Case Q106

Members:
MB Hogan Ch
P Gerber M
GW Beck M

Tribunal:
No. 3 Board of Review

Decision date: 2 November 1983.

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M.B. Hogan (Chairman)

The only issue in this reference which concerns the year ended 30 June 1977, is whether a deduction is allowable under the provisions of Subdiv. BA of Div. 3 of Pt. III of the Act covering that year of income; the Commissioner contends that the materials on hand at the commencement of the year of income are not ``trading stock'' within the meaning of that term as used in sec. 6 and 82B(1) of the Act. The taxpayer is a partner in a group which at the relevant time were project home builders, whose modus operandi was to build houses of the group's own design on land owned by other people.

2. The group operated a sophisticated system whereby a substantial part of the house to be erected was assembled (to use a neutral word) in a workshop/warehouse operated by the group. Broadly, the system, in the words of the public accountant who prepared the income tax returns of the company and the group (a partnership) and who was the principal witness on behalf of the taxpayer, was to the following effect:

``When they start the house they prepare the site and level it and put the concrete footings down, put bricks up, fill the centre, put the drains in and then pour a slab. All these costs and all these materials are all directed straight to work in progress and when the slab is down then the frame is delivered with all the bits and pieces. The subcontractor is responsible

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for all these bits and pieces. He hangs onto them until he puts them into the site. It is all by subcontract. There is no employee labour involved out on the sites at all.''

His reference to ``the frame... with all the bits and pieces'' which the subcontractor ``hangs onto... until he puts them into the site'' was to a shipment from the workshop/warehouse produced from a computer printout prepared from feeding the selected design details into the computer which the witness had earlier described in these terms -

``... it (the printout) goes out of the office out to the workshop floor. Then they bundle up everything onto the conveyor units and put the work order in process to manufacture the frames. They do not carry advanced stocks of frames or roof trusses or kitchens; everything is made up for the particular job, so they do not go out and just pick out a kitchen from the storeroom, there are no kitchens made up in advance, everything is just straight off the computer sheet and they make up a kitchen and they make up a set of roof trusses. As soon as it is made up it is loaded up onto the truck.''

The second and final shipment to the site is what the witness referred to as P.C. items when he described the accumulation of items included in the balance sheet figure for the end of the previous year of income, as including -

``... some P.C. items; there were five stoves there and an extra cook top. There were baths, mirrors, bathroom cabinets, towel rails, shower screens, glass, timber for the windows, louvre doors, dressed timbers for the fixings for quad and two by one architraves, sections to making up the shower screens, parts for the kitchens, the kitchen tops, sink tops, breakfast bars; all those sort of things; tilter doors, there were 16 tilter doors to go on garages, all the tiler's fittings of soap holders and vents and grates, hot water units; 25 hot water units, laundry tubs, there were 13 laundry tubs, plus doors, glass doors.''

All those materials had been delivered to the sites before the end of the year of income but had not, in the accounting system, been appropriated to particular contracts in progress. There is no evidence, however, that the material had not at the end of the year of income been either wholly or substantially installed in premises being erected on sites belonging to some person other than the company.

3. The deduction claimed by the partnership, of which the taxpayer was a member, embraces materials falling under three headings. (I use the word ``materials'' purely as a neutral word - not intended to reflect any pejorative view of the claims of either the taxpayer or the Commissioner):

• (i) Materials on hand in factory
• These consist of the stock of manufactured or processed materials held in the group's factory premises, being materials held as a sort of warehouse stock for jobs, largely building materials, though it may have included some minor P.C. items. The value was fixed by physical stocktake at the groups warehouse/factory.
• (ii) Materials delivered to sites but not at balance date allocated in the accounting system to completed dwellings
• These consist of materials and assembled wall frames and roof-trusses, delivered to sites ex the group's workshop/warehouse, the materials and assembled frames and trusses providing the whole of the internal fittings for the brick shell of brick veneer houses, other than P.C. items.
• (iii) P.C. items, either on hand in the warehouse or on site (and there fixed or unfixed) but not at balance date allocated by the accounting system to completed dwellings.

In respect of the total of all these items as at 1 July 1977, totalling in all $683, 718 as at that date, the taxpayer sought a deduction for Trading Stock Valuation Adjustment under Subdiv. BA of Div. 3 of Pt. III of the Act in the calculation of its share of ``net income'' from the partnership operation carried on in the group's name for the year of income ended on 30 June 1977. The disallowance of this claim by the Commissioner has led to this reference to the Board.

4. In brief, the taxpayer claims that all the items comprised in the heading in the Profit

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and Loss Account for that year, ``Stock on Uncompleted Jobs 1.7.76'', constitutes trading stock for purposes of Subdiv. BA and should be so treated in determining the net income of the partnership. Section 82B(1) contains a definition of ``trading stock'' expressed to operate -

``... without extending or limiting by implication the meaning of that expression for any purpose of this Act other than the application of this Subdivision...''

The exclusions included in that definition do not in my view affect the circumstances of this reference. Accordingly, in my view, the relevant definition of ``trading stock'' for purposes of deciding this reference is that contained in sec. 6(1) of the Act, where it is stated that -

``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;
• ...''

5. In his fifth edition of the Manual of the Law of Income Tax In Australia, Professor Ryan Q.C. indicates that ``the definition is not exhaustive but rather extends the ordinary sense of the term'' (at p. 99). So much emerges fairly clearly from the decisions of Stephen, Mason and Jacobs JJ. ( Murphy J. agreeing with Mason and Jacobs JJ.) in
F.C. of T. v. St. Hubert's Island Pty. Ltd. 78 ATC 4104 , but little emerges from those individual decisions to give much indication of the ordinary meaning of the words ``trading stock'' except perhaps the observation by Mason J. at p. 4111 in the following terms -

``No doubt it [the definition] extends the ordinary meaning by its reference to `live stock' in the manner explained in
F.C. of T. v. Wade (1951) 9 A.T.D. 337 ; (1951) 84 A.L.R. 105 , but in other respects it may be doubted whether the definition does more than express inadequately what one might have gathered from the ordinary meaning of the term.''

Hannan, in his Principles of Income Taxation in the chapter dealing with Trading Stock and Raw Material at p. 463 and subheaded ``(A) Nature of Trading Stock'' gives practical expression to the parameters of the extended meaning of the term ``trading stock'' as adopted for purposes of Commonwealth Income Tax, in the following terms -

``In this chapter the term `trading stock' is used to describe not only the goods which a retailer sells in the form in which they have been purchased by him (e.g. tins of jam and cakes of soap) but also materials which are transformed into new articles for sale (e.g. a tailor's lengths of cloth, a baker's stocks of flour, the drugs used by a chemist in making up prescriptions).''

The statement appears to me to be too limited if it is intended to be descriptive of the full range of the extended meaning; though properly emphasising that the stock must be acquired or brought into existence for purposes of sale (or exchange), it ignores the reference to ``purposes of manufacture''. It seems clear that stock produced or manufactured or acquired for purposes of manufacture must also be classed as ``trading stock'' for purposes of the Act, even though the proximate purpose of their production, manufacture or acquisition may not have been sale or exchange. To that extent, at least, the concept developed by Hannan needs to be enlarged.

6. Using this enlarged concept, the question to be decided is whether any of the materials, etc., incorporated in the three headings summarised in para. 3 constitute ``trading stock'' for purposes of the Act. In a recent case
Hewitt & Ors. v. Court & Anor. (now reported at (1983) 57 A.L.J.R. 211 ), all five Justices of the High Court decided (to quote the A.L.J.R. headnote) that:

``The contract for supply of the house was a contract for provision of work and materials and not a contract for the sale of goods; in this respect it was not to be distinguished from a contract to construct a house on land as its permanent site.''

A copy of a document described as ``Specification And Contract'' under which all homes were erected, recites in the first paragraph under the heading ``Specification'' -

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``THIS IS THE SPECIFICATION of works to be done and materials to be used in and about the construction of a BRICK VENEER dwelling known as a `X... HOME', referred to in the articles of agreement and conditions of contract.''

(My emphasis.)

It is quite plain in the circumstances that the contract is not a contract for sale of goods and that, therefore, the materials in respect of which the claim is advanced, cannot be said to have been acquired, produced or manufactured for purposes of sale.

7. Nor can the materials in the workshop/warehouse be said to have been acquired for purposes of manufacture. If I have understood that provision of the definition correctly, it is intended to bring into account as trading stock for purposes of the Act, raw materials acquired or produced not with an immediate purpose of sale, but for purposes of manufacture, before being sold or exchanged; otherwise, it could be argued that those unprocessed (or partly processed) raw materials could not be included as trading stock as they would not have been acquired for purposes of sale or exchange. Here, however, the raw materials in the workshop/warehouse have not been acquired for any purposes other than the purpose of erecting houses on the land of other people. One simply does not manufacture a house in those circumstances. If the group were producing mobile homes for sale from the workshop/warehouse, it may be that it could be regarded as acquiring materials for purposes of manufacture; in the light of the decision in Hewitt & Ors. (supra), it would not be a purpose of manufacture where the product was for installation on property belonging to another. A contract for installation is a contract for the provision of work, labour and materials, and that is not, on my understanding of the term, a process of manufacture. Accordingly, I find that the goods in the workshop/warehouse do not constitute trading stock.

8. There is of course an additional difficulty in relation to those materials and assemblies delivered to sites in that once they have become fixtures, they would become the property of the landowner. Here, there is nothing in the evidence to indicate what, if any, of the materials and assemblies delivered have not become fixtures. The same situation arises in relation to P.C. items.

9. I would confirm the Commissioner's assessment in this reference.