Citation: 2010 TCC 375
Date: 20100713
Docket: 2009-871(IT)G
BETWEEN:
TRANSALTA CORPORATION,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Miller J.
[1]
This is a case about
goodwill, more specifically, the allocation of the purchase price between net
tangible assets and goodwill in an $800,000,000 sale of Transalta Energy
Corporation’s ("Transalta") assets and business to AltaLink Limited
Partnership ("AltaLink") in 2002. In their Purchase and Sale Agreement,
Transalta and AltaLink allocated approximately $190,000,000 to goodwill and
$602,000,000 to net tangible assets. The Respondent, relying upon section 68 of
the Income Tax Act (the "Act"), allocated nothing to
goodwill and everything to the net tangible assets, on the basis primarily that
no goodwill exists in a regulated industry, thus Transalta’s allocation of
$190,000,000 to goodwill was unreasonable. The Appellant’s position is that
hard bargaining took place between Transalta and AltaLink establishing the
allocation and, therefore, such allocation cannot be regarded as unreasonable.
Transalta further submits that the Government has been unable to demonstrate
the allocation was clearly unreasonable.
Facts
[2]
The Parties provided a
Joint Book of Documents and an Agreed Statement of Facts, augmented by the
testimony of Mr. Woo, an officer of Transalta and project manager of the
transaction in question, as well as by evidence of an expert from each party:
Ms. Glass from KPMG for the Appellant and Mr. Lawritsen from Meyers Norris
Penny LLP for the Respondent.
AGREED
STATEMENT OF FACTS
The parties hereto by their respective
solicitors agree on the following facts, provided that this agreement is made
for the purpose of this appeal only and may not be used against either party on
any other occasion, and that the parties may add further and other evidence
relevant to the issues and not inconsistent with this agreement. It is also
agreed that the admission of these facts is not a concession of the weight or
degree of relevance to be attributed to these facts.
1 OVerview
1.1
Throughout 2001 and 2002, among the Appellant’s
wholly owned subsidiaries were TransAlta Utilities Corporation (“TAU”)
and TransAlta Energy Corporation (“TEC”).
1.2
The Appellant determined to cause TAU to sell
its electricity transmission business (the “Transmission Business”) by
way of sealed bid auction process targeted to a limited number of recipients
(the "Sealed Bid Auction") conducted by CIBC World Markets
Inc. (“CIBC”).
1.3
As a result of the sealed auction, AltaLink,
L.P. (“AltaLink”) acquired the Transmission Business.
1.4
Representatives of AltaLink’s partners and the
Appellant negotiated the terms of the sale, including an allocation of the
purchase price to depreciable property, goodwill and certain other items, as a
result of which $190,824,476 was allocated to goodwill.
1.5
$190,824,476 was also approximately the amount
by which the purchase price exceeded the net regulated book value ("NRBV")
and working capital of the Transmission Business’ assets, and was referred to
by TransAlta and other parties relative to the transaction as the "premium".
1.6
The Minister reassessed under section 68 of the
Income Tax Act, R.S.C. 1985, c.1 (5th Supp.), Chapter 63, as amended (the “Act”)
on the basis that the portion of the purchase price allocated to goodwill was
unreasonable and should have been allocated to depreciable property.
1.7
As a result of this reassessment, the Appellant
appealed to the Tax Court.
2 The Parties
2.1
The Appellant is a corporation subject to the Canada
Business Corporations Act, and at all material times was a "taxable
Canadian corporation" as defined in subsection 89(1) of the Act.
2.2
TEC and TAU were, at all material times, wholly
owned subsidiaries of the Appellant.
2.3
The Appellant is a publicly traded corporation.
2.4
AltaLink is a limited partnership formed under
the laws of Alberta by the
members of the Consortium, as defined below, for the purpose of acquiring the
Transmission Business.
2.5
At all material times, AltaLink was owned either
directly or indirectly (through another limited partnership, known as AltaLink
Investments, L.P. ("Investments")) by four limited partners,
as follows:
(a)
as to 50%, SNC Lavalin Transmission Ltd., a
wholly owned subsidiary of SNC Lavalin Inc. ("SNC");
(b)
as to 25%, OTPPB TEP Inc., a wholly owned
subsidiary of the Ontario Teachers’ Pension Plan Board ("Teachers");
(c)
as to 15%, Macquarie Transmission Alberta Ltd.,
a wholly owned subsidiary of Macquarie North America Ltd. (“Macquarie”);
and
(d)
as to 10%, 3057246 Nova Scotia Company, a wholly
owned subsidiary of Trans Elect Inc. (“Trans Elect”).
2.6
At all material times, AltaLink, the Consortium
and each of the Consortium’s partners dealt at arm’s length with the Appellant,
TAU and TEC.
2.7
At all material times, Investments’ general
partner was AltaLink Investments Management Ltd., which owned a nominal
percentage of Investments.
2.8
At all material times, AltaLink’s general
partner was AltaLink Management Ltd., which owned a nominal percentage of
AltaLink.
2.9
At all material times, AltaLink Management Ltd.
and AltaLink Investments Management Ltd. were controlled indirectly by SNC, Teachers,
Macquarie and Trans Elect in
the same percentages as they indirectly controlled AltaLink.
2.10
At all material times, 75% of AltaLink was
indirectly controlled by “taxable Canadian corporations” as defined in the Act
as result of the fact that each of the subsidiaries of SNC, Macquarie and Trans
Elect that were partners in Investments were "taxable Canadian
corporations", whereas the subsidiary of Teachers was not.
2.11
AltaLink’s income and deductions for taxation
purposes flowed through to its partners at all material times.
2.12
To the extent that AltaLink’s income and
deductions for taxation purposes flowed through to Investments, such income and
deductions flowed through to Investments’ partners.
2.13
Investments limited partners are deemed owners
of the Transmission Business utility for Public Utilities Board Act (Alberta) purposes.
3 the Transmission business
3.1
The Transmission Business consisted of
approximately 11,600 km of transmission lines and 260 substations that supply
almost 60% of the Alberta
population with electricity.
3.2
The original cost of the Transmission Business
assets was approximately $1.4 billion. Depreciation for accounting purposes
with respect to those assets throughout TransAlta's ownership was approximately
$780 million, which resulted in a book value for accounting purposes of
approximately $640 million.
3.3
The Transmission Business’ NRBV at the time of
the sale to AltaLink was approximately $590 million with respect to depreciable
property, and $617 million in total. This is the amount on which the owner of
the Transmission Business is entitled to earn a regulated rate of return, on
the basis described below.
3.4
The Transmission Business was a consistently
profitable going concern prior to its sale to AltaLink.
3.5
The Transmission Business included certain
transferable rights, licenses and permits (the “Permits”).
4 the auction
4.1
The Appellant offered the Transmission Business
for sale in early 2001, and retained CIBC, an arms length party, in that regard
to contact potentially interested parties and conduct a sealed bid auction with
a view to selling the Transmission Business.
4.2
The sealed bid auction process commenced in the
Spring, 2001 and concluded in June, 2001.
4.3
During the course of the sealed bid auction, the
Appellant received bids for the Transmission Business that ranged from $655
million to the $855 million.
4.4
Various bidders referred in their bids to their
intention to pay a premium in excess of NRBV for the Transmission Business.
4.5
NRBV is the amount respecting which the owner of
a utility regulated by the Board is entitled to receive a regulated rate of
return.
4.6
A consortium known as the AlbertaLink Consortium
(the “Consortium”) was formed by representatives of SNC Lavalin Inc. (“SNC”),
Ontario Teachers’ Pension Plan Board (“Teachers”), Macquarie North America Ltd.
(“Macquarie”) and Trans-Elect Inc. (“Trans-Elect”) to bid for the
Transmission Business.
4.7
During the bidding process, the Consortium
indicated that if it were the successful bidder, it intended to create a
limited partnership for the purpose of carrying out the acquisition of the
Transmission Business.
4.8
The Consortium bid $855 million for the
Transmission Business, and was the high bidder.
5 THE Sale
of the Transmission business
5.1
The Appellant negotiated the terms of definitive
sale agreements and related documents (the “Agreements”) with
representatives of the Consortium with respect to a sale of the Transmission
Business (the “Transaction”).
5.2
During the course of those negotiations:
(a)
certain assets were excluded from the
Transaction and various other adjustments were made, as a result of which the
purchase price was reduced to $818 million, a $37 million decline from the
Consortium’s initial bid of $855 million;
(b)
the Consortium asked TEC to increase the portion
of the purchase price allocated to depreciable assets and at closing $36
million more of the purchase price was allocated to depreciable assets than
TransAlta had originally proposed to the Consortium;
5.3
The negotiation of the terms of the Transaction
commenced shortly after TransAlta received the Consortium's bid on June 15,
2001, and continued until July 2, 2001, at which time all terms of the
Agreements were settled.
5.4
The Consortium caused AltaLink to be formed on
July 3, 2001.
5.5
From July 2, 2001 to July 4, 2001, lawyers
produced execution copies of the Agreements, and the Agreements were signed on
July 4, 2001 (the “Signing Date”).
5.6
The Consortium caused AltaLink to execute the
Agreements on the Signing Date.
5.7
The Agreements provided for a purchase price of
$818,150,705, and contained a purchase price allocation clause which allocated
the purchase price as follows:
(a)
$590,582,039 to depreciable assets;
(b)
$11,897,581 to land;
(c)
$14,583,208 to land rights;
(d)
$10,263,401 to working capital; and
(e)
$190,824,476 to goodwill.
5.8
The amounts allocated to depreciable assets and
land were equal to the Appellant’s NRBV in that regard at the Transaction’s
effective date, being in total $602,479,620.
5.9
The Agreements contemplated that the
Transmission Business would first be transferred by TAU to TEC under section 85
of the Act, and then transferred by TEC to AltaLink.
6 Regulatory Approval
6.1
On August 22, 2001 TAU applied to the Board for
approval to transfer the Transmission Business to TEC, and then for TEC to
dispose of same to AltaLink, in accordance with the Agreements.
6.2
After a regulatory review and approval process
with respect to the Transaction conducted by the Board, approval for the
Transaction was received on March 28, 2002.
6.3
Consequently, the sale of the Transmission
Business to AltaLink closed on April 29, 2002 in accordance with the
Agreements.
6.4
The Board’s approval of the Transaction required
that:
(a)
The Appellant’s closing undepreciated capital
cost (“UCC”) for regulatory purposes must equal AltaLink’s opening UCC
for regulatory purposes; and
(b)
The Appellant’s closing NRBV with respect to the
Transmission Business must equal AltaLink’s opening NRBV, and that the premium
could not be recovered through future rate increases.
6.5
The Board’s approval did not require that the
Appellant’s closing UCC for actual taxation purposes equal AltaLink’s opening
UCC for actual taxation purposes.
7 applicable Regulatory Regime
7.1
At all material times, the Board set the rates
the Transmission Business could charge for its services so as to enable the
Transmission Business to earn a reasonable rate of return on the NRBV of the
capital it employed as set through the regulatory process.
7.2
In particular, at all material times the Board
generally set rates based on forecasts submitted by the Transmission Business
so as to permit the Transmission Business to:
(a)
recover the NRBV of its assets as they
depreciated for regulatory purposes;
(b)
recover the estimates of or proxies for expenses
the Transmission Business planned to incur, including interest with respect to
its debt to the extent approved by the Board, taxes and other amounts; and
(c)
earn a reasonable return on the portion of the
NRBV the Board deemed to be equity for this purpose.
8 Why the premium was paid
8.1
AltaLink paid the premium at least in part
because:
(a)
AltaLink expected that it would receive as part
of its annual revenues permitted by the Alberta Energy and Utilities Board (the
“Board”) an allowance for income taxes (the “Tax Allowance”) that
would exceed the income tax actually paid by its partners;
(b)
AltaLink believed that the return on equity offered
by the Board was attractive relative to other investments available to it given
the risks it was required to undertake to earn that return; and
(c)
AltaLink expected to be able to arrange its
affairs to use more leverage than was assumed by the Board for ratemaking
purposes;
8.2
During the regulatory approval process with
respect to the Transaction, ratepayers raised concerns with regard to the
premium, including that AltaLink would try to recover the premium by way of
rate increases.
8.3
As a result, AltaLink represented to the Board
that the premium could be justified by AltaLink on that basis that:
(a)
a performance based regulation (“PBR”)
plan could result in a sharing of benefits with customers that would enhance
earnings;
(b)
the possibility of sustained growth in the
regulated rate base could dilute the size of the premium; and
(c)
the existence of competitive merchant
transmission projects could provide opportunities to enhance earnings and
growth.
AltaLink
concluded its submission to the Board by indicating that its customers were
protected by AltaLink's commitment to exclude any portion of the premium from
the rate base, and that AltaLink's ability to earn returns that will justify
the payment of the purchase price, including the premium, is a matter of
commercial risk for AltaLink's partners.
8.4
PBR is a form of regulation that if implemented
would enable operators of businesses like the Transmission Business to earn
additional returns as a result of creating cost saving efficiencies that would
benefit their customers.
8.5
The Appellant represented to the Consortium
during the auction process as well as the negotiation of the terms of the
Agreements, that each of the following opportunities had substantial value:
(a)
PBR, in the range of $6 to $8 million per year
in incremental revenues;
(b)
Potential growth in the regulated aspect of the
Transmission Business, with total capital expenditures of between $655 and 955
million projected over a five year period;
(c)
Growth in non-regulated aspects of the
Transmission Business, including telecommunications (wireless and fibre optic),
non-regulated or merchant transmission facilities, engineering, procurement,
construction management and operations and maintenance services.
9 altalink’s tax allowance
9.1
The Tax Allowance does not generally equal actual
income taxes paid.
9.2
AltaLink expected to receive a Tax Allowance in
excess of the income taxes its partners would pay as a result of Teachers’ tax
deferred status.
9.3
The Board eventually denied AltaLink the right
to collect the portion of the Tax Allowance attributable to Teachers.
10 the reassessment and appeal
10.1
The Minister reassessed the Transaction by way
of a Notice of Reassessment (the “Reassessment”) with respect to TEC’s
December 31, 2002 taxation year on the basis that section 68 of the Act applied
to reallocate TEC’s proceeds of disposition on the sale of its Transmission
Business to AltaLink so as to reduce the amount that TEC allocated to goodwill
and land rights, and to correspondingly increase the amount allocated to
depreciable property and land.
10.2
The Appellant amalgamated with TEC and TAU on
January 1, 2009.
10.3
The Appellant filed a Notice of Objection with
respect to the Reassessment on December 17, 2008.
[3]
The Appellant further appealed the Reassessment by way of Notice
of Appeal filed March 18, 2009.
[4]
There are several
provisions of the July 4, 2001 Purchase and Sale Agreement worth reproducing at
this point:
…
2.1
Purchase and Sale
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. [emphasis added]
2.2
Purchase Price
(1) The 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:
(a) the Net Regulatory Book Value of the
Assets at December 31, 2000 (which the Parties agree is $613,200,000)
multiplied by 1.31 for a total of $803,300,000 (the "Base Purchase
Price"); and
(b) an amount related to certain changes to
the Assets from and after December 31, 2000 which amount shall be the amount
determined by the adjustments set forth in Section 2.3 hereof.
…
(2) The Vendor 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 Purchase Price.
…
Schedule 2.2(2) Allocation of Purchase Price
The Purchase Price determined under Section 2.2 shall be allocated
among the Assets as follows:
(a) Those of the Assets which constitute
Current Assets shall have allocated thereto such amount as may be determined in
the calculation of Working Capital under Section 2.3 as at the Time of Closing;
(b) Those of Assets which constitute
"non-depreciable capital property" (within the meaning of the Income
Tax Act) shall have allocated thereto the amount of $11.3 million;
(c) Those of the Assets which constitute
"depreciable property" within the meaning of the Income Tax Act
and which are described in Class 8 in Schedule II to the Income Tax Act
Regulations shall have allocated thereto the aggregate of $15 million and
the cost to the Vendor of additions to such Class from December 31, 2000 to the
Time of Closing;
(d) Those of the Assets which constitute
"depreciable property" within the meaning of the Income Tax Act
and which are described in Class 10 in Schedule II to the Income Tax
Regulations shall have allocated thereto the aggregate of $5 million and
the cost to the Vendor of additions to such Class from December 31, 2000 to the
Time of Closing;
(e) Those of the Assets which constitute
"depreciable property" within the meaning of the Income Tax Act
and which are described in Class 1 and Class 2 in Schedule II to the Income
Tax Regulations shall have allocated thereto an aggregate amount equal to
the "Net Regulatory Book Value" for such Assets as at the Time of
Closing, such amount to be further allocated as between the Class 1 Assets and
the Class 2 Assets as follows:
(i) As to Class 1 the aggregate of $304
million plus the cost of additions to such Class from December 31, 2000 to the
Time of Closing;
(ii) As to Class 2 the remaining balance;
(f) The remaining unallocated balance of the
Purchase Price shall be allocated to those Assets which constitute
"eligible capital property" within the meaning of the Income Tax
Act.
…
APPENDIX A GLOSSARY
…
"Assets" means the undertaking and all of the 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:
(i) the Sites and Buildings;
(ii) the Equipment;
(iii) the Land Rights;
(iv) the Current Assets;
(v) the full 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 including, without limiting the generality of the foregoing, all
forward commitments of the Vendor or TransAlta Utilities Corporation or any of
their Affiliates for supplies or materials entered into in the usual and
ordinary course of Business whether or not there are any written contracts with
respect thereto, but excluding, for clarity, contracts or commitments of a
general nature that do not Primarily relate to the Business;
(vi) the Warranties, if any;
(vii) the Permits;
(viii) computer software listed in Schedule
1.1(a);
(ix) the goodwill of the Business including,
without limiting the generality of the foregoing,
A. 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
B. to the extent transferable, all customer
lists and supplier lists of the Business;
(x) all plans and specifications in the
possession of the Vendor or TransAlta Utilities Corporation or any of their
Affiliates Primarily relating to the Sites, the Buildings and the Equipment
including, without limiting the generality of the foregoing, all such
electrical, mechanical and structural drawings related thereto as are in the
possession of the Vendor or TransAlta Utilities Corporation; and
(xi) all Records;
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 the 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; all of which are to be transferred to the
Purchaser as a going concern but does not include the Generation Facilities or
Excluded Assets;
…
[5]
Mr. Woo addressed the
1.31 over the “NRBV” premium identified in section 2.2(1)(a) of the
Agreement in the following manner. He identified several factors supporting the
premium by pointing out that in AltaLink’s bid for the Transalta business it
included a section called "Business Plan", identifying core
strategies as follows:
…
Growth
The Consortium plans to continue to support the investment of
additional capital into the development of the Alberta transmission network. In its current forecast, the Consortium has
forecast significant capital expenditures over the next five years to expand
and maintain the business.
EPCM
The Consortium recognizes the internal expertise of TransAlta’s EPCM
Transmission Projects Group. As part of this transaction, SNC-Lavalin plans to
offer the Transmission Projects Group employees’ positions in its Alberta based engineering operations.
…
Regulation
Continuing the process that TransAlta has started, the Consortium
plans to take an active role in the establishment of a regulatory regime that incentivizes
the development of the Alberta
transmission network. The implementation of a performance based ratemaking
regime will provide the requisite incentives to attract additional capital to Alberta.
The Consortium recognizes the significant contribution that the
transmission employees have made to the development of the business, which has
resulted in it being rated in the top quartile in efficiency in North America. The Corporation does not
require restructuring to the transmission business and plans to other similar
benefits packages to retain key staff.
…
[6]
This view was confirmed
at AltaLink’s first rate hearing after the acquisition in January 2002,
before the Board, at which it argued:
…
5.0 The Purchase Premium Concern is a Red
Herring
Notwithstanding AltaLink’s commitment that
no portion of its purchase premium will be included in rate base, the Customer
Group continues to ruminate on the reasons why AltaLink would pay 1.31x book
value for the transmission assets. AltaLink submits that as long as the
purchase premium is not included in rate base and recovered from customers, the
entire purchase premium discussion is a red herring and is certainly not
sufficient to give rise to any concern respecting "harm".
…
Notwithstanding the irrelevance of how or if AltaLink’s partners
will ever feel justified in paying more than book value for the transmission
assets, there are at least three bases on which the payment of such a premium
could be justified.
·
A PBR plan could result in a sharing of benefits
with customers that would enhance earnings.
·
The possibility of sustained growth in the
regulated rate base will "dilute" the size of the premium.
·
The existence of competitive merchant
transmission projects can provide opportunities to enhance earnings and growth.
AltaLink submits that there is nothing nefarious about paying a
premium above book value for utility assets. As is well-known to the Board,
utility shareholders have historically paid such premiums when purchasing
shares in the securities markets.
…
[7]
Mr. Woo also suggested that
a move to Performance Based Regulation ("PBR"), given TransAlta’s
efficient environment, could result in $6,000,000 to $8,000,000 in opportunity.
He also referred to TransAlta’s Information memo (basically their marketing
tool) to quantify the business growth opportunities both in the regulated and
non-regulated sectors. Transmission growth opportunities were estimated at an
additional $600,000,000 to $900,000,000 capital cost. The non-regulated
opportunities were identified as telecommunications, merchant transmission,
EPCM (engineering, procurement and construction management) and operations and
maintenance service.
[8]
Mr. Woo explained some
of these opportunities in more detail. Merchant transmission is the
non-regulated business of transmission lines crossing territories, with
capacity sold at market rates, not regulated rates. TransAlta’s estimate of
potential capital expenditures ran over $3 billion.
[9]
The EPCM component
involves the construction and management of lines, preferably in the
non-regulated sector. AltaLink’s interest in this element of the deal was such
that SNC, one of the partners, offered jobs to 76 members of the EPCM group,
and contracted those services back to AltaLink pursuant to a 10-year contract.
Many years later when the chartered accounting firm of Grant Thornton supplied
an expert report in support of AltaLink’s rate application, it stated:
…
When the 76 employees were transferred to SNC-ATP, AML indicated
that the transfer of risk was to the benefit of AltaLink and no compensation
was paid. An alternative interpretation is that the transfer of the employees
gave a valuable asset to SNC-ATP.
When a business is purchased, a value is typically assigned to the
assembled workforce. The method of valuation differs with the skills and
experience of the workforce and the difficulty of assembling a similar
workforce.
…
[10]
It is evident from
AltaLink’s press release in July 2001 how favourably
it viewed the quality of workforce it was acquiring:
…
"This acquisition is a milestone occasion for SNC-Lavalin since
it is an important investment in Alberta, and capitalizes on our engineering and financing expertise,"
said Pierre Anctil, Executive Vice-President, Office of the President
responsible for SNC-Lavalin Investment. "By combining the strengths of the
TransAlta team with our considerable financial and technical expertise, we are
well placed to deliver top quality transmission services to Albertans, and meet
current and future needs."
…
"This is our first acquisition, and with our North American
focus, this will put Trans-Elect in the forefront as an independent
transmission owner," said Frederick Buckman, Chairman and CEO of
Trans-Elect. "In any acquisition, it’s the people who make the difference
and the capabilities and dedication of TransAlta’s Transmission personnel are
outstanding. We are excited about becoming part of the economy and community in
Alberta."
…
AltaLink will integrate employees of TransAlta’s transmission
sector. As a key part of the transaction, SNC-Lavalin will integrate
TransAlta’s engineering, procurement, construction management (EPCM)
transmission projects team into its power engineering group.
"The benefits of this new pooling of expertise are
two-fold," said Klaus Triendl, Executive Vice-President, Office of the
President responsible for SNC-Lavalin Power. "It’s good for our new
employees, because they are linking up with a world class case on which to
build their considerable expertise in power transmission systems. This combined
force will be a global leader in transmission power expertise, while ensuring
that AltaLink continues to provide first class services. From SNC-Lavalin’s
perspective, this new power base will provide us with the key to better meet a
crucial and increasing demand globally for the kind of services we can provide
– engineering, energy control systems, procurement, construction, operations
and training. This is clearly a win-win situation."
…
[11]
Mr. Woo also briefly
explained the concept of a deemed income tax allowance, whereby a utility is
allowed to recover projected taxes. The Respondent had assumed AltaLink paid
the $190,000,000 premium because it expected an annual income tax allowance of
approximately $30,000,000. Mr. Woo indicated the allowance will differ from
actual taxes paid due to the differing undepreciated capital cost amounts for
regulated rate purposes versus for tax purposes. He did not give any indication
of the amount of any potential benefit to AltaLink, though, as will be clearer
when discussing the expert’s evidence, the tax allowance may not have been as
significant as assumed by the Respondent.
[12]
Finally, Mr. Woo
pointed out that the financial statements of AltaLink for 2002 and 2003 as
prepared by Ernst & Young reflected the goodwill of $200,000,000, as did
the 2007 and 2008 financial statements prepared by Deloitte & Touche.
[13]
Turning now to the two
experts, I will briefly summarize their findings and opinions, starting with
Ms. Glass, the expert from KPMG put forward by TransAlta. Ms. Glass is an
expert valuator having conducted a considerable amount of work in the utilities
industry. She firstly addressed the question of what constitutes goodwill in
the TransAlta – AltaLink transaction, and secondly, provided a valuation of
TransAlta’s net tangible assets.
[14]
Before reviewing Ms.
Glass’ findings in her 85 page report, it was interesting to note that both she
and Mr. Lawritsen, the expert put forward by the Respondent, agreed that a
valuator’s approach to defining goodwill is what I call a residual approach,
that is, it is the amount by which a purchase price exceeds the Fair Market Value
("FMV") of tangible assets: in effect, it is a plug. I will have more
to say on that later.
[15]
With respect to the
identification of goodwill, Ms. Glass noted that for goodwill to exist, there
must be a least one of the following factors: excess earnings, excess return or
strategic factors. If none of these exist, there can be no goodwill.
[16]
She then went on to
raise seven factors that likely led to goodwill in this case:
I. Excess
Earnings
i. PBR;
and
ii. tax
allowance.
II. Excess
Returns
i. leverage.
III.
Strategic Factors
i.
EPCM;
ii.
Merchant Transmission;
iii.
new markets/growth; and
iv.
skilled employee base.
[17]
The following is taken
from Ms. Glass’ report:
Performance Based Regulation
…
197 At the relevant time, the Transmission
Business operated under a traditional cost-of-service model, although the EUB
and the Alberta government were
actively exploring the introduction of a PBR model. Under such a model,
efficiencies are shared between the utility and the customer, such that the
utility is able to recover an amount above that allowed under a cost-of-service
model if costs are reduced below a threshold level. Thus PBR will give rise to
excess earnings.
198 On October 6, 2000, TransAlta and a number
of interveners negotiated an augmentation to the terms of a negotiated
settlement for the Utility’s 2001 GTA, pursuant to which the parties agreed to
begin discussions aimed at achieving agreement on a PBR model. The terms of the
negotiated settlement were approved by the EUB in Decision 2001-4. As at
Closing, a PBR model was expected to be introduced in the foreseeable future.
199 The bid received from the Consortium
indicated that an element of AltaLink’s business plan would be to take an active
role in the establishment of a PBR regime. Further, in its written argument
relating to EUB Decision 2002-038 (which approved the Transaction), AltaLink
indicated that the potential for PBR benefits was one of the factors that
caused it to pay a premium for the Transmission Business.
…
201 The prospect of the adoption of a PBR model
created the potential for the Utility to generate future excess earnings. As
such, any portion of the premium relating to the potential for a future PBR
model would be appropriately allocated to goodwill.
…
Income Tax Allowance
…
133 A cost-of-service model allows a utility to
recover a deemed income tax allowance. As a limited partnership
("LP"), AltaLink was not itself subject to tax. Therefore, AltaLink
would have received an annual deemed tax allowance, but would not have been
required to pay corresponding taxes. In contrast, the corporate entities that
were the ultimate limited partners in the AltaLink structure were taxable
entities, and were required to report their share of AltaLink’s income on their
corporate tax returns. The Partners controlled AltaLink, and therefore had
access to the tax allowance, which was intended to offset the Partners’ tax
liability.
…
141 In 2003, AltaLink filed its first GTA, and
one of the issues addressed in the application was whether or not AltaLink
should be entitled to a tax allowance, given its LP status. In Decision
2003-061, the Board stated:
"On the evidence before it, the Board accepts that the partners
are taxable entities in Canada
and will assume that there is a reasonable expectation that income taxes in the
range approved by the Board will be incurred and paid by the partners with the
exception of OTPPB TEP Inc."
142 The Board then disallowed 25% of the deemed
income tax allowance, being the portion relating to OTPPB TEP Inc., the entity
representing Teachers. …
a) It leads one to conclude that Teachers was
likely not required to pay tax and, therefore, the Consortium might have
expected a tax benefit in the case of Teachers, and was frustrated in that
regard. …
…
149 The evidence indicates that, with the
possible exception of Teachers, the Partners were Canadian corporations that
paid Canadian income tax in the usual way. Since at least three of the Partners
were subject to the payment of tax on income earned by the Utility, the deemed
tax allowance cannot explain the full premium.
…
175 In summary, with the possible exception of
Teachers, it is likely that the Partners were required to pay tax on their
share of AltaLink’s earnings. Therefore, the income tax allowance would not
explain the full premium.
176 In the case of Teachers, it is possible that
the income tax allowance might have explained a portion of the premium. …
…
Leverage
211 Leverage refers to the manner by which an
investment is financed, and in particular, the percentage of equity financing
relative to debt financing.
212 When considering the capital structure
allowed by the regulator, a purchaser would prefer a higher degree of equity,
since allowed returns on equity are higher than allowed returns on debt. In
contrast, when actually financing the acquisition, the purchaser would prefer
to use a higher amount of debt, since debt can be obtained at a lower cost,
particularly once income taxes are considered.
213 In 2002, the Board allowed 35% equity and
65% debt for rate-making purposes. However, it is probable that the Consortium
would have financed the acquisition using more that 65% debt. Based on the
manner in which infrastructure investments were financed by major players at
the time, it would be reasonable to assume that the overall debt ratio would
have been 75% at a minimum, and possibly as high as 90%.
214 Based on our review of AltaLink’s financial
statements, AltaLink itself was financed using only 60% debt and 40% equity. As
such, the equity capital contributed to AltaLink by the Partners would likely
have been further debt financed by the Partners.
…
220 In summary, given the manner in which
infrastructure investments were financed in 2002, it is highly likely that a
portion of the premium paid by AltaLink related to the Consortium’s ability to
lever the investment beyond debt levels allowed by the EUB. All such additional
leverage would have arisen outside of AltaLink – that is, it would have arisen
as a result of the Partners borrowing to make their equity investments in
AltaLink. Hence, the additional leverage could not have related to the tangible
assets.
…
EPCM
…
268 … In EUB Decision 2003-061 [TransAlta’s Lost
of Documents, no. 67], the Board described this contract as follows:
"AltaLink applied for approval of an executed ten-year
exclusive contract with SNC-ATP, a subsidiary of SNC-Lavalin Inc., a 50%
partner in AltaLink partnership, to provide engineering, procurement and construction
management (EPCM) services for all capital projects undertaken by AltaLink.
These would primarily be the direct assign contracts AltaLink receives from the
AESO, potentially amounting to hundreds of million of dollars over the next
seven years"
269 …SNC would nonetheless have been willing to
pay premium value for AltaLink given that the Transaction resulted in:
a) The potential for hundreds of million of
dollars in additional revenue over the ensuing seven years, thus reducing
future revenue risk and avoiding high costs (proposals, marketing expenditures,
etc.) required to source projects elsewhere. In addition, this potential
revenue backlog would have been expected to positively influence SNC’s public
share price.
b) The transfer of 76 highly-trained
professionals that SNC could use to service not only AltaLink contracts, but
also other opportunities, thus adding to SNC’s expertise, and avoiding costs
and risks associated with recruiting, hiring and training new personnel.
…
271 In short, we are of the view that the
ability to integrate the Utility’s EPCM projects team, together with the
opportunity to enter into a 10-year exclusive contract with AltaLink would have
represented a strategic benefit to SNC.
Merchant Transmission
…
273 At the relevant time, a number of merchant
transmission projects had been proposed and these projects were expected to
become increasingly more important. The opportunity to be able to bid for these
projects and execute them using the Utility’s skilled workforce would have
represented a strategic opportunity for SNC and Trans-Elect.
…
276 It is reasonable to conclude that SNC had a
strategic focus in merchant transmission, considering its partnership with
Hydro-Québec and its participation in the construction and operation of the
MurrayLink merchant transmission line. Consequently, we would conclude that the
opportunity to add to its expertise as a result of obtaining access to the
Utility’s skilled workforce, along with increased access to opportunities arising
in the Alberta market would
have represented a strategic benefit for SNC.
277 SNC is not the only Partner that stood to
benefit from merchant transmission projects. Currently, Trans-Elect had two
multi-state projects under development: the Wyoming-Colorado Intertie, a TOT3
transmission line between Wyoming and Colorado, and the High Plains Express, which will run 1,100
miles through Colorado and New
Mexico into Arizona. On its
website, Trans-Elect outlines the experience and reputation it has gained through
its past projects and partnerships with utilities and governments, including
its acquisition of AltaLink.
…
283 …we are of the view that the Consortium
would have viewed the potential for future merchant transmission projects as a
positive factor in its analysis of the Transmission Business.
New Markets/Growth
…
248 … The value of the Utility would comprise
the value of earnings from the tangible assets sold by TransAlta, plus the
value of earnings from yet-to-be-acquired assets. The former would constitute
the FMV of the tangible assets sold by TransAlta, whereas the latter would
constitute goodwill.
…
253 As earlier noted in the Industry Overview
section of this Report, the Alberta transmission industry provided significant opportunities for growth
– and we are of the view that the potential for future growth combined with the
ability to further lever the investment, likely accounted for a substantial
portion of the purchase premium. The documents produced in the current dispute
are replete with references to future growth potential. For example, the bid
received from the Consortium [TransAlta’s List of Documents, no. 19 at pg 8]
indicated that:
"The Consortium plans to continue to support the investment of
additional capital into the development of the Alberta transmission network. In its current forecast, the Consortium has
forecast significant capital expenditures over the next five years to expand
and maintain the business."
…
255 On July 5, 2001, the Globe and Mail
contained an article quoting Mr. Leo de Bever, senior
vice-president of Teachers:
"Mr. de Bever said the AltaLink team met yesterday with
Premier Ralph Klein and Energy Minister Murray Smith to explain how the
purchase would see the province’s transmission system expanded … "We plan
to interconnect our grid both east and west and to the U.S. market in the south," Mr. de Bever said. He projected
$300-million to $500-million of capital spending at AltaLink in the next few
years to meet this goal."
Skilled Employee Base
…
291 However, the employees could have been used
not only with the regulated business but also for non-regulated business
purposes, in one of two ways:
a) Directly – by transferring the employees
out of the Utility and integrating them with the non-regulated business of one
or more of the Partners, as was the case for the Utility’s EPCM team; or,
b) Indirectly – via knowledge sharing amongst
the Utility’s employees and those of the Partners; by accessing the expertise
of the employees via informal staff rotations between the utility and the
businesses of the Partners, via conferences and meetings, etc. We recognize
that these benefits cannot be numerically quantified and, to some, they might
appear rather nebulous. However, access to knowledge and innovation is a valuable
intangible asset for which purchasers are willing to pay. As was earlier noted,
the Utility ranked as a first-quartile performer in terms of cost, reliability
and efficiency. To the extent that informal knowledge sharing of the type
described herein resulted in the Partners gaining access to a few new ideas or
processes that might save costs, improve efficiency, or improve safety
techniques in their own businesses, they would stand to benefit.
[18]
Ms. Glass concluded
this part of her opinion with a list of utilities’ acquisitions over the last
few years indicating goodwill allocation ranging from $1,000,000 to almost $2 billion.
[19]
With respect to the
second part of Ms. Glass’ report, the valuation of the net tangible assets, it
was clear Ms. Glass proceeded from a premise that in a regulatory setting,
tangible assets should be set at their NRBV:
378 In a non-regulated setting, the net book
value of tangible assets will not necessarily equal FMV. However, in a
rate-regulated setting such as that of the Utility, the NRBV of tangible assets
would be expected to equal FMV for two reasons:
a) The earnings of rate-regulated business
are inextricably linked to the NRBV of its tangible assets. This situation is
unlike that faced by a non-regulated business, where there is often little
association between earnings and the net book value of tangible assets.
b) In a rate-regulated industry, all of the
economic benefits or risks associated with the tangible assets, over and above
NRBV, effectively accrue to the customers. In contrast, in a non-regulated
setting, all such economic risks and benefits accrue to the business itself.
[20]
With respect to the
valuation itself, of the three normal approaches to valuation, Ms. Glass opined
that only the income, or in this case, the discounted cash-flow approach made
sense. She also acknowledged that the results of a discounted cash-flow
analysis will usually differ only slightly from NRBV. Not surprisingly, she
proceeded to prove her point through a lengthy technical discounted cash-flow
analysis which resulted in the value close to NRBV.
Mr. Lawritsen’s Report
[21]
Mr. Lawritsen, the
expert called by the Crown, was not asked to do a valuation of the net tangible
assets, but instead his mandate was to determine if TransAlta "received as
part of the payment any goodwill and if so, how much". I presume the
question was intended to mean whether TransAlta received any amount for
goodwill. Mr. Lawritsen was a qualified valuator though did not have an
extensive background in the utilities industry. In his report, he concluded,
"that there was a nominal amount if any paid for goodwill". He cited
three reasons:
I. The income available to an acquirer of
the Transmission Business is regulated and is tied strictly to the regulated
asset base;
II. The ability of an acquirer of the
Transmission business to increase the profitability is very limited as under
the regulatory process, efficiencies gained do not allow for ongoing cost
savings nor is the operator able to command a charge to the public above rates
set by the regulator; and
III.
Because of the nature of the Transmission
Business it is my view that the Transmission Assets are effectively an income
producing property akin to a rental property or a bond.
[22]
In effect, Mr.
Lawritsen opined that all AltaLink was buying was access to the $100,000,000
per year of earnings before interest, taxes, depreciation and amortization
("EBITDA"), which in a regulated industry is solely tied to
the net tangible assets upon which the rate of return on equity is calculated.
He described the ability to improve the operating margin as limited.
[23]
Mr. Lawritsen described
three types of goodwill arising in open market transactions:
…
9.08 Financial Synergies: This type of
synergy relates to a particular buyer or type of buyer having a competitive
advantage in their cost of capital. It is my view that financial synergies are
not pertinent in this instance. … In this instance, even if it is accepted that
market participants had a lower cost of capital than TransAlta, it is my view
that acquirers were paying for the income stream that attaches to the tangible
regulated assets.
9.09 Operational Synergies: Such synergies
relate to the ability of a buyer to realize post acquisition cost savings or
other benefits unique to its own operations. Again, it is my view that
operational synergies are not pertinent in this instance – the ability of an
acquirer to sustain an economic benefit from perceived efficiencies is limited
as the regulatory authority will subsequently take steps to reapportion the
operating costs such that any savings flow through to the customer. As such, it
is my view that goodwill attributable to operational synergies is minimal, if
at all.
9.010 Strategic Synergies: There may be
reasons for a buyer to view an acquisition as strategic in that it provides
for: access to new markets, products, brands, technical expertise, etc. As with
the case of an income producing property, it is my view that such value
attaches to the assets being acquired. …
[24]
Mr. Lawritsen did not
go through a process of valuing net tangible assets, as did Ms. Glass, as he
was not asked to do so.
Issue
[25]
Section 68 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 a taxpayer,
(a) the 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; and
…
[26]
The framing of the
issue is important in a case such as this where section 68 of the Act
is not written in terms of an amount representing FMV, in other words an
exact amount, but instead is written in terms of how an amount can reasonably
be regarded. This necessarily implies a range rather than a single definitive
amount. For example, when valuators agree on a FMV of goodwill of $100,000,000,
does that mean that $80,000,000 or $120,000,000 could not reasonably be
regarded as consideration for the goodwill? Not at all. But what if two
valuators suggested FMV was $60,000,000 and $140,000,000 respectively? Is that
now the range within which an amount can reasonably be regarded as
consideration for goodwill? Because two reputable valuators have divergent
views, is the Court bound to define a reasonable range accordingly? I am not
convinced. I only raise this to confirm my view that the
concept in section 68 of the Act of how to reasonably regard an amount cannot
be an inquiry defining one number, and then suggesting anything other than that
number is unreasonable. That would make no sense. So, why is this important in
framing the issue? Presume I were to find that the range in this case is
zero to $190,000,000. If I framed the question in terms of whether the
Minister’s reallocation of zero can reasonably be regarded as consideration for
goodwill, I would have to answer yes (given the range) and the Appellant would lose.
But if I frame the question in terms of whether the arm’s length parties’
allocation $190,000,000 could reasonably be regarded as consideration for
goodwill, again I would have to answer yes (given the range) and the Appellant
would win.
[27]
The Appellant suggests
section 68 of the Act revolves around the reasonableness of the Parties’
allocation, not the Minister’s reallocation. I agree that that is the
appropriate starting point for the analysis. The first issue, therefore, in a
section 68 analysis is: can the amount the arm’s length parties agree to
allocate to the asset reasonably be regarded as consideration for that asset,
in effect, fall within the range of what is reasonable? If it can be,
then section 68 of the Act is simply not engaged. If it cannot be, then
a reallocation is in order.
[28]
It is important to keep
in mind who is doing the reasonable regarding and in what context. If I ask the
Parties to the Agreement or KPMG or those in the utilities industry whether the
$190,000,000 can reasonably be regarded as consideration for goodwill, I would
get a resounding yes. If I ask Mr. Lawritsen’s firm, Meyers Norris Penny LLP or
officials from the Canada Revenue Agency, I would get a resounding no. If
I ask the man on the Clapham omnibus, with all due respect to him, he would not
have the foggiest idea what I was on about. If section 68 of the Act is
engaged, it is the Judge who makes the call on what is reasonable. But the Judge
does so on the basis that the determination of a reasonable allocation is for
the purpose of applying the appropriate tax to the sale of property: that is,
some asset must be sold at a certain amount that will attract some level of
tax.
[29]
Returning then to
framing the issue, if I find the Parties’ allocation of $190,000,000 cannot
reasonably be regarded as consideration for goodwill, what question comes next?
It is not whether the amount CRA allocated (in this case zero) can reasonably
be regarded as consideration for goodwill: a reasonable range should be
determined. Once a range is established, great weight should be given to the arm’s
length Parties’ agreement, and the end of the range closest to that agreement
should govern.
[30]
[31]
This discussion of
framing the issue for a section 68 analysis presumes there is agreement as to
the assets being sold, and the analysis revolves around the allocation between
or amongst those assets. In this case, however, one side denies the very
existence of the asset: the Respondent’s position is that goodwill was not part of the
transaction as there simply was no goodwill for Transalta to sell. Before there
can be an allocation, there must be a determination as to whether, for tax
purposes, goodwill was an asset of Transalta which it sold to AltaLink.
[32]
In
summary, the issues in this appeal are:
i. was
goodwill one of the assets sold by Transalta to AltaLink? If not, Transalta’s appeal
must be dismissed.
ii. if so, can the
amount of $190,000,000 allocated to goodwill by the Parties to the Agreement
reasonably be regarded as consideration for goodwill? If so, Transalta’s appeal must
be allowed.
iii. if not, what
amount can reasonably be regarded as consideration for goodwill?
Analysis
(i) Was goodwill sold by Transalta to AltaLink?
[33]
I will start this
analysis with a wonderfully written description of goodwill, often referred to,
from the judgment of Lord Macnaghten in the House of Lords decision of The
Commissioners of Inland Revenue v. Muller and Co.’s Margarine Limited:
… 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 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.
…
[34]
This definition
confirms that goodwill is amorphous: it will vary from one industry to the
next, one business to the next. It is a moving target. It is one of those
"I will know it when I see it" things. It is what must drive those in
more exact professions, accountancy for example, crazy. It is no surprise,
therefore, that experts from that profession, steeped in principles of
valuation and exactitude define goodwill as simply a number, the number between
the purchase price and the amount attributed to tangible assets. This residual
approach to goodwill, approved by both experts in the case before me, is less a
definition and more simply a formula, not quite what Lord Macnaghten had in
mind. I am reluctant to adopt the residual value definition as the defining legal
test for purposes of applying section 68 of the Act. It may be that
for accounting purposes, goodwill is not truly even an asset, but simply a
plugged-in number. This may have a benefit of certainty, but it lacks depth of
inquiry into the real nature or even existence of the asset. And for tax
purposes, that is what is required as goodwill is considered an asset, an asset
with some value.
[35]
There is no doubt the
Parties intended to, and did, agree to include goodwill as part of the
transaction. It was defined in the Purchase and Sale Agreement and obviously a
significant dollar amount was attached to it. The Respondent claims that this
significant amount, the Premium, was no more than an increased price for the
tangible assets, as it was only from those hard assets, that AltaLink could
make any return, given the return was regulated in the industry based on those
hard assets. Transalta counters that there were several factors that went
beyond reasons for paying more for hard assets and went directly to what would,
in commercial circles, be considered goodwill. I agree with the Appellant.
[36]
The following are the
items that the Appellant raised as constituting goodwill:
(i) EPCM
(ii) Market transmission
(iii) New markets/growth
(iv) Skilled employee base
(v) Ability to take
advantage of new Performance Based Regulation regime ("PBR")
(vi) Tax allowance
(vii) Leverage
I will have more to say about whether all of these
constitute goodwill when discussing the reasonableness of the allocation, but
for now, for the purposes only of determining if there was any goodwill at all,
I can readily identify the merchant transmission, skilled employee base, and,
hand-in-hand with that, the EPCM elements of the sale as falling squarely
within the Macnaghten definition. These factors, I believe, all go directly to
the retention and expansion of a profit producing customer base, and cannot and
should not be considered as part of the value of the tangible assets. Further,
a skilled employee base operating in an efficient manner can eke out more
profit from an existing client base even within a regulated industry. These
factors very much represent that intangible element of what Transalta had to
offer to a purchaser. I conclude it is goodwill.
[37]
The Crown’s objection
is that such factors do not bring dollars in the door, which the Crown argues
is key to any definition of goodwill. I disagree. The Crown suggests the
goodwill cannot arise from increased profits from an existing customer base.
Why not? Even the Crown expert acknowledged in his report there can be
operational synergies creating an economic benefit from efficiencies, but he
suggested the ability to do so in a regulated industry is limited. That goes to
allocation of the amount of goodwill, not to the very existence of goodwill:
indeed, it acknowledges the existence of goodwill. And, in fact, Transalta
created significant additional profits from its efficient cost-conscious
culture. That is something to take to the bank and something a buyer would pay
for. That is goodwill.
[38]
Even if I were to
accept the Respondent’s theory of goodwill that it requires more dollars in the
door, an expanded customer base, I find that Transalta’s positioning to take
advantage of merchant transmission, and to expand markets in the regulated
industry itself, fit well within goodwill as defined by the Crown.
[39]
Black’s Law Dictionary
has defined goodwill as the difference between the purchase price and the value
of the assets acquired. This implies goodwill is not in and of itself an asset.
Cases have relied on this residual price definition of goodwill (see for
example Les Placements A & N Robitaille Inc. v. The Minister of National
Revenue
and Teleglobe Canada Inc. v. R.)
but, as this case reveals, there is a fine distinction between value
attributable to goodwill and value attributable to reasons why a purchaser may
pay more for tangible assets. While not discounting the usefulness of the
residual price definition, in this case my preference is to rely more on the
definition proposed by Lord Macnaghten as it is a greater attempt to identify
what is really being sold as an asset.
[40]
The residual approach
unquestionably makes life easier for the valuator as it requires the simpler
task of evaluating the tangible assets. I prefer to come at the issue more in
terms of attempting to define what exactly AltaLink was buying from Transalta,
as this is a case about establishing proceeds of disposition from a sale of
something for tax purposes.
[41]
Although at trial Mr.
Lawritsen, the Respondent’s expert, made it clear he was of the view there was
no goodwill, his report acknowledged that there could be a nominal amount
allocated to goodwill – some acknowledgement that goodwill was an asset
Transalta had to sell. Having concluded there is goodwill, for the balance of
this analysis, I will, therefore, proceed on the basis that the Respondent’s
allocation to goodwill is one dollar.
(ii) Can $190,000,00
be reasonably regarded as consideration for goodwill?
[42]
The Appellant’s
position is that once it is established the Parties conducted hard bargaining
in coming to the allocation, the reasonableness of the allocation has been
proven and can only be overcome by the Respondent proving a clear or patent
unreasonableness in the allocation. The Appellant argues this is the correct
approach for the Court to follow based on the case law to date surrounding the
application of section 68 of the Act. This is an appropriate time to
review that case law, which, somewhat surprisingly, is not extensive.
[43]
The key case on section
68 of the Act, comes from the 1986 Supreme Court of Canada decision of The
Queen v. Golden.
Interestingly, four judges found section 68 of the Act did not apply,
while three found it did apply, while all seven agreed the allocation by the
parties in that case was reasonable, notwithstanding a valuation from the Crown
far below the amount allocated by the Respondent to the property. Also, it is
to be noted that Golden had more to do with the interpretation of
section 68 of the Act as to its applicability to property and something
else other than property, than to the correct approach or method in engaging
section 68 of the Act. With respect, it provided little by way of an
analytical road map. It certainly made no use of the term "hard bargaining",
though the Supreme Court of Canada clearly agreed with the Federal Court of
Appeal in placing great weight on the fact the agreement on allocation was
between parties dealing at arm’s length. As Justice Heald stated at the Federal
Court of Appeal in George Golden v. The Queen:
… It is my opinion that the correct approach to a section 68
determination would be, as suggested by the above authorities, to consider the
matter from the viewpoint of both the vendor and the purchaser and to consider
all of the relevant circumstances surrounding the transaction. Where, as in
this case, as found by the Trial Judge, the transaction is at arm’s length and
is not a mere sham or subterfuge, the apportionment made by the parties in the
application agreement is certainly an important circumstance and one which is
entitled to considerable weight. …
[44]
Also, Chief Justice
Thurlow at the Federal Court of Appeal stated:
…
Given that the agreement was reached between parties who were
dealing at arm’s length and that it is not a sham or subterfuge, it appears to
me that, notwithstanding the evidence of respective values on which the learned
trial judge relied, the amount that can reasonably be regarded as the proceeds
of disposition of the depreciable assets included in the transaction,
irrespective of the form or legal effect of the contract, operating as it does
only to govern the rights of the parties inter se, was the $750,000 for
which the vendors agrees to sell and the purchaser agreed to purchase them.
…
[45]
Shortly after the Golden
decision, Justice Rip decided the case of R.L. Petersen v. The Minister
of National Revenue,
a case involving the sale of a daycare centre. In applying section 68 of the Act,
Justice Rip commented:
… Where an agreement, although evidencing neither sham or
subterfuge, stipulates an amount which is clearly unreasonable in the
circumstances, it is still very much open to the Court to conclude that section
68 should apply to reallocate the proceeds in a reasonable manner.
In the case at bar there is no evidence, nor did the respondent even
suggest, the agreement in issue was a sham or subterfuge. However, the
appellant’s claim of $45,000 to goodwill is suspect. The business operated
throughout its existence with losses and there was no indication of any change
in the future. The evidence also indicated that problems existed with respect
to the operation and licensing of the business.
…
The lack of any foundation for a value to goodwill in the business
sold, let alone a value of $45,000, coupled with the absence of bargaining
between the purchaser and vendor in allocating the purchase price would
ordinarily lead me to conclude the allocation, in which approximately 30% of
the purchase price is said to be for goodwill, is not reasonable.
…
[46]
Cases prior to Golden
do make mention of the concept of hard bargaining in the application of the
section 68 of the Act. In the case of Dr. Harold Robbins v. The
Minister of National Revenue,
Chairman Cardin summarized his approach as follows:
…
As I understand it, though expressed in different terms in the
various decisions cited by both counsel, the key to the interpretation and the
application of section 68 is that the allocation of value of various assets, in
a contract, to be accepted by the taxing authorities and binding by the parties
must be, as suggested by counsel for the appellant, the result of a mutual
decision between the vendor and purchaser. However, in order to determine
whether the allocation is in fact based on a mutual decision, the Courts have
introduced the consent of "the genuinely negotiated apportionment which
results from bargaining between the parties to the agreement". The onus of
establishing that the allocation was arrived at by mutual consent after genuine
bargaining rests on the appellant. If he fails to satisfy that onus, the
allocation stipulated in the agreement is not decisive and the reasonableness
of the allocation for tax purposes must be determined on other grounds "irrespective
of the form or legal effect of the contract or agreement".
…
[47]
As stated earlier, I
find these cases do not comprise extensive authority with respect to the
approach to section 68 of the Act, though there are some common threads
to build upon. In answering the question whether the allocation of price to an
asset made by the parties to an agreement can reasonably be regarded as consideration
for the asset, I will be guided by the following principles.
(i) where there is sham
or subterfuge, a section 68 analysis is engaged and the Court shall determine a
range for a reasonable allocation considering the following factors:
- the
nature of the industry, including industry norms,
-
the nature of the asset,
-
the fair market value
of the asset,
-
the context of the
transaction,
-
the foundation for the
Respondent’s allocation,
-
any other relevant
factors.
If the Crown’s allocation falls within the range of
what is reasonable, it shall govern. This is not the situation before me.
(ii) If the Appellant
and the other party to the sale agreement have not agreed to the allocation
sought by the Appellant, the Court shall determine a range for a reasonable allocation
considering the factors set out in (i) above as well as considering:
-
the allocation in the
agreement, if any; if not, the foundation of the Appellant’s allocation,
-
if there was an agreed
allocation then:
·
whether the parties
were dealing at arm’s length
·
the relative equality
of the parties’ respective bargaining positions
Again, this situation does not apply in the case
before me, so it is unnecessary to determine at what point in the range the
allocation should be pegged.
(iii) Where arm’s length
parties to an agreement for sale have agreed on the allocation submitted by the
Appellant, evidence of real bargaining with respect to the allocation between
such parties with relatively equal bargaining positions is prima facie
proof of the reasonableness of the allocation.
(iv) The Respondent can
only challenge such finding of reasonableness by proving a fundamental mistake
in the foundation of the parties’ agreement: a difference of opinion on value
would not be sufficient.
(v) If the Appellant has
failed to meet the requirements in principle (iii), the Court shall determine a
range of what is reasonable, and where there is an agreed allocation between
arm’s length parties to the agreement, the amount within the range closest to
the parties’ agreed allocation shall be the reallocated amount for purposes of
section 68 of the Act. In determining the range, the Court shall
consider:
-
the nature of the
asset,
-
the nature of the
industry including industry norms,
-
the context of the
transaction,
-
the fair market value
of the asset,
-
any other relevant
factors.
Were Transalta and AltaLink dealing at arm’s length?
[48]
Yes, the facts clearly
establish an arm’s length relationship.
Did
Transalta and AltaLink have relatively equal bargaining positions?
[49]
Certainly, with respect
to the overall negotiation of the purchase and sale, Transalta and AltaLink
were on an equal footing. Both were corporations of some considerable means,
with the ability to engage professional advisors to assist in the negotiation
and finalization of the deal. This was by no means a David and Goliath
situation.
[50]
With respect to their
respective bargaining positions concerning the question of allocation itself,
there was some evidence from Mr. Woo as to Transalta’s position, and he speculated
as to AltaLink’s position. The experts likewise speculated as to AltaLink’s
position and, not surprisingly, their views differed. Before addressing the
Parties’ positions, I note that sales in this regulated industry often took
place at NRBV for the hard assets, exactly where the Parties ended up.
[51]
There is agreement that
Transalta’s position on the allocation was that it was more advantageous for
them to have as much attributable to goodwill as possible. Having heard the
experts’ views on the value of the tangible assets, I find Transalta’s original
position that something less than NRBV should be allocated to the tangible
assets was likely wishful thinking. From AltaLink’s perspective, the key figure
for them was the NRBV, as that was the figure on which their return would be
based. Understandably, they would be reluctant to agree to anything less than
NRBV for the allocation to tangible assets. But did they care if more than NRBV
was allocated to tangible assets or goodwill? We have no direct evidence from
anyone from AltaLink on that point and differing views from the experts.
I conclude that given the similar rates for capital cost allowance or
depreciation between the tangible assets and eligible capital property under
the provisions of the Act, and given the amount involved for any
possible tax shielding was limited, that it would have made little difference
to AltaLink which way the allocation went over and above NRBV. I conclude that,
while the bargaining positions in the overall deal were equal, Transalta had a
stronger hand when it came to the allocation due to AltaLink’s indifference
beyond NRBV.
Did the Parties engage in "hard" bargaining?
[52]
It follows from what I
have just said that the bargaining on the issue of allocation only went so far
as get to the NRBV, but no further. From Mr. Woo’s description of the two-week
negotiations, and from a review of summaries made at the time with respect to
those negotiations, it appears this was a typical exchange of views, horse
trading, as Mr. Woo put it, in a major commercial transaction. The Appellant
put great emphasis on the concept of "hard bargaining", whatever that
might mean. I suppose evidence of considerable back and forth, with strongly
worded letters from both sides as to how critical their particular position is
on a certain item would constitute hard bargaining; whereas, a concession
following a first request may be soft bargaining or indeed no bargaining at
all, passive acceptance perhaps. Rather than trying to define bargaining by
attaching such a general adjective as "hard" to it, my preference is
to look at the circumstances surrounding the bargaining (parties’ positions,
importance to the deal, nature of the issue, magnitude of dispute, nature of
negotiations, time spent, etc.) and determine if cumulatively these
circumstances demonstrate that each side reluctantly had to give something up
to reach a compromise agreement.
[53]
In conducting such a
review of the Transalta/AltaLink negotiations, I conclude that the
bargaining regarding allocation of price was minimal, the amount was not
significant in the context of the overall deal, there was an indifference on
one side and the Parties ended up where the industry norm and business logic in
the regulated industry would naturally take them. I see little compromise.
[54]
In these circumstances
(respective bargaining positions and minimal bargaining on allocation), I am
not satisfied that the Appellant has made the prima facie case of
reasonableness. I find it is necessary for the Court to determine the range of
reasonableness for the purposes of a section 68 reallocation.
[55]
Before getting into the
factors to consider in determining a reasonable range, I want to be clear that
great weight is still to be attached to the arm’s length parties’ agreement: in
the circumstances before me, their agreement is simply not conclusive. I will
consider other factors.
Nature of asset
[56]
I have determined
goodwill was an asset sold as part of the transaction. I need not revisit
my reasons in this regard. I rely on a definition of goodwill other than the
"residual price" definition, notwithstanding such definition’s
acceptability in accounting circles and to some degree, in legal circles. My
concern with the residual price definition is that it would, by its very
definition, sweep into goodwill an amount that really represents the reason why
a purchaser might pay more for tangible assets rather than payment for the
separate asset – goodwill. This is important not only when determining goodwill
exists as an asset being sold, but also in attempting to put a price on the
goodwill. As discussed earlier, under any definition of goodwill, I am prepared
to find goodwill as part of this transaction. But in attempting to allocate
price to the asset, I agree with the Respondent that I must draw
distinction between what constitutes the asset and what are simply reasons why
a purchaser would pay more for the tangible assets.
[57]
The Respondent cites
the example of R. v. Jessiman Brothers Cartage Ltd.
Jessiman that involved the sale by a private enterprise of a fleet of
postal trucks to Canada Post, upon the Government’s decision that Canada Post
take over the responsibility for mail transportation. In effect, the Government
needed the fleet and was prepared to pay an "operational value" of approximately
$91,000. The trucks had a trade-in value of only $57,000. The Court ruled:
13. … I see no merit in the proposition that
the amount over and above their trade-in value was paid for something other
than the trucks simply because the Post Office has an immediate need for them
"as is" and was prepared to pay that extra amount to satisfy that
need.
14. While its context was very different, the
essential question here is really quite similar to that considered by Jackett,
P, as he then was, in Ottawa Valley Power Company v. Minister of
National Revenue, [1969] C.T.C. 242, 69 D.T.C. 5166. There the
taxpayer had a long-term contract to sell 25 cycle power to Ontario Hydro.
Sixty cycle power was needed. It was estimated that the cost to Ontario Hydro
of its own facility to convert the power would be about $2.5 million while the
cost of modifying the taxpayer’s facility would be less than $2 million. The
modification was done by Ontario Hydro and, in support of its claim to Ontario
Hydro’s expenditure as its own capital cost for tax purposes, the taxpayer
contended that it had given up, as consideration, its "bargaining
position". At page 252 [5172-3] President Jackett observed:
With great respect, it seems to me that this contention is based on
a confusion of thought. I may have a good "bargaining position" as
consideration. I use the "bargaining position" as a means of
persuading the other party to give me more than he otherwise would for the
property or other consideration that I have to dispose of.
…
16. The other "nothing" is said to be
the fact that it had a fleet in being, not just 60 individual trucks, that it
had maintained its drivers and sold, in addition to the trucks regarded as so
much iron, an operating entity and that the Post Office paid for that in order
to satisfy its imperative of uninterrupted service. That "nothing",
which was variously stated, was really the defendant’s bargaining position
which led the Post Office to pay the operating value rather than the market
value for the trucks.
17. I have come to the conclusion that no part
of the $91,675 can reasonably be regarded as consideration for anything other
than the 60 trucks and that the plaintiff’s actions must succeed.
…
[58]
I interpret the Court as
saying that the purchaser’s reasons for buying, or its bargaining position, is
not goodwill of the vendor. Canada Post was just buying trucks and nothing else
from the vendor. The situation before me is not as simple as the sale of
trucks, but I believe that some of what the Appellant calls goodwill, based on
a residual value definition, really represents reasons why AltaLink paid more
for the tangible assets.
[59]
Two areas that the
Appellant claims constitute goodwill, I find are reasons particular to AltaLink
and have nothing to do with any goodwill that Transalta has created or
developed.
[60]
The first area of
concern is the leverage AltaLink could achieve by structuring its affairs
through a partnership for carrying on the electrical transmission business. It
is unnecessary to describe in any more detail than is described by Ms. Glass
(see the section entitled "leverage" in paragraph 19 of these
reasons) the concept of leverage. It is entirely a function of how AltaLink
financed the operations – nothing to do with anything Transalta did or created
to maintain or increase its customers. It is, from AltaLink’s perspective, a
reason it wanted into this regulated industry. It was how AltaLink could get
more return from the NRBV, not how Transalta was able to get more return. Transalta
was not selling AltaLink any particular asset that could be tied directly to
AltaLink’s ability to leverage its investment. Transalta was selling its
business and AltaLink could arrange its affairs to get some additional benefit
from the return on the NRBV.
[61]
Even considering a residual
price definition of goodwill, does the amount of the premium that relates to
the leverage fall into goodwill as part of the residual plug? No. The flaw in
the plug approach is that it does not recognize that a reason, like leverage,
for paying more for a business attaches to the income-producing assets of the
business and is more aptly part of their value. It is a fine distinction, but a
distinction nonetheless.
[62]
On the same basis, I
reach a similar conclusion with respect to the tax allowance element of what
the Appellant contends is part of goodwill. Again, reviewing Ms. Glass’
explanation of the tax allowance, it does not pertain to anything Transalta was
selling other than the hard assets. It results in part due to how AltaLink structured
itself. Why call that an asset of Transalta, other than by having to rely on
the residual price definition, but even then, I find that the benefit of the
tax allowance is more attachable to tangible assets than to anything else?
[63]
All other elements that
the Appellant contends make up goodwill, I accept. All of them (PBR, EPCM,
merchant transmission, new markets/growth and skilled employee base) all have
value as they go to what Transalta created or developed to maintain or expand
its customer base, and consequently it owned something – goodwill – to sell.
AltaLink would do well carrying this business forward because Transalta had
created an efficient, cost conscious organization that would flourish under a PBR
regime: it had created an EPCM contingent geared to prosper in both a regulated
and non-regulated setting: it had positioned itself to take off into the
merchant transmission regime and similarly positioned itself by reputation and
otherwise to grow and enter new markets: it did all this through the creation
of a well qualified skilled employee base. That all was significant and it was
something Transalta had to sell and was certainly something AltaLink was happy
to buy. It had some considerable value.
Nature of industry
[64]
There are only a couple
of points I wish to make regarding the industry. First, the Respondent argues
there can be no goodwill in a regulated industry and consequently no value can
attach to it. I simply disagree. Transalta has shown it can produce more profit
than anticipated in a regulated industry. It has shown it can position itself to
take advantage of future opportunities. It can create a reputation. It is a
business with some restrictions, but a business nonetheless that I find can
have goodwill to sell.
[65]
The second point is
that the evidence was that the sale of hard assets in the industry at NRBV was
the norm. The Respondent’s response was that that does not make it right. Maybe
so, from the Respondent’s perspective, but as I have tried to make clear,
section 68 of the Act is not about only one number being reasonable. It
is about considering several factors and determining a range of what can
reasonably be regarded as consideration for the goodwill. How can the industry
norm simply be ignored in a search for what is reasonable? It cannot. Yet, I
acknowledge the industry norm is not based on determining a value for goodwill
for tax purposes. Also, it would not be in the industry’s best interest to
allocate nothing to goodwill. All to say the industry norm and the fact that professional
accounting firms continued to account for the goodwill in AltaLink’s books is
indicative, but not conclusive of value.
Context of transaction
[66]
The context of the
transaction was not the isolated sale of hard assets. The agreement was very
clear that it was the sale of Transalta’s business and all that entailed.
AltaLink was not starting afresh simply with some of Transalta’s transmission
lines that it would buy and somehow turn into something different. It was
buying all the expertise, efficiencies and those other nebulous traits of a
business being sold in toto. I find support for some considerable value
attaching to goodwill in such circumstances.
Fair Market Value
[67]
Mr. Lawritsen was not
asked to conduct a valuation analysis, yet he had certainly opined that there
was minimal value attached to the goodwill. Ms. Glass was asked to conduct a
valuation analysis, and relying on a residual value approach, having valued the
tangible assets, she concluded the goodwill was the excess amount, being the $190,000,000.
It would be far too easy to suggest that two reputable valuators necessarily
set the range of what is reasonable. This would ignore the Court’s concern
about relying on a questionable definition of goodwill, and effectively deprive
parties of a proper judicial hearing.
[68]
Where, as in this case,
there is an agreed allocation between arm’s length parties, I am of the view
that the end of the range of reasonableness closest to that bona fide
agreement is the just price for purposes of a section 68 reallocation. Given
that, and given that I found Ms. Glass’ support of some considerable value
attributable to goodwill persuasive, my approach in this case is to start with
the agreed allocation by the Parties and determine what amounts, if any, should
be deducted from it to get to the top end of the reasonable range. There is no
need then to attempt to determine the other end of the range.
[69]
I have concluded that
amounts attributable to leverage or tax allowance, that Ms. Glass included in
her valuation of goodwill, are not part of the asset that Transalta had to
sell; consequently, something must be deducted from the agreed allocation of
$190,000,000 to reflect those amounts.
[70]
With respect to the tax
allowance, AltaLink may have anticipated some greater benefit than it
ultimately received, but it did pay the higher price in the expectation of some
amount for the tax allowance. The Respondent assumed the allowance was as much
as $30,000,000 a year, which would explain a significant portion of the
premium. Ms. Glass opined that only a small portion of the premium might have
been paid as a result of the tax allowance. She was of the view that the
Respondent’s calculation of a tax allowance benefit ignored the reality that
AltaLink, the partnership, would have to fund the partners’ obligation to pay
the tax. The only real possible benefit was in connection with the one partner,
Ontario Teachers Pension Plan Board, who may not have had to pay tax. As
it turned out, in 2003 the Board disallowed 25% of the deemed tax allowance,
being the portion related to Ontario Teachers Pension Plan Board. One further
fact to consider is that, according to Ms. Glass, in 2001 the actual tax
allowance was just under $20,000,000. Taking all this into account, I find Ms.
Glass’ opinion that the benefit of the tax allowance was significantly less
than what the Respondent claims more persuasive: at best, 75% of $20,000,000 a
year or $15,000,000 a year, with an expectation, again according to Ms. Glass,
that tax rates were declining. Noting that the partners would be obliged to pay
the tax in any event, I conclude a reasonable amount of the premium
attributable to the tax allowance is the range of $25,000,000 to $50,000,000.
[71]
With respect to the
portion of the premium that is attributable to leverage, it was acknowledged by
Ms. Glass that "the consortium would have been able to consistently earn a
higher return by structuring the transaction using additional leverage…".
She anticipated this possible return around 2%, which, interestingly, is close
to what Transalta achieved above the regulated rate due to the efficient
managing of its operation; such percentage representing approximately
$5,000,000 to $6,000,000 a year. A reasonable value for such a deemed benefit
for leverage would be approximately $25,000,000.
[72]
I conclude that a range
of $50,000,000 to $75,000,000 represents amounts attributable to the premium
that do not relate to any goodwill Transalta was selling. They relate more
closely to the rate of earnings based on the NRBV of the tangible assets, and
specifically AltaLink’s ability to eke out more return from those assets, not
due to anything Transalta did to retain or expand its customer base and are,
therefore, properly allocated to those tangible assets. This is not an outright
rejection of Ms. Glass’ valuation of the tangible assets. My sense of that
elaborate valuation was that some minor tweaking of assumptions (tax rates for
example) could cause a several million dollar difference. There was room for
some flexibility in that valuation that could accommodate a $50 million dollar
difference.
[73]
I conclude that the
upper end of the range of what can reasonably be regarded as consideration for
goodwill sold by Transalta to AltaLink is the amount agreed to by Transalta and
AltaLink less $50,000,000. I therefore allow the appeal and refer the matter
back to the Minister for reassessment on the basis that $140,824,476 is to be allocated
to goodwill. Costs to the Appellant.
Signed at Ottawa, Canada, this 13th day of July, 2010.
“Campbell J. Miller”
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