TABL 5551/TABL 5559
Term 1, 2024
Week 7: 27 March 2024
Announcements
• Assignment is due on Friday 5 April, 2024 on or before 6.00
pm (WEEK 8)
• Please ensure you are familiar with the Moodle Link for
submission of the assignment
Recap of previous week and plan for
today
• Last class, we continued looking at deductions, specifically:
– The treatment of travel, home office, clothing and self-
education expenses
– Those ‘before’ and ‘after’ expenses
– The revenue/capital distinction (the 1st negative limb)
• Today, we’ll mostly complete deductions, including the various
capital allowance regimes
• Then we’ll look at trading stock and tax accounting broadly
7.1 Capital allowance regimes
• Capital expenditure is not deductible under section 8-1 (it fails
the positive limbs, or falls in the 1st negative limb), however it
may be deductible under one of the capital allowance regimes
• These regimes may allow a taxpayer to claim a deduction for
the capital expenditure, or include it in CGT asset’s cost base
• Importantly, these capital allowance regimes require the
expenditure to be capital
• The expenditure generally can’t be deducted immediately – it is
deducted, or ‘depreciated’, over time
7.1 Capital allowance regimes
• If you can’t get a deduction under one of the capital allowance
regimes, think to CGT asset cost base inclusion
– This in turn reduces the taxpayer’s capital gain
• All the capital allowance regimes have an ‘assessable income-
producing’ requirement, similar to the section 8-1 positive limbs
– expenditure must be relevant to the income-producing activity
• Challenge: identifying the regime that applies to certain capital
expenditure
• We’ll deal with tangible assets first, then intangible assets
7.1 Capital allowance regimes
Trading stock (ss 6-5,
8-1 and Division 70)
Depreciating assets
(Division 40)
Capital works
(Division 43)
CGT regime and CGT
assets
• Cost of purchase =
deduction
• Sale proceeds =
assessable income
• Compare stock on
hand at beginning and
end of income year
• Increase in stock over
year = assessable
income
• Decrease in stock
over year = deduction
• Cost of depreciating
asset deductible over
effective life of asset
• Choice of prime cost
or diminishing value
method
• Sale of asset =
balancing adjustment
• Cost of capital works
deductible over 40
years (2.5% per year)
• Generally, no
balancing adjustment
on disposal
• Purchaser of capital
works obtains Division
43 deductions
• Asset satisfies both
Divisions 40 and 43 =
Division 43 applies
• Actual costs included
in cost base
• If amount deductible
under Division 43,
amount excluded from
cost base
• Capital gains/losses
on sale of depreciating
asset disregarded
under CGT regime if
Division 40 deductions
claimed
7.1 Capital allowance regimes
Depreciating assets – Division 40
• Deduction is under section 40-25 – the asset must be used for a
taxable purpose, e.g. producing assessable income
– Deduction is reduced to extent asset used for non-taxable
purpose
• Asset’s cost includes purchase cost and costs of getting asset
into its current condition or position
• Taxpayer has choice of using prime cost method of diminishing
value method to calculate the depreciation
7.1 Capital allowance regimes
• Prime cost (straight line) method:
Asset’s cost × (days held ÷ 365) × (100% ÷ asset’s effective life)
• Diminishing value method:
Base value × (days held ÷ 365) × (200% ÷ asset’s effective life)
• Days held: number of days asset held in the income year and
used, or installed ready for use, for any purpose
• Asset’s effective life: you can use the ATO’s determinations of
effective life, or self-assess the effective life yourself
7.1 Capital allowance regimes
• Sale of depreciating asset gives rise to balancing adjustment
event – requires comparison between asset’s termination value
(sale proceeds) and adjustable value (written down value)
• If asset’s termination value > adjustable value = difference is
included in taxpayer’s assessable income
• If asset’s termination value < adjustable value = taxpayer can
claim the difference as a deduction
• Recall that capital gains or capital losses made from CGT event
involving depreciating asset is disregarded: section 118-24
7.1 Capital allowance regimes
Capital works – Division 43
• Deduction is under section 43-10 – must be used to produce
assessable income
• Taxpayer calculates capital works deduction on straight-line day-
by-day basis over 25 years (4% rate) or 40 years (2.5% rate)
• Capital works usually form part of a larger CGT asset – this
means construction expenditure can form part of cost base
– Cost base or reduced cost base will exclude any capital
works deductions claimed: section 110-45(2)
7.1 Capital allowance regimes
• Generally, no balancing adjustment occurs when a taxpayer
disposes of Division 43 capital works
– Instead, the disposal will give rise to a CGT event
– Double counting of expenditure is avoided by reducing
cost base or reduced cost base by capital works deduction
• If taxpayer disposes of Division 43 capital works, the purchaser
is entitled to a capital works deduction for the un-deducted
construction expenditure (where purchaser’s use is to produce
assessable income)
7.1 Capital allowance regimes
CGT regime and CGT assets
• Recall capital gains and capital losses are disregarded for:
– Trading stock: section 118-25(1)
– Depreciating assets used solely for a taxable purpose:
section 118-24(1)
• As mentioned before, capital works usually form part of a larger
CGT asset – this means cost base or reduced cost base is
reduced to the extent a capital works deduction has been
claimed: section 110-45(2)
7.1 Capital allowance regimes
How do we identify the applicable regime?
• Trading stock is generally the thing a business purchases for
the purpose of selling in the ordinary course of business
• Depreciating assets have a limited effective life and can
reasonably be expected to decline in value over time, e.g.
electric tools and computers
– Land, trading stock and some intangible assets are not
depreciating assets: section 40-30(1)
• Accounting definition of ‘asset’ is relevant: something that is
expected to provide a future benefit, e.g. property
7.1 Capital allowance regimes
• Caution when reading provisions in Divisions 40 and 43:
– Section 40-30(3) says Division 40 applies to improvements
to land, or a fixture on land, whether or not removable, as if
it were a separate asset to the land – a building would be
an example of an improvement or fixture
– This suggests the costs of constructing or extending a
building are deductible under Division 40
– However, when we read section 43-20(1) it says Division 43
applies to capital works, being a building, or extension,
alternation or improvement to a building
7.1 Capital allowance regimes
• Buildings appear to fall within both Divisions 40 and 43 – how
do we reconcile this?
• Answer: Division 43 takes priority – Division 40 is expressly
stated as not applying to capital works a taxpayer can deduct
under Division 43: section 40-45(2)
• There is a qualification – if the expenditure falls under one of
the exceptions in section 43-70(2) it is taken out of Division 43
– Examples: expenditure on acquiring land and ‘plant’
• ‘Plant’ is defined to include articles, machinery, tools: section
45-40(1) – note it is an inclusive definition
7.1 Capital allowance regimes
• As the definition of ‘plant’ is inclusive, ‘plant’ can also have its
ordinary meaning as determined by case law
• ‘Plant’ in case law is generally defined as the items or objects
that play a part in taxpayer’s operations, e.g. manufacturing – in
other words it is the taxpayer’s tools of trade
• There is a qualification – the ordinary meaning of ‘plant’ does
not include the setting for taxpayer’s operations and staff, and/or
that provides protection from the elements, e.g. sun or rain
• This is what we call the mere setting qualification
• Most buildings and items or objects attached to, or forming part
of, a building are therefore not plant
7.1 Capital allowance regimes
• Articles, within its ordinary meaning, includes items or objects,
e.g. desk, chair and bookcase
• Machinery, within its ordinary mean, includes machines or an
apparatus using mechanical power
• Carpentaria Transport involved the issue of what is machinery:
– Taxpayer operated a freight business (moving freight/cargo)
– Issue was whether roller shutter doors, electrically operated,
forming part of sides of building were ‘plant’
– Court held an item can be machinery even if it forms part of
taxpayer’s setting (usually buildings)
7.1 Capital allowance regimes
• Carpentaria Transport (continued):
– The roller shutter doors went up and down to let trucks in, but
also kept out the elements, e.g. wind and rain
– Court did not set out a definition of ‘machinery’ – the case
was sent back to the AAT for decision
• TR 2004/16 sets out the Commissioner’s view of ‘plant’ in a
residential rental property – useful as it cites relevant case law
– ‘Machinery’ is something that uses energy to operate, e.g.
roller shutter doors in Carpentaria Transport, oven used for
cooking, portable heaters, built-in air-conditioning system
7.1 Capital allowance regimes
• Key takeaway: ‘plant’, within its ordinary meaning, can be items
or objects that form part of setting for taxpayer’s operations and
staff, and/or that provides protection from the elements
• Immediate ‘write-off’ deduction available for non-business
depreciating assets costing $300 or less
– Taxpayer can claim an immediate deduction
– Asset must be used mainly to produce assessable income,
but not from carrying on a business
– Asset must cost $300 or less (if greater than $300, taxpayer
can deduct the decline in value)
7.1 Capital allowance regimes
• There are 2 capital allowance regimes that may allow taxpayer
to deduct expenditure on intangibles that is capital:
– Project pools
– Business-related capital expenses (black-hole expenditure)
Project pools
• Project must involve some continuing activity and be operated
for a taxable purpose, e.g. producing assessable income
• The expenditure must be directly connected to the project and
allocated to a project pool for the project
7.1 Capital allowance regimes
• Section 40-832 contains formula for deduction for a year:
Pool value x 200%
DV project pool life
• ‘Pool value’, for the first year, is the ‘project amount’ being the
sum of the expenditure allocated to the project pool, and for
subsequent income years, is the closing value of the project
pool for the previous income year
• ‘DV project pool life’ is the estimate of how long the project will
last (e.g. 10 years): section 40-845
7.1 Capital allowance regimes
• ‘Project amount’ includes amounts incurred for feasibility studies
or environmental assessments for the project: section 40-840
• Taxpayer can start deducting amounts for a project pool in the
income year the project starts: section 40-855
• If project is abandoned, sold or disposed of, the taxpayer can
deduct the balance of the project pool’s value for the year the
abandonment, sale or disposal occurs: section 40-830(4)
7.1 Capital allowance regimes
Business-related capital expenses (black-hole expenditure)
• Taxpayer may be able to claim deduction for some capital
expenses under section 40-880 – object of this provision is to
make certain business-related capital expenses deductible
• The deduction is usually spread over 5 years, i.e. 20% per year
• Section 40-880 requires expenditure to be incurred by taxpayer
in relation to:
– Taxpayer’s business, or
– A business that used to be, or is proposed to be, carried on
7.1 Capital allowance regimes
• The term ‘in relation to’ has been suggested as being similar to
the positive limbs in section 8-1 – it requires the expenditure to
be sufficiently connected to the taxpayer’s business
• Apportionment, through the expression ‘to the extent that’, is
contemplated for expenditure serving more than one purpose or
object
• Section 40-880 is limited to business taxpayers – it does not
apply to non-business taxpayers, e.g. taxpayers holding passive
property, such as rental property, can’t claim a deduction under
this provision
7.1 Capital allowance regimes
• Section 40-880(5) contains exceptions to claiming a deduction
under section 40-880 – applies to expenditure which:
– Forms part of cost of depreciating asset: s 40-880(5)(a)
– Is deducted elsewhere, e.g. project pools: s 40-880(5)(b)
– Is incurred in relation to a lease or other legal right: s 40-
880(5)(d)
– Could be taken into account in working out capital gain or
capital loss under CGT regime: s 40-880(5)(f)
• Lease premium would be covered by the 3rd exception above in
section 40-880(5)(d)
7.1 Capital allowance regimes
• CGT asset cost base: if expenditure fits under any of the 5
elements below, section 40-880 doesn’t provide a deduction:
– Money paid for CGT asset
– Incidental costs of acquiring CGT asset or CGT event
– Costs of owning CGT asset
– Capital costs to increase or preserve value of CGT asset
– Capital costs to preserve or defend title or rights to CGT
asset
• Important to note that the 4th element does not apply to goodwill:
section 110-25(5A)
7.1 Capital allowance regimes
• This means capital expenditure incurred to preserve value of
goodwill won’t fit under 4th element of cost base of the goodwill
(CGT asset) – in turn section 40-880(5)(f) won’t exclude it from
section 40-880
• However, section 40-880(6) says CGT asset cost base exception
in section 40-880(5)(f) doesn’t apply if the expenditure both:
– Preserves, but doesn’t enhance, the value of the goodwill
– Is in relation to a legal right, and the value to the taxpayer of
the legal right is solely attributable to the effect it has on
goodwill
7.1 Capital allowance regimes
• Goodwill is a CGT asset: section 108-5(2)(b)
• Goodwill can be defined as the attraction of customers to a
business through the combined use of physical and human
‘assets’ of the business
• First requirement in section 40-880(6) is that the expenditure
preserves, not adds to, goodwill
• Second requirement envisages taxpayer acquiring a legal right,
where legal right has no value on its own, and only has effect on
the goodwill
7.1 Capital allowance regimes
FCT v Sharpcan Pty Ltd
• Taxpayer, hotel and gaming business operator, purchased
gaming machine entitlements (GMEs) for $600,000, giving them
right to conduct gaming for 10 years – $600,000 held was capital
• Court held $600,000 satisfied positive requirement of section 40-
880 as it was incurred in relation to hotel and gaming business
• The $600,000 fit under 1st element of cost base – this meant it
was a denied deduction under section 40-880 due to exception in
section 40-880(5)(f)
7.2 Other deduction conferral provisions
• Recall deduction conferral provisions may provide or confer a
deduction where section 8-1 does not
• We’ve considered several deductions so far, e.g. section 25-
100: travel between 2 workplaces, section 30-15: gifts or
donations
• Today we’ll focus on interest, repair and other categories of
deductions
– Note that interest is not deductible under specific deduction
conferral provision – only section 8-1 can apply – however
we will consider some general deductibility principles and
key distinctions
7.2A Interest etc.
• Interest is the cost of money, or cost of hiring money – not to be
confused with ‘borrowing costs’ such as loan establishment fees,
valuer’s fees, etc.
• Section 8-1 is the only provision applicable to interest
• The usage of the interest is the test under positive limbs of section
8-1: were borrowed funds used to purchase an assessable income
producing asset, or used in process of operating a business?
• Caution not to state the test as being the purpose of the borrowing
– this would fail to take into account change of use of an asset,
e.g. from home for living in, to rental property for leasing out
7.2A Interest etc.
• Interest expenses will hardly ever be capital – it also doesn’t need
to be incurred in the same year the assessable income is derived,
or have to actually produce assessable income for it to be
deductible: see Steele case
• In case of business no longer operating, interest is deductible
where the original borrowing was used in a business directed at
producing assessable income: see Brown case
• Interest expenses incurred by taxpayer who is unable to find a
tenant for rental property, but makes genuine attempts to find one,
e.g. advertising for tenants, are still deductible
7.2A Interest etc.
• Section 26-102 denies deduction for costs associated with holding
land without substantial and permanent structure, i.e. vacant land
• Extension of deduction denial: even if there is a building on the
land that is residential premises, the deduction denial applies,
unless the premises:
– Can be lawfully occupied, i.e. fit for human occupation
– Are leased or available for lease: section 26-102(4)
• Exception to deduction denial: land is in use, or available for use,
in carrying on business: sections 26-102(1), (9), and where the
taxpayer is a company: section 26-102(5)
7.2A Interest etc.
• Borrowing costs are those costs of setting up the loan, or taking out
the loan – these are often charged by lender, e.g. valuer’s fee
• Revenue vs. capital distinction: if asset acquired with loaned funds
is on capital account, borrowing costs take on same character
• Assuming loan is used to produce assessable income, section 25-
25 will provide a deduction for borrowing costs
• Deduction under section 25-25 is spread over the shorter of 5
years and the term of the loan
• Immediate deduction for borrowing costs totaling $100 or less
7.2A Interest etc.
• Mortgage discharge expenses (costs involved in discharging the
mortgage), e.g. solicitor’s fees for preparing discharge, usually
capital under section 8-1
– This is assuming loaned funds used to produce assessable income –
the mortgage is security for repayment of the loan
– Section 25-30 may provide deduction – it covers costs of discharging a
mortgage
• Travel costs associated with residential rental property, e.g. travel
to inspect property, are denied a deduction: section 26-31
– Exceptions: taxpayer is carrying on a business: section 26-31(1)(b), or
taxpayer is a company: section 26-31(2)
7.2B Repairs
• Taxpayer can deduct expenditure on repairs to premises, part of
premises or depreciating asset used solely for producing
assessable income: section 25-10(1)
• Apportionment is contemplated where the premises or asset only
partly used for producing assessable income
• No deduction allowed if the expenditure is capital: section 25-10(3)
• Repair means to remedy or make good defects, i.e. fix something,
cf. maintenance which is likely deductible under section 8-1
• Irrelevant how property came to be damaged, e.g. wear and tear
7.2B Repairs
• Repair is to be contrasted from improvement – idea is whether
‘repair’ has merely restored efficiency of function of the premises
or asset, without changing its character: W Thomas & Co Pty Ltd
• Western Suburbs Cinemas case:
– Taxpayer replaced damaged Celotex ceilings in its cinemas with fibro
ceilings – Celotex was no longer available
– Held to be an improvement
– Ceilings were major part of structure, the work went beyond mere
restoration and fibro had considerable advantages, e.g. reduction in
repair bills in the future
7.2B Repairs
• TR 97/23 sets out Commissioner’s view of when expenditure on
repairs is deductible under section 25-10 – likely an improvement
where property is brought into more valuable or desirable form
• Relevant considerations include whether the work:
– Extends the income providing ability of the property
– Extends the expected life of the property
– Significantly enhances the property’s saleability or its market
value
• Repair can involve renewal or replacement of subsidiary parts of
a whole – this raises the entirety vs. subsidiary issue
7.2B Repairs
• There is no one test for what is a subsidiary part and what is an
entirety – paragraph 115 or TR 97/23 provides guidelines:
– Is the thing physically, commercially and functionally an
inseparable part of an entirety?
– Is the thing separately identifiable as a principal item of
capital equipment?
– Is the thing capable of providing a useful function on its own?
– Is the thing functionally separate and independent?
• Example: ceiling, floor or walls of building are subsidiary parts,
while building is the entirety: Western Suburbs Cinemas case
7.2B Repairs
• Initial repairs, while a repair within its ordinary meaning, is capital
• Broad idea is that expenditure to repair an asset after purchase,
which was in a damaged state at time of purchase, will be capital
under ‘initial repairs doctrine’ – the expenditure is really part of
the acquisition cost of the asset
• Test: whether the need for repair was due to previous owner’s
use of the asset, or the new owner’s use?
• Irrelevant whether new owner knew of asset’s damaged state,
whether they obtained discount to reflect damage, or whether
asset could be used immediately by new owner
7.2B Repairs
• If the new owner has used the asset for some time before they
repaired the damaged asset, the expenditure on repairs must be
apportioned: see Law Shipping Company Ltd case
• Expenditure on ‘notional’ repairs, i.e. an amount it is estimated a
repair would have cost, but not in fact incurred, is not deductible:
see Western Suburbs Cinemas case
• Section 25-10 should be used as basis for deducting repair
expenditure – the analysis will be the same as under the general
deduction provision, section 8-1
• If you fail section 25-10, consider the capital allowance regimes
7.2C Others
• There are other deduction conferral provisions, some of which we
have covered in previous weeks – will leave you to read yourself
• Section 25-5: expenses incurred in managing own tax affairs, e.g.
fee paid to registered agent for lodging your tax return
• Section 25-45: loss of money as result of employee stealing,
embezzling or misappropriating the funds
• Section 30-15: gifts or donations to deductible gift recipients, e.g.
charities
7.3 Deduction denial provisions
• Deduction denial provisions operate to deny a deduction that
would have otherwise been allowed under section 8-1 – some
examples below, but will leave you to look at in your own time
• Section 26-5: fines and penalties imposed under an Australian
or foreign law, or ordered by the courts – case law did not allow
deductions for such expenses under section 8-1: Madad case
• Section 26-35: excessive payments to relative or other related
entity may be denied deduction, e.g. doctor pays his spouse
$100,000 to be receptionist in medical practice, when market
rate for receptionist is only $70,000
7.3 Deduction denial provisions
• Section 26-35 effectively ‘reconstructs’ the transaction for tax
purposes, so that it takes place at market value, i.e. $70,000 –
deduction for doctor reduced to $70,000 and assessable income
of spouse reduced to $70,000
• Section 32-5: entertainment expenses are non-deductible – no
need to go into exceptions to deduction denial in Division 32
• Entertainment may be provided by way of food, drink, recreation,
e.g. business lunches with clients, staff social functions
• Some specific entertainment expenses are deductible, e.g. cost
of meals and coffee provided to employees in staff cafeteria
7.3 Deduction denial provisions
• Section 26-105: employer is denied deduction for salary or
wages paid to employee if the employer either fails to:
– Withhold pay-as-you-go-withholding (PAYGW) tax from the
salary or wages paid to the employee
– Notify, i.e. report to, the ATO that they have paid salary or
wages during the relevant reporting period
• The amount denied a deduction is the salary or wages paid
• Recall that if an amount satisfies section 8-1 and a deduction
conferral provision, you deduct the amount under the provision
that is most appropriate: section 8-10
7.4 Tax accounting: an overview
• Income tax is payable on taxable income for an income year – in
turn, taxable income is assessable income less deductions
• In short, tax accounting deals with allocating a taxpayer’s
assessable income amounts and deduction amounts to their
correct income year
• Generally, taxpayers prefer to defer inclusion of assessable
income, and accelerate inclusion of deductions, as this leads to
lower income tax payable in the current income year
• We generally don’t consider tax accounting in this course, with 2
exceptions: timing of acquisitions for CGT and trading stock
7.5 Trading stock
• Broadly, approach to trading stock is similar to approach to
inventories of entities for accounting purposes – income tax uses
different concepts (assessable income and deductions) to that in
accounting (cost of goods sold) to largely achieve same outcome
• Income tax rules use combination of sections 6-5 (ordinary
income), 8-1 (general deductions) and 70-45 (valuing trading
stock) to deal with purchase, holding and sale of trading stock
• Trading stock: defined as anything produced, manufactured or
acquired that is held for purposes of manufacture, sale or
exchange in ordinary course of a business: section 70-10(1)(a)
7.5 Trading stock
• If an asset is trading stock, capital gains and capital losses are
disregarded under CGT regime: section 118-25(1)
• Key trading stock rules:
– Cost of purchasing trading stock is deductible and not a
capital outgoing: sections 8-1 and 70-25
– Sale proceeds from trading stock is assessable income:
section 6-5
– Taxpayer must do end-of-year stocktake and record value
of trading stock on hand both at beginning of income year,
and end of income year
7.5 Trading stock
– If value of closing stock > value of opening stock, excess is
included in taxpayer’s assessable income
– If value of opening stock > value of closing stock, excess is
a deduction to the taxpayer
• Central idea is that a deduction for the purchase of trading
stock is effectively deferred until the income year in which the
taxpayer sells the item of trading stock
• ‘On hand’ means the taxpayer has the power to dispose of the
trading stock – it is not necessary for taxpayer to actually own
the trading stock, or have it in their physical possession
7.5 Trading stock
• 2019-20: taxpayer can deduct $100 for purchase, and includes
$100 in assessable income because CS is $100 > than OS –
result is no taxable income and no tax loss
• 2020-21: taxpayer includes $130 from sale in assessable income
and can deduct $100 because OS is $100 > than CS – result is
taxable income of $30
2019-20 2020-21
Zero opening stock (OS)
Purchased trading stock for $100
No sales
Closing stock (CS) of $100
Opening stock (OS) of $100
No purchases
Sales of $130
Zero closing stock (CS)
7.5 Trading stock
• Although taxpayer obtained deduction for cost of purchase in
2019-20, deduction was effectively deferred until 2020-21 as it
was on hand at end of 2019-20 – it is because it fails to be on
hand at end of 2020-21 that effectively gives the taxpayer a
deduction in 2020-21
• Taxpayer has options for assigning value to trading stock on
hand at year-end – the option applies to each item of trading
stock: section 70-45(1)
– Cost price method: the cost of purchasing the trading stock,
including costs of getting it to current condition and location
7.5 Trading stock
– Market selling value method: value of stock if it is sold in the
normal course of business
– Replacement value method: cost to obtain almost identical
item that is available in the market
• Taxpayer only has the option to value the trading stock on hand
at the end of year – no option to value at beginning of year:
section 70-45(1)
• Valuation at year-end becomes the opening stock valuation at
the beginning of the following year: section 70-40(1)
7.5 Trading stock
• There are difficulties with identifying the cost where taxpayer has
numerous items of uniform stock, and it is not practically possible
to identify specific items
• Example: Woolworths may have 30,000 packets of 500g frozen
peas, some purchased at $1.10 each, and others at $1.20 each
• Solution is to apply trading stock movement assumptions:
– FIFO: items purchased first are the items first to be sold,
therefore those on hand are the most recent purchases
– LIFO: items purchased more recently were sold first,
therefore those hand are the oldest purchases
7.5 Trading stock
– Average cost (or weighted average cost): cost allocated to
those on hand determined by taking cost of those on hand at
beginning of year, and cost of purchases during year, to
determine a per unit cost of the items of hand
• For tax purposes, the FIFO and average cost (or weighted
average cost) assumptions are acceptable – LIFO is not accepted
• ‘Cost’ to manufacturer of trading stock: determined by absorption
cost method, which includes in cost material, direct labour costs
and appropriate proportion of production overhead costs (without
which trading stock wouldn’t be produced)
7.5 Trading stock
• Only the items ‘on hand’ at midnight on 30 June of the income
year are included in closing stock at year-end
• ‘On hand’ asks the question: does the taxpayer have ‘dispositive
power’ over the trading stock at midnight on 30 June? In other
words, do they have the power to sell it?
• This is a practical test – it does not matter whether the taxpayer
has legal rights to, or physical possession of, the trading stock
• Trading stock held to be ‘on hand’ when on a ship on the way to
Australia, but ownership had already passed: All States Frozen
Foods
7.5 Trading stock
• Deduction deferral, or anti-timing mismatch, rule in section 70-15
overcomes decision in Raymor (NSW) Pty Ltd – taxpayer incurred
expenditure to purchase trading stock, but the stock was not
ascertainable or delivered until after end of income year
• The rule denies taxpayer a deduction, otherwise available under
section 8-1, for purchase cost of trading stock if stock is not:
– Disposed of by taxpayer by end of year of purchase
– On hand at year-end
• Deduction deferred until first income year in which stock becomes
on hand to taxpayer, or amount is included in assessable income
from disposal of the stock
7.5 Trading stock
• Market value substitution rule applies in cases of overpayment for
purchase of trading stock: section 70-20 – similar to CGT regime
• Taxpayer purchases trading stock in non-arm’s length transaction,
and cost is more than market value, then purchaser’s deduction is
reduced to the market value
• Seller’s assessable income is also reduced to the market value
• Taxpayer disposes of trading stock outside the ordinary course of
business, then taxpayer’s assessable income includes market
value of the stock: section 70-90(1)
7.5 Trading stock
• If section 70-90(1) applies, the actual amount received for the
disposal is not included in assessable income: section 70-90(2)
• The party acquiring the trading stock is taken to have acquired it
at the same amount, i.e. at market value: section 70-95
• Observations about disposals of trading stock:
– If disposal is within ordinary course of business, section 6-5
operates to include sale proceeds in assessable income
– If disposal is outside ordinary course of business, section 70-
90 operates to include market value in assessable income
7.5 Trading stock
• When does a disposal occur outside ordinary course of business?
It depends on the facts and is determined on case-by-case basis
• Pastoral & Development Pty Ltd case provides guidance:
– Taxpayer sold trading stock to related party at a significant
undervalue (compared to market value)
– Aim was to let related party purchaser make significant profit
on ultimate sale of trading stock to outside party
– Held disposal was outside ordinary course of business, the
key consideration being the significant undervalue of price
– Predecessor to section 70-90 applied to include market value
End of lecture
• Thank you – enjoy your week