Case Q106

Judges: MB Hogan Ch
P Gerber M

GW Beck M

Court:
No. 3 Board of Review

Judgment date: 2 November 1983.

---

Dr. G.W. Beck (Member)

This corporate taxpayer is one of five companies trading in partnership and sharing profits and losses equally. The partnership engages in project home building and the partnership's public accountant, who represented the taxpayer at the hearing, described the business modus operandi of what he referred to as the ``group'' as follows:

``They build houses on other people's land. They sell their own particular brand of design of house as a complete package on the owner's land. Contracts are signed after a quotation is given and council approval is given and then they commence construction. They have their own warehouse and factory units where they

---

ATC 552

buy all the materials in and have them delivered to this factory or to the warehouse part of it and there they manufacture all their roof trusses, their roof frames, their kitchens, the windows, all those types of things, and they are all delivered out to the jobs as they are required.''

This description was not totally correct for it turned out that a large quantity of materials, especially things such as bricks and tiles, went direct to job sites from the suppliers. In the partnership tax return for the 1977 year a stock valuation adjustment of $34,185 was claimed and when this deduction was not allowed the taxpayer's one-fifth share in the partnership net income was increased by $6,837. It is this increase that is before the Board and, put succinctly, the question at issue is whether the partnership had trading stock on hand at 1 July 1976 totalling $683,719 eligible for trading stock valuation adjustment in accordance with Subdiv. BA of Div. 3 of Pt. III of the Act. The Commissioner did not dispute that the claimed deduction of $34,185 was correctly calculated as prescribed by sec. 82D(1) or that items with a cost of $683,719 were held by the partnership at 1 July 1976. However, he did dispute that the items were trading stock as defined in sec. 6 of the Act and modified by sec. 82B(1).

2. The accountant representing the taxpayer had been associated with the partnership ever since the business began - a period of about 20 years - and he was familiar with the day-to-day operations, the accounting system and the computer hardware and software by which all transactions were recorded. Although there was initial doubt whether he could provide the evidence necessary for the taxpayer's case, it became clear that he had first hand and detailed knowledge of the partnership's affairs and, in fact, he was probably the most appropriate witness to give the Board an analysis of the figures and to specify what types of items they represented.

3. The accountant explained that each job was carefully scheduled to conform to a predetermined pattern of construction and, to the greatest possible extent, components were put together in the factory and despatched in assembled form to the job site where they were ``built-in'', i.e. made a fixed part of the house, with minimum delay. As I understood his evidence at any point of time - the relevant point of time here was the close of business on 30 June 1976 - there were, therefore, items (for want of a better word) spread throughout the system as follows:

• (a) building raw materials of all types, e.g. timber, wall board, nails and so on, held in the warehouse and factory;
• (b) P.C. items, e.g. baths, vanity basins, light fittings and so on, and doors and similar items also held in the warehouse and factory;
• (c) partly constructed trusses, wall frames, kitchen units and similar items in process in the factory;
• (d) completed components of the type in (c) in the factory and not yet despatched to house sites;
• (e) completed components of the type in (c) delivered to house sites but not built-in to the houses; and finally,
• (f) houses in process at various stages of completion.

4. Because sec. 82B(1) specifically says that for purposes of Subdiv. BA trading stock ``does not include land or an interest in land'', and because the houses in process had become inseparable from the land, the partnership did not claim a stock valuation adjustment deduction on houses in progress appearing in the partnership balance sheet at $922,760. In the words of the accountant the amount of $683,719 shown in the profit and loss account and balance sheet as ``Stock on Uncompleted Jobs 1.7.76'' was made up of the following:

         $

      256,580  
"
material in the factory at the

                  end of June
"


      347,469  
"
completed trusses, etc.,

                  structural things like that
"


       79,196  
"
P.C. items and various fixing

                  out materials for kitchens
"


      -------

      683,245

      -------
      

The discrepancy of $474 was not explained but it is of no consequence. In answer to a question as to the location of the completed trusses, he said:

---

ATC 553

``There would be probably three or four or so in the yard, but that would be all. There were 68 of those roof truss sets - about three or four would be in the yard, the rest of them would be out on site. They were building eight houses a week at that stage, so there would be about three or four of those on the ground, the rest of them were all at stages of erection or completion.''

It subsequently emerged that as well as ``trusses, etc.,'' and ``structural things like that'' other items were included in the figure of $347,469. The accountant elaborated:

``the materials for the concrete slab, the plastic sheeting, the chairs to go in the slab, the oxide to go in the concrete, all the particular fixing nails and things to go onto the slabs with the frame, windows; all those first items, they all go out to the job and they are included in that item $347,469.''

He agreed there was no way of reliably estimating what part of the total amount of $347,469 resulted from items that had become part of houses in process and what part resulted from items that were ``un-built-in'' and located on site or in the factory. In view of this inability to separate a portion of the total amount that was clearly ineligible for the stock valuation adjustment from a portion that might be eligible I will consider that amount no further. No deduction is possible under such circumstances.

5. The $79,196 represented P.C. items and some other materials that had all gone to job sites. There remained in the warehouse a stock of P.C. items and the cost of those items was included in the figure $256,580. No information could be provided regarding the part, if any, of the $79,196 which was represented by P.C. items and other materials as yet, i.e. at 30 June 1976, not installed in the houses in process. For the same reasons that no deduction was allowable in respect of the $347,469 of ``trusses and structural things'', no deduction is allowable in respect of the $79,196 made up of P.C. items and materials on job sites.

6. That leaves only what I think can be described as building raw materials, doors, windows, P.C. items and so on, all of which items were at 1 July 1976 held in the partnership's warehouse and factory and which would eventually be formed into parts for yet-to-be-started houses or were yet to be despatched to and installed in houses. As has already been indicated, items costing $256,580 are included in this category and I can see no reason for denying a deduction in respect of the stock valuation adjustment based on this amount.

7. The definition of trading stock in sec. 6 so far as it is relevant for this case indicates that ``trading stock includes anything... acquired or purchased for purposes of manufacture...'' Consumable aids to manufacturing have been held to be not trading stock ( Case 115,
(1951) 1 T.B.R.D. ) but the things which, on the evidence as I understand it, go to make up the amount of $256,580 are not aids to manufacture but rather are components of the completed items from the manufacture of which the partnership derives its assessable income, i.e. houses. So far as I can ascertain, none of the extant cases cast any doubt on my classification of these items as trading stock and none of the qualifications in sec. 82B(1) applies. Because one usually tends to think of the output of manufacturing as appearing as goods for sale in retail outlets it does not follow that other things are not manufactured. Are ships and aeroplanes not manufactured? Windeyer J. in
M.P. Metals Pty. Ltd. v. F.C. of T. (1967) 14 A.T.D. 407 ; (1968) 117 C.L.R. 631 was concerned with determining whether certain plant was manufacturing plant and he had, therefore, to determine whether the plant operations resulted in manufactured goods. He developed a conviction ``that the expression `manufactured goods' is not a technical term capable of a precise definition universally applicable'' (p. 639). I find myself, respectfully, possessed of the same conviction, and I have no difficulty in accepting that a refrigerator, a caravan and a house are all ``manufactured'' in essentially the same way; only the scale is different. The fact that the caravan and the house would not normally be described as ``goods'' does not seem to have any relevance for a determination as to whether or not they are manufactured. The Commissioner's case seemed to find some strength in the view that the partnership did not trade in houses, but simply derived its income from providing building services on land owned by others.

---

ATC 554

Regardless of what the partnership traded in or sold, the irrefutable evidence was that it derived income by constructing houses for which it bought in all the necessary component parts and employed labour to work on and with those parts to achieve a completed house. I have concluded that such activity is ``manufacturing'' and that is what is called for by the definition in sec. 6.

8. I would allow the partnership a deduction calculated in accordance with sec. 82AD(1) of an amount in respect of stock valuation adjustment on $256,580 of trading stock on hand at the commencement of 1977 tax year. In consequence, the taxpayer's assessed interest in the net income of the said partnership is reduced by an amount equal to one-fifth of that deduction and the taxpayer's taxable income is reduced accordingly by the same amount.

Claim allowed in part