The Concept of Income
7.3. The legal meaning of income is drawn very largely from judicial decisions— many of them borrowed from the United Kingdom—extended and refined by specific provisions. The primary characteristic of the tax law's approach has been to express what the word may be taken to mean in ordinary English usage. Some basic notions underlie the meaning. One of these is the idea of gains (in some contexts a receipt, in others a profit) from the carrying on of organised activity—an employment, a business or profession, or a business deal—directed to the making of gains. Another is the idea of gains derived from property which leave the property intact—a fruit of the tree as distinct from the tree itself. A third is the idea of compensation which substitutes for gains that would have been income. A fourth is the idea of gains periodically received. None of the ideas is sharp in its outlines, least of all the third and fourth. Thus compensation which substitutes for gains that would have been income must be distinguished from compensation for an asset that would have produced such gains. Gains periodically received must be distinguished from receipts of a fixed sum by instalments.
7.4. For analysis in terms of economic principles in which theory comes first and practicalities are wrestled with later, economists have sought a primary definition of income in any period that is a measure of the flow of an individual's actual and potential satisfactions. One of the most thorough-going efforts to this end is that associated with the American economist Henry Simons whose Personal Income Taxation, published in 1938, has had great influence in academic debate. That formulation centres upon ‘increases in economic power’ to command satisfactions.
7.5 The economists' definition would in general include in income all of the gains that the law includes: salary and
wages; profits from a business or profession or business deal; interest, rent, dividends; compensation for income; and
periodical receipts. But it also covers a great many gains that would probably not be reckoned as income in ordinary
English usage, and have not been brought in, or have been brought in
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only to a very limited extent, by
judicial and legislative extensions and refinements of that usage. The comprehensive tax base would include:
- (a) capital gains: gains from the realisation of property, when the realisation is not an aspect of the carrying on of a business or a profession, or the carrying out of a business deal;
- (b) bequests and gifts received;
- (c) lottery and casual gambling winnings;
- (d) retirement benefits and compensation for loss of office;
- (e) compensation for physical injury to person received in a lump sum or for injury to reputation; and
- (f) non-money income.
Some comment on each of these is called for.
7.6. Except to a limited extent resulting from the provisions of sections 26 (a) and 26AAA of the Income Tax Assessment Act, which define the base to include gains from the sale of property acquired for the purpose of profit-making by sale and gains made within a period of twelve months, capital gains (as defined in paragraph 7.5) are not included in the present base, though the introduction of a tax on such gains has been announced. The Committee's recommendations for the taxing of capital gains are set out in Chapter 23.
7.7 The present base does not include bequests and gifts received except where the receipt is one of a number received periodically, for example an annuity, or where, in the case of a gift, it is included as salary or wages or as a business gain or a gain from a profession. In Chapter 24 the Committee rejects the possible extension of the income tax base to include all bequests and gifts and proposes the continued taxation of property the subject of bequests and gifts on a separate basis.
7.8. Lottery and casual gambling winnings are not infrequently described as ‘windfall gains’, though the phrase has no very precise meaning. It suggests gains that are more or less unexpected. A quality of unexpectedness also belongs to some capital gains, but the Committee takes the view that this is not an argument for freeing capital gains from tax. However, taxing lottery and casual gambling winnings raises awkward problems, some of them administrative, others concerned with the deductions that should be allowed. There would be difficulties of enforcing the law with respect to casual gambling winnings. The problems associated with the allowance of deductions may be illustrated by asking how one would deal with the coins fed into a poker-machine. The Committee has no proposal to extend the tax base to include lottery and casual gambling winnings.
7.9. Retirement benefits and compensation for loss of office which are not periodically
received are by an express provision included in the present base only to the extent of 5 per cent of the amounts
involved. Were it not for this provision, a retirement benefit would be wholly included as a gain from an employment,
while compensation for loss of office received in a lump sum—sometimes called a ‘golden handshake’—would be wholly
excluded. Such compensation might be treated as embodying a capital gain if the notion of ‘property’ for the purpose
of bringing capital gains to tax were broadened to include an office. Alternatively, it might be regarded as a
substitute for salary which would have been earned and thus income. If any change is to be made in the existing law
there is much to be said for treating retirement benefits and compensation for loss of office in identical fashion.
Moreover,
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the best way of dealing with these receipts depends quite crucially on how the tax law treats
superannuation benefits and life insurance proceeds, and the matter is further considered in Chapter 21.
7.10. Compensation for physical injury to person received in a lump sum or for injury to reputation is not at present included in the income base. In theory the compensation could be regarded as embodying a capital gain if the notion of property were made wide enough to extend to human capital. It would, however, be impossible to identify the gain, since the cost of acquiring human capital cannot readily be ascertained. Some of the compensation may be in respect of income already lost and in respect of a loss of capacity to earn income in the future, in which cases it could be regarded as a substitute for the income that would have been earned. To this extent, at least, it might be thought appropriate to include it in the base. If compensation is received in the form of periodical payments, it will be income as received, whether given for lost income or some other aspect of the taxpayer's loss. These matters are further considered in paragraphs 7.34–7.41.
7.11. The major item of non-money income currently omitted from the income base is imputed rent of the owner-occupied home. This omission is discussed later in paragraphs 7.42–7.57. But houses are not the only form of property that may yield flows of satisfaction to which imputed income might be attached. Works of art and consumer durables in general are other obvious examples. Inclusion in the tax base of imputed income from these latter items of property would of course involve great administrative problems, and is not proposed.
7.12. Goods produced for one's own consumption or services performed for oneself are currently excluded from the income base. Whatever the case in economic theory for their taxation, it would be administratively impracticable and the Committee has no proposals to change the present position.
7.13. Other instances of non-money income that would be included in the comprehensive tax base may be found in the fringe benefits an employee receives from his employer. The gain may be in the form of goods received, services received, relief from an obligation that would ordinarily have been incurred or valuable rights.
7.14. The general rule of the income tax law is that a gain must be valued by reference to the amount of money that could be obtained for it. On this principle of valuation, a made-to-measure suit is likely to be valued at the price it would bring as a second-hand suit. A service one receives from another, such as the use of a motor-car or a residence available only to oneself or free holiday travel as an airline employee, has no value. Similarly the relief from the payment of interest enjoyed by a person who has an interest-free loan has no value; nor has a person's right to take up shares in a company, if not assignable, unless there is a way in which he can make the benefit of the right available to somebody else.
7.15. This general rule is, however, qualified in important respects by section 26 (e) of the Act, but only in relation to income gains that are rewards for services rendered. This provision substitutes ‘the value to the taxpayer’ for the test of value under the general rule. The special rule certainly limits the tax-planning possibilities opened up by the general provision, but its operation is not entirely clear. It has not prevented the offering and accepting of fringe benefits in substitution for cash, under employment contracts. Some of these benefits are certainly taxed; but to the extent that they are valued for income tax purposes below what would be paid for them in cash outside the income-producing relationship, the equity of the tax system is seriously affected.
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There may be a form of collusion between employer and employee by their splitting the saving of tax that attends a full deduction to the employer of the cost of providing the benefit and a lesser amount being included in the income of the employee. There is, however, no easy solution to the problem of making adequate provision. In many instances, the fringe benefit is so interwoven with the normal performance of the services for which the fringe benefit is a reward that the element of gain may be very difficult to identify. The commonplace illustration is the use of a motor-car for both employment and personal purposes. The question of the taxation of fringe benefits is explored in Chapter 9.