Australasian Jam Co v FCT (1953)

It would be very easy to manipulate your taxable income by purchasing a whole lot of trading stock just before 30 June, if it was not for the closing stock provisions.  To work it out, assume sales of $500.
 Opening stock ($200) + purchasers in the year ($400) – what is left over at 30 June ($300), cost of goods sold is $300.  (p71 D’s N)

Division 70 ITAA97 deals with trading stock.  S70-10 is a definition – note “anything produced or bought for the purpose of resale in the ordinary course of business.  Under Div 70, your assessable income includes any excess of the value of the stock at the end of the year over the value at the start of the year, in this case $300 (closing stock) less $200 (opening stock) which equals $100.  That is included in assessable income.  So here, assessable income is $500 sales plus $100 (difference in closing and opening stock). 

S70-25 says it’s not capital so you get a deduction for it. 

Section 70-45 says you can elect to value each item of trading stock on hand at the end of the income year at:
• its cost
• its market selling value, or
• its replacement price

S70-40 says whatever method you use to value your stock at the end of the year; you must use that same valuation method for your opening stock in the new year. By changing methods of valuation at the end of year, you can increase or decrease your taxable value.  It allows you to accelerate or defer the recognition of taxable income, but it adjusts in next year. 

Section 70-45 ITAA97 provides three alternative bases for valuing closing stock on hand:
• cost – Although there is no clear authority on the point, it appears that, where goods are purchased in a condition ready for sale, “cost” includes not only the invoiced purchase price but also costs such as freight, insurance and duty incurred in getting the stock into its condition and location at year end (ie the place where it is “on hand”).  In the case of a retailer or wholesaler, the place where it is “on hand”). 
• market selling value (which is not necessarily the same as market value) – There is no definition of the term “market selling value” in ITAA97, and there is little authority on the meaning of that term.  However, based on the decision in Australasian Jam Co Pty Limited v FC of T it seems that the term means the amount which will be realized in the company’s own selling market in the ordinary course of business
• replacement value – There is no definition of the term “replacement value” in ITAA97 and there is little decided authority on the meaning of the term.  It appears to be generally accepted that the term means the value at which the taxpayer can replace the goods on the land day of the year of income, and that, where goods are normally bought rather than manufactured, the value includes freight, insurance and other such costs which would have to be incurred to bring goods into their existing condition and location.  (p810 ATL)

In each case it is the value net of GST that is taken into account (s70-45(1A)).
In addition to the three “normal” methods of valuing trading stock, s70-50 permits a taxpayer to elect to value an item of trading stock at lower than its cost, market selling value or replacement value, if the item of trading stock is obsolete and the real obsolescence value is reasonable. 

(4) Compensation
ITAA 1997, ss 15-30, 20-20(2), 70-115

A compensation payment which replaces an amount which would have been ordinary income if received will be assessable as ordinary income under s6-5 ITAA97.  Where the replaced amount would have been assessable as statutory income if received, and falls outside s6-5, the amount will be assessable as statutory income under s6-10 and 15-30.

(f) Cancellation of a “structural” agreement

The general principle here is that the compensation takes the character of the item it replaces. E.g. if the asset being compensated for is trading stock, then the compensation receipt will be income.  Similarly, if compensation is for loss of a revenue asset, it will also be assessable.
Where it gets more difficult is where compensation is for cancellation of agreements.  It is a question as to what place the agreement has in the whole structure as to whether the cancellation of the agreement or compensation for the cancellation of the agreement will constitute income or capital.

Van den Berghs v Clark [1935] – Compensation for the cancellation of an agreement affecting the fundamental structure of a business, or for the permanent loss of a fixed asset, is capital in character and not assessable at common law. 

Facts: There the taxpayer (“Van den Berghs”) manufactured and sold margarine.  The taxpayer agreed to “work in friendly allegiance” with a Dutch company, and the parties entered into agreements under which they set out the way in which profits and losses were to be shared, territories allocated, and various ancillary matters dealt with.  In due course the parties fell out, the agreements were terminated, and the Dutch company paid Van den Berghs £450,000 in consideration of its release from the agreement. 

Held: The House of Lords unanimously characterized the compensation payment as capital. The House of Lords said the agreements were not ordinary commercial contracts made in the course of carrying on their business such as contracts for the disposal of products.  The agreements regulated the taxpayer’s activities, it went to the whole structure of the business in that it regulated the taxpayer’s activities, defined what they may or may not do and affected the whole of their business, and the compensation for cancellation of the agreement was therefore capital. 

Similarly, compensation for the “permanent loss of a fixed asset” is capital in character and not assessable at common law. 

Restriction On Ability To Carry On A Business

If you dispose of your whole business it is obviously a capital receipt.  What happens if you do not get rid of your business, but restrict part of it in return for compensation.

Dickenson v FCT (1958)

Facts: Taxpayer owned a petrol station in Kingsgrove.  He was approached by Shell, who was setting up a system of tied sites, by way of restrictive covenant.  Taxpayer agreed to receive money for selling Shell products only, for 10 years.

Held: HC held the receipt was capital.  Dixon said the taxpayers business constituted a profit-yielding organisation of a definite structure, and he received the money as an inducement to change a major feature of it.  Kitto J said it was capital.  It was a lump sum payment for restriction to one brand of petroleum products.  This was in the nature of a sale price for a substantial and enduring detraction from pre-existing rights.

Cancellation of Business Contracts

Heavy Minerals v FCT (1966) 

Facts: Taxpayer Company had the right to a rutile mining lease, and entered into long-term contracts to supply overseas purchasers. After these contracts were entered into, the world rutile market collapsed, so the overseas purchasers negotiated a cancellation of their contracts & made lump sum compensation payments to the taxpayer.

Held: HC (single judge – Windeyer) held that the lump sum compensation payments made to Heavy Minerals were assessable. Windeyer J said the damages received as compensation for non-performance of a business contract stand on the same footing as the profits for the loss of which the damages are paid. There is no difference between whether money is earned as profit or paid as compensation for loss of the opportunity of earning that profit.