Chapter 1
[1.1] By s. 17 of the Income Tax Assessment Act, income tax is levied “upon the taxable income derived during the year of income by any person”. In the case of a natural person, other than a natural person in the capacity of a trustee, tax is imposed on taxable income of a year of income, by the Income Tax (Individuals) Act applicable to that year of income, at rates declared by the Income Tax (Rates) Act. In the case of a company (other than a company in the capacity of a trustee) tax is imposed on taxable income of a year of income by the Income Tax (Companies, Corporate Unit Trusts and Superannuation Funds) Act applicable to that year of income. “Company” is defined in s. 6. It includes all bodies or associations, corporate or unincorporate, but does not include partnerships.
[1.2] Where a person derives income in the capacity of a trustee, save where he derives in the capacity of a trustee of a superannuation fund, tax is levied by ss 98, 99 and 99A of Div. 6 of Pt III on the whole of, or a share of, “the net income of the trust estate” derived during the year of income. Section 17 would appear to be inapplicable, because the trustee does not derive “taxable income”, though net income of the trust estate is by s. 95 calculated in the manner applicable to the calculation of the taxable income of a natural person, or a company, that is not a trustee. The notion of year of income is in this instance imported by the hypothesis—“as if the trustee were a taxpayer”—on which the calculation is made. Tax is imposed by the Income Tax (Individuals) Act applicable to the year of income.
[1.3] Where a person derives income in the capacity of trustee of a superannuation fund, tax is levied by ss 121CA, 121CB, 121D, 121DA and 121DAB of Div. 9B of Pt III on “income” (s. 121CA), “income” (s. 121CB), “investment income” (s. 121D), and “the amount” (ss 121DA and 121DAB) of a year of income. An amount on which tax is levied by these sections, other than s. 121D, is by s. 121DC deemed to be “taxable income”, and would for this reason be the subject in any case of levy by virtue of s. 17. Tax is imposed by the Income Tax (Companies, Corporate Unit Trusts and Superannuation Funds) Act applicable to the year of income.
[1.4] “Year of income” is defined in s. 6. In relation to a company (except a company in the capacity of a trustee), it means the financial year next preceding the “year of tax”, or the accounting period, if any, adopted under s. 18 of the Assessment Act in lieu of that financial year. By s. 6, “year of tax” means the financial year for which income tax is levied. In relation to a person other than a company, and in relation to a company in the capacity of a trustee, “year of income” means the financial year for which income tax is levied, or the accounting period, if any, adopted under s. 18 in lieu of that financial year. Thus companies, other than companies in the capacity of trustees, are taxed on a preceding year basis, and other persons are taxed on a current year basis.
[1.5] Section 18 provides that, with the leave of the Commissioner, any person may adopt a substituted period, being the 12 months ending on some date other than 30 June. Leave to adopt a substituted accounting period is not readily given. If leave is given, it will be given on such terms as to ensure that tax is not avoided or deferred by the adoption of the substituted period.
[1.6] Section 17 levies tax on “taxable income”. By s. 6, “taxable income” means “the amount remaining after deducting from assessable income all allowable deductions”. “Allowable deduction” means “a deduction allowable under [the] Act”. Where tax is levied on “net income of a trust estate”, under Div. 6 of Pt III, in the hands of a trustee, or on an amount, however named, in the hands of a trustee of a superannuation fund under Div. 9B of Pt III, the calculation requires the bringing in of “assessable income” and the deduction of “allowable deductions”.
[1.7] “Allowable deductions” are the subject of Part II of this Volume. What is included in assessable income depends on the claims to jurisdiction to tax made in the Assessment Act. It also depends on the meaning of income, a matter explored in some depth in this Part. The operation of the claims to jurisdiction, and the boundaries of the concept of income, raise questions about the structure of the Assessment Act. Some indication of these questions is given by drawing attention to one further phrase in which the word “income” appears in the Act— the phrase “gross income” in s. 25. Omitting words added in 1984, that section, in subs. (1), provides:
“The assessable income of a taxpayer shall include—
which is not exempt income.”
[1.8] A submission of this Volume is that any item which enters “assessable income”, in the sense of an amount from which allowable deductions are deducted to bring out an amount of income on which tax is levied, must have entered through s. 25(1). The word “gross” in the phrase “gross income” is intended to ensure that the phrase embraces all items which are made income by the Assessment Act. Associated with this submission is another—that, at least for purposes of tax by assessment, the word “income” as used in the Assessment Act has only one meaning, a meaning drawn from all the provisions of the Act.
[1.9] It will be seen that the existence of a coherent structure in the provisions of the Assessment Act depends on these submissions being valid. It is acknowledged that the first submission has been made untenable by words added to s. 25(1) in 1984. A redrafting can however restore a coherent structure without any abandonment of the intention of the added words.
[1.10] The effect of s. 25(1), s. 23(q) and subss (1) and (1A) of s. 44 may be summarised as follows:
[1.11] These propositions require qualification where the item of income is interest or royalties derived from sources in a country with which Australia has a double tax Agreement, and the relevant Agreement limits the rate of tax which may be imposed by the country of source. In these circumstances the interest or royalties is not exempt from Australian tax (Income Tax (International Agreements) Act, s. 12), but credit against Australian tax will be given under the terms of the relevant Agreement and the provisions of the Income Tax (International Agreements) Act.
[1.12] Where a dividend paid from profits having a source out of Australia is received by a taxpayer who is a resident of Australia, and the dividend has been taxed in the country of residence of the company paying the dividend, there will, generally, be a credit under s. 45 of the Assessment Act against the Australian tax on the dividend. There will however be no credit if the taxpayer receiving the dividend is a company and there is a full rebate of tax on the dividend under s. 46. There is, in effect, in this situation no Australian tax against which credit might be allowed: see subss (2) and (3) of s. 46 of the Assessment Act and subss (4) and (5) of s. 15 of the Income Tax (International Agreements) Act.
[1.13] “Resident of Australia” is defined in s. 6. There are some specific provisions of the Assessment Act in regard to source, for example ss 25(2) and 44(1), but generally the meaning of source is left to judicial interpretation. Section 44(1) determines source in relation to a dividend. The subsection, it should be noted, is not an independent provision operating parallel with s. 25(1): its function is to explain s. 25(1) where the item in question is a dividend.
[1.14] These propositions as to the relevance of residence and source will require qualification in some circumstances when there is a double tax Agreement between Australia and another country, and the provisions of the Agreement have been made law by enactment as a Schedule to the Income Tax (International Agreements) Act.
[1.15] Where the levy of tax does not depend on a calculation of taxable income by the subtraction of allowable deductions from assessable income of the person subject to the levy, the application of the tests of jurisdiction in s. 25(1) presents difficulties. Until 1979, Div. 6 of Pt III required a calculation of “net income of the trust estate”, on which a beneficiary or the trustee might be subject to tax, by making an hypothesis that the trustee was a taxpayer who derived income. The hypothesis did not attribute any residence status to this notional taxpayer, and the High Court in Union-Fidelity Trustee Co. (1969) 119 C.L.R. 177 held that the only test of jurisdiction in s. 25(1) that could be applied was source of the income. It followed that the levy of tax on the trustee provided for in Div. 6 could apply only to Australian source income. Division 6 has now been amended so that the calculation of what is now referred to as “net income” is made on the hypothesis that the notional taxpayer is an Australian resident. Where the levy of tax is on the trustee, jurisdiction is now claimed on the basis that the trust estate is a resident trust estate, as defined in Div. 6.
[1.16] The application of the tests of jurisdiction in s. 25(1) presents like difficulties in relation to the levy of tax on the trustee of a superannuation fund by Div. 9B of Pt III. In only one instance does the drafting of Div. 9B take into account the decision of the High Court in Union-Fidelity Trustee Co. (1969) 119 C.L.R. 177. Section 121D imposes a liability to tax on the trustee of a superannuation fund in respect of income that is “investment income”, defined in s. 121B. Investment income is the income of a s. 23F employees’ superannuation fund, or a s. 23(ja) self-employed person’s fund, that is denied the exemption from tax that it would otherwise have under one of those provisions because of a failure of the fund to meet the requirements of investment in Government securities imposed by s. 121C. Tests of jurisdiction are imposed by the definition which requires calculation “as if the trustee of the fund were a taxpayer in respect of that income, being a resident”.
[1.17] Section 121CA imposes tax on other income of a s. 23F fund which is denied exemption by provisions of s. 23F itself, but there are no jurisdictional tests specified, and it is arguable that the Union-Fidelity decision will apply so that the income on which tax is imposed will be limited to Australian source income. Indeed s. 121CA is deficient in another respect. By not referring to the condition “as if the trustee were a taxpayer” that appears in the definition of investment income, it opens the way to an argument that the fund does not have any income because the fund does not derive beneficially.
[1.18] Section 121CB imposes tax on the trustee of a s. 23FB superannuation fund—an employee or self-employed person’s fund meeting the conditions imposed by s. 23FB—in respect of “assessable income” of the superannuation fund. The reference to assessable income is presumably a reference to income that is not exempt income by virtue of s. 23FB. But no tests of jurisdiction are specified, and the Union-Fidelity decision may apply. Again there is no condition “as if the trustee were a taxpayer”.
[1.19] Section 121DAB imposes tax on the trustee of a superannuation fund that is not of any of the kinds already referred to, and meets conditions imposed by the section. The drafting in this instance returns to the language “calculated as if the trustee were a taxpayer”. It does not however add the words “being a resident”, and thus does not take into account the Union-Fidelity decision.
[1.20] Section 121DA imposes tax on the trustee of any other superannuation fund. The drafting follows the language of s. 121DAB, and thus does not take into account the Union-Fidelity decision.
[1.21] Section 121DAA, which imposes tax on the trustee of an “ineligible approved deposit fund”, also follows the language of s. 121DAB. An ineligible approved deposit fund is presumably an “approved deposit fund” as defined in s. 27A(1), that is not an “eligible approved deposit fund” under s. 23FA.
[1.22] A rational solution to the problems of jurisdiction posed by Div. 9B would be to treat the division as supplementing the law in Div. 6, which in turn simply explains the operation of s. 25(1). It would follow that Div. 6 would supply, in s. 95, the basis for determining the income of the superannuation fund, subject to any express exclusion, and a concept of a resident trust. Section 25(1) would supply the tests of jurisdiction and thus the basis of determination of assessable income. That determination would have regard to the exemptions given by s. 23F and paras (jaa) and (ja) of s. 23 (as qualified by s. 121CB), and by s. 23FB.
[1.23] Section 121DB, in providing that “Except as provided by Division 11A” (which relates to withholding tax) “the income of a superannuation fund … is not subject to income tax otherwise than as provided by [Division 9B]”, is not necessarily inconsistent with the solution offered. Any alternative solution which would insist that Div. 9B owes nothing to s. 25 and Div. 6, will have unacceptable consequences. Thus the definition of “investment income” in s. 121B, which includes the words “calculated as if the trustee of the fund were a taxpayer in respect of that income, being a resident”, when taken in conjunction with s. 121D which simply provides that the trustee of the fund “shall be assessed and liable to pay tax … upon the investment income of the fund” would involve an assertion of jurisdiction to tax a foreign resident trustee on foreign source income. The trustee is, in effect, deemed to be a resident and s. 23(r)—which exempts income derived by a non-resident from sources wholly out of Australia—could have no application. Where in other sections of Div. 9B the trustee is simply deemed to be a taxpayer, Union-Fidelity Trustee Co. (1969) 119 C.L.R. 177 will preclude tax on an Australian resident trustee, save where the income has an Australian source. Where no deeming at all is provided, the superannuation fund will have no income. In the outcome Div. 9B would be a rather sad bungle.
[1.24] The effect of s. 7A, added in 1973, is that the Assessment Act, subject to Div. 1A of Pt III, operates in relation to the Territories of Norfolk Island, Cocos (Keeling) Islands and Christmas Island as if they were part of Australia.
[1.25] Division 1A of Pt III provides for a number of exemptions which mitigate the consequences of the extension of the Assessment Act, in this way, to these Territories. The exemptions are in respect of income with sources outside the Territories and Australia, and in respect of income with sources in the Territories. The exemptions are available to individuals, companies and trusts in various ways closely connected with one of the Territories. And there is an exemption in respect of income from an office or employment where duties are performed in one of the Territories by a person who went to the Territory intending to remain for a period of more than six months.
[1.26] The discussion of s. 25(1) and, indeed, all the discussion so far in this chapter, has assumed that the income in question falls to be taxed by assessment.
[1.27] The Assessment Act, in Div. 11A of Pt III, provides for the levy of income tax on income in the form of certain dividends and interest. This tax is referred to as withholding tax. It is levied, not by assessment, but by procedures of withholding under Div. 4 of Pt VI and, if necessary, by recovery of the tax, following service of a notice, from the person liable to pay the tax (s. 128C). The ascertainment of the amount of withholding tax is not an assessment (s. 128C(6)) and dividends and interest on which withholding tax is payable “shall not be included in the assessable income of a person” (s. 128D). The procedures of objection, reference and appeal are not available in relation to a levy of withholding tax. The levy may be challenged, where the tax has been collected by withholding, in proceedings to recover the tax under s. 221YS, or, where the Commissioner sues to recover the tax from the person he claims is liable, by way of defence in those proceedings.
[1.28] A regime similar to withholding tax is applied by Div. 13A of Pt III, to film and videotape royalties paid to a non-resident. Liability for the tax is imposed on the receiver, but there are provisions for collection of the tax from the person making the payment. As in the case of withholding tax, the royalties are excluded from assessable income and thus from tax by assessment.
[1.29] There are provisions in Div. 11C of Pt III relating to payments in respect of mining operations on Aboriginal land. Liability for tax on such payments rests on the person who receives the payment or for whose benefit the payment was applied. Tax may be collected from the person who makes a payment. It is expressly provided that ascertainment of the amount of tax is not an assessment. In other respects the relationship of tax under Div. 11C to tax by assessment is obscure.
[1.30] The word income is used by economists and by lawyers. Economists tend to argue about what income “is”. The argument is obviously sterile, though, as will be seen, it may be instructive to know what a particular economist means by the word. Lawyers argue about what the word means in a particular legal context. Trust law has a meaning for the word. Income tax law has another, perhaps two others, for purposes of tax by assessment and, it may be, yet another for purposes of tax by withholding. The income tax law meaning or meanings owe a good deal to trust law. But income tax law is fundamentally statute law, and the concern of this Volume is with the meaning of income as the word is used in the Assessment Act in relation to tax by assessment.
[1.31] The submissions have been made in [1.8] above:
[1.32] The first of these submissions may be identified as the central provision analysis of the structure of the Assessment Act. The second submission may be identified as the single meaning analysis. These submissions are at odds with conventional dogma which would assert, in contradiction of the second submission, that the word income as used in relation to tax by assessment has two meanings. One of these meanings is imported by the Act from the ordinary usage of the word. The other meaning refers to all items made income for purposes of the Act by provisions other than s. 25(1). Income in the first meaning is designated “ordinary usage income”. Income in the second meaning is generally, if not universally, designated “assessable income” with attendant confusion with the notion of assessable income as the amount from which allowable deductions are deducted to bring out an amount on which tax is levied. Conventional dogma, in this regard, may be identified as the two meanings analysis.
[1.33] In contradiction of the first submission, conventional dogma would assert that the items which enter assessable income through s. 25(1) are only those items which are income in the ordinary usage of the word. Other items enter by virtue of other provisions by which items are specifically described and are designated “assessable income”. Conventional dogma, in this regard, may be identified as the parallel provisions analysis. It is an analysis which has received legislative endorsement by words added to s. 25(1) in 1984.
[1.34] If items, which one might be allowed to describe as items “made income” by provisions other than s. 25(1), are carried direct to assessable income by those provisions, the Assessment Act would appear to assert an unlimited jurisdiction to tax them. And it would appear that none of these can ever be excluded from tax as exempt. Save s. 44(1), and then only in relation to jurisdictional limitations, none of these other provisions contains any jurisdictional limitations or any exclusion as exempt. Thus s. 26 opens with the words “the assessable income of a taxpayer shall include”, and then lists items in a series of paragraphs.
[1.35] It may be argued that s. 23(r) supplies the jurisdictional limitations. But that provision applies, on the parallel provisions analysis, only to items which are income within the ordinary usage of the word. And, in any case, s. 23(r) operates through s. 25(1) to prevent an item becoming assessable income. It cannot take out of assessable income an item which has already been carried to assessable income. These observations in regard to s. 23(r) may also be made in relation to other provisions which purport to exempt items for reasons other than jurisdictional limitations. Among these are the other paragraphs of s. 23.
[1.36] The central provision analysis avoids the fatal flaws. Parke Davis & Co. (1959) 101 C.L.R. 521, which is the principal source of support in judicial opinion for the central provision analysis, was concerned with s. 44(1) which in fact carries its own jurisdictional limitations, though not the exclusion from tax by exemption. The latter would be supplied by the central provision analysis. Income which is made such by s. 44 is taken up into the word “income” in s. 25(1). If it is within any category of exemption, it will, by the exclusion of exempt income expressed in s. 25(1), be prevented from entering assessable income.
[1.37] Though it avoids the fatal flaws, the central provision analysis must admit to some problems which arise from the drafting of s. 25(1) and of the specific provisions. And it must admit to the rejection of the analysis by words added to s. 25(1) in 1984. The word “gross” is used in conjunction with the word “income” in s. 25(1). There is a line of reasoning which would begin with the assertion that income within the ordinary usage of the word is always a gross amount, in the sense of an amount which is “not net”. Out of this assertion, indeed, has come the conventional dogma that the Assessment Act, save where there is some express provision, brings into assessable income a receipt and never a profit. The argument would go on to a conclusion that s. 25(1) must be concerned only with income within the ordinary usage of the word since some, at least, of the items with which other provisions are concerned are profits and not gross amounts. The assertion that income in the ordinary usage of the word is always a gross amount, is challenged in this Volume. In any case, the use of the word “gross” does not connote “not net” of any cost. If it did, the accounting notion of “gross profit” would involve a contradiction in terms.
[1.38] There is another reply to any argument based on the word “gross” that is directed against the central provision analysis. Where the word is used in an arithmetical sense, it has another meaning—“total”. In this meaning the word asserts the central provision analysis. The reference to “gross income” in s. 25(1) is to all items which are income for the purposes of the Assessment Act.
[1.39] An amendment to s. 25(1) in 1984 added the following words at the end of the subsection: “an amount to which s. 26AC or s. 26AD applies or an eligible termination payment within the meaning of Subdivision AA.” It must be acknowledged that the amendment proceeds on the parallel provisions analysis. The amendment involves an assumption that without it “an eligible termination payment”, for example, might be included in assessable income both under s. 25(1) and Subdiv [?] AA of Div. 2 of Pt III. The assumption adopts the minority view of Stephen J. in Reseck (1975) 133 C.L.R. 45, where the question was whether s. 25(1) could include in assessable income the whole of an amount that s. 26(d) expressly provided should be included only as to part of its amount. Stephen J. held that it could. The assumption has a tangle of implications in relation to other sections of the Act that make express provision which on the central provision and single meaning analyses will simply go to the meaning of income for purposes of s. 25(1), and it is inconsistent with the assumption behind the drafting of other provisions. Thus, s. 26AAC(10), in excluding the operation of s. 26(e) in relation to benefits in the form of the issue of shares or share options to employees, proceeds on the assumption that the meaning of income in s. 25(1) is thus modified. No express provision has been made in s. 25(1) in regard to s. 26AAC, in the manner of the words now added to s. 25(1) in relation to “an eligible termination payment”. Comment on s. 25AAC(10) is made in [2.25] below. It is fair to say that parity with the reasoning behind the words now added to s. 25(1) would require express provision in s. 25(1) excluding from s. 25(1) any specific provision that is intended to cover the relevant field. Thus the provisions of s. 44(1) and following sections, even though intended to cover some or the whole of the field of corporate distributions in determining their income character, will fail in that intention unless there are further words added to s. 25(1) excluding the operation of s. 25(1) in relation to such distributions.
[1.40] The aspect of the general pattern of drafting which is most awkward for the central provision analysis is the use of the same words in the opening of s. 25(1) as in the specific provisions. These opening words are “The assessable income of a taxpayer shall include”. The central provision analysis would be unquestionably valid if the word “means” were used in s. 25(1) instead of “includes”, and if the specific provisions referred only to “income” and not to “assessable income”. The parallel opening words of s. 25(1) and of the other provisions may be thought to suggest the parallel provisions analysis. But they are ambivalent: they equally suggest that the provisions subsequent to s. 25(1) fulfil or carry out s. 25(1).
[1.41] The single meaning analysis advanced in the second submission of this Volume concedes that in the fashioning of the word “income” in s. 25(1) one must begin with the meaning of the word in ordinary usage. To this extent the meaning of the word income for purposes of the Assessment Act draws on the ordinary usage meaning of the word. Some specific provisions may simply declare that some part of the meaning of the word income in ordinary usage is income for purposes of the Assessment Act. Other specific provisions, in fashioning the meaning of “income” in s. 25(1), may extend, limit or modify the meaning of the word in ordinary usage. Whether a specific provision operates to limit, or modify by limiting, is a matter of construction of that provision. Unless the specific provision expressly provides that an item which is in fact within the ordinary usage of the word income, shall not be included in assessable income, the construction of the provision requires a decision as to whether the specific provision “covers the field” in which the item lies, or may be said to be a code in relation to a group of items of which it is one. Thus, it will be seen in [2.261] below, an answer to the question whether a cash distribution (other than the distribution referred to in s. 6(4)) by a company to its shareholder from share premium account is income, requires a decision whether Subdiv. D of Div. 2 of Pt III (which deals with dividends) is a code, and a code in relation to distributions by companies to shareholders. Where the specific provision expressly provides that an item shall not be included in assessable income, the single meaning analysis would assert that the meaning of income for purposes of the Act does not include that item.
[1.42] The two meanings analysis raises acute problems as to what is to be taken to be the meaning of income when the word is used in provisions which do not themselves define income, but rely on a meaning determined by other provisions of the Assessment Act. Among them are the definition of “exempt income” in s. 6(1), the word “income” in s. 47(1) and the word “income” included by the opening words of s. 23 in the various paragraphs of that section.
[1.43] Judicial experience with the two meanings analysis is hardly encouraging. The problems of identifying the meaning intended by the word income as it is used in the definition of “exempt income” in s. 6(1), or as it is used in s. 23 are resolved under the two meanings analysis, by choosing one of the meanings, but the resolution produces absurd results. The two meanings analysis dictates a choice between a conclusion that the word income as used in ss 6, 47 and 23 refers only to items which are such in the ordinary usage of the word or, it seems, are deemed to be income in the ordinary usage of the word, and a conclusion that the word refers only to items that are made income by specific provisions. It is an absurd view of the operation of the Assessment Act that s. 23(q) may exempt a trading profit from a foreign source but not a profit from a foreign source which is income only by force of s. 25A(1). It is equally absurd that s. 23(q) may exempt only income from a foreign source that is income by force of specific provisions. The perplexities of the attempt in Harrowell (1967) 116 C.L.R. 607 to reconcile the two meanings analysis with a meaning for the word income, in the phrase “represents income” in s. 47, which would include a deemed dividend arising in liquidation, condemn both the parallel provisions analysis and the two meanings analysis.
[1.44] Whatever analyses are adopted, there is need to explore the ordinary usage meaning of income. It is the substratum of the meaning of income for purposes of the Assessment Act. In one provision, s. 26(f), it is expressly referred to in defining the scope of a specific provision. It might be expected that the content of ordinary usage income will be provided by judicial decisions, many of them United Kingdom decisions on the meaning of income in the United Kingdom income tax legislation. Chapter 2 of this Volume will examine the ordinary usage meaning, noting at the same time the provisions of the Assessment Act which confirm aspects of that meaning, or which, on a single meaning analysis, have the effect of excluding, limiting or modifying the ordinary usage meaning as it is imported into the meaning of income for purposes of the Assessment Act.
[1.45] As background to the examination of the ordinary usage meaning, and of the exclusions, limitations and modifications of that meaning, it is instructive to consider what is meant by income in the thinking of those economists who identify income with “accretions to economic power”. These economists would say that an income tax has a rational and appropriate operation so far as it taxes such accretions, and taxes only such accretions.
[1.46] The view that accretions to economic power, also referred to as spending power, is the appropriate base for an income tax is most often associated with the name of Henry Simons. In his classic work, Personal Income Taxation (Univ. of Chicago Press, Chicago, 1938 [1980 Reprint]), he wrote (pp. 50–51):
“Personal income may be defined as the algebraic sum of (1) the market value of rights exercised in consumption and (2) the change in the value of the store of property rights between the beginning and end of the period in question. In other words, it is merely the result obtained by adding consumption during the period to ‘wealth’ at the end of the period and then subtracting ‘wealth’ at the beginning. The sine qua non of income is gain, as our courts have recognised in their more lucid moments—and gain to someone during a specified time interval. Moreover, this gain may be measured and defined most easily by positing a dual objective or purpose, consumption and accumulation, each of which may be estimated in a common unit by appeal to market prices. This position, if tenable, must suggest the folly of describing income as a flow and, more emphatically, of regarding it as a quantity of goods, services, receipts, fruits, etc. As Schäffle has said so pointedly, ‘Das Einkommen hat nur buchhalterische Existenz’. It is indeed merely an arithmetic answer and exists only as the end result of appropriate calculations. To conceive of income in terms of things is to invite all the confusion of the elementary student in accounting who insists upon identifying ‘surplus’ and ‘cash’. If one views society as a kind of giant partnership, one may conceive of a person’s income as the sum of his withdrawals (consumption) and the change in the value of his equity or interest in the enterprise. The essential connotation of income, to repeat, is gain—gain to someone during a specified period and measured according to objective market standards.”
[1.47] It is a view adopted in the Memorandum of Dissent contained in the Final Report of the United Kingdom Royal Commission on the Taxation of Profits and Income (1955, Cmd. 9474). That Memorandum may be taken to express the thinking of the English economist, Lord Kaldor, who was one of the three signatories of the Memorandum. It states (pp. 355–356):
“5. In our view the taxable capacity of an individual consists in his power to satisfy his own material needs, i.e., to attain a particular living standard. We know of no alternative definition that is capable of satisfying society’s prevailing sense of fairness and equity. Thus the ruling test to be applied in deciding whether any particular receipt should or should not be reckoned as taxable income is whether it contributes or not, or how far it contributes, to an individual’s ‘spending power’ during a period. When set beside this standard, most of the principles that have been applied, at one time or another, to determine whether particular types of receipt constitute income (whether the receipts are regularly recurrent or casual, or whether they proceed from a separate and identifiable source, or whether they are payments for services rendered, or whether they constitute profit ‘on sound accountancy principles’, or whether, in the words of the Majority … they fall ‘within the limited class of receipts that are identified as income by their own nature’) appear to us to be irrelevant. In fact no concept of income can be really equitable that stops short of the comprehensive definition which embraces all receipts which increase an individual’s command over the use of society’s scarce resources—in other words, his ‘net accretion of economic power between two points of time’.
6. Definitions of income giving expression to this basic principle have been offered by various writers on public finance, all of which, subject to minor differences, agree in regarding ‘income’ as the sum of two separate elements, namely personal consumption and net capital accumulation. In the words of one writer income can be looked upon either as ‘(a) the amount by which the value of a person’s store of property rights would have increased, as between the beginning and the end of the period, if he had consumed (destroyed) nothing; or (b) the value of rights which he might have exercised in consumption without altering the value of his store of rights’. Hence income is the ‘algebraic sum of (1) the market value of rights exercised in consumption, and (2) the change in the value of the store of property rights between the beginning and the end of the period in question’ (H. Simons, Personal Income Taxation, pp. 49–50).
7. The above definition focuses attention on two fundamental aspects of the concept of income which reflects the increment of ‘spending power’ or ‘economic power’ in a period. One is that income is a measure of the increase in the individual’s command over resources in a period, irrespective of how much or how little of that command he actually exercises in consumption. The private choice of an individual as to how much he spends and how much he saves is irrelevant to this notion: income is the sum of consumption and net saving. The second is that ‘net saving’ (and hence income) includes the whole of the change in the value of man’s store of property rights between two points of time, irrespective of whether the change has been brought about by the current addition to property which is saving in the narrower sense, or whether it has been caused by accretions to the value of property. From the point of view of an individual’s command over resources, it is the change in the real value of his property which alone matters, and not the process by which that change was brought about.”
[1.48] The view was also adopted in the Canadian Report of the Royal Commission on Taxation (1966), Vol. 1, pp. 9–10:
“We are completely persuaded that taxes should be allocated according to the changes in the economic power of individuals and families. If a man obtains increased command over goods and services for his personal satisfaction we do not believe it matters, from the point of view of taxation, whether he earned it through working, gained it through operating a business, received it because he held property, made it by selling property or was given it by a relative. Nor do we believe it matters whether the increased command over goods and services was in cash or in kind. Nor do we believe it matters whether the increase in economic power was expected or unexpected, whether it was a unique or recurrent event, whether the man suffered to get the increase in economic power or it fell in his lap without effort.
All of these considerations should be ignored either because they are impossible to determine objectively in practice or because they are irrelevant in principle, or both. By adopting a base that measures changes in the power, whether exercised or not, to consume goods and services we obtain certainty, consistency and equity.”
[1.49] A tax on accretions to spending power will not be concerned to know whether that spending power has been exercised in consumption. There is thus a vital difference between an income tax, of the kind favoured by Simons, and a tax, such as a sales tax, which in its effective incidence may be seen as a tax on the exercise of spending power (whether power arising from current accretions, or from savings of past accretions). And there is a difference between a Simons income tax and a tax on spending power at a point of time such as an estate duty or an annual wealth tax.
[1.50] The Memorandum of Dissent ([1.47] above) supports an income tax on accretions to spending power over a period as a better income tax than the United Kingdom income tax as it operated at the time of the Royal Commission. One may take it, however, that Kaldor would prefer a tax on the actual exercise of spending power in consumption in the form, not of a sales tax, but of an expenditure tax—a phrase used here to refer to a tax with a progressive rate structure and a base which is the total of an individual’s exercises of spending power over a period. Kaldor’s preference for an expenditure tax is expressed in his book An Expenditure Tax (George Allen & Unwin, London, 1955). The Canadian Royal Commission did not share Kaldor’s preference. The Canadian Commission was a most powerful advocate for an income tax with a base of accretions to spending power.
[1.51] Much of modern opinion would share Kaldor’s preference. His preference is supported by the report of the Meade Committee (The Structure and Reform of Direct Taxation: Report of a Committee chaired by Professor J. E. Meade (George Allen & Unwin, London, 1978)). That Committee relied to a degree on proposals for an expenditure tax by a Swedish lawyer, Professor Lodin, made in his report of an investigation carried out for a Swedish Commission on Taxation in 1972 (S. O. Lodin, Progressive Expenditure Tax—An Alternative? (Liber Förlag, Stockholm, 1978)). A selection of modern opinion is expressed in the report of a conference entitled “What Should be Taxed: Income or Expenditure?” (J. A. Pechman (ed.) (The Brookings Institution, Washington D.C., 1980)).
[1.52] It will be apparent from the examination of the meaning of income in the Assessment Act undertaken in Pt I of this Volume that the base of our income tax differs in a number of respects from the base advocated by Simons, Kaldor and the Canadian Royal Commission, a base which may be identified as the “comprehensive tax base”. While generally the base of our income tax is made up of accretions to spending power, the base may include an item because of an element of periodicity in its derivation, even though that item reflects only realisation of an asset: there has been no more than a transformation of spending power. It will be seen in [2.215]ff. and [4.106]ff. below, that s. 27H of the Assessment Act seeks to prevent tax on the transformation-of-asset element in periodical receipts, so as to leave only the accretion element subject to tax, but it does not achieve this result in all circumstances.
[1.53] There is a view of the operation of the Assessment Act which would say that, unless there is some express provision to the contrary, the Act taxes “receipts” in some primitive sense that connotes “what comes in”, and does not embrace a gain which must be calculated by the subtraction of an expense from a receipt. This view is rejected in this Volume. So far as it is a correct view, that view involves the consequence that the base of the income tax will include the proceeds of realisation of an asset as distinct from the profit from that realisation. In this there would be a stark difference from the comprehensive tax base. And it would be no justification of that difference to say that the cost of the asset has most likely been allowed as a deduction in fixing the base of the tax in an earlier year. That deduction would itself have been at odds with the comprehensive base, since it would have diminished the base in circumstances that did not reflect any decrease of spending power.
[1.54] The more obvious differences between the base of our income tax and the base advocated by Simons concern want of comprehensiveness of the former. There are however two preliminary points that should be made. In one respect both our income tax and the comprehensive base are less than comprehensive. None of Simons, Kaldor and the Canadian Royal Commission would, as a general rule, include in an income tax base the unrealised appreciation in the value of an asset. Simons’ broad pronouncements quoted above may suggest that he advocated the inclusion of unrealised appreciation. But in other parts of his text he was at least equivocal on the matter, and probably favoured realisation of the accretion as a condition of the inclusion of an item in the base. The Memorandum of Dissent signed by Kaldor includes the following:
“8. In applying the basic conception of income as the power to satisfy material needs to any workable tax system, a number of guiding principles need to be introduced. (1) The first of these is, in the words of the Majority … that ‘no income [should be] recognised as arising unless an actual receipt has taken place, although a receipt may take the form of a benefit having money’s worth received in kind as well as of money or of a payment made to a third party in discharge of another’s legal debt’. The obvious corollary to this principle is that no deduction should be recognised from any gross receipt in arriving at the net receipt unless an actual outlay has taken place, whether in money or money’s worth. Hence improvement or deterioration in the market value of a man’s property should not be recognised until it is reflected (as in the long run it must be) in his actual receipts, or in the outlays that he can properly charge against those receipts …” (United Kingdom Royal Commission on the Taxation of Profits and Income, Final Report (1955, Cmd. 9474), p. 356).
The Canadian Royal Commission favoured realisation as a condition of the derivation of an accretion, though with some qualification. Thus the Commission favoured a principle that gains in the value of property should be deemed to have been realised on the death of the owner.
[1.55] The scope for including unrealised appreciations in the base of our income tax is limited, it will be seen, by the general exclusion of capital gains from the base. Where there is scope, there is no required inclusion of unrealised gains, though there may be an inclusion under the trading stock provisions, considered in Chapter 14, at the choice of the taxpayer who wishes to anticipate a profit.
[1.56] In another respect both our income tax and the comprehensive tax base may be thought to be more than comprehensive. They may include accretions which are unreal. Simons was aware of the distortion of the base that could arise in times of inflation. He said (in Personal Income Taxation, p. 55):
“Our definition of income may also be criticised on the ground that it ignores the patent instability of the monetary numéraire … and it may also be maintained that there is no rigorous, objective method either of measuring or of allowing for this instability. No serious difficulty is involved here for the measurement of consumption—which presumably must be measured in terms of prices at the time goods and services are actually acquired or consumed. In periods of changing price levels, comparisons of incomes would be partially vitiated as between persons who distributed consumption outlays differently over the year. Such difficulties are negligible, however, as against those involved in the measurement of accumulation. This element of annual income would be grossly misrepresented if the price level changed markedly during the year. These limitations of the income concept are real and inescapable …” But he offered no solution.
[1.57] The Memorandum of Dissent signed by Kaldor observes:
“38. It must also be remembered that taxable capacity is essentially a relative concept, and those property owners who make capital gains during an inflation are undoubtedly in a better position than those who own fixed interest securities, and who therefore lose part of their real capital as a result of the rise in prices. Equity cannot be secured by ignoring relative changes in the taxable capacities of different property owners; and, if it were held to be desirable (and possible) to exempt that part of capital appreciation which was commensurate with the general price rise, it would follow that any lesser degree of capital appreciation should be regarded as a loss. It is not our view that the tax code should be so devised as to insure taxpayers against the risk of inflation. Indeed we should consider any such intention singularly inappropriate, for taxation must be regarded as one of the principal weapons in the armoury of the central government for combating inflation. In the event of a drastic depreciation it might become necessary to revise the basis of all monetary obligations and commitments, including tax payments—as was done in Belgium after the First World War, and in Belgium and France after the Second World War. But we do not regard such a situation as within the foreseeable circumstances which tax regulations, or tax reforms, should take into account.” (United Kingdom Royal Commission on Taxation of Profits and Income, Final Report (1955, Cmd. 9474), p. 366).
[1.58] The Canadian Report of the Royal Commission on Taxation offered no solution. It stated (Vol. 3, p. 349):
“It has been argued that it would be inequitable to tax a gain that resulted from a general increase in the price level. The point is made that such a gain is illusory because it does not represent any real increase in purchasing power. This argument, when used to support the exemption of stock market gains, appears over-emphasised if the substantial increases in the stock market averages are compared with the rather smaller increase in the cost-of-living index. In addition, we cannot overlook the fact that there are many members of society with fixed incomes who suffer losses in economic power because of inflation and are unable to protect themselves against it. This is in contrast to the equity holder who, during a period of inflation, will generally experience some growth in the dollar value of his assets. Because it is not possible to make provision for complete recognition of declines in purchasing power brought about by inflation, we have concluded that it should not be the function of the tax system to attempt to relieve only some segments of the population from the effects of inflation. The tax system should therefore, in our opinion, continue to be based on current dollars and not on constant dollars.”
[1.59] Following recommendations made by the Mathews Committee (Report of the Committee of Inquiry into Inflation and Taxation (A.G.P.S., Canberra, 1975)) provisions were introduced into the Assessment Act to make an adjustment to the amount of gains from the sale of trading stock to allow for the effect of inflation. The adjustment was discontinued with effect from the end of the 1979 year of income. The relevant provisions are referred to in Chapter 15.
[1.60] The point has been made that the differences between the base of our income tax and the base advocated by Simons concern a want of comprehensiveness of the former. Putting the differences in this way assumes that, to a degree, our income tax base does reflect an idea of accretions to spending power. The law in regard to periodical receipts and the view that the law taxes receipts, as distinct from gains, may raise doubts about that assumption. Nonetheless, the submission of this Volume, and the manner in which the propositions expressing the ordinary usage notion are stated, assert that the law does reflect an idea of accretions. If an idea of accretions is rejected as irrelevant, we are left with no unifying idea, and the law appears as the accidents of usage and the pronouncements of judges. Such consequences were described in the Memorandum of Dissent from the Final Report of the United Kingdom Royal Commission in this way (p. 355):
“3. A system of personal income taxation which operates without any clear definition of what constitutes ‘income’ is exposed to a double danger. On the one hand the simple view that income is an unambiguous word, not subject to various interpretations, may ensure general complacency, and the particular notion of “taxable income” hallowed by legal tradition tends to become identified with taxable capacity as such. On the other hand, in the absence of any clear underlying principle, revisions and interpretations of the law proceed, in the light of particular considerations, to introduce successive concessions which have the effect of constantly shifting the tax burden in a manner which is no less far-reaching for being unobtrusive. Lacking a firm basic conception, neither the public nor the legislature nor the courts are conscious of the extent to which the tax system, behind a facade of formal equality, metes out unequal treatment to the different classes of the taxpaying community.”
[1.61] The want of comprehensiveness of the base of our income tax is evident in the failure, complete or partial, to include in the base the following accretions to spending power:
[1.62] Except to a limited extent resulting from the provisions of s. 25A(1) and s. 26AAA of the Assessment Act, considered in Chapter 3, which define the base so as to include gains from the sale of property acquired for the purpose of profit-making by sale and gains from the purchase and sale of property made within a period of 12 months, capital gains are not included in the base of our income tax. Whether or not the base of the tax should be extended to include capital gains has been the subject of a good deal of debate. The case for including capital gains is made in terms of the need to make the income tax comprehensive in order to cure inequity. There is a failure to treat equally persons with equal gains, and those who are not taxed because their gains are capital gains tend to be those who in total have the greater gains. Implicit is an assertion that the idea underlying the concept of income in our Act is accretions to spending power. The case for extending the base of the United Kingdom income tax to include capital gains was made in the same way by the Memorandum of Dissent contained in the Final Report of the United Kingdom Royal Commission on the Taxation of Profits and Income. The case for extending the base of the Canadian income tax was made by the Canadian Royal Commission in the same way.
[1.63] The case against including capital gains is sometimes made in terms that the underlying idea of income in the Assessment Act does not embrace such gains. This argument tends to bury the debate in legal semantics which amount to no more than an assertion that the underlying idea cannot be accretions to spending power because capital gains are accretions and they are not included in income by the present law. The debate can only be instructive if the case against extension is put in terms of reasons why the equity argument for including capital gains should not prevail. A case can be made against extension in terms of not discouraging investment. That case was recognised by the Memorandum of Dissent from the United Kingdom Royal Commission’s Final Report, and by the Canadian Report of the Royal Commission on Taxation. It finds expression in the special treatment accorded capital gains in both the United Kingdom law and the Canadian law. Since 1965, the United Kingdom has taxed capital gains under provisions distinct from those applicable to the income tax so that they are accorded privileged treatment. Canada, since its Royal Commission Report, has extended the base of its income tax so as to include in the base one half of capital gains.
[1.64] The Australian Taxation Review Committee (the Asprey Committee), in its Preliminary Report in 1974, recommended the taxing of capital gains, but in a way that would preserve a privileged treatment for capital gains: they would be taxed at only one half of the rate applicable to income gains. Mr Crean, the Treasurer at the time, announced in September 1974, that capital gains not subject to the income tax would be taxed as from the date of the announcement in a manner in general accord with the recommendation of the Asprey Committee. Dr Cairns, who became Treasurer in the meantime, withdrew the announcement in January 1975.
[1.65] It will be apparent from the discussion in the Taxation Review Committee’s Full Report (A.G.P.S., Canberra, 1975) (see also Chapter 15 below) that there are problems associated with the taxing of capital gains which go beyond any discouragement of investment that the prospect of the tax may involve. The liquidity difficulties and the administrative and compliance difficulties in regard to valuation, which would attend a tax on unrealised gains, virtually dictate that the tax must be applied only to realised gains. A White Paper by the Canadian Government in 1969 (Proposals for Tax Reform, Ministry of Finance) did propose that Canada should apply a tax on unrealised gains in the value of Stock Exchange listed securities. The proposal was not implemented. But an optional system that will tax unrealised gains has now been introduced. A tax confined to realised gains discourages realisation. It has a “lock-in” effect, putting a brake on the mobility of capital. There is an attendant question as to what is to be done on the death of a taxpayer who holds assets which have increased in value. Canadian law deems a realisation at market value to have occurred on the death of the owner of assets, or on his making a gift of them. The United Kingdom law provided in this way initially. However it is now provided, in the case of death, that there is no realisation of a gain, though the person who acquires the asset takes it with a cost equal to its market value. Thus, death in the United Kingdom provides an “escape-hatch” from capital gains tax. The Asprey Committee proposed that there should be a deemed realisation on death, but also proposed that there should be a limited exemption from tax for gains realised on death, or realised after the age of 65. The United Kingdom law increases the “lock-in” effect of capital gains tax: there is a clear advantage in holding until death. The exemption proposed by the Asprey Committee would have a like effect until the taxpayer attains 65. The Canadian law and the general proposal of the Asprey Committee mitigate the lock-in effect by denying a death escape hatch.
[1.66] A tax on realised gains creates “bunching” difficulties. A gain which may have accrued over a number of years will all be taxed in one year, unless some special provision is made. The Asprey Committee proposed that a special averaging device should be applied in taxing capital gains (Full Report, para. 23.36).
[1.67] In conditions of inflation at least some element of a capital gain is likely to be unreal if the gain is calculated by subtracting the historical cost from the proceeds of realisation. The historical cost of an asset will be less than the cost expressed in terms of the value of money at the time of realisation. Simons, Kaldor and the Canadian Royal Commission were all aware of the difficulty, though none offered an answer. The Asprey Committee had no adequate answer. Indexation of the historical cost and the subtraction of the cost as indexed is appropriate where the taxpayer has not used borrowed funds. Where he has borrowed, there should, on the face of it, be an adjustment to take account of the fall in value of the liability to repay the borrowing. But there will be difficulties in linking the acquisition of the asset and the borrowing. Inflation poses similar difficulties in relation to gains presently subject to income tax. Attempts to solve them in that context have not been successful. The matter is further considered in Chapter 15 below.
[1.68] Simons proposed the inclusion of bequests and gifts received in the base of an income tax. The Canadian Royal Commission recommended their inclusion in the base of the Canadian income tax. However, no country has taken the idea of a comprehensive income tax base as far as Simons and the Canadian Royal Commission thought appropriate. Bequests and gifts have, generally, been left to the operation of death and gift taxes and accession taxes. The Canadian White Paper that followed the Report of the Royal Commission on Taxation asserted that bequests and gifts were the province of the Canadian estate and gift duties, and were not the province of the income tax. Canada’s estate duty has since been repealed but bequests and gifts have not been included in the income tax base. Canada, it seems, now consider that it is enough that the capital gain in respect of the asset bequeathed or given is brought within the income tax as a result of the realisation deemed to occur at death or gift.
[1.69] Bequests and gifts were until recently the province in Australia of the federal estate and gift duties, and of death and gift duties in the Australian States. The federal estate and gift duties have been abolished and State death and gift duties have almost all been repealed. These repeals raise questions about the Australian tax system as a whole. The Asprey Committee had agreed with the view that bequests and gifts are not the province of the income tax, but proposed the continued taxation of property the subject of bequests and gifts by strengthened and integrated death and gift taxes (Full Report, Ch. 24). The Committee had proposed a shift away from the present emphasis on income tax in the Australian tax system towards a broad-based tax on goods and services. Taxes on goods and services are taxes on consumption and leave saving untaxed. A shift away from income tax thus increases the scope for accumulation of wealth. Effective death and gift taxes will limit the transmission of that wealth by bequest or gift. The Asprey Committee’s views may be said to favour the institution of inheritance against the view of the Canadian Royal Commission. The Commission, it will be recalled, expressed itself as “completely persuaded” about the comprehensive tax base. But the Asprey Committee would nonetheless want such qualification on the institution of inheritance as may result from the operation of death and gift taxes. The comprehensive income tax base, when extended to bequests and gifts, denies any special treatment to accretions to spending power arising from inheritance or gift. Treating bequests and gifts as outside the province of the income tax opens the way to according them favoured treatment under death and gift taxes.
[1.70] The exclusion of gifts from the base of the Australian income tax requires the drawing of a line which may not always be easily drawn. These difficulties are considered in [2.132]ff. below. It is enough for present purposes to note that some gifts in the sense of voluntary payments—for example the tip received by a taxi driver—are income of the taxpayer who receives them.
[1.71] Such gains are referred to in this Volume as “windfall gains”. The phrase does not have a precise meaning. Indeed it is sometimes used to cover capital gains, and perhaps also bequests and gifts received. All these have some quality of unexpectedness, but this is hardly a justification for giving them a common classification and excluding them from the income tax base. In the case of lottery and casual gambling winnings, the justification for exclusion must rest on difficulties of administration and compliance.
[1.72] Simons and the Canadian Royal Commission would have included them in the income tax base. The Memorandum of Dissent contained in the Final Report of the United Kingdom Royal Commission on the Taxation of Profits and Income is not uncompromising:
“… [R]eceipts which cannot reasonably be brought within the scope of taxation because their control and enforcement is beyond the power of any efficient tax administration are better ignored altogether (even though they are beneficial receipts) since their inclusion creates unfairness to the disadvantage of the honest taxpayer. (Gambling winnings may be regarded as an example of this.)” (Para. 8(2), pp. 356–357.)
[1.73] The Australian income tax probably excludes lottery winnings from the base in all circumstances. It will in some circumstances treat gambling winnings as within the base—where there is a business of gambling or where gambling is incidental to some other business, for example, operating a casino or training horses. But where there is no business activity, gambling winnings are not within the base. To include all lottery and gambling winnings would invite evasion. And honest taxpayers might find it difficult to prove their losing investments. If losing investments were denied as being consumption expenditure, the tax would be felt to be unfair. The Asprey Committee (Full Report, para. 7.8) did not propose that the tax base be extended to include lottery or casual gambling winnings.
[1.74] The comprehensive tax base would clearly extend to the whole of each of these items. But the Australian income tax base extends to them in only a limited degree. Prior to 1 July 1983, only 5 per cent of the amount of an item of these kinds was included in the base, under s. 26(d). Since 1 July 1983, a payment in consequence of the termination of any employment of a taxpayer, or a payment made from a superannuation fund in respect of the taxpayer, is income under s. 27B where it relates to service after 1 July 1983, though it is taxed at lower rates than other income. If it relates to service before 1 July 1983, 5 per cent of the amount is included in income. The reason for this favoured treatment of a retirement benefit which is a reward for services may have been to give what appears to be a very generous relief against bunching. Where the benefit is not a reward for services, but comes, for example, from a superannuation fund, it would not, apart from s. 26(d), and now, s. 27B, be income. The ordinary usage notion of income would not extend to it and there is no other relevant specific provision of the Assessment Act.
[1.75] Apart from the operation of s. 27B, lump sum compensation for loss of office or employment would not ordinarily be within the base of the income tax. It may yet be held that an office or employment can be a revenue asset of what would be a business or profession of holding offices or employments. But this is a remote prospect. Compensation for the loss of the office or employment would be seen as having at least kinship with a capital gain. Section 27B thus operates, as it does in relation to a lump sum superannuation benefit, to bring to tax an amount that would not otherwise be taxed. The operation of s. 27B is further considered in [2.408], [2.419] and [4.138]ff. below.
[1.76] The Asprey Committee, in Chapter 21 of its Full Report, proposed the inclusion in the income tax base of the whole of lump sum retirement benefits and compensation for loss of office or employment. It did, however, propose special transitional provisions, so as to recognise existing expectations, and continuing provisions to give special relief against bunching. The proposals are some of the background of the amendments to the law made in 1984, which introduced s. 27B.
[1.77] So far as the compensation is for income receipts, for example wages or salary already lost, compensation for injury to the person could be within the base of the Australian income tax. Inclusion in the base of any part of compensation for injury to the person will however generally be precluded by the principle in Allsop (1965) 113 C.L.R. 341 discussed in [2.558]ff. below, which stands in the way of the dissection or apportionment of a lump sum receipt which includes a non-income element so as to isolate the income element and bring it to tax.
[1.78] In other respects a lump sum receipt for injury to person to reputation is not within the base of the Australian income tax. So far as it represents compensation for loss of earning capacity, the lump sum receipt is a gain from the realisation of human capital. It is a capital gain, and one which it might be difficult to embrace within a tax on capital gains. The problem would be to identify the gain. It may be asked what expenses, otherwise seen as private or domestic, would be regarded as costs of the human capital? The matter was considered by the Asprey Committee (Full Report, paras 7.34–7.40) but no recommendation for change was made.
[1.79] Simons, Kaldor and the Canadian Royal Commission would presumably wish to see compensation for loss of earning capacity included in an income tax base. There is some reference to damages in the Canadian Report of the Royal Commission on Taxation, Vol. 3, pp. 63, 69, but no adequate discussion.
[1.80] The compensation may include amounts in respect of non-economic loss—for pain and shortened expectation of life or for ridicule suffered. Lump sum receipts in respect of such loss are not within the Australian income tax base and the Asprey Committee did not propose any extension to include them. There is no indication of how Simons, Kaldor and the Canadian Royal Commission would regard such items.
[1.81] Non-money accretions may take these forms:
[1.82] The principal illustrations of non-money accretions in the form of benefits in kind and valuable rights are afforded by the fringe benefits that an employee receives from his employer. They are considered in [2.30]ff. and [4.38]ff. below. The inclusion of such items, in the amount of their “value to the taxpayer” which may be greater than their realisable value, is provided for in s. 26(e) of the Assessment Act. The operation of that provision is, however, now qualified in its application to benefits in the form of housing by s. 26AAAA and s. 26AAAB. The operation of s. 26(e) is also qualified, in relation to employee share acquisition schemes, by s. 26AAC.
[1.83] Where a benefit in kind or a valuable right is derived otherwise than in respect of an employment or rendering of services, the item can be within the base of the Australian income tax only to the extent of its realisable value. The realisable value may be little or nothing, though the item has significant value in the sense of what a person in the position of the taxpayer would have been prepared to pay to obtain it. In the result, accretions to spending power which the taxpayer has derived and which the comprehensive tax base would require to be included, are not included in the base of the Australian income tax.
[1.84] Setting the scope of the notion of benefits in kind and valuable rights derived by a taxpayer, poses problems which may indicate that the comprehensive tax base, as a measure of the appropriateness of the law’s definitions of income, may itself require definition. There is a difference, one would think, between a home provided rent-free by an employer, and a flat in a building in which the caretaker of that building is required to live and for which he is not charged any rent. In the case of the caretaker, there is a question of how much of the value of the flat is a benefit, and how much is simply an enjoyment inherent in performing the duties of the employment. The latter is referred to later in this Volume as a “condition of employment”. Simons gave some attention to the problem but offered no means of separating benefit from condition:
“A similar difficulty arises with reference to receipts in the form of compensation in kind. Let us consider here another of Kleinwächter’s conundrums. We are asked to measure the relative incomes of an ordinary officer serving with his troops and a Flügeladjutant [Aide-de-Camp] to the Sovereign. Both receive the same nominal pay; but the latter receives quarters in the place, food at the royal table, servants, and horses for sport. He accompanies the Prince to theatre and opera, and, in general, lives royally at no expense to himself and is able to save generously from his salary. But suppose, as one possible complication, that the Flügeladjutant detests opera and hunting. The problem is clearly hopeless. To neglect all compensation in kind is obviously inappropriate. On the other hand, to include the perquisites as a major addition to the salary implies that all income should be measured with regard for the relative pleasurableness of different activities—which would be the negation of measurement. There is hardly more reason for imputing additional income to the Flügeladjutant on account of his luxurious wardrobe than for bringing into account the prestige and social distinction of a (German) university professor. Fortunately, however, such difficulties in satisfactory measurement of relative incomes do not bulk large in modern times; and, again, these elements of unmeasurable psychic income may be presumed to vary in a somewhat continuous manner along the income scale.” (Personal Income Taxation, p. 53.)
The phenomenon of expense account living may lead one to wonder if Simons is correct in saying that the difficulties the describes do not bulk large in modern times.
[1.85] The principal illustration of non-money accretions in the form of flows of satisfaction yielded by property owned by the taxpayer, is the imputed rent of an owner-occupied house. A comprehensive tax base would include the value of the services a house performs for its owner. The base of the Australian income tax does not include imputed rent. It was not always so. From 1915 to 1923, 5 per cent of the capital value of an owner-occupied residence was included in the base of the income tax. Deductions were allowed against this amount for expenses by way of repairs, rates and land taxes, and mortgage interest. This inclusion depended on express statutory provision. It is assumed that the ordinary usage notion of income does not include imputed rent, though the reason is not very apparent. One might point to an absence of derivation in that there has been no receipt from another person, and no realisation of property. Consumption, it would be said, is not realisation.
[1.86] Clearly there is a substantial inequity in the treatment of homeowners and taxpayers who are tenants, if imputed rent is not included in the base. But there are arguments against inclusion. Some of these concern the need for valuation in fixing the amount of the imputed rent. Others concern the liquidity difficulty and hardship for a taxpayer who, for example, may be a widow continuing to occupy a large family home. The Asprey Committee did not recommend the extension of the income tax base to include imputed rent, though it did propose a limited deduction of rent paid by a person who occupies his home as a tenant. (Full Report, paras 7.11, 7.42–7.57.)
[1.87] There are other cases of non-monetary accretions in the form of flows of satisfaction yielded by property owned by the taxpayer. The Asprey Report refers to works of art and consumer durables as yielding flows of satisfaction, but it did not propose extension of the tax base to include such flows, pointing to the administrative problems that would result from the extension.
[1.88] The theory of a comprehensive tax base would suggest that there should be included in the base the value of goods produced by a taxpayer for his own consumption, and the value of services performed by a taxpayer for himself. But Simons, Kaldor and the Canadian Royal Commission saw the need to put reins on logic so that it might not overrun what was administratively feasible, and indeed, overrun the equity that a comprehensive tax base would aim to serve. Taxing the value of self-produced goods and self-rendered services might be thought unfair, when the enjoyment of leisure by those who pay others to produce and render services is not taxed.