Page 224 - SAIT Compendium 2016 Volume2

IN 11 (3) Income Tax acT: InTeRPReTaTIon noTes IN 11 (3)
4.2 De nition of trading stock in section 1(1) [paragraph (a)(ii)]
Paragraph (a)(ii) of the de nition of ‘trading stock’ in section 1(1) includes anything the proceeds from the disposal of which forms or will form part of the taxpayer’s gross income. It follows that paragraph (jA) assets comprise trading stock irrespective of whether they have been applied for purposes other than disposal in the ordinary course of trade.
4.3 Recoupment of expenditure [paragraph (i) of the proviso to section 8(4)(a)]
Paragraph (i) of the proviso to section 8(4)(a) excludes from recoupment under section 8(4)(a) any amount included in gross income under paragraph (jA). This exclusion ensures that when the assets are sold, the amount received or accrued on disposal is subject to tax only once.
4.4 Trading stock applied for a purpose other than disposal in the ordinary course of trade [paragraph (d) of the proviso to section 22(8)(b)(iv)]
Section 22(8)(b)(iv) provides for a market value inclusion in income when trading stock has been applied for a purpose other than disposal in the ordinary course of trade. Through a process of elimination it is evident that section 22(8)(b)(iv) was intended to cover, for example, trading stock which is –
• consumed by the taxpayer for the purposes of trade; or
• used by the taxpayer as a capital asset when the asset is a paragraph (jA) asset.
Paragraph (d) of the proviso to section 22(8) prevents an inclusion in income under section 22(8)(b)(iv) when a paragraph (jA) asset is applied as a capital asset.
Note: While a conversion of trading stock to a capital asset is normally dealt with under section 22(8)(b)(v) (asset which ceases to be held as trading stock) this provision cannot apply to a paragraph (jA) asset since such an asset remains trading stock until it is disposed of. This outcome follows from paragraph (a)(ii) of the de nition of ‘trading stock’ which includes in trading stock ‘anything the proceeds from the disposal of which forms or will form part of the taxpayer’s gross income’. Since the proceeds on disposal of a paragraph (jA) asset will always be included in gross income it will remain trading stock despite any change in usage.
In order to prevent any double taxation, any inclusion in income will therefore only be accounted for under paragraph (jA) when the asset is ultimately disposed of and not under section 22(8).
See Interpretation Note No. 65 (Issue 2) dated 5 February 2014 ‘Trading Stock – Inclusion in Income when Applied, Distributed or Disposed of Otherwise than in the Ordinary Course of Trade’ for a discussion on section 22(8).
Example – Trading stock applied for a purpose other than for disposal in the ordinary course of trade
Facts:
A company imports computer parts and assembles them into desktop computers which it sells. The parts and assembled computers comprise trading stock. Some of the computers assembled by the company are used by its sales personnel for demonstration purposes. These computers are used as capital assets and not for disposal in the ordinary course of trade. After two years the demonstration computers are sold to the company’s employees at their then prevailing market values.
Result:
The demonstration computers comprise trading stock under paragraph (a)(ii) of the de nition of ‘trading stock’ in section 1(1) because any proceeds on their disposal will form part of the company’s gross income under paragraph (jA).
Upon application of the demonstration computers as capital assets
Section 22(8)(b)(iv) deems the market value of the computers to be included in the company’s income when they are applied as capital assets. However, paragraph (d) of the proviso to section 22(8) prevents this deemed inclusion for paragraph (jA) assets.
Under the de nition of ‘trading stock’ the demonstration computers remain trading stock despite their deployment as capital assets. Therefore there will also be no deemed inclusion in the company’s income under section 22(8)(b)(v) (assets held as trading stock which cease to be held as trading stock).
Upon sale of the demonstration computers to employees
Any amounts received by or accrued to the company from the disposal of its demonstration computers to its employees on or after 12 December 2001 are included in its gross income under paragraph (jA).
It follows that the company must include the market value of the demonstration computers in its gross income under paragraph (jA) only when they are ultimately disposed of to its employees and not when they are applied as capital assets.
4.5 Interaction between paragraph (jA) and section 22
4.5.1 Closing stock [section 22(1)]
Under section 22(1) a taxpayer must include in closing stock the amount of any paragraph (jA) assets held and not disposed of at the end of the year of assessment because such assets comprise trading stock as de ned in section 1(1).
Section 22(1) details the method by which trading stock must be valued at the end of the year of assessment for the purpose of determining the taxable income of the taxpayer. The basis of valuation generally will be cost less the amount by which the value of such stock has been diminished by reason of damage, deterioration, change in fashion, decrease in the market value or for any other reason satisfactory to the Commissioner. In this regard a decrease in the market value of the assets as a result of their use in the taxpayer’s trade will be a satisfactory reason to reduce their value under section 22(1). In this way the trading stock will be valued at the lower of cost or net realisable value.
216 saIT comPendIum oF Tax LegIsLaTIon VoLume 2