Andrew Taylor v. Minister of National Revenue, [1990] 2 CTC 2040, 90 DTC 1574

Mogan, T.C.J.: —In this appeal, the respondent used section 10 of the Income Tax Act to value the appellant’s inventory at December 31, 1985 and to increase the appellant's reported income for 1985 by the amount of $25,000. The principal issue is whether the conditions were present in 1985 to justify the application of section 10 of the Act. A collateral issue is whether paragraph 45(1)(a) of the Act might also apply in 1985.

This appeal was heard in 1989 just before the appellant's 82nd birthday. He is a veteran of World War Il and, in 1946, he opened his own business in Ottawa under the name 'Andrew Taylor Engineering”. He and his wife moved to Winnipeg in 1965 where he continued his business until 1972 when he retired at the age of 65. The appellant's hobby was collecting books. He started this hobby seriously in 1946 and, when he retired in 1972, his house was filled with about 24,000 books. He had so many books in 1965 when he moved from Ottawa to Winnipeg that he needed more than half of a freight car to move his books.

Upon his retirement in 1972, the appellant and his wife decided to open a small store as an outlet to sell the books he had collected over the preceding 26 years. They rented 1,200 square feet on the second floor of a building in a retail area on the Pembina Highway going out of Winnipeg. His books were of general interest and were not acquired in one or more particular subject areas. From the appellant's evidence, the book selling operation sounded like an amateur endeavour. He put a sign in his window: “Help Fight T.V.—Come and Buy a Book”. In terms of selling to any particular class of customers, he stated: "We weren't really selling to anybody”. Indeed, he acknowledged in cross- examination that he was not proceeding in a business-like manner.

He had to leave his location on the Pembina Highway in 1975 because he had no lease. He then rented 3,000 square feet on Dalhousie Street which was farther out of the city than his Pembina location. He kept the Dalhousie site until 1978 when his wife became terminally ill. Since 1978, he has operated his book business out of his house. The appellant stated that his books are his life and that he was a compulsive buyer of books. I have no hesitation in believing him. When this appeal was heard, the appellant still regarded some unspecified portion of his book collection as property with which he would not part. When he opened his first store in 1972, he did not obtain any accounting or bookkeeping advice and it would appear that no such advice was obtained up to the end of 1985. To the best of his recollection, he would have reported some book sales in each income tax return since 1972. In his 1985 income tax return, the appellant reported the result of his book business as follows:

The above statement demonstrates that the appellant has used a simple "cash method" of accounting to report the profit or loss of his book business without recognizing the cost or value of his book collection as being relevant in the computation of profit. The decision of the Exchequer Court in Ken Steeves Sales Ltd. v. M.N.R., [1955] Ex. C.R. 108; [1955] C.T.C. 47; 55 D.T.C. 1044 and many subsequent decisions establish the principle that, for a person engaged in a trading business, the "Cash Receipts and Expenditures" method is not an acceptable method of computing income under the Income Tax Act. In 1986, the appellant was visited by a Ms. K. Mills, an auditor from Revenue Canada, Taxation, who inquired about his book business. At some point in his discussions with her, the appellant wrote out and signed the following memorandum which was entered in evidence as Exhibit R-1:

10 September 1986

Following the visit here today of Mrs. Kelly Mills, auditor, we agreed that a figure of $25,000 be used in setting up the inventory for adjusting my tax return for the year 1985.

Andrew Taylor

The respondent has, quite rightly in my view, construed this memorandum as an admission by the appellant that his book collection had a value of $25,000 in 1985. On September 18, 1986, the Director of Taxation in the Winnipeg District Office of Revenue Canada, Taxation sent the following letter to the appellant (Exhibit R-2 herein):

Dear Mr. Taylor:

As a result of our audit of your Income Tax Returns, the December 31, 1985 inventory of your business was determined to be an amount of $25,000.00 rather than the amount of Nil as reported by you. In accordance with subsection 10(3) of the Income Tax Act and the authority delegated to me by subsection 900(2) of the Income Tax Regulations, you are advised that the property described in the inventory of your business at the commencement of the 1985 taxation year in the amount of Nil has been deemed to have been valued as required by subsection 10(1) of the Income Tax Act and the Regulations made thereunder.

Yours truly,

On April 9, 1987, a notice of reassessment was sent to the appellant with respect to his 1985 taxation year adjusting his reported income as follows:

It is the above reassessment which is under appeal. The respondent relies on the following provisions of the Income Tax Act:

10(1) 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.

10(3) Where the property described in the inventory of a business at the commencement of a taxation year has, according to the method adopted by the taxpayer for computing income from the business for that year, not been valued as required by subsection (1), the property described therein at the commencement of that year shall, if the Minister so directs, be deemed to have been valued as required by that subsection.

Section 248

''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;

For accounting purposes, the appellant has never recognized his books as the inventory of his business because he has not relied on the cost or value of his books in determining his profit or loss. He has used only a simple “cash method" of accounting. These circumstances appear to justify the respondent's use of subsection 10(3) because, according to the cash method" adopted by the appellant for computing his 1985 business income, the property described in the inventory of his business at the commencement of 1985 (the value of which was ignored by the appellant) has not been valued as required by subsection 10(1) of the Act. Therefore, the direction of the Minister in the letter of September 18, 1986 (Exhibit R-2) deems the inventory at the commencement of 1985 to have been valued as required by subsection 10(1).

Subsection 10(3) permits the Minister to rely on subsection 10(1) to change the value of a taxpayer's inventory at the end of a particular year without requiring the Minister to change the value of the inventory at the start of that year. If a taxpayer has valued his inventory by a method not authorized by the Act, and if the Minister applies subsections 10(1) and 10(3) in a particular year; the inventory at year end will be valued by the Minister in accordance with a method authorized by the Act; and any accumulation of erroneous income reporting in prior years resulting from the taxpayer's unauthorized inventory values will be brought into account in the particular year by retaining the unauthorized inventory value at the start of the year.

Subsection 10(3) assumes that a taxpayer has adopted a method of valuing his inventory and that his method is not authorized by subsection 10(1). Note the following words in subsection 10(3): “according to the method adopted by the taxpayer for computing income from the business for that year". On the evidence, I find that all or substantially all of the appellant's book collection had become his inventory by 1985. I also find that he had not valued it in 1985 but had simply ignored its cost or value. In the particular circumstances of this case, the application of subsections 10(1) and 10(3) on a stand-alone basis leaves the appellant with deemed income of $25,000 in 1985 related only to (i) the recognition of his books as inventory; and (ii) the valuation of those books at year end in accordance with subsection 10(1). The provisions of section 10, standing alone, would not recognize the contribution of the book collection to the retail operation.

If, by applying section 10 of the Act, 1985 becomes the first taxation year in which the appellant's book collection is recognized for income tax purposes as the inventory of his retail business, then it seems appropriate to apply also in 1985 the provisions of paragraph 45(1)(a) of the Act:

45(1) For the purposes of this subdivision the following rules apply:

(a) where a taxpayer,

(i) having acquired property for some other purpose, has commenced at a later time to use it for the purpose of gaining or producing income therefrom, or for the purpose of gaining or producing income from a business,

(ii) ..

he shall be deemed to have

(iii) disposed of it at that later time for proceeds equal to its fair market value at that later time, and

(iv) immediately thereafter reacquired it at a cost equal to that fair market value;

With respect to the book collection, the appellant has really worn two hats. For, most of his adult life, books were his hobby and he accumulated a significant collection which was, of course,a capital property. In 1972, after age 65, he attempted to develop a retail business which he hoped would become an avenue for disposing of his book collection. And in that attempt, he started to encroach upon the books in his collection. It is clear from the evidence that his attempt to develop a retail business has not been successful because, in 1985, he still had substantially all of the collection.

By applying paragraph 45(1)(a) of the Act in 1985, the appellant wearing the hat of a hobby collector is deemed to have disposed of his book collection as capital property at the settled value of $25,000. And at the same time, the appellant wearing the hat of the aspiring retailer is deemed to have reacquired his book collection as inventory at the same settled value of $25,000. If the application of section 10 and paragraph 45(1)(a) were to be integrated with the appellant's cash method of reporting profit or loss as set out above, the determination of the appellant's gross profit for 1985 may appear somewhat as follows:

The above projection of gross profit (loss) is only speculative, however, and a more detailed computation would have to be determined by representatives of the appellant and the respondent. Paragraph 45(1)(a) would not have any bearing on this appeal if the appellant had not accumulated such a significant book collection before the time when he embarked upon the business of selling books. In my view, the provisions of paragraph 45(1)(a) of the Act apply to the 1985 taxation year of the appellant if that is the first year when the cost or value of his book collection is recognized as relevant in computing the profit or loss of his book selling business. I would allow the appeal with costs and refer the reassessment for 1985 back to the respondent for reconsideration and reassessment for the purpose of applying both section 10 and paragraph 45(1)(a) of the Income Tax Act.

Upon such reconsideration and reassessment, the respondent should review an expense in the amount of $ 1,288.55 deducted by the appellant and identified by him as "rent". According to the evidence, the appellant moved his book business out of his last commercial location in 1978 and has, since then, operated out ofhis house. If he owns the house, it is not clear how he could deduct the amount of $1,288.55 as rent. If he pays rent in respect of the house, there may be some question as to the allocation of rent between his domestic residence and his book business.

Appeal allowed.