Consoltex Inc. v. The Queen, 96 DTC 1812, [1996] 1 CTC 2752 (TCC)

Lamarre J.T.C.C.: — This appeal arises out of a determination by the Minister of National Revenue (the “Minister”) ascertaining the amount of the appellant’s non-capital loss for the taxation year ending December 31, 1982, to be $3,032,718. This determination was made pursuant to subsection 152(1.1) of the Income Tax Act (the “Act”). In computing its noncapital loss for the 1982 taxation year, the appellant valued its opening and closing inventory at fair market value resulting in a non-capital loss for the year in the amount of $5,313,739. The Minister reduced the appellant’s loss by the amount of $2,426,253 on the basis that the Appellant was required to value its opening and closing inventory at the lower of cost or fair market value.

Facts

The appellant is a company incorporated under Part I of the Companies Act of the province of Quebec and is a wholly owned subsidiary of Consolidated Textile Mills Ltd. (“Consolidated”), which in turn is controlled by Carrington Viyella, a British Company. The appellant is a fabric manufacturer and, prior to February 1979, it specialized in synthetic fibres.

Bruck Mills Limited (“Bruck”) was a company incorporated under the Canada Business Corporations Act. Prior to February 1979, Bruck was a wholly owned subsidiary of Toyobo Co. Ltd. (“Toyobo”), a Japanese company. Before its dissolution in 1979, Bruck was also a fabric manufacturer, specializing in polyesters. Bruck’s operations and production capacity were similar in size to the appellant’s, although a little smaller.

In February 1979, Consolidated purchased all the shares of Bruck for a nominal sum of $1.00. As part of that arrangement, Toyobo subscribed for common shares in the capital stock of Consolidated for the sum of $8,595,000 and concurrently made a cash contribution of $3,612,000 to the capital of Consolidated. As a result of these transactions, Toyobo acquired 20 percent of Consolidated.

In April 1979, Consolidated wound up Bruck and acquired its assets and business operations. Bruck was then dissolved. In addition to acquiring the assets and liabilities of Bruck, the Appellant also acquired the accumulated tax losses of Bruck. In its financial statement dated April 30, 1979, Bruck had accumulated tax losses amounting to approximately $15,900,000. Everyone involved in the transaction was aware of the loss carry-forward and the fact that because the two companies were in the business of manufacturing and selling textile products, these losses would be available to the combined entity. At the time that the purchase of Bruck took place, there was a 5 year period for claiming non-capital losses carried forward.

Both in 1979 and in prior years, the appellant valued its inventory by the lower of cost or market (“LCM”) method for financial statement and income tax purposes. In 1980, 1981 and 1982, however, it readjusted its inventory to market value, which was greater than cost, for income tax purposes. Then, in 1983, the appellant switched back to valuing its inventory according to the LCM method for income tax purposes, so that there was once again consistency with the method used for financial statement purposes. The appellant contends that the switch to market value in 1980, 1981 and 1982 was so that its inventory valuation method would be consistent with Bruck’s inventory valuation method at the end of 1979. It was however conceded by the appellant that the decision to value Bruck’s inventory at market at the end of 1979 was made by Consolidated.

In Bruck’s last income tax return, dated October 27, 1979 (Bruck’s operations ended April 30, 1979), Bruck valued its inventory for tax purposes at market value. It is unclear what valuation method Bruck used for tax purposes prior to 1979. At trial, Mr. Yager, controller of the appellant in 1979, testified that he thought Bruck had, for tax purposes, valued its inventory according to the LCM method in the years prior to 1979. For financial statement purposes, Bruck had at all times used the LCM method for valuing its inventory. This is most likely due to the fact that, according to generally accepted accounting principles, for financial statement reporting purposes inventory must be valued by the LCM method.

The results of Bruck adjusting its closing inventory to market value for tax purposes in 1979 were that the closing inventory in 1979 increased by $1,496,836, and the cost of goods sold during 1979 decreased by the same amount. Consequently, its income for financial statement purposes had to be adjusted upwards by $1,496,836 for income tax purposes. In addition, the appellant decreased its taxable income by $1,496,836 to take into account the increase in its cost of goods sold resulting from the transfer of Bruck’s inventory at market value. According to Mr. Yager, this decrease in income had the effect in fact of “cancelling the increase in the taxable income of Bruck,” resulting in no impact on the taxable income position of the appellant from Bruck having valued its inventory for 1979 at market value rather than cost. The only real impact that it did have was that in 1979 Bruck was able to use an additional amount of $1,496,836 of loss carry-forward. In 1979, it used $3,154,303 of its loss carry-forward, leaving $12,822,468 as a loss to carry-forward against its future income. Out of this amount, $124,638 was to expire in 1980, $6,195,761 in 1981, $4,828,520 in 1982, and $1,673,549 in 1983.

Although the purchase of Bruck was made in 1979, the appellant did not value its closing inventory for tax purposes at market value in that year. Instead, it was not until 1980 that it began to value its inventory at market value for tax purposes.

In 1980, as a result of revaluing its closing inventory from cost for financial statement purposes to market for income tax purposes, $5,928,202 was added to the taxable income of the appellant. Altogether, in 1980, the appellant was able to claim $9,871,458 of the losses carried forward that it inherited from Bruck. This left $2,951,010 to be carried forward to future years.

In 1981, the appellant valued its opening and closing inventory for tax purposes at market. In revaluing its inventory from cost for financial statement purposes to market for income tax purposes, taxable income for the year decreased by $743,841, for a total taxable income of $2,951,010. This amount was claimed against the loss carried forward, thus reducing taxable income to nil and leaving no more loss to be carried forward.

Similarly, in 1982, the appellant again valued its opening and closing inventory for tax purposes at market. In revaluing its inventory from cost to market, the net loss for the year increased by $2,426,253.

In 1983, the appellant switched back to the LCM method to value its closing inventory for tax purposes. As a result of this switch in inventory methods, taxable income for the year decreased by $2,758,108.

Appellant's Position

The appellant concedes that one of the reasons why the inventory valuation method was changed was to take advantage of the loss carry-forward inherited from Bruck before it expired. According to Counsel for the appellant, section 10 of the Act combined with section 1801 of the Income Tax Regulations (the “Regulations”) as it read in the years in issue, specifically authorized the appellant to choose for tax purposes three methods of inventory valuation, including valuation at fair market value. The only requirement imposed by the Act and the Regulations is, Counsel said, that the inventory at the commencement of the year be the same as the inventory at the end of the immediately preceding year, which requirement the appellant respected. Furthermore, it was pleaded that the Act specifically recognizes the possibility of using losses from prior years to reduce current taxable income. By using the method of valuing its inventory at fair market value, the appellant merely followed the prescription of the Act in order to benefit from an advantage contemplated by the Act.

Counsel also submits that another reason why the LCM method was changed to the market value method was because it better represented the economic reality of the purchase transaction. The appellant argues that by valuing the inventory at market value, it allowed Toyobo and Consolidated to ascertain the true value of the assets they were acquiring. The appellant’s expert witness, Mr. Marcinski, testified that market value represented a “truer picture” of the appellant at that time. He stated that it was essential for both parties to the transaction to value all of their shares at fair market value on February 29, 1979 (when the subscription by Toyobo for shares in Consolidated occurred) in order to determine whether either party would want to engage in the transaction. In order for the shares to be valued at fair market value, the assets, including the inventory, had to be valued at market value.

In justifying its switch back to the LCM method in 1983, the appellant submits that by 1983, the inventory had been disposed of, the two companies had been fully integrated, and it was obvious that the combination of the companies was going to last. Thus, since the “truer picture” of the appellant required in 1979 for the purchase transaction was no longer needed, the appellant switched back to the LCM method so that the inventory valuation method would be the same for both financial statement and income tax reporting purposes.

Respondent's Position

The respondent submits that the change from LCM method to market value method does not give a “truer picture” as contended by the appellant. Instead, the respondent submits that the sole reason for the change in valuation method was so that the loss carry-forward could be used up before it expired. Evidence produced at trial showed that if the appellant had not changed its valuation method, $3,399,598 of loss carry-forward would have expired without being used. The Minister supports this position with three arguments.

First, the respondent states that the appellant did not value its closing inventory for tax purposes at market value in 1979, when the transaction occurred. Thus, when the “truer picture” was supposedly required in 1979, no such “truer picture” existed, since in 1979 both entities used different inventory valuation methods. It was not until sometime in 1981, when the financial statements and the tax returns for 1980 were prepared, that the “truer picture” was available. Thus, the Minister submits that there was no reason to alter the inventory valuation for tax purposes in 1980, when all of the inventory was already valued at cost (for financial statement purposes), and when the need for a “truer picture” was no longer there, since the purchase transaction had already taken place.

Second, the appellant’s witness, Mr. Yager, believed that the appellant did not apply market valuation to its inventory in 1979 because of the unavailability of the Bruck losses to apply against profits by the appellant in that year. Under subsection 88(1.1) of the Act, the appellant would only have access to Bruck losses in the taxation year commencing after the winding-up of Bruck - i.e. 1980. Thus, the fact that the appellant did not begin to apply market valuation to its inventory in 1979, but in 1980, supports the position that the sole reason for the change to market valuation was to take advantage of the available loss carry-forward.

Third, the respondent submits that his position can be supported by looking at the income fluctuations resulting from the change in valuation methods. The initial increase of $5,928,202 in 1980 due to the change from the LCM method to market value matches exactly the decreases in income for the 1981, 1982 and 1983 years. In addition, the Minister contends that the appellant switched back to the LCM method in 1983 because by 1983 the losses had been used up and there was nothing left from Bruck to be carried forward.

Given the fact that there was no good business or commercial reason to change the valuation method other than to utilize the loss carry- forward, the Minister submits that the change in the valuation method for the years 1980 to 1982 should not be allowed. Further, as a result of the change, the income of the appellant for the period 1980 through 1983 is distorted. The alteration brings into income unrealized gains in 1980. This profit in 1980 actually belongs to 1981, 1982 and 1983. Thus, it offends the principles of consistency, matching, and bringing into income unrealized gains. Therefore, contrary to the submissions of the appellant, the changes in valuation methods do not provide a “truer picture” of the company, but instead distorts its income.

Analysis

The issue in this appeal is whether the appellant is permitted to value its opening and closing inventories in 1982 at fair market value without regard to the cost of those inventories notwithstanding that the appellant used the LCM method in valuing its inventory in the taxation years preceding 1980. In other words, is the appellant entitled under section 10 of the Act to change the method of valuing its inventory, without regard to sound busi ness or commercial principles. And if not, did the appellant offend those principles by acting as it did in the computation of its income for tax purposes in the years 1980 through 1983.

The computation of business income for tax purposes has its basis in section 9 of the Act. This section provides that the income from a business is the profit for the year. The loss from a business is the loss from that source computed by applying the provisions of the Act respecting computation of income from that source mutatis mutandis. The Act does not define “profit” nor does it provide any rules for the computation of profit. As was pointed out very recently by Major J. of the Supreme Court of Canada in Friesen v. R., (sub nom. Friesen v. Canada; sub nom. Friesen v. The Queen), [1995] 3 S.C.R. 103, [1995] 2 C.T.C. 369, 95 D.T.C. 5551, at page 127 (C.T.C. 382, D.T.C. 5558):

...tax jurisprudence has established that the determination of profit under subsection 9(1) is a question of law to be determined according to the business test of “well-accepted principles of business (or accounting) practice” or “well- accepted principles of commercial trading” except where these are inconsistent with the specific provisions of the Income Tax Act: see Gresham Life Assurance Society v. Styles, [1892] A.C. 309 (H.L.); Neonex International Ltd. v. The Queen, 78 D.T.C. 6339 (F.C.A.); Symes v. R, (sub nom. Symes v. Canada) [1994] 1 C.T.C. 40, 94 D.T.C. 6001, [1993] 4 S.C.R. 695, at page 723; Materials on Canadian Income Tax, at page 291; and R. Huot, Understanding Income Tax for Practitioners (1994-95 edition), at page 299.

In a business involved in sales and carrying inventories, the value of unsold inventory is relevant in the computation of business income as it is taken into account in the calculation of the cost of goods sold. Subsection 10(1) of the Act establishes that for the purpose of computing income from a business, the property described in an inventory shall be valued at its cost to the taxpayer or its fair market value, whichever is lower, or in such other manner as may be permitted by regulation. Section 1801 of the Regulations provided in the years in issue two alternative methods of

valuing inventory: valuation at cost and valuation at fair market value. [1] Counsel for the appellant, relying on the decision of the Supreme Court of Canada in Stubart Investments Limited v. R., (sub nom. Stubart Investments v. The Queen), [1984] S.C.R. 536, [1984] C.T.C. 294, 84 D.T.C. 6305, contends that the specific wording of section 10 of the Act should receive its plain meaning within the context of the Act, and its interpretation must be harmonious with its object and scheme and with the intent of Parliament. According to counsel, Parliament’s express intention in adopting section 10 of the Act was to permit a derogation from the determination of profit on a yearly basis and some flexibility in the valuation of inventories. Indeed the predecessor of subsection 10(1), subsection 14(2), provided that a taxpayer could not change methods of valuation inventory without obtaining the prior consent of the tax authorities. This requirement had been removed in 1958 and it is only since 1990, that the Act was again amended by the introduction of subsection 10(2.1) to provide that the closing inventory of a given year must be valued according to the same method as that of the valuation of the inventory for the end of the previous year, unless prior consent of the tax authorities is obtained. According to counsel for the appellant, the change in method of inventory valuation was not prohibited in the years under issue.

The plain meaning of section 10 was analyzed in Friesen, supra. As stated by Mr. Justice Major, these provisions of the Act recognize “the well accepted commercial and accounting principle of requiring a business to value its inventory at the lower of cost or market value. This principle is an exception to the general principle that neither profits nor losses are recognized until realized.... The underlying rationale for this specific exception to the general principles is usually explained as originating in the principle of conservatism” (supra, footnote 1, page 129 (C.T.C. 370; D.T.C. 5559)). Justice Major then relied on a passage of D.E. Kieso et al., Intermediate Accounting (2nd ed. 1986), at pages 421-22, which states the following:

A major departure from adherence to the historical cost principle is made in the area of inventory valuation. Applying the constraint of conservatism in accounting means recognizing known losses in the period of occurrence. In contrast, known gains are not recognized until realized. If the inventory declines in value below its original cost for whatever reason...the inventory should be written down to reflect this loss. The general rule is that the historical cost principle is abandoned when the future utility (revenue-producing ability) of the asset is no longer as great as its original cost. A departure from cost is justified on the basis that a loss of utility should be reflected as a charge against the revenues in the period in which the loss occurs. Inventories are valued, therefore, on the basis of the lower of cost and market instead of an original cost basis.

From this passage, Mr. Justice Major inferred that:

As the above passage makes clear, the well- accepted principle of conservatism which underlies the valuation method in s. 10(1) represents not only an exception to the realization principle (in cases of loss) but also an exception to the principle of symmetry since gains are not recognized until they are realized. Thus the taxpayer who is entitled to rely on s. 10(1) is allowed to claim a business loss where the value of inventory falls but is not required to declare a business profit until the inventory is sold even if the value of the inventory rises.

In Ostime v. Duple Motor Bodies Ltd., [1961] 2 All E.R. 167 (H.L.), at page 172-73, Lord Reid discussed the fact that generally items should be valued at historical cost but that the “lower of cost or market” exception allows valuation at market value only if market value falls below cost. As Lord Reid pointed out, this lack of symmetry is not entirely logical but it represents good conservative accountancy and therefore has always been recognized as legitimate for taxation purposes:

If market value [rather than cost] were taken [in all cases], that would generally include an element of profit, and it is a cardinal principle that profit shall not be taxed until realised;

Finally, Mr. Justice Major summarized the object and purpose of subsection 10(1):

Section 10(1) is specifically designed as an exception to the principles of realization and matching in order to reflect the well-accepted principle of accounting conservatism. In addition to recognizing accounting conservatism, the section is designed to stop a business from accumulating pregnant losses from declines in the value of inventory. The object and purpose of the section is to prevent businesses from artificially inflating the value of inventory by continuing to hold it at cost when market value of that inventory has already fallen below cost (supra, footnote 1, page 129 (C.T.C. 370; D.T.C. 5561-62)).

While in Friesen the Supreme Court of Canada did not approach directly the question of the possibility for a taxpayer of valuing its inventory at either cost, market or LCM (whichever he wishes to use) in a case where the market value is greater than cost, I deduce from the analysis done that section 10 of the Act will not permit such a practice if it goes beyond well-recognized commercial and accounting principles. It was established that the valuation scheme in section 10 does not provide an automatic deduction from income but rather mandates how the valuation procedure must take place when ordinary commercial and accounting principles establish that the value of inventory is relevant to the computation of business income in a taxation year (supra, footnote 1, page 129 (C.T.C. 370; D.T.C. 5558)). Moreover, although the inventory valuation scheme in subsection 10(1) of the Act represents an exception to the normal principle of realization, the exception itself is also a well-accepted commercial and accounting principle.

As was stated and accepted by Mr. Justice Hidden of the Queen’s Bench Division (Crown Office List) in R. v. Inland Revenue Commissioners, ex parte SG Warburg & Co., [1994] B.T.C. 201, at page 216:

... The view of the courts is clear that the difference in value between the cost of an unsold asset and its current market value is an unrealised profit or an unrealised loss. While such a valuation is acceptable as an anomalous exception to the rule in the case of an unrealised loss, there is no such exception in relation to an unrealised profit....

Thus the difference between the cost of an unsold asset and its higher market value is an unrealised profit, as Lord Reid says, [in Duple, supra, page 751-752] ... and the courts have never accepted that unrealised profit can be brought into accounts for tax purposes ... Since MTM [“mark to market” basis of stock valuation] does just that, it anticipates an unrealised profit and thus violates the taxing statutes....

As to tax law, the position was stated by Lord Reid in BSC Footwear Ltd v Ridgway, [1971] 2 All E.R. 534 (H.L.) at page 536:

... There are no statutory rules about this, and it is well settled that the ordinary principles of commercial accounting must be used except insofar as any specific statutory provision requires otherwise. ...

The application of the principles of commercial accounting is, however, subject to one well established though non-statutory principle. Neither profit nor loss may be anticipated. ...

This principle is subject to an exception as regards stock-in-trade. If it were applied logically, stock-in-trade must always be valued at the end of the year at cost, even if it could have been bought at the end of the year much more cheaply. But for half a century at least traders have been allowed to value such stock at the end of the year at its market price or market value at that date if that is lower than the original cost price: on the other hand, the trader is not required to value his stock at market value if that is higher than the original cost. ... That

exception has been expressed by the phrase ‘cost or market value, whichever is the lower’.

And Viscount Dilhorne, in the same decision, said at page 546:

... It is axiomatic that profits should only be included in the account for the year in which they are realised and not in any previous year. Mr. Lawson, the chief accountant who gave evidence for the Crown, said that in his opinion it was a cardinal principle of commercial accounting that one must avoid anticipating profits.

According to those well-accepted commercial and accounting principles, it has long been established by our courts that the applicable method of accounting within the taxation context should be that which best reflects the taxpayer’s true income position. This approach was adopted by the Federal Court of Appeal in West Kootenay Power and Light Co. v. R. (sub nom. West Kootenay Power & Light Co. v. Canada; sub nom. West Kootenay Power and Light Co. v. The Queen) ) , [1992] 1 C.T.C. 15, 92 D.T.C. 6023, at page 22 (D.T.C. 6028), as follows:

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.

The result often will not be different from what it would be using a consistency principle, but the “truer picture” or “matching approach” is not absolute in its effect, and requires a close look at the facts of a taxpayer’s situation.

If we look closely at the facts in the present case, we realize that when Bruck was purchased by Consolidated, the transaction was recorded as a share purchase and that the inventory was transferred from Bruck to Consolidated at cost for financial statement purposes. According to Mr. Marcinski, it was incumbent upon both parties to the transaction to value the assets in both the appellant’s and Bruck’s inventories at fair market value as any prudent purchaser would do in this type of transaction. This value was established on a pro forma basis at the date of closing in February 1979. Mr. Marcinski then suggested that to be consistent with this notional balance sheet and to reflect the transaction which occurred in 1979 and which inevitably would distort the profit in that year for both the appellant and Bruck, it was reasonable to value the inventories at the end of the year in a similar manner, that is at market value. However, no adjustment of inventory figures was made as between the two companies, in order to reflect the market value of the transaction in their financial statements. The decision to use for tax purposes the market value method of valuing closing inventory in Bruck was that of Consolidated, which controlled the appellant and which had just bought Bruck. It is not a situation in which the company acquired had already valued its inventory at market value for tax purposes. Bruck ceased its operations in April, 1979, and its assets were distributed to the appellant. At that time, all that existed was the appellant, and all the inventory which had belonged to Bruck now belonged to the appellant. Although the winding- up took place in 1979, the appellant did not apply market valuation to its inventory for tax purposes in 1979 as it should have done according to Mr. Marcinski. The cost method was used for opening and closing inventory, which was consistent with its previous practice. The obvious reason for that was the fact that under subsection 88(1.1) of the Act, the appellant did not have access to Bruck’s losses in the year 1979. It would only have access in the taxation year commencing after the winding-up of the subsidiary in the parent, that is to say in 1980.

The net result for the appellant in changing the valuation method of its closing inventories at the end of 1980 from cost to market for tax purposes only was to cause an increase of $5,928,202 in its income in that year, and a decrease in income of the exact same amount for the years 1981, 1982 and 1983. The appellant, having used all Bruck’s losses by that time, then reverted to its method of valuing inventories at cost for tax purposes as it had done in the years prior to 1980.

In Minister of National Revenue v. Anaconda American Brass Ltd., (sub nom. Minister of National Revenue v. Anaconda American Brass Ltd.), [1955] C.T.C. 311, 55 D.T.C. 1220, the Privy Council stated the fundamental principle of income tax computation as this at page 319 (D.T.C. 1224):

The income tax law of Canada, as of the United Kingdom, is built upon the foundations described by Lord Clyde in Whimster & Co. v. Inland Revenue Commissioners, (1925) 12 T.C. 813, 823, in a passage cited by the Chief Justice which may be here repeated. “In the first place, the profits of any particular year or accounting period must be taken to consist of the difference between the receipts from the trade or business during such year or accounting period and the expenditure laid out to earn those receipts. In the second place, the account of profit and loss to be made up for the purpose of ascertaining that difference must be framed consistently with the ordinary principles of commercial accounting, so far as applicable, and in conformity with the rules of the Income

Tax Tax Act...

In Duple, supra, the House of Lords was asked to choose between two different methods of valuation. The House expressed the view that, if a method had been applied consistently in the past, it should not be changed unless there was good reason for the change sufficient to outweigh any difficulties in the transitional year (page 175).

The principle of consistency in relation to a company’s own previous tax returns as well as to its financial statements was applied by the Federal Court of Appeal in Cyprus Anvil Mining Corp. v. R., (sub nom. Cyprus Anvil Mining Corp. v. Canada; sub nom. The Queen v. Cyprus Anvil Mining Corp.), [1990] 1 C.T.C. 153, 90 D.T.C. 6063. Urie J.A. said at page 157 (D.T.C. 6066-68):

In essence, it was the contention of the Appellant’s counsel that the combina- tion of subsection 10(1) and its complementary subsections (2) and (3) [which for purposes of this appeal are not important] and Regulation 1801, do not override the requirement of accounting principles of consistency in computing business income. A long line of cases such as Dominion Taxicab Association v. Minister of National Revenue 54 D.T.C. 1020 at 1021, Canadian General Electric Co. Ltd. v. Minister of National Revenue 61 D.T.C. 1300 at 1304, and Neonex International Ltd. v. H.M.Q. 78 D.T.C. 6339 at 6348, have held that profits from a business must be determined in accordance with “ordinary commercial principles unless the provisions of the Income Tax Act require a departure from such principles”. In counsel’s submission, permitting by statute a taxpayer a choice of three methods of inventory valuation in computing its income does not per se derogate from the overriding accounting principle of requiring consistency in financial reporting to ensure that the true financial picture of the taxpayer has been portrayed in its accounts. Since the valuations of the opening and closing inventories are important elements in the computation of profit for a year normally the same

method should be used to avoid distortion of profits for the year.

Counsel conceded, however, that if the method used in such valuations does not, in the computation of income for tax purposes, fairly and accurately portray the profit picture of a taxpayer, the principle of consistency will not apply and, since the repeal of subsection 14(1) which permitted a change in inventory valuation methods only with the consent of the Minister, a taxpayer may change to one of the other methods of inventory valuation without the permission of the Minister having to be obtained, if it is only in this way that a true and accurate profit of the taxpayer can be ascertained.

Counsel for the Respondent argued that the only requirement in the Act or Regulations as among the three permitted methods of inventory valuation, is that the opening inventory be valued at the same amount as the closing inventory of the preceding year. There is no requirement, in his view, that closing inventory be valued on the same basis as opening inventory. Nor is there, he said, a requirement in the Act or Regulations that the taxpayer’s method of inventory valuation be the same from year to year and cited the evidence of his expert witness, Harrison, to support this assertion. He agreed with Appellant’s counsel that section 9 of the Act requires computation of profit, prima facie, to be made in accordance with generally accepted accounting principles including the requirement of consistency in reporting. However, in his submission, section 10 specifically permits a departure from such principles and, therefore, must prevail over the general provisions of section 9.

I am unable to agree with the Respondent’s submissions, particularly the latter one.

Subsection 9(1) prescribes that a taxpayer’s income for a taxation year from a business is his profit therefrom for the year.

Subsection 10(1), and Regulation 1801, on the other hand, both include the opening words “[if] for the purpose of computing income from a business ...”. It is not limited to any particular period of time whether it be the taxpayer’s fiscal year, his taxation year or any longer or shorter period. In other words, it is a provision of general application conferring the possibility for a taxpayer to make a choice of his method of inventory valuation without reference to any time period. Computation of income, on the other hand, must relate to the taxpayer’s taxation year. I do not think, therefore, that it can be said that subsection 10(1) is a specific provision overriding the general one, subsection 9.

Admittedly, subsection 10(1), (a) neither contains a prohibition against changing the method of inventory valuation from time to time, nor (b) permits the method selected to be changed at will, nor (c) provides a departure from the generally accepted accounting practice of valuing inventory only at cost or the lower of cost or market. But, in my view, it must be construed within the context of the Act and be harmonious with its scheme and with the object and intention of Parliament.Driedger, 2nd ed page 87 To permit the change in inventory valuations espoused by the Respondent as approved by the Trial Judge, has the effect of distorting the Respondent’s profit in both the 1973 and 1974 tax years. In other words, by failing to adhere to the consistency principle in the computation of income, the Respondent has not fairly and accurately portrayed its profit picture. The witness Harrison testified to the effect that valuing the inventory at market at the end of the exempt period more accurately reflects the profit earned in that period for the purpose of maximizing the tax advantages accruing from the exemption. But even he admitted that although it had been a practice which had been frequently resorted to by mining companies, apparently without question by the taxing authorities, it was contrary to generally accepted accounting principles to do so. The critical principle, however, is that there be consistency in the computation of profit as that term is understood in subsection 9(1) of the Act which means that it must be the computation thereof for a taxation year. The profit calculation under subsection 10(1) ought not to be a different one from that made for the same or overlapping period for tax purposes. If a different principle of computation of profit for the exempt period were permissible, surely the Act or the Regulations would have so stated. They did not.

I would apply the same reasoning in the present instance. I am of the opinion that by changing the method of valuing its inventory to market for three years in order to anticipate its profit for the first year (1980) and therefore benefit from Bruck’s loss carry-forward, and thereafter to recuperate this increase in profit through corresponding deductions in the following years (1981, 1982, 1983), and by changing again the method of valuation of its inventory to cost in 1983, the appellant distorted its income for that period. Even if the valuation system established by the Act is a specific legislated exception to the principles of matching, realization and symmetry, it however reflects well-recognized commercial and accounting principles, which aim at achieving a conservative picture of business income. And such a conservative picture does not permit, from a commercial

This passage was cited with approval by the Supreme Court of Canada in Friesen, supra, footnote 1, page 369 (D.T.C. page 5569).

and accounting point of view, the reporting of gains when they are not actually realized, as that would not give a truer picture of income for the year. In the present case, from the figures disclosed in evidence and from the principles of accountancy referred to in the cases above, it seems obvious that this is what the appellant tried to do. On the other hand, even if I accept Mr. Marcinski’s theory that a distortion in computing profit was inevitable for either the appellant or Bruck in order for there to be consistency with the notional balance sheet established at fair market value in February 1979, such distortion should have occurred in the same year and not one year later when Bruck did not even exist anymore and the inventories were all consolidated in the appellant.

On that basis and for the above reasons, the appeal must fail. I am of the opinion on the one hand, that the appellant was not entitled to take advantage of section 10 of the Act in valuing its inventory at market without regard to well-accepted principles of business or accounting practice. On the other hand, the appellant has not convinced me that by changing its method of valuing its inventories for tax purposes to market, without having regard to cost, for the taxation years 1980, 1981 and 1982, it presented a fair and accurate picture of its income for those years or that it presented a truer picture of its income. I am rather of the opinion that the change in inventory valuations had the effect of distorting the appellant’s profit in each of the 1980, 1981, 1982 and 1983 taxation years and was not consistent with the way it reported its income in previous years; this was not in accordance with the provisions of the Act.

I therefore conclude that the appeal should be dismissed with costs.

Appeal dismissed.