Private ruling: Income Tax - Assessable Income - Trading Stock - Disposal of Trading Stock
Date of advice: 11 December 2017
Published: April 2018
Ruling period: Income year ending 30 June 2018
Date scheme commenced: 1July 2017

Ruling: Q1: Will the proposed transfer of trading stock from the X Unit Trust (the Trust) to the corporate trustee of the Unit Trust (the Trustee) result in the market value of the trading stock being included in the assessable income of the Trust pursuant to section 70 - 90? | A1: No

Relevant facts and circumstances: A corporate entity acts as trustee for a Trust. The Trust carries on a business. The Trust has two unitholders. The Trustee and the unitholders wish to restructure the business ownership to a corporate structure, as the business has grown significantly since it was established. Future growth is expected to require a substantial reinvestment of profits and the possibility of additional capital. The restructure will be done in accordance with the requirements in subdivision 124-N of the ITAA 1997, and is to be achieved by converting the Trust to a proprietary company limited by shares (NewCo). Under the proposed restructure, the Trust will dispose of all of its assets, including the trading stock, so these assets will then be held by NewCo. It is proposed that NewCo will be the Trustee – that is, the existing Trustee - so that the company that currently acts as Trustee of the Trust will cease to hold the trading stock in its capacity as trustee, and begin to hold the trading stock in its own capacity. In turn, NewCo will operate the business in its personal capacity. Following the transfer of all of its assets to NewCo, the Trust will vest and cease to exist.

Relevant legislative provisions: Income Tax Assessment Act 1997 Division 70 | Income Tax Assessment Act 1997 Section 70-90 | Income Tax Assessment Act 1997 Section 70-95 | All subsequent legislative references within this ruling are to the Income Tax Assessment Act 1997 (ITAA 1997), unless otherwise indicated.

Reasons for decision: Detailed Reasoning - Division 70 Trading Stock: Division 70 deals with amounts becoming assessable or deductible as a result of: (a) the acquisition of trading stock; (b) the disposal of trading stock outside the ordinary course of business; (c) the conversion of trading stock into something else; and (d) the holding of trading stock at the start or end of the income year. | Detailed Reasoning - Section 70-90: Subsection 70-90(1) provides: (1) If you dispose of an item of your *trading stock outside the ordinary course of a *business: (a) that you are carrying on; and (b) of which the item is an asset; your assessable income includes the *market value of the item on the day of the disposal. (Items marked with an asterisk (*) are defined in the dictionary at section 995-1 of the ITAA 1997) When an item of trading stock is disposed of outside the ordinary course of business, and the item is an asset of that business at the time of disposal, a taxpayer is required to account for the market value of that stock as assessable income in accordance with section 70-90. Section 70-95 states that if an entity disposes of an item of the entity's trading stock outside the ordinary course of business, the entity acquiring the item is treated as having bought it for the amount included in the disposing entity's assessable income under section 70-90. The conditions that need to be satisfied before section 70-90 can apply are as follows: 1. there must be a disposal; 2. the item must be trading stock as defined in section 70-10; 3. which is an asset of the business; 4. that is carried on by the taxpayer; and 5. the disposal was not in the ordinary course of carrying on a business. | Detailed Reasoning - Disposal: The word 'dispose' is not defined in the ITAA 1997. The word 'dispose' in the context of the now repealed subsection 36(1) of the Income Tax Assessment Act 1936 (ITAA 1936) was considered by the High Court of Australia in Rose v Federal Commissioner of Taxation (1951) 84 CLR 118 (Rose). It was stated in reference to the former provision that: In employing the words "dispose of" s. 36 doubtless meant to include every alienation of trading stock. "Disposition" and "dispose of" are expressions of the widest import. But the subject of the disposition must be considered as well as the ambit of the expression "dispose of". Section 36 is concerned with the disposal of the whole or part of the assets of a business when trading stock is included in the disposition…When s. 36 speaks of disposing of the assets of a business it is speaking of a transfer of the proprietor's ownership of the assets, including the immediate right to their possession, subject of course to any encumbrance, whether existing or newly created…Plainly, it is directed at the disposal of the entirety of ownership in the assets and not the conversion of a single ownership into collective ownership. Taxation Determination TD 96/ 2 Income tax: can section 36A of the Income Tax Assessment Act 1936 apply if a sole trader who owns trading assets declares himself or herself to be a trustee of a discretionary trust over the assets? (TD 96/2) is presently relevant. It outlines the approach of the High Court in Rose, noting that section 36 of the ITAA 1936 only applies where there is a disposal of the entirety of the ownership of the asset. Under the proposed restructure, the Trust will dispose of all of its assets, including the trading stock, to NewCo. It is proposed that NewCo will be the corporate Trustee. As the corporate Trustee currently holds the legal interest in the trading stock, and will continue to hold this after the proposed transfer, it is considered that there will be no disposal of trading stock pursuant to section 70-90. Accordingly, it is unnecessary to consider the other conditions specific to the application of section 70-90. | Detailed Reasoning - Conclusion: Section 70-90 will not apply to include in the assessable income of the Trust the market value of trading stock, as it is considered that there has not been a disposal of trading stock outside the ordinary course of business. As per the facts, the Trustee holds the legal interest in the trading stock, and will continue to hold this after the proposed transfer. Accordingly, there will be no disposal of trading stock in the circumstances.

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