10 June 1991 Internal T.I. 910307 F - Retail Inventory Method

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Dear Sirs:

Re:  Subsection  10(1) of the Income Tax Act

This is in reply to your letter of January 29, 1991 concerning the retail inventory method.

A corporation meets the three conditions set out in paragraph 17 of IT-473. These are requirements for establishing that the retail inventory method of valuing inventory may be used for computing income.  Although it also keeps records of original cost, the corporation has regularly followed the retail method of valuing its inventory.  However, in a particular year, unusual factors have resulted in a large markdown in the selling prices of the stock on hand.  As a consequence, the retail inventory method results in an ending inventory which is valued below the original cost.

Paragraph 14 of IT-473 indicates that regardless of the method of valuing inventory a valuation that recognizes in the current year losses that arise after the year end is not acceptable.  In a similar vein, the paragraph states, a reduction on account of profit margin which recognizes a loss in the current year so that a normal profit results in the year of disposition is equally unacceptable.

You have asked whether a corporation may use the retail inventory method even though it maintains records of original cost and whether the comments in paragraph 14 are applicable in the situation set out above.

Where a corporation meets the requirements of paragraph 17 of IT-473 the use the retail method of computing income would not be denied solely as a result of the fact that original cost records are also kept.

A valuation of an inventory below original cost and current fair market value has the effect of recognizing a loss that has not yet (and might never) occur. Such a valuation may also have the effect of reducing a current year's profit so that a normal profit is recognized in the year of disposition.  Paragraph 14 indicates neither of these situations is acceptable to the Department. Consequently, in these circumstances, a valuation placed on the ending inventory using the retail method cannot be accepted for tax purposes.  We also note that in some circumstances claiming large markdowns before year end may be viewed as an attempt to set up a contingency reserve against future profit reductions.  Such a reserve is not allowed for income tax purposes (paragraph 18(1)(e) of the Income Tax Act).

In an actual situation similar to the above a taxpayer should submit the facts and circumstances to the local District Office for consideration of the appropriate value to be placed on the ending inventory.

We trust these comment will be of assistance.

for DirectorBusiness and General DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch