Citation: 2012 FCA 20
HER MAJESTY THE QUEEN
REASONS FOR JUDGMENT
appeal concerns the existence, valuation and price allocation of commercial
goodwill in regulated industries for income tax purposes.
TransAlta Corporation (“TransAlta”) sold its regulated electricity transmission
business in Alberta to AltaLink, L.P.
(“AltaLink”) at a price negotiated as 1.31 times the net regulated book value
of its tangible assets. The bulk of the 31% premium over net regulated book
value – an amount of $190,824,476 – was allocated by the parties to goodwill.
This was a standard allocation for regulated industries, which was supported by
valuation theory, audited financial statements and long-standing industry
Minister of National Revenue (“Minister”) challenged this allocation on the
ground that no goodwill exists in a regulated industry. Consequently, the
Minister reassessed TransAlta under section 68 of the Income Tax Act,
R.S.C. 1985, c.1 (5th Supp.) (“Act”) – which allows for a price
reallocation on a reasonableness standard – by reallocating the entire goodwill
amount of $190,824,476 to tangible assets. The Minister contends that the
long-standing practice of regulated industries to allocate to goodwill the
premiums paid above the net regulated book value of their tangible assets is
unreasonable since it allows the vendors to avoid recapture of capital cost
reassessment was challenged by TransAlta before the Tax Court of Canada, and in
reasons cited as 2010 TCC 375, Justice Campbell Miller of the Tax Court of
Canada (“Tax Court judge”) concluded that goodwill can exist in a regulated
industry and was in fact sold in this case with TransAlta’s regulated
electricity transmission business. However, on the basis of a definition of
goodwill developed well over a century ago by Lord Macnaghten in The
Commissioners of Inland Revenue v. Muller & Co.’s Margarine, Limited,
 A.C. 217 (“Muller”), the Tax Court judge concluded that two items
which were said to represent goodwill – the potential for leverage and a
potential tax allowance benefit – were in fact attached to the tangible assets
sold. He assessed the value of those two items at $50,000,000 which he deducted
from the allocation to goodwill made by the parties to the transaction.
TransAlta is appealing from this judgment, and the Crown is cross-appealing.
concept of goodwill has evolved considerably since the beginning of the 20th
century. Whereas business goodwill was formerly considered to pertain to good
name, reputation and connection principally with respect to customer relations,
the concept has now taken on a broader meaning influenced by economic,
accounting and valuation theories.
has three characteristics: (a) it must be an intangible; (b) it must arise from
the expectation of future earnings, returns or other benefits in excess of what
would be expected in a comparable business; (c) it must be inseparable from the
business to which it belongs and cannot normally be sold apart from the sale of
the business as a going concern. If these three characteristics are present, it
can reasonably be assumed that goodwill has been found.
to determine if an amount can reasonably be regarded as the consideration for
the disposition of a particular property, section 68 of the Act requires
considering whether a reasonable business person, with business considerations
in mind, would have allocated that amount to that particular property.
Consequently, long-standing regulatory and industry practices, as well as
auditing and valuation standards and practices, are relevant to such a
the very nature and purpose of the regulatory process, the net regulated book
value of the regulated tangible assets of the transmission business at issue in
this case may reasonably be understood as reflecting the fair market value of
those assets. The regulated book value of the regulated assets is one of the
bases upon which the regulatory authorities determine the regulatory rate of
return. The industry standard allows for the allocation to goodwill of any
premium paid above the net regulated book value of those assets. Such a premium
can reasonably be understood as the value of the special advantages of the transmission
business which allow it to potentially achieve returns in excess of what is
deemed by its regulator to be a normal market return. The reasonableness of
this long-standing industry practice is supported in this case by the
regulatory process itself and by valuation and accounting theory and practice.
The allocation of such a premium to goodwill can thus be regarded as reasonable
for the purposes of section 68 of the Act.
therefore allow TransAlta’s appeal and dismiss the Crown’s cross-appeal with
Background to these proceedings
electricity transmission business – which it owned through subsidiaries –
consisted of approximately 11,600 km of transmission lines and 260 substations
that supplied almost 60% of the Alberta
population with electricity. The original cost of the transmission assets was
approximately $1.4 billion. Depreciation of those assets for accounting
purposes throughout TransAlta’s ownership was approximately $780 million, which
resulted in a book value for accounting purposes of approximately $640 million.
time of the transaction, TransAlta’s transmission business was regulated by the
Alberta Energy and Utilities Board (“Board”) pursuant to the Electric
Utilities Act (Alberta), S.A. 1995, c. E-5.5. The Board is
an independent, quasi-judicial agency of the Government of Alberta, which is
responsible for regulating the Alberta electricity transmission
industry. At all material times, the Board set the rates that the transmission
business could charge for its services based on a cost-of-service regulatory
approach. These rates were usually set on the basis of forecasts submitted to
the Board by TransAlta so as to allow its transmission business to: (a) recover
the net regulated book value of its assets as they depreciated for regulatory
purposes; (b) recover the estimates of the operating expenses the transmission
business planned to incur, including interest with respect to its debt, taxes
and other amounts; and (c) earn a reasonable return on the equity investment
portion of the net regulated book value of its assets that the Board deemed
ratio was set at 35% equity and 65% debt for rate-making purposes. The Board-approved
after-tax return on equity at the time of the transaction was 9.75%. The actual
return on equity earned by TransAlta from the transmission business ranged from
11.79% in 1999 and 2000 to 13.57% in 2001.
revenues were not retroactively adjusted to reflect actual costs incurred,
except in the case of certain capital additions. Consequently, when expenses
were lower than forecast as a result of efficiencies, the resulting excess net
income was retained by TransAlta.
TransAlta resolved to divest itself of its transmission business and initiated
a bidding process. The transaction contemplated by the bid documents was that
of a sale of shares in a new subsidiary which would hold the transmission
business assets but none of its debt. In addition to the existing regulated
transmission business, the bid documents identified significant business
opportunities resulting from the sale, including the potential to construct
major additional transmission capacity in Alberta, the potential introduction
of performance-based regulation by which cost efficiencies would be shared by
the regulator between the clients and the owner of the transmission business,
and the potential to grow non-regulated earnings in the areas of
telecommunications, merchant transmission, engineering, procurement and
construction management services, as well as operating and maintenance
were received. The bidders proposed to buy the transmission business at various
prices which varied from the net regulated book value of the regulated assets to
various premiums on that value. The consortium which eventually formed AltaLink
submitted what was considered the best offer. That consortium was comprised of
SNC Lavalin Inc. (50%), Ontario Teachers’ Pension Plan Board (“Teachers”)
(25%), Macquarie North America Ltd. (15%) and a wholly-owned subsidiary of
Trans Elect Inc. (10%). It is not disputed that these were knowledgeable and
experienced investors dealing with TransAlta at arm’s length.
consortium’s revised proposal was to purchase the transmission business through
a limited partnership structure at a book value multiple of 1.31 at closing.
During the course of the negotiations resulting from this proposal, certain
assets were excluded from the transaction and various other adjustments were
made. Moreover, an additional $36 million of the purchase price was allocated
to depreciable assets over what TransAlta had originally proposed to the
The final purchase
and sale agreement was executed on July 4, 2001 and amended on January 21,
2002. For the purpose of this appeal, the key elements of that amended
agreement are sections 2.1 and 2.2 and the definitions of “Assets”, “Business”,
“Net Regulatory Book Value” and “Rate Base” in Appendix A:
In consideration for the payment to the
Vendor by the Purchaser of the Purchase Price and assumption by the Purchaser
of the Assumed Liabilities, and upon and subject to the terms and conditions
hereof, at the Time of Closing the Vendor shall assign, transfer and set over
to the Purchaser, and the Purchaser will acquire from the Vendor as a going
concern, the Assets and the Business […]
purchase price to be paid to the Vendor by the Purchaser (the “Purchase Price”)
shall be the sum of the amounts set forth in Sections 2.2(1)(a) and (b) below:
Regulatory Book Value at December 31, 2000 (which the Parties agree is
$613,200,000), less $8,565,705 (which represents the Parties estimate of that
portion of the Net Regulatory Book Value allocated to the Withheld Assets (…))
equalling $604,634,295, multiplied by 1.31 for a total of $792,070,926.50 (the
“Base Purchase Price”); and
determined by the adjustments set forth in Section 2.3 hereof.
and the Purchaser shall allocate the Purchase Price among the Assets in
accordance with Schedule 2.2(2) hereof; and the Purchaser and the Vendor, in
filing their respective income tax returns, shall use such allocation of the
“Assets” means the undertaking and
all tangible or intangible property (whether real, personal or mixed, choate or
inchoate), rights, benefits, privileges, assets or entitlements owned by the
Vendor or TransAlta Utilities Corporation or any of their Affiliates, or to
which the Vendor or TransAlta Utilities Corporation or any of their Affiliates
is entitled and used exclusively or Primarily in the Business, of every kind
and description and wheresoever situate. Without limiting the generality of the
foregoing, the Assets include:
benefit of the Contracts and all other contracts or commitments to which the
Vendor or TransAlta Utilities Corporation or any of their affiliates is
entitled in connection with the Business […]
Warranties, if any;
software listed in Schedule 1.1(a);
goodwill of the Business including, without limiting the generality of the
exclusive right of the Purchaser to represent itself as carrying on the
Business in continuation of and in succession to the Vendor and TransAlta
Utilities Corporation and the non-exclusive right to use any words indicating
that the Business is so carried on, and
extent transferable, all customer lists and supplier lists of the Business.
and specifications […]
But excluding, in any event,
the Excluded Assets.
“Business” means the existing
electrical transmission business carried on by the Vendor or TransAlta
Utilities Corporation or any Affiliate on their behalf, including Transmission
Facilities and associated systems and services in the Province of Alberta and
the operations, maintenance and construction of facilities service business,
telecommunications initiatives, the engineering procurement and management
services and the merchant transmission services; the all of which are to be
transferred to the Purchaser as a going concern but does not include the
Generation Facilities or Excluded Assets;
“Net Regulatory Book Value” means
the total cost of the Vendor’s and TransAlta Utilities Corporation’s assets
(other than current assets) forming the Assets and the Withheld Assets, less
the accumulated depreciation (which excludes accumulated amortization of
Customer Contributions) thereon and unamortized Customer Contributions, as
determined in accordance with generally accepted accounting principles and
which would be included in Rate Base;
“Rate Base” means all Assets of
the Business used in the determination of regulated transmission revenue
requirements as approved by the AEUB [Alberta Energy and Utilities Board] from
time to time, including, without limiting the generality of the foregoing,
transmission property, allocated corporate property, allowance for working
capital and customer contributions;
amended schedule 2.2(2) of the purchase and sale agreement, the parties agreed
on the formula for the allocation of the purchase price. The final agreed
purchase price –including the Base Purchase Price and the adjustments – was set
at $818,150,705. The allocation under the agreed allocation formula was as
a. $590,582,039 to depreciable
b. $11,897,581 to land;
c. $14,583,208 to land rights;
d. $10,263,401 to working
e. $190,824,476 to goodwill.
The amounts allocated to depreciable assets and land were
equal to TransAlta’s net regulatory book value of the transmission business on
the effective date of the transaction, being a total of $602,479,620.
was reviewed by the chartered accounting firm of Ernst & Young as part of
its audit procedures for AltaLink. Though some reservations were expressed
about items which are not in dispute in these proceedings, no reservation was
made in respect of the allocation to goodwill: letter of August 22, 2002
reproduced at p. 949 and following of the appeal book. This allocation to
goodwill has since been recorded in the audited financial statements of
purchase and sale transaction was subject to regulatory approval. The Board
approved the transaction on March 28, 2002 in its Decision 2002-038. In this
process, the potential recapture of the premium paid over the net regulated
book value and the impacts on ratepayers were expressly considered. The
principles applied by the Board for such purposes are known as the “no-harm
test”. The no-harm test determines whether a proposed transaction can proceed
in a fashion that ensures ratepayers are left at least no worse off than they
were prior to the proposed transaction. This may be in the form of financial
compensation – such as a recapture of the premium – the setting of appropriate
conditions or a combination of measures. The Board had extensively considered
the no-harm test in its prior Decision 2000-41 in which it approved the
transfer of the electricity distribution business of TransAlta at 1.5 times the
net regulatory book value of the tangible assets of that business.
committed to abide by a condition under which the closing net regulatory book
value – or closing rate base balance – of TransAlta would be equal to the
opening net regulatory book value – or opening rate base – of AltaLink. Any
premium paid over net regulatory book value would thus not be included in the
future rate base of AltaLink. The Board considered this condition appropriate
and consistent with its prior Decision 2000-41 regarding the recovery of a
purchase premium, and therefore did not order a recapture of the premium in
favour of the ratepayers.
The reasons of the Tax Court
Minister reassessed by reallocating to the tangible assets the full amount of
$190,824,476 which had been allocated to goodwill by the parties to the
transaction. TransAlta appealed this reassessment to the Tax Court of Canada.
evidence relied upon by the Minister in the Tax Court of Canada in support of
that reallocation was an opinion report of Mr. Scott S. Lawritsen which
concluded that no goodwill exists when a purchase or sale of regulated assets
Court judge rejected this contention, principally on the ground that TransAlta
had created significant additional profits from its efficient cost-conscious business
culture, and that an intangible business culture was something a buyer would
pay for; this constituted goodwill: reasons at paras. 37, 64 and 65.
there was no direct evidence submitted to the Tax Court judge as to why
AltaLink paid the 31% premium over net regulatory book value, the Crown and
TransAlta agreed that the premium was paid at least in part because of a
potential tax allowance benefit and the potential for leverage.
potential tax allowance benefit would have resulted from the Board’s
consideration of taxes for the purposes of setting the rates for the
transmission business. In light of this, AltaLink may have expected that it
would receive as part of its annual revenues permitted by the Board an
allowance for income taxes that would exceed the income tax actually paid by at
least one of the partners, namely Teachers. As a limited partnership, AltaLink
was not itself subject to income tax, but the tax liabilities associated with
its operation of the transmission business would flow to its partners, of which
one was a non-taxable pension fund. Consequently, there may have been an expectation
that 25% of the allowance for income tax authorized by the Board – representing
Teachers’ interest in the limited partnership – might potentially flow to
Teachers on a tax free basis.
also believed that AltaLink could potentially arrange its affairs to use more
leverage than was assumed by the Board for ratemaking purposes. Although, as a
minimum, the 65:35 debt-to-equity ratio would be maintained in AltaLink, the
partners could finance part of their equity participation in AltaLink itself through
loans, thus leveraging their respective expected returns.
regulatory approval process relating to the transaction, AltaLink represented
to the Board that the premium could be justified on the basis that:
a. a performance-based regulation
plan could possibly result in a sharing of benefits with customers that would
enhance earnings; this was being considered by the Board at the time of the
b. the possibility of sustained
growth in the regulated base could dilute the size of the premium; important
capital investments were indeed expected in the electricity transmission
business which could potentially yield additional returns; and
c. the existence of competitive
merchant transmission projects could provide opportunities to enhance earnings
The Tax Court judge recognized
that these items constituted goodwill: reasons at paras. 36, 38 and 63.
also concluded, adopting the definition of goodwill developed by Lord
Macnaghten in Muller, that the potential for leverage and the potential
tax allowance benefit described above could not be attributed to any goodwill
sold by TransAlta: reasons at paras. 33, 34 and 39. He also interpreted the
decision of Mahoney J. in R v. Jessiman Brothers Cartage Ltd., 
C.T.C. 274, 78 D.T.C. 6205 (“Jessiman”) as drawing a distinction
between “goodwill” and “reasons why a purchaser would pay more for tangible
assets”: reasons at paras. 56 to 58.
Court judge then proceeded to discard the allocation of the purchase and sale
price which had been agreed to between TransAlta and AltaLink. Although he
recognized that the parties had negotiated at arm’s length, he found that no
hard bargaining had taken place between them concerning the allocation. He
reached that conclusion on the basis of his findings that “the amount was not
significant in the context of the overall deal, there was indifference on one
side and the Parties ended up where the industry norm and business logic in the
regulated industry would naturally take them”: reasons at para. 53. He
consequently found that TransAlta had not made out a prima facie case of
reasonableness, and proceeded to determine what he considered to be a
reasonable allocation based on his own valuation: reasons at para. 54.
of his findings that the potential for leverage and the potential tax allowance
benefit were not part of the goodwill of TransAlta, the Tax Court judge deducted
their respective value from goodwill and allocated their combined value to the
tangible assets. For this purpose, he determined a value in the range of $25,000,000
to $50,000,000 for the tax allowance benefit and a value of $25,000,000 for
leverage. The Tax Court judge provided limited explanations as to the valuation
methodology he used to determine these amounts. Using the lower range of his
valuation, he deducted $50,000,000 from the agreed allocation of $190,824,476
series of issues to be addressed in this appeal concern the concept of goodwill
in regulated industries. The Crown contends that no goodwill exists in a
regulated industry, while the Tax Court judge concluded that the potential for
leverage and the potential tax allowance benefit did not form part of the
goodwill sold in this transaction. These issues call for a review of both the
legal framework governing the regulated transmission business and the legal
concept of goodwill. These are primarily questions of law, to be determined on
a standard of correctness: Housen v. Nikolaisen, 2002 SCC 33, 
S.C.R. 235 at paras. 8 and 9.
series of issues to be addressed are whether the Tax Court judge erred in ruling
that the allocation agreed to between TransAlta and AltaLink was unreasonable
under section 68 of the Act, and whether he could substitute his own allocation
based on his own valuation. These issues raise questions concerning: (a) the
legal test under section 68, which is a question of law to be decided on a
standard of correctness: Ludco Enterprises Ltd. v. Canada, 2001 SCC 62,
 2 S.C.R. 1082 at para. 34; and (b) the application of that test to the
facts in this case, a question of mixed fact and law to be decided in this appeal
on a standard of reasonableness.
First Series of Issues:
Goodwill in regulated industries
expert, Mr. Lawritsen, expressed the opinion that what is acquired in a
purchase and sale transaction involving a regulated business is the cash flow –
or revenue stream – generated by the tangible regulated assets of that business.
Thus, even though the negotiations between TransAlta and AltaLink were premised
on a multiple of the net regulated book value of the tangible assets of the
transmission business, the price paid for the business was in effect directly
tied to the revenue stream that would be generated by those assets.
Consequently, the entire purchase price must be allocated to these tangible
Lawritsen recognized that his opinion diverged from standard industry and
valuation practices. In essence, he – and by necessary implication, the
Minister – challenged the validity of the economic and legal theories
underlying the regulatory system. The following exchange at the end of Mr.
Lawritsen’s cross-examination clearly illustrates his position (Transcript at
pages 499 to 501, reproduced in the appeal book at pages 1661 to 1663):
Q […] So, if you - - if you disagree
with the conclusion, then you’re disagreeing with the validity of the economics
underlying the regulatory system. Is that - - is that correct?
A Absolutely. I mean, there’s - -
there’s a couple fundamental distinctions here, right? The - - the regulator
was saying that, “We’re targeting a 9.75 percent rate of return.” In reality,
we saw 12 - - 11, 12, 13 percent rates of return being realized.
A As well, there’s no market determining
that that 9.75 percent is a - -
A - - market rate of return. It’s up to
the individual buyers. So, each individual buyer would, in fact, not be looking
at this, per se: would be going out there and saying, “Look, I’ve got $105
million of EBITDA. It attaches to these assets. What do I want to pay for those
A Well, if I can pay $800 million for [$]105
EBITDA in 2002 in a volatile economy, I’m going to be happy.
Q So, this last question, Mr. Lawritsen,
and then I promise I’m done. So, the - - the basic disagreement is over the
legitimacy of the - - of the numbers that are coming out from the Board as
market proxies? That’s - - that’s the score of your concern with Ms. Glass’s -
A Yeah, in - -
Q - - NPV model?
A Miss Glass says NRBV [net regulatory
book value] equals fair market value of the - -
Q No, I’m - -
A - - tangible assets because the
regulator says so.
comprehensive valuation report prepared by TransAlta’s expert witness, Ms.
Susan H. Glass of KPMG, expressed a different view. Ms. Glass opined that (a)
businesses that operate in rate-regulated industries are subject to
restrictions that typically reduce the multiple of net book value that a
purchaser is willing to pay for the business, which in turn might reduce, but
would not eliminate, the potential for goodwill; (b) these same restrictions
generally result in the fair market value of rate-regulated tangible assets
being equal to the net regulated book value of those same assets; and (c) as a
result, in a rate-regulated industry, any premium over net regulatory book
value would normally be attributable to goodwill or other intangible assets:
KPMG valuation at para. 177, reproduced at p. 1082 of the appeal book.
further explained that the standard valuation method in such circumstances is
to assess the fair market value of the tangible assets and identifiable
intangible assets, and to allocate to goodwill the difference between that fair
market valuation and the actual price paid for the assets.
the tangible assets which were part of the TransAlta transaction in accordance
with the income valuation approach – or discounted cash-flow approach – which
she determined as the most appropriate valuation approach in the circumstances.
This valuation resulted in a fair market value for the assets of $600,698,000,
which was within 2.7% of the net regulated book value of these assets, and well
within an acceptable margin of error: KPMG report at paras. 371 to 373, reproduced
at p. 1118 of the appeal book.
illustrate further, Ms. Glass identified a number of goodwill factors related
to excess earnings, excess returns, growth and strategic benefits that could
and likely would have had an impact on the price AltaLink was willing to pay
for the transmission business. She recognized that these factors cannot be
precisely quantified; nevertheless, their rough quantification supported her
expert opinion that, as of the closing date of the transaction: (a) the fair
market value of the tangible assets and intangible land rights sold by
TransAlta equalled the net regulatory book value of the assets; (b) the fair
market value of goodwill related to the transmission business equalled the full
purchase premium paid by AltaLink; and therefore (c) the purchase price
allocation negotiated by TransAlta and AltaLink was in accordance with the fair
market value of the tangible and intangible assets bought and sold: KPMG report
at paras. 401 and 414, reproduced at pp. 1123 and 414 of the appeal book.
framework of the regulatory system
purpose of regulating, through rates, the prices charged by TransAlta’s
transmission business is to control potential abuses of the monopoly position of
that business. TransAlta’s electricity transmission business is thus regulated
in order to ensure an efficient and cost-effective essential service to its
clients, while also ensuring a fair and reasonable rate of return for the
capital required to provide that service.
process for setting rates in a regulated industry has been described in Northwestern
Utilities Ltd. v. City of Edmonton,  S.C.R. 186. In that case, the
Board of Public Utility Commissioners of Alberta made an order in 1922
fixing rates chargeable for gas supplied in the City of Edmonton. The Board
fixed the rates on the basis of an allowance of 10% as a fair return on the
investment in the enterprise. In 1926, Northwestern Utilities applied for a
continuation of the rates. In determining the rates, the Board reduced the
return to 9% in view of altered conditions in the money markets. In rejecting
the appeal, Justice Lamont made the following comments [at pp. 192-193]:
The duty of the Board was to
fix fair and reasonable rates; rates which, under the circumstances, would be
fair to the consumer on the one hand, and which, on the other hand, would
secure to the company a fair return for the capital invested. By a fair
return is meant that the company will be allowed as large a return on the
capital invested in its enterprise (which will be net to the company) as it
would receive if it were investing the same amount in other securities
possessing an attractiveness, stability and certainty equal to that of the
company's enterprise. In fixing this net return the Board should take into
consideration the rate of interest which the company is obliged to pay upon its
bonds as a result of having to sell them at a time when the rate of interest
payable thereon exceeded that payable on bonds issued at the time of the
hearing. To properly fix a fair return the Board must necessarily be
informed of the rate of return which money would yield in other fields of
investments. Having gone into the matter fully in 1922, and having fixed
10% as a fair return under the conditions then existing, all the Board needed
to know, in order to fix a proper return in 1927, was whether or not the
conditions of the money market had altered, and, if so, in what direction, and
to what extent.
process was adopted in Alberta for the purpose of setting
the rates for the transmission business at the time of its sale by TransAlta.
Under that regulatory process, the rates set by the Board provided enough
revenue not only for operating expenses, but also for the capital costs of the
business financed through debt and equity participation. The rate of return and
associated debt-to-equity ratio was determined by the Board and revised
periodically, usually after public hearings. The regulatory process thus served
as a form of proxy to a market environment.
under the theory supporting the system of regulation operated by the Board for
the transmission business at issue, returns to equity holders determined for
regulatory purposes should normally be equivalent to the returns these equity
holders would obtain through investments in other businesses having comparable
legally mandated result has important consequences for the purpose of
determining the fair market value of the assets underlying a regulated
business. Since returns on equity are determined on the basis of a fair market
approach, the market value of the tangible assets of a regulated business
should normally reflect the regulated book value of these assets. This is an
inherent consequence of the legal mandate under which the regulator operates.
reality, regulated industries may sometimes achieve returns on equity which are
higher than those approved by a regulator for rate-making purposes.
additional returns may result from the fact that the managers of the regulated
business have achieved exceptional performances beyond those achieved in
comparable businesses. Efficient management controls of costs may allow for
more of the regulated income streams to be directed towards equity returns and
thus providing above-market returns for an investment at a comparable level of
risk. Additional returns on equity may also be achieved through new business
opportunities generating additional earnings. These efficiencies and new
opportunities may be explicitly or implicitly encouraged by the regulatory
environment since they may potentially be recaptured in whole or in part for
the benefit of the ratepayers.
even without additional returns, a regulated business may present strategic
business opportunities which enhance its value as a business without
necessarily enhancing the value of its underlying tangible assets. These
strategic factors may vary considerably, but the opportunity for new market
developments is surely an important one.
of the regulatory system results in the fair market value of the tangible
assets sustaining the regulated business being largely equivalent to the
regulated book value of those assets. As noted above, this is a result flowing
from the legislated regulatory framework adopted for this industry.
Consequently, any increased value of the business achieved through excess
returns resulting from exceptional business management, from new business
opportunities or other strategic factors should normally be allocated to goodwill.
itself implicitly recognized this. As occurred in this case, a regulated
business may be sold at a premium to the regulated book value of its underlying
tangible assets. This premium may result from the fact the regulator has not
accurately assessed the market returns on equity for comparable investments and
has thus set the regulated rate of return too high. This premium may also
result from abrupt market changes since the last regulatory rate determination.
However, in regulatory theory, such errors or abrupt market changes would
normally be rapidly corrected through subsequent regulatory rate renewal
commented as follows on this issue in its Decision 2004-052 concerning the
generic cost of capital, under the heading “Market-to-Book Ratios and
Board agrees with the Applicants that there are a number of factors impacting
market-to-book ratios of utility holding companies and that one has to be
cautious making inferences regarding the regulated utilities. The Board also
agrees that there may be strategic factors affecting the price that is paid to
acquire a utility.
example, NGTL submitted that its parent did not acquire a further interest in
the Foothills pipeline, paying 1.6 times book value, for the opportunity to
earn a return at the NEB formula rate; rather, the investment was made in an effort
to increase the probability that TCPL will participate in a Northern pipeline
project. The Board also recognizes that, in some cases, a premium might be
paid for regulated assets in anticipation of significant future growth in rate
base, to achieve geographic diversification or to obtain a foothold in a new
market. However, parties are also aware of the constraints placed on
regulated utilities with respect to affiliate transactions, particularly those
with unregulated affiliates.
the absence of such strategic factors, the Board would not expect a prudent
investor to pay a significant premium unless the currently awarded returns are
higher than that required by the market.
The Board acknowledges the views of some parties that payment of a premium over
book value for a regulated utility indicates that the recent ROE awards may
have been higher than required by the market. The Board is not aware of the
strategic factors that may have affected the price paid to acquire Alberta utilities in
recent years. Nevertheless, the experience regarding the market-to-book values
of utilities and the experience regarding the acquisition of Alberta utilities in
recent years gives the Board some comfort that its recent ROE awards have not
been too low.
concept of goodwill
Court judge relied on the following definition of goodwill set out by Lord
Macnaghten in Muller at pp. 223-224:
What is goodwill? It is a thing very easy to
describe, very difficult to define. It is the benefit and advantage of the good
name, reputation, and connection of a business. It is the attractive force
which brings in custom. It is the one thing which distinguishes an
old-established business from a new business at its first start. The goodwill
of a business must emanate from a particular centre or source. However widely
extended or diffused its influence may be, goodwill is worth nothing unless it
has power of attraction sufficient to bring customers home to the source from
which it emanates. Goodwill is composed of a variety of elements. It differs in
its composition in different trades and in different businesses in the same
trade. One element may preponderate here and another element there. To analyze
goodwill and split it up into its component parts, to pare it down as the
Commissioners desire to do until nothing is left but a dry residuum ingrained
in the actual place where the business is carried on while everything else is
in the air, seems to me to be as useful for practical purposes as it would be
to resolve the human body into the various substances of which it is said to be
composed. The goodwill of a business is one whole, and in a case like this it
must be dealt with as such.
definition was developed well over a century ago at a time when a client base
and good reputation were understood as the principal elements of goodwill.
Although this definition is still useful, important developments in the fields
of business, accounting, valuation and law in the last century also need to be
taken into account in order to better understand the modern concept of
by Lord Macnaghten, goodwill is a concept which is difficult to define. It is
composed of a variety of elements, and its composition varies according to
different trades and different businesses in the same trade. Consequently, even
after much study and numerous publications on the subject, a proper definition
of goodwill has eluded both the legal and the accounting professions. Like the
accounting profession, I conclude from this that any attempt to define goodwill
is doomed to failure. Rather, various characteristics inherent to the notion of
goodwill should be identified and then used to ascertain goodwill on a case-by-case
at the outset of these reasons, three characteristics must be present in order
for goodwill to be found: (a) goodwill must be an unidentified intangible as
opposed to a tangible asset or an identified intangible such as a brand name, a
patent or a franchise; (b) it must arise from the expectation of future
earnings, returns or other benefits in excess of what would be expected in a
comparable business; (c) it must be inseparable from the business to which it
belongs and cannot normally be sold apart from the sale of the business as a
going concern. If these three characteristics are present, it can be reasonably
assumed that goodwill has been found: see John W. Durnford, “Goodwill in the
Law of Income Tax” (1981), 29(6) Canadian Tax Journal 759 (“Durnford”), at pp. 763
to 775; see also Muller above; Manitoba Fisheries Ltd. v. Canada,
 1 S.C.R. 101; Dominion Dairies Limited v. Minister of National
Revenue (1965), 66 D.T.C. 5028 (Ex. Ct.); Les Placements A & N
Robitaille Inc. v. The Minister of National Revenue (1994), 96 D.T.C. 1062
(T.C.C.); FCT v. Murray (1998), 155 ALR 67 (Aus. H.C.).
established reputation, customer satisfaction, a unique product or process
leading to a monopolistic position, good or astute management, favourable
location, manufacturing efficiency, harmonious labour relations, advertising,
quality of products, and financial standing have all been found to constitute
goodwill insofar as they meet the three characteristics: Durnford at pp.
in this case, efficient management by TransAlta and the potential for new
business opportunities flowing from TransAlta’s transmission business can thus
be viewed as goodwill. These intangible assets arise from the expectation of
future earnings, returns or other benefits in excess of what would be expected
in a comparable business; they are inseparable from the business to which they
belong, and they cannot normally be sold apart from the sale of the business as
a going concern. All of these are characteristics of goodwill.
address the distinction between “goodwill” and “reasons why a purchaser would
pay more for tangible assets” drawn by the Tax Court judge from Jessiman.
At issue in Jessiman was the sale of postal trucks, not the sale of the
postal delivery business as a going concern to which the trucks belonged. Since
one of the characteristics of goodwill identified above is that it can only be
sold with the business as a going concern, no goodwill could therefore be
transferred or sold in the context of the sale of trucks considered in Jessiman:
see FCT v. Murray, above. Jessiman
stands for no more than this.
conclusion, I agree with the Tax Court judge that the Minister was wrong in law
to take the position that no goodwill could exist in a regulated industry.
Did the Tax Court judge err in finding
that leverage and the tax allowance were not part of goodwill?
As the Tax
Court judge found, goodwill was sold and purchased in this transaction. The
business being purchased and sold included not only the transmission business,
but also the “maintenance and construction of facilities service business,
telecommunications initiatives, the engineering procurement and management
services and the merchant transmission services”: see the definition of
“Business” in final amended purchase and sale agreement reproduced above. These
were all potential sources of revenues and returns which TransAlta had marketed
to potential buyers in it bidding process. Similarly, the Tax Court judge found
that many other elements justifying the premium paid over net regulatory book
value could be attributed to goodwill.
he also concluded that the potential for leverage and the potential tax
allowance benefit were not part of the goodwill sold by TransAlta, but their
value should be allocated to TransAlta’s tangible assets: reasons at paras. 60
to 62. Did he err in so concluding?
Court judge excluded the potential for leverage from goodwill based on his
definition of goodwill (reasons at para. 72):
They [amounts related to leverage] relate
more closely to the rate of earnings based on the NRBV [net regulatory book
value] of the tangible assets, and specifically AltaLink’s ability to eke out
more return from those assets, not due to anything Transalta (sic) did to
retain or expand its customer base and are, therefore, properly allocated to
those tangible assets.
to the narrow concept of goodwill applied by the Tax Court judge, goodwill is
not limited to the retention or expansion of a customer base. Goodwill will
also arise if a business can potentially generate returns in excess of what
would be expected in a comparable business. The potential for leverage in the
transmission business is an intangible asset which, if prudently used, can
potentially lead to additional returns. The fact that TransAlta itself did not
leverage its investment in its electricity transmission business does not mean
that the potential for excess returns resulting from leverage is not one of the
intangible assets which it held in that business. The potential for leverage is
an intangible asset which can be marketed and sold to potential purchasers of a
business who have the ability to use it.
potential for leverage is an intangible asset which may sustain an expectation
of future returns in excess of those in a comparable business; leverage is
inseparable from the business, and the potential for leverage cannot be sold
apart from the sale of the business as a going concern. The potential for leverage
thus holds all the characteristics of goodwill discussed above. Barring a good
reason to find otherwise (which is not present here), the potential for
leverage was thus part of the goodwill sold with the transmission business.
The Tax Court
judge also concluded that the potential tax allowance benefit was not goodwill
since it resulted from the way TransAlta had structured itself. The benefit of
the use of a tax allowance by a non-taxable partner could not therefore be
viewed as an asset of TransAlta. I agree. However, that same reasoning also
leads to the conclusion that the potential tax allowance benefit cannot be
attached to the tangible assets sold by TransAlta. Consequently, the potential
tax allowance benefit, in law, was neither part of TransAlta’s goodwill nor
attached to TransAlta’s tangible assets. Rather, it was an intangible of
AltaLink or of Teachers.
Does this conclusion
justify deducting on this basis between $25,000,000 and $50,000,000 from the
goodwill allocation – representing between 13% and 26% of the premium paid by
AltaLink – as the Tax Court judge did in this case? For three distinct reasons,
it does not.
value of this potential tax allowance benefit was much lower than that assessed
by the Tax Court judge. Although both TransAlta and the Crown believe that
AltaLink may have considered the potential tax allowance benefit in setting the
premium it paid for the transmission business, they have not agreed on the
value which TransAlta may have attributed to this potential benefit. The only
valuation submitted as evidence in this case was the KPMG valuation report. In
that report, the KPMG expert valuator, Ms. Glass, concluded that “only a small
portion of the premium might have been paid as a result of the tax
allowance”: KPMG valuation report at para. 135, reproduced at p.1075 of the
appeal book, emphasis added. She also noted that in accordance with valuation
theory, none of this allowance could be attributed to the value of the tangible
assets: KPMG valuation report at para. 168, reproduced at p.1080 of the appeal
book. The expert valuator also noted that no goodwill impairment was recorded
after the tax allowance was adjusted by the Board to account for Teachers’
participation in the limited partnership: KGMP valuation report at para. 150,
reproduced at p. 1078 of the appeal book. In light of the contingent and
uncertain nature of this potential benefit, it is likely that a prudent
investor would have largely discounted its value.
even if a small portion of the premium which was paid could be attributed to
the potential tax allowance benefit, it was not unreasonable for the parties to
the transaction to allocate that portion to goodwill for the purposes of
section 68 of the Act. Indeed, as I have already noted, the potential tax
allowance was neither part of TransAlta’s goodwill nor of its tangible assets.
As further discussed below, section 68 sets up a reasonableness test for the
purposes of a price allocation. Thus, an amount which is not “goodwill” in the
legal sense of the concept may still be allocated to “goodwill” for accounting
and taxation purposes if such an allocation can be regarded as reasonable. In
this case, since the allocation of the potential tax allowance benefit cannot
be made to the tangible assets which were sold, any portion of the premium
which could be attributed to the potential tax allowance benefit, for
accounting and taxation purposes, would receive the same treatment as if it
were goodwill. In such circumstances, the parties’ allocation of that portion
to goodwill can be regarded as reasonable for the purposes of section 68 of the
dealing with a multitude of goodwill elements, it is improper to assign a
specific separate value to each of its constitutive elements. Goodwill is
inherently difficult to value, since different aspects of goodwill will be
given different values depending on the circumstances. As noted by Lord
Macnaghten in Muller (at p. 224):
One element may preponderate here and another
element there. To analyze goodwill and split it up into its component parts […]
seems to me to be as useful for practical purposes as it would be to resolve
the human body into the various substances of which it is said to be composed.
The goodwill of a business is one whole, and in a case like this it must be
dealt with as such.
why the residual approach to valuing goodwill is preferred. Under that
approach, the more easily valued assets (such as tangible assets) are first
given a fair market value, and any consideration paid in excess of this fair
market value is assigned to goodwill. In this case, that was the valuation
method on which both the Minister’s expert and TransAlta’s expert were
in agreement. The following extract from the cross-examination of Mr. Lawritsen
is instructive [at pp. 432 and 443-444 of the transcript, reproduced at pp.
1594 and 1605-1606 of the appeal book]:
Q So, as it - - so, what
you’re saying is that - - that goodwill is a residual concept? You and Ms.
Glass agree on that, basically?
Q Okay, thank you. Now, Mr.
Lawritsen, I asked you a moment ago about your - - the residual nature of
goodwill, and I think you and I agreed in paragraph 5.05(3), in one of your
definitions, you mention:
Goodwill cannot be quantified/determined
specifically (directly). It is only the excess of the purchase price over the
identifiable net assets.
I think that’s what you and I agreed on a few
A It’s a typical type of definition reference
that an appraiser would use.
that some intangible elements that do not constitute “goodwill” in the legal
sense may be captured through such a valuation method – such as the potential
tax allowance benefit – does not mean that the valuation method is wrong or
improper. The method simply reflects the fact that these types of intangibles
should be treated as goodwill for all practical purposes – including accounting
and taxation purposes - even though they may not squarely fall under the legal
concept of goodwill.
in accordance with the unanimous opinion of the experts who testified in this
case, goodwill should normally be valued as a residual whole. The Tax Court
judge had no basis to conclude otherwise.
Second Series of Issues: The
Reasonableness of the Goodwill Allocation
The test under section 68
of the Act
of the Act reads as follows:
68. Where an amount received or
receivable from a person can reasonably be regarded as being in part
the consideration for the disposition of a particular property of a taxpayer
or as being in part consideration for the provision of particular services by
part of the amount that can reasonably be regarded as being the
consideration for the disposition shall be deemed to be proceeds of
disposition of the particular property irrespective of the form or legal
effect of the contract or agreement, and the person to whom the property was
disposed of shall be deemed to have acquired it for an amount equal to that
part of the amount that can reasonably be regarded as being
consideration for the provision of particular services shall be deemed to be
an amount received or receivable by the taxpayer in respect of those services
irrespective of the form or legal effect of the contract or agreement, and
that part shall be deemed to be an amount paid or payable to the taxpayer by
the person to whom the services were rendered in respect of those services.
68. Dans le
cas où il est raisonnable de considérer que le montant reçu ou à
recevoir d’une personne est en partie la contrepartie de la disposition d’un
bien d’un contribuable ou en partie la contrepartie de la prestation de
services par un contribuable :
a) la partie
du montant qu’il est raisonnable de considérer comme la contrepartie
de cette disposition est réputée être le produit de disposition du bien,
quels que soient la forme et les effets juridiques du contrat ou de la
convention, et la personne qui a acquis le bien à la suite de cette
disposition est réputée l’acquérir pour un montant égal à cette partie;
b) la partie
du montant qu’il est raisonnable de considérer comme la contrepartie
de la prestation de services est réputée être un montant reçu ou à recevoir
par le contribuable pour ces services, quels que soient la forme et les
effets juridiques du contrat ou de la convention, et être un montant payé ou
payable au contribuable par la personne à qui ces services ont été rendus.
apparent from the language of section 68, the applicable test is one of
reasonableness. The concept of reasonableness for taxation purposes was
reviewed by Cattanach J. in Gabco Limited v. Minister of National Revenue (1968),
68 D.T.C. 5210 (Ex. Ct.) (“Gabco”), albeit in a different statutory
context. The following test was applied in that case (at p. 5216):
It is not a question of the Minister or
his Court substituting its judgment for what is a reasonable amount to pay, but
rather a case of the Minister or the Court coming to the conclusion that no
reasonable business man would have contracted to pay such an amount having only
the business consideration of the appellant in mind.
test was adopted by this Court for determining if the deduction of an expense
was reasonable for the purposes of section 67 of the Act: Petro-Canada v. Canada, 2004 FCA 158, 2004 D.T.C.
6329 at para. 62.
concept of reasonableness under section 68 of the Act is similar to that used
for the purpose of section 67 of the Act. Consequently, for the purpose of
section 68 of the Act, I conclude that an amount can reasonably be regarded as
being the consideration for the disposition of a particular property if a reasonable
business person, with business considerations in mind, would have allocated
that amount to that particular property. In this context, long-standing
regulatory and industry practices, as well as auditing and valuation standards
and practices, are relevant.
submits that where parties dealing at arm’s length have agreed to the
allocation of the proceeds of the disposition of a property, considerable
weight must be given to their agreement, particularly if the parties have
specifically negotiated with respect to the allocation: The Queen v. Golden
et al,  1 S.C.R. 209, 86 DTC 6138 and George Golden v. Her Majesty
The Queen, 83 D.T.C. 5138 (F.C.A.).
allocation agreed between the parties to an arm’s length transaction is an
important factor to consider for the purpose of section 68 of the Act. However,
the weight to be given to such an agreement will vary according to the
circumstances. An agreement where the parties have strong divergent interests
concerning the allocation will be given considerable weight, while an agreement
where one of the parties is indifferent, or where both parties’ interests are
aligned as regards the allocation, will be given less weight: R.L. Petersen
v. The Minister of National Revenue (1987), 88 D.T.C. 1040 at pp.
The fact that
the parties have agreed to an allocation does not trump the reasonableness test
under section 68 of the Act. As I have already noted, that test is whether a reasonable
business person, with business considerations in mind, would have made the
allocation. That the parties to an arm’s length transaction have agreed on an
allocation is an important factor to consider, but an agreed allocation which
does not meet the reasonableness test may still be challenged under section 68.
The application of the test
Court judge understood the reasonableness test under section 68 as a two-tiered
(a) first determine if the
allocation agreed to by parties to an arm’s length transaction was the result
of “real bargaining with respect to the allocation between such parties with
relatively equal bargaining positions”; if such is the case, that agreed
allocation is prima facie proof of the reasonableness of the allocation
which can only be challenged by the Minister if there is “a fundamental mistake
in the foundation of the parties agreement”: reasons at subparagraphs 47(iii)
(b) failing real bargaining in
an equal bargaining position, “the Court shall determine a range of what is
reasonable”, such range being understood as a range of possible fair market
values based on the nature of the asset and the industry, the context of the
transaction and “other relevant factors”: reasons at subparagraph 47(v) and
paras. 26 to 28.
Court judge concluded that the parties to the transaction had failed to engage
in real bargaining. He found that AltaLink was indifferent to an allocation of the
price to goodwill beyond the net regulatory book value of the tangible assets.
He reached this finding on the basis that TransAlta’s post-transaction rates
for capital cost allowances would be similar whether the price allocation went
to tangible assets or to goodwill: reasons at para. 51. This indifference
resulted in “the Parties end[ing] up where the industry norm and business logic
in the regulated industry would naturally take them”: reasons at para. 53. This
conclusion allowed the Tax Court judge to proceed with his own valuation.
used by the Tax Court judge is complex and sets out no guiding principles. It
is a test based partly on form, which allowed him to substitute his own
subjective allocation for that agreed upon by the parties in compliance with
industry and regulatory standards.
Tax Court judge applied the correct test, and considered whether a reasonable business
person, with business considerations in mind, would have allocated the amount
of $190,824,476 to goodwill, he would have been compelled to consider industry
and regulatory standards, as well as accounting and valuation theory, which all
point in the direction of the agreed allocation. That agreed allocation was
reasonable precisely because of its compliance with industry and regulatory
norms and its consistency with standard valuation theory for regulated
businesses and standard accounting principles applied in such industries.
reasons set out above, I would allow the appeal, set aside the Tax Court of
Canada’s judgment, dismiss the cross-appeal, allow the appeal of the Minister’s
reassessment of TransAlta Energy Corporation, the appellant’s predecessor by
way of amalgamation, and remit the matter to the Minister for reassessment in
accordance with these reasons. I would also award costs to TransAlta.
M. Evans J.A.”