- Supreme Court of Canada Confirms the Tax Treatment of Future Obligations Assumed by a Purchaser
- May 28, 2013
- Law Firm: Cassels Brock Blackwell LLP - Toronto Office
On May 23, 2013, the Supreme Court of Canada (the “SCC”) issued its highly anticipated decision in Daishowa-Marubeni International Ltd. v. The Queen, dealing with the tax treatment of future obligations that are assumed by a purchaser of assets. The Daishowa decision is important because it examines whether the cost of future obligations (i.e., non-monetized obligations) that are assumed by a purchaser of assets should be included in the seller’s proceeds of disposition and subject to tax.
At issue in Daishowa was whether the estimated cost of reforestation obligations (as discussed below) assumed by a purchaser of a timber licence should be included in computing the seller’s proceeds of disposition for the timber licence. The SCC held that the estimated cost of the reforestation obligations should not be included in the seller’s proceeds of disposition.
The principles established in the SCC’s decision are relevant to any type of asset sale; however, the SCC’s decision has particular relevance for the mining industry in which a purchaser of resource properties regularly assumes reclamation obligations of the seller.
Background and Lower Court Decisions
In 1999 and 2000, Daishowa-Marubeni International Ltd. (“Daishowa”) sold two Alberta timber mill divisions in separate asset sales to different purchasers. The assets of the timber mill divisions included the related timber licences, which entitled the owner of each timber licence to cut or remove timber from land owned by the province of Alberta. Under these timber licences, the owner of each timber licence was obligated to reforest the lands after it harvested the timber (the “reforestation obligations”). Under Alberta’s regulatory regime, a timber licence could not be transferred unless the reforestation obligation was assumed by the transferee. As a result, under the purchase agreements, the purchasers from Daishowa agreed to assume the reforestation obligations.
In reporting its income from the asset sales, Daishowa did not include the estimated cost of the reforestation obligations as part of its proceeds of disposition. Subsequently, the Minister of National Revenue (the “Minister”) reassessed Daishowa to include such estimated cost in Daishowa’s proceeds of disposition. (Interestingly, the approach advanced by the Minister would lead to asymmetry between the purchaser’s adjusted cost base of the timber licence and Daishowa’s proceeds of disposition of the timber licence [i.e. the purchaser’s adjusted cost base of the timber licence would not include the estimated reforestation obligations assumed by the purchaser, but Daishowa’s proceeds of disposition would include the estimated reforestation obligations assumed by the purchaser].)
The Tax Court of Canada (the “TCC”) held that the estimated cost of the reforestation obligations should be included in Daishowa’s proceeds of disposition, but discounted the amount of these reforestation obligations. On appeal to the Federal Court of Appeal (the “FCA”), a majority of the FCA panel held that the entire amount of the estimated cost of the reforestation obligations should be included in Daishowa’s proceeds of disposition.
Supreme Court of Canada - Decision
Although the SCC confirmed the general principle that the assumption by a purchaser of assets of a separate existing debt of the vendor forms part of the sale price of the assets, the SCC held that the estimated cost of the reforestation obligations was not such a separate existing debt and Daishowa was not required to include any portion of the estimated cost of the reforestation obligations in its proceeds of disposition. In summary, the basis for the SCC’s decision was that:
the estimated cost of a reforestation obligation is embedded in a timber licence by virtue of Alberta’s regulatory scheme, which prevented Daishowa from selling a timber licence without the purchaser assuming the related reforestation obligation;
a reforestation obligation is not a liability that can be separated from a timber licence, and
a reforestation obligation is simply a future cost tied to a timber licence that depresses the value of the timber licence (i.e. in the same way that a building that requires repair work has a depressed value compared to a well-maintained building).
The SCC’s decision is welcome news in the tax community, as the decision resolves the uncertainty previously surrounding the tax treatment of future obligations assumed by a purchaser of assets and is in keeping with the previous general business and tax practices. The SCC’s comment in support of an interpretation of tax statutes that promotes symmetry and fairness is also welcome.
Taxpayers must continue to pay attention to the purchase price (and satisfaction of the purchase price) provisions in asset and share purchase agreements, particularly when the assumption of any liabilities or obligations is contemplated, and should consult with a tax lawyer to manage any associated tax implications.