On 27 September 2019, just over a year since delivering judgement in another matter with very similar facts, the Supreme Court of Appeal in CSARS v Atlas Copco South Africa (Pty) Ltd (834/2018)  ZASCA 124 gave a judgement on the valuation of trading stock for income tax purposes.
The general (and oversimplified) principle is that taxpayers are allowed, as a deduction, the value of opening trading stock during a year of assessment, while the value of the closing trading stock is required to be included in taxable income. From a tax perspective, the higher the value attributed to closing stock at the end of a tax year, the lower the cost of sales for that year will be and the greater the taxable income of the taxpayer. Conversely, the lower the value attributed to closing stock, the higher the cost of sales and the lower the taxable income for that year. The value of the trading stock is generally the cost thereof, less an amount which SARS may think is just and reasonable as representing a diminishing in that value due to damage, deterioration, change of fashion, decrease in the market value or for any other reason.
Taxpayers often use accounting (or IFRS) values for the determination of stock values. These valuation methods usually involve a time-based approach. I.e. a write-down of stock if it has not been sold for several months. The more the number of months since the stock was last sold, the higher the write down. This approach is often based on internal policies. The court notes (in the previous judgement) that:
“If taxpayers had a free hand in determining the value of trading stock at year-end it would open the way for them to obtain a timing advantage in regard to the payment of tax, by adjusting the value of closing stock downwards. They could by adjusting these values manipulate their overall liability for tax in the light of their anticipations in regard to future rates of tax, future trading results, the need to incur significant expenses in the future and the like.”
The Court finds that IFRS values, based on “net realisable value” are explicitly forward-looking and that using this value for tax purposes, has the effect that expenses incurred in a future tax year in the production of income accruing to or received by the taxpayer in that future tax year, become deductible in a prior year. Whether IFRS values was a sensible and business-like manner of valuing trading stock from an accounting perspective was neither here nor there for tax purposes. The concern was whether it accurately reflected the diminution in value of trading stock. For income tax purposes, the exercise is thus one of looking back at what happened during the tax year in question.
SARS may only grant a just and reasonable allowance in respect of a diminution in value of trading stock in two circumstances. The first is where some event has occurred in the tax year in question causing the value of the trading stock to diminish. The second is where it is known with reasonable certainty that an event will occur in the following tax year that will cause the value of the trading stock to diminish.
It may, therefore, be necessary that taxpayers keep to sets of trading stock valuations: one for accounting purposes and one for tax purposes.
Although often only a timing issue between opening stock (for which a deduction is allowed) and closing stock (which is taxable), it could happen that the assessment in respect of the year during which the deduction applies, may have prescribed by the time the dispute relating to the closing stock matter has been finalised. In such an instance, any difference becomes permanent, and not merely a timing difference. It is therefore advisable that any disputes relating to trading stock be dealt with by taxpayers as a matter of urgency.