House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Rt. Hon. Phillip Lynch, M.P.)

Main Features

The purpose of this memorandum is to explain the main features of two income tax Bills.

Income Tax Assessment Amendment Bill 1977

The first Bill - the Income Tax Assessment Amendment Bill 1977 - will effect a number of changes to the provisions of the Income Tax Assessment Act. The main proposals in the Bill are outlined below.

Commonwealth Rebate for Apprentice Full-Time Training (CRAFT) Scheme (Clauses 3 and 15)

Rebates payable to employers under the CRAFT scheme that came into operation on 15 January 1977 are to be exempt from income tax. Special allowances payable in certain circumstances to apprentices under the scheme are to be subject to pay-as-you-earn tax instalment deductions in the same way as are salary and wages or other similar periodical payments and allowances in the nature of income.

Exemption of certain pensions (Clause 4)

The long-standing subjection to tax of all pensions paid under the superannuation scheme for members of the Defence Force, which has been disturbed by a recent decision of the High Court, is being restored.

Purchase of trading stock not at arm's length (Clause 5)

Associated with the proposed trading stock valuation adjustment scheme referred to below, special safeguarding measures are to be introduced to counter possible avoidance of tax through non-arm's length purchases of trading stock at inflated prices. One purpose of the proposal is to prevent excessive benefits being drawn from the trading stock adjustment. At the same time it will ensure that deductions for the cost of trading stock under the general provisions of the income tax law are not enlarged by transfer pricing arrangements between associated persons.

Disposal on change of ownership or interests (Clause 6)

With the introduction of the trading stock valuation adjustment scheme proposed by clause 8 of the Bill, an amendment to section 36A of the Principal Act is proposed, to qualify the circumstances in which an election may be made to transfer trading stock at cost price or replacement price instead of market value where there has been a partial change in the ownership of the stock such as in consequence of the formation, dissolution or variation in the interests of a partnership. The right to make such an election will, in future, be available only if the market value of the trading stock at the time of the transfer is greater than the cost price to the former owner or owners or the price for which the stock could be replaced.

Gifts, calls on afforestation shares, etc. (Clause 7)

Gifts of $2 or more to the Queen Elizabeth II Silver Jubilee Trust for Young Australians will, by the amendment proposed, become allowable as deductions from assessable income.

Trading stock valuation adjustment (Clause 8)

A special income tax deduction, measured by reference to the annual increase in the index for the goods component of the Consumer Price Index, is to be allowed to firms and companies holding eligible trading stocks for business purposes. The range of trading stock to which the adjustment is to apply includes most goods and livestock held and properly accounted for as trading stock for income tax purposes. It does not include property, not being goods, such as land, buildings, construction work-in-progress, shares, securities and other legal rights or industrial property such as patents and copyrights. Animals used for sporting or domestic purposes are also outside the scope of the scheme.

The annual adjustment for a firm or company is to be made by way of a deduction calculated as a percentage of the value of its trading stock of goods on hand at the beginning of the year of income or at a relevant time. For these purposes the value of trading stock will be that adopted for income tax purposes or the cost price of the stock, whichever is the less.

Special provisions are proposed where, during a year of income, a business changes hands or there is a change in the interests of the proprietors. Broadly, the amount of any adjustment in these circumstances will be calculated on a time basis. The adjustment is generally not to be available to the proprietor of a business in the income year in which it is brought to an end but, where a business is terminated on the death of its proprietor, it will be treated as having been disposed of on the date of death and a part-year deduction allowed. The percentage to be applied in ascertaining the amount of the deduction will be one-half of the percentage increase, measured on a June quarter to June quarter basis, in the index for the goods component of the Consumer Price Index during the year of income.

The deduction by way of the trading stock valuation adjustment will be allowable for the 1976-77 income year, being based on the trading stock on hand at the commencement of that year, and calculated by reference to the increase in the relevant index from the June quarter of 1976 and the June quarter of 1977.

Income tax averaging (Clauses 9 to 11)

A technical amendment to the method of calculating average incomes for the purpose of determining the rates of tax payable on taxable incomes of primary producers for 1976-77 and subsequent years is proposed. The amendment will provide that if the taxable income of any year within the averaging period exceeds $16,000, the excess of the taxable income over that amount is to be disregarded for income tax rate purposes.

Instalments of company tax (Clauses 13 and 14)

An amendment of the Income Tax (Companies and Superannuation Funds) Act 1976, as proposed in the second Bill will bring back into operation in 1977-78 the system for collection of company tax by instalments. Associated amendments of the Income Tax Assessment Act will limit the number of instalments to be paid in that financial year to 2 and set the earliest due dates for payment at 15 November 1977 for the first instalment and 15 February 1978 for the second instalment. The balance of the tax assessed on the 1976-77 income of a company that has been called upon to pay one or both of those instalments will be payable by the due date of its assessment - ordinarily a date within the final quarter of the 1977-78 financial year. In the following financial year, 1978-79, the quarterly payments system will be in full operation, with the first of 3 instalments being due not earlier than 15 August 1978.

Cancellation of registration of tax agent (Clauses 16 and 17)

Since 1 July 1976, the Administrative Appeals Tribunal Act 1975 has provided that a tax agent whose registration has been cancelled by a Tax Agents Board may have the Board's decision reviewed by the Administrative Appeals Tribunal and not by the courts at present specified in section 251K of the Principal Act. Section 251K is being amended by clause 16 to reflect these changed appeal arrangements. A complementary amendment by clause 17 will remove the relevant appeal provisions from the Administrative Appeals Tribunal Act 1975.

Income Tax (Companies and Superannuation Funds) Bill 1977

The second Bill - the Income Tax (Companies and Superannuation Funds) Bill 1977 - will amend the Income Tax (Companies and Superannuation Funds) Act 1976 to facilitate re-introduction in 1977-78 of the system for collection of company tax by instalments. It will incorporate a new provision in that Act, which declared the rates of tax payable by companies and superannuation funds for the 1976-77 financial year, to provide that instalments of tax are payable by companies in respect of 1976-77 income in accordance with Division 1A of Part VI of the Income Tax Assessment Act 1936 (referred to in these notes as the "Principal Act").

Notes on Clauses

INCOME TAX ASSESSMENT AMENDMENT BILL 1977

The main features of this Bill have been referred to in the introductory pages of this Memorandum. The following notes relate to the individual clauses of the Bill.

Clause 1: Short title and citation

This clause formally provides for the short title and citation of the Amending Act and the Principal Act.

Clause 2: Commencement

Section 5(1A) of the Acts Interpretation Act 1901 provides that every Act shall come into operation on the twenty-eighth day after the day on which the Act receives the Royal Assent, unless the contrary intention appears in the Act. By this clause, it is proposed that, with the exception of clauses 16 and 17, the amending Act is to come into operation on the day on which it receives the Royal Assent.

Clauses 16 and 17 are to be deemed to have come into operation on 1 July 1976 for the reasons given in the notes on those clauses.

Clause 3: Exemptions

This clause is related to the new CRAFT scheme - the Commonwealth Rebate for Apprentice Full-Time Training - which came into operation on 15 January 1977.

The CRAFT scheme provides rebates for employers in respect of wage costs that they incur in respect of apprentices released to attend technical colleges for compulsory full-time basic trade training or to undertake full-time off-the-job training. These rebates are to be tax-free in the employers' hands.

Clause 3 inserts in section 23 of the Principal Act a new provision - paragraph (jc) - which will expressly exempt the rebates from income tax. Clause 18 provides for the exemption to apply in employers' assessments in respect of income of the 1976-77 income year and of all subsequent years.

Clause 4: Exemption of certain pensions

The amendment proposed by this clause will give effect to the recent announcement of a Government proposal that the income tax law be amended so that all pensions paid under the superannuation scheme for members of the Defence Force will be liable to tax.

This amendment is in consequence of the High Court's recent decision in the case of Goodfellow v. Commissioner of Taxation. The issues in that case concerned the application of provisions, since re-enacted as section 23AD(3)(b) and (c) of the Principal Act, to an invalidity pension paid under the Defence Forces Retirement Benefits Scheme to a former naval officer who was disabled as the result of an accident sustained in the course of duty. The provisions exempted from tax pensions regarded as being of a similar nature to exempt repatriation disability pensions, as well as certain wounds and disability pensions of the kind specified in a provision of United Kingdom legislation that applies to former members of the United Kingdom armed forces.

Pensions payable under the DFRB Scheme had always been regarded as outside the scope of those provisions but, in the particular case, the High Court held that the first of the provisions mentioned applied to exempt the former officer's pension.

The Commissioner of Taxation has taken the view that the Court's decision affects all invalidity pensions paid under the DFRB Scheme and the successor DFRDB Scheme. He also regards it as applying to pensions paid under those schemes to widows of men who, at the time of death, were in receipt of invalidity pensions and to widows of men who died while in the Defence Force.

The main purpose of the proposed amendment is, in these circumstances, to establish that section 23AD does not operate to exempt from tax any pension paid under those superannuation-type schemes after the date specified in the announcement referred to earlier, i.e. after 21 April 1977.

Clause 4 proposes the addition to section 23AD of the Principal Act of a new sub-section (4). This sub-section will provide that nothing in section 23AD exempts from tax any payment made under specified Acts. Since all members of the permanent army, and some other service personnel, were covered by the ordinary Commonwealth Superannuation Scheme prior to the introduction of the DFRB Scheme in 1948, the sub-section includes a reference to the relevant Superannuation Acts by which they were covered. Also specified are the Acts which give effect to the DFRB and DFRDB Schemes. The opportunity has further been taken to declare expressly that superannuation and similar pensions paid by the Commonwealth under other Acts are not within the scope of the exempting provision.

By sub-clause (2) of clause 18 of the Bill the amendment made by clause 4 will apply for assessment purposes in relation to pensions paid after 21 April 1977 and, by sub-clause (3) of clause 18, it will apply for the purposes of pay-as-you-earn tax deductions in respect of pensions paid on or after the date the Bill receives the Royal Assent.

Clause 5: Purchase of trading stock not at arm's length

This clause proposes an amendment to the Principal Act to insert a new section - section 31C - that is intended to close avenues for legal tax avoidance by means of arrangements under which trading stock is transferred at excessive prices between parties not dealing with each other at arm's length. In general terms, the arrangements which the new section is intended to prevent would seek to maximise the tax benefits to be provided under the scheme of trading stock valuation adjustments to be introduced by clause 8 of the Bill. They would, however, also inflate deductions available for the cost of purchasing trading stock under the general deduction provisions of the income tax law.

Stated very broadly, section 31C will enable the Commissioner of Taxation to calculate the respective income tax liabilities of the vendor and purchaser of trading stock that is sold at excessive prices in a non-arm's length sale as if the sale had been made at the price for which the purchaser could have acquired identical trading stock in an arm's length dealing with the vendor or an alternative supplier.

Sub-section (1) of section 31C identifies the transactions in respect of which the Commissioner is to be authorised to set aside, for income tax assessment purposes, the actual price paid for the trading stock and to substitute a notional purchase price. The section will apply where, in broad terms :

(a)

a person has purchased an article of trading stock from another person;

(b)

the Commissioner of Taxation is satisfied that the parties were not dealing with each other at arm's length in respect of the transaction; and

(c)

the Commissioner is also satisfied that -

(i)

the purchase price exceeded the amount that the purchaser would have paid the vendor had they been dealing at arm's length; or

(ii)

that the purchaser could have obtained identical trading stock from another person at a lower total acquisition cost than that actually incurred by the purchaser in acquiring the stock purchased from the vendor.

Paragraph (a) of the sub-section specifies that the section is to apply to transactions entered into whether before or after the commencement of the section, whereby a purchaser acquires trading stock from a vendor. By clause 2 of the Bill the section will come into operation on the day on which the Bill receives the Royal Assent. Sub-clause (4) of clause 18 of the Bill provides for the new section 31C to apply generally in respect of assessments for the year of income that commenced on 1 July 1976 and subsequent years but not in relation to trading stock purchased before the commencement of the 1976-77 income year. This will make it clear that the section does not apply so as to disturb the value on purchase price of trading stock held by a purchaser at the commencement of the 1976-77 income year, either for general assessment purposes or for the purposes of the trading stock valuation adjustment scheme which is to apply in the first instance by reference to the value of trading stock on hand as at the commencement of the 1976-77 income year.

It is also made clear in paragraph (a) that the section is concerned only with the purchase of articles that are trading stock for income tax purposes in the hands of the purchaser. "Trading stock" in this context carries the meaning given to that term by section 6(1) of the Principal Act and includes anything (including livestock) produced, manufactured, acquired or purchased for purposes of manufacture, sale or exchange.

Paragraph (b) of sub-section 31C(1) will require the Commissioner of Taxation to have regard to any connexion between the vendor and purchaser or to any other relevant circumstances in satisfying himself whether the vendor and purchaser were dealing with each other at arm's length in relation to the sale of trading stock under examination. It would be appropriate, for example, where the parties concerned are companies, to take into account whether they were members of the one company group or had substantially the same people as shareholders. In relation to individual persons, dealings in trading stocks between relatives or between members of a partnership would not be regarded as arm's length dealings and will thus be capable of examination by the Commissioner.

Paragraph (c) of the sub-section specifies the remaining matter on which the Commissioner must be satisfied in order to bring section 31C into operation, namely, that the purchase price paid by the purchaser for the trading stock was, in the particular circumstances, excessive. This will be the case if, as provided in sub-paragraph (c)(i), the Commissioner is satisfied that the purchaser would have been able to purchase the trading stock at a lower price from the associated vendor had they been dealing with each other at arm's length. A simple illustration of such a situation would be where the vendor was known to be generally willing to supply identical stock to other persons at lower prices than the price paid by the purchaser concerned.

Alternatively, in terms of sub-paragraph (c)(ii), the Commissioner may be satisfied -

•

that the purchaser could have purchased, and obtained delivery at much the same time, identical trading stock from some other source (clause (A));

•

that the total costs attributable to purchasing and obtaining delivery of the trading stock actually purchased were greater than those that would have been incurred had the identical stock been acquired from the alternative available source (clause (B)); and

•

that the purchase price actually paid was also greater than the purchase price that, in the opinion of the Commissioner, would have been paid if identical stock had been purchased from the alternative source (clause (C)).

Where the Commissioner is satisfied that an excessive price has been paid in terms of sub-paragraphs (c)(i) or (ii) and the pre-conditions specified in paragraphs (a) and (b) are also met, sub-section 31C(1) declares that the purchaser is, for all purposes of the application of the Principal Act, to be regarded as having paid the vendor in respect of the relevant trading stock an amount ascertained in accordance with sub-section (2) and the vendor is to be taken as having received the amount so ascertained.

The effect of this will be to allow the Commissioner to disregard for income tax assessment purposes, in relation to both the purchaser and vendor in respect of the transaction, the actual price paid and to treat the trading stock as having changed hands at a lower price determined by the application of sub-section (2). In practical terms, the amount deemed to have been paid may, as a consequence, be taken into account in determining in respect of the purchaser -

•

the amount allowable as a deduction under section 51 of the Principal Act as expenditure necessarily incurred on the acquisition of trading stock for the purchaser's business;

•

the value at which the trading stock may be taken into account under section 28 of the Principal Act at the end of a year of income of the purchaser under the general trading stock provisions of the Principal Act (i.e. where the purchaser elects under section 31 to bring the trading stock to account at cost price); and

the amount of any deduction allowable in relation to the trading stock under the proposed trading stock valuation adjustment scheme which will be determined by reference to cost unless, for general assessment purposes, a lower value has been adopted (see the notes on clause 8 of the Bill).

For the vendor, the practical effect of applying section 31C in relation to a non-arm's length sale of trading stock will be to reduce to the amount ascertained under sub-section (2) the amount to be included in the assessable income of the vendor as attributable to the sale of the relevant trading stock.

Sub-section (2) of proposed section 31C sets the rules by which the Commissioner is to fix the amount that is to be adopted, for the purposes of the assessment of both vendor and purchaser, in lieu of the actual purchase price of trading stock when he finds that the transaction falls within the category defined in sub-section (1).

Where the Commissioner is satisfied that the purchaser could have bought the trading stock from the vendor for a lower price (referred to as the "arm's length price") had they been dealing at arm's length but is not satisfied that the purchaser could have obtained identical stock from an alternative source at a total acquisition cost lower than that actually incurred, then the purchase price will be deemed to be the "arm's length" price (paragraph (2)(a)).

This would be the situation, for example, where the vendor was the sole manufacturer or distributor of the kind of trading stock in question.

The second set of circumstances provided for (in paragraph (2)(b)) is where the Commissioner is satisfied that identical trading stock could have been obtained from an alternative source at both a lower purchase price and a lower total acquisition cost, taking into account differentials in freight charges or other expenses directly attributable to the acquisition, but has not formed a view that the actual vendor would have supplied the stock at a lower price had the parties dealt at arm's length. An example of such a situation could arise where a retailer purchased stock from an associated wholesaler at wholesale prices although identical stock could readily be obtained by the retailer from a manufacturer at lower prices.

In the circumstances specified in paragraph (2)(b), the purchase price is to be deemed to have been an amount equal to the sum of the alternative purchase price that would have been charged by another supplier for identical trading stock plus such additional sum as the Commissioner considers fair and reasonable taking into account any extra costs (e.g. for freight or insurance of the stock in transit) as would have been incurred had the purchaser elected to purchase from the alternative supplier.

Paragraph (c) of sub-section (2) deals with the final possibility that the Commissioner is satisfied as to the matters specified in both sub-paragraphs (c)(i) and (ii) of sub-section (1) i.e. that the purchaser could have purchased the stock at a lower price from the vendor had they dealt at arm's length and also that identical stock could have been obtained from an alternative source at a lower total acquisition cost.

In that event the purchase price is to be deemed to have been the lesser of the following amounts -

(i)

the price that would have been paid to the vendor had the parties not been at arm's length (the "arm's length price"); or

(ii)

the purchase price that would have been charged for identical stock by the alternative supplier plus a fair and reasonable sum to take account of any additional costs that would have been directly incurred in freight and other expenses had the purchaser availed himself of the alternative source of supply.

Sub-section (3) of proposed section 31C is designed to make it clear that the section is to apply in relation to dealings in trading stock between a partnership and its members whether or not the transactions arise in the ordinary course of carrying on a business.

It will bring within the scope of the section two broad categories as follows -

(a)

Transfers of undivided fractional interests in trading stock forming part of the assets of a business such as may occur on the formation, variation or dissolution of a partnership - under section 36A of the Principal Act (which is described in the notes following in relation to clause 6 of the Bill), a transfer of this kind is deemed to constitute a disposal of trading stock for the purposes of section 36 of the Principal Act. Section 36 applies to disposals not in the ordinary course of carrying on business. A sale by a member of a family of a business, including trading stock, to a partnership of which he and other family members are the partners would be an example of a disposal that is brought within the scope of section 36 by the operation of section 36A;

(b)

Sales of trading stock between a partnership and its members. Sales of this kind may occur in the ordinary course of business such as where one of the members of a partnership, acting as sole proprietor of a business, sells trading stock to the partnership for sale by it in the course of carrying on the business of the partnership.

Sub-section 31C(4) is a drafting measure intended to make it clear that references in sub-section (1) to the cost to a person of purchasing trading stock are read as meaning not only the purchase price paid to the vendor (or, where appropriate, the price that would have been paid to another person had stock been purchased from that other person) but also any expenditure over and above the purchase price that is directly attributable to purchasing or obtaining delivery of the trading stock. Examples of expenditure in addition to the purchase price that would be included by sub-section (4) are freight charges, import duties and insurance premiums for insurance of stock-in-transit.

The practical effect of sub-section (4) will be to allow a proper comparison to be made of the actual cost of acquiring stock in a transaction under examination and the alternative cost of acquiring identical stock elsewhere in order to establish whether an excessive price was paid in a non-arm's length dealing.

Sub-section (5) will make it clear that section 31C applies in relation to a purchase of trading stock notwithstanding standing that the purchase was made in the course of an ordinary family or commercial dealing. The fact that the purchase price paid for trading stock is explicable by ordinary family or commercial dealing will not therefore prevent the Commissioner from substituting a lower notional price if he is satisfied that the price actually paid for trading stock was excessive in terms of sub-section (1).

Clause 6: Disposal on change of ownership or interests

This clause proposes an amendment to section 36A of the Principal Act which applies to transfers of undivided fractional interests in trading stock associated with the formation, variation or dissolution of a partnership. Section 36A is designed to make clear that such a change of interests is to be treated as a "disposal" of the trading stock for the purposes of section 36 of the Principal Act. That section requires that where trading stock forming the whole or a part of the assets of a business is disposed of by a taxpayer other than in the ordinary course of carrying on the business, the value of the trading stock is to be included in his assessable income. The value to be brought to account as assessable income of the former owner or owners in these circumstances is generally the value ascertained in accordance with sub-section (8) of section 36, that is, the market value at that time. The stock is also taken to have been acquired at that value by the new owners.

The existing sub-section 36A(2) allows the operation of section 36 to be varied in cases where the former owner or owners retain an interest of 25 per cent or more in the trading stock after the change in ownership. In broad terms, sub-section 36A(2) allows the parties to elect that the stock be regarded for the purposes of section 36 as having been transferred at the cost price to the former owner or owners or at the cost at which it could be replaced rather than at market value. The underlying purpose of sub-section 36A(2) is to allow the deferral, until such time as stock is sold by the new owners, of any tax on the difference between the cost price to the former owners and the market value at the date of transfer.

However, section 36A(2) as presently drafted would also permit taxpayers to elect that trading stock, not acquired under arm's length arrangements, be regarded for income tax purposes as having been transferred at cost price even if this exceeded the market value. This could occur in the case of obsolescent or unfashionable goods.

In these circumstances the proposed trading stock valuation adjustment would be based on cost values in excess of the arm's length value to which the new adjustment is intended generally to apply.

It is therefore proposed to replace the present sub-section 36A(2) with a new sub-section 36A(2) which will limit elections under the section to cases where the market value of the stock is greater than the value that would have been taken into account if there had been no disposal.

Such an amendment, which will accord with the original intention of the section, will not inhibit the application of section 36A in carrying out its intended function of deferring the tax on the difference between cost and market value of trading stock until the stock has been sold.

The amendment will apply in respect of transfers of interests in trading stock that occur during the 1976-77 income year and subsequent income years.

Clause 7: Gifts, calls on afforestation shares, pensions, etc.

An amendment to section 78 of the Principal Act is proposed by this clause to authorise deductions for gifts made to the Queen Elizabeth II Silver Jubilee Trust for Young Australians. The clause proposes the insertion of a new sub-paragraph - sub-paragraph (xiv) - in paragraph (a) of section 78(1) which authorises as allowable deductions gifts of the value of $2 and upwards to funds, authorities or institutions specified therein. The new sub-paragraph will list the Queen Elizabeth II Silver Jubilee Trust for Young Australians as a fund to which section 78(1)(a) applies.

Clause 8: Trading stock valuation adjustment

Introductory Note

The purpose of this clause is to insert in Part III of the Principal Act a new subdivision - Subdivision BA of Division 3 - the provisions of which will authorise deductions by way of trading stock valuation adjustments calculated by reference to the increase in the index for the goods component of the Consumer Price Index and the value of eligible trading stock held by firms and companies at the commencement of a year of income or such other time as is relevant. The adjustment is to be available in respect of the year of income that commenced on 1 July 1976 and subsequent years.

The broad plan of the adjustments scheme is to allow taxpayers who carry on a business throughout a year of income a special deduction related to the value of specified trading stock on hand at the commencement of the year of income. The deduction is to be ascertained by applying to the value of that trading stock, a percentage equal to one-half of the percentage increase in the index for the goods component of the Consumer Price Index between the June quarter of the year preceding the year of income and the June quarter of the year of income. The deduction is to be available in the first instance in relation to the 1976-77 income year.

Eligible trading stock for the purposes of the scheme will include most classes of trading stock, including livestock, the value of which is required to be brought to account under the general trading stock provisions of the income tax law in determining whether a taxpayer has a taxable income. The scheme will not apply in relation to land, buildings, construction work-in-progress, consumable stores or spare parts, or to shares, debentures, public securities or other choses in action. Nor will it apply in relation to animals, birds or fish for use in, or in connexion with, sporting or recreational activities or to be kept as pets or for other domestic purposes.

The deduction is, in the case of a continuing business, to be calculated by reference to the income tax value at which opening stock is brought to account for general assessment purposes or to its cost price, whichever is the less. If stock is brought to account for general income tax purposes at a value greater than cost price, the deduction will be based on cost price.

Separate provision is made for cases where a business is carried on for part only of a year of income. A deduction will generally not be available where a business is discontinued before the end of the income year but, where a business is terminated after the death or bankruptcy of a proprietor, a proportionate deduction will be allowable in respect of the period ending on the date of death or bankruptcy.

Where a business is sold by a taxpayer as a going concern during a year of income and the Commissioner of Taxation is satisfied that the taxpayer expected that the business would be carried on for the remainder of the year, a proportionate deduction will be allowable to the taxpayer in respect of the part of the year in which the taxpayer carried on the business. The purchaser will also receive a pro rata deduction for the time he carries on the business. Broadly speaking, the adjustment will, in the case of each party, be measured by reference to the value of the trading stock of the business at the commencement of that year in which the sale takes place or the value of the trading stock at the date of the sale, whichever is the less. Special provisions apply, however, where the vendor of a business had only acquired or commenced a business within the income year in which the sale takes place.

A taxpayer who starts up a new business during a year of income will also be entitled to a pro rata deduction in respect of trading stock held in relation to the business. As there will have been no stock on hand at the commencement of the income year, provision is being made for the initial deduction in the case of a new business to be calculated by reference to two-thirds of the value of trading stock on hand at the end of the income year.

Where a business is transferred from one company to an "associated" company (as defined), for example, in the course of a re-organisation of a company group, the associated company will, if both companies so elect, be entitled to claim the deduction otherwise allowable to the vendor company in addition to that available to it in its own right.

Special provisions will apply to reduce the deduction otherwise available where there is a permanent reduction in the scale of operations of a business, or where it is considered that a business is holding an unnecessarily high level of stocks.

A detailed explanation of the new trading stock valuation adjustment provisions is contained in the following notes dealing individually with the various sections that are to make up the new Subdivision BA of Division 3 of Part III of the Principal Act.

Section 82B : Interpretation, etc.

For the purposes of new Subdivision BA, an interpretation section - Section 82B - ascribes particular meanings to a number of terms and expressions that have been used in drafting the Subdivision. It also contains a number of other measures to facilitate the drafting of the operative provisions of the Subdivision.

Sub-section (1) of the proposed new section 82B defines terms used in Subdivision BA:-

"acquisition" : is defined as including the acquisition of a business under a will or by operation of law. The latter phrase brings within the scope of these provisions a business that devolves on a person from the estate of intestate persons or that is transferred by reason of the bankruptcy of a proprietor (e.g. by vesting in the Official Receiver on sequestration of a bankrupt).

"disposal" : is given a corresponding meaning to acquisition. Accordingly a deceased person or bankrupt will be treated as having disposed of a business where the relevant law operates to transfer the assets of a business to another on the happening of the relevant event.

"index number" : The deduction to be allowed by way of the trading stock valuation adjustment for a year of income is to be an amount equal to the prescribed percentage of the value of eligible trading stock. The prescribed percentage is defined (see below) in terms of the movement in the index for the goods component of the Consumer Price Index over the course of the relevant financial year. The term "index number" is defined to facilitate the drafting of the definition of the "prescribed percentage" and means the index number for the goods component of the CPI, being the weighted average of 6 State capital cities published by the Australian Statistician.

"prescribed percentage" : As explained in relation to the definition of "index number", the deduction to be allowed for a year of income is to be an amount equal to the prescribed percentage of the value of eligible trading stock. The term "prescribed percentage" is defined in terms of the "index number" (already defined as the index number of the goods component of the CPI) and is to be ascertained in accordance with the formula

(50 * (a - b))/( b)


As a and b respectively are the index numbers for the June quarter of the year of income and for the June quarter of the year next preceding the year of income, it follows that the prescribed percentage will be a percentage equal to one-half of the percentage increase in the "index number" between those 2 quarters.

The application of the formula is illustrated below by reference to the hypothetical index numbers of 105 for the goods component of the CPI for the June quarter of 1976 and 120 for the June quarter of 1977. Thus

a = 120


b = 105


(prescribed percentage) = (50*(120 - 105))/ (105)


= 7.1%


"relevant financial year" : The definition of "prescribed percentage" makes reference to index numbers for the relevant financial year as being the financial year ending on 30 June irrespective of the accounting period adopted in lieu thereof and will ensure that, for any particular year of income, the same prescribed percentage is applied in calculating the deductions allowable to all taxpayers qualifying for the trading stock valuation adjustment.

"trading stock" : A definition of trading stock is included in the proposed new Subdivision to make it clear that the trading stock valuation adjustment is not to apply in relation to land or an interest in land or in relation to certain other items of property which in certain circumstances may be brought to account as trading stock. Except as provided by the definition, "trading stock" will have the same meaning for the purposes of the new Subdivision as it has in section 6(1) of the Principal Act.

The items which are not to be treated as trading stock for the purposes of the Subdivision whether or not they are properly brought to account as trading stock for the general purposes of the Income Tax Assessment Act are as follows:

(a)

land or an interest in land;

(b)

shares in, or debentures of, companies;

(c)

bonds, debentures, stock or other securities issued under an Act of the Australian Parliament;

(d)

bonds, debentures, stock or other securities issued by -

(i)

a State;

(ii)

a Territory;

(iii)

a municipal corporation, other local governing body or public authority constituted by or under an Act or by or under a law of a State or Territory;

or

(iv)

a foreign government or an authority of a foreign government;

(e)

choses in action;

or

(f)

animals (including birds and fish) for use in, or in connexion with, sporting or recreational activities or to be kept as pets or to be kept for other domestic purposes.

Buildings and construction work-in-progress owned by a taxpayer would represent an interest in land and would be excluded from the scope of the adjustment by paragraph (a) of the definition in the event that they were properly brought to account as trading stock under the general provisions of the Principal Act.

The exclusion of choses in action (paragraph (e) of the definition) will have the effect of excluding industrial property, television program rights and other choses in action from the scope of the scheme whether or not they are properly brought to account as trading stock for general assessment purposes.

Property that may not properly be brought to account as trading stock will, of course, be outside the scope of the scheme. Thus items held for use in a business such as spare parts and consumable stores will not qualify for the adjustment.

Sub-section (2) of section 82B proposes, subject to sub-section (3) described below, that if the Australian Statistician revises an index number previously published in respect of the June quarter of a financial year and publishes the revised index number, the new index number is nevertheless to be disregarded for the purposes of the new Subdivision BA. This will ensure that the same prescribed percentage is applied consistently to all taxpayers in respect of a particular income year irrespective of when an assessment is made in respect of the income of that year.

Sub-section (3) of section 82B covers the situation where a new reference base is adopted by the Australian Statistician for the goods component of the Consumer Price Index. In this event, the index numbers for successive June quarters to be compared in arriving at the prescribed percentage will be those published in terms of the series founded on the new reference basis.

Sub-section (4) of the section is a drafting measure to give effect to the requirement that the "prescribed percentage" be calculated to the nearest 1 decimal place. It provides for the prescribed percentage calculation to be made initially to 2 decimal places and, if the figure for the second decimal place is greater than 4, the first decimal place is to be increased by one, e.g., if the percentage calculated to 2 places is, say, 7.26 then the "prescribed percentage" becomes 7.3.

Sub-section (5) of section 82B will provide a basis for determining the value at which trading stock is to be brought to account at a relevant time for the purpose of calculating the amount allowable as a deduction under the new subdivision BA.

Paragraph (a) of sub-section (5) will apply where the commencement or end of a year of income is a relevant time for determining the value of trading stock for the purposes of the new Subdivision. It will provide that the value for these purposes is to be the lesser of the value at which the stock is brought to account at that time under section 28 of the Principal Act in ascertaining whether a person has a taxable income, or the cost price of the trading stock.

For general assessment purposes trading stock is required, at the taxpayer's choice, to be valued at cost price, market selling value or the price at which it can be replaced. Special provisions that apply in relation to the valuation of wine stocks and natural increase of livestock may, in some circumstances, result in those classes of trading stock being taken into account for general assessment purposes at a value that is less than cost price. In other cases, the market selling value or replacement price selected for income tax purposes by holders of other kinds of trading stock may fall below the cost price of the stock. Section 28 of the Principal Act requires, for the purpose of ascertaining the taxable income of a person carrying on a business, that a comparison be made between the values of trading stock on hand at both the commencement and end of a year of income. Where the value of closing stock exceeds the opening stock value, the excess is treated as assessable income. If it is less, the reduction in values is allowable as a deduction. Under section 29, the value of trading stock on hand at the commencement of a year of income is, for the sake of consistency, required to be taken into account at the same value as it was accounted for as stock on hand at the end of the previous year.

Paragraph (b) of proposed sub-section (5) will apply where the relevant time for determining the value of trading stock on hand in relation to a business is the day on which a business is disposed of or acquired. In these cases, it is provided that the value of trading stock for purposes of the scheme is to be the value included in the assessable income of a person under section 36 or 37 of the Principal Act.

As discussed in the earlier notes on clause 6 of the Bill, section 36 of the Principal Act, broadly stated, applies where a taxpayer disposes by sale, gift or otherwise of trading stock that forms the whole or part of the assets of a business and the disposal does not take place in the ordinary course of business. In these circumstances, section 36 generally has effect so that the market value of the trading stock is included in the assessable income of the taxpayer while the person acquiring it is treated as having purchased the trading stock at a price equal to the market value.

Section 37 of the Principal Act applies in a similar way where trading stock forming the whole or part of the assets of a business devolve on the death of the proprietor. It provides that the market value of the stock is to be included in the assessable income derived by the deceased taxpayer up to the date of death and the person on whom the trading stock devolves is to be taken as having purchased it at the same value except where the trustee and beneficiaries of the deceased taxpayer's estate unanimously elect to carry the trading stock over to the estate at the tax value (generally the cost) at which the stock would have been accounted for as closing stock of the deceased proprietor.

By virtue of proposed paragraph 82B(5)(b), the value determined under sections 36 or 37 in relation to the trading stock of a business that is disposed of other than in the ordinary course of business, or by devolution on the death of the proprietor, will be taken into account as relevant in determining the deduction entitlements of the former proprietor and new proprietor in relation to the income year in which the change of ownership occurred under rules contained in proposed section 82D discussed later.

Sub-section (6) of section 82B determines the time when a taxpayer is to be taken to have commenced to carry on a business. This is necessary for the purpose of calculating the taxpayer's entitlement to a proportionate deduction under this Subdivision, on a time basis, in respect of the year in which he commences to carry on business.

Paragraph (a) of sub-section (6) provides that a taxpayer who acquired a business from another person is to be treated as having commenced to carry on the business at the date of acquisition, e.g., on the day on which the business was purchased under a contract of sale.

Paragraph (b) of sub-section (6) applies to a taxpayer who commences a new business. It provides, broadly, that a taxpayer is to be treated as having commenced to carry on the business on the first day of the month following the time when his total expenditures on the acquisition of trading stock amounted to at least one-third of the value of stock on hand in relation to the business at the end of the initial year of income or at the date of earlier disposal.

Where trading stock is first acquired in the last month of the year of income, the taxpayer is to be taken to have commenced to carry on business immediately before the commencement of the next succeeding income year. The practical effect of this provision is to ensure that the opening value of trading stock on hand at the commencement of that succeeding income year is the base for the allowance of a stock valuation deduction in relation to that year.

A taxpayer who carries out the initial steps to commence a new business during a year of income, but does not acquire stocks for the purpose of the business until the following year, will be taken as commencing the business in the year in which he first acquires trading stocks.

Sub-section (7) of section 82B applies where a taxpayer carries on 2 or more businesses and provides that, in those circumstances, the Subdivision is to be construed as applying separately in relation to the operations of, and to any acquisition or disposal of, each of those businesses.

Sub-section (8) of section 82B further provides that a taxpayer shall not be taken to have carried on 2 or more businesses at any time by reason only that, at that time, he carried on business operations of a similar kind at 2 or more locations. Thus, a taxpayer who operates a chain of retail stores, such as a supermarket chain, will be treated as carrying on one business for the purposes of the Subdivision and the opening of a new store of the same kind will be regarded only as an expansion of his existing business and not as the commencement of a new business.

Sub-section (9) of section 82B is consistent with, and supplements the operation of, sub-sections (7) and (8). It will provide that where a taxpayer acquires a business (referred to as the 'acquired business') in a year of income, and the Commissioner of Taxation is satisfied that immediately before and after the taxpayer acquired the business, the taxpayer carried on another business (referred to as the 'original business') that was similar to the acquired business then, for the purposes of the Subdivision in relation to the taxpayer -

(i)

the taxpayer shall not be taken to have commenced to carry on the acquired business;

(ii)

the taxpayer will not be regarded as carrying on 2 or more businesses by reason only of his carrying on both the original and the acquired business; and

(iii)

the operations of the taxpayer in connexion with the acquired business will be treated as operations in connexion with the original business.

Shortly stated, this means that a taxpayer who acquires a business of a similar kind to one which he is already conducting will be regarded as having merely extended his original business. It will follow that any deduction available to the taxpayer under Subdivision BA will as a general rule be calculated only by reference to the value of stock held in relation to the original business as at the commencement of the income year in which the additional business was acquired.

Sub-section (10) of section 82B will bring within the scope of the trading stock valuation scheme, transfers of undivided fractional interests in trading stock forming the whole or part of the assets of a business which would not otherwise be regarded as constituting a disposal of the trading stock. The cases in mind are those where something less than the entire ownership of the trading stock concerned is transferred between the parties.

Examples of the situations to which the sub-section will apply include the formation or dissolution of a partnership, a variation in the constitution of a partnership or in the interests of the partners and where, as a consequence, a change has occurred in the ownership of, or in the interests of persons in, a business. The proposed sub-section will ensure that Subdivision BA has effect as if the business was disposed of by the former owners and acquired by the new owners on the day of the transfer, etc., notwithstanding that some of or all of the former owners might retain an interest in the business.

Sub-section (11) of section 82B will require the Treasurer to publish in the Commonwealth Gazette, as soon as practicable after the end of a financial year, the "prescribed percentage" (described earlier in these notes) in relation to that financial year. It is expected that this will be done within a few weeks after the end of the financial year.

Section 82C : Application of Subdivision

This section will formally provide that where there has been no increase in the goods component of the Consumer Price Index between the June quarter of a financial year and the June quarter of the next preceding financial year, Subdivision BA is to have no application in relation to the year of income corresponding with the financial year.

Section 82D : Deduction in respect of value of trading stock

This section is the operative provision which will authorise a special deduction, for taxpayers carrying on a business, in relation to the value of eligible trading stock on hand where the index for the goods component of the Consumer Price Index increases between the June quarters of successive financial years.

In the general case, where a taxpayer carries on a business throughout the whole of an income year, the deduction will be expressed as a percentage (the "prescribed percentage" as described in the earlier notes on proposed section 82B) of the value of eligible trading stock on hand as at the commencement of the income year.

Where a new business is commenced during the year of income, or where a business changes hands, the section makes provision for taxpayers to be allowed proportionate deductions according to the respective part year periods during which they carried on business. In these cases, the value of trading stock on hand at other relevant times (i.e. other than at the commencement of the income year) may form the basis on which the special deduction is to be allowed.

A more detailed explanation of the operation of new section 82D is contained in the notes on the individual sub-sections hereunder.

Sub-section (1) of section 82D will apply to the general case of a continuing business, i.e., one where a taxpayer has carried on the business for the whole of the year of income and had carried it on before the commencement of that year of income. In these circumstances, a deduction from the taxpayer's assessable income will be allowed of an amount equal to the prescribed percentage of the value of eligible trading stock on hand in relation to the business at the commencement of the year of income. As discussed earlier in these notes, the value for this purpose is the cost price of the relevant trading stock or, if a lower value has been or will be taken into account under section 28 of the Principal Act, that lower value. If there was no stock on hand at the commencement of the year of income, no deduction will be allowable.

As an illustration of the operation of sub-section (1), if the value of eligible trading stock on hand in relation to a taxpayer's business at the commencement of a year of income was $10,000 and the prescribed percentage relating to that year is 7.1%, the deduction allowable would be $710.

Sub-section (2) of section 82D and the associated sub-section (4) will authorise deductions in cases where a taxpayer disposes of a business during a year of income.

Sub-section (2) describes the circumstances in which, subject to sub-section (3), a deduction is allowable and specifies the formula by which the deduction is to be calculated. Sub-section (4) defines the terms used in that formula and in so doing identifies the part of the year in respect of which the deduction is to be allowed and fixes the date for determining the value of trading stock to which the prescribed percentage is to be applied.

In broad terms, a deduction will be allowable, in accordance with the formula, on a proportionate basis related to such period of time as the taxpayer carried on the business during the year of income before disposing of it. It will generally be a pre-condition to the allowance of a deduction that the Commissioner of Taxation be satisfied that the taxpayer disposed of the business in the expectation that the business would be carried on to the end of the taxpayer's year of income.

Paragraphs (a) to (d) of sub-section (2) specify the circumstances in which a deduction may be allowed to a person who has disposed of a business after the commencement of a year of income.

Paragraph (a) provides for a deduction to be allowed to the vendor of a business where the disposal of the business results from the terms of a will or from operation of law. By virtue of the definition in proposed section 82B, "disposal" in relation to a business includes transmission by will or by operation of law. Accordingly where, on the death of the proprietor, the assets of a business vest in a trustee or executor of his estate or, in the event of an intestacy, in the administrator of the estate, a deduction will be allowable in the assessment up to the date of death on the same basis as if the proprietor had actually disposed of the business on that date. The same will be true where the property of a bankrupt vests in the official receiver or where a court orders that the property of a company in liquidation is to vest in the liquidator.

Paragraph (b) provides for a deduction to be allowed where a business has been disposed of and the Commissioner is satisfied that the vendor, not being a company, disposed of the business with the expectation that it would be carried on at least until the end of the year of income of the taxpayer in which the disposal took place. A deduction will not be allowable where a taxpayer brings a business to an end or disposes of it in the knowledge that it is to be brought to an end before the end of the year of income in which the disposal takes place.

Paragraph (c) provides for a deduction to be allowed where the vendor of a business is a company and the purchaser is a person other than a company or a company that was not associated with the vendor at the time of disposal. (The test of whether companies are "associated" is contained in sub-section (12)). Here again the Commissioner must be satisfied that the vendor disposed of the business with the expectation that it would be carried on at least until the end of the year of income of the taxpayer in which the disposal took place.

Paragraph (d) specifies a further situation in which a taxpayer company may qualify for a deduction under sub-section 82D(2). This is where a business is disposed of to an associated company (sub-paragraph (i)) and either the business is carried on until the end of the year of income of the taxpayer in which the disposal takes place (clause (A) of sub-paragraph (ii)) or, where the business is not carried on until the end of that year of income, the requirements of clause (B) of sub-paragraph (ii) are met. These are in effect that, before the end of the year of income of the taxpayer, the business has again changed hands in a transaction in which the vendor and purchaser were not "associated" in the sense in which that term is used in sub-section (12) and the vendor entered into that transaction with the expectation that the business would be carried on until the end of the year of income of the taxpayer company.

Put very broadly, associated companies that successively carry on a business during a year of income will be eligible for a deduction under sub-section 82D(2) provided either that the business is not discontinued before the end of the income year, or ownership of the business passes to an unrelated person other than in the expectation that the business will be terminated before the end of that income year.

Where the criteria for allowance of a deduction under sub-section (2) are satisfied, the amount of the deduction is to be ascertained in accordance with the formula

(x*y)/(365)


, the factors x and y being defined in sub-section (4).

Sub-section (3) provides that where, immediately before the commencement of a year of income, there was no trading stock on hand in relation to a business then carried on by a taxpayer, sub-section (2) does not apply if the business is disposed of during that year of income. Accordingly, and consistent with the position under sub-section (1) where there was no trading stock on hand at the commencement of a year of income in relation to business carried on by a taxpayer throughout the year of income, a taxpayer whose trading stocks had been reduced to nil at the end of the year of income prior to that in which a business is disposed of will not be entitled to a deduction in the year of disposal. This will be the case even if there is trading stock on hand at the date of disposal.

The factors x and y of the formula in sub-section (2) are defined in sub-section (4).

x is defined as the number of days in that part of the year of income prior to disposal during which the business was carried on by the taxpayer.

y is defined as the "prescribed percentage" of the value of trading stock by reference to which the trading stock valuation adjustment is to be calculated.

Where the taxpayer had carried on the business immediately before the commencement of the year of income and continued to do so up to the date of disposal, the prescribed percentage will be applied, in terms of paragraph (a) of the definition, to the lesser of -

•

the value of any stock on hand at the commencement of the year of income;

•

the value of stock on hand at the date of disposal of the business.

Where the taxpayer had acquired the business during the year of income and the business had been carried on by another person immediately before the commencement of that year of income, the prescribed percentage will, in terms of sub-paragraph (b)(i) of the definition be applied to the least of the following -

•

the value of trading stock on hand in relation to the business at the commencement of the year of income (i.e., the stock owned by the then proprietor);

•

the value of stock on hand when the taxpayer acquired the business; and

•

the value of stock on hand at the time when the taxpayer disposed of the business.

Sub-paragraph (b)(i) does not apply, however, where there was no trading stock on hand at the commencement of the year of income or the value of that trading stock cannot be ascertained under section 82B(5). This latter situation will arise, for example, where the person who carried on the business at the commencement of the taxpayer's income year has adopted an accounting period for income tax purposes that is different from that of the taxpayer. Neither does sub-paragraph (b)(i) apply where the business disposed of by the taxpayer is a "new" business, i.e., one that was started either by the taxpayer or by another person after the commencement of the year of income in which the taxpayer disposes of the business. Nor does paragraph (b)(i) apply if the business was acquired without trading stock. In these cases, the prescribed percentage will, in terms of sub-paragraph (b)(ii), be applied to an amount equal to two-thirds of the value of the trading stock on hand in relation to the business at the date of disposal.

It should be noted that, where the business disposed of by a taxpayer is a new business that was started by him after the commencement of the year of income in which it is disposed of, the provisions of sub-section 82B(6) will need to be applied in order to fix the date of commencement of the business for the purpose of ascertaining the number of days (i.e., x in the formula) in the part of the year during which the taxpayer carried on the business.

Examples of the operation of sub-sections 82D(2) and (4) are given below.

(1)

Assume that a taxpayer acquired on 1 October 1976, a business that was in operation before the commencement of the year of income. He subsequently sold the business on 30 April 1977. The value of stock on hand in relation to the business at 1 July 1976 was $8,000, at the date of acquisition $7,000 and on disposal by the taxpayer $10,000. The prescribed percentage for the year ended 30 June 1977 is, say, 7.1%. Both the taxpayer and the person from whom he acquired the business balance at 30 June.

Applying the formula

(x*y)/(365)


-

x = 212

y = the least of the three stock values mentioned (i.e., $7,000) multiplied by the prescribed percentage (7.1%).

The allowable deduction is therefore

((212) /(365)) * ((7,000)/(1))* ((7.1)/(100)) = $288


(2)

Assume that a taxpayer began a new business on 1 January 1977 and sold the business on 31 May 1977 when the value of trading stock on hand was $14,000. His purchases of stock did not reach $4,667 (i.e. 1/3 of disposal stock) until 20 February (82B(6)(b)) (so that x will start to run on 1 March). The prescribed percentage for the year ended 30 June 1977 is, say, 7.1%.

Applying the formula

(x*y)/(365)


-

x = 92

y = 7.1% of (2)/(3) * (14,000)/(1)


The allowable deduction is therefore

((92)/(365)) * ((2)/(3)) * ((14,000)/(1)) * ((7.1)/(100)) = $167


Sub-section (5) of section 82D in conjunction with sub-section (6) will authorise deductions in respect of the trading stock of a business where a taxpayer, after acquiring a business from another person during a year of income or starting up a new business during the year, carries on that business until the end of the year of income.

Sub-section (5) provides that where a taxpayer commenced to carry on a business on or after the first day of a year of income of the taxpayer and carried on that business throughout the remainder of the year of income, there shall be a deduction allowed from the taxpayer's assessable income of that year of income of an amount equal to the amount ascertained in accordance with the formula

(r*s) /(365)


.

The factors r and s of the formula in sub-section (5) are defined in sub-section (6).

"r" is defined as the number of days in the period during which the taxpayer carried on the business during the year of income, i.e., the number of days in the period commencing on the day on which, by virtue of sub-section 82B(6), he is to be taken to have commenced to carry on the business and ending on the last day of the year of income.

"s" is defined as the "prescribed percentage" of the value of trading stock by reference to which the trading stock valuation adjustment is to be calculated.

Where the business was one that had been carried on immediately before the commencement of the year of income by the taxpayer or by another person, the prescribed percentage will, in terms of paragraph (a) of the definition, be applied to the lesser of -

•

the value of trading stock on hand in relation to the business at the commencement of the year of income in which the business was acquired; or

•

the value of trading stock on hand in relation to the business at the time when the taxpayer commenced to carry on the business - this will be the date of acquisition of the business (82B(6)(a)).

(The reference to the business being carried on by the taxpayer before the commencement of the year of income refers to the case where a taxpayer disposes of a business and re-acquires the same business in the same year of income.)

Paragraph (a) does not apply, however, where there was no trading stock on hand in relation to the business at the commencement of the year of income in which the taxpayer commenced to carry it on, or the value of that trading stock cannot be ascertained under sub-section 82B(5). Neither does paragraph (a) apply where the taxpayer started up a new business during a year of income or acquired a business that had been started by another person during the year of income. Nor does paragraph (a) apply if the business was acquired without trading stock. In these cases, the "prescribed percentage" will, by virtue of paragraph (b) of the definition, be applied to an amount equal to two-thirds of the value of trading stock on hand in relation to the business at the end of the year of income.

Sub-section (7) of section 82D will modify the operation of the Subdivision where there has been a substantial reduction in the value of trading stock on hand at the end of a relevant period in which a business was carried on by a taxpayer as compared with the value of the stock on hand at the beginning of the period and the reduction was due to a permanent reduction in the scale of operations of the business or to a permanent change in the manner in which the business is conducted.

Where the Commissioner of Taxation is of the opinion that the reduced scale of operations is not merely temporary or that the change in the manner in which the business is conducted is not temporary, the sub-section will require the value of trading stock at the end of the relevant period to be taken into account in determining the amount allowable as a deduction instead of basing the deduction on the value of the trading stock on hand at the commencement of the relevant period. The effect of this will be for the deduction allowable to be based on the reduced value of trading stock on hand as at the end of the period.

A taxpayer who is dissatisfied with a decision of the Commissioner of Taxation in relation to the application of this sub-section will, of course, have the usual rights of objection and reference to a Taxation Board of Review, or to the court on appeal.

Sub-section (8) of section 82D is complementary to sub-section (7) and defines the "relevant period" in relation to which the opening and closing values of trading stock of a business may be examined to determine whether there has been a substantial reduction in value. The relevant period is -

(a)

Where a business was carried on by a taxpayer for the whole of the year of income - the whole of the year of income (i.e., where section 82D(1) applies); and

(b)

Where the taxpayer carried on the business for part only of the year of income and disposed of the business before the end of the year - the period in the year during which the taxpayer carried on the business up to the date of disposal (i.e., where section 82D(2) applies);

(c)

Where the taxpayer commenced to carry on the business after the commencement of the year of income and carried it on until the end of the year - the period from the date on which the taxpayer commenced to carry on the business and ending on the last day of the year of income (i.e. where section 82D(5) applies).

Sub-section (9) of section 82D is designed to prevent misuse of the deduction conferred by this Subdivision by the deliberate accumulation of excessive amounts of trading stock so as to obtain a greater stock adjustment than would otherwise be the case. Broadly stated, the Commissioner of Taxation will be authorised to notionally reduce the value of trading stock on hand at any time where he is of the opinion that the proprietor of a business has accumulated trading stock in excess of the normal requirements of the business with a view to securing for himself or any other person an excessive trading stock valuation adjustment.

The sub-section provides that where the Commissioner of Taxation is of the opinion that -

(a)

at any relevant time the amount of the trading stock on hand in relation to a business carried on by a taxpayer exceeded the amount of the trading stock reasonably required for the purposes of the business; and

(b)

some or all of that trading stock was produced, manufactured, acquired or purchased by the taxpayer for the purpose of securing for the taxpayer or some other person a deduction under this Subdivision greater than the deduction that would otherwise have been allowable;

then, for the purposes of the application of Subdivision BA in relation to the taxpayer or that other person, the value of the trading stock on hand in relation to the business at the relevant time or any later time shall be such amount as the Commissioner considers fair and reasonable.

The Commissioner will be able to examine the value of trading stock on hand at any relevant time including the end of a year of income (and as a consequence the value of trading stock on hand at the commencement of the next succeeding year of income) or at the date of disposal or acquisition of trading stock where a business has changed hands, for the purpose of deciding whether the level of stocks held is excessive. Where the Commissioner is of the opinion that the level of trading stocks held is above the normal requirements of a business, the prescribed percentage will be applied only to such value of trading stock as is determined by the Commissioner to be fair and reasonable.

A taxpayer who is dissatisfied with a decision of the Commissioner of Taxation in relation to the application of this sub-section will have the usual rights of objection and reference to a Taxation Board of Review, which may substitute its own opinion for that of the Commissioner.

Sub-section (10) of section 82D is intended to apply where a continuing business is transferred from one company to an associated company in the course of a reorganisation of a company group. It will authorise the associated company acquiring the business to claim any trading stock valuation adjustment deduction to which the vendor would otherwise be entitled as well as any entitlement to a deduction in its own right, where the companies agree and a joint election to that effect is lodged with the Commissioner of Taxation.

The sub-section provides that where a company has disposed of a business to an associated company and a deduction would, but for this sub-section, be allowed to the vendor company in respect of the year of income of that company in which the disposal took place, the deduction will instead be allowed to the purchaser if the companies make a joint election to invoke the operation of this sub-section.

The formal procedures for making an election are specified in sub-section (11) of section 82D and are described in the notes that follow. The qualification of companies to be regarded as "associated" for this purpose is contained in sub-section (12) of section 82D and broadly depends on the concept of control. An explanation of that sub-section is also contained in later notes.

As mentioned, sub-section (11) of section 82D prescribes the manner in which an election is to be made for the purposes of sub-section (10). It requires that such an election be in writing signed on behalf of each of the companies concerned and lodged with the Commissioner of Taxation not later than 2 months after the end of the relevant year of income of the company acquiring the business, or within such further time as the Commissioner of Taxation allows.

Sub-section (12) of section 82D defines an "associated company" for the purposes of the section. A company will be associated with another company at a particular time if, at that time, either company controls or is able to control the operations of the other.

Provision is also made for instances where a parent company controls a number of subsidiary companies. Each subsidiary may be legally independent of every other subsidiary although the operations of each may be subject to the common control exercised by the parent company. The sub-section will accordingly ensure that companies will be regarded as associated companies if their operations are controlled, or are able to be controlled, by the same person or persons.

Clause 9: Average income

The Income Tax (Rates) Act 1976, which declares the rates of tax payable on the taxable incomes of individuals and trustees for 1976-77 and subsequent years, lays down in Schedule 2 the method of determining the rates of tax payable by taxpayers to whose incomes the averaging provisions of the Income Tax Assessment Act apply. Those provisions apply only to the incomes of primary producers.

Schedule 2 provides for the first $16,000 of a primary producer's taxable income to be taxed at the rate applicable to $16,000 or, if his average income is less than that amount, the rate applicable to his average income. If the taxable income exceeds $16,000, the portion in excess of that amount is taxed at the general rates applicable to that range of income. Accordingly, that portion of the taxable income does not attract for a primary producer any benefit from the application of the averaging system.

The method of determining the average income used for rating purposes is laid down in section 149 of the Principal Act, as affected by other provisions in Division 16 of Part III of that Act. In its present terms, section 149 provides that the "average income" of a taxpayer means the average of his taxable incomes of the "average years" - ordinarily the year of income in relation to which the average income is to be determined and the 4 preceding years.

Clause 9 will repeal the existing section 149 and substitute a new section. Sub-section (1) of the new section 149 will re-enact, with some drafting refinements, the provisions of the existing section but make its operation subject to a qualification set out in the new sub-section (2).

Sub-section (2) will declare that, in the calculation of the average income under sub-section (1), any amount by which the taxable income of the taxpayer of any one of the averaging years exceeds $16,000 shall be disregarded. The purpose is to ensure that the part of taxable income taxed at general rates in any year will not affect the level of rates on the first $16,000 of taxable income of that year or any of the next 4 years.

The modifications effected by sub-section (2) will apply to assessments made in respect of the year of income that commenced on 1 July 1976 and subsequent years.

Clause 10: Permanent reduction of income

Sub-section (1) of section 155 of the Principal Act allows a primary producer to have calculations of his average income started afresh, with high taxable incomes of previous years being dropped out, if he is able to establish that retirement from his occupation or some other event has resulted in his taxable income having been permanently reduced to an amount which is less than two-thirds of his average taxable income.

Sub-section (2) defines "average taxable income" to mean, in effect, the average income of the taxpayer in relation to the year concerned less any income received by him from sources from which he does not usually receive income.

Clause 10 will omit the existing sub-section (2) and substitute a new sub-section having the same effect but ensuring that the amount of average income used as a starting point to determine the average taxable income for the purposes of sub-section (1) will be the average of his actual taxable incomes for the average years - not the amount that would be the average income calculated on the new basis provided for by the amendment of section 149.

A use of the new basis of calculation for section 155 purposes would be inappropriate. It could, for example, mean a deferment of the time when the primary producer would first be able to establish that the necessary reduction of his taxable income had occurred.

Clause 11: Rebate in case of disposal of assets of business of primary production

This clause will amend section 160 of the Principal Act, which provides for the allowance of a rebate of tax where the whole of the assets of a business of primary production are disposed of for the purpose of putting an end to that business, the assets include livestock which is disposed of at a profit and the taxpayer has not elected to have his income reduced under section 36 or 36AAA.

A rebate is allowable if the tax otherwise payable by the taxpayer would exceed an amount of notional tax calculated in accordance with sub-section (3) of section 160. Sub-section (3) provides for the notional tax to be calculated by adding together -

(a)

tax on the abnormal income (the profit on the sale of the livestock) calculated by applying to that income - without regard to the $16,000 limits set by Schedule 2 of the rating Act referred to in the notes on Clause 9 - the rate applicable to the average income of the taxpayer; and

(b)

tax on the normal income calculated on the basis that that income is the taxpayer's only taxable income with the rate being determined by reference to his average income but subject to the limits set by Schedule 2.

In effect the notional tax is the amount to be paid by the taxpayer if it is less than the actual tax.

Section 160 was incorporated in the Principal Act in 1951 for the purpose of preserving the benefits of the original averaging system for income from abnormal disposal sales of livestock. The original averaging system provided for the tax on the taxable income of a taxpayer to be determined by applying to that income the rate applicable to his average income. The system was modified in 1951 by applying a limit (now $16,000) to the amount of taxable income to be taxed at average rates.

To allow section 160 to continue to operate according to its original purpose, tax on the abnormal income, which is determined in accordance with paragraph (a) of sub-section (3), needs to be calculated at the rate applicable to the average of his actual taxable incomes for the average years (i.e. without regard to the amendment proposed by clause 9), while tax on the normal income, which is determined in accordance with paragraph (b) of sub-section (3) needs to be calculated at the rates set by Schedule 2 of the rating Act having regard to an average income calculated on the new basis provided for by the amendment of section 149.

Clause 11 will amend paragraph (a) of sub-section (3) to replace references to "average income" with the expression "average taxable income" and to include a definition of the new expression in sub-section (5). Under the terms of the definition, "average taxable income" is to mean the amount that would be the average income of the taxpayer ascertained under section 149 if the new sub-section (2) of that section had not been enacted. The expression "average income" used in paragraph (b) of sub-section (3) will, by the definition of that expression in sub-section (5), take the new meaning given to it by the amendment of section 149.

The amendments of section 160 will apply to assessments made in respect of the year of income that commenced on 1 July 1976 and subsequent years.

Clause 12: Amendment of assessments

This clause will amend section 170 of the Principal Act which governs the power of the Commissioner of Taxation to amend income tax assessments. Sub-section (10) of section 170 provides that nothing in the section is to prevent the amendment of an assessment at any time for the purpose of giving effect to specified provisions of the Principal Act.

Paragraph (a) of clause 12 will insert in sub-section 170(10) a reference to the proposed new section 31C that is to be introduced by clause 5. In broad terms, section 31C may authorise the Commissioner of Taxation to substitute an arm's length price for income tax purposes for the price actually paid for trading stock when assessing the respective income tax liabilities of the vendor and purchaser of trading stock sold at inflated prices in a non-arm's length dealing.

As amended, sub-section 170(10) will enable the Commissioner to give effect to the provisions of section 31C by amending assessments of each of the parties concerned at any time in respect of a year of income in which it is found that trading stock has changed hands at excessive prices.

Paragraph (b) of clause 12 will also amend sub-section 170(10) to insert a reference to the proposed section 82D to be contained in new Subdivision BA of Division 3 of Part III of the Principal Act. Section 82D is the operative provision that will authorise deductions under the trading stock valuation adjustment scheme to be introduced by clause 8 of the Bill.

This will similarly enable the Commissioner to amend assessments of vendors or purchasers of trading stocks at any time where this is necessary to give effect to the terms of section 82D.

Clauses 13 and 14: Collection by instalments of tax on companies

Introductory Note

Under the existing terms of Division 1A of Part VI of the Principal Act, comprising sections 221AA to 221AJ, the Commissioner of Taxation is authorised - provided that a relevant rating Act declares that instalments of tax are payable by companies in respect of income of the year concerned - to call upon a company to pay part of the tax assessed on its income for 1976-77 and each subsequent year of income by 3 instalments payable not earlier than 15 August, 15 November and 15 February in the financial year following the relevant year of income.

Amendments proposed by clauses 13 and 14 will cut down to 2 the number of instalments that a company may be called upon to pay in the 1977-78 financial year in respect of its 1976-77 income and set the earliest due dates for payment at 15 November 1977 and 15 February 1978. As explained elsewhere in this memorandum, the provision of rating Act authority to collect instalments of tax in respect of 1976-77 income is proposed by the associated Income Tax (Companies and Superannuation Funds) Amendment Bill 1977. A company that has been called upon to pay one or both of the instalments will be required to pay the balance of the tax assessed on its 1976-77 income by the due date shown on its notice of assessment, which will be not earlier than 30 April 1978.

The terms of Division 1A are not being amended in any other material way. Accordingly, they will allow for the quarterly payments system - entailing the payment by a company of an instalment of tax in each of the first 3 quarters of a financial year with a balancing payment in the final quarter - to come into full operation in the 1978-79 financial year. They will allow also for the amount payable as an instalment of tax in 1977-78 or a subsequent financial year to be determined in the same way as were amounts payable in 1975-76. A company will have no liability to pay an instalment unless the Commissioner notifies it that the payment of a specified amount is required by a specified due date.

As in past years, the Commissioner will not serve notices on companies to pay instalments of less than $250. Companies not brought within the system for collection by instalments in a particular financial year will ordinarily be required to pay their assessments in full by a due date falling not earlier than within the third quarter of that year.

Clause 13: Liability to pay instalments of tax

Sub-section (1) of section 221AC lays down the number of instalments to be paid by a company in a year during which instalments are payable by virtue of a rating Act declaration. In its present terms, the sub-section specifies -

•

in paragraph (a) - that 1 instalment is payable in respect of 1973-74 income;

•

in paragraph (b) - that 2 instalments are payable in respect of 1974-75 income;

•

in paragraph (c) - that 3 instalments are payable in respect of income of 1976-77 and each subsequent year.

Instalments in respect of income of a particular year are to be paid in the year immediately following that year of income.

Clause 13 proposes the substitution of 2 new paragraphs in place of the existing paragraphs (a), (b) and (c) of the sub-section. References to instalments for past years are no longer necessary and will be omitted. The new paragraph (a) will thus provide that only 2 instalments of tax are payable in respect of income of the 1976-77 income year (to be paid in the 1977-78 financial year). The new paragraph (b) will provide for 3 instalments of tax to be paid in respect of income of 1977-78 and each subsequent year of income.

Clause 14: When instalments of tax payable

Sub-section (1) of section 221AF provides for a company to be served with a notice specifying the amount payable as an instalment of tax in respect of its income of the year of income and the date on which that amount is due and payable.

Sub-section (2), provides that the date to be specified in a notice under sub-section (1) as the due date for payment of the instalment of tax is to be no earlier than 30 days after the date of service of the notice and not earlier than the dates specified by paragraph (a) in relation to the one instalment payable in respect of income of the 1973-74 year and by paragraph (b) in relation to the 3 instalments payable in respect of income of subsequent years of income.

Clause 14 will replace paragraph (a) of sub-section 221AF(2) with a new paragraph (a) which will specify an earliest due date for each of the 2 instalments that are now proposed to be payable by a company in respect of its 1976-77 income. The existing paragraph (b) will remain undisturbed and continue to specify the earliest due dates on which each of the 3 instalments are to be paid by a company in respect of its income of each succeeding year of income, that is, 15 August, 15 November and 15 February in the following financial year.

The earliest due dates to be specified in the new paragraph (a) are -

•

for the first instalment of tax in respect of 1976-77 income - 15 November 1977

•

for the second instalment of tax in respect of 1976-77 income - 15 February 1978

Clause 15: Interpretation

This clause also is related to the Commonwealth Rebate for Apprentice Full-Time Training (CRAFT) scheme (see notes on clause 3).

In addition to rebates for employers, the CRAFT scheme provides, in certain circumstances, for special allowances to be paid to apprentices required to leave home to obtain or remain in apprenticeship. These allowances will be taxable in the same way as are other similar periodical payments and allowances.

Clause 15 inserts in the definition of "salary or wages" in sub-section 221A(1) of the Principal Act a new paragraph - paragraph (h). Paragraph (h) will ensure that special allowances paid to apprentices under the CRAFT scheme are subjected to pay-as-you-earn (PAYE) tax instalment deductions in the same way as are other similar payments and allowances that are treated as "salary or wages" for PAYE purposes.

Clause 16: Cancellation of registration of tax agents

This clause proposes technical amendments to section 251K of the Principal Act to reflect changed appeal arrangements that have obtained since 1 July 1976 by virtue of the Administrative Appeals Tribunal Act 1975.

Section 251K provides that a Tax Agents' Board may cancel the registration of a tax agent in certain circumstances. Sub-sections (5), (5A) and (6) of section 251K provide a tax agent with a right of appeal to certain specified courts against a Board's decision to cancel his registration.

By virtue of Part XIX of the Schedule to the Administrative Appeals Tribunal Act 1975, a tax agent's right of appeal against cancellation of his registration has, since 1 July 1976, been to the Administrative Appeals Tribunal instead of to the courts specified in sub-sections (5) and (5A) of section 251K.

It is proposed by clause 16 to replace the superseded sub-sections (5), (5A) and (6) of section 251K with two new sub-sections - sub-sections (5) and (6).

The new sub-section (5) will provide for an application to be made to the Administrative Appeals Tribunal for a review of the decision of a Tax Agents' Board under section 251K of the Principal Act to cancel the registration of a tax agent where that cancellation is made after the commencement of sub-section (5), i.e., in respect of any cancellation made on or after 1 July 1976.

The new sub-section (6) will provide that, for the purposes of a review in pursuance of an application under the new sub-section (5), the Administrative Appeals Tribunal shall be constituted by a presidential member alone.

The new sub-sections (5) and (6) reflect the appeal arrangements at present in Part XIX of the Schedule to the Administrative Appeals Tribunal Act 1975. A complementary amendment is being made by clause 17 to delete Part XIX of the Schedule to that Act. This amendment will apply in respect of any registration cancelled on or after 1 July 1976.

The overall effect of the changed appeal arrangements is that a tax agent whose registration was cancelled before 1 July 1976 had a right of appeal to the courts specified in the now superseded sub-sections (5) and (5A) of section 251K. The right of appeal is to the Administrative Appeals Tribunal in respect of a cancellation on or after that date.

By virtue of sub-clause 2(2), the amendments proposed by clause 16 are deemed to have come into operation on 1 July 1976.

Clause 17: Amendment of Administrative Appeals Tribunal Act

By clause 17, it is proposed to effect the complementary amendment of the Administrative Appeals Tribunal Act that is explained in the notes to clause 16.

By virtue of sub-clause 2(2), the amendment proposed by clause 17 is deemed to have come into operation on 1 July 1976.

Clause 18: Application of amendments

This clause governs the application of the amendments proposed by the Bill. The dates or years of income from which the various amendments will first apply have been noted in the explanatory notes on the separate clauses.

INCOME TAX (COMPANIES AND SUPERANNUATION FUNDS) AMENDMENT BILL 1977

Provisions governing the system for collection of company tax by instalments are in the Income Tax Assessment Act and make up Division 1A of Part VI. One of the provisions - section 221AC - provides, among other things, that instalments of tax are not payable in respect of the income of a particular year unless an Act declaring the rates of company tax payable on income of that year, or on income of the next preceding year, provides that instalments of tax are payable in accordance with the provisions of the Division.

The purpose of this Bill is to provide the legislative authority needed to bring back into operation in the 1977-78 financial year the system for collection of company tax by instalments. The manner in which the system is to be reintroduced has been explained in notes on features and clauses of the Income Tax Assessment Amendment Bill 1977.

Clauses 1 and 2 : Short Title : Commencement

These are formal provisions. Their purposes are the same as those explained in notes on the corresponding clauses of the Income Tax Assessment Amendment Bill 1977.

Clause 3: Instalments of tax

This clause will amend the Act that declared the rates of tax payable on 1975-76 incomes of companies - the Income Tax (Companies and Superannuation Funds) Act 1976 - by adding a new section 11 to provide that instalments of tax are payable by companies in respect of 1976-77 income in accordance with the relevant provisions of the Income Tax Assessment Act. This will enable the collection of instalments to be resumed, as proposed, in the 1977-78 financial year, with the first instalment being due and payable no earlier than 15 November 1977.