Accounting Principles

Commentary

Canadian judicial statements of the degree of persuasiveness or relevance of accounting principles or practices in the determination of income from a business or property under section 9 have varied over the years. The most authoritative statements on this subject are the comments of Iacobucci J. in the Canderel case and, to a lessor extent, his comments in the Symes case. These statements are notable for their reference to "well-accepted business principles" rather than to generally accepted accounting principles (the touchstone that has been favoured by the Agency), and for his affirmation of the "truer picture" doctrine, i.e., the preference for that accounting method "which more fairly and accurately portrays income" or "presents the 'truer picture'" of the taxpayer's income.

The first extended discussion of the truer picture approach in a Canadian case is that in the Publishers Guild case (although that phrase is not employed). In that case as well as Gulf and Anaconda it has been found that accounting methods that might be appropriate for use by other taxpayers were not appropriate in the particular circumstances of the taxpayer before the court. One might speculate that accounting principles which are required to be of general application (and that, therefore, are required to be applied even if the circumstances of the particular company depart substantially from those of companies to which the principle typically is applied) may be given less weight than accounting methods which the court is satisfied have been carefully selected in light of the particular factual circumstances of the taxpayer, or tailored to those circumstances. For example, in the Publishers Guild case, collectability at the point of billing was not assured, so that income recognition was not required. On the other hand, in the West Kootenay and Maritime Telegraph cases, income recognition was required even prior to billing because the quantum of income to be included was only subject to minor measurement difficulties.

Further discussion of accounting principles may be found under General Concepts.

Cases

Bernick v. Canada, 2004 DTC 6409, 2004 FCA 191

A Bahamian partnership of which the taxpayer was a member purchased bonds at less than 10% of their maturity value, recorded the bonds in its financial statements as having a cost equal to the maturity value, and recorded a resulting loss when the bonds were sold within the following two years for values ranging from 10% to 14% of maturity value.

In finding that the Minister had correctly disallowed the deduction by the taxpayer of his share of the supposed losses on these bonds, Sharlow J.A. indicated that the accounting method followed by the partnership violated the principle established in the Canderel case, 98 DTC 6100 "that an accounting method is not acceptable for income tax purposes unless it results in an accurate determination of income" (p. 6412).

Sharlow J.A. went on to indicate (at p. 6412) that "in this context, 'accuracy' means reasonable accuracy, bearing in mind that any computation of profit may involve estimates and judgment calls relating to timing, allocation, estimates of value, and other such matters that accountants are often called upon to make".

Locations of other summaries Wordcount
Tax Topics - General Concepts - Evidence foreign law presumed the same 60
Tax Topics - Income Tax Act - Section 54 - Adjusted Cost Base cost of bonds equal to their FMV 137
Tax Topics - Income Tax Act - Section 9 - Computation of Profit 173

Canderel Ltd. v. Canada, 98 DTC 6100, [1998] 1 S.C.R. 147

Before going on to find that the taxpayer was entitled to immediately expense for tax purposes the amount of tenant inducement payments that it had capitalized for accounting purposes, Iacobucci J. indicated that: tax computations, unlike financial accounting, may entail the use of a different methodology for calculating profit from that employed in a previous year; that while generally-accepted accounting principles may more often than not parallel well-accepted business principles recognized by the law, there may be occasions on which they will differ, in which case the latter must prevail; and that if some method other than the matching principle best depicts the reality of the financial situation of the particular taxpayer, is permissible under well-accepted business principles, and is not prohibited by the Act or some specific rule of law, there is no principled basis on which the Minister should be entitled to insist that the matching principle be employed.

Gulf Canada Resources Ltd. v. The Queen, 95 DTC 5189 (FCTD), partially rev'd 96 DTC 6065 (FCA).

partially rev'd on other grounds 96 DTC 6065 (FCA).

McKeown J. found (at p. 5196) that the decision of the taxpayer to capitalize all expenses of its start-up operation net of revenues "gave a truer picture of its financial position" than the alternative of recognizing revenues and operating costs, in light of the decision of management that the project was not yet substantially complete and capable of reasonable commercial output.

Symes v. Canada, 94 DTC 6001, [1993] 4 S.C.R. 695

Iacobucci J. indicated (p. 6009) that in considering what types of expenses may be deducted under s. 9, it is more appropriate to refer to "well accepted principles of business (or accounting) practice" or to "well accepted principles of commercial trading", rather than to generally accepted accounting principles (which "connotes a degree of control by professional accountants which is inconsistent with a legal test for 'profit' under s. 9(1)".

West Kootenay Power and Light Co. Ltd. v. The Queen, 92 DTC 6023 (FCA)

In finding that the trial judge had erred in finding for the Crown on the basis of a requirement for conformity between the taxpayer's financial statements and its tax returns, MacGuigan J.A. stated (p. 6028):

"In my view it would be undesirable to establish an absolute requirement that there must always be conformity between financial statements and tax returns, and I am satisfied that the cases do not do so. The approved principle is that whichever method presents the 'truer picture' of a taxpayer's revenue, which more fairly and accurately portrays income, and which 'matches' revenue and expenditure, if one method does, is the one that must be followed."

Maritime Telegraph and Telephone Co. Ltd. v. The Queen, 91 DTC 5038 (FCTD), aff'd 92 DTC 6191 (FCA)

"The accounting principle which requires consistency in reporting from year to year, to ensure that an accurate picture of the taxpayer's financial position is portrayed is applicable here" (p. 5040).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 9 - Timing services performed but not billed 105

The Queen v. Nomad Sand and Gravel Ltd., 91 DTC 5032 (FCA)

Before finding that security deposits paid to the provincial government were not currently deductible, Urie J.A. stated (p. 5035):

"The proper accounting of those payments for the taxpayer's financial purposes, to most accurately reflect its actual financial position at any given time, may well be that they be recorded as expenses incurred for the purpose of gaining or producing income. That may not, as a matter of law, be the proper way for them to be recorded in the calculation of the taxpayer's taxable income."

The Queen v. Foothills Pipe Lines (Yukon) Ltd., 90 DTC 6607 (FCA)

Before finding that an amount which was a liability for accounting purposes nonetheless was a revenue receipt for income tax purposes, Urie J.A. stated (at 6612):

"[A]ccording to generally accepted accounting principles, sums received by a taxpayer should be recorded in a taxpayer's financial statements, in the way which most nearly reflects its actual financial position at any given time or for any given period, but for purposes of ascertaining the taxpayer's income for tax purposes the receipt of the sums may require [sic] to be recorded differently."

The Queen v. Metropolitan Properties Co. Ltd., 85 DTC 5128, [1985] 1 CTC 169 (FCTD)

Walsh J. indicated (at p. 5137) that GAAP "should normally be applied for taxation purposes also, as representing a true picture of a corporation's profit or loss for a given year" but "by exception they need not be applied for income tax purposes if there is some section or sections in the Income Tax Act which justify a requirement of departure from them or do not correspond with what are commonly accepted business and commercial practices".

Neonex International Ltd. v. The Queen, 78 DTC 6339, [1978] CTC 485 (FCA)

The taxpayer, which was in the business of producing custom-made electrical signs, in its financial statements included costs of constructing incompleted signs in its inventory of work-in-progress. Before finding that the deduction of such costs on a current basis would not result in a fair or accurate portrayal of the taxpayer's income for purposes of the Act, Urie J.A. stated (p. 6348):

"There is no doubt that the proper treatment of revenue and expenses in the calculation of profits for income tax purposes with a view to obtaining an accurate reflection of the taxable income of a taxpayer, is not necessarily based on generally accepted accounting principles. Whether it is so based or not is a question of law for determination by the Court having regard to those principles ..."

The Queen v. Marchand, 78 DTC 6507, [1978] CTC 763 (FCTD), aff'd [1979] CTC xvii (FCA)

Addy, J. stated "that a taxpayer can now deduct an amount from income only on two conditions: first, that it would be normal practice according to generally accepted accounting principles to deduct this sum from an income account, and secondly, that the prohibitory provisions of section 18(1) do not prevent such a deduction."

Silverman v. MNR, 60 DTC 1212, [1960] CTC 262 (Ex Ct)

At 1214-1215:

"[S]ince what is declared to be the income from a business is the profit therefrom for the year, the method adopted must be one which accurately reflects the result of the year's operations, and where two different methods, either of which may be acceptable for business purposes, differ in their results, for income tax purposes the appropriate method is that which most accurately shows the profit from the year's operations."

Wilson and Wilson Ltd. v. MNR, 60 DTC 1018, [1960] CTC 1 (Ex Ct)

The completed contract, which was followed for accounting purposes, was found to be unacceptable for purposes of computing a contractor's income under s. 9.

MNR v. Publishers Guild of Canada Ltd., 57 DTC 1017, [1957] CTC 1 (Ex Ct)

Before agreeing with the accounting experts that the taxpayer's instalment method of accounting for its sales of magazines was more appropriate than the accrual method which underlaid the Minister's reassessments, Thorson P. stated (p. 1026):

"The prime consideration, where there is a dispute about a system of accounting, is, in the first place, whether it is appropriate to the business to which it is applied and tells the truth about the taxpayer's income position and, if that condition is satisfied, whether there is any prohibition in the governing income tax law against its use."

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 9 - Timing 159

MNR v. Anaconda American Brass Ltd., 55 DTC 1220, [1955] CTC 311 (PC)

Viscount Simonds found the F.I.F.O. method to be preferable for income tax purposes, because it corresponded more readily to the actual physical usage of the taxpayer's stock of metals, notwithstanding evidence that for accounting purposes the L.I.F.O. method was preferable.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 10 - Subsection 10(1) 248

Dominion Taxicab Association v. Minister of National Revenue, 54 DTC 1020, [1954] CTC 34, [1954] S.C.R. 82

"The expression 'profit' is not defined in the Act. It has not a technical meaning and whether or not the sum in question constitutes profit must be determined on ordinary commercial principles unless the provisions of the Income Tax Act require a departure from such principles."

See Also

Ford Credit Canada Limited v. The Queen, 2006 DTC 3424, 2006 TCC 441

Before going on to find that the taxpayer was specifically required by s. 181(3) to treat retractable preferred shares in its capital as debt, given that the shares were treated as debt for accounting purposes, Bowman C.J. noted that, in the absence of s. 181(3), the legal substance of the preferred shares as equity rather than debt would have been respected (pp. 3428-3429:

"Generally speaking the Canadian courts in tax matters show low deference to GAAP ... we are not, in Part I.3 dealing with the computation of income, a function that courts have jealously guarded to themselves."

Consoltex Inc. v. The Queen, 96 DTC 1812 (TCC)

The taxpayer had valued its inventories of the lower of cost on market for financial statement and income tax purposes in its 1979 and prior years, and in its 1983 and subsequent years, but in its 1980, 1981 and 1982 years, valued its inventories at market value for income tax purposes in order to fully absorb non-capital losses of a subsidiary that had been wound-up into it. Lamarre TCJ. concluded (at p. 1820) that the taxpayer had not convinced her that this change in method of inventory valuation for tax purposes to market "presented a fair and accurate picture of its income for those years or that it presented a truer picture of its income" and concluded, instead, that this change "had the effect of distorting the appellant's profit".

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 10 - Subsection 10(1) 96

Ikea Ltd. v. The Queen, 94 DTC 1112 (TCC), aff'd 96 DTC 6526 (FCA), aff'd 98 DTC 6092 (SCC)

In doubting the relevance of the treatment of a tenant inducement payment in the taxpayer's financial statements, Bowman J. stated (p. 1117):

"One needs only to read the one and one-half page explanation of the meaning of 'generally accepted accounting principles' in the CICA Handbook to realize that to found a system of fiscal law upon practices and policies based upon subjective professional judgement would quickly lead to a state of uncertainty and confusion."

Gallagher v. Jones, [1993] BTC 310 (CA)

In finding that two leasing companies were required to amortize large initial lease payments made by them over the terms of the leases in accordance with generally accepted accounting principles rather than deducting such payments in full when incurred, Bingham M.R. stated (pp. 328-329)

"Subject to any express or implied statutory rule, of which there is none here, the ordinary way to ascertain the profits or losses of a business is to apply accepted principles of a commercial accountancy .. .. As has often been pointed out, such principles are not static: they may be modified, refined and elaborated over time as circumstances change and accounting insights sharpen. But so long as such principles remain current and generally accepted they provide the surest answer to the question which the legislation requires to be answered ... . Different considerations arise where there is no accounting evidence or where there are two or more principles either or any of which is generally accepted."

Willingale v. International Commercial Bank Ltd. (1978), 52 TC 242 (HL)

In finding that discounts on bills should be taken into income on the disposition of the bills rather than on a straight-line basis, as was done for accounting purposes, Lord Fraser stated (p. 272):

"... the Crown, relied on the general rule that the principles of commercial accounting should normally prevail. But that rule is of little or not assistance to his argument, because the method in which the Bank's accounts were drawn up was not the only method that would be in accordance with sound principles of commercial accounting."

Administrative Policy

Income Tax Technical News, No. 41, 23 December 2009 Under "Conversion from Canadian GAAP to IFRS".

7 June 1995 Internal T.I. 7-950615 -

Respecting a taxpayer who has deducted accrued vacation pay for income tax purposes but not for financial statement purposes, such a deduction will be permitted if the taxpayer has a legal obligation before the end of the year to pay the vacation entitlements, such liability is quantifiable, and taking the deductions would "present a truer picture of the taxpayer's income or more accurately match revenues and expenditures for the relevant taxation years".

1994 Institute of Chartered Accountants of Nova Scotia Roundtable Q. 23, 7-940148 -

The decision in West Kootenay (92 DTC 6023) "confirms that income for tax purposes, must be computed in accordance with a method within GAAP that produces the 'truer picture' and when there is only acceptable method within GAAP and that method is reflected in the financial statements, the income for tax purposes, absent a specific provision of the Act, should not be different".

1994 APFF Round Table, Q. 40

"In some cases, a taxpayer may select from among a number of accounting methods, each one equally valid. The profit for tax purposes should be established using the method that gives the fairest presentation of the profit and the best revenue/expenditure matching."

25 September 1992 T.I. (Tax Window, No. 23, p. 11, ΒΆ2171)

Changes in the shareholders of a corporation (including an acquisition of control) will not by themselves justify a change in the accounting policies followed by the corporation.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 9 - Computation of Profit 43

IT-417R "Prepaid Expenses and Deferred Charges".

It is an essential requirement of GAAP that the method of accounting be consistent from year to year, and this requirement is insisted upon for income tax purposes.

Articles

Mike Wilson, Fraser Gall, "No Impact on Tax - Wrong!", CA Magazine, November 2008, p. 42: Discussion of impact of IFRS standards.

David Nathanson, "Determining Business 'Profit' for Income Tax Purposes", Tax Litigation, Vol. X, No. 4, 2002, p. 646.

1995 British Tax Review

, No. 5, Special Issue - Accounting Standards and Taxable Profits, p. 433.

Ewens, "Proposed Amendments Affecting Debt and Equity Reorganizations", Canadian Petroleum Tax Journal, 1993, Vol. 6, No. 1, p. 49: Discussion of relevance of GAAP to the computation of income.

Nathanson, "Canadian Courts Increasingly Support Revenue Canada's GAAP Requirement but Appelate Court Sanction Remains Elusive", Nathanson on Tax Litigation, 1992, p. 8

Nathanson, "GAAP Treatment is not Mandatory for Tax Accounting Purposes", Nathanson on Tax Litigation, 1992, p. 2