Part 4

Part
4
Timing Issues
When determining income tax payable, the taxation formula is applied to

the relevant financial year. In Australia, the financial year generally runs
from 1 July until 30 June the following year. Therefore, it is necessary to
determine what amounts, whether income or deductions, fall within the
financial year.
Chapter 16 deals with issues of tax accounting. Tax accounting is primarily

concerned with income and expense recognition. The relevant rules
are a combination of common law and statutory principles. In relation
to income, Div 6 includes income in the year in which it is “derived”.
Derived income is determined by reference to accounting and common
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law principles. A taxpayer will use either the cash or accruals basis for
determining what income is derived in a relevant year, the method
selected being determined according to the accounting method which
provides a substantially correct reflex of the taxpayer’s true income.
While the meaning of “derived” is different depending on whether the
taxpayer operates on a cash or accruals basis, the meaning of “incurred”
for the purposes of recognising deductions has the same meaning under
both methods. The chapter also deals with the reconciliation of financial
accounts to taxation law in order to determine the tax payable by the
business entity.
In addition to the general timing rules for income derived and losses or
outgoings incurred, Div 70 of the Income Tax Assessment Act 1997 (Cth)
(ITAA 1997) contains a specific regime which applies to taxpayers who
both carry on business and have trading stock. This Division is discussed
in Chapter 17. Students may be familiar with accounting for trading stock
which takes into account net profits and losses on disposal of trading
Sadiq, E. A. (2020). Principles of taxation law 2021. ProQuest Ebook Central <a
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554 PRINCIPLES OF TAXATION LAW 2021
stock. Income tax accounting for trading stock does not employ the same
method. Rather, Div 70 applies a de facto formula to produce an overall
result that properly reflects the taxpayer’s activities with trading stock
during the income year. Chapter 17 outlines the formula to be applied
along with special rules which may be relevant to a taxpayer.
16
Tax accounting
Key points.................................................................................................... [16.00]
Introduction................................................................................................ [16.10]
Derivation of income.................................................................................. [16.20]
Meaning of “derive”............................................................................. [16.20]
Timing of derivation............................................................................. [16.30]
Cash vs accruals accounting............................................................... [16.40]
SBE taxpayers.......................................................................................... [16.50]
Large firms and businesses..................................................................... [16.60]
Switching between cash and accruals basis.......................................... [16.70]
Payment before earning activity has commenced............................. [16.90]
Sales under a “lay-by method”............................................................ [16.95]
Dividend income –when derived...................................................... [16.100]
Derivation of income –delay because of dispute............................ [16.110]

Timing –deductions and deductibility................................................... [16.120]
Expenses............................................................................................ [16.120]
Expense of an earlier income year........................................................ [16.140]
Incurred after business ceases to operate............................................ [16.150]
Relevant to reduction of future expenses............................................. [16.160]
When no income is being generated.................................................... [16.170]
Prepaid expenses................................................................................... [16.180]
Amounts specifically excluded.............................................................. [16.182]
SBE taxpayers........................................................................................ [16.185]
Not satisfying the 12-month rule –non-business expenditure............ [16.186]
Provisions........................................................................................... [16.190]
Long service leave and annual leave.................................................... [16.190]
Bad debts................................................................................................ [16.220]
Insurance companies............................................................................. [16.230]
Questions................................................................................................... [16.250]

556 [16.00] PRINCIPLES OF TAXATION LAW 2021
Key points
[16.00]
• Financial accounts, such as profit and loss statements and balance
sheets, are prepared according to the relevant accounting standards.
When a tax return is being prepared, the accounting reports need to be
reconciled with taxation requirements.
• Taxpayers are required to use either accruals accounting or cash
accounting for taxation purposes, and there are taxation implications
of changing between cash and accruals accounting.
• Small business entity taxpayers have a choice in recognising the
derivation of income on the cash or accruals basis.
• The term “derivation of income” is not defined in the Income Tax
Assessment Acts.
• Taxpayers are taken to have received the derived amount as soon as it
is applied or dealt with in any way on their behalf or as they direct.
• Dividend income is derived by the shareholder and treated as income
when it is actually paid.
• The taxation treatment of an expense differs from the financial
accounting treatment of the deductibility of the expense.
• Taxpayers accounting on a cash basis can still claim a deduction for
expenses that have been incurred but not paid for by the end of the
financial year. On an accruals basis, once the liability to pay the expense
or outgoing has been incurred, it can be deducted from assessable
income.
• A deduction is not available for a provision for bad debts, long service
leave and holiday pay. Bad debts are covered by a specific deduction
provision: s 25- 35 of the Income Tax Assessment Act 1997 (Cth).
Section 26-10 confirms that a deduction for long service leave may
only be claimed in the year paid.
• Deductions by an insurance company for a provision to meet future
claims may be based on an estimate of claims likely to be made and is
deductible from assessable income.
• There are legislative provisions that regulate the timing of the
deductibility of prepaid expenses and prevent a taxpayer claiming a
deduction for the prepayment of expenses in certain circumstances.
Introduction
[16.10] Tax accounting is based on financial events happening over a financial
year. It is quite different to financial accounting. One of the most important
tasks that an accountant undertakes is to reconcile the financial statements
to tax requirements contained in both the statutory and common law. Many
financial accounting treatments for recognising income and deductions are not
Income tax payable must be determined according to the provisions of the

Income Tax Assessment Act 1997 (Cth) (ITAA 1997). As a starting point, s 4-10
of the ITAA 1997 states:
4-10 How to work out how much income tax you must pay
(1) You must pay income tax for each financial year.
(2) Your income tax is worked out by reference to your taxable income for the
income year. The income year is the same as the financial year, except in
these cases:
(a) for a company, the income year is the previous financial year;
(b) if you have an accounting period that is not the same as the financial
year, each such accounting period or, for a company, each previous
accounting period is an income year.
There are many areas in taxation law where the method used to account
for income or deductions differs from the Generally Accepted Accounting
Principles (GAAP). The important areas of difference are examined in this
chapter and outlined in Figure 16.1.
Derivation of income
Meaning of “derive”
[16.20] Division 6 of the ITAA 1997 uses the term “derived” to refer to income
of the taxpayer. However, the term “derived” is not defined in either Income
Tax Assessment Acts. As such, it is left to the common law to determine the
meaning of “derived”. The following quote from Gibbs J in Brent v FCT (1971)
125 CLR 418 at 570 provides an excellent definition:
The Act does not define the word “derived” and does not establish a method to be
adopted as a general rule to determine the amount of income derived by a taxpayer,
although particular situations not relevant to the present case are dealt with. The
word “derived” is not necessarily equivalent in meaning to “earned”. “Derive” in
its ordinary sense, according to the Oxford English Dictionary, means “to draw,
fetch, get, gain, obtain (a thing from a source)”. It has become well established
that unless the Act makes some specific provision on the point the amount of
income derived is to be determined by the application of ordinary business and
commercial principles and that the method of accounting to be adopted is that
which “is calculated to give a substantially correct reflex of the taxpayer’s true
income” (Commissioner of Taxes (South Australia) v Executor, Trustee and Agency
Company of South Australia Limited (Carden’s Case) (1938) 63 CLR 108 at 152-4;
1 AITR 416 at 441-2).
Timing of derivation
[16.30] An important step in calculating the taxpayer’s assessable income is
determining when that income has been “derived” in a tax year. There are two
Example 16.1: Cash vs accruals basis – timing

Marieke places $10,000 with her bank in a term deposit for one year at
4.5% interest. The term deposit matures on 1 July and $450 is paid in
interest by the bank by crediting Marieke’s account with the money.
If Marieke accounted for the interest of $450 on a cash basis, it would be
included in the current year, but if she accounted on an accruals basis,
then it would be included in the previous year as the interest accrued
to her.

There is nothing in the statutory law that compels taxpayers to adopt an

accruals method or cash method to calculate the amount of taxable income
they have gained in a particular tax year. However, from a practical perspective,
accountants and lawyers should have regard to the Australian Taxation Office
(ATO) public ruling, TR 98/1. The approach taken by the ATO in the ruling is
that trading income should be returned on an accruals or earnings basis and
income from non-trading activities such as specialised knowledge and skill,
investment income, and rent and royalties could be returned on a cash or
receipts basis.
Case study 16.1: Recoverable debt

The issue of using the correct method of accounting arose in the case of
Barratt v FCT (1992) 23 ATR 339 where the taxpayer was not able to sue
for the recovery of a bad debt until six months after the service had been
provided to the customer. The taxpayer was carrying on the business of
a pathology practice and the Medical Practitioners Act 1938 (NSW) had
the effect of rendering fees not recoverable as a debts for a period of at
least six months after the service. The taxpayer used the cash method of
accounting on the basis that they could not recover the non-payment of
fees for at least six months after the provision of the service. The ATO
contended that due to the size of the practice and the case law on this
point that the most appropriate method of accounting was the accruals
method. The Full Bench of the Federal Court held that the appropriate
method was indeed the accruals method and that the concept of a
“recoverable
debt” did not justify the use of a cash basis of accounting.
SBE taxpayers
[16.50] Any business that is an eligible small business entity (SBE) may
account on either a cash or accruals basis. The test to be applied is that the
entity must have an average turnover of less than $10 million (previously
16: Tax accounting [16.70] 561
$2 million). The Government encourages small businesses to account on a

cash basis as this is better for cashflow purposes when calculating income tax
payable and GST owing to the ATO.
Large firms and businesses

[16.60] In Henderson v FCT (1970) 119 CLR 612 (see Case Study [16.2]), the
High Court established the legal principle that with large professional firms the
appropriate method to be used in calculating taxable income is the accruals
basis. It is however acceptable for small professional practices and small
businesses to use the cash basis as it provides a cashflow advantage when
businesses first start because their assessable income is based only on cash
received. Any income tax payable can then be met from the cash received.
Switching between cash and accruals basis

[16.70] If a small business grows into a large business, then it may be
appropriate for that business to change from accounting on a cash basis to an
accruals basis for taxation purposes. The change would occur at the start of a
new financial year.
Example 16.2: Impact of changing from cash to accruals basis

In Year 1, ABC Pty Ltd accounted on a cash basis and its taxable income
was $200,000. In Year 2, ABC Pty Ltd accounted on an accruals basis and
its taxable income was $600,000.
Cash ($) Invoice/accruals ($)

Year 1 200,000 500,000
Year 2 800,000 600,000
What is the effect of the $200,000 of cash that is not included in ABC’s
Year 2’s taxable income? Is this amount subject to income tax and, if so,
how? Case Study [16.2] provides the answer.

Case study 16.2: Changing from cash to accruals basis

Henderson v FCT (1970) 119 CLR 612 illustrates what happens when
taxpayers change the method they use to calculate their taxable income.
In this case, the change was from a cash basis to an accruals basis.
The taxpayer, Mr Henderson, was a partner in an accounting practice and
calculated the partnership income for the year ended 30 June 1964 on
a cash basis, then prepared the partnership’s tax return on that footing.
Mr Henderson returned his income on the same basis. The Commissioner
accepted these returns and assessed Mr Henderson for income tax on the
basis of them. Fees outstanding at the end of that year were not brought
in as assessable income in that year. If the partnership income were
computed for the year ending 30 June 1965 upon an earnings (accruals)
basis and the relevant earnings were confined to the earnings of that tax
year, those fees outstanding, which amounted to a considerable sum in
the order of $179,000, if no other action was taken, would be collected
without ever being subject to income tax.
The High Court held that where the professional accounting practice
employed more than 295 people, the correct method was the accruals
basis of accounting and not the cash basis. The cash basis was accepted
as appropriate for small professional practices, as was the situation in
Commissioner of Taxes (South Australia) v Executor, Trustee and Agency
Company of South Australia Limited (Carden’s Case) (1938) 63 CLR 108,
where a single doctor was conducting a medical practice.
The fact that changing from a cash to an accruals method resulted in
income from an earlier year that had not been collected in that year, and
was not subject to income tax in the current year, made no difference to
the finding of the High Court.
According to Barwick CJ at 647:
[T]‌
he whole purpose of calculating your taxable income each year is to
provide a true “reflex of income” for that period. It is not a two year period or
any other period. The earnings of a prior year are subject to income tax in that
year. In this case the earnings on a cash basis that are not included in the next
year because of calculating assessable income on an accruals basis is not
subject to income tax. The uncollected fees earned in a prior year cannot be
included in the assessable income of the next year. They are simply untaxed
earnings.
For the Commissioner’s views on the treatment of the outstanding debts

and
the CGT consequences: see ID 2014/1.
[16.80] If a taxpayer kept changing from a cash to accruals basis and then
back again in order to derive tax-free income, then the ATO could assert that
the taxpayer was engaged in tax avoidance under Pt IVA of the Income Tax
Assessment Act 1936 (Cth) (ITAA 1936) and could impose penalties for such
conduct.
Payment before earning activity has commenced

[16.90] The question of recognising income may arise when a business
receives a prepayment for goods or services and the goods or services which
will be provided over a period of time and over more than one financial year.
Arthur Murray (NSW) Pty Ltd v FCT (1965) 114 CLR 314 illustrates the way
in which the income is said to have been derived in these circumstances.
Generally, amounts received in advance will not be regarded as income and
will only be recognised when the goods or services are provided.
Case study 16.3: Derivation of income where prepayment occurs

In Arthur Murray (NSW) Pty Ltd v FCT (1965) 114 CLR 314, the taxpayer,
Arthur Murray, was in the business of providing dancing lessons to the
public. Students would pay for five, 15 or 30 hours of tuition over a period
of time but not exceeding one year unless they paid for a lifetime of
lessons. Payment was to be made by instalments or a lump sum and the
contract did not provide for a refund in the case of students not wanting
to complete their course of classes, but, in some instances, refunds were
made to students. The company, on receipt of payment, would credit the
amount to an account styled “Unearned Deposits –Untaught Lessons
Account”. When the lessons were given, amounts were then transferred
to an account styled “Earned Tuition Account”. The company would not
include amounts that represented fees in advance in its assessable income
for tax return purposes. Income was only recognised when the lesson
had been given and the income had been earned. The Commissioner
assessed the taxpayer on the total of the income received prior to the end
of the financial year.
In the joint judgment of Barwick CJ, Kitto and Taylor JJ at 318:
[A]‌ccording to established accounting and commercial principles, in the case

of a business either selling goods or supplying services, amounts received
in advance of the goods being delivered or the services being supplied are
not regarded as income. We have not been able to see any reason which
should lead the courts to differ from accountants and commercial men on
the point.
Nothing in the Act [ITAA 1936] is contradicted or ignored when a receipt
of money as a prepayment under a contract for future services is said not
to constitute by itself a derivation of assessable income. On the contrary, if
the statement accords with ordinary business concepts in the community –
and we are bound by the case stated to accept that it does –it applies the
provisions of the Act according to their true meaning.

Sales under a “lay-by method”

[16.95] The situation may also arise where retail stores “sell” goods on an
instalment basis and the legal title to the goods is not transferred nor the
physical possession until full payment has been received. These arrangements
are referred to as “lay-by sales”. The question arises as to what stage the
taxpayer derives the income. In this case, the income is only derived when
legal title passes to the customer and not when the contract is entered into. In
the meantime, the income is held in a suspense account and only recognised
as income when the full payment has been made and the goods delivered or
the customer defaults on the arrangement.
Dividend income –when derived

[16.100] Dividends are assessable income pursuant to s 44(1) of the
ITAA 1936 leading to the question of when dividends are recognised as
income. Dividends are treated as income in the hands of the shareholder
when actually paid, not when declared by the directors. The directors can
rescind the decision to pay the dividend at any time up until payment, so the
shareholders are not absolutely entitled to the dividends until they are paid.
Authority for this statement is Brookton Co-operative Society v FCT (1981)
147 CLR 441.
Example 16.3: Derivation of dividend income
Company XYZ Ltd declares a dividend of 25 cents per share on 4 May
2020. Your client is due to receive a dividend of $550. The dividend is paid
on 15 July 2020. The question is whether the client has derived the $550
in the 2019–2020 financial year or the 2020–2021 financial year.
According to the decision in Brookton Co-Operative Society v FCT, the

dividend is regarded as income when paid and not when it is declared.
The income is derived in the 2020–2021 financial year. The income is
recognised on a cash basis, not an accruals basis.

Derivation of income –delay because of dispute

[16.110] If a taxpayer is owed money for goods sold, but the amount of
money is subject to a dispute, then the question arises as to what stage that
money should be brought to account as assessable income: when the dispute
has been resolved or when the goods have been sold. In the case of BHP
Billiton Petroleum v FCT (2002) 51 ATR 520, this exact issue was decided by a
Full Bench of the Federal Court. The main legal issue decided in this case is set
out in Case Study [16.4]. In that case, the Court held that income is only derived
when a dispute is settled.
Case study 16.4: Income derived in the case of a legal dispute

In BHP Billiton Petroleum v FCT (2002) 51 ATR 520, the two taxpayers, BHP
Billiton and Esso Australia, were involved in the production of petroleum
products in the Bass Strait. The taxpayers entered into contracts for the
sale of gas (or ethane) to six buyers. The buyers agreed to pay an annually
determined amount for the gas. Monthly statements were to be issued
and payment was to be made within 15 days of receipt by the buyer.
There was provision in the 12th month for an adjustment to be made to
ensure that the amount to be paid reflected the annual contract amount.
Following the replacement of the royalty and excise regime with the
petroleum resource rent tax (the PRRT) from 1 July 1990, the sellers
notified the buyers that they intended to pass on the effect of the PRRT
directly to the buyers (the pass-on amount). The pass-on amount could
only be determined some time after gas was delivered.
The buyers did not pay the pass-on amounts. The matter was subject to
dispute and arbitration, including a (lapsed) appeal to the Supreme Court
of Victoria. It was eventually settled, with the parties agreeing not only
to settle the claim for the pass-on amounts for the past, but also to settle
claims that would arise in the future. The settlement thus involved the
payment of two lump sums, one for the past claim and one for the future
claim. The assessability of the second lump sum payable (ie, that paid for
release for future pass-on amounts) was not the subject of dispute.
The Commissioner assessed the taxpayers on the basis that they had
derived the additional income, namely the pass-on amounts at the time
the gas was invoiced monthly, even though the amounts were in dispute.
The Federal Court, per Hill and Heerey JJ at 539, held that the additional
amounts of income were only derived when the dispute had been settled.
Their conclusion was:
It is clear that there is no Australian authority which requires the conclusion
that where there is a bona fide dispute a taxpayer on an accrual basis is
obliged to account for trading income that is the subject of dispute in the
year where goods are sold, if the taxpayer is a trader in goods or in the year
when services are rendered, if the taxpayer derives income from services
performed.
As should by now be clear a principle which requires the taxpayer to account
for disputed income in the year goods are sold conflicts with accounting
practice. That practice regards income to be derived when the dispute is
concluded, whether through arbitration, litigation or settlement.
The only justification for the principle for which the Commissioner here
contends is one that proceeds on the fiction that a successful litigant was
always going to be successful and was always going to receive the amount
which the arbitral or litigation result achieves. The court should be slow to
adopt a fiction in preference for reality in a case such as the present. The
deferral of derivation until the conclusion of the dispute (or perhaps receipt if
that occurs earlier) avoids the difficulties which arise where the accounts of
the year in which the trader sells goods cannot be reopened and where the
availability of a deduction for a bad debt may be the subject of doubt. It avoids
too the unfairness to a taxpayer in being required to pay tax immediately
where recoverability of what is owed to the taxpayer and which is the fund
out of which the tax might be expected to be paid, is, as a result of a bona
fide dispute, outside the control of the taxpayer. It accords with the common
sense solution arrived at in both the United States and Canada where the tax
law does not permit reopening of the tax accounts.
The Commissioner’s submission that in the present case the taxpayer’s
derived income at the time gas was delivered to purchasers for the purpose
of the ITAA 1936 should be rejected. Because the parties accept that no
different result flows from the Petroleum Resource Rent Tax Assessment
Act 1987 (Cth), it follows that the taxpayer likewise derived the consideration
receivable from the sale of gas only when the dispute between the buyers
and the taxpayers themselves was settled. The appeals should accordingly
be allowed with costs.

Timing –deductions and deductibility

Expenses
[16.120] In order to claim an expense or outgoing as a deduction pursuant to
s 8-1 of the ITAA 1997, the question arises as to whether it is necessary to have
paid for that expense or whether it is sufficient that the liability to pay has been
incurred. Another consideration is whether an expense that relates to a previous
financial year or a future financial year can still be claimed as a deduction in the
current financial year. The taxation treatment of the recognition of an expense
even when not paid or the timing of the deduction of that expense differs from
the financial accounting treatment of the deductibility of the expense. These
differences are discussed in detail below. The starting point for deductions
is s 8-1.
8-1 General deductions
(1) You can deduct from your assessable income any loss or outgoing to the
extent that:
(a) it is incurred in gaining or producing your assessable income; or
(b) it is necessarily incurred in carrying on a business for the purpose of
gaining or producing your assessable income.
(2) However, you cannot deduct a loss or outgoing under this section to the
extent that:
(a) it is a loss or outgoing of capital, or of a capital nature; or
(b) it is a loss or outgoing of a private or domestic nature; or
(c) it is incurred in relation to gaining or producing your exempt income
or your non-assessable non-exempt income; or
(d) a provision of this Act prevents you from deducting it.
The term “incurred” does not have the opposite meaning to “derived” when
looking at income. If a taxpayer is accounting on a cash basis, then he or she
can still claim a deduction for expenses that have been incurred but not paid
for, a hybrid approach and, similarly, if accounting on an accruals basis, then
once the liability to pay the expense or outgoing has been incurred, it can be
deducted from assessable income.
The loss or outgoing must be incurred in gaining or producing the taxpayer’s

assessable income. It is not necessary to match the loss or outgoing with the
income earned in the same income year, at least where a continuing business
is involved. The financial accounting “matching principle” has no relevance to
the taxation treatment of the deductibility of expenses. The expense may be
relevant to any of the following circumstances:
• an earlier income year;
• when a business has ceased to be owned by the taxpayer;
• the reduction of future expenses; or
• deductible when no income is generated but may be in the future.
[16.130] Ruling TR 97/7 is relevant to understanding what is meant by the

term “incurred” as well as timing of the deductibility of expenses.
Taxation Ruling –TR 97/7 –Income tax: section 8-1 –meaning of “incurred” –
timing of deductions
…
Incurred
4. There is no statutory definition of the term “incurred”.
5. As a broad guide, you incur an outgoing at the time you owe a present
money debt that you cannot escape. But this broad guide must be read
subject to the propositions developed by the courts, which are set out
immediately below.
6. The courts have been reluctant to attempt an exhaustive definition of a
term such as “incurred”. The following propositions do not purport to do
this, they help to outline the scope of the definition. The following general
rules, settled by case law, assist in most cases in defining whether and
when a loss or outgoing has been incurred:
(a) a taxpayer need not actually have paid any money to have incurred an
outgoing provided the taxpayer is definitively committed in the year
of income. Accordingly, a loss or outgoing may be incurred within
section 8-1 even though it remains unpaid, provided the taxpayer is
“completely subjected” to the loss or outgoing. That is, subject to
the principles set out below, it is not sufficient if the liability is merely
contingent or no more than pending, threatened or expected, no
matter how certain it is in the year of income that the loss or outgoing
will be incurred in the future. It must be a presently existing liability to
pay a pecuniary sum;
• …
Accounting practice
8. The principles set out above relating to the interpretation of the word
“incurred” derive from cases where taxpayers operated on an earnings
basis. However, the cases have not generally sought to limit the meaning
of the word “incurred” by reference to the nature of a taxpayer’s accounting
system.
9. In these circumstances, subject to the propositions outlined above, a
taxpayer who uses a cash receipts based accounting system need not
necessarily have paid or borne a loss or outgoing in order for that loss or
outgoing to have been “incurred” for the purposes of section 8-1.
The Commissioner recently released Taxation Ruling TR 2020/1 explaining the
circumstances in which employees incur deductions for work expenses but
refers the reader back to TR 97/7 for guidance on the timing of the deduction
under s 8-1.
Expense of an earlier income year

[16.140] Placer Pacific Management Pty Ltd v FCT (1995) 31 ATR 253
illustrates the taxation principle that an expense is deductible in a later year
when the event that gave rise to the expense occurred in an earlier year.
Case study 16.5: Expense of earlier year deductible in later year

In Placer Pacific Management Pty Ltd v FCT (1995) 31 ATR 253, the
taxpayer, a manufacturer of conveyor belts, installed a conveyor belt for
NWCC. In July 1981, it sold its business. In August 1981, NWCC sued
the taxpayer, claiming that the conveyor belt was defective. In 1989, the
taxpayer settled the action by paying NWCC $325,000 and claimed the
amount as a deduction in the year of income ending 1989. The Federal
Court held that the expense was deductible and followed the decision in
AGC (Advances) Ltd v FCT (1975) 132 CLR 175.
The Federal Court held a great deal of injustice would follow if in the
present case Placer was unable to claim a deduction for the cost of
the compensation and legal fees payable as a result of having sold
a defective conveyer belt some years before the business ceased to
operate. The expenses were deductible and the High Court decision in
AGC (Advances) Ltd v FCT was followed and the High Court’s view of the
decision in Amalgamated Zinc (De Bavay’s) Ltd v FCT (1935) 54 CLR 295
was accepted as correct.
The following quote from the joint judgment of Davies, Hill and Sackville JJ
at 258 provides an excellent statement of the taxation law as it currently
stands:
On the facts of the present case the occasion of the loss or outgoing ultimately
incurred in the year of income was the business arrangement entered into
between Placer and NWCC for the supply of the conveyor belt which was
alleged to be defective. The fact that the division had subsequently been sold
and its active manufacturing business terminated does not deny deductibility
to the outgoing. A finding to the contrary would lead to great inequity. Many
businesses generate liabilities which may arise in the considerable future.
Such liabilities are sometimes referred to as “long tail liabilities”. To preclude
deductibility when those liabilities come to fruition on the basis that the active
trading business which gave rise to them had ceased would be unjust.

Incurred after business ceases to operate

[16.150] It is possible to claim, as a deduction in the current financial year,
expenses that were committed to many years prior and for a business that is
no longer owned by the taxpayer. In FCT v Jones (2002) 49 ATR 188, the High
Court held that the interest expense on a loan taken out when a business was
operational was still deductible even when the business was no longer owned
by the taxpayer.
Case study 16.6: Expense incurred in earlier year by former

business owner
In FCT v Jones (2002) 49 ATR 188, a loan was taken out to finance a
business owned by Mr and Mrs Jones. When the taxpayer’s husband
became ill and eventually died, the proceeds from the sale of the business
did not cover the loan and Mrs Jones had an ongoing liability to the
financial institution. The loan was secured against the family home and at
one stage was refinanced in order to take advantage of a lower interest
rate. The taxpayer, Mrs Jones, continued to pay the interest on the loan
out of her salary as a nurse and claimed a deduction pursuant to s 8-1

of the ITAA 1997. The ATO denied the deduction on the basis that the
business was no longer owned by the taxpayer.
The Federal Court held that the interest expense was deductible even
though the business was not still owned by the taxpayer. They followed
the precedent of both AGC (Advances) Ltd v FCT (1975) 132 CLR 175
and Placer Pacific Management Pty Ltd v FCT (1995) 31 ATR 253 in that
expenses are still deductible even when the business ceases to operate.
The fact that the loan was refinanced did not break the nexus between
the expense and the business operations that were used to gain the
assessable income in the first place. Mrs Jones had an obligation to
keep paying the interest on the loan until the loan had been fully repaid,
otherwise
she would have lost the family home.
Relevant to reduction of future expenses

[16.160] W Nevill & Co Ltd v FCT (1937) 56 CLR 290 illustrates the taxation law
principle that an expense is still deductible in the current financial year even
though it results in a reduction of expenses in future years. There is no need in
tax accounting to match the expense to the benefit derived by the action of the
taxpayer which may only occur in a future financial year.
Case study 16.7: Current-year deduction where expense reduces

future expenses
In W Nevill and Co Ltd v FCT (1937) 56 CLR 290, Mr William Nevill was
managing director of the taxpayer company. Due to his bad health, he
thought it advisable that someone should be brought into the business
to help him in its management. On 11 July 1930, the company employed
Mr King as joint managing director of the company with Mr Nevill for
a term of five years from 1 July 1930 at a remuneration of £1,500 per
annum together with a certain percentage of the profits.
When the joint managing director arrangement did not work efficiently,
Mr King was asked to resign. He was prepared to resign from the ninth
day of March 1931, on the basis that the company pay him the sum of
£2,500 as follows: £1,500 cash and the balance of £1,000 by 10 equal
monthly instalments of £100 terminating December 1931 to be covered by
10 promissory notes of the company. The money and promissory notes
were paid and the company claimed a deduction for the total amount in
the year in which the expense was incurred.
The High Court held that the expense was deductible, even though it
was incurred to reduce future deductions. The wording of s 8-1 of the
ITAA 1997 does not discuss taxable income but assessable income and a
reduction in expenses increases assessable income. The payment to the
retiring managing director was not of a capital nature as it was not used
to buy plant or equipment or provide a permanent improvement to the
business. The payment should be apportioned between the two financial
years and not deducted in the year in which the obligation to pay was
incurred.

When no income is being generated

[16.170] Steele v DCT (1999) 197 CLR 459 is an important precedent for finding
that expenses may be deductible even though no income is derived at the time
the expense is incurred but where, as a result of the expense, the taxpayer may
generate income in the future. The High Court decision reinforces the fact that
the “matching” of expenses to the gaining of assessable income is not required
for taxation purposes before an expense is deductible pursuant to s 8-1 of the
ITAA 1997.
Case study 16.8: Expenses deductible where no income generated

Mrs Steele purchased a large area of land to be used as the site of a motel.
A large amount of money was borrowed to buy the land and the interest
expense was claimed by Mrs Steele even though the motel had not been
built many years after the land had originally been purchased. A small
amount of income was generated from agisting horses on the land.
The main question was whether the interest expenses could be deductible
pursuant to s 8-1 of the ITAA 1997 (s 51(1) of the ITAA 1936), even though
the interest was incurred in purchasing a capital asset that did not generate
the volume of assessable income that was originally contemplated by the
taxpayer.
The High Court held that the interest expense was deductible even
though the capital asset was not used as intended and the volume of
assessable income was not produced as originally intended. The High
Court was of the opinion that the positive limbs must be applied to the
expense before the Court then looks at the application of the negative
limbs. Finally, the High Court dismissed the notion that the expense must
be contemporaneous to the gaining of the assessable income.
Prepaid expenses
[16.180] Sections 82KZL–82KZMG of the ITAA 1936 regulate the timing of
the deductibility of advance expenditure. These provisions were introduced
to prevent a taxpayer claiming a deduction for the prepayment of expenses
in a current financial year for several years’ worth of expenses. For example,
prior to these provisions being introduced, a business could have prepaid a
five-year lease of a motor vehicle for a business with one payment and claimed
a deduction for the entire amount. If the annual lease cost was $12,000, then
instead of claiming only this amount, if the entire lease payments were paid at
once ($12,000 × 5 = $60,000), then a deduction for $60,000 could be claimed
in year 1.
Where expenditure covers a period of more than one tax year, the general
principle is that the taxpayer must apportion that expenditure over the eligible
service period of the expenditure. There are, however, exceptions to this
general principle. The two main exceptions are amounts of expenditure which
are specifically excluded from the apportionment rule and certain payments
made by SBEs and non-business taxpayers.
Amounts specifically excluded

[16.182] In some situations, it is necessary to pay for expenses, such as
insurance premiums, and annual fees, such as licences and registration fees,
over a 12-month period. These types of expenses are excluded from the 12-
month rule by virtue of s 82KZL(1).
Section 82KZL(1) states that the following types of expenditure are excluded
from the 12-month prepayment rules:
• amounts of less than $1,000;
• amounts required to be incurred by a court order or law of the
Commonwealth, State or Territory;
• payments of salary or wages (under a contract of service);
• amounts that are capital, private or domestic in nature; and
• certain amounts incurred by a general insurance company in connection
with the issue of policies or the payment of reinsurance premiums.
Example 16.4: Amount required to be incurred under a State law

John operates a cartage business and paid $1,200 on 31 December 2019
to register his truck for 12 months from 1 January 2020 to 31 December
2020. The truck is used exclusively for business purposes. Although the
registration fee is over $1,000 and it covers a period spreading across
more than one income year, it is excluded expenditure. This is because it
is required to be incurred under a State or Territory law. The prepayment

rules do not apply to this type of expenditure and the fee is deductible in
the year it is incurred.

SBE taxpayers
[16.185] SBE taxpayers and non- business taxpayers, such as passive
investors, can pay for a service up to 12 months and obtain an immediate
deduction: s 82KZM of the ITAA 1936.
Example 16.5: Prepaid expense that is immediately deductible

The Jacobs Trust is a small business entity. On 1 June 2020, it made
a payment of $24,000 to cover the lease of its business premises for a
12-month period commencing on 1 July 2020 and ending on 30 June 2021.
As the eligible service period for the expenditure does not exceed
12 months and ends on or before the last day of the income year following
the year in which the payment was made, the prepayment satisfies the
12-
month rule. The Jacobs Trust can therefore choose to claim an
immediate deduction of $24,000 in the 2019–2020 income year.

Not satisfying the 12-month rule –non-business

expenditure
[16.186] If the non-business expenditure’s eligible service period is more than
12 months or it ends after the last day of the next income year, it is necessary
to use the following formula to work out the amount of the deduction:
Number of days of eligible service period in the income year

Expenditure ×
Total number of days of eligible service period
Example 16.6: Deduction for non-business expenditure with eligible

service period >12 months
Tom Pty Ltd is a small business entity. On 31 May 2019, it paid $15,000
for business advertising to cover the period 1 June 2019 to 30 June 2020
(396 days). Because the eligible service period is longer than 12 months,
the prepayment does not satisfy the 12-month rule. Tom Pty Ltd cannot
claim an immediate deduction for the prepayment. Instead, the deduction
for the expenditure must be apportioned over the eligible service period
as follows:
2019 (1 June 2019 to 30 June 2019)
30
$15, 000 × = $1136
,
396
2019–2020 (1 July 2019 to 30 June 2020)
366
$15, 000 × = $ 13, 864
396

The total deduction allowed proportionately over the 2018–
2019 and
2019–2020 income years will be $15,000.

Provisions
Long service leave and annual leave
[16.190] The two cases, FCT v James Flood Pty Ltd (1953) 88 CLR 492 and
Nilsen Development Laboratories Pty Ltd v FCT (1981) 11 ATR 505, relate to
the deductibility of provisions for future expenses, such as long service leave
and annual leave for employees. In both cases, the High Court held that the
provision for these future expenses was not deductible as there was no actual
liability at the time of making the provision.
Case study 16.9: Holiday and sick pay as future expenses

In FCT v James Flood Pty Ltd (1953) 88 CLR 492, the taxpayer carried on
business as a motor-body builder and general engineer. The company
was a party to the variation of an award made by the Commonwealth
Court of Conciliation and Arbitration. The award as varied provided:
Annual Leave. Period of Leave. 13A. (a) Except as hereinafter provided a
period of fourteen consecutive days’ leave shall be allowed annually to an
employee after twelve months’ continuous service (less the period of annual
leave) as an employee in any one or more of the occupations to which this
award applies.
When the company lodged its tax return for the year ending 30 June
1947, the return was accompanied by a manufacturing account which
showed, under the heading “Manufacturing overhead”: “holiday

and sick pay etc. £1,888 8s 2d”. In answer to a request for further
information by the Commissioner, the company stated that, of the
sum of £1,888 8s 2d, £578 10s 2d represented holiday and sick pay
which had accrued, but which had not been paid in the year of income.
The Commissioner disallowed the sum of £579 as a deduction from
assessable income.
The High Court held that in order for an expense, loss or outgoing, to
be incurred (pursuant to s 8-1 of the ITAA 1997), it does not require the
amount to be actually paid, but it does require a liability to meet the
payment that is fixed and cannot be changed. In this case, the liability
to pay holiday pay was subject to contingencies, such as an employee
leaving before 12 months of service. The time to claim a deduction is
when the employee takes his or her holiday leave and the money is paid
and
that usually occurs in the later financial year.
[16.200] In Nilsen Development Laboratories Pty Ltd v FCT (1981) 11 ATR

505, the High Court confirmed its earlier decision in FCT v James Flood Pty Ltd
(1953) 88 CLR 492 that provisions for leave were not deductible until actually
paid in a particular financial year.
The situation relating to the deductibility of a provision for long service leave
and annual leave has subsequently been legislated by virtue of s 26-10 of the
ITAA 1997.
[16.210] Statutory solution. Section 26-10 of the ITAA 1997 confirms that a
deduction for leave, such as long service leave, annual leave and sick leave,
may only be claimed in the year paid. Section 26-10 states:
26-10 Leave payments
(1) You cannot deduct under this Act a loss or outgoing for long service leave,
annual leave, sick leave or other leave except:
(a) an amount paid in the income year to the individual to whom the leave
relates (or, if that individual has died, to that individual’s dependant or
legal personal representative); or
(b) an accrued leave transfer payment that is made in the income year.
A provision or an allowance for the anticipated expense is not deductible.
Bad debts
[16.220] Provisions for bad debts are not allowable deductions. Provisions
are usually book entries, for financial accounting purposes, made in respect
of anticipated or possible future loss contingencies. At the time of making

the provision, it is not yet possible to say that a loss or outgoing has been
“incurred” as the relevant “triggering” event has not yet occurred.
Bad debts are now covered by a specific deduction, s 25-35 of the ITAA 1997.
Insurance companies
[16.230] Insurance companies incur liabilities at the time that certain events
occur but of which the insurance company may not become aware until some
time in the future. It has been necessary for insurance companies to make
an estimate of future liability, usually by reference to historical experience
or educated estimates. Insurance companies are allowed a deduction for
estimated costs associated with future claims.
Case study 16.10: Insurance companies –estimated future deductions

In RACV Insurances Pty Ltd v FCT (1974) 4 ATR 610, the taxpayer set aside
amounts to cover unreported third party claims. These amounts were
estimates of the likely cost of claims arising out of accidents occurring
before the end of the income year, but not yet reported.
The Commissioner disallowed the deduction. The Supreme Court of
Victoria held that the estimated cost was deductible. The fact that the
amount was estimated and that it may have to be adjusted in light of
later events does not bar the claim for a deduction. Once the event had
occurred, the accident out of which absolute liability arose, s 8-1(1) of the
ITAA
1997 applied, which was not dependant on a notice of the claim.
[16.240] Commercial Union Assurance v FCT (1977) 7 ATR 435 was similar
to RACV Insurances Pty Ltd v FCT (1974) 4 ATR 610 and affirmed the right to
be able to claim a deduction based on an estimate of claims likely to be made.
In this case, the provision was deductible even though it included an estimate
of damages to be paid by policy holders that had not notified the insurance
company within the stipulated time limit.
Case study 16.11: Deduction for an insurance provision for

future claims
As was the situation in RACV Insurances Pty Ltd v FCT (1974) 4 ATR 610
(see Case Study [16.10]), the taxpayer, Commercial Union Assurance Co
of Australia Ltd, claimed a deduction for the provision of insurance claims
that had not been notified but would have to be met, even though, as
a condition precedent of the policy, the insured was required to notify

the taxpayer company within a specified time. The Commercial Union
Assurance Company did pay claims even if they were not notified within
the time limit. The Commissioner accepted the provision that was based
on notified claims as a deduction, but disallowed this extra provision
on the basis that it did not follow the situation in RACV Insurances Pty
Ltd v FCT.
The Victorian Supreme Court confirmed the correctness of the decision
in RACV Insurances Pty Ltd v FCT and held that a provision for future
claims, even where the insurance policy document required notification
of a claim within a time limit, was also deductible. The issue of whether
a provision could include potential claims from earlier years when the
premiums had been paid was also held to be deductible, based on the
authority of AGC (Advances) Ltd v FCT (1975) 132 CLR 175.
Questions
[16.250]
16.1 Your client is a small IT consulting business consisting of a husband and
wife as the principals and two employees. From the time the business
was established, 1 July 2015, it has been accounting for tax purposes
on a cash basis. For the current financial year, your client has decided
to account on an accruals basis as the size of the business is increasing.
As at 30 June it has $40,000, which was paid to it from the previous
financial year, and this amount was not included in its assessable
income for that year. Must it be included in the current financial year?
Would your answer be different if your client had deliberately told the
customer not to pay its account for $40,000 until after 30 June?
16.2 Your client is a medium-sized building company and has provided you
with its accounting records for the current financial year. Included in
the accounting figures are the following amounts. How would you treat
them for tax purposes?
(a) Provision for long service leave for 10 employees –$25,000. The
actual amount paid during the year was $12,000.
(b) Insurance premium on the plant and equipment –$22,500, paid on
1 June for 12 months.
(c) As at 30 June, there is an outstanding electricity account for $1,500
and telephone account for $4,500.
(d) A maintenance contract on the computer equipment for

12 months –$12,000. The payment was made in the current year
but ends in May of the following year.
(e) The sum of $165,000 was paid to the sales manager on 30 June
as compensation for the early termination of his employment
contract. The employment contract had one year to go; it would
have ended on 30 June of the following year.
(f) Interest expense of $56,000 on a loan that has five years to run
that was originally used to purchase a computer repair business
which ceased to operate on 30 June 2019.
16.3 For the year ended 30 June, BBNT Pty Ltd, a lawn mower manufacturer,
reported an operating (accounting) profit of $750,000. The company
does not elect to be taxed as a SBE taxpayer.
In coming to this profit figure, the financial accountant had taken into
account the following items:
(a) $30,000 has been claimed as a deduction being the amortisation
of goodwill arising from the acquisition of a business two years
earlier.
(b) A provision has been raised for future warranties equal to 2% of
sales. During the year, the sales amounted to $5 million.
(c) Depreciation on the buildings was $50,000. However, for tax
purposes, only $25,000 is tax deductible.
(d) The company spent $75,000 on legal expenses opposing an
application by Heavy Mowers Pty Ltd to extend its patent on a
brand of mower. If the patent was not extended, then BBNT could
produce a similar mower.
(e) The company borrowed $200,000 on 1 January of the current
year to cover the purchase of new plant. The loan is repayable in
10 years. The cost of borrowing was $2,500, and this amount was
written as a deduction in the company financial accounts when it
was paid.
(f) Because of a shortage of working capital, the company was forced
to sell off some land for $300,000 in February of the current year.
The land had been bought in October 1995 at a cost of $180,000.
The company only brought to account in its financial statements
the difference between the current market value of $220,000 and
the proceeds, namely $300,000, as their accounting gain on sale.
(g) The directors also advised the financial accountant to make a
provision for:
(i) bad and doubtful debts of $30,000;
(ii) annual leave and long service leave of $60,000.
(h)
The company also purchased for the managing director a new car
at a cost of $120,000. The car was purchased by the company
on 1 July of the current year. The effective life of the car is
7.5 years. For accounting purposes, the financial accountant
has claimed depreciation in the accounts of $12,000 being 10%
of the cost.
(i) The company also needed to acquire a series of parts to hold
as stock on hand. At the end of the year, the company had
closing stock of $146,000. Of this figure, the directors believed
that $85,000 represented obsolete stock and wished to write
off this amount. The financial accountant had not done this
in deriving the profit of $750,000 as he was unsure of how
to account for it in the financial accounts. The obsolete stock
had been scrapped at the end of the year and taken to a metal
recycler.
The company has carry forward losses of $150,000. There has
been no change in the ownership of the company between the
start of the loss year and the end of the current year other than
35% of the shares were sold year to a Perth-based (unrelated)
company. The company received the following dividends:
• Cash dividend from BHP Ltd of $23,000 fully franked.
• Dividend from Intergroup Ltd of $7,800 which was 75% franked. The
company had elected to reinvest the dividend and receive shares
instead of cash.
• Cash dividend from Microsoft Inc, a US company, of A$8,200. An

amount of A$1,447 had been withheld as tax by the US Internal
Revenue Service.
• Dividend of $3,000 unfranked from Golden Beach Pty Ltd which was
declared on 5 May of the previous year by the directors but not
actually paid until 5 July of the current year.
The company accountant had only brought to account as income
the actual cash when received in respect of the above dividends. It
did not account for any dividends due.
The company directors come to you as the taxation adviser of the
company and wish to know what the taxable income is for the
company and the tax payable. The company wishes to maximise its
tax deductions.
16.4 You are the tax accountant for Computer Consultants Pty Ltd, a large
company with a turnover of $24 million. You have been asked to
review the 30 June accounts for the company. After you conducted
your review, you notice the following items had been claimed as a tax
deduction in the financial reports:
• Provision for long service leave $60,000 (an amount of $21,000 was
actually paid).
• Maintenance contract fee of $60,000 (this related to the period May
of the current year to May in the following year).
• Provision for bad debts $40,000 (this was an estimate only by the
marketing staff and no legal action has been taken).
You are required to write a report to the directors explaining the
correct taxation treatment of the above items. In your report, you
should refer to the sections of the Act and any relevant case law.
16.5 When are taxpayers allowed to account for their taxable income on
a cash basis and when are they required to account for their taxable
income on an accruals basis? Could a business with a turnover of
$20 million account on a cash basis?
16.6 If your client is required to pay interest on a loan that was used in
a business that was sold last year, are they still entitled to claim a
deduction for the interest expense even though they are not able to
match the expense to the derivation of assessable income from the
business?
16.7 Would it be tax effective if your client paid for the lease payments on
their photocopier for the next two years in one lump sum just before
the end of the financial year?
16.8 If you are accounting on a cash basis in your accounting practice and a
client came in to pay their account on 30 June, but you did not bank it
until the next day, namely 1 July, when are you taken to have derived
that income? Would it make any difference if you were accounting on

an accruals basis?
16.9 If your client owns a small business selling designer clothes and sells
dresses on a “lay-by” system, when are they said to have derived their
income? Is it when the final payment is made or when the first payment
has been made?
16.10 Emily has a sickness insurance policy that will pay a weekly benefit and
is renewable in advance each July. She receives the renewal notice
each June and pays it in July. It what year will Emily be able to deduct
the payment for the policy?
16.11 Ms Lei is a sole practitioner accountant. Her practice also acts as an
agent for a local energy supplier accepting payments. The income is
small with five regular employees, including her son and daughter
who each work 30 hours a week. The regular employees do not have
professional accounting qualifications, so Ms Lei takes responsibility
for all work that is completed. Occasionally, where there are difficult
tax questions, Ms Lei hires an accountant to do work for the practice.
Except for three regular clients who are billed on a quarterly basis, all
others are billed when work is complete.
Should Ms Lei account for her income on a cash or accruals basis?
16.12 Samuel is the sole shareholder, director and employee of a company.
Samuel’s company owns and hires out a digger and truck. The
business rents the digger and truck out at a fixed rate per hour. The
rate is for the backhoe, the truck and Samuel’s labour. The business
never rents the backhoe or truck out without Samuel’s labour. For the
purposes of taxation, the company has always returned the income
from its business on the basis of cash received. The business does not
usually extend credit and requests payment on completion of a job.
The company maintains simple books of account, recording income
when received. For purposes other than taxation, the business records
income on a receipts basis, although the business accounts do record
debtors and creditors.
For taxation purposes, should the business account for the income on
a cash or accruals basis?
17
Trading stock
Key points.................................................................................................... [17.00]
Introduction................................................................................................ [17.10]
Meaning of trading stock........................................................................... [17.20]
Common items of trading stock.......................................................... [17.30]
Accounting for trading stock..................................................................... [17.50]
Acquisitions.......................................................................................... [17.60]
Non-arm’s length transactions................................................................ [17.70]
Disposals.............................................................................................. [17.80]
Disposals in the ordinary course of the taxpayer’s business................ [17.90]
Disposals outside the ordinary course of the taxpayer’s business..... [17.110]
Year-end adjustments........................................................................ [17.120]
Value of trading stock at start of year................................................... [17.130]
Value of trading stock at end of year.................................................... [17.140]

Comprehensive example................................................................... [17.210]
Trading stock on hand.............................................................................. [17.220]
Special rules.............................................................................................. [17.240]
Asset of taxpayer becomes trading stock......................................... [17.250]
Item ceases to be trading stock but continues to be owned by
taxpayer....................................................................................... [17.260]
Lost or destroyed stock..................................................................... [17.270]
Small business entities............................................................................ [17.280]
Interaction with other income tax rules................................................. [17.290]
Questions................................................................................................... [17.300]

Key points
[17.00]
• Taxpayers who are carrying on a business may have a class of assets
known as trading stock which are subject to a special statutory tax
accounting regime in Div 70 of the Income Tax Assessment Act 1997 (Cth).
• The trading stock provisions outline what constitutes trading stock
and the timing and quantum of any assessable income or deduction
amounts in relation to trading stock.
• The definition of “trading stock” is very broad, and it is necessary to
determine the taxpayer’s purpose in holding an item to determine
whether it is trading stock of the taxpayer.
• The timing of income and deductions in relation to trading stock will
generally depend on whether the stock is “on hand” for the taxpayer.
• The assessable income or deduction amount in relation to trading stock
may be altered by special rules, where the taxpayer and the other party
to the transaction do not deal with each other at arm’s length.
• Taxpayers will have an assessable income amount or a deduction
amount at the end of the financial year, depending on the value of
trading stock at year-end as compared to the value of trading stock at
the start of the year.
• Taxpayers have a choice of three methods in valuing trading stock at
year-end unless the stock is obsolete.
• Special rules govern the tax consequences for a taxpayer, where assets
owned by the taxpayer become trading stock or an item of trading stock
ceases to be trading stock but continues to be owned by the taxpayer.
Introduction
[17.10] Chapter 16 discusses how income and deductions are generally
taken into account for tax purposes, that is, on a cash or accruals basis. In this
chapter, we look at the statutory tax accounting regime for a particular class
of assets known as “trading stock”. If an asset is classified as trading stock, the
timing and quantum of income and deductions relating to trading stock are
governed by Div 70 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997).
The trading stock provisions essentially match the cost of trading stock with the
revenue from its sale. Where the stock remains unsold at year-end, the taxpayer
has simply converted one asset (cash) to another (stock). The taxpayer should
not be entitled to a deduction in this case as there has been no change in
the taxpayer’s economic position. The trading stock provisions provide for an
adjustment at year-end to take into account any unsold stock at that time. The
trading stock provisions in Div 70 are very similar to the accounting treatment
of trading stock. However, there are some differences, such as the methods for
valuing stock at year-end.
Meaning of trading stock
[17.20] “Trading stock” is defined in s 70-10 of the ITAA 1997 as follows:
Trading stock includes:
(a) anything produced, manufactured or acquired that is held for purposes of
manufacture, sale or exchange in the ordinary course of a business; and
(b) livestock;
but does not include a Div 230 financial arrangement.

Note that:
• It is clear from the expression “includes” that this is not an exhaustive
definition as to what constitutes trading stock. There may be items
which do not satisfy this definition but are nonetheless treated as
trading stock for tax purposes. However, given the wide definition of
“trading stock” in para (a), it is likely that this would only occur in rare
instances.
• “Anything” can be trading stock. In FCT v St Hubert’s Island Pty Ltd
(1978) 8 ATR 452, the High Court suggested that the term “anything”
should have the widest possible meaning and includes intangibles.
The definition is certainly wide enough to encompass the accounting
concept of “inventory” and the ordinary commercial meaning of
trading stock.
• As “anything” can be trading stock, the key to determining when
an item will constitute trading stock is in the purpose for which it is

held. An item must be held for the purpose of manufacture, sale or
exchange to constitute trading stock. The test is focused on the holding
of the asset and will therefore depend on the individual taxpayer at a
particular point in time and on the individual asset.
• An item does not have to be held directly for manufacture, sale or
exchange and items held indirectly for this purpose (eg, spare parts or
consumables) can constitute trading stock.
• Items held for hire to customers will not be trading stock as they are not
held for “manufacture, sale or exchange”: Cyclone Scaffolding Pty Ltd
v FCT (1987) 19 ATR 674; Ruling TR 98/8.
• An item can be trading stock of a taxpayer even if the taxpayer is not its
legal owner: see [17.220].
17: Trading stock [17.20] 587
Example 17.1: Meaning of “trading stock”
Tom is a chair manufacturer. He holds chairs in his factory for sale to retail
customers. He takes one of the chairs for use in his office. Simon is Tom’s
accountant. He purchases one of Tom’s chairs for use in his office.
The chairs held at the factory are trading stock for Tom as they are being
held for the purpose of sale. However, the chair which Tom takes for use
in his own office, while trading stock at one time, ceases to be trading
stock as it is not held for the purpose of manufacture, sale or exchange
once Tom uses it for other purposes.
The chair purchased by Simon, although trading stock for Tom, is not
trading stock for Simon as it is not held by Simon for the purpose of
manufacture, sale or exchange.

For an item to constitute trading stock, it must be held for the relevant purpose
in the ordinary course of the taxpayer’s business. It is therefore necessary to
determine whether the taxpayer is carrying on a business and the nature of
that business: see Chapter 8.
Example 17.2: Meaning of “trading stock”
TS Pty Ltd builds houses which it rents to residential customers. Due
to cashflow problems, it decides to sell 10% of the houses in its latest
development project. The houses are not trading stock for TS Pty Ltd.
Although they are held for the purpose of sale, this is not in the ordinary
course of TS’s business. TS’s ordinary business is to build houses to
produce rental income: see ARM Constructions Pty Ltd v DCT (1987) 18
ATR 407.

The only item that is clearly trading stock per the definition is livestock.
“Livestock” is defined in s 995-1(1) as not including animals used as beasts
of burden or working beasts in a business other than a primary production
business. Generally, all animals used in a primary production business will be
trading stock: FCT v Wade (1951) 84 CLR 105. “Primary production business”
is defined in s 995-1 and includes activities such as maintaining animals for
the purpose of selling them or their bodily produce and taking or culturing
pearls or pearl shell. Examples of livestock include bees kept for use in a honey
production business (Determination TD 2008/26) and horses owned by a horse
breeder: Ruling TR 2008/2. Examples of livestock that are not trading stock
include birds for display in a tourist park (ATO ID 2009/25) and dogs used as
guard dogs in business premises (ATO ID 2011/18).
The only item that is definitely not trading stock per the definition is a Div 230
financial arrangement.
Common items of trading stock

[17.30] In FCT v St Hubert’s Island Pty Ltd (1978) 8 ATR 452, the High Court
found that land constituted trading stock, where the land is held by a land
developer for the purpose of sale in the ordinary course of business. In that
case, the taxpayer was in the business of land development, and the Court
found that the taxpayer’s undeveloped land constituted trading stock as it was
held for the purpose of sale in the ordinary course of business. It did not matter
that the land was not in a condition ready for sale at that time.
In FCT v St Hubert’s Island, the High Court also confirmed that raw materials
(items which are used to make something else) and partly finished goods would
constitute trading stock of a manufacturer. However, a distinction has been
drawn between goods and services. Unbilled work in progress of a professional
services firm generally does not constitute trading stock: Henderson v FCT
(1970) 119 CLR 612.
Example 17.3: Work in progress not trading stock

Tom’s accountant, Simon, has been assisting Tom with the preparation of
his monthly accounts. As at 30 June, Simon had spent approximately 10
hours working on Tom’s accounts, but had yet to bill Tom for this work.
The unbilled work is “work in progress” for Simon, but does not constitute
trading stock.

Intangibles (non-physical items), such as shares, may also constitute trading

stock if they are held with the relevant purpose: Investment & Merchant Finance
v FCT (1971) 2 ATR 361; Patcorp Investments Ltd v FCT (1976) 6 ATR 420.
Spare parts held by a business for performing repairs will also generally
constitute trading stock as they are held for the purpose of exchange in the
ordinary course of business. However, spare parts would not constitute
trading stock, where they are used to repair items used by the taxpayer in his
or her business or are used in the repair of goods which are still owned by the
taxpayer (eg, goods leased to customers).
Example 17.4: Spare parts as trading stock

Tom, the chair manufacturer, includes a complex spring system which
he acquires from another business in the chairs that he manufactures. He
offers a one-year warranty on the spring systems as they can sometimes

prove problematic. He holds some extra spring systems in stock for
performing repairs. He uses these spring systems for repairs on chairs
sold to customers, whether or not they are still under warranty. If they
are no longer under warranty, he charges the customer for the cost
of the new spring system. He also uses the spring systems to repair
chairs used in his own business and to repair chairs that are leased to
customers.
The spring systems used to repair the chairs owned by customers
constitute trading stock.
The spring systems used to repair the chairs owned by Tom, that is, the
chairs used in his own business, and the chairs leased to customers, will
not constitute trading stock as the chairs are still owned by Tom.

The Commissioner provides some guidance in Ruling TR 93/ 20 on when

computer spare parts will constitute trading stock. In this Ruling, he suggests
that if it is possible to track the use of each spare part individually, this should
be done to determine whether the part constitutes trading stock. However,
where it is not possible to track spare parts individually, the Commissioner
suggests that taxpayers may treat a whole pool of spare parts as trading stock
if at least 80% of the pool is used as trading stock.
There are limits as to the amount of spare parts that can be accumulated by a
taxpayer and treated as trading stock. The taxpayer should only hold a sufficient
amount of spare parts for the business to continue operating efficiently and
any excess would be treated as a capital asset: Ruling IT 333; Guinea Airways
v FCT (1950) 83 CLR 584.
Case study 17.1: Spare parts as trading stock

In Guinea Airways v FCT (1950) 83 CLR 584, the taxpayer had accumulated
a large stockpile of spare parts in order to avoid shipping delays. The High
Court found that the excessive amount was not trading stock, but capital
assets.

[17.40] Items used by a service provider in the course of providing services

(consumables) will also constitute trading stock in certain circumstances. In
Ruling TR 98/8, the Commissioner suggests that such items would constitute
trading stock, where:
• the taxpayer is carrying on a business;
• the items are supplied in the course of providing services;
• the items are separately identifiable things before and after the services
are provided (ie, the items are not used up or significantly changed in
the provision of the services); and
• ownership of the items passes to the customers.
Example 17.5: Consumables as trading stock
Tom has a chair repair business. He holds timber, springs and glue which
he uses to repair chairs.
The timber and springs would constitute trading stock as they are
separately identifiable items before and after Tom repairs a chair. The glue
would not constitute trading stock as it is no longer separately identifiable
after Tom uses it to repair a chair.

Packaging materials held by a taxpayer may also constitute trading stock in

certain circumstances. In Ruling TR 98/7, the Commissioner suggests that
packaging items would constitute trading stock, where they are disposed of
in conjunction with “core goods” (what the taxpayer sells) and are so closely
associated with the core goods that they form part of the core goods or are
necessary to bring the core goods into the form, state or condition in which
they are sold.
Example 17.6: Packaging materials as trading stock

Lee owns a takeaway shop selling fried rice and noodles. He holds
plastic containers, forks, chopsticks and serviettes, which he provides to
customers at the time of sale.
The plastic containers constitute trading stock as they are related to the
“core good” (the rice or noodles) and are a necessary part of the sale.
The forks, chopsticks and serviettes are not trading stock as they are not
related to the core goods and are not a necessary part of the sale.
Source: Adapted from Example 2, Ruling TR 98/7.

Accounting for trading stock

[17.50] A taxpayer will have tax consequences arising:
• from the acquisition of trading stock: see [17.60];
• from disposals of trading stock: see [17.80]; and
• at year-end: see [17.120].
Acquisitions
[17.60] The acquisition of trading stock by a taxpayer is a deduction under
s 8-1 of the ITAA 1997 as the expense of acquiring trading stock is “necessarily
incurred in carrying on a business to gain or produce assessable income”.
Although the taxpayer is acquiring a business asset, the expense is not treated
as a capital expense due to the operation of s 70-25.
Although the cost of acquiring trading stock is deductible under s 8-1, the
timing of that deduction is governed by s 70-15. The cost of acquiring trading
stock will be deductible:
• when the trading stock is “on hand”: see [17.220]; or
• when an amount is included in the taxpayer’s assessable income in
relation to the disposal of the trading stock.
Non-arm’s length transactions

[17.70] Where the buyer and the seller do not deal with each other at “arm’s
length” and the amount of the expense is greater than the “market value” of
the trading stock, the amount of the deduction for the acquisition of the trading
stock is taken to be market value: s 70-20 of the ITAA 1997.
Section 995-1 does not provide a definition of “arm’s length” but suggests that
in determining whether a transaction is at arm’s length, any connection between
the parties and any other relevant circumstances must be taken into account. It
has been suggested that in determining whether a transaction is at arm’s length,

it is necessary to consider whether the outcome of the dealings between the
parties is a matter of real bargaining: Granby Pty Ltd v FCT (1995) 30 ATR 400;
Trustee for the Estate of the late AW Furse No 5 Will Trust v FCT (1990) 21 ATR
1123. For example, a transaction between members of the same corporate
group may be a non-arm’s length transaction, but whether or not it is actually
a non-arm’s length transaction will depend on the individual circumstances. If
the transaction is conducted on the same terms as a transaction with unrelated
entities, it is unlikely to be a non-arm’s length transaction.
The term “market value” is also not defined in the tax legislation. A generally
accepted definition of “market value” is the price that would be agreed to in an
open and unrestricted market by a willing but not anxious purchaser and seller
who are aware of current market conditions: Spencer v Commonwealth (1907)
5 CLR 418.
Note that where the non-arm’s length transaction is not caught by s 70-20 (eg,
where the transaction amount is below market value), the purchaser may be
deemed to acquire the trading stock at market value if it is a disposal of trading
stock for the vendor which is considered to be a disposal outside the ordinary
course of its business: see [17.100]–[17.110].
Disposals
[17.80] The tax consequences of a disposal of trading stock will depend on
whether the disposal is in or outside the ordinary course of the taxpayer’s
business.
Disposals in the ordinary course of the taxpayer’s business

[17.90] Gross receipts received by a taxpayer will be assessable as ordinary
business income under s 6-5 of the ITAA 1997. The timing as to when the gross
receipts must be included in the taxpayer’s assessable income is stipulated
by s 70-5(2)(b). The gross receipts from the disposal of trading stock will be
assessable when the trading stock ceases to be “on hand”: see [17.220].
[17.100] Non-arm’s length transactions. Where there is an adjustment to

the purchaser’s deduction under s 70-20, because the transaction was not at
arm’s length (see [17.70]), s 70-20 provides that the amount that is included in
the taxpayer’s assessable income will also be market value. Note that where
the non-arm’s length transaction is not captured by s 70-20 (eg, where the
purchaser is not acquiring trading stock or the transaction amount is less than
market value), the non-arm’s length transaction may be treated as a disposal
outside the ordinary course of the taxpayer’s business: see [17.110]. The terms
“arm’s length” and “market value” are discussed at [17.70].
Disposals outside the ordinary course of the taxpayer’s

business
[17.110] The tax consequences of a disposal of trading stock outside the
ordinary course of the taxpayer’s business are governed by s 70-90 of the ITAA
1997. A common example of a disposal of trading stock outside the ordinary
course of a taxpayer’s business is where trading stock is disposed of as part of
the sale of a business. In Pastoral & Development Pty Ltd v FCT (1971) 2 ATR
401, the Federal Court suggested that a sale of trading stock between related
parties at an extremely low or high price (a non-arm’s length transaction) may
also be considered a disposal outside the ordinary course of business. A gift or
donation of trading stock will also be a disposal outside the ordinary course of
business (a deduction may be allowed under s 30-15, where the conditions for
deductibility in that section are satisfied: see Chapter 13).
Where trading stock is disposed of outside the ordinary course of the taxpayer’s
business, the taxpayer must include the market value of the trading stock on
the day of disposal in assessable income. Any amount actually received by the
taxpayer is treated as non-assessable, non-exempt income under s 70-90(2).
Under s 70-95, the purchaser is deemed to acquire the trading stock for the
same value, that is, market value. “Market value” is discussed at [17.70].
Year-end adjustments
[17.120] As the cost of acquiring trading stock is deductible once the trading
stock is on hand for the taxpayer, an adjustment is required at year-end to
take into account any unsold trading stock which is held by the taxpayer at
that time. The year-end adjustment ensures that taxpayers are only allowed
a deduction for the cost of acquiring trading stock when there is an actual
economic decline or “outgoing”. Where the trading stock is “on hand” at year-
end, the taxpayer has simply converted one asset (cash) to another (trading
stock).
Under s 70-35 of the ITAA 1997, taxpayers are required to compare the “value”
of trading stock on hand at the start of the year and at the end of the year.
Where the:
• value of trading stock at year-end is greater than the value of trading
stock at the start of the year, the difference is included in the taxpayer’s
assessable income; or
• value of trading stock at year-end is less than the value of trading stock
at the start of the year, the difference is a deduction for the taxpayer.
The “value” of stock at year-end is ascertained by working out which items
of trading stock are on hand at year-end and prescribing an amount to each
item of trading stock in accordance with one of three methods set out in
the legislation (see [17.140]). The legislation does not require that taxpayers
undertake a physical stocktake, but this is generally the best method for
accurately determining what items of trading stock are on hand at year-end.

Taxpayers who maintain accurate records of all purchases and disposals and
undertake regular checks throughout the year to account for any losses or
errors will not need to perform a year-end stocktake. See further Determination
TD 93/125. Small business taxpayers can choose not to perform a stocktake
under the concessions discussed at [17.280].
Value of trading stock at start of year

[17.130] Under s 70-40 of the ITAA 1997, the value of a taxpayer’s trading
stock on hand at the start of the year must equal the value of its trading stock at
the end of the previous income year. In Hua Wang Bank Berhad v FCT (No 19)
[2015] FCA 454, the Federal Court confirmed that the value of trading stock at
the end of the previous income year must have been taken into account for tax
purposes to be used as the value of trading stock at the start of the following
year. For example, if the taxpayer did not lodge a tax return for a particular
year, the value of trading stock at the start of the following year will be nil as
the trading stock value at the end of the previous year has not been taken into
account for tax purposes.
Value of trading stock at end of year

[17.140] The taxpayer has three choices when determining the value of
trading stock on hand at the end of the year. Under s 70-45 of the ITAA 1997,
the stock can be valued at:
• cost: see [17.150];
• market selling value: see [17.170]; or
• replacement value: see [17.180].
The taxpayer can use a different method for valuing different items of trading
stock with the only restriction being that the year-end value must be used for
the value of the particular item of trading stock at the start of the following year.
There is also no restriction on the taxpayer changing valuation methods from
year to year. The taxpayer does not have to use one of these three methods in
valuing obsolete stock: see [17.190].
The amount of any GST input tax credits (see Chapter 25) is excluded from the
value of stock under all three methods: s 70-45(1A).
[17.150] Cost. The meaning of “cost” in this context is not provided in

the legislation, and the courts have held that cost should be determined in
accordance with relevant accounting principles: Philip Morris Ltd v FCT (1979)
10 ATR 44; FCT v Kurts Development Ltd (1998) 39 ATR 493.
In the case of manufacturers, the courts in Philip Morris Ltd v FCT (1979) 10
ATR 44 and FCT v Kurts Development Ltd (1998) 39 ATR 493 suggested that
the “direct cost method” is not appropriate and taxpayers should use the
“absorption cost method” to determine the cost of trading stock. In IT 2350, the
Commissioner states that under the “absorption cost method”, the following
three elements should be taken into account in determining the cost of trading
stock manufactured by a taxpayer:
• material costs (the cost of materials used to manufacture the particular
item of trading stock);
• direct labour costs (the cost of labour used directly in the manufacturing
operations); and
• production overhead costs (all production costs excluding material
costs and direct labour costs).
The “direct cost method” would only include the first two elements in the cost
of an item of trading stock.
Production overhead costs are also known as factory overheads, indirect

manufacturing costs, manufacturing overheads or manufacturing expenses.
These costs fall into two categories –variable production overheads which
vary with the volume of production (eg, factory light and power, stores and
most indirect labour) and fixed production overheads which remain constant
and do not vary with the volume of production (eg, factory rent, insurance
and depreciation). It is necessary to determine the extent to which production
overhead costs relate to manufacturing and non-manufacturing purposes and
only the portion relating to the manufacturing operations should be included in
the product cost under the absorption cost method.
Expenses on marketing, storage, advertising, selling, distribution, finance,

research and development, general administration, employee benefits (eg,
cafeteria, training, recreational facilities) and income tax are generally not
considered production overhead costs. Costs associated with strikes, rework,
scrap and spoilage are also not considered to be production overhead costs.
The determination as to which expenses are to be included as production

overhead costs is not a straightforward issue. In FCT v Kurts Development Ltd
(1998) 39 ATR 493, for example, the Full Federal Court held that infrastructure
and external costs of the subdivision formed part of the cost of individual
allotments of land.
In the case of retailers and wholesalers, the Commissioner adopts the view
in Ruling TR 2006/8 that the “absorption cost method” is the appropriate
methodology for determining the “cost” of trading stock. As such, the cost
of each item of trading stock includes all direct and indirect expenditure
incurred in bringing the item to its present location and condition up to the
time that the item is located in its final selling location. Examples of expenses
that would be included in the “cost” of trading stock under this method
include the purchase price of the stock; any import duties and taxes that
are not subsequently recoverable; inwards transport and handling charges;

adjustments and assembly costs incurred in preparing the trading stock for
sale; costs incurred in operating a purchasing department; and administrative
costs associated with receiving and inspecting the trading stock. Any
distribution centre and off-site storage costs should also be apportioned and
included as relevant.
Where the deduction for the acquisition of trading stock is taken to be market
value under s 70-20 of the ITAA 1997 (ie, a non-arm’s length transaction), the
“cost” of the trading stock for the purposes of the year-end valuation will also
be taken to be its market value: s 70-20, Note 1.
[17.160] Where it is not possible for the taxpayer to determine which

individual item of trading stock is on hand and which item has been disposed
of, the High Court in Australasian Jam v FCT (1953) 88 CLR 23 held that
taxpayers should use the first-in-first-out (FIFO) method for determining cost.
Other methods, such as the last-in-first-out method (LIFO), are not acceptable
in determining cost.
Example 17.7: Cost of trading stock
A retail company purchases 1,000 cans of soup for sale to customers. It
purchased the cans as follows:
• 1 July: 200 cans for $0.50 each;
• 1 December: 700 cans for $0.60 each;
• 1 March: 100 cans for $0.55 each.
At 30 June, 600 cans of soup were still on hand. Assume that there were
no cans of soup on hand at the start of the year. The taxpayer is unable
to accurately determine which cans of soup have been sold and which
have not.
The value of the remaining cans of soup (trading stock on hand at year-end)
using the cost method would be (100 × $0.55) + (500 × $0.60) = $355.
Under the FIFO method, it is assumed that all of the cans purchased for
$0.50 and 200 of the cans purchased for $0.60 have been sold.

In Australasian Jam v FCT (1953) 88 CLR 23, the High Court also accepted
that taxpayers could use a “standard or average cost” method for determining
the cost of trading stock. However, the standard or average cost must be
determined using reasonable values.
Case study 17.2: Cost of trading stock

In Australasian Jam v FCT (1953) 88 CLR 23, the taxpayer had determined
the standard cost of its trading stock (jars of jam) in one income year
and continued to use that standard cost for valuing its trading stock
over the next 30 years. The High Court accepted the method used
by the taxpayer, but found that the values used were not reasonable.
The Court accepted the Commissioner’s valuation of the taxpayer’s
trading stock, which had also been determined using the standard cost
method, although the standard cost had been calculated using updated
amounts.

Example 17.8: Average cost of trading stock

Following on from Example 17.7, the taxpayer could also determine the
cost of the cans of soup on hand at year-end using the average cost. The
average cost of the cans of soup would be [(200 × $0.50) + (700 × $0.60)
+ (100 × $0.55)]/1,000 = $0.58. The value of the taxpayer’s stock at year-
end would be 600 × $0.58 = $348.

Note that the FIFO basis or average cost method should only be used, where
the taxpayer is unable to determine which items of trading stock have been
sold and which items remain on hand: Ruling IT 2289. Where the taxpayer is
able to make that determination, the actual cost of the item should be used.
[17.170] Market selling value. Market selling value is the amount for which
the taxpayer could sell the trading stock in the ordinary course of its business
in its ordinary market: Australasian Jam v FCT (1953) 88 CLR 23. For example,
the market selling value of a wholesaler would be the amount for which it
could sell the stock in the wholesale (not retail) market. Further, the value is to
be determined in accordance with the taxpayer’s normal selling arrangements
and not, for example, under sale conditions.
The note to s 70-45 of the ITAA 1997 confirms that “market selling value” may
not be the same as “market value”. “Market value” is discussed at [17.70].
[17.180] Replacement value. The replacement value of trading stock is the

amount the taxpayer would have to spend to replace the stock. Again, the
amount must be the relevant amount for the taxpayer: Parfew Nominees
Pty Ltd v FCT (1986) 17 ATR 1017. For example, the replacement value for a
wholesaler would be the amount for which it could purchase the stock, and not,
for example, the amount it would pay if it acquired the stock in the retail market.
In Parfew Nominees Pty Ltd v FCT (1986) 17 ATR 1017, the Court stated that
while actual replacement is not necessary and only notional replacement is
required, there may be situations where replacement value is not an option for
the taxpayer as replacement must be possible and not defy business reality. The
Commissioner suggests that taxpayers can only use replacement value, where
the items are available in the market and are substantially identical to the replaced
items: Determination TD 92/198. For example, an antiques dealer is unlikely to be
able to take into consideration replacement value in valuing its year-end trading
stock as antiques are unique and not readily available in the market.
[17.190] Obsolescence. Under s 70- 50 of the ITAA 1997, taxpayers may

value trading stock at a value lower than the three methods provided by
s 70-45, where:
• the stock is obsolete; and
• the value used by the taxpayer is reasonable.
In Ruling TR 93/23, the Commissioner suggests that stock will be obsolete,
where it is or it is going to be out of use, out of date, unfashionable or outmoded.
In para 5 of the Ruling, the Commissioner suggests the following factors as
being relevant in making that determination:
(a) the age of the stock on hand;
(b) the quantities of the stock on hand which, according to the operating and sales
budgets, are expected to be used or sold during the year and in the future;
(c) the length of time since the last sale, exchange or use of an item of
the stock;
(d) industry experience/taxpayer expertise in relation to the same kind or class
of trading stock;
(e) the price at which the last sale of the stock was made, the price of the stock
on the taxpayer’s price list and the price at which the taxpayer is prepared
to sell the stock; and
(f) if the stock is spare parts:
(i) the past movements of the stock and the expected future movements
of the stock compared with the total number of units in existence
which might require that stock; and
(ii) the approximate date by which the last of those units can be expected
to have gone out of use.
The Commissioner suggests that the accurate value of obsolete stock will
generally be the value of the stock at which it is reasonable to assume that
it will be sold in the future, or its scrap value if the stock will not be sold. The
stock may have a nil valuation, where it cannot be sold or be used for any other
purpose.
[17.200] New livestock from reproduction. Where the taxpayer has new
livestock through natural reproduction, the cost of the livestock is, of course,
zero. Section 70-55 of the ITAA 1997 allows taxpayers to value such livestock
at any cost up to their market value subject to prescribed minimum values.
Comprehensive example
[17.210] The following example illustrates the application of the rules
regarding the acquisition, disposal and year-end adjustments of trading stock.
Example 17.9: Comprehensive example
Tom is a chair manufacturer. He sells chairs directly to the public through
a catalogue. His books of account provide the following information:
1 July 30 June
Completed chairs ready for sale $3,000 $1,000
Partly completed chairs $1,500 $3,000
Timber $700 $500
Springs $1,000 $600
Total purchases of timber during the year = $3,000
Total purchases of springs during the year = $1,000
Total sales of chairs during the year = $20,000
Tom’s income tax consequences in relation to the chairs are as follows:

• The chairs are trading stock as Tom holds them for the purpose
of sale in the ordinary course of his business: s 70-10 of the
ITAA 1997.
• The partly completed chairs and the timber and springs are also
trading stock under s 70-10, as confirmed by FCT v St Hubert’s
Island Pty Ltd (1978) 8 ATR 452.
• The acquisition of timber and springs during the year is a
deduction under s 8-1 and the expenses are deductible when the
springs and timber are on hand or an amount is included in Tom’s
assessable income in relation to their disposal: s 70-15.
• The $20,000 received for the sale of chairs must be included in
Tom’s assessable income under s 6-5 once the chairs are no
longer “on hand”: s 70-5(2)(b).
• Tom has a year-end adjustment under s 70-35 of $1,100, being
the difference between the value of his stock on hand at year-end
and the value of his stock on hand at the start of the year. The
difference is a deduction as the value of Tom’s stock at year-end
is less than the value at the start of the year.
Trading stock on hand

[17.220] It is very important for a taxpayer to determine when trading stock is

“on hand”. Whether or not trading stock is on hand determines:
• when a taxpayer includes gross receipts on sale of trading stock in
assessable income;
• when a taxpayer can claim a deduction for the acquisition of trading
stock; and
• the value of trading stock at year-end.
There is no guidance in the legislation as to when trading stock is “on hand”.
It is generally accepted that trading stock will be on hand, where the taxpayer
has dispositive power over the stock: Farnsworth v FCT (1949) 78 CLR 504;
FCT v Suttons Motors (Chullora) Wholesale Pty Ltd (1985) 157 CLR 277;
All States Frozen Foods Pty Ltd v FCT (1990) 20 ATR 1874; see also Ruling
IT 2670.
A taxpayer has dispositive power, where the taxpayer has the power to dispose
of the stock. Generally, legal ownership will provide dispositive power, but this
is not always the case. Whether or not a taxpayer has dispositive power will
depend on the individual facts of a case and no single factor (eg, possession,
ownership or control) will be determinative. Taxpayers may have dispositive

power without having physical possession of the items.
Case study 17.3: Trading stock not “on hand”

In Farnsworth v FCT (1949) 78 CLR 504, the taxpayer was a fruit grower who
had delivered her fruit to a packing house, where it would be processed
with other fruit prior to being packed and sold. The taxpayer’s fruit was
not separately identifiable once it was delivered to the packing house and
the taxpayer received progressive payments based on estimated sales.
The High Court found that the fruit that had been delivered to the packing
house was no longer trading stock on hand of the taxpayer. The Court
noted that the taxpayer no longer had direct power or control over the
disposal of her fruit.
The fact that the taxpayer no longer had possession, control and risk in
relation to her trading stock meant that she no longer had dispositive
power over the trading stock. As the taxpayer did not have dispositive
power
over the stock, it was no longer “on hand”.
Case study 17.4: Trading stock “on hand”

In FCT v Suttons Motors (Chullora) Wholesale Pty Ltd (1985) 157 CLR
277, the taxpayer was a car dealer who had cars from the manufacturer
under a floor-plan arrangement. Under the arrangement, the taxpayer
had possession of the cars, risk and control over the cars and the right
to sell them. However, the taxpayer did not actually have ownership of
the cars. It only had the right to acquire the cars, which it did once it had
found a buyer for a car.
The High Court found that the cars were trading stock of the taxpayer,
even though it did not have ownership of the cars because, under the
terms of the floor- plan arrangement, the taxpayer had the power to
dispose
of the cars even though it did not have ownership over them.
Case study 17.5: Trading stock “on hand”

In All States Frozen Foods Pty Ltd v FCT (1990) 20 ATR 1874, the taxpayer
was a wholesaler of frozen goods. At year-end, some of its frozen goods
were on ships at sea en route to Australia. The Full Federal Court found
that the frozen goods were trading stock on hand of the taxpayer as the
taxpayer had dispositive power over the goods.
In this case, the fact that the taxpayer did not have possession of the goods
did not matter because, under the terms of the shipping agreement, the
taxpayer had control, risk and ownership of the goods once they were
placed on the ship (Cost, Insurance and Freight contract). Therefore, the
taxpayer
had the power to sell the goods even while they were still at sea.
[17.230] Where the trading stock is land or buildings on land, the Full Federal
Court in Gasparin v FCT (1994) 28 ATR 130 held that the time when the land or
buildings cease to be trading stock is the date of settlement of the contract of
sale as that is the time when dispositive power over the land or buildings is lost.
The Commissioner has issued a number of rulings and determinations as

to when a particular item of trading stock is “on hand”. The Commissioner
suggests that:
• goods sold under a lay-by arrangement which are still in the seller’s
possession are trading stock on hand of the seller: Ruling TR 95/7;
• goods sold under a conditional contract are trading stock on hand of the
buyer if they are in the buyer’s possession at year-end. However, they
revert to being trading stock of the seller if they are returned: Ruling TR
97/15;  and
• goods provided to prospective purchasers or retailers for display
purposes only remain trading stock of the wholesaler until the
purchaser or retailer enters into a contract of sale or consignment for
the goods: Determination TD 95/48.
Special rules
[17.240] Whether an item constitutes trading stock of the taxpayer depends
on the taxpayer’s purpose in holding the asset. Therefore, the characterisation
of an asset can change over time depending on the taxpayer’s purpose in
holding that asset, even though there is no change in ownership.
There are special rules that govern the tax consequences for a taxpayer, where
an asset which was previously owned by the taxpayer becomes trading stock
(see [17.250]) or where an item of trading stock ceases to be trading stock, but
continues to be owned by the taxpayer: see [17.260].
Asset of taxpayer becomes trading stock

[17.250] Where an asset that is owned by a taxpayer becomes trading stock,
the taxpayer is deemed to have disposed of the asset and re-acquired an item
of trading stock under s 70-30 of the ITAA 1997. The taxpayer has a choice
under the section as to whether the deemed disposal and re-acquisition is
done at “cost” or at “market value”. “Cost” is determined in accordance with
s 70-45 (see [17.150]): s 70-30(3). Where the item was originally acquired for no
consideration, its cost is determined in accordance with s 70-30(4).
The tax consequences arising upon the deemed disposal will depend on the
taxpayer’s holding of the asset prior to the change.
Where the asset was held as a depreciating asset prior to becoming trading
stock, a balancing adjustment may be required under Div 40 to account for the
deemed disposal: see Chapter 14.
Where the asset was held as a CGT asset prior to becoming trading stock, the
tax consequences will depend on whether the deemed disposal was done at
“cost” or “market value”. Where the taxpayer elects for the deemed disposal to
be done at “cost”, any CGT consequences arising on the deemed disposal are
disregarded: s 118-25. Where the taxpayer elects for the deemed disposal and
re-acquisition to take place at “market value”, CGT Event K4 happens to the
taxpayer at that time under s 104-220. The tax consequences for the taxpayer
will be:
• a capital gain where the market value of the asset on the day it becomes
trading stock is greater than the cost of the asset; or
• a capital loss where the market value of the asset on the day it becomes
trading stock is less than the cost of the asset.
Upon the deemed re-acquisition of the asset, the taxpayer will be entitled to
a deduction under s 8-1 for the cost of acquiring the trading stock –this will
either be “cost” or “market value” depending on the taxpayer’s election in
relation to the deemed disposal. If the stock is still on hand at the end of the
year, the taxpayer will have to include the value of the trading stock in the value
of its trading stock on hand at year-end.
Example 17.10: Asset of the taxpayer becomes trading stock

Declan owns a block of land, Blackacre, which he purchased in Year 1 for
$200,000. Since that time, Declan has become involved in a number of
land development activities and in Year 3 he decided to venture Blackacre
into the business. The value of Blackacre at that time was $500,000. In
Year 4, Declan sold Blackacre for $700,000.
In Year 3, a capital asset of Declan’s became trading stock. At that time,
Declan is deemed to have disposed of Blackacre for either cost or market
value and is deemed to re-acquire it on the same day for the same value.
Declan’s tax consequences on the disposal of Blackacre in Year 4 will
depend on his choice of method in Year 3.
Option 1: Declan chooses “cost”

Year 3
Declan would claim a deduction under s 8-1 for the cost of acquiring
trading stock ($200,000). However, that amount would be reflected in the
value of Declan’s trading stock at year-end as Blackacre is still on hand
at that time. Therefore, under the trading stock rules, Declan effectively
has no tax consequences from the asset becoming trading stock in
Year 3. (The capital gains tax provisions may give rise to separate tax
consequences for Declan.)
Year 4
Declan includes the $700,000 received for the sale of Blackacre in his
assessable income. As Blackacre is no longer on hand at year-end, Declan
will effectively receive a deduction of $200,000 in that year as that amount
is included in the value of his trading stock on hand at the start of the year,
but not in the value of his trading stock on hand at the end of the year.
Therefore, Declan is in a net income position of $500,000 in Year 4.
Option 2: Declan chooses “market value”
Year 3
Declan would have a capital gain of $300,000 under s 104-220 as the cost
of the asset ($200,000) is less than its market value on the day of the
deemed disposal ($500,000).
Declan would claim a deduction of $500,000 under s 8-1 for the “cost” of
acquiring trading stock (Declan is deemed to have reacquired Blackacre

for $500,000 which is the market value at that time). However, that
amount would be reflected in the value of his trading stock at year-end as
Blackacre is still on hand at that time.
Therefore, Declan has a capital gain of $300,000 on the asset becoming
trading stock in Year 3 and no further tax consequences under the trading
stock provisions.
Year 4
Declan includes the $700,000 received for the sale of Blackacre in his
assessable income. As Blackacre is no longer on hand at year-end, Declan
will effectively receive a deduction of $500,000 in that year as that amount
is included in the value of his trading stock on hand at the start of the year,
but not in the value of his trading stock on hand at the end of the year.
Therefore, Declan is in a net income position of $200,000 in Year 4.
Essentially, the two options merely result in a timing difference. However,
as an individual who has owned the CGT asset for more than 12 months,
Declan would be entitled to discount the $300,000 capital gain on
Blackacre to $150,000 (assuming he has no capital losses) and Option

2 would therefore provide Declan with a better overall tax outcome.
Where the taxpayer is a company, the two options only result in a timing
difference as companies cannot discount a capital gain: see Chapter 11.

Item ceases to be trading stock but continues to be

owned by taxpayer
[17.260] Where a taxpayer ceases to hold an item as trading stock, but
continues to own it, the taxpayer is deemed to have disposed of the item and
re-acquired it for “cost” under s 70-110 of the ITAA 1997. An item of trading
stock would generally cease to be trading stock when the taxpayer’s purpose
in holding the asset changes. Section 70-110 provides the example of a sheep
grazier who takes a sheep from stock for personal consumption.
The taxpayer will have to include the “cost” of the trading stock in assessable
income under s 6-5 in the income year in which he or she ceases to hold the
asset as trading stock.
Upon re-acquisition, the cost of the trading stock will become the asset’s cost
base if the taxpayer holds it as a CGT asset or its cost under Div 40 if the
taxpayer holds it as a depreciating asset.
Example 17.11: Item ceases to be trading stock of taxpayer

Michael owns a bookstore specialising in first-edition books. He purchased
a first-edition copy of The Chronicles of Narnia by CS Lewis for $12,000
for the store. The book did not sell and, after a few months, he decided to
remove the book from the shelf and keep it for himself.
The acquisition of the book is the acquisition of an item of trading stock
as Michael sells books in the ordinary course of his business. Therefore,
the $12,000 is deductible under ss 8-1 and 70-15 as the book is on hand.
When Michael takes the book from the store for himself, it ceases to be
trading stock and Michael is deemed to have disposed of it for cost under
s 70-110. As such, Michael must include $12,000 in his assessable income
for the year.
Although Michael is also deemed to have acquired the book for its cost
($12,000), the $12,000 is not deductible as the book is for Michael’s private
or domestic use (see Chapter 12). The $12,000 may form part of the cost
base of the book should there be capital gains tax consequences at a later
point in time.

Each year the Commissioner publishes a Taxation Determination, which provides

the amounts that the Commissioner will accept as reasonable estimates of the
value of goods taken from trading stock for private use by taxpayers in certain
businesses such as a bakery, butcher and restaurant. The relevant Determination
for the 2019–2020 income year is TD 2020/1. At the time of writing, the relevant
Determination for the 2020–2021 income year had yet to be published.
Lost or destroyed stock
[17.270] Any lost or destroyed stock is effectively taken into account through
the year-end adjustment as the stock is not “on hand” at that time and is not
included in the value of the trading stock at year-end. Any amount received as
compensation for lost or destroyed stock (eg, insurance proceeds) is included
in the taxpayer’s assessable income under s 70-115 of the ITAA 1997.
Small business entities

[17.280] A “small business entity” can choose not to account for changes
in the value of stock for an income year, where the difference between the
opening value of stock on hand and a reasonable estimate of stock on hand
at year-end is less than $5,000: s 328-285. As with other taxpayers, the value
of trading stock at year-end becomes the value of trading stock at the start of
the following year: s 328-295. In this context, a “small business entity” is a sole
trader, partnership, company or trust that operates a business for all or part
of the income year and has an aggregated turnover of less than $10 million:
s 328-110. In the 2020 Federal Budget, it was announced that entities with
an aggregated annual turnover of less than $50 million will be able to access
these concessions from 1 July 2021. Broadly, “aggregated turnover” is the
entity’s turnover plus the annual turnover of any business that is connected or
affiliated to the entity. Taxation Ruling TR 2019/1 provides guidance as to when
a company carries on a business for the purposes of s 328-110.
Where the “small business entity” chooses to account for changes in the value
of trading stock, the general trading stock rules discussed in this chapter apply.
Interaction with other income tax rules

[17.290] An asset that is trading stock may also qualify as a CGT asset and be
subject to tax under the CGT rules discussed in Chapter 11. This is prevented
from happening by s 118-25 of the ITAA 1997, which provides that any capital
gain or loss arising is disregarded if, at the time of the CGT event, the CGT
asset is classified as trading stock.
Similarly, an item of trading stock may also qualify as a depreciating asset and
be subject to the capital allowances regime discussed in Chapter 14. This is
prevented from happening by s 40-30(1)(b), which excludes an item of trading

stock from the definition of “depreciating asset”.
However, an item of trading stock that is a financial arrangement under

Div 230 will be subject to tax under those provisions and not the trading stock
provisions: s 70-10.
Questions
[17.300]
17.1 Consider whether the following are trading stock:
(a) Bees kept for use in a honey production business.
(b) Horses used in the city horse carriage tour business.
(c) Horses owned by a horse- training business for racing in
competitions.
(d) Horses owned by a race horse breeder.
(e) Undeveloped land owned by a land developer.
(f) Motherboards owned by a computer manufacturer for making
computers.
(g) Partly finished computers of a computer manufacturer.
(h) Lemon trees on a lemon farm.
(i) Lemons which have been picked from the trees on a lemon farm
and are ready for sale.

(j) Car oil used by a mechanic when servicing cars.
1
7.2 Alex is an ardent movie watcher. He believes that the quality of the movie
watching experience is much better on a DVD instead of via a streaming
service. He is also an active environmentalist and likes to reduce
consumption. He has combined his two loves by running a DVD rental
business and has a collection of more than 1,000 DVDs available for rental.
Are the DVDs held in Alex’s DVD rental business trading stock?
17.3 Best Juice is a juice retail company in Australia. The company purchases
exotic juices from various wholesalers and sells the juices to the public
through various pop-up outlets. The company started operations during
the last financial year and had no stock on hand at the start of the year.
During the year, the company undertook the following transactions:
• 1 August: Purchased 3,000 bottles of juice for $1 each;
• 1 December: Purchased 5,000 bottles of juice for $1.50 each;
• 1 February: Purchased 3,000 bottles of juice for $1.10 each.
The company has determined that at 30 June, it has 1,000 bottles of
juice in stock. However, it is unable to determine when these bottles
were purchased. At 30 June, the bottles of juice could be purchased
by the company for $1.30 each and the company sells the bottles for
$2.50 each.
Advise Best Juice as to how it should value its stock on hand at 30
June if it wishes to minimise its tax liability for the year.
17.4 Isabelle lives in Melbourne, Australia. She has a little shop in the city
selling colourful umbrellas. Isabelle only sells colourful umbrellas
because she thinks that people need to see lots of colours on a rainy
day. She purchases these umbrellas from various suppliers in other
countries. During the year, Isabelle had the following transactions:
(a) Purchased $7,500 worth of umbrellas on 20 June from an overseas
supplier. The umbrellas were loaded on to a ship the next day
and under the terms of Isabelle’s agreement, she takes ownership,
control and risk of the umbrellas only once they are delivered to
her in Melbourne and she deems them to be of acceptable quality.
Isabelle received the umbrellas on 2 July and returned $500 worth
of umbrellas the same day.
(b) Gave away 10 umbrellas to family and friends as gifts. The
umbrellas cost $10 each and Isabelle sells them for $100 each.
(c) Took an umbrella home for her own use as it was raining heavily,
and she had forgotten to bring her umbrella to work. The umbrella
cost $10 and Isabelle would have sold it for $100.
(d) On 15 June, Isabelle decided to have an “all stock must go” sale so
that she could buy new umbrellas for the new financial year. She
sold all of her remaining stock (100 umbrellas) for $50 each. The
umbrellas had cost $10 each.

Advise Isabelle as to her income tax consequences arising from
the above information.
17.5 Bad Backs Be Gone manufactures and sells ergonomic office chairs and
desks to the general public. The company’s books of account provide
the following information:
1 July 30 June
Completed chairs and desks ready for sale $25,000 $17,000
Partly completed chairs and desks $20,000 $15,000
Timber to manufacture chairs and desks $14,000 $18,000
Joinery used in manufacturing process (not separately $11,500 $12,000
identifiable once the chairs and desks are manufactured)
Total purchases of timber during the year = $13,000
Total purchases of joinery during the year = $11,000
Total sales of chairs and desks during the
year = $250,000
Advise Bad Backs Be Gone of its income tax consequences arising

from the above information.

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When determining income tax payable, the taxation formula is applied to

Chapter 16 deals with issues of tax accounting. Tax accounting is primarily

Derivation of income –​delay because of dispute............................ [16.110]

Income tax payable must be determined according to the provisions of the

Example 16.1: Cash vs accruals basis –​ timing

There is nothing in the statutory law that compels taxpayers to adopt an

Case study 16.1: Recoverable debt

$2 million). The Government encourages small businesses to account on a

Large firms and businesses

Switching between cash and accruals basis

Example 16.2: Impact of changing from cash to accruals basis

Cash ($) Invoice/​accruals ($)

Case study 16.2: Changing from cash to accruals basis

For the Commissioner’s views on the treatment of the outstanding debts

Payment before earning activity has commenced

Case study 16.3: Derivation of income where prepayment occurs

[A]‌ccording to established accounting and commercial principles, in the case

Sales under a “lay-​by method”

Dividend income –​when derived

According to the decision in Brookton Co-​Operative Society v FCT, the

Derivation of income –​delay because of dispute

Case study 16.4: Income derived in the case of a legal dispute

Timing –​deductions and deductibility

The loss or outgoing must be incurred in gaining or producing the taxpayer’s

• deductible when no income is generated but may be in the future.

[16.130] Ruling TR 97/​7 is relevant to understanding what is meant by the

Expense of an earlier income year

Case study 16.5: Expense of earlier year deductible in later year

Incurred after business ceases to operate

Case study 16.6: Expense incurred in earlier year by former

out of her salary as a nurse and claimed a deduction pursuant to s 8-​1

Relevant to reduction of future expenses

Case study 16.7: Current-​year deduction where expense reduces

When no income is being generated

Case study 16.8: Expenses deductible where no income generated

Amounts specifically excluded

Example 16.4: Amount required to be incurred under a State law

is required to be incurred under a State or Territory law. The prepayment

Example 16.5: Prepaid expense that is immediately deductible

Not satisfying the 12-​month rule –​non-​business

Number of days of eligible service period in the income year

Example 16.6: Deduction for non-​business expenditure with eligible

Case study 16.9: Holiday and sick pay as future expenses

showed, under the heading “Manufacturing overhead”: “holiday

[16.200] In Nilsen Development Laboratories Pty Ltd v FCT (1981) 11 ATR

A provision or an allowance for the anticipated expense is not deductible.

of anticipated or possible future loss contingencies. At the time of making

Case study 16.10: Insurance companies –​estimated future deductions

Case study 16.11: Deduction for an insurance provision for

a condition precedent of the policy, the insured was required to notify

(d) A maintenance contract on the computer equipment for

• Cash dividend from Microsoft Inc, a US company, of A$8,200. An

that income? Would it make any difference if you were accounting on

Value of trading stock at end of year.................................................... [17.140]

but does not include a Div 230 financial arrangement.

an item will constitute trading stock is in the purpose for which it is

Common items of trading stock

Example 17.3: Work in progress not trading stock

Intangibles (non-​physical items), such as shares, may also constitute trading

Example 17.4: Spare parts as trading stock

offers a one-​year warranty on the spring systems as they can sometimes

The Commissioner provides some guidance in Ruling TR 93/​ 20 on when

Case study 17.1: Spare parts as trading stock

Derivation of income –delay because of dispute............................ [16.110]

Example 16.1: Cash vs accruals basis – timing

Case study 16.1: Recoverable debt

Switching between cash and accruals basis

Example 16.2: Impact of changing from cash to accruals basis

Cash ($) Invoice/accruals ($)

Case study 16.2: Changing from cash to accruals basis

Case study 16.3: Derivation of income where prepayment occurs

Sales under a “lay-by method”

Dividend income –when derived

According to the decision in Brookton Co-Operative Society v FCT, the

Derivation of income –delay because of dispute

Timing –deductions and deductibility

[16.130] Ruling TR 97/7 is relevant to understanding what is meant by the

Expense of an earlier income year

Case study 16.5: Expense of earlier year deductible in later year

out of her salary as a nurse and claimed a deduction pursuant to s 8-1

Case study 16.7: Current-year deduction where expense reduces

Example 16.4: Amount required to be incurred under a State law

Not satisfying the 12-month rule –non-business

Example 16.6: Deduction for non-business expenditure with eligible

Case study 16.10: Insurance companies –estimated future deductions

Common items of trading stock

Example 17.3: Work in progress not trading stock

Intangibles (non-physical items), such as shares, may also constitute trading

Example 17.4: Spare parts as trading stock

offers a one-year warranty on the spring systems as they can sometimes

The Commissioner provides some guidance in Ruling TR 93/ 20 on when

Case study 17.1: Spare parts as trading stock

Example 17.6: Packaging materials as trading stock

Accounting for trading stock

Non-arm’s length transactions

[17.100] Non-arm’s length transactions. Where there is an adjustment to

accurately determining what items of trading stock are on hand at year-end.

Value of trading stock at start of year

Value of trading stock at end of year

Case study 17.2: Cost of trading stock

Example 17.8: Average cost of trading stock

[17.190] Obsolescence. Under s 70- 50 of the ITAA 1997, taxpayers may

Trading stock on hand

Case study 17.3: Trading stock not “on hand”

Case study 17.4: Trading stock “on hand”

Case study 17.5: Trading stock “on hand”

the goods: Determination TD 95/48.

Asset of taxpayer becomes trading stock

Example 17.10: Asset of the taxpayer becomes trading stock

Option 1: Declan chooses “cost”

Interaction with other income tax rules

prevented from happening by s 40-30(1)(b), which excludes an item of trading

and are ready for sale.

umbrellas had cost $10 each.