That very question was posed by Justice Rothstein of the Supreme Court of Canada in the opening paragraph of his judgment on behalf of a unanimous Court in Daishowa-Marubeni International Ltd. v Canada,1 released on May 23, 2013. Kudos to Justice Rothstein for injecting a bit of humour into Canadian tax jurisprudence (a "taxing" task perhaps). Kudos also to the Court for allowing the taxpayer's appeal and arriving at the correct conclusion – the assumption by the purchaser of reforestation obligations on the sale of forest tenures did not constitute part of the purchase price received by the taxpayer on the sale.
The principles articulated by the Supreme Court in Daishowa-Marubeni set parameters on the general principle that the assumption of a vendor's liability by a purchaser will constitute part of the sale price of the property sold and, therefore, part of the proceeds of disposition of the property. The critical distinguishing factor in Daishowa-Marubeni is that rather than being a distinct liability that is assumed, the reforestation obligations at issue were embedded in the relevant forest tenures by virtue of Alberta's regulatory regime, which prevents a vendor from disposing of forest tenures unless the purchaser assumes the reforestation obligations. Accordingly, the reforestation obligations were more akin to damage to property that depresses its value than a free-standing liability.
However, it should be noted that the Court expressly stated as an aside that it "would certainly not foreclose the possibility that obligations associated with a property right could be embedded in that property right without there being a statute, regulation or government policy that expressly restricts a vendor from selling the property right without assigning those obligations to the purchaser."2
Prior to the dispositions at issue, the taxpayer held two forest tenures that allowed it to cut and remove timber from Alberta-owned land. The regulatory regime under which tenures were granted obliged the taxpayer to undertake certain reforestation or silviculture activities after it harvested the timber. The reforestation obligations would generally take eight to fourteen years to satisfy.
The taxpayer sold the forest tenures in two separate transactions and, in both transactions, the purchaser assumed the reforestation obligations. As required under Alberta law, the taxpayer sought and received Alberta's consent to the assignment of the forest tenures. As a precondition to such consent, the associated reforestation obligations were required to be assumed by the purchaser. Alberta, an intervener in the proceedings, informed the Court that its position is that, upon assignment of a forest tenure, the purchaser is solely responsible for carrying out the reforestation activities and the vendor is relieved of any liability for satisfying the reforestation obligations.
In filing its tax returns for the respective years of sale, the taxpayer did not include in its income any amount in respect of the purchasers' assumption of the reforestation obligations. The Minister of National Revenue reassessed the taxpayer on the basis that it was required to include an amount equal to the estimated cost of the reforestation obligations assumed by the purchasers in its "proceeds of disposition" of the forest tenures.
Supreme Court decision
Analogies provided by the Minister and the taxpayer are apt at demonstrating the nature of the issue that was before the Court. The Minister submitted that a forest tenure, with its corresponding reforestation obligations, is analogous to property encumbered by a mortgage. Accordingly, the purchaser's assumption of reforestation obligations, like the assumption of a mortgage, forms part of the sale price and must be included in the vendor's proceeds of disposition.
By contrast, the taxpayer argued that a forest tenure with reforestation obligations is more analogous to property that is in need of repair. If that property is sold, the purchaser's assumption of the cost of repairs does not form an additional part of the sale price of the property.
The Court agreed with the taxpayer and held that the reforestation obligations represented a future cost embedded in the forest tenure that serves to depress the tenure's value at the time of sale. The key fact in coming to that conclusion was that the obligations could not be severed from the tenure. A purchaser of the tenure has no choice but to assume the obligations and take into account the costs of carrying out the reforestation obligations when valuing the tenure.
The Court addressed the Minister's analogy by observing that a mortgage does not affect the value of the property it encumbers. A vendor of a mortgaged property can sell the property for fair market value and then pay off the mortgage. Conversely, "the reforestation obligations were not a distinct existing debt, like a mortgage, but were embedded in the tenure so as to be a future cost associated with ownership of the tenure."3
The Court also observed that the Minister's approach would lead to asymmetry between the vendor's proceeds of disposition relating to the disposition of, and the purchaser's adjusted cost base relating to acquiring, the forest tenure, since the purchaser's adjusted cost base would not include the estimated reforestation obligations assumed. The absurdity of this position was highlighted by the Court with the following example:
Under the Minister's approach, the sale of the [forest tenure] to Tolko would have resulted in taxable proceeds of $31 million for DMI ($20 million received plus $11 million in assumed reforestation obligations). However, Tolko's adjusted cost base would be $20 million (just the amount paid). The Minister's asymmetrical approach means that if Tolko sold the forest tenure to a new purchaser the very next day, Tolko would be assessed taxable proceeds of $31 million (the amount received plus the assumption of the future reforestation costs). That is, Tolko would be assessed $11 million of taxable income, despite in no way receiving such additional income.4
Thus, the Court concluded that if a tree falls in the forest and you are not around to replant it, you are not required to include the anticipated cost of the replanting in your proceeds of disposition. Accordingly, the matter is now remitted to the Minister to "chop down" the tax reassessment.
Despite appearing to "clear-cut" away some of the uncertainty surrounding how a taxpayer is to account for the assumption of certain liabilities in the context of a sale of property, a number of questions remain. What does it mean for an obligation to be "embedded" in property? How does one distinguish between a "future cost embedded" in property and a separate obligation of a vendor that, if assumed by the purchaser, must be included in the proceeds of disposition of the property? Unfortunately, these questions stand among the many that may become the subject of tax litigation in the future.