Contents
- How is trading stock taxed?
- Valuation of trading stock
- Trading stock that stops being held as trading stock
- Trading stock that is disposed or sold outside of a business
Division 70 of the ITAA 1997 outlines the tax treatment of trading stock. Section 70-10 ITAA 1997 defines trading stock as including anything produced, manufactured or acquired that is held for the purposes of manufacture, sale or exchange in the ordinary course of business. Essentially, it is the trading items of a business. Examples of trading stock include the following:
- Food for a taxpayer who operates a business of selling groceries.
- Furniture for a taxpayer who operates a business of selling furniture.
- Live stock for a taxpayer who operates a business of primary production.
- Land for a taxpayer who operates a business of acquiring and selling land.
- Shares and units for a taxpayer who operates a business of trading shares or options.
- Work in progress for a taxpayer who is a manufacturer.
Certain items will not constitute trading stock. Examples of items which are not trading stock include the following:
- Work in progress of a long-term construction project for a taxpayer in the business of construction.
- Work in progress of a professional services firm.
How is trading stock taxed?
The taxation works as follows:
- The cost of acquiring the trading stock or materials used to produce the trading stock that are on hand = allowable deduction.
- The proceeds from the sale of the trading stock = assessable income.
- Any excess of the value of trading stock on hand at the end of the income year over the value of trading stock on hand at the beginning of the income year = assessable income.
- Any excess of the value of trading stock on hand at the beginning of the income year over the value of trading stock on hand at the end of the income year = allowable deduction.
Example:
Buddy Pty Ltd is a business established to sell advanced cameras. On 1 July 2023, the business has no trading stock on hand. Then, on 31 December 2023, Buddy Pty Ltd acquired a camera from an overseas supplier. The camera and associated costs for delivery were $10,000. On 30 June 2024 (end of income year), the camera remained unsold in store. Then, on 31 December 2024, the camera (the only item in store) was sold for $13,000. Therefore, there was no trading stock on 30 June 2025 (end of income year).
For the income year ending 30 June 2023:
there was no trading stock and therefore no assessable income or allowable deductions.
For the income year ending 30 June 2024:
- there is a $10,000 allowable deduction for the camera purchased and on hand.
- the value of closing stock being $10,000 (based on a cost valuation of camera) exceeds the value of opening stock of $0. The excess of $10,000 is assessable income.
- Therefore, assessable income is $10,000 and allowable deductions are $10,000.
For the income year ending 30 June 2025:
- there is $13,000 in assessable income for the proceeds received for selling the camera.
- the value of opening stock of $10,000 exceeds the value of closing stock of $0 ($0 as the taxpayer has no more stock on hand by year end). The excess of $10,000 is an allowable deduction.
- Therefore, assessable income is $13,000 and allowable deductions are $10,000.
Overall, we can see that the net result of the purchase and sale of the trading stock is the recognition of a $3,000 tax profit. As can be seen in the above example (look particularly at the analysis in respect of the income year ending 30 June 2024), the ultimate deduction for trading stock is essentially deferred and matched with the year in which the trading stock is sold.
Generally, a deduction for acquired trading stock is not available until at least the time at which the stock becomes ‘on hand’. Essentially, this is when the taxpayer has the power to dispose the stock. Note the taxpayer does not necessarily have to be in possession of the stock for the power of disposal to exist. Note also that stock on lay-by will be considered on hand until that relevant item is retrieved by the buyer.
Valuation of trading stock
As mentioned, the value of closing stock must be determined at the end of every income year. The value of opening stock will simply match the closing stock of the prior income year. Note these values exclude any GST. Technically, each item of trading stock should be valued. The method applied to value stock can vary between different items and from year to year. The yearly choice afforded to taxpayers means it is normal for stock on hand to be valued using the method that results in the lowest valuation. This defers tax on an increase in the value of stock on hand at year end.
The available valuation methods include the following: (i) cost method, (ii) market value method, (iii) the replacement value method, (iv) a special obsolescence method available in relation to obsolete stock.
Cost method
Under this method, an item of trading stock is valued as the cost of the item or parts comprising the item plus ‘associated costs’ to bring the item in to a sale-ready condition and location e.g. freight, insurance, customs, excise duties, warehousing and distribution costs. The associated costs which are appropriate to add to the value of trading stock can vary from business to business. For example, a manufacturer would likely include the costs of labour and materials, plus an appropriate proportion of factory overheads. On the other hand, a land developer would include the costs of infrastructure and the costs of meeting the conditions for council approval.
In many instances, it is difficult or even impossible to determine the actual cost of each item of trading stock on hand using the cost method. For example, where there is high volume of items being traded. To deal with this practical difficulty, there are several cost valuation sub-methods that can be employed. These include the following:
- First-in first-out method: trading stock is deemed disposed in the order it was acquired. Therefore, the value of trading stock on hand at year end essentially reflects the cost of items most recently acquired.
- Average cost method: essentially, the average cost of each type of item which was on hand at the beginning of the year and which is acquired during the year.
- Standard costs method: a predetermined standard cost per unit.
- Retail inventory method: the retail selling price of the goods less the mark-up amount.
Note the cost method has restricted application where parties are not acting at arm’s length and buying or selling stock at an under-value or over-value. In these circumstances, market value should be used to assess the value of stock on hand.
Market value method
Under this method, an item of trading stock is valued according to its market value. The market value is based on the value of the stock in the taxpayer’s own unique selling market. For a wholesaler, the current wholesale value of a comparable item should be used. For a retailer, the current retail selling value of the item should be used. This method may not be appropriate for niche items of stock as market value may be unknown or difficult to determine.
Replacement value method
Under this method, an item of trading stock is valued according to its replacement value. This is the amount the taxpayer would pay in an arm’s length market on the last day of the income year for a substantially identical item.
Obsolescence method
This method is only available where the stock is obsolete and has a value less than its cost. The taxpayer may make a reasonable estimate of the stock value.
Trading stock that stops being held as trading stock
If the trading stock is no longer held as trading stock but continues to be owned by the taxpayer, it is deemed to have been sold at cost and immediately re-acquired at cost.
For example, take Buddy who is a sole trader and is in the business of selling lawn mowers to store customers. The lawn mowers are all purchased from a manufacturer for $5,000. Buddy beginnings using one of those lawn mowers personally and no longer holds the mower out for sale. The lawn mower will be deemed to have been disposed and re-acquired at cost. This results in Buddy having $5,000 in assessable income (assuming no associated costs) in the income year the asset ceased being trading stock.
Trading stock that is disposed or sold outside of a business
If the trading stock is disposed outside of the ordinary course of the taxpayer’s business, it is deemed to have been sold at market value on the date of disposal.
Continuing on from the example above – Buddy, instead of using the mower for personal purposes, gifts one of the lawn mowers to his friendly neighbour. The retail market value of the lawnmower is $8,000 at the date of disposal. In this instance, Buddy includes $8,000 in assessable income in the income year of disposal.
This article is general information only and does not provide advice to address your personal circumstances. To make an informed decision you should contact an appropriately qualified professional.