Latest / Tax Break: South African tax for professionals / Valuing trading stock for tax purposes

Transcript

Valuing trading stock for tax purposes · Tax Break: South African tax for professionals

• 0:11
  Welcome and thank you for joining me for Tax Break.
• 0:13
  This is a podcast about South African tax, 4 South African tax
• 0:17
  professionals and practitioners. My name is Peter Finjan and in
• 0:20
  each episode I share my thoughts with you on a topic or a recent
• 0:23
  development in South African tax.
• 0:26
  And I try to keep the episode short enough that you can listen
• 0:29
  to them whenever you've got a few minutes in your calendar.
• 0:33
  I would like to ask you if you like the podcast or even just
• 0:38
  this episode to consider sending the link to the podcast or the
• 0:44
  episode from your podcast player to any other person who you
• 0:47
  think would also be interested in listening to the podcast.
• 0:52
  If you do this, you help me to grow the listener base.
• 0:56
  And yeah, I guess that that's always good for for any podcast.
• 1:03
  We are talking about trading stock today and specifically how
• 1:08
  to value trading stock your closing stock for tax purposes.
• 1:13
  Now there is a few F followed and do follow case law quite
• 1:19
  closely would know that there were a few cases over the past
• 1:22
  number of years actually a few years ago.
• 1:25
  Firstly the the the Volkswagen case and the in the Atlas Copco
• 1:29
  case. And I think if we can take the
• 1:32
  high level message from these cases is that the value of
• 1:37
  closing stock for tax purposes is not the same as the value for
• 1:42
  accounting purposes. So accounting requires that you
• 1:46
  value the your stock at the lower of cost or net realizable
• 1:50
  value, whereas there's a different rule for tax.
• 1:54
  So what does the tax law say in the case of trading stock?
• 1:59
  And we find this in section 22 one before I start going into
• 2:03
  the detail 22 one states that in the case of trading stock other
• 2:08
  than trading stock has contemplated in paragraph B.
• 2:10
  So that some financial instruments the cost priced to
• 2:15
  such person of the trading stock.
• 2:17
  So in other words, you value your trading stock at year end
• 2:21
  at cost less such amount as the Commissioner may think just and
• 2:25
  reasonable as representing the amount by which the value of
• 2:30
  such trading stock, not being any financial instrument has
• 2:34
  been diminished by reason of damage, deterioration, change in
• 2:39
  fashion, a decrease in the market value or for any other
• 2:43
  reason that satisfactory to the commissioner.
• 2:46
  So let's maybe just quickly recap what how exactly does this
• 2:51
  provision on closing stock work? So if a, if a trader buys stock,
• 2:57
  they said it's Section 11A deduction for the purchase price
• 3:01
  of the stock. But then if the stock is unsold
• 3:04
  at year end, so if it's still held by the tax buried year in
• 3:08
  Section 22 requires that the value of closing stock be added
• 3:12
  back. So if there's no decrease in
• 3:16
  value, then your section 11A deduction would be neutralised
• 3:21
  by the closing stock inclusion. And this closing stock inclusion
• 3:25
  becomes your opening stock deduction the next year.
• 3:28
  And so this there's deduction keeps rolling forward and it
• 3:32
  really only materialises in the year in which the stock is sold.
• 3:36
  The relevance of Section 22, one thing is to say, but if you've
• 3:40
  got unsold stock at year end and they said the diminishing, the
• 3:46
  value has been diminished for some reason, then essentially
• 3:50
  the difference between your 11A deduction, what you paid for the
• 3:54
  stock and what the stock is worth.
• 3:56
  Now that difference the the decrease in the value of the
• 4:00
  stock, you can actually then climb that as a reduction in
• 4:02
  this year even though you haven't sold the stockade.
• 4:05
  So that's really in simple terms what Section 22 one does.
• 4:10
  I think if you, if we read Section 22 one, it's fairly
• 4:14
  clear that there is a discretion for the Commissioner and this
• 4:18
  discretion is one of these discretions that if it's
• 4:21
  exercised by such, it is subject to objection and appeal.
• 4:27
  Now let's go delve into the how do you determine this reduction
• 4:34
  in the value of your trading stock in a bit more detail.
• 4:37
  Now for a long time practice Note 36 was the authority that
• 4:42
  Zach issued on that. This practice note was issued in
• 4:45
  1995, so about 30 years ago and interestingly even 30 years ago.
• 4:52
  The practice note starts off by a statement to say that they are
• 4:56
  various questionable methods that expose are using to write
• 5:00
  off stock. The then goes into a bit of
• 5:03
  detail to say what's acceptable, what not, what would be required
• 5:06
  of a tax payer. The first point it makes is that
• 5:09
  you can't just do a fixed percentage right off.
• 5:11
  So you can't just write off 20% to the end of the year.
• 5:14
  That's not what Section 22 one allows.
• 5:18
  The crux of what in practice now 36 said was that where the stock
• 5:23
  was not valued at costs. In other words, it was the that
• 5:28
  it was it. It's been taken into account
• 5:30
  this closing stock at the lower value.
• 5:32
  The tax payer is required to reveal this to the receiver of
• 5:36
  revenue as such was back then. Do submit reasons for this and
• 5:41
  indicate how the lower value was arrived at.
• 5:44
  And if it wasn't the actual value that was used as the the
• 5:49
  the basis for the the reduction, if it was some sort of a fixed
• 5:53
  variable or other basis, it was up to the tax payer to justify
• 5:57
  that basis to such. So that's really the essence of
• 6:00
  practice Note 36, why we are talking about this topic today.
• 6:05
  Practice note 36 was recently withdrawn and replaced by
• 6:09
  interpretation of 140. So I would like to highlight a
• 6:15
  few things from this interpretation note.
• 6:17
  The first thing is that the focus of the interpretation note
• 6:21
  is to make it very clear that what you can get this reduction
• 6:27
  is the diminution in value of your trading stocks.
• 6:30
  So in other words, the value of your trading stock had to
• 6:33
  decrease. So that means and in principle
• 6:38
  you you calculate the decrease as the cost minus the value of
• 6:42
  your stock now. So if you're if the value of
• 6:45
  your stock now isn't leased, then the cost then there is no
• 6:49
  reduction under section 22. One, what such indicates in the
• 6:53
  practice note is whether the value is diminished or not is a
• 6:57
  question of fact at the end of the year.
• 6:59
  They are not prescriptive as to when and how it may be seeing
• 7:03
  that I'm sure that these various types of stocks, various
• 7:07
  industries. So it's very difficult to be
• 7:09
  prescriptive. What the interpretation of then
• 7:12
  does is it considers the meaning of what damage would typically
• 7:17
  be, what deterioration would be, changes in fashion and decreases
• 7:21
  in market value. It then also talks about the
• 7:25
  last category to say that if there are other factors that
• 7:30
  caused the decrease, so not damage, deterioration, changes
• 7:34
  in fashion or decreases in market value.
• 7:37
  That is something you need to consider on a case by case
• 7:40
  basis. What it does make quite clear is
• 7:43
  that it's not natural realizable value write offs.
• 7:46
  That's not what is being contemplated.
• 7:50
  What the interpretation are then also makes not clear is that the
• 7:54
  tax payer babies the onus of proof to show that the value of
• 7:59
  the trading stock is actually less than than the cost.
• 8:03
  The last point about value reductions or decreases in value
• 8:08
  that the interpretation would also touches on is to say that
• 8:13
  timing of when that event that causes the the reduction in
• 8:19
  value occur. And it says that the event must
• 8:23
  have either already occurred or it must be a reasonably certain
• 8:28
  event that will still occur. So, but it's, it's really
• 8:33
  something that you you already need to know that that the value
• 8:37
  of the trading stock has gone or will go down, right?
• 8:41
  The last point that the interpretation it also touches
• 8:44
  on is the question if as to do you need to write off an item by
• 8:48
  item basis or a category basis. Now proviso 2 specifically deals
• 8:55
  with and it was specifically introduced to allow for write
• 8:59
  offs of specific items even if the categories value is more
• 9:05
  than its cost. So in other words, if you've got
• 9:07
  a whole category of stock, the value of the category exceeds
• 9:11
  the cost, but there are some items in there that are for
• 9:14
  example, damaged proviso do allows you to write off the
• 9:18
  damaged items to do to a lower value.
• 9:22
  What the interpretation are then goes on to say is your the the
• 9:25
  decision. Do you do the right off on an
• 9:28
  item by item or category basis. Otherwise that depends on the
• 9:32
  facts and circumstances. So if you for example, got high
• 9:36
  volume, low value items, it might be sensible to look at the
• 9:41
  category of stock and to to determine the the the write
• 9:45
  down. Whereas if you've got unique
• 9:47
  items or low volume, high value items, you could actually
• 9:52
  consider the market value or the value of of each item
• 9:55
  individually. So it depends on the facts and
• 9:58
  circumstances where the item for item or category based write
• 10:02
  offs are appropriate. So to conclude, I think the few
• 10:07
  points you can take home, first point practice note 36 was
• 10:10
  replaced by interpretation note 140.
• 10:14
  The interpretation out contains a lot more detailed guidance
• 10:18
  about these write down factors than practice note #36 and the
• 10:24
  burden to prove that there's been a diminution in the value
• 10:28
  of the stock is clearly on the tax payer.
• 10:32
  Right? That's it for today's episode.
• 10:35
  If you've got any questions, comments, please send me an
• 10:37
  e-mail. My e-mail address is in the show
• 10:39
  notes. As always, I just want to remind
• 10:43
  you that nothing in this podcast is intended to be tax advice.
• 10:47
  The podcast is only for information purposes.
• 10:50
  Until next time, goodbye.