Jake Friesen v. Her Majesty the Queen, [1992] 1 CTC 296, 92 DTC 6248

Rouleau, J.:—Mr. Jake Friesen is appealing the reassessments of business income by the Minister of National Revenue for the 1983 and 1984 taxation years.

The plaintiff, a businessman, resides in the municipality of Clearbrook, British Columbia. He is a member of a group of people who, on January 29, 1982, acquired a parcel of raw land in the city of Calgary known as the “ Styles Property". This property was registered in the name of Trinity Western College which was to hold the land as trustee for the plaintiff and the other members of the group.

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 as a charitable donation as well as to other such similar charitable organizations; the balance was to be divided on a pro rata basis amongst the members of the group, including the plaintiff.

The plaintiff valued his interest in the property at the lower of cost and fair market value in accordance with subsection 10(1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the"Act"). He claimed business losses in his 1983 and 1984 income tax returns in the amounts of $252,954 and $25,800 respectively. The $252,954 that was originally claimed by the taxpayer is now recognized to be a mathematical error and it is agreed that the correct sum is $197,690.

The Minister disallowed these business losses on the basis that the property was not "inventory in a business” of the plaintiff within the meaning of subsections 10(1) and 248(1) of the Income Tax Act. The Minister also submitted that the plaintiff overstated his share of the cost of the property and that he failed to identify the fair market value of his interest in the land at the end of the 1983 and 1984 taxation years in claiming the "write-downs."

The issue is whether or not the raw land purchased by the plaintiff, who is not engaged in an ordinary trading business, is "inventory" in a business pursuant to subsection 10(1) of the Income Tax Act, thus entitling the taxpayer to an inventory "write-down".

It is the plaintiff's position that the property is inventory and that he is therefore entitled to write down its value from cost to the fair market value pursuant to subsection 10(1) of the Act which provides as follows:

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

In order to interpret this provision of the Act and apply it correctly, it is important to ascertain what is contemplated by the words “business” and inventory".

The definition of "business" in subsection 248(1) "includes a profession, calling, trade, manufacture or undertaking of any kind whatever and, except for the purposes of subsection 18(2), section 54.2 and paragraph 110.6(14)(f), an adventure or concern in the nature of trade, but does not include an office or employment". The courts have defined many of these terms over the years. For example, the word "trade" was considered in The Commissioners of Inland Revenue v. Livingston (1926), 11 T.C. 538 at page 542:

. . .a single transaction falls as far short of constituting a dealer's trade, as the appearance of a single swallow does of making a summer. The trade of a dealer necessarily consists of a course of dealing, either actually engaged in or at any rate contemplated and intended to continue.

The ph rase "adventure or concern in the nature of trade" was considered by the Exchequer Court of Canada in M.N.R. v. Taylor, [1956] C.T.C. 189, 56 D.T.C. 1125, at page 199 (D.T.C. 1131):

It is, I think, plain from the wording of the Canadian Act, quite apart from any judicial decisions, that the term "trade" and "adventure or concern in the nature of trade" are not synonymous expressions. . .

Considering the circumstances in which a transaction may be"an adventure or concern in the nature of trade”, Thorson, J. wrote at pages 210-11 (D.T.C. 1137):

But "trade" is not the same thing as "an adventure in the nature of trade" and a transaction might well be the latter without being the former. . .The very word "adventure" implies a single or isolated transaction and it is erroneous to set up its singleness or isolation as an indication that it was not an adventure in the nature of trade.

In a more recent decision, Bailey (D.R.) v. M.N.R., [1990] 1 C.T.C. 2450, 90 D.T.C. 1321 (T.C.C.), Mr. Justice Rip concluded that, for the purpose of subsection 10(1), "business" as defined in subsection 248(1) includes "an adventure or concern in the nature of trade". He added that continuity is not necessary to compute income from a business. From this reasoning one can conclude that an isolated transaction may fall within the meaning of the word "business" in subsection 10(1).

On the basis of the foregoing, counsel for the plaintiff relying on the definition of "business", submits that even if the plaintiff was not in the “business of trading properties" and that this was an isolated transaction, it can be argued that the plaintiff was engaged in an adventure in the nature of trade and therefore in a"business" for the purposes of subsection 248(1) and 10(1) of the Act.

The question of whether or not land purchased in an adventure in the nature of trade constitutes inventory for the purposes of subsection 10(1) was also canvassed in the Bailey decision, supra, where it was determined that land acquired for resale in a trade or an adventure or concern in the nature of trade could be classified as inventory for the purposes of subsection 10(1). However, if the intent of the taxpayer was to hold the land as an investment such as "capital property", it could not be classified as" inventory" for the purposes of subsection 10(1). This was reviewed in Gilmour v. M.N.R., [1989] 2 C.T.C. 2454, 89 D.T.C. 658, by Taylor, T.C.C.J. at page 2455 (D.T.C. 659):

As I see it, the taxpayer had always treated the land as a capital asset not a trading asset, by adding to its original cost the carrying charges of interest and taxes, permitted under section 53 and 54 of the Income Tax Act.

In that case, it was held that the vacant land was held by the taxpayer as a capital asset and therefore was not eligible for valuation in accordance with subsection 10(1).

In Van Dongen v. The Queen, [1990] 1 C.T.C. 86, 90 D.T.C. 6633, my colleague Cullen, J. looked to the Bailey decision, supra, as representative of the state of the law on the issue. As mentioned earlier, in Bailey, supra, it was established that land held as an adventure in the nature of trade was eligible for inventory "write-down"; that a parcel of raw farmland purchased by the taxpayer for resale was" inventory" pursuant to subsection 10(1) despite the fact that the purchase of the land was not used in trade but was an isolated transaction. This reasoning was also applied in Weatherhead v. M.N.R., [1990] 1 C.T.C. 2579, 90 D.T.C. 1398 (T.C.C.).

Both parties having conceded that the property in issue was acquired for speculative reasons, the plaintiff contends that based on the jurisprudence, the land may be characterized as "inventory" for the purposes of subsection 10(1) of the Act. Accordingly, the plaintiff should be entitled to write down the property in the 1983 and 1984 taxation years.

In my view, subsection 10(1) should not be interpreted as suggested. It is a well established principle that any provision in the Income Tax Act must be read in light of the Act as a whole. A section of the Act cannot be interpreted in isolation (Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536, [1984] 1 C.T.C. 294, 84 D.T.C. 6305). For the purposes of interpreting subsection 10(1), other relevant sections of the Act must be considered, namely subsections 248(1) and 9(1).

10. Valuation of inventory property

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

248. (1) In this Act,

Inventory" means a description of property the cost or value of which is relevant in computing a taxpayer's income from a business for a taxation year.

“Business” includes a profession, calling, trade, manufacture or undertaking of any kind whatever and, except for the purposes of paragraph 18(2)(c), section 54.2 and paragraph 110.6(14)(f), an adventure or concern in the nature of trade but does not include an office or employment;

9. Income from business or property

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

In the computation of profit for the purposes of subsection 9(1), a taxpayer's profit must be determined in accordance with ordinary commercial and ac- counting principles and practices. The applicable method of accounting should be one which best reflects the taxpayer's true income position. This principle has been well settled in a number of decisions including the recent decision of Madam Justice Reed of the Federal Court-Trial division, in Maritime Telegraph and Telephone Company Ltd. v. The Queen, [1991] 1 C.T.C. 28, 91 D.T.C. 5038.

Ordinary commercial principles and practices dictate that in any business, the revenue should be matched against the expenses before any loss or profit is recognized. Generally, in the case of a trading business, the following method is used since it best reflects the business's true income position:

Adopting this formula, a trading business can determine its cost 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.

This approach is supported by the Supreme Court of Canada decision in M.N.R. v. Shofar Investments Corporation, [1979] C.T.C. 433, 79 D.T.C. 5347. There, with respect to subsection 14(2) [now subsection 10(1)] of the Act, the Court wrote at pages 435-36 (D.T.C. 5349-50):

The value of inventory, which is used in determining profit, is determined on the basis of cost or fair market value, whichever is lower, or in such other manner as may be permitted by regulation. By virtue of ss. 14(2), therefore, the cost of an inventory item is a factor which has relevance in determining inventory value. To that extent it can affect the ascertainment of the gross profit of the business, but it is not, in itself, deductible from the taxpayer's income. . .

Items in inventory that are not yet sold are relevant in calculating profit of a trading business since they are factored into the cost of sales formula as previously outlined. Profit or loss is always dependent on the inventory valuation.

The computation of profit in the case of a business with relatively few transactions is somewhat different than that of the continuous trading business. The “cost of sales" formula is not generally applied in these circumstances since it does not reflect the true picture of this business' income position.

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.

Subsection 10(1) clearly states that only property described as inventory" can be written down. According to subsection 248(1), “inventory” includes property whose cost or value is relevant in computing a taxpayer's income. In a business of few transactions, the value of its inventory is not relevant in computing income until disposition. As a result, in a year when the property is not sold, it would not be included in the computation of income for tax purposes and therefore, subsection 10(1) would not apply. Counsel for the plaintiff submits that the definition of "business" in subsection 248(1) specifically includes an adventure in the nature of trade except for the purposes of subsection 18(2), section 54.2 and paragraph 110.6(14)(f). Subsection 10(1) is not included in the exceptions, therefore,"business" used in the subsection must include an adventure in the nature of trade. I disagree.

It has been well established that what is not specifically excluded from a legislative provision may remain excluded if it would otherwise create an the absurdity. In this case, applying subsection 10(1) to an adventure in the nature of trade would, in my opinion, lead to such an absurdity since the Act does not tax unrealized profits and it follows that it 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 its disposition.

Consider the case of a judge who acquires a piece of raw land in an adventure in the nature of trade. Due to a downturn in the economy, this land loses value. Should this judge be allowed to write down this land pursuant to subsection 10(1) of the Act and claim a business loss against his or her judge's salary? From a practical standpoint, I think not.

Since subsection 10(1) of the Act deals with the valuation of inventory property for the purpose of determining income from a business, it cannot be interpreted without having regard to subsection 9(1) of the Act. When considering subsection 9(1), it becomes apparent that an inventory "write-down" of the ^Styles Property” would not reflect the truest picture of the plaintiff's income position. As a result, subsection 10(1) does not apply to this plaintiff.

The plaintiff's action is therefore dismissed. Costs to the defendant.

Appeal dismissed.