Wallaceburg-Singer Limited v. Minister of National Revenue, [1972] CTC 2109, 72 DTC 1087

W O Davis:—This appeal came on before me for hearing at the City of London, Ontario, on December 1, 1971 at a sittings of the Tax Appeal Board as it was then constituted.

The appellant company, whose fiscal period ends on the 31st day of December each year, has appealed from an assessment to income tax dated February 3, 1970, wherein tax in the amount of $46,789.04 was levied in respect of its 1968 taxation year, and wherein the Minister had disallowed as a deduction from income an amount of $50,924 written off by the appellant in respect of its supply inventory of goods not intended for resale.

In its income tax return for the year in question, the appellant described the nature of its business as the manufacture of brass forgings. For the purposes of its business, it operates a number of. large machines which from time to time require the renewal or replacement of vital parts. In order to minimize the length of the delays experienced due to the loss of use of a machine in need of a replacement part, the appellant has followed the practice of keeping on hand an assorted supply of those parts which, in the light of past experience, are most likely to call for replacement from time to time for one reason or another.

Prior to the year under review, it had been the practice of the appellant to maintain an inventory of the assorted repair parts and supplies on hand for servicing plant machinery. As a result of adopting this method of accounting, only those parts actually used during the year as replacements were taken into account and their cost included as part of the operating charges for the year. At the close of a year, the inventory of parts and supplies on hand was carried forward into the next year where the total amount was shown among the company’s assets.

At the close of the 1968 taxation year, the appellant, without the sanction of the Minister of National Revenue, charged to operating expense the cost of the entire inventory of supplies and parts on hand, regardless of the fact that the total value of the supplies on hand and unused at the close of the year amounted to $50,924. This write-off did not meet with the approval of the Minister and the amount was promptly disallowed as a deductible item of expense for the year.

In its notice of objection to the said disallowance, the appellant said:

Supply inventory which does not include goods for resale, but does include repair parts for machinery and equipment, and factory supplies has been written off for income tax purposes when the expenditure has been made but inventoried in the company’s books for control purposes. The Minister disallowed the deduction of the supply inventory in the amount of $50,924.

The company objects to the said assessment as follows:

1. The supplies do not fall within the definition of inventories in the Canadian Income Tax Act.

2. Many companies with similar supplies expense these items as they are purchased and the company’s tax position should be no worse than other companies.

To this objection, the Minister replied by confirming the assessment on the grounds that income has been computed in accordance with the provisions of sections 3 and 4 of the Income Tax Act and that supplies of $50,924 are properly included in inventory in accordance with the provisions of paragraph 139(1)(w) of the said Act.

Paragraph 139(1 )(w) reads:

139.(1) In this Act,

(w) “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,

It is a fact that during each of the taxation years 1964 to 1967 inclusive the appellant’s inventory of supplies and replacement parts on hand had always been included as an asset in its balance sheet. With respect to the 1968 taxation year now under review, substantially all of the inventory of manufacturing supplies on hand, to a value of $50,924, was, for the first time, deducted from the appellant’s profits for the year, as reflected by its financial statements, for the purpose of determining its taxable income for the year but not for other purposes. This inventory was made up as follows:

It was admitted that these supplies could not be, and were not, consumed in the course of the appellant’s 1968 taxation year.

There can be no question that, by ordinary commercial and accounting principles, the said supplies were property the cost or value of which was relevant in computing the appellant’s income from its business in the year in question and therefore, by the same token, and pursuant to the definition contained in paragraph 139(1)(w) of the Act, should be included in inventory.

Section 4 of the Income Tax Act provides that, subject to the other provisions of Part I of the said Act, income for a taxation year from a business is the profit therefrom for the year. Because the determination of “profit” would, in accordance with recognized accounting principles, demand the use of the same method for determining opening and closing inventory values, a change in method from one year to the next, although not forbidden by statute, must be approved by the Minister, as otherwise it would result in a break in continuity in the amount attributable for inventory from one year to the next.

To prevent the escape of tax revenue in such an eventuality, subsection 14(3) of the Income Tax Act stipulates that, in keeping with the principles of consistency demanded by good accounting practice, the property described in an inventory at the commencement of a taxation year shall always be valued at the same amount as that at which it was valued at the end of the immediately preceding year for the purpose of computing income for that preceding year.

If the appellant felt that the procedure which it had been following worked to its disadvantage, perhaps it should have sought the concurrence of the Minister with regard to some method of prorating the entire inventory over several years and gradually bringing the cost of unused replacement parts into its record of business expenses for income tax purposes.

In computing the income from a business, it is fundamental to good accounting practice that the method employed from year to year should be consistent. Having for a number of years previous to 1968 charged off to operating expense only that part of its inventory of parts and supplies which was actually utilized during the taxation year, the appellant cannot expect to be allowed to change its accounting procedure so drastically without any notice to the Minister of its intention to make such a change, or without any request for the Minister’s approval of the proposed procedure of charging off as a business expense in the year 1968 its entire inventory of supplies and parts, even though none of the items still shown in the inventory were used in that taxation year and a large proportion of them may not even have been purchased in that year, the unused inventory having been carried on hand from year to year since 1964 without the cost thereof having been reflected in the business expenses for those years except in the case of parts actually used as replacements during the year. To make such a change in practice and charge the entire cost of the supply inventory on hand against its income for 1968 was incompatible with good accounting practices and the Minister was justified in refusing to accept it.

In the circumstances, therefore, the appeal cannot succeed and can only be dismissed.

Appeal dismissed.