Taxation Consequences of Business Transactions Analysis

This homework assignment analyzes the taxation consequences for Our Earth Pty Ltd, an Australian company manufacturing biodegradable coffee cups. The analysis addresses the tax implications of a design patent infringement, lost revenue due to a competitor's actions, interest received on damages, and reimbursement of legal fees. The assignment applies the Principle of Replacement, relevant case law, and sections of the Income Tax Assessment Act 1997 (Cth) to determine whether the income is treated as ordinary income or capital gains. The document concludes that damages for design patent infringement are treated as capital gains, lost revenue and interest are ordinary income, and the legal fees reimbursement is ordinary income.

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

1TAXATION
Issue
The issue in this present scenario is the taxation consequences of the above transactions.
Rule
The treatment of the compensation payment for the purpose of tax treatment is to be made
in accordance with the Principle of Replacement. Under this principle, any compensation
payment that has been received with respect to any item that would have incurred tax
implications will be treated in an identical way as that of the item it has been replacing. The
compensation payments will have the same consequences or would be treated as the same
item that it has been replacing for the purpose of taxation. The same can be illustrated with
the case of Commissioners of Taxation (NSW) v Meeks (Public Officer of the Sulphide
Corporation Limited) [1915] HCA 34; 19 CLR 5681. In this case, the court held that the
character of the item that is being replaced will be assumed by the compensation.
In that context, it can be stated that in case a compensation has been received as a
replacement of an item that would have been treated as an ordinary income while assessing
the tax consequences of the same, the compensation would also be assessable as an ordinary
income under section 6-5 of the Income Tax Assessment Act 1997 (Cth) (ITAA 97)2. On the
other hand, a loss of permanent nature of a factory would be construed to be a capital loss and
the compensation received with respect to the same would also be rendered as the capital
income. This can be illustrated with the case of Federal Commissioner of Taxation v Dixon
[1952] HCA 653. On the other hand, a loss of profit that has been caused owing to a loss of a
capital asset would be construed to be an ordinary income.
1 Commissioners of Taxation (NSW) v Meeks (Public Officer of the Sulphide Corporation Limited) [1915]
HCA 34; 19 CLR 568
2 The Income Tax Assessment Act 1997 (Cth), s. 6-5
3 Federal Commissioner of Taxation v Dixon [1952] HCA 65

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In the case of Californian Oil Products Ltd v. Federal Commissioner of Taxation. (1934)
52 CLR 284, the taxpayer has been an exclusive with respect to certain product. The
distribution of this product has been the sole business of the taxpayer and it has not dealt in
any other product. The supplier has cancelled the contract after two years, which has been
required to last for five years. The compensation that has been received owing to the same
would be categorized as capital income as business of the taxpayer has been destroyed to its
entirety. However, in this case, the compensation with respect to the loss of profit has to
treated as ordinary income. The treatment of the compensation received against the loss of
profit is to be construed as an ordinary income as profit in its ordinary treatment is assessed
as ordinary income. This can further be contended with the case of Allied Mills Industries v
FCT [1989] 89 ATC 43655.
Under section 6.5 of the ITAA 97, any interest that has been received on damages is
required to be treated as an ordinary income. This is because there is a recurrence or
regularity pertaining to the nature of interest6. The same can be illustrated with the case of
Commissioner of Taxes (Vic) v Phillips [1936] HCA 117. The reimbursement of legal fees is
to be construed to be an ordinary income. This is because the legal fees has already been
deducted as a general deduction under section 8.1 of the ITAA 978.
Application
In the instant situation, Our Earth Pty Ltd, an Australian owned company, are the
manufacturers of a specially designed bio-degradable, disposable coffee cup made from
sustainable materials. They are currently the sole supplier to coffee shops in Australia. The
4 Californian Oil Products Ltd v. Federal Commissioner of Taxation. (1934) 52 CLR 28
5 Allied Mills Industries v FCT [1989] 89 ATC 4365
6 The Income Tax Assessment Act 1997 (Cth), s. 6.5
7 Commissioner of Taxes (Vic) v Phillips [1936] HCA 11
8 The Income Tax Assessment Act 1997 (Cth), s. 8.1

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income that Our Earth Pty Ltd. has been earning from the same is required to be assessed for
the tax purposes as an ordinary income as under section 6-5 of the ITAA 979.
During this year, Our Earth Pty Ltd discovered that Coffee Bean Pty Ltd, the owner of a
chain of coffee shops Australia wide, had been contracting an overseas company to
manufacture a similar cup based on their design, for a cheaper price. Coffee Bean Pty Ltd had
not informed its customers that it was not the original Australian made Our Earth product that
they were using. This has the likelihood of disrupting the business of the Our Earth Pty Ltd. It
has caused losses to the business with respect to several aspects. Firstly, there has been a
damage that has been caused to the business with respect to design patent infringement.
Secondly, a part of the revenue has been lost over the 12-month period that Coffee Bean Pty
Ltd had been using the other product. Thirdly, there has been an interest that has been
accrued in connection to the damages. Moreover, there has been an expense of legal fees that
is required to be considered.
In this context, it can be stated that any compensation payment that has been received with
respect to any item that would have incurred tax implications will be treated in an identical
way as that of the item it has been replacing. Owing to these losses, the proceeding against
the Coffee Bean Pty Ltd has earned $300,000 damages for design patent infringement. The
design patent is to be treated as a capital asset, hence any compensation with respect to the
same is also required to be treated as a capital gain. This can be supported with the case of
Californian Oil Products Ltd v. Federal Commissioner of Taxation10.
Again, the same proceeding has accrued $200,000 for expected lost revenue over the 12-
month period that Coffee Bean Pty Ltd had been using the other product. This is a loss of
profit of the business. Profit, in its general implication is assessable as an ordinary income for
9 The Income Tax Assessment Act 1997 (Cth), s. 6-5
10 Californian Oil Products Ltd v. Federal Commissioner of Taxation. (1934) 52 CLR 28

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the tax purposes. Hence, applying the principle of replacement, it can be said that the
compensation that has been received with respect to the profit lost is required to be treated in
the same way as that of the treated the profit would have been subjected to. Hence,
compensation with respect to the revenue lost will be treated as an ordinary income for the
purpose of taxation.
In addition, $15,000 interest received on the damages pay-out is to be treated as an
ordinary income. This is because there is a recurrence or regularity pertaining to the nature of
interest. The same can be supported with the case of Commissioner of Taxes (Vic) v
Phillips11.
However, it can be stated that $40,000 reimbursement of legal fees incurred by Our Earth
Pty Ltd needs to be treated as an ordinary income. This is because the legal fees has already
been deducted as a general deduction under section 8.1 of the ITAA 97.
Conclusion
Hence, it can be concluded that the proceeding against the Coffee Bean Pty Ltd has earned
$300,000 damages for design patent infringement, which can be treated as a capital gain.
$200,000 for expected lost revenue over the 12-month period that Coffee Bean Pty Ltd had
been using the other product is to be treated as ordinary income. $15,000 interest received on
the damages pay-out is to be treated as an ordinary income. $40,000 reimbursement of legal
fees incurred by Our Earth Pty Ltd needs to be treated as an ordinary income.
11 Commissioner of Taxes (Vic) v Phillips [1936] HCA 11

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Reference
Allied Mills Industries v FCT [1989] 89 ATC 4365
Californian Oil Products Ltd v. Federal Commissioner of Taxation. (1934) 52 CLR 28
Commissioner of Taxes (Vic) v Phillips [1936] HCA 11
Commissioners of Taxation (NSW) v Meeks (Public Officer of the Sulphide Corporation
Limited) [1915] HCA 34; 19 CLR 568
Federal Commissioner of Taxation v Dixon [1952] HCA 65
The Income Tax Assessment Act 1997 (Cth)