The Income Tax Act 1962 requires opening and closing trading stock to be taken into account in determining taxable income derived from carrying on any trade in any assessment year. Section 22(1)(a) of the Act deals with the valuation of the stock, and provides that in respect of a taxpayer’s trading stock that is held and not disposed of, the closing value is the cost price to the taxpayer less a just and reasonable amount by which such stock has diminished through damage, deterioration, change of fashion, decrease in the market value or any other reason satisfactory to SARS.

According to the case of CSARS V Atlas Capco South Africa (Pty) Ltd, the Supreme Court of Appeal (SCA) held that a time-based rather than fact-based reduction in value cannot be the basis of unsold stock valuation for purposes of income tax assessment under section 22(1)(a).

The taxpayer in that case was a member of Atlas Capco Group, with its parent company in Sweden. The taxpayer carried on the business of selling or leasing machinery and equipment imported from Sweden for use in the mining and related industries in South Africa. The taxpayer’s parent company had conceived a policy known as the Finance Controlling and Accounting Manual (FAM) or The Way We Do Things (WAY) which was followed by all companies within the group. In terms of the policy, the taxpayer was required to write down the value of its closing stock by 50%, if such closing stock had not sold in the preceding 12 months, and by 100% if it had not sold in 24 months.

The taxpayer applied this policy by writing down its closing stock by the fixed percentages reflected in the policy. In its 2008 and 2009 tax returns, the taxpayer included the amounts by which it claimed the value of its trading stock had diminished during those years of assessment. SARS, however, contended that this method used by the taxpayer to write down the value of the stock was not in line with section 22(1)(a). In assessing the taxpayer, SARS accordingly added back the amounts the taxpayer initially claimed its stock to have diminished by.

The taxpayer appealed to the Tax Court. In upholding the appeal, the Tax Court held that because the write-down policy of the group was in line with international accounting standards, it could be accepted as representing the value of trading stock held and not disposed of at the end of the relevant year for purposes of section 22(1)(a).

On a further appeal by SARS, the SCA found that the Tax Court had erred in its findings. The SCA held that the taxpayer had not presented satisfactory evidence to support the diminution by reason of damage, deterioration, change of fashion, decrease in the market value as set out in section 22 (1)(a). In fact, the taxpayer’s auditor testified that they had identified three products which were sold at approximately 24 to 26 % less than their cost. In this regard, the SCA stated that ‘the true factual position is thus a far cry from the application of a fixed 50 or 100%.’ This time-based approach was accordingly not in line with the criteria in section 22(1)(a).

The taxpayer operated in the mining sector and it had to meet orders at relatively short notice. For this reason it had surplus stock of various items from time to time. The policy was applied to these items, not because they had deteriorated, but because they had been on hand for longer than the group’s 12-month or 24-month policy. There was no indication of any diminution in these items; it was ‘at best an unmotivated guesstimate’ as to whether there would in future be demand for them.  The SCA therefore upheld SARS’s appeal and held that it cannot be said that SARS failed to exercise its discretion reasonably and properly.

The case is CSARS V Atlas Capco South Africa (Pty) Ltd.