O'BOYLE and Duplessis (1971) Inc v. Minister of National Revenue, [1976] CTC 2200, 76 DTC 1168

The Chairman:—This is the appeal of O’Boyle and Duplessis (1971) Inc from an income tax assessment in respect of the 1971 taxation year, heard in Sherbrooke, Quebec cn April 29, 1976.

In its 1971 tax return the appellant estimated its inventory as of June 30, 1971 at $66,058.72. By Notice of Assessment dated September 25, 1974 the respondent, on the basis of the lower of cost or market value, fixed the value of the inventory in 1971 at $75,440.05, which increased the appellant’s declared taxable income by $9,381.33.

The facts in this appeal are as follows: Mr Gregory W O’Boyle had been the beneficial owner of a television and small electrical appliance store in Lennoxville for some 30 years. In 1971, in an arm’s length transaction after the end of the company’s fiscal year that ended June 30, 1971, Mr O’Boyle sold all his shares in the company to his employees at their net book value.

At the hearing of the appeal, the appellant was not represented. Mr O’Boyle, who no longer owned shares in the appellant company, was nevertheless an interested party with respect to the Minister’s assessment of the appellant company in that, by an offer of sale which was accepted by the purchasers on November 12, 1971 (Exhibit A-3, page 8, paragraph (I)), Mr O’Boyle undertook to reimburse to the appellant company all taxes which might be levied against it, as well as any interest and penalties thereon, as a result of assessments or reassessments of income tax, corporation tax or municipal taxes made by the federal, provincial or municipal governments in respect of the appellant’s last fiscal year, ie, the year ending June 30, 1971. He was therefore represented by his accountant.

Mr O’Boyle, through his agent, contends that, in evaluating the company’s inventory for the 1971 fiscal year, he complied with the requirements of subsection 10(1) of the Income Tax Act and section 1801 of the Income Tax Regulations by applying a 20% markdown on all television sets and a markdown varying from 15% to 50% on smaller electrical appliances and replacement parts. Mr O’Boyle further contends that he has evaluated his inventory on that basis for the past 30 years and that such a procedure is in accordance with accepted accounting principles.

In his testimony, Mr O’Boyle explained how the value of television sets at one period of the fiscal year had to be marked down at the end of the next because of their relative obsolescence on the arrival of new models selling at approximately the same price, etc.

I don’t believe that anyone will seriously dispute the fact that certain commercial items such as TV sets are more subject to a diminution in value within the period of a year because of obsolescence than are certain other items, and that the decrease in the value of such items must be reflected in the overall value of the inventory at a given date.

I fully understand and appreciate Mr O’Boyle’s problem in arriving at a value for his TV sets at the end of a fiscal year. However, I do not believe that, by choosing an arbitrary markdown figure of 20% of cost in evaluating his year-end inventory, as Mr O’Boyle admitted doing, he is complying with the provisions of the Income Tax Act.

lt may be that Mr O'Boyle's long-established practice of basing the value of his inventory on a 20% markdown is considered to be, for accounting purposes, an acceptable method, since the consistency of Mr O’Boyle’s valuation of his inventory would not abnormally distort his profit and loss statement from one year to another. However, for tax purposes, such a method of evaluating inventory does not, in my view, meet the requirements of the Act.

The evidence adduced does not support Mr O’Boyle’s contentions. Exhibit R-2 is a comparison of cost and sale of 31% of the items on the appellant company’s inventory of June 30, 1971, on which the 20% reduction was claimed and disallowed by the respondent. In that comparison, it appears that no item of inventory was subsequently sold at a price below the cost price, three items were sold at cost, and the average markup for that portion of the appellant’s 1971 inventory was 22.2% over cost. Subsection 14(2) of the Income Tax Act states:

14. (2) For the purpose of computing income, the property described in an inventory shall be valued at its cost toi the taxpayer or its fair market value, whichever is lower, or in such other manner as may be permitted by regulation.* [1]

It is evident, from the 22.2% markup over cost realized by the appellant company on the sales of TV sets in 1971, that the method of evaluating his inventory on the basis of cost price less 20% used by Mr O’Boyle is unrealistic. There is a difference of 42.2% between the appellant company’s basic evaluation and the price at which the inventory was actually sold.

It is equally clear, in my opinion, that the basis of the appellant company’s valuation is not in accordance with section 1801 of the Regulations, which states that an inventory may be valued at cost or at the fair market value. The appellant’s valuation of his inventory in 1971 is, in my view, neither the cost nor the fair market value. Nor, for the same reason, can such a 20% markdown of the cost price in evaluating the appellant’s inventory be considered as the lesser of cost or fair market value pursuant to subsection 14(2) of the Income Tax Act.

I believe that it is significant that the firm of McDonald, Currie & Co, Chartered Accountants, in its auditors’ report to the appellant shareholders on November 15, 1971, after a physical inventory of the appellant company’s major stock items had been taken, felt it necessary to include therein the following statement:

We were unable to verify the valuation of inventories in detail as the valuation was determined by Mr G W O’Boyle the President, on an estimated basis only. (Exhibit A-2)

For these reasons, I have come to the conclusion that the appellant company’s inventory was valued on a basis which is not in keeping with either section 1801 of the Income Tax Regulations or subsection 14(2) of the Income Tax Act, and is not an authorized method of inventory valuation for income tax purposes.

The appeal is therefore dismissed.

Appeal dismissed.