What is Income?
Income in common language is income from:
• salaries and wages
• business and self-employment income
• unemployment benefits
• rental income
• profit from selling capital assets
• New Zealand resident overseas income
However income has more to it. What you think of income is actually termed as assessable income in tax legislation.
Income has a very important place in tax calculations, as Income Tax Act 2007 imposes tax on income, thus understanding income becomes pretty important for taxpayers.
• Section BB1 states tax is imposed on taxable income.
• Section BC5 states taxable income for a tax year is determined by subtracting any available tax loss that the person has from their net income.
• BC4 (1) Net income = annual gross income - annual gross deduction
• BC2 - A person's annual gross income for a tax year is the total of their assessable income that is allocated to the corresponding income year.
In assessable income the most important part is income under ordinary concept. Because section CA1 states
1. An amount is income of a person if it is their income under a provision in this Part.
2. An amount is also income of a person if it is their income under ordinary concepts.
Income Tax Act 2007 defines “assessable income” in tax terms. So to understand income, we need to look at what is assessable income.
Section BD1 (5) Assessable income: have two limbs positive and negative
Assessable income is an amount of income of a person in the calculation of their annual gross income (positive limb), if it is not income of any of the following kinds (negative limb):
(a) exempt income:
(b) excluded income:
(c) non-residents' foreign-sourced income.
The legislation does not define income and it has been purposely left open to capture all types of transactions. In response to this, the courts have made the definition of this simple and in ordinary language.
In Reid v Commissioner of Inland Revenue (1983) 6 NZTC 61,624 (HC) concept of income was described, which has three key features:
1. Income is something which comes in
2. Periodicity, recurrence or regularity
3. Quality in the hands of the recipient
Characteristics of Income
- Income must have quality in the hand of recipient, and it must have money or money’s worth.
- Need to stay in the taxpayer shows that why this income has been received
- For example a gift on a birthday cannot be income in the hands of the recipient
- Income is something which comes in, which means coming into your pocket.
- Income may not be in cash but even if this can be converted into cash it would be income.
- Income is something which is periodic in nature, which comes in regularly such as rent, interest, salary & wages.
- Winning lottery tickets or money from tab cannot be regarded as income
- A one off gift where love & affection is involved is not income in the hands of the recipient.
- Holiday package offered to an employee by the employer is not his income; however it would be subject to fringe benefit tax.
- Tips received by the hotel staff would be income since it is regular or periodic in nature. Because the income they received it is in lieu of services they provide. But if an accountant received $200 gift from their client which is not in lieu of his service, will not be an income of the accountant.
- The important thing is motive, what was the motive behind the whole transaction. Courts have determined that you must stand in the taxpayer shoes.
- Often there is an argument between the taxpayer and the revenue authorities in defining capital receipts.
- Receipts which are capital in nature are treated differently from tax point of view.
- Capital is tree and income is fruit of that tree.
- Think from rental house perspective, house is a capital and rent is an income
- Water reservoir is capital and water outlet is income
Section CE 9 restrictive covenants
Generally employer put few conditions in the exit of the employee;
- Location clause geographic location
- Customers can not approach them
- Trade secrets cannot be revealed
Any payments received by the employee would be their income.
Income from selling personal property
- Section CB 3 An amount that a person derives from carrying on or carrying out an undertaking or scheme entered into or devised for the purpose of making a profit is income of the person
- It does not talk about the sale, which means even if hold the asset for a long time can still be liable for tax. There is no reference to the property this is left wide open.
- The main important point in this section is purpose even - how important the purpose is, it has to be the dominant purpose.
- If the dominant purpose was profit making then proceeds will be taxable
- Another important thing is timing, when you need to have the profit making purpose. Basically the purpose has to be when entered into or derived the property, so at the time of entering into the undertaking if the purpose was to make profit CB3 will trigger.
- The onus of proof is on the taxpayer to prove the purpose.
What is undertaking or scheme?
- Have to have some sort of plan, some sort of formulation referring your game plan.
- CB3 will not trigger if you are just merely selling off the asset it would just be realisation.
- For example you sold your car on trade me, if you make some money out of it, this will not be your income
- It is not regular in nature
- This is merely realisation of your asset
In order to define business income one must look at what is business.
- Business is something which is more than a hobby
- Business needs some planning, budget preparation, set number of hours, place of work, accounting records.
- Overall it must have motive to earn/maximise profits.
If you want to claim deductions against business income, you must be able to show you are running a business. The problem here could be when the nature of business is actually hobby for example artist, gambler, and sports professional or horse breeder.
Features of business:
- Look at regularity- hobbies are adhoc, whereas business is continuous
- Pattern of activity is important. Courts have said frequency is important but not required. There may be some businesses which are seasonal. As long as you can justify the reason of idle time you can get away.
- scale/size/investment- at what scale you are operating the business and how much money, time or efforts are invested
- o Scale is important but not that much, even if it is done at small scale this can be referred as business.
- Particular industry
- o Even though you do everything differently than the other industry members, your business can still be referred as business. As long as you can justify it.
They are all part of the mix, don’t need ticks at every level, all points must be checked then come to the conclusion overall.
When does your business start?
Your business starts when your current operations start. Income and deductions would be deductible from that point onwards.
Pilot project/feasibility study cannot be business. The whole idea behind this is you have not made up your mind yet.
Once business is terminated you can no longer claim the deduction.