Cargill Ltd. v. R., [1996] 2 CTC 2102, 97 DTC 72

Sarchuk J.T.C.C.: — This is an appeal by Cargill Limited from reassessments of tax in respect of its 1980 and 1981 taxation years. At the commencement of the hearing counsel for the parties filed a Agreed Statement of Facts. It reads as follows:

Overview

1. The Appellant, Cargill Limited (“Cargill”), is a Canadian resident corporation which is the continuation of Cargill Grain Company, Limited.

2. The facts described herein only apply to Cargill’s 1980 and 1981 taxation years, except where context indicates otherwise.

3. The taxation years in issue are Cargill’s taxation years ending respectively on May 31 in 1980 and 1981.

4. Cargill is a licensed primary elevator operator (“Elevator Operator”) and grain dealer and, inter alia, operates primary elevators (“Elevators”) throughout Western Canada.

5. Cargill provides two types of storage facilities to grain Producers (“Producers”):

(a) one which places grain of equivalent grade and quality delivered by

several Producers in a common “bin” (“Commingled Grain”) and

(b) one, which preserves the identity of the grain delivered by a Producer by “specially binning” that grain in a separate container.

This appeal relates only to Commingled Grain.

6. Cargill acts as agent for the Canadian Wheat Board for certain kinds and grades of grain. The matter at issue does not relate to grain delivered to Cargill acting as agent for the Canadian Wheat Board (the issue of the availability of an inventory allowance in respect of Canadian Wheat Board grain has been decided by the Federal Court of Appeal in Saskatchewan Wheat Pool v. R., [1985] 1 C.T.C. 31; leave to appeal to the Supreme Court of Canada denied).

7. Grain is a fungible commodity and is tangible property. The price a Producer receives for grain depends on the quantity, kind and grade delivered and the location of the Elevator to which delivery is made. There is no significant difference between the prices offered by different Elevator Operators in the same location (“Location Market Price”).

8. Cargill always tries to maximize its present and future profit from the sale of grain. Due to general market conditions, Cargill’s profit margin is generally similar with respect to sales from different locations. However, its profit margin may, and does frequently, differ from location to location due to market conditions prevailing in particular locations.

Producers Options

9. When a Producer delivers grain which will be commingled the Producer has two options:

(a) The Producer may, at the time of delivery, establish the price for the grain at that date and receive payment for it. In such a case, he is issued a “Cash Purchase Ticket” for the purchase price of the grain at the then current Location Market Price. Grain for which a Cash Purchase Ticket has been issue is hereinafter referred to as “Purchased Grain”;

(b) The Producer may simply deliver the grain to the Elevator, in which case a “price” for the grain is not established at that date. In such case he is issued a “Graded Storage Receipt” indicating the quantity, kind and grade of the grain delivered. Grain for which Graded Storage Receipts have been issue is hereinafter referred to as “Storage Grain”.

10. A Cash Purchase Ticket is a type of negotiable instrument issued to a Producer in full payment for grain delivered. Once a Cash Purchase Ticket has been issued, a Producer has no further right with respect to the grain delivered other than to receive payment in the amount specified in the Cash Purchase Ticket. A Producer will usually take a Cash Purchase Ticket if, inter alia, he believes that the maximum Location Market Price has been reached or if he needs the cash for other reasons.

11. A Producer may prefer to obtain a Graded Storage Receipt (as opposed to a Cash Purchase Ticket) for a number of reasons, including:

(a) The Producer may prefer to obtain only one Cash Purchase Ticket once he has delivered all grain he intends to deliver;

(b) The Producer may believe the Location Market Price for the grain delivered has not yet peaked;

(c) The Producer may want to defer the receipt of payment for his grain for tax purposes; or

(d) The Producer may want the grain referred to in the Graded Storage Receipt for feed grain, but have insufficient storage facilities on his own farm for such purposes.

Movement and Sale of Grain

12. From the time of delivery of grain to be commingled, Cargill mixes, upgrades, forwards and otherwise deals with Commingled Grain to improve the economic yield of the grain. Cargill solely benefits from any improvements or suffers the loss from degradation in such handling of the grain.

13. Cargill moves grain from its individual Elevators to terminal elevators as soon as the means of transportation allow in order to: facilitate an efficient rail transportation system, to facilitate sales, and to keep its Elevator system from becoming engorged.

14. In moving grain to terminal elevators, Cargill first moves grain from the

individual Elevators that are most engorged with Commingled Grain.

15. Cargill offers all Commingled Grain for sale as soon as it receives delivery of it.

16. Throughout the relevant time, it was industry practice to sell Storage

Grain and to deal with Commingled Grain to improve its economic yield.

Pricing or Redemption of Storage Grain

17. Where a Producer has received a Graded Storage Receipt, the Producer may subsequently decide either to “Price” his Graded Storage Receipt, or he can have the same quantity, kind and grade of grain as referred to in the Graded Storage Receipt returned to him. (The latter entitlement is referred to as “Redemption” or “Redemption of a Graded Storage Receipt”.)

18. Since grain is a fungible commodity and since Storage Grain is commingled with other Purchased and Storage Grain, the Producer is not entitled to Redemption of the exact same grain delivered.

19. The Pricing of grain referred to in paragraph 17 herein is a transaction by which a Producer surrenders the Graded Storage Receipt to Cargill, and is then issued a Cash Purchase Ticket for an amount normally equal to the current Location Market Price for the quantity, kind, and grade of grain specified on the Graded Storage Receipt.

20. Pricing or Redemption of Graded Storage Grain Receipts is done at the request of and at the time chosen by the Producer, but must be done at the issuing Elevator.

21. Cargill had the legal right to charge “Storage Fees” for the period of time, between the time of delivery and time of Pricing or Redemption of the grain. During the years in issue it was a policy of Cargill not to charge “Storage Fees”. The question of the Producer’s potential liability for Storage Fees is primarily a matter of competition.

22. In rare circumstances, a Producer may ask for Redemption of a Graded Storage Receipt. “Redemption” would entail the levy of elevation charges by Cargill and transportation costs in transporting the grain to another primary, terminal or processing elevator, or back to the Producer’s farm.

23. If Cargill had an insufficient quantity of grain in a location to satisfy a Producer’s Redemption request, Cargill agreed with the Producer in the vast majority of cases to Price the Graded Storage Receipt grain (perhaps at a premium). Alternatively, it could purchase grain locally either from another Elevator Operator or from another Producer in order to meet that Redemption request.

Cargill’s Method of Operation

24. A Producer may sign a “Waiver”, as set out in the Canada Grain Act waiving his right to demand Redemption of the quantity, kind and grade of grain referred to in the graded Storage Receipt.

25. An Elevator Operator may issue a “Notice” to a holder of a Graded Storage Receipt requesting the holder to take delivery of the grain referred to in the Graded Storage Receipt within 10 days. If after the expiry of 10 days the holder has not complied with the request, he is no longer entitled to Redemption of the quantity, kind and grade grain referred to in the Graded Storage Receipt.

26. Only in rare instances did Cargill obtain Waivers, and Cargill never gave Notice. It was not industry practice in the relevant years to obtain such Waivers or give such Notice.

27. In Cargill’s view the process of obtaining Waivers or giving Notice was very cumbersome and unnecessary since Redemption requests were rare occurrences. The Respondent does not agree that the process was cumbersome or unnecessary in light of the obligations imposed under the Canada Grain Act.

28. Cargill offers all Commingled Grain (whether covered by Cash Purchase Tickets or Graded Storage Receipts) for sale as soon as it is received, regardless of whether it is Purchased Grain or Storage Grain, or in the latter case, whether or not sufficient Waivers were obtained or Notices given.

29. For the purposes 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.

30. As a result of the practice referred to in paragraph 28, Cargill sometimes sells more grain of a kind from an individual Elevator than the quantity of Purchased Grain of that kind available at that Elevator. This sale of Storage Grain in excess of Purchased Grain creates what is referred to in these proceedings as a “Negative Inventory” at certain individual Elevators.

31. (a) Cargill sometimes sells more grain of a kind than the aggregate of all its Purchased Grain of that kind available in its Elevator system as a whole.

(b) Cargill never sells more grain of a kind than the aggregate of all Purchased and Storage Grain of that kind available in its Elevator system at any time.

(c) Cargill does not sell more grain of a kind from an individual Elevator than the aggregate of all Purchased Grain and Storage Grain of that kind available at that Elevator at any time.

32. Cargill’s storage capacity is substantially less than the annual volume of grain for which Cash Purchase Tickets and Graded Storage Receipts are issued. Had Cargill not sold Storage Grain, its storage system would have rapidly become engorged. It is the Respondent’s view that Storage Grain could only be legally sold by Cargill when a Waiver was obtained or Notice was given under the Canada Grain Act.

33. Cargill hedges its exposure to the fluctuations in the market price of grain with future sales contracts with respect to Purchased Grain and with future purchase contracts with respect to sold Storage Grain.

34, As Cargill does not have any economic exposure to the market price for unsold Storage Grain, it does not enter into any hedging contracts with respect to unsold Storage Grain.

35. Futures contracts are contracts whereby one agrees to buy or sell a fixed quantity, kind and grade of grain at a set price and a future date.

36. Futures contracts with respect to Sold Storage Grain permit Cargill to buy at determined price and future date, the same quantity, kind and grade of grain as it had sold, thereby limiting its liability with respect to sold Storage Grain.

37. Cargill has never effected a transfer of grain from one individual Elevator to offset a Negative Inventory in another, since the transportation costs involved would make this uneconomic. Grain may, on rare occasions, be transferred to other individual Elevators for other reasons such as cleaning or to permit the closing of an individual Elevator.

38. Cargill does not notify Holders of Graded Storage Receipts when Storage Grain is sold. Nor do Producers receive any interest or other compensation with respect to amounts Cargill receives upon its sale of Storage Grain.

Canadian Grain Commission

39. The Canadian Grain Commission (the regulatory agency established under the Canada Grain Act) was aware at all relevant times that:

(a) it was industry practise for Elevator Operators to sell Storage Grain and to deal with Commingled grain to improve its economic yield;

(b) some Elevator Operators had at times sold more of a kind of grain than the aggregate of all stocks of Purchased Grain of that kind in their Elevator system as a whole; and

(c) Redemption requests were rare occurrences.

The Canadian Grain Commission did not collect, on a regular basis, the type of information from which it could determine the extent to which the industry or individual Operators were selling storage grain. The Canadian Grain Commission was also not aware of the extent to which it was industry practice not to obtain Waivers or give Notice.

40. Under the Canada Grain Act, in order to obtain an Elevator Operator licence, Cargill had to post a bond in an amount determined by the Canadian Grain Commission. Such a bond is intended to provide security as to Cargill’s solvency and its ability to pay Producers, as well as to meet its other liabilities as provided for under the Canada Grain Act. The bonding requirement is based on the total storage capacity of the Elevator Operator.

41. Cargill is also required to insure the grain it holds against Storage Receipts. The Insurance policies obtained by Cargill, in compliance with the obligation imposed under the Canada Grain Act, stipulate that proceeds are payable to the Producers who hold Graded Storage Receipts. The actual proceeds under the Insurance policies were in fact paid to Cargill.

42. Cargill is obliged to furnish yearly statements to the Canadian Grain Commission indicating the quantity of grain it holds in its system. These figures do not differentiate between “Purchased Grain” and “Storage Grain”.

43. In 1985, the Canadian Grain Commission issued “Circular” No. 85-7 to all primary Elevator Operators. In the Circular, the attention of Elevator Operators was directed to the provisions of paragraph 49(b) of the Canada Grain Regulations and the industry was advised by the Canadian Grain Commission that “an operator of a primary elevator cannot dispose of any non-Board grain in his elevator for which there is a Graded Storage Receipt outstanding”. Thereafter, the Canadian Grain Commission also took additional measures to allow Elevator Operators and grain dealers to force Producers to price outstanding Storage Receipts. Elevator Operators, on their own accord, also started issuing new Graded Storage Receipts on the basis that the receipts must be priced within a limited number of days.

Cargill’s Method of Accounting for Inventory"

For the purposes of this Appeal Cargill’s accounting system can be summarized as follows:

44. The matter at issue does not concern the integrity and reliability of Cargill’s accounting system.

45. There are no specially defined Generally Accepted Accounting Principles (“GAAP”) with respect to grain accounting which would provide for different accounting practices in the grain industry from those which apply in business generally.

46. Cargill uses what is known in accounting terms as a perpetual inventory accounting system. Such systems are recognized as consistent with GAAP.

47. Cargill’s individual Elevator accounting systems consists of both financial records and quantity records. Cargill uses only the financial records in preparing its year-end financial statements; the quantity records are not required for such purposes.

48. The quantity records of the local elevators reflect the quantities and kind of “Purchased Grain” and “Storage Grain” received and sold at a local elevator. The grain accounting records contain no financial data.

49. Separate financial records are kept at Cargill’s head office for each of the individual Elevators. These records are combined by Cargill with the remainder of the corporate records maintained at Cargill’s head office at year-end for purposes of preparing year-end financial statements for income tax purposes (“Tax Financial Statements”) and external purposes (“Audited Consolidated Financial Statements”).

50. Audited Consolidated Financial Statements (which are presented to shareholders) are a consolidation of the financial statements of all companies within the Appellant’s (Cargill) group of companies throughout the world and therefore differ from the Tax Financial Statements which are prepared on a legal entity basis.

51. The financial records maintained for each Elevator for each kind of grain include, inter alia, a “Revenue Account”, “Receivables Account”, “Payables Account”, “Cost of Sales Account” and an “Inventory Account”.

52. For accounting purposes, Cargill assumes that it first sells Purchased Grain to the extent available at individual Elevators and that Storage Grain is only sold if quantities of Purchased Grain available at an individual Elevator are insufficient to cover the quantity of grain sold from that location.

53. The cost of Purchased Grain to Cargill is recorded as an increase (debit) in the Inventory Account of the Elevator upon the issuance of a Cash Purchase Ticket.

54. A cost is only entered in an Elevator’s Inventory Accounts when grain referred to in a Graded Storage Receipt is Priced by the Producer and thereby becomes Purchased Grain.

55. Cargill values each Elevator’s Inventory Accounts to Location Market Price on a monthly basis.

56. GAAP requires that, for the proper measurement of income, cost of sales must be matched against the revenues from those sales. Failure to do so would result in mis-stating income.

57. In order to properly measure its income in respect of sales of Storage Grain from individual Elevators, Cargill must recognize an “Estimated Cost” of the Storage Grain which has been sold.

58. In these circumstances, such Estimated Cost is most appropriately equal to the Location Market Price.

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.

61. That Negative Position is equal to the Estimated Cost mentioned in paragraphs 57 and 58 herein.

62. Cargill has a legal obligation to Producers in respect of Storage Grain.

63. The Negative positions at individual elevators represent the market value of sold Storage Grain at the end of each month and fiscal year at that elevator.

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 grain 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 the Income Tax Act with 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.

Differences in the presentation of Cargill’s 1980 and 1981 audited consolidated financial statements

71. The method of calculation used in determining the “cost” of Cargill’s inventory at year-end in Cargill’s 1980 Audited Consolidated Financial Statements differed from the method of calculation used in respect of its 1981 Audited Consolidated Financial statements.

72. In 1980, Cargill did not net any Negative Positions in individual Elevator Inventory Accounts (arising as described in paragraphs 59(d) and 60 herein) against positive positions in other Elevators’s Inventory Accounts for grain of the same kind (this “Location by Location Basis” of accounting for inventory is described in paragraph 68 herein). Pursuant to this method, an Estimated Liability for sold Storage Grain was recorded in Cargill’s balance sheet as an account payable in the amount of Negative Positions (as described in paragraphs 65 and 66 herein) arising in its individual Elevator’s Inventory Accounts.

74. This difference in methods of calculation was not material for purposes of preparing Cargill’s Audited Consolidated Financial Statements and does not affect the calculation of income.

Filing history and Accounting practices in respect of Inventory prior to 1980

75. In 1980, Cargill changed the method of calculation of its inventory for its Tax Financial Statements from a System Wide Basis to a Location by Location Basis. The Location by Location Basis of filing was consistently used by Cargill after 1980.

76. Prior to the 1980 taxation year, for the purposes of determining the “cost” of its inventory at year-end, Cargill used the System Wide Basis method of calculation in both its Audited Consolidated Financial Statements and Tax Financial Statements prepared for tax purposes.

77. Cargill’s initial filing position for income tax purposes, prior to 1980 taxation year, was to claim the 20(1 )(gg) inventory allowance on System Wide Basis.

78. In 1981 Cargill requested a change in its filing position in respect of the calculation of its inventory for inventory allowance purposes for its 1978 and 1979 taxation years. Revenue granted, but states that it did not review the requested change. Pursuant to that change in filing position, Cargill was allowed to file on a Location by Location Basis rather than by a System Wide Basis.

79. Cargill’s 1978 and 1979 taxation years are now statute- barred. However, Cargill’s 1980 and 1981 taxation years were not statute-barred when, in 1986, Revenue Canada reviewed the above filing position and issued the current reassessments under dispute in this action.

80. The calculation of its taxable profits for the year is unaffected by the question of whether the Appellant “nets” its inventories or not.

Issue for the Court to Determine

81. The only issue between the parties is whether, for purposes of calculating the inventory allowance provided for under paragraph 20(1 )(gg) of the Income Tax Act as 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 of the Statement of Agreed Facts) against the costs of Purchased Grain physically available in its Elevator system in 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 is 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.

In addition Mr. D. Gregory Doyle (Doyle) testified on behalf of the Appellant. A member of the Institute of Chartered Accountants of Manitoba, he has been since 1976 employed by Peat, Marwick, Thorne (Winnipeg) and has been a partner since 1982. He was involved in auditing the Appellant’s financial statements for the years in issue and is aware of all relevant accounting facts pertaining thereto. Doyle has also been involved in auditing the financial statements of grain companies other than Cargill. His qualifications were not contested.

An affidavit by Doyle was filed with the Court. In this affidavit he states, inter alia:

Matching Principle

6. Under Generally Accepted Accounting Principles, the cost of sales must be matched to the revenue from these sales in order to properly measure income.

7. No cost is initially entered by Cargill in its financial records in respect of Storage Grain.

8. Where Storage Grain has been sold by Cargill from a local elevator, pursuant to the principle stated in paragraph 6 herein, Cargill must recognize an estimated cost for that sold Storage Grain in order to properly measure its income from these sales of Storage Grain.

9. In these circumstances, that estimated cost, at any date, is most properly the price Cargill would pay to producers if the producers were to price their Graded Storage Receipt as of that date. That price is equal to the market price, for the location from which the Storage Grain was sold, for the quantity, kind and grade of Storage Grain sold.

Cargill's Liability for Sold Storage Grain

10. For accounting purposes, 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.

11. Pursuant to Cargill’s grain accounting practices, when Cargill sells Storage Grain from a location, the inventory account in the financial records maintained for that location will go into a negative position. This amount is equal to both the estimated cost of sold storage grain referred to in paragraph 9 herein and to the amount of Cargill’s liability to holders of Graded Storage Receipts for sold Storage Grain referred to in paragraph 12 herein.

12. Cargill has an [sic] liability to holders of Graded Storage Receipts in respect of sold Storage Grain which has to be recorded in its financial statements.

13. The best accounting treatment of such a liability, according to Generally Accepted Accounting Principles, is to reflect such liability as an account payable.

14. As a result of this principle, Cargill makes an adjusting entry to each local elevator financial record whose inventory account is in a negative position (as described in paragraph 11 herein) at year-end. The effect of this adjusting entry is to record the liability mentioned in paragraph 12 herein in the payables account, and to remove the negative position mentioned in paragraph 11 herein from the inventory account.

15. In order to give the most accurate reflection of the financial position of Cargill, it was most appropriate for Cargill to account for these liabilities to holders of Graded Storage Receipts for sold Storage Grain on a location by location basis.

16. These adjusting entries mentioned in paragraph 14 herein are reversed immediately after year-end.

17. The reversing entries mentioned in the above paragraph are but one of many reversing entries that Cargill needs to effect in order to avoid having to make complex calculations on an ongoing basis and to ensure that transactions are not recorded twice.

Differences in the presentation of Cargill's 1980 and 1981 audited consolidated financial statements

18. Cargill’s liability for sold Storage Grain was calculated on a location by location basis in its 1980 audited consolidated financial statements whereas it was calculated on a system-wide basis in its 1981 audited consolidated financial statements.

19. This difference in calculation was not material for purposes of preparing Cargill’s audited consolidated financial statements.

20. However, the most accurate calculation of this liability would be to calculate it on a location by location basis.

Appellant’s Submissions

The Appellant contends that it has claimed an inventory allowance in respect of grain acquired through the issuance of cash purchase tickets and physically on hand at the commencement of the relevant taxation years. This allowance was limited to the aggregate of such grain at each of its individual elevator locations. The Appellant says it did not include storage grain, whether sold or unsold, in its year-end balance sheet inventory figures for purposes of calculating the amount of the inventory upon which the allowance is claimed.

It is argued that the issue between the parties does not relate to the fact that the amount of purchased grain on which the inventory allowance has been claimed has not been established. According to counsel for the Appellant the problem arises because the Minister has taken the position that when it sells storage grain, as it does regularly in its business, it must “make up” such sales by netting them against the purchased grain which it has on hand within its system. However the Appellant contends that it conducts its grain business on a location-by-location basis, not on a system- wide basis. Its entire accounting system is based on a location-by-location computation of grain quantities and its financial records as a whole are simply the aggregation of the individual elevator operations. Furthermore, it is the Appellant’s practice to hold storage grain for sale from the moment it is delivered to the elevator. Such storage grain is sold with or without the consent of the producer holding a graded storage receipt. Whether such grain should have been sold without the Appellant first having obtained a waiver from the producer or given a notice before doing so pursuant to the provisions of the Canada Grain Act is irrelevant. What is relevant is what it actually did, rather than whether it may not have been in compliance with the technical provisions of the statute. Counsel submits that the reality of the Appellant’s business is that it is a series of separate small businesses, each of which has profits or losses and each of which has liabilities to holders of graded storage receipts which only it can be called upon to fulfil. Accordingly, system-wide “netting” is neither feasible nor possible.

It is not disputed that purchased and storage grain are commingled, and it is impossible to distinguish between them. Only the grain accounting records (which are not financial records, but merely a mechanism for tracking the physical quantities of grain in the system) maintain a distinction between purchased and storage grain. In these records no recording of cost or value occurs; they are limited to physical quantities of grain. On the other hand, in the financial records of the Appellant, only purchased grain is accounted for in relation to cost, which cost is adjusted to market at the end of each month, since at that point it is the only grain in respect of which the Appellant has incurred a cost. There is, however, one exception: that is in the case of storage grain which has been sold at a particular location. In that case the Appellant’s accounting system generates a “cost” of the storage grain which has been sold, which is the market value of that grain as of the date the financial statements are prepared. That market value is the amount which the Appellant would have to pay to replace the grain if the producer insisted on redemption of the graded storage receipt or the amount which it would have to pay the producer through a cash purchase ticket if the producer elected to price the grain at that time. This amount is reflected in the financial records as a liability to producers at that location. It follows, according to the Appellant, that the value of sold storage grain is relevant in computing the Appellant’s income otherwise the gross proceeds of sale would be brought into income but would not be matched by a cost of that which has been sold. Failure to apply the matching principle would lead to an overstatement of income in the year of sale.

Counsel for the appellant contends that the computation of the Appellant’s income (from an accounting perspective) for the taxation years under appeal is not affected by the present dispute. Furthermore, the appellant’s accounting system is agreed to possess the appropriate integrity and reliability. This accounting system took into account the sale of storage grain at particular locations which fact, it is argued, reveals a contradiction in the Minister’s position in that he accepts the Appellant’s computation of income in accordance with the financial statements, but when it comes to computation of the inventory allowance the same accounting system is no longer acceptable to the Minister. The Appellant submits that it meets all the statutory requirements for the deduction of an inventory allowance as claimed and argues that there is no basis for the arbitrary reduction of the deduction particularly one which relates not to the inventory of purchased grain but instead to unrelated sales of storage grain.

Respondent’s Position

The purpose of paragraph 20(1 )(gg) of the Income Tax Act (the “Act”) was to counteract the impact of inflation on the laid-down costs incurred by taxpayers in the year. In order to take advantage of the calculation permitted by paragraph 20(1 )(gg) of the Act, the Appellant is required to first establish that the property is described in an inventory which is owned by the Appellant; second, that the valuation of the inventory to ascertain the “cost amount” is “for the purpose of computing income”; third, that being so, reference must be made to subsection 10(1) of the Act since it provides that for the purpose of computing income from a business, the property described in an inventory shall be valued at the lower of cost or market. [R. v. Dresden Farm Equipment Ltd. (sub nom. Canada v. Dresden Farm Equipment Ltd.) [1989] 1 C.T.C. 99, 89 D.T.C. 5019 (F.C.A.)]

The Respondent contends that the Appellant does not have a proprietary interest in the inventory since the storage grain it holds is the property of the producer. Relying on a number of provisions of the Canada Grain Act and Regulations (Grain Act) counsel argues that the Appellant is markedly restricted with respect to its ability to sell storage grain. [Canada Grain Act, S.C. 1970-71-72, subsections 2(1), 2(11), 2(19), 2(23), 2(36), 2(47), 40(1), 41(1), 42(53), 54(1), paragraph 86(b). Canada Grain Regulations, subsections 22(1), 22(3), paragraph 49(b), 50.] Accordingly storage grain cannot be said to be property described in an inventory owned by the Appellant.

The Respondent also contends that the Appellant incurred no cost with respect to storage grain since it never purchased the goods, thus there could be no “cost amount” for inventory upon which the calculation permitted by paragraph 20(1 )(gg) of the Act could be made in the computation of the Appellant’s income from its business.

For the property to be described in inventory, its cost or value must be relevant in computing the income of the business. Storage grain is not relevant in computing the income of the Appellant since it has not incurred any cost with respect thereto. Although the Appellant’s position is that its system necessarily creates a cost when storage grain is sold at individual elevators otherwise its income would be overstated, the Respondent contends that this is not the case, since income is not reported on an elevator- by-elevator basis. Its income is reported on a system-wide basis with all revenues for sales reported when they are received. The cost with respect to these sales is taken on an ongoing basis by the accounting entries referred to in paragraph 59 of the Agreed Statement of Facts. While it is agreed that GAAP requires that for the proper measurement of income, cost of sales must be matched against the revenues from those sales, the Respondent argues that the income in issue is the income of the Appellant, not the income of each individual elevator, and while it may be correct that if one was in fact measuring or calculating the income at an individual elevator it would be necessary to recognize an estimated cost of the storage grain which has been sold. This would only apply if each individual elevator were in fact a separate business, which it is not. The Respondent submits that the phrase “the cost amount to the taxpayer” in paragraph 20(1 )(gg) of the Act means, in the factual situation present in this case, that “laid down costs” are the costs which are relevant. Such laid down costs would be reduced as sales take place in the Appellant’s entire elevator system as a whole and revenues are received with respect to those sales.

According to the Respondent the Appellant’s basic assumption for accounting purposes is that with respect to commingled grain it sells purchased grain before it sells any storage grain. In the taxation years in issue this assumption was only applied by the Appellant in respect of the inventory accounts for particular kinds of grain at individual locations. Prior to 1980 the assumption that the Appellant only sells storage grain after it has sold all purchased grain was applied by it on a system-wide basis. Counsel for the Respondent submits that a system-wide basis of accounting assumes there is only one set of financial records as described in paragraph 59 of the Agreed Statement of Facts for the Appellant’s system of elevators as a whole. In any event, counsel argues, no matter what basis of accounting for inventory is used, it is the aggregate of all revenues less the aggregate of all entries to cost of sales which ultimately determines the Appellant’s profit for the year. The Appellant, for the taxation years in issue, now takes the position that it should no longer calculate its inventory on the aggregate of all inventory accounts. By using what has been described as a location-by-location basis of inventory accounting the Appellant only reflects in its financial statements the aggregate of inventory accounts and a positive position and leaves out those accounts in a negative position. The Respondent contends this is incorrect and that the true effect of not netting the inventory accounts permits the Appellant to claim the inventory allowance in respect of storage grain sold.

Statutory Provisions

Paragraph 20(1 )(gg) reads as follows:

20(1) Notwithstanding paragraphs 18(l)(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 for sale in the ordinary course of the business

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

The definitions of “inventory” and “cost amount” set out in subsection 9(1), subsections 10(1) and (2) and subsection 248(1) are also relevant. These subsections read:

9(1) Subject to this Part, a taxpayer’s income for a taxation year from a business or property is his profit therefrom for the year....

10(1) For the purpose of computing income from a business, 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.

(2) Notwithstanding subsection (1), for the purpose of computing income for a taxation year from a business, the property described in an inventory at the commencement of the year shall be valued at the same amount as the amount at which it was valued at the end of the immediately preceding year for the purpose of computing income for that preceding year.

248(1 )In this 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;

“cost amount” to a taxpayer of any property at any time means, except as expressly otherwise provided in this Act,

(c) where the property was property described in an inventory of the taxpayer, its value at that time as determined for the purpose of computing his income....

Analysis

Briefly put, the issue is whether the Appellant may claim the inventory allowance provided for by paragraph 20(1 )(gg) of the Act by calculating the inventory on a location-by-location basis.

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; and 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.

Dresden Farm Equipment Ltd. [1] stands as authority for the proposition that a taxpayer must have a proprietary interest in goods in order to be entitled to claim the inventory allowance provided by paragraph 20(1 )(gg). As to the question of ownership the respective rights of the Appellant and the producers to storage grain are clearly delineated by the Grain Act. The effect of these provisions is that the producer upon delivery of storage grain to the Appellant becomes the holder of an “elevator receipt” which entitles him upon production of that receipt to the delivery of grain of the same kind, grade and quantity or to payment at the market price on the day the receipt is surrendered. The Appellant for its part is entitled to a storage charge (if it chooses to impose one) and may sell the grain (but only in accordance with the procedure set out in the Grain Act) to recover such charges. The Appellant is also entitled to require the holder of the elevator receipt to take redelivery. [S.S. 53 Grain Act] I note that failure to do so within the period of time prescribed in the notice merely disentitles the producer to future redelivery. [2] Other statutory and regulatory provisions preclude the Appellant from assigning, mortgaging, pledging or hypothecating any grain stored in the elevator for which elevator receipts are outstanding. [Regulation 49(b)] As well the Appellant is required by regulation to keep all grain in the elevator fully insured with the proceeds to be paid to the holders of elevator receipts for grain stored in the elevator. [Regulation 22(3)] In my view, it is the producers and not the Appellant who had property in the storage grain and it 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. [3] In this context, reference may be made to the following comment by Mr. Justice Joyal in Burrard Yarrows Corp. v. R. (sub nom. Burrard Yarrows Corp. v. The Queen), [1986] 2 C.T.C. 313, 86 D.T.C. 6459 at page 317 (D.T.C. 6461-62):

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 was 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).

and to the observation of Hugessen J. in Saskatchewan Wheat Pool v. R. (sub nom. Saskatchewan Wheat Pool v. The Queen): [1985] 1 C.T.C. 31, 85 D.T.C. 5034 at page 34 (D.T.C. 5036):

It could not seriously be suggested that grains delivered to the Pool for storage under a Graded Storage Receipt are sold to the holder of such receipt at the time they are taken out of storage. The relationship is not one of vendor and purchaser but of warehouseman and holder of a warehouse receipt.

I have concluded that the Appellant did not have a property interest in the storage grain sold by it in the taxation years in issue.

I am also satisfied that the Appellant incurred no cost with respect to sold storage grain since it never purchased the goods. Thus there could be no “cost amount” for inventory upon which the calculation permitted by paragraph 20(1 )(gg) could be made. [Dresden Farm Equipment Ltd. (supra, at page 110-12; D.T.C. 5027.] I agree with the Respondent’s contention that the 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 or may not occur depending on the position taken by a producer with respect to his storage grain. The Appellant has no role in that determination (excepting its statutory right to require the producer to take redelivery). This ongoing commitment to a producer to re-deliver the storage grain is not irrelevant. It was the Appellant’s legal obligation to do so if required. Furthermore, the liability alleged to be incurred by the Appellant to such a producer is not quantifiable because the true value of the storage grain can only be established if and when the producer decides to sell. [4] 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. The liability which the Appellant says it incurs at the time of its improper sale of the producer’s storage grain constitutes at best a non-deductible contingent liability within the meaning of paragraph 18( 1 )(e) of the Act. As such it is not a cost incurred in respect of property described in an inventory of the Appellant.

In the 1980 and 1981 taxation years the Appellant, for the purpose of claiming the inventory deduction pursuant to paragraph 20(i)(99) of the Act, included in its inventory both grain which was purchased from producers for which a cash purchase ticket was issued and amounts referred to as “negative inventories”. These amounts were recorded in the inventory account of a primary elevator when it sold more grain than was purchased at that particular location (i.e. storage grain). The Appellant’s claim for the inventory allowance was based on its year end inventory balance, which included adjusting entries to bring the “negative inventories” to a nil position. In those taxation years, the Appellant calculated its inventory on an elevator-by-elevator basis rather than on a system-wide basis. This calculation 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.

The Appellant argued that system-wide “netting” is not feasible or possible since its business does not lend itself to that form of operation. 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. The Appellant is only one business entity and all of the investment in the business is the investment in the Appellant, not in each individual elevator. The income from each and all of the elevators is that of the Appellant. There is no real basis why it becomes necessary for income tax purposes to treat each individual elevator as a separate business recording separate inventories on an elevator-by-elevator basis without netting the various inventory accounts. In fact that very treatment misstates the inventory position. I refer specifically to Schedule I - Cargill Limited Negative Inventory. [5] This document discloses that when inventory is calculated on the basis of inventory by location by commodity the inventory disclosed for 1980 was $31,670,520. However when calculated for the same period using the system wide basis the inventory was $6,668,219. For taxation year 1980 the difference between the two was approximately $25,000,000. [6]

I am of the view that failing to net its inventory accounts on a system wide basis distorts and in fact misstates the inventory position upon which the Appellant is entitled to calculate the allowance. Paragraph 20(1 )(gg) is a provision designed to provide certain taxpayers whose business requires them to invest in and carry an inventory of tangible goods other than real property some relief from the effects of inflation. [Per Teitelbaum J. in R. v. Mattabi Mines Ltd., [1989] 2 C.T.C. 94, 89 D.T.C. 5357 (F.C.T.D.) at page 5367 ([1992] 2 C.T.C. 8, 92 D.T.C. 6252 (F.C.A.)); Saskatchewan Wheat Pool v. The Queen, [1985] 1 C.T.C. 31, 85 D.T.C. 5035 (F.C.A.).] It was not enacted as an incentive for taxpayers to arrange their affairs so as to gain a tax benefit, but to aid those whose affairs had already been arranged in a particular way that led to an unfair tax disadvantage. [Bastion Management Ltd. v. Minister of National Revenue, [1995] 2 C.T.C. 252, 95 D.T.C. 5238, at page 5251.] That is not the case here.

Paragraph 20(1 )(gg) provides for an exception from the general rule for computing income for the purposes of taxation. A taxpayer seeking to benefit from such exception must bring himself clearly within the language of the Statute. For the reasons expressed, the Minister’s assessment with respect to the inventory allowance claimed by the Appellant is upheld. The parties are agreed that a calculation error in the assessment in respect of the 1980 taxation year had the effect of improperly reducing the inventory allowance by the amount of $44,850. As agreed the appeal will be allowed to permit the Appellant an additional amount of $44,850 inventory allowance.

The Appellant is entitled to no other relief.

Appeal dismissed for the most part.