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Ruling

Subject: Trading stock - valuation

Question 1

Is the 'cost' of aquaculture trading stock (salmon and trout) for the purposes of paragraph 70-45(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) calculated using the full absorption cost method for smolt and fingerlings purchased by the taxpayer from independent suppliers?

Advice/Answers

No

Question 2

Are the expenses incurred in rearing and maintaining the fish until harvest and sale deductible under section 8-1 of the ITAA 1997?

Advice/Answers

Yes

This ruling applies for the following periods:

Year ended 30 June 2012

Year ending 30 June 2013

Year ending 30 June 2014

Year ending 30 June 2015

Year ending 30 June 2016

The scheme commences on:

1 July 2011

Relevant facts and circumstances

The taxpayer has an aquaculture business.

The taxpayer is engaged in the task of rearing and maintaining acquired salmon smolt and trout fingerlings to grow into mature stock for harvest and sale.

The taxpayer operates a sea farm.

The smolt and fingerlings are purchased by the taxpayer from an independent hatchery and transported to the taxpayer's sea farm.

The costs incurred acquiring the smolt and fingerlings are:

· Purchase of the smolt and fingerlings on a per fish basis; and

· Truck transport costs.

The sea farm operations consist of the following:

· The smolt and fingerlings are placed into sea cages;

· The smolt and fingerlings are fed and maintained until they reach up to 18 months old;

· Adult salmon and trout are then removed from the sea cages and are harvested.

The costs incurred in the sea farm operations are generally as follows:

· Labour costs;

· Facility maintenance ( the cost of maintaining the cages and nets to house the smolt and fingerlings);

· Feed;

· Depreciation; and

· Utilities.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 70-5

Income Tax Assessment Act 1997 section 70-10

Income Tax Assessment Act 1997 section 70-45

Income Tax Assessment Act 1997 section 995-1

Issue 1

Question 1

Summary

The 'cost' for determining the value of the trading stock on hand at the end of the income year under paragraph 70-45(1)(a) of the ITAA 1997 does not need to be calculated using the full absorption cost method for all expenses of acquisition and production.

Detailed reasoning

Section 70-10 of the ITAA1997 defines trading stock as including;

(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.

The use of the word 'includes' in the definition of trading stock in section 70-10 of the ITAA 1997 signifies that a thing may be trading stock for the purposes of the provision if it meets the requirements in paragraphs 70-10(a) or 70-10(b) of the ITAA 1997 or is otherwise trading stock within the ordinary meaning of that term.

The term 'live stock' is defined in subsection 995-1(1) of the ITAA 1997 to 'not include animals used as beasts of burden or working beasts in a *business other than a *primary production business'.

The High Court in Federal Commissioner of Taxation v. Wade (1951) 84 CLR 105; (1951) 9 ATD 337 considered this definition of live stock when it was then found in subsection 6(1) of the Income Tax Assessment Act 1936. Dixon and Fullagar JJ stated at CLR 110; ATD 342 that the definition, by inference, makes it clear that all animals used in a primary production business are included as live stock.

Paragraph (b) of the definition of 'primary production business' in subsection 995-1(1) of the ITAA 1997 includes as a primary production business a business of 'maintaining animals for the purpose of selling them or their bodily produce (including natural increase)'.

Salmon and trout are animals. Therefore, salmon and trout acquired for sale are considered to be trading stock both within the ordinary meaning of the term and as live stock for the purpose of section 70-10 of the ITAA 1997.

The taxpayer acquires from a hatchery salmon smolt and trout fingerlings. The fish are then transported to the taxpayer's sea farm where they are maintained until they are ready for harvest and sale.

Under subsection 70-45(1) of the ITAA 1997 the taxpayer must elect to value each item of trading stock on hand at the end of the income year at either:

· its cost; or

· its market selling value; or

· its replacement value.

Taxation Ruling IT 2350 recognises that the courts have established the following general propositions about how a taxpayer values manufactured trading stock at 'cost price' under subsection 31(1) of the Income Tax Assessment Act 1936 (ITAA 1936):

· 'cost price' is read simply to mean 'cost' (Fullagar J in Australasian Jam Co Pty Ltd v. Federal Commissioner of Taxation (1953) 88 CLR 23; (1953) 10 ATD 217; (1953) 5 AITR 566).

· 'cost' is directed to the expenditure needed to bring the article to the state in which it was when it became trading stock (Jenkinson J in Philip Morris Ltd v. Commissioner of Taxation (Cth) (1979) 79 ATC 4352; (1979) 10 ATR 44 ( Philip Morris Case )); and

· the absorption cost method is the correct method to value the 'cost' of manufactured trading stock (Jenkinson J in Philip Morris ).

Section 70-45 of the ITAA 1997, which replaces subsection 31(1) of the ITAA 1936, is compatible with the case law and rulings relating to subsection 31(1) of the ITAA 1936. Under paragraph 70-45(1)(a) of the ITAA 1997, trading stock is valued at 'cost' rather than 'cost price'.

The Commissioner accepts that the acquisition and production of the salmon and trout stock does not constitute manufacture. However, the same principles of valuing manufactured trading stock apply such that the absorption cost method is the appropriate method to use to include those costs sufficiently associated with the acquisition and ongoing maintenance of the stock.

On this basis, all costs of acquisition and production in bringing the salmon smolt and trout fingerlings to a saleable condition would need to be capitalised into the value of the trading stock on hand. However, in order to be consistent with generally accepted practice in relation to the rearing and maintenance of livestock, the ongoing production costs will be allowed as a deduction as and when they are incurred in the normal carrying on of an aquaculture business.

As such, 'cost' would only include those expenses incurred in relation to the acquisition of the salmon smolt and trout fingerlings.

Therefore, the 'cost' for determining the value of the trading stock on hand at the end of the income year under paragraph 70-45(1)(a) of the ITAA 1997 does not need to be calculated using the full absorption cost method for all expenses of acquisition and production.

Question 2

Summary

The expenses incurred in rearing and maintaining the fish until harvest and sale will be allowed as a deduction under section 8-1 of the ITAA 1997 as and when they are incurred in the normal carrying on of the aquaculture business.

Detailed reasoning

After acquisition of the salmon smolt and trout fingerlings, the taxpayer's business is to maintain the animals for the purpose of harvest and sale. That is, the business is limited to the rearing and maintenance of the fish.

In order to be consistent with accepted practice in relation to the rearing and maintenance of livestock generally, the ongoing production costs will be allowed as a deduction as and when they are incurred in the normal carrying on of the aquaculture business.

There are three keys features of tax accounting for trading stock in section 70-5 of the ITAA 1997. Paragraph 70-5(2)(a) of the ITAA 1997 provides for the first part of the second key feature as follows:

(2) Those outgoings and earnings are on revenue account, not capital account. As a result:

(a) the gross outgoings are usually deductible as general deductions under section 8-1 (when the trading stock becomes trading stock on hand);…

Expenses of production after the salmon and trout becomes trading stock on hand would be deductible as incurred.

Paragraph 8-1(1)(b) of the ITAA 1997 provides you can deduct from your assessable income any loss or outgoing to the extent that 'it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income'.

Therefore, the expenses incurred in rearing and maintaining the fish until harvest and sale will be allowed as a deduction under section 8-1 of the ITAA 1997 as and when they are incurred in the normal carrying on of the aquaculture business.

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