TMI Blog1955 (12) TMI 37X X X X Extracts X X X X X X X X Extracts X X X X ..... t during the year. The effect of increasing the taxable income was to increase the excess profits tax of the company for 1947 by about $ 241,000 and the income tax for that year by about $ 483,000. Only the excess profits tax was in issue on this appeal, the parties having agreed as regards the income tax to be bound by the outcome of this appeal. The substantial question in the appeal was whether, as contended by the Minister, in estimating the cost of the metals used by the company during the year the first metals purchased by the company would be the first metals used by it, known as the first-in-first-out, or Fifo, assumption, or whether, as contended for by the company as being the modern accounting practice, the last costs incurred in purchasing the metals were the first costs charged, known as the last-in-first-out, or Lifo, method. The Exchequer Court of Canada (Thorson P.) and, on appeal, the Supreme Court of Canada (Taschereau, Locke and Cartwright JJ., Kerwin C.J. and Estey J. dissenting) held that the Lifo method was applicable in the circumstances of the present case. 1955. November I5, 16, 17, 2I. C.F.H. Carson Q.C., W.R. jackett Q.C., Allan Findlay Q.C. ( ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r when prices of metals were fixed. In 1947, however, very substantial increases took place, which have led to the question which method should be used. The effect of the minister applying Fifo was to attribute to a substantial part of the metals used a lower price paid by the company. The effect of Lifo was to attribute to a substantial part of the metals the higher price paid by the company. The result was that the company's cost of metals for 1947 as determined by the Minister is lower by $ 1,611,756 than the cost arrived at by the company. It is submitted: (i) The cost of metals which the company may charge as an expense in arriving at profits for tax purposes is the amount paid by the company for the metals used in the manufactured products sold by it during the year. (2) In determining this amount an estimate must be made because the company's records do not indicate what metals were used in such products. (3) The Minister made an estimate by adopting the Fifo assumption that the first metals purchased would be the metals used in the products sold during the year, so that the last metals purchased would be still in the company's stock. (4) The company is not en ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The difference between the rule as to running expenses, as in Vallambrosa Rubber Co. Ltd. v. Farmer###, and the rule as to expenditure on stock in trade is explained by Rowlatt J. in Naval Colliery Co. Ltd. v. Inland Revenue Commissioners.(7) Absalom v. Talboj(8) raised the question as to how that part of the price which was to be paid in the future was to be taken into account in determining profits there was no disagreement as to the meaning of profits . The respondent company contended that the actual physical flow of raw materials and processed goods is irrelevant in determining whether Lifo or Fifo is the accounting method appropriate to determine the annual profits of a particular business. The Minister applied Fifo, however, on an assumption of the physical flow. Lifo reflects a recent change in accounting principles. Originally Fifo was based on an assumption of the physical flow of goods. It is submitted that the amount arrived at by the Minister was a much more accurate estimate of what the company actually paid for the stock-in-trade than the company's figure. The criticism of the base stock method in Lucas v. Kansas City Structural Steel Co.* is, on the evidenc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... though to estimate the profit in this way would be contrary to commonly accepted commercial and accounting principles. No witness in this case suggested that in all circumstances to follow that rule of law would be in accordance with accepted commercial and accounting principles. If there is no such rule of law, and it is submitted that there is not, and the annual profit is accordingly to be estimated in accordance with commonly accepted commercial and accountancy principles, then because what are those principles and what are the profits estimated in accordance with them are questions of fact, there are here concurrent findings of the courts below which this Board will not disturb. It is conceded that if there is such a rule as the appellant contends for, this appeal succeeds. It succeeds not because it is established that Fifo does in this case give a more accurate estimate of cost of materials actually used, or that Fifo is designed to do so; it succeeds simply because the respondent has not established that the figure obtained by it gives a more accurate estimate than the Minister's figure. The contentions of the respondent are: (1) There is no such rule of law as conte ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ar and not to particular transactions during that year. The way in which one attributes is a question of commercial practice so as to arrive at what a business man or accountant in Canada would call the true profit of the year. There is nothing in Coltness Iron Co. v. Black*** which gives rise for credence that profits of a business for income-tax purposes are other or different from ordinary commercial profits in the sense in which business men would understand them. Costs incurred in the acquiring stock-in-trade are no different from other costs incurred in the course of the business. Again, in Whimster Co. v. Inland Revenue Commissioners# there is nothing which suggests that the income for the purposes of the taxing Act is in any respect different from the income for ordinary commercial purposes. [Reference was also made to the Vallambrosa Rubber case##, McGowan's case### and Ryan's case(7).] Considerable reliance was placed by the appellant on Sun Insurance Office v. Clark(8), but the effect of that case is that one has to use a method of estimating, and the only rule is that the method must be such that the result must closely approach the true gains. The above ca ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... accurately ascertained the company's annual profit, which in this case would be the same thing as its taxable profit. The trial judge found these facts in favour of the company, and in doing so accepted the evidence of the company's witnesses and rejected that of the Crown, as he was entitled to. His findings of fact were concurred in by the majority of the Supreme Court and they should not be disturbed. Carson Q.C., in reply, referred to Johnston v. Minister of National Revenue [1948] S.C.R. 486 and Anderson Logging Co. v. The King [1925] S.C.R. 45, 50. December 13. The judgment of their Lordships was delivered by VISCOUNT SIMONDS. This appeal from a judgment of the Supreme Court of Canada, which dismissed an appeal from a judgment of the President of the Exchequer Court of Canada, raises a question of novelty and importance. The appellant is the Minister of National Revenue, the respondent a limited company, Anaconda American Brass Ltd. The Minister, on the assessment of the respondent company to income tax and excess profits tax for the year 1947, increased the amount of taxable income declared by the company by the sum of $ 1,611,756.43, with the result that i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... an estimate at the beginning of each month of the quantity of metals which will be used during the next month and to order from its suppliers the same quantity to replace such metals. It maintains an inventory or stock of metals at all times of about one-third to one-quarter of its annual requirements, so that it turns over its inventory three or four times a year. About two-thirds of the copper and zinc inventory is continuously in process in the plant: this indicates that the average time in process is about eight weeks. The company did not keep records from which the actual metals used during the year could be identified or the amounts paid for those metals determined. But it kept records of the quantities of metals (a) in its inventory at the beginning of the year, (b) purchased during the year, and (c) in its inventory at the end of the year. It also kept records of the prices paid for the metals purchased from time to time. Thus in the year 1947 the company knew what stock it had in hand at the beginning, what stock it had purchased during the year, and what stock it had in hand at the end of it. It also knew what prices it had paid during the year for the metals it pu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not yet been exhausted by the cost attributed to metal consumed; this has been called the unabsorbed residue of cost. Thus in the case under appeal the stock of copper in hand at the close of the year 1947 (the closing inventory as it is conveniently called) consisted of 14,291,007 pounds: and under the Lifo system it was treated as follows: (a) 6,50,000 pounds were regarded as having a cost of 7.5 cents per pound (the average cost of the copper in the inventory when Lifo was adopted in 1936) amounting to $ 487,500; (b) 802,697 pounds were regarded as having a cost of 9.466 cents per pound (the average price paid in 1936) amounting to $ 75,983.30; (c) 17,577 pounds were regarded as having a cost of 11.191 cents per pound (the average price paid in 1937) amounting to $ 1,967.04; (d) 639,807 pounds were regarded as having a cost of 10.443 cents per pound (the average price paid in 1938) amounting to $ 66,847.04; (e) 973,477 pounds were regarded as having a cost of 11.036 cents per pound (the average price paid in 1939) amounting to $ 107,432.92; (f) 3,151,684 pounds were regarded as having a cost of 11.5 cents per pound (the price paid in 1945) amounting to $ 362 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... define more closely the position of the parties. The Minister concedes that in the absence of physical identification some assumption about the material in fact used during the financial year must be made. He does not dispute that there may be in the closing inventory some metal which had been purchased in previous years. But he contends that the method which he has adopted attains more nearly the result postulated by Lord Loreburn L.C. in Sun Insurance Office v. Clark that the true gains are to be ascertained as nearly as it can be done. He urges that it is a principle of income tax law which has been adopted from commercial accounting practice that the values of the stock-in-trade at the beginning and end of the period covered by the account should be entered at cost or market value, whichever is the lower, and he says that for this purpose the actual stock in hand must be regarded and its actual cost so far as possible ascertained, and that an assumption or estimate is necessary only so far as ascertainment is not possible. Upon this basis he says that the Fifo method more nearly than the Lifo method represents the facts, and supports that contention by reference not only to t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Clyde in Whimster Co. v. Inland Revenue Commissioners* 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 Act, or of that Act as modified by the provisions and schedules of the Acts regulating Excess Profits Duty, as the case may be. For example, the ordinary principles of commercial accounting require that in the profit and loss account of a merchant's or manufacturer's business the values of the stock-in-trade at the beginning and at the end of the period covered by the account should be entered at cost or market price, whichever is the lower; although there is nothing about this in the taxing statutes. For many years before and eve ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h which alone the Minister is concerned. It may well be prudent for them to carry in their books stock valued at a figure which represents neither market value nor its actual cost but the lower cost at which similar stock, was bought long ago. A hidden reserve is thus created which may be of use in future years. But the Income Tax Act is not in the year 1947 concerned with the years 1948 or 1949: by that time the company may have gone out of existence and its assets been distributed. Seventy years ago Lord Herschell said in Russell v. Town and County Bank*: The profit of a trade or business is the surplus by which the receipts from the trade or business exceed the expenditure necessary for the purpose of earning those receipts. This is only one of many judicial observations in which it is implicit that no assumption need be made unless the facts cannot be ascertained, and then only to the extent to which they cannot be ascertained. There is no room for theories as to flow of costs, nor is it legitimate to regard the closing inventory as an unabsorbed residue of costs rather than as a concrete stock of metals awaiting the day of process. It is in their Lordships' opinion the f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es, serve to equalize the results of operations during a series of years... : see Lucas v. Kansas City Structural Steel Co.* In this passage the distinction is nicely made between what is permitted for tax purposes and what prudent business men may think fit to do. So, also, in the United Kingdom an attempt has been vainly made to uphold the base stock method for income tax purposes. In the recent case of Patrick v. Broadstone Mills Lid.** Singleton L.J., in words that are equally apt if applied to the Lifo method, declined to accept the base stock method as conformable to income tax law, though it might be approved by accountancy practice. In the result their Lordships are of opinion that this appeal must be allowed, the judgments of the Supreme Court and the Exchequer Court set aside and the appeal of the respondent company from the Minister's assessment rejected, and they will humbly advise Her Majesty accordingly. They repeat that they have reached this conclusion not because they dissent from any finding of fact by the President of the Exchequer Court, of whose lucid and exhaustive judgment no criticism can from this aspect fairly be made, but because his findings of ..... X X X X Extracts X X X X X X X X Extracts X X X X
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