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Ruling

Subject: acquisition of trading stock and the application of sections 70-90 and 70-95 of the Income Tax Assessment Act 1997

Question 1

Is Entity A treated as having bought items of trading stock for the market value of the items, being the amount required to be included in the assessable income of Entity B and Entity C, pursuant to sections 70-90 and 70-95 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following periods:

1 July 2010 to 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

Entity A signed an Asset Sale Agreement with Entity B, parent company of Entity C, to acquire businesses in Australia.

The Asset Sale Agreement concerns the sale of the businesses (comprising of business assets) and contains typical clauses requiring the seller to continue operating the businesses until settlement and restricting the seller from soliciting customers, soliciting transferring employees and competing in business after settlement.

The assets referable to the Australian business acquired by Entity A can be categorised into three broad categories:

1. trading stock, including raw materials acquired for the purpose of manufacture;

2. trade debtors and other receivables; and

3. plant and equipment.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 70-90

Income Tax Assessment Act 1997 section 70-95

Reasons for decision

Section 70-90 of the ITAA 1997 states:

(2) If you dispose of an item of your trading stock outside the ordinary course of a business:

(a) that you are carrying on; and

(b) of which the item is an asset;

your assessable income includes the market value of the item on the day of the disposal.

Section 70-95 of the ITAA 1997 states:

If an entity disposes of an item of the entity's trading stock outside the ordinary course of business, the entity acquiring the item is treated as having bought it for the amount included in the disposing entity's assessable income under section 70-90.

Sections 70-90 and 70-95 of the ITAA 1997 were introduced in the Tax Law Improvement Act 1997. Similar provisions previously existed in the now repealed section 36 of the Income Tax Assessment Act 1936 (ITAA 1936). Subsection 36(1) of the ITAA 1936 stated:

Subject to this section, where:

(a) a taxpayer disposes by sale, gift, or otherwise of property being trading stock, standing or growing crops, crop-stools, or trees which have been planted and tended for the purpose of sale;

(b) that property constitutes or constituted the whole or part of the assets of a business which is or was carried on by the taxpayer; and

(c) the disposal was not in the ordinary course of carrying on that business;

the value of that property shall be included in the assessable income of the taxpayer, and the person acquiring that property shall be deemed to have purchased it at a price equal to that value.

Disposal of trading stock

Section 70-90 of the ITAA 1997 requires that an entity dispose of an item of trading stock.

Dispose

The word 'dispose' is not defined in the ITAA 1997. The word 'dispose' in the context of the now repealed subsection 36(1) of the ITAA 1936 was considered by the High Court of Australia in Rose v Federal Commissioner of Taxation (1951) 84 CLR 118 (Rose). Dixon, Fullager and Kitto JJ observed at page 123 that:

In employing the words "dispose of" s. 36 doubtless meant to include every alienation of trading stock. "Disposition" and "dispose of" are expressions of the widest import. But the subject of the disposition must be considered as well as the ambit of the expression "dispose of".

The Asset Sale Agreement required Entity B and Entity C to dispose of items to Entity A.

Trading stock

Section 70-10 of the ITAA 1997 states that:

"Trading stock" includes:

(a) anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business; and

(b) live stock;

but does not include a Division 230 financial arrangement.

The items disposed of by Entity B and Entity C and acquired by Entity A included finished goods, work in progress and raw materials. The finished goods consisted of finished products or items held for the purpose of sale to the various customers of Entity B and Entity C. The work in progress and raw materials consisted of items held for the purpose of manufacturing further finished goods that would also be sold to customers of Entity B and Entity C.

The finished goods, work in progress and raw materials disposed of by Entity B and Entity C to Entity A satisfy the definition of trading stock in section 70-10 of the ITAA 1997. Accordingly, Entity B and Entity C are taken to have disposed of items of trading stock to Entity A for the purposes of section 70-90 of the ITAA 1997.

Disposal of trading stock outside ordinary course of business

Section 70-90 of the ITAA 1997 requires that the disposal of items of trading stock be outside the ordinary course of business.

Disposal of trading stock outside the ordinary course of business was considered in relation to the now repealed section 36(1) of the ITAA 1936 by the High Court of Australia in Farnsworth v Federal Commissioner of Taxation (1949) 78 CLR 504 (Farnsworth).

In Farnsworth a question to be determined was whether or not a fruit grower, that delivered fruit to a packing company where it became inextricably mixed with the fruit of other growers, disposed of trading stock for the purposes of section 36(1) of the ITAA 1936.

Latham CJ observed at page 514 that:

Section 36 relates to the disposal of the assets of a business, including, inter alia, trading stock. The terms of the section show that it was intended to be applied to a case where there was a disposal of the assets of a business as such whether in whole or in part, and whether or not the assets were disposed of because the seller was going out of business or because the business was sold to another person. The section is intended to deal with a walk-in walk-out sale, with a clearing sale, and with a transaction which represents, not an ordinary sale of goods in the course of carrying on a business, but a disposal of the assets of the business so that the business is no longer being carried on by the person who has disposed of it.

Dixon J observed at page 519 that section 36(1) of the ITAA 1936:

…deals with the case of a taxpayer's disposing of the whole or any part of the assets of a business. If the whole or any part of such assets are disposed of by sale or otherwise howsoever, whether for the purpose of putting an end to the business or any part thereof or not, and the assets include any property being, amongst other things, trading stock, then the value of the property must be included in the taxpayer's assessable income.

This provision is generally considered to have no application to the regular disposal of trading stock in the ordinary course of carrying on a business.

In Farnsworth it was determined that the trading stock had not been disposed of outside the ordinary course of business.

The term 'in the ordinary course of business' was previously used in the now repealed paragraph 95(2)(b) of the Commonwealth Bankruptcy Act 1924. The term was considered in Downs Distributing Co Pty Ltd v Associated Blue Star Stores Pty Ltd (Downs Distributing).

In Downs Distributing a question to be determined was whether a transfer of property in a bankruptcy had taken place in the ordinary course of business. Rich J at page 477 observed that the term 'in the ordinary course of business' as used in paragraph 95(2)(b) of the Commonwealth Bankruptcy Act 1924

…does not require that the transaction shall be in the course of any particular trade, vocation or business. It speaks of the course of business in general. But it does suppose that according to the ordinary and common flow of transactions in affairs of business there is a course, an ordinary course. It means that the transaction must fall into place as part of the undistinguished common flow of business done, that it should form part of the ordinary course of business as carried on, calling for no remark and arising out of no special or particular situation.

Entity B and Entity C had obligations under the Asset Sale Agreement to continue carrying on the businesses as a going concern until final settlement of the Asset Sale Agreement.

The Asset Sale Agreement required disposal of the trading stock as part of an overall agreement for the sale of the businesses operated by Entity B and Entity C to Entity A. Entity B and Entity C ceased operating the businesses and were prohibited from establishing or carrying on any similar businesses for a period of time after final settlement of the Asset Sale Agreement.

It is considered therefore, that the items of trading stock disposed of by Entity B and Entity C and acquired by Entity A involved a disposal which was outside the ordinary course of business.

Conclusion

Entity B and Entity C disposed of the trading stock outside the ordinary course of business. The items of trading stock disposed of by Entity B and Entity C were acquired by Entity A.

Section 70-90 of the ITAA 1997 applies to the disposal so that the market value of the items of trading stock would be included in the assessable income of Entity B and Entity C.

Section 70-95 of the ITAA 1997 applies to the acquisition of the items of trading stock by Entity A. Entity A is treated as having bought the items of trading stock for the amount included in the assessable income of Entity B and Entity C.

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