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.
913231 24(1)
Dear Sirs:
Re: Application of Subsection 78(1) of the Income Tax Act (the "Act") to Costs of Goods Sold
This is in reply to your telephone enquiry (Holloway/19(1)) related to our response to your firm dated October 23, 1991 concerning the application of subsection 78(1) to the costs of construction capitalized to inventory. As explained in that response, the situation you presented to us appeared to be an actual fact situation which we could not comment directly upon, accordingly our response took the form of general comments and did not address each item raised in your original enquiry.
Specifically you enquired whether or not subsection 78(1) would apply to the cost of inventory once it became deductible, that is when the inventory is sold and is charged against income as cost of goods sold.
Our Opinion
Subsection 78(1) applies where an amount in respect of a deductible outlay or expense is owing by the taxpayer to a non-arm's length person at the end of the second taxation year following the year in which the outlay or expense was incurred. If an amount is owing as a result of an inventory purchase, the fact that this particular item of inventory is sold does not change the nature of the amount owing, the amount is still owing in respect of the inventory purchase. It is not owing as a result of the item being sold. As an outlay or expense in respect of inventory is not considered to be a "deductible outlay or expense" for purposes of subsection 78(1) and (2) of the Act (Interpretation Bulletin IT-109R, p.5), section 78 would not be applied to the unpaid amount upon the subsequent sale of the inventory item.
These comments represent our understanding of the law as it applies generally. Our response could differ in a particular fact situation. We trust these comments will be of assistance.
Yours truly,
E. Wheeler for DirectorBusiness and General DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch
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