Philip Morris Ltd. v. Federal Commissioner of Taxation.

Jenkinson J

Supreme Court of Victoria

Judgment date: Judgment handed down 19 July 1979.

Jenkinson J.: Appeals pursuant to sec. 187(1)(b) of the Income Tax Assessment Act 1936 in respect of seven years of income.

The appellant, which was incorporated on 24 May 1967, has always carried on the business of manufacturing and selling

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cigarettes and other tobacco products. From its incorporation it has used a method of valuing its trading stock which the Commissioner does not accept for the purpose of making assessment of the appellant's taxable income. The method adopted and continued in use by the appellant is commonly called direct or variable costing, and the Commissioner has used what is called absorption or conventional costing in making his assessments. The parties have adduced in respect of the last of the years of income under consideration, 1975, all the evidence they consider relevant to a determination of that appeal, except the evidence upon which to determine the value of trading stock on hand on 1 July 1974, and they invite me to say by what method I think the value of trading stock ought to be ascertained before any attempt is made by me to apply the method in calculation.

The sections of the Income Tax Assessment Act 1936 to which counsel directed attention in their submissions are:

``28.(1) Where a taxpayer carries on any business, the value, ascertained under this subdivision, of all trading stock on hand at the beginning of the year of income, and of all trading stock on hand at the end of that year shall be taken into account in ascertaining whether or not the taxpayer has a taxable income.

(2) Where the value of all trading stock on hand at the end of the year of income exceeds the value of all trading stock on hand at the beginning of that year, the assessable income of the taxpayer shall include the amount of the excess.

(3) Where the value of all trading stock on hand at the beginning of the year of income exceeds the value of all trading stock on hand at the end of that year, the amount of the excess shall be an allowable deduction.

29. The value of live stock and of each article of other trading stock to be taken into account at the beginning of the year of income shall be its value as ascertained under this or the previous Act at the end of the year immediately preceding the year of income.

31.(1) Subject to this section, the value of each article of trading stock (not being live stock) to be taken into account at the end of the year of income shall be, at the option of the taxpayer, its cost price or market selling value or the price at which it can be replaced.

(2) Where the Commissioner is satisfied in relation to any trading stock of a taxpayer, that, by reason of obsolescence of, or any other special circumstances relating to, the trading stock, the value of the trading stock to be taken into account at the end of the year of income should be an amount, being less than the amount that is the lowest value that could be applicable under the last preceding sub-section, determined by the Commissioner to be the fair and reasonable value of the trading stock having regard to -

  • (a) the quantity of the trading stock on hand at the end of the year of income;
  • (b) the quantity of the trading stock sold, exchanged or used in manufacture by the taxpayer after the end of the year of income and the prospects of sale, exchange or use in manufacture of further quantities of that trading stock;
  • (c) the quantity of trading stock of the same kind sold, exchanged or used in manufacture by the taxpayer during the year of income and preceding years of income; and
  • (d) such other matters as the Commissioner considers relevant,

the value of the trading stock to be so taken into account shall, notwithstanding any exercise of the option of the taxpayer under that sub-section, be the value so determined by the Commissioner.

(3) The last preceding sub-section does not apply in relation to a taxpayer unless, by written notice signed by or on behalf of the taxpayer and lodged with the Commissioner on or before the last day for the furnishing of the return of income of the taxpayer for the year of income, or within such further time as the Commissioner allows, the taxpayer notifies the Commissioner that he wishes that sub-section to apply.''

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In sec. 6 of the Act is the following provision:

``(1) In this Act, unless the contrary intention appears -... `trading stock' includes anything produced, manufactured, acquired or purchased for purposes of manufacture, sale or exchange, and also includes live stock.''

The number of finished, packaged cigarettes on hand on 30 June 1975 was 667.6 million. On 30 June 1968 it was 244 million. The mean daily production of cigarettes in the latter year was 15.2 million, but in 1975 it was 51.8 million. Throughout the period under consideration the number of cigarettes on hand at 30 June of each year was not less than 5 per centum of the number of cigarettes produced during that year, nor more than 7.8 per centum thereof. The number of cigarettes on hand at 30 June in each of those years was not less than 7.5 times the mean daily production for the year, nor more than 16.8 times that number.

In respect of each of the years of income under consideration the appellant exercised the option conferred on it by sec. 31(1) of the Act to value its trading stock at ``cost price''. Counsel for the parties accepted the opinion of Fullagar J. in
Australasian Jam Co. Pty. Ltd. v. F.C. of T. (1953) 88 C.L.R. 23 at 29 that, in their application to manufactured goods, the words ``cost price'' in that subsection should be understood as meaning ``cost''. In those circumstances I think that I should proceed on the basis of that opinion, although the alternative course of denying manufacturers that mode of valuation does not seem to me to be out of the question. (See
F.C. of T. v. St. Hubert's Island Pty. Ltd. 78 ATC 4104 at pp. 4107-4108; (1978) 52 A.L.J.R. 367 at 369).

The appellant determined the cost of the finished cigarettes on hand at the end of a year of income by treating as elements of that cost only prices paid by it for the materials of which the cigarettes consist and the wages of those employees who moved, or performed operations on, those materials (whether directly by hand or in manipulation of machinery and other contrivances) in the course of the manufacturing process. The Commissioner determined the cost of the finished cigarettes on hand by treating as elements of that cost certain further expenses incurred by the appellant in carrying on its manufacturing activities, and also amounts referable to the depreciation of plant and machinery owned by the appellant and used in those activities.

The wages of employees called ``fixers'', who adjust and set machines used in the manufacture of cigarettes, both at the commencement of a shift and as occasion arises during the shift, but who do not otherwise operate the machines, were treated by the Commissioner as an element in the cost of the finished cigarettes on hand at the cost of the year of income, and some witnesses called by the appellant to give expert evidence of the practices and theories of accountants agreed that those wages should be so treated. But the appellant does not.

The wages of employees, called by the appellant ``inspectors'', who watch the operation of the machines and the complementary movements of materials and the products of the manufacturing processes from place to place at the points of discharge from machines and at places where materials are fed into machines, but who do not themselves move materials or products or operate machines (except in exceptional circumstances) were treated by the Commissioner as an element in the cost of the finished cigarettes on hand at the end of the year of income. These employees are concerned to intervene by directing attention to deficiencies of performance by machine or by operator and to arrange temporary relief for operators, and to assist their superiors in supervision of the manufacturing work.

The appellant's witnesses who were expert in accountancy justified the exclusion of the wages of fixers and inspectors from the computation of the cost of the cigarettes by several considerations. It was said that a variation in the number of cigarettes manufactured in a year which was less than 8 per centum of that number would occasion no variation in the aggregate of fixers' and inspectors' wages payable in respect of that year. The production of such a number of cigarettes as were on hand at the end of a year had not caused any increase in the expense incurred during that year on account of such wages, and therefore no part of that expense ought to be subtracted from the

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aggregate of the expenses to be brought into account in the calculation of the year's profit. Annual costs of production which did not vary in response to variations in the number of articles annually produced, within a range measured by the number of articles on hand at the end of the year, were said to be ``fixed'', and fixed costs were said to be not divisible, but to relate to ``the provision of big chunks of production or sales capability, rather than to production or sale of a single unit of product''. (See C.T. Horngren, Cost Accounting (1977), p. 270.) By including an amount referable to such fixed costs in the cost of the cigarettes on hand at the end of the year the Commissioner had wrongly denied that amount recognition, in the calculation of the year's profit, as an expense of that period, it was said. Or, at the most, such an expense ought to be regarded as an ``unexpired'' cost to be carried forward into the next year (as an addition to the value assigned to cigarettes on hand) only to the extent to which that expense may be seen to be likely to have a favourable economic effect in the next year or later.

The Commissioner's inclusion of an amount referable to the wages of the fixers and inspectors as an element of the cost of cigarettes on hand at the end of the year was in accordance with the recognised and widely practised accounting method of valuing a manufacturer's trading stock which is called absorption costing or conventional costing. The appellant's exclusion of any such an amount was in accordance with another such a method of valuing a manufacturer's trading stock, called direct costing or variable costing. Both methods are recognised as acceptable in the statement of accounting standards issued by the Institute of Chartered Accountants in Australia and the Australian Society of Accountants. Those two methods were the subject of consideration and comparison by the House of Lords in
Duple Motor Bodies Ltd. v. I. R. Commrs. (1961) 1 W.L.R. 739. The absorption costing method was said to be more extensively used than the direct costing method.

In discussing the question whether land might be trading stock within the meaning of that expression in the sections of the Income Tax Assessment Act with which I am concerned, Mason J. observed:

``It has been pointed out previously that, unlike the United Kingdom income tax legislation, the Act does not provide for the assessment of tax on the profits or gains of a business - see
Commercial and General Acceptance Ltd. v. F.C. of T. 77 ATC 4375, at pp. 4379-4380; (1977) 51 A.L.J.R. 842, at p. 843, and the cases there cited;
J. Rowe & Son Pty. Ltd. v. F.C. of T. 71 ATC 4157, at p. 4160; (1971) 124 C.L.R. 421, at pp. 450-451. One consequence of this difference is that some accounting principles and practices which have been held to be appropriate in the ascertainment of a taxpayer's profit may have no application here because our statutory provisions specifically instruct us as to what constitutes assessable income and as to the items that shall be allowed as deductions from that income. The trading stock provisions contained in sec. 28 to 36 are a case in point. Accounting principle and practice cannot prevail over them. However, as the definition of `trading stock' contained in sec. 6(1) is not an exclusive definition, it requires us to give effect to the ordinary, and in this case that happens to be the commercial, meaning of the expression, notwithstanding that in part at least it is a meaning which may have derived from or may have been influenced by accounting principle or practice.''

(F.C. of T. v. St. Hubert's Island Pty. Ltd. 78 ATC 4104 at p. 4113; (1978) 52 A.L.J.R. 367 at 373).

It ought, I think, to be kept in mind that in enacting those trading stock provisions ``the legislature has itself made some specific provision affecting a particular matter or question'' known to bear upon the ascertainment of income. (Cf.
Commr. of Taxes (S.A.) v. E.T. & A. Co. of S.A. Ltd. (1938) 63 C.L.R. 108 at pp. 151-160.) Recognising that the ``computation of profits from manufacture and trading has always proceeded upon the principle that the profit may be contained in stock-in-trade and `outstandings','' Parliament has defined the extent to which assessable income shall vary in response to variation in the value of trading stock and has specified the methods by which valuation may be made. In those circumstances my concern cannot be merely to consider, as the courts in England do, which of the methods of valuing the

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appellant's trading stock ``is better calculated... to reveal the full amounts of the profits or gains of the company''. (See
B.S.C. Footwear Ltd. v. Ridgway (1972) A.C. 544 at p. 558). My concern must rather be to seek to understand what method the legislature has directed to be applied in valuation of trading stock.

That understanding cannot be derived by determining what meaning is now - or was at the commencement of the Income Tax Assessment Act 1936 - accorded to a word or a phrase in the Act. The expression ``cost price'' in sec. 31(1) does not now have - nor had it in 1936 - a meaning, in the common usage of accountants or men of business, of relevance to the valuation of a manufacturer's finished goods on hand. Concerning the valuation of such goods it is to a conception, not to an exposition of usage, which the reasoning of Fullagar J. in Australasian Jam Co. Pty. Ltd. v. F.C. of T. (supra) leads: a conception which he, not Parliament, expressed by the word ``cost'', and by the expression ``actual cost''. (Cf.
B.P. Refinery (Kwinana) Ltd. v. F.C. of T. (1961) 12 A.T.D. 204 at pp. 206-208).

The evidence was undisputed that in 1936 the direct costing method of valuing stock on hand which was adopted, and is advocated, by the appellant was not in use by accountants, and that before the Second World War valuation of a manufacturer's finished goods on hand on the basis of ``cost'' would have been made by the application of the absorption costing method. I shall assume, without deciding, that the legal conception of what is required, or permitted, by sec. 31(1) when a manufacturer exercises his option to value an article of trading stock at cost may be enlarged or varied by proof of relevant changes in accounting principle or practice.

The provision made in sec. 31(1) for an annual choice by the taxpayer between several bases of valuation of each article of trading stock indicates legislative recognition that what has been called ``the asset-expense measurement problem'' contributes to the difficulty of ascertaining with accuracy the gains and losses in a business during a particular accounting period. That provision, and the further provisions introduced by the addition of subsec. (2) and (3) of sec. 31 in 1963, can be seen to be legislative directions designed to solve the problem, or at least to palliate its grosser manifestations.

The justifications of the two competing methods of costing are, I think, well expounded and criticised in an article (exhibit ``O'') by Professors C.T. Horngren and G.H. Sorter. The article includes the following observations, which were given less elaborate expression in the oral evidence of expert opinion:

``Variable costing is the inventory costing method which applies only variable production costs to product; under this method fixed factory overhead is not assigned to product. Typically variable production costs are direct material costs, direct labor costs, and variable overhead costs. Variable costing differs from conventional costing, sometimes called absorption costing, because fixed factory overhead is treated as a period cost (charged against revenue immediately) rather than as a product cost (assigned to units produced).

Advocates of variable costing maintain that the fixed portion of factory overhead is more closely related to the capacity to produce than to the production of specific units. Opponents maintain that inventories should carry a fixed cost component because both variable and fixed costs are necessary to produce goods; both these costs should be inventoriable regardless of the differences in their behavior patterns...

The difference between variable and conventional costing is really one of timing. Proponents of variable costing contend that fixed factory overhead costs become expenses as incurred, while opponents insist that such costs become assets until the goods to which they are related are sold. Thus the issue depends upon the nature of asset and expense.

Although many definitions of assets have been advanced, there seems to be wide acceptance of the concept of assets as service potential and somewhat less clear acceptance of the concept of expenses or losses as the expiration of service potential... costs are assets if they can

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justifiably be carried forward to the future, if they bear revenue-producing power, if they are beneficial to future operations - if they possess service potential. Thus the justification for treating fixed factory overhead as an asset must meet the test of service potential...

The concept of service potential depends on expectations. Some assumptions about the future are necessary to make the idea of service potential meaningful and measurable. Expectations or anticipations are an integral part of the decision to hold back a cost as an asset, to transfer the cost to another asset class, or to release the cost as expense or loss...

The major assumption that supports the dichotomy of asset or expense is as follows: `The going concern' concept assumes the continuance of the general enterprise situation. In the absence of evidence to the contrary, the entity is viewed as remaining in operation indefinitely. Although it is recognized that business activities and economic conditions are changing constantly, the concept assumes that controlling environmental circumstances will persist sufficiently far into the future to permit existing plans and programs to be carried to completion.

The going concern postulate is surprisingly the only assumption about the future needed to demonstrate service potential for any unexpired cost - except in the case of fixed factory overhead, as we shall soon see...

Accounting is a tool for decision-making by managers, investors, and all interested parties. Usefulness for decision-making thus becomes the overriding criterion for judging existing financial reports. Relevant costs are the only costs that have a bearing on managerial or investment decisions. But what are relevant costs? Relevant costs are those costs that will be different between two or more future actions, those costs that may be avoided by not undertaking a given alternative. Irrelevant costs are those that have no influence on a decision because they remain the same for all alternatives regardless of the choice. If a given cost has no influence on future operations, it is irrelevant and not helpful for decision-making. Therefore, assets should consist only of relevant costs, costs that will influence future results. If costs will not have an impact on future results, they have no service potential because they cannot affect future cost incurrence. We submit that costs must be relevant costs in order to be termed assets. But relevant to what? Some series of events must be anticipated to which these unexpired costs will relate. Again the reasonable assumption is enterprise continuity (going concern). A cost is an asset if it is relevant to the future as envisioned by the going concern concept. As service potentials, assets represent rights to future usage of bundles of services for the benefit of the enterprise. The very recognition of the asset implies that a decision has been made about the future. We submit that a cost has service potential, in the traditional accounting sense, if its incurrence now will result in future cost avoidance in the ordinary course of business. In other words, assets (unexpired costs) ordinarily represent costs whose reincurrence is unnecessary in the future. If future cost avoidance will not be affected by the cost in question, the cost has no relevance to future events and therefore cannot embody any benefit, any future service. Irrelevant costs, given the going concern assumption, cannot be assets. Expressed another way, if the total future costs of an enterprise will be decreased because of the presence of a given cost, that cost is relevant to the future and is an asset; if not, that cost is irrelevant and is expired. Conceptually, a given cost can reduce future costs in two ways: (1) by avoiding the reincurrence of the same type of cost or (2) by reducing a different cost (possibly an opportunity cost) in the future.

In practice, only the first type of cost avoidance is capitalized. The most widely applied test to determine if a cost is an asset is whether the absence of a given cost would necessitate a replacement expenditure to sustain normal operations as a going concern. As will be discussed below, merchandise inventory is a cost avoidance of the first type and is capitalized; whereas an employee training

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program, which easily may represent a cost avoidance of the second type (i.e., avoid future losses caused by insufficient training), is typically expensed.

This orientation thus takes on a replacement cost flavor with, however, original cost as a maximum boundary. A strong case may be made for the traditional accounting view that no more than the original cost of an asset should be charged to income over the asset's life. The original cost is an objectively verifiable, unambiguous amount. However, the allocation of part of that original cost to one period or another is necessarily subjective. Without violence to the original cost restraint, such allocation should be consistent with the concept that an asset is the present value of its future services. The appropriateness of the original cost restriction need not and should not concern us here. The notion of an asset as future cost avoidance is valid with or without the original cost restrictions...

In normal circumstances direct materials, direct labor, and variable factory overhead costs are assets because a decision to incur them in one period will reduce total future costs. Their absence would necessitate replacement expenditures to sustain normal operations as a going concern...

Proponents of conventional costing maintain that income is greater when production exceeds sales than when production is at the same level as sales, because fixed facilities are better utilized and render more benefit in the form of inventories that will bring future revenue.

Proponents of variable costing maintain that fixed factory overhead provides capacity to produce. Whether that capacity is used to the fullest extent or not used at all is usually irrelevant insofar as the expiration of fixed costs is concerned. The salient factor is that production in advance of sale usually does not avoid any fixed factory overhead costs in future periods. The incurrence of fixed costs in a current period ordinarily has no bearing on the reincurrence of the same kind of fixed costs next period. As the clock ticks, fixed costs expire, to be replenished by new bundles of fixed costs that will enable production to continue in succeeding periods...

Fixed factory overhead is inventoriable only when it represents service potential, only when the utilization of these costs through production this period will reduce total future costs. Under what assumptions will this latter situation occur? Only if failure to produce now would lead to additional costs in the future period. In other words, if inventory was not built up during the current period, additional costs would have to be incurred in future periods in order to sustain contemplated operations. What assumptions about the future are then necessary to justify the inventorying of fixed factory overhead?

Assumption 1

Future production at maximum capacity with future sales in excess of capacity by the amount of increase in ending inventory...

Assumption 2

Variable production costs are expected to increase...

The income concept underlying variable costing is clear-cut: income can change only if revenue or cost incurrences vary from period to period. The income concept underlying conventional costing is obscure: income is a function not only of revenue and cost incurrence but also of production during a period. The stability, growth, or decline of inventories will influence reported profits. Consequently, variable costing will permit more accurate forecasts because net incomes will have a direct relationship with sales instead of the fuzzy, twisting relationship which results when sales, production, and changes in inventories are all considered.''

The exclusion of fixed costs from the value of manufactured goods on hand and the corresponding inclusion of those costs in the expenses of the period in which the stock was manufactured require a conception of ``cost'' as in itself a measure of the gains of the business. Although the emphasis in what I have quoted from the article is heavily laid

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upon prediction of future gains and losses, the value selected from closing stock by the application of the direct costing method is also calculated to provide, in itself, a measure of gain by the business during the period which is ending. The value is the expression of an allocation of expense between that period and the next and the direct costing method justifies itself, not as accurately indicating what the article has cost the manufacturer to make, but as accurately indicating what contribution to the manufacturer's gains for the year in which it was manufactured the holding of the article at the end of the year has made. But in my opinion the conception which is expressed in sec. 31(1) by the words ``cost price'' is not in itself any such a measure of gain or loss. The statutory conception of ``cost price'' or, in the case of a manufacturer's stock, ``cost'' is merely a measure of a value at a particular time which does not purport itself to measure any gain. The gain or loss is to find expression only in the amount by which the aggregate of closing stock values exceeds or falls below the aggregate of opening stock values. This is in my opinion indicated by the provision in sec. 31(1) of a choice of methods by which to value each article of trading stock at the end of the year of income. The development of the conception of cost in relation to manufacturer's trading stock which direct costing theory and practice involves is therefore, in my opinion, a departure from the conception which I think that sec. 31 expresses.

The concept expressed by the words ``cost price'' in sec. 31(1) in my opinion is, in its application to an article of trading stock manufactured by a taxpayer, directed to ascertainment of the expenditure which has been incurred by the taxpayer, in the course of his materials purchasing and manufacturing activities, to bring the article to the state in which it was when it became part of his trading stock on hand. Analogy between acquisition by purchase, which the expression ``cost price'' plainly contemplates, and acquisition by manufacture suggests as much, although the analogy is imperfect; and I have not found elsewhere in the provisions relating to the valuation of trading stock a contrary indication. Because the calculation of expenditure of that kind is made for successive periods of a year, the ascertainment of expenditure referable to one of very many identical manufactured articles is, I think, ordinarily to be achieved by allocating to each of the articles manufactured during a year an equal share of the year's expenditure incurred in manufacturing them all.

The appellant was incorporated in May 1967. The number of finished cigarettes on hand at 30 June 1968 was 7.8 per centum of the number of cigarettes manufactured during the year which ended on that day. For the next seven years of income the number of finished cigarettes on hand at the end of each year was not more than 7 nor less than 5 per centum of the number manufactured during the year. The cigarettes were manufactured in Melbourne and held in stock in each of the Australian States. The system of despatch out of stock was described as ``very close to a first in first out system'' and it was said that nearly all the cigarettes on hand at 30 June would have been manufactured during June and would have passed out of stock during July.

The appellant having chosen to maintain its rate of production during those eight years within the range indicated by those percentages, I think that each cigarette manufactured during a year of income should, in the absence of evidence that some of them required more time for their manufacture than others or that in the course of manufacture some of them occupied more time of the fixers or the inspectors than others of them occupied, be found to have occasioned in its manufacture an equal share of the expenditure incurred by the appellant on account of the wages earned in that year by those employees. Therefore the cost of each of the finished cigarettes forming part of trading stock on hand at the end of the year will include an amount equal to the amount of that share.

The expenditure incurred in respect of the manufacture of cigarettes during the year should be shared among finished cigarettes and ``work in progress''. If work in progress be put to one side for the present, the apportionment of that expenditure should be so made as to attribute to each cigarette manufactured during the year an equal amount as the cost of that cigarette, except

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where the evidence shows that the manufacture of some cigarettes occasioned expenditure of greater magnitude. The objections to that application of absorption costing which are discussed in Duple Motor Bodies Ltd. v. I.R. Commrs. (supra), are hardly relevant to the circumstances of the appellant's manufacturing and trading activities. If they were relevant, it may well be that the enactment of subsec. (2) and (3) of sec. 31 has answered them. Whether or not that be so, I think that the conception of cost which subsec. (1) of the section expresses requires the conclusion I have stated.

The calculations in fact made by the appellant for the costing of its trading stock were based upon annually estimated costs of production of each of its several brands of cigarette. The estimation was made in the middle of each year of income. Comparison was made monthly between the estimate and costs actually incurred, and adjustments were made in the appellant's accounts to reflect what the comparisons revealed. This ``standard cost'' system may be combined with either direct or absorption costing, and the Commissioner was not concerned to displace the system, either in assessment or on the hearing of the appeal. What I have said of all the cigarettes on hand at the end of a year of income is applicable, when the taxpayer's accounting records enable differentiation to be made between several brands, to all cigarettes on hand of the same brand.

Because the tobacco leaf material used by the appellant in the manufacture of cigarettes is stored after purchase for more than a year, the appellant has adopted a method of averaging cost prices of tobacco purchased, and I understand the method is acceptable to the Commissioner in relation to the valuation of trading stock on hand.

The appellant subjects samples of the materials of which cigarettes are made to regular testing and analysis in order to determine various physical and chemical properties of the materials. The aggregate in the year of income of the wages of those engaged in these activities, the price of materials employed in the processes (other than the materials of which cigarettes are made) and certain expenses of repairing the equipment used and of necessary travel by some of those employed in this work (all of which expenditure was designated, in documents tendered in evidence, ``quality control'') was included by the Commissioner in his calculation of the cost of trading stock on hand at the end of the year.

Most of the information obtained as a result of those activities is utilized to maintain and improve the qualities which are considered desirable in the cigarettes which the appellant manufactures. Insofar as the activities are carried on for that purpose the expenditure is, I think, part of the cost of manufacturing cigarettes and ought to be apportioned as an element of the cost of trading stock on hand in the same way as I have indicated that the wages of the fixers and inspectors ought to be apportioned. There was, however, evidence by the appellant's finance director, Mr. K.W. Schultz, which suggested that the information was required also in order to apprise those of the appellant's servants whose function it is to promote sales of the appellant's cigarettes of changes in the quality of what they sell, and in order to facilitate the financial control of all the appellant's activities. It may be that those circumstances justify some apportionment of the expenditure between the manufacturing and the selling operations of the appellant. Even if the case of each party to the appeal in respect of the year ended 30 June 1975 were regarded as irrevocably closed (a view I do not presently hold) further evidence on the question could be adduced in the other appeals.

Like the expenses called ``quality control'', the expenditure incurred by the appellant each year for the removal and disposal of waste substances resulting from the manufacture of cigarettes does not vary in response to variations in the rate of production of the kind under consideration in these appeals. It is, however, expenditure incurred in manufacturing the cigarettes and ought in my opinion to be apportioned in the same way as the wages of the fixers and inspectors. (It may be that some of the expenditure ought to be excluded as not related to manufacture: see the items on p. 29 of exhibit ``D'' - ``Despatch'', ``Advertising Store'', ``Canteen Car Park''). So also would I apportion expenditure

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incurred in controlling insect infestation of raw tobacco and expenditure on account of the wages of fitters, electricians, greasers and trade assistants engaged in maintaining, moving, modifying and repairing machinery and other production equipment and plant used in treating tobacco and manufacturing cigarettes, except so much of that expenditure as might be referable to the cost of installing plant and equipment and be capitalised accordingly. So too with the expenditure on spare machine parts, tools and materials used in maintenance and repair by those employees.

The appellant's boiler house provides steam, compressed air, vacuum and chilled water. These services are not wholly committed to use in the manufacturing of cigarettes. Although the appellant's documentary evidence relating to the apportionment of costs incurred in the running of the boiler house - and to the apportionment of certain other costs yet to be mentioned - was very well prepared, the witnesses who might have interpreted that evidence to enable me to use it in accordance with sound accounting practice were directed rather to the more general issues of direct and absorption costing. I think it better that I express no view, until I have heard counsel further, and perhaps heard further evidence, upon the allocation of boiler house expenditure to the cost of trading stock on hand. In like case is the expenditure discussed in para. 1, 2.3, 2.4, 5.1, 5.2, 5.4, 6.1, 8 and 9 of exhibit ``D''.

I am presently of the view that payments made to an employee in the year of income on account of sick pay, tea money and holiday pay ought to be treated for the purposes of calculating the cost of trading stock on hand as if the payments had been made on account of wages earned by that employee in that year of income. Payments on account of payroll tax ought, I think, to be similarly treated. It may be that the appellant's records are kept on such a basis as to make that course inconvenient. I would hear counsel further on those questions.

The sums of money specified in the accounts of the appellant in respect of depreciation of leaf treatment plant and machinery and cigarette manufacturing machinery during a year of income ought in my opinion to be treated, for the purpose of ascertaining the cost of trading stock on hand at the end of that year, as costs of manufacturing the total number of cigarettes manufactured during that year and apportioned equally among that number in calculating the cost of trading stock on hand. Sums relating to the items specified in para. 7.3 of exhibit ``E'' may require further consideration.

I have not so far referred to articles of trading stock other than finished cigarettes. I hope that what I have said in respect of the latter articles will be found not unhelpful in application to the former. As I indicated during the addresses of counsel, it seems to me that the Commissioner's method of calculation of the increase in value of closing stock over the amount specified in the appellant's return of income may give an incorrect value for articles other than finished cigarettes. But I will hear counsel further on that question.

The further hearing of the appeals is adjourned to a date to be fixed, so that the parties may consider these reasons.

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