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Ruling

Subject: Income Tax: Bailment Plan Facility - used vehicle dealer

Question 1

Is the 'supply' of a used vehicle to the financier for GST purposes considered a sale for the purposes of section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Does the payment of a curtailment to the financier represent a purchase of trading stock?

Answer

No

Question 3

Does the dealer have a tax deduction for the curtailment payment under section 8-1 of the ITAA 1997?

Answer

No

Question 4

On the basis that the dealer does not own the goods until the last payment on the bailment plan has been paid and title transferred, is the value of trading stock subject to the bailment agreement $nil under section 70-35 of the ITAA 1997 for the year ended 30 June 2011?

Answer

No

This ruling applies for the following period:

Year ended 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The following description of the scheme is based on information provided by the applicant. The following documents, or relevant parts of them, form part of and are to be read with the description:

o Private ruling application form, including attachments.

o Fax from applicant, including attachments.

o Fax from applicant, including attachments.

o Fax from applicant.

Scheme:

The taxpayer is in the used vehicle sales business.

The taxpayer has a Bailment Plan Facility (the agreement) in place with the financier.

The taxpayer must insure all bailed vehicles for all usual risks under a policy that is acceptable to the financier and the financier must be recorded on the insurance policy as the appropriately ranked mortgagee.

The Applicant provided an example of the manner in which the Bailment Plan operated.

Record of conversation with applicant:

Titles of the used vehicles pass to the financier when the taxpayer sells the used vehicles to them under the agreement.

Title of each used vehicle does not return to the taxpayer until the vehicle is sold to a customer and the financier is paid or the curtailment payments reduce the balance of the bailed vehicle to zero.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 70-10

Income Tax Assessment Act 1997 Section 70-35

Income Tax Assessment Act 1997 Section 70-45

Income Tax Assessment Act 1997 Subsection 70-80(1)

Reasons for decision

Question 1

Summary

The proceeds received for the 'supply' of a used vehicle to the financier should not be included in the ordinary income of the taxpayer under section 6-5 of the ITAA 1997.

Detailed reasoning

Subsection 6-5(2) of the ITAA 1997 provides that for an Australian resident, your assessable income includes the ordinary income you derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

Subsection 70-80(1) of the ITAA 1997 provides that 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 of the ITAA 1997) as ordinary income.

You have in place a Bailment Plan Facility (the agreement) with the financier, the terms of which are not strictly enforced.

Bailment is an arrangement where a financier purchases a motor vehicle or other equipment and then entrusts those goods to a dealer who is given control over them for the purpose of display and sale. When a customer is found, title to the goods is passed by the financier to the dealer, who in turn passes title to its customer.

Bailment arrangements in relation to used stock differ from other bailment agreements in that the used stock is purchased by the dealer who may then ask the financier to bail it. If the financier agrees to do so, it will take title of the stock and pay the dealer an agreed amount. The dealer continues to hold the bailed stock for the purpose of display and sale, as well as retaining the risks of ownership.

AASB Standard AASB 118 - Revenue provides the following in relation to the recognition of revenue at paragraph 14:

14 Revenue from the sale of goods shall be recognised when all the following conditions have been satisfied:

(a) the entity has transferred to the buyer the significant risks and rewards of ownership of the goods;

(b) the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold;

(c) the amount of revenue can be measured reliably;

(d) it is probable that the economic benefits associated with the transaction will flow to the entity; and

(e) the costs incurred or to be incurred in respect of the transaction can be measured reliably.

Further example 5 of AASB 118 - Revenue provides the following:

5 Sale and repurchase agreement (other than swap transactions) under which the seller concurrently agrees to repurchase the same goods at a later date, or when the seller has a call option to repurchase, or the buyer has a put option to require the repurchase, by the seller, of the goods

For a sale and repurchase agreement on an asset other than a financial asset the terms of the agreement need to be analysed to ascertain whether, in substance, the seller has transferred the risks and rewards of ownership to the buyer and hence revenue is recognised. When the seller has retained the risks and rewards of ownership, even though legal title has been transferred, the transaction is a financing arrangement and does not give rise to revenue…

In the taxpayers case the used stock has been bailed to the financier, with title of the vehicle passing from the taxpayer to the financier under the terms of the agreement. Despite title passing the taxpayer retains all the risks of ownership associated with the vehicle until it is sold to a customer at which stage the customer obtains title and possession of the vehicle.

The taxpayer has noted in their private ruling application that the method of accounting for this bailment facility is to treat the amount received from the financier as a loan. As a result a sale of trading stock is not recognised by the taxpayer until the bailed vehicle is sold to a customer.

This treatment is consistent with the application of AASB 118 - Revenue.

Having regard to the circumstances of the taxpayer, the proceeds received for the 'supply' of a used vehicle to the financier should not be included in the ordinary income of the taxpayer under section 6-5 of the ITAA 1997 but rather continue to be treated in the same way as a financing arrangement.

Question 2

Summary

The curtailment payments do not represent a purchase of trading stock but rather a repayment of the original bailed amount to the financier.

Detailed reasoning

Financiers may require that curtailment payments be made by dealers in respect of slow moving stock. In some circumstances the curtailment payment is made to ensure the financiers' investment reflects the true value of the stock. That is, it is directly related to the decrease in market value of the stock over the time that it has been bailed to the dealer. In such a case, the curtailment payment does not create any ownership interest for the dealer in respect of the stock bailed.

As per the agreement, curtailment payments are defined as "payments made to the financier to reflect the reduction in the market value of the bailed goods."

This means the curtailment payments progressively reduce the bailed amount of the vehicle, thus reducing the amount that the taxpayer must pay to the financier to buy the bailed goods once they are sold to a customer.

You have advised that where the curtailment payments reduce the bailment amount to be paid to the financier upon the sale of the vehicle to zero, then the title of the vehicle is passed to the taxpayer at this time rather than when it is eventually sold.

Therefore the curtailment payments effectively represent a repayment of the original bailment amount paid by the financier for the vehicle.

As the title does not pass back to the taxpayer until such time as the curtailment payments reduce the balance of the bailed vehicle to zero, they do not represent a purchase of trading stock but rather a repayment of the original bailed amount to the financier.

Question 3

Summary

There is no deduction under section 8-1 of the ITAA 1997 for a curtailment payment.

Detailed reasoning

Section 8-1 of the ITAA 1997 provides that 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.

As discussed in the answer to Question 2, curtailment payments are a repayment of the original bailed amount to the financier.

As the bailed amount from the financier is treated as a loan, then that the curtailment payments are a repayment of that loan.

As such there would be no deduction under section 8-1 of the ITAA 1997.

Question 4

Summary

Where the used vehicles that are subject to the agreement remain on hand or unsold at the end of the income year, the taxpayer is considered to have sufficient dispositive power over these vehicles and will need to include them in the value of trading stock on hand in accordance with section 70-35 of the ITAA 1997.

Detailed reasoning

Section 70-35 of the ITAA 1997 provides that a taxpayer who carries on a business must include the value of their trading stock on hand in working out their assessable income and deductions.

'Trading stock' is defined in paragraph 70-10(a) of the ITAA 1997 to include: 'anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business'.

Taxation Ruling IT 2670 Income Tax: Meaning of 'trading stock on hand' provides guidance on the matters to consider in determining what constitutes 'trading stock on hand'.

Paragraph 13 of IT 2670 provides that where a taxpayer does not own the stock, the Commissioner will treat the taxpayer as having sufficient dispositive power for the stock to be trading stock on hand where the circumstances explained by the High Court in Federal Commissioner of Taxation v Sutton Motors (Chullora) Wholesale Pty Ltd (1985) 157 CLR 277; 85 ATC 4398; (1985) 16 ATR 567 are, in substance, the same.

Paragraph 12 of IT 2670 refers to this passage:

The relevant vehicles were, at the commencement of the tax year, plainly in the possession and at the risk of the Suttons Group. They were held by the Group for the purpose, and only for the purpose, of being offered for sale in the ordinary course of the composite business which that Group, looked at as a whole, carried on. They represented the stock which the Group held to offer for sale and to sell in the course of that overall business and which it had become entitled to, and commercially though not legally obliged to, purchase from G.M.H.'s wholesale price at the time it took delivery. If the Group's overall business from the original acquisition of possession of vehicles under the floor plan arrangement to the ultimate retail sale of them to the public be viewed as a composite whole, it appears to us that the relevant motor vehicles were, at the commencement of the tax year, the trading stock on hand in relation to that business within the traditional and central meaning of the term 'trading stock'.

Taxation Ruling IT 2325 Income Tax: Deduction for cost of motor vehicles under floor plan arrangements provides guidance on the effect of the decision in the Sutton Motors case on accounting for trading stock.

The preamble to IT 2325 provides the following:

Taxation Ruling No. IT 2207 comments upon the application of the decision of the High Court in FCT v Sutton Motors (Chullora) Wholesale Pty Ltd, 85 ATC 4398; 16ATR 567. The final paragraph of the ruling states:

"In returns of income for the year ended 30 June 1986 and subsequent years the value of motor vehicles held by motor vehicle dealers under floor plan arrangements at the beginning and end of the year should be disclosed as trading stock on hand at the beginning and end of the year."

Paragraphs 6 and 7 of IT 2325 addresses the solution presented to motor vehicle dealers for vehicles held under floor plan arrangements as follows:

Later on in the decision, in response to a submission on behalf of the Commissioner that the floor plan vehicles had no "cost price" because at the commencement of the tax year Suttons Motors had neither paid nor incurred a binding legal obligation to pay any price for them, it is said:-

"The simple answer to that submission is that the cost price of the vehicles was what was in truth the wholesale purchase price described as a "Hiring Amount" under the floor plan agreement which the taxpayer had agreed to pay on the purchase which would, as a matter of commercial reality, take place in due course."

The term 'incurred' in subsection 51(1) has been the subject of much judicial consideration. For present purposes it is sufficient to say that it does not require actual payment - what is required is that, in the particular year of income, the taxpayer should have definitely committed himself to the outgoing. In the light of the quoted observations from the decision in the Sutton Motors case it is to be taken that dealers operating under floor plan arrangements incur expenditure in acquiring motor vehicles when they take delivery of the motor vehicles. Income tax deductions under subsection 51(1) for the cost of the motor vehicles will be allowable, therefore, in the year in which delivery occurs.

Taxation Ruling TR 93/29 Income Tax: Motor vehicle dealers: valuation of stock on hand: motor vehicles traded in explains how motor vehicle dealers should apply section 70-45 of the ITAA 1997 (formerly subsection 31(1) of the Income Tax Assessment Act 1936) to the valuation of motor vehicles traded in.

Subsection 70-45(1) of the ITAA 1997 provides that where trading stock remains on hand at the end of an income year that you must elect to value each item of trading stock at its cost, its market selling value or its replacement value.

The cost price is the trade-in price shown on the contract plus any additional expenses incurred in bringing the vehicle into its existing condition and location at the end of the year of income.

Marketing selling value is the value at which a vehicle could be sold in the dealer's retail market at the end of the year of income.

Replacement price is the price which a motor vehicle dealer would pay in the dealer's buying market in order to acquire a substantially identical vehicle at the end of the year of income. The dealer must use either an independent valuation or a recognised industry guide when determining this price.

Therefore, where the used vehicles that are subject to the agreement remain on hand or unsold at the end of the income year, the taxpayer is considered to have sufficient dispositive power over these vehicles and will need to include them in the value of trading stock on hand in accordance with section 70-35 of the ITAA 1997.