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.
Principal Issues:
1. Whether escrowed shares are identical to free shares of the same class.
2. If so, whether 47(1) applies to shares that are held as inventory so as to average the cost of the shares.
Position TAKEN:
1. Yes.
2. In the present case, the cost of the shares should be averaged (but not pursuant to 47(1)).
Reasons FOR POSITION TAKEN:
1. Long-standing position.
2. 47(1) applies to capital property. IT-473, para. 11, describes how to value inventory.
August 8, 1995
Mr. Dennis Luciuk HEADQUARTERS
Director J.D. Brooks
Vancouver Tax Services Office 957-8953
Attention: Thea Kruger
Technical Advisor
Appeals
951766
Sections 10 and 47 of the Income Tax Act
This is in reply to your memorandum of July 5, 1995 in which you requested our views on the following fact situation.
FACTS
1.An individual purchased and sold shares which are traded on the Vancouver Stock Exchange.
2.The individual's portfolio included shares that could be traded without restrictions ("Free Shares") and shares that were subject to extensive restrictions imposed by the Vancouver Stock Exchange ("Escrowed Shares"). The Escrowed Shares were issued and are held by XXXXXXXXXX The Escrowed Shares are subject to being cancelled if certain performance criteria are not met.
3.Both the Free Shares and the Escrowed Shares were shares of the same corporation. We have assumed that they are shares of the same class.
4. XXXXXXXXXX.
5.Since 1989, the individual has purchased and sold many Free Shares, and the prices varied from $.25 to $5.35 per share.
6.It is understood that none of the Escrowed Shares have been released from escrow.
7.The trading has been reassessed by the Department on the basis that the sales were income transactions and were not capital transactions.
ISSUE
The issue is whether the Escrowed Shares are identical to the Free Shares and, if so, whether the cost of shares disposed of should be calculated based on the moving average cost of all shares of the same class.
REPRESENTATIVE'S VIEW
The representative referred to section 1510.01 of the CICA Handbook and stated that the Escrowed Shares are not a current asset since it is not anticipated that they will be realized within one year. In referring to section 3030.07 of the CICA Handbook, he stated that the Escrowed Shares are not similar to the free shares and thus it is not appropriate to average their costs.
The representative states that subsection 47(1) is not applicable to shares that are not held as capital property.
He also referred to the Taylor (88 DTC 1571) case for support, wherein the Tax Court of Canada held that escrowed shares are not identical to free shares.
AUDITOR'S VIEW
The individual has been reassessed on the basis that the Escrowed Shares and the Free Shares are identical properties and therefore it is appropriate to calculate the cost of the shares on a perpetual averaging basis pursuant to subsection 47(1) of the Income Tax Act (the "Act").
OUR VIEW
As stated in paragraph 6 of Interpretation Bulletin IT-387R2, it is the Department's view that "shares of the capital stock of a corporation which are subject to an escrow agreement so as to prevent the owner thereof from dealing in them (escrowed shares) and shares of the same class and kind of the capital stock of the same corporation which are not so restricted (free shares) are considered to be identical properties, notwithstanding that the value of the escrowed shares may be less than the value of the free shares." While IT-387R2 concerns primarily section 47 of the Act, the statements it makes on identical properties have general application. That is, whether a property is identical to another property is not dependant on the properties being capital properties. Thus, one can rely on paragraph 6 of this bulletin even where the properties are sold on income account.
As you pointed out, the Appeals Division of Headquarters stated in their Decision 89-11 dated March 6, 1992 that the Department considers the decision by the Tax Court in the Taylor case, that escrowed shares are not identical to free shares, is wrong in law and therefore that decision should not be considered a precedent. It remains the Department's view that escrowed shares are identical to free shares of the same class.
As to the applicability of subsection 47(1) of the Act, the preamble of that subsection states that it is applicable for purposes of computing the adjusted cost base ("ACB") of each identical property. However, it is our view that ACB would not be relevant to the calculation of taxable income where specific rules in the Act are applicable. Such would be the case in the calculation of the income from a business or property pursuant to section 9 of the Act and in the valuation of inventory property under section 10. Subsection 47(1) is located in subdivision c of the Act and it is our view that this subdivision is applicable only in respect of capital properties.
The LIB document to which you referred (EC1768) was a proposal which was presented to the Review Committee of the Rulings Directorate in 1982. However, there is no evidence that that proposal was accepted. It has also been considered that the definition of ACB may apply to properties other than capital properties, although it appears that there may be no consequence of such.
Although it is our view that subsection 47(1) does not apply in the present situation, one needs to consider how income should be calculated under section 9 where the properties disposed of are identical properties. It is our view that shares of a corporation are fungible property and accordingly one cannot identify a specific share by reference to a share certificate or otherwise once it is held by a person who owns other shares identical thereto. We maintain this view even though some of the shares are subject to an escrow arrangement. It is therefore our opinion that the shares sold in any given year by the individual would not necessarily be the shares acquired in that year.
In considering how cost should be determined for purposes of valuing inventory, paragraph 11 of Interpretation Bulletin IT-473 (Inventory Valuation) states:
Except where inventory is valued entirely at fair market value (section 1801 of the Regulations), a method must be chosen for identifying the costs which represent inventory at the end of the taxation year. Where it is practical to identify costs by reference to specific items, the cost is determined by ascertaining the laid-down cost of the specific items. If it is not practical to determine cost by reference to specific items, it is necessary to use an arbitrary cost selection method which has the effect of making a presumption as to the order in which inventory is sold. Among the methods most commonly used in determining cost are:
(a) specific item
(b) average
(c) first in first out (fifo). The Department will not accept the last in first out (lifo) method or the base stock method.
As stated above, since shares are fungible property, a taxpayer is not able to identify which specific fungible property is disposed of and therefore the use of the specific item cost would not be feasible in the case at hand. The use of the FIFO method would not appear to be desirable to the individual due to the low cost of the first-acquired shares. Thus, it is appropriate in the case at hand to average the cost of shares acquired.
In West Kootenay Power and Light Company (92 DTC 6023), the Federal Court of Appeal confirmed the principle of using accounting methods which give the "truer picture" of the revenue. Where properties are fungible, it is generally not possible to identify which specific property is disposed of and thus it is our view that the use of average costs would yield the truer picture of the individual's income.
for Director
Business and General Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch
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