Associates Commercial Corporation of Canada Limited v. Minister of National Revenue, [1988] 1 CTC 2471, 88 DTC 1301

Taylor, T.C.J.:—These are appeals heard on common evidence in Toronto, Ontario, on February 24, 1988, against income tax assessments for the years 1981, 1983 and 1984 in which the Minister of National Revenue disallowed deductions claimed during these years as "inventory allowance" provided in paragraph 20(1)(gg) of the Income Tax Act. A brief description of the genesis of the dispute was provided in the notice of appeal for 1981 as follows, which was filed for the appellant corporation ("ACCCL").

— ACCCL provided funding to purchasers of assets under Sale and Security Agreements (Agreement). Pursuant to the Agreement, ACCCL had title to, ownership of, and a security interest in the assets until such time as the Agreement was fully performed.

— In the event of default under the Agreement, the assets were seized by or on behalf of ACCCL and held by ACCCL for the purpose of resale.

— The assets in paragraph (4) were described as "collateral held for resale" in the financial statements of ACCCL and were recorded in the financial statements at a cost equal to the amount owing to ACCCL at the time the asset was repossessed.

— The assets were eventually sold by ACCCL for an amount equal to their fair market value.

— In computing its income for its 1981 taxation year, ACCCL deducted $14,642* [1] being 3% of the amount referred to in paragraph (5) pursuant to paragraph 20(1)(gg) , Income Tax Act S.C. 1970-71-72, c.63 as amended.

The assets described in ACCCL's financial statements as "collateral held for resale" fall within the definition of "inventory" for purposes of paragraph 20(1)(gg) Income Tax Act on the basis that:

(a) the assets were held for the specific purpose of resale;

(b) the assets were clearly itemized in ACCCL's financial statements and records and were identified as being held for sale;

(c) the assets were sold by ACCCL in the ordinary and reoccurring part of its business; and

(d) the amount referred to in paragraph (5) is relevant in computing ACCCL’s income from its business in 1981.”

For the respondent, the factors which supported the assessments were:

— The repossessed collateral was resold to minimize loss in the Appellant's business of providing funding to purchasers of assets. It was not described in the inventory in respect of the business.

— The Appellant’s business had no “tangible property (other than currency)" in inventory in respect of the business.

— The “collateral held for resale” was not inventory for the purpose of paragraph 20(1)(gg).

The witnesses presented for the appellant, described the procedures followed by the company in financing. In effect the last step available to ACCCL was to repossess the asset, and every effort was expended to avoid this juncture. It was unusual for the company to recover all its costs after repossession, more regularly ACCCL lost money on the deal. Nevertheless the capacity to repossess, and indeed to do so when necessary was a vital and important part of the operation. There was no other practical way of being in the financing business. It was not unusual for ACCCL to have on hand — for resale — as much as $4 million of repossessed assets. The internal record-keeping procedure was that the amount of the unpaid balance on that asset was transferred from regular “accounts receivable” to the account called “collateral held for resale". That account was shown as a current asset on the balance sheet of the company under the general heading of "Finance Receivables”.

In argument, counsel for the appellant provided a detailed and complete summary of the jurisprudence relative to the "inventory allowance" question, and he relied heavily on his view that all the conditions cited by Joyal, J. in Burrard Yarrows Corporation v. The Queen, [1986] 2 C.T.C. 313; 86 D.T.C. 6459 (F.C.T.D.), at page 316 (D.T.C. 6461, had been met by ACCCL:

Before a taxpayer is eligible to claim a paragraph 20(1)(gg) inventory allowance, four preconditions must be met. First, the allowance must be claimed on the cost amount of the property in question at the beginning of each taxation year in question. Next, the property against which it is claimed must be tangible property other than real estate or an interest therein. Thirdly, it must be established that the property was described in the taxpayer's inventory in respect of his business, and finally, that it was held for sale or to be processed, manufactured, incorporated into, attached to, or otherwise converted into property for sale in the ordinary course of that business. Failure to establish the existence of any one of these elements results in a disentitlement to a reserve under that paragraph. The position of counsel for the defendant was that the third and fourth preconditions were not met.

For his part, counsel for the respondent cited certain relevant case law, in particular Blue Water Currency Exchange Ltd, v. M.N.R., [1987] 2 C.T.C. 2401; 87 D.T.C. 306 (T.C.C.), from page 2404 (D.T.C. 308):

While it may have been possible in some circumstances during the period under review for foreign currency to be looked upon as being in a taxpayer's inventory for the purposes of paragraph 20(1) (gg) the appellant’s method of doing business did not lend itself to the U.S. currency held by it being so regarded. One of the kinds of property described in a taxpayer's inventory that was within paragraph 20(1)(gg), and the the only kind that could have any relevance to this appeal, is tangible property held by him for sale. This was not, however, the true nature of the appellant's business in relation to U.S. currency. It did not acquire that currency for the purpose of holding it for sale. Rather, it acquired it in the execution of the principal focus of its business which was realizing 1.65 per cent above the international exchange rate in the process of and in consideration for converting U.S. money into Canadian currency. This was followed by the necessarily incidental sequel of conversion of these American funds back into Canadian currency in order to perpetuate the process. This was accomplished by exchanging the American money for Canadian funds at the appellant's places of business at one-half of 1% and using the remainder of that money to purchase Canadian currency.

I should also add however that two other very important points were made by counsel for the respondent:

(1) that "inventory" as the term is used in paragraph 20(1)(gg) is not simply some (or any) form of asset, nor is the characteristic of "inventory" as an asset acquired simply by calling something by that name. He stated that inventory for purposes of the Income Tax Act, must be in keeping with the definition provided in section 248 as follow:

248(1)

"Inventory" — "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;

Further according to counsel, reference should be made to subsection 10(1) of the Act:

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

in an inventory shall be valued at its cost to the taxpayer or its fair market value, whichever is lower, or in such other manner as may be permitted by regulation.

(2) that paragraph 20(1 )(gg) does not exist in the Act in isolation, but should be read in connection with the preamble to section 20 as follows: 20. Deductions permitted in computing income from business or property.

(1) Notwithstanding paragraph 18(1)(a), (b) and (h), in computing a taxpayer's income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:

Obviously a serious argument can be understood that the repossessed item involved in this matter had not been valued (when transferred to the “collateral held for resale") so as to meet the conditions expressed in subsection 10(1) of the Act, particularly when the words "for the purpose of computing income from a business . . . ” from that section of the Act, are virtually the same as those to be found on subsection 20(1) of the Act . . . in computing a taxpayer's income for a taxation year from a business . . . ” In addition, whether the procedure of deducting the "inventory allowance amount" from "net income for the year" (from the financial statements) which was done in these appeals, in arriving at a "taxable income" amount, rather than deducting the amount calculated as part of the regular accounting procedure in arriving at the net income of the corporation fulfills the conditions of subsection 20(1) of the Act, is a very major question. This reservation about the lack of conformity with subsection 20(1) of the Act had been referenced in earlier case law — (Plaza Pontiac Buick Ltd. v. M.N.R., [1983] C.T.C. 2371; 83 D.T.C. 316). While the Court was impressed with these references by counsel for the respondent, it appears to me that the general practice with regard to the allowance — both in assessing by the Minister, and in any review by the Courts leaves very little room at this point in time for a strict application of either subsection 10(1) or subsection 20(1) of the Act. Indeed, it might well be that to do so would conflict with the general principles of interpreting the Act as outlined in Stubart Industries Ltd. v. The Queen, [1984] C.T.C. 294; 84 D.T.C. 6305 (S.C.C.). In any event, this judgment will deal first with the point at issue within the context of the interpretation arising out of Burrard Yarrows Corporation, supra, as suggested by counsel for the appellant, and then examine (if necessary) the circumstances as they compare to those reflected in Blue Water Currency Exchange Limited, supra.

From Burrard Yarrows Corporation:

First, the allowance must be claimed on the "cost amount" of the property . . .

[Emphasis added]

While it could well be questioned that the assets set up in the “collateral held for resale” account were "at cost”, neither can it be conclusively said they did not represent "cost", or the best approximation of it available to the appellant at the time of repossession. I would accept that the appellant meets this condition.

Next, the property. . .must be tangible property . . .

[Emphasis added]

This condition is met.

Thirdly, it must be established that the property was described in the taxpayer's inventory in respect of his business . . .

[Emphasis added]

I shall return to this point.

Finally, that it was held for sale . . .

[Emphasis added]

This condition is met.

Returning to the third point above, in my view this gives the appellant the greatest difficulty. A major point made by the Minister (see reply to notice of appeal above) was that the "resale" operation was not the business of the appellant, but merely incidental to that business of financing, and only done to reduce losses. While I agree it was not the main business of the appellant I am satisfied that the financing business could not be conducted economically and profitably without recourse to the repossession and resale functions. It is my view that the "expenses . . . in respect of the business", should be interpreted in the light of the similar term arising out of subparagraph 20(1)(gg)(ii) ” . . . in the ordinary course of the business" and that the resale function was part of the "ordinary course" of the appellant's business. Turning then to the term "the property was described in the appellant's inventory . . . ", I can agree with the point made by counsel for the respondent, that there is no commonly understood reconciliation of the "inventory", on the financial statements of the appellant which would represent the usual trading format. But I do not agree that the particular method of recording the “repossessions and resales" for internal purposes should of itself, negate the claim of the appellant. In my view the appellant should not be denied the claim on these purely technical points.

I turn now to a very formidable hurdle facing the appellant — B/ue Water Currency Exchange Limited, supra. The critical comment therein, as it applies to these appeals, in my view is:

. . . It did not acquire that currency for the purpose of holding it for sale. Rather, it acquired it in the execution of the principal focus of its business which was realizing 1.65 per cent above the international exchange rate in the process of and in consideration for converting U.S. money into Canadian currency. This was followed by the necessarily incidental sequel of conversion of these American funds back into Canadian currency in order to perpetuate the process.

As I understand that comment, a clear distinction can be made between the operation of Blue Water Currency Exchange Limited, supra, and the appellant. ACCCL, in this matter acquired the property (took possession of it, to complete any question of title “which arose out of the conditional sales contract") for the sole purpose of sale (or resale to be specific); and it cannot be said that such acquisition was for the purpose of perpetuating the process, indeed ACCCL would have preferred that no such repossession occurred.

In summary, the appellant has fulfilled the conditions in paragraph 20(1)(gg) of the Act in order to claim the "inventory allowance" at issue. The appeals are allowed, and the entire matter is referred back to the Minister for reconsideration and reassessment. The appellant is entitled to party and party costs.

Appeals allowed.