Edited version of your written advice

Authorisation Number: 1051389385329

Date of advice: 25 June 2018

Ruling

Subject: Disposal of trading stock

Unless otherwise noted, all statutory references below are to the Income Tax Assessment Act 1936 (“ITAA 1936”) or the Income Tax Assessment Act 1997 (“ITAA 1997”), as appropriate.

Question 1:

Is the product trading stock for income tax purposes, as defined in section 70-10 of the ITAA 1997, while held by Organisation A?

Answer:

Yes

Question 2:

For the purpose of section 70-90 of the ITAA 1997, should the transfer of the product back to Authority A be regarded as a disposal of trading stock within the ordinary course of business?

Answer:

Yes

Question 3A:

If the answer to Question 2 is “Yes”, should the amount on which Organisation A is assessed for income tax purposes, as a result of the transfer of the product, be equal to the amount paid as reimbursement for the product as determined by Authority A?

Answer:

Yes

Question 3B:

If the answer to Question 2 is “No”, will the amount on which Organisation A is assessed for income tax purposes, as a result of the transfer of the product, be equal to:

(a) any amount paid as reimbursement for the product as determined by Authority A?

Answer:

Not applicable

(b) the market value of the product?

Answer:

Not applicable

Question 4:

If the answer to question 3B(b) is “Yes”, does the Commissioner accept the current “as is” value per the valuation report as a proxy for market value? Consequently, the tax effect for Organisation A of the transfer of the product, is as follows:

Assessable income pursuant to section 70-90 ITAA 1997: $XX.XX (A)

Deduction pursuant to section 70-35 ITAA 1997: $YY.YY (B)

Net taxable gain realised on the disposal of the product: $ZZ.ZZ (A-B)

Answer:

Not applicable

This ruling applies for the following period

1 July 20XX to 30 June 20XX

The Scheme commences on

1 July 20XX

RELEVANT FACTS AND CIRCUMSTANCES

Background

1. Organisation A was formed under an Act.

2. Organisation A is a body corporate pursuant to the Act.

3. Organisation A operates a self-funded business model and has shareholder return obligations.

4. Organisation A is subject to federal income tax.

Organisation A’s role, objects and activities in general

5. Organisation A’s main function is to provide services.

6. Organisation A has a number of additional functions.

7. Organisation A generates income (and working capital) from the execution of its functions, which internally funds its activities.

8. Organisation A has contractual agreements with Authority A for the provision of services.

9. In addition to the above, Organisation A makes a payment of dividends to Authority A based on a % of net profit after tax.

10. As per Organisation A’s corporate plan, Organisation A has other objectives in addition to providing services.

11. Since being established, Organisation A has undertaken many transactions related to product acquisition, development or disposals with a number of entities.

Vesting of the product in Organisation A – XX XX 20XX

12. Ownership of the product was vested in Organisation A from Authority A on XX XX 20XX.

13. The product was transferred to Organisation A to support its primary function of providing services.

14. Organisation A paid Authority A an amount of $XX.XX for the transfer of the product, which was established as the fair market value at the date of transfer. This amount paid by Organisation A to Authority A is part of the cost base in the product for the purpose of section 70-35 of the ITAA 1997.

15. The total GST-exclusive cost incurred by Organisation A with regard to the product amounted to $XX.XX, comprising:

a. $XX.XX consideration for the product;

b. $XX.XX stamp duty; and

c. $XX.XX transaction costs (i.e. legal fees relating to the transfer of the product).

16. Additionally, Organisation A incurred additional costs in relation to the holding of the product from the date of acquisition to the date of the transfer back to the Authority A, increasing the “cost” of the product for the purpose of section 70-35 of the ITAA 1997 to $XX.XX. This is broken down as below:

Description of costs	Amount ($)
Acquisition costs	XX.XX
Professional fees on acquisition	XX.XX
Duties on acquisition	XX.XX
Development planning costs	XX.XX
Travel costs	XX.XX
Staff overheads	XX.XX
Adjusted cost base of the product	XX.XX

17. Organisation A also incurred routine annual costs relating to the product amounting to $XX.XX. These amounts were claimed as annual tax deductions in the year incurred pursuant to section 8-1 of the ITAA 1997. These costs have not been capitalised into the cost base of the product for income tax purposes.

Additional section 8-1 deductions	Amount ($)
Professional fees on acquisition	XX.XX
Product holding costs	XX.XX
Travel costs	XX.XX
Staff overheads	XX.XX
Valuation costs	XX.XX
Legal, tax and accounting advice	XX.XX
Total	XX.XX

Product held as trading stock by Organisation A

18. Organisation A expected that the product would be re-worked and thus able to be developed. However, any application for re-working of the product, and development approval, would have required significant additional costs and time investment by Organisation A.

19. As such, Organisation A’s intention in respect of the product was to develop and construct assets for sale to the public.

20. Consequently, the product was classified as inventory in Organisation A’s financial management information system.

Disposal of the product back to the Authority A – XX XX 20XX

21. On XX XX 20XX, Authority A wrote to Organisation A, confirming that it would need to re-acquire the product site from Organisation A.

22. On XX XX 20XX, Authority A directed Organisation A to transfer the product to Authority A, pursuant to the Act (the “Direction”).

23. Accordingly, on XX XX 20XX, Organisation A completed its requirements to facilitate transfer of the product to Authority A.

24. Negotiations between Organisation A and Authority A in respect of the amount to be reimbursed for the cost of Organisation A complying with the Direction are still ongoing.

Information provided

25. You have provided a number of documents, including:

a. Private Binding Ruling (‘PBR’) Application, dated XX XX 20XX

b. Appendix A to the PBR Application – list of product transactions between Organisation A and entities

c. Appendix B to the PBR Application – list of transactions between Organisation A and other entities

d. Appendix C to the PBR Application – Organisation A’s 20XX financial statements

e. Appendix D to the PBR Application – letter from Authority A to Organisation A, dated XX XX 20XX

f. Appendix E to the PBR Application – letter from Organisation A to Authority A, dated XX XX 20XX

g. Appendix F to the PBR Application – letter from Organisation A to Authority A, dated XX XX 20XX, including attachment

h. Appendix G to the PBR Application – letter from Organisation A to Authority A, dated XX XX 20XX, including attachment

i. Appendix H to the PBR Application – Final Valuation Report, dated XX XX 20XX (the “Valuation Report”)

j. Appendix I to the PBR Application – Retrospective Market Value Assessment, dated XX XX 20XX (the “retrospective market value assessment report”)

k. Appendix J to the PBR Application – declaration pursuant to section 388-65 of Schedule 1 of the Taxation Administration Act 1953

26. We have referred to the relevant information within these documents in applying the relevant tests to your circumstances.

Assumption(s)

Not applicable.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-1

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 70-35

Income Tax Assessment Act 1997 Section 70-80

Income Tax Assessment Act 1997 Section 70-90

Further issues for you to consider

Not applicable.

REASONS FOR DECISION

QUESTION 1:

SUMMARY

The product is trading stock for income tax purposes, as defined in section 70-10 of the ITAA 1997, while held by Organisation A.

DETAILED REASONING

Definition of Trading Stock

27. “Trading stock” is defined in section 70-10 of the ITAA 1997 as follows:

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

(b) livestock.”

28. The Explanatory Memorandum to the Bill that originally introduced the trading stock provisions stated that:

“Trading stock is the things (e.g. goods, product, intangible property) in which a business trades. Trading stock includes the raw materials and partially finished products that a manufacturer will convert into finished goods for trading.”

29. Accordingly, where an asset is held for the purpose of manufacture, sale or exchange in the ordinary course of business, the asset will be classified as trading stock.

30. To determine whether the product can be classified as trading stock while held by Organisation A, it is first necessary to analyse whether Organisation A is carrying on a business and, assuming that it is carrying on a business, the nature of that business.

Organisation A is a company for the purposes of the ITAA

31. For the purpose of the ITAA 1997, section 995 defines “company” broadly as a body corporate or any other unincorporated body of persons, not including a partnership or a non-equity joint venture. “Body corporate” is not defined in the ITAA 1997.

32. Organisation A is a body corporate.

33. Organisation A is liable to pay income tax under the ITAA 1997 in relation to its assessable income.

34. Accordingly, Organisation A should be treated as a company for the purpose of determining its obligations under the ITAA 1997.

Organisation A is carrying on a business

35. Whether a taxpayer is carrying on a business is a question of fact and degree, and is ultimately determined by a weighing up of the particular facts and circumstances surrounding the relevant taxpayer. The main indicators of carrying on a business are outlined and discussed in Taxation Ruling TR 97/11: am I carrying on a business of primary production? Although it focuses on primary production businesses the principles applied in this Ruling can be applied to determine whether any type of business is being carried on. The determination is arrived at as a result of the process of weighing all relevant factors with no single test being determinative.

36. Although no single factor will be determinative, the case law suggests, and the Commissioner supports the view, that key factors in determining whether a business is being carried on include:

a. whether the activity has a significant commercial purpose or character, and a purpose of profit as well as a prospect of profit from the activity;

b. whether the activity is planned, organised and carried on in a business-like manner such that it is directed at making a profit, rather than a hobby, a form of recreation or a sporting activity;

c. whether there is repetition and regularity of the activity;

d. the size, scale and permanency of the activity.

37. These indicators must be considered in combination, and should be interpreted for the purpose of understanding the “large or general impression” of the relevant taxpayer. The Commissioner refers to the existence of a “commercial flavour” as the relevant issue to be resolved.

(a) Commercial intent and purpose of generating profit

38. The primary role of Organisation A is the provision of services.

39. Additionally, Organisation A has a further obligation to add to shareholder value by making commercial returns and paying commercial dividends to Authority A.

40. Given that Organisation A funds its operations through the receipt of fees and charges from performing certain other roles, rather than direct funding from Authority A, the achievement of such positive financial results underpins Organisation A’s ongoing viability.

41. Accordingly, Organisation A is required to operate on a commercially sustainable, i.e. profitable, basis.

(b) Activity is planned, organised and carried on in a business-like manner, rather than a hobby or recreational in nature

42. The activities of Organisation A are governed in accordance with the resolutions of its board of directors. The Board of Directors is responsible for the proper and efficient performance of Organisation A’s functions, subject to any directions given by Authority A.

43. The Managing Director is responsible for conducting the operational affairs of Organisation A and any policies determined by, and directions given by, the Board. The Managing Director oversees Organisation A’s strategic direction, organisational structure, staff, performance and relationships with key stakeholders.

44. The Managing Director is supported by the Senior Executive Group, which assists to ensure Organisation A fulfils its role. It provides leadership, guides performance, implements and delivers against the Corporate Plan and ensures accountability of Organisation A’s activities. In particular, the Chief Financial Officer is responsible for fiscal management, investment management and funding strategies, and strategic planning and valuation services.

45. In addition, staff in Organisation A’s head office are responsible for overseeing strategic development, operational programs, corporate governance and corporate support (e.g. information technology, finance, human resources, marketing and communications).

46. The division of roles and responsibilities in the manner discussed above ensures that Organisation A’s activities and operations are undertaken in a business-like manner.

(c) Repetition and regularity of activities

47. Based on evidence provided in Appendices A and B it is clear that transactions in product between Organisation A and entities, as well as other entities, are a recurring element of Organisation A’s activities.

48. Organisation A has engaged in numerous transactions involving the acquisition of products since its establishment.

49. Additionally, Organisation A has also undertaken significant product development activities in order to provide services and, ultimately, to generate proceeds upon disposal.

(d) Size, scale and permanency of activities

50. The size and scale of Organisation A’s operations can be inferred with reference to the transactions in product undertaken by Organisation A since its establishment.

51. Ultimately since Organisation A has conducted a wide-ranging enterprise in relation to the acquisition, development, management and sale of product, the agency is being conducted in a business-like manner.

52. The weighing of all the relevant factors described in TR 97/11 together, as discussed above, indicate that Organisation A is carrying on a business.

The product should be regarded as being held by Organisation A for the purpose of manufacture, sale or exchange in the ordinary course of its business

53. The ordinary course of Organisation A’s business involves the acquisition of product for the purpose of development, and ultimate sale of surplus developed and non-developed products for profit.

54. It is clear that Organisation A “acquired” and “held [the product] for purposes of … sale or exchange in the ordinary course of business”.

55. Accordingly, the product should be treated as the trading stock of Organisation A.

QUESTION 2:

SUMMARY

For the purpose of section 70-90 of the ITAA 1997, the transfer of the product back to Authority A should be regarded as a disposal of trading stock within the ordinary course of business.

DETAILED REASONING

56. Section 70-90 of the ITAA 1997 states:

(1) 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…

(2) Any amount that you actually receive for the disposal is not included in your assessable income (nor is it exempt income).

57. As stated by Dr G W Beck (Member) in Case R85 84 ATC 569:

“whether one regards transactions as being in the ordinary course of business depends on one’s assessment of:

(a) the precise nature of the business that is being carried on;

(b) the character of transactions one could reasonably expect to be called for in the course of going about that business; and

(c) the character of the disputed transaction.

Transfer of the product

58. The product was originally transferred to Organisation A to support its primary function of providing services. As part of that arrangement there was an expectation that the product would be re-worked and subsequently developed by Organisation A to provide services as well as for re-sale to public for profit.

59. On XX XX 20XX, Authority A wrote to Organisation A, confirming that it would need to re-acquire the product from Organisation A.

60. Pursuant to the Direction, dated XX XX 20XX, Organisation A was directed to transfer the product to Authority A with effect from XX XX 20XX.

61. Organisation A completed its requirements to facilitate transfer of the product to Authority A on XX XX 20XX, which is the date on which the product was effectively transferred to Authority A.

Nature of Organisation A’s business and the transactions reasonably expected to be undertaken

62. As outlined above, Organisation A is created by and carried on pursuant to the provisions of the Act. The Act determines the functions, powers, structure, delegations and conduct of the Organisation A, its Board of Directors and Authority A with respect to Organisation A’s operations.

63. Accordingly, the ordinary business of Organisation A, as relating to the purchase, development and disposal of product for the purpose of providing services and generating profits, is conducted in accordance with the Act. Organisation A is required to operate on a self-funded and profitable basis with the further obligation of adding to shareholder value by paying commercial dividends to Authority A.

64. Moreover, Organisation A’s powers as set out in the Act are qualified by various powers of Authority A to give directions, with which Organisation A must comply. Accordingly compliance by Organisation A with the directions of Authority A in the course of its ordinary business of acquiring, disposing and managing product is a part of the ordinary business of Organisation A.

65. The nature of Organisation A’s business and its established business practices are such that the disposal of the product by Organisation A to Authority A pursuant to a Direction, constitutes an example of a transaction undertaken by Organisation A in the ordinary course of its business and is undoubtedly the type of transaction that Organisation A could reasonably be expected to participate in. Specifically, the Direction given by Authority A to Organisation A to transfer the product to Authority A with effect from XX XX 20XX was provided on XX XX 20XX and complied with by Organisation A as part of its obligations. This transfer of the product was therefore in the ordinary course of business.

QUESTION 3A:

SUMMARY

The amount on which Organisation A is assessed for income tax purposes, as a result of the transfer of the product to Authority A, is to be equal to the amount paid as reimbursement for the product as determined by Authority A.

DETAILED REASONING

66. To determine the taxable income of a taxpayer for an income year, it is necessary to calculate their assessable income for the year, pursuant to section 4-15(1) of the ITAA 1997. Section 6-1 of the ITAA 1997 provides that “ordinary income” is included in a taxpayer’s assessable income.

67. Section 6-5(1) of the ITAA 1997 defines “ordinary income” as “income according to ordinary concepts”. The legislation does not provide specific guidance on the meaning of income according to ordinary concepts. However, a substantial body of case law exists which identifies likely characteristics.

68. This reference to “income according to ordinary concepts” in section 6-5(1) can be traced to the judgment of Jordan J in Scott v Commissioner of Taxation (NSW) (1935) 3 ATD 142, concerning the Income Tax Management Act 1928. His Honour stated (at pp 144-145):

“The word ‘Income’ is not a term of art, and what forms of receipts are comprehended within it, and what principles are to be applied to ascertain how much of those receipts ought to be treated as income, must be determined in accordance with the ordinary concepts and usages of mankind…”

69. In Federal Commissioner of Taxation v Cooke & Sherden 80 ATC 4140, Brennan, Deane and Toohey JJ stated (at [4147-4148]):

“Whether a receipt is to be treated as income or not is determined according to ‘the ordinary concepts and usages of mankind’… except where statute sweeps in particular receipts or amounts which would not ordinarily be taken to fall within the concept.”

70. It is broadly accepted that the disposal of trading stock in the ordinary course of business is treated as ordinary income. As such, it constitutes assessable income under section 6-5(1).

71. This is further supported by section 70-80(1) of the ITAA 1997, which states the following:

When you dispose of an item of your trading stock in the ordinary course of business, what you get for it is included in your assessable income (under section 6-5) as ordinary income.

72. Organisation A is entitled to be reimbursed by an amount, determined by Authority A, to be the amount of financial detriment suffered as a result of complying with the Direction in respect of the transfer of the product.

73. As at the date of this Application, Authority A has notified Organisation A that they have determined that the amount of $XX.XX reflects the costs Organisation A has incurred as a result of complying with the Direction in respect of the transfer of the product. However, a final amount is yet to be determined.

74. As the reimbursement to be paid by Authority A to Organisation A should be treated as a payment for trading stock sold in the ordinary course of Organisation A’s business (as discussed in Question 2 above), the amount to be received by Organisation A in respect of the transfer of the product site should be treated as income according to ordinary concepts and included in Organisation A’s assessable income.

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