In Daishowa-Marubeni International Ltd. v. Canada, 2013 SCC 29, the Supreme Court of Canada (“SCC”) held 9:0 that Daishowa-Marubeni International’s (“DMI”) proceeds from the disposition of two forest tenures should not include the reforestation obligations that were assumed by the purchasers.
DMI consisted of two divisions that each had a forest tenure that allowed them to harvest timber on land owned by the province of Alberta. These tenures included reforestation obligations.
In 1999 and 2000 DMI sold its divisions to Tolko Industries Ltd. (“Tolko”) and Seehta Forest Products Ltd. (‘Seehta”) respectively. The Tolko agreement allocated $20 million of the sale price to the value of the forest tenure, with both parties agreeing that the cost of reforestation would be approximately $11 million. The Seehta agreement did not explicitly allocate any of the purchase price to the tenure nor estimate the cost of reforestation. Both agreements provided that the purchaser would assume DMI’s reforestation obligations, a necessary condition to receive consent for the transfer from the province of Alberta.
DMI did not include the liability assumed by the purchasers relating to the cost of reforestation in its income for 1999 or 2000. The Minister of National Revenue reassessed DMI for both years and found that DMI should have included the liability assumed relating to the cost of reforestation as part of the sale price under s.13(21) of the Income Tax Act, R.S.C. 1985, c.1 (5th Supp.). The Minister accepted the estimated $11 million reforestation cost in the Tolko agreement to be the appropriate cost, and therefore found that DMI’s proceeds to disposition should be increased by that amount in 1999. Using DMI’s accounting records, the Minister determined the appropriate liability assumed relating to the cost of reforestation for the Seehta agreement was $2,996,380, and increased DMI’s proceeds to disposition by this amount for 2000.
The trial judge in the Tax Court ruled in favour of the Minister. DMI appealed the decision. The majority in the Federal Court of Appeal decision found that the vendor’s proceeds to disposition should include the full cost of the assumed reforestation obligation. They applied the principle that proceeds to disposition include the sale price, which includes all consideration received in the transfer, including the assumption of a liability. The majority characterized the reforestation obligation as a liability, and therefore the assumption of the liability was to be included in the proceeds of disposition. They characterized the obligation as a liability for two reasons. The first was other bids for the divisions had a separate portion of consideration for assuming the reforestation obligations. The second reason was DMI stated that if the purchasers had not assumed the obligation, the amount of the cash portion of the purchase price would have had to be greater.
Unlike the Federal Court of Appeal, the SCC, in a decision delivered by Rothstein J, unanimously ruled that the cost of reforestation should not be included in the proceeds of disposition. The SCC agreed that when the sale price includes the assumption of a vendor’s liability, the proceeds of disposition should include the assumption of that liability. However, they found that the reforestation obligation was not a liability, but that it was a future cost embedded in the land tenure.
The Minister submitted that the purchase of the tenures was similar to purchasing a building encumbered by a mortgage. The purchaser can pay for the building with cash, or can pay partly in cash, and also agree to assume the mortgage. If the purchaser agrees to assume the mortgage, then the appropriate proceeds of disposition would include the value of the mortgage. The SCC did not agree with this analogy, and instead found that the purchase of the tenures and assumption of the reforestation obligations, was similar to purchasing a building that needed repairs. The Minister acknowledged that in such a case the vendor’s proceeds of disposition would not include the repair costs, because the cost of repairs cannot be severed from the building. As such the value of the building is adjusted according to the repairs that are required. Similarly the cost of reforestation was embedded in the tenure, and could not be severed as a result of the Province’s scheme surrounding forest tenures. The purchaser should consider the embedded reforestation obligation to be a future cost that decreases the value of the tenure. Including the reforestation costs in the proceeds to disposition would result in an overvaluation of the tenure.
Further the SCC was concerned with the asymmetrical tax treatment that would result if the obligations were treated as the Minister had proposed. Even though the Minister wanted to include the cost of reforestation in the vendor’s proceeds of disposition, the Minister took the position that the purchaser would not be allowed to include the cost of reforestation in their adjusted cost base. This interpretation is not fair, as the sale price is then treated differently for the vendor and the purchaser.
The key to determining the proceeds of disposition from a sale that includes the assumption of an obligation, is characterizing that obligation. In this case the SCC used two analogies, buying a building with a mortgage, versus buying a building that needs repairs, to characterize the assumption of the reforestation obligations. The Court concluded that because the reforestation obligations were embedded in the tenures, it was not correct to characterize them as a liability, and therefore found that the proceeds of disposition should not include the reforestation obligations that were assumed by the purchasers.