Income Definition and Capital Distinction Essay for Taxation

This essay delves into the complexities of income definition and its distinction from capital for income tax purposes. It begins by analyzing the statement by Hannan and Farnsworth regarding the lack of a specific definition for income. The essay explores the concept of income, referencing the Income Tax Act 2007 (ITA 2007) and relevant New Zealand and international cases. It defines income, distinguishing between income under ordinary concepts and statutory income. The essay then examines the characteristics of income, including its monetary form, periodicity, and its nature in the hands of the recipient. The discussion also covers the income/capital distinction, including the "Fruit Tree analogy" and the concept of Capital Gains Tax (CGT). The analysis includes relevant case law and statutory provisions to provide a comprehensive understanding of income taxation principles.

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Introduction
As per the analysis laid down by Hannan and Farnsworth, the term “income” cannot
have a specific definition for the same to be considered in meeting the requirements of the
government and the regulators including the legislation.1 The purpose of this essay is to
analyse Hannan and Farnsworth statement regarding an income definition. Therefore, this
essay will consist of a discussion on the concept of income for income tax purposes and the
distinction between income and capital. The analysis will be referred to as relevant
legislation, the Income Tax Act 2007 (ITA 2007),2 and New Zealand (NZ) and international
cases defining different types of income.
1. The concept of income
1.1 Defining Income
In general, income is the revenue a business earns from selling its goods or/and
services or the money an individual receives in compensation for his or her labour, services
or investments. The concept of income serves as a touchstone against which the rules of the
current income tax can be evaluated.3 Once the distribution of income is measured the effects
of various proposed policy changes on income distribution can be analysed.4 Given the
importance of the uses of the income concept, how income is defined can make a difference.5
For instance, if it considered desirable for the income tax to approximate the ideal concept of
income as closely as possible, it becomes crucial whether that ideal treats gifts and
inheritance as income. Moreover, the pattern of income distribution and the effects of a
change in tax or other policy on that distribution may vary significantly depending on how
income is defined.6
Under statutory basis, section CA 1 provide the list of taxable income and sCA 2 provide a
list of exempt income and excluded income.7 Furthermore, sCB shows an income for
businesses and trade-like activities.8 Besides, the term “income” means different
things to different groups. For example “In economic terms, income and
1 John Peter Hannan and Albert Farnsworth. Principles of Income Taxation (Stevens & Sons, London, 1946).
2 Income Tax Act 2007 (ITA 2007).
3 James Coleman and others New Zealand Taxation (12th ed., Thomson Reuters, Wellington 2018).
4 Victor Thuronyi. The concept of Income. Tax Law Review 46(1), at 45.
5 Victor Thuronyi n 4 at 46.
6 Victor Thuronyi n 4 at 46.
7 ITA 2007 n 2 section CA.
8 ITA 2007 n 2 section CB.

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gain are interchangeable terms”9 and are equivalent to increases in
wealth.10
1.3 Income under Ordinary Concepts
Income in NZ includes income according to ordinary concepts and statutory income
that is defined in tax legislation.11 Income according to the ordinary concepts includes income
from employment, running a business and from performing services.12 Receipts from one-off
prize such as winning a cash windfall from undertaking a hobby are not considered income
under the ordinary concept.13 Literally, the word means “what comes in” but it does not
follow that everything that comes in is income for income tax purposes.14
In Scott v Commissioner of Taxation, Jordan CJ observed that “…. the word ‘income’ is not a
term of art, and what form of receipts are comprehended within it, and what principles are to
be applied to ascertain how much of those receipts ought to be treated as income, must be
determined in accordance with the ordinary concepts and usage of mankind, except in so far
as the statute states or indicates an intention that receipts which are not income in ordinary
parlance are to be treated as income or that special rules are to be applied for arriving at the
taxable amount of receipts.”15
1.4 Characteristics of Income
The following basic principles are used to determine whether a receipt is “income” in its
ordinary sense, case law:16
9 W Chan, “Income – A Subjective Concept” (2001) Vol 7:1 New Zealand Journal of Taxation Law and Policy
26 as cited in Clinton Alley and Andrew Maples (2006). The concept of Income within the New Zealand
taxation system. (Department of Accounting Working Paper series, Number 87). Hamilton, New Zealand:
University of Waikato.
10 S Ross and P Burgess, Income Tax: A Critical Analysis, (Sydney, The Law Book Co Ltd, 1996), p 40 as cited
in Clinton Alley and Andrew Maples (2006). The concept of Income within the New Zealand taxation system.
(Department of Accounting Working Paper series, Number 87). Hamilton, New Zealand: University of
Waikato.
11 James Coleman and others n 3 at ch 3.
12 Braedon Clark. The meaning of income: the implications of Stone v FCT [online]. Revenue Law Journal, Vol.
14, 2004: 178-189.
13 Braedon Clark n 12 at 179.
14 Mapp v Oram (1969) 45 T.C. 651 as cited in Andrew Alston, “Concepts of Capital and Income,” Canterbury
Law Review vol. 1, no 2 (1981): p.146-154.
15 Scott v Commissioner of Taxation (NSW) (1935) 35 SR (NSW) 215 (NSWSC).
16 CCH Commentary NZ: Updating Master Tax Guide [¶5 – 021].

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1.4.1 Income is something that comes in, and it should be in money or money’s worth.17
Referring to the Lambe v Inland Revenue Commissioners case, the appellant
taxpayer had lent out a loan on which interest was due but he never received it and
is unlikely that he would receive it in the future.18 Nevertheless, the commissioner
argued that the interest should be included in the taxpayer’s total income however,
the court held that income was something that actually comes in.19
There are situations where something does not come in, but assessable income
still results from the transaction.20 According to the ITA 2007 sCC 7(1), when the
money is borrowed for use in business that is carried on in NZ and the
consideration is not interest, relief from an obligation or convertible into money.21
The commercial transaction is still income to the lender despite not coming in or
being in money or money’s worth.22
1.4.2 Income generally has the features of periodicity, recurrence and regularity23. In
Federal Commissioner of Taxation v. The Myer Emporium Ltd case, both the
Victorian Supreme Court and the Full Federal Court held lump payment from
selling any property, plant & equipment is not deemed to be an income.24
In Reid, the Court of Appeal observed that if the transaction has the quality of
regularity or recurrence, then payment become part of the receipts, which a
recipient spend on his/her living expenditure. However, the relationship between
payer and payee must be considered in order to determine the quality of the
payment, whether it is taxable income or not.25
1.4.3 The character of a receipt may depend on its quality in the hands of the hands of
the recipient26. In Scott v Federation Commissioner of Taxation case, the client
gives a gift of 10,000 pounds to the taxpayer, but the High court held that the
17 CCH Commentary n 16.
18 Lambe v Inland Revenue Commissioners [1934] 1 KB 178.
19 Lambe v Inland Revenue Commissioners n 17.
20 James Coleman and others n 3.
21 ITA 2007 n 2.
22 James Coleman and others n 3.
23 CCH Commentary n 16.
24 Federal Commissioner of Taxation v The Myer Emporium Ltd (1987) ATC 4363.
25 Reid v Commissioner of Inland Revenue [1986] 1 NZLR 129 (CA).
26 CCH Commentary n 16.

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10,000 pounds were not income in the ordinary concept.27 Hence, a gift is not
deemed to be an income. However there are various situation where gift can be an
income.28 In addition, the receipt of loyalty points or prizes from points earned by
using the card will be not considered income, assuming the receipts of the prizes
are irregular.29
1.5 Career v Hobby
According to Moore v Griffiths case, the taxpayer was not taxable for 1,000 pounds
which he won during playing football for the club as the payment was the testimonial to the
taxpayer to mark his participation in an exceptional event and it was a reward.30 On the other
hand, in Kelly v Federation Commissioner of Taxation, the taxpayer was an employee of the
club so when he won a cash award of $20,000 during the football league and also he receives
a set amount from the club for playing each game.31 Thus, the court held that the receipt of
$20,000 is an income.32 These two above cases demonstrate how income can be defined
variously in different situations.
2 Income/Capital distinction
2.1 Definition of Capital
The other most important point that is required to be focussed and addressed is the
distinction between Income and Capital as “income” is taxed but “capital” is non-taxable. A
the term income, “capital” is not specifically defined within the acts and it is therefore
necessary to turn to the courts to find the ordinary meaning of the word.33 The income of a
person is the amount which is earned by the individual from the normal course of actions
undertaken by him/her. However, there are also incomes that are earned by the individual
because of an asset which was held by him/her for a long course of time.
2.2 What is Fruit Tree Analogy?
27 Scott v Federal Commissioner of Taxation (1966) 117 CLR 514.
28 ITA 2007 n 2 section CA 1(2).
29 James Coleman and others n 3.
30 Moore v Griffiths [1972] 3 All ER 399.
31 Kelly v Federation Commissioner of Taxation (1985) 85 ATC 4283.
32 Kelly v Federation Commissioner of Taxation n 31.
33 James Coleman and others n 3 at ch 3.

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There is a “Fruit Tree analogy” which is being used to distinct capital and income. In
the fruit tree analogy, capital is considered as tree (reservoir), where an asset is capable of
producing wealth for the business and income is considered as fruit, which generate a profit
from the asset.34 Referring to Eisner v Macomber, where Pitney J of the supreme court
observed “The fundamental relation of ‘capital’ and ‘income’ has been much discussed by
economists, the former being likened to the tree on the land, the latter to the fruit or the crop;
the former depicted as a reservoir supplied from springs, the latter as the outlet stream to be
measured by its flow during a period of time... Here we have the essential matter; not a gain
accruing to capital; not a growth or increment of value in the investment; but a gain, a profit,
something of exchangeable value, proceeding from the property, severed from the capital,
however invested or employed, and coming in, being ‘derived’ — that is received or drawn
by the recipient (the taxpayer) for his separate use, benefit and disposal — that is income
derived from property. Nothing else answers the description.”35
Referring to the Union Steamship co of NZ Ltd v Commissioner of Inland Revenue, where a
shipping company sold a ship and accepted a payment in instalment over the three years
period of time.36 The commissioner argued that this is a taxable income but the court of
appeal held that the payments were capital.37 A payment which is a capital in nature does not
acquire the character of revenue simply because it is paid by instalments and is set off against
an obligation to pay a trading expense.38
2.2 Capital Gains Tax (CGT)
For the income arising on those assets, there is provision of charging the same under
CGT. The CGT in case of NZ is charged on the amount of difference that is arrived between
the amount received during sale and the amount paid during the purchase of specified assets
popularly known as “chargeable assets”.39 Furthermore, there have been clarification with
34 “Income/Capital Distinction”, The concept of Income Source and Residence, for ACCT707 course (lecture
slides, AUT University, week 2).
35 Eisner v Macomber (1919) 252 US 189 as cited in CCH Commentary: Australian Federal Tax Reporter
(ITAA 1997) [¶18-300].
36 Union steamship co of NZ Ltd v Commissioner of Inland Revenue (1996) 17 NZTC 12,629 (CA).
37 Union v CIR n 36.
38 James Coleman and others n 3 at ch 3.
39 CCH Commentary: NZ Updating Master Tax Guide [¶1-500].

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respect to categories to be included under the head “chargeable assets”.40 There is a bright-
line test which test, which asset/property apply CGT, which follows as below:41
 Possessions of Personals excluding vehicles that have value of $6,000 or more
 Any other real estate property owned which is not the main home of the individual
 The home in case used for business or if it’s given for rent or if it’s very huge
 Assets held in Business
The provisions of Capital Gains Tax states the fact that irrespective of the residential status of
an individual, CGT is required to be paid on all NZ assets. Furthermore, in case of residents
of NZ non NZ assets may also be subjected to CGT.42 The amount computed as CGT is
added back to the income to form total taxable income.43 The rate of CGT varies according to
the income band of the individual and also have different rate of tax for home and for other
chargeable assets.44
Conclusion
It can be observed that the facts in the statement laid down by Hannan and
Fansworth have been examined and upon examination it has been observed that the concept
of income and its definition as determined by them are correct since there is no concrete
definition of income and the same varies from countries to countries because of the difference
in their structure of legislation. Therefore, in nutshell it can be concluded that the definition
of income cannot be clearly defined and identified and the analysis of the same depends from
legislations to legislation and from country to country. We can only have an inclusive list for
the considerations of income. The paper also consists of the major difference between the
income and capital for the treatment of tax purposes and explained ‘fruit tree analogy’ to
distinct income/capital.
40 CCH Commentary: NZ Updating Master Tax Guide [¶1-500].
41 “Capital – CGT and the Bright-line Test”, The concept of Income Source and Residence, for ACCT707
course (lecture slides, AUT University, week 2).
42 Atkinson A.B. (2012) NZ estimates of top income shares 2009–2010: revised note on methods, World Top
Incomes Database Methodological Notes, 12 April.
43CCH Commentary: Australian Income Tax Guide [¶3-080].
44CCH Commentary: Australian Income Tax Guide [¶55].

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Bibliography
A Books
James Coleman and others New Zealand Taxation (12th ed., Thomson Reuters, Wellington
2018)
B Cases
Commissioner of Taxation v Cooke (1980) 10 ATR 696 (FCA)
Federal Commissioner of Taxation v The Myer Emporium Ltd (1987) ATC 4363.
Kelly v Federation Commissioner of Taxation (1985) 85 ATC 4283.
Lambe v Inland Revenue Commissioners [1934] 1 KB 178
Moore v Griffiths (Inspector of Taxes) [1972] 3 All ER 399
Reid v Commissioner of Inland Revenue [1986] 1 NZLR 129 (CA).
Scott v Commissioner of Taxation (NSW) (1935) 35 SR (NSW) 215 (NSWSC).
Scott v Federal Commissioner of Taxation (1966) 117 CLR 514.
Tennant v Smith (Surveyor of Taxes) [1892] AC 150.
Union steamship co of NZ Ltd v Commissioner of Inland Revenue (1996) 17 NZTC 12,629
(CA).
C Database
1 CCH New Zealand and Australia
CCH Commentary: Australian Federal Tax Reporter (ITAA 1997) [¶18-300]
CCH Commentary: Australian Income Tax Guide [¶3-080]
CCH Commentary: Australian Income Tax Guide [¶55].
CCH Commentary: NZ Updating Master Tax Guide [¶1-500].
CCH Commentary NZ Updating Master Tax Guide [¶5 – 021].
Eisner v Macomber (1919) 252 US 189 as cited in CCH Commentary: Australian Federal
Tax Reporter (ITAA 1997) [¶18-300].

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D Journal Articles
Atkinson A.B. (2012) NZ estimates of top income shares 2009–2010: revised note on
methods, World Top Incomes Database Methodological Notes, 12 April.
Braedon Clark. The meaning of income: the implications of Stone v FCT [online]. Revenue
Law Journal, Vol. 14, 2004: 178-189.
John Peter Hannan and Albert Farnsworth. Principles of Income Taxation (Stevens & Sons,
London, 1946).
Mapp v Oram (1969) 45 T.C. 651 as cited in Andrew Alston, “Concepts of Capital and
Income,” Canterbury Law Review vol. 1, no 2 (1981): p.146-154.
S Ross and P Burgess, Income Tax: A Critical Analysis, (Sydney, The Law Book Co Ltd,
1996), p 40 as cited in Clinton Alley and Andrew Maples (2006). The concept of Income
within the New Zealand taxation system. (Department of Accounting Working Paper series,
Number 87). Hamilton, New Zealand: University of Waikato.
Victor Thuronyi “The Concept of Income” 46 Tax L. Rev. 45-106 (1990).
W Chan, “Income – A Subjective Concept” (2001) Vol 7:1 New Zealand Journal of Taxation
Law and Policy 26 as cited in Clinton Alley and Andrew Maples (2006). The concept of
Income within the New Zealand taxation system. (Department of Accounting Working Paper
series, Number 87). Hamilton, New Zealand: University of Waikato.
E Legislation
New Zealand Income tax Act 2007.
F Notes
“Capital – CGT and the Bright-line Test”, The concept of Income Source and Residence, for
ACCT707 course (lecture slides, AUT University, week 2).
“Income/Capital Distinction”, The concept of Income Source and Residence, for ACCT707
course (lecture slides, AUT University, week 2).