Federal Commissioner of Taxation v. All States Frozen Foods Pty. Limited

Davies J

Federal Court

Judgment date: Judgment handed down 6 October 1989.

Davies J.

This is an appeal from a decision of the Administrative Appeals Tribunal (``the Tribunal''). The Tribunal took a view different from that of the Commissioner as to the meaning of the words ``trading stock on hand'' in sec. 28(1) of the Income Tax Assessment Act 1936 (Cth) (``the Act''). The appeal is brought under sec. 44 of the Administrative Appeals

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Tribunal Act 1975
(Cth) and is limited to questions of law.

Section 6(1) of the Act provides:

```trading stock' includes anything produced, manufactured, acquired or purchased for purposes of manufacture, sale or exchange, and also includes live stock;''

Section 28 provides:

``(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.''

Section 29 provides:

``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.''

In its return of income for the year ended 30 June 1985, the taxpayer, Allstates Frozen Foods Pty. Limited, claimed to have stock in transit of the value of $1,420,479. The taxpayer brought that stock to account as part of ``Inventories... $7,028,447'' in its balance sheet for the year and, in an attached note, dissected this item between ``Stock in Warehouse'' of $5,607,968 and ``Stock in Transit'' of $1,420,479. Neither the stock nor the cost thereof was brought to account in the taxpayer's trading account for the year; but the income tax return stated that ``Stock In Transit is raised as an asset in the Balance Sheet with a corresponding Creditor raised as a liability''. The income tax return claimed that $1,420,479 was an outgoing incurred in respect of goods in transit and was deductible under sec. 51(1) of the Act. The Commissioner allowed the deduction claimed but brought the stock to account as stock on hand at the end of the year of income. Before the Tribunal, the relevant value for the stock in transit was said to be $1,389,517.

The Tribunal made these findings of fact [88 ATC at pp. 940-941]:

``At midnight on 30 June 1985 shipping containers filled with a variety of frozen products as diverse as chow mein from Taiwan; cooked and peeled prawns from Malaysia; hake fillets from Uruguay; calamari from Japan; vegetables from Belgium; and fish fingers from New Zealand were en route by cargo ships to Australia. They were in the course of being delivered to the applicant with a view to sale by the applicant. They were to become part of the `trading stock' of the applicant if they were not already part of the trading stock of the applicant. Each delivery was being made pursuant to a contract entered into between a supplier (as vendor) and the applicant (as purchaser). The price in each case had been paid. The question for determination is to what extent the total cost of the goods in transit ($1,389,517) is to be taken into account in calculating the taxable income of the applicant for the year of income ended 30 June 1985.

2. The applicant is a company which carried on business as a dealer in such frozen products. In the ordinary course of its business it received such goods delivered from its suppliers; it received them into storage under the control of the applicant; it de-containerised the products delivered; it tested them for conformity to standards; and it marketed them to other wholesalers and retailers within Australia. I accept that it was no part of the business of the applicant to deal in such products outside Australia and no part of its business to deal in such products while in transit. I find that in one instance, as an alternative to having one container delivered to its own store, the applicant had that container delivered direct to the store of a purchaser (Order 4139 $30,396).

3. According to the documents presented in evidence, the contracts fell into the following categories:

      1. FIS (free into store)

         7 contracts                         177,238

      2. CIF (cost insurance freight)

         3 contracts                         102,943

      3. C and F (cost and freight)

         21 contracts documentation

           pre-1 July                      1,067,250

         2 contracts documentation

           post-30 June                       42,086
           TOTAL                          $1,389,517

4. I find that, on or before 30 June 1985, all contracts for purchase had been in all respects completed as to their terms; payment of the purchase price had been completed; none of the goods had reached Australia; and none of the goods were in the direct physical control of the applicant. I further find that, of the CIF and C and F contracts, in all instances save two (for $42,086), bills of lading had been delivered to the applicant before 30 June 1985. I find that the physical delivery of goods into Australia and into the control of the applicant (or in one instance, its customer) only occurred after 30 June 1985.''

The Tribunal concluded [88 ATC at p. 948]:

``It may be that, by reason of the `passing of property' the frozen products in question became `trading stock' of the Applicant at 30 June 1985. But, even if that were so, it was not trading stock `on hand'. On 30 June 1985, the products in question could not have been sold in the ordinary course of business.''

In the appeal, Mr K.R. Handley Q.C., with whom Mr P.J. Lanigan and Mr S.W. Gibb of counsel appeared for the Commissioner, conceded that as at 30 June 1985, the property in the goods purchased under the seven FIS contracts, valued at $177,238 and under the two C&F contracts in respect of which the documentation was delivered after 30 June 1985, valued at $42,086, had not passed. Mr Handley conceded that those goods totalling $219,324 in value were not stock on hand as at 30 June 1985. Mr Handley contended that the balance of the goods valued at $1,170,193 were stock on hand at that time. In respect of these goods, delivery of the bills of lading had been effected prior to 30 June 1985.

The law and practice with respect to the effect of the delivery of bills of lading under CIF and C&F contracts was stated by Bowen L.J. in Sanders Brothers v. Maclean & Co. (1883) 11 Q.B.D. 327 at p. 341:

``The law as to the indorsement of bills of lading is as clear as in my opinion the practice of all European merchants is thoroughly understood. A cargo at sea while in the hands of the carrier is necessarily incapable of physical delivery. During this period of transit and voyage, the bill of lading by the law merchant is universally recognised as its symbol, and the indorsement and delivery of the bill lading operates as a symbolical delivery of the cargo. Property in the goods passes by such indorsement and delivery of the bill of lading, whenever it is the intention of the parties that the property should pass, just as under similar circumstances the property would pass by an actual delivery of the goods. And for the purpose of passing such property in the goods and completing the title of the indorsee to full possession thereof, the bill of lading, until complete delivery of the cargo has been made on shore to some one rightfully claiming under it, remains in force as a symbol, and carries with it not only the full ownership of the goods, but also all rights created by the contract of carriage between the shipper and the shipowner. It is a key which in the hands of a rightful owner is intended to unlock the door of the warehouse, floating or fixed, in which the goods may chance to be.''

Likewise, in The Prinz Adalbert (1917) A.C. 587 at p. 589, Lord Sumner said:

``By general mercantile understanding, which has the force of law where transactions originate, like the present, in time of peace without prospect of war, the delivery of an indorsed bill of lading, made out to the shipper's order while the goods are afloat, is equivalent to delivery of the goods themselves, and is effectual to transfer ownership if made with that intention. The bill of lading is the symbol of the goods.''

See also the more detailed examination made by Devlin J. in
Kwei Tek Chao & Ors v. British Traders and Shippers Ltd. (1954) 2 Q.B. 459 at pp. 480-481, 486-487 and Halsbury's Laws of

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4th ed., Vol. 43, para. 494, Benjamin's Sale of Goods, 3rd ed., para. 1445.

Although sec. 6, 28 and 29 of the Act must be given effect according to the words which the legislation uses, the concept which is enshrined in those sections is not just a taxation concept. In
F.C. of T. v. Suttons Motors (Chullora) Wholesale Pty. Ltd. 85 ATC 4398 at p. 4400; (1985) 157 C.L.R. 277 at pp. 281-282, Gibbs C.J., Wilson, Deane and Dawson JJ. said:

``Section 6(1) of the Act provides that, in the absence of a contrary intention, ``trading stock' includes anything produced, manufactured, acquired or purchased for purposes of manufacture, sale or exchange, and also includes live stock'. The definition is expansive in that it operates `cumulatively upon the ordinary meaning' of trading stock (per Stephen J.,
F.C. of T. v. St. Hubert's Island Pty. Ltd. 78 ATC 4104 at pp. 4106-4107; (1978) 138 C.L.R. 210, at p. 216 and see, to the same effect, at ATC pp. 4113-4114; C.L.R. p. 229 (per Mason J.) and ATC p. 4117; C.L.R. p. 235 (per Jacobs J.)). It is not relevant here to consider the extent to which the `definition' actually widens the ordinary meaning of the term: (cf. St. Hubert's Island case at ATC pp. 4111ff. and 4121; C.L.R. pp. 225ff. and 243). What is important for present purposes is that it does not restrict that ordinary meaning...

The ordinary meaning of the term `trading stock' upon which sec. 6(1) builds is that which is attributed to it by legal and commercial people for accounting and other purposes. That ordinary meaning has been held to include shares purchased and held for resale by a share trader
Investment & Merchant Finance Corporation Ltd. v. F.C. of T. 71 ATC 4140; (1971) 125 C.L.R. 249) and land which a dealer in land holds as an object of his dealing (St. Hubert's Island case at ATC pp. 4111-4112; C.L.R. p. 225). It has been said to include the stock of raw materials which a manufacturer holds for use in manufacture (St. Hubert's Island case at ATC pp. 4112-4113; C.L.R. pp. 226-227 and cf. Act, sec. 6(1)). It is not necessary for present purposes however to explore the outer limits of the area covered by that ordinary meaning of the term. Its traditional and narrower denotation still lies at the centre of that meaning and is adequate for present purposes. That denotation is of goods held by a trader in such goods for sale or exchange in the ordinary course of his trade. When used in relation to `a business', as the term is used in the Act generally (see sec. 28) and in sec. 82D(1) in particular, that central meaning comprehends the goods held on hand in the business for the purpose of sale or exchange in the ordinary course of trade. The fact that particular goods may not have been paid for or may not be owned by the trader does not preclude their being trading stock on hand in relation to his business if, notwithstanding lack of payment or ownership, they are legitimately held in the possession of the trader as or as or as part of the body of stock to be sold or exchanged in the ordinary course of the trade of that business.''

It has long accorded with the ordinary practices of trading concerns and with ordinary accounting principles and practice for the profits and income of a trading concern to be calculated after taking into account receivables and outgoings for the year and also the value of stock held both at the beginning and at the end of the year or other accounting period. A calculation of profit or income without taking into account levels of trading stock, or circulating capital as it is sometimes called, will not give a true reflection of the trading results for the period. In
Commissioner of Taxes (S.A.) v. Executor Trustee and Agency Co. of South Australia Ltd. (Carden's case) (1938) 63 C.L.R. 108 at pp. 155-156, Dixon J. said:

``The reasons which underlie the practice of estimating for taxation purposes the income from trade or manufacture by means of a commercial profit and loss account consist in the impracticability of computing income in any other way and in the adoption for fiscal purposes of recognized commercial principles. 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. Whether this is to be explained on some view that the purpose is to ascertain what is the detachable increase in circulating capital, or more simply on the ground of common sense and the teachings of experience, the result for the purposes of taxation is the same. The result is that a tax

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upon the profits or income of such a business must be understood as a tax upon the profits or income computed according to the system, because, according to common understanding and commercial principles, that is the method of determining the profits. The basis of a trading account is stock on hand at the begining and end of the period and sales and purchases. In such an account book debts represent what before sale was trading stock and it is almost inevitable that they should be taken into consideration upon an accrual and not a cash basis.''

These principles were further examined and applied in F.C. of T. v. St. Hubert's Island Pty. Ltd. (in liq.) 78 ATC 4104; (1978) 138 C.L.R. 210 by Stephen J. at ATC pp. 4107-4108; C.L.R. pp. 218-219, by Mason J., with whom Jacobs and Murphy JJ. agreed, at ATC pp. 4112-4113; C.L.R. pp. 226-228 and by Aickin J. at ATC pp. 4112-4113; C.L.R. pp. 244-245.

In this light, the taxpayer's method of accounting for the subject transactions during the year of income was erroneous. The transactions were not just balance sheet items reflecting assets and liabilities. In respect of the subject goods, more than $1m had been paid or incurred and the expenditure was in respect of trading stock. The transaction was a revenue transaction. It was inconsistent with the ordinary practices of the commercial and business world, with ordinary accounting principles and practice and with taxation principles and practice to treat the transactions as balance sheet transactions only not to be reflected in the profit and loss account until the goods had actually been received into the taxpayer's warehouse. Entries reflecting the transactions should have been made in trading accounts and reflected in the taxpayer's profit and loss account for the year.

How could the cost of the goods have been entered just as a liability in the balance sheet? The expenditure was not expenditure on fixed capital. The taxpayer had purchased the subject goods for use as stock. Having accepted the bills of lading it was the owner of the goods, they were at its risk, it was entitled to possession of them and it had control, dispositive power over them. Why then were not the goods recorded as stock and why was not the cost thereof included with other amounts in the item ``Purchases'' in the trading account?

Of course, if the correct accounting entries had been made, it is likely that the taxpayer's claim in this case would not have been pursued.

Mr R.F. Edmonds, counsel for the taxpayer, submitted that goods were not trading stock unless held ready for sale in the ordinary course of business. Those were not Mr Edmonds' precise words but that was the substance of his submissions. Mr Edmonds referred inter alia to the judgments in Suttons Motors. But in the passage set out above, their Honours did not say that, in its ordinary denotation, trading stock consisted of goods ready for sale or exchange in the usual course of business. Their Honour referred rather to goods held for the purpose of sale or exchange in the ordinary course of trade. The subject goods in the present case were purchased by the taxpayer in the ordinary course of its business for the purpose of sale in the ordinary course of its business.

Although the word ``stock'' may sometimes be used in ordinary parlance to describe the goods which a trader, particularly a retailer, has ready for sale, the term ``trading stock'' is not limited to that sense in the Act nor is it limited to that sense when what is in issue is the calculation of the annual profits or income of the trader. Section 6(1) of the Act does not require that goods be ready for sale or even that they be purchased or acquired in the ordinary course of business. It simply requires that goods be produced, manufactured, acquired or purchased for purposes of manufacture, sale or exchange. Work in progress is thus trading stock for the purposes of the Act, as it is in ordinary commercial and accounting concepts of stock on hand.

As Mason J. said in the St. Hubert's Island case at ATC p. 4112; C.L.R. p. 226:

``Even today it would be correct to speak of the trading stock or stock-in-trade of Steptoe & Son. But whereas both expressions may have had this limited meaning in times gone by, trading stock has acquired a more extensive denotation in modern times. It is a commercial term, ordinarily employed by accountants and auditors and it is to usage by commercial men that we must look in determining what it signifies, rather than to standard dictionaries which so often fail to reflect current usage and just as frequently fail to reflect modern commercial usage.''

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At ATC p. 4113; C.L.R. pp. 228-229, his Honour said:

``If trading stock according to its ordinary meaning denotes land as well as goods and commodities, it must follow that land may form part of the trading stock of a business before it has been converted into the condition in which it is intended to be sold. Just as raw materials and partly manufacturerd goods form part of the trading stock of a manufacturer, so also virgin land which has been acquired by a land developer for the purpose of improvement, subdivision and sale in the form of allotments will form part of his trading stock.''

Mr Edmonds submitted, nevertheless, that the words ``on hand'' appearing in sec. 28, introduced a concept different from trade and accounting concepts and that stock in transit was not stock on hand for the purposes of the Act. Mr Edmonds pointed out that the Income Tax Assessment Act 1922 did not use the words ``on hand''.

But the words ``on hand'' or ``in-hand'' have long been terms used to refer to the stock held by a trader at a particular time, whether currently or at a time of stocktaking or at a balancing date. The Shorter Oxford English Dictionary gives this meaning of the word ``stock'':

``VI. 10. The aggregate of goods, or of some specified kind of goods which a trader has on hand as a provision for the possible future requirements of customers 1696.''

The term ``on hand'' was in fact used in an explanatory handbook showing differences between the Income Tax Assessment Act 1936 and the Income Tax Assessment Act 1922 which was published in August 1936 under the authority of the Commonwealth Treasurer and was used as if the term added nothing to the new provisions. Neither The Law of Income Tax by Radcliffe, McGraw and Hughes, published in 1938, nor Dr Hannan's monograph on the principles of income taxation, published in 1946, suggested that the words ``on hand'' imported any element other than that the stock referred to was stock held by the taxpayer on the relevant date.

The words ``trading stock on hand'' in sec. 28 thus refer to the trading stock held by the taxpayer at the specified time. Because the trading stock provisions are based upon well known concepts of trade and accountacy, those concepts of what stock a trader holds and thus what should be brought to account in a calculation of the profits or income of the year provide a guide as to the stock ``on hand'' at the relevant date. In the present case, that stock included the goods in respect of which bills of lading were held.

Much of the hearing was devoted to an examination of
J. W. Greene & Co. v. I.R. Commrs (1927) I.R. 240,
Benjamin Smith & Son v. I.R. Commrs (1928) 139 L.T. 97,
Edward Collins & Sons Ltd. v. I.R. Commrs (1924) 12 T.C. 773 and
I.R. Commrs v. Huntley & Palmers Ltd. (1928) 12 T.C. 1209. I need not discuss these cases or the dicta therein. They were all cases involving the forward purchase of stock which had not been physically delivered as at the balance date and in respect of which bills of lading had not been delivered and were not held by the taxpayer. The decision in each case accords with the decision which would have been reached under Australian taxation law. The cases are illustrative of the circumstance where goods which a taxpayer has contracted to purchase have yet to become part of his stock on hand. They do not touch the present case in which the taxpayer, by accepting bills of lading, obtained ownership and control of the stock and an unrestricted power to dispose of it.

In the circumstances, I am of the view that the Tribunal made an error of law in its interpretation of the words ``on hand'' in sec. 28 and that, as a matter of law, the decision of the Tribunal cannot stand.

In this circumstance, Mr Handley sought an order that the decision of the Tribunal be set aside and that the matter be remitted to the Commissioner for reconsideration with the direction that the goods to the value of $1,170,193 were trading stock on hand as at 30 June 1985 but that the goods valued at $219,324 were not on hand at that date. Mr Edmonds joined with Mr Handley in seeking this order, if I were satisfied, as I am, that the Tribunal's decision turned upon a question of law and must be set aside. The order of the Court will go accordingly. I shall reserve leave to the parties to apply with respect to costs.

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