Dear Sirs:
Re: Subsection 10(2.1) of the Income Tax Act
This is in reply to your letter of March 5, 1991 wherein you requested our views on new subsection 10(2.1) of the Income Tax Act as proposed by the Technical Amendments Bill of July 13, 1990. Your analysis of this new provision is as follows:
1. It is your understanding that this new provision requires that inventory held by a taxpayer in the course of a business at the end of a year must be valued on the same basis as the inventory of that business was valued at the end of the preceding year. An exception to this rule is provided where a change is approved by the Minister of National Revenue. You are also of the view that the amendment as described in the technical notes accompanying the draft July 13, 1990 legislation is intended "to clarify that taxpayers are required to be consistent in applying whichever acceptable method of valuing their inventory they have chosen for income tax purposes."
2. You have also pointed out that in paragraph 4 of Interpretation Bulletin IT-473, the Department provides that once a taxpayer has adopted one of the enumerated methods of valuing inventory, the taxpayer must continue to use that method on a consistent basis in subsequent years. You understand that the Department's position in this respect only deals with a taxpayers' use of one of the enumerated methods of valuing inventory. In other words, if a taxpayer wishes to change his method of valuing inventory from the lower of cost or market to a straight fair market value basis approval of the Minister would be required.
3. It is also your understanding that neither the current position of the Minister as set out in IT-473 nor the proposed legislation require the approval of the Minister in connection with a change in the determination of "cost" where the lower of cost and market is used by the taxpayer for purposes of valuing inventory, provided the basis of determination of cost is in accordance with generally accepted accounting principles.
Based on the above analysis you have asked us to confirm that the proposed amendment in the Technical Bill is simply to statutorily provide for the Department's existing position as set out inInterpretation Bulletin IT-473 and does not extend to other matters related to the valuation of inventory.
Our Comments
We would agree with your conclusion that the Technical Amendment referred to above has been legislated to add support to the Department's position described in paragraph 4 of Interpretation Bulletin IT-473. It is generally recognized in commercial and accounting practice that inventory must be valued in the same manner from year to year unless exceptional circumstances dictate otherwise as discussed in paragraph 4 of IT-473. As a result the alternative valuation methods set out in Section 10 of the Act and in Regulation 1801 should not be construed to permit unwarranted changes in method and especially not repeated changes primarily for the purpose of minimizing taxes.
With reference to item 3 of your analysis, we agree that proposed subsection 10(2.1) does not appear to go beyond the determination of the method of inventory valuation to be selected from among the three statutory alternatives, as described in paragraph 4 of IT-473. However, with respect to your reference to a change in determination of "cost" where the lower of cost and market is used for the purpose of valuing inventory, we would point out the word "cost", either alone or as part of the phrase "the lower of cost or market" must be determined in accordance with generally accepted accounting principles ("GAAP"). As pointed out in the CICA handbook in Section 3030 once a basis for determining cost has been selected, it will be followed consistently from one period to another unless circumstances warrant a change. The Department has in the past expressed its view that "cost" for tax purposes will be given its accounting sense as recommended by the CICA. If a change in the basis for determination of cost is made, the Department would consider the reasonableness of the taxpayer's approach from an overall perspective. If we are satisfied that the taxpayer's method does not materially distort the year end inventory amount, that figure would likely be accepted for tax purposes. However, if the method used by the taxpayer could result in a material distortion of the profit, contrary to the spirit of subsection 9(1) of the Act, then the Department could challenge such changes in method as being unacceptable.
The above comments are only expressions of opinion on the application of the Income Tax Act and as such should not be construed as advance income tax rulings, nor are they binding on the Department. Should you require an advance ruling with respect to a specific situation please follow the procedure described in Information Circular IC 70-6R2.
We trust our comments are of assistance to you
Yours truly,
for DirectorBusiness and General DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch