Dresser Canada Inc. v. Minister of National Revenue, [1996] 1 CTC 2093, 96 DTC 3226

O’Connor J.T.C.C.:—This appeal was heard in Toronto, Ontario on September 13, 1995 and relates to the appellant’s 1984 taxation year.

Issue

The only issue is how certain agreements of sale and purchase are to be interpreted insofar as they relate to the calculation of the cost of certain inventory acquired by the appellant pursuant to the said agreements.

Facts

The facts are set forth in a statement of agreed facts (“statement”) which, so far as material, reads as follows:

1. This is an appeal by Dresser Canada Inc. (“Dresser Canada”) with respect to its 1984 taxation year.

2. Dresser Canada is a wholly-owned subsidiary of Dresser Industries Inc.

3. WABCO-Standard Inc. (“WABCO”) is a wholly-owned subsidiary of American Standard Inc. (“ASI”)

4. By an agreement of sale and purchase dated as of April 26, 1984, Dresser Industries Inc. for itself and certain of its subsidiaries purchased the construction and mining equipment business (the“CED business”) owned by ASI and its subsidiaries. The CED business was carried on by ASI and its subsidiaries at various locations located in the United States, Canada, Belgium and Australia. [Attached to the statement as Appendix A was the said agreement]

5. Dresser Industries Inc. and ASI were at all times dealing at arm’s length.

6. [Also attached to the statement as Appendix B was] the agreement of sale and purchase dated June 1, 1984 between WABCO and Dresser Canada concerning the purchase and sale of the Canadian CED business, assets and properties.

7. [Also attached to the statement as Appendix C was a]“Combining statement of net assets sold” accepted by Dresser Industries Inc. and ASI as the basis for the determination of the price paid for the CED business.

8. The aggregate consideration paid by Dresser Industries Inc. and its subsidiaries to acquire the CED business in the four jurisdictions of Canada, United States, Australia and Belgium, was US$90,003,000 consisting of cash totalling US$66,328,000 and assumed liabilities totalling US$23,675,000.

9. The position of the appellant and the respondent [as to] the calculation of the cost of inventory acquired by Dresser Canada is as follows:

STAT

	APPELLANT		RESPONDENT
Combined Equity of Net
Assets Sold
(as per Appendix C)	$ 106,646,000
			$ 106,646,000
Discounts		(40,318,000)	(40,318,000)
Cash Consideration
		66,328,000		66,328,000
Consolidated Eliminations				1,248,000
				1,248,000
Acquisition Costs		121,000		Nil
Assumed Liabilities		23,675,000		Nil
				Nil
Allocation to Belgium		(1,303,000)		(1,603,000)
				(1,603,000)
Allocation to Australia		(3,879,000)		(3,879,000)
				(3,879,000)
Purchase Price to be allocated
between Canada and the United
States (in U.S. Dollars)		$84,942,000	$	62,094,000
Allocation between Canada and
the United States as per formula
contained in Schedule 3 to
the Agreement (Appendix A)
^14,873,000 x 84 945 ooo
			14,873,000
				x 62,094,000
102,412,000			102’412’000
			102,412,000
Allocation to Canada
(US Dollars)		12,336,000		9,018,000
Canadian Liabilities				1,519,000
	$	12,336,000		10,537,000
Allocation to Inventory
(Canadian Dollars)	$	12,120,804	$	9,860,801

10. The respondent has no knowledge of but does not put in issue the position of the appellant that the method used by Dresser Canada to allocate the purchase price between Canada and the United States was also used by Dresser Industries Inc. in its American tax returns.

11. It is agreed that the reassessment by the Minister of National Revenue of the appellant’s 1984 taxation year did not take into account the costs of acquisition of $121,000. This amount should be taken into account in calculating the worldwide price paid for the CED business.”

Although the above calculations differ in several respects, counsel for the parties acknowledged that the only issue relates to how the assumed liabilities are to be dealt with. The $121,000 figure for acquisition costs is to be resolved in accordance with paragraph 11 of the statement.

The appendix A agreement will be hereafter referred to as the master agreement and the appendix B agreement will be hereafter referred to as the subsidiary agreement. The relevant provisions of these agreements and the schedules thereto are the following:

MASTER AGREEMENT

2.3 Subsidiaries and subsidiary agreements. SELLER [Dresser Industries Inc.] shall cause each of the subsidiaries which has assets included in the purchased assets to enter into a separate agreement with BUYER [ASI] or buyer’s nominee (each being herein called a“subsidiary agreement”) under which such subsidiary will sell its property and assets which are included in the purchased assets to BUYER or buyer’s nominee at a purchase price to be determined in accordance with provisions of Article III, with an allocation in the purchase price among SELLER and its subsidiaries calculated in accordance with Schedule 3 attached hereto.

ARTICLE III. PAYMENT AND DELIVERY

3.1 preliminary purchase price and assumption of liabilities. As consideration for the purchased assets, BUYER shall at the closing and on the closing date deliver the“preliminary Purchase Price” as calculated in subparagraph 3.1.1....

3.1.1 ...the preliminary purchase price shall be the“combined equity” as set forth on the preliminary closing balance sheet, minus the sum of $21,200,000. The preliminary purchase price shall be further reduced by discounting the preliminary purchase price by the prime rate of interest of Chemical Bank on the closing date plus one per cent and compounded annually for two fiscal years from the closing date.... As further consideration for the purchased assets BUYER shall at the closing assume all of the assumed liabilities described in Schedule 5 of this agreement (the “assumed liabilities”).

3.2 closing. The sale and transfer of the purchased assets, assumption of the assumed liabilities and delivery of the preliminary purchase price (herein called the“closing”) shall take place at 10 A.M. on May 31 1984 or on such other date as may be agreed upon by the parties (such time and date being herein called the“closing date”)....

3.2.2 Delivery by BUYER. Subject to the terms and conditions of this agreement, at the closing and on the closing date, BUYER shall deliver to SELLER:

(i) The preliminary purchase price through a bank transfer of U.S. dollar....

(ii) The opinion of BUYER’S legal counsel....

(iii) Appropriate instruments...evidencing the assumption by BUYER or buyer’s nominee of the assumed liabilities.

3.2.3 Post-closing Final balance sheet.

(a) not more than 60 days after the closing date, SELLER shall... deli ver to BUYER an audited combining balance sheet of CED as of the closing of business on the closing date (the“post closing final balance sheet”).... The post-closing final balance sheet shall be prepared on The pro-forma basis in accordance with procedures and generally accepted accounting principles both consistent with those applied in the preparation of the year-end 1983 balance sheet....

3.2.4 Post-closing Adjustment of the Preliminary Purchase Price. Within two days after the post-closing final balance sheet becomes binding in accordance with subparagraph 3.2.3, the final purchase price shall be determined on the basis thereof. The final purchase price shall be the“combined equity” as set forth in the post-closing final balance sheet, minus the sum of $21,200,000. The final purchase price shall be further reduced by discounting it by the prime rate of interest of Chemical Bank on the closing date plus one per cent and compounded annually for two fiscal years from the closing date. Within five days after such determination of the final purchase price, SELLER shall pay to BUYER in cash the amount of any decrease in the amount of the final purchase price as compared with the preliminary purchase price, or BUYER shall pay to SELLER in cash the amount of any increase in the final purchase price as compared with the preliminary purchase price.

10.4 Allocation of purchase price. Schedule 3 annexed hereto sets forth the method of allocation of the purchase price as agreed between buyer and seller.

SCHEDULE 3 [Master agreement]

Allocation of purchase price

The purchase price should be determined in accordance with Article III, section 3.1 and section 3.2.4 of the agreement of sale and purchase between American Standard Inc. and Dresser Industries, Inc. The allocation of the final purchase price among the SELLER and its subsidiaries will be made as set forth in this schedule. As the CED Business has manufacturing facilities only in the United States and Canada, and as the preponderance of the CED Business is carried on in the United States and Canada, and recognizing the value of the assets held by the SELLER’S subsidiaries in Belgium and Australia, the portion of the purchase price allocable to the SELLER’S subsidiaries in Australia and Belgium will be the equity as shown on the post closing final balance sheet under columns headed Australia and Belgium. The remainder of the final purchase price will be allocated to SELLER and SELLER’s Canadian subsidiary based on the ratio of the equity of each to the sum of the equity of the two, using equity shown on the post closing final balance sheet in the columns headed United States and Canada. Upon closing the buyer and seller will agree to the allocation of the final purchase among the United States and Canadian assets and assumed liabilities.

SCHEDULE 5 [Master agreement]

I. Buyer or buyer’s nominee will assume at the closing Date the following liabilities of seller or seller’s subsidiaries to the extent such liabilities remain to be performed or paid after the closing date.

1. Liabilities on the post closing final balance sheet in the accounts listed on the schedule attached hereto.

SUMMARY OF LIABILITIES ASSUMED

— Federal Unemployment Tax 232-004

THIS AGREEMENT is made this 1st day of June , 1984 by and between WABCO - Standard Inc. (“SELLER”), ... and Dresser Canada, Inc. (“BUYER”),

— Group Insurance	232-006
Accrued Liabilities — Utilities	242-001
Accrued, Sales Property and Use Taxes	246
Accrued Liabilities	249
— Commissions	249-020
— Special Price Allowances	-021
— ontingencies	-022
— Warranty Service Allowance	-023
— Field Service Support	-024
— Consigned Equipment	-025
Sales Commitments — Trading Company	249
Product Warranty Complaint Expense	248-001
Other Liabilities
Other Accrued Liabilities	249-002
Deferred Credits (except relating to Korte and Muller)	249-030
Deferred Special Discount	249-051
	to 057
Other LTD — Equity in MDSI software for NC Machine	319-004
LTD — GE Pension Fund — Bldg. AA	317-001
SUBSIDIARY AGREEMENT

WITNESSETH:

That, in consideration of the respective representations, warranties, covenants, and agreements contained herein, SELLER and BUYER agree as follows:

I. PRELIMINARY STATEMENT

1.1 SELLER is a wholly owned subsidiary of American Standard Inc. (“ASI”) and BUYER is a wholly owned subsidiary of Dresser Industries, Inc. (“Dresser”). On April 26, 1984, ASI entered into an agreement with Dresser (“ASI-DI agreement”) to sell certain of its business, assets and properties which are part of its Construction and Mining Equipment Business (“CED Business”) and Dresser agreed to purchase the CED Business, assets and properties. SELLER conducts its CED Business in Canada utilizing certain of its business, assets and properties (“the Canadian Purchased Assets”) forming a part of the Purchased Assets as defined in the ASI-DI agreement. The Canadian Purchased Assets are situated in various locations including but not limited to Paris, Ontario (the “Canadian CED Business”).

II. ACQUISITION AND DISPOSITION

2.1 Canadian Purchased Assets. SELLER desires to sell the Canadian Purchased Assets forming part of the Canadian CED Business to BUYER. BUYER desires to purchase the Canadian Purchased Assets included in Schedule 1 to the ASI-DI agreement for the Canadian purchase price, upon the same terms and subject to the same conditions as set forth in the ASI-DI agreement ... Unless otherwise indicated, each section and subsection of this agreement supersedes, modifies or adds to the corresponding provision of the ASI-DI agreement, and for ease of reference has the same section or subsection number. For the purpose of applying the terms of the ASI-DI agreement to this agreement, any reference in the ASI-DI agreement to Purchased Assets shall mean Canadian Purchased Assets as defined herein, and any reference in the ASI-DI agreement to “CED Business” shall mean the Canadian CED Business as defined herein. ...

ARTICLE III. PAYMENT AND DELIVERY

3.1 Preliminary Canadian purchase price and Assumption of Liabilities.

As consideration for the Canadian purchased assets, BUYER shall at the closing and on the closing date deliver the"preliminary Canadian purchase price” as calculated in subparagraph 3.1.1 ...

3.1.1 The preliminary Canadian purchase price shall be the “Equity” of seller’s Canadian CED business as set forth in the preliminary closing balance sheet as provided in the ASI-DI agreement subject to allocation of the reduction provided for in section 3.1.1 of the ASI-DI agreement pursuant to Schedule 3 to the ASI-DI agreement.

As further consideration for the Canadian purchased assets, BUYER shall at the closing assume the assumed liabilities of the Canadian CED Business described in Schedule 5 of the ASI-DI agreement (the “assumed Canadian liabilities”). At the closing BUYER shall deliver to SELLER an appropriate instrument satisfactory in form and substance to SELLER evidencing the assumption by BUYER of the assumed liabilities.

3.2 Closing. The sale and transfer of the Canadian purchased assets, assumption of the assumed Canadian liabilities and delivery of the preliminary Canadian purchase price (herein called the “closing”) shall take place at 10 a.m. on May 31, 1984 or on such other date as may be agreed upon by the parties (such time and date being herein called the“closing date”), …

3.2.3 Post closing final balance sheet. The post closing final balance sheet provided in section 3.2.3 of the ASI-DI agreement shall include SELLER’S Canadian CED business and adjustments thereto as provided in section 3.2.3 and 3.2.4 of the ASI-DI agreement and shall be binding on SELLER and BUYER.

The post-closing final balance sheet contemplated in section 3.2.3 of the Master agreement and the subsidiary agreement is reproduced below.

COMBINING STATEMENT OF NET ASSETS SOLD

May 31, 1984

(In thousands)

United

States Australia Belgium Canada Eliminations Combined Current assets:

Inventories —

Raw materials $18,805 2,551 21,356 Work-in-process 29,378 7,155 36,533 Finished goods 43,037 6,529 2,019 4,052 (1,248) 54,389

91,220 6,529 2,019 13,758 (1,248) 112,278

Less reserve for

slow-moving

and obsolete items 7,752 2,454 219 1,044 11,469

83,468 4,075 1,800 12,714 (1,248) 100,809 Land 580 587 Land 580 7

Other current assets	1,284	41	30	162	1,517
Total currents assets 84,752 4,116 1,830 12,876					(1,248) 102,326
Property, plant and
equipment, at cost:

Buildings 22,243 2,308 24,551

24,551

Machinery,

equipment and other 32,454 196 169 4,181 37,000

	55,277	196	169	6,496		62,138
Less accumulated
depreciation	34,056	139	148	2,980		37,323
	21,221	57	21	3,516		24,815
Investment in
Road Machinery
Company	3,180					3,180
Total assets	109,153 4,173 1,851 16,392 (1,248) 130,321
Current liabilities:
Accounts payable	12,541	79	44	997		13,661
Accrued liabilities	7,732	215	204	522		8,673
Total current
liabilities	20,273	294	248	1,519		22,334
Obligations under
capital leases	1,341					1,341
Net assets sold	$87,539	3,879	1,603	14,873	1,248)	106,646

ASSUMPTION OF LIABILITIES (SUBSIDIARY AGREEMENT)

Subject to and upon the terms and conditions of the agreement of sale and purchase dated June 1, 1984 by and between WABCO Standard Inc. (“seller”) and Dresser Canada, Inc. (“buyer”), (the “Canadian agreement”) and the agreement of sale and purchase dated April 26, 1984, by and between Dresser Industries, Inc. and American Standard Inc. (the “ASI-DI agreement”) attached to and incorporated in said Canadian agreement, Buyer assumes as of the date hereof and agrees to pay and discharge:

1. Liabilities of seller exclusively related to the Canadian CED business on the post closing balance sheet provided in section 3.2.3 of the ASI-DI agreement in the accounts listed on the attachment to Schedule 5 of the ASI-DI agreement.

On September 14, 1984 Dresser Industries Inc. sent the following calculation of the final purchase price to American Standard Inc. for approval.

FINAL PURCHASE PRICE OF THE ASSETS PURCHASED BY DRESSER INDUSTRIES, INC. AND ITS SUBSIDIARIES (“DRESSER”) FROM AMERICAN STANDARD INC. AND ITS SUBSIDIARIES (“ASI”) PURSUANT TO THE agreeMENT OF SALE AND PURCHASE MADE THE 26th DAY OF APRIL, 1984 (THE“ AGREEMENT”).

Final purchase price, computed in accordance with Section 3.2.4 of the agreement, is as follows:

Combined Equity as shown on Combining Statement of
Net Assets Sold of the WABCO Construction and Mining
Equipment Division as of the close of business
on May 31, 1984.	$	106,646,000
Discount		21,200,000
		21,200,000
Balance	$	85,446,000
Balance after Financial Discount (.77626)	$	66,328,312
Less Preliminary Purchase Price paid		58,219,500
		58,219,500
June 1, 1984
Balance Owed ASI by Dresser	$	8,108,812

Appellant’s Submissions

The principal submissions of counsel for the appellant are recited in his written memorandum of argument and read:

3. The consideration for the business and assets in the four jurisdictions was US$90,003,000 consisting of cash of US$66,328,000 and assumed liabilities of US$23,675,000.

4. In assessing the appellant in 1984, Revenue Canada accepted that the allocation of the purchase price among the four jurisdictions was to be in accordance with the terms of the arms length agreement dated April 26, 1984 entered into between Dresser Industries Inc. and American Standard Inc. (the“agreement”).

5. There are two provisions in the agreement which deal with the allocation of the purchase price among the four jurisdictions. (Counsel then cites sections 2.3, 10.4 and Schedule 3 of the master agreement which are recited above.)

7. Revenue Canada assumed that properly interpreted the agreement required only the cash portion of consideration be allocated in accordance with Schedule 3. It is the appellant’s submission in this appeal that this assumption by Revenue Canada was erroneous and that properly interpreted, the agreement requires the total purchase price (cash and assumed liabilities) to be allocated in accordance with Schedule 3.

8. The term purchase price, as used in section 2.3 and 10.4, is not defined in the agreement. The appellant respectfully submits that when the agreement refers in sections 2.3 and 10.4 to“purchase price” and provides for the“purchase price” to be allocated in accordance with Schedule 3, the agreement is referring to the aggregate consideration of US$90,003,000. It is submitted such an interpretation accords with the meaning given by the courts to the term“purchase price”.

I am of the opinion that a strict narrow meaning to the words “purchase price” should not be given so as to include only the funds actually paid to the vendor but that it must reasonably have meant to include the total costs of acquisition.

Torino Drywall Co. v. Blairville Developments Ltd. (1985), 14 C.L.R. 260 (Ont. S.C.), at page 264;

Connoil Estates Agent v. Begej, [1993] E.G. 125 (Eng. C.A.);

Galyen and Petroleum Company v. Svoboda (1986), 383 N.W. (2d) 49;

Knudsen Dairy Products Co. v. State Board of Equilization (1970), 90 Cal. Rptr. 533

9. It is submitted that inclusion in“purchase price” of the assumed liabilities is consistent not only with other judicial interpretations of that term but also with the intent of the agreement as disclosed in Article 3.1 which provides in part:

As further consideration for the purchased assets BUYER shall at the closing assume all of the assumed liabilities described in Schedule 5 of this agreement (the“assumed liabilities”).

10. It is submitted that the provision in the opening sentence of Schedule 3 to the effect that purchase price is to be determined in accordance with, inter alia, section 3.1 of the agreement is a further indication that Schedule 3 was intended to be determinative of the allocation of the entire consideration and not just the cash consideration since section 3.1 specifically provides for the assumption of liabilities as part of the consideration for the transaction.

11. In the appellant’s submission, the total purchase price paid for the Canadian assets is US$12,336,000. In the appellant’s submission this consists of the assumed liabilities of US$1,519,000 identified for Canada in the post-closing balance sheet and cash of US$10,817,000. It is submitted that the appellant’s position concerning the proper allocation of the purchase price is therefore totally consistent with Dresser Canada Inc.’s having assumed no more of the assumed liabilities than those identified for Canada in the post-closing balance sheet.

12. It is respectfully submitted that the respondent erred in assuming that the allocation provisions in Schedule 3 of the agreement applied only to the cash considerations for the transaction between Dresser Industries Inc. and American Standard Inc. and that properly interpreted the agreement provides for the entire purchase price of $90,003,000 to be allocated in accordance with Schedule 3....

Respondent’s Submissions

The respondent’s submissions are essentially that the agreements should be interpreted as respondent did in paragraph 9 of the Statement. The only liability assumed by the appellant was the $1,519,000 and the respondent has allowed that amount in calculating the cost of the Canadian inventory.

Analysis and Decision

It is evident that there are many situations where the purchase price in an agreement of sale and purchase will comprise not only cash but other considerations. The most obvious examples are the purchase of real estate for cash plus the assumption of any existing mortgages thereon or the purchase of personal property for cash plus the assumption of any outstanding liens thereon. Another example would be where a purchaser pays cash plus some other form of property.

In the agreements the terms“purchase price” and“assumptions of liabilities” are almost always treated as two different things. Sections 3.1 of the agreements distinguish those terms. These sections state at the outset that“as consideration for the purchased assets the buyer shall...deli ver the preliminary purchase price”. Later in section 3.1.1 we see“as further consideration buyer shall assume...the assumed liabilities”. Simply indicating that this is further consideration does not necessarily make the amount of assumed liabilities part of the cost of the inventory.

Schedule 3 of the master agreement first states that the purchase price shall be determined in accordance with Article III, section 3.1 and section 3.2.4. This schedule then contemplates an allocation of the final purchase price among the seller and its subsidiaries as per the post closing final balance sheet. The last sentence states“Upon closing the buyer and seller will agree to the allocation of the final purchase among the United States and Canadian assets and assumed liabilities.” This sentence is confusing but probably refers to an allocation of the final purchase price and an allocation of assumed liabilities between the United States and Canada. In my opinion however it demonstrates that the term“purchase price” does not necessarily contain the element of‘assumed liabilities”. Once again they are treated separately.

Again the calculation of the“final purchase price” makes no reference to“assumed liabilities”. Counsel for the appellant minimizes the importance of this document stating it simply is an adjustment of the cash differential between the preliminary purchase price and the final purchase price. This may be so but it is also indicative of the parties intentions to deal separately with purchase price and assumed liabilities.

In my opinion, not all liabilities assumed upon the purchase of a business, including the inventory of that business, are necessarily to be included in the calculation of the cost of that inventory. It appears to me that there must be some relationship between the liability assumed and

the inventory acquired. It may not necessarily have to be a liability secured by that inventory but there must be some relationship. For example, if the liabilities assumed included an obligation on the buyer to pay the unpaid labour and material costs that went into producing the inventory there would be a relationship.

In the present case the Canadian liabilities assumed which have a relationship to the Canadian inventory amount to $1,519,000. The Minister has allowed this amount in the calculation shown in paragraph 9 of the statement. This appears to be the only liability which the appellant assumed with respect to Canadian inventory and, in my opinion, it is the amount of that liability that is to be included in the cost of the inventory and this the Minister has done. I find that the relevant provisions of the Master agreement and of the subsidiary agreement support the above interpretation.

Consequently the appeal is dismissed.

Appeal dismissed.