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 vendor.
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 total liability.
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 sold.
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, and
- 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.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
