There are three aspects of trading stock that might contain a tax surprise: consignment stock, demonstration stock, obsolescent stock.

Consignment stock

Your business acquires its retail stock on consignment, ie the stock is not legally owned by your retail business but rather is owned by the manufacturer who provides the stock. The stock is delivered to you on an “on sale or return” basis. Do you need to take account of the stock for tax purposes?

Yes.

The generally accepted proposition is that goods are trading stock on hand where your business in a position to dispose of the goods. This is the case notwithstanding that they have not been physically delivered to your business premises or outlet. This is referred to as having “dispositive power”.

For income tax purposes, you’re taken to have dispositive power over stock notwithstanding that they do not have legal ownership of the stock under a consignment stock arrangement. Such arrangements typically have the following characteristics:

  • the stock on consignment is held among other trading stock until sold in the ordinary course of business
  • payment by the purchaser is not required for the stock until after its sale
  • the seller is notified of the sale and an invoice is issued, and
  • the seller has no control over the sale of the consignment stock once it is received by the purchaser.

The ATO has set out some general principles that apply to consignment stock, including:

  • Goods never become part of the trading stock of a consignee where stock on consignment refers to the delivery of goods to an agent for its sale on behalf of the consignor as principal. The goods remain the trading stock of the consignor (the manufacturer) with the consignee (the retailer) being paid commission for any sales made on behalf of the consignor.
  • A consignee is effectively committed to the ultimate purchase of the particular goods from the time of their delivery where goods are delivered to the consignee “on approval” or “on sale or return” and a sale to the consignee is contemplated.

The stock in this case is taken by your retail business on an “on sale or return” basis. As such, the stock delivered is taken to be “on hand” for tax purposes as the business is committed to the ultimate purchase of the goods.

As a result, your business can claim a deduction for the cost of the consignment stock delivered in the year.

Demonstration stock

You provide your products to prospective customers on a trial basis as demonstrators and also provide them as demonstrators to retailers throughout your store network. You retain ownership of the stock at the time that they are provided as demonstrators, and they are not placed on consignment. Do you need to take account of the stock for tax purposes?

Yes, probably.

The ATO confirms that, as a general rule, where stock is provided as demonstrators to prospective customers or to retailers for display purposes only, such stock is considered to remain on hand with the taxpayer at year end to the extent that:

  • the prospective purchasers are still yet to contractually agree to the purchase of the demonstrators, or
  • the retailers still hold them for display purposes only.

In contrast, stock will not be on hand at year end where the prospective purchasers have agreed to purchase the demonstrators or once the retailer has the power to sell it. This ordinarily arises from the wholesaler/manufacturer having entered into a contract of sale or consignment for the demonstrators and therefore no longer having the dispositive power.

Obsolescent stock

There are certain items within your stock which are simply not selling or have, in the case of fresh food, passed their expiration date. You intend to dump these items. How should they be value for trading stock purposes?

As a general rule, the closing value of trading stock for income tax purposes can be valued using one of 3 bases being either cost, market selling value or replacement value. Notwithstanding these 3 bases, the ATO has issued guidance for trading stock valuations where the stock has become obsolete or other special circumstances apply.

For stock to be obsolete, the ruling states that a taxpayer must be able to show that there is no reasonable prospect of future sales of the stock. In addition, the ruling states that a nil valuation for stock is acceptable if the stock is to be “dumped” or destroyed within a reasonable amount of time after the end of the income year in which it is written down (usually six months).