Taxation Law Case Study: Analysis of Taxable Income and Capital Gains Tax Issues

This case study analysis focuses on taxable income and capital gains tax issues related to compensation damages, interest, legal fees, and sale of subdivided land. It includes rules, applications, and conclusions based on relevant laws and court decisions.

Running head: TAXATION LAW
Taxation Law
Name of the Student
Name of the University
Authors Note
Course ID

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Table of Contents
Answer to question 1:.................................................................................................................2
Issues:.....................................................................................................................................2
Rule:.......................................................................................................................................2
Application:............................................................................................................................4
Conclusion:............................................................................................................................6
Answer to question 2:.................................................................................................................7
Issues:.....................................................................................................................................7
Laws:......................................................................................................................................7
Application:............................................................................................................................9
Conclusion:..........................................................................................................................11
References:...............................................................................................................................12

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Answer to question 1:
Issues:
a. Is the taxpayer considered taxable relating to the value of $300,000 that is received as
the compensation damages for breach of patent rights?
b. Whether the taxpayer will be considered taxable as per the ordinary concepts of
“section 6-5, ITAA 1936” for the loss of income in the last twelve months?
c. Will the taxpayer be held liable for tax for the amount of interest that is received
within the judicial meaning of “section 6-5, ITAA 1997”?
d. Is reimbursement of legal fees amounts to ordinary income?
Rule:
Where the money received relates to the sterilization of the assets as loss to the
business operations or the usage of assets or some form of revenue producing activity then it
is held as capital receipts. The court in “Glenboig Union Fireclay Co Ltd v IRC (1921)”
viewed the compensation payment as capital since the amount was paid to the taxpayer for
the loss of capital asset or use of it (Reinhardt & Steel, 2016). The amount that is received
represents the unavoidable profits and was considered immaterial.
Where the taxpayer receives the lump sum payment as the compensation then the
amount received may hold the characteristics of either income or capital in nature. The
federal commissioner in the “Federal Wharf Co Ltd v FCT” stated that the amount of
compensation that is received by the business includes the loss associated to the money are
held as income in nature (Krever, 2013). Where it is found that the compensation payment
received by an entity as the right of seeking compensation or as a result of cause of action
bought forward by the taxpayer relating to the right of underlying asset are treated as
compensation receipts. Upon the receipt of the compensation damages the amount will be

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considered as assessable income within the “Division 6 of the ITAA 1997” or may be treated
as statutory income for tax purpose.
The definition given under “section 25 (1), ITAA 1997” explains that compensation
payment received by the taxpayer in relation to the loss of income or profits which is related
to the previous year are usually held taxable (Burns, 2017). The judgement denoted in the
instance of “Mc Laurin v FC of T (1961)” held that the sum of compensation that was paid
to the recipient was held as assessable income within the legislation of “subsection 25 (1),
ITAA 1936” till the extent that the payment amounts to recognizable income (Long et al.,
2016).
A taxpayer may in certain situations realise the capital amount from the sale of assets
or compensation from the loss of capital assets. Generally, the amount received for contract
termination, changes in the contractual terms or business dealings which is made in the
ordinary business process are considered as having the nature of income (Campbell, 2018).
The compensation amount that are received are held as loss to income and are assumed that
the compensation is paid as the substitute of lost earnings.
The federal commissioner verdict in “Californian Oil Products Ltd v FCT (1934)”
held that where the taxpayers are paid with the compensation as the recovery or to cover the
lost earnings are treated as ordinary income within the legislation of “section 6-5, ITAA
1997” (King, 2016). These amounts are generally held as income since it was derived from
carrying on the business activities even though it occurred as a result of uncertain situations.
While in the alternative verdict of high court in “CT (Vic) v Phillips (1936)” the
commissioner stated that on receipt of any amount of compensation for damages that are
related with the business loss or commercial structure that forms the portion of business
activities, the compensation amount that is received is regarded as the loss to capital asset

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(Yuan, 2016). Similarly, in the event of “FCT v Spedley Securities Ltd (1988)”
compensation received for the loss of business goodwill was considered as capital in nature.
Apart from the compensation receipts, interest received as the share of compensation,
the amount is held as assessable income inside the general meaning of “section 6-5, ITAA
1997”. The verdict in “Whitaker v DFCT (1998)” explained that post-judgement interest
holds the character of income under the ordinary concept of “section 6-5, ITAA 1997” (Datt
& Keating, 2018). Where a taxpayer receives interest for the lost income then the interest
amount is regarded as the ordinary income provided that the post judgement interest is paid
on the amount that is computed in respect of the period that was ascertainable and
outstanding.
In the meantime, if the taxpayers are permitted to obtain deduction for tax purpose
relating to the legal outgoings under the legislation of “section 8-1 of the ITAA 1997” then
the amount that is paid or the award associated to the legal expenditure should be included for
taxable purpose in the form of recovery under the “subdivision 20-A”. Legal outgoings that
is paid to a business or a person is mainly for indemnifying the receiver for the expenses
occurred on the legal proceedings (White et al., 2019). The legal fees are not treated as
ordinary income in terms of the ordinary concepts instead it is regarded as the assessable
recoupment within the “subsection 20-20 (2)”.
Application:
As understood in the case of Our Earth Pty Ltd the company is engaged in the
manufacturing of bio-degradable environmental coffee cups. However, on one occasion the
design of the coffee cups were stolen by Coffee Beans Pty Ltd which resulted in the breach of
patent design for Our Earth Pty Ltd. The company was eventually sued by Our Earth Pty Ltd
where a sum of $300,000 was received as the compensation for the breach of patent

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infringement. In the current case of Our Earth Pty Ltd, whether the compensation amount that
is received for breaching the design of patent can be regarded as capital in nature or income is
completely reliant on the nature of receipts. In light of the decision made in “CT (Vic) v
Phillips (1936)” the compensation amount of $300,000 that is received by the company
should be considered as the loss to the business foundations (Peiros & Smyth, 2017). In other
words, the compensation amount that is received mainly constitutes the breach of patent and
initiating an injury to the asset. The compensation amount of $300,000 is a capital receipts
and cannot be included into the taxable income.
In the following stages of the case, Our Earth Pty Ltd was also awarded with the
amount of $200,000 as the loss of anticipated profits over the period of twelve months. By
denoting the judgement which was made by federal commissioner in “Californian Oil
Products Ltd FCT (1934)” it can be explained that sum of $200,000 is held as taxable
income for the Our Earth Pty Ltd (Butler, 2016). The primary reason for considering the
amount of $200,000 as the taxable income because the amount is received by the company as
the revenue loss that has the characteristics of income. Therefore, the value of $200,000 will
be included into the taxable income of the Our Earth Pty Ltd since it is an income with in the
ordinary concepts of the “section 6-5, of the ITAA 1997”.
In the later stages of the case, Our Earth Pty Ltd was awarded with the interest as the
part of compensation payment. With reference to the decision of the federal commissioner in
the case of “Whitaker v FCT (1998)” it can be stated the interest that is received by the
taxpayer is regarded as the post-judgement interest that is earned in the ordinary business
course for the lost earnings (Duncan et al., 2018). The interest income will be included within
the ordinary meaning of “section 6-5, ITAA 1997” for assessment purpose.

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The taxpayer here Our Earth Pty Ltd also reports the receipt of legal fees in the form
of reimbursement. The legal fees amounts to compensation that is paid to Our Earth Pty Ltd
as the successful party to have occurred the expenditure (Pinto & Evans, 2018).
Consequently, reimbursement of the legal expenditure must not be viewed as ordinary
income. Therefore, the amount will be included for assessment purpose as the chargeable
earnings under the legislation of “subdivision 20-A”.
Conclusion:
In light of the above stated analysis a conclusion can be reached to the case of Our
Earth Pty Ltd by stating that the amount of $300,000 should not be treated as ordinary
income because it constitutes a loss to business foundations and hence the amount will be
considered as non-taxable capital receipts. On the other hand, the compensation amount of
$200,000 and the post-judgement interest should be included for assessment purpose within
the ordinary meaning of section 6-5, ITAA 1997. The reimbursement of the legal fees will be
considered under the legislation of “subdivision 20-A”.

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Answer to question 2:
Issues:
The case study introduces the capital gains tax issues that are originating from the sale
of the subdivided land which may be considered for taxation either under “section 25 (1)” or
“section 26 (a)”.
Laws:
Capital gains tax is generally applied on the assets that is purchased on after the
introduction of the capital gains tax system on 20th September 1985. It must be noted that the
word pre-CGT and post-CGT is generally used by the taxpayers to refer the assets that are
obtained or events that are happening following or after the date (White et al., 2019). The
first and foremost step in ascertaining whether the transactions or events is subjected to the
capital gains tax is to ascertain whether the capital gains tax events have occurred or not.
As a general note, capital gains tax functions prospectively and it is applied only
when the capital gains tax events takes place involving the capital gains tax asset that are
purchased after the 20th September 1985. For most of the capital gains tax events, there are
certain exemptions if the CGT asset that is purchased before the 20th September 1985 (Pinto
& Evans, 2018). Consequently, “subsection 104-10 (5) of the ITAA 1997” states that the
assets which are bought prior to the capital gains tax introduction then it is exempted from the
capital gains tax regimes.
Majority of the instances suggest that the land owners possess the prospect of subdividing
and selling the land that is owned by them from a long time. This kind of situation mainly
happens for the primary producers that owns the land in the outskirts urban centres and
believes that the property development for residential purpose is the best usage of land as a
substitute of carrying the activities of farming (Joulfaian, 2018). In few of the situations, such

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kind of property development can be considered very much substantial with the objective of
deriving large amount of profits from the project. Nevertheless, this brings forward the
questions as how the profits of the taxpayer’s should be characterised for capital gains tax
purpose. Usually, there are three alternatives;
a. The substantial land development in the form of subdivision and sale of land might
qualify as the simple realisation of the capital asset.
b. The scale of development might be such that it comprises of carrying the business of
property development.
c. The development may go further than simple land realisation however it might fall
short of the requirements associated to carrying on the business (Morgan & Castelyn,
2018). In such case the activities will be considered as the profit deriving scheme or
undertaking.
To correctly classify the activities, it is necessarily important, especially when the pre-
CGT asset is involved. A capital gains or capital loss is generally made when the CGT events
takes place to the asset. According to the “section 108-5 (1), ITAA 1997” CGT asset is
regarded as any form of property or legal or equitable rights which is not the property
(Woellner et al., 2016). Land is regarded as the CGT asset and the sale of land will result in
CGT event A1. According to the “section 104-10, ITAA 1997” a CGT event A1 happens
when the taxpayer sells the CGT asset.
More importantly the subdivision of land cannot be regarded as the sale of land within
the “section 104-10, ITAA 1997” (Barkoczy, 2016). According to the Taxation
Determination TD 97/3 if the sale of land gives rise to a business or portion of business, then
the income will be considered taxable as the ordinary income, within the “section 6-5, ITAA
1997” (Graetz & Warren, 2016). As held in the case of “Scottish Australian Mining Co Ltd

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v FCT (1950)” the federal commissioner imposed tax on the profits that were derived by the
taxpayer from the sale of numerous lots of land. The federal commissioner held that the
profits were considered taxable either under the “section 25 (1), ITAA 1936” or it was treated
as income from performing the business of development of land as the profit making scheme.
Similarly, the federal commissioner in “FCT v Whitfords Beach Pty Ltd (1982)” held
that the taxpayer was taxable on the gains derived from the disposal of land within the section
25 (1) because it had gone further than the mere realisation of the capital asset and its
activities are looked upon as carrying the business of land development.
Application:
The evidences that is gathered from the case study explains that the Sam purchased a
land in 1984 which actually costed $270,000. The land was initially acquired for carrying the
business of cattle breeding. In later years, Sam bought an additional 20 acre of land just
adjoining the previous land for a sum of $110,000 so that he can expand his business
operations. After sometime, Sam decided to retire from the farming business and engaged the
service of local real estate agent to subdivide the land in several lots. Finally, the land was
sold for $1,100,000.
Land is regarded here as the CGT asset under “section 108-5 (1), ITAA 1997”. The
sale of land by Sam resulted in the CGT event A1 under “section 104-10, ITAA 1997”.
However, it must be noted that the 80 acres of land that was purchased by Sam was before
the introduction of the CGT system (Sadiq, 2019). In other words, the 80 acre of land was
purchased on May 1984 and as a result the land will be regarded as the pre-CGT asset under
“subsection 104-10 (5) of the ITAA 1997”. The capital gains that is made from the sale of
the 80 acre of land will be exempted from the capital gains tax.

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Beside this, an additional 20 acre of land that was bought adjoining to the previous
plot constitutes a post-CGT asset because it is bought following the introduction of the capital
gains tax. Sam commenced the subdivision and sale of land in the year April 2018.
Consequently, the proceeds that are derived following the disposal of the subdivided plot
constitute a taxable capital gains and the will be included into the gross earnings of the
taxpayer as the taxable income.
With reference to the “Taxation Determination TD 97/3” the effect of registering the
new titles under the subdivided land by Sam is mainly for the capital gains tax purpose.
consequently, the subdivided plot of land by Sam is considered as the acquired by the owner
in the form of original parcel (Butler, 2019). Additionally, to determine the taxability of the
subdivided parcel of land it is necessary to understand that Sam originally purchased the
property for carrying agriculture business. The profit making motive arrived in the later
stages.
In light of the verdict passed in “FCT v Scottish Australian Mining Co Ltd (1950)”
the profits that is earned following the subdivided land should be taxable under the legislative
provision of “section 25 (1) of the ITAA 1997”. The gains constitute income for Sam from
carrying the business of land development (Bankman et al., 2018). This is because the gains
have originated from carrying the business of profit making undertaking or scheme. The
taxpayer here Sam has realised the asset in the most advantageous manner so that the best
possible price can be fetched following the rezoning of the land and the capital gains made
thereof constitute assessable income.
Further reference to the case of “FCT v Whitfords Beach Pty Ltd (1982)” can be
made in the situation of Sam to bring the profits within the legislation of capital gains tax
(Sadiq, 2019). The activities undertaken by Sam represents that extensive amount of work

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was done on the subdivided plots and that the situation of Sam is indistinguishable from the
case of “FCT v Scottish Australian Mining Co Ltd (1950)”. The actual intention of the
taxpayer prior to entering into the transaction was to derive profit. Therefore, the taxpayer
here Sam will be considered taxable for the profits that are derived from the sale of the
subdivided land within the “section 25 (1)” since he had gone outside the concept of simple
realisation of the capital assets and the activities should be regarded as carrying the business
of land development.
Calculations of Capital Gains Tax
In the Books of Sam
Particulars Amount ($) Amount ($)
CGT Event A1 (S- 104-10(1))
Sales Revenue from 20 acres of Land $ 11,00,000.00
Add: Agent Commission and Legal fees $ 45,000.00
Gross Proceeds $ 11,45,000.00
Cost base item (S- 110-25 (1)
Element 1: Cost of Acquisition (S-110-25 (1) $ 1,10,000.00
Element 4: Capital Enhancement Cost (S- 110-25 (4)) $ 4,50,000.00
Total Cost Base $ 5,60,000.00
Net Capital Gains $ 5,85,000.00
Conclusion:
In light of the above stated explanation a conclusion can be draw by stating that 80
acre of land is a Pre-CGT asset and any capital gains that are made from the sale of land
should be ignored under “subsection 104-10 (5) of the ITAA 1997”. While the subdivision of
20-acre of land should be considered as the Post-CGT asset and capital gains made thereof
should be included into the assessable income for assessment purpose. The extensive amount
of development undertaken by Sam and subdivision was greater than the mere realisation of
the asset. It amounted to work done in the ordinary course of business activities.

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