Gay Lea Foods Co-operative Ltd. v. The Queen, 94 DTC 6285, [1994] 2 CTC 245 (FCTD)

Jerome A.C.J.:—This matter came on for hearing before me at Toronto, Ontario on November 16, 1993. At issue is the plaintiffs right to claim an inventory allowance deduction 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") for the 1981 taxation year. At the conclusion of argument, I took the matter under reserve and indicated that these written reasons would follow.

Facts

The plaintiff is a resident Canadian corporation with its head office in Weston, Ontario. In the taxation year in question, the plaintiff participated in a price support programme (the “Plan B programme") created by the Canadian Dairy Commission (the "commission"). The purpose of the programme was to relieve the seasonal strains in the dairy industry by ensuring a steady production and supply of butter. In order to accomplish this, the commission would purchase butter (Plan B butter) from participating producers in times of high production and would sell the butter back to the producers in times of lower production.

Pursuant to a contract between the plaintiff and the Commission dated April 1, 1981, the commission purchased butter produced by the plaintiff during the period of April 1, 1981 to September 15, 1981. The plaintiff covenanted to repurchase the butter no later than March 26, 1982. The plaintiff treated the Plan B butter sold to the commission as inventory in its financial statements for the 1981 taxation year and recorded the amounts received from the commission as a liability.

In computing its income for fiscal 1981, the plaintiff claimed an inventory allowance deduction pursuant to paragraph 20(1 )(gg) of the Act. By notice of assessment dated July 2, 1986, the Minister of National Revenue (the Minister) disallowed the deduction claimed for the Plan B butter, claiming that the butter was not inventory. The plaintiff filed a notice of objection but the notice of assessment was confirmed by the Minister on July 23, 1987.

Statutory provisions

Paragraph 20(1 )(gg) of the Act reads as follows:

20 (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;

Submissions

The defendant contends that the taxpayer has not met the requirements of paragraph 20(1 )(gg). It was argued that based on the contract signed between the commission and the plaintiff, title in the Plan B butter passed from the plaintiff to the commission. Because the plaintiff lost title to the Plan B butter, he could not be said to be holding the butter for sale. In essence, the butter was simply being warehoused by the plaintiff for the commission. The plaintiff contends that the programme was essentially a financing arrangement designed to encourage production and ensure an adequate supply of butter during the winter months. Thus, the wording of the contract did not accurately reflect the real intentions of the parties who did not wish that title in the Plan B butter be transferred. The plaintiff also argues that the fact that it recorded the funds received from the commission as a liability showed that the butter remained as part of its inventory.

Analysis

Paragraph 20(1)(gg) was introduced into the Act in 1977 (S.C. 1977-78. c. 1, subsection 14(1). The paragraph was repealed by S.C. 1986, c. 55, subsection 5(1).) in order to help mitigate the increased tax liability of businesses whose year- end inventories were being artificially over-valued by constant and substantial inflation. The paragraph has been considered on numerous occasions by both levels of this Court. [1] In order to successfully claim the deduction, the taxpayer must meet all of the following pre-conditions: [2]

1. The allowance must be claimed on the cost amount of the property in question at the beginning of each taxation year in question;

2. The property against which it is claimed must be tangible property other than real estate or an interest therein;

3. It must be established that the property was described in the taxpayer's inventory in respect of his business; and,

4. The property must be 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.

This fourth requirement of holding the property for sale or for processing, etc., was closely examined by the Federal Court of Appeal in Canada v. Dresden Farm Equipment Ltd., supra (note 1, at pages 104-06 (D.T.C. 5022-24)). In concluding that the taxpayer must have a property interest in the inventory upon which he seeks the allowance, the Court cited with approval the following comments of Mr. Justice Joyal from Burrard Yarrows Corp. v. The Queen, supra (note 2, at page 317 (D.T.C. 6462)).

In order for a taxpayer to meet the paragraph 20(1 )(gg) requirement holding property for sale, he must have property in it which he can sell. Here, as I noted above, the property in the ships vested in the purchasers and not in the plaintiff taxpayer. As a result the plaintiff did not have property in the ships which he could sell and, therefore, he could not be said to be holding them for sale within the meaning of paragraph 20(1 )(gg).

[Emphasis added.]

A nearly identical argument to the one put forward by the plaintiff was considered by Taylor J.T.C.C. in R.G. & D.H. Holdings Ltd. v. M.N.R., [1986] 2 C.T.C. 2364, 86 D.T.C. 1730 at pages 2369-70 (D.T.C. 1734) That case involved a similar contract for the purchase and sale of Plan B butter. The learned Tax Court judge considered the contract and reached the following conclusion:

In my view . . . there is no basis for the contention of the appellant that the purchase by C.D.C. [the commission] of the Plan “B” butter was some form of a "financing" arrangement. It was a simple agreement by C.D.C. to take excess butter production during certain periods of the year, and supply the appellant, as well as other producers, with the same quantities of butter, during other periods of the year, so that the producers could maintain an even supply of butter to their customers. Title and ownership in every respect to the Plan "B" butter passed to the C.D.C. The butter might be stored on the premises of the appellant—at the option of the C.D.C.—but that in no way altered this elementary situation. The appellant, acting as "warehouseman" for C.D.C. and thereby required by the contract to pay certain attendant costs such as insurance on the goods stored, would not convert someone else’s property into the taxpayer's inventory, or in this case "reconvert" it into the appellant’s inventory.

[Emphasis added.]

An examination of the facts in the case at bar leads me to the same conclusion as Taylor J.T.C.C. with respect to the applicability of paragraph 20(1 )(gg) to the plaintiff’s situation. The wording of the contract is clear and unequivocal that title in the Plan B butter passed from the plaintiff to the commission. As a result, the plaintiff could not be said to be “holding the butter for sale". Rather, it was the commission which was holding the butter for resale to the plaintiff.

The fact that the plaintiff treated the butter sold to the commission as part of its inventory and that the amounts received by the commission for the butter were recorded as a liability in its financial statements, is not sufficient to bring the plaintiff within the requirements of paragraph 20(1 )(gg).

Conclusion

In light of the clear and unambiguous wording of the contract between the plaintiff and the commission, there can be no doubt that title in the Plan B butter was passed to the commission. As a result, the butter cannot form part of the plaintiff's inventory for the purposes of claiming the paragraph 20(1 )(gg) deduction. The taxpayer’s appeal will therefore be dismissed without costs.

Appeal dismissed.