Senate

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Ralph Willis, MP)

Chapter 3 - Cost price of natural increase of live stock

Overview

3.1 Part 3 of Schedule 1 of the Bill will make amendments to section 34 of the Income Tax Assessment Act 1936 (the Act) to ensure that natural increase of live stock for which no minimum value is prescribed is valued at its actual cost where taxpayers elect to value such stock at cost. [Item 21]

Summary of the amendments

Purpose of the amendments

3.2 The purpose of the amendments is two fold:

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to eliminate an inappropriate deferral of tax that gives advantages to existing producers over new producers. The amendments ensure that, where taxpayers elect to value natural increase of live stock for which no minimum value is prescribed at cost, such stock is brought to account at the actual cost of production;

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to clarify the valuation rules in respect of natural increase of live stock.

3.3 The effect of the amendments is to eliminate an inappropriate deferral of tax under the present law. The existing law gives an unintended tax advantage to those primary producers that opt for valuation at cost and may use a value which once was the cost of production. For classes of live stock for which no minimum value is prescribed, some existing producers are in a position to use historical costs that have become negligible compared to actual costs. This substantially defers tax, and gives these producers a corresponding advantage over commercial competitors who must use costs at or close to actual costs as the value of such stock.

Date of effect

3.4 The amendments will apply to natural increase occurring after 30 June 1994. [Item 24]

Background to the legislation

Effect of existing provisions

3.5 Where a taxpayer carries on a business, changes between the value of trading stock on hand at the beginning and at the end of a year of income are taken into account in determining the taxpayer's taxable income for that year (section 28). Where the value of trading stock on hand at the end of the year is greater, the excess is added to assessable income. Where the value of trading stock on hand at the end of the year is less, the reduction is an allowable deduction from assessable income. For tax purposes, taxpayers may value live stock at either cost price or market selling value (subsection 32(1)).

3.6 Where a primary producer has adopted cost price as the basis for valuing live stock, special arrangements exist for valuing natural increase of some classes of live stock. Minimum values are prescribed in the Income Tax Regulations for the natural increase of cattle, horses, pigs, sheep, deer and goats. If a minimum value is prescribed, the natural increase cannot be brought to account at a cost less than the prescribed minimum, unless the lesser cost is the actual cost (section 34).

3.7 If no minimum value is prescribed for a particular class of live stock, the natural increase may be brought to account at the value used previously or at actual cost of production (section 34).

3.8 The effect of the present law is that natural increase of classes of live stock for which no minimum value is prescribed can be valued at a one-off actual cost price and this cost price can be rolled over each year as the nominated cost price on an indefinite basis. After some years the value at which the natural increase is brought to account may be considerably less than the actual cost of producing the stock. This undervaluation gives rise to an inappropriate deferral of taxation revenue - the expenses associated with natural increase in stock are fully allowed as deductions (subsection 51(1)) but the costs are not reflected in the value of closing stock (subsection 28(2)).

3.9 The deferral of tax does not benefit all taxpayers with live stock of a particular class equally. One taxpayer may be a company using a cost of production that dates back to the 1920s. That cost may be less than a twentieth of actual cost now. That taxpayer's competitor may have commenced operations only a few years ago, and be using a cost hardly less than actual cost now. So the deferral of tax could operate to give one taxpayer a commercial advantage over another, as well as a tax benefit at the expense of the revenue generally.

Explanation of the amendments

3.10 The amendments ensure that natural increase of a class of live stock for which no minimum value is prescribed is brought to account at the actual cost of production for that year of income. This is in accordance with the Assistant Treasurer's Press Release (No.78) of 30 June 1994. The valuation method announced has been slightly modified so that natural increase for which no minimum value is prescribed is valued at the actual cost of production, rather than at the greater of the actual cost of production or the value used in a previous year of income. The modified method is a simpler basis of valuation than was announced and will produce values no higher, and in some cases lower, than the basis announced. The actual cost of production is calculated for income tax purposes on a full absorption cost basis. This method involves taking account of both fixed and variable costs, absorbing capital expenditure at an appropriate rate. This method of costing is the same basis of costing as must be used in other industries.

3.11 Amended subsection 34(1) operates so that it will only apply in valuing natural increase of a class of live stock for which a minimum cost price is prescribed [item 22, new subsection 34(1)] . The provision will operate as follows.

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A taxpayer who has adopted cost price as the basis of valuation of live stock and who has previously brought to account natural increase of a particular class, will be required to continue to bring in natural increase at the same value or at the minimum prescribed value in respect of that class whichever is the greater (subparagraph 34(1)(a)(i)).

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Alternatively, a taxpayer may obtain leave from the Commissioner to adopt some other value for valuing a class of natural increase providing the value is not less than the minimum prescribed value (subparagraph 34(1)(a)(ii) and (1)((b)(i)).

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A taxpayer may also use actual cost to value the natural increase of a class of live stock provided the taxpayer elects to do so and the actual cost price per head of natural increase of that class is less than the prescribed minimum value (subparagraphs 34(1)(a)(iii) and (1)(b)(ii))

3.12 New subsection 34(2B) ensures that if no minimum value is prescribed in respect of a class of live stock, the cost price per head of natural increase of that class of live stock for tax purposes is the actual cost price per head of natural increase of that class [item 23, new subsection 34(2B)] . The cost price is the full absorption cost, as for other valuations of trading stock at cost by taxpayers in other industries. The full absorption cost includes appropriate costs associated with bringing the natural increase into existence.

3.13 Taxpayers affected by new subsection 34(2B) should consider whether a more desirable option would be to establish prescribed minimum values for those classes of live stock that currently have none. Establishing such values would reduce compliance costs as taxpayers would not be compelled to calculate actual costs of natural increase each year provided the cost they use is no less than the prescribed minimum.

3.14 In the past there have been cases where a one-off increase in the valuation of stock has been written-off over a number of years. No transitional measure exists for bringing natural increase of live stock for which no minimum value is prescribed to account at actual cost. Such measures have only been brought in, in situations where the changed rules for valuing stock have affected all taxpayers in the industry in the same way. However, the current live stock anomaly benefits long established producers to the disadvantage of new producers and therefore to phase out the anomaly would be to maintain an unfair advantage over competing producers.

Example 1

Farmer Brown incurs certain expenditure in the 1994-95 income tax year in respect of her ostrich breeding business including:

Natural increase for the 1994-95 year is 20 ostriches. If natural increase is valued at cost the cost price per head of ostriches for this year will be calculated for tax purposes as being,

$3 950 / 20 ostriches = $197.50 per ostrich


Example 2

The cost price per head at which Farmer Jones last took his natural increase of deer into account for tax purposes was at $18 per head from a previous year of income. For the 1994-95 income year the actual cost price per head of natural increase under absorption costing for deer is $16. The minimum value of deer prescribed in the regulations is $20.

Farmer Jones makes an election under subparagraph 34(1)(a)(iii) of the Income Tax Assessment Act 1936 and can therefore value the natural increase of his deer for tax purposes at $16 per head.

If Farmer Jones does not make any election under section 34 then his natural increase of deer will be valued at $20 per head. This value is the minimum cost price prescribed in the regulations for natural increase of deer. Subparagraphs 34(1)(a)(i) and 34(1)(a)(ii) ensure, in effect that a value less than the prescribed minimum value may be used only if it is the actual cost.