The Chief Justice (concurred in by Thurlow, J):—This is an appeal from a judgment of the Trial Division dismissing, with costs, an appeal from a decision of the Tax Appeal Board dismissing an appeal from the appellant’s assessment under Part I of the Income Tax Act for the 1960 taxation year.
The sole question involved in the appeal is whether the respondent erred in applying subsection 12(3) of the Income Tax Act (as applicable to the 1960 taxation year) in computing the appellant’s profit from a sale of land made in 1960, which profit was, admittedly, properly included in computing the appellant’s income for the 1960 taxation year.
The appellant purchased the land in question from a corporation with which it was deemed to be “not dealing at arm’s length”* for $174,000, of which it paid $1,000 cash and agreed to pay the balance, without interest, in nine annual instalments of $17,500 and one further instalment of $15,500.
On July 21, 1960, as the result of a sale of some of the appellant’s shares, the appellant ceased to be a corporation “deemed” not to deal at arm’s length with the corporation from whom it bought the land.
Later on July 21, 1960, the appellant sold the land for $373,000. The question is whether the profit from that sale that is to be included in the computation of the appellant’s income for the 1960 taxation year for the purposes of Part I of the Income Tax Act is, as the appellant contends, the sale price of $373,000 less $174,000 (the price at which the appellant bought the land), being $199,000, which is the profit from the sale determined in accordance with ordinary business or commercial principles, or whether that profit is, as the respondent contends, the sale price of $373,000 less $18,500 (the amount that, by the end of 1961, the appellant had paid on account of the price for which it had bought the land), being $353,500, which is the profit as computed in accordance with the respondent’s view as to the effect, in the circumstances, of subsection 12(3) of the Income Tax Act as applicable to the 1960 taxation year.
Subsection 12(3) reads 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.
The appellant contends that subsection 12(3) does not apply in the circumstances for two different reasons, viz:
(a) it says that the price for which it bought the land was not “an otherwise deductible outlay or expense” within the meaning of those words in subsection 12(3), and
(b) it says that the price for which it bought the land was not, in any event, “payable ... to a person with whom [it] was not dealing at arm’s length” within the meaning of those words in subsection 12(3).
The question whether the price for which a trader bought property for re-sale in his business is a “deductible outlay or expense” for the purposes of subsection 12(3) is one that, in my view, is of considerable difficulty.
For the purposes of the Income Tax Act, “income” for a taxation year from a business is the “profit” therefrom for the year. Profit must be determined in accordance with ordinary business and commercial principles (subject to any special direction in the tax statute). In the case of a trader, leaving aside special revenue items and dis- bursements, the profit from the business is the gross profit from the trading operations less the normal operating expenses, such as salaries, rents, repairs, advertising, etc, and less special statutory allowances such as bad debts, interest, capital cost allowances, etc.
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 MNR v Irwin, [1964] S.C.R. 662; [1964] CTC 362; 64 DTC 5227, per Abbott, J, delivering the judgment of the Court, at pages 664-65 [pp 364; 5228]). 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 subsection 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 subsection 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.t Presumably, however, subsection 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 subsection 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 subsection 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 turn to the question whether, for the purposes of applying subsection 12(3) in the circumstances of this case, it can be said that the price payable by the appellant for the land was “payable ... to a person with whom [it] was not dealing at arm’s length”.
In that connection it is to be noted that subsection 12(3) lays down a rule which, if it applies at all, applies “In computing” the appellant’s income for its 1960 taxation year and, in particular, it applies in the computation of the gross profit accruing to the appellant from a sale of land in that year. In my view, the question whether the “otherwise deductible outlay or expense” was payable by the appellant to “a person with whom he was not dealing at arm’s length” must be determined as of the time of, or after, that transaction. Prior to the sale, the cost of the land was not deductible because there was no sale price to deduct it from. It is only from the moment of the sale on, therefore, that the cost of the land could conceivably be described as “an otherwise deductible outlay or expense” but, from that moment on it could not be described as “payable by the taxpayer to a person with whom he was not dealing at arm’s length” because, before that time, the appellant had ceased to be related to the payee and was, therefore, no longer “deemed” not to deal at arm’s length with that company.
It follows, in my view, that subsection 12(3) does not apply in respect of the cost of the land that was the subject of the sale that gave rise to the profit in question.
Either of the aforesaid grounds would be sufficient for my conclusion that subsection 12(3) was not applicable in the circumstances of this case.
I am therefore of opinion that the appeal should be allowed with costs in the Trial Division as well as in this Court, the judgment of the Trial Division should be set aside, and the assessment of the appellant under Part I of the Income Tax Act for the 1960 taxation year should be referred back to the respondent for reassessment on the basis that subsection 12(3) of the Income Tax Act has no. application in respect of the cost of the land that was the subject of the sale that gave rise to the profit that is the subject of the assessment.
Pratte, J:—I do not wish to express any opinion on the question of whether the price for which a trader bought property for re-sale in his business is a deductible expense or outlay within the meaning of subsection 12(3) of the Income Tax Act.
However, I share the view expressed by The Chief Justice that, on the facts of this case, subsection 12(3) did not preclude the appellant, in computing its profit from the sale of the land here in question, from deducting the purchase price of that land. That purchase price, assuming it to be an “outlay or expense”, clearly did not become “otherwise deductible” until the land was sold by the appellant and, at that time, it was no longer payable to a person with whom the appellant was not dealing at arm’s length.
For these reasons, I would dispose of this appeal as proposed by The Chief Justice.
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