Minister of National Revenue v. Irwin, [1964] SCR 662

Supreme Court of Canada

Minister of National Revenue v. Irwin, [1964] S.C.R. 662

Date: 1964-10-06

The Minister of National Revenue Appellant;

and

Joseph S. Irwin Respondent.

1964: May 13, 14; 1964: October 6.

Present: Cartwright, Abbott, Martland, Judson and Spence JJ.

ON APPEAL FROM THE EXCHEQUER COURT OF CANADA.

Taxation—Income tax—Profit from sale of oil interests by petroleum engineer—Whether business income—Computation of profit—Valuation of inventory—Income Tax Act, R.S.C. 1952, c. 148, ss. 3, 14(1), 14(2), 139(1)(e),139(1)(w).

Over a number of years, the respondent, a petroleum engineer, acquired interests in prospective oil lands and in 1952, 1953 and 1955 disposed of some of them for cash payments and reservations of a royalty. The payments received were in excess of the cost to him of such rights. The Minister added to his reported income for 1952, 1953 and 1955 the profits realized on the sale of these rights on the ground that he was a trader in oil interests. The Income Tax Appeal Board confirmed the assessments. The Exchequer Court held that the respondent was a trader in oil interests, but ruled that under the combined effect of s. 14(2) of the Act and reg. 1800 of the Regulations, he was entitled to bring such interests into computation of profit as property described in an inventory and valued at fair market value, although such market value was considerably higher than the cost. This method would place the profits in earlier transaction years, rather than in those under appeal. The appeal was therefore allowed. The Minister appealed this latter ruling to this Court and the respondent cross-appealed the finding that he was trading in oil interests.

Held: The Minister's appeal should be allowed and the cross-appeal dismissed.

The law was clear that for income tax purposes gross profits, in the case of a business which consists of acquiring property and reselling it, is the excess of sale price over cost, subject only to any modification effected by the "cost or market, whichever is lower" rule. That rule is based upon the ordinary principles of commercial accounting, and s. 14(2) of the Act gave it statutory recognition. M.N.R. v. Anaconda American Brass Ltd., [1956] A.C. 85, referred to. It was doubtful whether the combined effect of s. 14(2) and reg. 1800 made a change in that settled concept of profit. However it was not necessary to express an opinion on this point. The respondent did not in fact adopt the inventory method of computing income and, under the provisions of s. 14(1) of the Act, could not have done so without the permission of the Minister. Such permission was not granted. The respondent's profits were taxable and he was not entitled to adopt the fair value market method of inventory valuation.

APPEAL by the Crown and cross-appeal by the respondent from a judgment of Noël J. of the Exchequer Court of

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Canada1, allowing an appeal from a decision of the Income Tax Appeal Board. Appeal allowed and cross-appeal dismissed.

G. W. Ainslie and G. F. Jones, for the appellant.

J. H. Laycraft, Q.C., for the respondent.

The judgment of the Court was delivered by

Abbott J:—The material facts in this appeal and cross-appeal are not in dispute. Over a number of years commencing in 1942, respondent a petroleum engineer acquired interests in prospective oil lands and in the years 1952, 1953 and 1955 disposed of some of these interests for cash payments and reservations of a royalty. The payments received were in excess of the cost to him of such rights.

The appellant re-assessed the respondent for his 1952, 1953 and 1955 taxation years as having carried on business as a trader in oil interests, and included in his income for those years the net profit arising from the sale and partial disposition of the rights referred to. These assessments were confirmed by the Income Tax Appeal Board.

On appeal to the Exchequer Court2, Noël J. held that respondent was a trader in oil interests but he accepted respondent's contention, that if he was a trader in such interests—which of course respondent had denied—they should be brought into computation of profit as property described in an inventory and valued at market value (although such market value was considerably higher than the cost) and allowed the appeal.

A few weeks before the trial in March 1962, respondent had a statement prepared by an accountant, the witness Morton, showing what purported to be the fair market value of oil interests held by him at the end of the 1951, 1952, 1953, 1954, 1955, and 1956 taxation years. Opinion evidence as to the fair market value of these interests in those years was adduced by respondent through a petroleum engineer, the witness Sproule. On the basis of that evidence the witness Morton also prepared profit and loss statements purporting to show that respondent had incurred a loss during the years in question.

On cross-examination Morton acknowledged that as an accountant he would not be prepared to certify the profit

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and loss statements prepared by him as accurately reflecting either the loss or profit of respondent from dealing in oil leases; that the statements were simply an exercise in arithmetic based on valuations furnished by Dr. Sproule; and that an accountant in preparing financial statements would not value inventory at market value if the market value was in excess of cost.

The Crown appealed the finding of the Exchequer Court that in computing profits respondent was entitled to value oil rights as though described in an inventory at their fair market value. The respondent cross-appealed the finding that he was trading in oil rights.

At the hearing before this Court, counsel for appellant was informed that we did not need to hear him in reply on the cross-appeal which would therefore be dismissed.

Section 2 of the Income Tax Act, the charging section, imposes tax upon the taxable income of every person resident in Canada. Section 3 provides that such income includes income from a business, and s. 4 that income from a business is the profit therefrom for the year.

The basic concept of "profit" for income tax purposes has long been settled. A recent statement of the principle is that of Viscount Simonds in Minister of National Revenue v. Anaconda American Brass Ltd.3:

The income tax law of Canada, as of the United Kingdom, is built upon the foundations described by Lord Clyde in Whimster & Co. v. Inland Revenue Commissioners, (1925) 12 T.C. 813, 823, in a passage cited by the Chief Justice which may be repeated. "In the first place, the profits of any particular year or accounting period must be taken to consist of the difference between the receipts from the trade or business during such year or accounting period and the expenditure laid out to earn those receipts. In the second place, the account of profit and loss to be made up for the purpose of ascertaining that difference must be framed consistently with the ordinary principles of commercial accounting, so far as applicable, and in conformity with the rules of the Income Tax Act, or of that Act as modified by the provisions and schedules of the Acts regulating Excess Profits Duty, as the case may be. For example, the ordinary principles of commercial accounting require that in the profit and loss account of a merchant's or manufacturer's business the values of the stock-in-trade at the beginning and at the end of the period covered by the account should be entered at cost or market price, whichever is the lower; although there is nothing about this in the taxing statutes."

The law is clear therefore that for income tax purposes gross profit, in the case of a business which consists of acquiring property and reselling it, is the excess of sale

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price over cost, subject only to any modification effected by the "cost or market, whichever is lower" rule. That rule as Lord Clyde indicated in the passage which I have quoted is based upon what he described as the ordinary principles of commercial accounting and s. 14(2) of the Act gave it statutory recognition.

This appeal has raised the question whether the inventory provisions of the Act and the Regulations have effected a change in that settled concept of profit. I doubt whether the combined effect of s. 14 of the Act and reg. 1800 of the Income Tax Regulations, to which I shall refer in a moment, has made any such change, and I am also doubtful whether, in any event, the inventory provisions referred to, are applicable in the circumstances of a case such as this where the actual cost and sale price of each particular piece of property are well established. However since I have reached the conclusion that the appeal succeeds on other grounds I find it unnecessary to express any opinion on these two points, and I therefore refrain from doing so.

The following provisions of the Income Tax Act, relevant to inventory, are applicable to the three years in issue here, 1952, 1953 and 1955:

14. (1) When a taxpayer has adopted a method for computing income from a business or property for a taxation year and that method has been accepted for the purposes of this Part, income from the business or property for a subsequent year shall, subject to the other provisions of this Part, be computed according to that method unless the taxpayer has, with the concurrence of the Minister, adopted a different method.

(2) For the purpose of computing income, the property described in an inventory shall be valued at its cost to the taxpayer or its fair market value, whichever is lower, or in such other manner as may be permitted by regulation.

139, (1)(w) "inventory" means a description of property the value of which is relevant in computing a taxpayer's income from a business for a taxation year.

This definition was repealed effective July 28, 1955 and the following was substituted:

(w) "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.

Regulation 1800 of the Income Tax Regulations reads as follows:

1800. For the purpose of computing the income of a taxpayer from a business

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(a) All the properties described in all the inventories of the business may be valued at the cost to him; or

(b) all the property described in all the inventories of the business may be valued at the fair market value.

Respondent acknowledged on cross-examination that at no time had he kept any document of inventory or valuation of the petroleum oil and natural gas reservations or oil leases acquired by him, and in particular that he had kept no inventory record or account as required by the Act. During the period in issue here, the Respondent was required to report any profit from his business, and if he had used the inventory method he would have been obliged to calculate such profit on the basis of cost or market whichever was the lesser. This was so prior to the enactment of s. 14 of the Act and of reg. 1800 because that was the law as stated in the Anaconda case.

As I have said, the Respondent did not in fact adopt the inventory method of computing income either prior to, upon, or after the enactment of reg. 1800, and under the provisions of s. 14(1) of the Act he could not have adopted that method without the permission of the Minister. That no such permission was granted is obvious from the fact that the respondent first put forward his market values at the trial before the Exchequer Court. Moreover if he had been keeping inventories on the "market value basis", he should have reported income in respect of his transactions in earlier years, which he failed to do. The repeal of s. 14(1) in 1958 could not have the retroactive effect of permitting him to change the method of computing income after 1958 without the permission of the Minister in respect of years that were past when the sub-section was repealed.

I would allow the appeal, dismiss the cross-appeal, and restore the assessments made by the Minister for the respondent's 1952, 1953 and 1955 taxation years. The appellant is entitled to his costs here and in the Exchequer Court.

Appeal allowed with costs; cross-appeal dismissed with costs.

Solicitor for the appellant: E. S. MacLatchy, Ottawa.

Solicitors for the respondent: Chambers, Saucier, Jones, Peacock, Black, Gain & Stratton, Calgary.