Taxation Law: Tax Consequences of Compensation and Property Sale

Running head: TAXATION LAW
Taxation Law
Name of the Student
Name of the University
Author Note

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Question 1
Issue
In this present case, Our Earth Pty Ltd has been supplying and manufacturing a specially
designed biodegradable coffee cups that has been manufacture from sustainable materials.
The cups that Our Earth Pty Ltd supplies is exclusive to them and no other business supplies
and manufactures this kind of cups. Again, Our Earth Pty Ltd has discovered that another
business owner namely Coffee Bean Pty Ltd has been supplying the same cups as that of the
Our Earth Pty Ltd but for a cheaper price. On top of that, the cups that Coffee Bean Pty Ltd
has been supplying was availed from a company operating overseas. In addition, the Coffee
Bean Pty Ltd. failed to disclose that their cups are not original Our Earth Pty Ltd branded
cups. This has made Our Earth Pty Ltd to proceed for a litigation and under this litigation,
several compensation has been received by Our Earth Pty Ltd. The litigation has gained
certain compensation payment being made to Our Earth Pty Ltd.
The issue in the instant situation is the tax consequences of the following transactions
pertaining to Our Earth Pty Ltd:
 $300,000 damages for design patent infringement.
 $200,000 for expected lost revenue over the 12-month period that Coffee Bean Pty
Ltd had been using the other product.
 $15,000 interest received on the damages payout.
 $40,000 reimbursement of legal fees incurred by Our Earth Pty Ltd.
Law
The tax implication with respect to compensations is to be assessed in conformity with the
rules relating to replacement. The rules of replacement renders the compensation to have the
same implications with respect to taxation as that of the item of income against which the

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compensation has been received. In this context, it can be contended that the compensation
that has been received against any of the taxable items replaces that item for the purpose of
taxation. This would render the tax consequence with respect to compensation to be identical
as that of the item it has been replacing or in return for which it has been received. This can
be explained with the case of Shord v Commissioner of Taxation [2016] FCA 761. This case
has made it evident that the compensation received in relation to the loss of any of the items
taxable will be assessed to have the same status under the tax assessment as that of the item
he has been compensating. The compensation will be treated as the item itself for the purpose
of taxation.
The compensation that has been received for the purpose of mitigating the losses arising
out of the damage in relation to the income that has normally been accrued as an ordinary
income would also be treated as an ordinary income as provided in section 6.5 belonging to
the Income Tax Assessment Act 1997 (Cth) (ITAA 97). This contention has been based on the
fact that the compensation, which has been received to replace the ordinary income should
also be treated as an ordinary income as the same has been extended to moderate the loss of
the ordinary income. Accordingly, it can be stated that any compensation that has been
received for the loss that has been occurred by the destruction or deprivation of some asset of
capital nature would also be treated as capital gain. This is because the capital assets are
probable to earn capital gain in case it has been sold. Hence, any loss of the same would also
be considered as the loss of that probability of the capital gain. This renders any
compensation that has been received against the same to be treated as a capital gain as it has
been replacing a loss arising out of a capital asset. The same can be illustrated with the case
of Futuris Corporation Limited v Commissioner of Taxation [2010] FCA 935. In this case, it
has been discussed that factory having a permanent nature would be construed to be a capital

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asset owing to which, the compensation that would follow the destruction or the loss of the
same will also be construed to be a capital gain.
In the case of Commissioner of Taxation v Ashwick (Qld) No 127 Pty Ltd [2011] FCAFC
49, the person who has been liable to pay the tax has been dealing with a product upon which
he has been enjoying exclusive rights. This right has been infringed by some other dealer and
the compensation has been accrued to mitigate the infringement. This compensation has been
taxed as a capital gain as the right has been construed to be a capital asset. Again, it has been
contended by the court that any profit that has been sacrificed for the infringement would also
be considered to be ordinary income as the profit that would have arisen out of the right
would have been taxed as an ordinary income. It has been held in the case of Federal
Commissioner of Taxation v Northumberland Development Co Pty Ltd 95 ATC 4483 that any
profit would have the tax implication as an ordinary income and similarly any compensation
that has been following any loss of such profit would also be considered as an ordinary
income.
In addition, interests pertaining to damages that has either being received or accrued
would be considered to be ordinary income within the meaning provided under section 6.5,
the ITAA 97. This has been made evident by the court in the case of Orica Limited v
Commissioner of Taxation [2015] FCA 1399. Any reimbursement that has been received
with respect to any legal expenditure that has been incurred in any proceeding would be
considered to be an ordinary income as such expenses have already been deducted under the
general deductions as has been provided under section 8.1, the ITAA 97.
Application
In this present case, Our Earth Pty Ltd has been supplying and manufacturing a specially
designed biodegradable coffee cups that has been manufacture from sustainable materials.