Dresden Farm Equipment LTD v. Minister of National Revenue, [1982] CTC 2377, 82 DTC 1388

John B Goetz:—This is an appeal by the appellant with respect to its 1977 and 1978 taxation years whereby, pursuant to the provisions of paragraph 20(1 )(gg) of the Income Tax Act, SC 1970-71-72, c. 63, as amended, (said paragraph 20(1 )(gg) was enacted in 1977), the appellant claimed as an inventory allowance the sum of $9,650.44 in its 1977 taxation year and the sum of $17,140.65 for its 1978 taxation year. The Minister of National Revenue, in his assessment, disallowed these deductions on the ground that the inven- tory allowance taken by the appellant was improper in that the inventory consisted, in large part, of goods on consignment for sale by the appellant and that they were held by the appellant at all times as the property of John Deere Limited.

Issue

The issue is whether the inventory allowance deduction set forth in paragraph 20(1 )(gg) was properly taken by the appellant in the relevant taxation years.

Facts

At the outset of the hearing counsel for the Crown noted an objection that all evidence adduced by the appellant would be subject to an argument as to admissibility under what he referred to as the “parol evidence rule”.

There is no doubt that the goods were shipped to the appellant under a John Deere Limited Authorized Agricultural Deal Agreement (hereinafter referred to as “the Agreement”) which is most comprehensive. The goods of a value of over $1,000 were termed “Consigned Goods” whereas goods such as service parts and attachments of a price of $1,000 or less were termed as “Sold Goods” for which the appellant had to pay immediately upon being invoiced. The John Deere contract was a tightly drawn document but it should be noted that, in addition to the John Deere basic dealer Agreement, there were many other forms provided for the dealer by John Deere, whereby the appellant kept records of all goods shipped to it. I shall not attempt to refer to the voluminous exhibits filed but merely deal with what I consider the relevant portions of the John Deere Dealer Agreement and which read as follows:

8. DEALER'S DUTY TO STORE AND CARE FOR CONSIGNED GOODS. The Company retains title to Consigned Goods and the Dealer will hold them as the property of the Company unless and until they are sold or leased by him on behalf of the Company under the authority set out in Section 9. Dealer will keep Consigned Goods properly warehoused and protected and will not permit removal of any part from any item of Consigned Goods. He is responsible for all loss, damage or deterioration to consigned Goods after delivery to him. The Company will arrange for physical damage insurance on Consigned Goods against perils listed in a certificate of insurance to be supplied to the Dealer. The cost of such coverage will be charged to the Dealer and the Dealer agrees to pay the same. The Dealer will promptly pay to the Company the full amount of any loss, damage or deterioration in Consigned Goods, however caused, which is not covered by the foregoing insurance. The Dealer will pay when due all charges for customs duties, sales, use, excise, personal property, or other similar taxes and penalties, license fees and other charges of any kind that may be assessed or charged on the Goods, the sale, lease or use thereof, or the Dealer’s premises. If the Dealer fails to pay such charges, the Company may pay them and the Dealer agrees to reimburse the Company on demand for all moneys so paid out, with interest at the highest contract rate permitted by law but not in excess of 14% per annum.

At the request of the Company, the Dealer will ship any item or items of Consigned Goods requested by the Company to the destination and in the manner directed by the Company, F.O.B. the Dealer’s town.

10. CARRY-OVER DEPOSIT. The company publishes a Schedule of Selling Periods for Consigned Goods. This Schedule provides an “Original Selling Period” for each class of machine, applicable to all of the machines of that class shipped to the Dealer during each “shipping period” into which the year is divided. In the case of most classes of machines, the Schedule also provides an “Extended Selling Period” applicable to a stated percentage of machines of like kind in each particular class shipped during the shipping period, should they still be in the Dealer’s possession unsold at the end of the Original Selling Period.

If the Dealer has failed to sell during the Original Selling Period any machine which is not eligible for the Extended Selling Period, he agrees, as security for the discharge of his obligations hereunder, to pay to the Company in cash a carryover deposit of 25% of the wholesale price as of that date.

13. TITLE TO SOLD GOODS. Title to, ownership and the right to possession of all Sold Goods shipped by the Company to the Dealer is and shall remain vested in the Company until full payment of the indebtedness therefor and any other indebtedness now or hereafter owing by the Dealer to the Company shall have been made to the Company. Sales for value received may be made to users by the Dealer in the ordinary course of retail business. If one of the events enumerated in Subsections (c) through (j) of Section 3 above shall occur, the Company may, at its option:

(a) Declare immediately due and payable all indebtedness owing by the Dealer to the Company and collect the same together with court costs and reasonable attorney’s fees;

(b) Discontinue or withhold delivery of Sold Goods to the Dealer or make further deliveries only on a cash or C.O.D. basis;

(c) Take possession, with or without legal process, of any Sold Goods the title to which is in the Company.

18. SHIPMENT. Shipment of Goods will be governed by the following provisions:

(d) Delivery to Dealer; Risk of Loss. Delivery of Goods by the Company to a carrier, including agents or employees of the Dealer as well as common and contract carriers, shall constitute delivery to the Dealer, and the Dealer shall bear all risk of damage or loss thereafter.

20. BOOKS AND ACCOUNTS; REPORTS. The Dealer will keep complete and accurate books and records of account, in a form recommended by the Company, in accordance with recognised accounting practices, including adequate stock and sales records of Goods. At the end of his fiscal year and at other times as the Company requests, the Dealer will furnish the Company with complete financial and operating statements and such other reports as the Company may request. He will furnish the Company at any time on request full information regarding Consigned Goods on hand, Consigned Goods sold or leased, and the proceeds thereof. At the request of the Company, the Dealer agrees to prepare a detailed and comprehensive inventory of all Sold Goods he has in his possession; and he further agrees to furnish the Company with a copy of this information. The Company will have the right, at any reasonable time during regular business hours, to inspect the Dealer’s books and records and to examine and take inventory of any Consigned Goods and examine Sold Goods held by him. (Italics mine).

A Mr Lloyd Northcott, president of Dresden Farm Equipment Ltd (the appellant) stated that pursuant to a John Deere Agreement, he became exclusive dealer for John Deere in the Ashton area whereby he was to promote the sale of equipment, parts and attachments of John Deere equipment and give full service and warranty service. He stated that, on occasion, he had tried to send goods back to John Deere but this procedure was refused by John Deere. He admitted that the final payment for Consigned Goods was at the time the goods were either sold retail or to another dealer, which was permitted under the John Deere contract.The John Deere contract provided certain terms whereby the appellant was required to pay 25% of unsold equipment which it held as inventory; that it had to sell 75% of everything that it received or ordered and that it was ultimately responsible for full payment of goods shipped to it, whether on goods sold or goods on consignment. He stated that when he paid out John Deere he was entitled to deduct the 25% deposit payments made by the appellant until the items were sold.

The appellant indeed kept very careful records of all shipments to it by John Deere and Exhibits A-1 and A-2 covering these forms and records are at least five inches in thickness.

From the sections of the dealer’s contract already noted, it is clear that even once the company, after receiving an order from the appellant, delivered Consigned Goods to a carrier, the appellant became totally responsible for the goods so shipped. Although the Company purports to provide some form of insurance, it is not clear what it covers but, in any event, cost of such insurance was borne by the appellant and any further insurance which undoubtedly was necessary had to be assumed and provided for by the appellant. Once physical delivery was made to the appellant’s yard and accepted, it was totally responsible for the goods thereafter. Only at the time of delivery could the appellant look to John Deere or to the carrier for recoupment of the cost of effecting the necessary repairs to damaged shipments. Other costs involved were: (1) the unloading of equipment which could take up to 25 hours; (2) all labour costs involved; and (3) the assembly of attachments to machinery were all paid for by the appellant and charged for each item of equipment shipped on a special card which showed equipment cost, unloading and assembly.

Volume 1 of Exhibit A-1 consists of the back-up documentation relating to the statements of account and receipts of equipment on the forms provided for by John Deere. For instance, as of October 29, 1976, there is a statement of account form sent to the appellant by John Deere showing under the term “Total balance” $653,411.20; under “Consigned Goods” $566,442.25; under what is termed “Extended Terms” account $83,275.27; “Current Terms” account $3,693.68; under the heading “Amount Subject to Volume” $677,414.47. Page 3 of that statement of account shows under the heading “Current Terms” account the sum of $22,450.94, which appears to be a credit to the appellant for payment for goods sold and taken out of its inventory. The taxpayer was charged interest on the inventory after a stated period if it had not sold same and payments called “Deposits” were also required, as mentioned above, if goods are not sold during a requisite period. The vendor retained the option to remove inventory or transfer it to another dealer. While John Deere, under this Agreement, retained title to the goods as security for payments, long-established business practice is that the taxpayer must sell and pay for the goods if it intends to stay in business.

All Consigned Goods sent from John Deere to the appellant were described in the appellant’s books as inventory. As a practical person, I can see no other way in which they could be described because, obviously, pursuant to the instructions of its chartered accountants, every item, large or small, delivered and invoiced, payments made thereon, ultimate sale or transfer to another dealer, were all duly recorded according to proper accounting procedures.

Mr Harry Erlichman, counsel for the Crown, declined to cross-examine Mr Northcott, the key witness.

lan Tilley, a chartered accountant since 1962, started handling the appellant’s books commencing with the fiscal year 1977. Mr Tilley’s qualifications seemed quite clear and were not challenged by Mr Erlichman. Mr Tilley disagreed with the presentation of the financial statements up to the point in time when he took the responsibility for the preparation of same.

Mr Tilley prepared the financial statements for the fiscal year ending September 30, 1977, showing inventories totalling $870,823. He appends a notation to this statement as follows:

Inventories are valued at the lower of cost and net realizable value. The Company adopts the policy of recording goods shipped “on consignment” from John Deere Limited as purchases. Although title remains with John Deere Limited until the goods are paid for or sold to third parties, Dresden Farm Equipment Limited is committed, at specific dates, to pay for equipment received. The amount of “consigned” equipment included in inventories is $571,355 at 30 September 1977 and $653,411 at 30 September 1976.

In Schedule I to the 1977 financial statement he shows the total liability payable to John Deere Limited being $685,840.

Mr Tilley stated that when an item was sold from the voluminous records carefully kept by the appellant, the item was removed from the inventory at its cost price and placed into cost of sales of new farm machinery. He would naturally have an opening inventory and a closing inventory each year which consist of items on hand. In his view, he did not consider that goods received by the appellant by John Deere were properly termed “Consigned Goods” from an accounting point of view. Although the dealer contract with John Deere uses the term “Consigned Goods” to a large degree, he holds the view that indeed shipments delivered to the appellant were not Consigned Goods in the true sense in that liability on the part of the appellant for payment of the whole of the amount existed from the point of delivery. Mr Tilley prepared the 1978 financial statements in the same manner and on the same basis. Again Mr Erlichman declined to cross-examine.

Findings

“Inventory” is defined as follows in section 248 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 relevant section to be considered by me is paragraph 20(1 )(gg) of the Act which reads as follows:

20. (1) Notwithstanding paragraphs 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 amount as may reasonably be regarded as applicable thereto:

(gg) an amount in respect of any business carried on by the taxpayer in the year, equal to that portion of 3% of the cost amount to the taxpayer, at the commencment of the year, of the tangible property (other than real property or an interest therein) that was

(i) described in the taxpayer’s inventory in respect of the business, and

(ii) held by him for sale or for the purposes of being processed, fabricated, manufactured, incorporated into, attached to, or otherwise converted into or used in the packaging of, property for sale in the ordinary course of the business

that the number of days in the year is of 365; (Italics mine).

The definition of “inventory” is of no assistance nor has there been any jurisprudence on the interpretation of paragraph 20(1) (gg) as it comes before me in this appeal. Counsel for the Crown handed to me xerox copies of excerpts from some textbook, relating to what he calls the “Parol Evidence Rule”. He did not in any way attempt to assert what provisions of these excerpts related to the situation at hand. He asked the Board to refer to extremely fine print on the left hand corner of the documentation in Volume Il of Exhibit A-1 which reads as follows:

If consigned stock is shown above I acknowledge that it is in stock and is the property of John Deere Limited on consignment with me pursuant to the agreement between us. No proceeds have been received thereon unless shown. If other goods are shown above, I state that they are in stock with no claims against them other than that of John Deere Limited. Other items shown above, if any, are acknowledged to be correct.

He maintained that the appellant simply held the goods until retail sale and that the 25% deposit merely added a “carryover”. He concluded his argument with these words: “The appellant to succeed should have title”. Counsel for the respondent did quote to me the meaning of the word “cost” from the Oxford Dictionary as being “the price to be paid for a thing”, and what was vital was the “cost amount” to the taxpayer. “Cost amount” is described in subsection 248(1) of the Act as follows:

248. (1) In this Act,

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

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

I can only surmise that the purpose for this definition is to allow for the ravages of inflation. In any event, returning to the wording of paragraph 20(1 )(gg), the inventory relates to subparagraph “(i) described in the taxpayer’s inventory in respect of the business, and (ii) held by him for sale . . . .” The stock-in-trade of the appellant was John Deere equipment, attachments and parts and the only sensible and comprehensible way that it could keep a record of such items was in the stock-in-trade inventory. The deliveries from John Deere were described as part of its inventory in the relevant taxation years. Certainly, the goods were held for sale. Paragraph 20(1 )(gg) has no mention whatsoever of title and, indeed, the John Deere Agreement ws a very powerful document in favour of John Deere, giving it the most wide protection possible in the retention of title to it. Nevertheless, the Agreement read as a whole certainly changed the true meaning of the simple words “On Consignment”. Once John Deere had placed the shipment ordered by the apellant onto the flat deck of the motor carrier, for delivery to the yard of the appellant, risk, at that point in time, fell upon the appellant. Paragraph 8 of the John Deere Agreement clearly sets out the risks and responsibilities involved and falling upon the appellant. The appellant certainly had possession once it took delivery and cleared up any insurance matters relating to damage in transit. Once deliveries were accepted at the appellant’s yard, it was obliged, pursuant to the major Agreement, to make payments therefor at specified times. It could not return the goods to John Deere. It could only sell retail, or transfer to another dealer or lease subject to the terms set out by John Deere. In that responsibility fell upon the appellant from the time of delivery, it recorded on its card system every item down to the smallest part as a liability item until it was sold and then it would be taken out of inventory.

John Deere equipment, parts and attachments delivered to the appellant were its stock-in-trade in the same manner as a real estate agent acquiring an inventory of buildings purchased under an Agreement for Sale for the purpose of reselling at a profit. I can see no difference with respect to the question of title upon which Mr Erlichman rested his case than from that of a real estate agent dealing in such a manner. The holding of the legal title to the equipment by John Deere as security did not affect the true issue any more than the taking of security on all equipment, parts and attachments in the form of a chattel mortgage which could have been done.

Referring to the words of Cattanach, J in MNR v Wardean Drilling Limited, [1969] CTC 265; 69 DTC 5194, at 270 and 5197 respectively, he says:

In my opinion the proper test as to when property is acquired must relate to the title to the property in question or to the normal incidents of title, either actual or constructive, such as possession, use and risk.

In summary, all the characteristics of ownership fell upon the appellant once delivery was made to it in that the goods were entirely at its risk, they were in its possession and its use of same related to the sale, leasing or transferring to another dealer. This was its business. This constituted its use of the goods. Further, it should be clearly understood, from the evidence given by Mr Northcott, and I found him completely honest and forthright, and obviously so did Mr Erlichman because he did not deign to cross- examine him, that the goods, once delivered to the appellant, could not be returned to John Deere and that it had to make instalment payments thereon and ultimately pay out the full price after a certain period of time, regardless of whether it had sold or transferred the items in its possession. All machinery, parts and attachments were treated as stock-in-trade and were sold and recorded (and I may add very accurately) by his accountants.

I think the appellant company has dealt with an onerous contract with John Deere in a very straightforward, honest and efficient manner and the evidence relating thereto was clear and uncontradicted. I therefore allow the appeal and refer the matter back to the respondent for reconsideration and reassessment.

Appeal allowed.