Taxation 3B

COXTB3

Eduvos (Pty) Ltd (formerly Pearson Institute of Higher Education) is registered with the Department of Higher Education and Training as a private higher education institution under the
Higher Education Act, 101, of 1997. Registration Certificate number: 2001/HE07/008
Week 1: Trading Stock
Introduction

1. Definition of Trading Stock

2. Treatment of Trading Stock in terms of the Income Tax Act No 58 of 1962
3. Purpose and Objective
1. to briefly examine the trading stock provisions contained in the Act and the
relationship to capital/revenue cases
2. to apply the principles of case law to specific situations
4. Review Pre-Lecture Problems
Trading Stock
Gross Income: receipts and accruals from trading

Capital: fixed vs floating capital (New State Areas Ltd v CIR)

• Trading stock (inventory) produces revenue
• it is the reason for trading
• selling the items is the trade
• floating capital
• acquire trading stock in order to sell
• therefore receipts and accruals = revenue

BUT often acquire in one year and sell in the next or more

• S11(a) allows deduction of any amount actually incurred for the purpose of earning trade income
• no matching principle as in accounting

• S22 is therefore an attempt to match deduction of trading stock to sales of trading stock
Income Tax Act Section to Note

Section 1 Defines Trading Stock

Section 22 Treatment of trading stock (excluding farming) – treatment same as accounting

Section 22A Schemes of arrangement involving trading stock

Section 23F Acquisition and disposal of trading stock

Section 1 Definition
‘trading stock’ includes -

(a) anything-
(i) produced, manufactured, constructed, assembled, purchased or in any other manner acquired by a taxpayer for the purposes of manufacture, sale
or exchange by him or on his behalf; or

(ii) the proceeds from the disposal of which forms or will form part of his gross income, otherwise than in terms of paragraph (j) or (m) of the
definition of 'gross income', or as a recovery or recoupment contemplated in section 8 (4) which is included in gross income in terms of paragraph
(n) of that definition; or

(b) any consumable stores and spare parts acquired by him to be used or consumed in the course of his trade, but does not include a foreign currency option
contract and a forward exchange contract as defined in section 24I (1);

“includes” suggesting not exhaustive

De Beers Holdings (Pty) Ltd v CIR 1986 (1) SA 8(A), 47 SATC 229 it was held that this definition is in fact
exhaustive.

Gross Income (jA): special inclusion: asset manufactured, produced, constructed or assembled similar to
other such assets for purposes of manufacture sale or exchange – disposal = Gross Income

- Always remain trading stock even if used by taxpayer as a capital asset

S22 treatment of trading stock
s22: treatment of trading stock (excluding farming)
(1) closing stock taken into account (add to income);
(1A) exclude VAT
(2) opening stock taken into account (deduct);
(2A) construction stocks remain contractor’s until completion
(3) cost price = cost etc., or Market Value if converted from capital asset #12(2)(c);
(3A) cost price of construction stock
(4) acquisition for no value: Market Value;
(4A) security for loans: assets remain borrower’s
(5) not use LIFO;
(6) yoa = period of assessment if shorter
(8) application of trading stock other than normal trade;

(9) value of security trading stock

Trading Stock
Section 22: treatment of trading stock – not applicable to farming (1st Schedule)
(1) closing stock taken into account (add to income); “held and not disposed of
… at the end of the year of assessment”
value is lower of cost or net realisable value
cost is all amounts incurred (s22(3)) excluding VAT (s22(1A))
where was a capital asset now trading stock: s22(3)(a)(ii) read with para 12(2)(c) of the
Eighth Schedule cost is market value on date of change
where revenue asset to capital asset: Market Value at time of change
= proceeds for TI/Base cost for CGT: s22(8)(b)(B) & #35 read with #20
(2) opening stock at beginning of yoa is closing stock from previous year – is a
deduction from income – same value as closing in prior year
Trading Stock Valuation and
Treatment
Acc – Lower of C NRV
Tax Closing – value = lower of cost or MV?

Trading stock received for 0 (inheritance, gift, donation etc): carry at Market Value (s22(4)) as closing stock if
still on hand BUT SARS practice to allow as opening stock @ Market Value (tax effect 0) but see
Ernst Bester Trust v C:SARS (2008) ZASCA 55 (Case No:282/07) 70 SATC 151
Tax payer raised issue of SARS practice – SARS silent – court held that no evidence, and not in law
Also held that trading stock provisions not applicable to items acquired and sold in the same yoa.

Cap/rev cases: timing of change of intention becomes NB because MV’s change because of CGT

NB to raise trading stock provisions and link to cases – not done in Pick ’n Pay Shareholder Trust case – not
argued & thus not decided but in that case held (3-2) that cannot have floating capital if not trading.
Issue not important since the introduction of CGT and the transition of capital asset to trading stock
Trading Stock
Section 22(8) application of trading stock
anti-avoidance section - treatment of trading stock used or applied for purposes other than for sale.
no longer be on hand at the end of yoa and no sale thus no Gross Income but deduction was
allowed.
• private or domestic purposes: cost price added to income.
• all other cases other than donations to which s18A applies, the market value is to be added to
income.
• s18A applies, the value taken into account in trading stock (either the net realizable value or
the cost) is added to income.
If used for a trade purpose (e.g. advertising): market value may be deducted as expenditure incurred
Where s18A applies, the value added to income is the value of the donation.
Trading Stock
Section 22A: schemes of arrangement involving trading stock
anti-avoidance section
Schemes of arrangement or reconstruction of company (including amalgamations)
Sanctioned by order of court
Effectively t/s of transferee company in Gross Income and for transferor co is deemed to acquire for
cost

Section 23F: Acquisition or disposal of trading stock

disallows s11(a) deduction if trading stock acquired and neither disposed of nor included in closing
stock.
expenditure deemed incurred in first subsequent year of assessment in which either disposed of or
included in closing stock or was destroyed or for some reason cannot be disposed of.
1. Practice Activities on
MyLMS
2. Textbook Examples
 •Revise Section 4.3 in your textbook
What Happens
Next? •Prepare for Week 2
•Companies, Close Corporations and Dividends Tax