T-910-73
The Queen (Plaintiff)
V.
Jawl Industries Ltd. (Defendant)
Trial Division, Cattanach J.—Victoria, Novem-
ber 29,30,1973; Ottawa, January 24, 1974.
Income tax—Deductions—Business losses—Deduction to
be taken in year loss was suffered i.e. the year delivery was
taken—Income Tax Act, s. 12(1)(e)—B.C. Sale of Goods
Act, R.S.B.C. 1960, c. 344, secs. 8, 11, 22, 23 and 24, Rule
S.
The defendant company, engaged in purchasing lumber
and other building materials for resale at a profit, entered
into contracts in 1969 for the purchase of lumber at a cost
of $72,000; within the same year, the market value of the
lumber was depressed to a value of $53,000. Delivery was
taken by the defendant in 1970. The sum of $19,000,
representing the difference between the above amounts, was
claimed by the defendant as a business loss incurred in its
1969 taxation year. The deduction was disallowed by the
Minister and restored on appeal to the Tax Review Board.
Held, reversing the Tax Review Board, the defendant was
not entitled to deduct the sum in question. The lumber was
no part of the defendant's inventory in its 1969 taxation
year. Since the lumber was not inventory, recourse could
not be had to the provisions of section 14(2) of the Income
Tax Act, to fix an inventory valuation; and the deduction of
the amount claimed as a loss in the 1969 year was prohib
ited by section 12(1)(e) of the Act. The loss would be the
difference between the contract price and the market price
at the time delivery was taken in 1970, the taxation year in
which the loss was suffered.
INCOME tax appeal.
COUNSEL:
N. A. Chalmers, Q.C. and C. H. Fryers for
plaintiff.
C. F. Jones and M. Jawl for defendant.
SOLICITORS:
Deputy Attorney General of Canada for
plaintiff.
de Villiers, Jones & Co., Victoria, for
defendant.
CATTANACH J.—This is an appeal by Her
Majesty the Queen from a decision by the Tax
Review Board whereby the defendant's appeal
from an assessment made by the Minister of
National Revenue in respect of the defendant's
taxation year ending June 30, 1969 was allowed.
In assessing the defendant as he did, the
Minister disallowed as a deduction the sum of
$19,589.10 which had been so claimed by the
defendant in computing its income for that taxa
tion year.
The Tax Review Board found that the amount
in question was properly deductible and accord
ingly allowed the defendant's appeal in this
respect.
It is from that decision that the present appeal
results the sole issue being whether the sum of
$19,589.10 was properly deductible by the
defendant in computing its income for its 1969
taxation year.
The defendant is a joint stock company incor
porated pursuant to the laws of the Province of
British Columbia and at all material times has
carried on the business of buying lumber and
other building material and supplies for resale at
a profit.
During the conduct of its business in its 1969
taxation year the defendant entered into binding
and irrevocable purchase commitments with
three of its principal suppliers to purchase cer
tain quantities of lumber at fixed and specific
prices.
In the circumstances that followed the pur
chase commitments by the defendant, the deals
turned out to be imprudent ones for it.
Immediately after the defendant made its
commitments the lumber market became
depressed and remained so for a prolonged
period of time as a consequence of which the
market value of the lumber, as at June 30, 1969,
was much less than the purchase price that the
defendant had committed itself to pay. The
extent of that difference can best be expressed
visually and narratively in tabular form as
follows:
Difference
between
Aggregate Market Value Cost and
Purchase as at Market
Supplier Price June 30, 1969 Value
Cooper-Widman $23,881.05 $20,626.40 $ 3,254.65
R. S. Plant 18,832.96 12,276.44 6,556.52
B.C. Forest
Products 29,981.98 20,204.05 9,777.93
Totals $72,695.99 $53,106.89 $19,589.10
The foregoing figures are not in dispute and it
is the sum of $19,589.10 which is the difference
between the cost price to the defendant and the
market value of the quantity of lumber covered
by the defendant's purchase commitments, as at
June 30, 1969, the defendant's financial and
taxation year end, that the defendant seeks to
deduct as a business loss incurred in its 1969
taxation year.
The defendant did not take physical delivery
of any portion of the lumber nor were any
invoices sent to or received by the defendant in
respect of any portion of the lumber prior to
June 30, 1969.
The defendant took delivery of all of the
lumber covered by the purchase commitments
in its 1970 taxation year and was invoiced
therefor by its suppliers in its 1970 fiscal period
and paid those invoices in that period. There
was no evidence of the total amount paid by the
defendant for the lumber in its 1970 taxation
year but that is immaterial bearing in mind that
the defendant seeks the deduction in its 1969
taxation year rather than its 1970 year and it is
the assessment for the 1969 year that is under
review.
In the balance sheet of the financial state
ments of the defendant as at June 30, 1969
there is included on the liability side an item
reading as follows:
Liability arising from loss on
purchase commitments (Note 3) $19,589.10
In the operating statement the gross profit of
the defendant was computed as follows:
Sales $846,995.68
Cost of Sales
Inventory July 1, 1968 $ 47,316.26
Purchases including
freight 772,046.60
819,362.86
Less Inventory—
June 30, 1969 82,834.75 736,528.11
110,467.57
Loss on Purchase
Commitments (Note 3) 19,589.10
Gross Profit $ 90,878.47
The net income of the defendant was comput
ed and reported as $35,454.18. To this amount
the Minister added the loss claimed on purchase
commitments in the amount of $19,589.10 and
reassessed the defendant accordingly.
Note 3 referred to in the items in the balance
sheet and operating statement respecting the
loss from purchase commitments reads:
Note 3:
At June 30, 1969 the Company had purchase commit
ments payable of $72,695.99. The current replacement
cost of these goods however was $53,106.89, thus
giving rise to the expense and liability of $19,589.10
reflected in these statements.
The auditors' report to the shareholders
appended to the balance sheet reads in part as
follows:
In our opinion these Financial Statements present fairly
the financial position of the Company as at June 30, 1969
and the results of its operations for the year then ended, in
accordance with generally accepted accounting principles
applied on a basis consistent with that of the preceding year.
I particularly note the use of the language in
the auditors' report to the effect that the finan
cial statements were prepared in accordance
with generally accepted accounting principles so
as to truly represent the financial position of the
defendant at its year end.
For the defendant's own commercial pur
poses this loss on purchase commitments might
well be included in its operating costs in its
1969 taxation year. The purchase commitments
obligating the defendant to take and pay for a
fixed quantity and quality of lumber at a fixed
price were entered into by the defendant in its
1969 taxation year. It suffered a loss from what
it did in 1969.
However it is not to the purpose to consider
whether the incurrence of this obligation by the
defendant in its 1969 year is a proper deduction
from the point of view of the defendant or its
auditor in making up the financial statements
for the defendant's own purposes.
The question is whether such amount is a
proper deduction in computing the defendant's
income for its 1969 taxation year within the
meaning of the provisions of the Income Tax
Act. It is not a question of accountancy but
whether the accountancy principle adopted and
relied upon in this particular case is based on
sound postulates.
The position taken by the Minister is that no
portion of the lumber had been taken into the
defendant's inventory as at June 30, 1969 as a
consequence of which there could not be
deducted as an inventory loss or adjustment any
portion of the sum of $19,589.10.
On the other hand it was contended on behalf
of the defendant that the lumber comprised part
of the defendant's inventory and should have
been included in its year end inventory,
although, as I understand the financial state
ment, this was not precisely what was done by
the auditor. He sought, in effect, to show a loss
in the 1969 taxation year.
An assumption upon which the Minister
assessed the defendant as he did was that no
portion of the lumber had been taken into the
defendant's inventory as at June 30, 1969. '
The onus is upon the defendant to "demolish"
that assumption and, in my opinion, the defend
ant has not successfully discharged that onus.
On this particular point the evidence of Mr.
Jawl was unsatisfactory. He purported to speak
of matters which were beyond his knowledge
and what he did say in this respect was con
tradicted by a witness called by the plaintiff
having precise knowledge of the subject matter
whereof he spoke.
At this point reference to the British
Columbia Sale of Goods Act' is useful.
Section 8, subsections (1), (3) and (4) read:
8. (1) A contract of sale of goods is a contract whereby
the seller transfers or agrees to transfer the property in
goods to the buyer for a money consideration, called the
"price." There may be a contract of sale between one part
owner and another.
(3) Where under a contract of sale the property in the
goods is transferred from the seller to the buyer, the con
tract is called a "sale"; but where the transfer of the
property in the goods is to take place at a future time or
subject to some condition thereafter to be fulfilled, the
contract is called an "agreement to sell."
(4) An agreement to sell becomes a sale when the time
elapses or the conditions are fulfilled subject to which the
property in the goods is to be transferred.
Section 11(1), under the heading "Subject-
matter of Contract", reads:
11. (1) The goods which form the subject of a contract of
sale may be either existing goods owned or possessed by the
seller, or goods to be manufactured or acquired by the seller
after the making of the contract of sale (in this Act called
"future goods').
Under the heading, "Transfer of Property as
between Seller and Buyer", sections 22 and 23
read:
• 22. Where there is a contract for the sale of unascertained
goods, no property in the goods is transferred to the buyer
unless and until the goods are ascertained.
23. (1) Where there is a contract for the sale of specific
or ascertained goods, the property in them is transferred to
the buyer at such time as the parties to the contract intend it
to be transferred.
(2) For the purpose of ascertaining the intention of the
parties, regard shall be had to the terms of the contract, the
conduct of the parties, and the circumstances of the case.
' R.S.B.C. 1960, c. 344.
Section 24, unless a different intention
appears, outlines rules for ascertaining the
intention of the parties as to the time at which
property in goods is to pass to the buyer.
The contention by the Minister is that in the
circumstances of the present appeal Rule 5(1)
so outlined in section 24 is applicable.
Rule 5(1) reads:
Rule 5. (1) Where there is a contract for the sale of
unascertained or future goods by description, and goods of
that description and in a deliverable state are unconditional
ly appropriated to the contract, either by the seller with the
assent of the buyer, or by the buyer with the assent of the
seller, the property in the goods thereupon passes to the
buyer. Such assent may be express or implied, and may be
given either before or after the appropriation is made;
"Specific goods" is defined in section 2 as
meaning goods identified and agreed upon at the
time the contract of sale was made.
It follows that non-specific or unascertained
goods, though not defined in the statute, are
goods that are not identified.
With respect to when goods are in a deliver-
able state, section 5 reads:
5. Goods are in a "deliverable state" within the meaning
of this Act when they are in such a state that the buyer
would under the contract be bound to take delivery of them.
Mr. Jawl testified that the lumber covered by
the purchase commitments was identified and
appropriated to the defendant as buyer by the
vendors. If that were the case there would have
been an unconditional contract for the sale of
specific goods in a deliverable state and prop
erty in the goods would have passed to the
buyer when the contract was made.
I have already stated that in testifying as he
did Mr. Jawl purported to speak of subject
matter beyond his knowledge.
With respect to the transactions between the
defendant and B.C. Forest Products, Mr. C. L.
Clagu, the sales manager of that company care
fully examined each purchase order placed by
the defendant with his company. From his
detailed knowledge and long experience in this
industry he unequivocally stated that with
respect to the bulk of the orders so placed the
lumber was not available. It was in log form or
standing in the forest. The company did have
some lumber on its premises at certain times
answering the description of that ordered by the
defendant but that lumber was stored in a
common pile and was available to all of its
customers. None of that lumber had been
allocated to the defendant.
Furthermore Mr. Clagu testified that all
lumber on its premises was the property of B.C.
Forest Products and that insurance was carried
on it as inventory. He also described how the
lumber was picked up by the local market. The
purchaser would send a truck to pick up lumber.
It would be loaded on the purchaser's truck
from the common pile. That common pile was
available to all customers. The load was then
tallied and the amount of the load was deducted
from the purchase commitments outstanding if
those commitments existed. Between an order
and a pick up the lumber continued to be inven
tory of the vendor and was treated as such.
It is impossible that the lumber could be car
ried on the inventory of two different persons,
that is on that of both the vendor, in this case,
B.C. Forest Products, and the buyer, in this
case, the defendant.
There is no doubt that, with respect to the
lumber covered by the purchase commitments
of the defendant to B.C. Forest Products, the
contracts were for the sale of unascertained or
future goods and that goods of that description
in a deliverable state were not unconditionally
appropriated to those contracts.
Therefore property in the lumber did not pass
to the defendant in its 1969 taxation year and
the lumber did not form part of the defendant's
inventory. It was acknowledged that the ven
dors "owed" the defendant the quantity of
lumber ordered by it at the agreed price but that
is far different from title to the lumber passing
to the defendant in its 1969 taxation year.
B.C. Forest Products was but one supplier of
three to the defendant under commitment
orders. However because the other two sup
pliers carried on their business in a like manner,
which is one common to the industry, on the
balance of probabilities it has not been proven
by the defendant that title passed to it from the
other two suppliers but rather the preponder
ance of the evidence was that property
remained in them also until delivery.
It is for these reasons that I have concluded
that the defendant has not discharged the onus
cast upon it to establish that property in the
lumber passed to it in its 1969 taxation year.
Therefore the defendant has not demolished the
Minister's assumption that no portion of the
lumber was taken into the defendant's inventory
in its 1969 taxation year.
On behalf of the defendant it was submitted
that, quite apart from the question of the prop
erty to the lumber passing to the defendant in its
1969 taxation year, the defendant entered into
agreements with its suppliers in its 1969 taxa
tion year and thereby incurred, during the
course of its business in that year, a binding
legal obligation to pay for the lumber at that
price. While the price was paid in 1970 the
obligation was incurred in 1969 from which it
was argued that the loss was deductible in the
1969 taxation year.
In answer to this submission by the defendant
the Minister submits that the deduction of the
sum of $19,589.10 as a loss on the purchase
commitments is a deduction which is prohibited
in computing the defendant's income by the
provisions of section 12(1)(e) of the Income Tax
Act reading:
12. (1) In computing income, no deduction shall be made
in respect of
(e) an amount transferred or credited to a reserve, contin
gent account or sinking fund except as expressly permit
ted by this Part,
The plan of the Income Tax Act is that tax is
payable for each taxation year. It follows that
the profits of a business shall be computed
annually. Accordingly only those elements of
profit or gain enter into that computation which
are earned or ascertained in the year in ques
tion. In like manner only those elements of loss
or expense enter into that computation which
are suffered or incurred during that year.
It is clear from a commercial point of view
the defendant would have to take a loss in the
future, but I fail to follow how that loss can be
fairly measured by the difference between the
agreed and certain contract price for the lumber
and the market value as at June 30, 1969, being
the date of its year end, when its balance was
struck.
There was evidence that the lumber market
continued to be depressed at a constant level
but this is hindsight. The defendant could not
foresee as at June 30, 1969 what the market
value of the lumber would be on the dates when
delivery was taken. The difference between the
contract price and the market price on those
dates is, in my opinion, the true measure of the
defendant's loss and those dates, in my opinion,
are the dates on which the defendant's loss
occurred.
In my view the issue falls to be determined on
the question whether the lumber was taken into
the defendant's inventory in its 1969 taxation
year and the appropriate inventory accounting
in that event.
In the computation of business profits it has
long been recognized that the value of stock-in-
trade is an important element and that the right
method of ascertaining profit is to take into
account the value of the stock-in-trade at the
beginning and at the end of the accounting
period. While for income tax purposes profits
are normally those realized in the course of the
taxation year, nevertheless, the ordinary princi
ples of commercial accounting have provided an
exception where traders still hold goods in
inventory at the end of the year. The trader is
permitted, in compiling his inventory, to enter
those goods at cost or market value, whichever
is the lower.
The accounting practice so described has
been included in the Income Tax Act, section
14(2) of which is as follows:
14. (2) For the purpose of computing income, the prop
erty described in an inventory shall be valued at its cost to
the taxpayer or its fair market value, whichever is lower, or
in such manner as may be permitted by regulation.
The effect of section 14(2) is to permit, what
is in common parlance, a "hidden reserve"
which, but for section 14(2), would otherwise be
precluded by section 12(1)(e) quoted above.
Since the value of the closing inventory is
deducted from the value of the sum of the
opening inventory and goods purchased during
the accounting period to obtain the cost of the
goods sold and the result is, in turn, deducted
from the value of the sales to arrive at the
profits, it follows that it is a distinct advantage
to the taxpayer, in order to reduce the amount
of the profit which would be subject to tax, to
enter the closing inventory at as low a figure as
possible.
In the present appeal the defendant by virtue
of section 14(2) would have the choice of deter
mining the value of each item of its inventory at
the lower of its cost or its fair market value.
However the foregoing is predicated upon the
lumber in question comprising part of the
defendant's inventory in its 1969 taxation year.
For the reasons given I have concluded that the
lumber was not part of the defendant's inven
tory in that year.
If the lumber is not inventory of the defend
ant in its 1969 taxation year, as I have found it
not to be, then the amount of the loss which the
defendant suffered when delivery of the lumber
was taken in 1970 was unknown, unforeseeable
and contingent as of June 30, 1969 and there
fore the defendant is precluded from deducting
the sum of $19,589.10 in its 1969 taxation year
by the provisions of section 12(1)(e) of the
Income Tax Act.
For the reasons I have given I find that the
defendant, in computing its income for its 1969
taxation year, is not entitled to deduct the sum
of $19,589.10 as a loss incurred in that year.
In summary those reasons are;
(1) the lumber was not part of the defend
ant's inventory in its 1969 taxation year;
(2) not being inventory resort could not be
had to the provisions of section 14(2) of the
Income Tax Act to fix an inventory valuation
and the deduction of the amount claimed as a
loss in the 1969 taxation year is prohibited by
section 12(1)(e) of the Act, and
(3) the loss would be difference between the
contract price and the market price when
delivery was taken in 1970 and 1970 would
be the taxation year in which the loss was
suffered.
The appeal is allowed and Her Majesty the
Queen is entitled to her taxable costs.
You are being directed to the most recent version of the statute which may not be the version considered at the time of the judgment.