What to deduct?
By Kara Fischer
South African Revenue Services v Volkswagen South Africa (Pty) Ltd, a decision of the Supreme Court of Appeal on 19 September 2018, dealt with the value of trading stock for income tax purposes. Which of the two parties was correct as to the interpretation of section 22(1)(a) of the Income Tax Act, would determine whether Volkswagen’s income tax (with interest) for the relevant period would increase by around R30 million.
For a trader to determine its cost of sales for income tax purposes, the trader must add the value of its trading stock at the beginning of the tax year to the value of the trading stock sold during the year, and deduct the value of its trading stock at the end of the tax year. So, the lower the value of trading stock at the end of the tax year, the higher the cost of sales, and consequently the lower the income tax payable.
Simplified, in terms of section 22(1)(a), the value of trading stock at the end of a tax year is the cost price of the stock less any amount by which such value has been diminished by reason of damage, deterioration, change of fashion, decrease in the market value, or for a similar reason.
Volkswagen applied an international financial reporting standard published by the accounting standard-setting body of the IFRS Foundation to determine the value of its trading stock at the ends of the relevant tax years. The reporting standard applies to the accounting treatment of inventories, and defines “net realisable value” as the estimated selling price of inventory in the ordinary course of business, less the estimated (future) costs to making the sales. Hence Volkswagen ‘deducted’ anticipated future cost items such as the cost of transporting vehicles from Volkswagen’s distribution yard to dealerships, and distribution fees to be paid to its holding company.
Volkswagen had overlooked the fact that an accounting point of view is entirely irrelevant to the determination of the value of closing trading stock in terms of section 22(1)(a). Taxable income is determined, and taxation levied, from tax year to tax year, on the basis of events during the relevant tax year (backward looking). In contract, the reporting standard is concerned with the net amount that the trader is likely to receive when the stock is sold in future (forward looking). SARS won.