The Supreme Court of Canada recently released a decision which overturned previous court decisions and confirmed that the assumption of reforestation liabilities by a purchaser does not constitute additional sale proceeds to the vendor if the liabilities are embedded in the underlying timber rights. This decision is also of particular importance to other resource sectors, where purchasers typically assume reclamation and other obligations.
The case of Daishowa-Marubeni International Ltd. v. The Queen involved a vendor (Daishowa) that sold a forestry division, which included timber rights that gave rise to certain reforestation obligations. The agreement set out a purchase price of $169,000,000 and the assumption by the purchaser of reforestation obligations of $11,000,000 (subject to adjustment based on a post-closing estimate). The lower courts had held that the purchaser’s assumption of the reforestation obligations constituted additional proceeds of disposition upon which the vendor was taxable, although the Tax Court had discounted that amount on account of the uncertain nature of the reforestation obligations.
The Court’s Decision and the Implications
The Court noted that the assumption of a vendor’s liability by a purchaser may give rise to additional proceeds to the vendor depending on the circumstances. However, the Court held, in a unanimous decision, that the reforestation obligations were a future cost embedded in the timber rights and depressed the value of the timber rights. The reforestation obligations were not a distinct liability and could not be severed from the timber rights. The Court considered the reforestation obligations to be more akin to repairs required on a building, rather than to a mortgage that is a separate existing liability that does not impact the value of the property. In support, the Court observed that commercially the vendor could not have received more than the agreed purchase price (i.e., $169 million minus the equipment and related assets) for the timber rights.
The Court indicated that it is irrelevant whether or not the parties agreed on an amount for the reforestation obligations. Further, the Court noted that its approach avoided the asymmetrical tax treatment where any additional sale proceeds arising due to the assumption of obligations would be taxable to the vendor but would not give rise to an increased cost basis in the property for the purchaser.
This decision was eagerly anticipated due to its potential impact on various resource sectors, where the assumption of obligations is part and parcel of the sale of properties. The finding that the reforestation obligations were embedded in the timber rights was based on applicable law and policy that effectively required the purchaser to assume the vendor’s reforestation obligations in order for the transfer to receive government approval as required by applicable legislation and to relieve the vendor of future liability for those obligations. The Court specifically left open the possibility that certain liabilities may be embedded in the property where the purchaser is not required by law or government policy to assume those liabilities on the transfer of the underlying property. This is relevant to other resource sectors where purchasers generally assume certain reclamation or other obligations, but where there may be different legislative schemes in place.
The Court noted that whether the reforestation obligations were “contingent liabilities”, which had been addressed by the lower courts, was also irrelevant. The assumption of the reforestation obligations was excluded from the purchase price due to the embedded nature of such liabilities and independent of whether the liabilities were absolute or contingent. However, various types of obligations are assumed by a purchaser in asset transactions. Whether an obligation assumed by a purchaser is contingent may be relevant for assumed obligations that are not as clearly tied to a particular asset, such as pension, severance and tort obligations. The considerations for those types of assumed obligations will also likely be different as the parties may not agree to an estimate of those obligations.