On September 23, 2011, the Federal Court of Appeal (FCA) rendered its decision in Daishowa-Marubeni International Ltd. v The Queen (2011 FCA 267). This decision will be of interest to parties in any asset sale where there is an assumption of contingent or future obligations.
The principal issue in this decision was whether the Minister of Revenue (Minister) was correct in including the reforestation obligations assumed by the purchaser in calculating the appellant's proceeds of disposition.
In 1999, the appellant (Daishowa) sold one of its timber mill divisions to Tolko Industries. The agreement of purchase and sale (Agreement) with Tolko provided for a purchase price of $169 million plus or minus the value of net working capital. In addition, under the Agreement certain liabilities (including the reforestation liabilities) were assumed by Tolko and a payment was contemplated if there was any difference between the preliminary $11 million reforestation liability estimate and the final determination of the assumed reforestation obligations. In the final analysis, the reforestation obligations exceeded the original estimate, resulting in Daishowa paying Tolko an amount equal to that excess. The parties admitted that if Tolko had not assumed the reforestation obligations, the cash or other consideration payable by Tolko would have been greater.
The Minister included the amount of the reforestation obligations as indicated in the Agreement in Daishowa's proceeds of disposition. Daishowa argued that no such amount should be included in its proceeds of disposition and that, alternatively, if the amount was to be included, it should be entitled to an offsetting deduction in calculating its income.
Tax Court of Canada
The Tax Court of Canada (TCC) determined that Daishowa's liabilities assumed by Tolko were to be included in calculating the proceeds of the sale, and that Daishowa was not entitled to an offsetting deduction. The TCC considered Tolko to have extracted an $11 million price concession as a result of its assumption of the reforestation liabilities. However, the TCC did not consider that this amount was the actual value of the consideration received by Daishowa. The TCC regarded the $11 million amount as solely an estimate and that the value of the liabilities had to be ascertained. Based on a number of factors, the TCC determined that the amount to be included as proceeds was the aggregate of the amount of the current reforestation liability, plus the amount of the long-term reforestation liability discounted by 80%.
Federal Court of Appeal
The FCA concluded that no error had been committed by the TCC in finding that Tolko's assumption of Daishowa's reforestation liabilities constituted consideration for the assets. However, the FCA disagreed with the TCC's evaluation of those liabilities.
In the FCA's opinion, Tolko and Daishowa had clearly agreed to attribute a specific value of $11 million to the liabilities. Under the Agreement, this precise amount had been taken into account in determining the balance of the purchase price payable by Tolko in cash and other consideration. The Agreement also provided that, in the event that the amount of the reforestation obligations, either (i) as finally approved by the purchaser based on the reforestation statement to be prepared by Daishowa or (ii) as finally determined by the accountants or arbitration, was different from the original $11 million estimate, Daishowa would make a payment to Tolko or Tolko would make a payment to Daishowa. Other bids made for the division also included the assumption of reforestation obligations as a separate portion of the consideration. The fact that the original calculation of the reforestation obligations was an estimate did not render it so uncertain as to be indeterminate. It was indeed an agreed-upon value and the subsequently determined amounts were in fact not characterized as estimates and actually "affected the legal obligation for cash payment."
The real issue, the FCA found, was what the parties had agreed to accept as consideration for the property. In the opinion of the FCA, the Minister had been correct in including, in calculating Daishowa's proceeds of disposition, the value of the assumed liabilities as agreed by the parties in their contract. Whether the liability was absolute or contingent was completely irrelevant in the FCA's opinion. The sole question was what value the parties had attributed to the liability. According to the FCA, "If the parties attribute no value to a future liability, then there is nothing to be added to the seller's proceeds of disposition." For instance, the FCA explained, since the parties attributed no value to the purchaser assuming all future tort liability flowing from the timber mill division sold, no amount was to be included in Daishowa's proceeds of disposition in respect thereof.
Although the FCA's decision was rendered in the context of the assumption of reforestation liabilities, the analysis and conclusions are relevant for any type of contingent or future liability, including, for instance, reclamation obligations or pension obligations. The FCA observed that the jurisprudence seems concerned only with the value attributed to assumed liabilities by the parties and that their contingent or absolute nature is irrelevant in determining the seller's proceeds of disposition. The parties to a purchase and sale agreement should therefore bear this in mind.
Where negotiations between a purchaser and a vendor reveal that a value was attributed to a contingent liability in arriving at the cash purchase price, it may be worthwhile to consider whether the agreement among the parties should reflect that price concession in order to avoid any uncertainty. It may also be worth noting that, while the seller may be required to include the agreed value of such assumed liabilities as proceeds of disposition, the treatment of such an assumption for the purchaser, and more specifically the timing of the recognition of such an assumption as cost of property, remains uncertain. With respect to contingent liabilities, the Minister's position is typically that they may not be recognized by the purchaser until actually incurred.
Application for leave to appeal to the Supreme Court of Canada was completed by the appellant on November 21, 2011. There was indeed a dissenting judgment in the FCA which essentially considered that the reforestation obligations were part and parcel of the timber resource properties, given the TCC finding of fact that the provincial authorities will not consent to the assignment of forest tenures unless the reforestation obligations are assumed by the transferee. Indeed, it was not open to the appellant to retain the reforestation obligations, carry out the reforestation work and claim a deduction for it. The reforestation obligations were inexorably linked to the timber resource properties and simply had as a consequence the impairment of the value of those timber resource properties, much like a building that requires repairs in order to meet building code standards within a period of time stipulated by a regulation or bylaw.
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