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23. Chapter 18 Income Taxation in Relation to Particular Industries: Primary Production
18.1. The Income Tax Assessment Act contains a number of provisions that relate only to income from primary production. The relevant sections or divisions may be grouped as follows:
- (a) The definition provisions, for example those of ‘primary production’ and ‘forest operations’: section 6 (1).
- (b) Provisions dealing with the valuation of livestock: sections 32, 33 and 34.
- (c) Provisions allowing for a spreading or averaging of income for the purpose of counteracting either the bunching of income or the effect of substantial variations in annual income due to seasonal conditions and instability of commodity prices: section 26B (insurance recoveries on losses of livestock and trees); section 26BA (double wool clips); section 36 (disposal of trading stock in consequence of the resumption of land, fire, flood, drought or the lease of land for tick eradication purposes); section 36AAA (forced disposal of livestock—alternative election); section 36AA (compensation for death or compulsory destruction of livestock); Division 16 (averaging of incomes); Division 16B (drought bonds); section 160 (rebate in case of disposal of the assets of a business of primary production).
- (d) Provisions allowing for depreciation on plant and structural improvements and a write-off of certain capital expenditure: sections 54, 70 and 75A.
- (e) A provision allowing for writing off over an indefinite period of previous years’ losses incurred in carrying on a business of primary production: section 80AA.
- (f) A provision of now very limited application enabling Crown leases used for primary production to be treated for taxation purposes as though they are free-hold property: section 88A.
18.2. Since the Committee commenced its review, significant changes have been made to the law affecting the determination of net income from primary production: sections 57AA, 57AB, 62AB, 75 and 76 have been terminated and section 75A enacted. All the terminated provisions were regarded as involving concessions and not as being necessary for the determination of true net income. Sections 57AA and 57AB allowed an accelerated write-off, over five years, of the cost of plant and certain structural improvements; section 62AB provided for an investment allowance of 20 per cent of the cost of new units of depreciable property acquired after 14 August 1963; and sections 75 and 76 allowed a full deduction in the year of income for specified capital expenditure on certain improvements to land. The new provision, section 75A, allows deductions over ten years for certain capital expenditure formerly allowed in full under section 75 in the year in which it was incurred.
18.3. To be eligible for the application of some of the primary production provisions, a taxpayer during a year of income must have carried on a business of primary production. Other sections contain a similar requirement stated in slightly different terms; but in the case of depreciation on structural improvements, the test is whether the land upon which the improvements are situated was used for certain of the pursuits defined by the Act as constituting ‘primary production’.
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18.4. Eligibility for the application of these provisions is not dependent, however, on primary production being the principal activity of the taxpayer. This has led taxpayers with income from other sources to engage in primary production on a very small scale to obtain the benefits of the primary production provisions and has even encouraged taxpayers to undertake activities involving income losses but offering prospects of capital gains.
The Definition Provisions
18.5. Production of timber from tree farming was regarded as primary production prior to 1963, when the definition of ‘primary production’ in section 6 (1) was amended to include ‘production resulting from … forest operations’. However, the definition of ‘forest operations’, also inserted in section 6 (1) in 1963, in addition to describing tree farming operations extends to the activities of persons who merely fell trees in a forest.
18.6. The inclusion of the activity of felling trees in the definition of ‘primary production’ has the consequence that persons who, in a business operation, fell trees in a forest carry on the business of primary production and are thus entitled to the benefit of the averaging provisions, even though they own no forests or plantations but obtain their timber supplies through rights or licences to cut timber given to them by other persons. And it might also have the consequence that logging contractors who do not become the owners of the fallen timber are to be regarded as persons carrying on the business of primary production entitled to the benefit of averaging.
18.7. The introduction of the definition of ‘forest operations’ into the Act was accompanied by an amendment to section 54, which provided for the allowance of depreciation on structural improvements used in forest operations. Thus in so far as the definition of forest operations describes activities additional to tree farming, it extends the scope of allowance of depreciation.
18.8. The Committee can see no reason why persons who carry on a business of felling timber but who do not plant or tend trees in a forest or plantation for the purpose of felling should be regarded as primary producers entitled to the benefit of the averaging provisions: it does not appear to the Committee that they are especially subject to income fluctuation. It accordingly recommends that in so far as the definition of forest operations extends beyond the concept of tree farming it should expressly apply only for the purpose of allowance of depreciation.
Valuation of Livestock
18.9. As explained in paragraph 8.124 trading stock other than livestock may be valued at its cost price, market selling value or replacement cost. In the case of livestock a primary producer must elect to adopt either a cost price or market selling basis of valuation, but the Commissioner may give a taxpayer leave to adopt some other basis for the whole or part of the livestock, and in fact does so where valuable stud animals are acquired.
18.10. Once having adopted either a cost price or market selling basis of valuation, a primary producer is prohibited from changing that basis except with the leave of the Commissioner.
18.11. Where the cost price basis is adopted, a primary producer is required at the end of a year of income to value
natural increase born during that year at a cost price
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selected by him, which must not be less than the
minimum value prescribed in Regulation 5 of the income tax regulations.
18.12. The minimum values now contained in Regulation 5 have remained unchanged since 1935. Prior to 30 June 1961, maximum values were also prescribed but were excluded by amendment of the regulation in that year. Minimum values are prescribed as follows for the undermentioned classes of livestock only:
| Sheep | $0.40 |
| Cattle | $2.00 |
| Horses | $2.00 |
| Pigs | $0.50 |
18.13. All livestock in a business of primary production are treated by the Act as trading stock even though some animals are not acquired for the purpose of sale. Although animals not acquired for the purpose of sale (for example, stud stock) could be regarded as more akin to plant than trading stock, there is no provision in the Act for writing off annual amounts of depreciation from their cost. But what is tantamount to depreciation may be written off in other ways: (i) by adopting a market selling value basis of valuation, which will allow for true depreciation; or (ii) by seeking leave of the Commissioner, where the cost price basis of valuation has been adopted, to value stud stock at the end of a year of income at values that will reflect depreciation of original cost values.
18.14. The cost price basis of valuation tends to place values on livestock on hand which are less than cost. Under this method in practice, values are generally determined on the average cost of animals in a herd or flock. In calculating average cost, the purchased stock are brought to account at their cost price and natural increase at values that are somewhat arbitrary but may not be less than the minimum values. In the case of those graziers who prefer to build up or maintain their stock numbers by breeding rather than by purchasing, the adoption of low values for natural increase tends to lead to a fall in the average cost of their stock. Over a period of years during which relatively small numbers are purchased, the average cost of stock tends to approach the minimum value used for natural increase. Under normal conditions these average cost values, which are employed for computing net income, are substantially lower than market values. The cost price system thus contains a bias in favour of bred stock as against purchased stock.
18.15. Another consequence of the cost price system of valuation is that it permits a deferment of tax when animals are bred for sale or immature animals are purchased for ultimate sale. This arises from the fact that the cost of maintaining animals until they reach maturity does not form part of the cost value. To some extent the deferment can be justified on the ground that primary producers are not in a position to pay tax until sales are made. However, where a build-up of numbers from breeding is prolonged over a period, there will be an inevitable accumulation of unrealised profits.
18.16. It has been claimed that the present system of permitting only one basis of valuing livestock to be adopted at the
end of a year of income is unfair to primary producers because section 31 allows other taxpayers a choice of bases.
However, the two situations are not comparable: the cost price basis to which section 31 applies takes into account all
costs of production incurred to the time of valuation, whereas the cost price basis for valuing livestock excludes the
cost of maintenance during the livestock's growth and conditioning periods. To allow primary producers to exercise a
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free choice of bases in these circumstances would lead to the possibility of wide fluctuations in net income
from year to year. In the United States primary producers are permitted to adopt either a cost price or a market selling
basis of valuing livestock at the end of a year of income. But the cost price of livestock must include the cost of
maintaining animals until they reach maturity.
18.17. Systems of valuing livestock vary from country to country and no wholly satisfactory system has been evolved. Ideally, livestock should be treated as though they constitute work-in-progress and maintenance costs should be added to the value of animals year by year until they reach maturity; but the introduction of such a system would create complications not inherent in the present system. The United States system, which does provide for this, has proved to be unsatisfactory in practice with the result that an alternative system has been instituted in that country, under which a switching of bases at the end of the year of income is not permitted without leave of the Tax Commissioner. The alternative cost price basis provides for standard costs of animals according to age to be taken into account.
18.18. While the Australian system contains the defects mentioned in paragraphs 18.14–18.15, it is easily understood and is administratively simple. The Committee is not disposed to recommend any significant alteration; but it considers that the bias in favour of breeding stock, and the accumulation of unrealised profits, would be mitigated if minimum cost values of natural increase were periodically reviewed with regard for increases in costs of production, and it therefore recommends that such periodical reviews be undertaken.
Spreading and Averaging Provisions
18.19. No less than four of the provisions referred to in paragraph 18.1 deal with the spreading of profits arising from the forced disposal of livestock. These provisions give relief against the bunching of income that occurs when income from the disposal (or loss) of a substantial number of livestock has to be brought to account. As indicated previously, two of the main causes of bunching of livestock profit are the adoption of minimum cost values for natural increase and the failure to include maintenance costs in the cost price valuation of livestock on hand at the end of the year of income. While adoption of higher cost values for natural increase, as recommended above, will remove one of these causes, the continued presence of other causes appears to the Committee to justify the retention of the provisions.
18.20. The spreading allowed by section 26BA where advance shearing is made because of flood, fire or drought and two wool clips are sold in one year would appear to be justified, and the Committee therefore recommends the retention of this section.
18.21. Consideration is given in Chapter 14 to the question of the averaging of incomes, and recommendations on this matter and on the use of drought bonds are made. If, as recommended, an averaging system that is not limited by a ceiling of incomes is adopted, section 160 can be repealed. The section ensures that a taxpayer who is entitled to be assessed by reference to an average income and whose taxable income exceeds $16,000 will be allowed the benefit of his average rate of tax in respect of that part of his income representing profit from the disposal of livestock made in the course of putting an end to his business. But if the present averaging system is retained, this provision should also be retained for reasons similar to those given in paragraph 18.19.
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Capital Expenditure and Depreciation
18.22. Section 56 allows depreciation on plant to taxpayers generally, on the basis specified in section 55 which requires the rate of depreciation to accord with the effective life of a depreciable unit. Primary producers are in a special position inasmuch as the word ‘plant’ in section 54 is defined to include structural improvements on land used for agricultural or pastoral pursuits. Certain structural improvements in forest and pearling operations also come within the definition.
18.23. Primary producers also incur capital expenditure that does not result in any unit of property within the definition of ‘plant’ in section 54 coming into existence. Some items of capital expenditure of this nature are subject to the special provisions of section 75A. These are:
- (a) the eradication or extermination of animal or vegetable pests from the land;
- (b) the destruction and removal of timber, scrub or undergrowth indigenous to the land;
- (c) the destruction of weed or plant growth detrimental to the land;
- (d) the preparation of the land for agriculture;
- (e) ploughing and grassing the land for grazing purposes;
- (f) the draining of swamp or low-lying lands where that operation improves the agricultural or grazing value of the land;
- (g) preventing or combating soil erosion or flooding on the land; or
- (h) conserving or conveying water for use in carrying on primary production on the land.
18.24. The section allows deduction for the cost of these items over ten years. Such expenditure is distinguishable from expenditure of a similar description incurred in ploughing agricultural fields, maintaining pastures and keeping down the incidence of plant and animal pests. The latter is ordinary revenue expenditure which is deductible in full under section 51 in the year in which it is incurred.
18.25. Although it is acknowledged that some of the expenditures qualifying for capital allowances under section 75A may be of benefit for periods exceeding ten years, overall this section and the provision regarding depreciation on structural improvements are considered to be a reasonable compromise in providing allowances appropriate to the determination of true net income.
18.26. Prior to the termination of the provisions of section 75, the Committee received a great number of submissions protesting against the concessions allowed under that section. For the most part they were made by persons or organisations concerned with the protection of the environment and were directed mainly at subsection (1) (b) of section 75, which allowed deductions for the destruction and removal of timber, scrub or undergrowth indigenous to the land.
18.27. The deductions now allowed under section 75A over a period of ten years were previously allowed (in respect of
expenditure incurred before 21 August 1973) in full under section 75 in the year in which the expenditure was incurred.
Where a taxpayer improved a farm for sale as part of a profit-making undertaking and at the same time carried on a
business on that farm, when the farm was sold he was able by virtue of section 82 (3) (a) to obtain a deduction for
expenses already deducted under section 75 in computing any profit subject to tax. In no longer allowing a full deduction
for capital expenditure described in section 75 or a double deduction for such
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expenditure (when allowable
under section 75A), amendments to the Act have removed the tax assistance aspect of the provisions in regard to the cost
of clearing land. In the Committee's view, therefore, no further amendment to meet the case for protection of the
environment is called for.
18.28. Another type of capital expenditure for which a deduction has been sought in submissions is the cost of extending power lines incurred by primary producers. At present the cost of extending telephone lines is allowable as a deduction in ten equal instalments. The cost will contain elements of both private expenditure and business capital expenditure. In the latter aspect, deduction seems appropriate whether for telephone lines or power lines: such costs would normally have been deductible if the expenditure had been incurred by the relevant authority and recouped by way of additional current charges for the service. In the private expenditure aspect, deduction can in the Committee's view be justified on the ground of remoteness of the place of living, which dictates that the additional cost be incurred.
Losses of Previous Years
18.29. Under the present law primary production losses may be carried forward for an unlimited period. In Chapter 8 the Committee has proposed that unlimited carry-forward of losses be allowable to all taxpayers.
Restriction of Benefit of Primary Production Provisions
18.30. A number of submissions to the Committee have suggested that the only persons who should receive the benefit of the application of the primary production provisions are those whose principal activity is engagement in primary production. Other submissions indicate that the benefit of the averaging provisions should be extended only to those persons whose income from primary production is more than 50 per cent of their total income.
18.31. The question of whether a person engaged in primary production should be entitled to the benefit of the averaging provisions would, under the Committee's recommendations proposed in Chapter 14, require the application of the further test that the activity should provide his chief source of income.
18.32. In general the primary production provisions of the Act are available only to a person who carries on a business of primary production. The question of whether an activity is carried on as a business or as a hobby poses problems in the administration of income tax. It is often difficult for the Commissioner to refute a claim by a taxpayer that his activities constitute a business even though there is little likelihood of any profit being derived. The High Court in Tweddle's Case note has held that a profit motive is not essential in carrying on a business and it is not for the Courts or the Commissioner to say how much a taxpayer should spend in earning his income. Thus, even though a taxpayer carries on no more than minimal activities on a farming property, which can only result in losses (for example, when the activity involves hobby or pleasure farming), the losses will in all probability be deductible from other income derived by him.
18.33. This problem has been recognised in overseas countries. In the United Kingdom, Canada and the United States special provisions have been enacted to deal with losses from hobby or pleasure farming. In West Germany, too, losses from hobby farms are not deductible unless profits arise over several years. In the United Kingdom a loss is not allowable as a set-off against other income if it arises from carrying on a trade, profession or vocation in respect of which there is not a reasonable expectation of profit. The provision, though aimed at hobby farmers, applies to other kinds of hobby businesses. In the United States deduction is similarly denied for losses arising from an activity not engaged in for profit.
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18.34. In Canada farm losses, which are not necessarily hobby losses, are allowed on a restricted basis as deductions from other income where the taxpayer's chief source of income is not farming. This compares with the recommendation of the Carter Commission which proposed that, if business losses have been incurred in three years out of a five-year period, the loss for the latest year should not be deductible from other income: losses would again be deductible, in the year the business again became profitable. The Commission made this recommendation because it found difficulty in defining what constitutes a hobby business.
18.35. Of the alternative methods for dealing with the problem of hobby or pleasure farming suggested by the experience of these countries, those used by the United Kingdom and the United States would seem the most appropriate. Accordingly, the Committee recommends that a loss arising from a primary production activity should not be allowable as a set-off against income from other sources nor should it be available for set-off against the income of any other year, unless the inference can be drawn from the extent and manner of the activity that it was engaged in for profit and in fact there was a reasonable expectation that a profit would result.