On May 23, 2013, the Supreme Court of Canada (SCC) rendered its decision in Daishowa-Marubeni International Ltd. v Canada in which it concluded that reforestation obligations assumed by the purchaser simply impaired the value of the forest tenures sold, rather than giving rise to additional proceeds of disposition. This decision will be of interest to parties in any asset sale involving an assumption of contingent or future obligations.
In 1999, the appellant (Daishowa) sold one of its timber mill divisions to Tolko Industries. The agreement of purchase and sale (Agreement) with Tolko provided for a purchase price of $169 million plus or minus the value of net working capital. In addition, under the Agreement certain liabilities (including the reforestation liabilities) were assumed by Tolko and a payment was contemplated if there was any difference between the preliminary $11 million estimate of the reforestation liability and the final determination of the reforestation obligations.
The minister of revenue (Minister) included the amount of the reforestation obligations as indicated in the Agreement in Daishowa’s proceeds of disposition. Daishowa argued that no such amount should be included in its proceeds of disposition and that, alternatively, if the amount was to be included, it should be entitled to an offsetting deduction in calculating its income.
The Tax Court of Canada (TCC) determined that Daishowa’s liabilities assumed by Tolko were to be included in calculating the proceeds of the sale, and that Daishowa was not entitled to an offsetting deduction. The TCC considered Tolko to have extracted a price concession as a result of its assumption of the reforestation liabilities.
The Federal Court of Appeal (FCA) agreed with the TCC that Tolko’s assumption of Daishowa’s reforestation liabilities constituted consideration for the assets. However, the FCA disagreed with the TCC’s evaluation of those liabilities.
In the FCA’s opinion, Tolko and Daishowa had clearly agreed to attribute a specific value of $11 million to the liabilities. Under the Agreement, this precise amount had been taken into account in determining the balance of the purchase price payable by Tolko in cash and other consideration. Whether the liability was absolute or contingent was completely irrelevant in the FCA’s opinion. The sole question was what value the parties had attributed to the liability.
In a dissenting judgment, Mainville J. considered that the reforestation obligations were part and parcel of the timber resource properties, given the TCC finding of fact that the provincial authorities will not consent to the assignment of forest tenures unless the reforestation obligations are assumed by the transferee. The reforestation obligations were inexorably linked to the timber resource properties and simply had as a consequence the impairment of the value of those timber resource properties.
Supreme Court of Canada
The SCC concluded that the FCA had erred in finding that the estimated cost of the reforestation obligations should be included in Daishowa’s proceeds of disposition. According to the SCC, the reforestation obligations were simply a future cost embedded in the assets that depressed their value. They should not be included in the proceeds of disposition.
The SCC agreed with Mainville J.’s dissent and ruled that, in Alberta, reforestation liabilities cannot be severed from forest tenures because the province’s regulatory scheme prevents the sale of forest tenures unless reforestation obligations are also assigned to the purchaser. The SCC compared the reforestation obligations to property that is in need of repair, in which the need to repair, whether or not required by law, depresses the fair market value (FMV) of the property as a future cost, but is not additional consideration.
The SCC rejected the Minister’s argument that the assumption of the reforestation obligations is analogous to the assumption of a mortgage that forms part of the sale price based on the fact that the mortgage, being the vendor’s indebtedness, is external to the property and does not affect its FMV.
Regarding Daishowa’s argument that the reforestation liabilities should not be included in the proceeds of disposition because they should be considered contingent liabilities, the SCC found that this debate was misplaced. Classifying the reforestation liabilities as either contingent or absolute would implicitly acknowledge that the liabilities are separate from the forest tenures rather than embedded in them.
In support of its view, although not determinative, the SCC considered the position that the reforestation liabilities were embedded was to be favoured over the Minister’s argument that the liabilities were an additional part of the sale price because the latter would give rise to an asymmetrical result. We note that a similar asymmetrical result exists in the case of any contingent liability that is, in contrast to Daishowa’s case, actually part of separate consideration.
The decision potentially has significant impact on the tax treatment of any asset sale. The SCC clearly draws a distinction between future costs that are embedded in transferred assets and external debts. The former affects the FMV of the transferred asset and is not included in the proceeds of disposition, whereas the latter does not affect the FMV and is included in the proceeds of disposition.
Although the SCC’s decision was rendered in the context of the assumption of reforestation obligations, the analysis and conclusions may be relevant for other types of future obligations, including, for instance, environmental clean-up obligations or reclamation obligations. The interrogation should focus on whether a particular liability or obligation is simply a contingent obligation that is external to the assets acquired or is instead part and parcel of such assets.
In particular, the comments of Rothstein J. in obiter dictum should be noted. He indicated that obligations may be considered embedded in a property right even though there is no legal requirement that the obligations be assigned to or assumed by the purchaser. The extent of this possibility is somewhat unclear. Consider whether, for instance, liabilities that follow the assets into the hands of a purchaser as a result of bulk sales statutes may be considered liabilities that simply impair the value of the assets. This would be surprising.
Perhaps the obiter dictum is meant to address situations where, although not part of the assets themselves, the liabilities are imposed, as a matter of law, upon the owner or operator of such assets. Consider also, for example, an assignment of intellectual property where the intellectual property is acquired subject to an existing and less than favourable licence that restricts the use of the intellectual property. Surely, the existing licence is simply an impairment on the value of the intellectual property rather than additional proceeds.
What is unfortunate is that, due to the particular facts of this case, the SCC was not required to settle the significant uncertainty and asymmetry associated with the treatment of contingent liabilities and contingent payments in general. The entire saga underlines the absence of and the need for a comprehensive legislative scheme that deals with contingent liabilities in a fair and equitable manner.
The silver lining is that the SCC recognized certain future obligations need not be parsed from the assets to which they relate, and the comments in obiter dictum suggest that this concept may extend beyond situations where a regulatory or legislative framework inexorably links an obligation to an asset.