Trading stock: residential properties instalment sales contracts - stock on hand

Are residential properties 'trading stock on hand' of the taxpayer at the end of the income year for the purposes of section 70-35 of the Income Tax Assessment Act 1997 (ITAA 1997) when the properties are the subject of instalment contracts which have yet to reach settlement?

Yes. The residential properties are 'trading stock on hand' at the end of the income year for the purposes of section 70-35 of the ITAA 1997, as the taxpayer has not lost dispositive power over the properties.

The taxpayer carries on a business of buying and selling residential properties. The properties are sold under instalment sales contracts with vendor finance.

The instalment sales contract has the following features: • the sale price represents a profit over the investor's purchase price • the purchaser will pay the investor a deposit • vendor finance is provided to the purchaser with interest charged at a premium above the rate of interest paid by the investor on their mortgage on the property • payment of the balance of the price, plus interest, is by instalments over a substantial period such as 25 years • the deposit and instalments are not refundable • the purchaser is licensed to occupy and entitled to possession of the property during the term of the instalment contract • the contract states that this occupation or possession is not by way of lease • the purchaser is required to reimburse the investor for the rates and taxes on the property • the purchaser is required to keep the property in good condition and repair • the investor retains title to the property until the final instalment is paid and the contract is completed • if the purchaser defaults on the contract the deposit and instalments paid are forfeited to the investor

The taxpayer did not use the properties for any other purpose prior to sale. The properties were sold for an amount that was in excess of the amount paid by the taxpayer to acquire the property. Each property was sold within six months of it being acquired by the taxpayer.

The properties are trading stock for the purposes of subdivision 70-C of the ITAA 1997.

Section 70-35 of the ITAA 1997 compares the value of trading stock on hand at the start of the income year with the value of trading stock on hand at the end of the income year, for the purpose of working out the assessable income and deductions of a taxpayer.

The properties are 'trading stock on hand' of the taxpayer, provided the taxpayer has dispositive power over the properties.

The test of dispositive power was applied in the decision of the High Court of Australia in Farnsworth v. Federal Commissioner of Taxation (1949) 78 CLR 504; (1949) 9 ATD 33; (1949) 4 AITR 25. In that case, a fruit grower had delivered dried fruit to a packing house where it had been mixed with other growers' fruit. The High Court held that the fruit was not stock on hand of the taxpayer. In the leading judgment, Dixon J (with whom McTiernan J agreed) at page 518 relied on the fact that the taxpayer had no dispositive power over the fruit, and no power to direct or control the disposal of it by the packing house.

The issue of whether real property was 'trading stock on hand' was considered in Gasparin v. Federal Commissioner of Taxation (1994) 50 FCR 73 ; 94 ATC 4280; (1994) 28 ATR 130 (the Gasparin Case). In that case, the court found that the allotments of land remained trading stock on hand until settlement. Von Doussa J at page 81 stated:

The allotments in question remained registered in the name of the vendors until settlement. Until then the vendors had not lost all dispositive power, and had not ceased to have any proprietary interest in the land. If, for any reason a purchaser under an unsettled contract of sale did not proceed, the vendors could elect to treat the contract at an end, and resell the allotment. Prior to settlement, under the contracts of sale the purchasers undoubtedly acquired interests in equity and rights to specific performance, but the vendors did not become bare trustees for the purchasers. The vendors retained substantial interests in the allotments which they enjoyed as beneficial owners...

Under the relevant instalment contracts, the purchaser pays for the property by monthly instalments over a lengthy period, such as 25 years. Title to the property does not pass to the purchaser until the final instalment is paid. The purchaser is licensed to occupy the premises from the date of possession. If the purchaser defaults under an instalment contract, the taxpayer retains the deposit and instalments and may resell the property.

Based on the decision in the Gasparin Case, the taxpayer does not lose dispositive power over the properties until settlement. This is the case even though the time between when the taxpayer enters into the contract and settlement occurring is a lengthy period, such as 25 years.

Therefore, the properties, the subject of instalment contracts, will be 'trading stock on hand' of the taxpayer for the purposes of section 70-35 of the ITAA 1997 at the end of the income year.