Taxation Review Authority clarifies the meaning of “stop” in s EC20

Summary

The Tax Review Authority ("the TRA") concluded that the use of the phrase "stops deriving income from the sale of specified livestock" in s EC 20 of Income Tax Act 2007 ("the ITA") is to be read as requiring a permanent stop. A "stop" for one income year is not sufficient to be able to use the livestock valuation provisions in s EC 20.

Impact

This decision clarifies the position that a taxpayer must stop deriving income from the disposal of specified livestock permanently to use the process for valuing herd livestock in s EC 20 of the ITA.

Facts

The taxpayers are trusts that operated in a partnership. The trustees were "Mr and Mrs Smith" and their accountant, "Mr Brown". The taxpayers owned a herd of dairy cows which they milked on the "XY Trust No 2" farm. They also owned 4 hectares of land on which they raised jersey bull calves. The dairy herd was sold on 1 June 2012 and the jersey calves in September and October 2012 (i.e. in the 2013 tax year) and as at 1 November 2012, the taxpayers did not own any specified livestock. Mr and Mrs Smith personally purchased 18 jersey bull calves on 11 December 2012, which were kept on the 4 hectares of land owned by the taxpayers.

On 29 November 2012 the accountants for the taxpayers wrote to the Commissioner advising that the partnership had ceased farming and that they elected to use the 2012 National Average Market Values ("NAMVs") under s EC 20 of the ITA to calculate their 2013 livestock income.

In the 2014 and 2015 tax years, the taxpayers purchased further jersey bull calves, keeping and raising them on their 4 hectare property.

It was accepted that between 1 November 2012 and 31 May 2013, the taxpayers (the trusts) did not own any livestock so had stopped deriving income from the disposal of specified livestock in the 2013 tax year (only). It was also accepted that that the taxpayers derived income from the disposal of specified livestock in the income years subsequent to the 2013 tax year.

On 5 September 2013, the taxpayers filed their 2013 income tax returns using the 2012 NAMVs. The 2013 NAMVs were lower than the 2012 NAMVs and the effect of using the 2012 NAMVs was a deduction for opening stock of $1,160,612 rather than $993,490 if the 2013 NAMVs were used.

The challenge concerned the ability for the taxpayers to use the 2012 NAMVs to value their livestock in the 2013 tax year under section EC 20 of the ITA.

Decision

A person is allowed a deduction for the property on hand at the start of an income year under s DB 49 of the ITA and the value of the property at the end of income year is income under s CH 1. Subpart EC of the ITA sets out the valuation of livestock that is deducted under s DB 49 and is the relevant subpart to this challenge. The usual rule, under s EC 2, is that opening value of stock is the closing value from the previous year.

The herd scheme is a valuation method that values each type of livestock on the basis of the NAMVs. The scheme treats livestock as a capital asset, despite its similarity to trading stock. The taxpayers used the herd scheme valuation method.

Section EC 16 of the ITA provides the method for valuing livestock under the herd scheme. It modifies the effect of s EC 2 so that rather than the opening value of the stock in a given year being the same as the closing value from previous year, the opening value equates to the closing value in the same year. The effect of this is that, under the herd scheme, any movements in herd values over the year are not subject to income tax and no deductions arise.

However, the situation changes again if s EC 20 applies. In that case, there is no revaluation of the opening value under s EC 16(3) (revaluating it to the closing value for the same year). Instead, if s EC 20 applies, the opening value of the livestock is the closing value from the previous year.

The taxpayers submitted that the interpretation of s EC 20 was a matter of first principles and the purpose of the provision was to enable farmers to obtain certainty as to their income tax requirements.

The Commissioner submitted that whilst the dictionary definition of "stop" indicates that deriving income from the disposal of specified livestock has come to an end or been discontinued, there remains an ambiguity as to whether the disposal of livestock has come to an end in a single year or permanently. Having regard to the immediate and general legislative context, the social, commercial or other objectives of the enactment and the legislative history, parliamentary debates, and reports, the Commissioner submitted that a taxpayer must stop deriving income from the disposal of specified livestock permanently in order to satisfy the requirements of s EC 20.

The TRA adopted the comprehensive analysis of the legislative history of s EC 20 provided by the Commissioner, including extrinsic material (such as Officials Issues Papers) and set this out.

The TRA did not accept that the meaning of the section was plain on its face, and agreed with the Commissioner that the meaning of "stops" was not clear whether it meant comes to an end in a single year or permanently. Where the plain and ordinary meaning of the text is not clear, it is necessary to determine the meaning most consistent with the context and purpose of the provision. It is apparent from a review of the legislative history and extrinsic material that the purpose of s EC 20 was "to help remove delays on windup" for farmers who "cease farming" and allow them to use the previous year's herd values in their accounts, rather than being "forced to wait until the market values are released for that year before commencing wind up".

There was no change in meaning with the introduction of the word "stops" instead of "ceases" in s EC 20 in the Income Tax Act 2004 and that the section does not include the word "permanently" is not determinative. In the TRA's view, the context and purpose of s EC 20 clearly supports the interpretation that the farming activity is to be stopped permanently.

Contrary to the taxpayers' submission that a farmer could not predict whether the NAMVs would advantage or disadvantage the famer, the TRA agreed that the issue was identified as a problem in the extrinsic material and, here, the taxpayers "had a fair idea" what the 2013 NAMVs were likely to be. The position taken by the taxpayers was tantamount to "cherry picking" which NAMVs to apply and was completely in contradiction to the measures taken by Parliament to eradicate "flexibility of the rules being inappropriately used".

The TRA was satisfied that s EC 20 is to be read as meaning that for the section to apply, the taxpayer must stop deriving income from the disposal of specified livestock permanently. Here, as the taxpayers did not permanently stop deriving income from the disposal of livestock, they were not able to use the 2012 NAMVs under s EC 20. The TRA dismissed the challenge and upheld the Commissioner's assessments using the 2013 NAMVs.