The Queen v. Bastion Management Ltd., 94 DTC 6272, [1994] 2 CTC 70 (FCTD), aff'd 95 DTC 5238 (FCA)

Reed, J.:—The defendant is a trader in commodity futures. The transactions to which the present case relates are the purchase and sale of actual physical quantities of gold and silver bullion.

The physical market for gold and silver is comprised of users such as mints and jewellers who use the commodity to produce articles of manufacture as well as some large banking institutions such as the Bank of Nova Scotia. Traders in commodities futures contracts do not normally use the physical market.

Mr. Friedberg, president of the defendant gave evidence of only one occasion on which the defendant had entered the physical market during all its years of trading. This related to purchases of pepper and no real explanation was given as to why that course of action had been taken in the particular instance in question. Traders in commodity futures do not enter the physical market because their object is to make money from fluctuations in commodity prices. Attempting to achieve that purpose by taking physical possession of the commodity would be inefficient and cumbersome.

On July 26, the defendant purchased, on the physical market, quantities of gold and silver bullion: 15,000 ounces of gold at $192.30 per ounce and 500,000 ounces of silver at $5.435 per ounce. On the same day, the defendant "sold" 150 contracts of gold (i.e., 15,000 ounces) at $192.30 per ounce, for August delivery, and 100 contracts for silver (i.e., 500,000 ounces) at $5.435 per ounce, for August delivery. Thus the defendant's purchase of the bullion and "sale" of the contracts for future delivery at the same price meant that the defendant could not make a profit on the purchase of the bullion. Indeed, the transaction necessarily cost the defendant money since interest charges were incurred on the money borrowed to purchase the bullion. There were commissions and storage charges as well. These amounted to approximately $12,000.

The defendant's action of buying the bullion and simultaneously "selling" the contracts was done to ensure that the defendant, in buying the bullion, did not increase its net exposure to price fluctuations in the market. The defendant was already long on 110 contracts of gold (i.e., 11,000 ounces) and 30 contracts of silver (i.e., 150,000 ounces). Mr. Friedberg's evidence was that, while it was planned to increase the defendant's maximum exposure in the futures market with respect to both gold and silver, he did not want that to occur on July 26, 1978 and, in any event, did not want the exposure to increase to the levels which would have occurred had the offsetting contracts not been sold.

The defendant's year end was July 31, 1978. On August 3, 1978, the defendant sold the gold and silver bullion at $201.40 per ounce and $5.543 per ounce, respectively, and at the same time liquidated the offsetting futures positions for the identical amount per ounce.

The purchase and sale of the physical quantities of bullion were made on the advice of the defendant's accountant who pointed out that a tax deduction was available pursuant to paragraph 20(1 )(gg) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"):

(1) 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 three per cent 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 for sale in the ordinary course of the business

that the number of days in the year is of 365;

The purpose of this temporary provision of the Income Tax Act (it had a ten- year life span) has been described in several decisions of this Court. In Saskatchewan Wheat Pool v. The Queen, [1985] 1 C.T.C. 31, 85 D.T.C. 5034 (F.C.A.) at page 33 (D.T.C. 5036), Mr. Justice Hugessen said:

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. . . .

See also: The Queen v. Boehringer Ingelheim (Canada) Ltd., [1985] 2 C.T.C. 211, 85 D.T.C. 5443 (F.C.T.D.) at page 214 (D.T.C. 5446), aff'd [1987] 2 C.T.C. 245, 87 D.T.C. 5442 (F.C.A.); Mattabi Mines Ltd. v. M.N.R., [1989] 2 C.T.C. 94, 89 D.T.C. 5357 (F.C.T.D.) at page 106 (D.T.C. 5367), aff'd [1992] 1 C.T.C. 8, 92 D.T.C. 6252 (F.C.A.); Plaza Pontiac Buick Ltd. v. M.N.R., [1991] 2 C.T.C. 259, 91 D.T.C. 5547 (F.C.T.D.) at page 260 (D.T.C. 5547-48), aff'd [1994] 1 C.T.C. 27, 94 D.T.C. 6058 (F.C.A.).

Descriptions of the purpose of the provision can also be found in B.J. Arnold, Timing and Income Taxation: The Principles of Income Measurement for Tax Purposes (Canadian Tax Foundation, 1983) at page 376 and in D.H. Bonham, “Accounting, Inflation and Taxation” in B.G. Hansen, V. Krishna and J.A. Rendall, eds., Essays on Canadian Taxation (1978) 509 at page 518.

It is trite law that, regardless of the purpose of a provision in a taxing statute, if a taxpayer can bring itself within the specific wording of the provision, then, the provision will apply. Counsel for the defendant refers, in this regard, to the text of Madame Justice Wilson’s decision in Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536, 84 D.T.C. 6305 at page 540 (C.T.C. 318, D.T.C. 6325), where she agrees with Mr. Justice Estey:

I am also of the view that the business purpose test and the sham test are two distinct tests. A transaction may be effectual and not in any sense a sham (as in this case) but may have no business purpose other than the tax purpose. The question then is whether the Minister is entitled to ignore it on that ground alone. If he is, then a massive inroad is made into Lord Tomlin’s dictum that "Every man is entitled if he can to order his affairs so that the tax attaching under the appropriate Acts is less than it would otherwise be”: I.R.C. v. Duke of Westminster, [1936] A.C. 1 at page 19. Indeed, it seems to me that the business purpose test is a complete rejection of Lord Tomlin's principle.

Counsel for the defendant argues that what is required by paragraph 20(1 )(gg) is that: (1) the defendant must have held tangible property at the commencement of its 1979 taxation year; (2) the tangible property must have been described in the defendant's inventory in respect of the business carried on by it; and (3) the tangible property must have been held by the defendant for sale. He states that the defendant's holding of bullion on August 1, 1978 satisfied all these requirements.

Argument centred around the phrase "property for sale in the ordinary course of the business” which appears at the end of subparagraph 20(1 )(gg)(ii). That provision is not very grammatically framed. At first reading, I was inclined to accept the defendant's argument that the phrase modifies only the tangible property of the taxpayer which is held for the purpose of being ”. . .manufactured . . . into . . . property for sale”, and that it does not modify “tangible property. . .held for sale". This accords with the structure of the provisions as they are set out in Interpretation Bulletin IT-435R (June 23, 1982) and with the decision in G.S.W. Appliances Ltd. v. M.N.R., [1993] 2 C.T.C. 325, 93 D.T.C. 5502 (F.C.T.D.) at page 330 (D.T.C. 5505).

On reflection, however, this way of reading the paragraph does not make sense. Why should tangible property held for manufacturing into a product for sale be included only if the manufactured product will be held for sale in the ordinary course of business, while tangible property, which has already been manufactured into an article for sale, need not be held for sale in the ordinary course of business to qualify for the deduction. I think the analysis found in British Columbia Telephone Co. v. M.N.R., [1986] 1 C.T.C. 2410, 86 D.T.C. 1286 (T.C.C.) is apposite. As I read that case, the last phrase in subparagraph 20(1 )(gg)(ii) was applied not to property being used to manufacture articles but also to the articles for sale once they had been manufactured. The tangible property in that case was being held for sale to other telephone companies. An analysis of the relevant phrase, at pages 2415-16 (D.T.C. 1290) of the decision, states:

The term used in paragraph 20(1)(gg) is not “ordinary course of business,” but “ordinary course of the business,” that is, the ordinary course of the business carried on by the taxpayer. Thus I must consider the business of B.C. Telephone to determine whether the property sold by it to Okanagan Telephone and other corporations was in the ordinary course of its business.

In a bankruptcy matter before the High Court of Australia, Rich, J. wrote that for transactions to be considered in the ordinary course of business supposes “that according to the ordinary and common flow of transactions in affairs of business there is a course, an ordinary course. It means that the transaction must fall into place as part of the undistinguished common flow of business done, that it should form part of the ordinary business as carried on, calling for no remark and arising out of no special or particular situation”: Downs Distributing Co. v. Associated Blue Star Stores Ltd. (In Liquidation) (1948), 76 C.L.R. 463, at page 477. Street, J., of the Supreme Court of New South Wales stated that “the transaction must be one of the ordinary day-to-day business activities, having no unusual or special features, and being such as a manager of a business might reasonably be expected to be permitted to carry out on his own initiative without making prior reference back or subsequent report to his superior authorities, such as, for example, to his board of directors.”: Re Bradford Roofing Industries Ltd. (1966), 84 W.N. (Pt. 1) (N.S.W.) 276 at page 285; Street, J., borrowed with minor adaptations the words of Rich, J.: “the requirement is that the transaction must fall into place as part of the undistinguished common flow of the company's business, that it should form part of the ordinary course of the company’s business as carried on, calling for no remark and arising out of no special or particular situation". See also Re Pacific Mobile Corporation; America Biltrite (Canada) Ltée v. Robitaille, 44 C.B.R. 190 at pages 201-05.

[Emphasis added.]

I accept this as a proper interpretation of the phrase “in the ordinary course of the business" in subparagraph 20(1 )(gg)(ii). When that test is applied to the facts in this case, it is clear that the gold bullion owned by the taxpayer at the beginning of its 1978-79 fiscal year does not qualify. While this finding is sufficient to dispose of this case, I will deal with some of the other arguments which have been raised.

I accept counsel for the defendant's argument that insofar as paragraph 18(1 )(a) of the Income Tax Act would operate so as to require that the inventory be acquired for the purpose of gaining or producing income from a business or property, this is suspended because paragraph 20(1 )(gg) is expressed to operate "notwithstanding paragraphs 18(1)(a), (b) and (h)". At the same time, I agree with the plaintiff's argument, that the textual requirements of paragraph 20(1 )(gg) have not been met because the bullion in question cannot be said to be “inventory in respect of the [taxpayer's] business".

During the time in question the word "inventory" was defined in subsection 248(1) of the Income Tax Act

“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;

This is a very broad definition. On its face it seems to include all property owned by a taxpayer which is relevant to its business. I accept counsel for the plaintiff's argument that such a broad definition is not proper. What constitutes inventory must be interpreted in the commercial and accounting contexts within which that term is normally used. Inventory is usually acquired for the purpose of selling it to make a profit thereon. There is usually an opening inventory and closing inventory by reference to which a taxpayer's income for a taxation year is calculated. In this case, the gold and silver bullion was not acquired for any trading purpose. The intention was not to try to make a profit therefrom. Indeed, the structure of the transactions was such that no profit could possibly be made, and expenses were bound to be incurred. As noted, these amounted to $12,000. An inventory allowance, for tax purposes, of $196,000 was however claimed.

I accept counsel for the defendant's argument that one transaction can be an "adventure in the nature" of trade and therefore constitute a business for tax purposes. But, the single transaction must have a profit making motive. None such existed in this case, I have not been persuaded that the bullion in question falls within the taxpayer’s inventory in respect of a business carried on by it.

Counsel for the plaintiff also argues that the expense claimed comes within section 67 and subsection 245(1) of the Act:

67. General limitation re expenses.— In computing income, no deduction shall be made in respect of an outlay or expense in respect of which any amount is otherwise deductible under this Act, except to the extent that the outlay or expense was reasonable in the circumstances.

245(1) Artificial transactions.— In computing income for the purposes of the Act, no deduction may be made in respect of a disbursement or expense made or incurred in respect of a transaction or operation that, if allowed, would unduly or artificially reduce the income.

Having reached the conclusions already set out, I do not need to deal with those arguments.

For the reasons given the appeal is allowed.

Appeal allowed.