Supreme Court of Canada
Minister of National Revenue v. Shofar Investment
Corporation,  1 S.C.R. 350
The Minister of
National Revenue Appellant;
1979: January 29; 1979: October 2.
Present: Martland, Ritchie, Pigeon, Dickson
and Beetz JJ.
ON APPEAL FROM THE FEDERAL COURT OF APPEAL
Taxation—Income tax—Sale of land—Vendor not dealing at arm’s length—Computation of
profit—Income Tax Act, R.S.C. 1952, c. 148, s. 12(3).
In April 1959, the respondent (Shofar)
purchased a parcel of land from Lanber Investment Corporation (Lanber) at
$110,000 of which $1,000 was paid in cash and the balance in nine annual
instalments of $11,000 each. In June 1960, when there still was an unpaid
balance of $98,000 on the purchase price, Shofar sold the parcel of land for
$250,000. At the time of the purchase and at the time of the sale, Shofar was
not dealing at arm’s length with Lanber. The sole question for determination is
whether the difference between the cost price and the resale price ($140,000)
or, as contended by the Minister, the difference between moneys actually paid
on the purchase price and the sale price ($238,000) is profit. The Minister’s
assessment was sustained by the Trial Division of the Federal Court but
reversed by the Federal Court of Appeal, from which judgment the present appeal
to this Court is brought.
appeal should be dismissed.
The cost of an inventory item is not, in
itself, “an otherwise deductible outlay or expense” for the computation of a
taxpayer’s income, and so it is not within the provisions of s. 12(3) of
the Income Tax Act. The provisions of this subsection have
reference to unpaid amounts of expenses incurred for services, such as
salaries, rent and interest and do not apply to unpaid amounts for the purchase
Oryx Realty Corporation v. Minister of
National Revenue,  2 F.C. 44, applied.
APPEAL from a judgment of the Federal Court of Appeal
reversing a judgment of the Trial Division. Appeal
W. Lefebvre and Jacques Côté, for the
Philip F. Vineberg, Q.C., for the
The judgment of the Court was delivered by
MARTLAND J.—The question in issue in this appeal
is as to whether or not subs. (3) of s. 12 of the Income Tax Act, R.S.C.
1952, c. 148, has any application in the assessment of income tax payable by
the respondent (“Shofar”) in respect of Shofar’s 1960, 1961 and 1962 taxation
The facts are not in dispute, an agreed
statement of facts having been filed before trial. The agreed facts are as
Shofar was incorporated on June 11, 1958. On April 20, 1959, it purchased a parcel of land
from Lanber Investment Corporation. At the time of the purchase, Shofar was not
dealing at arm’s length with Lanber Investment Corporation.
The purchase price of the parcel of land was
$110,000 of which $1,000 was paid in cash and the balance of $109,000 was
payable in nine annual instalments of $ 11,000 each, with a final payment of
$10,000 due in 1970.
On June 15, 1960, Shofar sold the parcel of land
for $250,000, with a cash payment of $35,000 and payments due on June 15 each
year in varying amounts from 1961 to 1966. At the time of this sale, Shofar was
not dealing at arm’s length with Lanber Investment Corporation.
Shofar followed an accrual system of accounting
for tax purposes.
Subsection (3) of the Income Tax Act, in
effect at the time relevant in these proceedings, provided as follows:
12. (3) In computing a taxpayer’s income
for a taxation year, no deduction shall be made in respect of an otherwise
deductible outlay or expense payable by the taxpayer to a person with whom he
was not dealing at arm’s length if the amount thereof has not been paid before
the day one year after the end of the taxation year; but, if an amount that was
not deductible in computing the income of one taxation year by virtue of
this subsection was subsequently paid,
it may be deducted in computing the taxpayer’s income for the taxation year in
which it was paid.
There is no issue about taxability or otherwise
in respect of its gain on the sale of the parcel of land. The sole question for
determination is whether Shofar which bought the parcel of land at $110,000 and
resold it at $250,000 should proceed on the basis of calculating its income in
relationship thereto (subject to any other relevant deductions or reserves) at
$140,000, being the difference between the cost price and the resale, as
contended by Shofar, or at $238,000 gross profit as contended by the appellant
(“Minister”). The position taken by the Minister is that, applying subs. 12(3),
out of a total cost of $110,000 for the land, only the $1,000 paid in 1960 and
the $11,000 paid in 1961 should be allowed in the assessment for 1960 tax
purposes and the remaining $08,000 out of the total land cost should be
disallowed because it was payable to a person with whom Shofar was not dealing
at arm’s length and was not paid before the day one year after the end of the
An appeal by Shofar from the Minister’s
assessment was dismissed by the Tax Appeal Board, whose decision was sustained
on appeal to the Trial Division of the Federal Court. Shofar’s appeal from that
decision to the Federal Court of Appeal was allowed, from which judgment the
present appeal to this Court is brought.
The judgment of the Federal Court of Appeal was
“that section 12(3) of the Income Tax Act has no application in
respect of the cost of the land that was subject of the sale that gave rise to
the profit that is the subject matter of the assessment”.
This conclusion was obviously reached on the
basis of an earlier judgment of the Federal Court of Appeal in Oryx Realty
Corporation v. Minister of National Revenue.
The Oryx case had been tried at the same time and by the same judge
the Shofar case. The judgment of the majority in
the Oryx case was delivered by Chief Justice Jackett. Pratte J.
expressed no opinion on the point now in issue, but concurred in allowing the Oryx
appeal on a second ground, also adopted by the majority, which does not
arise in the present case.
The reasons of Chief Justice Jackett for
deciding that subs. 12(3) was not applicable in this case are contained in the
following passage from his judgment, commencing at p. 47:
What we are concerned with here is “gross
profit”. “The law is clear… that for income tax purposes gross profit, in the
case of a business which consists of acquiring property and re-selling it, is
the excess of price over cost…” (see M.N.R. v. Irwin,  S.C.R. 662,
per Abbott J., delivering the judgment of the Court, at pages 664-65). Gross
trading profit for a taxation year may be obtained by adding together the
profits of the various transactions completed in the year or by adding together
the prices at which sales were effected in the year and deducting the aggregate
of the costs of the various things sold. Either of such methods would be
suitable for a business consisting of relatively few transactions. In the
ordinary trading business, however, the practice, which has hardened into a
rule of law, is that profit for a year must be computed by deducting from the
aggregate “proceeds” of all sales the “cost of sales” computed by adding a
value placed on inventory at the beginning of the year to the cost of
acquisitions in the year and deducting a value placed on inventory at the end
of the year.
In considering what application
section 12(3) has, there can be no doubt that “gross profit” must be
computed before income can be determined and that, at least in the second
method of computing “gross profit” indicated above, the price for which the
property was bought is “deductible” in its computation. If, on the other hand,
the computation of “income” for a taxation year is thought of as commencing
with “gross profit” then the “cost” of the property bought is not an amount
that is “deductible” in its computation. When, moreover, one thinks of applying
section 12(3) to a trader whose transactions are so numerous or of such a
character as to dictate the use of the proceeds of sales less cost of sales
formula, then, in the “computation” of the “taxpayer’s income for a taxation
year” there is no deduction, at least as such, of the cost of the goods that
were sold in the year. Presumably, however, section 12(3) is to have the
same effect in relation to the
computation of a taxpayer’s income for a
year regardless of the method that has to be used to compute “gross profit”.
With considerable hesitation, I have come to the conclusion that
section 12(3) should be. interpreted, in the case of business income, as
referring to the computation of “income” or “profit” for a year from the “gross
profit” for the year; and was not, therefore, applicable in the circumstances
of this case. In reaching that conclusion, I am conscious that, in other
contexts, for more than a century the general statements in the leading cases
concerning business profits have treated the computation of profit as including
the computation of gross profit. What has brought me to the opposite conclusion
in the interpretation of section 12(3) is the necessity of giving such
meaning to that subsection as will operate with consistency in the
different circumstances to be encountered in the normal course of events.
I am in agreement with his conclusions.
of s. 12 is concerned
with an outlay or expense payable by a taxpayer to a person with whom the
taxpayer is not dealing at arm’s length, which would be “deductible” from his
income except for the application of the subsection. A payment to be made by a
trading corporation for an item of inventory is not, per se, deductible
from income. As Chief Justice Jackett points out, the practice “hardened into a
rule of law” 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.
The Act, in subss. (2) and (3) of s. 14,
contains mandatory provisions as to inventory valuation:
14. (2) For the purpose of computing
income, the property described in an inventory shall be valued at its cost to
the taxpayer or its fair market value, whichever is lower, or in such other
manner as may be permitted by regulation.
(3) Notwithstanding subsection (2),
for the purpose of computing income for a taxation year the property described
in an inventory at the commencement of the year shall be valued at the same
amount as the amount at which it was valued at the end of the immediately
preceding year for the purpose of computing
income for that preceding year.
The value of inventory, which is used in
determining profit, is determined on the basis of cost or fair market value,
whichever is lower, or in such other manner as may be permitted by regulation.
By virtue of subs. 14(2), therefore, the cost of an inventory item is a factor
which has relevance in determining inventory value. To that extent it can
affect the ascertainment of the gross profit of the business, but it is not, in
itself, deductible from the taxpayer’s income. It is not, in itself, a
“deductible outlay or expense” and is not within the provisions of subs. 12(3).
The standard accounting approach is illustrated
in Gilmour Income Tax Handbook 1967-1968 at pp. 205-208 (and
corresponding provisions in earlier volumes). As stated at p. 207 in
commenting on subs. 12(3):
It would seem that the provisions of this
Section can have reference only to unpaid amounts of expenses incurred for
services, such as salaries, rents, interest and the like, and can have no
application to unpaid amounts arising out of the purchase of assets, whether
these be assets such as stock-in-trade, whose cost is eventually absorbed
against income on resale, or depreciable assets whose cost is absorbed against
income by capital cost allowances.
The provisions of this Section only apply
“whether an amount in respect of a deductible outlay or expense that was owing
by a taxpayer… is unpaid at the end of that second year”. The word “outlay”
normally refers to an amount which is laid out or which is paid, and it is
difficult to conceive of an unpaid outlay. Accordingly, it appears that the
Section applies only to an unpaid expense and few accountants would concede
that the cost price of an asset, such as inventory, can be applied against
revenues until the asset has been resold in normal trading operations.
I am in agreement with this approach to the
application of subs. 12(3).
I would dismiss the appeal with costs.
Appeal dismissed with costs.
Solicitor for the appellant: Roger Tassé,
Solicitors for the respondent: Phillips
& Vine-berg, Montreal.