Taxation Laws

This document provides an in-depth analysis of taxation laws related to compensatory damages, interest receipts, and legal expenses. It also discusses the tax implications of land subdivision and sale. The case study examples and relevant case laws help in understanding the practical application of these laws.

Running head: TAXATION LAWS
Taxation Laws
Name of the Student:
Name of the University:
Author’s Note

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Table of Contents
Answer to Question 1......................................................................................................................2
Issues:..........................................................................................................................................2
Laws.............................................................................................................................................2
Application..................................................................................................................................4
Conclusion...................................................................................................................................6
Answer to Question 2......................................................................................................................7
Issues............................................................................................................................................7
Laws.............................................................................................................................................7
Application..................................................................................................................................9
Conclusion.....................................................................................................................................11
Reference.......................................................................................................................................12

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Answer to Question 1
Issues:
Will compensatory damages receipts be held liable for taxes under “Division 6” or
“subsection 25 (1), ITAA 1936”? Are the receipts of interest from damages pay out be included
in assessable income of Our Earth Pty Ltd? Will the reimbursement received by the taxpayer for
legal expenses undertaken be treated as assessable income?
Laws
A compensation receipt which is received by a business generally includes a right of
seeking compensation or for any action or proceedings introduced in the business or in relation
to an underlying asset of the business. These sort of compensation which is received by a
business are considered as compensatory receipts for the business. Compensation which is
received for any damages would be included in the assessable income with respect to ordinary
income under “Division 6 of the ITAA 1997” or the same can be included in statutory income.
As per the provisions which is stated under “section 25 (1), ITAA 1997” compensatory
payments would be considered taxable when the same is related to loss of revenue or profits
which relate to previous year. As per the case rulings of “Mc Laurin v FC of T (1961)” the
receipts of compensation would be considered taxable within the legislative rulings of
“subsection 25 (1), ITAA 1936”. The only consideration in this regard is that the payment
should be recognizable so that the same can be assessable for income (Bankman et al., 2018).
In order to ascertain whether the compensation for the losses would be treated as capital
receipts or ordinary income depends on nature of the payment. As per “section 6-5, of the ITAA
1997” the compensatory payments which is considered depends on the nature of income with

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respect to ordinary concepts. As per the rulings which was held in “Californian Oil Products
Ltd v Federal Commissioner of Taxation (1934)” that any amount which is paid in ordinary
course of business for damages, losses of income would be considered under the purview of
taxation. The main reason due to which the verdict was provided as the profit was derived from
carrying out operations of the business even though the nature of the revenue is extraordinary in
nature.
The case of “CT (Vic) v Phillips (1936)” where a verdict was passed that if a taxpayer
receives compensation for loss of business revenue or commercial scheme and forms the
substances of business activity, then the amount which is received as compensation would be
considered as loss of capital assets. Therefore, if there is an absence of countervailing
examination than the receipts from the same would be treated as capital receipts. It was held in
the case rulings of “FC of T v Spedley Securities Ltd (1988)” that compensatory damages on
goodwill was considered as capital loss for the business. The compensation which was received
by the taxpayer was treated as an injury to the capital asset.
In the case where a taxpayer receives interest as compensation then the interest would be
treated as taxable amount for the taxpayer considering normal provisions. As per the opinion of
the federal court in the case “Whitaker v FCT (1998)” interest should be treated as income in
ordinary sense which is provided to the taxpayer as compensation for lost earnings.
The provisions of “section 8-1, ITAA 1997” states that the taxpayer would be eligible for
deductions for the legal expenses which is undertaken by the tax payer and then the payment or
the reward would also be included in the assessable income of the taxpayer in the form of
recovery under “subdivision 20-A”. The legal expenses which is awarded to the taxpayer is

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usually paid to the for indemnifying them or recipient is the successful party for the cost of
lawsuit. It is therefore for these reasons that legal expenses are not included in income for
ordinary course of business. The legal expenses which is incurred under “subsection 20-20 (2)”,
is treated as taxable recoupment (Delany, 2013). This means that the amount which is received is
regarded as recoupment of loss or expenditure which is taxable if the taxpayer has received the
amount as indemnity and this sum is also deductible under the legislations of “ITAA 1936 or
ITAA 1997”.
Application
As per the case study which is provided relates to a business which is engaged in
developing special designed coffee cups. The name of the company is Our Earth Pty Ltd and the
company is known for its sustainable practices in developing the products. It was noticed by the
management of the company that a company name Coffee Beans Pty Ltd had stolen the design of
the coffee cups and sold the products in overseas market (Martin, 2019). The product was
offered in the overseas market at a lower price as well with an intention to increase the sales of
the business. Therefore, the management of Our Earth Pty Ltd filed a legal suit which was won
and received an amount of $ 300,000 as compensation for the damage which was caused to the
patent rights of Our Earth Pty Ltd.
In order to ascertain whether the compensatory damages which is received by Our Earth
Pty Ltd is of capital nature or is ordinary income. The decision regarding the nature of payment
can be judged by applying the case laws of “CT (Vic) v Phillips (1936)” which shows that
amount $ 300,000 is associated with a core business function and is a business loss. The loss is
done to a capital asset and therefore the same would be treated as receipt of capital nature
(Gunnoe, 2014). In addition to this, there is an absence of countervailing examination so the

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receipts for damages is considered to be of capital nature. In accordance with the case of FC of T
v Spedley Securities Ltd (1988)”, the amount of $ 300,000 is paid as a compensation for
infringement of patents (Butler & Conitsiotis, 2013). As the nature of the payment is of capital
nature, the same would not be held assessable and the amount is paid as compensation for the
damage done to patent rights of the business.
In addition to this, Our Earth Pty Ltd has also received $ 200,000 from Coffee Beans Pty
Ltd for the loss of revenue of profits for the period of last 12 months. Applying the verdict of
“Californian Oil Products Ltd v Federal Commissioner of Taxation (1934)”, the amount which
is received by the business by Our Earth Pty Ltd as damages or compensation for loss of profit
which is in ordinary course of business and the same is covered under “section 6-5, of the ITAA
1997”
The management of Our Earth Pty Ltd also received reimbursement for an amount of $
40,000 which was given as legal fees by Coffee Beans Ltd. The legal costs are received by Our
Earth Pty Ltd as an award for being successful party which filed the legal suit. The legal costs
reimbursement cannot be treated as ordinary income (Burton, 2017). However, the same would
be included into assessable income of Our Earth Pty Ltd as taxable recoupment of expenses
under “subdivision 20-A”.
Calculation of Assessable Income
In the Books of Earth Pty Ltd
For the year ended 30th June 2019
Particulars Amount ($) Amount ($)
Receipts of expected loss 200000
Receipts of Interest 15000
Reimbursement of Legal fees 40000
Total Assessable Income 255000

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Conclusion
The above discussion effectively shows that the compensatory damages which is received
by Our Earth Pty Ltd for damages of $ 300,000 which is for infringement of patents. The amount
of $ 300,000 would be treated as capital receipts. In addition to this, the amount of $ 200,000
which is received by Our Earth Pty Ltd is for loss of profits and the same would be treated as
ordinary income and would also be assessable for taxes. The sum of $200,000 will be treated as
income under the ordinary concepts of “section 6-5, ITAA 1997”. The legal charges which is
received by Our Earth Pty Ltd will be included for assessment of taxation under “subdivision
20-A”.

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Answer to Question 2
Issues
Will the taxpayer be held liable for capital gain taxes when the taxpayer is selling off sub-
divided land under “section 25 (1)” or “section 26 (a)” or the taxpayer has simply realised the
capital asset?
Laws
Capital gains taxes are only applicable on sales of assets which have been purchased on
or after 20th September 1985. Any asset which is purchased before 20th September 1985 would be
treated as Pre-CGT asset and assets which are purchased after 20th September 1985 are
considered to be Post CGT asset. Capital gains is applicable where an amount is realised from
sale of a capital asset or from another specified event. The first step is to decide whether the
transaction or event forms a Subject of CGT and whether the event is ever taken out. As per
general rules, Capital gain taxes are applied prospectively and therefore it is only applicable if an
asset is disposed after 20th September 1985. A capital gain also arises when certain event takes
place under section 104-10, ITAA 1997” to the CGT asset when the taxpayer sells the asset. A
CGT asset is regarded as an asset which includes any type of property, legal or equitable right
which is not considered as a property.
There are several events which can be considered in relation to sub-division of land
which are kept for long time. These lands were basically used for agriculture purposes but have
been sold for residential development. In such a situation, the development of property on land
can be considered to make significant profits. In such cases three alternatives are established as
to how the profits are to be treated:

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 The subdivision and selling of land may be regarded as simple realisation of the capital
asset of the business.
 The degree of land development would be such that it constitutes carrying the business
developments,
 The activity of land development may go beyond simple realisation of land but not be
associated with performance of the business (Fullerton, 2017). In such a case, such
activities would be considered as profit deriving arrangements.
As per “Taxation Determination TD 97/3” simple sub-division of land cannot be treated as
sale of land within the meaning of “section 104-10, ITAA 1997”. The rulings specifies that the
proceeds which are derived from sale of land would be regarded as income which would be
assessable under “subsection 25 (1), ITAA 1936”.
The profits which is generated by performing a profit deriving scheme in relation to the
property which is purchased prior to introduction of CGT or Pre-CGT asset which is mainly
considered under assessable income as per the legislation of section 15-15, ITAA 1997”. The
improvements which are made on the land would also be considered for CGT provisions
(Schmalbeck, Zelenak & Lawsky, 2015). Any capital improvements which is made to the capital
asset after the purchase date would be added to the cost of the capital asset.
As per the case of “Scottish Australian Mining Co Ltd v FC of T (1950)” the federal court
passed its verdict that a significant profit was derived by the taxpayer from the sale of plot of
lands. The income which was generated by the taxpayer was held liable for taxes. As per the
commissioner of taxation, the profits which was generated by the taxpayer would either be
considered taxable under the “section 25 (1), ITAA 1936” as gains for development of land or

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considered under the provisions of “section 26 (a)” as the profits that are made from the revenue
generating undertaking.
Therefore, the law makes it clear that acquisition of land and sale of the same would lead to
generation of revenue which would definitely treated as assessable income which would be in
ordinary course of business. The ultimate purpose of the taxpayer was to generate profits from
the disposal of land.
Application
The case study which is shown relates to the situation where Sam purchases 80 acres of
land at first and then 20 acres of land. The purpose if 20 acres of land was to expand the
agricultural operations. But after a certain time period, Sam lost his interest in agriculture and
decided to move to residential property development by selling off his lands. Sam got advice that
he should dispose off his lands by sub-dividing them so that more profits can be generated by
him.
The first step is to determine whether capital gains actually arises by considering the date
of purchase of lands plots (Posner, 2014). As per information Sam purchased first 80 acres of
land in 1984 and therefore the same is to be treated as pre-CGT asset (Enever, Isaac & Daley,
2014). It is also to be noted that no CGT would be applicable on the sale of 80 acres of land as
any gains would be exempted from the point of view of tax.
On the other hand, Sam purchased 20 acres of land in February 1985. The land should be
treated as the post-CGT asset because it is bought after the introduction of capital gains scheme
(Huizinga, Voget & Wagner, 2018). The process of Sub-division started in 2017 and the land

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was disposed off in April 2018. Therefore, the revenue which is generated from sale of 20 acres
of land would be subjected to CGT.
In the case of Sam, the land development project would be generating significant amount
of revenue. By considering the provisions of Taxation Determination TD 97/3” the income
which is generated from the sale of plot of land would be considered as taxable under the
“subsection 25 (1), ITAA 1936”. The land which was sold was not actually purchased for
making profits by resale or for purpose of development (Zucman, 2015). The intention of making
profits developed at a later stage.
Referring to the case of Scottish Australian Mining Co Ltd v FC of T (1950)” Sam
makes considerable profits from sale of subdivided plots of land. Therefore, the profits which is
generated by Sam would be considered for Capital Gain Taxes under the provisions of “section
25 (1), ITAA 1936” in the form of gains made from carrying the business of land development or
within the legislative provision of “section 26 (a)” as the profits that are made from the revenue
generating undertaking.
The legal expenses which is undertaken by Sam and amount which is paid to property
agent would be deducted from the value of land which is considered for the purpose of taxes.
The gains which is generated from sale of land would be included in assessing the taxable
income of the taxpayer.
Calculations of Capital Gains Tax
In the Books of Sam
Particulars
Amount
($)
Amount
($)
CGT Event A1 (Section 104-10(1))
Sales Proceeds of 20acrs Land 1100000

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Agent Commission and Legal fees 45000
Total Sales Proceeds 1145000
Cost base item (Section 110-25 (1)
Element 1: Cost of Acqusition (section 110-25 (1) 110000
Element 4: Capital Enhancement Cost (section 110-25 (4)) 450000
Total Cost Base 560000
Net Capital Gains 585000
Conclusion
The analysis of the situation of Sam shows that the 80 acres land which was initially
purchased does not fall under the purview of CGT as the land was purchased before 1984 and
therefore the same would be considered as pre-CGT asset. While at the same time, 20 acres land
which was purchased on February 1985 would be considered as post CGT asset. The provisions
of taxation “section 25 (1) of the ITAA 1936” makes it clear that sale of subdivided plots of land
would be taxable in the form of gains which are made for carrying the business of land
development or any other legislature.

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Reference
Bankman, J., Shaviro, D. N., Stark, K. J., & Kleinbard, E. D. (2018). Federal Income Taxation.
Aspen Publishers.
Burton, M. (2017). A Review of Judicial References to the Dictum of Jordan CJ, Expressed in
Scott v. Commissioner of Taxation, in Elaborating the Meaning of Income for the
Purposes of the Australian Income Tax. J. Austl. Tax'n, 19, 50.
Butler, D., & Conitsiotis, T. (2013). Seeking compensation for defective ATO
administration. Taxation in Australia, 47(10), 660.
Delany, T. (2013). Easements: The tax considerations. Taxation in Australia, 48(1), 21.
Enever, N., Isaac, D., & Daley, M. (2014). The valuation of property investments. Estates
Gazette.
Fullerton, D. (2017). Distributional effects of environmental and energy policy. Routledge.
Gunnoe, A. (2014). The political economy of institutional landownership: Neorentier society and
the financialization of land. Rural Sociology, 79(4), 478-504.
Huizinga, H., Voget, J., & Wagner, W. (2018). Capital gains taxation and the cost of capital:
Evidence from unanticipated cross-border transfers of tax base. Journal of Financial
Economics, 129(2), 306-328.

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Martin, F. (2019). Unincorporated associations: Legal and tax consequences. Taxation in
Australia, 53(8), 420.
Posner, R. A. (2014). Economic analysis of law. Wolters kluwer law & business.
Schmalbeck, R., Zelenak, L., & Lawsky, S. B. (2015). Federal Income Taxation. Wolters Kluwer
Law & Business.
Zucman, G. (2015). The hidden wealth of nations: The scourge of tax havens. University of
Chicago Press.