Section 10

The taxpayers, which carried on consulting businesses, computed their income for financial statement purposes by valuing the work in progress at the end of each year at fair market value (i.e., including a portion of the profit on uncompleted consulting contracts based on a percentage-of-completion method). The trial judge (2008 TCC 106) found that they were required to follow the same method for purposes of computing their income under the Act, given that a different conclusion would have made section 34 of the Act, which permitted certain professions to exclude income in respect of work in progress in computing their income, meaningless.

The Court of Appeal disagreed. Noël J.A. stated at para. 33 that s. 10(1), which requires that inventory be valued at the lesser of cost or fair market value, overrides any GAAP considerations. Noël J.A. also stated at para. 35:

With respect, it is incorrect to say that section 10 applies whenever section 34 applies. These two provisions operate differently. Taxpayers subject to section 10 must account for the value of their inventoried work in progress based on cost or FMV, depending on the circumstances; however, section 34 gives taxpayers the choice of excluding their inventoried work in progress in computing their income, in which case, section 10 does not apply.

The taxpayer, who along with others held an interest in an undeveloped real estate property as an adventure or concern in the nature of trade, was able to deduct an unrealized decline in the value of his share of the property in computing his income. Among other arguments, Major J. rejected a contention that s. 10(1) applies only to those who "carry on a business", and that s. 10(1) was merely a codification of the common law practice with respect to the valuation of inventories at the lower of their cost or fair market value, a practice which was restricted in its scope to "stock-in-traders". Although it was not necessary to resort to the object and purpose of the provision, the above interpretation was consistent with an objective of restricting trading in pregnant losses (as reflected in a subsequent amendment to Regulation 1801).

In commenting on the Anaconda case, Reed J. stated (p. 5298):

"... I think it is well known that the reasoning of the Privy Council in overruling both the Exchequer Court and the Supreme Court of Canada has been widely criticized ... As I understand it, most commentators have been of the view that the choice of LIFO (last in first out) as a method of inventory costing is not in conflict with the purpose of the Income Tax Act providing that method is used consistently over the years by the taxpayer."

The taxpayer acquired a residence and condominium from his son in order to secure a loan which he previously had made to his son, rather than in connection with an adventure in the nature of trade. Accordingly, although a property which is held in connection with an adventure in the nature of trade may be written down in accordance with the lower of cost and market rule in this case because the properties were not inventory, the taxpayer was precluded from taking such a deduction.

The taxpayer, which had a calendar year-end, generally computed its income for accounting and income tax purposes using the lower of cost and market method. For purposes of computing its income from a new mine for the three year period ending 31 January 1973 it initially valued its closing inventory at cost, but later, after reassessment, filed on the basis that its closing inventory should be valued at market, thereby increasing the amount of the exemption which the taxpayer claimed pursuant to former s. 83(5), which provided that "there shall not be included in computing the income of a corporation income derived from the operation of a mine during the period of 36 months commencing with the day in which the mine came into production."

Hugessen J.A. (with whom Pratte J.A. concurred) allowed the Crown's appeal simply on the ground that the words in s. 83(5) "can only mean that the income derived from the operation of the mine must be computed on the same basis as the income from which it is to be deducted." Urie J.A., in addition to allowing the appeal on essentially this basis found, in light of an admission that departing from the taxpayer's previous practice of valuing inventory in accordance with the lower of cost and market method was contrary to GAAP, that in order for the taxpayer's income for the 36-month exempt period not to be computed on a "distorted" basis, the consistency principle should be followed, i.e., the lower of cost and market method which was used for the taxpayer's calendar years should be utilized.

Late-payment charges which were in respect of inventory purchases and whose deduction was denied by s. 18(4) were not permitted to be added to the cost of the inventory. "Generally accepted accounting principles cannot ... be invoked as authorizing the capitalization of interest payments the deduction of which is expressly prohibited by the statute."

Amounts expended by a developer in installing sewers, water mains, street lights, paved roads and sidewalks, telephone and electrical services and other municipal improvements respecting a residential subdivision prior to deeding such improvements to the municipality, were treated as part of the cost of the developer's inventory of remaining land in its financial statements in accordance with GAAP. Since there was no specific provision in the Act requiring a departure from GAAP in this case, the expenditures also formed part of the cost of the developer's land inventory for purposes of the Act.

Although "it may be that shares held by a company which is in the business of buying and selling shares can be regarded as inventory" the shares in question here had been acquired instead as an investment - the intent of the taxpayer in acquiring the shares was to make available to the issuing corporation a substantial amount of long-term equity capital.

It was held that "the cost of landscaping around dwelling houses constructed for sale in the course of business is clearly a part of the cost of what is to be sold and is thus properly included in the cost of inventory on hand at the end of a fiscal period".

S.10(1) appears to have been interpreted as requiring that all the inventory be valued at cost or all the inventory be valued at fair market value. The plaintiff's calculation of opening inventory, which valued new stock at cost and obsolete inventory at a discount from cost (representing fair market value), accordingly was rejected.

Closing inventory was valued by applying an historical gross margin percentage to its retail (price tag) value. Since closing inventory thus was valued at cost, and since "'the preferred treatment under generally accepted accounting principles is that the opening and the closing inventories for a particular year be valued on a consistent basis'", it was held that the opening inventory also should be valued at cost.

The practice required by the Act "in the computation of the profit of a trading business is to deduct from the aggregate proceeds of all sales the cost of sales computed by adding the value placed on inventory at the beginning of the year to the cost of acquisitions to inventory during the year, less the value of inventory at the end of the year."

For financial statement purposes, the taxpayer, whose business was the processing of silver, used a perpetual inventory costing system under which inventory was carried at the same cost as at the previous year-end or, in the case of net additions to inventory, at the lowest cost at which purchases were made in the year. Cost of sales was determined using replacement cost, except when the base stock of inventory was depleted.

The adoption of this method by the taxpayer for income tax purposes was held to be inappropriate. Heald, J. accepted the position of the Crown's expert that under perpetual costing systems, either average cost or specific costs should be used. In addition, Heald, J. characterized the taxpayer's method as disregarding the known physical facts.

A mining stock promoter acquired treasury shares of a junior mining company and while he was selling as many shares as he could on The Toronto Stock Exchange also bought substantial quantities of the shares in order "to maintain the market". At the end of his fiscal year (May 31, 1955) his shares had an average cost of 34.1¢ and a market quotation of 67¢.

With respect to determining the fair market value of the shares, Pigeon J. found that "the trial judge was fully justified in holding that there was no evidence that a reasonable program of disposition of the inventory would have brought the market price below cost" (p. 5157). With respect to the cost of the shares, a proposal to specifically identify the shares remaining in the promoter's inventory by an examination of the serial numbers on the certificates ignored the fungibility of shares at law, and there was no convincing evidence that the Fifo method was used to any extent by persons in a situation similar to the promoter's or that this basis of determining cost was "closer to reality" than the average cost basis underlying the reassessment of the Minister. The cost-recovery method also was rejected.

Abbott J. indicated, in obiter dicta that he doubted whether the combined effect of s. 14 of the pre-1972 Act and Regulation 1800 made any change to the principle that for income tax purposes gross profit, in the case of a business which consists of acquiring property and reselling it, is the excess of the sale price over costs, subject only to modification by the lower of cost and market rule, and that he was doubtful that such provisions were applicable in the circumstances of a case (such as that a bar) where the actual cost and sale price of each particular piece of property were well-established.

The taxpayer, which for corporate purposes had been using the F.I.F.O. method for determining the cost of its sales of manufactured metals and its closing inventories, in 1946 and 1947 switched to the L.I.F.O. method for income tax purposes. The Minister reassessed on the basis that its taxable income for its 1947 year should be determined on the basis of applying the F.I.F.O. method.

Viscount Simonds effectively affirmed the Minister's reassessment in the absence of evidence that the L.I.F.O. method more closely approximated the actual pattern of physical usage of purchased metals by the taxpayer than the F.I.F.O. method (p. 1225):

"There is no room for theories as to flow of costs: nor is it legitimate to regard the closing inventory as an unabsorbed residue of cost rather than as a concrete stock of metals awaiting the day of process. It is in their Lordships' opinion the failure to observe, or, perhaps it should be said, the deliberate disregard of, facts which can be ascertained and must have their proper weight ascribed to them, which vitiates the application of the L.I.F.O. method to the present case. It is the same consideration which makes it clear that the evidence of expert witnesses, that the L.I.F.O. method is a generally acceptable, and in this case the most appropriate, method of accountancy, is not conclusive of the question that the Court has to decide."

S.10(2) "deals with the valuation of inventory, not whether inventory exists or not." S.10(2) accordingly does not indicate "that a taxpayer cannot have opening inventory for the purposes of subsection 20(1)(gg) if it does not have closing inventory for the previous year."

The taxpayer corporation, whose taxation years ended on December 31, benefited from an exemption for new mines which applied, in its case, to the three-year period ending on January 31, 1973. The taxpayer corporation in 1977 retroactively changed the basis of valuation of the inventory which it held on January 31, 1973 from cost to market. Collier, J. held : "The change to a market value basis of valuing closing inventory at January 31, 1973, while it involves a departure from the accounting principle of consistency, is a departure permitted by the statute."

In 1968, the taxpayer company ceased to add back to its income for tax purposes the full amount of depreciation and depletion recorded in its books, but instead excluded from the amount of the "add-back" the amount of depreciation and depletion (namely, $1.3 million) included in the cost of its closing inventory for financial statement purposes - on the ground that the deduction of the $1.3 million was not prohibited by s. 18(1)(b) until 1969, when the inventory goods were sold. The court accepted the taxpayer's expert evidence that the net effect of adding the amount of depreciation included in opening inventory for 1968 to 1968 income would have the effect of subjecting the same amount to double taxation, and accordingly excluded that opening amount from 1968 income.

A s. 10(3) direction must be made prior to the assessment giving effect to it. A direction made 3 days before trial accordingly was a nullity.

The taxpayer kept a stock of spare parts at a facility for the production of gaseous oxygen and nitrogen, and a cryogenic facility for the production of liquid hydrogen. The parts were kept on hand because of the extensive lead times for obtaining replacement parts, and many of the parts would not be used before the expiration of the useful lives of the associated facilities.

McNair, J. held that the spare parts were capital property rather than inventory in light of accounting evidence that the parts should be regarded as part of the corporation's fixed assets rather than inventory, and in light of the fact that the stock of spares was not held for prospective immediate use but instead represented an asset to be used in the future in carrying on the income-earning enterprise of the taxpayer.