22 June 1993 External T.I. 9301695 F - Change in Method of Inventory Valuation

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.

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Attention:  XXXXXXXXXX

Dear Sirs:

RE:  Change in Method of Inventory Valuation Subsection 10(2.1) of the Income Tax Act (the "Act")

This is in reply to your letter of January 18, 1993 in which you requested our opinion on the application of subsection 10(2.1) of the Act. We apologize for the delay in replying to you.

Specifically, you enquired as to whether a taxpayer would be required to seek Departmental approval to change the method of determining cost of inventory from one acceptable method to another, for instance from using average cost to using first-in, first-out.

It is your view that such approval would not be required since the inventory would still be valued at the lower of cost or fair market value as provided by subsection 10(1) of the Act.

Our Comments:

The situation you described appears to involve specific taxpayers and specific contemplated transactions or events. As explained in Information Circular 70-6R2 dated September 28, 1990, assurance as to the tax consequences of proposed transactions is provided by the Rulings Directorate but only on an advance income tax rulings basis and only with respect to the taxpayers identified in such rulings. Nevertheless, we have set out below some comments of a general nature.

Subsection 10(2.1) inserts into the Act the accounting principle that financial statements are to be prepared using consistent principles from one year to the next. This concept is also contained in subsection 10(1) since it refers to computing income from a business rather than computing income for a taxation year from a business.

Subsection 10(2.1) was added to provide legislative support to the Department's longstanding position which was described in paragraph 4 of IT-473. That position, which is continued in the Special Release to the bulletin dated April 30, 1993, is that a change in method of valuing inventory will be accepted if it can be shown that, considering the circumstances, the new method:

(a)     is a more appropriate way of calculating the taxpayer's income,

(b)      will be used for financial statement purposes by the taxpayer, and

(c)      will be used consistently in subsequent years.

The Department's primary concern is that there is a consistent application of an accepted valuation method. Once a method of valuing inventory has been used and accepted, the taxpayer should normally continue to use that method.

The term "method" as used in subsection 10(2.1) is not a defined term. It is the Department's view that "method" entails more than one of the two general methods referred in subsection 10(1) which enable a taxpayer to value properties at the lower of cost or fair market value ("LCM"), or to value all properties at fair market value. In fact, subsection 10(1) uses the term "manner" rather than "method". Throughout our Interpretation Bulletin IT-473 the term "method" has been used more broadly than a reference to the two general valuation methods. In paragraph 11 of IT-473, it is stated that a "method" must be chosen for identifying the cost of properties where the LCM approach is used. The use of specific item cost, average cost or first-in, first-out each represents a different "method" of determining cost, and hence each represents a different "method" of determining inventory valuation. In paragraph 16 of IT-473, it is stated that the Department will not accept a change in the method used in determining "cost" or in determining "market" unless the new method is determined to be more realistic in the circumstances and the change is also made for financial statement purposes.

Based on the above, in our view, the valuation of inventory using the LCM method whereby net realizable value is used to determine FMV would be a different method than using the LCM method whereby replacement cost is used to determine FMV. Similarly, the determination of cost using average cost is a different method of inventory valuation than using first-in, first-out, notwithstanding that both methods could be categorized as being LCM methods of valuation. In our opinion, a taxpayer would be required pursuant to subsection 10(2.1) of the Act to obtain Departmental approval of a change in its method of determining the cost of properties in its inventories.

We trust that our comments are of assistance.

Yours truly,

R. Albert for DirectorBusiness and General DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch