Accounting Principles

Two Ontario partnerships of which the taxpayers were members paid for research to be carried out on their behalf by a Brazilian research corporation, in part, by issuing notes to the research corporation denominated in Brazilian currency and payable in annual installments commencing seven years hence.

The amount of the expenditures made by the partnerships should be determined, in light of generally accepted accounting principles on the basis of substantially discounting the value of the notes given that the interest rates borne by the notes were substantially lower than prevailing Brazilian interest rates (which, in turn, reflected high rates of inflation).

Before going on to affirm the deductibility under s. 20(1)(l) of an allowance for doubtful accounts which the taxpayer had taken for tax and financial statement purposes, Reed J. stated (p. 5297):

"... in determining a reserve for doubtful debts, the principal factors that are used for the preparation line.gifl statements, as governed by the generally accepted accounting principles approved by the Canadian Institute of Chartered Accountants, are applicable, unless: (1) the Income Tax Act expressly requires otherwise or (2) the Income Tax Act implicitly requires otherwise."

Because it was a question of law whether the taxpayer's obligation to effectively repay special charges which it had made to shippers in certain events was a liability, the evidence of experts on this issue was not conclusive.

Considerable weight was given to accounting evidence, to the effect that a stock of spare parts constituted fixed assets for accounting purposes rather than inventory, in determining that such parts constituted capital property for income tax purposes.

Expert accounting evidence was found to be relevant to the application of s. 20(1)(e).

After citing the Metropolitan Properties case for the proposition that GAAP "should normally be applied in tax cases unless of course there is a clear departure from them under income tax rules" (p. 6295), Joyal J. went on to note, with respect to considering whether an expenditure was made by the taxpayer on capital account, that the accounting treatment of the expenditures (which generally was to capitalize them) was not determinative of the issue before him.

Before finding that the deduction of cargo claims was prohibited by s. 18(1)(e), Cullen J. stated (p. 6338) that "the case law is clear on the point that the fact of acceptability in accounting does not in itself make the expenditure in question a proper deduction for tax purposes".

Jerome A.C.J. indicated (at p. 5375) that he had no reason to depart from the treatment of an expenditure accorded to it in the taxpayer's financial statements, which was to treat the expenditure as part of the capital cost of an extension to the taxpayer's hotel (which was a capital property).

Accounting principles for depreciable assets were found to have no particular relevance to the determination of the effect of reimbursements received by a taxpayer on the cost of his assets for tax purposes.

An obligation of the taxpayer to make future repairs pursuant to maintenance agreements was found to be a contingent liability notwithstanding accounting evidence to the contrary.

Before finding that both ss.20(1)(c) and 12(1)(c) "require accounting in conformity with ordinary commercial practices and/or generally accepted accounting principles" (p. 6188) Reed J. stated (p. 6186): "A distinction must be made between a requirement that income for tax purposes be accounted for generally in conformity with accounting principles and a requirement that the taxpayer's treatment of his financial statements and his tax returns be identical."

In refusing to follow accounting evidence that a deduction for a future lease pick-up payment in the amount of $500,000 was a fixed liability instead of a contingent liability, Heald J. stated (p. 5214):

"The fact of the acceptability in accounting practice of dealing with a particular item in a particular manner, cannot, by itself, make that practice a proper deduction for income tax purposes. Notwithstanding the evidence of accounting practice, the fact remains that, on the facts here present, the deduction is prohibited by subsection 12(1)(e) of the Act."

Addy J. found that the financial statements of a film promoter which had sold a film to a limited partnership failed to reflect reality and economics substance in showing the unpaid purchase price for the film as a debt owing to it.

Before going on to prefer the taxpayer's method (a formula developed by its accountants) for allocating income of a cross-border railway venture between Canada and the U.S. to that of the Minister, Dubé J. stated (at p. 5178):

"Where the Income Tax Act does not provide a particular system of accounting, the validity of a formula depends on whether or not it tells the truth about the taxpayer's income."

Before finding that the deduction of sales tax liabilities of the taxpayer was not prohibited by s. 12(1)(e) of the pre-1972 Act, Kearney J. stated (p. 1006):

"I think [the auditor's] evidence establishes that the appellant by showing the sales tax in its books of account as an ordinary liability was conforming to usual commercial and good accounting practice, and such practice must prevail unless there are statutory provisions to the contrary."

Before finding that scientific research expenditures of the taxpayer were non-deductible capital expenditures notwithstanding that they were deducted currently for financial statement purposes, Cattanach J. stated (p. 5348):

"It is quite understandable that a commercial enterprise in its books of account for its own purposes will treat certain classes of expenditures as revenue expenditures which are, in reality, for income tax purposes capital expenditures and conversely many items treated in the accounts of business as capital receipts are for income tax purposes taxable as income."

Evidence as to accounting practice could not prevail over the prohibition in s. 12(1)(b) of the pre-1972 Act against the deduction expenditures.