SE Machinery Pty Ltd [SEM] is a private resident Australian company incorporated in 1981. The company develops and manufactures Teftoffel, a component used in the manufacture of small engines. The...

Required 1(a)
Section 6-5 of the Income Tax Assessment Act 1997 deals with income according to
ordinary concepts or ordinary income which is included in assessable income and as per the
section; it includes all the income that is derived during the income year. In accordance with
the provisions of this section in respect of an Australian resident, the assessable income
includes all the ordinary income derived directly or indirectly from all sources, whether in or
out of Australia during the income year.(CCH, 2012) The section further advises that, in
order to determine whether an ordinary income has been derived or not, and where it has
een derived, the amount is said to have been received as soon as it is applied or dealt with in
a manner as per on behalf of or on direction of the taxpayer.
In order to determine whether an amount is ordinary income, the courts have established
various principles such as the nature of the payment in the hands of the recipient, the form of
the receipt- whether lump sum or periodical, and the motive of the person making the
payment (Re Hayes v FC of T). As was held in the case of Kelley v FCT, it is important that
the amount received must have a connection with the earning activity of the tax payer and the
eceipt must come to the tax payer beneficially. Also, as regards a lump sum payment, it has
een held that it is important to consider that any expenditure to expand or enhance a profit
making structure will be taken to be on capital account. Re case law Sun Newspapers Ltd &
Associated Newspapers Ltd v FCT (1938). However, it was held in the case of Commissioner
of Taxation v Western Subu
s Cinemas Ltd (1952) that any repair or restoration of the profit
yielding structure shall be taken to be on revenue account.
In order to understand the meaning of the term ‘derived’, we rely on the use of the generally
accepted principles based upon the decisions of the various courts. These suggest that
depending upon the circumstance of the taxpayer; the ordinary income may be derived on
eceipts or accruals basis. If the receipts basis is most appropriate for him, income shall be
derived when received and if accruals basis is most appropriate, income will be derived when
a recoverable debt is there in respect of the income and no further steps are needed to make
the recipient entitled to it.
On application of these above stated and explained principles to the issue in hand, we find
that the amount of $500,000 is seen to be derived on accruals basis as the payment is received
in advance on 1 May 2011 in respect of supply of Teftoffelex, a new product, in August
2012. Further, it is made in respect of modifications and alterations required in the company’s
existing production system for the purpose of manufacture of Teftoffel. The payment comes
under the explanation of ordinary income as it has a clear connection with the business
activity of the tax payer and is coming beneficially to the tax payer. Thus, on the basis of
above discussion and the application of these principles and the stated case laws, we conclude
that the said amount is assessable under Section 6-5.
(b)
The decision in the leading case of Arthur Mu
ay lays down the principle for meaning of the
term ‘derived income’ as envisaged in section 6-5 of the ITAA 1997. It enforces that a
prepayment of income does not represent income until it is actually earned by the taxpayer. A
prepayment essentially refers to an advance payment of goods and services. The funds have
een received by the taxpayer but income is not said to be derived unless the service has been
actually provided. As per the ruling in the Arthur Mu
ay case and the principle determined,
it is considered that the income is not said to be derived until the good or...