SARS increases its focus on inventory and cost of sales
SARS increases its focus on inventory and cost of sales
By Zandi Setai, Junior Consultant
The financial statement items inventory and cost of sales are moving higher up SARS's verification agenda. With more data-led reviews and enhanced analytics, inconsistencies between annual financial statements, ITR14 disclosures, inventory balances and cost of sales claims are more likely to attract attention.
This is not just a tax compliance detail: it is a governance and audit-readiness issue. SARS expects businesses to be able to substantiate the numbers reported, including by providing stock reconciliations, inventory schedules, costing calculations and supporting documentation for amounts included in inventory and cost of sales.
A recurring trigger is a mismatch in the ITR14: closing stock is often disclosed in the balance sheet section with no corresponding closing stock amount in the gross profit or loss section. This often occurs where cost of sales is disclosed as a single line item, without separately reflecting opening stock, purchases and closing stock.
The risk is broader than disclosure. SARS may also test whether amounts claimed as cost of sales are genuinely deductible, correctly classified and directly linked to the goods sold during the relevant year of assessment. Cost of sales should never become a catch-all category for expenses that are difficult to classify or support. Where a business cannot provide clear inventory schedules, reconciliations and supporting source documentation, SARS may question the composition of the deduction and, where appropriate, disallow amounts that cannot be adequately substantiated.
In addition, stock write-downs should be reviewed to ensure compliance with SARS Interpretation Note 140, which provides guidance on the write down in the value of closing stock under section 22(1)(a) of the Income Tax Act. A write-down is only permissible where the value of trading stock has diminished below cost price because of damage, deterioration, change of fashion, decrease in market value, or another reason satisfactory to the Commissioner.
The write-down may be determined on an item-by-item basis, or an appropriate category of trading stock may be used where justified. The fact that other items of trading stock have increased in value does not prevent a write-down in stock that has diminished in value for one of the prescribed reasons. The taxpayer should be able to substantiate the write-down with reference to the specific facts and circumstances, supported by objective evidence demonstrating that cost is no longer an appropriate measure of the inventory's value.
Where trading stock is valued below cost price, the taxpayer must disclose this fact in the relevant tax return. This disclosure is important because the amount by which closing stock may be written down under section 22(1)(a) is subject to the Commissioner's discretion. The Commissioner can only exercise this discretion if made aware of the actual write-down and the basis on which it has been determined.
In addition, taxpayers should be prepared to provide supporting information when submitting their returns, including:
Details of the basis on which trading stock has been valued.
Where trading stock has been valued below cost, the reasons for the write-down and the methodology applied in determining the reduced value.
- Where stock has been written off using a fixed, variable, or any other basis that does not reflect the actual diminution in value, a reasonable justification for the approach adopted.
- SARS may also request supporting documentation to substantiate both the write-down and the information disclosed in the return.
- The practical consequences of inadequate inventory records, unsupported write-downs, or incorrectly classified cost of sales values may include avoidable SARS queries, delays in the assessment process, increased administrative burden, and potential exposure to assessments, penalties, and interest.
What finance teams should do:
- Reconcile inventory balances reflected in the annual financial statements to the corresponding ITR14 disclosures.
- Ensure that opening stock, purchases, and closing stock are separately identifiable, where relevant.
- Retain inventory schedules, valuation support, and costing calculations to substantiate reported amounts in the event of a SARS query.
- Review cost of sales to confirm that only qualifying inventory-related costs have been included.
- Assess stock write-downs against the requirements of section 22(1)(a) and SARS Interpretation Note 140, ensuring that sufficient supporting evidence is retained and all relevant disclosures are made in the tax return.
Bottom line: Inventory and cost of sales reporting should be accurate, consistent, and fully supportable. Taxpayers should maintain sufficient documentation to demonstrate the link between inventory held, costs incurred, and goods sold during the year of assessment, as well as the basis for any stock write-downs. Businesses that can clearly substantiate these amounts and comply with the relevant disclosure requirements will be better positioned to withstand SARS scrutiny and support the deductions claimed.