Tax and SARS knowledge base
How to value closing inventory for income tax
How should a business value closing inventory for income tax?
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Direct answer
For income tax, a business should identify its trading stock on hand at year end and value it under the applicable tax rules, generally starting with cost. A reduction below cost is not a routine accounting choice: a claimed diminution needs a supportable tax basis, evidence and a clear link to the particular stock.
SARS Interpretation Note 140 discusses diminution in the value of closing stock. It is a useful starting point for companies with aged, damaged or obsolete stock, but it does not replace a review of the Income Tax Act and the company’s facts. The stock-count file, costing records and tax computation must align.
What this means in practice
Financial statements and tax returns do not always use the same language or measurement objective. An accounting provision based on net realisable value may identify a commercial issue, but it is not automatically the amount that can be used for income-tax closing-stock purposes. Keep the tax analysis separate and explain every adjustment.
First establish what is trading stock. Then complete a credible physical or system-supported count at year end. The company should be able to show stock code, description, quantity, location and cost. Inventory that is held by a third party, in transit, on consignment or subject to ownership terms needs specific attention because a system total may not answer who owned it at year end.
Cost needs a consistent and reconcilable basis. For a retailer, manufacturer or importer, that may involve purchase invoices, freight, customs, production records and allocation methods. The tax preparer should reconcile the inventory ledger to the general ledger and explain material differences. Unsupported balancing figures invite difficulty during a SARS verification.
Step-by-step
- Fix the stock-count date and process.
Plan the count at year end or use controlled roll-forward and roll-back procedures. Record who counted, which locations were covered, how damaged goods were marked and how count discrepancies were resolved.
- Create a detailed inventory schedule.
Include unique item descriptions or codes, quantities, locations and status. Separate saleable stock from goods that are damaged, expired, returned, slow moving or held for scrap. Do not combine them into a general provision.
- Reconstruct the tax cost.
Link stock to supplier invoices, manufacturing records or import cost schedules. Make the costing method clear and apply it consistently. Keep a reconciliation from the detailed schedule to the closing-stock figure in the accounts.
- Identify proposed diminution items.
If the company proposes a value below cost, identify each class or item and why. Relevant evidence may include dated photos, technical reports, expiry data, discontinued product notices, failed quality reports, markdown authorisation and sales after year end.
- Apply the tax analysis.
Use the current legislation and SARS guidance to assess whether the facts support a diminution. Do not copy a financial-statement impairment percentage into the tax computation. The calculation should show cost, claimed value, evidence and reviewer conclusion.
- Reconcile to the ITR14 working papers.
The ITR14 is a declaration of the company’s financial transactions. Ensure that stock movement, cost of sales, closing stock and any tax adjustment are traceable from the return back to the stock file.
Documents and records to keep
Keep signed count sheets, system inventory reports, stocktake instructions, reconciliation schedules, supplier invoices, landed-cost calculations and production costing records. For any claimed reduction, keep ageing reports, condition evidence, markdown approvals, post-year-end sales records and disposal or scrap documentation. Retain the tax calculation and review notes with the ITR14 workpapers.
Important limits and exceptions
This is not financial-reporting advice and does not determine VAT on inventory transactions. It also does not cover capital assets, consumables that are not trading stock, foreign-currency valuation or sector-specific rules.
Slow turnover alone does not prove that tax value is below cost. The record needs to show why the stock was worth less at year end and why the calculation is reasonable. Material stock, complex manufacturing, consignment arrangements, related-party stock transfers and businesses using retail estimate methods merit specialist review.
When to get tailored advice
Get tailored advice where stock is high value, perishable, technologically obsolete, regulated, imported or difficult to count. Ask for a review before filing if the proposed tax figure differs materially from the accounting inventory figure or if an audit previously queried stock valuation.
TaxProof can help organise the count and evidence file. We cannot approve an unsupported stock write-down or replace a technical valuation where specialist input is needed.