9 May 1995 GST/HST Interpretation 11745-4 - FST Inventory Rebate

                                                                        Telephone: (613) 954-8585
Fax: (613) 990-1233
File: 11745-4(kpm)
s. 120
 XXXXX

I refer to your telephone discussion with Garry Ryhorchuk of my staff on February 3, 1995, regarding the eligibility for the federal sales tax (FST) inventory rebate provided by section 120 of the Excise Tax Act (Act).

As requested, the information that was subsequently forwarded to us has been reviewed and the following are our comments.

The FST inventory rebate claim by XXXXX was originally approved based on the information provided in the 1991 Audited Financial Statements, which showed the information for the year 1991 and comparative figures for 1990. Subsequently, the audit showed that XXXXX had restated items for 1990 "to agree with the presentation adopted in 1991." A restatement is usually done because of a change of use of asset or a change of accounting policy.

The FST inventory rebate is based on the status of the particular assets as at January 1, 1991. Because of this, the use of the 1991 Financial Statements with comparatives for 1990 may have led to an incorrect assessment.

The review, using the 1990 audited financial statements of XXXXX showed that amounts in Accounts Receivable and Fixed Assets were re-stated and classified as "Fixed Assets, Materials, and Supplies held for Resale." It was on this amount that the FST inventory rebate claim was based and approved. The difference between the $ XXXXX shown in the accounting records and the $ XXXXX covered by the claim represented ineligible items such as lands and building.

According to the CICA Handbook, section 1506.05 states "The classification of an item in the financial statements may be different from that in the financial statements of prior periods as a result of a change in the allocation or grouping of items within or among relevant categories. Such a change in classification is a matter of presentation and not, in itself, a change in accounting policy. However, to enhance comparability with the financial statements of the current period, the item is reclassified in the financial statements of prior periods to conform with the new basis." The eligibility of the particular assets for the FST inventory rebate is determined by how the particular assets were treated, and not by what they were called in a financial statement.

The fact that XXXXX restated their 1990 figure for comparison with 1991 statements did not alter the intended use of the particular assets as at January 1, 1991. In the letter from XXXXX to XXXXX on November 9, 1994, with respect to the accounting of assets to XXXXX , they state "In 1990, in anticipation of a formal partnership agreement, XXXXX began to acquire assets." This statement appears to contradict other statements in the letter indicating that XXXXX was to be a joint venture - "The transfer was accounted for at cost as the assets were acquired with the sole intention of developing the XXXXX network. The accounting for the contribution of assets to XXXXX was in accordance with generally accepted accounting principles for joint ventures and CICA Handbook section 3055."

A joint venture and a partnership, as you know, are treated very differently for the purposes of the GST, as the Act recognizes partnerships as persons. Joint ventures are not recognized as persons in the Act, therefore, if any transfer of assets occurs between the joint venture and the venturer, the transfer would not be considered a supply. Policy Paper P-171 - Distinguishing between a Joint Venture and a Partnership for Purposes of section 273 Joint Venture Election (DRAFT) provides more information on the differences between joint ventures and partnerships that may be applicable to this situation.

The financial statements for 1990 indicate that on January 1, 1991, no assets were held for sale in the ordinary course of a commercial activity. The particular assets classified under Fixed Assets were being held for use in a joint venture and, therefore, were not eligible for the FST inventory rebate.

As well, XXXXX would not be eligible for the FST inventory rebate for the value of the particular assets shown as Accounts Receivable in the 1990 financial statements. The very definition of the phrase "accounts receivable" preclude any eligibility of the particular assets being "inventory." Webster's Third International Dictionary defines "accounts receivable" as "a balance due from a debtor on a current account." For there to be a debt, a sale must have occurred, i.e., the ownership of the particular goods would have already been transferred to XXXXX the other party involved in this joint venture/partnership. If this is the case, the particular assets were not available for resale on January 1, 1991, and, therefore, not eligible for the FST inventory rebate.

The Court, in Gay Lea Foods Co-operative v. the Queen [1994] E.T.C. 2029, held that if title passes from the particular person to a third party, the fact that the particular person recorded the funds received from that party as a liability and treated the particular assets as part of its inventory, it is still not sufficient to bring the particular person within the requirements that "The property must be held ... for sale in the ordinary course of that business" (ITA paragraph 20(1)(gg) - repealed effective February 26, 1986).

If the financial statements for 1990 were restated in 1991 according to CICA Handbook section 1506.05 - for presentation purposes only - and not as a result of an error in a prior period or a change to accounting policy, the restatement would not have effected the eligibility of the particular assets for the FST inventory rebate.

In the case of The Queen v. Bastion Mgmt. Ltd. [1994] 2 C.T.C. 70, Reed, J., stated that "It is trite law that, regardless of the purpose of a provision in a taxing statute, if a taxpayer can bring itself within the specific wording of the provision, then, the provision will apply." More than just the appearance of the item on the financial statements must be taken into account before it qualifies for an FST inventory rebate.

Assuming the position that there was a partnership agreement in place on January 1, 1991 — which would indicate that there were errors in the audited 1990 statements — it is doubtful that the particular assets were sold "in the ordinary course of a commercial activity."

"Commercial activity" is defined in subsection 120(1) as "a business carried on by the person ..., except to the extent to which the business involves the making of exempt supplies ... ." "In the ordinary course of a commercial activity" then, is analogous to the term "in the ordinary course of business."

The Courts have considered the term "ordinary course of business" on many occasions. In the case of The Queen v. Bastion Mgmt. Ltd. [1994] 2 C.T.C. 70, Reed, J., stated:

"In a bankruptcy matter before the Hight Court of Austria, Rich, J. wrote that for transactions to be considered in the ordinary course of business supposes "that according to the ordinary and common flow of transactions in affairs of business there is a course, an ordinary course. It means that the transaction must fall into place as part of the undistinguished common flow of business done, that it should form part of the ordinary business as carried on, calling for no remark and arising out of no special or particular situation": Downs Distributing Co. Pty., Ltd. v. Associated Blue Star Stores Pty., Ltd. (In Liquidation), (1948), 76 C.L.R. 463, at page 477. Street, J., of the Supreme Court of New South Wales stated that "the transaction must be one of the ordinary day-to-day business activities, having no unusual or special features, and being such as a manager of a business might reasonably be expected to be permitted to carry out on his own initiative without making prior reference back or subsequent report to his superior authorities, such as, for example, to his board of directors.": Re Bradford Roofing Industries Pty. Ltd., (1966) 84 W.N. (Pt. 1) (N.S.W.) 276 at page 285; Street, J., borrowed with minor adaptations the words of Rich, J.: "the requirement is that the transaction must fall into place as part of the undistinguished common flow of the company's business, that it should form part of the ordinary course of the company's business as carried on, calling for no remark and arising out of no special or particular situation". See also Re Pacific Mobile Corporation; America Biltrite (Canada) Ltee v. Robitaille, 44 C.B.R. 190 at pages 201 to 205."

Reed, J., further commented on the definition of "inventory" and whether or not inventory for a "one time" transaction falls within a person's inventory in respect of a business carried on by that person:

"What constitutes inventory must be interpreted in the commercial and accounting contexts within which that term is normally used. Inventory is usually acquired for the purpose of selling it to make a profit thereon. There is usually an opening inventory and closing inventory by reference to which a taxpayer's income for a taxation year is calculated.

I accept counsel for the defendant's argument that one transaction can be an "adventure in the nature" of trade and therefore constitute a business for tax purposes. But, the single transaction must have a profit making motive. None such existed in this case, I have not been persuaded that [the goods] in question falls within the taxpayer's inventory in respect of a business carried on by it."

Although the cases mentioned are in respect of an inventory allowance for a person's business pursuant to the Income Tax Act, they have been used by the Canadian International Trade Tribunal (CITT) as a basis for determining if goods are eligible for the FST inventory rebate, for example, in Archer's Sign's & Trophies v MNR [1993] E.T.C. 4518.

Unless XXXXX can provide proof that it meets the above interpretations with respect to the phrase "in the ordinary course of a commercial activity", the FST inventory rebate should be denied even if the particular assets were determined to be "assets held for sale".

If you require any further information, please do not hesitate to contact Mr. Karl Marten of my staff at (613) 952-2214.

H.L. Jones
Director
General Tax Policy
GST Rulings and Interpretations
Policy and Legislation Branch

GTP: XXXXX