Understanding Taxation Law 2012 by Gilders, Taylor, Walpole, Burton, Ciro. Suggested answers to Activities and Questions by Frank Gilders

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1 Understanding Taxation Law 2012 by Gilders, Taylor, Walpole, Burton, Ciro Suggested answers to Activities and Questions by Frank Gilders Chapter 11: Trading Stock 2012 Reed International Books Australia Pty Limited trading as LexisNexis Permission to download and make copies for classroom use is granted. Reproducing or distributing any material from this website for any other purpose requires written permission from the Publisher. Questions What consequences would follow if the stock adjustments in ITAA97 s were not made? 2. Reference should be made to ITAA97 s 70-25: Cost of trading stock is not a capital outgoing An outgoing you incur in connection with acquiring an item of trading stock is not an outgoing of capital or of a capital nature. Note: This means that paragraph 8-1(2)(a) does not prevent the outgoing from being a general deduction under section 8-1. Does this provision affect the conclusion you reached in discussing Question 1, above? If the adjustments in s were not made, taxpayers would be entitled to claim a deduction for all trading stock purchased, whether or not it was sold. This is evident from s that deems purchases of trading stock not to be of a capital nature. However, even in the absence of s 70-25, purchases of trading stock are deductible under s 8-1 because on the authority of Lister Blackstone Ltd (see 11.2) trading stock is on revenue account. Solutions for Gilders et al, Understanding Taxation Law 2012, Ch 11 1

2 Activity 11.1 Comment on whether the following items would be trading stock: paint held by a sign writer; spare tyres held by a car rental firm; milk cartons held by a dairy; plants in pots held by a nursery; fertiliser held by a nursery; eggs held by a poultry breeder; building materials held by a builder; milk crates used by a dairy; stationery held by a debt collector; a demonstration vehicle used by a car dealer. These items qualify by virtue of the s definition: see 11.3: sign writer s paint: one would not ordinarily regard sign writing as manufacture, sale or exchange with the result the paint is not trading stock (but would be deductible on a usage basis under s 8-1); spare tyres: not trading stock Guinea Airways 11.12; milk cartons: trading stock 11.13; plants in pots: trading stock 11.10; IT 33; fertiliser: trading stock if held for sale; analogous to spare parts if held for internal use; eggs: held for manufacture ; chickens are livestock and hence trading stock; building materials: trading stock by definition partially completed buildings are work-inprogress; milk crates: plant, meaning depreciable assets for Div 40 purposes; stationery: not held for manufacture etc ; demonstration vehicle: vehicles held by a dealer are essentially acquired for the purpose of sale and so are trading stock. However, ss and specifically provide for changes in the characterisation of assets when they cease to be held for sale (but are still owned: s ) and, being owned, become trading stock (s 70-30). Solutions for Gilders et al, Understanding Taxation Law 2012, Ch 11 2

3 Questions Trading stock provisions of Div 70 Indicate how the trading stock provisions of Div 70 apply to the following events: (i) The proprietor of a men s clothing store took a suit from trading stock for his own use. The suit cost $350 and had a retail value of $500. (ii) The owner of a confectionery store presented two staff members with a box of chocolates as Christmas presents. (iii) Local retailers donate items to fill a Christmas hamper to be raffled by the Carlyle Bowling Club. (iv) O Owner sold the Corner Store for $100,000 plus stock as valued (SAV). Stock was valued at $25,000. (v) PhotoCo is in the business of leasing photocopying equipment. At the conclusion of a lease agreement, equipment more than five years old is sold. (vi) BuildCo carries on business preparing building sites. This involves supplying and compacting sand. BuildCo pays $100,000 for title to a property containing sand reserves. (vii) A concrete manufacturer pays a land owner $2 per cubic metre to extract gravel from a quarry on the owner s land. (viii) A quantity of paint owned by a sign writer is destroyed in a fire. (ix) A viticulturist is forced to dispose of a quantity of pesticides and fertiliser that have been contaminated. (x) A toy retailer acquired 2000 yoyos for 0.50 cents each. Not one item has been sold in five years. (i) Suit: Section applies. The proprietor is deemed to have sold the suit for cost and s makes that amount assessable. In effect, the cost of acquiring the suit is cancelled. (ii) Gift of chocolates to staff: This is an in-house property fringe benefit (Chapter 7). The cost of providing fringe benefits is an allowable deduction to an employer, unless a specific denying provision applies. The ordinary operation of s 8-1/70-35(3) provides the deduction. (iii) Retailers donations of stock: The issue is whether the disposal is outside the ordinary course of business. If it is, s assesses the market value and cancels the deduction. The issues are discussed at Arguably, this is a routine promotional or sponsorship activity and the normal operation of s 8-1/s 70-35(3) provides the deduction. (iv) Stock valuation at time of business sale: This is a s non-business disposal. The seller is assessable on the amount of $25,000 and the purchaser is deemed by s to have acquired the stock at $25,000. Section deems the amount not to be of a capital nature. (v) Sale of leased equipment: This question raises the issues examined in Memorex Pty Ltd: Section now applies. There is a notional disposal and reacquisition at either cost or market value. (vi) Acquisition of property for sand reserves: The expenditure is capital. The land itself is not trading stock: see See also Nizich v FCT 91 ATC The issue there was whether the payment was for trading stock or whether, being a payment for Solutions for Gilders et al, Understanding Taxation Law 2012, Ch 11 3

4 land or a right to obtain trading stock, it is of a capital nature. French J (at 4755) relied on the Stow Bardolph Gravel Co case to hold that sand and gravel did not become part of stock in trade of the company which extracted it until it had been removed and concluded the payment was capital in nature: The outlay in this case acquired for the appellants the right to remove sand which was incorporated in and part of the land What was acquired was a proprietary right to mine the land for sand. The attempt to equate that proprietary right to the purchase of a pile of sand in what was said to be the business sense of the operation fails (vii) Payment for right to extract gravel: The product of land (in this case, the gravel) can be trading stock once it is severed from the land: see (viii) Paint: Accepting that paint held by a sign writer is not trading stock, Div 70 does not apply. See Guinea Airways (ix) Disposal of pesticides and fertiliser: These items are not trading stock so Div 70 does not apply. (x) Obsolete yoyo stock: The options for the valuation of trading stock apply: ss 70-45, 70-50; Section provides for valuation of stock on hand at a reasonable value where that is warranted due to obsolescence or other special factors. 2. Bacchus Wines Bacchus Wines carries on business as a viticulturist and wine maker. For income tax purposes, it elects to value stock on hand at cost price. Comment on the tax treatment of the following items of expenditure relating to stock on hand at 30 June: land preparation costs storage costs for bottled wine interest on money borrowed to finance business operations rent on wine-bottling machine labour costs attributable to grape growing pesticides and fertilisers. Winemaking is a distinct industry and not an incident of viticulture. It is not an agricultural pursuit: G Gramp & Sons Ltd v FCT (1965) 14 ATD 75. Viticulture (vine growing), although not specifically mentioned in the s 995-1(1) definition of primary production, would seem to fit para (a): cultivating or propagating plants. IT 2350 sets out the overhead costs to be taken into account in valuing closing stock under the cost option for manufacturing businesses generally: 11.21, Costs include factory light, power, rent, repairs, rates and taxes, insurance, administration and depreciation of factory, plant and equipment, indirect labour (including leave, superannuation and workers compensation), raw materials and indirect materials, and quality control. Excluded are selling and distribution expenses, finance, taxes and administration. IT 2001 addresses the cost valuation option for stocks of wine on hand. It should be considered within the context of the Philip Morris decision requiring absorption costing. If closing stock on hand is to be valued at cost, and in determining cost of goods manufactured generally, absorption costing requires capitalisation of labour, materials and apportionment of overhead costs. If winemakers grow their own grapes, trading stock cost is to include relevant costs of growing grapes. Overheads do not include the costs of establishing a vineyard such as land preparation, propagation etc. Administration, selling, finance and (usually) storage costs are not part of overheads. Where storage plays a part in obtaining a finished product wine, brandy etc some apportionment is required. The cost of storing bottled wine would not normally be included. Solutions for Gilders et al, Understanding Taxation Law 2012, Ch 11 4

5 However, it is submitted that costs such as storage in maturation casks would be an element in the cost of production. Rent is generally regarded as a financial rather than a production cost. However, the ruling does not indicate what rented items would be covered by this statement and leaves open the possibility that special circumstances may indicate a contrary treatment is appropriate. Arguably, rental costs paid in respect of items that, if owned, would give rise to depreciation charges (overheads) in part attributable to inventory, should be similarly treated. In accounting terminology, if the rent is a product cost, it should be treated as an inventory cost. The following costs are specifically excluded: interest, insurance, bank fees, stationery, telephone, postage, subscriptions, licences etc, selling expenses. Pesticides and fertilisers are costs connected with the vines and land rather than with the grapes which do not become trading stock until they are severed from the land/vines: Solutions for Gilders et al, Understanding Taxation Law 2012, Ch 11 5

6 3. Glo-worm Pty Ltd Glo-worm Pty Ltd manufactures torch batteries. During the year ended 30 June, 10 million packets were manufactured and the following (taxation) costs incurred: administration costs $27,500 direct labour 210,000 factory overheads 130,000 interest on overdraft 7,500 raw materials purchased 160,000 sales expenses 45,000 warehouse rent 15,000 (a) Raw materials: opening stock of raw materials 30,000 closing stock 25,000 (b) Work in progress. Opening stock: nil. Of the 10 million units manufactured during the year, 9.7 million were sold (in addition to opening stock); 100,000 units complete and 200,000 units 50% complete remain on hand. (c) Opening stock of finished goods was 100,000 ($5000). Required: (i) What amounts are deductible/assessable to Glo-worm under Div 70 (and other provisions)? (ii) Calculate Glo-worm s closing stocks of raw material, work in progress and finished goods at the cost option. Inventory costs $ Other $ Direct labour 210,000 Administration 27,500 Factory overheads 130,000 Interest 7,500 Raw materials 160,000 Rent 15,000 Sales expenses 45,000 Total 500,000 Total 95,000 Solutions for Gilders et al, Understanding Taxation Law 2012, Ch 11 6

7 Inventories Raw materials $ opening stock 30,000 purchases 160,000 closing stock (25,000) s 70-35(3) 5,000 (Equivalent) finished goods opening stock 5,000 $0.05) closing stock* 10,000 $0.05)* Assessable s 70-35(2) 5,000 *10 million units manufactured; 9.7m sold; 100,000 completed units on hand; 200,000 units 50% complete (= 100,000 equivalent units). Total on hand: 200,000. Inventory costs: 500,000; 10 million produced = average cost $0.05. Deductible $ Inventory costs 500,000 s 70-35(3) 5,000 s 70-35(2) (5,000) Other 95,000 Total 595,000 Solutions for Gilders et al, Understanding Taxation Law 2012, Ch 11 7