Income tax: Deferral of deductions for trading stock purchases involving prepayments

This Ruling contains general guidance on the operation of subsection 51(2A) of the Income Tax Assessment Act 1936 (the Act), and explains how the provision applies to certain expenditure by primary producers and to expenditure incurred under certain livestock breeding arrangements. Subsection 51(2A) was inserted by section 14 of the Taxation Laws Amendment Act 1992. The subsection defers deductions in respect of certain expenditure incurred in a year of income in acquiring stock which will become trading stock of a taxpayer but has not become trading stock on hand at the end of the year of income.

Paragraph 51(2A)(a) describes the type of expenditure which is potentially subject to subsection 51(2A) as expenditure incurred "in connection with the acquisition of stock that will become trading stock on hand of the taxpayer". In our view, these words, read in the context of the subsection and the rest of the Act, have the effect that the subsection cannot apply to expenditure incurred in bringing trading stock into existence through manufacturing or production processes of the taxpayer, except to the extent that the expenditure relates to the acquisition of inputs to the manufacturing or production process which are themselves trading stock (and then only where the rest of the subsection is satisfied in relation to the last-mentioned trading stock). A corollary of this is that the subsection can only apply to expenditure that is incurred in the acquisition of stock which is expected to come on hand as trading stock of the taxpayer.

This Office has received enquiries about whether subsection 51(2A) can apply to expenditure of a primary producer on seed for planting or on semen for the artificial insemination of livestock, or the part of the purchase price of an orchard that is attributable to a growing crop. Our view is that subsection 51(2A) does not apply to these types of expenditure.

We have also been asked whether the subsection applies to expenditure by taxpayers under what might be termed livestock breeding arrangements. The view of this Office is that, if a taxpayer's participation in such an arrangement constitutes or forms part of a business of the taxpayer of breeding livestock (whether carried on alone or in partnership), the subsection will not apply. The subsection can apply, however, where the taxpayer's participation does not constitute or form part of such a business. In such a case the subsection will apply to so much of the expenditure incurred under the arrangements as is incurred in acquiring the livestock as trading stock of the taxpayer.

This Ruling explains the operation of subsection 51(2A), which applies to relevant expenditure incurred after 19 December 1991. Therefore it has both a past and future application (see Taxation Ruling TR 92/20). However, it does not have a past application for a taxpayer who has agreed to a settlement of a dispute to the extent that the Ruling is less favourable than the settlement terms. To the extent that the Ruling is more favourable, it does not have a past application for the taxation years the subject of the settlement.

The views expressed in paragraphs two, three and four of this Ruling are based on what we consider to be the ordinary meaning of subsection 51(2A) conveyed by its text. Other related parts of the Act, the potential capricious operation of other interpretations and the intention of Parliament evinced from extrinsic material confirm that meaning.

The words "acquisition", "manufacture" and "production" are all used separately in the definition of "trading stock" in subsection 6(1) of the Act. In the related context of subsection 51(2A), it would seem to follow that the ordinary meaning of "acquisition" cannot be taken to include "production" or "manufacture". The words "will become" in paragraph 51(2A)(a) merely ensure that the provision can apply to forward purchase contracts where payment precedes the coming on hand of the stock purchased and under which the particular stock itself is trading stock of a taxpayer when it comes on hand. The words do not describe a process by which stock "becomes" trading stock by changing its nature in some way. They do not, for example, describe the process by which seed acquired for planting grows into a crop ready for harvesting, a growing crop turns into a harvested crop, an embryo grows into a live animal, or raw materials are made into a manufactured article.

If "acquisition" included manufacture and production the subsection could apply to defer deductions for the cost of inputs to those processes that are themselves "stock" that has not attracted the subsection in its own right. If "become" included the processes by which the metamorphoses referred to above occurred, the subsection could apply to expenditure on, say, crop seed or raw materials but not on fertiliser or fuel. It would be surprising if Parliament intended the provision to have these capricious operations.

Extrinsic material supports the meaning ascribed to paragraph 51(2A)(a) in paragraph two of this Ruling. The Explanatory Memorandum to the Taxation Laws Amendment Bill (No.4) 1991, states that the provision was intended to deal with forward purchase contracts (exemplified in F C of T v Raymor (NSW) Pty Ltd 90 ATC 4461, (1990) 21 ATR 458) and other situations, such as goods in transit, where expenditure on the direct acquisition of trading stock is incurred before what is being purchased itself becomes trading stock on hand.

The phrase "livestock breeding arrangements" in paragraph four of this Ruling is intended to describe generally arrangements under which a taxpayer or taxpayers incur expenditure for the production of livestock. Usually the livestock are bred under the arrangement using the services of a person with expertise in some specialist breeding technique. Often the arrangement involves the taxpayer or taxpayers leasing livestock for the term of the arrangement for use in the breeding process. The question arises whether the expenditure incurred under the arrangement is subject to subsection 51(2A) in the sense that it is expenditure incurred in connection with the acquisition by the taxpayer or taxpayers of the livestock produced under the scheme.

Cases that have dealt with livestock breeding arrangements such as Ferguson v F C of T 79 ATC 4261, 9 ATR 873, Hanlon v F C of T 81 ATC 4617, 12 ATR 540, Walker v F C of T 85 ATC 4179, 16 ATR 331, F C of T v Solling; F C of T v Pepper 85 ATC 4518, 16 ATR 753 and Case R7 84 ATC 151, Case 5827 CTBR(NS) 515 make it clear that it cannot be assumed that a participant in such an arrangement will be entitled to a deduction for the expenditure incurred under the arrangement, nor that participation will automatically make the livestock produced the trading stock of the taxpayer. As the cases show, the answers to those questions depend on the circumstances of the individual taxpayer. Subsection 51(2A) will not be relevant, of course, if the expenditure is not deductible in the first place or, if deductible and incurred in acquiring the livestock, the livestock are not trading stock of the taxpayer.

The view expressed in paragraph four of this Ruling that subsection 51(2A) does not apply to expenditure incurred under a livestock breeding arrangement which constitutes or forms part of a livestock breeding business of the taxpayer is arrived at because in such a circumstance, the product of the arrangement (that is, the livestock which the taxpayer receives) is considered to be brought into existence as a result of the taxpayer's own production activities, and so is not acquired by the taxpayer in the sense contemplated by subsection 51(2A) (as explained in paragraph two of this Ruling).