Income Tax in Accounting: Income Definition and Capital Analysis

This essay provides an analysis of the definition of income for income tax purposes, focusing on the statement by Hannan and Farnsworth that income cannot have a specific definition to meet the requirements of the government and regulators. It discusses the concept of income under ordinary concepts and statutory basis, referring to the Income Tax Act 2007 (ITA 2007) and relevant case law in New Zealand and internationally. The characteristics of income, including periodicity, recurrence, and the recipient's perspective, are examined. Furthermore, the essay differentiates between income from various sources such as employment, business, and property. It also addresses the distinction between income and capital, using the "Fruit Tree analogy" to clarify the differences. The essay concludes by highlighting the importance of understanding these concepts for accounting studies.

Taxation for Accounting Studies
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 criterion against which the rules of the
current income tax can be assessed.3 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.4
1.2 Statutory basis
Income in NZ includes income according to ordinary concepts and statutory income that is
defined in tax legislation.5 Under statutory basis, section CA 1 provides the list of taxable
income and sCA 2 provide a list of exempt income and excluded income.6 Furthermore, sCB
shows an income for businesses and trade-like activities.7 Besides, the term “income”
means different things to different groups. For example “In economic
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 n 4 at 46.
5 James Coleman and others n 3 at ch 3.
6 ITA 2007 n 2 section CA.
7 ITA 2007 n 2 section CB.

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terms, income and gain are interchangeable terms”8 and are equivalent to
increases in wealth.9
1.3 Income under Ordinary Concepts
Income according to the ordinary concepts includes income from employment,
running a business and from performing services.10 The word means “what comes in”, but it
does not follow that everything that comes in is income for income tax purposes.11
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.”12
1.4 Characteristics of Income
The following basic principles are used to determine whether a receipt is “income” in its
ordinary sense, case law:13
1.4.1 Income is something that comes in, and it should be in money or money’s worth.14
Referring to the Lambe v Inland Revenue Commissioners case, the 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.15 Nevertheless, the commissioner argued that
8 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.
9 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.
10 Braedon Clark. The meaning of income: the implications of Stone v FCT [online]. Revenue Law Journal, Vol.
14, 2004: 178-189.
11 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.
12 Scott v Commissioner of Taxation (NSW) (1935) 35 SR (NSW) 215 (NSWSC).
13 CCH Commentary NZ: Updating Master Tax Guide [¶5 – 021].
14 CCH Commentary n 13.
15 Lambe v Inland Revenue Commissioners [1934] 1 KB 178.

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the interest should be included in the taxpayer’s total income; however, the court
held that income was something that actually comes in.16
There are situations where something does not come in, but assessable income
still results from the transaction.17 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.18
The commercial transaction is still income to the lender despite not coming in or
being in money or money’s worth.19
1.4.2 Income generally has the features of periodicity, recurrence and regularity20. 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.21 Since
there is no recurrence of receipts.
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.22
1.4.3 The character of a receipt may depend on its quality in the hands of the hands of
the recipient23. 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
10,000 pounds were not income in the ordinary concept.24 Hence, a gift is not
deemed to be an income. However, there are various situation where gift can be an
income.25 In addition, the receipt of loyalty points or prizes from points earned by
16 Lambe v Inland Revenue Commissioners n 15.
17 James Coleman and others n 3.
18 ITA 2007 n 2.
19 James Coleman and others n 3.
20 CCH Commentary n 13.
21 Federal Commissioner of Taxation v The Myer Emporium Ltd (1987) ATC 4363.
22 Reid v Commissioner of Inland Revenue [1986] 1 NZLR 129 (CA).
23 CCH Commentary n 13.
24 Scott v Federal Commissioner of Taxation (1966) 117 CLR 514.
25 ITA 2007 n 2 section CA 1(2).

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using the card will be not considered income, assuming the receipts of the prizes
are irregular.26
1.5 Income sources
A person’s tax obligations depend on their employment status, in particular, whether
the person is an employee or independent contractor; a person runs a business; or income is
coming from selling a property.27
1.5.1 Income from individuals: Under section CE1, amounts derived from employment is
primarily taxed under income from individuals by employees.28 Whereas self-
employed person is subject to pay tax on their income (revenue minus expenditure)
under s CB 1.29 Moreover, if employee gets a benefit allowance (e.g. meal allowance)
and if it meets s CW17 C(1) criteria then it is exempt income.30 For employees, there
is no deduction on travel costs and accommodation but can get a deduction on
donation. However, independent contractors can deduct travel costs and
accommodation costs from their income.
1.5.2 Income from business: section CB 1(1) defined income from business as “an amount
derived by a person from business is income of that person”.31 Looking at Mainzeal
Holdings Ltd v Commissioner of Inland Revenue where the court held MH has no
profit-making intention when the venture was entered into.32 There is a sole test for
determining the existence of a business whether the taxpayer is carrying on a
particular venture with the intention of making a profit.33 As per s YA1 describes
there should be “profession, trade or undertaking carried on for profit”.34
1.5.3 Income from property: This is the most complex source to determine income as rules
on property transactions capture a different type of transaction. As the transaction can
26 James Coleman and others n 3 at ch 3.
27 James Coleman and others n 3.
28 ITA 2007 n 2.
29 “Employee/Independent Contractor: Comparisons”, Income from Individuals, for ACCT707 course (lecture
slides, AUT University, week 4).
30 ITA 2007 n 2.
31 ITA 2007 n 2.
32 Mainzeal Holdings Ltd v Commissioner of Inland Revenue (2002) 20 NZTC 17,409 (CA)
33 James Coleman and other n 4.
34 ITA 2007 n 2

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be treated as income, under s CB 1, and capital under s DB 64.35 In Plimmer v
Commissioner of Inland Revenue where the court held that a profit arising from
reselling the preference shares are not assessable as no purpose of sale existed.36
As per Barrowclough CJ observed that “A man’s purpose is usually, and more
naturally, understood as the object which he has in view or in mind. One can scarcely
have a purpose of selling without having also an intention of selling, but, in ordinary
language, ‘purpose’ connotes something added to ‘intention’, and the words are not
regarded as synonymous. Though ‘purpose’ may sometimes mean ‘intention’, the
Court should hesitate to adopt that more restricted meaning unless the statute clearly
evidences such an intention.”37
1.5 Career vs Hobby
Receipts from one-off prize such as winning a cash windfall from undertaking a hobby
are not considered income under the ordinary concept.38 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.39 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.40 Thus, the court held that the receipt of $20,000 is an income.41 These
two above cases demonstrate how income can be defined variously in different situations.
2 Income/Capital distinction
2.1 Definition of Capital
35 ITA 2007 n 2
36 Plimmer v Commissioner of Inland Revenue [1958] NZLR 147 (SC)
37 James Coleman and others n 3 at 160.
38 Braedon Clark n 10 at 179.
39 Moore v Griffiths [1972] 3 All ER 399.
40 Kelly v Federation Commissioner of Taxation (1985) 85 ATC 4283.
41 Kelly v Federation Commissioner of Taxation n 40.

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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.
The term income, “capital” is not explicitly defined within the acts and it is, therefore,
necessary to turn to the courts to find the ordinary meaning of the word.42 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?
There is a “Fruit Tree analogy” which is being used to distinct capital and income. In
the fruit tree analogy, capital is considered as the tree (reservoir), where an asset is capable of
producing wealth for the business and income is considered as fruit, which generates a profit
from the asset.43 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.”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 a nutshell, it can be concluded that the definition
of income and capital cannot be clearly defined and identified and the analysis of the same
42 James Coleman and others n 3 at ch 3.
43 “Income/Capital Distinction”, The concept of Income Source and Residence, for ACCT707 course (lecture
slides, AUT University, week 2).
44 Eisner v Macomber (1919) 252 US 189 as cited in CCH Commentary: Australian Federal Tax Reporter
(ITAA 1997) [¶18-300].

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depends from legislation to legislation and from country to country. We can only have an
inclusive list for the considerations of income.

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Bibliography
A Books
James Coleman and others New Zealand Taxation (12th ed., Thomson Reuters, Wellington
2018)
B Cases
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.
Mainzeal Holdings Ltd v Commissioner of Inland Revenue (2002) 20 NZTC 17,409 (CA).
Plimmer v Commissioner of Inland Revenue [1958] NZLR 147 (SC).
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.
C Database
1 CCH New Zealand and Australia
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].
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).

Taxation for Accounting Studies
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
“Employee/Independent Contractor: Comparisons”, Income from Individuals, for ACCT707
course (lecture slides, AUT University, week 4).
“Income/Capital Distinction”, The concept of Income Source and Residence, for ACCT707
course (lecture slides, AUT University, week 2).