Generally trading contracts entered into by a business are usually revenue assets which are dealt with by a business for the purpose of generating a profit. If a trading contract is cancelled the compensation payments are treated as assessable income. Structural contracts are capital assets and cancellation of such a contract substantially affects the business. Compensation for a structural contract is generally a capital receipt .
To consider whether the compensation paid to Clara Lees is as assessable income or a capital receipt, we could refer the situation of Clara Lees cakes Pty Ltd to Allied Mill Industries Pty Ltd v FCT (1996) where the court held the compensation amount of $372,000 to be an assessable income. The amount paid was to compensate the loss of profit when the food manufacturer and distributors' rights to manufacture Vitawheat as a sole agent were terminated due to the cancellation of its contract.
The court held the compensation to be an assessable income as the taxpayer was engaged in many business contracts at the same time and the cancellation of one of these contracts did not affect the capital structure of the business.
As Clara Lees cakes Pty Ltd were engaged in 25 different agreements of the same nature, the compensation was received for cancellation of a contract made in the ordinary course of business and did not affect the conduct of the Clara Lees's business. Clara Lees could refer to the outcome of Californian Oil Products Ltd v FCT (1934) where the court held the compensation were capital in nature as the taxpayer had the power to carry on other business activities but it chose to restrict its business operations to marketing a particular brand of petroleum products which resulted in the liquidation of business after cancellation of the agency contract.
To be a capital receipt, it needed to a substantial part of the business but as it was one of many contracts held by Clara Lees and, as such, compensation for its loss cannot constitute a capital item. The compensation received as a result of cancellation of its contract is to be considered as an income for the loss of anticipated profits. Therefore, the compensation received by Clara Lees will be assessable in full under sec 6-5