Edited version of your written advice

Authorisation Number: 1051319128361

Date of advice: 14 December 2017

Ruling

Subject: Valuation of trading stock.

Question

Does the election to value spare parts, being trading stock of XY Pty Ltd, by writing them down by the percentages specified in the table below, meet the requirements of section 70-50 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Year	Percentage Write-down
Year of purchase	0%
1 year after purchase	15%
2 years after purchase	30%
3 years after purchase	60%
4 years after purchase	95%

Answer

Yes.

This ruling applies for the following periods:

Year ended 31 December 20XX

Year ended 31 December 20XX

Year ended 31 December 20XX

The scheme commences on:

1January 20XX

Relevant facts and circumstances

XY Pty Ltd

1. XY Pty Ltd is a part of a Global Group.

2. XY Pty Ltd supplies machinery to customers.

3. XY Pty Ltd provides ongoing maintenance and repairs for all of its customers and as such maintains a supply of spare parts to be made available when required. The spare parts for machinery are held at the head office and in a number of branches.

4. Each machine sold by XY Pty Ltd generally has a three year warranty period, with optional arrangements that may be entered into with a customer to provide for a warranty period longer than three years.

Trading stock

5. To ensure that XY Pty Ltd is able to fulfil its warranty obligations and to ensure more generally that it is able to provide spare parts to its customers upon demand, XY Pty Ltd is required to maintain sufficient stock of spare parts to ensure that all potential repair and maintenance requests in respect of items of machinery sold by XY Pty Ltd can be met in a timely fashion.

6. In certain circumstances, immediate turn-around of replacement parts is crucial to the customers’ business.

7. Resultantly, XY Pty Ltd maintains a high level of spare parts on hand in storage, much of which may never be called upon for use prior to the machine sold being updated to a newer model. The updating of models substantially reduces the demand for spare parts but does not reduce the obligation upon XY Pty Ltd to hold sufficient spare parts on hand to meet all demands.

8. The major classes of spare parts align to a model lifestyle of 5 years.

9. The carrying value of stock in the financial accounts is written down to provide for the ongoing obsolescence and diminishing value of the spare parts.

10. The obsolescence accounting policy employed by XY Pty Ltd in writing down the carrying value of spare parts is in accordance with the Global Group Relevant policy and involves writing down spare parts, for accounting purposes, to 1% where that specific part has not been purchased or sold in a certain number of years.

11. XY Pty Ltd has provided a breakdown of the net valuation of spare parts comparing the accounting policy and the proposed, and historically applied, tax treatment indicating that there has historically been minimal variance between the accounting and tax value of spare parts as trading stock.

12. The accounting policy takes into account that while the spare parts are on hand, there is a very small chance they will actually be used.

13. XY Pty Ltd receives negligible proceeds on the sale of scrapped spare parts.

Assumption

1. The key aspects of the business of XY Pty Ltd relevant to the valuation of spare parts under section 70-50 of the ITAA 1997 will not change materially throughout the periods covered by this private binding ruling.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 70-45

Income Tax Assessment Act 1997 subsection 70-50

Reasons for decision

Detailed reasoning

Trading stock is ordinarily valued in accordance with section 70-45 (1) of the ITAA 1997:

You must elect to value each item of trading stock on hand at the end of an income year at:

(a) its cost; or

(b) its market selling value; or

(c) its replacement value.

However, this is modified by the application of section 70-50 of the ITAA 1997:

You may elect to value an item of trading stock below all the values in section 70-45 if:

(a) that is warranted because of obsolescence or any other special circumstances relating to that item; and

(b) the value you elect is reasonable.

Special Circumstances

Paragraph 16 of Taxation Ruling TR 93/23 Income Tax: valuation of trading stock subject to obsolescence or other special circumstance (TR 93/23) states the following in respect of special circumstances:

16. While it is not possible to give a comprehensive definition of special circumstances, fact situations which we do consider to be special circumstances include:

….

(d) an unavoidable overstocking of spare parts to satisfy warranties and future service needs;

…

It is clear that XY Pty Ltd is required to maintain substantial stock of spare parts to satisfy warranties and future service needs. Based on the particular circumstances of XY Pty Ltd, there is an unavoidable requirement to overstock spare parts to ensure they are able to service their customers.

Therefore paragraph 70-50(a) of the ITAA 1997 is satisfied.

Reasonable

The question of whether the values provided are reasonable usually take into account industry circumstances, past indicators recorded by the company, external factors and changes in environment.

Paragraph 17 of TR 93/23 states:

17. Provided adequate documentation supporting the calculation is maintained, we accept any fair and reasonable value which is calculated taking into account the factors listed in paragraphs 31(2) (a)-(c). In addition, for the purposes of subsection 31(2)(d), the following factors may also be relevant, depending on a taxpayer's circumstances:

(a) the quantities of the stock on hand which, according to the operating and sales budgets, are expected to be used or sold during the year and in the future;

(b) the length of time since the last sale, exchange or use of an item of the stock;

(c) industry experience/taxpayer expertise in relation to the same kind or class of trading stock;

(d) the price at which the last sale of the stock was made, the price of the stock on the taxpayer's price list, and the price at which the taxpayer is prepared to sell the stock; and

(e) if the stock is spare parts:

(i) the past movements of the stock and the expected future movements of the stock, compared with the total number of units in existence which might require that stock; and

(ii) the approximate date by which the last of those units can be expected to have gone out of use

More broadly in relation to the reasonableness of the write-down paragraphs 21 and 22 of TR 93/23 states:

21. A standard write down for a particular kind or class of stock will only be accepted if a taxpayer can show that the particular kind or class of stock is always subject to special circumstances in the same degree. If previous models or versions of the stock have suffered differing degrees of special circumstances, a standard write-off will not be accepted. Therefore, as a general rule, the application of formulae based on predetermined criteria will not be appropriate in determining the amount of stock to be written down.

22. While it is acceptable to decide what stock was subject to special circumstances after the end of an income year, the circumstances that caused the stock to be subject to special circumstances must have occurred in the particular income year. Stock cannot be written down in anticipation that special circumstances will arise in the future.

The accounting policy of XY Pty Ltd seeks to align obsolescence write down (in circumstances where they are still required to hold the spare part) to actual obsolescence. Where a part has not been purchased or sold by XY Pty Ltd in a number of years it is written down to one percent of either average cost or purchase price.

The reasonableness of the rates used to determine the value by which the spare parts will be written off is strongly supported by the minimal level of variance from the international accounting policy applied by XY Pty Ltd.

The value of the write off resulting from the historical write down rates used for tax closely aligns to the vastly different methodology used for accounting purposes which is based on writing down almost all of the value after a period of 3 years in which that particular part had no movement.

Consequently, the rates proposed for the write down of the value of spare parts are reasonable and paragraph 70-50(b) of the ITAA 1997 is satisfied.