Edited version of your written advice

Authorisation Number: 1051304369381

Date of advice: 3 November 2017

Ruling

Subject: Trading Stock

Question

Should the proceeds from the sale of cattle under the Sale Contract be returned by the partners in Partnership A in the 2016 or 2017 income year?

Answer

2017 income year

This ruling applies for the following period

Year ended 30 June 2017

The scheme commences on

DDMMYY

Relevant facts and circumstances

1. Trust B and Trust C are in a partnership trading as Partnership A, who carried on a primary production business in Australia.

2. The transaction, the subject of this ruling, concerns the sale of Property and Trading Stock in Australia (the Sale) by Partnership A (the Seller) to the Buyer. The sale was completed in the second half of November 2016.

3. The Sale documentation consists of:

(a) a Station Sale Contract (SSC) entered into between the Seller, the Buyer and the Guarantor on DDMMYY

(b) a Livestock Sale Agreement (LSA) entered into between the Seller, the Buyer and the Guarantor on DDMMYY

(c) a Deed entered into between the Seller, the Buyer and the Guarantor on July 2016, and

(d) a Facilitation Agreement entered into between the Seller, the Buyer, the Guarantor and another party on October 2016.

Station Sale Contract

4. The Sale Contract was entered into on DDMMYY, under which Partnership A agreed to sell the ‘Assets’ and the ‘Property’ the Buyer.

5. The specified number of Trading Stock has been set in the Sale Contract and there is Conditions Precedent within this contract and if any of the Conditions Precedent are not satisfied or waived by the Sunset Date of the contract then either party is entitled to terminate this contract. Specifically, it says that completion is conditional upon that the Buyer obtaining necessary consent from authorities to the acquisition of the Property and the Assets and for all other necessary regulatory approvals and consents being received to enable the transfer of the Property and the Assets to the Buyer.

Livestock Sale Agreement

6. The LSA was entered into between the same parties as the SSC and executed on DDMMYY to sell the remaining Trading Stock.

The Deed

7. Due to some delays in satisfying the Conditions Precedent set out in the SSC, including from the FIRB, the Deed was entered into between the parties to the SSC on July 2016.

Facilitation Agreement

8. The parties to the SSC and Argyle Company Pty Ltd (Argyle) entered into a Facilitation Agreement on October 2016.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Subsection 6-25(2)

Income Tax Assessment Act 1997 Paragraph 70-10(1)(b)

Income Tax Assessment Act 1997 Section 70-90

Income Tax Assessment Act 1997 Subsection 70-90(1)

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise stated.

Summary

The partners in Partnership A should return the proceeds from the sale of Trading Stock under the SSC in the 2017 income year.

Detailed reasoning

Assessable income on disposal of trading stock outside the ordinary course of business

Livestock is included in the definition of trading stock. Generally, sales proceeds received from the disposal of trading stock in the ordinary course of business are treated as ordinary income and therefore assessable under section 6-5. In other cases where the trading stock is disposed of outside the ordinary course of business, section 70-90 includes in your assessable income the market value of the item on the day of the disposal.

The question whether a disposal is outside the ordinary course of the business being carried on by the taxpayer is a question of fact to be determined on the basis of the following considerations:

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

(2) the character of transactions that could reasonably be expected to be called for in the course of going about that business, and

(3) the character of the disputed transaction or transactions.

The SSC required the partners to sell the Assets that included the Trading Stock, and the Property to the Buyer.

The High Court in Farnsworth v Federal Commissioner of Taxation (1949) 78 CLR 504 (Farnsworth) held that the former subsection 36(1) of the Income Tax Assessment Act 1936 (ITAA 1936) did not apply to a regular disposal of trading stock in the ordinary course of business. The issue in Farnsworth was whether or not the delivery of fruit by the taxpayer to a packing house in which she (together with other growers) had an interest meant that the fruit had ceased to be her ‘trading stock on hand’ at that time. It was held that the fruit was not ‘trading stock on hand’.

Latham CJ stated (at 514):

Section 36 relates to the disposal of the assets of a business, including, inter alia, trading stock. The terms of the section show that it was intended to be applied to a case where there was a disposal of assets of a business as such whether in whole or in part, and whether or not the assets were disposed of because the seller was going out of business or because the business was sold to another person. The section is intended to deal with a walk-in walk-out, with a clearing sale, and with a transaction which represents, not an ordinary sale of goods in the course of carrying on a business, but a disposal of the assets of the business so that the business is no longer being carried on by the person who has disposed of it. (Emphasis added)

The Sale involved Partnership A disposing of the Trading Stock as part of selling its primary production business as a going concern (a walk-in walk-out sale). The sale the Trading Stock was not typically part of the common flow of transactions in the affairs of partnership A’s business. By selling the primary production business, Partnership A ceased to carry on that business. Therefore the disposal of the cattle is considered to be a disposal outside the ordinary course of its business.

Subsection 70-90(1) states:

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.

As Partnership A disposed of the Trading Stock outside the ordinary course of its business, section 70-90 will apply to include in the partner’s assessable income the market value of the Trading Stock on the day of the disposal.

While the disposal may also result in an amount assessable to the partners as ordinary income under section 6-5, subsection 6-25(2) states:

Unless the contrary intention appears, the provisions of this Act (outside this Part) prevail over the rules about ordinary income.

Since there is no contrary intention, section 70-90 will prevail over the ordinary income rule in section 6-5.

Determination of disposal time for trading stock

The word 'dispose' is not defined in the ITAA 1997. The word 'dispose' as used in the former subsection 36(1) of the ITAA 1936 was considered by the High Court of Australia in Rose v Federal Commissioner of Taxation (1951) 84 CLR 118 at 126 where Dixon, Fullager and Kitto JJ stated:

In employing the words "dispose of" s.36 doubtless meant to include every alienation of trading stock. "Disposition" and "dispose of" are expressions of the widest import. But the subject of the disposition must be considered as well as the ambit of the expression "dispose of".

Since the market value that is included in the taxpayer's assessable income under section 70-90 is determined at the date of disposal, it is important to establish when the disposal occurs. While this date is normally easy to establish, difficulties arise where a contract for the sale is entered into on one day, but the actual sale or settlement does not occur until a later time. This typically arises where goods are sold under a conditional contract. A 'conditional contract' refers to an arrangement under which goods are typically sold by a seller to a purchaser on the basis that the parties intend that property in the goods passes immediately to the purchaser on delivery of the goods, Where this happens, the seller derives the income once the goods are delivered to the buyer, even if the buyer has the right to return the goods: Taxation Ruling TR 97/15. It is at the point of delivery that the seller becomes presently entitled to demand payment of the sale price within a specified period.

In the Commissioner of Taxation v Woolcombers (WA) Pty Ltd (1993) FCA 956 it was emphasised that it was necessary to look at the particular language of the contract and the particular circumstances of the case at hand citing James Flood, the High Court said (at 506):

It is probably going too far to say that the obligation must be indefeasible.

In our view, much will depend upon the particular circumstances of the case at hand. If the defeasibility takes the form of a contingency such as drought or a similar frustrating event which ordinarily would be implied as a matter of business efficacy, it is difficult to argue that by reason of the existence of this contingency, no liability to pay the price has accrued.

After examining the SSC, it is clear that the parties did not intend for the sale of the Trading Stock to be concluded until after all the Conditions Precedent and other requirements had been satisfied. In particular, Completion was conditional upon the Buyer obtaining consent from the FIRB to the acquisition of the Property and the Assets and for all other necessary regulatory approvals and consents being received to enable the transfer of the Property and the Assets to the Buyer. Up until Completion, it was the Seller who carried on the ongoing business and title to the Trading Stock remained with the Seller till that point in time. At no time is it stated that the Buyer may dispose of the cattle. In fact, the Facilitation Agreement required the Buyer not to sell Trading Stock without the prior approval of the Seller.

The clauses in the SSC that are listed on the relevant facts and circumstances of this ruling were considered in arriving at this decision.

Therefore, as the disposal of the cattle was not concluded until Completion of the SSC, which is the second half of November 2016, the proceeds from this sale is to be included in the partners’ assessable income in the 2017 income year.

Conclusion

Trust B and the Trust C are to include the proceeds from the disposal of the cattle in their assessable income for the 2017 income year.

ATO view documents

Taxation Ruling TR 97/15: Income tax: conditional contracts: derivation of income; allowable deductions; trading stock on hand

Other references (non ATO view)

Case R85, 84 ATC 569

Rose v Federal Commissioner of Taxation (1951) 84 CLR 118

Farnsworth v Federal Commissioner of Taxation (1949) 78 CLR 504

Commissioner of Taxation v Woolcombers (WA) Pty Ltd (1993) FCA 956