The Queen v. Boehringer Ingelheim (Canada) Ltd., 85 DTC 5443, [1985] 2 CTC 211 (FCTD), aff'd 87 DTC 5442, [1987] 2 CTC 245 (FCA)

Reed, J:—This is an appeal from a decision of the Tax Review Board allowing the defendant taxpayer, Boehringer Ingelheim (Canada) Ltd, to deduct the inventory allowance, provided for by paragraph 20(1)(gg) of the Income Tax Act, SC 1970-71-72, c 63, as amended, in computing his income for the 1977 taxation year. Subsection 20(1 )(gg) provides:

. . in computing a taxpayer's income for a taxation year ... there may be deducted . . . an amount in respect of any business carried on by the taxpayer in the year, equal to that portion of 3% of the cost amount to the taxpayer, at the commencement of the year, of the tangible property (other than real property or an interest therein) that was

(i) described in the taxpayer’s inventory in respect of the business, and

(ii) held by him for sale or for the purposes of being processed, fabricated, manufactured, incorporated into, attached to, or otherwise converted into or used in the packaging of, property for sale in the ordinary course of the business

that the number of days in the year is of 365; .. .

The taxpayer is owned indirectly (through a Canadian investment holding company) by a German company (partnership) named C H Boehringer Sohn. Prior to 1971-1972 that company operated in Canada through the corporation Ciba-Geigy Canada Ltd. The arrangement between the two companies provided that Ciba-Geigy would develop, manufacture, market and distribute Boehringer’s products in Canada. Ciba-Geigy and Boehringer are competitors in the pharmaceutical market and operate at arm’s length.

In 1971 it was decided that Boehringer would operate in Canada through a separate corporation, a corporation which eventually became the taxpayer in this case, Boehringer Ingelheim (Canada) Ltd. The two companies (Ciba-Geigy and Boehringer Sohn) agreed to a gradual disengagement of their existing business relationship. An agreement dated January 1, 1971 was signed, providing that: as of October 1, 1971 Boehringer would become responsible for the development of its own products (ie: the development programs and obtaining government approval necessary to permit marketing); commencing January 1, 1973 Boehringer would conduct its own marketing; Ciba-Geigy would continue manufacturing, packaging and distributing Boehringer’s products until December 31, 1976. On that date the agreement between the two companies was to terminate automatically unless Boehringer gave notice that it wished an earlier termination. The 1971 agreement also provided that Boehringer would purchase the relevant inventory of Ciba-Geigy on January 1, 1977 and the packaging materials relating to such products as were unusable by Ciba-Geigy. In 1977 paragraph 20(1 )(gg) was added to the Income Tax Act allowing for the deduction provided therein for the 1977 taxation year and following. (Transitional provisions made it applicable to taxation years ending after March 1977.)

The agreement with Ciba-Geiby was not terminated by Boehringer Sohn prior to the December 31, 1976 date and thus expired automatically at that time. The inventory to which the agreement related was physically transferred from Ciba-Geigy to Boehringer Ingelheim (Canada) Ltd in stages during the months of December 1976 and January 1977. Slightly less than one half was transferred during the first week of January 1977; the remaining amount was transferred within a fairly short period of time thereafter. Boehringer assumed responsibility for insuring the inventory from December 1, 1976 forward. Ciba-Geigy invoiced Boehringer Ingelheim (Canada) Ltd for all of the inventory (including that shipped after the beginning of the year) on invoices dated January 1, 1977. These invoices although dated January 1, 1977 show the physical transfer as having occurred January 4 and 6. Boehringer Ingelheim (Canada) Ltd balance sheets show no inventory for December 31, 1976.

The defendant argues that it had inventory as of the commencement of the 1977 taxation year and therefore is entitled to the inventory allowance provided for by paragraph 20(1)(gg). The plaintiff argues that this is not the case because: (1) as a factual matter the defendant did not acquire the inventory until after the commencement of the taxation year, and (2) in any event a taxpayer cannot have an opening inventory at the beginning of the taxation year, for the purposes of paragraph 20(1)(gg) if it did not have a closing inventory for the 1976 taxation year.

The first argument relates to the conclusion that should be drawn from the facts. The plaintiff argues that the defendant did not acquire the inventory until sometime after midnight on December 31, 1976 and this was after the commencement of the taxation year. Particular emphasis is put on the fact that the 1971 agreement provided for purchase on January 1, 1977. The defendant argues that the inventory was acquired as of midnight on December 31, 1976 and as such was held by it as of the commencement of its taxation year.

The defendant's contention as to the proper conclusion to be drawn from the facts is the better. The time at which property is transferred from one person to another is a conclusion based upon the intention of the parties* [1] as drawn from the terms of the contract, the conduct of the parties and the circumstances generally. In this case the conduct of the parties and the circumstances generally are consistent with the conclusion that the inventory was the defendant's as of the beginning of 1977. The defendant had accepted the risk of loss by that time; it had physical possession of close to one-half the inventory; it had the right to possession and use of the rest of the goods during the whole of the first day of January 1977. The contract in providing for the termination of the agreement on December 31, 1976 and purchase of inventory on January 1, 1977, is not indicative of two separate transactions. Clearly the parties intended that the termination of the relationship with Ciba-Geigy and the taking over of the inventory by Boehringer Ingelheim (Canada) Ltd were to be coincident.

The plaintiff's second argument is based on the wording of subsection 10(2) of the Income Tax Act:

Notwithstanding subsection (1), for the purpose of computing income for a taxation year from a business, the property described in an inventory at the commencement of the year shall be valued at the same amount as the amount at which it was valued at the end of the immediately preceding year for the purpose of computing income for that preceding year.

On the basis of this section it is argued that a taxpayer cannot have opening inventory for the purposes of paragraph 20(1)(gg) if it does not have closing inventory for the previous year. I do not think subsection 10(2) operates in this way. Subsection 10(2) must be read within the context of the section in which it is found. That section deals with the valuation of inventory, not whether inventory exists or not. Subsection 10(1) provides:

For the purpose of computing income from a business, the property described in an inventory shall be valued at its cost to the taxpayer or its fair market value, whichever is lower, or in such other manner as may be permitted by regulation.

Thus subsection 10(2) is a qualification of the rule found in subsection 10(1). It requires that the taxpayer adopt a consistent method of valuing inventory from one year to the next. I cannot interpret it as a limitation on paragraph 20(1)(gg) as is argued by the plaintiff.

The plaintiff next argues that paragraph 20(1)(gg) must be interpreted to require a closing inventory because of the context in which the subsection operates. Particular emphasis is put on the fact that the deduction is allowed with respect to “the cost amount to the taxpayer,at the commencement of the year”. Cost amount is defined in subsection 248(1) as:

“cost amount” to a taxpayer of any property at any time means, except as expressly otherwise provided in this Act, . . .

(c) where the property was described in an inventory of the taxpayer, its value

at that time as determined for the purpose of computing his income,

And:

“inventory” means a description of property the cost or value of which is relevant in computing a taxpayer’s income from a business for a taxation year;

These definitions refer a reader to section 10 and the valuation of inventory rules but, as noted above, I have not found the argument that the valuation rules have the effect of creating a limitation on paragraph 20(1 )(gg), of the kind suggested, a convincing one. Indeed, it seems to me that if the legislator had intended the deduction to be based on the value of the closing inventory of the preceding taxation year it would have drafted paragraph 20(1 )(gg) to clearly so provide.

The purpose of paragraph 20(1 )(gg) is to allow a deduction in recognition of the fact that inflation results in a significantly higher cost of replacing inventory at the end of the taxation period over the cost which existed at the beginning of the taxation year. Thus profits (income) on paper can be in excess of actual disposable profits (income). The allowance is related to the 1977 taxation year (taxation years ending after March 1977), and it is designed to operate as an allowance relating to the replacement of 1977 inventory. Thus, I can see no reason arising out of the purpose of the section which requires the interpretation for which the plaintiff contends.

Accordingly, the appeal is dismissed with costs.

Appeal dismissed.