SARS Interpretation Note 140: Diminution in the value of closing stock (source: https://www.sars.gov.za/legal-intr-in-140-diminution-in-the-value-of-closing-stock/)
INTERPRETATION NOTE 140
DATE: 16 October 2025
ACT : INCOME TAX ACT 58 OF 1962
SECTION : SECTION 22(1)(a)
SUBJECT : DIMINUTION IN THE VALUE OF CLOSING STOCK
Contents
Preamble.............................................................................................................................. 1
1. Purpose .................................................................................................................... 2
2. Background ............................................................................................................. 2
3. The law ..................................................................................................................... 2
4. Interpretation and application of the law ............................................................... 3
4.1 Introduction ............................................................................................................... 3
4.1.1 Meaning of “diminish” and when the diminution must be determined ......................... 4
4.1.2 Meaning of “damage” ................................................................................................ 6
4.1.3 Meaning of “deterioration”.......................................................................................... 8
4.1.4 Change of fashion ..................................................................................................... 9
4.1.5 Decrease in market value .......................................................................................... 9
4.1.6 Other reasons satisfactory to the Commissioner ..................................................... 11
5. Determining the diminution .................................................................................. 13
5.1 “Item-by-item” or “category” basis ............................................................................ 13
5.2 Timing of the events that resulted in the diminution of value .................................... 14
5.3 Disclosure required in respect of diminution in the value of closing stock ................ 15
6. Conclusion ............................................................................................................. 16
Annexure – The law ....................................................................................................................... 18
Preamble
In this Note unless the context indicates otherwise –
• “closing stock” means trading stock held and not disposed of by the taxpayer
at the end of a year of assessment as contemplated in section 22(1)(a);
• “IAS” means an International Accounting Standard;
• “IFRS” means the International Financial Reporting Standards issued by the
International Accounting Standards Board;
• “section” means a section of the Act;
• “the Act” means the Income Tax Act 58 of 1962;
• “the TA Act” means the Tax Administration Act 28 of 2011;
• “trading stock” means trading stock as defined in section 1(1); and
• any other word or expression bears the meaning ascribed to it in the Act.
1. Purpose
This Note provides guidance on the determination of the diminution in the value of
closing stock, which is deducted from the cost of that closing stock for purposes of
determining the amount of closing stock that must be included in gross income under
section 22(1)(a). 1
This Note does not deal with the valuation of trading stock in the case of mining
operations, 2 farmers or trading stock falling under section 22(1)(b).
This Note replaces Practice Note 36 “Income Tax: Valuation of Trading Stock” issued
on 13 January 1995.
2. Background
Generally speaking, if the requirements of a relevant section are met, taxpayers are
allowed to claim a deduction for expenditure and losses actually incurred during the
year of assessment against their income received or accrued in that year. Taxpayers
are generally allowed to claim a deduction under section 11(a) for the expenditure
incurred in acquiring trading stock in the year of assessment in which the trading stock
is acquired, as the expenditure would be incurred in the production of income and not
of a capital nature. For example, if trading stock is purchased and sold during the same
year of assessment, there would be an inclusion of the selling price in the taxpayer’s
gross income, and a deduction under section 11(a) for the expenditure incurred in
purchasing the trading stock. If trading stock is not sold during the year of assessment
in which it is purchased, there would be no inclusion in the taxpayer’s gross income,
but there would be a deduction under section 11(a) for the trading stock purchased.
Section 22 addresses this timing mismatch by aligning the year in which a deduction
is effectively given with the year in which there is an inclusion of the selling price in
gross income. This is, broadly speaking, achieved by section 22(1)(a) that requires
that the amount of closing stock must be added to gross income when determining
taxable income, and section 22(2) that effectively allows a deduction for opening stock
in the subsequent year of assessment.
Section 22(1)(a) also prescribes the basis on which the amount of closing stock must
be determined. Specifying the basis tells taxpayers how the amount must be
determined and in so doing also prevents possible manipulation that may arise by, for
example, a taxpayer adopting a basis that gives a lower amount, therefore a lower
gross income inclusion and a lower taxable income in the particular year of
assessment.
3. The law
The relevant sections of the Act are quoted in the Annexure.
1 Read with proviso (i).
2 The terms “mining operations” and “mining” are defined in section 1(1). The amount of closing stock
is determined under section 15A.
4. Interpretation and application of the law
4.1 Introduction
Section 22(1)(a) provides that the amount of closing stock is the cost price of the
closing stock less such amount that the Commissioner may think just and reasonable
as representing the amount by which the value of such closing stock, not being a
financial instrument, has diminished by reason of damage, deterioration, change of
fashion, decrease in market value or any other reason satisfactory to the
Commissioner. The amount of such diminution is subject to the discretion of the
Commissioner, which is subject to objection and appeal. 3
Financial instruments 4 are included at cost price, since they are specifically excluded
from trading stock for which taxpayers are permitted to potentially take into account
any diminution in the value of closing stock.
Under section 22(3), 5 the cost price of trading stock is described as the cost incurred
by a taxpayer, whether in the current or any previous year of assessment, in acquiring
the trading stock, including any further costs incurred by the taxpayer, in terms of IFRS
in the case of a company, in getting the trading stock into its then existing condition
and location but excluding exchange differences relating to the acquisition of the
trading stock. In addition, in determining the cost price of an item of trading stock it is
not acceptable to use a basis that treats the last item of trading stock as the first item
disposed of on or after the date of acquisition. 6
In the context the words “amount … by which the value of such closing stock … has
diminished” refers to the amount by which the cost price of the closing stock has
diminished owing to one of the specified reasons. 7
Wallis JA in C: SARS v Volkswagen South Africa (Pty) Ltd 8 confirmed this
interpretation:
“The only way to make sense of the expression “value of such trading stock” in this context
is to accept that it refers to an artificial concept of value represented initially by the cost
price of the goods. That is the baseline against which any diminution in the value of the
goods must be measured.
…
I conclude that on a proper interpretation of section 22(1)(a) the cost price of the goods,
and not the actual or anticipated market value on their sale, is the benchmark against which
any claimed diminution in value is to be measured.
…”
3 Section 3(4)(b) includes section 22(1).
4 See definition in section 1(1).
5 See section 22(3) and section 22(3A) for further detail.
6 Section 22(5).
7 That is, due to damage, deterioration, change in fashion, decrease in market value or any other
reason satisfactory to the Commissioner.
8 2019 (2) SA 362 (SCA), 81 SATC 24 at 36 and 37.
In summary, the amount of closing stock can therefore be represented as:
Amount of closing stock = cost price − amount of the diminution in the value of
closing stock
The diminution in the value of closing stock can be represented as follows:
Amount of the diminution in value of closing stock = cost price − value of closing
stock
• If the result is negative, there is no diminution in value.
• If the result is positive, there has been a diminution, but it will be allowed only
if the diminution is owing to one of the specified reasons.
The words “diminished”, “damage”, “deterioration” and the phrases “change in fashion”
and “decrease in market value” are not defined in the Act. Therefore, these words and
phrases must be interpreted according to their ordinary meaning as applied to the
context and the subject matter with regard to which they are used. 9 See below for a
consideration of these words and phrases.
4.1.1 Meaning of “diminish” and when the diminution must be determined
Section 22(1)(a) requires a taxpayer to include an amount in respect of closing stock
at the end of the year of assessment in gross income. The amount of closing stock to
be included in gross income is equal to cost price less the amount by which cost price
has diminished (see 4.1).
Section 22(1)(a) refers to “diminished” which is the past tense of the word “diminish”.
The Dictionary.Cambridge.org defines the words “diminish” 10 and “diminution”, 11
respectively, as follows:
“(v) to reduce or be reduced in size, importance or value:”
“(n) a reduction in size, importance, or value:”
The Merriam Webster dictionary defines the word “diminish” as follows: 12
“[2] to make smaller in amount, volume, or extent:
Synonyms for diminish: abate, de-escalate, decrease, dent, deplete, downscale,
downsize, drop, dwindle, ease, knock down, lessen, lower, reduce.”
9 EA Kellaway Principles of Legal Interpretation of Statutes, Contracts, and Wills (1995) Butterworth’s
at 224. See also C: SARS v Terraplas SA (Pty) Ltd [2014] 3 All SA 11 (SCA), 76 SATC 377 at 385
and Natal Joint Municipal Pension Fund v Endumeni Municipality 2012 (4) SA 593 (SCA) at 604.
10 www.dictionary.cambridge.org/dictionary/english/diminish [Accessed 16 October 2025].
11 www.dictionary.cambridge.org/dictionary/english/diminution [Accessed 16 October 2025].
12 www.merriam-webster.com/thesaurus/diminish [Accessed 16 October 2025].
Whether the cost price of the closing stock has diminished owing to one of the specified
reasons, has to be determined at the end of the year of assessment based on the facts
of the specific case (see 5.2 for the timing of the events that can be taken into account
in determining the diminution).
If the same item of trading stock is still on hand at the end of a succeeding year of
assessment, whether the cost price of that item has diminished is determined based
on the facts applicable at the end of that succeeding year of assessment. For example,
new events may have occurred that caused the amount of the diminution in the value
of closing stock at the end of the succeeding year of assessment to increase or
decrease, or it may have stayed the same.
Example 1 – Determining the diminution in trading stock in subsequent years of
assessment
Facts:
Trading stock Item A, not a financial instrument, had a cost price of R500. At the end
of year 1 it was still on hand and its market price had decreased to R400.
At the end of year 2 Item A remained unsold and its market price had increased to
R550. Item A was sold during year 3 for R550.
Result:
Year 1
Section 22(1)(a) requires a taxpayer to include an amount in respect of closing stock
at the end of the year of assessment in gross income. The amount of closing stock to
be included in gross income is equal to cost price less the amount by which cost price
has diminished owing to the decrease in market value [one of the specified reasons in
section 22(2)(a)]. The market value of Item A had declined to R400 at the end of the
year of assessment, the amount of closing stock is therefore:
Diminution = Cost price of R500 − Value of R400 = R100
Closing stock = Cost price of R500 − R100 (diminution) = R400
Note: This effectively means that, through the mechanism of section 11(a) (a
deduction of R500) and closing stock (an inclusion in gross income of R400), there will
be a net deduction of R100 in year 1.
Year 2
Opening stock equals the prior year closing stock amount of R400. Item A remained
unsold at the end of year 2, therefore under section 22(1)(a) an amount in respect of
closing stock at the end of the year of assessment must be included in gross income.
The market value of Item A had increased to R550 at the end of the year of
assessment, the amount of closing stock is therefore:
Diminution = Cost price of R500 − Value of R550 = -R50 (negative so no diminution)
Closing stock = Cost price of R500 − Rnil (diminution) = R500
Note: This effectively means that, through the mechanism of opening stock (a
deduction under section 22(1)(a) of R400) and closing stock (an inclusion in gross
income of R500), the net deduction of R100 in year 1 will be reversed by a net inclusion
of R100 (R500 − R400) in year 2.
Year 3
Item A was sold during year 3 and will therefore not be included in closing stock at the
end of the year of assessment under section 22(1)(a).
Note: This means that through the mechanism of gross income (selling price of R550
included in gross income) and opening stock (section 22(2)(a) of R500), a net amount
of R50 (R550 – R500) will be included in taxable income in year 3.
4.1.2 Meaning of “damage”
Dictionary.com defines the word “damage” as follows: 13
“[1] (n) injury or harm that reduces value or usefulness:”
Actual damage to the trading stock from an action or event that causes it to have a
loss in value or usefulness is required.
Damage to trading stock could be caused by natural elements (fire, water and wind),
human intervention, a combination of both or other factors, for example, damage in
transit. Damage may occur to an item, some of the items or a category of trading stock.
Further, as noted in 4.1, the damage to the trading stock must diminish the value of
that stock below the cost price recognised for that trading stock. A mere possibility that
the trading stock could have been subject to damage at the end of the year of
assessment is insufficient to write down its value at the end of the year of assessment.
For example, Taxpayer A has 5 000 items of X on hand at the end of the year of
assessment. Taxpayer A was aware that during the year a unit of X was damaged
during a transfer between two stores and had to be sold at below cost. There is a risk
that the units of X on hand at the end of the year of assessment may similarly have
been damaged during transfers between stores. The risk and possibility of damage is
in itself insufficient to support a conclusion that there has been a diminution in value of
trading stock on hand at year-end. Taxpayer A would need to do further work to assess
whether items of trading stock on hand at the end of the year of assessment were
damaged and, as a result, if and to what extent they could be sold only for a price
below cost. Depending on the facts, an item-by-item or category basis may be
appropriate (see 5.1).
The nature of the damage must be so severe when measured against the cost price
that it can be said in common parlance “the goods are no longer worth that”. 14 Goods
only slightly damaged may still be profitably sold, that is, sold above cost, such that
there is no diminution. Only reductions in value below the cost price of the trading stock
would justify an exercise of the Commissioner’s discretion, 15 and be taken into account
in determining the amount of closing stock.
13 www.dictionary.com/browse/damage [Accessed 16 October 2025].
14 C: SARS v Volkswagen South Africa (Pty) Ltd 2019 (2) SA 362 (SCA), 81 SATC 24 at 36.
15 C: SARS v Volkswagen South Africa (Pty) Ltd 2019 (2) SA 362 (SCA), 81 SATC 24 at 36.
The taxpayer bears the onus to prove 16 the damage as well as the extent of such
damage, and the impact on its value. Each case will be determined having regard to
the specific facts.
Example 2 – Amount of closing stock
Facts:
Company A’s year of assessment ends on 31 March.
Company A purchased the following trading stock on 15 March year 1:
a) Three units of Item A, not a financial instrument, at a cost of R60 000 each.
b) Two units of Item B, not a financial instrument, at a cost of R120 000 each.
Company A expected to sell the units of Item A for R80 000 each, and the units of
Item B for R150 000 each in year 2.
During the year-end stock count on 31 March year 1, it was discovered that the two
units of Item B had suffered extensive damage, and, as a result, Company A will not
be able to sell the units for more than their reduced market value of R105 000 each.
The market value of each Item A at year end was R80 000.
Result:
Year 1:
R
Gross Income – Closing Stock [section 22(1)(a) and proviso (i);
see note 2] 390 000
Less: Cost of Trading Stock [section 11(a); see note 1] (420 000)
Net (30 000)
Through the combined operation of section 11(a) and section 22(1)(a), Company A
effectively deducts the diminution below cost on the two units of Item B in year 1.
Note:
R
1) Cost of Trading Stock:
Item A = 3 units × cost of R60 000 per unit 180 000
Item B = 2 units × cost of R120 000 per unit 240 000
420 000
2) Closing stock = cost price − diminution in value of closing stock*
* Diminution in value = cost price − value of stock; if the result is negative
there is no diminution in value, if it is positive there has been a diminution
but it will be allowed only if the diminution is attributable to one of the
specified reasons.
16 Section 102 of the TA Act.
Item A:
Diminution = Cost of R60 000 − value of R80 000 = -R20 000; negative so no
diminution
Closing stock = 3 × (Cost price of R60 000 − Rnil diminution) = R180 000
Item B:
Diminution = Cost of R120 000 − value of R105 000 = R15 000; positive so there
is a diminution in the value of closing stock the cause of which was the permitted
reason of damage.
Closing stock = 2 × (Cost price of R120 000 − R15 000) = R210 000
Total value of closing stock = Item A + Item B = R180 000 + R210 000 = R390 000
4.1.3 Meaning of “deterioration”
Dictionary.com defines the words “deterioration” and “deteriorate”, respectively, as
follows: 17
“(n) 2. the state or condition of having deteriorated.”
“verb 1. to make or become worse or inferior in condition, character, quality, value etc.”
Deterioration of trading stock can result in it becoming impaired or inferior in quality,
functioning or condition. The taxpayer bears the onus to prove 18 that deterioration has
occurred as well as the extent of such deterioration, and the impact on the trading
stock’s value.
For example, certain trading stock needs to be sold or consumed within an estimated
time from the date of manufacture, production or packaging. This requirement results
from the trading stock having a limited “life span” or “shelf life”. Typically, this type of
trading stock has either or both a “sell by” and “best before” date on the packaging of
the product. After a certain time period the trading stock becomes less effective or
suitable for its intended purpose, and this will often impact on the value of the trading
stock as it may sell only if the selling price is reduced. Another example is that a “sell
by” date could have an influence on the decision by prospective purchasers on which
product to purchase, with the result that the same or similar product with a later “sell
by” date may be purchased instead of a product with an earlier “sell by” date. This
situation could result in increased quantities of trading stock with shorter shelf-lives
that are held and not disposed of at the end of the year of assessment and it may, but
not necessarily, mean that a reduced price will be required in order to sell the items.
There may therefore be a diminution in value. The condition of trading stock could also
deteriorate whilst in transit or in storage. For example, a cargo of first grade rice
undergoing heating at sea, such that it has to be downgraded to second or third grade,
which trades at a value lower than first grade rice. 19
17 www.dictionary.com/browse/deterioration and www.dictionary.com/browse/deteriorate
[Accessed 16 October 2025].
18 Section 102 of the TA Act.
19 C: SARS v Volkswagen South Africa (Pty) Ltd 2019 (2) SA 362 (SCA), 81 SATC 24 at 36.
Similar to “damage” (see 4.1.2), the nature of the deterioration must be so severe when
measured against the cost price that it can be said in common parlance “the goods are
no longer worth that”. 20 Goods that have only slightly deteriorated may still be profitably
sold, that is, sold above cost, such that there is no diminution. Only reductions in value
below the cost price of the trading stock would justify an exercise of the
Commissioner’s discretion 21 and be taken into account in determining the amount of
closing stock.
4.1.4 Change of fashion
Trading stock that is, for example, subject to constant technological innovation or
seasonal fluctuations is likely, but not necessarily, to decrease in value.
Products subject to technological changes include, for example, computers and cell
phones. The extent and speed of the decrease in value will depend on, amongst
others, the degree and speed of technological innovation of new products, and whether
the current demand for the existing product, as supported by the most recent sales
data, has declined. Clothing is an example of trading stock that may be subject to
seasonal fluctuations. The value of seasonal clothing that is unsold at the end of the
year of assessment will often, but not necessarily, suffer a decline in value. Although
it is normally retained for sale in the following year of assessment, it may sell only at a
lower price owing to the lower demand for the prior year’s fashion trends.
The taxpayer bears the onus 22 to substantiate the decrease in value below cost owing
to a change in fashion by reference to, for example, the necessary documentary
evidence at or close to the end of the year of assessment. As noted above, only
reductions in value below the cost price of the trading stock will be taken into account
when determining the amount of closing stock at the end of the year of assessment.
4.1.5 Decrease in market value
Factors that could lead to a decrease in market value of an existing product include
the following:
• A supply into the market of generic equivalents that are cheaper than the
original product.
• An oversupply caused by a manufacturing overrun or a lack of demand owing
to obsolete technology.
• A significant decrease in the exchange rate of the currency in which the trading
stock was imported that results in the cost of currently imported trading stock
being much lower and retailers passing on the savings to customers through a
reduced selling price.
If, for example, one of the factors listed above, resulted in a taxpayer reducing the
selling price of its trading stock, there would be a decrease in market value. However,
only reductions in value below the cost price of the trading stock will be taken into
account when determining the amount of closing stock at the end of the year of
assessment.
20 C: SARS v Volkswagen South Africa (Pty) Ltd 2019 (2) SA 362 (SCA), 81 SATC 24 at 36.
21 C: SARS v Volkswagen South Africa (Pty) Ltd 2019 (2) SA 362 (SCA), 81 SATC 24 at paragraph 21.
22 Section 102 of the TA Act.
In C: SARS v Atlas Copco South Africa (Pty) Ltd 23 the taxpayer had written off slow
moving and obsolete trading stock for accounting and tax purposes according to its
group accounting policy of a 50% write-off if the trading stock had not sold in 12 months
and a 100% write-off if it had not sold in 24 months. The taxpayer’s argument was
essentially that “market value” equalled net realisable value in terms of IAS 2 and, by
implication, because their fixed time-based method was acceptable as NRV for
accounting purposes, it was also acceptable for tax purposes. The group accounting
policy percentages that were applied were not tested for appropriateness against
evidence available at the time, for example, the actual price at which the items were
sold. To the contrary, the taxpayer’s auditors identified only three products that were
sold at 24% to 26% below cost. The higher provisioning of 50% and 100% was,
however, acceptable from an accounting NRV perspective as it meant there was a low
probability that stock was being carried at above NRV. The court disagreed with the
taxpayer’s view that “market value” equalled NRV and found that SARS had exercised
its discretion reasonably and properly in finding that the taxpayer’s write-down did not
comply with the requirements of section 22(1)(a) since “there was no diminishing in
value at year end for a deduction to be claimed as a result of damage, deterioration,
change of fashion or decrease in market value”. In the Volkswagen case considered
in 4.1.6 of the Note, the taxpayer unsuccessfully tried to argue that a diminution
reflected in NRV (determined on a different basis to Atlas Copco and arguably more in
line with IAS 2), which was lower than cost constituted a diminution “for any other
reason satisfactory to the Commissioner”.
The taxpayer bears the onus 24 to substantiate the decrease in market value by, for
example, the reference to the necessary documentary evidence such as sales invoices
at or close to the end of the year of assessment. As noted above, only reductions in
value below the cost price of the trading stock will be taken into account when
determining the value of closing stock at the end of the year of assessment.
Example 3: Diminution based on group accounting policy
Facts:
Taxpayer B is part of the MM Group that sells air fryers to the public. The group’s
accounting policy requires all subsidiary companies to provide a provision for
diminution in the value of closing stock equal to 25% of the cost of all air fryers included
in closing stock at the end of the financial year. The end of the financial year is the
same as the end of the year of assessment.
At the end of the year of assessment Taxpayer B had three models of air fryers in
closing stock, A1 (1 000 units at a cost of R1 000 per unit), A2 (1 200 units at a cost of
R1 500 per unit) and A3 (500 units at a cost of R2 500 per unit).
Sales after year-end reflect a selling price for A1 of R1 500, A2 of R1 275 and A3 of
R1 900.
Taking the group accounting policy into account, Taxpayer B raised a provision for
financial reporting purposes equal to 25% of cost for the diminution in the value of
closing stock held and not disposed of at the end of its year of assessment.
23 2020 (4) SA 61 (SCA), 82 SATC 116.
24 Section 102 of the TA Act.
Result:
Section 22(1)(a) requires a taxpayer to include in gross income an amount in respect
of closing stock at the end of the year of assessment. The amount of closing stock to
be included in gross income is equal to cost price less the amount by which the cost
price has diminished by reason of damage, deterioration, change of fashion, decrease
in market value, or for any other reason satisfactory to the Commissioner.
The method adopted by Taxpayer B for accounting purposes of reducing the cost price
of all items of closing stock by a fixed percentage of 25% may not be used by
Taxpayer B when calculating the amount of closing stock for income tax purposes. The
accounting method does not comply with the requirements of section 22(1)(a) as any
diminution must be determined on an item-by-item or an appropriate category of
trading stock basis (see 5.1) and “air fryers” as a whole is not an appropriate category
given the different market profile for different types of air fryers. In addition, the method
of a blanket 25% provision does not consider whether there has in fact been a
diminution in value of the air fryers and the extent of such diminution by taking into
consideration, for example, recent sales.
The diminution in the cost price of closing stock is determined as follows:
Cost Price Selling Price Diminution (per unit)
(R) (R) (R)
A1 1 000 1 500 0
A2 1 500 1 275 225
A3 2 500 1 900 600
The selling price of Item A1 is in excess of its cost price therefore there is no diminution
and the amount for purposes of inclusion of closing stock in gross income under
section 22(1)(a)(i) will be its cost price.
The selling price for Items A2 and A3 have decreased to below the cost price of the
items therefore under section 22(1)(a) a diminution owing to a decrease in the market
value for the items has occurred. In determining the amount of closing stock to be
included in gross income under section 22(1)(a)(i), the cost price per unit of Item A2
and A3 may be reduced by R225 and R600, respectively.
4.1.6 Other reasons satisfactory to the Commissioner
Section 22(1) contemplates the possibility of there being other reasons for a diminution
of value apart from the four reasons specified in 4.1.2 to 4.1.5. For that reason it
empowers the Commissioner to make a just and reasonable allowance to
accommodate a diminution in amount of closing stock for any other reason that may
be satisfactory to the Commissioner. As noted above, only reductions in value below
the cost price of the trading stock will be taken into account when determining the value
of closing stock at the end of the year of assessment.
The taxpayer bears the onus to prove 25 that the decline in value was attributable to
another reason which, in the context of section 22(1)(a), should be satisfactory to the
Commissioner. Each case will be determined having regard to the specific facts.
25 Section 102 of the TA Act.
In C: SARS v Volkswagen South Africa (Pty) Ltd 26 the taxpayer contended that there
had been a reduction in the amount of its closing stock “for another reason”. The
taxpayer contended that the net realisable value (NRV) of closing stock, as determined
under IAS 2, 27 properly reflected the value of closing stock and therefore if NRV was
below cost, there was a diminution in value of trading stock that was owing to “any
other reason satisfactory to the Commissioner” which should be recognised in
determining the amount of closing stock.
“Net realisable value” is defined in IAS 2 as –28
“the estimated selling price in the ordinary course of business less the estimated costs of
completion and the estimated costs necessary to make the sale”.
The Court disagreed with the taxpayer and found that while there is scope for overlap 29
between section 22(1)(a) and IAS 2, there are elements in IAS 2 that are outside the
scope of section 22(1)(a). The NRV was therefore not an acceptable basis for
determining the value of closing stock and the diminution of the NRV below cost did
not therefore constitute “any other reason satisfactory to the Commissioner”.
In the judgment Wallis JA found as follows: 30
“Whether the concept of NRV reflects a diminution of value of trading stock for the purposes
of s 22(1)(a) depends therefore, not on its acceptance as part of GAAP [Generally Accepted
Accounting Practice], but on its conformity to the requirements for such a diminution in
value as determined on a proper interpretation of that section.”
After analysing IAS 2 and the determination of NRV, and in addition to identifying some
practical difficulties, Wallis JA held that the use of NRV is inconsistent with two basic
principles that underpin the Act and therefore section 22(1)(a). The first principle is that
generally taxable income is determined and taxation levied from year-to-year on the
basis of events that have taken place during the relevant tax year. In contrast to this
“backward looking” approach, NRV is explicitly “forward looking”. It is concerned with
the amount that the trader is likely to receive when the goods are realised and therefore
takes expenses that will still be incurred in making the sale into account. The second
principle is that using NRV has the effect that expenses incurred in a future tax year
become deductible in a year prior to being actually incurred which is contrary to one of
the requirements in section 11(a) that the expenditure must be actually incurred.
If, on the facts of a particular case, the determination of NRV included only overlapping
elements and amounts between section 22(1)(a) and IAS 2 and did not include any
elements or amounts which are outside the scope of section 22(1)(a), then there could
be alignment between NRV as determined for accounting purposes and the “value of
closing stock” 31 as determined for purposes of section 22(1)(a). Section 22(1)(a) and
NRV are frequently not aligned, therefore cognisance of this fact must be taken into
account when completing the tax return.
26 2019 (2) SA 362 (SCA), 81 SATC 24.
27 IAS 2 prescribes the recognition, measurement and disclosure of inventories (trading stock)
financial accounting purposes.
28 IAS 2 at paragraph 6.
29 For example, if, before year end, trading stock was damaged, wholly or partially obsolete or the
selling prices had declined below cost, the diminution below cost for one of these reasons would be
recognised under IAS 2 and section 22(1)(a).
30 C: SARS v Volkswagen South Africa (Pty) Ltd 2019 (2) SA 362 (SCA), 81 SATC 24 at 38.
31 See 4.1 – the “value of closing stock” is used in determining the amount of the diminution in value
of closing stock which, in turn, is used in determining the amount of closing stock.
Other reasons satisfactory to the Commissioner could be taxpayer or trade specific.
The reasons, which must be satisfactory to the Commissioner, will be assessed on a
case-by-case basis.
5. Determining the diminution
5.1 “Item-by-item” or “category” basis
In the Volkswagen case the Court noted that “(f)or tax purposes the question is thus
whether trading stock as a whole had suffered a diminution in value” and that a
taxpayer cannot take advantage of the “swings” when the value was lower than cost
price but disregard the “roundabouts” when the reverse was true. 32
This aspect of the judgment raised some concerns as, before the above-mentioned
judgment, many taxpayers and SARS had practically considered whether there had
been a diminution in the value of closing stock on an item-by-item or, where
appropriate, a category basis and a diminution on one item of trading stock was not
reduced by an unrealised increase in the value above cost on another item.
Subsequent to the Volkswagen case, the legislature introduced proviso (ii) into
section 22(1)(a) which provides that –
“(ii) in determining any diminution in the value of trading stock, no account must be taken
of the fact that the value of some items of trading stock held and not disposed of by the
taxpayer may exceed their cost price…”.
Proviso (ii) confirms that the recognition of a diminution in the value of any item of
closing stock is not affected by an appreciation in the value of another item of closing
stock. In calculating the value of closing stock, a taxpayer may therefore claim a
reduction for the diminution in value below cost of a specific item of trading stock, or,
if appropriate, a category of trading stock, for one of the specified reasons
notwithstanding that other items of trading stock may have appreciated in value.
Whether it is appropriate to analyse closing stock on an item-by-item basis or a
category basis and, if the latter, what constitutes appropriate categories, must be
determined on the facts of the particular case. For example, if there are large volumes
of the same small items of closing stock it is often appropriate to group those items
into one category and to determine the value of the closing stock and the amount of
the diminution below cost for the category using suitable sampling. However, there
may be conditions that make grouping the same items into one category inappropriate.
For example, if one had 1 000 units of a particular spare part on hand at the end of the
year of assessment, 200 of which had been damaged during transportation before
year-end and 800 of which were in pristine condition, it may be inappropriate to put all
the units into one category if the damaged versus undamaged status has a significant
impact on the value of the item and therefore a significant impact if one category had
been used. In the case of large value items or unique items, it is often, but not
necessarily, more appropriate to analyse each item on an item-by-item basis.
Taxpayers must consider their specific circumstances when deciding whether it is
reasonable and appropriate to analyse closing stock on an item-by-item basis or in
categories (and if in categories, what categories) and must be able to support their
decision with reference to their facts and supporting evidence.
32 C: SARS v Volkswagen South Africa (Pty) Ltd 2019 (2) SA 362 (SCA), 81 SATC 24 at 24.
5.2 Timing of the events that resulted in the diminution of value
In C: SARS v Volkswagen South Africa (Pty) Ltd the Supreme Court of Appeal noted
the following: 33
“The taxpayer is required to determine the value of its trading stock at a particular point
in time, namely, the end of the tax year. As is generally the case in determining the
taxpayer’s taxable income that is an exercise of looking back at what happened during the
tax year in question. An important aspect of the language in section 22(1)(a) is that the
allowance that the Commissioner may think just and reasonable is ‘an amount by which
the value of the trading stock has been diminished’. That language is couched in the past
tense. The section is accordingly not concerned with what may happen to the trading stock
in the future, but with an enquiry as to whether a diminution in its value has occurred at the
end of the year of assessment. All the instances expressly referred to in the section, namely
damage, deterioration, change of fashion and decrease in market value, relate to a
diminution of value occurring prior to the taxpayer rendering its return as a result of events
occurring prior to that date.”
In C: SARS v Atlas Copco South Africa (Pty) Ltd 34 the Court took the same approach
in holding as follows:
“Section 22(1)(a) is concerned with the value of the trading stock of a taxpayer as
trading stock at year end. It empowers SARS to allow a deduction from the cost price, by
way of a just and reasonable allowance, in the … circumstances specified … The section
is couched in the past tense. It is concerned with an enquiry as to whether a diminution in
value has already occurred. In other words, the cost price must already have diminished.
The circumstances expressly mentioned in the section relate to a diminution of value as a
result of events occurring prior to the rendition by the taxpayer of its tax return. The exercise
is thus one of looking back at what happened during the tax year in question.”
In the Volkswagen case the Supreme Court of Appeal went on to hold that, consistent
with the proposition that the assessment of income tax relates to events that have
already occurred rather than events that may occur in the future, SARS may allow a
just and reasonable allowance in respect of a diminution in the valuation of trading
stock only in two circumstances, namely –35
• an event, which caused the value of closing stock to diminish for one of the
specified reasons, has occurred during the relevant tax year; or
• it is known with reasonable certainty that an event will occur in the following tax
year that will cause the value of closing stock to diminish for one of the specified
reasons.
The Supreme Court of Appeal provided the following example of an event that might
constitute one that it is known with reasonable certainty will occur in the following tax
year. 36
“... knowledge that a glut had built up in the market for a perishable commodity, where
that glut would ensure a marked, certain and unavoidable decline in the price of that
commodity.”
33 2019 (2) SA 362 (SCA), 81 SATC 24 at 34.
34 2020 (4) SA 61 (SCA), 82 SATC 116 123.
35 C: SARS v Volkswagen South Africa (Pty) Ltd 2019 (2) SA 362 (SCA), 81 SATC 24 at 35 and 37.
36 C: SARS v Volkswagen South Africa (Pty) Ltd 2019 (2) SA 362 (SCA), 81 SATC 24 at 35.
Example 4 – Timing of event that resulted in the diminution of trading stock
Facts:
Taxpayer C sells furniture at a standard mark-up of 75%. Taxpayer C moved furniture
from a warehouse to two of its retail stores. During the transfer, the furniture was
physically damaged and as a result of the damage the furniture had to be sold at a
discount of 50%.
Result:
If the trading stock was transported and damaged before the end of year 1, the event
would have taken place during year 1 and the diminution in the value below cost would
be taken into account in determining the value of any of the damaged trading stock still
on hand at the end of year 1.
In contrast, if the trading stock was transported and damaged during year 2, at the end
of year 1 the event is not one which had taken place during year 1 and it is not one
which was known with reasonable certainty at the end of year 1. Therefore, the
diminution in the value below cost would not be taken into account in determining the
amount of closing stock at the end of year 1.
However, if trading stock was transported and damaged during year 1 but the taxpayer
became aware of the damage only in year 2, any diminution in value of trading stock
on hand must be taken into account in year 1 since the event took place during year 1.
As noted above, there will be scope for an allowance only if the events in question
have led to the cost price of the goods ceasing to be a proper measure of their value.
In substance, the allowance enables the taxpayer to say that, because of the
diminution in value of its trading stock, it has suffered a loss in the current year and it
should be permitted to set off that loss in the determination of its taxable income for
the current year instead of waiting for it to materialise when the goods are sold in a
later year. 37
5.3 Disclosure required in respect of diminution in the value of closing stock
A taxpayer that values trading stock below cost price must disclose this fact to the
Commissioner in the relevant tax return. The disclosure of the above information will
assist the Commissioner in the exercise of the discretion contained in section 22(1)(a).
The value by which closing stock has diminished in section 22(1)(a) is subject to the
discretion of the Commissioner. This discretion can be applied only if the
Commissioner is made aware of the actual write-down. In ITC 1489 Conradie J held
as follows: 38
“If a method of reducing the cost of stock by a percentage is adopted, (because, for
example, it is impractical to value individual items of stock) the percentage reduction should
not only be supported by trading history and, where appropriate, post balance sheet
experience, but the Revenue should be told how that percentage is arrived at. There is a
good deal to be said for the view that the Act by implication requires such a disclosure. The
Commissioner has to exercise a discretion with regard to the amount by which the value of
37 C: SARS v Volkswagen South Africa (Pty) Ltd 2019 (2) SA 362 (SCA), 81 SATC 24 at 37.
38 (1990) 53 SATC 99 (C) at 104.
trading stock has been diminished. He cannot exercise that discretion if he is not told on
what basis the accounts submitted to him have been prepared.”
In addition, when submitting the return, a taxpayer must provide, for example –
• details of the basis on which stock is valued;
• if applicable, reasons for valuing trading stock below cost and details regarding
the methodology used in valuing the written-down stock; and
• if stock has been written off on a fixed, variable or any other basis, not
representing the actual value by which closing stock has been diminished,
reasonable justification for the basis applied.
SARS may request supporting evidence for the write down and the information
provided in the return.
Trading stock that has been valued below cost may result in the imposition of
understatement penalties under section 222 of the TA Act if it transpires that the value
of closing stock has been understated.
A taxpayer bears the burden of proving that an amount or item is deductible or may be
set-off; 39 or that a valuation is correct. 40
6. Conclusion
Section 22(1)(a) is a balancing mechanism for the deduction claimed under
section 11(a) for trading stock purchased during the year but still on hand at the end of
the year of assessment. Closing stock held and not disposed of at the end of the year
of assessment is included in gross income. The value of that closing stock is the cost
price of the trading stock, less any amount that represents any diminution in value
which the Commissioner may think just and reasonable by reason of damage,
deterioration, change of fashion, decrease in market value or for any other reason
satisfactory to the Commissioner. The diminution in value refers to the amount by
which the cost price of the closing stock has diminished owing to one of the specified
reasons. The value of such diminution is subject to the discretion of the Commissioner
and subject to objection and appeal.
The diminution in the value of closing stock must be determined on an item-by-item
basis or, if appropriate, on a category basis.
The judgments of the Supreme Court of Appeal in the Volkswagen and Atlas Copco
South Africa cases may be referred to as authority on section 22(1) for the following
principles:
• The cost price of the goods and not the actual or anticipated market value is
the benchmark against which any claim for the diminution in value is to be
measured.
• A claim for a diminution of cost price must be based on events that exist at the
end of the year of assessment or events that it is known with reasonable
certainty will occur in the following year of assessment.
39 Section 102(1)(b) of the TA Act.
40 Section 102(1)(e) of the TA Act.
• There will be scope for a diminution of cost price only if the events in question
have led to the cost price of the goods ceasing to be a proper measure of their
value.
• The use of NRV to determine the value of closing stock under section 22(1)(a)
is inconsistent with the principles that underpin the Act.
Leveraged Legal Products
SOUTH AFRICAN REVENUE SERVICE
Annexure – The law
Section 1(1) – Definition
“trading stock”—
(a) includes—
(i) anything produced, manufactured, constructed, assembled, purchased or in any
other manner acquired by a taxpayer for the purposes of manufacture, sale or
exchange by the taxpayer or on behalf of the taxpayer;
(ii) anything the proceeds from the disposal of which forms or will form part of the
taxpayer’s gross income, otherwise than—
(aa) in terms of paragraph (j) or (m) of the definition of “gross income”;
(bb) in terms of paragraph 14(1) of the First Schedule; or
(cc) as a recovery or recoupment contemplated in section 8(4) which is included
in gross income in terms of paragraph (n) of the definition of “gross income”;
or
(iii) any consumable stores and spare parts acquired by the taxpayer to be used or
consumed in the course of the taxpayer’s trade; but
(b) does not include—
(i) a foreign currency option contract; or
(ii) a forward exchange contract,
as defined in section 24I(1);
Section 22
22. Amounts to be taken into account in respect of values of trading stocks.—(1) The
amount which shall, in the determination of the taxable income derived by any person during any year
of assessment from carrying on any trade (other than farming), be taken into account in respect of the
value of any trading stock held and not disposed of by him at the end of such year of assessment, shall
be—
(a) in the case of trading stock other than trading stock contemplated in paragraph (b), the
cost price to such person of such trading stock, less such amount as the Commissioner
may think just and reasonable as representing the amount by which the value of such
trading stock, not being any financial instrument, has been diminished by reason of
damage, deterioration, change of fashion, decrease in the market value or for any other
reason satisfactory to the Commissioner: Provided that for the purposes of this
subsection—
(i) the amount of trading stock must be taken into account in determining taxable
income by including such amount in gross income; and
(ii) in determining any diminution in the value of trading stock, no account must be
taken of the fact that the value of some items of trading stock held and not disposed
of by the taxpayer may exceed their cost price; and
(b) in the case of any trading stock which consists of any instrument, interest rate
agreement or option contract in respect of which a company has made an election which
has taken effect as contemplated in section 24J(9), the market value of such trading
stock as contemplated in such section.
1(A) Where in respect of any year of assessment…
(2) The amount which shall in the determination of the taxable income derived by any person
during any year of assessment from carrying on any trade (other than farming), be taken into account
in respect of the value of any trading stock held and not disposed of by him at the beginning of any year
of assessment, shall—
(a) if such trading stock formed part of the trading stock of such person at the end of the
immediately preceding year of assessment be the amount which was, in the
determination of the taxable income of such person for such preceding year of
assessment, taken into account in respect of the value of such trading stock at the end
of such preceding year of assessment; or
(b) if such trading stock did not form part of the trading stock of such person at the end of
the immediately preceding year of assessment, be the cost price to such person of such
trading stock.
(2A) (a) Where any person carries on any construction, building, engineering or other trade …
(3) (a) For the purposes of this section the cost price at any date of any trading stock in relation
to any person shall—
(i) subject to subparagraphs (iA) and (ii), be the cost incurred by such person, whether in
the current or any previous year of assessment in acquiring such trading stock, plus any
further costs incurred by such person, in terms of IFRS (in the case of a company), up
to and including the said date in getting such trading stock into its then existing condition
and location, but excluding any exchange difference as defined in section 24I(1) relating
to the acquisition of such trading stock;
(iA) include an amount that has been included in that person’s income in terms of
section 8(5), which was applied in reduction or towards settlement of the purchase price
of that trading stock;
(ii) in the case of any trading stock which is in terms of paragraph 12(2)(c) of the Eighth
Schedule treated as having been acquired at a cost equal to the market value, be that
market value; or
(iii) in the case of— …
Diamond Export Levy Act, 2007
