Deductions
Trading stock
Trading stock is anything a business produces, manufactures or buys to sell, including partly finished goods and raw materials, and it has special income tax rules at the end of each year.
Trading stock includes items you hold for sale or exchange in the ordinary course of business, as well as things you are producing or manufacturing for sale, such as raw materials and work in progress. A retailer's shelves, a builder's materials held for sale and a farmer's livestock held for sale or breeding commonly fall into this category. Items you use to run the business, such as a shop counter, are not trading stock; they may be depreciating assets instead.
The tax rules for trading stock work by comparing the value of stock at the start and end of the income year. If the value at the end of the year is higher than at the start, the increase is generally included in assessable income. If it is lower, the decrease is generally deductible. This means the cost of stock effectively becomes a deduction only to the extent that stock has been sold or otherwise used up during the year.
At the end of each income year you must value each item of stock using one of three permitted methods. These are cost, market selling value, or replacement value. You can generally choose a different method for different items, and the choice is typically made each year. Obsolete stock can also be valued at a lower amount in certain circumstances, which needs to be supported by evidence.
Small businesses benefit from a simplification. If the difference between your opening and closing stock is below a threshold set by the ATO, and you can reasonably estimate it, you may choose not to do a full stocktake and count your stock. The threshold is a fixed legislated figure and should be checked on ato.gov.au. This simplification does not remove the need to account for stock properly in your records.
GST works separately from this valuation. A business registered for GST can generally claim a credit on stock bought for resale at the time of the purchase, in the BAS for the period of the tax invoice, regardless of whether the stock has yet been sold. The GST charged to customers on sale is then reported in the BAS for that period. Stock purchases are reported as non-capital purchases at G11.
Common mistakes include not recording stock taken home for private use, miscounting at year end, and mixing up trading stock with business equipment. Stock you take for your own personal use is generally treated as having been sold at market value, and GST adjustments may apply. This is general information only, so confirm your situation with the ATO or a registered tax professional.
Worked example
A registered gift shop starts the year with stock valued at $20,000 and ends with stock valued at $26,000, both at cost. The $6,000 increase is added to assessable income. During the year it bought $60,000 of stock, plus GST of $6,000. The GST credits were claimed progressively on its BAS, and the cost of stock sold is effectively $60,000 - $6,000 = $54,000 deducted through the stock calculation.
Practical tips
- Take a proper stocktake at year end unless you qualify for the small business simplification, and keep the count sheets.
- Record stock you take for private use, because it is not a business expense and may need a GST adjustment.
- Value obsolete stock only at a reduced figure if you have evidence supporting why.