The SCC recently granted the taxpayer leave to appeal in the case of Daishowa-Marubeni International Ltd. v. The Queen, which involved the sale of timber licences and an estimated cost obligation for reforestation activities.
“It will be interesting to get the Supreme Court of Canada’s take on this and their views,” says Janice Vohrah, an associate in the tax group of Cassels Brock & Blackwell LLP. “I think it’s possible the courts will come up with the right answer.”
In 1999, Daishowa sold two Alberta sawmill operations in separate assets sales to third parties. Included in the assets were licenses to cut timber. These licences obliged the owner to reforest all lands it cut in the future.
Under Alberta law, the timber licences could not be transferred unless the reforestation liabilities associated with the licences were also transferred to the new owner. The parties estimated the cost of each reforestation liability and reduced the purchase price accordingly, as is consistent with prevailing practice.
“It’s common to have contingent liabilities being assumed but the way the parties dealt with it is a little novel in the fact that they put a specific amount and agreed to a specific amount on what that future liability would be,” says Vohrah.
The estimated contingent amounts were disclosed in the purchase agreements, and the parties agreed they would make adjustments if the final determination of the reforestation liabilities was higher or lower than the estimates.
Vohrah says it is standard practice to only include in the calculation of the purchase price actual amounts that appear on the balance sheet and no contingent liabilities.
“Normally, it’s agreed there is a future contingent liability, but how to quantify that amount is not agreed upon,” she says. “It’s our opinion no value should be attributed and it’s not necessarily something that is in the purchase price section. It shouldn’t be part of the consideration,” says Vohrah.
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.
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 specific issues:
• Should the reforestation liabilities inherited by the purchaser be included in the proceeds of disposition?
• Does it matter that the parties agreed to the future amount of the restoration liability?
A hearing date has not been set.