Development of court practice on tax accounting of inventory shortages

On 19 May 2017 the Arbitration Court of the Moscow Region rendered a decision in case No. А41-69837/2016 under the claim of KVINTMADI Closed Joint Stock Company (the “Company”).
Among the issues considered in this case were the tax implications of writing off inventory shortages.
As follows from the decision, the Company did an inventory of a spare parts warehouse. At the end of the inventory the Company discovered both inventory overages and shortages. These facts were recorded in stock variance reports. It was not possible to determine the cause of the discrepancies because, due to their job descriptions, all of the Company’s employees had access to the warehouse and received and issued goods. The Company did not recognize those shortages as expenses for profit tax purposes. The Company also did not charge VAT thereon.
In the opinion of the competent tax authority (the “Inspectorate”), disposal of assets (shortage) is a realization of goods without consideration. Therefore, the Inspectorate charged the Company VAT and late payment interest.
In light of the clarifications in paragraph 10 of Russian Supreme Arbitration Court Resolution No. 33 on Certain Issues Arising When the Arbitration Courts Consider Cases Related To Charging Value Added Tax of 30 May 2014, the court disagreed with the Inspectorate’s position and found its decision with regard to charging VAT on the inventory shortages to be illegal, stating the following:

  • The Company had properly recorded shortages on the basis of stock variance reports as specified in the order of the Company’s director issued in accordance with the law.
  • The Inspectorate had not established that the information in the stock variance reports was inaccurate, failed to submit proper proof to the case file that the Company had realized the written-off products to third parties or that the information stated in the documents submitted by the Company to confirm disposal of the assets without them being transferred to third parties was inaccurate.
  • The Inspectorate had not furnished proof of the existence of an agreement for realization of written off spare parts without consideration, or proof that the Company intended to transfer it to third parties.
  • Considering the nature of the business and the Company’s explanation that all employees actually had access to the warehouse, the court found that shortages and overages are usual for that type of business and, therefore, did not have doubts that the assets had been disposed of against the Company’s will.
  • The inventory results had been documented and the fact that the discovered shortages had been written off without contacting the law enforcement authorities evidences that guilty parties cannot be identified, and not that there is no documented proof that the spare parts were disposed of.

It should be noted that the court also stated separately that the Company did not have to reinstate input VAT (evidently having in mind the VAT deducted at the time of purchase of the goods for which shortages were discovered during inventory).
Although the taxpayer was able to successfully defend itself in court in this case, the issue of how to account for stock loss (spoilage and shortages) continues to raise many questions in practice. For this reason reflecting stock loss in tax accounting requires careful analysis of the specific circumstances and drafting of documents to record the disposal of assets.
The lawyers of Dentons’ Tax practice have considerable experience advising major retailers and other companies in the FMCG sector and representing them in tax disputes. Our lawyers are proficient in a wide range of matters: from structuring a business (asset acquisition, real estate ownership, intellectual property management, arranging financing, and structuring commodity flows) to specific tax aspects of operations (investing in retail space, tracking stock loss (spoilage and shortages), disposing of spoiled goods, writing off retail furniture and equipment, customer loyalty programs, advertising, promotional events, merchandise display and joint product promotion, bonuses, premiums and discounts from product suppliers, and many other operations). We would be happy to provide you with comprehensive support both at the stage of developing and implementing a strategy on these issues, and as soon as a tax dispute arises.

Valentin Larin

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Anna Knelz

Anna Knelz