Self-Help To Remedy Inventory Errors Creates Disaster

The recent decision of Yorkwest Plumbing Supply Inc. v. The Queen (2020 TCC 122) demonstrates the court’s reluctance to embrace self-help remedies as an alternative to amending previously filed returns in the manner prescribed by law. Tax preparers need to exercise extreme caution when taking accounting shortcuts, especially when the amounts concerned are material, lest the tax preparer become the author of the client’s misfortune.

The taxpayer converted its periodic inventory system to a perpetual inventory system in 2009, which caused a significant disruption and required considerable attention from management. The taxpayer acquired $1.3 million of inventory before the end of its 2009 taxation year. Since the taxpayer had not fully transitioned the inventory system, a special purpose account was created to enable payment to its suppliers. Unfortunately, the taxpayer forgot about this account until 2012. In the taxpayer’s 2010 and 2011 taxation years, revenue from this inventory was recorded in real time as it was sold, but the cost of sales was not deducted. As a result, the taxpayer’s net income was overstated by $1.3 million—a substantial amount for a taxpayer with annual revenue of $60 million.

It was open to the taxpayer to amend its tax returns for its 2010 and 2011 taxation years to correct the error. However, the taxpayer determined that this exercise “would have diverted time and energy from more important matters.” Instead, in 2012, the taxpayer decided to write down its inventory to effectively create a deduction for the cost of these sales. As a result, the taxpayer’s 2012 taxable income was underreported by $1.3 million, and the CRA reassessed accordingly. The deadline for filing an adjustment to the taxpayer’s 2010 tax return had passed by that time, so the taxpayer’s only option was to contest the reassessment.

On appeal, Spiro J confirmed that “inventory” means goods available for sale in the current taxation year, and therefore it cannot include goods that were sold in an earlier taxation year. Since the goods acquired in 2009 had been sold in the taxpayer’s 2010 and 2011 taxation years, the goods were not inventory and could not be written down in 2012. Spiro J held further that the cost of inventory is recognized only in the taxation year in which the inventory is sold. This precluded the taxpayer from deducting the $1.3 million at issue in its 2012 taxation year, or in any year other than the year in which the inventory was sold.

The taxpayer argued that its only possible choice was to take the deduction in 2012, and that this resulted in an accurate picture of the taxpayer’s overall profit in accordance with the SCC’s decision in Canderel ([1998] 1 SCR 147). Spiro J was not persuaded. The taxpayer’s argument relied on an incorrect calculation of its cost of sales, so it could not possibly produce an accurate picture of income and did not meet the Canderel standard. While this result of the reassessment may be unfair, it was the only legally permissible outcome.

Ryan W. Antonello
Felesky Flynn LLP, Edmonton

Canadian Tax Focus
Volume 11, Number 1, February 2021
©2021, Canadian Tax Foundation