In a rare oral hearing, the Supreme Court of Canada granted
leave in the case of Daishowa-Marubeni International Ltd. v.
The Queen. This case has far-reaching tax implications for
asset sales where the purchaser assumes a future obligation of the
Background to Case
In 1999, Daishowa decided to sell two Alberta timber mill
divisions in separate assets sales to third parties. Included in
the assets were timber licenses to cut or remove timber. These
licenses obliged the owner in the future to reforest all lands cut
over by it (the "reforestation liability").
Under Alberta law, the timber licenses could not be transferred
unless the reforestation liabilities associated with the licenses
were also transferred to the new owner of the license. The parties
estimated the cost of each reforestation liability and reduced the
purchase price accordingly, as is consistent with prevailing
practice. The estimated contingent amounts were disclosed in the
purchase agreements, and the parties agreed that they would make
adjustments if the final determination of the reforestation
liabilities was higher or lower than the estimates.
When reporting the income from the asset sales for tax purposes,
Daishowa did not include the estimated contingent amounts of the
reforestation liabilities in its proceeds of disposition. The
Minister of National Revenue reassessed Daishowa to include such
amounts in respect of both sales. Daishowa appealed to the Tax
Court of Canada.
The Tax Court held that the reforestation liabilities should be
included in Daishowa's proceeds of disposition, but discounted
the amounts since the agreements only included estimates of the
On appeal, a majority of the Federal Court of Appeal held that
the entire amounts the parties estimated for the reforestation
liabilities should be included in Daishowa's proceeds. The
dissenting judge would have not included any amount in respect of
the reforestation liabilities in the proceeds of disposition
because in his view, the liabilities were an integral part of the
timber licenses that depressed the value of such licenses but did
not result in separate consideration when the licenses were
SCC Decision on Leave
In its leave application, Daishowa raised several issues that it
asked the Court to consider on appeal, including the more general
question of whether contingent liabilities should be included in
the proceeds of disposition in an asset sale. However, the Court
limited the issues to be heard to two:
Whether the reforestation liabilities are included in the
proceeds of disposition because they relieve the vendor of a
liability or are integral to and run with the timber licenses,
Whether it makes a difference that the parties agreed to a
specific amount of the contingent reforestation liability.
Observations and Recommendations
It is our standard practice to only include in the computation
of purchase price actual amounts that appear on the balance sheet
and no contingent liabilities. The lower courts were clearly
influenced by the fact that the parties agreed on estimated amounts
of the contingent liabilities. Accordingly, care should be taken
before attributing any value to an assumed obligation in a sale
agreement, and a covenant of the purchaser to assume obligations
should not be included in the purchase price clause. It is highly
recommended that a member of the tax department review any asset
purchase agreement, especially the purchase price clause.
We will keep you apprised once the Supreme Court of Canada has
rendered its judgment in this case.
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