Friesen v. The Queen, 93 DTC 5313, [1993] 2 CTC 113 (FCA), rev'd supra.

Létourneau, J.A. (Linden, J.A. concurring):—

Facts and issues

This is an appeal from a decision of a judge of the Trial Division of this Court which upheld the National Revenue Minister's disallowance of certain noncapital losses claimed by the appellant in relation to his participation in a speculative real estate venture involving property in the City of Calgary. The property was known as the "Styles property".

The facts are not contested. The appellant is a member of a group of people who bought, in January 1982, a parcel of raw land in the City of Calgary. The land was registered in the name of Trinity Western College. The college held the property as nominee for the group.

The "Styles property" was acquired for the purpose of reselling it at a profit. Part of the anticipated profit was to be paid to the college as a charitable donation and to other charitable organizations and the balance of the profit to be divided on a pro rata basis among the members of the group, including the appellant.

Unfortunately, the property substantially decreased in value in the years immediately following its acquisition and was eventually foreclosed in 1986. In 1983 and 1984, the appellant valued his interest in the property at the lower of cost and fair market value in accordance with subsection 10(1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") and Regulation 1801 as it then read and claimed business losses for those years ($252,954 in 1983 and $25,800 in 1984) in his income tax returns. It is those losses that the Minister of Revenue disallowed. I might add that the amount claimed for 1983 was found to be erroneous and it was agreed that the correct sum should be $197,690.

This appeal raises the question as to whether section 10 of the Income Tax Act which deals with the valuation of an inventory property applies to a property held as an adventure in the nature of trade. In the affirmative, it calls for a decision as to when such property is eligible for inventory write-down. To put it another way, we are asked in this respect to decide whether accrued but unrealized losses due to a decrease in the value of the property still owned by the appellant at that time could be deducted from his income.

The decision under appeal

The Trial Division of this Court upheld the Minister’s decision to disallow the appellant's claims for the 1983 and 1984 business losses on two grounds. Broadly stated, the learned judge of the Trial Division held that when a business has only one item in inventory, business profit or loss cannot be ascertained until the disposition of that item since, before disposition, there would be no business income against which to set off the costs. As a result, subsection 10(1) of the Income Tax Act which allows for the writing down of a property described as inventory would not apply and therefore, in a year when the property is not sold, costs would not be included in the computation of income for tax purposes for that year. He also found that subsection 10(1) does not apply to a business which is an adventure in the nature of trade as this would lead to an absurdity. As a result, subsection 10(1) would be applicable only when the business income derives from the carrying on of a business as opposed to a mere adventure in the nature of trade.

These are the two questions that I will address but in reverse order.

Whether subsection 10(1) of the Income Tax Act applies to an adventure in the nature of trade

Counsel for the respondent contends that subsection 10(1) was introduced in the legislation to statutorily recognize the common law rule that only "ordinary trading businesses” could use the lower of cost or market rule and that it was not intended to extend the use of that rule to cases where there is only a single transaction. It may be as counsel suggested that this is what was intended but, with respect, this is certainly not what was done.

Subsection 248(1) of the Act defined "business" in the following terms:

“business” includes a profession, calling, trade, manufacture or undertaking of any kind whatever and, except for the purpose of paragraph 18(2)(c), an adventure or concern in the nature of trade but does not include an office or employment.

[Emphasis added.]

It is clear from this extended definition that an adventure in the nature of trade is a business. [1] This is not disputed by the respondent. What the respondent wants, however, is to read into that definition the words "except for the purpose of section 10” and thereby to add another exception to the definition which would in effect deny those engaged in an adventure in the nature of trade the possibility of valuing an inventory property under section 10. We cannot do that especially as there is evidence from the very definition itself as it then read and as amended in 1988 that Parliament has excluded an adventure in the nature of trade when it saw fit to do so. [2] Except in the context of a charter challenge, judicial discretion does not enable a judge to read into a provision what he or a party to a proceeding would like to see in it.

It is true that the inventory rule makes more sense in the context of an ordinary trading business where goods are regularly bought and sold, making it difficult to keep track of the actual cost and sale price of each piece of property. The rule becomes then the only sound basis for computing the profits from the sales made in the year. Like Martland, J. in M.N.R. v. Irwin, [1964] S.C.R. 662, [1964] C.T.C. 362, 64 D.T.C. 5227, at page 665 (C.T.C. 364-65, D.T.C. 5229), I doubt that there is a need for the rule to apply in a case like the present one when there is only one item and its actual costs and eventual sale price can easily be established. But I cannot conclude that its application to an adventure in the nature of trade necessarily leads to an absurdity. The fact that there are fewer transactions when it is a mere adventure in the nature of trade than there would be if it were an ordinary trading business does not render section 10 nugatory with respect to adventures in the nature of trade.

On the legislation as it reads, a property, including a raw land, which is not held as a capital asset but which is held for resale and as an adventure in the nature of trade, can be inventory under subsection 10(1) and is eventually eligible for inventory write-down (see Bailey and Van Dongen, supra, note 1). The question is not whether it is eligible but rather when it is so eligible.

Whether the appellant could apply subsection 10(1) to the taxation years 1983 and 1984

As was found by our Court in Cyprus Anvil Mining Corp. v. Canada, [1990] 1 C.T.C. 153, 90 D.T.C. 6063, at page 158 (D.T.C. 6067) (F.C.A.), section 10 of the Income Tax Act is a provision of general application which confers to the taxpayer the possibility of making a choice of his method of inventory valuation without reference to any time period and subsection 10(1) is not a specific provision overriding the general one, to wit, section 9, which establishes the basic rules for determining business income. It therefore means that section 10 becomes relevant only when it comes to the computation of the business income and, under section 9 of the Act, such computation does have a time reference and must relate to the taxpayer's taxation year.

It is clear that the valuation of inventory property authorized by subsection 10(1) of the Act is "for the purpose of computing income from a business". Under subsection 9(1) of the Act a taxpayer's income for a taxation year from a business is his profit therefrom for the year. Furthermore, the definition of "inventory" in subsection 248(1) of the Act is also linked to a taxpayer's income from a business for a taxation year:

"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.

In Canada v. Dresden Farm Equipment Ltd., [1989] 1 C.T.C. 99,89 D.T.C. 5019, a case dealing with consigned goods in which the taxpayer had no property, Urie, J.A. concurred in by the two other members of our Court, described in the following terms the relationship between subsections 9(1), 10(1) and 248(1) at pages 105-06 (D.T.C. 5023):

First and foremost, it is clear from the definition that for property to be "inventory" in a taxation year, its cost or value must be relevant in the computation of income from a business in that year. By virtue of subsection 9(1), income for a taxation year from a business is the profit therefrom for the year. The significance of the inclusion of "inventory" in the calculation of income from a business in a taxation year is well illustrated in the following passage from the unanimous judgment of the Supreme Court of Canada delivered by Martland, J. in M.N.R. v. Shofar Investment Corp., [1979] C.T.C. 433, 79 D.T.C. 5347, at page 435 (D.T.C. 5348) citing with approval the judgment of Jackett, C.J. in this Court:

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, /ess the value of inventory at the end of the year.

[Emphasis added.]

The Act, in subsections (2) and (3) of section 14 [new subsections 10(1) and 9(3)] 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 subsection 14(2), therefore, the cost of an inventory item is a factor which has relevance in determining inventory value.

It is clear, then, that the property to be designated as inventory for tax purposes in a year in which it is not sold, it must be property that would be included in the computation of income (i.e., profit) for tax purposes. That is what the definition in subsection 248(1) says. If it is that kind of property its value must be calculated in accordance with subsection 10(1), i.e., at the lower of its cost to the taxpayer or its market value or in such other manner as may be permitted by regulation of which there is none applicable in this situation. Nor, in the circumstances prevailing in this case, can there by any "cost" to the taxpayer until the sale of the consigned goods has been effected.

As it appears from this decision of our Court, a property is inventory in a taxation year because its cost or value is relevant in the computation of the business income in that year. This is so in the year in which the property is sold. A property can be designated as inventory in a taxation year in which it is not sold if that property is included in the computation of the income produced by that business in that year. However, there has to be a computation of income, i.e., profit or loss, from the business.

In cases where the business itself consists in the buying and reselling of a parcel of land as in the present case, there are no business receipts or proceeds, and therefore no possible determination of a business profit or loss within the terms of subsection 9(1), unless and until the land bought is disposed of. The valuation of inventory property according to subsection 10(1) then becomes relevant in assessing the profit, i.e., the business income, for that year because it determines the cost of the sale. When there is more than one sale and more than one property held in inventory, the cost of sales is “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” (see M.N.R. v. Shofar Investment Corp., [1979] C.T.C. 433, 79 D.T.C. 5347, at page 435 (D.T.C. 5348) (S.C.C.)). As can be seen from these provisions, the value of inventory is relevant in determining the profit of a business, and the cost of an inventory item, as the Supreme Court of Canada ruled, "can affect the ascertainment of the gross profit of the business, but it is not, in itself, deductible from the taxpayer's income” (page 436 (D.T.C. 5349-50) per Martland, J.).

A similar conclusion was reached by our Court in Oryx Realty Corp. v. M.N.R., [1974] C.T.C. 430, 74 D.T.C. 6352, at page 434 (D.T.C. 6354) (F.C.A.) when ascertaining the profit resulting from the business income of a private company dealing in real estate. The Court found that prior to the sale, the cost of the land was not deductible because there was no sale price to deduct it from.

In my view, the learned trial judge was right in holding that the cost or the value of the "Styles property" could not be deducted until there was disposition of it as it was the only item in inventory and therefore that the appellant's losses could not be claimed in 1983 and 1984. This was consistent with the "matching" principle which requires that in the determination of income revenues be matched with the expenditures made to earn them. [3] Here there was, firstly, no business income and no statement of such income in 1983 and 1984 to be matched with the losses claimed by the appellant and, secondly, these losses incurred to eventually produce a business income in an adventure in the nature of trade could not be matched with, and deducted from, an income from another source when they were not engaged to earn that income from that other source.

I would dismiss the appeal with costs.

Marceau, J.A.:— I, too, have reached the conclusion that this appeal should not succeed. I have some difficulty, however, with the views expressed by my colleague Létourneau and I wish to submit my own reasons. These do not need to be elaborate though and I shall be brief.

My colleague responds affirmatively to the initial question of whether subsection 10(1) of the Income Tax Act applies to an adventure in the nature of trade; the question for him is only when it is to be applied. The reasoning advanced appears to be straightforward. Once it is accepted that the purchase of the Styles property for resale was an adventure in the nature of trade (thereby classifying the returns as income from a business rather than capital gains), the activity falls within the definition of "business" in subsection 248(1) of the Act, and since subsection 10(1) is not one of the sections for which assimilation of an adventure in the nature of trade to a business is excluded, the provision applies.

With respect, I disagree. To me, the provision does not apply either in the year of disposition, when, in any event, it would, as I see it, be too late and of no use, or in the intervening years between acquisition and disposition. I leave aside the reasons developed by counsel for the respondent based on the proposition that an application of the section would go against the basic requirement that a taxpayer use, in computing his profit or loss, the method that leads to the most accurate or truest picture of his income. I more simply believe that the very wording of the section does not permit application in the circumstances and I share the view of the trial judge that, were it not so, an application of the disposition would lead to an absurdity.

As to the wording, I note, first, that section 10 can only be relied on "for the purpose of computing income for a taxation year from a business”. I suggest that there is no calculation of income involved when absolutely nothing, no transaction that could lead to a receipt or expense, is performed throughout the year with respect to that business. The mathematical formula with zero figures suggested by counsel is simply that: a mathematical formula. I note, second, that section 10 applies to" inventory" which is defined in section 248 of the Act as "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". It seems to me that the definition makes no sense when the whole business is itself the one property.

As to the absurdity I contemplate, it would result from the fact that nowhere is there a provision in the Act that would require a taxpayer, who has claimed a loss for a decrease in the market value of a property acquired in the context of an adventure in the nature of trade, to pay tax, in all the subsequent years until he disposes of the property, for increases in that market value. Only section 9 of the Act could be invoked based on the proposition that, once a taxpayer has chosen to report on his "continuing adventure", he is bound to follow-up each subsequent year in spite of the obvious practical problems involved. It appears to me that section 9 could hardly be construed as having implicitly such an extraordinary effect. The valuation of inventories in a trading business flows naturally from the carrying on of the business; the same can obviously not be said for an adventure in the nature of trade involving a single property. In other words, section 10, in the case of a trade, necessarily implies writing up and writing down inventory values, where the market value of the inventories are used in computing the cost of goods sold year after year, but not so in the case of a so-called adventure in the nature of trade, involving a sole property.

As my brother Létourneau, J., therefore, I would dismiss the appeal with costs.

Appeal dismissed.