Edited version of private ruling

Authorisation Number: 1011747705827

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Ruling

Subject: Trading Stock - aquaculture - valuation method - salmon and trout

Question 1

Is the 'fry' stage in the life cycle of the trading stock (salmon and trout) the point when expenses cease to be absorbed into the 'cost' of the trading stock?

Answer

Yes

Question 2

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 all expenses of acquisition and production up until the 'fry' stage in the life cycle?

Answer

Yes

Question 3

Will the expenses of production of the taxpayer incurred after the 'fry' stage in the life cycle, be deductible under section 8-1 of the ITAA 1997?

Answer

Yes, provided these expenses have been incurred in gaining or producing assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income, and are not expenses to which subsection 8-1(2) of the ITAA 1997 applies, expenses of the taxpayer incurred after the 'fry' stage of production will be deductible under section 8-1 of the ITAA 1997.

This ruling applies for the following periods:

Year ended 30 June 2010

Year ending 30 June 2011

Year ending 30 June 2012

Year ending 30 June 2013

Year ending 30 June 2014

The scheme commences on:

1 July 2009

Relevant facts and circumstances

The taxpayer is a company carrying on an aquaculture business.

The taxpayer operates both a land-based hatchery and a sea farm at separate locations.

Hatchery operations

The fish hatchery produces salmon smolt and trout fingerlings (small or immature fish).

The hatchery operations consist of the following:

A stock of cultured salmon and trout are grown and kept on site to produce eggs and milt (sperm)

The mixture of milt and eggs extracted from the salmon and trout is then subject to a number of artificial processes in order for the eggs to be fertilised

Fertilised eggs are incubated and then left to hatch, approximately 60 days after these artificial processes are completed

After hatching, salmon and trout pass through the Alevin, Fry and Parr life stages in fresh water

The life cycle of a wild salmon is as follows (Note: This can also be used to demonstrate the life cycle of a trout which has a similar life cycle):

Eggs - hatch in about 3 months

Alevin - feeds off yolk-sac for several weeks

Fry - 5 to 10 weeks old and swimming

Parr - several months old, develops 'finger' markings

Salmon Smolt (or Trout Fingerlings) - from 1 to 3 years old, will group and head out to sea

Adult - spends 1 to 8 years at sea

Spawning Adult - spawn and die within 2 weeks.

The salmon and trout stay in the hatchery (indoors) and tanks and ponds (outdoors) until they reach a size/age where they can survive in a marine (salt water) environment

Smolt/fingerlings are then transported to the taxpayer's sea farm.

Survival rates for salmon and trout in the hatchery were provided by the taxpayer:

From the rates provided it is calculated that the taxpayer allows less than 50% of green eggs to become transferrable fish to sea site.

Fish that are hand graded before transporting to the sea site are discarded or provided at no cost for either wild release or for research.

The taxpayer currently sells a percentage of its smolt to another unrelated fish farm. The smolt are sold to the fish farm at around the age of 10 to 14 months. The remaining smolt are retained for grow out and ultimate sale.

100% of fingerlings are retained for grow out until ultimate sale.

The taxpayer does not generally buy any production stock as part of its normal operations. Production stock would only be purchased in the rare circumstances of an unexpected loss at the Hatchery, in order to recover numbers. If this were to occur it could be at any stage of the lifecycle and would be dependent on the availability of such stock around the industry.

Sea farm operations

The smolt/fingerlings are transferred to the taxpayer's sea farm.

The sea farm operations consist of the following:

· The smolt and fingerlings are placed into sea cages

· The smolt and fingerlings are merely fed and held to grow out, up until they reach up to 18 months old

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

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 subsection 31(1)

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 paragraph 70-45(1)(a)

Income Tax Assessment Act 1997 subsection 70-55(1)

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Question 1

Summary

The Commissioner accepts that it is at the fry stage of the salmon and trout life cycle that expenses cease to be absorbed in to the 'cost' of the trading stock.

Detailed reasoning

Section 70-10 of the ITAA 1997 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.

* denotes a term defined in section 995-1 of the ITAA 1997.

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 produced 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 produces salmon and trout for sale, the process beginning at its hatchery and finishing at its sea farm.

The taxpayer has provided the life cycle of a wild salmon, which can also be used to demonstrate the life cycle of trout which has a similar growth cycle.

The life cycle of a wild salmon is as follows:

Eggs - hatch in about 3 months

Alevin - feeds off yolk-sac for several weeks

Fry - 5 to 10 weeks old and swimming

Parr - several months old, develops 'finger' markings

Salmon Smolt or Trout Fingerlings - from 1 to 3 years old, will group and head out to sea

Adult - spends 1 to 8 years at sea

Spawning Adult - spawn and die within 2 weeks.

The taxpayer has asserted that a live, identifiable fish is first created at the fry stage of the life cycle and it is at this point that they have live stock and an item of trading stock.

It is from this point that the taxpayer must also begin to feed the fish until it has grown into adulthood and is sold.

Hatchery survival rates provided by the taxpayer for the salmon and trout in an average year indicate that a maximum survival rate of 90% plus occurs at the first feeding stage of production.

Fry fit into the first feeding stage of the survival table. Parr is the stage between fry and smolt, with the term referring to the dark marks that develop on the sides of the fish as they grow. During the first feeding stage the fish evolve through fry and parr stages of development.

It is considered that the natural increase of salmon and trout is produced at the fry stage, at which a substantial majority of the fish would be expected to be transferred to sea farms.

ATO ID 2011/23 Trading stock: natural increase - relevance of survival rates provides the following:

…Atlantic salmon bred in a land-based nursery as part of an aquaculture business become an 'animal that you hold as live stock' for the purposes of section 70-55 of the ITAA 1997 when they reach the 'fry' stage of development.

Therefore, the Commissioner accepts that it is at the fry stage of the salmon and trout life cycle that expenses cease to be absorbed in to the 'cost' of the trading stock.

Question 2

Summary

The 'cost' of aquaculture trading stock (salmon and trout) for the purposes of paragraph 70-45(1)(a) of the ITAA 1997 is calculated using the full absorption cost method for all expenses of acquisition and production up until the fry stage of development.

Detailed reasoning

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.

There are also special valuation rules for working out the cost of natural increase of live stock. Subsection 70-55(1) of the ITAA 1997 states:

The cost of an animal you hold as *live stock that you acquired by natural increase is whichever of these you elect:

(a) the actual cost of the animal;

(b) the cost prescribed by the regulations for each animal in the applicable class of live stock.

*denotes a term defined in section 995-1 of the ITAA 1997.

The regulations do not prescribe a cost for the natural increase of spawning species such as fish. Therefore, for the purposes of the trading stock provisions, the cost of the natural increase of these species is the actual cost of producing the animals.

The taxpayer has referred to ATO Interpretative Decision ATO ID 2003/44 Trading Stock: Valuation of Abalone and have compared their operation to that of the abalone operation.

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 'actual cost' (see 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 (see 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 (see 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'.

As with abalone, the Commissioner accepts that the production of salmon and trout does not constitute manufacturing. 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 production of trading stock. This is consistent with the definition of trading stock which includes 'anything produced', as well as 'anything manufactured'.

On this basis, all costs of production in bringing the salmon and trout to the point at which natural increase is recognised as having been produced would need to be capitalised into the value of the trading stock on hand.

The term 'cost' for the purposes of section 70-45 of the ITAA 1997 is considered to mean the cost of the stock to the taxpayer including charges in getting it into its existing condition and bringing it to a place where it is 'on hand'.

The salmon and trout would not be considered to be an 'animal you hold as trading stock' until they reach the fry stage of development as was recently determined in ATO ID 2011/23.

Accordingly, the 'cost' of salmon and trout for the purposes of paragraph 70-45(1)(a) of the ITAA 1997 would be calculated using the full absorption cost method for all expenses of acquisition and production up until the fry stage of development.

Question 3

Summary

The ongoing expenses of production incurred after the fry stage of development will be deductible when incurred provided they satisfy the requirements of section 8-1 of the ITAA 1997.

Detailed reasoning

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 reach the fry stage of the life cycle would be deductible as incurred, as this marks the beginning of a period of rearing and maintenance and the trading stock is on hand.

Therefore, once the fish reach the fry stage of development, the ongoing production costs 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.