Private ruling: Transfer of trading stock
Date of advice: 22 November 2016
Published: March 2017
Ruling period: 1 July 20YY to 30 June 20ZZ

Ruling: Q1: Will the proposed transfer of trading stock (cattle) satisfy the requirement of paragraph 70-100(6)(a) of the Income Tax Assessment Act 1997 ('ITAA 1997')? | A1: No. As the requirement of paragraph 70-100(6)(a) of the ITAA 1997 is not satisfied, the taxpayer is not entitled to make an election under subsection 70-100(4) of the ITAA 1997. | Q2: Will the Tax Office apply Part IVA of the Income Tax Assessment Act 1936 ('ITAA 1936') when two elections are made under section 70-100 of the Income Tax Assessment Act 1997 ('ITAA 1997') in respect of two transfers of trading stock (cattle), the second 24 hours after the first? | A2: As the transferor in each transaction will not be able to make an election under subsection 70-100(4) of the ITAA 1997, it will not be necessary to consider the application of Part IVA of the ITAA 1936 to the scheme.

Relevant facts and circumstances: (as per the ruling application) History ● The taxpayer is a Partnership that operates a family run cattle farming business that has carried multiple generations of the family. The taxpayer has established operating procedures, protocols and systems for the conduct of the cattle farming business that have been developed over the generations. ● The Partnership consists of XX and XY, the X Family Trust and the Estate of XYZ Deceased. ● The ABC Pty Ltd (ABC) was registered in 20XX and has acted as the manager of the Partnership since that time. ● The issued shares in the company effectively match and mirror the Partnership holdings of the taxpayer. Restructure The family conducting the cattle farming business are reviewing their affairs and wish to transfer Z % interest in cattle livestock from the taxpayer partnership to ABC for the following reasons: ● Family and succession planning ● Protection from personal liability ● Business development and evolution ● Easier commercial operations Proposal ● The Partnership owns Z% interest in its trading stock of cattle ● The Partnership wishes to transfer this Z% interest in its trading stock to ABC and proposes to do so in the following steps. ● The existing partners of the Partnership propose to transfer an equal interest of V% in the trading stock to ABC such that there will be a new partnership formed. The new partnership will consist of ABC and members of the existing partnership. ● An election will be completed such that this interest in the cattle transferred at closing value for taxation purposes (less than market value) under subsection 70-100(4) of the ITAA 1997. ● One working day later the remaining X% interest in the trading stock will be transferred to ABC once again at closing value for taxation purposes via an election in accordance with subsection 70-100(4) of the ITAA 1997. ● There will be a new partnership that will exist for a very short time in order to comply with subsection 70-100(4) of the ITAA 1997 in order to transfer Z% of the cattle trading stock from the existing Partnership to the new partnership and ultimately to ABC. ● The effect of the above two stage transfer will be that ABC will commence a primary production business of maintaining the cattle with the purpose of selling the cattle including its natural increase with a view to generating a profit. ● The interim partnership that will be established after the first transfer will also conduct a business of primary production. ● The cattle trading business to be conducted by both the interim partnership and ABC will be done in accordance with the current operating procedures, protocols and systems that currently exist. ● The cattle will continue to graze on the farming lands that are currently made available to the Partnership. These lands are controlled by XX and XY, X and family members and will be made available to both the interim partnership and ABC but are not subject to formal lease agreements but are rather made available due to commonality. ● The existing Partnership will continue to exist and retain other assets consisting of significant plant and equipment, property improvements and other infrastructure. ● All the assets, procedures and elements required to conduct a successful business will be made available to both the interim partnership and ultimately to ABC.

Relevant legislative provisions: Income Tax Assessment Act 1936 Part IVA | Paragraph 177C(2)(a) | Paragraph 177D(b) | Income Tax Assessment Act 1997 Subdivision 70-D | Section 70-10 | Section 70-75 | Section 70-80 | Section 70-90 | Section 70-100 | Subsection 70-100(4) | Subsection 70-100(5) | Subsection 70-100(6) | Subsection 70-100(10) | Section 995-1

Reasons for decision: Summary: As the condition in paragraph 70-100(6)(a) of the ITAA 1997 is not satisfied, the taxpayer is not entitled to make an election under subsection 70-100(4) of the ITAA 1997. The assets will be deemed to be transferred at market value on the day they ceased to be the trading stock of the transferor. | Detailed Reasoning - Disposals of trading stock outside the ordinary course of business: Sections 70-90 and 70-100 of the ITAA 1997 deal with disposals (or deemed disposals) of trading stock outside the ordinary course of the taxpayer's business. Section 70-80 of the ITAA 1997 explains why the rules relating to disposals or items otherwise ceasing to be held as trading stock are necessary. Subsection 70-80(3) of the ITAA 1997 states that an item stops being a taxpayers trading stock if, inter alia , interests in it change. Subsection 70-80(2) of the ITAA 1997 states that if an items stops being a taxpayers trading stock for reasons other than a disposal in the ordinary course of business an amount is generally included in assessable income to balance the reduction in trading stock on hand. Subsection 70-100(1) of the ITAA 1997 provides: An item of trading stock is treated as having been disposed of outside the ordinary course of business if it stops being trading stock on hand of an entity (the transferor) and, immediately afterwards: (a) the transferor is not the item's sole owner; but (b) an entity that owned the item (alone or with others) immediately beforehand still has an interest in the item. Example: A grocer decides to take her daughters into partnership with her. Her trading stock becomes part of the partnership assets, owned by the partners equally. As a result, it becomes trading stock on hand of the partnership instead of the grocer. This section treats the grocer as having disposed of the trading stock to the partnership outside the ordinary course of her business. Note: If the transferor is the item's sole owner after it stops being trading stock on hand of the transferor, section 70-110 applies instead of this section. The Explanatory Memorandum to the Tax Law Improvement Bill 1997 at chapter 10 explains how the section operates: | Detailed Reasoning - What if there is a change in interests?: If the interests in an item of stock change (e.g. a partnership takes in a new partner), then the law may treat it as being a disposal outside the ordinary course of business [section 70-100] . This happens when there is not a complete change in interests but the item ceases to be trading stock of the original entity. This disposal outside the ordinary course of business would normally be treated as occurring at market value. However, if the item is an asset of the new owners business, and all the owners agree, they can elect to roll it over for the value at which the original entity would have taken it into account at the end of the year. A 25% continuity of interests is required for this election to be available. Where subsection 70-100(1) of the ITAA 1997 Act applies, subsections 70-100(2) and (3) of the ITAA 1997 provide: (a) As a result, the transferor's assessable income includes the market value of the item on the day it stops being trading stock on hand of the transferor. (b) The entity or entities (the transferee ) that own the item immediately after it stops being trading stock on hand of the transferor are treated as having bought the item for the same value on that day. However, an election can be made to treat an item of trading stock as having been disposed of for what would have been its value as trading stock of the transferor on hand at the end of an income year ending on the day that it stops being trading stock pursuant to subsection 70-100(4) of the ITAA 1997, provided that the conditions in subsection 70-100(6) of the ITAA 1997 are met. The conditions in subsection 70-100(6) of the 1997 Act are as follows: (a) immediately after the item stops being trading stock on hand of the transferor, it is an asset of a business carried on by the transferee; (b) immediately after the item stops being trading stock on hand of the transferor, the entities that owned it immediately beforehand have (between them) interests in the item whose total value is at least 25% of the item's market value on that day; and (c) the value elected is less than that market value; and (d) the item is not a thing in action. Where the election in subsection 70-100(4) of the ITAA1997 is made, the transferor will include the value elected in its assessable income for the income year. The transferee is taken to have bought the trading stock for that same value on the same day: subsection 70-100(5) of the ITAA 1997. Subsection 70-100(8) of the ITAA 1997provides that the election must be in writing and signed by or on behalf of each of the entities that owned the item immediately before it stops being trading stock on hand of the transferor and signed by or on behalf of the entities that own it immediately after. The election must be made before 1 September following the income year in which the item stops being trading stock on hand of the transferor. However, the Commissioner may allow the election to be made later: subsection 70-100(7) of the ITAA 1997. | Detailed Reasoning - Application to your circumstances: At the present time the beneficial owner of the trading stock (cattle) is a partnership consisting of two individuals, a family trust and a deceased estate (the taxpayer). It is the taxpayer's intention to transfer the trading stock to a newly incorporated company known as the ABC Pty. Ltd (ABC). The scheme will involve a 2-stage process, in which the trading stock will initially be transferred to a new partnership consisting of members of the existing partnership and the newly incorporated company. This new partnership will in turn transfer the trading stock to ABC. ABC will ultimately own Z% of the taxpayer's trading stock. For each transfer an election will be made under subsection 70-100(4) of the ITAA 1997 to treat the trading stock as having been disposed of for what would have been their value as trading stock of the transferor on hand at the date of transfer. As mentioned above, the making of an election is dependent upon the conditions in subsection 70-100(6) of the ITAA 1997 being satisfied. One of those conditions is that immediately after the item stops being trading stock on hand of the transferor, it is an asset of a business carried on by the transferee. Under the proposed scheme the initial transferee (the new partnership) will only hold the assets for one working day before a further transfer of the assets to ABC is made. The Commissioner's views on the meaning of carrying on an enterprise are detailed in Miscellaneous Taxation Ruling MT 2006/1 The New Tax System: the meaning of entity carrying on an enterprise for the purposes of entitlement to an Australian Business Number More specifically, the Commissioner's views on primary production enterprises are set out in Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? We do not consider that the mere ownership of the assets (the cattle) for one day would amount to the carrying on of a business. Accordingly, the cattle are not assets of a business being carried by the transferee. As the condition in paragraph 70-100(6)(a) of the ITAA 1997 is not satisfied, the taxpayer is not entitled to make an election under subsection 70-100(4) of the ITAA 1997. The assets will be deemed to be transferred at market value on the day they ceased to be the trading stock of the transferor. As the taxpayer will not be able to make the election under subsection 70-100(4) of the ITAA 1997 it is not necessary to consider if Part IVA of the ITAA 1936 will apply to the proposed scheme. | Detailed Reasoning - Question 2: Part IVA is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable. In broad terms, Part IVA will apply where the following requirements are satisfied: ● there is a scheme (see section 177A); ● a taxpayer has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme (see section 177C); and ● the dominant purpose of a person who entered into or carried out the scheme, or any part of the scheme, was to enable the relevant taxpayer to obtain a tax benefit in connection with the scheme, or to enable the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (paragraph 177D(b)). The application of Part IVA depends on a careful weighing of all the relevant facts and surrounding circumstances of each case. Subsection 177A(1) of the ITAA 1936 defines a scheme broadly as follows: (a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and any scheme, plan, proposal, action, course of action or course of conduct. The Taxpayer's proposed course of action, to restructure its business and elect to treat the disposal of its trading stock at the tax value rather than the market value by making elections under section 70-100, would fall within the term "scheme" as defined in subsection 177A(1) of the ITAA 1936. As the Taxpayer is not entitled to make an election under subsection 70-100(4) of the ITAA 1997, the proposed scheme cannot be implemented. Therefore it will not be necessary to consider the application of Part IVA of the ITAA 1936. | Detailed Reasoning - Other matters for your consideration - Part IVA and successive elections - Commissioner's views: Subparagraph 177C(2)(a)(i) of the ITAA 1936 provides that Part IVA will not apply as a consequence of making a choice. However subparagraph 177C(2)(a)(ii) of the ITAA 1936 excludes any scheme to create a situation where a choice could be made. Taxation Determination TD 96/3 clearly enables an election to be made where there is a transfer of trading stock from a sole trader to a partnership and from the partnership to the trustee of a discretionary trust, on the basis that at least a 25% ownership interest in the assets is maintained and where all parties sign an agreement. Therefore, TD96/3 allows the interposition of a partnership as part of a 2-stage transfer and a subsequent election being made, without a determination ultimately being made that Part IVA of the ITAA 1936 applies to the transaction.