s. 95 without the aid of s. 101A. Where it is not, the question is whether the action taken by the deceased and the action taken by the trustee may be added together. Where the further action is taken by other persons, for example partners of the deceased who complete a matter uncompleted at the time of death, a like question arises. These matters are further considered in [11.66]ff. and [11.150]ff. below.
[4.92] Section 99B stands outside the general operation of Div. 6. Subject to some qualifications, it gives an income quality to a derivation of property of a trust estate by a beneficiary, the derivation being a payment to him of that property, or an application of it for his benefit. The qualifications involve some logical impossibilities which courts will need to tolerate. Thus, one qualification excludes an amount “that is or has been included in the assessable income of the beneficiary in pursuance of s. 97”. It has been explained above that what is income derived by a beneficiary under s. 97 involves an imputed derivation of part of an amount that is derived by the hypothetical person in s. 95. This imputed derivation calls on the actual entitlement of the beneficiary to trust law income of the trust, in fixing the part of the amount derived by the hypothetical person that is to be imputed. It is only by some breaking through the barriers of logic, that property in fact paid to a beneficiary by the trustee can be said to represent an amount included in the income of the beneficiary under s. 97.
[4.93] Division 9B, in providing for the taxing of the receipts of superannuation funds and ineligible approved deposit funds, as defined in s. 121B, in the hands of the trustees of those funds, uses the same technique as Div. 6. Division 9B was considered above in [1.16]–[1.23]. The element of beneficial receipt which will give the quality of income to receipts by the trustee which are otherwise income, is supplied by the hypothesis that the trustee is a taxpayer. The relevant provisions are s. 121B in the definition of “investment income”, s. 121D, s. 121DAA and s. 121DAB. These provisions are further considered in [4.166]ff. below. One observation might be made here. In defining “investment income”, s. 121B expressly excludes contributions to the fund. It thus appears to assume that contributions to a superannuation fund will be income of the hypothetical person. The only relevant positive principle would be the periodical receipts principle (Proposition 11), but that principle would not be thought to be satisfied.
[4.94] In any case, the hypothesis that the trustee derives beneficially does not deny the actual obligations on the trustee imposed by the contributor in making the contribution, obligations which attract the contribution to capital principle (Proposition 7) and deny any income quality that might otherwise have been given by the periodical receipts principle.
[4.95] The prospect that the periodical receipts principle, and, indeed, the gains from property principle and the compensation receipts principle, may in their operations defeat the principle that gain is an essential quality of income has been raised on a number of occasions in this Volume. The operation of the undeducted purchase price provisions of s. 27H in achieving some saving of the principle from that defeat is considered in [2.215] above and [4.106]ff. below.
[4.96] The provisions of Div. 6 (trusts) and Div. 9B (superannuation funds and ineligible approved deposit funds) considered under the last heading ([4.86]-[4.94] above), involve tax to a trustee on an amount which does not involve gain. In the case of a trust which is not a superannuation fund or deposit fund, there is income of the trustee as trustee to the extent of the whole or part of the amount calculated as provided in s. 95 on an assumption that the trustee derives beneficially. The amount of income of the trustee is the amount remaining after allocations of the s. 95 amount to beneficiaries who have present entitlements to trust law income, or have deemed present entitlements by the operation of s. 95A(2) or s. 101. The operation of Div. 9B is considered in [4.166]ff. below and in [1.10]-[1.23] above.
[4.97] In the treatment of the principle of mutuality in [2.45]ff. above the effect of ss 119 and 121 in displacing that principle is explained. Section 119 makes income certain of the receipts of a co-operative company as defined in s. 117. Section 121 makes income premiums derived by an association formed for the purpose of insuring members of the association “against loss, damage or risk of any kind in respect of property”. To the extent that the principle of mutuality would otherwise have applied to these receipts and premiums, ss 119 and 121 displace the principle that gain is an essential quality of income. The principle of mutuality is a particular application of the principle of the ordinary usage meaning of income that asserts that gain is an essential quality of income.
[4.98] The possible effect of s. 26(g) in extending the ordinary usage meaning of income, so as to displace the negative proposition that a contribution to capital is not income, is the subject of comment in [2.131] above.
[4.99] Two provisions of the Assessment Act—ss 26(e) and 26(g)—might have been given a construction that would have extended the ordinary usage meaning of income so as to displace, in some degree, the negative proposition that a “mere” gift does not have the character of income.
[4.100] Section 26(e) might have been construed to include gains associated with the performance of services which are not, within the ordinary usage notion, “products” of those services. The discussion of s. 26(e) in [2.367] above and in [2.373] above indicates that the section has not been given such a construction.
[4.101] Section 26(g), which relates to “any bounty or subsidy received in or in relation to the carrying on of a business”, could be construed so as to include gains related to the carrying on of a business which bear a more tenuous relationship than is required by the ordinary usage notion of income, which extends only to items which are products of the business as illustrated in Squatting Investment Co. Ltd (1954) 88 C.L.R. 413. There is no decision that it will be so construed. The construction of s. 26(g) is the subject of some observations in [2.131].
[4.102] The effect of s. 25A and s. 26AAA in displacing to a degree the negative proposition (Proposition 10) which sets, in some respects, the scope of the principles which make up the ordinary usage meaning of income, was referred to in [2.166]-[2.171] above. Those sections are the subject of close examination in Chapter 3 above.
[4.103] In a number of its provisions the Assessment Act allows deductions for what is capital expenditure which would not be deductible under s. 51, in respect of the cost of property used in producing income. Thus the depreciation provisions, ss 54–62, allow deductions in respect of expenditure on items which are plant or articles used for the purpose of producing income, plant for this purpose including certain structural improvements. Other provisions are concerned with capital expenditure in general mining activities (Div. 10 of Pt III), capital expenditure in relation to the transport of certain minerals (Div. 10AAA of Pt III), capital expenditure in relation to petroleum mining (Div. 10AA of Pt III), capital expenditure in respect of timber operations (Subdiv. A of Div. 10A of Pt III), capital expenditure in respect of timber mill buildings (Subdiv. B of Div. 10A of Pt III) and capital expenditure in respect of commercial or industrial property (Div. 10B of Pt III). In all these provisions there will be found a section which is directed to bringing in as income an amount received on disposal of the item of property, so far as the amount exceeds the capital expenditure after subtracting the amounts that have been allowed or were allowable as deductions. In a sense these sections extend the concept of income under the Act into the field of capital gains. But their function is only to reverse the allowance of the deductions, where the expenditure has been recouped by the consideration received on disposal. The sections are confined to this function by express provisions which limit the amount that is income to the amount of the deductions allowed or allowable. To the extent that the consideration received on disposal exceeds the capital expenditure, it cannot be income. The sections which provide for bringing in consideration received on disposal are s. 59 (depreciation provisions), s. 122K (general mining), s. 123C (transport of minerals), s. 124AM (petroleum mining), s. 124G (timber operations) and s. 124P (commercial or industrial property).
[4.104] Section 26AAB, inserted in the Act in 1980, in its terms makes income a profit on the sale of a motor vehicle which has been the subject of a lease to the taxpayer or his associate, and has been acquired by the taxpayer from the lessor. The profit—the difference between the cost on the acquisition and the consideration receivable in respect of the disposal—would in many instances be a capital gain, and the section thus, on its face, extends the concept of income under the Act into the field of capital gains. The function of the section, like the function of the other sections referred to in the last paragraph, is, however, only to reverse the allowance under s. 51 of deductions for charges paid by the lessee under the lease where those charges have been recouped by the profit on the acquisition and disposal of the item. Section 26AAB(2), in the calculation of the amount of the profit that is income, confines the function of the section in this way.
[4.105] To the extent that the section makes income what is a recoupment of a deduction allowed not to the taxpayer, but to an associate as defined in the section, there is some departure from the principle of the ordinary usage meaning that the quality of income must be judged in the circumstances of its derivation by the taxpayer.
[4.106] Attention has already been directed, in [2.215]-[2.223] above, to the contribution s. 27H, in its deductible amount provisions, may make to protecting the principle that gain is an essential quality of income, and to the problems that may arise in identifying the “undeducted purchase price” from which the deductible amount will be calculated. Attention has also been directed to the question of correlation between the provisions of s. 27H and the periodical receipts principle. That problem has been made more difficult by the words added to s. 25(1) in 1984, from which an inescapable conclusion must be drawn that s. 27H cannot displace the ordinary usage principle of periodical receipts. The consequence would be that the deductible amount by which the amount of an annuity that is taxed under s. 27H is reduced, is income subject to tax as ordinary usage income under the periodical receipts principle.
[4.107] There are other problems of correlating the provisions of s. 27H and the business receipts principle. In this instance a conclusion that s. 27H does not displace the ordinary usage principles would be accepted. A person who is engaged in a business of dealing in mining rights may sell mining rights for amounts to be paid periodically in respect of each ton of ore obtained in working the mining rights during a fixed period of years. The amounts, it is assumed, are income as an annuity. The business receipts principle would direct that the proceeds of sale, less the cost of the mining rights, are income. Section 27H would direct that the annuity receipts are income as each is received less an appropriate part of the purchase price of the annuity, which, in this instance, would be the value of the mining rights—not their cost—at the time of their sale for the annuity receipts. There are tax accounting problems in relation to the operation of the business receipts principle in this context. One question would be whether the trading stock provisions apply, in which event J. Rowe & Son Pty Ltd (1971) 124 C.L.R. 421 would be relevant though it would not dictate the method of accounting. If the mining rights are not trading stock, profit accounting would be applicable. But whatever method of accounting were applicable, there is no obvious way of correlating the business receipts principle and s. 27H, except by denying the operation of the section. There could be room for s. 27H only if the transaction is regarded as two transactions: a sale of the mining rights for the value of the annuity, and the application of that value in the purchase of the annuity. There would be like problems of correlation if the mining rights had been acquired and sold in circumstances that attracted the operation of s. 25A(1) or s. 26AAA.
[4.108] The deductible amount provisions of s. 27H, taken with the definitions of “undeducted purchase price” and “purchase price” in s. 27A(1), are more complex than the provisions of s. 26AA which s. 27H replaced. The “purchase price” in relation to a pension payable from a superannuation fund (which is an annuity for purposes of s. 27H) is the sum of contributions made by any person to the superannuation fund—which will include contributions by an employer of the taxpayer—to obtain superannuation benefits consisting only of the superannuation pension, and so much as the Commissioner considers reasonable of contributions made by any person to the superannuation fund to obtain superannuation benefits including the pension payable from the fund. In relation to an “eligible annuity”, which includes any immediate annuity not payable from a superannuation fund, the purchase price is the sum of payments made solely to purchase the annuity, and so much as the Commissioner considers reasonable of payments made to purchase the annuity and to obtain other benefits. There is no definition of purchase price for purposes of a deferred annuity unless it is a “roll-over annuity”—one purchased in the rolling-over of an eligible termination payment by the exercise of an election given to the taxpayer by s. 27D—or an annuity payable under a superannuation policy within the meaning of Div. 8.
[4.109] The definition of “undeducted purchase price” must be read against a background of other provisions of Subdiv. AA of Div. 2 of Pt III, more especially ss 27B, 27C and 27D examined in [4.138]ff. below. It will be noted that the definition of “undeducted contributions”, the comparable provision concerned with the operation of ss 27B and 27C which tax distributions from superannuation funds that are not annuities, does not extend to contributions before 30 June 1983. The “undeducted purchase price” definition does not make separate provision in regard to the purchase price of a superannuation pension and the purchase price of another annuity. It is only by recalling the distinction drawn in the definition of “purchase price” that the appropriate areas of operation of the definition of undeducted purchase price can be determined. Thus the “undeducted purchase price” of an annuity purchased by the roll-over under s. 27D of some part of the amount of an eligible termination payment is not confined to the contributions made to the superannuation fund in respect of the distribution that is rolled over. The undeducted purchase price is the amount rolled over, though under s. 27D the taxpayer might specify that his roll-over is of that part of the eligible termination payment that represents the undeducted contributions to the fund.
[4.110] One common thread in the undeducted purchase price provisions and in the undeducted contributions provisions, is that the purchase price or contributions must not be allowable deductions. In the case of contributions to a superannuation fund or a purchase price of an annuity, paid prior to 1 July 1983, there is a further requirement that the contributions or purchase price must not be rebatable amounts under s. 159N or be amounts in respect of which a rebate of income tax has been allowed.
[4.111] The undeducted purchase price of an annuity acquired by payments that involve the roll-over of the whole or part of an eligible termination payment cannot include an amount rolled over that would have been taxed under s. 27B if there had not been a roll-over. Such an amount will not include the undeducted contributions in respect of that amount. Undeducted contributions are excluded by s. 27B(1) from the amount taxed under that section. The amount of the undeducted contributions may itself be rolled over under s. 27D, and there may be distinct roll-overs of amounts that would otherwise be taxed under s. 27C(1), and “concessional components” that would otherwise be taxed under s. 27C(2). In all instances other than an amount that would have been taxed under s. 27B had there not been a roll-over, the amount rolled over will be the “undeducted purchase price” of the annuity.
[4.112] A possible operation of s. 262 which would give the Commissioner power to attribute the quality of income to “periodical payments” was considered in [2.224]-[2.225] above.
[4.113] The effect of s. 26AB in providing that a premium is income in specified circumstances is considered above in [2.302]–[2.308]. The view expressed is that s. 26AB does not deny the character of income to a premium in other circumstances, if it would be income within the ordinary usage principles either as a gain derived from property or as a business gain.
[4.114] The meaning of royalties as the word is used in s. 26(f), and the effect of that provision in possibly extending the meaning of income in the Act beyond the ordinary usage notion of income derived from property, is the subject of comment in [2.309]–[2.366] above.
[4.115] At the time of the decisions in McCauley (1944) 69 C.L.R. 235 and Stanton (1955) 92 C.L.R. 630 the Assessment Act contained no definition of “royalty”. Those cases proceeded by the fixing of a meaning for the word royalty and an examination of the facts to see if the amounts derived were within that meaning. Whether the amounts might be income as income derived from property, within the ordinary usage meaning of income, was not considered. Nor was any consideration given to the question whether the effect of s. 26(f) is to extend the meaning of income beyond ordinary usage.
[4.116] The meaning given to “royalties” in s. 26(f) unaided by any definition would not appear to take the meaning of income under the Act beyond its ordinary usage meaning. However, Mason J. in Sherritt Gordon Mines Ltd (1977) 137 C.L.R. 612 at 626 appeared to be of the view that “royalties” covers payments by the owner triggered by the use by the owner of property that has been wholly transferred to that owner. It is not finally settled that such payments are income of the transferor within the ordinary usage meaning of income derived from property, though the view taken in this Volume would be that they are. There remains the possibility that the phrase “by way of royalties”, as distinct from the phrase “as royalties”, may give an extended meaning to income. But there is no decision on the effect of that phrase other than Stanton, which must be taken to have decided that the receipts there in question were neither receipts “as royalties” nor “by way of royalties”. Sherritt Gordon Mines Ltd (1977) 137 C.L.R. 612 is a decision on the meaning of the word “royalty” in the phrase “consists of royalty” in s. 6C. It does not offer any assistance in deciding when an item may be said to be received “by way of royalties”. Aktiebolaget Volvo (1978) 78 A.T.C. 4316 is also a decision on the meaning of the word in the phrase “consists of royalty”. It does not decide that the receipts there in question could not be said to be receipts “by way of royalties” and thus income under s. 26(f). The phrase “by way of royalties” may extend the operation of s. 26(f) so that it includes receipts triggered by the use of know-how supplied to the payer, as in Sherritt Gordon Mines, or receipts triggered by the exercise of a right where the whole bundle of rights of which it is a part have been acquired from the taxpayer by the payer. In neither case, however, would s. 26(f) appear to have extended the meaning of income beyond the ordinary usage notion of income derived from property. The view taken in [2.352]–[2.355] above is that receipts triggered in these ways are within the ordinary usage meaning of income.
[4.117] Since the decisions in Stanton and Macauley a definition of “royalties” has been added to the Assessment Act. As at first drafted the definition was held, in Sherritt Gordon Mines, to have a narrow meaning resulting from the fact that the definition involved an incorporation by reference from the United Kingdom-Australia double tax agreement. As re-drafted, and after further re-drafting in an endeavour to overcome interpretation by Jenkinson J. in Aktiebolaget Volvo, the definition extends the meaning of the word “royalties” so that it embraces items which would not otherwise be regarded as described by the word, though it might be thought to remain inadequate to overcome what Jenkinson J. saw as a deficiency in the drafting: it does not cover an item that has accrued but has not yet been either paid or credited. The matter is considered in [4.13]–[4.14] above. It should be noted that the definition does not when taken with s. 26(f) make any item income that would not otherwise be income. Section 26(f) is drafted so that items received as or by way of royalties as defined, which are not received as or by way of royalties as the word is interpreted in McCauley, Stanton and Sherritt Gordon Mines, are not within the operation of s. 26(f), unless they are income by ordinary usage.
[4.118] How far the items listed in the definition of royalty in s. 6 are income by ordinary usage will depend on the principles explored in dealing with Propositions 11 (periodical receipts), 12 (gains from property), 13 (rewards for service), 14 (business gains) and 15 (compensation gains). Where a payment or credit is one of a series, the item is more likely to be income. The definition, however, extends to items “whether the payment or credit is periodical or not”. A single sum for an exclusive licence giving the “right to use” a “copyright, patent, design or model, plan, secret formula or process, trademark, or other like property or right”, is included by para. (a) of the definition. Such a sum will not be income by ordinary usage unless the taxpayer receiving the sum is in business, and the copyright or other property or right is a revenue asset of the business, or the method of calculation of the single sum is such that it is to be regarded as paid for the use of the copyright or other property or right. A single sum for “the right to use” “industrial, commercial or scientific equipment” is included by para. (b) of the definition. Such a sum may be seen as a premium for the property itself, and it will not be income if there is no operation of the business gains principle. Paragraph (c) of the definition covers a single sum “for the supply of scientific, technical, industrial or commercial knowledge or information”. Such a sum may be income in circumstances suggested by the decision in Rolls-Royce v. Jeffrey [1962] 1 W.L.R. 425 and explored in [2.361] and [2.490]–[2.491] above. A single sum for the supply of assistance referred to in para. (d) may be income as a reward for services. Paragraph (e), which will cover a single sum for the right to use motion picture films and like items of property, raises questions parallel with those raised by para. (a).
[4.119] Paragraph (f) was added to the definition following Aktiebolaget Volvo (1978) 78 A.T.C. 4316. It will be recalled that Jenkinson J. declined to express a view on whether the receipts were income, though in that case the receipts were in a series. The inference from Moriarty v. Evans Medical Supplies Ltd [1958] 1 W.L.R. 66 and Murray v. I.C.I. Ltd [1967] Ch. 1038 is that a lump sum received for a keep-out covenant is generally not income. There may be some prospect that it is income as a reward for services, but it may be doubted that it would be so regarded where the effect of the keep-out covenant is to leave the person in whose favour the covenant is given effectively with the exclusive use of property.
[4.120] The principal function of the definition in s. 6 is to expand the items given an Australian source by the operation of s. 6C. That section applies to “income” that “consists of royalty”. Section 6C has no function to make any item income.
[4.121] Section 26(i) makes income “any amount received as or by way of bonus other than a reversionary bonus on a policy of life assurance”. There is no judicial interpretation of the word “bonus” where first used in s. 26(i). If it refers to a bonus in the sense of additional remuneration paid to an employee, the paragraph confirms the ordinary usage principle in relation to rewards for services, and repeats the confirmation in s. 26(e). The word clearly includes a bonus in the sense of a payment before maturity to the holder of a life insurance policy. The operation of s. 26(i) in this regard would confirm the ordinary usage principle in regard to gains derived from property.
[4.122] The exclusion of a reversionary bonus on a policy of life assurance raises several questions. “Reversionary bonus” may refer to a bonus which is payable only on the maturity of the policy. Such a bonus, though added during the currency of the policy to the sum assured, would not be income under the gains from property principle until maturity of the policy and receipt by the taxpayer. Section 26(i) may have the effect of excluding such a bonus from income when received in money on maturity. It will have this effect if the paragraph is interpreted in the manner adopted by the majority in Reseck (1975) 133 C.L.R. 45 in relation to s. 26(d). The question of the effect of the words added to s. 25(1) in 1984 is, however, raised. Section 26(i) could not exclude from income an amount that is expressly made income by the provisions of s. 26AH, a section added to the Act in 1984 but prior to the addition of the words to s. 25(1). Section 26AH makes income specified fractions of bonuses received under a life insurance policy within 10 years of the commencement of the risk under the policy. Section 26AH appears to proceed on the assumption that a bonus has been excluded from income by s. 26(i)—presumably an immediate cash bonus or a reversionary bonus. That assumption could hardly be justified in regard to an immediate cash bonus. The question of the effect of s. 26AH in regard to a cash bonus will also depend on the consequences of the words added to s. 25(1). The combined operation of s. 26(i) and s. 26AH, taken with the words added to s. 25(1), is beyond any rational resolution.
[4.123] “Reversionary bonus” may also include a bonus which may be redeemed prior to maturity. The bonus will normally be redeemable in this way by a payment to the policy holder of an amount less than the amount payable as bonus on maturity. Such a bonus, if redeemed, would be income when redeemed under the ordinary usage principle. If s. 26(i) extends to such a bonus, it may have the effect of excluding the bonus from income whether received in money during the currency of the policy, or on maturity. It will have this effect if the paragraph is interpreted in the manner adopted by the majority in Reseck in relation to s. 26(d). Again, however, the question of the effect of the words added in 1984 to s. 25(1) posed in [2.223], [2.369] and [4.5] above is raised.
[4.124] The background to s. 26(1) is in the decision of the High Court in Peyton (1963) 109 C.L.R. 315, in which it was held that a particular payment by a lessee on the transfer of his lease was not deductible. The payment was the estimated cost of work to carry out repairs which the lessee was bound to effect in order to obtain the consent of the lessor to the assignment. The lease provided that if the lease was transferred before the repairs were effected, the lessee would pay the estimated cost of the repairs to the lessor. The High Court held that the payment was not deductible. It said (at 321):
“But according to the terms of the proviso he became liable to pay the amount upon the licence being transferred, that is to say upon and by reason of the final event in the process by which he ceased to be concerned in the business he had been conducting on the premises. He incurred the loss or outgoing, therefore, not in gaining or producing the assessable income but in parting with the means by which he had been gaining and producing it; not in carrying on the business for the purpose of gaining or producing such income, but in disposing of the business and ceasing thereby to gain or produce such income.”
[4.125] The Act was amended in 1963 by the addition of s. 53AA so as to allow a deduction where a payment is made by way of indemnity, compensation or damages in respect of an obligation to effect repairs. The section operates in circumstances wider than those of Peyton. Section 26(1) is intended to ensure that an amount “referred to in s. 53AA” is income of the grantor of the lease, or of a successor in title.
[4.126] Section 26(1) may be necessary to ensure that the receipt by the lessor is income where the circumstances are those in Peyton. The receipt is in effect a price of the lessor’s consent to the assignment of the lease, and may be regarded as a premium. The question whether a premium is income is considered in [2.297]–[2.308] above.
[4.127] Where the receipt is during the running of the lease and is compensation for the failure of the lessee to effect repairs, it could have the character of income without the aid of s. 26(1) as compensation for an income item in the nature of rent, being the value of the repairs the lessee has undertaken to effect. There may be a general assumption that the value of repairs effected by a lessee under the terms of a lease is not income of the lessor, but it is an assumption for which there is no judicial authority. The determination of the value of the repairs would present problems. Section 26(e) is not applicable and the measure must be realisable value. It is a mark of uncertainty in this area that Div. 4 of Pt III, now of very limited operation, made covenanted improvements by a lessee income of the lessor, but only in the amount of their value at the conclusion of the lease.
[4.128] Sections 44–47 contain a number of provisions by which distributions made by a company, whether as a going concern or in liquidation, are income of its shareholders. The interpretation of those provisions was examined in [2.235]–[2.269] above. Until amendments made in 1967, the courts had tended to limit the effect of the provisions by reading them in a way which would leave them as far as possible consistent with what was thought to be the ordinary usage meaning of income. Thus, in Uther (1965) 112 C.L.R. 630, a receipt by a shareholder in a reduction of capital where the amount received exceeded the amount of capital reduced, was held not to be income in any part under s. 44. The section was held not to make income what was, in ordinary usage language, not a gain derived from the share, but a receipt in partial realisation of the share itself.
[4.129] Sections 44–47, as now drafted, may have effectively excluded these limitations by writing out of the sections any continuing assumptions drawn from the ordinary usage meaning of income.
[4.130] There may, none the less, be room for continuing independent operation of the ordinary usage meaning of income in giving content to the meaning of income under the Act. The question raised is whether Subdiv. D is a code, and as to the scope of that code. The question of the effect of the words added to s. 25(1) in 1984 posed in [4.5] above is, however, again raised. While the added words remain, Subdiv. D cannot be interpreted so as to make it a code.
[4.131] Section 108 deems certain payments or assets distributed by a private company to be dividends paid by the company to the extent that, in the opinion of the Commissioner, they represent distributions of income. Section 109 deems sums paid or credited by a private company to be dividends where they are paid or credited to a person who is or has been a shareholder or director of the company, or a relative of a shareholder or director, if they are by way of remuneration for services, or they are retirement allowances. They will be deemed dividends to the extent that, in the opinion of the Commissioner, they exceed an amount that is reasonable.
[4.132] The sections are probably intended to deal with the character of the items both in relation to deductibility by the company and in relation to whether they are income of the person receiving the payment. But there are deficiencies in the drafting, so far as the character in the hands of the person receiving is concerned. There is an incomplete correlation with s. 44, which gives an income quality to a distribution paid to a shareholder where it is paid “out of profits”. Neither s. 108 nor s. 109 supplies a deeming that the receiver is a shareholder, though that element might be thought to be carried by the deeming of the distribution or amount paid or credited to be a dividend, which is defined in s. 6 as an amount distributed paid or credited to a shareholder. Neither provision deems the distribution or amount paid or credited to be “out of profits”. This aspect was considered in Rutherford (1976) 76 A.T.C. 4304. It is hard to see in what sense a payment can be said to be out of profits, when it is an outgoing in the gaining of profits.
[4.133} The possible use of s. 262 by the Commissioner to separate out and tax an element of interest in a series of payments is considered in [2.284] and [2.289] above.
[4.134] The possible operation of s. 26(e), s. 26(ea), s. 26AAAA and s. 26AAAB, in extending the ordinary usage principle whereby rewards for services are income has been considered in [2.367]–[2.374] and [4.38]–[4.83] above. Section 26(eb) may extend the ordinary usage principle by making an amount income if it is received under an understanding that the taxpayer will resume performing work for a person who is or was his employer, or a person to whom he renders or has rendered services. The more likely view is that s. 26(eb) merely confirms the ordinary usage principle. The amount received is income as a reward for services to be rendered.
[4.135] The effect of s. 26AAC in displacing the operation of s. 26(e) and, presumably, the ordinary usage principles whereby rewards for services are income, was considered in [2.25]–[2.26], [2.35] and [4.20]–[4.21] above. The effect of s. 26AAC in displacing the ordinary usage principle that the character of an item as income must be judged in the hands of the person who derives it, is considered in [4.85] above.
[4.136] Section 26(h) provides that “the amount of any fee or commission received for procuring a loan of money” is income. The paragraph simply confirms the operation of the ordinary usage principle that a reward for services has the character of income. The ordinary usage principle will operate even though the procuring of the loan is a casual act of service.
[4.137] Section 26(h) does not in its terms extend to a fee for giving a guarantee. A fee for giving a guarantee, even though there is only an isolated transaction, will be within the ordinary usage principle. Trenchard v. Bennett (1933) 17 T.C. 420 is authority, though the decision in the case was that the receipt of shares was not a reward for the giving of the guarantee. The taxpayer had guaranteed payment of a dividend by a company and received shares in that company. Finlay J. concluded that the giving of the guarantee was the consideration furnished for the acquisition of the shares, which were a capital asset in the hands of the taxpayer. The reasoning and the conclusion would seem unacceptable. The fact that shares, when acquired, are a capital asset in the hands of the taxpayer, does not make them any the less a reward for services, and income.
[4.138] Subdivision AA of Div. 2 of Pt III has four functions:
The function of Subdiv. AA in relation to annuities and pensions has already been considered in [2.215]–[2.223] and [4.106]ff. above.
[4.139] The function of Subdiv. AA in relation to payments made in consequence of the termination of any employment of a taxpayer and in relation to distributions from superannuation funds are of present concern. Attention is given to the operation of ss 27B and 27C in relation to those elements in the definition of an “eligible termination payment” in s. 27A(1) that are comprised in paras (a) and (b). Sections 27B and 27C and para. (a), it will be seen, include amounts in assessable income, in whole or in part, that would not be income under ordinary usage principles as to the derivation of a reward for services within an employment. These amounts would be distinguished from rewards for services within an employment as being amounts for giving up rights under a contract of service, or for accepting a restriction on one’s capacity to perform services. Sections 27B and 27C and para. (a), in another aspect of their operations, exclude from assessable income, as to some part, amounts that would be income by ordinary usage principles as rewards for services. They thus have including and excluding effects. In their excluding effect, they give tax relief to amounts that had, in a sense, accrued before 1 July 1983, and to other amounts that have accrued at any time and are made under an approved early retirment scheme (s. 27E) or are bona fide redundancy payments (s. 27F) or are invalidity payments (s. 27G).
[4.140] The function of Subdiv. AA in relation to distributions from superannuation funds is to include in assessable income, in whole or in part, amounts that would not be income derived by a member of a fund under ordinary usage principles. Constable (1952) 86 C.L.R. 402, considered in [2.17] and [2.22] above, would have precluded their inclusion in assessable income.
[4.141] Sections 27B and 27C have an exclusive operation in regard to items that are within the definition of “eligible termination payment”. This is the consequence, it has been noted ([4.5] above), of the words added to s. 25(1) in 1984.
[4.142] The justification in policy for the operation of s. 27B and s. 27C in relation to amounts within para. (a) of the definition of “eligible termination payment” that would not be income by ordinary usage, is that they should be seen as rewards for services or compensation for rewards for services. The justifications in policy for the operation of s. 27B and s. 27C in relation to amounts within para. (b) of the definition are several. In treating as assessable income that aspect of a distribution that reflects the contributions an employer has made to the fund, the provisions endorse a view that derivation of the employers’ contributions should not be precluded by the fact that the contributions have moved through a superannuation fund. The employee should, at the time of distribution, be treated as having derived assessable income in the amount of those contributions. Justifications for treating as assessable income distributions which reflect the employee’s own contributions that were the subject of a deduction allowable to him, and the accumulations of income in the fund, are not so easily stated. The justification in relation to so much of the amount distributed as reflects the employee’s own contributions as were the subject of an allowable deduction would assert that the allowable deduction in effect involved a deferral of tax on the derivation of the amount which was the subject of the contribution. That deferral should not be continued when the amount is distributed from the fund. The justification in relation to the accumulated income of the fund is similar. The income of the fund will have been specially treated: it will either have been exempt from tax in the hands of the fund or been given other privileged treatment. The exemption or privilege should be seen as a deferral of tax that should not continue when the amount is distributed. These deferrals of tax are given in the promotion of saving and a distribution is a likely occasion of consumption.
[4.143] The operation of ss 27B and 27C and para. (b) of the definition of “eligible termination payment” is not confined to distributions from a superannuation fund to an employee. Contributions by a self-employed person that are allowable deductions may have been made to a fund by a self-employed person, and the self-employed person have been entitled to a deduction under ss 82AAS and 82AAT, and the fund may have enjoyed privileged treatment.
[4.144] The justifications in terms of withdrawing a deferral of tax when the interest in promoting saving no longer operates, are reinforced by the provisions of s. 27D, which allow a “roll-over” of an amount that is within para. (a) or (b) of the definition and would otherwise be taxed under s. 27B and s. 27C. The roll-over may be made at the election of the taxpayer within a specified period following the making of the eligible termination payment. The roll-over requires a payment of the amount to a superannuation fund, to an approved deposit fund (defined in s. 27A(1)), or to a life assurance company or registered organisation in the purchase of an annuity. In all instances saving will continue. It will continue until a distribution is made to the taxpayer from the superannuation fund or the approved deposit fund, or a payment is made of the annuity. On distribution from the superannuation fund or approved deposit fund, assuming there is no election to roll-over further, there will be assessable income of the taxpayer under s. 27B or s. 27C. An annuity receipt will be income under s. 27H.
[4.145] An approved deposit fund is an entity specially created to receive roll-overs. Its income will be exempt if the fund qualifies under s. 23FA. If it does not, its income is subject to tax under s. 121DAA.
[4.146] Subdivision AA of Div. 2 of Pt III replaces s. 26(d), which achieved some of the functions of Subdiv. AA in a provision characterised by brevity, if not determinateness. It provided:“The assessable income of a taxpayer shall include 5% of the capital amount of any allowance, gratuity or compensation where that amount is paid (whether voluntarily, by agreement or by compulsion of law) in a lump sum in consequence of retirement from, or the termination of, any office or employment, not being—
Some comparisons between the language of Subdiv. AA and s. 26(d) are made in what follows.
[4.147] Paragraph (a) of the definition of “eligible termination payment” provides that eligible termination payment means:
The excluded items are the subject of some comment in later paragraphs. The significance of the words “in respect of the taxpayer” were the subject of comment in [4.23] above. The immediate concern is with the notion of “termination of any [office or] employment”.
[4.148] “Termination of employment” has definitive significance in Subdiv. AA. Where the question is whether an item of receipt for surrender of rights to perform services is within ordinary usage principles, a notion of termination of employment does not have such significance. In Henley v. Murray [1950] 1 All E.R. 908, Evershed M.R. expressed the view that a receipt while employment continues is likely to be regarded as a reward for services, and explained Tilley v. Wales [1943] A.C. 386 and Cameron v. Prendergast [1940] A.C. 549 on this basis. An employment may continue for this purpose notwithstanding that there has been a change in contractual relations under which services are performed, as for example in the facts of Tilley v. Wales and Cameron v. Prendergast, or the Australian High Court decision in Bennett (1947) 75 C.L.R. 480. Employment is thus a concept that transcends contractual relations. In Henley v. Murray, Evershed M.R. in referring to the United Kingdom cases, said (at 910): “the contract of service remains in one form or another”.
[4.149] “Employment” in the definition of an eligible termination payment may be a similar notion. An employment may not necessarily be terminated if the employee continues to serve, though he serves under a contract of service whose terms differ from the earlier contract. And a brief gap in time between the conclusion of service under one contract and the commencing of service under another may not involve a termination of employment. Reseck (1975) 133 C.L.R. 45 proceeded on the basis that there had been a termination of employment notwithstanding a continuance by the taxpayer of service under a new contract. But there was no argument directed to the matter.
[4.150] If the notion of employment can be abstracted from the contract of employment, it may be possible to abstract it from the person of the employer. It would follow that an employee who serves a new employer who has acquired a business from his former employer may be held not to have experienced a termination of employment. An employee who ceases to work under a contract with a company and immediately enters a new contract might be held to continue in the same employment. In this instance, it may be relevant that there has been a significant change in the capacity in which he is employed.
[4.151] The word “office” as it appeared in s. 26(d), and as it now appears in the definition of employment for purposes of Subdiv. AA of Div. 2 of Pt III, has not been the subject of any Australian judicial decisions. The meaning of the word, in a distinct context, has been considered in the United Kingdom in Great Western Railway Co. v. Bater [1920] 3 K.B. 266 and in Edwards v. Clinch [1982] A.C. 845. In the former case Rowlatt J. thought it was a sound argument that those who use the language “an office or employment” meant “an office or employment which was a subsisting, permanent, substantive position, which had an existence independent of the person who filled it, which went on and was filled in succession by successive holders, and that if a man was engaged to do any duties which might be assigned to him, whatever the terms on which he was engaged, his employment to do those duties did not create an office to which those duties were attached; he merely was employed to do certain things, and the so-called office or employment was merely the aggregate of the activities of the particular man for the time being” (at 274). A position established by statute or royal charter may fit the description. A position that has statutory recognition, though it is not established by statute, for example the office of director or auditor of a company, may also fit the description, though it would be doubted that one could create an office of consultant to a company by providing in the articles of association for the position. One could not however create an office by the description of a position to be offered, or by the terms of a contract under which the position is filled.
[4.152] The method of taxing an eligible termination payment under s. 27B and s. 27C, depends on the nature of the payment. Section 27C(1) is applicable to payments that relate in part to a period of service before 1 July 1983. Its general effect is to bring to tax only 5 per cent of the amount of an eligible termination payment that relates to service before that date. The operation of the section depends on the definitions of “eligible service period” and the calculation specified in s. 27C(1). Section 27C(2) has a like operation in regard to the “concessional compenent” of a termination payment, to whatever period of service it may relate. The assessable income of the taxpayer includes only 5 per cent of the amount. The concessional component is so much of a termination payment as relates to an approved early retirement scheme (s. 27E), a bona fide redundancy payment (s. 27F), or an invalidity payment (s. 27G).
[4.153] Section 27B includes in assessable income the whole of an amount of a termination payment, where it relates to a period of service after 1 July 1983, save where it relates to an approved early retirement scheme, a bona fide redundancy payment or an invalidity payment. The amount included in assessable income is taxed in the same manner as other income of the taxpayer, subject however to a rebate provided for in s. 160AA that will impose generally a ceiling of 30 per cent. Where the taxpayer is over 55, the ceiling is 15 per cent in respect of the first $50,000.
[4.154] A termination payment in respect of a taxpayer includes a payment made after his death to the trustee of his estate: s. 27A(3). Section 27A(4), however, provides that the payment in these circumstances shall be reduced by such amount as the Commissioner considers appropriate having regard to the extent to which the dependants of the deceased may reasonably be expected to benefit from the estate. “Dependant” is defined in s. 27A(1).
[4.155] The items excluded from para. (a) of the definition of termination payment include an amount that is a termination payment by virtue of para. (b), which relates to distributions from a superannuation fund. Thus a payment from a superannuation fund in consequence of the termination of an employment is dealt with as a payment from a superannuation fund. As a payment within para. (b) its character as a payment in consequence of termination is not relevant.
[4.156] The exclusion of the amount of an annuity or supplement to an annuity to which s. 27H applies, leaves s. 27H to operate outside of the code constituted by the provisions of Subdiv. AA applicable to eligible termination payments, with consequences noted in [4.158].
[4.157] The exclusion of a fund to which s. 121DA applies leaves a distribution from such a fund to the operation of ordinary usage principles. A s. 121DA fund is not a superannuation fund as defined for purposes of Subdiv. AA. A distribution from a s. 121DA fund is not therefore within para. (b) of the definition of eligible termination payment. The distribution will in most instances not be income of the taxpayer who receives it: Constable (1952) 86 C.L.R. 402 will apply ([2.17] and [2.22] above). The income of s. 121DA fund does not attract exemption or privileged treatment. It is taxed at 60 per cent. Contributions to a s. 121DA fund are not allowable deductions to an employer (s. 82AAC(2) and s. 82AAR) or to an employee (s. 82AAS, definition of “qualifying superannuation fund”). There is therefore no justification in policy for taxing the distributions from the fund, except that the contributions by the employer, on the authority of statements in Constable, were not treated as assessable income of the employee. The fact that the contributions by the employer have not been taxed to the employee on their entering the fund has not been treated as significant when the eligible termination payment provisions are applicable.
[4.158] The exclusion of an amount to which s. 26AC (relating to a payment in respect of unused annual leave) or s. 26AD (relating to a payment in respect of unused long service leave) applies, may operate in a different way from the exclusion in relation to s. 27H. It will be seen that, on the authority of the interpretation of words in the former s. 26(d), neither s. 26AC nor s. 26AD has any application to a payment in more than one amount. Such a payment is therefore not excluded from the definition of eligible termination payment, and will be taxed under s. 27B and s. 27C. Its treatment under those provisions may be more generous than under s. 26AC or s. 26AD, if one of them had applied. The deductible amount under s. 27H remains an amount to which s. 27H applies. It is not brought back into the operation of the eligible termination payments provisions. In the result, it may be subject to tax as ordinary usage income. That is a consequence that could not have been intended. But the words added to s. 25(1) in 1984, in their manner of making the eligible termination payment provisions a code, have excluded the possibility that any other specific provisions can be a code.
[4.159] The last item excluded from para. (a) of the definition of eligible termination payment is an amount that under the provisions of the Assessment Act is deemed to be a dividend paid to the taxpayer. The principal illustration is s. 109, to which reference is made in [4.131]–[4.132] above. Section 109 is defective in a way disclosed in Rutherford (1976) 76 A.T.C. 4304. It may operate to deem an amount paid by a company to a taxpayer who is a shareholder or director of the company, as a termination payment, to be a dividend that is income of the taxpayer. In the result the amount is taken out of the operation of ss 27B and 27C and brought within the operation of s. 109, but it may not be income of the taxpayer under that section. If it is not, the question will remain whether, having been taken out of the code applicable to termination payments by attracting s. 109, the item is now exposed to tax as ordinary usage income which is a reward for services. It would follow from the view taken in this Volume as to the effect of the words added to s. 25(1) in 1984, that it is so exposed. Items that are income by ordinary usage cannot be excluded from assessable income, save by express provision in terms lifting the operation of s. 25(1).
[4.160] The drafting of para. (a) of the definition of eligible termination payment differs in a number of respects from the drafting of the former s. 26(d). Section 26(d) referred to the “capital amount of any allowance, gratuity or compensation” where “that amount is paid … in a lump sum in consequence of retirement from, or the termination of, any office or employment”. The words “capital amount” in s. 26(d) do not appear in the definition in para. (a) of eligible termination payment. Their meaning in s. 26(d) was always obscure, save that they were held to cover an amount that was paid in commutation of an annuity, as in McIntosh (1979) 79 A.T.C. 4325. The words “paid … in a lump sum”, after a good deal of controversy, were ultimately held in the decision of the Federal Court in Knight (1983) 83 A.T.C. 4789 to refer to a payment in one sum as distinct from several. A payment in two amounts thus became a simple way of avoiding the operation of s. 26(d). It is not open as a way of avoiding s. 27B and s. 27C. There is no reference to “lump sum” in the provisions which control the operation of those sections. Each of several payments attracts their operation. The words “allowance, gratuity or compensation” may have had a restrictive effect on the operation of s. 26(d). None of them seems appropriate to a payment from a superannuation fund that is a return of the taxpayer’s own contributions. But the words do not appear in the definition of eligible termination payment. The word “payment” substitutes for them.
[4.161] The phrase “in consequence of” in the reference in para. (a) of the definition of “eligible termination payment” to a payment made “… in consequence of the termination of any employment of the taxpayer”, is common to s. 26(d) and the paragraph of the definition. In McIntosh the phrase, as it was used in s. 26(d), was held to bring into the definition an amount received in commutation of a pension that was undoubtedly being paid in consequence of termination. And in Freeman (1983) 83 A.T.C. 4456 the phrase was held not to include amounts paid to directors of a company nominally as retiring sums, the amounts being paid to the directors from funds received by the company some time after the company had ceased to carry on business, and the employments of the directors had terminated. In the Federal Court, Northrop and Fisher JJ. said ((1983) 83 A.T.C. 4456 at 4472):
“In the present case it cannot be said that the taxpayers had any entitlement, in the sense of enforceable entitlement, to be paid the lump sums. They were essentially voluntary and gratuitous payments by the old company. Thus in our view the question is, in circumstances such as the present, whether there was sufficient causal nexus between the payment and the retirement to make the retirement the occasion of the payment.”
Observations in other cases carry the matter very little further than a requirement of “a sufficient causal nexus”. A mere temporal connection is not enough. On the other hand it is not necessary that the payment have the termination as its dominant cause.
[4.162] Paragraph (b) of the definition of “eligible termination payment” covers: “any payment made from a superannuation fund in respect of the taxpayer by reason that the taxpayer is or was a member of the fund, not being a payment that is:
[4.163] The words “in respect of the taxpayer” have already been the subject of comment in [4.23] above. The significance of the exclusion of a payment that is income of the taxpayer is obscure. It is no doubt the intention, following the example of para. (a) where the intention is express, to exclude an amount that is income under s. 27H, a section concerned with annuities (including superannuation pensions) and supplements to such annuities. In this role the exclusion cannot refer to income in any sense other than income for purposes of the Assessment Act, though it is obviously necessary to imply a qualification which might be expressed as “other than an amount that is income as an eligible termination payment”. Otherwise the use of the word will create a circularity. It may also have been the intention to exclude an amount that would be income because the distribution from the superannuation fund is held not to be covered by the decision in Constable (1952) 86 C.L.R. 402. There may be circumstances where the receipt is not simply in satisfaction of the taxpayer’s rights in the fund, but can be identified with the contributions made by the employer to the fund in a way that was held not to be possible in Constable.
[4.164] Section 26AF makes income a benefit of any kind, out of, or attributable to, assets of “a para. 23(ja) fund” (defined in s. 26AF(3)), “or a s. 23FB fund”, where the benefit is received or obtained otherwise than in accordance with approved terms and conditions applicable to the fund at the time when the benefit is received or obtained. There are other considerations which must be satisfied before the benefit is to be treated as assessable income, the conditions involving a discretion given to the Commissioner. There is also a provision in s. 26AF(2) which will make assessable income a receipt of valuable consideration in respect of the transfer by the taxpayer to another person of a right to receive a benefit from one of the funds referred to. The intention is to deny the privileged treatment given to “an eligible termination payment”, to a distribution in breach of fund conditions or to the proceeds of realisation of rights in a fund. Where a s. 26AF(2) amount has been or will be included in assessable income of the member of the fund, the amount will not be included again, as an eligible termination payment, in the assessable income of that taxpayer, on a payment being made from the superannuation fund to the transferee from that taxpayer. This is the effect of the reduction provided for in para. (b) of the definition of “eligible termination payment”. The prospect that there would be an eligible termination payment of the member on payment to the transferee arises from s. 27A(3) (a)(iii), referred to [4.23] above. Subsequent to the inclusion of the eligible termination payment provisions, s. 26AFA was added to the Act. It is a provision which in its reference—in s. 26AFA(1)—to s. 26(d), then already repealed, shows its origin as a matter of drafting in an earlier time. Section 26AFA makes provision in regard to s. 23F funds similar to those made in regard to s. 23(ja) and s. 23FB funds by s. 26AF. No express provision was inserted in the definition of “eligible termination payment” to deal with the addition of s. 26AFA. The non-application of the eligible termination payment provisions would appear to depend on the reference to s. 26(d)—“notwithstanding paragraph 26(d)”—or, perhaps, the exclusion from “eligible termination payment”, by para. (b)(i) of the definition, of a payment that is “income” of the member of the fund. The difficulty with the latter explanation involves the meaning to be given to the word “income” in para. (b)(i)— whether it extends beyond ordinary usage income—and the need for the express reference to s. 26AF(1). The difficulty with the explanation in terms of the reference to s. 26(d) will be in treating the reference to s. 26(d) as a reference to the eligible termination payment provisions, as provisions replacing s. 26(d).
[4.165] An understanding of the policy that is expressed in para. (b) of the definition of eligible termination payment and the provisions of ss 27B and 27C may be assisted by a review of the law in three areas: the tax treatment of receipts by superannuation funds; the tax treatment of income of superannuation funds; and, ss 27B and 27C aside, the tax treatment of distributions from a superannuation fund. Jurisdictional issues in relation to the taxing of superannuation funds were considered in [1.10]–[1.23] above.
[4.166] A superannuation fund involves a trust and the office of trustee. If one excludes the operation of Div. 9B, in particular s. 121DB, Div. 6 of Pt III would be applicable, and the derivation of income by the trust would be determined on the hypothesis that the trustee is a taxpayer (s. 95). The significance of this hypothesis was the subject of observations in [4.26]–[4.30] and [4.96] above: it displaces the principle that beneficial entitlement is an essential quality of an income receipt. None the less, a conclusion that contributions to the trust, whether by the employer or by the employee, are income of the trust would not easily be drawn. The contributions, if made in a series, might be periodical receipts of the trust, though it would not be easy to find in the receipts any element that would bring them within the substance of the periodical receipts principle. That substance is examined in [2.175]–[2.208] above. At least in the case of employee contributions to the fund, the operation of a periodical receipts principle to give an income character to the receipts by the trustee would seem in any case to be precluded by the contribution to capital principle examined in [2.113]–[2.131] above. The hypothesis that the trustee is a taxpayer will give an income character to most other receipts by the trust, generally receipts from investments, that would have an income character if derived by an individual.
[4.167] In relation to contributions by the employer, there is a further question: whether derivation by the trust is a derivation by the member employee in respect of whom the contributions were made. An argument may be made that there is an immediate benefit to the employee in the increase in the value of his interest in the fund, and that benefit is his income, either by the operation of ordinary usage, or by the operation of s. 26(e). The amount of income might be small if ordinary usage alone is to be considered, but it would be significant if s. 26(e) operates, when the amount of income would be the value to the taxpayer of the increase in his interest. In Constable (1952) 86 C.L.R. 402 the majority expressed the view that there was no derivation of a benefit by the employee that would be his income as a reward for services, on the making of a contribution to the fund by the employer. The minority (Webb J.) took the contrary view. The majority view appears to have been accepted in the practice of the Commissioner, though the facts in Constable were special in that the contribution to the fund made by the employer was made in respect of all employee members, and it was the function of the trustee to make allocations to the accounts of individual members. Where a trustee receives a contribution made in respect of a particular employee, the argument that there is a derivation of a benefit by the employee that is a reward for his services is the stronger.
[4.168] On distribution from the fund to a member of amounts representing the contributions of the employer, there would not be income receipts by the member. Constable is authority that where the occasion of receipt by the member is one of a “contingent right that became absolute” (at 418), the receipt does not have the character of a reward for services which it may have had in its origin as a payment by the employer. Constable has its parallel in the United Kingdom decision in Abbott v. Philbin [1961] A.C. 352 at 379, where the receipt of shares following the exercise of options granted by an employer was seen as proceeds of the “exploitation of a valuable right”.
[4.169] A distribution from the fund to a member of amounts representing the contributions made by the member himself is simply a return of capital contributed by the member. On the authority of H. R. Sinclair Pty Ltd (1966) 114 C.L.R. 537, considered in [2.547]–[2.552] above, it would not be income of the member, even though the contribution by the member was deductible by him.
[4.170] The returns from the trust’s investments would be income of the trust, if they are within the income derived from property principle, and would be subject to tax as trust income under Div. 6. The tax on that income would generally be on the trustee, if it be assumed that there is no present entitlement in a member of the fund in the year of derivation by the trust, arising from an appropriation of trust income to the account of the member. There would, however, be the prospect of tax to a member on distribution to him under s. 99B—a provision that will apply to give rise to a tax liability on the member in respect of income not already taxed to the trustee.
[4.171] Where the distribution from the fund would be said to have been received by the taxpayer in a lump sum in consequence of termination of employment, s. 26(d) would have been applicable if the payment had been made prior to 1 July 1983. Section 26(d) would have displaced any operation of the ordinary usage concept of income. Reseck (1975) 133 C.L.R. 45 and Constable (1952) 86 C.L.R. 402 would have been irrelevant. Section 26(d) would presumably have displaced any operation of s. 99B.
[4.172] The preceding paragraphs have sought to show the application of ordinary usage principles within the overlap of Div. 6 of Pt III. The conclusions reached are relevant to a fund that does not qualify as a superannuation fund within the definition in s. 121B of Div. 9B of Pt III. “Superannuation fund” is there defined to mean “a provident, benefit, superannuation or retirement fund”.
[4.173] Where the fund is one within that definition, the overlap of Div. 9B must also be considered. The view was taken in [1.16]–[1.23] above that Div. 9B should be seen as adding to and modifying the structure of s. 25(1) and Div. 6 on which it builds, and not as a wholly distinct set of provisions.
[4.174] The implications of the further overlap of Div. 9B may be summarily stated. Contributions to the superannuation fund whether by the employer or by the employee will not be income of the fund. This is the effect of s. 121B in the definition of investment income, s. 121D, s. 121DA and s. 121DAB. Division 9B, in this respect, simply confirms the operation of Div. 6. The income of a Div. 9B superannuation fund may be exempt from tax under one of the provisions—s. 23F, s. 23(jaa), s. 23(ja) and s. 23FB—which give exemption to certain of the income of superannuation funds. Where income is not thus exempt it may be taxed at a concessional rate or may be taxed at the maximum marginal rate applicable to an individual: s. 121CA, s. 121CB, s. 121D, s. 121DA and s. 121DAB.
[4.175] The question whether a derivation by a superannuation fund of an employer’s contribution is a derivation of a resulting benefit that is income of the employee will be answered, as it is answered in [4.167] above, in relation to a trust not subject to Div. 9B.
[4.176] Distributions by the superannuation fund that do not qualify as eligible termination payments under para. (a) or (b) of the definition of “an eligible termination payment” in s. 27A(1), will not be income of the member of the fund if they are protected by the principles in Constable (1952) 86 C.L.R. 402. Presumably, s. 99B of Div. 6 would not operate. The inference from the terms of that section is that it applies only to a distribution from a fund whose income is subject to tax under Div. 6, a fund that is not a Div. 9B fund. Section 99B applies only to distributions from income that could have been taxed under ss 99, 99A, 97 or 98. The operation of those provisions in taxing the income of a Div. 9B superannuation fund is excluded by s. 121DB.
[4.177] A distribution from a Div. 9B superannuation fund that is a s. 121DA fund will not be within para. (a) or (b) of the definition of eligible termination payment. It is not a distribution from a superannuation fund as defined for purposes of Subdiv. AA, so that it cannot be within para. (b). And it is expressly excluded from para. (a). It follows that the distribution received by a member of such a fund will not be his income, so long as it enjoys the protection of the principles in Constable.
[4.178] The treatment of a distribution from a superannuation fund that is within para. (a) or (b) of the definition of eligible termination payment may now be considered. A distribution may be within para. (a) if it is a distribution from a fund that is not a superannuation fund within Div. 9B, and is thus a fund taxed under Div. 6. The situation may be remote in view of the wide definition of superannuation fund for purposes of Div. 9B, but it cannot be dismissed. A distribution from a superannuation fund that is a Div. 9B fund cannot be within para. (a). This is the consequence of the exclusion from para. (a) of distributions within para. (b), and the express exclusion of a distribution from a s. 121DA fund. It was necessary to exclude expressly a distribution from a s. 121DA fund because the definition of a superannuation fund for purposes of para. (b), while including other Div. 9B funds, does not include a s. 121DA fund. A distribution to which para. (a) applies will be taxed under ss 27B and 27c in ways already explained.
[4.179] A distribution from a superannuation fund that is within para. (b) will be taxed under the provisions of s. 27B and s. 27c in ways already explained. Where s. 27B in other respects includes the whole of an amount in assessable income, a deduction from the amount so included is allowed, being the amount of undeducted contributions. “Undeducted contributions” are defined in s. 27A (1) so that they mean “so much of the eligible termination payment as is attributable to contributions made by the taxpayer, or any other person, after 30 June 1983 to a superannuation fund in order to obtain superannuation benefits, being contributions in respect of which no deduction is allowable or has been allowed to the taxpayer or the other person”. The intention is primarily to exclude from tax at the time of distribution from a fund an amount that might be said to have been taxed at the time of contribution to the fund. It will have been taxed if it has not been the subject of an allowable deduction to the employee or employer, and the employee or employer had income against which a deduction might have been allowed. The inclusion in “undeducted contributions” of an amount contributed by an employer that was not the subject of an allowable deduction by the employer may, in any event, have unintended consequences. The taxpayer’s employer may be an exempt body which cannot have allowable deductions. The amount of the employer’s contributions in these circumstances cannot in any sense be said to have been taxed at the time of contribution to the fund. It may be possible for a court, relying on Cooper Brookes (Wollongong) Pty Ltd (1981) 147 C.L.R. 297, to give the definition of undeducted contributions a construction which will preserve the policy it was intended to express.
[4.180] The taxation of distributions from superannuation funds reflects policies to which reference has already been made. These policies are:
(i) Where a contribution to a superannuation fund may be said to have been made from income that has not been taxed because a deduction has been allowed to the taxpayer or to his employer in respect of the contribution, it ought to be subject to tax when it is distributed from the fund;
(ii) Where the income derived by a superannuation fund from the investment of contributions has enjoyed significant relief from tax in the hands of the fund, it ought to be subject to tax when it is distributed from the fund. One observation might be made in regard to those policies. The fact that an employer has been denied a deduction of a contribution to a superannuation fund so that he has been taxed on income whence the contribution was made, ought not to be sufficient to justify relief from tax to the employee on the distribution to the employee of the amount of that contribution. The policy should not extend beyond relief from tax on distributions to the employee where the amount of the distribution was taxed to the employee at the time of the contribution of that amount to the fund. Subdivision AA has accepted the statement of the majority in Constable (1952) 86 C.L.R. 402 that the employer’s contributions to a superannuation fund are not income of the employee at the time of their contribution, but has not fully corrected the distortion that flows from that conclusion.
[4.181] The definition of eligible termination payment in s. 27A(1) is subject to three exceptions. The first of these (para. (k) of the definition) is a payment by way of advance or loan made on terms and conditions similar to the terms and conditions that could reasonably be expected to apply in respect of an advance or loan to the payee, by a person with whom the payee was dealing at arm’s length in relation to the advance or loan. The exception at once confirms that a loan may be a payment for purposes of para. (a) or (b) of the definition and provides for an exception of what may be seen as a genuine loan. It is an anti-avoidance provision. The genuine loan will not be income of the taxpayer who receives it.
[4.182] The second exception (para. (m)) is “consideration of a capital nature for, or in respect of, a legally enforceable contract in restraint or trade by the taxpayer, to the extent to which the amount or value of the consideration is, in the opinion of the Commissioner, reasonable having regard to the nature and extent of the restraint”.
[4.183] The second exception is only significant where the amount of the consideration would otherwise be an eligible termination payment within para. (a) of the definition. And the exception only operates in relation to “consideration of a capital nature” which, presumably, means an amount that would not be income under ordinary usage principles. Consideration received under a provision of a service agreement, or an amended service agreement, which is payable immediately on the making of the agreement could not be said to be a payment in consequence of termination so as to be within para. (a) of the definition. Where the consideration is to be paid on termination, though provided for in the service agreement, it may be held to be within the definition. Where the consideration is payable under the terms of an agreement by which the employment is terminated it will be within the terms of the definition. A payment under the terms of a distinct agreement entered into after termination may be within the terms of the definition: the issue will be whether there is a sufficient causal nexus between the termination and the payment. The question whether the consideration is within the exception as consideration of a capital nature will be answered in terms of the authorities discussed in [2.409]ff. above. In some circumstances a receipt which is, as a matter of form, a receipt for a restrictive covenant, may be held to be a further reward for services and income on that ground. The exception will not operate and the amount will remain an eligible termination payment to be taxed under Subdiv. AA, if it can be said to be a payment in consequence of termination.
[4.184] The exception is confined to an amount which is in respect of a “legally enforceable contract”. Under ordinary usage principles an amount may be held not to be income because it is an amount for accepting a restriction on one’s freedom of action, notwithstanding that the restriction is not legally enforceable against the taxpayer. The matter is considered in [2.414] above. That amount will not, however, attract the exception, and will be taxed as an eligible termination payment if it is received in consequence of termination. The law in regard to the enforceability of restrictive covenants is likely to undergo some development in the future in tax cases.
[4.185] The third exception takes out of the definition:
“(n) consideration of a capital nature for, or in respect of, personal injury to the taxpayer, to the extent to which the amount or value of the consideration is, in the opinion of the Commissioner, reasonable having regard to the nature of the personal injury and its likely effect on the capacity of the taxpayer to derive income from personal exertion;”
There will be circumstances in which consideration received in respect of personal injury will be received in consequence of termination of employment. An agreement in which a taxpayer relinquishes his employment may contain a provision by which he is compensated for personal injury suffered in the course of his employment. If the consideration is in substance for the personal injury, it will come within the exception if it is of a capital nature. Generally it will be of a capital nature. The discussion in [2.542] above would indicate that a receipt by way of damages for personal injury will not be income despite an element of economic loss to which the damages award relates. Observations by Barwick C.J. in Atlas Tiles Ltd v. Briers (1978) 144 C.L.R. 202 at 209 support such a view. A receipt under an agreement of the kind suggested may be treated differently, more especially if an amount is specifically appropriated to an element of economic loss. There will, of course, in relation to a payment referable to several elements, be problems arising from the application of McLaurin (1961) 104 C.L.R. 381 and Allsop (1965) 113 C.L.R. 341. In that regard a question may arise whether an amount becomes an amount “of a capital nature”—the words of para. (m)—because the whole receipt includes an amount in respect of an element of a capital nature from which an amount in respect of an element of an income nature cannot be separated.
[4.186] The more likely circumstances in which exception (n) will be relevant is a payment from a superannuation fund that would otherwise be an eligible termination payment within para. (b) of the definition of eligible termination payment. A superannuation fund, as defined for purposes of Subdiv. AA of Div. 2 of Pt III, may include a fund that provides retirement benefits and provident benefits which will include payments in respect of personal injury suffered by a member of the fund. The views of Barwick C.J. will be relevant on the question whether the receipt is of a capital nature. If it is of an income nature it will in any event be outside the definition of eligible termination payment. This is the effect of para. (b)(i) of the definition. In Slaven (1984) 84 A.T.C. 4077 the provisions of the Victorian Motor Car Act were held to determine the character of receipts for personal injury and to give them a non-income character. In that case the payments under the Victorian Motor Car Act were expressed by the Act to be for loss of earning capacity. The provisions of the trust deed of the superannuation fund may determine the character of the payment by the fund, though the significance to be given to the words of a trust deed may not be the same as the significance to be given to the words of a statute.
[4.187] Section 26AC, inserted in 1978, applies to lump sum payments made after 15 August 1978, in consequence of a taxpayer’s retirement from, or the termination of an office or employment, where the lump sum is in lieu of annual leave. The whole of the amount is income: the section confirms a characterisation that would follow from the ordinary usage meaning and the exclusion of the operation of Subdiv. AA of Div. 2 of Pt III by the definition of “eligible termination payment”. Section 160AA allows a rebate of tax, so as to limit the rate of tax applicable to the standard rate.
[4.188] Section 26AD, inserted in 1978, applies to lump sum payments made after 15 August 1978 in consequence of a taxpayer’s retirement from, or the termination of an office or employment, where the lump sum is in lieu of long service leave entitlement attributable to qualifying service after 15 August 1978. The whole of the amount is income: the section confirms a characterisation that would follow from the ordinary usage meaning and the exclusion of the operation of Subdiv. AA of Div. 2 of Pt III by the definition of “eligible termination payment”. Section 160AA allows a rebate of tax, so as to limit the rate of tax applicable to the standard rate. Section 26AD raises problems of interpretation similar to those raised by s. 26(d).
[4.189] Sections 26AC and 26AD continue to use the words “paid … in a lump sum” that first appeared in s. 26(d), now repealed and replaced by Subdiv. AA of Div. 2 of Pt III. Subdivision AA, it has been noted, does not use those words. As interpreted in Knight (1983) 83 A.T.C. 4789, those words are not satisfied if the relevant amount is paid in more than one instalment. There is in the result a way of avoiding the operation of s. 26AC or s. 26AD. If an amount is paid in more than one instalment it will not be an amount to which either section applies. It will thus, as a “payment in consequence of the termination of any employment of the taxpayer”, fall within para. (a) of the definition of “eligible termination payment” and be subject to tax under ss 27B and 27C with consequences explained in [4.138]ff. above.
[4.190] The effect of s. 26(g), in expressly providing that “any bounty or subsidy received in or in relation to the carrying on of a business (other than subsidy received under an agreement entered into under an Act relating to the search for petroleum)” is income, was the subject of some comment in [2.131] above. Its general effect is, it seems, to confirm that bounties or subsidies which are within the ordinary usage meaning, are income. The words in parentheses, however, raise a problem of the kind raised by the now repealed s. 26(d) and the subject of the decision in Reseck (1975) 133 C.L.R. 45. The intention, presumably, was to take the items mentioned out of the meaning of income for purposes of the Act. But the inference to be drawn from the words added to s. 25(1) in 1984 defeats that intention. The general issue is considered in [1.39], [2.223], [2.369] and [4.5] above.
[4.191] Sections 28–34, in combination with s. 51(2), displace the ordinary usage principle that to be income an item must be a gain by the taxpayer, and the principle that an item is income only if it has been derived by the taxpayer. It displaces these principles in the context of continuing business dealings with “trading stock”, as defined in s. 6.
[4.192] Were it not for these provisions, the operation of the ordinary usage notion of income would require that:
[4.193] By inference, ss 28–34 and s. 51(2) make the whole proceeds of realisation of an item of trading stock income, when the realisation is in the course of carrying on a continuing business. Section 51(2) provides that “expenditure incurred or deemed to have been incurred in the purchase of stock used by the taxpayer as trading stock shall be deemed not to be an outgoing of capital or of a capital nature”. Some observations on this provision made by Dixon C.J. in John Fairfax & Sons Pty Ltd (1959) 101 C.L.R. 30 may suggest that it is intended to overcome doubts about deductibility thought to be unreal. With respect, the function is to displace a principle which would otherwise require that the outgoing be “capitalised”, in one accounting sense of the word, and treated as a cost which will be subtracted in computing the profit which is income on realisation of the item of stock. It is in this sense that the cost would otherwise be regarded as “of a capital nature”. The sense is different from that in which the words are understood in the contradistinction between working expenses, and expenses which are of a capital nature because they relate to the structure of the business. It is a corollary of the allowance of a deduction for the cost of trading stock that the whole proceeds of realisation will be income. The same result would follow in any event from the operation of s. 82, which will deny the subtraction of a cost in computing a profit which is income, where that cost has been allowed as a deduction. These matters are the subject of further consideration in Chapter 14 below.
[4.194] The requirement of the ordinary usage notion of income that an element of profit is not income until the revenue asset has been realised is displaced by ss 31 and 32 of the Assessment Act, to the extent that the taxpayer may in effect elect that an unrealised profit on an item of trading stock will be treated as present income derived. This election is made by selecting market value as the value of stock to be taken into account at the end of the year of income where market value exceeds cost. The cost of trading stock is deductible in the year of acquisition. But the effect of ss 28–29 is that this deduction is offset, where the item is not realised in the year of income in which it is acquired, by the operation of the provision that the excess of the value of closing stock over opening stock is income. The deduction is thus deferred until the item is realised. Where the taxpayer elects that the item should be brought to account at market value at the end of the year of income, the result will be the bringing in of an amount of unrealised profit.
[4.195] In relation to livestock this election is controlled by s. 33. And it will be apparent that where there is an unrealised loss, the operation of an election is to allow a deduction of the unrealised loss.
[4.196] Where trading stock which are or were assets of a continuing business are disposed of otherwise than in the ordinary course of carrying on the business, s. 36 requires that the value of the trading stock shall be included in the taxpayer’s income. The effect is to displace the ordinary usage principle that a business gain is income only when it arises from an act done in carrying on a business.
[4.197] Section 37 provides that where trading stock of a business devolve by reason of death the value of the stock is income. The effect is also a displacing of the ordinary usage principle.
[4.198] The operations of ss 36 and 37 extend not only to trading stock, but also to standing or growing crops, crop-stools, or trees which have been planted and tended for the purpose of sale. The operations of ss 36 and 37, in these contexts, assume that the costs associated with the standing or growing crops, crop-stools, or trees which have been planted and tended for the purpose of sale are deductible as incurred. In this there is some contradiction of the ordinary usage principle that would require that such costs should be “capitalised” and subtracted in determining the profit on realisation.
[4.199] The operation of s. 36 is qualified by s. 36A, and the operation of s. 37 by s. 37(2). Sections 36, 36A and 37 are further considered in Chapter 14 below.
[4.200] Sections 36AAA and 36AA operate in various ways to displace the business gains principle, so as to defer the derivation of income, where gains which would otherwise be regarded as derived arise on the forced disposal, death or compulsory destruction of livestock.
[4.201] Sections 38–43 are concerned with the determination of the amount of profits from the realisation of trading stock which will be income and have an Australian source. The sections have a history which includes an earlier time when Australia did not assert jurisdiction to tax on the basis of residence of the taxpayer, and they are imperfectly adapted to the present assertions of jurisdiction. When read with other provisions of the Act, their operation is confined to the determination of Australian source income of a non-resident, and, possibly, to the determination of foreign source income of an Australian resident which may be exempt under s. 23(q).
[4.202] The effect of s. 43 is to displace the operation of the trading stock provisions, ss 28–31 and 51(2), considered above, and, probably, ss 36–37. Section 43 confirms ordinary usage principles, though it may be arbitrary in the specifying of the costs that may be subtracted in computing the profit that is income.
[4.203] In some of its provisions—ss 129 (overseas ships), 143 (non-resident insurer)—the Assessment Act deems an amount to be “taxable income”. In no case is any extension of the ordinary usage meaning of income intended. The operation of the sections is generally to impute allowable deductions determined by reference to the amount of income which is assessable. Difficulties of ascertaining the amount of allowable deductions are thus overcome in a manner that is to a degree arbitrary.
[4.204] Section 26(j) was the subject of some observations in [2.553]-[2.557] above. In [2.553] above, attention was drawn to the possibility that s. 26(j) is a code in regard to receipts by way of compensation, and displaces at least in part the ordinary usage principles in regard to compensation receipts. The extent of the displacement would depend on a conclusion as to the extent of the field that s. 26(j) must be taken to have covered. A submission that s. 26(j) is a code in relation to receipts by way of insurance or indemnity was made in the Board of Review proceedings in Carapark Holdings Ltd (1967) 115 C.L.R. 653, but was not made in the appeal to the High Court. It has been assumed in this Volume that s. 26(j) does not displace the operation of the ordinary usage notion of income. Any conclusion that it is a code would contradict the inference to be drawn from the words added to s. 25(1) in 1984. The general issue is considered in [1.39], [2.223], [2.369] and [4.5] above.
[4.205] In one respect, at least, s. 26(j) extends the meaning of income in the Act beyond its meaning in ordinary usage. The section makes income an amount received by way of insurance or indemnity for or in respect of “any loss or outgoing which is an allowable deduction”. It will be recalled that the ordinary usage compensation receipt principle, as it is formulated in Carapark Holdings, may make income a compensation receipt in respect of an outgoing “on revenue account”. An item may be an allowable deduction, though it is not an outgoing on revenue account. A receipt under an insurance policy which provides for the payment to the taxpayer, in the event of his illness, of the amount of contributions the taxpayer has undertaken to make to a self-employed superannuation fund, would be income under s. 26(j), but not under the ordinary usage compensation receipts principle. The contributions, it is assumed, are deductible under s. 82AAT, but they are not outgoings on revenue account.
[4.206] A number of questions depend for their answers on the meaning of the words “in respect of” in s. 26(j). Herron and Sugerman JJ. in Williamson v. Commissioner for Railways [1960] S.R. (N.S.W.) 252 considered that s. 26(j) made income a compensation payment for a gate and fencing destroyed by fire, because expenditure on those items by a primary producer were at the time made allowable deductions by specific provisions of the Act. If the words “in respect of” are given the widest meaning they can carry, it is possible to say that the compensation is in respect of the expenditure incurred in erecting the gate and fence destroyed, or in the erecting of a new gate and fence.
[4.207] A wide meaning for the words “in respect of” in s. 26(j) could involve a substantial extension of the meaning of income, so that an amount which is calculated by reference to income gains that would have been derived from, or from the use of a capital asset, will be income, though it would not have been income under the ordinary usage principle. The operation of the ordinary usage principle is considered in [2.506]-[2.552] above. In Williamson, Sugerman J. expressed the view that s. 26(j) does not extend the meaning of income in this way. There is support for this view in Polites v. Hydro-Electric Commission (1978) 78 A.T.C. 4013, and it was adopted in Slaven (1984) 84 A.T.C. 4077.
[4.208] It would appear from Allsop (1965) 113 C.L.R. 341 and H. R. Sinclair Pty Ltd (1966) 114 C.L.R. 537 that s. 26(j) does not extend the ordinary usage meaning of income so that an amount by way of refund, in a sense which will describe the receipts in those cases, will be income as a compensation receipt. The limitation on the ordinary usage principle of compensation receipts which arises from those cases is considered in [2.547]ff. above.
[4.209] Section 26(j) is clearly not limited in its operation by any requirement that the receipt of compensation must be a business gain. Attention was drawn in [2.507] above to an assumption that appears to have been made in Carapark that the ordinary usage compensation receipts principle is simply a special application of the business gains principle, and that it has no independent operation. Other authorities contradict that assumption. If, however, it is a correct assumption, s. 26(j) will assume special importance as an extension of the ordinary usage meaning of income.
[4.210] Because s. 26(j) has some operation in extending the ordinary usage meaning, it becomes important to know what the scope of the paragraph may be in other respects. There is some assistance in judicial interpretation, though a number of questions remain unresolved. Opportunities to consider the scope of the paragraph were not taken in Allsop, Sinclair and Carapark Holdings Ltd (1967) 115 C.L.R. 653.
[4.211] The word “is” in the phrase “which is an allowable deduction” may suggest that s. 26(j) has no application to a receipt of compensation in respect of an item of loss or outgoing which has not been incurred at the time of the receipt. A like suggestion might be drawn from the phrase “which would have been income” in s. 26(j), where the item is a loss of profit or income. Sugerman J. in Williamson v. Commissioner for Railways considered that s. 26(j) could apply in relation to a prospective item. Walsh J. expressed doubt. The majority judges, Hogarth and King JJ. in Lonie v. Perugini (1977) 77 A.T.C. 4318 considered that s. 26(j) had no application to compensation for a future loss of profits. The dissenting judge, Bray C.J., thought that s. 26(j) could apply to future losses. Hutley J.A. in Pennant Hills Restaurants Pty Ltd v. Barrell Insurances Pty Ltd (1978) 78 A.T.C. 4032 expressed agreement with Bray C.J.
[4.212] The meaning of the words “by way of insurance or indemnity” remains unresolved. Dixon and Fullagar JJ. in Wade (1951) 84 C.L.R. 105 at 112 observed:
“No doubt s. 26(j) is primarily directed to the recovery under a policy of insurance or other contract of indemnity of the amount of any loss. But the word ‘indemnity’ is not qualified and it expresses a notion which, it may be said, the ‘compensation’ awarded under the Milk Act … ought to satisfy.”
The reference to the Milk Act was a reference to an Act providing for compensation upon the compulsory destruction of diseased dairy cattle. In the same case Kitto J. held (at 115) that the words “by way of … indemnity” may be satisfied as well by a receipt pursuant to a statutory right as by a receipt under a contract. In Williamson v. Commissioner for Railways [1960] S.R. (N.S.W.) 252 at 274, Sugerman J. held that s. 26(j) “should … be construed as extending to receipts by way of compensation otherwise within its terms (including awards of damages) as well as to receipts by way of insurance”. In Goldsbrough Mort & Co. Ltd (1976) 76 A.T.C. 4343 Walters J. held that s. 26(j) applied to a receipt by the vendor, on the completion of a contract of sale of land, or part of an amount he had paid for rates.
[4.213] In Goldsbrough Mort the item in respect of which compensation was received—the payment of rates—had occurred before the making of the contract of sale. It is arguable that “by way of insurance or indemnity”, however widely construed in other respects, should be held to extend only to circumstances where the right to compensation may be said to subsist before the loss or outgoing is incurred. An argument of this kind was made by the taxpayer in National Commercial Banking Corp. of Australia Ltd (1983) 83 A.T.C. 4715. It was accepted by Hunt J. at first instance who declined to follow Goldsbrough Mort. The Federal Court, on appeal, found it unnecessary to decide the question. The court said (at 4722): “Even if [s. 26(j)] were given its widest meaning of reimbursement to the taxpayer of an outgoing which was an allowable deduction (see in particular the judgment of Walters J. in the Goldsbrough Mort case) the joining fee would not answer that description for the reasons already given by us.” Those reasons are referred to and are the subject of some comment in [2.570] above.
[4.214] No suggestion has been made in any case decided since 1973 that an inference should be drawn from the language of s. 26(k) that the words “insurance or indemnity” in s. 26(j) have a narrow meaning. In 1973, s. 26(k) was amended so that it refers to an amount received “by way of insurance, indemnity, recoupment, recovery or reimbursement”.
[4.215] The language of s. 26(j) is confusing, in that it uses the word “loss” in three distinct senses. In the phrase “loss … of trading stock” the sense of the word is “deprivation”—an event which gives rise to a loss in the second sense in which the word is used. This second sense is the one intended in the phrase “loss … of profit or income”. It is the failure to realise a gain. A third sense is intended in the phrase “loss or outgoing”, where the reference is to a failure of an asset to realise its cost.
[4.216] As now drafted, s. 26(k) uses the widest of language to make income a receipt “by way of insurance, indemnity, recoupment, recovery or reimbursement in respect of the whole or part of a loss that has been allowed or is allowable under s. 71 …”.
[4.217] Like s. 26(j), s. 26(k) extends the ordinary usage principle in regard to compensation receipts: it will apply to compensation in respect of a “loss” that may not involve a loss or outgoing on revenue account. Section 71 is intended to allow deductions in circumstances where, at least in the view of Kitto J. in Levy (1960) 106 C.L.R. 448, there would not be a deduction under s. 51.
[4.218] The word “loss” as used in s. 26(k) and in s. 71 may be confusing. The reference is to a deprivation of money. It is not inappropriate to allow a deduction of the value of a deprivation where the item is cash. None the less, the deduction is strictly of a loss, in the sense of the failure of a revenue asset to realise its cost. Where the item is a revenue asset other than money, the deduction should be the amount of the cost of the asset, not its value at the time of deprivation.
[4.219] Section 26(k) extends the ordinary usage meaning of income by applying to an amount “by way of reimbursement”. It will be recalled that the ordinary usage principle of compensation receipts does not extend to a “refund”, in a sense that will describe the receipts in Allsop (1965) 113 C.L.R. 341 and Sinclair (1966) 114 C.L.R. 537.
[4.220] Section 63(1) allows a deduction for the write-off of certain bad debts. The operation of the subsection is considered in [10.50]–[10.82] below. Its effect is to advance the allowance of a deduction, which would become allowable in any case when the debt is realised by disposition or discharge. At least this is so if it be assumed that debts owing to a person who is in business as a money lender are revenue assets.
[4.221] Section 63(3) makes income an amount received in respect of a debt for which a deduction has been allowed. There may be some doubt whether the ordinary usage compensation receipts principle would extend to a recoupment of this kind. In any case the recoupment would appear to be income as a business gain.
[4.222] Section 63(3) will presumably be applicable in circumstances beyond the allowance of a deduction under s. 63(1). Debts which are revenue assets may include debts not referred to in s. 63(1). A loan to an employee, or to a trader’s customer or supplier, may be a revenue asset, and a loss suffered by the lender on the disposition or discharge of such a debt will be deductible as a working expense. A recoupment of such a loss would appear to be within s. 63(3).
[4.223] Section 72(2) provides:
“Where a taxpayer receives in the year of income a refund of an amount paid for rates or taxes which has been allowed or is allowable as a deduction, or in respect of which a rebate of tax has been allowed or is allowable, in an assessment for income tax under this Act or a previous law of the Commonwealth, his assessable income shall include that amount.”
[4.224] A deduction for rates or taxes may be allowable under s. 72(1) where the amount is paid in respect of land used for the purpose of gaining or producing income, or under s. 51 where the rates or taxes are working expenses. Section 72(2) will make any refund income, where the refund is of an amount of rates or taxes deductible under s. 72(1) or s. 51(1). The rates or taxes referred to in s. 72(2) may, it seems, extend beyond those of which s. 72 allows a deduction: Sinclair (1966) 114 C.L.R. 537. In making a refund income, s. 72(2) extends the ordinary usage principle of compensation receipts. Indeed s. 72(2), and a provision in s. 74(2) in regard to refunds of election expenses, were relied on in Sinclair as express provisions demonstrating that there was no general principle of ordinary usage by which refunds as such can be income as compensation receipts. Observations on the decision in Sinclair have been made in [2.547]–[2.552] above.
[4.225] Section 72(2) makes income a “refund of an amount paid for rates or taxes … in respect of which a rebate of tax has been allowed or is allowable”. In this aspect, s. 72(2) reflects a change made in the law in 1975 whereby a concessional deduction for rates or land tax in respect of a taxpayer’s sole or principal residence, was replaced by a concessional rebate. There is a ceiling imposed by s. 72(1D) on the amount which may be a “rebatable amount” under s. 159V. If the total of this and other rebatable amounts exceeds a specified amount, currently $2,000, the taxpayer is entitled to a rebate of tax of 30 per cent of the amount by which the total of his rebatable amounts exceeds $2,000: s. 159N. Section 72(2) will require that the taxpayer treat as income a refund of an amount “in respect of which a rebate of tax has been allowed or is allowable”. Presumably there can be no operation of s. 72(2) in this aspect unless the taxpayer’s total of rebatable amounts exceeded $2,000. There will then be a question of how much of the rebatable amount in respect of rates and land tax is an amount in respect of which a rebate of tax has been allowed or is allowable. It is curious that the amount of a refund which can at best have generated relief from tax at 30 cents in the dollar, should be subject to tax at the taxpayer’s marginal rate.
[4.226] Section 72(2) in its application to refunds of rebatable amounts clearly extends the ordinary usage meaning of income.
[4.227] Subdivision AA of Div. 3 of Pt III is a code (s. 82AAR) in regard to the deduction of contributions made by an employer to a superannuation fund for the benefit of employees. Section 82AAQ provides that where an employer has been allowed a deduction and thereafter receives a payment or benefit from the fund, the amount of the payment or the value of the benefit is his income. Section 82AAQ extends the ordinary usage principle of compensation receipts so as to make a refund income. It has a function like that of s. 26(k) and s. 72(2). The refund would presumably be income in any event under the business gains principle.
[4.228] Subsections (2)–(5) of s. 59 will make income the amount or value received or receivable, under a policy of insurance or otherwise, in respect of the loss or destruction of an item of property in respect of which depreciation has been allowed or is allowable. The amount is income only to the extent that it recoups a deduction that has been allowed or was allowable under s. 54. It will be seen in [10.188]ff. below that it will recoup a deduction if it exceeds the depreciated value of the item of property, and only to the extent that it does not exceed the cost of the item on which depreciation has been allowed.
[4.229] Subsections (2)–(5) of s. 59 stand outside the ordinary usage principle of compensation receipts, in that they relate to the recoupment of an outgoing which was not on revenue account.
[4.230] There may be thought to be some overlap with s. 26(j). If there is, the more specific provisions will presumably prevail. There will however only be an overlap if s. 26(j) is held to extend to compensation for property in relation to which an outgoing has been allowed. It has been noted in [4.206] above that such an operation for s. 26(j) was contemplated by Sugerman J. in Williamson v. Commissioner for Railways [1960] S.R. (N.S.W.) 252.
[4.231] Reference was made in [4.103]–[4.105] above to a number of sections which have the effect of reversing the allowance of deductions in respect of capital expenditure, when an amount received on the disposal of property recoups that expenditure. The sections are s. 122K (general mining), s. 123C (transport of minerals), s. 124G (timber operations), s. 124JB (timber mill buildings) and s. 124P (commercial or industrial property). Those sections are also applicable when an amount is received on the loss or destruction of the property, under a policy of insurance or otherwise, in respect of the loss or destruction.
[4.232] The sections operate in a fashion similar to subss (2)–(5) of s. 59 and the comments made above in relation to subss (2)–(5) of s. 59 are relevant.
[4.233] Specific provisions, whereby an item may be made income or excluded from income, differ in an important respect from the ordinary usage notion of income operating through the use of the word “income” in s. 25. Any specific provision is likely to be framed in words that are, or become by interpretation, words of legal art. As such, they invite the adoption of legal forms which will engage or escape the operation of the specific provision, as the interests of the taxpayer may direct. An approach to the application of the Assessment Act which prefers form to substance will reinforce the action of the taxpayer. A form approach will insist that where the Act in its specific provisions invites the adoption of a legal form, the application of the Act must be determined by reference only to the form that has been adopted. Indeed, it might be said that there is no room for a substance approach, because there is no relevant substance. The identification of substance is the identification of a broad principle which will not be expressed in terms of legal art. There are no broad principles in the provisions which seek to extend or modify the ordinary usage meaning of income.
[4.234] The more the words of a specific provision become words of legal art by interpretation, the more is the invitation to adopt legal forms which will engage or escape the operation of the provision. An illustration is afforded by the interpretation of the word “royalty” in s. 26(f) explored in [4.114]–[4.120] above. The interpretation of the word in Stanton (1955) 92 C.L.R. 630, McCauley (1944) 69 C.L.R. 235 and Sherritt Gordon Mines Ltd (1977) 137 C.L.R. 612 has left its meaning confined, among other respects, to a receipt for the use by another of property. Such an interpretation invites casting a transaction in a legal form which cannot be seen as involving a receipt for the use of property. Aktiebolaget Volvo (1978) 78 A.T.C. 4316 may be an example. The receipts in that case were in legal form for the giving of the keep-out covenant by Volvo Sweden, because they were expressed to be the consideration for that covenant.
[4.235] If one assumes that the interpretation of the word “royalty” by the courts has given effect to the legislative intention, form and substance approaches to the application of the Act coalesce. One might wish to disagree with the finding of legislative intention, but this is a disagreement which can best be expressed by asking for a new expression of legislative intention in an amendment to the Act.
[4.236] There is, however, a vital difference between specific provisions going to the meaning of income, and the meaning of income supplied by the ordinary usage notion. The ordinary usage notion needs to be expressed in judicial decision, but the expressions, though made in terms of legal art, should never be taken to be the definitive formulation of the ordinary usage notion. There is simply no basis for saying that the judicial decisions reflect the legislative intent. The legislature has given the courts the function of expressing ordinary usage, not the function of displacing that usage with their own. An expression of ordinary usage in a judicial decision may afford a useful rule, but it must always be subject to principles which, when expressed at all, must be expressed in the broadest of terms, none intended to be terms of legal art.
[4.237] It follows that where the issue is whether an item is income in the ordinary usage meaning of the word, a resort to substance will always be appropriate. In a number of paragraphs ([2.410]–[2.412], [2.420]–[2.428] above) concerned with the ordinary usage meaning, attention was drawn to a form approach, in favour of, or against the taxpayer, in judicial decisions. A form approach will rely on some expression of the ordinary usage meaning in a rule which appears to invite the adoption of a legal form which will engage or escape the operation of the ordinary usage notion of income. The rejection of such an approach by Megarry J. in Pritchard v. Arundale [1972] 1 Ch. 229 where its adoption would have produced a conclusion that the taxpayer had derived income, when the substance of ordinary usage directed that he had not, may be thought to be beyond question. The approach rejected by Megarry J. was also rejected by the High Court in Dickenson (1958) 98 C.L.R. 460, where its effect may have been to favour the taxpayer. In fact the characterisation by reference to all the circumstances, in the application of a substance approach, produced an outcome favourable to the taxpayer in any event.
[4.238] A form approach may be equally inappropriate where issues other than the characterisation of an item as income are to be resolved. Thus, a form approach may be thought inappropriate where the question is whether an item has an Australian source. Here too the function of the courts, where there is no specific provision, is to find principles which can only be formulated in the broadest of terms, none intended to be terms of legal art. A recognition that this is their function is implicit in the frequent quotation of words from the judgment of Isaacs J. in Nathan (1918) 25 C.L.R. 183 at 190: “The ascertainment of the actual source of a given income is a practical, hard matter of fact.” The words quoted are clearly not intended to be taken literally—a matter of fact is a matter of what the facts are, a matter of source must be a matter of a legal conclusion from those facts. But the words emphasise that the legal conclusion is a matter of characterisation in terms of broad principles which will take count of all the facts.
[4.239] The courts have expressed the notion of source in a number of rules which appear to invite the adoption by the taxpayer of a legal form which ensures that income does not have an Australian source, and there are occasions when a form approach has been taken to support the taxpayer. Atkiebolaget Volvo (1978) 78 A.T.C. 4316, referred to above, may afford an illustration. One rule expressing the notion of source suggested by the authorities, is that a source in Australia is given by the fact that the receipts are for the use of property in Australia. The conclusion reached by Jenkinson J. that the receipts were not royalties depended on their form as receipts for a restrictive covenant. They did not have the form of receipts for the use of Volvo Sweden’s goodwill in Australia associated with the name “Volvo”. Whatever the appropriateness of the form approach on the question whether the items were royalties, it ought not to resolve the question of source. The fact that goodwill in Australia was made exclusively available to Volvo Australia by the keep-out covenant in respect of which the payments were made, was, and should have remained, relevant. Jenkinson J. concluded that other factors required a conclusion that the source was not in Australia, but he appears to have taken the view that the making available of goodwill in Australia was irrelevant unless “the agreement were to be characterised as an assurance to Volvo Australia of goodwill conceived as a species of Australian personal property” (at 4323), a characterisation he had already rejected in deciding that the receipts were not royalties.
[4.240] If a form approach is inappropriate where the question is whether an item is income by ordinary usage, it is equally inappropriate where the issue is whether an item is deductible as within the general provision in s. 51. The matter is explored in Chapter 9 below. Section 51 seeks to formulate principles, a task left to the courts in relation to the meaning of income by ordinary usage. But the principles are expressed in the same broad terms as are expected of the courts in giving meaning to income. Since the decision in Cecil Bros Pty Ltd (1964) 111 C.L.R. 430, the High Court has taken an approach to the application of s. 51 which bears comparison with the form approach to the application of s. 26(f) taken in Volvo. While it has been conceded that the form approach may be appropriate in the application of s. 26(f), it is clearly inappropriate in the application of s. 51. The approach in Cecil was confirmed by the Privy Council in Europa Oil (N.Z.) Ltd v. C.I.R. (N.Z.) (No. 2) (1976) 76 A.T.C. 6001. Both cases involve the assertion of a rule that the costs of trading stock are deductible, a rule which is not to be found in the Assessment Act: s. 51(2) does not so provide. That rule is then treated as sovereign in requiring a conclusion that a payment which a taxpayer is bound to make under a contract by which the consideration received for the payment is solely the supply of trading stock, is deductible. That the contract is relevant to the characterisation as deductible or not deductible would not be denied. But it is only one of the circumstances that is relevant in reaching a conclusion as to the operation of the principles expressed in s. 51. To insist that the Commissioner and the courts must wear blinkers and treat circumstances as irrelevant which are evidently relevant to the operation of those principles, is to subvert the Assessment Act. It is necessary to look at the “substance” of the matter, which is to say that in this area the intention of the Act is that tax consequences are not solely dependent on the legal forms that have been followed, as may be the case where the Act is in its terms framed in language that uses words of legal art.
[4.241] Some retreat from Cecil and Europa Oil (No. 2) may be evident in the judgments in South Australia Battery Makers Pty Ltd (1978) 140 C.L.R. 645, though that case qualified the form approach only to a degree and in a way which left the principles of s. 51 defeated—one is entitled to look to an advantage which in fact is gained by a third party as a result of the payment, if that advantage enures in its consequence to the taxpayer. The advantage will be irrelevant if it is confined to the third party, and this even though the third party is an associate of the taxpayer.
[4.242] What is called for is not some qualification on the form approach but its abandonment in the application of s. 51.