7 February 1991 Income Tax Severed Letter - Appropriate Method of Valuing Inventory in First Taxation Year of Corporation Formed by Merger

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.

Subject: XXX

This is in response to your memorandum of January 29, 1991 in which you requested our views on the appropriate method of valuing inventory the first taxation year of a corporation which was formed by a merger in respect of which the provisions of section 87 of theIncome Tax Act(the “Act”) were applicable. All statutory references are to theIncome Tax Actunless otherwise noted.

Our understanding of the Plaintiff's position is that since an amalgamated corporation is deemed to be a new corporation by virtue of paragraph 87(2)(a), the new corporation cannot be bound by the inventory valuation method of one of its predecessor. Implicit in this argument is that the new corporation did not have an inventory at the beginning of its first taxation year.

In our view, this position ignores the provisions of paragraph 87(2)(b) and, in particular, the following clause:
• ”... the property [the inventory] so included shall be deemed to have been acquired by the new corporation at the commencement of its first taxation year for an amount determined in accordance with section 10 thereof for the purpose of computing the income of the predecessor corporation for its last taxation year...”

In deeming the new corporation to have acquired the inventory at the commencement of its first taxation year, paragraph 87(2)(b) is incorporating the requirements of subsection 10(2) into section 87. Subsection 10(2) reads in part as follows:
• ”...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...”

By using the same words in paragraph 87(2)(b) and subsection 10(2) it is our opinion that the legislature intended the amalgamated corporation to have acquired its predecessor corporation's inventory and its valuation method. Since subsection 10(2) provides for the continuity of inventory valuation between two taxation years, the implicit reference in paragraph 87(2)(b) to the rules in subsection 10(2) would seem to be intended to ensure that the amalgamated corporation maintain the continuity of inventory valuation. As noted in D.W. Baines' December 19, 1990 memorandum the decision in Cyprus Anvil Mining Corporation ([1990] 1 C.T.C. 153) is relevant with respect to the principle of consistency as between the method employed in valuing the inventory at the commencement of the year and at the end of the year.

We would also note that in using the word “value” instead of “cost” [in] paragraph 87(2)(b) may be viewed as requiring the amalgamated corporation to maintain the predecessor corporation's inventory valuation method. In other provisions of section 87, the amalgamated corporation is deemed to have acquired an asset at a particular cost. The absence of the word “cost” in paragraph 87(2)(b) together with the specific timing requirements would indicate that the new corporation is not deemed to have acquired an inventory at a cost, in respect which the new corporation is intended to be able to choose a different valuation method.

In summary, we believe that the words used in paragraph 87(2)(b) envision continuity of inventory valuation methods and that such continuity of inventory valuation methods is consistent with the scheme of section 87.

The question next arising which is whether the Plaintiff was justified in changing its valuation method, was also dealt with in the Cyprus Anvil decision. Clearly a change in method or a departure from the method employed for accounting proposes is justified in circumstances where such change or departure is necessary to avoid a distortion in the calculation of profit. We would suggest such latitude is consistent with the decision in Cyprus Anvil and affords the means of dealing with the situation where two corporations with homogeneous inventories, but different methods of valuation amalgamate. In this regard, we not that the C.I.C.A. Handbook, paragraphs .63 and .65 at pages 1580.58 and 1580.69 address this issue for accounting purposes. We have not been provided with any evidence in this case that would justify a change in the method of inventory valuation.

While we have not specifically commented on the decision in case of Guaranty Properties Limited et al [[1990] 2 C.T.C. 94] (90 DTC 6363) it is our view that it does not clearly support the right of the amalgamated corporation to adopt a method of valuating its inventory at the end of the year that is different from the method used in valuing its inventory at the commencement of its first taxation year.

We trust the foregoing comments are of assistance.