In Canada, the Income Tax Act (Canada) (the "ITA")1 generally recognizes two broad categories of property owned or held by a business, namely inventory (i.e., property held on income account) and capital property.2 The ITA provides different treatment for the gains and losses generated by the disposition of each of these two types of property. Whereas the disposition of capital property generates capital gains or capital losses, the disposition of inventory will result in business income or losses. In 2016, the Federal Court of Appeal suggested that there may be a third category of property beyond capital and inventory.3 This commentary from the Federal Court of Appeal was recently discussed in Herring v. The Queen, 2022 TCC 41.

In a very general way, and subject to exceptions, the importance of characterizing capital gain or loss is that capital gains or losses are included in or deductible from income at 50% of their value, whereas the gains or losses on income account are included in or deductible from income at 100 % of their value.

The leading judicial authority on the characterization of property for Canadian income tax purposes is Friesen, wherein the Supreme Court of Canada distinguishes between business income and capital gain.4 Friesen held that property characterization is based primarily on the type of income that the property will produce.5 Inventory is property held for resale (the sale of which produces business income), whereas capital property creates a capital gain or loss upon disposition, as is often the case with machinery or equipment used to manufacture inventory, or shares of an operating subsidiary. The reason for this analytic structure is a direct result of the relevant provisions of the ITA:

  • Inventory is generally defined in subsection 248(1) as "property the cost or value of which is relevant in computing a taxpayer's income from a business". A taxpayer's income from a business for a taxation year is the taxpayer's profit under subsection 9(1), so property is inventory if the gain from its disposition increases profit.
  • Capital property in subsection 54 is generally defined as "any property ... any gain or loss from the disposition of which would, if the property were disposed of, be a capital gain or a capital loss" of the taxpayer. Subsection 39(1) defines a taxpayer's capital gain or capital loss by reference to the taxpayer's gain on the disposition of any property "that would not [otherwise] ... be included in computing the taxpayer's income for the year". Since a taxpayer's gain from the disposition of inventory is included in income on account of profit, the disposition of any other property results in a capital gain or loss, and would thus be capital property.6

Since the theoretical gains on all property, if disposed, must result in either (i) profit under subsection 9(1) or (ii) a capital gain or loss under subsection 39(1), one might reasonably conclude, as did the Supreme Court of Canada in Friesen, that all property for income tax purposes must be either inventory or capital property. As stated in Friesen, "The Act thus creates a simple system which recognizes only two broad categories of property."7 However, the decisions Herring v. The Queen, 2022 TCC 41 and Kruger v R, 2016 FCA 186 raise interesting questions as to whether such conclusions continue to withstand scrutiny.


1. Income Tax Act, R.S.C. 1985, c. 1 (5th Supp).

2. Friesen v. Canada, [1995] 3 SCR 103, para 28 ("Friesen"). See also the definitions of "inventory" in subsection 248(1) of the ITA, and the definition of "capital property" in subsection 248(1) and section 54 of the ITA.

3. See Kruger v R, 2016 FCA 186 paras 95-100.

4. Friesen, para 28.

5. Friesen, para 28.

6. This analysis applies in most cases. There are some complications to the analysis when referring to, e.g., "depreciable property". Depreciable property is directly included in the definition of capital property, although it is possible for the disposition of "depreciable property" to result in an income inclusion on account of recapture of previously deducted "capital cost allowances", which is the Canadian income tax equivalent of depreciation and amortization for accounting purposes.

7. Friesen, para 28.

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