5 February 1999 Internal T.I. 9902497 - STUMPAGE CHARGES INCLUDED IN INVENTORY COSTS

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.

		February 5, 1999

		Quebec Tax Services Office	Headquarters
		Audit Division	Resource Industries Section
		Richard Cloutier	Peter Lee
(613) 957-8977

			990249
	
Stumpage Charges Included in Inventory Costs

This is further to our discussions regarding whether the stumpage paid to a province for harvesting timber on Crown land and the capital cost allowance (“CCA”) in respect of a timber limit calculated pursuant to Schedule VI of the Income Tax Regulations (the “Regulations”) should be included in the inventory costs for both accounting and Income Tax Act (the “Act”) purposes.

In the case of Northwood Pulp and Timber Limited, 96 DTC 1104 (TCC), in concluding that silviculture expenses were period or running expenses rather than costs to be added to the cost of inventory, Margeson, T.C.C.J., commented as follows:

“The position taken by Mrs. O’Malley (the expert witness for Northwood) was that you treat silviculture costs as costs of inventory just the same as stumpage costs or part of log costs. Therefore, it becomes part of inventory costs and therefore part of the cost of goods sold formula. On the other hand, Ms. Holgate (the expert witness for the Crown) says that you write it off as you incur it, when you are obliged to do the silviculture work... Counsel suggested that Ms. Holgate’s position is incongruous. She would treat stumpage costs as a cost of inventory but would treat silviculture costs in a different manner... The type of expenses in issue here have never been considered by any other Court.... The Court finds that the position of Ms. Holgate was more realistic and it has difficulty in finding a direct relationship between the silviculture costs and the end product costs.”

The Federal Court of Appeal agreed with the lower court in this case that these silviculture expenses were properly period expenses rather than inventory costs because the actual expenses would not be incurred until a subsequent period. The Court quoted with approval the following comments of the Supreme Court of Canada in the case of Canderel Limited, 98 DTC 6100 (SCC):

“In ascertaining profit, the taxpayer is free to adopt any method which is not inconsistent with - inter alia - established case law principles.”

Even though the court did not have to decide whether stumpage charges would become part of inventory costs in the case of Northwood, it appears that generally accepted commercial principles would require such stumpage charges be included as part of inventory costs. This principle is consistent with established case law principles (see the cases of Metropolitan Properties Co. Limited, 85 DTC 5128 (FCTD), and Qualico Developments Ltd., 84 DTC 6119 (FCA)). The stumpage charges could be differentiated from silviculture expenses. Stumpage charges have a direct relationship with the production of inventory - they are incurred in the course of producing timber. This principle is consistent with the Department’s position in respect of inventory stated in paragraphs 6 to 8 of Interpretation Bulletin IT-473. Furthermore, stumpage charges on timber harvested on Crown land, is similar to royalties on production of oil and gas and minerals from Crown land. The 1982 Technical Notes in respect of an amendment to paragraph 18(1)(m) of the Act relating to Crown royalties clearly contemplated that such royalties would be included in inventory costs. Based on the above discussion, it is our view that the stumpage charges could be included as inventory costs.

With respect to CCA on timber limit calculated pursuant to Schedule VI of the Regulations, there is no requirement to include such CCA in the inventory costs for the purpose of section 10 of the Act. The taxpayer would be allowed to claim CCA for the year pursuant to paragraph 20(1)(a) of the Act and paragraph 1100(1)(e) and Schedule VI of the Regulations up to the maximum amount prescribed thereunder. However, if an amount that is an allowance in respect of depreciation, obsolescence or depletion is included in a taxpayer’s inventory costs at the end of the year, that amount would have to be included in the taxpayer’s income by virtue of paragraph 12(1)(r) of the Act. The amount included in income under paragraph 12(1)(r) of the Act is deductible in the following year by virtue of paragraph 20(1)(ii) of the Act. (See paragraph 9 of Interpretation Bulletin IT-473.)

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Legislation Access Database (LAD) on the Department’s mainframe computer. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the LAD version or they may request a severed copy using the Privacy Act criteria which does not remove client identity. Requests for this latter version should be made by you to Jackie Page at (613) 957-0682. The severed copy will be sent to you for delivery to the client.

If we could be of any further assistance to you, please contact the writer.

Manager
Resource Industries Section
Resources, Partnerships and Trusts Division
Income Tax Rulings and Interpretations Directorate
Policy and Legislation Branch
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