Cargill Ltd. v. R., 98 DTC 6126, [1998] 2 C.T.C. 192 (FCA)

Stone J.A.:

1 This is an appeal from a judgment of the Tax Court of Canada of January 19, 1996[FN1: <p>The case is now fully reported as<em>Cargill Ltd. v. R.</em>, [1996] 2 C.T.C. 2102 (T.C.C.).</p>] The case at trial was heard on an agreed statement of facts and on oral evidence. The appellant called one expert witness, and a witness was called by the respondent. The facts are not in dispute.

Nature of the dispute

2 The dispute is concerned with determining the correct amount of inventory allowance which the appellant is entitled to claim pursuant to paragraph 20(1)(gg) of the Income Tax Act (“the Act”) for the 1980 and 1981 taxation years. In those years, the appellant claimed deductions in respect of inventory allowance in the amounts of $2,776,876 and $3,961,423, respectively, on the basis of all purchased grain on hand in its system at the end of each year and without regard to storage grain that it sold in that year. On reassessment, the Minister disallowed a portion of the claimed inventory allowance in the amount of $232,406 for 1980 and $716,294 for 1981. The Minister based his assessment on the appellant's failure to reduce its inventory account of purchased grain in its system by the negative inventory balances of storage grain sold at individual elevators in the system.

3 By the judgment of the Tax Court of Canada, the Minister's assessment for the 1981 taxation year was upheld in its entirety. The assessment for the 1980 taxation year was also upheld, except that the Minister was directed to correct a calculation error which had the effect of improperly reducing the appellant's inventory for that year.

Factual background

4 The appellant conducts a grain business at numerous elevator locations in western Canada as a grain dealer and elevator operator. This business is transacted with grain producers in two ways. Producers could sell grain to the appellant and receive a cash purchase ticket. The grain thus sold is commonly referred to as “purchased grain”. Alternatively, producers could store their grain with the appellant without selling it, in which case they would receive a graded storage receipt which entitled them to sell the grain at a later date or have the same quantity, kind and grade of grain described in the receipt returned to them. Grain stored in this manner is referred to as “storage grain”.

5 The appellant co-mingles purchased and storage grain for sale as soon as it is received from a producer at an individual elevator, regardless of whether it is purchased grain or storage grain. This practice sometimes results in more grain of a kind from an individual elevator being sold than the quantity of purchased grain of the kind actually available at that elevator.

6 For accounting purposes, the appellant assumed that it first sold purchased grain and only sold storage grain when quantities of purchased grain available at a particular elevator were insufficient to cover quantities of grain sold from that site. The following paragraphs of the agreed statement of facts describe the appellant's method of accounting for “inventory”:

59. When a sale is made by Cargill, the particular Elevator's accounts for the kind of grain sold are adjusted as follows:

• a) the Revenue Account is increased (credited) by the selling price;

• b) the Receivables Account is increased (debited) by the selling price; and, at month end;

• c) the Cost of Sales Account is increased (debited) by the current Location Market Price of the grain sold;

• d) the Inventory Account is reduced (credited) by the current Location Market Price of the grain sold.

60. Since Cargill does not initially recognize a cost of Storage Grain in the individual Elevator Inventory Accounts, when Storage Grain is sold from an elevator, the entry with respect to inventory referred to in paragraph 59(d) will have the effect of bringing the individual Elevator's Inventory Account for the kind of grain sold to a Negative Position.

64. For purposes of preparing Cargill's balance sheet as at the date of its financial statements, Cargill recognizes a liability to Producers in respect of sold Storage Grain.

65. At year end, Cargill transfers any Negative Position for a particular kind of grain arising in an inventory account of an individual elevator as a result of the entries referred to in paragraph 59(d) herein, to an aggregate Payables Account in respect of all grain in all elevators having Negative Inventory positions, by increasing (debiting) the Inventory Account by the amount of the Negative Position and by increasing (crediting) the Payables Account by that same amount.

66. As a result of the year-end entries referred to in paragraph 65 herein, each of the Negative Inventory positions is brought to zero and the Payables Account is increased by an estimated amount of Cargill's legal obligations to holders of Graded Storage Receipts for the sold Storage Grain.

67. The entries mentioned in paragraph 65 herein are immediately reversed by Cargill after year-end in order to avoid having to make ongoing adjustments. As a general principle, the concept of reversing entries is consistent with GAAP if the initial entry was correct in the first instance.

68. The year-end figures appearing in the Inventory Accounts of each Elevator's financial records, adjusted as described in paragraph 65 herein for each Elevator from which Storage Grain has been sold as of year-end, are combined by kind of gain for purposes of preparing Cargill's year-end Tax Financial Statements.It is on these combined figures that Cargill claims an inventory allowance pursuant to paragraph 20(1)(gg) of the Income Tax Act, as it read in the relevant taxation years.

69. Cargill has not claimed the inventory allowance under s. 20(1)(gg) of theIncome Tax Actwith respect to sold Purchased Grain or unsold Storage Grain. Cargill has claimed the inventory allowance in respect of its full cost for unsold Purchased Grain physically available in its Elevator system. It has not, however, netted from that amount any Negative Position at individual Elevators arising as described in paragraphs 59(d) and 60 herein.[FN2: <p><em>Appeal Book</em>, vol. III, pp. 406-08.</p>]

[Emphasis added]

The judgment below

7 The Tax Court noted that the respective rights of the appellant and the producers to the storage grain are clearly outlined in the Canada Grain Act, S.C. 1970-71-72, c. 7, and its regulations. With respect to the appellant's argument that it did not calculate the inventory allowance claimed on the basis of storage grain but only on the basis of purchased grain on hand at year-end, the Tax Court Judge stated:

The Appellant contends that the issue of ownership of storage grain is moot since it did not claim an inventory allowance on such grain. That statement, although arguably correct, is somewhat misleading. There is no dispute that the Appellant's claim for the inventory allowance is predicated upon an acceptance of certain assumptions: first, that the Appellant at all times held storage grain for sale; second, it was entitled to sell that storage grain (i.e. it had a proprietary interest in that property); third, a cost was incurred with respect to storage grain sold; fourth, the value attributed by the Appellant to the sold storage grain used in computing income for the year is also the “cost amount” utilized by the Appellant in its computation of the inventory allowance permitted by paragraph 20(1)(gg) of the Act. Accordingly, since sold storage grain was an integral component in the Appellant's computation, the issue of ownership is neither completely irrelevant or moot, as argued. In my view, it is not only appropriate, but necessary in this appeal, to determine the ownership of storage grain, and whether the Appellant incurred a cost with respect thereto.[FN3: <p>Reasons for Judgment, at p. 15.</p>]

8 The Tax Court concluded from an examination of the Canada Grain Act that the producers, and not the appellant, owned the storage grain and that this property interest “remained with them until such time as the elevator receipt was surrendered, the grain was valued at market price, and a cash purchase ticket was issued by the Appellant”.[FN4: <p><em>Ibid.</em>, at p. 16.</p>] The Court concluded that the appellant did not have a property interest in the storage grain sold by it in 1980 and 1981.

9 The Tax Court also found that the appellant incurred no cost with respect to the sold storage grain because it never purchased the goods. As the Court put it,

...there could be no ‘cost amount’ for inventory upon which the calculation permitted by paragraph 20(1)(gg) could be made. ...[T]he year-end adjustment of transferring amounts from all elevators in a negative position to a payables account had the effect of artificially creating an immediate “expensing” of a “cost” with respect to the sale of storage grain. It is artificial because a disposition of storage grain by the Appellant creates nothing more than an estimated future liability with respect to an expense which may or may not occur depending on the position taken by a producer with respect to his storage grain.[FN5: <p><em>Ibid.</em>, at p. 17.</p>]

...not quantifiable because the true value of the storage grain can only be established if and when the producer decides to sell. Such liability is dependent upon a future event and no obligation to pay arises until the producer, as holder of the elevator receipt, surrenders it.[FN6: <p><em>Ibid.</em></p>]

10 The Tax Court Judge determined that as the appellant had no proprietary interest in the storage grain sold and had incurred no “cost amount” with respect to it, the amount of purchased grain upon which the appellant based its paragraph 20(1)(gg) inventory allowance calculation was overstated to the extent of the negative inventories of storage grain sold. He also concluded that the liability which the appellant claims to have incurred at the time of its sale of the storage grain is at most a non-deductible contingent liability within the meaning of section 18(1)(e) of the Act.

11 The Court noted that the appellant calculated its inventory on an elevator-by-elevator basis rather than a system-wide basis. This calculation, the Court found,

...had the effect of not netting the positive inventory at one location against the negative inventory at another location with the result that the inventory allowance claimed was overstated by an amount equal to the negative inventory.

...Although the Appellant may see it necessary to record separate profit centres for individual elevators as a matter of internal accounting the fact is that they are not separate businesses and do not have an infrastructure as a separate business.[FN7: <p><em>Ibid.</em>, at p. 18.</p>]

Issue

12 As the parties are not in agreement on the definition of the issue in this appeal, it is sufficient for this Court to determine whether the Tax Court Judge erred in disposing of the issue as defined by the parties in paragraphs 81-83 of the agreed statement of facts. Those paragraphs read:

81. The only issue between the parties is whether, for purposes of calculating the inventory allowance provided for under paragraph 20(1)(gg) of theIncome Tax Actas it read in the relevant years, the Appellant is required to file its account on a System Wide Basis as opposed to a Location by Location Basis.

82. It is the Appellant's position that it is not required to net Negative Positions arising in individual Elevator Inventory Accounts (as described in paragraphs 59(d) and 60 herein) against the costs of Purchased Grain physically available in its Elevator system [as] a whole at year-end (i.e. that the Appellant is not required to file on a System Wide Basis).

83. It is the Respondent's position that if the Appellant does not net its inventories of grain of the same kind contained in its system of Elevators as a whole, the result in an overstated “cost” for its inventory equal to the aggregate of all Negative Positions at year-end arising as described in paragraphs 59(d) and 60 herein.[FN8: <p><em>Appeal Book</em>, vol. V, at pp. 409-10.</p>]

The statute

13 Paragraph 20(1)(gg) of the Act reads:[FN9: <p>This paragraph was repealed pursuant to s. 5 of<em>An Act to amend the Income Tax Act and a related Act</em>, S.C. 1986, c. 55.</p>]

Notwithstanding paragraphs 18(1)(a), (b) and (h), 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) 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 the tangible property (other than real property or an interest therein) that was

  (i) 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 in the ordinary course of the business that the number of the days in the year is of 365;

14 The word “inventory” and the term “cost amount” are defined in subsection 248(1) of the statute.[FN10: <ul>Subsection 248(1) reads in part:<li><ul>In this Act,<li><p>“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.</p></li><li><ul>“cost amount” to a taxpayer of any property at any time means, except as expressly otherwise provided in this Act,<li><p>(c) where the property was properly described in an inventory of the taxpayer, its value at the time as determined for the purpose of computing his income, ...</p></li></ul></li></ul></li></ul>]

Position of the parties

15 The appellant's position is straightforward. It is that the appellant is entitled to the inventory allowance based on all purchased grain physically on hand at year-end in various individual elevator locations, undiminished by any reduction by reason of the sale of storage grain at other locations. In short, the sale of storage grain at any one of the locations is not to impact on the appellant's inventory of purchased grain at another location.

16 The appellant maintains that it does not seek to include storage grain in its calculation of the paragraph 20(1)(gg) allowance. It contends, further, that it meets all of the requirements of paragraph 20(1)(gg) and so qualifies for the allowance that it claimed in the 1980 and 1981 taxation years. The allowance was calculated on the basis of the “cost amount” to it of “tangible property” (purchased grain) that was “described in [its] inventory in respect of the business”, and the goods were “held ... for sale ... in the ordinary course of the business”.

17 The appellant argued in the Tax Court that by accepting its computation of income in accordance with its financial statements but refusing to do so in the calculation of the inventory allowance, the Minister has adopted a contradictory position. It submitted that its business is transacted in such a manner that each elevator constitutes an independently run business by a manager who buys and sells inventory. Accordingly, revenue arises from each of these individual profit centres. In support of this argument in this Court, the appellant relied on the provisions of paragraph 4(1)(b) of the Act, which applies where the taxpayer's business is carried on “partly in one place and partly in mother place”[FN11: <ul>Paragraph 4(1)(b) reads as follows:<li><ul>For the purposes of this Act,<li><p>(b) where the business carried on by a taxpayer or the duties of the office or employment performed by him was carried on or were performed, as the case may be, partly in one place and partly in another place, the taxpayer's income or loss for the taxation year from the business carried on by him or the duties performed by him in a particular place is the taxpayer's income or loss, as the case may be, computed in accordance with this Act on the assumption that he had during the taxation year no income or loss except from the part of the business that was carried on in that particular place or no income or loss except from the part of those duties that were performed in that particular place, as the case may be, and was allowed no deductions in computing his income for the taxation year except such deductions as may reasonably be regarded as wholly applicable to that part of the business or to those duties, as the case may be, and except such part of any other deductions as may reasonably be regarded as applicable thereto.</p></li></ul></li></ul>] . The appellant submitted that this paragraph requires a taxpayer to compute income at each of the different places where the business is carried on and that this, in turn, requires inventory calculations to be made as part of the computation of the cost of goods sold at each such place. The appellant argued from this that, as it carried on business in 1980 and 1981 in as many places as it operated an elevator, the Tax Court Judge erred in failing to recognize that the cost of goods at each location is different and that the goods had a “unique cost/value” at any such location.

18 The respondent's position is that the so-called “negative inventories” of sold storage grain must be deducted from the appellant's calculation of inventory for the entire system for the purposes of claiming the paragraph 20(1)(gg) deduction. A failure to do so, argued the respondent, inflates the system inventory of “purchased grain” by an amount of “storage grain” that did not belong to the appellant at the time of sale. Because this has occurred, it is of no consequence that the appellant's method of accounting for inventory brought the negative inventory to zero at year-end. The appellant's failure to recognize, for the purpose of calculating the inventory allowance pursuant to paragraph 20(1)(gg), that it held storage grain for storage and not for sale resulted in the appellant claiming an inventory allowance that exceeds what is permissible under the paragraph.

Analysis

19 In my view, neither the manner in which the appellant operated its business nor its reliance on provisions of the Act other than those directly in issue, must be allowed to detract from the real issue at stake. That issue, it seems to me, is whether the Tax Court Judge erred in construing the applicable provisions of paragraph 20(1)(gg) in the circumstances of this case.

20 This Court has had the opportunity in several recent decisions to comment on the proper interpretation of paragraph 20(1)(gg). The following statements of Linden J.A. for the Court in Bastion Management Ltd. v. Minister of National Revenue (1995), 95 D.T.C. 5238 (Fed. C.A.)at pages 5240-41, are of assistance in understanding the purpose of the legislation:

In the late 1970s, taxpayers with inventories were suffering from the effects of inflation, which artificially increased the apparent profit on which they had to pay tax. According to the then-Finance Minister, the purpose of this provisions was to partially offset the effects of inflation by allowing the taxpayer to deduct 3% of the opening value of qualifying inventories.... The Trial Division of this Court as well as this Court have adopted this view of the legislative aim on a number of occasions. (See Saskatchewan Wheat Pool v. The Queen, 85 D.T.C. 5034 (F.C.A.), at 5036; The Queen v. Boehringer Ingelheim (Canada) Ltd., 85 D.T.C. 5443 (F.C.T.D.), at 5446, affd. 87 DTC 5442 (F.C.A.); The Queen v. Mattabi Mines Ltd., 89 D.T.C. 5357 (F.C.T.D.), at 5357, affd. 92 DTC 6252; Plaza Pontiac Buick Ltd. v. The Queen, 91 D.T.C. 5547 (F.C.T.D.), at 5547-5548, affd. 94 DTC 6058 (F.C.A.); Gay-Lea Foods Co-operative Ltd. v. The Queen, 94 D.T.C. 6285 (F.C.T.D.), at 6286.

Mr. Justice Teitelbaum, for example, succinctly and accurately summarized the situation in Mattabi Mines, supra, at p. 5367:

As indicated by both counsel, the deduction was announced in the March 31, 1977 budget as a measure to provide some relief from the effects of inflation for taxpayers whose business required them to invest in and carry an inventory of tangible goods other than real property.

Similarly, Mr. Justice Hugessen stated in Saskatchewan Wheat Pool, supra, at p. 5036:

The inventory allowance permitted by paragraph 20(1)(gg) was introduced into the Income Tax Act in 1977. Its obvious purpose was to allow some relief to businesses from the increased tax liability due to “false” profits created by the effect of high inflation on year-end inventories...

It is clear then, that, properly construed, the paragraph 20(1)(gg) deduction was meant to give some tax relief from the effects of inflation to those taxpayers whose business involved carrying inventory. The Trial Judge rightly quoted and relied on these authorities in arriving at the decision.

21 In Burrard Yarrows Corp. v. R. (1986), 86 D.T.C. 6459 (Fed. T.D.), at page 6461, the Court described the four requirements which a taxpayer must meet in order to be eligible for the inventory allowance in paragraph 20(1)(gg). As Joyal J. stated:

First, the allowance must be claimed on the cost amount of the property in question at the beginning of each taxation year in question. Next, the property against which it is claimed must be tangible property other than real estate or an interest therein. Thirdly, it must be established that the property was described in the taxpayer's inventory in respect of his business, and finally, that it was held for sale or to be processed, manufactured, incorporated into, attached to, or otherwise converted into property for sale in the ordinary course of that business.

22 In addition to affirming these four criteria, this Court in R. v. Dresden Farm Equipment Ltd. (1988), 89 D.T.C. 5019 (Fed. C.A.)at page 5023, emphasized that a taxpayer must have a proprietary interest in the goods held as inventory in order to satisfy the requirement that the property be “held for sale”. This Court elaborated on this principle in GSW Appliances Ltd. v. R. (Fed. C.A.), where Linden J.A. expressed the following views at pages 10-11 of his reasons:

When interpreting the Income Tax Act, as with any statute, it is crucial to remember the purpose behind its provisions. In this case we are dealing with a government subsidy delivered through the tax system designed to help those businesses that are forced to carry inventory during inflationary periods. While, for purposes of this appeal, I do not find it necessary to deal with the issue of whether or not the appellant had property in the goods on January 1, 1977, it is instructive to consider this point for purposes of statutory interpretation. With regard to ownership it is important to look at the whole situation and understand the relationship between the taxpayer and the goods. In Pardee Equipment Ltd. v. The Queen Reed J. states:

While the Federal Court of Appeal in Dresden stated that in order to be inventory, goods have to be owned by the taxpayer, there was no analysis in that case of the type of ownership interest that was required. There was no analysis of the situation in which the indica of ownership are divided with someone other than the taxpayer holding the legal title until the point of sale. In addition, in this case the evidence establishes that treating the machines as inventory in the plaintiff's hands is consistent with ordinary commercial accounting and business practices because the risks and rewards associated with ownership rest with the plaintiff not Deere Canada.

Reed J. finds a qualification to the ownership criterion set down in The Queen v. Dresden Farm Equipment Ltd., but does so on a principled basis. That is, by establishing that, if the “risks and rewards” are to be the responsibility of the taxpayer, and therewith the risk of inflation, the taxpayer may be able to come within the scope of the deduction. [footnotes omitted]

Notwithstanding Linden J.A.'s qualification, what the case law makes manifestly clear is that a taxpayer must have an ownership interest in the inventory in order to be entitled to the allowance in paragraph 20(1)(gg).

23 Turning to the present appeal, I share the Tax Court Judge's view that the storage grain played a significant role in the appellant's calculation of its inventory allowance, and the ownership of this grain is therefore an important issue in this case. The appellant argued before us that it calculated its inventory allowance solely on the basis of the amount of purchased grain physically on hand in its system at year-end. There is no dispute that the appellant had an ownership interest in the purchased grain. My difficulty with the appellant's position arises from the manner in which the appellant accounted for sales of purchased grain and the ultimate impact of this accounting method on its year-end inventory calculation.

24 The appellant's method of accounting for inventory, as I understand it, may be illustrated in the following manner. Assume that at the commencement of a year the appellant holds 1000 tonnes of purchased grain and 1000 tonnes of storage grain in elevator A and equal amounts of purchased and storage grain in elevator B. Assume also that all of the purchased grain and 750 tonnes of the storage grain in elevator A are sold during the year and that none of the grain in elevator B is sold. The appellant first accounts for the amount of storage grain sold as a negative, in recognition of its liability to producers in respect of that grain. At year-end, however, this negative amount is brought to zero upon transferring it to an aggregate payables account to reflect the appellant's estimate of the amount of its liability to the producers under graded storage receipts. Assume, finally, as per paragraph 29[FN12: <p>Paragraph 29 reads:<blockquote><p>For the purpose of its accounting records, Cargill assumes that it first sells Purchased Grain and only sells Storage Grain if quantities of Purchased Grain available at a particular Elevator are insufficient to cover quantities of grain sold from that Elevator.</p></blockquote></p>] of the agreed statement of facts, that the appellant first sells purchased grain and only sells storage grain if quantities of purchased grain available at a particular elevator are insufficient to cover quantities of grain sold from that elevator. At year-end, according to the appellant's accounting method, there remains in the appellant's hands, in elevator B, 1000 tonnes of unsold purchased grain and 1000 tonnes of unsold storage grain. The appellant calculates its “inventory” for the purpose of paragraph 20(1)(gg) of the Act on all of the purchased grain in elevator B without regard to the negative inventory of the storage grain which has arisen during the year by the sale of such grain from elevator A.

25 At the evidence reveals, the appellant's practice was to sell storage grain even though it had no property interest in these goods. Despite the co-mingling of storage grain and purchased grain from the time of delivery, the storage grain was held primarily for storage and was owned by the producers. Where a producer had received a graded storage receipt, he could subsequently decide either to price his graded storage receipt or have the same quantity, kind and grade of grain described in the graded storage receipt returned to him. The pricing of grain is a transaction by which a producer surrendered his graded storage receipt in exchange for a cash purchase ticket for an amount normally equal to the current location market price for the quantity, kind and grade of grain specified in the receipt. The effect of pricing a graded storage receipt in this manner is to convert the transaction between the producer and the appellant from one primarily of storage to one of outright sale.

26 The evidence is clear that none of the holders of graded storage receipts had priced them prior to the dates as of which the appellant calculated its inventory allowance. Nor had they waived their right to have grain returned to them, or received notice from the appellant pursuant to subsection 53(1) of the Canada Grain Act that they must take delivery of the grain described in their receipts. The “storage grain” remained just that, and all of the terms and conditions of the storage receipts continued to bind even though some of this grain had been sold by the appellant.

27 It is therefore clear to me that the storage grain was not inventory “held for sale” by the appellant within the meaning of paragraph 20(1)(gg). Despite the fact that the appellant's method of accounting for inventory assumed that storage grain was “sold”, the appellant was never in a position under the Canada Grain Act to do so. The appellant could only lawfully sell purchased grain that it owned. It follows therefore that the only grain “held for sale” by the appellant, within the meaning of the paragraph, was the purchased grain. In reality, then, the negative inventories in the appellant's accounts at certain elevators in its system represented deficits of purchased grain, which, as I have already stated, were the only goods owned and “held for sale” by the appellant. By failing to offset these negative inventories against positive inventories of purchased grain in other elevators in the system, the appellant has, in my view, misstated its true inventory position with respect to purchased grain for the purpose of the paragraph 20(1)(gg) calculation.

28 Not to be entirely overlooked is that the holder of a graded storage receipt for grain that had been sold by the appellant could claim a paragraph 20(1)(gg) inventory allowance where that person kept his other books of account on the accrual basis. Indeed, there was some evidence that a small percentage of grain producers did in fact so keep their accounts.[FN13: <p>Evidence R.A. Best, Transcript,<em>Appeal Book</em>, vol. 4, at pp. 532-33.</p>]

29 In my view, the Tax Court Judge was correct in deciding as he did. Accordingly, I would dismiss the appeal with costs.