Date: 20081215
Dockets: A-122-08
A-123-08
A-121-08
Citation: 2008 FCA 400
CORAM: DÉCARY
J.A.
LÉTOURNEAU
J.A.
NOËL J.A.
A-122-08
BETWEEN:
CDSL CANADA LIMITED
Appellant
and
HER MAJESTY
THE QUEEN
Respondent
-----------------------------------------------------------------
A-123-08
BETWEEN:
GROUPE CGI INC. / CGI GROUP
INC.
Appellant
and
HER MAJESTY
THE QUEEN
Respondent
-----------------------------------------------------------------
A-121-08
BETWEEN:
CGI INFORMATION SYSTEMS AND
MANAGEMENT CONSULTANTS INC.
Appellant
and
HER MAJESTY
THE QUEEN
Respondent
REASONS FOR JUDGMENT
NOËL J.A.
[1]
These
are three appeals from decisions of Associate Chief Justice Rip of the Tax
Court of Canada (TCC), as he then was (TCC judge), confirming, following a
common hearing and based on a single set of reasons, the assessments made by
the Minister of National Revenue (Minister) under the Income Tax Act,
R.S.C. 1985, c. 1, (5th Supp.) (Act) regarding the three
appellants.
[2]
In
issue are the following: in the case of the appellant CDSL Canada Limited
(CDSL), the assessment made for its 1998 taxation year; in the case of the
appellant Groupe CGI Inc./CGI Group Inc. (CGI), the assessment made for its
1998 taxation year and the determination of losses for its 1999 taxation year;
in the case of the appellant CGI Information Systems and Management Consultants
Inc. (Systems), the assessments made for its 1998 and 1999 taxation years.
[3]
The
issue to be determined in each of the appeals is the same: does the Act, and
more specifically subsection 10(l), authorize the appellants to compute
their income in a manner that is inconsistent with Generally Accepted Accounting Principles (GAAP). The
TCC judge answered this question in the negative and dismissed the three
appeals with costs, which led to the three appeals before this Court.
BACKGROUND
[4]
The
facts are set out in an agreement that is reproduced in its entirety in the
reasons for judgment of the TCC judge. I will merely make a brief summary in
the following paragraphs, but before doing so, I find it would be appropriate
to reproduce subsection 10(1) of the Act:
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10. (1) For the purpose of computing a
taxpayer's income for a taxation year from a business that is not an
adventure or concern in the nature of trade, property described in an
inventory shall be valued at the end of the year at the cost at which the
taxpayer acquired the property or its fair market value at the end of the
year, whichever is lower, or in a prescribed manner.
|
10. (1) Pour le calcul du revenu d'un
contribuable pour une année d'imposition tiré d'une entreprise qui n'est pas
un projet comportant un risque ou une affaire de caractère commercial, les
biens figurant à l'inventaire sont évalués à la fin de l'année soit à leur
coût d'acquisition pour le contribuable ou, si elle est inférieure, à leur
juste valeur marchande à la fin de l'année, soit selon les modalités
réglementaires.
|
[Emphasis
added.]
[5]
The
appellants are companies that provide consulting services in the field of
computer technology. Each carries on a business in the true meaning of the
word. For accounting purposes, the appellants accounted for their work in
progress on a fiscal-year basis, which takes into account the portion of the
profit for work completed but not yet billed. The method, known as the
percentage-of-completion method and which accounts for the results of long-term
contracts based on the progress of the work, is consistent with GAAP (agreement,
paragraph e.).
[6]
The
parties agree that work in progress for services still being provided is
inventory subject to subsection 10(1) and that, in accordance with that
subsection, that work in progress must be valued at the lower of cost or fair
market value (FMV). To calculate their income for tax purposes, the appellants
valued their work in progress based on the cost, which was lower than the FMV
(agreement, paragraph i.).
[7]
No
expert evidence was filed in the TCC, the parties having agreed that the issue
was limited to determining whether section 9 and the GAAP that it incorporates
override section 10 (A.B., page 82 (A-121-08); page 57
(A-122-08); page 95 (A-123-08)). Instead of reporting their income on the
basis of earned income, as required by GAAP, they instead chose to be taxed on
the basis of their billed income. The appellants concede that their method does
not provide an accurate picture of their income.
[8]
According
to the agreement on facts, for its taxation years ending on
September 30, 1998, and September 30, 1999, Systems determined that
the cost of its inventoried work in progress was $7,234,328 and $11,819,377
respectively, whereas the FMV of this inventory was of $11,859,554 and
$19,376,028 on the same dates (agreement, paragraphs b. and f.). Similarly, for
its taxation years ending on September 30, 1998, and September 30, 1999, CGI
determined that the cost of its inventoried work in progress was $2,594,920 and
$523,597 respectively, whereas the FMV of this inventory was of $4,253,967 and
$858,356 on the same dates (agreement, paragraphs c. and g.). Lastly, for its
taxation year ending on September 30, 1998, CDSL determined that the cost of
its inventoried work in progress was $1,032,767, whereas the FMV of this
inventory was of $1,693,060 on that same date (agreement, paragraphs d. and
h.).
[9]
The
appellants’ 1998 income tax returns show that, to reconcile their tax income
with their book income and implement the reduction of income resulting from the
application of subsection 10(1), they made a downward adjustment (which
they call a “reserve”) representing the difference between the FMV and the cost
of the inventoried work (A.B., page 66 (A‑121‑08);
page 42 (A‑122‑08); page 74 (A‑123‑08)). The
following year, Systems and CGI reversed the reserve claimed in 1998 in order
to claim a new one that takes into account the cost of work in progress at the
end of 1999 (A.B., page 43 (A-121-08); page 46 (A-123-08)).
[10]
The
Minister was of the opinion that this method had the effect of deferring,
unduly and contrary to GAAP, recognition of income earned by the appellants. In
computing their income for the 1998 taxation year, the Minister added the
difference between the FMV and the cost of inventoried work in progress:
$4,625,226 in the case of Systems; $1,659,047 in the case of CGI; and $660,293
in the case of CDSL (agreement, paragraphs m., n., o.).
[11]
In
computing Systems’ income for the 1999 taxation year, the Minister added
$2,931,425, which is the difference between the net adjustment under the
heading of work in progress for 1999 ($7,556,651) and the net adjustment for
1998 ($4,625,226) (agreement, paragraph p.). In computing CGI’s income for
the1999 taxation year, the Minister added the difference between the FMV and
the cost of its inventoried work in progress, namely, $334,759. In that
assessment, the amount owed was deemed to be nil (agreement,
paragraph q.). The Minister then determined a loss for CGI for 1999,
taking into account the addition of $334,759 and deducting $1,659,047 for the
amount that it had added for 1998 (agreement, paragraph s.).
[12]
The
effect of the adjustments made by the Minister is the same in all three cases,
namely, substituting the FMV for the cost in the valuation of the inventoried
work in progress for the years in issue, thus eliminating the tax benefit that,
according to the appellants, resulted from the application of subsection 10(1).
DECISION UNDER APPEAL
[13]
At
the beginning of his analysis, the TCC judge stated that the issue to be
determined as it was presented to him is the following: does section 10
override subsection 9(1)? The parties had thus agreed on the definition of the
matter to be argued before the TCC (A.B., page 82 (A‑121‑08);
page 57 (A‑122‑08); page 95 (A‑123‑08)).
[14]
The
TCC judge refused to approach the issue in this manner. In his opinion,
subsection 9(1) and section 10 are not mutually exclusive (reasons,
paragraph 8). In saying this, the TCC judge relies on a passage from the
decision of this Court in Canada v. Cyprus Anvil Mining Corp., [1989]
F.C.J. No. 1146 (QL), at paragraph 22, which states “that it [cannot] be
said that subsection 10(1) is a specific provision overriding the general
one, section 9”. According to the TCC judge, these two provisions are
complementary and can be applied harmoniously.
[15]
The
TCC judge recognizes that the appellants meet the criteria for the application
of section 10 in this case (reasons, paragraph 10). He states that
subsection 9(1) is a general provision, whereas section 10 refers more
directly to the valuation of the inventory of a business (reasons,
paragraph 11). The method selected by taxpayers to determine their profit
must nonetheless give an “accurate picture” of their income (Canderel Ltd. v.
Canada, [1998] 1
S.C.R. 147).
[16]
In the subsection 10(1) formula, the cost of
sales (in this case, the cost related to the services provided) must be
deducted from the sales of the business (reasons, paragraph 15). According
to the TCC judge, determining the amount of the inventory is simply a stage in
the process required to establish the income of a business rather than another
way of determining the income (reasons, paragraph 17).
[17]
For taxation purposes, the appellants took a reserve
against their profit in order to defer the inclusion of profit relating to the
work in progress. The
TCC judge finds that, as acknowledged by the parties in their agreement
(paragraph i.):
[18] . . . The effect of this
practice is to defer by one year the inclusion of the profit related to work in
progress. Instead of reporting their income on the basis of earned income, they
instead chose to be taxed on the basis of their billed income. This is clearly
the problem since nothing in the Act allows such a reserve to be
deducted.
[18]
According
to the TCC judge, the valuation scheme in subsection 10(1) does not allow for
deducting any loss arising from inventory (reasons, paragraph 20). Only
when the FMV of the inventory is lower than its cost does section 10 indirectly
authorize the taking of a loss before the
actual disposition of the inventoried property (idem). The
TCC judge concludes by stating the following (paragraph 22):
Thus, the purpose of section 10 is
merely to determine how to account for inventory in the calculation of income
referred to in subsection 9(1) and it does not mean that profits from work in
progress should be disregarded. Again, this section deals only with the manner
in which to account for inventory for tax purposes. . . .
[19]
The
TCC judge adds that a different conclusion would make section 34 of the
Act meaningless. This section offers certain professionals the choice of
excluding their work in progress from their income. Subsection 10(5) states
that the work in progress of a business that is a profession is inventory.
Section 10 therefore applies whenever section 34 applies. If, as the appellants
claim, section 10 allowed for the exclusion of the profit portion of work in
progress from the calculation of income, section 34 would be meaningless
(reasons, paragraph 23).
[20]
In
addition to subsection 10(1) of the Act (which has been reproduced at
paragraph 4, above), the TCC judge cites the following provisions in his
reasons:
|
SECTION 9:
(1) Subject to this
Part, a taxpayer's income for a taxation year from a business or property is
the taxpayer's profit from that business or property for the year.
...
|
ARTICLE 9:
(1) Sous réserve des
autres dispositions de la présente partie, le revenu qu'un contribuable tire
d'une entreprise ou d'un bien pour une année d'imposition est le bénéfice
qu'il en tire pour cette année.
[...]
|
|
SECTION
10:
…
(2)
Notwithstanding subsection (1), for the purpose of computing income for a
taxation year from a business, the 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 preceding taxation year for the purpose of computing income
for that preceding year.
(2.1)
Where property described in an inventory of a taxpayer's business that is not
an adventure or concern in 2008 CCI 106 (the nature of trade is valued at the
end of a taxation year in accordance with a method permitted under this
section, that method shall, subject to subsection (6), be used in the
valuation of property described in the inventory at the end of the following
taxation year for the purpose of computing the taxpayer's income from the
business unless the taxpayer, with the concurrence of the Minister and on any
terms and conditions that are specified by the Minister, adopts another
method permitted under this section.
. . .
(5)
Without restricting the generality of this section,
a) property (other than capital property) of a
taxpayer that is advertising or packaging material, parts or supplies or work
in progress of a business that is a profession is, for greater certainty,
inventory of the taxpayer;
. . .
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ARTICLE 10:
[…]
(2)
Malgré le paragraphe (1), pour le calcul du revenu tiré d'une entreprise au
cours d'une année d'imposition, les biens figurant à un inventaire au début
de l'année sont évalués au même montant que celui auquel ils ont été évalués
à la fin de l'année d'imposition précédente pour le calcul du revenu de cette
année précédente.
(2.1) La
méthode, permise par le présent article selon laquelle les biens figurant à
l'inventaire d'une entreprise d'un contribuable qui n'est pas un projet
comportant un risque ou une affaire de caractère commercial sont évalués à la
fin d'une année d'imposition doit servir, sous réserve du paragraphe (6), à
évaluer les biens qui figurent à cet inventaire à la fin de l'année
d'imposition subséquente pour le calcul du revenu que le contribuable tire de
cette entreprise, sauf si celui-ci, avec l'accord du ministre et aux
conditions précisées par ce dernier, adopte une autre méthode permise par le
présent article.
[...]
(5) Sans
préjudice de la portée générale du présent article:
a) il demeure entendu que les biens (autres
que les immobilisations) d'un contribuable qui sont des travaux en cours
d'une entreprise qui est une profession libérale, du matériel de publicité ou
d'emballage, des pièces ou des fournitures doivent figurer parmi les éléments
portés à son inventaire;
[...]
|
|
SECTION 34:
In computing the
income of a taxpayer for a taxation year from a business that is the
professional practice of an accountant, dentist, lawyer, medical doctor,
veterinarian or chiropractor, the following rules apply:
a) where
the taxpayer so elects in the taxpayer's return of income under this Part for
the year, there shall not be included any amount in respect of work in
progress at the end of the year; and
b) where
the taxpayer has made an election under this section, paragraph (a)
shall apply in computing the taxpayer's income from the business for all
subsequent taxation years unless the taxpayer, with the concurrence of the
Minister and on such terms and conditions as are specified by the Minister,
revokes the election to have that paragraph apply.
|
ARTICLE 34:
Les règles suivantes
s'appliquent au calcul du revenu d'un contribuable pour une année
d'imposition tiré d'une entreprise qui consiste en l'exercice de la
profession de comptable, de dentiste, d'avocat, de médecin, de vétérinaire ou
de chiropraticien:
a) aucun
montant n'est inclus pour le travail en cours à la fin de l'année, si le
contribuable en fait le choix dans sa déclaration de revenu produite en vertu
de la présente partie pour l'année;
b)
l'alinéa a) s'applique au calcul du revenu du contribuable tiré de
l'entreprise pour les années d'imposition ultérieures, si celui-ci a fait le
choix prévu au présent article, à moins qu'il ne le révoque en ce qui
concerne l'application de cet alinéa avec l'accord du ministre et aux
conditions fixées par ce dernier.
|
[21]
The
definition of “inventory” found at subsection 248(1) of the Act should also be
reproduced:
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"inventory" means a
description of property the cost or value of which is relevant in computing a
taxpayer’s income from a business for a taxation year or would have been so
relevant if the income from the business had not been computed in accordance
with the cash method and, with respect to a farming business, includes all of
the livestock held in the course of carrying on the business;
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« inventaire » Description des
biens dont le prix ou la valeur entre dans le calcul du revenu qu’un
contribuable tire d’une entreprise pour une année d’imposition ou serait
ainsi entré si le revenu tiré de l’entreprise n’avait pas été calculé selon
la méthode de comptabilité de caisse. S’il s’agit d’une entreprise agricole,
le bétail détenu dans le cadre de l’exploitation de l’entreprise doit figurer
dans cette description de biens.
|
ANALYSIS AND DECISION
[22]
As
a preliminary remark, I would note that each of the appellants submitted that
the method used to compute its profit for tax purposes is consistent with past
practice (appellants’ memorandum, paragraph 15 or 17, as the case may be).
Although this statement is not in the agreement on facts, it was not contested
by the respondent. I will therefore consider it established.
[23]
The
parties make no mention of the standard of review in their respective
memoranda. I would point out that decisions involving questions of law are
subject to the standard of correctness, whereas those involving questions of
fact or questions of mixed fact and law are subject to the standard of
reasonableness (Housen v. Nikolaisen, 2002 SCC 33, [2002]
2 S.C.R. 235).
[24]
It
is common ground that the determination of a business’ profit under
subsection 9(1) of the Act is a question of law and that the profit of a
business for a given year is determined by setting against the revenues from
the business for that year the expenses incurred in earning said income (M.N.R.
v. Irwin, [1964] S.C.R. 662; Associated Investors v. M.N.R., [1967]
2 Ex. C.R. 96; Friesen v. Canada, [1995] 3 S.C.R. 103; Canderel,
supra).
[25]
It
is also common ground that the determination must be made in accordance with
“well‑accepted principles of business (or accounting) practice”, which
include GAAP, except where these are inconsistent with one or more specific
provisions of the Act (see Friesen, supra, paragraph 41, and cases
cited therein; see also Canderel, supra, paragraphs 40 and 54).
[26]
In
this case, it is not disputed that the appellants’ method of accounting for
their work in progress on a fiscal-year basis, which takes into account the
portion of the profit for work completed but not yet billed, is consistent with
GAAP and provides an accurate picture of their income.
[27]
However,
it is not disputed either that, for the years in issue, the appellants had
“inventory” within the meaning of subsection 2(1) and therefore had to comply
with subsection 10(1) rules for the valuation of this inventory.
[28]
The
first step in determining income is calculating gross profit, which, for a
business involved in sale, is calculated according to the following formula (Friesen,
supra, paragraph 42):
Gross Profit = Proceeds of Sale - Cost
of Sale
When there is inventory at the beginning or
end of a year, or both, the cost of sale is determined as follows (idem):
Cost of Sale = (Value of Inventory at beginning of year + Cost of Inventory
acquisitions) - Value of Inventory at end of year
[29]
According
to the subsection 10(1) formula, inventory shall be valued at the lower of cost
or FMV. The first consequence of this rule is that, if the FMV of the inventory
declines below its cost in a given year, the resulting “loss” is recognized in
that year (Friesen, supra, paragraph 45). The other consequence of
the subsection 10(1) valuation method is the following (Friesen, supra,
paragraph 46):
.
. . the well-accepted principle of conservatism which underlies the valuation
method in s. 10(1) represents not only an exception to the realization
principle (in cases of loss) but also an exception to the principle of
symmetry since gains are not recognized until they are realized. Thus the
taxpayer who is entitled to rely on s. 10(1) is allowed to claim a business
loss where the value of inventory falls but is not required to declare a
business profit until the inventory is sold even if the value of the
inventory rises.
[Emphasis added.]
[30]
That
is where the conflict arises between the application of section 10, claimed by
the appellants, and GAAP applicable under section 9, which, as set out above,
require that the appellants account for their work in progress taking into
account the portion of the profit for work completed but not yet billed. Since
the valuation of inventory is a relevant step in the computation of income (Friesen,
supra, paragraph 44), the two methods necessarily present different
pictures of the income. In my view, the parties rightly submitted to the TCC
judge that there was a conflict.
[31]
In
determining that subsection 10(1) does not conflict with section 9, the TCC
judge relies on the decision of this Court in Cyprus Anvil Mining Corp.,
supra. However, in that case, the Court concluded that the provisions were
not in conflict because subsection 9(1) applies to the computation of income
“for a taxation year”, and, at that time, subsection 10(1) applied to the
computation of income without reference to any year in particular (idem,
paragraph 22). However, not long after the decision was rendered, the Act
was amended to specify that subsection 10(1), like section 9, applies
to the computation of income for a given taxation year.
[32]
Here,
it seems undeniable that there is a conflict between section 9, which involves
GAAP, and subsection 10(1), which requires that inventory be valued at the
lower of cost or FMV. The question of whether subsection 10(1) of the Act
overrides section 9 therefore had to be answered.
[33]
In
my view, this issue has already been resolved. The Supreme Court determined in Friesen
that subsection 10(1) is
a mandatory provision requiring taxpayers who compute income from a business
with inventory to value their inventory according to the terms of that
subsection (Friesen,
supra, paragraph 12), that is, at the lower of cost or FMV. It is a mandatory provision that
rules out the general application of section 9 regarding the valuation
of inventory. That this method produces a result that is inconsistent with GAAP
is no bar to its application (Friesen, supra, paragraph 41; Canderel,
supra, paragraphs 40 and 54).
[34]
The
TCC judge’s further conclusion that the application of subsection 10(1)
renders section 34 meaningless is based on the following reasoning
(reasons, paragraph 23):
Section 34 offers certain professionals the choice of excluding amounts
relating to their work in progress from the calculation of their income.
Subsection 10(5) provides specifically that the work in progress of a business
that is a profession is inventory. Section 10 therefore applies whenever section
34 applies. If, as the Appellants claim, section 10 allowed the exclusion of
the profit portion of work in progress from the calculation of income, section
34 would be meaningless.
[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.
[36]
Even
if there was any incongruity between these two provisions, subsection 10(1)
could not be clearer, and as the Supreme Court noted in Shell Canada Limitée
v. Canada, [1999] 3 S.C.R. 622 at paragraph 45, the courts’ role is to
interpret and apply the Act as it was adopted by Parliament. As matters stand,
there is no basis for reserving the application of section 10 solely for
businesses referred to in section 34.
[37]
Lastly,
for the first time on appeal, counsel for the respondent raised the argument
that the reserves claimed by the appellants do no reflect the amounts to which
they are entitled, even assuming that they are subject to subsection 10(1).
However, the only issue before the TCC was whether the appellants had to value
their inventory according to the subsection 10(1) rule. Nowhere is it
suggested that the amount of the adjustments was contested. In my view, it is
too late at this point to change the nature of the issue.
[38]
For
these reasons, I would allow the three appeals, set aside the decision of the
TCC and, rendering the decision that the TCC judge should have rendered, refer
the assessments back to the Minister for reassessment on the basis that the
appellants are entitled to the adjustments they made in their income tax
returns to take into account the application of subsection 10(1) of the Act. I
would award costs to the appellants in the TCC and in this Court, calculated taking
into account the common hearing that took place in each case.
“Marc
Noël”
“I
agree.
Robert Décary J.A.”
“I
agree.
Gilles Létourneau
J.A.”
Certified
true translation
Tu-Quynh
Trinh
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