21 December 1994 Internal T.I. 9431677 - INVENTORY WRITE-DOWNS

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Memo to File #7-943167

As a follow up to a telephone call the Ottawa D.O. (Don Miller, Audit) faxed a sketchy set of facts which can be condensed as follows:

Aco gets 40% of Bco shares as consideration for guaranteeing a $15m bank loan. The bank held a $15m mortgage on townhouses under construction by Bco. Bank calls loan; Aco pays loan; Takes over the mortgage; ownership of townhouses transferred to Aco; Aco treats the townhouses (fmv $8m) as inventory and writes-off $7m as an inventory write-down. Is the $7m a capital loss or is the income loss in order.

Reply given by phone:

Section 79 sets Aco's cost at $15m which is also Bco's proceeds on account of income.

Since the debt held by Aco is a capital property, the difference between the amount realized in respect of the townhouses and the $15m deemed cost will be a loss on capital property, i.e., the debt. The fact that the completed townhouses are sold in a manner similar to that of a builder would not in itself cause the property to be inventory. Aco could take what ever action it wants to realize on the property acquired in settlement of the debt without it being an inventory transaction. If however the townhouse development was only partially completed, say, some finished, some partially finished and some empty lots not started, the finishing of the project would constitute more than would be acceptable as a mere realization on the asset acquired in settlement of the debt. At the time Aco commenced to take steps to complete the development, we would consider that a capital property acquired for $15m was converted to inventory at its fmv of $8m and the $7m would be a capital loss on the debt subject, of course, to subparagraph 40(2)(g)(ii) which would deny the loss unless the debt was acquired for the purpose of producing income from a property or business. At the point of converting the development from capital property to inventory at fmv, all subsequent transaction by Aco would be considered to be on account of income.

A.M. Brake

December 21, 1994