Boehringer Ingelheim (Canada) LTD v. Minister of National Revenue, [1982] CTC 2850, 82 DTC 1859

Guy Tremblay:—This case was heard on May 26, 1982, at the City of Toronto, Ontario.

1. The Point at Issue

The point at issue is whether the appellant company is correct in deducting, in the computation of its income for the 1977 taxation year, $24,334 which is 3% of its inventory at the commencement of the said year, as provided in paragraph 20(1 )(gg) of the Income Tax Act, SC 1970-71-72, c 63, as amended. The respondent refused the deduction, contending that this inventory was purchased on January 1, 1977. As the inventory on December 31, 1976, was nil, the respondent invokes subsection 10(2) of the Act and concludes that for the end of the Income Tax Act, the inventory was nil at the beginning of the year 1977.

2. The Burden of Proof

2.01 The burden is on the appellant to show that the respondent’s assessment is incorrect. This burden of proof results particularly from several judicial decisions, including the judgment delivered by the Supreme Court of Canada in Johnston v MNR, [1948] CTC 3 195; DTC 1182.

2.02 In the same judgment, the Court decided that the assumed facts on which the respondent based the assessment or reassessment are also deemed to be correct. In the present case, the assumed facts are described in the reply to notice of appeal as follows:

2. In assessing the Apppellant for its 1977 taxation year, the Respondent assumed, inter alia, the following:

(a) The facts admitted above;

(b) pursuant to the Agreement dated January 1, 1971 between C H Boehringer Sohn and Ciba-Geigy Canada Limited, the Appellant purchased from Ciba- Geigy Canada Limited on January 1, 1977 certain finished product and packaging materials;

(c) the Appellant’s audited December 31, 1977 balance sheet with comparative figures at December, 1976 indicates inventories valued at nil on hand at December 31, 1976 and states that all inventories from Ciba-Geigy Canada Limited were transferred to the Appellant as of January 1, 1977;

(d) the cost of the inventories from Ciba-Geigy Canada Limited, was $779,930.

In paragraph 1 of the reply to the notice of appeal, the respondent admitted the facts alleged in paragraphs 1, 2, 5, 8, 9 and 10 of the notice of appeal. They read as follows:

1. The Appellant is a corporation incorporated under the Canada Corporations Act by letters patent dated June 12th, 1972.

2. All the shares of the Appellant are owned indirectly by C H Boehringer Sohn, a German limited partnership, through a Canadian investment holding company (Ci- ba/Geigy Canada Limited).

5. The Manufacturing Agreement (dated January 1, 1971 between the German company and Ciba-Geigy) was not terminated orally (on December 31, 1976) but terminated pursuant to the automatic termination provided in Clause 16 (see para. 3.03 of The Facts).

8. In filing its tax return for its 1977 taxation year, the Appellant deducted an inventory allowance under paragraph 20(1 )(gg) of the Income Tax Act in the amount of $24, 334 being three per cent of the “cost amount of its opening inventory”.

9. By the reassessment aforesaid the Minister of National Revenue disallowed the inventory allowance claimed.

10. The Appellant duly filed a Notice of Objection to such reassessment and the Minister by Notice dated July 3, 1980 had confirmed the assessment.

3. The Facts

3.01 It is not disputed that:

(a) the nature of the business of the appellant is trading wholesale pharmaceuticals;

(b) the rights and obligations of the German company following the agreement dated January 1, 1971, (Exhibit A-1) were transferred to the appellant company after its incorporation in June 1972;

(c) the cost of the inventories from Ciba-Geigy Canada Limited was $779,930 and the amount claimed by the appellant as allowance pursuant to paragraph 20(1 )(gg) of the Income Tax Act was $24,334, despite the fact that the latter amount is not 3% of the former. The real amount is $23,397.90. The respondent, however, does not dispute the amount of $24,334.

3.02 By agreement (Exhibit A-1, Tab 1) dated as of January 1, 1971, (the “Manufacturing Agreement”) between C H Boehringer Sohn and Ciba- Geigy Canada Limited, the parties agreed, among other things, as follows:

(a) certain previous agreements dating back to January 1, 1957, were terminated effective December 1, 1972;

(b) some services previously provided by Ciba-Geigy were to be undertaken by a Canadian company to be incorporated by C H Boehringer Sohn, which is the appellant;

(c) new product development previously undertaken by Ciba-Geigy was to be undertaken by the appellant, and all product promotions previously undertaken by Ciba-Geigy were to be undertaken by the appellant;

(d) for a four year period commencing January 1, 1973, Ciba-Geigy had agreed to manufacture, package and distribute certain products on behalf of the appellent for a consideration which consisted of a reimbursement of its costs, together with a “margin equal to twenty three and one half per cent of the actual net sales”, as defined in the manufacturing agreement.

3.03 The termination of the agreement is provided for in section 16, which reads as follows:

16. Termination, (a) The provision under Section 8 may be terminated by Boehringer on twelve (12) months’ prior written notice on or after January 1, 1973.

(b) This Agreement shall automatically terminate in its entirety on December 31, 1976.

(c) No termination of this Agreement shall relieve either Party of its obligation to prevent disclosure of data or other information furnished to it of a confidential nature, or relieve either Party of any obligation or liability accrued hereunder prior to such termination.

(d) On April 1, 1976, CIBA-GEIGY shall deliver to Boehringer its written best estimate of, and on January 1, 1977, Boehringer shall purchase from CIBA-GEIGY, CIBA-GEIGY’s January 1, 1977 inventory of finished products previously paid for by CIBA-GEIGY and such packaging materials relating to such products as are unusable by CIBA-GEIGY in the manufacture of such products after January 1, 1977. In the case of an earlier termination of Section 8, this subsection applies accordingly.

3.04 In view of the execution of section 16 quoted above, the appellant rented a warehouse in Dollard des Ormeaux, Quebec, from Computer Leaseholds Corporation on July 23, 1976 (Exhibit A-2).

3.05 Also in the execution of subparagraph (d) of the said section 16, an amount of $325,038.73 of stock was moved prior to December 31, 1976, (Exhibit A-1, Tab 2 and Exhibit A-3) from the Ciba-Geigy premises to the appellant’s warehouse. The evidence is not clear that it is the only amount of stock transferred prior to December 31, 1976 (Exhibits A-4 and A-5). It seems that the balance of stock was transferred in January 1977 (Exhibit A-1, Tabs 3 and 4, and Exhibits A-6, A-7 and A-8).

3.06 On July 26, 1976, the appellant wrote to Reed Shaw Stenhouse Limited, insurance brokers, to insure the warehouse (Exhibit A-1, Tabs 6 and 7). The same broker also insured the stock and equipment in January 1977 (Exhibit A-1, Tabs 8 and 9).

4. Law — Cases at Law — Analysis

4.01 Law

The provisions of the Income Tax Act involved in the present case are subsections 10(1), 10(2) and paragraph 20(1 )(gg). They read as follows:

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.

(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.

20. Deductions permitted in computing income from business or property.

(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 amounts as may reasonably be regarded as applicable thereto:

20(1)(gg) Inventory allowance. — An amount in respect of any business carried on by the taxpayer in the year, equal to that portion of 3% of the cost amount to the taxpayer, at the commencement of the year, of the tangible property (other than real property or an interest therein) that was

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

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

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

4.02 Cases at Law

The counsel for the parties referred to the Board the following cases:

1. James Ivan Ferguson v MNR, [1978] CTC 2915; 78 DTC 1655;

2. HMQ v The Estates of Umberto Mastronardi, v MNR, [1977] CTC 355; 77 DTC 5217;

3. MNR v Wardean Drilling Limited, [1969] CTC 265; 69 DTC 5194;

4. HMQ v Henuset Bros. Ltd., [1977] CTC 228; 77 DTC 5169;

5. No. 336 v MNR, 15 Tax ABC 18; 56 DTC 180.

The counsel for the appellant also referred the Interpretation Bulletin IT-435 to the Board.

4.03 Analysis

4.03.1 It is obvious to the Board that the inventory purchased by the appellant on January 1, 1977, was legally transferred immediately after December 31, 1976, therefore, at the beginning of January 1977.

4.03.2 It is common ground that the Income Tax Act must be strictly construed.

In construing paragraph 20(1 )(gg) of the Act, it is obvious that . . the cost amount to the taxpayer (the appellant), at the commencement of the year, of the tangible property (other than real property or an interest therein) that was (i) described in the taxpayer’s inventory in respect of the business . ..” is $779,930. It is the word by word interpretation; it is the strict interpretation. However, this interpretation would not be disputed by the respondent, if section 10 of the Act did not exist.

4.03.3 Section 10 of the Act is entitled “Valuation of inventory property”. This title well describes the substance of the said section. In subsection 10(1) of the Act it is said that . . 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 subsection 10(2) of the Act, the legislator enunciates a basic principle to evaluate the inventories. The goods of the inventory at the beginning of the year must be valued at the same amount as the amount at which they were valued at the end of the preceding year. Everyone knows that the changes in the inventories at the beginning or at the end of the year may vary the profit. One must be consistent in using the valuation of his inventory in the computation of his income. It is also obvious that the nonapplication of this principle may have fiscal consequences. CCH Canadian Limited, in the Topical Law Reports, comments on subsection 10(2):

This provision will avoid situations under which amounts might otherwise escape tax or be taxed twice because of a change in the method of valuing inventory.

If one reads subsection 10(2) of the Act in considering the problem of the instant case, is it possible to arrive at the conclusion that the appellant made a change in the method of valuing its inventory? Certainly not. The inventory involved was not owned by the appellant on December 31, 1976. The evidence showed, however, that the inventory involved had the same value as it did for Ciba-Geigy on December 31, 1976. It is the amount that the appellant purchased it for; it is its cost.

In strictly construing subsection 10(2) of the Act, the Board does not see how the respondent arrived at the conclusion that it was not currently construed by the appellant. In the Board’s opinion, subsection 10(2) of the Act has no application in the present case. This provision only applies when the same inventory is owned by the same taxpayer at the end of a year and at the commencement of the following year.

It is the Board’s opinion that the allowance provided for in paragraph 20(1 )(gg) of the Act must be allowed. The tangible property of the appellant’s inventory at the commencement of the 1977 year was $779,930. It is the strict interpretation of paragraph 20(1 )(gg) (see para. 4.03.2).

5. Conclusion

The appeal is allowed and the matter referred back to the respondent for reassessment in accordance with the above reasons for judgment.

Appeal allowed.