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Ottawa, December 20, 1995
1995-111

Realization of Losses Relating to Adventures in the Nature of Trade

Finance Minister Paul Martin, today announced that he will propose amendments to the Income Tax Act relating to the valuation of business inventory and property held as an "adventure in the nature of trade". The amendments will apply to taxation years ending after today.

The proposed amendments will clarify that the rules which apply to the valuation of business inventory on an annual basis do not apply to property held as an adventure in the nature of trade. Consistent with Revenue Canada's historical practice, any income or loss experienced in respect of property held as an adventure in the nature of trade is to be recognized for tax purposes only on disposition of the property.

In circumstances where a taxpayer has claimed an inventory write-down for property held as an adventure in the nature of trade for a taxation year ending on or before today, the amount reported as the fair market value of the property (or such revised amount as determined on assessment or reassessment by Revenue Canada) will be considered to be the taxpayer's cost of the property for the purposes of computing any income or loss that may be realized in the future.

These amendments respond to the decision of the Supreme Court of Canada in Jake Friesen v. Her Majesty the Queen, in which it was held that the rules applying to the valuation of business inventory for the purposes of computing income from business also apply to property held as an adventure in the nature of trade.

The Minister also noted that some commentators have argued that the Friesen case also stands for the proposition that, in valuing inventory at the lower of cost and fair market value, one should ignore any increase in the fair market value of the property that would result in an upward adjustment of the valuation. The Minister said that such was not the intended result of the legislation and that the proposed amendments for taxation years ending after today will also clarify that business inventory valued at the lower of cost and fair market value should be reported as such, and not at the lower of cost and the last lowest value of inventory.

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For further information:

Andrew Nicholls
Tax Legislation Division
(613) 995-3586

Backgrounder

Adventure In the Nature Of Trade

In order to understand the ramifications of the Friesen case, it is important to understand the concept of an "adventure in the nature of trade". The income tax system generally distinguishes between property held on income account (such as the inventory of a business) and non-depreciable property held on capital account. There is, however, a third class of property which is neither held in the course of carrying on a business nor held as capital property. The income tax law has come to refer to such property as being property held as an "adventure in the nature of trade". An example is land purchased by an individual who is not in the land development business for eventual resale at a profit. Property held as an adventure in the nature of trade is treated in part like business income, in that profits or losses on the property are recognized on income account and, until the Friesen decision, in part like capital property, in that the profits or losses are recognized only on disposition.

The Friesen Decision

By interpreting the law so that the rules allowing for the write-down of business inventory apply to property held as an adventure in the nature of trade, the Friesen decision has cast doubt on Revenue Canada's historical practice of recognizing income or losses on property held as an adventure in the nature of trade only on disposition. The government is concerned that, because of the Friesen decision, a large number of taxpayers could claim deductions in computing income for the 1995 taxation year with respect to write-downs of the value of property held as an adventure in the nature of trade, thus destabilizing the tax base.

Some commentators have also taken the Friesen decision as meaning that business inventory valued at the lower of cost and fair market value should, in effect, be valued at the lower of the last lowest value and fair market value rather than at the lower of cost and fair market value. This is considered inappropriate since it would allow the deduction of accrued inventory losses until the inventory is sold, while not allowing the reversal of those deductions when the value of the inventory subsequently rises to eradicate the losses.