McDonald J.A.:
The issue to be decided in this case is whether a company, such as Pardee Equipment Limited (the “Respondent”), may claim inventory allowance deductions under s.20(1)(gg) of the Income Tax Act (the “Act”) for goods, the title of which is held by another company, while many of the other incidents of ownership are vested in the taxpayer. In other words, what proprietary interest is required before goods held for sale by a taxpayer may properly be considered its “inventory”.
The relevant portions of paragraph 20( 1 )(gg) of the Act read as follows:
20(1) ...in computing a taxpayer’s income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:
(gg) inventory allowance -- an amount in respect of any business carried on by the taxpayer in the year, equal to that portion of 3% of the cost amount to the taxpayer, at the commencement of the year, of tangible property (other than real property or an interest therein and currency that is held for other than its numismatic value) that was
(1) described in the taxpayer's inventory in respect of the business, and
(ii) held by him for sale or for the purposes of being processed, fabricated, manufactured, incorporated into, attached to, or otherwise converted into or used in the packaging of, property for sale in the ordinary course of business.
[emphasis added]
Facts (L12/R5186/T0/BT0) test_marked_paragraph_end (1370) 1.048 0131_3525_3657
The Respondent is in the business of selling, servicing and renting heavy industrial equipment at several locations in Alberta. It deals primarily in lines of equipment manufactured by Deere & Co., an American corporation. This equipment is distributed to dealers in Canada through John Deere Limited ("Deere Canada”) and bears the “John Deere” trademark. The Respondent has been a John Deere industrial equipment dealer since 1956.
From time to time, the Respondent signed dealer agreements with Deere Canada for each of its locations in Alberta where it carried on business (the “Dealer Agreements” or “Agreements”). The Agreements are virtually identical, except for the geographical “Area of Responsibility” assigned to each location and the specific lines of equipment to be sold at each location. The Agreements establish that the Respondent is an authorized dealer of John Deere equipment and contain the terms and conditions which govern this relationship.
The Dealer Agreements describe the equipment sold by the Respondent as “Consigned Goods” and expressly state that such equipment “will be shipped to Dealers on consignment for sale by the Dealer.” The terms and conditions of the Agreements also stipulate that Deere Canada retains title to the consigned goods and that the dealer will hold the equipment as the property of the company until it is sold or leased on behalf of Deere Canada. Furthermore, the proceeds from the sale of consigned goods are designated as the property of Deere Canada.
Other items, described as “Sold Goods” in the Dealer Agreements, are sent to the dealer on a different basis. “Title to, ownership and the right to possession” of these items, which include service parts, small attachments below a certain value and other small items, is transferred to the dealer im mediately upon receipt of payment. The inventory allowance deductions that are the subject of this appeal are only claimed in respect of Consigned Goods.
The Respondent orders all of its heavy industrial equipment directly from Deere US and the orders are shipped directly to the individual dealers from the factory. Deere Canada processes all of the paperwork for the Respondent’s equipment orders. At all material times, the Respondent, in its sole discretion, determined the number and type of industrial equipment it ordered.
Once a piece of equipment is ordered the Respondent cannot cancel the order, although some changes in specification and shipping dates may be made before the “freeze date”. All equipment orders are shipped to the dealers F.O.B. factory. The Dealer Agreements do not provide for the return of unsold equipment to Deere Canada or Deere US in the ordinary course of business. Upon request, a dealer must ship any item or items held on consignment to a destination specified by Deere Canada and in the manner requested.
Under the Agreements, Deere Canada is required to carry an insurance policy that covers the equipment for physical damage during transit and for some time after delivery. The cost of this insurance is charged to the Respondent. Upon delivery of the equipment, the Respondent is responsible for all loss, damage or deterioration and is required to pay Deere Canada for the full amount of any losses not covered by the insurance. The Respondent is also responsible for all set up and testing costs incurred in preparing the equipment for sale.
Once equipment is ordered and shipped, Deere Canada transmits an invoice to the dealer showing the “Wholesale Price” of the equipment. The Wholesale Price is equal to the sum of the Dealer Price (as published by Deere Canada), freight and handling charges, surcharges, duties and any sales or similar taxes arising from the transfer of the equipment to the dealer. From time to time, Deere Canada offers various promotions to induce the Respondent to place additional orders for certain pieces of equipment or to pay out any outstanding invoices.
The Respondent must pay the Wholesale Price to Deere Canada according to specified terms pertaining to the type of equipment that is ordered. Typically, there is a period of time after the delivery of the equipment when the Respondent is not required to make any payments unless the equipment is sold or leased (the “Selling Period”). During this period, no interest accrues on the outstanding amount of the Wholesale Price.
If the Selling Period for a piece of equipment expires and the dealer has failed to sell or lease the equipment, it is then required to pay a “carry-over deposit” (“COD”), in cash, to Deere Canada. The amount of the COD payment varies depending on the specific type of equipment, but is typically between 15% and 25% of the Wholesale Price of the unit. COD payments are credited against the outstanding balance owed in respect of the Wholesale Price of the equipment. Additional COD payments, equal to 25% of this outstanding balance, are due every six months thereafter until the equipment is sold or leased.
When a piece of equipment is sold the outstanding balance on the Wholesale Price of the unit becomes immediately due and payable. This balance is equal to the difference between the Wholesale Price, offered by Deere Canada, and the sum of all COD and other payments made in respect of the equipment. The Respondent is obligated to remit this amount to Deere Canada after every sale, regardless of the price at which the equipment was sold. Accordingly, the Respondent is entitled to keep the surplus, if any, between the outstanding balance and the purchase price as profit. The Respondent also bears the loss, if any, on the sale.
For accounting purposes, Deere Canada characterises COD payments as refundable deposits. Consequently, the sale of a piece of equipment is recorded as the receipt of the full Wholesale Price with a corresponding refund of any COD payments received prior to sale. When equipment is transferred between dealers, Deere Canada records the transaction as a full refund of all COD payments received, if any, to the transferor with a corresponding receipt of the same amount from the transferee.
The Dealer Agreements restrict the number of hours that any piece of equipment can be used for demonstration purposes. If equipment is used in excess of this time, the Respondent is required to pay depreciation or damage charges on the equipment. Payments in respect of wear and tear are applied against the outstanding balance owing on the equipment.
If a customer requires alterations to a piece of equipment to meet a specific need, the Respondent is entitled to make the required changes at its own cost and discretion. Typically, these alterations are in the form of specialized or customized attachments not manufactured by Deere US. Where the engineering department of Deere US approves the alterations, the “John Deere” warranty on the equipment remains valid.
Deere Canada performs monthly inspections of its dealer locations to ensure that all equipment with an outstanding balance remains at the location to which it was delivered, or if it is not at that location that there is an acceptable reason for its absence. When a dealer fails to provide a satisfactory explanation, the total amount owing on the missing equipment becomes immediately due and payable.
For each of its 1978 to 1982 taxation years, the Respondent included its “equity” in the equipment received from Deere Canada as an “Asset” on its balance sheet. This “equity” was equal to the value of the equipment less the balance of the Wholesale Price still owing to Deere Canada. In each taxation year, the Respondent claimed an inventory allowance deduction under s.20(l)(gg) of the Act equal to 3% of the aggregate of this “equity” and the value of all parts, supplies and used equipment in the Respondent’s inventory. The Minister allowed the claims in respect of the parts, supplies and used equipment but disallowed all claims relating to equipment with outstanding liability to Deere Canada (1.e. the Consignment Goods). The Respondent commenced an action claiming inventory allowances in respect of this equipment on January 19, 1990.
The Respondent used a different accounting procedure in each of its 1983 to 1986 taxation years. All outstanding amounts owed to Deere Canada were now shown as liabilities. The value of all equipment on hand (expressed as the lower of cost or market value) was declared as an asset. At trial, the Respondent adduced accounting evidence that this method gave greater consideration to the actual substance of the transactions between the Respondent and Deere Canada rather than the form in which they appear in the Dealer Agreements.
In each of these taxation years, the Respondent claimed a 3% inventory allowance deduction in respect of the lower of cost or market value for all equipment on hand. These allowances were disallowed but the Minister granted a 3% inventory allowance on the difference between the Respondent’s outstanding liability to Deere Canada and the lower of cost or market value of the equipment on hand.
In each of its 1983 to 1988 taxation years, the Respondent also claimed an investment tax credit pursuant to s.127 of the Act in respect of certain equipment in its possession. The Minister disallowed those credits in their entirety. On December 31, 1990 the Respondent commenced an action seeking inventory allowance deductions for each of its 1983 - 1986 taxation years and the investment tax credits for its 1983 to 1987 taxation years. This action was consolidated with the Respondent’s earlier action. Both actions were allowed by the Trial Judge. Revenue Canada appeals to this Court.
Decision of the Federal Court Trial Division: (1997), 97 D.T.C. 5279 (L14/R12/T0/BT0) test_left_indentation (1) 1.024 0135_2817_2983
(Fed. T.D.) (L264/R4482/T1/BT1) test_marked_paragraph_end (4470) 1.018 0135_3037_3191
The Trial Judge held that the relationship between Deere Canada and the Respondent was not properly characterized as a consignment. In reaching this conclusion, she found that it is trite law that the terminology of agreements does not control the legal characterization of the relationship created therein. Accordingly, the fact that the Dealer Agreements expressly described the equipment in question as “consigned goods” was not determinative of the issue.
After a thorough examination of the conduct of the parties, the Trial Judge found that the transactions involving the “Consigned Goods” were properly characterized as sales subject to a secured interest that was held by Deere Canada until the purchase price was fully paid. In her assessment of the facts, she found that the control exercised by Deere Canada over the equipment was more consistent with that of a secured creditor than that of an owner. Of central significance to her findings were the facts that: (1) the pieces of equipment in question were not and could not be returned to Deere Canada; and (2) although equipment could be transferred between dealers, such transfers were not cost neutral to the Respondent and required the consent of the other dealer.
Finally, the Trial Judge distinguished the instant case from the decision of this Court in À. v. Dresden Farm Equipment Ltd. (1988), 89 D.T.C. 5019 (Fed. C.A.). In that case, the Court disallowed the inventory allowance claims of an authorized John Deere dealer on the grounds that the dealer agreement established that the goods were held on consignment by the dealer and therefore could not be considered inventory. The Trial Judge acknowledged that the Court in Dresden established that the taxpayer must own the goods claimed as inventory, but found that the Court did not analyse the type of ownership interest that was required. Furthermore, she held that the Court in Dresden had not addressed the situation where the indicia of ownership were divided with someone other than the taxpayer holding legal title to the goods until the point of sale.
The Respondent argued that the Supreme Court of Canada had cast doubt on the correctness of the Dresden decision in Friesen v. R. (1995), 95 D.T.C. 5551 (S.C.C.). It was held in that case that “inventory”, as defined in s.248( 1 ) of the Act, should be interpreted by reference to its commonly understood meaning in a manner that is consistent with ordinary principles of commercial accounting and business. While the Trial Judge ultimately found that Friesen did not cast doubt on the Dresden decision, she adopted the Supreme Court’s approach to “inventory”. On the facts of this case she found that treating the equipment as inventory of the Respondent was consistent with ordinary accounting and business practices because the risks and rewards associated with ownership were primarily vested in the Respondent and not Deere Canada.
Accordingly, the Trial Judge found that the Respondent “held” the machines for sale as that term is used in s.20( I )(gg) of the Act and was entitled to inventory allowance deductions as set out in its claim. Since the Crown had acknowledged that such a finding would mean that the Respondent was entitled to investment tax credits under s. 127 of the Act for its 1983 - 1987 taxation years, she also held that these claims should be allowed.
Analysis (L6/R4936/T0/BT0) test_marked_paragraph_end (4254) 1.030 0136_5729_5895
There are four preconditions that must be satisfied before an inventory allowance deduction may be claimed under paragraph 20(1 )(gg) of the Act:
(i) the allowance must be claimed on the cost amount of the property at the beginning of each taxation year;
(ii) the property must be tangible property other than real estate or an interest therein;
(iii) the property must have been described in the taxpayer’s inventory; and
(iv) the property must have been held for sale in the ordinary course of the taxpayer’s business.
See Burrard Yarrows Corp. v. R. (1986), 86 D.T.C. 6459 (Fed. T.D.) at 6461; aff’d (1988), 88 D.T.C. 6352 (Fed. C.A.). Only the last two criteria are at issue in this appeal.
In Dresden, Mr. Justice Urie held that for property to be properly considered part of a taxpayer’s inventory, the taxpayer must have an ownership interest in the property: Dresden, supra at 5023. Accordingly, for the Minister to succeed he must demonstrate that the Respondent did not hold a sufficient ownership interest in the equipment for it to be considered part of the Respondent’s inventory.
As noted above, the decision of this Court in Dresden examined the terms and conditions of a dealer agreement between Deere Canada and an agricultural equipment dealer. The key provisions of the agreements in that case are substantially the same as those governing the relationship between Deere Canada and the Respondent in the case at bar. After examining the terms and conditions relating to the Consigned Goods, Mr. Justice Urie found that the equipment transfers between Deere Canada and its dealer were more properly characterized as consignments. Accordingly, the respondent never purchased the goods and there was no “cost amount” for the inventory upon which an inventory allowance deduction could be calculated.
It is clear that the Dealer Agreements describe the transfer of equipment from Deere Canada to the Respondent as a consignment. The Trial Judge found that it has long been recognized that calling a transfer of goods a consignment is not determinative. Accordingly, a review of all of the circumstances must be undertaken in order to determine the true arrangement between the parties: See Bristol Yacht Sales Inc., Re (1984), 51 C.B.R. (N.S.) 279 (B.C. S.C.) at 283; and Dresden, supra at 5024.
The notion of a “consignment sale” or “sale on consignment” developed as a method of inventory financing as an alternative to the conditional sale or the chattel mortgage: See B. Colburn, “Consignment Sales and the Personal Property Security Act” (1981-82) 6 Can. Bus. L.J. 40 at 42. Simply put, a consignment is a contractual arrangement whereby an owner delivers its goods to another party (the “consignee”) on the understanding that the consignee will sell the goods to a third party. The proceeds of the sale are to be remitted to the owner, less some amount to compensate the consignee for effecting the sale: see Stephanian's Persian Carpets Ltd., Re (1980), 34 C.B.R. (N.S.) 35 (Ont. Bktcy.) at 37-38.
The primary indicia of a consignment relationship include:
(i) when the consignee sells each item, it should be required to account to the consignor for the proceeds of the sale;
(ii) the consignee may establish the actual sale price of the goods and keep as its commission the difference between the sale price and the wholesale price established by the consignor;
(iii) the consignee should have a right of return and the consignor should have a right to demand its return at any time;
(iv) the risk of loss and transportation costs may be placed on either the consignee or consignor;
(v) separate accounts should be maintained by consignor and consignee;
(vi) title to the goods is directly transferred from consignor to the retail purchaser through the consignee as agent; and
(vii) goods held on consignment should be capable of being specifically identifiable as inventory on consignment and the supplier should monitor the inventory on a regular basis.
See Colburn, supra at 49-50.
The Dealer Agreements in this case vest title to the equipment in Deere Canada until the equipment is sold or leased to a third party. The Respondent is responsible for paying the full Wholesale Price to Deere Canada regardless of the price at which the equipment was sold. The proceeds from any sale or lease are considered the property of Deere Canada. There is no express right to return the equipment to Deere Canada, but Deere Canada may direct the dealer to ship equipment to any destination. The Respondent may transfer the goods to other dealers with the permission of Deere Canada. Deere Canada performs periodic inspections of its dealer sites and each dealer is required to account for the location of all equipment received on consignment.
Much was made at trial of the fact that the Respondent has no express right of return over the equipment. With respect, this factor is not determinative. It is merely a single factor to be considered when examining the relationship between Deere Canada and the Respondent.
The carry-over deposit payments made by the Respondent do not translate into a requirement to pay for the equipment prior to a retail sale or leasing arrangement. In the event that the equipment is sold, transferred to another dealer or if the dealer goes out of business these payments are credited to the dealer’s account. Accordingly, the COD payments are more properly characterized as refundable deposits which serve as an incentive to the dealer to sell the goods.
The Respondent argues that the terms and conditions of the agreement which expressly indicate a consignment relationship are to be recast in the light of ordinary commercial accounting and business practices. This argument cannot succeed. The Dealer Agreements were negotiated and entered into by sophisticated parties operating at arm’s length. The terms of the Dealer Agreements clearly indicate that the parties intended to enter into a consignment relationship. This is clearly indicated by the distinction that is drawn between the title provisions for Consigned Goods and Sold Goods in the Dealer Agreements. Title to the consigned equipment remains vested in Deere Canada until the equipment is sold or leased by the dealer on behalf of the company. Furthermore, the proceeds of sale are designated the property of Deere Canada. In contrast, title to the Sold Goods only remains vested in Deere Canada until the dealer pays the purchase price.
The comments of Mr. Justice Marceau in his concurring judgment in Saskatchewan Wheat Pool v. R. (1984), 85 D.T.C. 5034 (Fed. C.A.) seem applicable to this situation. He states at 5038:
This is not a case where a party wishes to rely on some extrinsic evidence either to prove the true nature of an agreement or to show that the writing prepared was not intended to express the whole of the agreement or to explain some unclear or incomplete provisions of the instrument. /f is a case where a party contends afterwards that what he intended to do, and indeed said he was in fact doing when he entered into the agreement, ts not to be accepted as such, because the legal effects of the agreement did not and could not correspond to what both he and his co-contractor thought they were then doing. It seems to me that such an unusual contention in a proceeding not seeking the nullity of a contract could only be accepted if indeed it is totally impossible to understand and adapt the rights and obligations actually flowing from the contract with what the parties intended them to be.
[emphasis added]
Indeed, there is no ambiguity in the terms of the Dealer Agreements. Clearly, the equipment is held on consignment. The Respondent intended to obtain, and did in fact obtain, the benefit of the consignment arrangement, namely interest free financing of its business as an industrial equipment dealer. It cannot be allowed now to seek to recast the agreement as providing sufficient ownership interest in the equipment for additional tax benefits.
Conclusions (L14/R4652/T0/BT0) test_linespace (264>253.98) 1.023 0139_8115_8245
There is no doubt that the parties did not contemplate the contractual relationship between them would be that of buyer and seller except for any goods designated as Sold Goods under the terms of the Dealer Agreements. After examining the Dealer Agreements as a whole and reviewing the conduct of the parties, I am satisfied that this relationship is more properly characterized as a consignment. Accordingly, title never vested in the Re- spondent, it passed directly to the retail purchaser or lessor through the Respondent as agent for Deere Canada. While some of the risks of ownership rest with the Respondent, this is not sufficient to invoke s.20(l)(gg) of the Act. The machines were held on consignment, accordingly there was no cost amount as the machines were not purchased by the Respondent from Deere Canada.
As I have held that the Respondent did not own the equipment in question and is not entitled to inventory allowance deductions under s.20(l)(gg) of the Act, it follows that the Respondent is not entitled to the investment tax credits claimed under s.127 of the Act. A taxpayer must own equipment before an investment tax credit can be claimed.
Disposition (L8/R4720/T0/BT0) test_marked_paragraph_end (2702) 1.024 0140_3747_3915
I would allow this appeal with costs here and in the Court below. I would set aside the decision of the Trial Judge and would dismiss the actions before her.
Appeal allowed.
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