Jake Friesen v. Her Majesty the Queen, [1995] 2 CTC 369

Major J. (Sopinka, L-Heureux-Dubé, J J, concurring):—

Background

As set out in greater detail in the reasons of my colleague Iacobucci J., the appellant was a participant in an adventure in the nature of trade involving a piece of Calgary real estate known as the Styles Property. The Styles Property was acquired for the sole purpose of reselling it at a profit. The anticipated profit was to be split between a charitable donation to Trinity Western College and other organizations and the investors in their personal capacity. Contrary to the expectations of the investors, real estate prices fell instead of rising.

The appellant claimed business losses on his 1983 and 1984 tax returns relying on subsection 10(1) of the Income Tax Act, S.C. 1970- 71-72, c. 63, which permits inventory to be valued at the lower of cost or market value. The Minister of National Revenue disallowed this claim.

II. Analysis

A. Introduction

The narrow issue in this appeal is whether land held for resale as an adventure in the nature of trade may be valued as inventory under subsection 10(1) of the Income Tax Act. I have read the reasons of my colleague Iacobucci J., and, with respect, I disagree with his conclusion. In my opinion the provisions of the Income Tax Act allow land held as an adventure in the nature of trade to be valued as inventory under subsection 10(1) and therefore I would allow this appeal.

B. The Scheme of the Income Tax Act

It is necessary to make some comments on the basic scheme of the Income Tax Act given my analysis of the issue raised in this appeal.

Section 3 of the Income Tax Act sets out the ground rules for the computation of a taxpayer’s income for a taxation year. Section 3 recognizes two basic categories of income: ’’ordinary income” from office, employment, business and property, all of which are included in s. 3(a), and income from a capital source, or capital gains which are covered by s. 3(b). The whole structure of the Income Tax Act reflects the basic distinction recognized in the Canadian tax system between income and capital gain.

Subdivision b of Division B of the Act entitled ’’Income or Loss from a Business or Property” contains all the rules which govern business and property income. The leading section in this subdivision is section 9 which provides that a taxpayer is taxable on the profit for a business or property for the year. Profit is not defined in the Income Tax Act.

Unlike business or property income which is fully taxable, income from capital sources was not subject to tax at all in Canada until 1972 and is still partially protected from taxation. Subdivision c of Division B of the Act entitled "Taxable Capital Gains and Allowable Capital Losses" contains all of the rules which apply to income derived from a capital source. The leading section in this subdivision is s. 38 which provides that a taxpayer is taxable on 3/4 of the capital gain from the disposition of property in the year.

The distinction between income from office, employment, business and property sources and that from a capital source and the preferential treatment of the latter has long been the subject of academic criticism: see

B. J. Arnold, T. Edgar and J. Li, eds., Materials on Canadian Income Tax (10th ed. 1993), at page 297; and Report of the Royal Commission on Taxation (Carter Report) (1966), vol. Ill, at pages 62-67. The distinction between amounts of an income nature and those of a capital nature was imported into the Canadian tax system from the United Kingdom where it is believed to have originated from a primarily agricultural economy whose concept of income was the fruits of productive source. In spite of the uncertainty of origins of the distinction between capital gain and other income and the criticisms of preferential tax treatment of capital gain, differential tax treatment of capital gain and income remains a fundamental feature of the Canadian taxation system.

C. Principles of Interpretation

The central question on this appeal of whether the appellant is entitled to take advantage of the inventory valuation method in section 10 of the Act involves a careful examination of the wording of the provisions of the Act and a consideration of the proper interpretation of these sections in the light of the basic structure of the Canadian taxation scheme which is established in the Income Tax Act.

In interpreting sections of the Income Tax Act, the correct approach, as set out by Estey J. in Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536, C.T.C. 294, D.T.C. 6305, is to apply the plain meaning rule. Estey J. at page 578 (C.T.C. 316, D.T.C. 6323) relied on the following passage from E.A. Driedger, Construction of Statutes (2nd ed. 1983), at page 87:

Today there is only one principle or approach, namely, the words of an Act are to be read in their entire context and in their grammatical and ordinary sense harmoniously with the scheme of the Act, the object of the Act, and the intention of Parliament.

The principle that the plain meaning of the relevant sections of the Income Tax Act is to prevail unless the transaction is a sham has recently been affirmed by this Court in Canada v. Antosko, [1994] 2 S.C.R. 312, [1994] 2 C.T.C. 25, 94 D.T.C. 6314. lacobucci J., writing for the Court, held at S.C.R. pages 326-27 that:

While it is true that the courts must view discrete sections of the Income Tax Act in light of the other provisions of the Act and of the purpose of the legislation, and that they must analyze a given transaction in the context of economic and commercial reality, such techniques cannot alter the result where the words of the statute are clear and plain and where the legal and practical effect of the transaction is undisputed: Mattabi Mines Ltd. v. Ontario (Minister of Revenue), [1988] 2 S.C.R. 175, [1988] 2 C.T.C. 294, at S.C.R. page 194; see also Symes v. Canada, [1993] 4 S.C.R. 695, [1994] 2 C.T.C. 40, 94 D.T.C. 6001.

I accept the following comments on the Antosko case in P.W. Hogg’s Notes on Income Tax (3rd ed. 1994), Section 22.3 "Strict and purposive interpretation", at page 22:12:

It would introduce intolerable uncertainty into the Income Tax Act if clear language in a detailed provision of the Act were to be qualified by unexpressed exceptions derived from a court’s view of the object and purpose of the provision....[The Antosko case] is simply a recognition that "object and purpose" can play only a limited role in the interpretation of a statute that is as precise and detailed as the Income Tax Act. When a provision is couched in specific language that admits of no doubt or ambiguity in its application to the facts, then the provision must be applied regardless of its object and purpose. Only when the statutory language admits of some doubt or ambiguity in its application to the facts is it useful to resort to the object and purpose of the provision.

D. Plain Meaning of Section 10

The primary section whose interpretation is in dispute is section 10:

10(1) For the purpose of computing income from a business, the property described in an inventory shall be valued as its cost to the taxpayer or its fair market value, whichever is lower, or in such other manner as may be permitted by regulation.

The plain reading of this section is that it is a mandatory provision requiring a taxpayer who computes income from a business to value the inventory at the lower of cost or market value or as permitted by regulation. Thus, prima facie, the taxpayer must meet two requirements in order to use this section: the venture at issue must be a "business” and the property in question must be "inventory".

1. Is the Appellant's Venture a Business?

The definition of "business" in subsection 248(1) specifically includes an adventure in the nature of trade:

"business", includes a profession, calling, trade, manufacture or undertaking of any kind whatever and, except for the purposes of paragraph 18(2)(c), an adventure or concern in the nature of trade but does not include an office or employment;

[Emphasis added.]

An adventure in the nature of trade is not defined in the Act but is a term which has a meaning established by the common law.

Both parties in this appeal accept that the appellant’s real estate venture constitutes an adventure in the nature of trade. Nevertheless, it is useful to briefly examine the requirements for an adventure in the nature of trade since these requirements serve to limit the scope of ventures which are eligible to use the provisions of subsection 10(1).

The concept of an adventure in the nature of trade is a judicial creation designed to determine which purchase and sale transactions are of a business nature and which are of a capital nature. This question was particularly important prior to 1972 when capital transactions were completely exempt from taxation. The question was succinctly stated by Clerk L.J. in Californian Copper Syndicate v. Harris (1904), 5 T.C. 159 (Ex., Scot.), at page 166:

Is the sum of gain that has been made a mere enhancement of value by realising a security, or is it a gain made in the operation of business in carrying out a scheme for profit-making?

The first requirement for an adventure in the nature of trade is that it involve a "scheme for profit-making". The taxpayer must have a legitimate intention of gaining a profit from the transaction. Other requirements are conveniently summarized in Interpretation Bulletin IT-459 ’’Adventure or Concern in the Nature of Trade" (September 8, 1980) which references Interpretation Bulletin IT-218 "Profit from the Sale of Real Estate" (May 26, 1975) for a summary of the relevant factors when the property involved is real estate.

IT-218R, which replaced IT-218 in 1986, lists a number of factors which have been used by the courts to determine whether a transaction involving real estate is an adventure in the nature of trade creating business income or a capital transaction involving the sale of an investment. Particular attention is paid to:

(i) The taxpayer’s intention with respect to the real estate at the time of purchase and the feasibility of that intention and the extent to which it was carried out. An intention to sell the property for a profit will make it more likely to be characterized as an adventure in the nature of trade.

(ii) The nature of the business, profession, calling or trade of the taxpayer and associates. The more closely a taxpayer’s business or occupation is related to real estate transactions, the more likely it is that the income will be considered business income rather than capital gain.

(iii) The nature of the property and the use made of it by the taxpayer.

(iv) The extent to which borrowed money was used to finance the transaction and the length of time that the real estate was held by the taxpayer. Transactions involving borrowed money and rapid resale are more likely to be adventures in the nature of trade.

The factual record in this case reveals a legitimate "scheme for profitmaking" with respect to the Styles Property. The appellant and his associates purchased the Styles Property with the intention of reselling it at a profit. The appellant and his associates planned to split the anticipated profit between designated charities and themselves on a pro rata basis. The persons involved in this venture were experienced business people who treated the transaction as a business venture. The land involved was undeveloped real estate which was suitable for resale but unsuitable as an income producing investment or for the personal enjoyment of the appellant or his associates.

I agree with lacobucci J. that the appellant meets the tests which have been established in the common law for an adventure of trade. The speculative venture in which the appellant was involved was clearly an adventure of a business nature rather than an investment of a capital nature. Like my colleague, I respectfully disagree with the trial judge (Friesen v. R., [1992] 1 C.T.C. 296, 92 D.T.C. 6248) and affirmed by Marceau J.A. ([1993] 2 C.T.C. 113, 93 D.T.C. 5313 (F.C.A.) that subsection 10(1) does not apply to a business which is an adventure in the nature of trade: see Bailey v.

[1990] 1 C.T.C. 2450, 90 D.T.C. 1321 at page 2459 (D.T.C. 1328) (T.C.C.). I affirm the succinct summary of the law contained in IT-218R:

The word "business" is defined in subsection 248(1) so as to include, inter alia, an adventure or concern in the nature of trade. This definition can cause an isolated transaction involving real estate to be considered a business transaction. As a business, any gain or loss which arises therefrom is, by virtue of section 9, required to be included in computing income or loss, as the case may be.

(2) Is the Styles Property "Inventory"?

In order to take advantage of the valuation method in subsection 10(1), a taxpayer must also establish that the property in question is inventory. A definition of "inventory" is contained in subsection 248(1) of the 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;

The first point to note about this definition of inventory is that property is not required to contribute directly to income in a taxation year in order to qualify as inventory. Provided that the cost or value of an item of property is relevant in computing business income in a year that property will qualify as inventory. Generally the cost or value of an item of property will appear as an expense (and the sale price as revenue) in the computation of income.

Reduced to its simplest terms, the income or profit from the sale of a single item of inventory by a sales business is the ordinary tracing formula calculated by subtracting the purchase cost of the item from the proceeds of sale. This is the basic formula which applies to the calculation of profit before the value of inventory is taken into account, as is made clear by Abbott J. in M.N.R. v. Irwin, [1964] S.C.R. 662, [1964] C.T.C. 362, 64 D.T.C. 5227 at page 664-665 (C.T.C. 364, D.T.C. 5228):

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 price over cost, subject only to any modification effected by the "cost or market, whichever is lower" rule.

Thus, for any particular item:

Income Profit = Sale Price - Purchase Cost.

It is clear from the formula above that the cost of an item of property sold by a business is relevant in computing the income from the business in the taxation year in which it is sold. As discussed above, an adventure in the nature of trade constitutes a business under the Act. Therefore, an item of property sold as part of an adventure in the nature of trade is relevant to the computation of the taxpayer’s income from a business in the taxation year of disposition and so is inventory according to the plain language of the definition in subsection 248(1).

The respondent argued that even if the Styles Property were inventory in the year of disposition it would not qualify as inventory in preceding years. Specifically the respondent urged that the phrase "relevant in com- puting a taxpayer’s income from a business for a taxation year" requires that the characterization of each item of property as inventory (or not) be made on an annual basis on the basis of the relevance of the item to the computation of income for that taxation year. The respondent relied on dicta to this effect in The Queen v. Dresden Farm Equipment Ltd., [1989] 1 C.T.C. 99, 89 D.T.C. 5019 (F.C.A.), at C.T.C. page 105, a case which held that a taxpayer may not deduct an inventory allowance on goods in which the taxpayer has no property but merely holds on consignment. The respondent’s argument on this point was accepted by Létourneau J.A. in the Federal Court of Appeal and is relied upon by lacobucci J. In my opinion, the interpretation urged by the respondent runs contrary to the natural meaning of the words used in the definition of inventory in subsection 248(1) and to common sense. The plain meaning of the definition in subsection 248(1) is that an item of property need only be relevant to business income in a single year to qualify as inventory: "relevant in computing the taxpayer’s income from a business for a taxation year". In this respect the definition of inventory in the Income Tax Act is consistent with the ordinary meaning of the word. In the normal sense, inventory is property which a business holds for sale and this term applies to that property both in the year of sale and in years where the property remains as yet unsold by a business.

In addition to the plain meaning of the words, several other considerations militate against the respondent’s interpretation of the definition of inventory in s. 248(1).

First, an examination of other definitions in the Income Tax Act reveals that there is a particular phraseology used in the definition of things, amounts or concepts which must be determined on an annual basis. The definitions of income (in section 9) and taxable capital gain (in s. 38), both of which must be determined on an annual basis, contain the characteristic phraseology which denotes that requirement:

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.

(2) Subject to section 31, a taxpayer’s loss for a taxation year from a business or property is the amount of his loss, if any, for the taxation year from that source computed by applying the provisions of this Act respecting computation of income from that source mutatis mutandis.

38. For the purposes of this Act,

(a) a taxpayer’s taxable capital gain for a taxation year from the disposition of any property is 3/4 of his capital gain for the year from the disposition of that property;

(b) a taxpayer’s allowable capital loss for a taxation year from the disposition of any property is 3/4 of his capital loss for the year from the disposition of that property;

[Emphasis added. ]

This formulaic phraseology appears innumerable times in the definitions in the Income Tax Act: see for example: section 3 "income"; section 5 "income from office or employment", "loss from office or employment", subsection 38(c) "allowable business investment loss"; section 39 "capital gain", "capital loss" and "business investment loss"; section 41 "taxable net gain"; subsection 63(3) "eligible child"; paragraph 127.2(6)(a) "sharepurchase tax credit"; paragraph 127.3(2)(a) "scientific research and experimental development tax credit"; subsection 248(1) "appropriate percentage", "balance-due day", and "gross revenue".

The respondent is asking this Court to interpret the definition of inventory as though it read:

"inventory" [for a taxation year] means a description of property the cost or value of which is relevant in computing a taxpayer’s income from a business for [the] taxation year;

The principal problem with the respondent’s interpretation is that the bracketed words do not appear in the definition in the Income Tax Act. The addition of these words to the definition effects a significant change to the sense of the definition. It is a basic principle of statutory interpretation that the court should not accept an interpretation which requires the insertion of extra wording where there is another acceptable interpretation which does not require any additional wording. Reading extra words into a statutory definition is even less acceptable when the phrases which must be read in appear in several other definitions in the same statute. If Parliament had intended to require that property must be relevant to the computation of income in a particular year in order to be inventory in that year, it would have added the necessary phraseology to make that clear.

The second problem with the interpretation proposed by the respondent is that it is inconsistent with the basic division in the Income Tax Act between business income and capital gain. As discussed above, subdivision b of Division B of the Act deals with business and property income and subdivision c of Division B deals with capital gains. The Act defines two types of property, one of which applies to each of these sources of revenue. Capital property (as defined in paragraph 54(b)) creates a capital gain or loss upon disposition. Inventory is property the cost or value of which is relevant to the computation of business income. The Act thus creates a simple system which recognizes only two broad categories of property. The characterization of an item of property as inventory or capital property is based primarily on the type of income that the property will produce.

As discussed above in the context of the definition of an adventure in the nature of trade, a comprehensive discussion of whether the sale of real estate will create income or capital gain can be found in Interpretation Bulletin IT-218R (September 16, 1986). The full title of this Interpretation Bulletin, "Profit, Capital Gains and Losses from the Sale of Real Estate, Including Farmland and Inherited Land and Conversion of Real Estate from Capital Property to Inventory and Vice Versa" emphasizes what the bulletin makes clear — real estate, like other forms of property, must fall into one of two basic categories under the Income Tax Act: inventory or capital property.

IT-218R clarifies that real estate which is held by the taxpayer as capital property may be used as personal-use property or as an investment for the purpose of gaining or producing income. The sale of this kind of property creates capital gain or capital loss. On the other hand, real estate which is purchased for profitable resale value is inventory which creates business income or loss. In determining whether the gains from a sale of real estate are income or capital particular emphasis is placed on the taxpayer’s intention at the time of the initial purchase of the real estate. Thus, a particular piece of real estate becomes either inventory or capital property in the hands of the taxpayer from the time of the original purchase.

The basic scheme of dividing property into one of two broad classes under the Income Tax Act is further assisted by subsections 13(7) and 45(1). These sections make specific provision for the conversion of real estate from capital property to inventory and vice versa in particular circumstances. As IT-218R explains, these circumstances arise only when the taxpayer’s intention and use of the property change subsequent to the initial purchase. Subsections 13(7) and 45(1) provide for the transfer to be made by means of a deemed disposition and reacquisition at fair market value. The deemed reacquisition at the time when the taxpayer’s intention with respect to the property is materially changed reflects the fact that the category of the property is determined according to the taxpayer’s intention at the time of acquisition.

The interpretation of "inventory" urged by the respondent is fundamentally incompatible with the statutory dichotomy between inventory and capital property in two respects. First, it would require a change in the characterization of particular items of property on the basis of annual relevance to income rather than according to the carefully tailored circumstances enumerated in ss. 13(7) and 45(1). Second, and more seriously, if an item of property is not relevant to income in a particular year, it does not convert to capital property unless it meets the requirements of ss. 13(7) and 45(1). Under the respondent’s proposed interpretation, an item of property would not be inventory in a year in which it was not relevant to income and thus would cease to exist for the purposes of the Income Tax Act in that year. This runs contrary to the scheme of the Act which classifies every piece of property owned by a taxpayer into one of the two broad classes. It creates an absurdity for items of property held for sale by a business to simply disappear from the scheme of the Act in years prior to sale.

Thirdly, the interpretation proposed by the respondent is inconsistent with the commonly understood definition of the term. In the ordinary sense of the term, an item of property which a business keeps for the purpose of offering it for sale constitutes inventory at any time prior to the sale of that item. The ordinary sense of the word also reflects the definition of inventory which is accepted according to ordinary principles of commercial accounting and of business. The Canadian Institute of Chartered Accountants has defined "inventory" as including, inter alia ”[i]tems of tangible property which are held for sale in the ordinary course of business": Terminology for Accountants (3rd ed. 1983), at page 81. In the specific context of real estate the Canadian Institute of Public Real Estate Companies states that land held for sale and land held for future development and sale is inventory: Canadian Institute of Public Real Estate Companies Recommended Accounting Practices for Real Estate Companies (November 1985), at page 204-1.

It was held in Bailey, and is accepted by Iacobucci J., that single pieces of real estate held for sale as an adventure of the nature of trade meet the definitions of inventory accepted by the commercial and accounting worlds. These definitions are consistent with the plain meaning interpretation of the definition in the Act which would require only that the item of property be relevant to the computation of income in a single year. However, the interpretation sought by the respondent is considerably more restricted because it would require a connection to income in years prior to sale. I agree with my colleague that the express wording of the Income Tax Act is capable of overruling accounting and commercial principles where it is sufficiently explicit. Nevertheless, the Court should be cautious to adopt a interpretation which is clearly inconsistent with the commonly accepted usage of a technical term particularly where an interpretation consistent with common usage is more natural on a plain reading of the definition.

The fourth problem with the interpretation of "inventory" proposed by the respondent is that the relationship between subsection 10(1) and the definition of "inventory" in section 248 would become circular. Specifically, reading subsection 10(1) and the definition of "inventory" proposed by the respondent in tandem would mandate the conclusion that subsection 10(1) applies if the property in question is inventory and that the property in question is inventory if subsection 10(1) applies. Under the respondent’s interpretation, if the inventory valuation method in subsection 10(1) applies then the cost or value of the property is relevant in computing income in the year in question and the property is inventory. On the other hand, if the valuation method does not apply then the cost or value of the property is not relevant to the computation of income and the property is not inventory. Interpretations which lead to circular definitions are contrary to common sense and should be avoided.

For all of the reasons discussed above, I conclude that the correct interpretation of the term of inventory in subsection 248(1) is the one which appears most obvious on a literal reading of the wording that an item of property is inventory if it is relevant to the computation of business income in a year. As a general principle, items of property sold by a business venture will always be relevant to the computation of income in the year of sale.

To the extent that Dresden Farm Equipment relies upon an interpretation which is inconsistent with this approach, I choose not to follow it as it does not deal directly with the issue raised in this case. Instead I prefer to follow the well-established line of cases which have specifically held as part of their rationes decidendi that real estate held for resale in an adventure in the nature of trade constitutes "inventory" for the purposes of subsection 10(1): Bailey; Weatherhead v. M.N.R., [1990] 1 C.T.C. 2579, 90 D.T.C. 1398 (T.C.C.); Van Dongen v. Canada, [1991] 1 C.T.C. 86, 90 D.T.C. 6633 (F.C.T.D.); Skerrett v. M.N.R., [1991] 2 C.T.C. 2787, 91 D.T.C. 1330 (T.C.C.); and Cull v. The Queen, [1987] 2 C.T.C. 63, 87 D.T.C. 5322 (F.C.T.D.). I endorse the approach taken in these cases of considering the definition of "inventory" in the context of the basic distinction between business income and capital gain. As Cullen J. stated in Van Dongen at page 87 (D.T.C. 6634):

The characterization of these properties as inventory is significant, because any gain or loss from the disposition of the inventory will be treated as business income or loss rather than capital gain or loss.

[Emphasis added.]

The Styles Property was relevant to the computation of business income in the taxation year of disposition and therefore it is correctly categorized as "inventory" for the purposes of the Income Tax Act both in that year and in preceding years.

(3) The Calculation of "Profit” in Section 10(1)

As noted earlier in these reasons, a taxpayer must establish that he or she is involved in a "business" and that the property in question is "inventory" before the valuation scheme in subsection 10(1) can be invoked. Since the appellant’s adventure in the nature of trade was a "business" and the Styles Property constituted "inventory", the appellant was prima facie entitled to make use of the valuation scheme set out in subsection 10(1). However, as Iacobucci J. has pointed out, the valuation scheme in subsection 10(1) does not provide an automatic deduction from income nor does it mandate that any taxpayer with inventory can deduct any loss on fair market value arising therefrom. Rather subsection 10(1) mandates how the valuation procedure must take place when ordinary commercial and accounting principles establish that the value of inventory is relevant to the computation of business income in a taxation year.

The computation of business income is rooted in section 9 of the Income Tax Act. Section 9 provides that the income from a business for a year is the profit and that loss is to be calculated by applying the same provisions mutatis mutandis:

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

(2) [Loss from a business or property] Subject to section 31, a taxpayer’s loss for a taxation year from a business or property is the amount of his loss, if any, for the taxation year from that source computed by applying the provisions of this Act respecting computation of income from that source mutatis mutandis.

The Act does not define "profit" nor does it provide any specific rules for the computation of profit. Tax jurisprudence has established that the determination of profit under section 9(1) is a question of law to be determined according to the business test of "well- accepted principles of business (or accounting) practice" or well- accepted principles of commercial trading" except where these are inconsistent with the specific provisions of the Income Tax Act: see Gresham Life Assurance Society v. Styles, [1892] A.C. 309, 3 Tax Cas. 185 (U.K.H.L.); Neonex Int’l Ltd. v. The Queen, [1978] C.T.C. 485, 78 D.T.C. 6339 (F.C.A.); Symes v. Canada, [1993] 4 S.C.R. 695, [1994] 2 C.T.C. 40, 94 D.T.C. 6001, at page 723 (D.T.C.) 6009; Materials on Canadian Income Tax, at page 291; and KR. Huot, Understanding Income Tax for Practitioners (1994-95 edition), at page 299,

In calculating profit under section 9 of the Income Tax Act, a business calculates its gross profit and then subtracts allowable operating and nonoperating expenses. Under well-accepted principles of business and accounting practice gross profit for a business involved in sale is calculated according to the following formula:

Gross Profit Proceeds of Sale - Cost of Sale

and:

Cost of Sale = (Value of Inventory at beginning of year + Cost of Inventory acquisitions) - Value of Inventory at end of year.

Thus for a business involved in sales:

Gross Profit = Proceeds of Sale - [(Value of Inventory at beginning of year + Cost of Inventory acquisitions) - Value of Inventory at end of year.]

This formula was originally designed for companies with significant inventories at a time when computer technology did not allow the specific cost of each item to be easily traced on an individual basis. The formula allowed a business to calculate gross profit on the basis of a single inventory valuation each year rather than keeping detailed ongoing records. It is rather an anachronism in an age where most businesses with significant inventories carefully track both the cost and sale price of each item by means of computer technology. A moment of thought, however, will lead to the conclusion that this formula is merely a convenient shorthand for a two-step process which recognizes profit as the excess of sale proceeds over value for inventory sold in the year and the change in the value of inventory still on hand at the end of the year. Thus the formula could equally be expressed as:

Gross Profit (Proceeds of Sale - Value of Inventory Sold) + Change in Value of Unsold Inventory.

Thus, under well-accepted principles of commercial and accounting practice the value of unsold inventory is relevant to the computation of business income. This is based on the accounting presumption that holding onto unsold inventory represents a cost to a business. This is a principle generally applicable to the calculation of business income from businesses of any size and with inventories of any size although the popular formula was originally created as a convenient shortcut for the computation of business income for companies with large inventories.

Subsection 10(1) of the Income Tax Act recognizes the well accepted commercial and accounting principle of requiring a business to value its inventory at the lower of cost or market value. This principle is an exception to the general principle that neither profits nor losses are recognized until realized. As well, it represents a departure from the general principle that assets are valued at their historical cost. The underlying rationale for this specific exception to the general principles is usually explained as originating in the principle of conservatism. The generally accepted accounting principle applicable in this situation is explained by D.E. Kieso et al., Intermediate Accounting (2nd ed. 1986), at pages 421-22, as follows:

A major departure from adherence to the historical cost principle is made in the area of inventory valuation. Applying the constraint of conservatism in accounting means recognizing known losses in the period of occurrence. In contrast, known gains are not recognized until realized. If the inventory declines in value below its original cost for whatever reason ..., the inventory should be written down to reflect this loss. The general rule is that the historical cost principle is abandoned when the future utility (revenueproducing ability) of the asset is no longer as great as its original cost. A departure from cost is justified on the basis that a loss of utility should be reflected as a charge against the revenues in the period in which the loss occurs. Inventories are valued, therefore, on the basis of the lower of cost and market instead of on an original cost basis.

[Emphasis added.]

As the above passage makes clear, the well-accepted principle of conservatism which underlies the valuation method in subsection 10(1) represents not only an exception to the realization principle (in cases of loss) but also an exception to the principle of symmetry since gains are not recognized until they are realized. Thus the taxpayer who is entitled to rely on subsection 10(1) is allowed to claim a business loss where the value of inventory falls but is not required to declare a business profit until the inventory is sold even if the value of the inventory rises.

In Ostime v. Duple Motor Bodies, [1961] 2 All E.R. 167 (U.K.H.L.), at pages 172-73, Lord Reid discussed the fact that generally items should be valued at historical cost but that the ‘lower of cost or market’ exception allows valuation at market value only if market value falls below cost. As Lord Reid pointed out, this lack of symmetry is not entirely logical but it represents good conservative accountancy and therefore has always been recognized as legitimate for taxation purposes:

If market value [rather than cost] were taken [in all cases], that would generally include an element of profit, and it is a cardinal principle that profit shall not be taxed until realised; if the market value fell before the article was sold the profit might never be realised. But an exception seems to have been recognised for a very long time; if market value has already fallen before the date of valuation, so that, at that date, the market value of the article is less than it cost the taxpayer, then the taxpayer can bring the article in at market value, and in this way anticipate the loss which he will probably incur when he comes to sell it. That is no doubt good conservative accountancy, but it is quite illogical. The fact that it has always been recognised as legitimate is only one instance going to show that these matters cannot be settled by any hard and fast rule or strictly logical principle.

[Emphasis added. I

The well-accepted business and accounting principles applicable to real estate held out as inventory are illustrated in the Canadian Institute of Public Real Estate Companies Handbook (September 1990), at sections 301 and 302:

301. INTRODUCTION

301.1 Real estate property in normally carried at the lower of cost and net realizable value if it is held as inventory and at cost if it held for investment purposes....

302. PROPERTY HELD AS INVENTORY

302.1 Property held as inventory should be stated at the lower of cost and net realizable value.

302.2 Land held for sale currently and land held for future development and sale is inventory and generally accepted accounting principles require that it be stated at the lower of cost and net realizable value.

(Note that "net realizable value" is the estimated selling price plus other estimated revenue reduced by the costs to improve and sell the property for the purposes of this analysis it is equivalent to fair market value.)

In summary, I conclude that the valuation method in subsection 10(1) is available for inventory held as part of an adventure in the nature of trade. The valuation method becomes relevant in any particular taxation year through the calculation of business income. Business income is calculated according to well-accepted commercial and accounting principles. According to these principles the value of inventory is relevant to the computation of income in years prior to sale since it comprises part of the cost of sale. According to the same principles inventory is to be valued at the lower of cost or market value, a specific exception to the general principle of realization. This exception is well accepted in the specific instance relevant to this appeal: the valuation of real estate inventory. This conclusion is fully consistent with the line of cases following Bailey. As Cullen J. states in Van Dongen at page 6639:

The later Bailey case appears to have settled the issue that land held as an adventure in the nature of trade is eligible for inventory write-down.

See also: Weatherhead, Skerrett, and Cull, supra

(4) The Common Law Restriction to Stock-in-Traders

The final argument of the respondent which should be addressed is that the inventory valuation method in subsection 10(1) is simply a codification of the common law and so is restricted to stock-in- traders. The respondent is correct to note that the common law recognized an exception to the realization principle by allowing inventory to be valued at the lower of cost or market value in the case of stock-in-trade. The common law in Canada is summarized in Minister of National Revenue v. Anaconda American Brass Ltd., [1956] C.T.C. 311, 55 D.T.C. 1220, a Canadian case which was appealed from this Court to the Privy Council. Viscount Simonds, speaking for the Privy Council stated at page 1224:

The income tax law of Canada, as of the United Kingdom, is built upon the foundations described by Lord Clyde in Whimster & Co. v. CIR (1925), 12 T.C. 812, 823, in a passage cited by the Chief Justice which may be here 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.

See also: Whimster & Co. v. CIR (1925), 12 T.C. 813 (Ct. Sess., Scot.), at page 823 (per Lord Clyde); and BSC Footwear Ltd. v. Ridgway, [1972] 2 All E.R. 534, A.C. 544 (U.K.H.L.).

Interestingly, the exception to the realization principle for stock-in- traders existed at common law without any statutory authorization and was based solely on ordinary commercial principles as they existed at that time. As discussed above, ordinary commercial principles would now suggest that all inventory be valued at the lower of cost or market value. The respondent, however, argues that subsection 10(1) is merely a codification of the common law as it existed in 1948 when the provision first appeared in the Income Tax Act. This argument is accepted by lacobucci J. who cites the comments of Abbott J. in Irwin as authority for this proposition.

I do not accept the argument that subsection 10(1) is merely a codification of ordinary commercial principles as they existed and were recognized by the common law in 1948. The obiter comments by Abbott J. in Irwin (at page 665, C.T.C. 365, D.T.C. 5229) to the effect that the former version of subsection 10(1), subsection 14(2), was merely a codification of the common law and that subsection 14(2) probably did not apply to single pieces of real estate were explicitly not made part of the ratio of the decision. Abbott J. did not give any consideration to the specific wording of subsection 14(2) which would have been a sine qua non to expressing an authoritative opinion on this point.

The appropriate focus in determining whether subsection 10(1) is a mere codification of the common law is upon the wording of the section itself. For ease of reference I quote that section once again:

10(1) For the purpose of computing income from a business, the property described in an inventory shall be valued as its cost to the taxpayer or its fair market value, whichever is lower, or in such other manner as may be permitted by regulation.

[Emphasis added.]

The common law rule was restricted to stock-in-traders. Subsection 10(1) on the other hand explicitly states that it applies to the inventory of a business. As discussed above, the word business is defined in the Act and specifically includes adventures in the nature of trade. If Parliament had wanted to simply codify the common law it could and would have used the term "ordinary trading business" or "stock-in-trader" both of which had judicially established definitions. Since Parliament chose to use the broader term "business", there is simply no basis on which to assume that subsection 10(1) was no more than a codification of a common law rule. To place such a judicial limit on the clear and unambiguous wording of the statute is a usurpation of the legislative function of Parliament.

In rejecting the principal argument of the respondent that subsection 10(1) is restricted to stock-in-traders, I must also, with respect, reject a number of other corollary arguments accepted by Iacobucci J.

First, I do not accept the argument that subsection 10(1) applies only to those who "carry on a business". A specific judicial interpretation has evolved for the phrase "carry on a business". That phrase is used in the Income Tax Act and is useful for determining the residence of a taxpayer (see section 253). Once again if Parliament had intended to restrict the ambit of subsection 10(1) to taxpayers which carry on a business it would have done so. I can do no better on this point than to quote with approval the response of Rip J.T.C.C. to this argument in Bailey at page 2461 (D.T.C. 1330):

Subsection 10(1) directs a property to be valued "for the purpose of computing income from a business". The phrase does not contemplate computing income only from carrying on a business, as suggested by counsel for the respondent. The phrases "carrying on a business" and carried on a business" are found in several provisions of the Act: see, for example, paragraph 2(3)(b) and subsections 115(1) and 219(1). "To carry on something," stated Jackett P. in Tara Exploration and Development Co. v. M.N.R., [1970] C.T.C. 557, 70 D.T.C. 6370 (Ex. Ct.) page 563 (D.T.C.6376), "involves continuity of time or operations such as is involved in the ordinary sense of a ‘business’". When this expression "carry on" is used in the Act, Parliament describes a continuity of time or operations with respect to the factual situation contemplated by the particular provision. Such continuity is not required in subsection 10(1) and its addition to that provision would add nothing to that provision’s ordinance.

I am also unable to accept the argument that because subsection 10(1) represents an exception to the general commercial and accounting principle of realization (see M.N.R. v. Consolidated Glass Ltd., [1957] S.C.R. 167, [1957] C.T.C. 78, 57 D.T.C. 1041, at page 174 (D.T.C. 1043), (per Rand J.)) and because this exception has been the subject of some academic criticism (see B. J. Arnold, Timing and Income Taxation'. The Principles of Income Measurement for Tax Purposes (1983), at pages 332-33), therefore the exception should be read more narrowly than the express words chosen by Parliament.

Although the inventory valuation scheme in subsection 10(1) represents an exception to the normal principle of realization, the exception itself is also a well- accepted commercial and accounting principle. While the realization principle applies with respect to capital property, it is subject to an exception in the case of inventory as Rand J. recognized in Consolidated Glass at page 174 (D.T.C. 1043):

"Losses sustained" and "profits and gains made" are clearly correlatives and of the same character; but how can profits and gains be considered to have been made in any proper sense of the words otherwise than by actual realization? This [sic] is no inventory valuation feature in relation to capital assets.

[Emphasis added.]

Furthermore, it is not the role of the court to restrict the interpretation of the clear statutory language because the exception created by the language has been the subject of academic criticism. Many sections of the Income Tax Act have been the subject of academic criticism. By way of example, the basic distinction between capital gain and income has been criticized in a tax text edited by the same Professor Arnold whose criticisms of conservative inventory valuation are relied upon by Iacobucci J.: see Materials on Canadian Income Tax, at page 297. Moreover, Professor Arnold’s criticisms of conservative inventory valuation are aimed at any exception to the realization principle and have no greater force when applied to an adventure in the nature of trade seeking to apply the exception on a single item of inventory than to stock-in-trader who seeks to apply the exception to hundreds if not thousands of items of inventory.

My colleague Iacobucci J. accepts the fact that subsection 10(1) applies to an adventure in the nature of trade. However, he would restrict the use of the valuation method in subsection 10(1) to stock-in-traders and those who ’’carry on" a business. This effectively prevents subsection 10(1) from being applied to an adventure in the nature of trade since by definition an adventurer in the nature of trade is neither a stock-in-trader nor does he "carry on" a business. The restriction placed upon this section by my colleague is based on his view that the object and purpose of the section is to provide a limited exception to the realization principle for stock-in- traders as was provided for at common law. However, as discussed at the beginning of these reasons, the clear language of the Income Tax Act takes precedence over a court’s view of the object and purpose of a provision. As Hogg stated in Notes on Income Tax at page 22:12:

It would introduce intolerable uncertainty into the Income Tax Act if clear language in a detailed provision of the Act were to be qualified by unexpressed exceptions derived from a court’s view of the object and purpose of the provision.

Therefore, the object and purpose of a provision need only be resorted to when the statutory language admits of some doubt or ambiguity. In this case, there is no doubt or ambiguity in the statutory language of subsection 10(1) which clearly applies to the inventory of a business including an adventure in the nature of trade. Although there is no need to resort to the object and purpose of the section in this case, I would note that the object and purpose of subsection 10(1) is fully consistent with allowing the valuation method in that section to be used for adventures in the nature of trade. Subsection 10(1) is specifically designed as an exception to the principles of realization and matching in order to reflect the well-accepted principle of accounting conservatism. In addition to recognizing accounting conservatism, the section is designed to stop a business from accumulating pregnant losses from declines in the value of inventory. The object and purpose of the section is to prevent businesses from artificially inflating the value of inventory by continuing to hold it at cost when the market value of that inventory has already fallen below cost.

Thus, it should not be assumed that Parliament is opposed to the inventory valuation exception to the realization principle simply because this exception allows unrealized losses in certain circumstances. Although the principal goal of the Income Tax Act is to raise national revenue, there are many competing demands and priorities which may shape tax policy in any given circumstances. Changes to the Income Tax Regulations, C.R.C. 1978, c. 945, made subsequent to the years at issue in this appeal strongly suggest that Parliament supports the principle of accounting conservatism which underlies the inclusion of inventory valuation in the determination of business income.

Section 10(1) provides that inventory must be valued at the lower of cost or fair market value or as otherwise permitted by regulation. The relevant regulation is Regulation 1801 which read as follows in the years in question on this appeal:

1801. [Valuation] Except as provided by section 1802, for the purpose of computing the income of a taxpayer from a business

(a) all the property 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.

The combined effect of subsection 10(1) and Regulation 1801 was explained in Interpretation Bulletin IT-473 "Inventory Valuation" (March 17, 1981 (as revised by Special Release dated December 5, 1986)) as follows:

Valuation of Inventory

4. Except where an individual has elected under subsection 10(6) to value inventory at nil in computing income from an artistic endeavour (see IT-504), subsection 10(1) of the Act and section 1801 of the Regulations provide three alternative methods of valuing inventory. These are:

(a) valuation at the lower of cost or fair market value for each item (or class

of items if specific items are not readily distinguishable) in the inventory;

(b) valuation of entire inventory at cost;

(c) valuation of entire inventory at fair market value.

Once a taxpayer has adopted, or has been required to adopt, one of the foregoing methods of valuing inventory, the taxpayer must continue to use that method on a consistent basis in subsequent years....

In 1989, Regulation 1801 was amended to read:

1801. [Valuation] Except as provided by section 1802, for the purpose of computing the income of a taxpayer from a business, all the property described an all the inventories of the business may be valued at its fair market value.

The 1989 amendment removed from the taxpayer the option of choosing to value inventory at historical cost and left only the more conservative methods of fair market value or the lower of cost or market value. The practical effect of this amendment is that in years following 1989 the taxpayer must declare a loss for taxation purposes in any year in which the fair market value of inventory falls below historical cost. The taxpayer no longer has the option of postponing this loss until the taxation year in which the loss is actually realized upon sale of the inventory. This is made clear in the "Regulatory Impact Analysis Statement" published along with the amended regulation, SOR/89-419:

This change, which is part of the measures announced by the Minister of Finance on January 15, 1987 relating to the application of losses and other deductions,will prevent a corporation from maintaining at cost inventories which have declined in value and thereby deferring the recognition of a loss by postponing the write-down to fair market value until after a change in control.

The Department of Finance release of January 15, 1987 which accompanied the introduction of this and other amendments to the Income Tax Act amply supports the appellant’s submission that this amendment was part of a concerted effort by the Department of Finance "to prevent trafficking in loss companies, that is, the acquisition by a profitable company of a "pregnant loss" company". Thus the Department had a valid policy reason to change the exception to the realization principle recognized by accounting conservatism from an optional to a mandatory requirement.

(5) Policy Considerations

Finally, I wish to address some of the policy concerns raised by counsel for the respondent.

The respondent has raised the concern that if subsection 10(1) inventory valuation applies to adventures in the nature of trade then the realization principle will only apply to capital property. The respondent also argued that the inventory valuation scheme in subsection 10(1) undermines the matching principle and gives rise to asymmetry since it allows for business losses when inventory declines in value but does not create taxable income where there has been an unrealized gain created by a rise in fair market value. All of these are valid criticisms of the inventory valuation scheme in subsection 10(1) but they cannot serve to thwart the intention of Parliament as expressed in the plain wording of the statute. Furthermore these criticisms are relevant to subsection 10(1) as a whole and have no particular application to adventures in the nature of trade. I cannot accept that applying subsection 10(1) to adventures in the nature of trade in accordance with the wording of that provision will cause significant harm especially when the respondent admits that the same section should be applied to all the inventory of all businesses with significant quantities of inventory.

Of greater concern is the interpretation proposed by the respondent which would create a whole new category of property unrecognized in the Act. This new class of property would attract the higher tax rate applicable to business income upon disposition but in years prior to disposition would be subject to the strictures which the realization, matching and symmetry principles impose upon the disposition of capital property. The Income Tax Act has established a system with two distinct categories of property inventory, which creates business income or loss, and capital property, which creates capital gain or loss. There are separate rules for each of these two categories of property and the taxpayer should be entitled to take the benefit as well as bear the burden applicable to the category into which the property falls. As Reed J. stated in Cull at pages 68 (D.T.C. 5325-26):

Had the partnership realized a profit from the venture, there can be no question that, on the basis of the Fraser line of cases, it would have been business income, and not a capital gain. Thus, the taxpayer should be allowed to treat the losses according to the same principle.

It is true that an annual appraisal of the property which constitutes inventory is required in order for the taxpayer to comply with the requirements of subsection 10(1). This, however, is simply a cost of doing business which must be borne by the taxpayer and it is no more burdensome than the same requirement which is imposed upon companies with far larger inventories to value that inventory each year. It should be remembered that the categorization of inventory (and hence subsection 10(1)) will only apply to those who meet the judicially established test for an adventure in the nature of trade, namely that the taxpayer has a trading or business intention with respect to the property. This categorization will not apply to taxpayers who own personal-use property or who hold property for the purpose of long-term investment since this is categorized as capital property.

The fear that allowing adventures in the nature of trade to take advantage of the inventory valuation in subsection 10(1) will lead to tax avoidance is unfounded. It is the rare taxpayer who will be faced with the situation of this appellant. In order to meet the test for an adventure in the nature of trade the taxpayer must have an intention to enter into a "scheme of profit-making". It is only where that scheme goes awry contrary to the intentions of the taxpayer that the taxpayer will be entitled to take advantage of the inventory valuation scheme in subsection 10(1) in order to recognize a business loss. Schemes entered into with the intention of creating a business loss would not qualify as adventures in the nature of trade and would be tantamount to a sham. Further, any loss claimed by a taxpayer when the fair market value falls below cost is subject to recapture by the Minister in the year of disposition if the fair market value rises again. For greater clarity, in the year of disposition the taxpayer is subject to taxation on the difference between the proceeds of sale and the lowest value ascribed to the inventory in the years prior to sale.

Sale - Cost of Sale [(Value of Inventory at beginning of year + Cost of Inventory acquisitions) - Value of Inventory at end of year] could lead to a negative cost of sale if the taxpayer chose to value inventory at fair market value as permitted by the current Regulation 1801. This problem can be obviated if the taxpayer chooses to value according to the lower of cost or fair market value method set out in subsection 10(1). This method only recognizes unrealized losses and never recognizes unrealized gains. It is only unrealized gains which could give rise to a negative cost of sale. A negative cost of sale is not, however, a problem confined to single items of inventory used in an adventure in the nature of trade where the fair market value method is chosen. Trading companies with larger inventories would face the same problem on a larger scale in any year where the increase in the market value of inventory on hand exceeds the value of new inventory purchased in a year.

Further, the fact that proceeds of sale may be zero in a given year does not cast any doubt on the applicability of the formula. In any year in which there is a loss under this formula, the proceeds of sale will be less than the cost of sale and the fact that proceeds of sale are zero simply reflects this general truth on a smaller scale. A taxpayer is statutorily entitled by section 9(2) to calculate loss using the same formula as would apply for the calculation of profit. Moreover, it is conceivable that a company with a large inventory could generate no sales in a year. It would be far more anomalous if the ability of such a company to recognize declines in the value of its inventory in a year were dependent on the existence of a single sale.

III. Conclusions

In summary I arrive at the following conclusions:

1. The appellant’s venture is a business pursuant to the definition in subsection 248(1) of the Act since it meets the test for an adventure in the nature of trade.

2. The Styles Property is inventory pursuant to the definition in subsection 248(1) because its cost or value is relevant to the computation of business income in a taxation year, namely the year of disposition.

3. The use of the valuation system established in subsection 10(1) and Regulation 1801 is governed by the application of well-recognized commercial and accounting principles. These principles establish that the value of inventory is relevant to the calculation of business income because it contributes to the cost of sale.

4. The valuation system established in subsection 10(1) and Regulation 1801 is a specific legislated exception to the principles of matching, realization and symmetry and reflects well- recognized commercial and accounting principles which aim to achieve a conservative picture of business income.

5. Neither the common law restriction to stock-in-traders nor other policy considerations can serve to override the explicit wording of subsection 10(1) which makes the valuation system therein applicable to all inventory used in the computation of business income.

6. The plain reading of subsection 10(1) would allow single items of inventory held as part of an adventure in the nature of trade to utilize the inventory valuation method contained therein. This conclusion is consistent with the basic dichotomy in the Act between income and capital and the different schemes for taxing each of these.

7. For all of the above reasons, the appellant was entitled to make use of the inventory valuation method in subsection 10(1) in order to recognize a business loss on the Styles Property in the taxation years in question, namely 1983 and 1984.

IV. Disposition

I would allow the appeal with costs in this Court and in the courts below and would direct that the Minister’s assessment for the taxation years 1983 and 1984 be set aside and that the appellant’s tax liability for the years in question be redetermined in a manner consistent with these reasons.

lacobucci J., (Gonthier, J, concurring):—This appeal involves a technical question of income taxation the disposition of which will have an important impact on the collection of tax revenues in Canada. It also has implications for many businesses because this Court is being asked to clarify how general commercial principles affect the determination of profit under income tax legislation.

The specific issue in this appeal is whether the vacant land purchased by the appellant, who is not engaged in an ordinary trading business but, instead, in an adventure in the nature of trade, is "inventory" in a "business" pursuant to s. 10(1) of the Income Tax Act, S.C. 1970-71-72, c. 63 and, hence, the land’s decline in value is deductible from profit as a business expense. The determination of this issue must, however, be made with an eye to the legal nature of "profit": in other words, whether it is consonant with income taxation principles and jurisprudence to permit a taxpayer to claim the fair market depreciation in the value of a piece of property as a business loss in taxation years in which the property was neither disposed of nor generated any income.

I conclude that the appellant fails to qualify for the valuation scheme established by subsection 10(1) and, therefore, cannot deduct the claimed expenses in the 1983 and 1984 taxation years.

1. Background

In January 1982, the appellant and several others bought a parcel of land (the "Styles Property") in the city of Calgary. The land was registered in the name of Trinity Western College. The College held the property as nominee for the group of investors. The property was acquired for the purpose of reselling it at a profit. Part of the anticipated profit was to be paid to the College and to other organizations as charitable donations and the balance of the profit was to be divided on a pro rata basis among the members of the investor group.

In the years immediately following its acquisition, the property substantially decreased in value and the mortgage thereon was eventually foreclosed in 1986. The appellant, relying on subsection 248(1), 10(1), section 9 and Regulation 1801 (as it then read) of the Income Tax Act, sought to deduct the decline in the fair market value of the land as a business loss in his 1983 and 1984 tax returns. The amounts claimed as business losses specifically relating to the Styles Property were $252,954 in 1983 and $25,800 in 1984. It should be noted that the amount claimed for 1983 was found to be incorrect and it was subsequently agreed by all parties that the correct sum should be $197,690. The appellant argued that he was entitled to make such fair market deductions because subsection 10(1) of the Act permits the use of such a valuation scheme should the initiative to purchase the land be deemed a "business" and should the land be defined as "inventory". I underscore that there was no disposition of the Styles Property in the 1983 or 1984 taxation years; in fact, the land remained completely undeveloped.

The Minister of National Revenue disallowed these business losses on the basis that the property was not "inventory in a business" within the meaning of ss. 10(1) and 248(1) of the Income Tax Act. The taxpayer appealed and both the Federal Court, Trial Division, [1992] 1 C.T.C. 296, 92 D.T.C. 6248 (F.C.T.D.) and the Federal Court of Appeal, [1993] 2 C.T.C. 113, 93 D.T.C. 5313, upheld the Minister’s disallowance of the losses. Leave to appeal was granted by this Court on April 28, 1994, [1994] 1 S.C.R. vii.

2. Relevant Statutory Provisions

Income Tax Act, S.C. 1970-71-72, c. 63

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

(2) [Loss from business or property] Subject to section 31, a taxpayer’s loss for a taxation year from a business or property is the amount of his loss, if any, for the taxation year from that source computed by applying the provisions of this Act respecting computation of income from that source mutatis mutandis.

10(1) [Valuation of inventory property] For the purpose of computing income from a business, the property described in an inventory shall be valued as 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) [Idem] 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 the preceding year.

248 (1) [Definitions] In this Act,

"business" includes a profession, calling, trade, manufacture or undertaking of any kind whatever and, except for the purposes of paragraph 18(2)(c), an adventure or concern in the nature of trade but does not include an office or employment;

"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; Income Tax Regulations, C.R.C. 1978, c. 945

1801. [Valuation] Except as provided in section 1802, for the purpose of computing the income of a taxpayer from a business

(a) all the property 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.

3. Judgments Below

Federal Court, Trial Division, [1992] 1 C.T.C. 296, 92 D.T.C. 6248

Rouleau J. dismissed the appellant’s appeal from the Minister’s reassessment. He first reviewed the case law which considered the definition of "business" and "adventure or concern in the nature of trade". In Bailey v. M.N.R., [1990] 1 C.T.C. 2450, 90 D.T.C. 1321, the Tax Court of Canada concluded that, for the purpose of subsection 10(1), "business" included "an adventure or concern in the nature of trade". As well, it was held that an isolated transaction may fall within the meaning of the word "business" in subsection 10(1). In Bailey it was also held that land acquired for resale in an adventure in the nature of trade could be classified as inventory for the purposes of subsection 10(1) and the land was eligible for an inventory "write down". This reasoning was also followed in Van Dongen v. Canada, [1990] 1 C.T.C. 86, 90 D.T.C. 6633 (F.C.T.D.), and Weatherhead v. M.N.R., [1990] 1 C.T.C. 2579, 90 D.T.C. 1398 (T.C.C.).

Rouleau J. noted that both parties conceded that the property in issue was an adventure in the nature of trade. However, he held that subsection 10(1) should not be interpreted in the manner suggested by the appellant. He emphasized that the Income Tax Act must be read as a whole. Thus, one must also consider other relevant provisions such as section 9 (meaning of income and loss) and subsection 248(1) (definition of inventory and business). Rouleau J. observed that a taxpayer’s profit must be determined in accordance with ordinary commercial and accounting principles and practices. It was held that these ordinary commercial principles and practices dictated that in any business the revenues should be matched against the expenses before any loss or profit is recognized. Generally, in the case of a trading business the profit (loss) equals the proceeds of sales less the cost of sales. The cost of sales is calculated by adding the value of the inventory at the beginning of the year to the cost of acquisitions during the year and subtracting the value of inventory at the end of the year. Rouleau J. then stated (at page 300 (D.T.C. 6251)):

Adopting this formula, a trading business can determine its costs of sales by calculating the change in the value of its inventory from the beginning to the end of a given period. The valuation of inventory can therefore affect the business’ gross profit. It is only to this extent that the inventory value becomes relevant. It is not by itself deductible from the taxpayer’s income.

Rouleau J. then referred to the decision in M.N.R. v. Shofar Investment Corp., [1980] 1 S.C.R. 350, [1979] C.T.C. 433, 79 D.T.C. 5347, for approval of this approach. It was emphasized that the computation of profit must be different for a business with relatively few transactions from that of a business engaged in continuous trading (at page 300 (D.T.C. 6251)):

For example, when there is but one item in inventory, profit or loss cannot be ascertained until the disposition of that particular item since, before disposition, there would be no revenues upon which to set off costs.

Rouleau J. held that in a business of few transactions the value of the inventory is not relevant in computing income until disposition. Thus, in a year when the property is not sold, it would not be included in the computation of income for tax purposes and subsection 10(1) would not apply. In the case at bar, the trial judge expressed the opinion that applying subsection 10(1) to an adventure in the nature of trade would lead to an absurdity since the Act does not tax unrealized profits and, accordingly, should not recognize unrealized losses. If the property had increased in value during the time it was held, there would be no taxation of the increased value until the moment of disposition. When considering section 9(1), Rouleau J. stated that it becomes apparent that an inventory "write down" of the property would not reflect the truest picture of the appellant’s income position.

Federal Court of Appeal, [1993] 2 C.T.C. 113, 93 D.T.C. 5313

(i) per Létourneau J.A. (majority)

The first issue discussed by Létourneau J.A. (writing for himself and Linden J.A.) was whether subsection 10(1) of the Income Tax Act applied to property held in an adventure in the nature of trade (at pages D.T.C. 5315): It is true that the inventory rule makes more sense in the context of an

ordinary trading business where goods are regularly bought and sold, making it difficult to keep track of the actual cost and sale price of each piece of property. The rule becomes then the only sound basis for computing the profits from the sales made in the year. Like Martland J. in M.N.R. v. Irwin, [1964] S.C.R. 662, C.T.C. 362, 64 D.T.C. 5227, at pages 664-665 (D.T.C. 5315), I doubt that there is a need for the rule to apply in a case like the present one when there is only One item and its actual costs and eventual sale price can easily be established. But I cannot conclude that its application to an adventure in the nature of trade necessarily leads to an absurdity. The fact that there are fewer transactions when it is a mere adventure in the nature of trade than there would be if it were an ordinary trading business does not render section 10 nugatory with respect to adventures in the nature of trade.

Thus, a property held for resale as an adventure in the nature of trade can be inventory under subsection 10(1) and is eventually eligible for inventory write-down. The only question is when this eligibility arises.

The issue, then, is whether the appellant could apply subsection 10(1) to the taxation years 1983 and 1984. It was noted that subsection 10(1) is not a specific provision overriding section 9 which establishes the basic rules for determining business income. Thus, section 10 becomes relevant only when it comes to computing business income; under section 9 such computation must relate to the actual taxation year. As well, the definition of "inventory" in subsection 248(1) is also linked to a taxpayer’s income from a business for a taxation year. Létourneau J.A. held (at page D.T.C. 5316):

As it appears from this decision of our Court [Canada v. Dresden Farm Equipment Ltd., [1989] 1 C.T.C. 99, 89 D.T.C. 5019 (F.C.A.)], a property is inventory in a taxation year because its cost or value is relevant in the computation of the business income that year. This is so in the year in which the property is sold. A property can be designated as inventory in a taxation year in which it is not sold if that property is included in the computation of the income produced by that business in that year. However, there has to be a computation of income, 1.e., profit or loss, from the business.

In cases where the business itself consists in the buying and reselling of a parcel of land as in the present case, there are no business receipts or proceeds, and therefore no possible determination of a business profit or loss within the terms of subsection 9(1), unless and until the land bought is disposed of. The valuation of inventory property according to subsection 10(1) then becomes relevant in assessing the profit, i.e., the business income, for that year because it determines the cost of sale. When there is more than one sale and more than one property held in inventory, the cost of sales is "computed by adding the value placed on inventory at the beginning of the year to the cost of acquisitions to inventory during the year, less the value of inventory at the end of the year". As can be seen from these provisions, the value of inventory is relevant in determining the profit of a business, and the cost of an inventory item, as the Supreme Court of Canada ruled, "can affect the ascertainment of the gross profit of the business, but is not, in itself, deductible from the taxpayer’s income".

[Emphasis in original.]

Létourneau J.A. concluded that, in the case at bar, the losses could not be claimed in 1983 and 1984 since there was no disposition of the property. As has been noted by the trial judge, this was consistent with the matching principle which requires the determination of income revenues to be paired with the expenditures made to earn them. Simply put, there was no business income in 1983 or 1984 to be matched with the losses claimed.

(ii) Marceau J.A. (concurring in the result)

Marceau J.A. shared his colleague’s view that the appeal should be dismissed but expressed reasons similar to those of the trial judge that the wording of subsection 10(1) does not apply to the case at bar. Otherwise, an application of the disposition would lead to an absurdity, this being a finding not arrived at by Létourneau J.A.

As to the wording of the provisions, Marceau J.A. stated that there is no calculation of income when no transaction that could lead to a receipt or expense is performed throughout the year. As well, the definition of "inventory" in section 248 as applied in s. 10 makes no sense when the whole business is itself composed of the one property alleged to be inventory.

The absurdity would result from the fact that the Act does not require a taxpayer who has claimed a loss for a decrease in the market value of a property acquired as an adventure in the nature of trade to pay tax in subsequent years where there are increases in the market value beyond original cost. Such increases are only taxable when the property is disposed of. Section 9 could hardly be construed as requiring the taxpayer to report income on his "continuing adventure" by apprising the property in each subsequent year. This would create obvious practical problems.

It was also held that the valuation of inventories flows from the carrying on of a business. The same cannot be said for an adventure in the nature of trade involving a single property. In closing, Marceau J.A. held (at page 611) that:

[S]ection 10, in the case of a trade, necessarily implies writing up and writing down inventory values, where the market value of the inventories are used in computing the cost of goods sold year after year, but not so in the case of a so-called adventure in the nature of trade, involving a sole property.

IV. Issue on Appeal

Can the appellant benefit from the valuation scheme established by subsection 10(1) and Regulation 1801 of the Income Tax Act with regard to the Styles Property and, if so, can the decline in the fair market value of that property be claimed as a business loss in each of the 1983 and 1984 taxation years?

V. Analysis

A. Introduction

In order for the appellant to prevail, he must satisfy this Court that the following two requirements are met:

1. He must demonstrate the he is eligible for the valuation scheme proposed by subsection 10(1) of the Act. In order to prove such eligibility, the appellant must show that his real estate transaction regarding the Styles Property was a business" pursuant to the definition set out in subsection 248(1) of the Acct.

and

2. Given that subsection 10(1) and Regulation 1801 simply create a valuation scheme and not an automatic taxation deduction, the appellant must show that he can, under the applicable principles and provisions of the Income Tax Act, utilize the subsection 10(1) valuation scheme in order to calculate and claim a business loss under section 9 of the Act. This involves an inquiry into whether the appellant is the kind of businessperson intended to be covered by subsection 10(1) and, furthermore, whether a single piece of property that realizes no income or loss can, pursuant to subsection 248(1) of the Act, be properly considered to be "inventory" for the taxation years in question.

Although the appellant’s initiative is in fact a "business", in my opinion the Styles Property is not "inventory” under subsection 248(1) for the taxation years in question. Persons in the position of the appellant cannot utilize the subsection 10(1) valuation scheme to deduct fair market depreciations in their "inventory” as business losses in years in which that "inventory" is not sold. I shall focus much of my attention on this latter consideration given that it raises important issues touching upon the interpretation of taxation legislation generally.

B. Are the Losses Deductible under Section 9 in the Years in Question?

As I have already outlined, the appellant must first satisfy this Court that (a) his speculative land deal constituted a "business", namely an adventure or concern in the nature of trade; and (b) that, under the governing principles and provisions of the Income Tax Act, the raw land constituted "inventory" under subsection 248(1) for the taxation years in question, namely 1983 and 1984.

(i) Is the Appellant’s Venture a Business?

The relevant definition of "business" is found in subsection 248(1):

"business" includes a profession, calling, trade, manufacture or undertaking of any kind whatever and except for the purposes of paragraph 18(2)(c), an adventure or concern in the nature of trade but does not include an office or employment;

[Emphasis added. I

Of all of the items included in the definition of "business", the one bearing the closest relationship with the appellant’s initiative is the "adventure in the nature of trade". The question that must now be answered is whether the appellant’s real estate venture in fact meets the judicial interpretation on what constitutes an "adventure in the nature of trade". Since this point is not seriously challenged by the respondent, I shall very quickly review the authorities on this point.

Perhaps the best place to start is Interpretation Bulletin IT-459 (September 8, 1980), which synthesizes the Canadian and U.K. jurisprudence on the definition of an "adventure or concern in the nature of trade" (such as, for example, Californian Copper Syndicate v. Harris (1904), 5 T.C. 159 (Ex., Scot.); Edwards v. Bairs tow, [1956] A.C. 14, [1955] 3 All E.R. 48 (U.K.H.L.); Irrigation Industries Ltd. v. M.N.R., [1962] S.C.R. 346, C.T.C. 215, 62 D.T.C. 1131; and Regal Heights Ltd. v. M.N.R., [1960] S.C.R. 902, [1960] C.T.C. 384, 60 D.T.C. 1270). There are several elements used to determine an "adventure in the nature of trade". These include:

(i) The taxpayer’s conduct: the consideration here is whether the taxpayer’s actions in regard to the property in question were essentially what would be expected of a dealer in such a property.

(ii) The nature of the property: sometimes an inference of "trading" will emerge from the type of property and whether it appears that its purchase cannot be justified by reasons that the property would procure personal enjoyment or a return to the purchaser other than arising from its disposition.

(iii) The intention of the taxpayer and the manner in which the property was purchased. Evidence that an attempt was made to sell the property shortly after its acquisition reveals such a trading intention.

(iv) It is clear that the mere fact that the transaction was a single or isolated one is neither determinative nor prohibitive of a finding that the initiative was in fact an adventure in the nature of trade.

See also E. C. Harris, Canadian Income Taxation (1979), at page 170; B. J. Arnold, T. Edgar and J. Li, eds., Materials on Canadian Income Tax (10th ed. 1993), at page 303 et seq.

In the case at bar, the factual record reveals that the Styles Property was acquired for the purpose of reselling it for financial gain. There was a purchase and an intention to derive a profit therefrom. This anticipated profit was planned to be given partly to charity and partly divided on a pro rata basis among the investors, including the appellant. The type of property in question was a parcel of raw land, often the subject matter of real estate trading ventures. Although the actual transaction was a single one, it does not appear that the individuals involved, at least certainly not the appellant, were inexperienced; quite the contrary: the evidentiary record reveals a sophisticated level of business correspondence among the parties to the arrangement in which it was obvious that they were treating it as a trading adventure. For these reasons, I find that the real estate deal was an adventure in the nature of trade and, consequently, a "business" under subsection 248(1) of the Income Tax Act.

However, on another note, I, with respect, disagree with the trial judge (and Marceau J.A.) that subsection 10(1) of the Act does not apply to a business such as the appellant’s which is an adventure in the nature of trade. Nowhere in subsection 248(1) is it indicated that something determined to be a "business" because it is an "adventure" is exempt from the definition of "business" for any provisions of the Act other than ss. 18(2)(c), 54.2, 95(1) and 110.6(4)(f). (Sections 54.2 and 110.6(4)(f) were added to the definition in 1988 and section 95(1) in 1995.) As noted by the Tax Court of Canada in Bailey, supra, at page 2459 (D.T.C. 1328):

The definition of "business" in subsection 248(1) includes "an adventure or concern in the nature of trade". It is the word "business" so defined that is used in subsection 10(1). When Parliament does not intend an adventure or concern in the nature of trade to be included in the word "business" it provides for the exception in the substantive definition of "business"; for example, the word "business" used in paragraph 18(2)(c) does not include an adventure or concern in the nature of trade....

Having found that the appellant’s undertaking comes within the definition of "business", the next question to decide is whether the appellant is entitled to claim the decline in his land value under section 9. This brings us to the principles and jurisprudence regarding that section of the Act.

(ii) The Governing Principles of Profit and Loss under Section 9 of the Act: Can the Appellant Use the Section 10(1) Valuation Scheme to Deduct as a Business Loss the Decline in the Fair Market Value of the Property?

At the outset, I underscore (as did Rouleau J. at trial) that neither subsection 10(1) nor Regulation 1801 provides a deduction from income nor do they mandate that any person with inventory can deduct any loss (on fair market value) arising therefrom. They simply give some direction as to how the valuation procedure should take place once ordinary commercial principles establish whether a business loss should be claimed under section 9.

As noted by Urie J.A. in The Queen v. Cyprus Anvil Mining Corp., [1990] 1 C.T.C. 153, 90 D.T.C. 6063 (F.C.A.), at page 158 (D.T.C. 6067):

Subsection 10(1) and Regulation 1801...[are]...provision[s] of general application conferring the possibility for a taxpayer to make a choice of his method of inventory valuation.... Computation of income, on the other hand, must relate to the taxpayer’s taxation year. I do not think, therefore, that it can be said that subsection 10(1) is a specific provision overriding the general one, subsection 9.

[subsection 10(1)] must be construed within the context of the Act and be harmonious with its scheme and with the object and intention of Parliament.

Under section 9 of the Act, a taxpayer is required to recognize profit from a business in a particular year as income. Profit (or loss) normally equals the proceeds of sales less the cost of those sales. I underscore that computation of profit and loss under section 9 runs independently from the determination whether a taxpayer is eligible for the subsection 10(1) valuation procedure. Inventory valuation is not an expense and is not in itself deductible as such: Shofar, supra, at page 355 (C.T.C. 435-436, D.T.C. 5349-5350) Consequently, this Court must thus determine whether, in this case, the appellant is entitled to use the subsection 10(1) procedure to compute his losses for the 1983 and 1984 taxation years and, then, whether he can deduct these from his proceeds from the same source, which were nil in both years.

This determination must be made with an eye to the principles that govern the computation of profit; in fact, I find these principles are largely dispositive of the instant appeal. As held by Thorson P. in Daley v. M.N.R., [1950] C.T.C. 254, 50 D.T.C. 877 (Ex. Ct.), at page 880 (D.T.C. 260):

[T]he first inquiry whether a particular disbursement or expense is deductible...[is] whether its deduction is permissible by the ordinary principles of commercial, trading or accepted business and accounting practice.

Cartwright J., in Dominion Taxicab Association v. M.N.R., [1954] S.C.R. 82, C.T.C. 34, 54 D.T.C. 1020, was even less equivocal on this

matter. He held (at page 85 (C.T.C. 37, D.T.C. 1021)):

The expression "profit" is not defined in the Act. It has not a technical meaning and whether or not the sum in question constitutes profit must be determined on ordinary commercial principles unless the provisions of the Income Tax Act require a departure from such principles.

[Emphasis added.]

See also V. Krishna, The Fundamentals of Canadian Income Tax (4th ed. 1993), at page 275 et seq.\ R. Huot, Understanding Income Tax For Practitioners (1994-95 edition), at page 299; and Materials on Canadian Income Tax, supra, at page 336 et seq.

Probably the key taxation principle relevant to the case at bar is the realization principle, which provides that, in the computation of income from an adventure in the nature of trade, gains or losses must be realized in order for them to be included in the computation of income for tax purposes: Friedberg v. Canada, [1993] 4 S.C.R. 285, 2 C.T.C. 306, 93 D.T.C. 5501. In M.N.R. v. Consolidated Glass Ltd., [1957] S.C.R. 167, [1957] C.T.C. 78, 57 D.T.C. 1041, Rand J. held at page 174 (C.T.C. 83, D.T.C. 1043):

[H]ow can profits and gains be considered to have been made in any proper sense of the words otherwise than by actual realization? This [sic] is no inventory valuation feature in relation to capital assets.... The word "loss" in the context means absolute and irrevocable, finality. That state of things is realized upon a sale.…

In the case at bar, it is obvious that the ’’loss" that the appellant seeks to deduct in computing his 1983 and 1984 income had not been realized at that time since the properties had not been disposed of. In fact, no revenues were generated from the Styles Property in either 1983 or 1984. In a sense, in the applicable taxation years the "adventure" consisted only of a purchase. It was therefore not fully completed. Although insufficient to extract it from the definition of "business" under subsection 248(1), the fact that the adventure was only half-completed in 1983 and 1984 strikes at the heart of the computation of any business losses arising therefrom during those years.

Professor B.J. Arnold, in Timing and Income Taxation: The Principles of Income Measurement for Tax Purposes (1983), remarks at page 333:

One of the basic principles of income taxation is that appreciation or depreciation in the value of property is not taken into account in the computation of income until such appreciation or depreciation has been realized, usually by means of a sale.

The importance of this principle is reflected in the fact that, whenever the Income Tax Act permits deemed dispositions at fair market value without actual realizations, it does so narrowly and in a highly circumscribed manner: for example, when a taxpayer ceases to be a Canadian resident (section 48 (now repealed)), or upon death (section 70), or upon change of control (section 111). Exceptions from the realization principle are thus clearly stipulated and explicitly codified, unlike the exception upon which the appellant seeks to rely. For the most part, the Act does not recognize "unrealized” or "paper” gains or losses: Krishna, supra, at pages 278-79.

The respondent correctly notes, however, that the principle of realization in the computation of profit and loss is subject to an exception in the case of stock-in-trade: Whimster & Co. v. Inland Revenue Commissioners (1925), 12 T.C. 813 (Ct. Sess., Scot.), at page 823, per Lord Clyde; BSC Footwear Ltd. v. Ridgway (Inspector of Taxes), [1972] A.C. 544, 2 All E.R. 534 (U.K.H.L.). In Canada, this exception is presently codified in subsection 10(1) of the Income Tax Act: M.N.R. v. Irwin, [1964] S.C.R. 662, C.T.C. 362, 64 D.T.C. 5227 (referring to the former version of subsection 10(1), subsection 14(2)). Such stock-in-trade can be valuated at the lower of cost and fair market value and, consequently, can permit a dealer therein to deduct unrealized losses through the cost of goods sold formula. The result of this principle is effectively to enable a business to increase its cost of goods sold and thus reduce its profits (or increase its losses) in a given year by the amount by which the market value of its inventory at the end of the year falls below the cost of that inventory. The effect of this is to permit a business to recognize as a loss the decline in the value of its inventory in the year in which this decline occurs as opposed to the year in which the inventory is actually sold. However, the commercial principles and jurisprudential authority underpinning the Income Tax Act do not recognize that this exception to the realization principle should operate for unsold single pieces of land that are held by adventurers in trade and alleged to be inventory. The situation of dealers in stock-in-trade is markedly different from that faced by a business adventurer such as the appellant. Whereas these dealers are engaged in the "carrying on of a business", the appellant has launched a single adventure. These dealers regularly purchase hundreds of goods which are quickly sold. Since there are many sales, over which it is impossible to keep track on an individual basis, an averaging formula is used and discrepancies are, over time, evened out: BSC, supra, at page 536. Such an averaging formula is required since it is not practicable for such dealers to determine their profit by looking at each individual item sold. In fact, in businesses where it is neither possible nor desirable to keep a running total of the cost of the goods being sold on a daily basis, the only feasible way to determine the cost of all the goods sold in an accounting period is to add the value of the inventory on hand at the beginning of the period to the cost of the inventory purchased during the period and then subtract the value of the inventory on hand at the end of the period: Krishna, supra, at page 324.

This situation must be contrasted with that in which the appellant finds himself. The profit/loss from the Styles Property is readily ascertainable in the year of disposition. The piece of inventory is easily traceable. The importance of these considerations was underscored by Jackett C.J. in his decision in Oryx Realty Corp. v. M.N.R., [1974] C.T.C. 430, 74 D.T.C. 6352 (F.C.A.). Although the facts of Oryx are different from those in the appeal at bar, I find the following passage (at page 433 (D.T.C. 6354)) to be helpful to the present analysis:

Gross trading profit for a taxation year may be obtained by adding together the profits of the various transactions completed in the year or by adding together the prices at which sales were effected in the year and deducting the aggregate of the costs of the various things sold. Either of such methods would be suitable for a business consisting of relatively few transactions. In the ordinary trading business, however, the practice, which has hardened into a rule of law, is that profit for a year must be computed by deducting from the aggregate "proceeds" of all sales the "cost of sales" [involving inventory].

Drawing from this decision, the respondent makes the following submission, which I fully endorse:

The introduction of section 10 in the Act was intended only to recognize statutorily the rule that only "ordinary trading businesses" [not the appellant] could properly use the lower of cost or market rule. The section was not intended to extend the use of that rule to cases such as the present one where there is only a single transaction.

This legal interpretation has even woven its way into the prior jurisprudence of this Court. In effect, in Irwin, supra, Abbott J. remarked, in passing at page 665, that he was "doubtful whether... the inventory provisions [presently subsection 10(1) and Regulation 1801]...are applicable in the circumstances of a case...where the actual cost and sale price of each particular piece of property are well established". At the time these comments were obiter dicta, but I now treat them as an important part of the ratio decidendi of the instant appeal.

It is well accepted that adventurers do not "carry on" a business. As remarked by Jackett P. (as he then was) in Tara Exploration and Development Co. v. M.N.R., [1970] C.T.C. 557, 70 D.T.C. 6370 (Ex. Ct.), at page 567 (D.T.C. 6376), aff’d [1974] S.C.R. 1057, [1972] C.T.C. 328, 72 D.T.C. 6288:

I have concluded that the better view is that the words "carried on" are not words that can aptly be used with the word "adventure". To carry on something involves continuity of time or operations such as is involved in the ordinary sense of a "business". An adventure is an isolated happening. One has an adventure as opposed to carrying on a business.

[Emphasis in original.]

Although an adventure in the nature of trade (just as a stock-in-trade retail establishment and other examples of "carried on" enterprises) are "businesses" under s. 248(1), I conclude that it is only persons who carry on a business who ought to be entitled to benefit from s. 10. This position is echoed in previous decisions of this Court: Irwin, supra, and Shofar, supra. In fact, in Shofar, Martland J., writing for a unanimous Court, held

at page 354 (C.T.C. 435, D.T.C. 5349):

[T]he practice, "hardened into a rule of law” in the computation of the profit of a trading business is to deduct from the aggregate proceeds of all sales the cost of sales computed by adding the value placed on inventory at the beginning of the year to the cost of acquisitions to inventory during the year, less the value of inventory at the end of the year.

[Emphasis added. ]

For his part, Harris, supra, remarks at page 170 that, if the taxpayer had "a trading motivation, his gain or loss on the transaction would be a business gain or loss". I highlight his use of the words "on the transaction": implicit in this terminology is the recognition that there be a purchase and a sale and that the proceeds arising therefrom be used to calculate the profit or loss flowing from that source and, in turn, be entered under section 9 in the year in which the trading venture is completed.

The appellant is concerned with the alleged unfairness resulting from the adoption of the respondent’s interpretation. According to the appellant, the respondent’s methodology would result in an inequitable situation in which a business, if it were to own 100 lots and sell one of these, would be eligible for the inventory "write down" and if it were to sell none it would not be so eligible. I do not see how the decision in the instant appeal would lead to such a result. It is clear that any profits or losses arising from that sale of the one piece of property actually sold could be included under section 9. However, the ability to deduct the fair market depreciation of the 99 unsold lots hinges not upon whether or not one lot is sold but, rather, upon the determination whether "ordinary commercial principles" would recognize the holding of 100 lots (in which only one was sold) as tantamount to "stock-in-trade". If so, then such a fictional taxpayer might very well be entitled to claim any decline in fair market value as a business loss. But this is a hypothetical question for a future court to decide. It does not arise upon the facts of this case. This appeal only involves one transaction, this being very far removed from the level of continuous activity at which the cost of goods sold formula is geared to operate.

What does arise in this case is my observation that, if adopted, the appellant’s argument would have a wide range of undesirable ramifications from a policy standpoint. It would create a situation in which any property acquired for the purpose of resale at a profit (that is as part of an adventure in the nature of trade), outside of the normal carrying on of a business (shares, art, stamps, gold, land, antiques), would constitute a source of income in each year, thus requiring, in the absence of the sale of the property, an annual computation of profit or loss in which, necessarily, a valuation of the fair market value of the property would have to be undertaken. Moreover, this loss could be carried over to offset any actual business profits regardless whether the loss was actually realized during the year. It would thus only be in cases of capital property that the realization principle would continue to operate. I have serious doubts that this was the intent of the drafters of the exception to the realization principle contained in subsection 10(1) and Regulation 1801. I also doubt that it was their intention to oblige the owners of such a vast array of property to make yearly appraisals of the worth of that property for taxation purposes; moreover, given that these calculations would merely be appraisals, significant uncertainty and unreliability in the computation of tax liability might very well arise.

The appellant’s interpretation would also undermine the matching principle underpinning section 9 of the Act: Neonex International Ltd. v. The Queen, [1978] C.T.C. 485, 78 D.T.C. 6339 (F.C.A.) (for an affirmation of the importance of this principle and an invalidation of an attempt to claim expenses in a year in which they were not incurred); see also West Kootenay Power and Light Co. v. Canada, [1992] 1 C.T.C. 15, 92 D.T.C. 6023 (F.C.A.). This principle emphasizes that receipts and expenditures which produce the net income are to be properly "matched" in the same time period: Krishna, supra, at page 279. The importance of the "match" flows from the critical role timing considerations play in taxation matters. In the case of an adventure in the nature of trade, the profit or loss from the transaction is computed at the time the adventure is effected, not in any year prior to the settlement: see Tobias v. The Queen, [1978] C.T.C. 113, 78 D.T.C. 6028 (F.C.T.D.). Instead, the adoption of the appellant’s interpretation would permit a wide array of these "adventures in the nature of trade" to expense the costs (or a portion thereof) in one taxation year while recognizing the revenues in another year.

As was proposed by the respondent before this Court:

It is submitted that it is settled law that in the case of an adventure in the nature of trade, the profit or loss from the transaction is computed at the time the adventure is settled and no computation of profit or loss is necessary or appropriate in any year prior to the settlement....

In the case of isolated transactions, the use of the lower of cost or market method typically would significantly distort the profit from such transactions. For example, where the sale of a particular piece of property does not occur for several years, the taxpayer would be permitted to deduct over the several years losses in respect of unrealized depreciations in value of the property. By contrast, with ordinary trading businesses, the stock-in-trade of the particular business typically turns over in the next fiscal period and, hence, the anticipated losses deducted at the end of any one year are more likely (because of the continuing sales activity of the trading business) to be in fact realized in the next year. The distortion of profit in such cases is therefore likely to be substantially less than in the case of an adventure in the nature of trade where the realization of the profit or loss may not take place for a number of years.

This distortion can, for those with profits and losses emanating from other non-related sources, effectively permit individuals to avoid tax through a careful balancing of their varied isolated investments. I cannot accept that this is conduct Parliament intended to encourage.

I also find that the appellant’s interpretation undermines broad principles of symmetry. If we permit the appellant to deduct the losses he claims he is entitled to, then, if the taxation system is to remain symmetrical, business gains on unrealized "inventory" would also have to be filed. This is not the case. I am aware of the fact that the appellant points out that, if in a year subsequent to acquisition but prior to disposition, a property which in a previous year fell in value then increases in value, any increase up to original cost will have to be taken into account in the income calculation. However, I observe that no unrealized increase beyond original cost is ever taxed, thereby giving rise to an asymmetry since any drop below cost would, on the appellant’s interpretation, immediately give rise to a business loss.

It was submitted before this Court that denying the appellant the benefit of subsection 10 impinges upon the principle of conservatism which constitutes a principal element of the generally accepted accounting procedures used to calculate profit/loss under section 9. In response, I note that this Court, in Symes v. Canada, [1993] 4 S.C.R. 695, [1994] 2 C.T.C. 40, 94 D.T.C. 6001, at page 723 (D.T.C. 6009), held that it is more appropriate in the taxation context to rely upon well-accepted commercial principles given that strict adherence to accounting conservatism might not be consonant with the purposes of the taxation system. This conclusion is echoed in the academic context. Arnold, supra, at page 332-33, concludes:

[T]he lower of cost and fair market value rule...is a product of the conservatism of accounting practice, which finds an understatement of income preferable to an overstatement. There is some justification for this conservatism for purposes of financial accounting; however, substantial doubt has been raised as to the validity of the lower of cost and fair market value rule even for financial accounting purposes. For tax purposes, there is no justification for either the lower of cost and fair market value rule or the "all fair market value" rule for the valuation of inventory.

It is for this reason that the lower of cost and market method of inventory valuation contained in subsection 10(1) and Regulation 1801 is recognized as an exception limited only to stock-in- traders. I see no reason to extend its reach beyond this group, and certainly not to adventures in the nature of trade. The applicable method of accounting within the taxation context should be that which best reflects the taxpayer’s true income position: Ken Steeves Sales Ltd. v. M.N.R., [1955] C.T.C. 47, 55 D.T.C. 1044 (Ex. Ct.); Publishers Guild of Canada Ltd. v. M.N.R., [1957] C.T.C. 1, 57 D.T.C. 1017 (Ex. Ct.), at pp. 1026 and 1030; Associated Investors of Canada Ltd. v. M.N.R., [1967] C.T.C. 138, 67 D.T.C. 5096 (Ex. Ct.), at pages 5098-99; and Maritime Telegraph and Telephone Co. v. Canada, [1991] 1 C.T.C. 28, 91 D.T.C. 5038 (F.C.T.D.). In the case at bar, the appellant’s income position is best reflected by not declaring the decline in the fair market value of the Styles Property as a business loss in 1983 and 1984, but instead waiting until the year of disposition to enter any such losses, this being 1986.

The appellant further alleges that the respondent’s interpretation of the expense scheme for inventory would lead to a mathematical absurdity. It is submitted that in determining the raw land to be inventory yet in insisting that the inventory valuation can only be done in the year of disposition, the Federal Court of Appeal has created a situation in which the real loss suffered by the taxpayer can never be realized. I have two responses to this line of argument.

First, the problem is entirely obviated if the land is not held to be "inventory” or the taxpayer is precluded from utilizing the inventory valuation scheme for the purposes of section 9; in such a scenario, the loss in the year of disposition is simply calculated by subtracting the proceeds of the disposition from the original amount disbursed to purchase the property (and vice versa for profits). Second, upon closer scrutiny, it is the appellant’s interpretation which yields mathematical improbabilities: it would recognize a negative cost of goods sold, something of a surprise, in a year in which there were in fact no sales, an even greater surprise. Furthermore, it would seem that a negative cost of goods sold would render askew the entire deemed realization formula contained within subsection 10(1).

In closing, I emphasize my discomfort with a ruling that would permit speculative investments constituting ’’adventures in the nature of trade" to be written down to the lower of cost and market value in years in which their value declines yet they are not sold. This discomfort appears to be shared by the drafters of the Act as well as the authors of much of the jurisprudence and academic commentaries dealing with the computation of profit under section 9 of the Act. Both the application of subsection 10(1) as well as the definition of "inventory" must be very sensitive to these considerations.

(iii) Is the land "inventory"?

With an eye to the aforementioned principles of profit and loss within the context of income taxation, I turn to the question whether the Styles Property could be considered to be "inventory". Subsection 248(1) defines "inventory" as follows:

"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;

[Emphasis added.]

In my mind the key element of this definition is that the property, in order to be properly classified as "inventory", must have a cost or value which, in the particular taxation year in question, bears some relevance to the amount of the taxpayer’s income (profit or loss) for that particular year. Under the principles of tax accounting, the value of inventory bears no direct relationship with profit/loss. Rather, profit or loss is calculated by subtracting the cost of sales (the value of the inventory at the beginning of the year plus the cost of acquisitions, less the value of the inventory at the end of the year) from the proceeds of sale: Shofar, supra. Thus, the value of inventory (which, according to subsection 10(1) can be based on cost or fair market value) only plays a part in calculating the cost of sales. Ostensibly, in order for there to be "costs of sales", there must have been a sale in the first place. Once again, the realization principle is triggered.

In 1983 and 1984 there was no sale of the land. Nor was there a purchase. The land was not involved in any transaction whatsoever. To this end, the drop in the fair market value of the land had no effect whatsoever on the income of the appellant. It may have affected the appellant’s wealth or the size of his asset portfolio, but neither of these constitute his "income" for the taxation years in question. In a sense, I find that the appellant has neglected the importance of the phrase "for a taxation year" inserted in the definition in subsection 248(1).

In fact, at paragraph 7(d) of his factum, the appellant submits that his "interest in the Styles Property was inventory because the cost or value of that property is relevant in determining his income from a business". Of course, over the lifetime of the business, the purchase of that property might very well have a significant impact on that business’s income. But the Income Tax Act does not levy funds based upon the lifetime of a business. Rather, taxation is organized in discrete yearly units; the ability to carry over deductions/inclusions from one year to the other is highly circumscribed. This rationale appears to have infused the definition of "inventory" since, in order to fit within this definition, there must be relevance to the income for that taxation year. This is plainly not the case in the appeal at bar. In short, the appellant should be able to claim, under the ordinary tracing formula (proceeds less the purchase cost), the drop in the value of the land in the year in which the property is disposed of, but not in years where the property remains dormant.

At this juncture, it must be remembered that the Act’s definition of "inventory" is not identical to the definition proposed for accounting or real estate purposes. After all, as this Court concluded in Symes, supra, at page 723, the Income Tax Act is motivated by the purpose of raising public revenues and, as such, differs from the goals of the accounting world. I note in this regard that the Canadian Institute of Chartered Accountants has defined "inventory" as including, inter alia, ”[i]tems of tangible property which are held for sale in the ordinary course of business": Terminology for Accountants (3rd ed. 1983), at page 81. Similarly, a publication entitled Canadian Institute of Public Real Estate Companies Recommended Accounting Practices for Real Estate Companies (November 1985) states that land currently held for sale and land held for future development and sale is inventory. Under both of these definitions, the appellant’s land would likely be included as "inventory". But the Income Tax Act has taken a very different approach. It has expressly codified (and hence, in cases of conflict, overruled the principles that underlie the accounting or commercial worlds) a definition that clearly connects the property to the yearly income and, in the appellant’s case, this link is missing for the taxation years 1983 and 1984. So, too, is the principal condition precedent to the applicability of the inventory valuation scheme, namely that the taxpayer be a stock-in-trader.

The appellant relies on a series of cases in support of the proposition that even undisposed property which is the subject matter of an adventure in the nature of trade can constitute inventory and, thus, should its fair market value drop, the taxpayer is entitled to register that unrealized decline in value as a business loss for that year: Bailey, supra; Weatherhead, supra; Van Dongen, supra; and Skerrett v. M.N.R., [1991] 2 C.T.C. 2787, 91 D.T.C. 1330 (T.C.C.). I note in passing that the Federal Court of Appeal has never heard any of these cases; in fact, the only Federal Court of Appeal authority in this area of the law is its decision in the case at bar. With respect, I choose not to follow this line of authority. I note that in none of these decisions was the meaning of "inventory” under subsection 248(1) properly placed within the context of the principles of profit and loss (developed under section 9 and the predecessor sections thereto) discussed supra which I have found to be of crucial importance.

For the reasons discussed above, I find the distinction drawn by Rouleau J. in the instant appeal between taxpayers holding one or a few items of inventory (such as the appellant) and those with thousands of items (a retail store) to be instructive. Retail companies do not purchase items and then retain them for years should the market turn against them. Items are generally purchased in bulk and then sold with quick turnaround. To this end, in such a situation it can be safely assumed that there is a relation between the value of the goods claimed to be inventory and the overall income of the taxpayer for the year in question (thus the definition of "inventory" would be met and subsection 10(1) would be applicable), even though in each individual case it might be impossible to trace the actual moment when the item in question was sold. It is consequently appropriate to rely upon averaging calculations. Thus, the "cost of sales" formula yields constructive and practical results; on the other hand, in a business with relatively few transactions such as the appellant’s, the cost of sales formula "does not reflect the true picture of [the] business’ income position" (per Rouleau J., at page 300 (D.T.C. 6251)).

VI. Conclusions and Disposition

To summarize, I arrive at the following conclusions:

1. The appellant’s initiative is a "business" pursuant to the definition thereof in subsection 248(1) of the Act since it amounts to an adventure in the nature of trade.

2. The exception to the realization principle carved out by subsection 10(1) and Regulation 1801 is not a method of valuation the benefit of which should accrue to adventurers such as the appellant. Instead, this exception is to permit cost of sale inventory valuations only for dealers in stock-in-trade, these persons necessarily being engaged in the "carrying on of a business".

3. The land is not inventory for the taxation years in question under the Income Tax Act’s definition (subsection 248(1)) since it bears no relation whatsoever to the appellant’s "business income" for tax purposes in those years. This conclusion is mandated by the principles underlying section 9. Consequently, the appellant cannot benefit from the application of the valuation system established by subsection 10(1).

I would therefore dismiss the appeal with costs. It should, however, be noted that, by rejecting this taxpayer’s appeal, this Court is not denying him the right to claim any losses (that are otherwise available) on the Styles Property as business losses. Rather, this Court is simply ensuring that these losses can only be recorded on his 1986 tax return, the only year in which they actually relate to his income.

Finally, with respect to my colleague Major J.’s reasons, I have the following comments. First, I do not dispute that the Income Tax Act is based on a system that recognizes only two broad categories of property, inventory or capital property. In my opinion, the analysis I have set out above is not inconsistent with this basic division. I agree that the Styles Property could be viewed as inventory in the year of disposition. In fact, I would note my disagreement with the trial judge and Marceau J.A. about the applicability of the inventory valuation method embodied in subsection 10(1) to an adventure in the nature of trade. Subsection 10(1) applies to a business which includes an adventure in the nature of trade. However, the real question is not whether the Styles Property is inventory, or whether subsection 10(1) is applicable, but whether the appellant is entitled to claim the decline in value under section 9, the defining section on business income. The analysis turns not upon whether the property is inventory, but upon determining the most appropriate method for determining a taxpayer’s profit. In the case of an adventurer in the nature of trade, who is not carrying on business, and who has made no disposition, it is not appropriate to determine profit using the inventory valuation method, for the reasons I have outlined above.

Second, I have difficulty with my colleague’s reasoning with respect to the difference between the phrasing "for the taxation year", and "for a taxation year". Income is determined under the Act each year, and the characterization of property can change from year to year. I fail to understand how property that has received a particular characterization in one year ipso facto receives that characterization in another, or all other, years.

Third, I disagree with my colleague that the inventory valuation method is an anachronism in this age of computer technology; rather, it is my view that the method is still a vital tool for businesses with significant and complex inventories.

Appeal allowed.