Private ruling: Trading stock
Date of advice: 9 February 2022
Published: May 2022

Ruling: Q1: Can Company A elect to value its spare parts (which are 'trading stock' as defined in section 70-10 of the Income Tax Assessment Act 1997 ( ITAA 1997 )) under section 70-50 of the ITAA 1997 due to obsolescence or special circumstances where the values elected are reasonable for the purposes of paragraph 70-50(b) of the ITAA 1997? | A1: Yes.

Relevant facts and circumstances: Company A supplies machines to customers within the Australia and Xxxxx regions and has limited manufacturing operations. Company A provides ongoing maintenance and repair services for machines sold to its customers and offers various warranties for its machines. Additionally, Company A enters into contracts pursuant to which Company A is obligated to supply spare parts to customers in a timely manner beyond any warranty period. Company A's customers typically maintain their machines with original parts purchased from Company A beyond any warranty period. Company A maintains a significant stock of spare parts on hand to ensure that it is able to fulfil its warranty obligations in a timely fashion, and to ensure more generally that it is able to provide spare parts to its customers on demand to fulfill any repair and maintenance requests that may arise. Company A sources the majority of its spare parts from overseas suppliers. Lead times for ordering spare parts from overseas production facilities are significant, and as a result Company A must carry a significant stock of spare parts in its stores in Australia in advance of any repair or maintenance obligations arising. Company A's customers place a premium on suppliers being able to provide spare parts at short notice. Company A therefore overstocks spare parts to remain competitive and to comply with its contractual obligations. Updated machine models are typically released by Customer A every X years. The average design life of the machines Company A sells is Y years. Whilst the release of a new machine model reduces the demand for spare parts for the superseded model, it does not alter Company A's contractual obligations and commercial requirement to hold sufficient spare parts on hand to meet any potential customer demand. This is because Company A's customers may seek to use and maintain their machines up to and beyond the design life of the relevant model and regardless of whether the relevant machine has been superseded by the release of a new model. Company A does not know with precision which specific parts for superseded models beyond design life (that are still being used by customers) are likely to be required. Company A's planning systems allow it to plan its stock holdings for current machine models with regular demand for spare parts. However, the planning system cannot accurately forecast demand for spare parts for superseded machine models where the number of active machines is trailing out. Company A continually assesses the requirement to hold spare parts and makes decisions to progressively scrap stock where deemed appropriate. Certain excess parts are generally sold for scrap for minimal proceeds, while other parts may require Company A to pay an amount in order to have them scrapped. Where a customer calls for a spare part, whether the part is for a current machine model, a superseded model and/or a model beyond the machine design life, the part is generally sold at retail price. Based on its industry experience, and having regard to historical data regarding the movement, sale and scrapping of its spare parts, Company A has determined that a significant portion of the stock of spare parts it maintains on hand will not be used for many years, or will ultimately never be called upon for use and will be scrapped.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 70-50

Reasons for decision: Summary: Section 70-50 of the ITAA 1997 states: You may elect to value an item of your *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. 'Trading stock' (as defined in section 70-10 of the ITAA 1997) is ordinarily valued in accordance with subsection 70-45(1) of the ITAA 1997, which states: 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. The operation of subsection 70-45(1) of the ITAA 1997 may be modified by section 70-50 of the ITAA 1997 in certain circumstances. | Detailed Reasoning - Obsolescence or any other special circumstances: Taxation Ruling TR 93/23 Income Tax: valuation of trading stock subject to obsolescence or other special circumstances ( TR 93/23 ) outlines the Commissioner's views in relation to former subsection 31(2) of the Income Tax Assessment Act 1936 , which was rewritten as section 70-50 of the ITAA 1997. TR 93/23 continues to have effect with respect to section 70-50 of the ITAA 1997 (see paragraph 32 of Taxation Ruling TR 2006/10 Public Rulings ). With respect to the meaning of 'obsolescence', paragraph 4 of TR 93/23 states: 4. In the context of subsection 31(2), 'obsolescence' refers to stock which is either: (a) going out of use, going out of date, becoming unfashionable or becoming outmoded (i.e. becoming obsolete); or (b) out of use, out of date, unfashionable or outmoded (obsolete stock). Paragraph 5(f) of TR 93/23 provides that spare parts may be stock in the process of becoming obsolete. With respect to the meaning of 'special circumstances', paragraphs 15 - 16 of TR 93/23 state: 15. For the purposes of subsection 31(2), special circumstances exist if: (a) stock becomes less marketable or useable in manufacture because of changed circumstances which relate to the stock; and (b) a true reflection of a taxpayer's taxable income for an income year will not be achieved if stock on hand at the end of that year is valued under subsection 31(1). 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... Having regard to the Relevant facts and circumstances , Company A may elect to value its spare parts (which are 'trading stock' as defined in section 70-10 of the ITAA 1997) under section 70-50 of the ITAA 1997 due to obsolescence or special circumstances where the values elected are reasonable for the purposes of paragraph 70-50(b) of the ITAA 1997.