Citation: 2010 TCC 317
Date: 20100611
Docket: 2007-4121(IT)G
BETWEEN:
DAISHOWA-MARUBENI INTERNATIONAL LTD.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Miller J.
[1]
In 1999 and 2000,
respectively, Daishowa-Marubeni International Ltd. ("Daishowa") sold
the assets of its two timber mill divisions, the one in High Level,
Alberta ("High Level Division") to Tolko Industries ("Tolko")
and the other near Red Earth, Alberta (the "Brewster Division") to
Seehta Forest Products Ltd. ("Seehta"). Part of the agreement in both
sales included a provision for the assumption by the purchasers of Daishowa’s
reforestation or silviculture liabilities. The Respondent assessed Daishowa by
including in the calculation of its proceeds of disposition of timber resource
properties, the amount of the estimated silviculture liability, being
$11,000,000 in the Tolko deal and $2,996,380 in the Seehta deal. Daishowa
argues no such amounts should be included in proceeds of disposition; and in
the alternative, if any amount is to be so included, it is entitled to an
offsetting deduction from income.
Facts
[2]
In 1999, Daishowa operated
the two timber divisions as well as operating the Peace River Pulp Division. It
had a Forest Management Agreement for the High Level Division and held a
timber quota for the Brewster Division: both included a right or licence to cut
or remove timber (the "timber licence") for the purposes of the
definition of "timber resource property" in section 13(21) of the Income
Tax Act (the "Act"). The Forest Management Agreement and
quota also obliged the owner to submit reforestation plans and reforest all
lands cut over by it (the silviculture or reforestation liability). A company
is not relieved of this obligation to reforest until the cut block passes a
free-to-grow survey, or if natural processes make achieving the regeneration
standard impossible. The free-to-grow period was generally eight to 14 years
after cutting.
[3]
It was the position of
the Alberta Department of Sustainable Resource Development that, based on
section 163
of the Timber Management Regulation,
a forest tenure cannot be assigned unless the assignee assumes the silviculture
liability associated with the forest tenure. Further, it was the position of
Alberta’s Department of Sustainable Resource Development, based on its interpretation
of the relevant statutory and regulatory provisions of the Forests Act
and Timber Management Regulation, that upon its consent to an
assignment of a forest tenure, the assignee assumes the reforestation liability
associated with the forest tenure, and that the assignor is no longer liable
for the reforestation liability. On that basis, the Province of Alberta has not pursued assignors for recovery of the reforestation
liability.
[4]
By 1999, Daishowa
decided to sell its timber divisions.
Sale of High Level Division
[5]
Five bids were received
by Daishowa for its High Level Division by September 23, 1999. The bid from
Tolko was considered by far the most favourable. Tolko proposed "a purchase
price of $180,000,000 plus an amount "equal to the estimated value of the
net purchased working capital less the estimated amount of the long term
reforestation liabilities of the division (the "Price"), subject to
the following conditions":
…
1. Price Adjustments: as generally
contemplated by DMI’s draft Asset Purchase Agreement, the Price
is subject to adjustment: (a) if the actual Net Purchased Working Capital
is more or less than the estimated amount calculated by DMI prior to closing;
and (b) for ordinary course adjustment items (ie. Property tax, other pre-payment
items etc.). A further adjustment to the Price will be required if the final
determination by the auditors of the long-term reforestation liability amount
changes from the estimated amount calculated by DMI prior to Closing.
…
[6]
Daishowa’s professional
advisors did not fully agree with the approach taken by Tolko, and in a memo from
Davis & Co. to Daishowa’s executive committee, Davis advised:
…
2.
PriceWaterhouseCoopers ("PWC") advises
that the pricing formula proposed by Tolko will have adverse tax consequences
for DMI because it sets a gross price and then deducts from that price an
amount that is allocated for long term reforestation liabilities (ie. $180
million, minus $10 million). In that situation, the amount allocated to long
term reforestation liabilities will be included in DMI’s income and subject to
tax. However, if the purchase price is the "net amount" and DMI
provides a representation and warranty that the long term reforestation
liabilities will not exceed a certain specified amount (ie. $170 million, with
an adjustment if the long term reforestation liabilities as of the Closing Date
and determined in the Working Capital Statement are less than or greater than
$10 million), then the amount that would be subject to tax under the existing
provision would not be subject to tax. PWC advises that the same end result,
without additional tax liability to DMI, can be achieved by simply
restructuring the purchase price and adjustment provisions of the agreement.
PWC believes that their proposed revisions will not have any adverse effect on
Tolko’s tax position. Tolko agreed that, as long as there is no material
adverse tax consequence to them, they will accommodate DMI’s reasonable
requests.
…
[7]
The final agreement
between Daishowa and Tolko dated November 1, 1999, read in part as follows:
…
2.1 Purchase and Sale. DMI hereby agrees to sell, assign and transfer the Purchased
Assets to the Purchaser free and clear of all Liens except Permitted
Encumbrances and Defects, and the Purchaser hereby agrees to purchase the
Purchased Assets for the Purchase Price, upon and subject to the terms and
conditions herein set forth.
2.2 Purchase Price. The Purchase Price for the
Purchased Assets will be the aggregate of:
(a)
$169 million; and
(b)
Plus (or minus) the value of the Net Purchased
Working Capital as of the Effective Time, determined in accordance with Section
2.4.
...
2.6 Allocation. The amount set forth in Section
2.2(a) will be allocated to the following asset classes:
Asset Class Allocated
Amount ($)
Land 1,000,000
Mill Buildings 18,000,000
Mill Machinery and Equipment 127,300,000
Logging Equipment, Roads and Bridges 199,000
Mobile Equipment 1,000,000
Lot Storage Area and Similar Surface
Construction 1,500,000
Forest Tenures 20,000,000
Other Assets 1,000
Total 169,000,000
…
3.1 Assumed Obligations. As of the Effective
Time, the Purchaser will assume and be responsible for the Assumed Obligations
but specifically excluding the Excluded Liabilities. The Purchaser will
indemnify and save DMI harmless from and against any claims, demands, actions,
causes of action, loss, damage, cost or expense whatsoever, including legal
fees, suffered or incurred by DMI by reason of the failure of the Purchaser to
pay or discharge any of the Assumed Obligations from and after the Effective
Time, and DMI will indemnify and save the Purchaser harmless from and against
any claims, demands, actions, causes of action, loss, damage, cost or expense
whatsoever, including legal fees, suffered or incurred by the Purchaser by
reason of the failure of DMI to pay or discharge the Excluded Liabilities.
…
3.2.1 Preparation of Reforestation Statement. DMI
estimates in good faith that the aggregate value of the current and long term
reforestation liabilities will be $11 million as at the Effective Time
("Estimated Amount"). Forthwith after the Closing, DMI will prepare
the Reforestation Statement setting out the current and long term reforestation
liabilities associated with the Division as at the Effective Time and will
cause the Reforestation Statement to be audited promptly by the Accountants. …
3.2.2 Reforestation Liabilities Adjustments. On
the third Business Day following DMI’s receipt of the Purchaser’s notice of
approval of the Reforestation Statement, or final determination of the
reforestation liabilities by the Accountants or arbitration, as the case may
be, pursuant to Section 3.2.1:
(a) DMI will pay to the Purchaser
by bank draft the amount, if any, by which the final determination of the
reforestation liabilities, exceeds the Estimated Amount together with interest
on the amount of such excess calculated from the Closing Date to the date of
payment at a rate equal to the Prime Rate; or
(b) the Purchaser will pay to DMI
by bank draft the amount, if any, by which the final determination of the
reforestation liabilities, is less than the Estimated Amount together with the
interest on the amount of such difference calculated from the Closing Date to
the date of payment at a rate equal to the Prime Rate.
…
The Parties also executed an Assignment
Agreement dated November 1, 1999 which stipulated:
…
NOW THIS INDENTURE WINESSES that in consideration of the
sum of ONE ($1.00) DOLLAR, and other good and valuable consideration, now paid
by the Assignee to the Assignor, (the receipt whereof is hereby acknowledged by
the Assignor) the Assignor hereby grants, assigns, transfers and sets over unto
the Assignee, its heirs, executors, administrators and assigns forever, all and
singular the Forest Management Agreement, the Coniferous Timber Quotas, the
Coniferous Timber Licences and the Coniferous Timber Permit comprising the
following lands, namely the lands described in the Forest Management Agreement,
in the Coniferous Timber Quotas listed in Schedule "C", the Coniferous
Timber Licences listed in Schedule "D", and in the Coniferous Timber
Permit and all the right, title and interest therein and thereto of the
Assignor subject to the payment by the Assignee of all the rents and other
proper charges accruing due in respect to the Forest Management Agreement,
Coniferous Timber Quotas, Coniferous Timber Licences and the Coniferous Timber
Permit and the performance of all covenants and agreements contained in the
Forest Management Agreement, Coniferous Timber Quotas, Coniferous Timber
Licences and the Coniferous Timber Permit.
…
[8]
On November 1, 1999,
Tolko gave Daishowa $185,628,000 cash being $169,000,000 allocated as set forth
in section 2.6 of the agreement, and $16,628,400 for the net working capital.
[9]
In accordance with
section 3.2 of the agreement, on November 19, 1999 PriceWaterhouseCoopers Inc.
provided a reforestation statement indicating:
In our opinion, the statement presents fairly, in all material
respects, the reforestation liabilities of the High Level Lumber Division as at
the Effective Time in accordance with the definition of Reforestation
Liabilities as set forth in the Purchase Agreement.
Current reforestation liability 2,057,498
Long term reforestation liability 9,238,727
Total 11,296,225
Of the total amount, only approximately $400,000 could
have been spent in 1999.
[10]
On January 20, 2000
Tolko, in accordance with section 3.2 of the agreement, requested the
additional $296,225. At the same time, there was an adjustment to the final net
purchase working capital requiring Daishowa to pay back $2,174,039 to Tolko.
[11]
According to Tolko,
based on incomplete data, it spent no less than the following amounts with
respect to the assumed silviculture liability:
|
2000
|
$1,374,824.43
|
|
2001
|
$246,004.39
|
|
2002
|
$1,404,221.74
|
|
2003
|
$107,616.91
|
|
2004
|
$108,570.82
|
|
2005
|
$385,355.46
|
|
2006
|
$280,405.11
|
|
2007
|
$610,840.65
|
|
2008
|
$215,344.99
|
|
Total
|
$4,733.184.50
|
Sale of Brewster Lumber Division
[12]
In its 2000 taxation,
Daishowa sold the Brewster Lumber Division including the forest tenures, a
"timber resource property" for the purposes of section 13(21) of the Act,
to Seehta. The agreement with Seehta was signed on August 11, 2000 with a
closing date of November 24, 2000.
[13]
The purchase price for
the Brewster Lumber Division included a) $6,100,000 for certain assets,
plus (or minus); and b) any difference between preliminary estimate of the net
purchased working capital or $4,919,000, and a final estimate of net purchased
working capital plus (or minus). The Parties allocated the purchase price as
follows:
Asset Class Allocated
Amount
Improvements $435,000,00
Equipment, furniture and fixtures $5,315,000
Forest tenures $350,000
Total $6,100,000
[14]
The net purchased
working capital was ultimately determined to be $4,459,019 so Daishowa returned
to Seehta the amount of $459,981 plus interest (the difference between the
preliminary and a final estimate of net purchased working capital).
[15]
The terms of the sale
for the Brewster Lumber Division also included the assumption of the silviculture
liability, found in article 3.1:
3.1 Assumed Obligations. As of the Effective
Time the Purchaser will assume and be responsible for all of the following
obligations and liabilities of DMI:
(a) the payment and discharge as and when due
of the liabilities of the Division shown on the Working Capital Statement;
(b) notwithstanding that the Purchaser will
not be given credit for reforestation liabilities in the determination of Net
Purchased Working Capital, all reforestation liabilities of the Division of any
nature both current and long term, whenever incurred;
…
[16]
Daishowa’s accounting
estimate of its reforestation obligations that appeared on its interim
financial statements dated October 31, 2000 was $2,966,308, $558,615 of which
was a current liability. Of the portion of the silviculture liability that was
current, only a small portion could have been spent on silviculture during
Daishowa’s 2000 tax year, as the only activity that could have been performed
during the period between November 21, 2000, the date of the sale and
December 31, 2000, the end of the tax year, was scarification.
[17]
With respect to both
the sale of the High Level Division and Brewster Lumber Division, the Province of Alberta consented to the assignment of the forest
tenures.
[18]
In income tax returns
for its 1999 and 2000 taxation years, Daishowa did not include in its proceeds
of disposition any amounts in respect of the assumed silviculture liability.
The Minister of National Revenue reassessed Daishowa in respect of both sales
by including in the calculation of the Appellant’s proceeds of disposition of
timber resource properties, the amounts of estimated silviculture liability
assumed by the purchasers.
Issues
[19]
The issues in these
appeals are:
a) whether in 1999 and
2000 taxation years, the Minister properly included in Daishowa’s proceeds of
disposition the amounts of silviculture obligations assumed by the purchasers.
b) whether these
additional assessed proceeds of disposition were properly allocated to timber
resource properties; and
c) whether the
Appellant is entitled to any deductions in respect of the assumed silviculture
obligations.
[20]
Daishowa argues that,
while there may be some benefit to Daishowa from Tolko’s assumption of the
reforestation liability, the fair market value of those liabilities was not
determinable at the time of closing and therefore no amount in respect of the
reforestation liabilities can be included in Daishowa’s proceeds of disposition.
Alternatively, Daishowa says that if the fair market value of the reforestation
liabilities at the time of closing could be determined, that fair market value
would inevitably be less than the accounting estimates of the liabilities (even
if one assumed that the accounting estimates were correct), because the
estimates reflected amounts which were estimated to be spent on reforestation
over the next 14 years, and were not discounted to reflect this fact; neither
were they discounted to reflect the fact that Daishowa remained secondarily
liable to perform the reforestation if Tolko and/or Seehta failed to. In the
alternative, Daishowa argues that if I find the parties did agree that the
accounting estimates of the reforestation liabilities equalled the fair market
value of those liabilities, or if the actual fair market value of the
reforestation liabilities equalled the accounting estimates (or some lesser
amount, provided I permit the Respondent to again reassess Daishowa for
proceeds of a lesser amount), Daishowa is entitled to an equivalent deduction
from income for having paid each of the purchasers with assets to assume
Daishowa’s liabilities, which liabilities were deductible when paid as they
were on income account.
[21]
The Respondent’s
argument is simply that the price in the two deals includes the consideration
of the assumption of liabilities, being the relief of Daishowa from further
obligation to the Province of Alberta in a quantifiable amount. According to the
Respondent, it was clear from the outset, certainly with respect to the Tolko
offer, that the purchase price started at $180,000,000 and was adjusted
downwards to take into account the amount of the reforestation liability. The
Respondent goes on to argue that no amount of that consideration should be
deductible as it is part of a capital transaction which cannot be parsed into
specific separate components of capital and income. Further, the Respondent
suggests that if the Appellant is considered to have made any expenditure by
foregoing consideration, the nature of that expenditure results in an enduring
benefit and, as such, is a capital outlay that is not deductible from income.
Analysis
[22]
I will reach a
conclusion based on an analysis of the Tolko deal, and will then indicate if
the Seehta deal differs significantly to lead to any different conclusion. As
counsel for the Respondent emphasized, the interpretation of these agreements,
specifically the determination of the role of the assumption of the
reforestation liability, depends on how one reads the structure of the deal.
Was this a purchase and sale between the two arms length parties of the forest
tenures for $31,000,000 or for $20,000,000 or for something in between? The
Respondent claims the purchase of the forest tenures was for $31,000,000 with
the consideration of $20,000,000 cash and assumption of the reforestation
liability valued at $11,000,000. Daishowa claims that it purchased the forest
tenures for $20,000,000 cash, with the agreement providing that the Purchaser, Tolko,
would pay, as required by Alberta policy, the reforestation liability
attached to those forest tenures, estimated to be $11,000,000, such estimate
not representing any agreed value of such consideration. Put another way, was
Tolko’s promise to incur expenditures in the future, estimated at $11,000,000,
to meet the Province of Alberta’s reforestation requirements,
consideration in its purchase of Daishowa’s forest tenures?
[23]
Both parties agree that
Tolko did oblige itself, in the Purchase and Sale Agreement and Assignment
Agreement, to pay the expenses of future reforestation, as required by the Province of Alberta. Was this consideration? If so, did the parties agree on the value of
that assumption? If not, is the value so uncertain that it is improper to bring
any amount into proceeds of disposition? If it is not so uncertain, how is the
value of the benefit of the assumption to be determined?
[24]
Dealing first with the
issue of consideration, Daishowa has acknowledged that a benefit was received
by it on the assumption by Tolko of the reforestation liability. Indeed there
is an admitted fact: "If Tolko had not assumed the Appellant’s
silviculture liability, the amount of cash or other consideration it would have
paid the Appellant would have increased". Given that acknowledgement and
admission, it is difficult to find the assumption of liability is not part of
the consideration in the deal notwithstanding Daishowa took great pains to have
that element of the deal removed from the definition of purchase price in the
final agreement.
[25]
Subsection 13(21) of
the Act defines proceeds of disposition to include the sale price of a
property. Price is commonly defined to include consideration, which in turn is
defined by Fridman in The Law of Contract in Canada (4th ed)
as "some right, interest, profit, or benefit accruing to one party or some
forbearance, detriment, loss or responsibility, given, suffered or undertaken
by the other". This certainly includes an assumption of a liability and a
promise to indemnify (for an example see the case of Loyens v. Queen).
[26]
What is the nature of
the liability, the relief of which leads to some benefit to Daishowa? It is not
one that, as I initially thought, passes automatically with the forest tenures.
From a careful review of the Alberta legislation and the Parties’ agreed facts,
it is clear that the Province
of Alberta will not approve of a transfer of the
forest tenures, unless a purchaser assumes the reforestation liability. This is
quite different from any suggestion that the liability, simply by the operation
of Alberta statutes, flows with the property; in
other words, whoever owns the forest tenures is legally responsible for the
reforestation obligation. No, the situation in Alberta
is that the Province effectively forces the purchaser to assume the
reforestation liability: no assumption – no transfer of forest tenures. Does
the fact that a third party, the Government of Alberta, forces an assumption of
liability, make the assumption of that liability any less consideration? No, it
does not affect the nature of the assumption of liability as consideration,
though it may affect the value of that assumption.
[27]
Does the fact that the
final agreement between the Parties specifically excluded the assumption of
liability from the purchase price have the legal effect of removing it from the
consideration for the forest tenures and consequently from the proceeds of
disposition? Further, does the fact that the Parties, in that agreement, only
allocated the cash purchase price amongst the assets, likewise have the legal
effect of removing the assumption of the liability as part of the
consideration? I would answer no to both those questions. To answer
positively would put form over substance in the interpretation of contracts
which is not a supportable approach.
[28]
Having concluded that
the assumption of the reforestation liability does represent part of the
consideration, I will now address the Appellant’s position that the value of
that purported benefit is so uncertain as to be unascertainable, and therefore
I should conclude that the value is zero. The Respondent counters that the Parties
got an estimate to the dollar of the reforestation liability, and that that
amount reflects the value of the consideration that should fall into proceeds
of disposition to be taxed. The Appellant’s fall-back position is that the
value of the assumption is considerably less than the face value of the
$11,000,000.
[29]
The first point to
address is whether the Parties ever agreed that the $11,000,000 represented the
value of the consideration. It was clear from the advice Daishowa received from
its advisors that Daishowa should avoid assigning any value to the
reforestation liability. The agreement itself refers to the $11,000,000 as an
"estimated amount". Further, in section 3.2.1 of that final Agreement
between Daishowa and Tolko it is stipulated:
"The Purchaser will advise DMI in writing whether the amount of
the current and long term reforestation liabilities is agreed to by the
Purchaser." …
[30]
This is important
because it shows that Tolko based its offer on an estimate of the reforestation
liability, and if the auditor’s reforestation statement indicated something
different then there would be a payment going one way or the other. This stipulation
was not in the context of estimating the value of the assumption of liability
for determining Daishowa’s proceeds of disposition, but to get to an accurate
cash purchase price. The reality is that the reforestation liability
calculation was an estimate, an audited estimate, but an estimate nonetheless.
There is nothing in the Sale Agreement that constitutes an agreement between
the Parties that Daishowa received additional consideration of $11,000,000 by
Tolko’s assumption of the reforestation liability. Where the Parties agreed to
values, such as in the determination of the net purchase working capital, they
specifically indicated such by referencing the term "value".
Certainly, the $11,000,000 estimate was a factor in the determination of the
cash price it was prepared to pay, but it was not an agreed upon value for
purposes of determining its value as consideration.
[31]
The Respondent’s
position was accurately summed up by Mr. Dan Carter of Canada Revenue Agency ("CRA")
in his June 2, 2005 letter to the Appellant: "What we are saying is that
Tolko reduced the cash consideration paid for the assets acquired as a result
of the assumption of liability". Clearly, the Respondent’s position is
that the value is equal to the estimated amount. Mr. Carter also went on to quote
a CRA technical interpretation which stated:
"When a business is sold, and the purchaser assumes a contingent
liability as part of the consideration for the business, it is our view that
the Vendor’s proceeds of disposition would include the Fair Market Value
("FMV") of the contingent liability assumed by the Purchaser."
[32]
The Appellant’s
argument is that determining a value of the reforestation liability cannot be
done with any degree of accuracy, and therefore no amount should be included in
Daishowa’s proceeds of disposition. In support of this proposition the Appellant
relies on comments in the Northland Pulp and Timber Ltd. v. Canada
that the "Courts have consistently disqualified for tax purposes, in
calculating taxable profits, amounts that are provisional estimates, are
conditional, contingent or uncertain." There are two elements to this
argument: the first, that the determination of an accurate Fair Market Value
("FMV") is not possible; and second, because of that, no amount shall
be attributed to the FMV of such a liability.
[33]
Dealing with the first
arm of this argument, there is considerable uncertainty in estimating the value
of an eight- to 14-year obligation to reforest that may be affected by a number
of factors: weather, pests, flooding, fires, natural regeneration…. As stated
in the auditor’s Reforestation Statement:
"The
preparation of the Reforestation Statement in conformity with generally
accepted accounting principles requires management to make significant
estimates and assumptions that affect the reported amount of reforestation
liabilities."
This recognizes that these amounts are just what they
say they are – estimates. Indeed, the Appellant’s High Level Lumber Division
Reforestation Liability Summary contains guiding principles, one of which is
that there should be a bi‑annual review. This makes sense given the
vagaries and uncertainties surrounding the need for reforestation. The industry
can however point to past history, though the Appellant claims the past
performance is not necessarily indicative of future results. Yet it is some
guidance, and obviously what auditors, in creating reforestation liability
statements, must rely upon.
[34]
It is this uncertainty
that underlies the decision in Northwood that, because actual
reforestation expenses were not incurred until subsequent periods, they were
not deductible until those subsequent periods. Or, as was put in the case of R.
v. Burnco Industries Ltd. et al,
"an obligation to do something which may in the future entail the
necessity of paying money is not an expense". Implicit in these approaches
is that you cannot deduct an amount when you are not sure what the amount is.
The liability may exist today, as soon as you cut the trees, but the cost of
reforesting that cut stand of trees will not be known until you actually incur
the expense. Does it make sense then that to avoid having to tax an uncertain
amount, the tax regime should only bring into the Vendor’s income, as proceeds
of disposition, such amounts when they are determinable, over the ensuing eight
to 14 years, as only then do the Parties and the Government know with certainty
the value of the benefit that Daishowa actually received? Neither party pursued
this possible approach to the taxation of the assumption of the reforestation
liability, so I will pursue it no further.
[35]
Returning then to the
Appellant’s argument that the Government cannot include in income (or deduct
from income – Northwood) uncertain amounts, the Appellant cites three
authorities, in addition to its reliance on Northwood and Burnco.
First, the case of Harysh (Peter) v. Minister of National Revenue
dealt with gift tax arising on the transfer of royalty payments to family
members. There were no producing wells. The Minister valued the rights based on
what the oil company paid to obtain the lease from the taxpayer. The Court held:
…
It might well be that under different circumstances the
method adopted here could be right, but I repeat that this case must be decided
on the evidence of this case only. Acceptance of the respondent's argument
would mean that because a certain amount is paid for the leasing of lands,
there must be oil of an equal value under the said lands; why not more? why not
less? why any at all? It is easy to see how one could be easily mislead if one
let himself be guided by possibility and conjecture. I do not think that it is
proper to delve into the realm of possibility and conjecture instead of
adhering to known facts, especially when one is dealing with a taxing statute.
On the whole, I am satisfied that the appellant has proven that the Minister
was wrong when assessing him as he did.
…
[36]
Second, in the Federal
Court of Appeal decision of Peter Brown v. R.,
the Court ruled that the value of shares was not ascertainable for purposes of
determining a taxpayer’s at risk amount in accordance with subsection 96(2.2)(b)
of the Act. The Court therefore attributed no value to the shares.
[37]
Finally, in J.
Stuart Robertson v. R.,
the Federal Court of Appeal held an employee did not receive a taxable benefit
at the time of receiving an option for shares in a company, not his employer,
as no quantifiable benefit arises until the option is acted upon. As the Court
stated:
… The fact is however that while the second benefit can be measured
by the discrepancy between the cost of exercising the option and the market value
of the shares at the time of the acquisition, the first benefit, although a
real one, eludes independent quantification. …
[38]
I note that none of the
above cases deal with proceeds of disposition arising from the assumption of a
liability, whose quantum is uncertain. There is a common thread, however, that
shows the tendency of the Courts to be reluctant to impose tax, regardless of
the taxing regime, in situations where the amount to be taxed is uncertain or
unascertainable. Certainly, the Federal Court of Appeal adopted this attitude
in Northwood, albeit in the context of determining the deductibility of
the reforestation liability, in citing the Tax Court of Canada’s comment:
…
The thrust of the cases referred to by both counsel show that the
Courts have consistently disqualified for income tax purposes, in calculating
taxable profits, amounts that are provisional estimates, are conditional,
contingent or uncertain. The estimates disallowed by the Minister here were
certainly of that nature.
…
[39]
It would be overly broad
to interpret these cases as supporting a general principle that if an amount is
uncertain it is never to be subjected to the tax regime, as income, expense,
proceeds, loss etc. A more apt approach is to consider the circumstances
surrounding the uncertainty, the nature of the amount itself and the element of
the tax regime to which it is to be subjected. In this case, I am influenced by
the fact that the uncertainty is spread over many years, the Appellant has
little control over factors that would render the amount more certain, the fact
that only when the amount becomes certain (i.e. on incurring the expense) is
the entity incurring the expense entitled to a deduction, and the significant
tax impact of finding the uncertain amount is subject to the tax regime (in
this case 100% of it would fall into income). In these circumstances, I am
reluctant to find that the full amount of an estimate is properly captured by
the provisions of the Act. But, at the same time, I am not prepared to
rely on any general principle that uncertain amounts are simply left out of the
tax regime. This leads to what I believe is the true issue to be determined in
this case – what value is to be attributed to Tolko’s assumption of the
reforestation liability and indemnity as consideration in the purchase of
Daishowa’s forest tenures. I conclude that uncertainty is a factor to take into
account.
[40]
The Respondent’s
position on value is simple. Tolko reduced the cash consideration by
$11,000,000, clearly indicating it valued the reforestation liability at its
estimated face amount. My concern with that approach is that it is imparting to
the Parties an intention that this determination, to get to the value of the
High Level Division that Tolko was prepared to pay, is somehow an implicit
understanding between the Parties that it thus represents the value of the
consideration Tolko is offering. It is not the same. Tolko knows it has to
assume the reforestation responsibility: the Province of Alberta demands it. Knowing that, it has to put a value on the
business it is acquiring, and naturally wants to discount the value to take
into account the liability. It successfully negotiates a dollar for dollar
reduction in the value of the asset it intends to buy. That negotiation is in a
different context than then valuing the assumption of liability as part of the
consideration for the business. The reforestation expense Tolko will have to
spend over the ensuing eight to 14 years will be whatever it will be (which
turns out to be considerably less than the estimate). The fact Tolko has
negotiated a reduction in the purchase price does not sway me that the benefit
to Daishowa of Tolko’s assumption of the liability must be the same amount. I
prefer looking at the value of the assumption of the liability and the
indemnification in light of the following:
I. Tolko had to assume
the liability. The Respondent argues that this should not matter. I believe it
does matter. Both Daishowa and Tolko knew that, in Alberta,
there could be no transfer of the Forest Management Agreement, the forest
tenures, without the Purchaser taking over the reforestation responsibilities. Alberta insisted upon it. Daishowa could not sell the forest
tenures without getting rid of the reforestation liability and by selling the forest
tenures, because of Alberta’s law and policy, it was no longer liable
for those future expenses. The new owner was liable. An assumption of a
liability in these circumstances does not equate to a negotiated arm’s length
determination of the value of the liability assumed. Expressed another way, if
the assumor (Tolko) is obligated to assume the liability, not by Daishowa, but
by the Province of Alberta, is Daishowa truly receiving a benefit equal to the
face value of that liability? In effect, Daishowa knows that its liability,
because of Alberta’s approach, cannot and will not extend
beyond its ownership of the forest tenures. How does one value a liability that
effectively disappears on the transfer of the forest tenures and cannot extend
beyond that? Daishowa is being relieved of the liability that it could not
possibly hold after the transfer of the assets in any event. The $11,000,000
represents what Tolko will have to spend as the new owner. Does it truly
reflect what Daishowa would have had to spend if it transferred the forest
tenures without assigning the liability? No, because that scenario, under Alberta law and policy, was simply not possible. I believe
the value of the liability should, accordingly, be discounted.
II. The liability was
based on Deloitte’s review of past history and speculation of future costs. It
represented what Daishowa believed would have to be spent over the next several
years. The estimate was not discounted to reflect any present day value.
III.
The estimated reforestation
liability was used by Daishowa and Tolko to ultimately determine the cash price
for the mill. There are two ways of looking at this. One, the Respondent’s
view, is that the purchase price was always $180,000,000, paid for by
$169,000,000 cash and an $11,000,000 assumption of liability. Two, the price
specifically excluded the $11,000,000 reforestation liability and was simply
the cash price. Certainly, the $180,000,000 was the starting point for the
deal, and yes, the advice Daishowa received was to rely on a net cash price to
avoid the very issue now before me. The Respondent argues the consideration has
simply been separated into two parts. But, to me, an analogy is that a reforestation
liability is like a dent in a car: you determine the value of the car without
the dent and then deduct an estimate of your repair cost to make a cash offer.
Does it make a difference to the vendor of the car if the vendor of the car
already obligated himself to make the repairs and the purchaser agrees to honour
that obligation? Is the vendor receiving:
a)
cash consideration for
a dented car; or
b)
greater consideration
in the form of cash plus an assumption of the estimated cost of repairs?
The purchaser is still just getting and the
vendor is still selling a dented car. The difference in the analogy is that
with the car, the purchaser could demand that the vendor do the repairs first
and then the purchaser will pay full price for an undented car. Here, it would
not have been possible for Daishowa to incur all the reforestation expenses
prior to handing the forest tenures to Tolko. The only such reforestation
expenses that could have been done were the short term expenses.
IV.
As I have already
discussed at length, the estimated liability is uncertain. I have concluded
Daishowa and Tolko agreed on the estimated amount for the purposes of
determining the cash purchase price, but they did not agree on that amount as
reflective of the value of the assumption of the liability as consideration.
V.
The Appellant
acknowledged the assumption was a benefit and has some value.
VI.
Reforestation costs,
according to Northwood are not deductible until paid.
[41]
Factoring all these
points together, I conclude that a fair approach is to include in proceeds of
disposition an amount for the assumption of the reforestation liabilities as
follows:
I.
The current
reforestation liability of $2,057,498;
II.
a significantly
discounted amount of the longer term reforestation liability due to the reasons
I have discussed. I reduce the long-term liability by 80% being 80% of
$9,238,727 or $7,390,981 leaving $1,847,746.
[42]
The Appellant argues
that I cannot do what I have just done: more accurately, the Appellant argues it
is not open for the Minister, who assessed on the basis that the accounting
estimate represented the value of the reforestation liabilities, to now argue
that it can be valued at something less. I find no merit in this approach. The
fact the Minister included the face value of the assumption of the liability in
proceeds of disposition is the very issue in this appeal. I find it is open to
me, based on the evidence I have heard, to conclude that the value should be
something less, and therefore something less should be included in proceeds.
I see no similarity with the case of Sean Walsh and Brett Walsh v. R.
referred to by Appellant’s counsel.
[43]
I turn now to the
Appellant’s contention that if I find any amount falls into proceeds of
disposition, then the Appellant is entitled to an offsetting deduction because
it incurred an expense on income account by paying Tolko with assets (the
forest tenures) to assume the reforestation liability.
[44]
The Appellant makes a
somewhat circuitous argument that it was not only the vendor of assets and a
recipient of consideration, but also a payer of consideration to have the
reforestation liabilities assumed – what the Appellant calls a partial barter
transaction. With respect, I do not see it. Daishowa did not pay Tolko
separately to incur the reforestation expenditures. This deal was for the sale
of capital assets: the assumption of the reforestation liability was simply
part of that capital transaction.
[45]
I do agree with the
Appellant that payments do not have to be made in cash to be deductible. That
is not the point. The nature of payment must be of an income or expense nature,
rather than of a capital nature. Even looking on the transfer of the forest
tenures by Daishowa as payment for Tolko to assume the future reforestation
costs, the payment smacks more of an enduring benefit than current expense of
the actual reforestation. As has been made clear in Alberta,
the forest tenures could not be transferred without the Purchaser assuming the reforestation
liability. It is part and parcel of the forest tenures: you own the forest
tenures and you are therefore responsible for the reforestation. It makes no
commercial sense to me to view the transaction as payment of the reforestation
costs by the transfer of the forest tenures. It is an Alice
in Wonderful topsy turvy approach.
[46]
The Appellant sought
further support for the position that the transfer of the forest tenures to
Tolko for Tolko’s assumption of the reforestation liability was on income
account in the case of Basell Canada Inc. v. R.
But the facts were significantly different. As Justice Lamarre made clear, the
element carved out of the business deal in that case was already a separate
stand-alone transaction, unlike here, where the forest tenures were an integral
and essential part of the overall deal. There would be no sale of the business
without the sale of the forest tenures and assumption of reforestation
liability. In Basell, Justice Lamarre stated:
…
32. In my view, an inference cannot be drawn
from the documentation provided in evidence and from the testimony of Mr.
Mineer that the intent was for the appellant to purchase as a complete package
the entire polypropylene operation located in Sarnia. Although the appellant certainly enlarged its profit-making
structure in acquiring Shell’s business in Sarnia, I tend to agree with the appellant that the assignment of the
Novacor Agreement was a subject matter that stood on its own in the
negotiations with Shell. Shell was linked to that agreement and it was wholly
in its interest to free itself from it by selling its business. The same cannot
be said of the appellant. The appellant could very well have purchased Shell’s
business without accepting the assignment of the Novacor Agreement if the
contract price of the propylene had not been advantageous to it at the time of
the transaction.
…
[47]
I agree with the Appellant
that there is a certain lack of symmetry in how the assumption of the
reforestation liability is treated for tax purposes. No deduction is allowed
until costs of reforestation are actually incurred, yet the value of the
assumption of that very liability to incur those costs falls into income as
proceeds in one fell swoop, with no recognition that the income recipient has
no future opportunity to deduct such expenses. This logic leads somewhat full
circle to justify my view that the face amount of the assumption of the
liability should be discounted to reflect this economic reality.
[48]
Finally, the parties
addressed the application of section 18(9) of the Act (which reads, in
part):
18(9) Notwithstanding any other provision of this Act,
(a) in computing a taxpayer's income for
a taxation year from a business or property (other than
income from a business computed in
accordance with the method authorized by subsection 28(1)),
no deduction shall be made in respect of an outlay or expense to the extent
that it can reasonably be regarded as having been made or incurred
(i) as
consideration for services to be rendered after the end of the year,
…
[49]
The Respondent argues
that this expressly precludes the deduction of any amount paid by Daishowa to
Tolko as it was for services to be rendered after the end of the taxation year.
The Appellant counters that this approach looks at what the payment was
received by Tolko for, not, more accurately, according to the Appellant, what
the payment was made by Daishowa for: the payment was made to Tolko to assume
the liability to render services. This is a somewhat fine distinction, but what
it does highlight for me is that this is simply not a prepaid expense
situation. No payment was made by Daishowa for services to be rendered to
Daishowa: that was not the nature of the payment, even if I were to consider
the transfer of the forest tenures as payment. In brief, section 18(9) is a red
herring.
[50]
The Appellant has not
convinced me that the transfer of forest tenures, being part of the sale of the
mill generally, is anything other than a capital transaction for the sale of
Daishowa’s business. The Appellant has also not convinced me that even if I was
to view the assumption of the reforestation liability as a separate transaction
paid for by Daishowa passing consideration in the form of forest tenures, that
this was on income or expense account. It was not.
[51]
In conclusion, the deal
for the sale of Daishowa’s business to Tolko was a single transaction, and the
assumption of the reforestation liabilities represented part of the
consideration; however, the value of that consideration to Daishowa is less
than the face value of the estimated amount of those liabilities. Factors of
uncertainty, lack of taxation symmetry, Alberta
policy that Tolko had to assume the reforestation liabilities, lack of
agreement on value and present-day valuing have led me to markedly discount the
long term liability. I wish I could be more arithmetically accurate, but some
of the principles on which I rely do not permit such accuracy. Even in taxation
law, the law can sometimes be imprecise. Having concluded that neither the face
value of the estimated reforestation liabilities, nor zero was the appropriate
amount to represent proceeds of disposition to be taxed (either of which would
have been an easier answer, but not to my mind an appropriate answer), then it
inevitably left me with the dilemma of quantification.
[52]
I see no difference in
the fact situation of the Seehta matter to reach any different conclusion. The
appeal is therefore allowed and referred back to the Minister for
reconsideration and reassessment on the basis that Daishowa received as
proceeds of disposition:
1. On the
sale to Tolko, an amount equal to the current silviculture liability of
$2,057,498 plus 20% of the long-term silviculture liability of $9,238,727, for
a total of $3,905,244; and
2. On the
sale to Seehta, an amount equal to the current silviculture liability of
$558,615 and 20% of the long-term silviculture liability of $2,407,693, for a
total of $1,040,153.
Costs to the Appellant.
Signed at Ottawa, Canada, this 11th
day of June, 2010.
"Campbell J. Miller"
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