Reforestation Obligations Don’t Increase Arm’s Length Proceeds of Disposition in Daishowa-Marubeni Decision

It is with some considerable relief that we report on the recent decision of Daishowa-Marubeni International Ltd. (2013 SCC 29). In this unanimous decision of the SCC rendered by Justice Rothstein, sanity and commercial common sense has prevailed.

The Daishowa-Marubeni decision considered whether the vendor of a forest tenure is required to include in its “proceeds of disposition” for the sale, as separate consideration, an estimate of the cost of the associated reforestation obligations assumed by the purchaser. The Court adopted a commercial approach holding that the reclamation obligations in issue were “embedded” in the property to which they related and thus affected the value of that property. Accordingly the reclamation obligations did not constitute a separate liability of the vendor as argued by CRA. As a result, the Court held that a purchaser’s assumption of such an embedded obligation does not constitute an assumption of a distinct existing liability of the vendor and, therefore, does not give rise to an amount that should be included in the vendor’s proceeds of disposition.

This writer finds it hard to believe that CRA took this case to the mat. Two arm’s length parties had agreed on the sale of a forest products company. Included in that transaction was the assumption of certain statutory reforestation obligations that come with and are embedded in the Forest Tenures that were being acquired. CRA took the position that the price paid by the purchaser included the value of all of the contingent, assumed reforestation obligations notwithstanding that the purchaser was on the hook for those obligations from the date of the completion of the sale merely as a consequence of buying a business that included forest tenures. As a result CRA took the view that the proceeds of disposition had been understated.

Sometimes one just has to wonder why it is that CRA takes a very legalistic approach instead of undertaking a reasoned and common sense approach in pursuing what should have been a clearly desirable policy result under the Tax Act that was fully supportable at law as the SCC has stated. Had this gone the other way, Big Government would have been in the position to second guess every purchase and sale deal in the country. It’s true, it is official CRA Policy – if in doubt – just say NO – just take the worst position and make the taxpayer pay through the nose to fight it! It is a very troubling aspect of what is otherwise an excellent and most important professional arm of our government’s financial administration.

Another classic example of this wrong headed completely legalistic approach was CRA’s pulling of the IT on interest deductibility as a result of the 1987 SCC Bronfman Trust case which resulted in the creation of some draft legislation to amend s.20(1)(c) that has never become law. A more careful reading of the case could have allowed CRA to carry on business as usual but instead they took the worst possible interpretation of that SCC decision (which itself is internally inconsistent) so that no one could accuse them of wasting taxpayers’ money.

In this case, the corporate taxpayer sold two forest tenures in Alberta. The purchasers assumed the concomitant reforestation obligations under Alberta’s regulatory scheme. The Minister added to the taxpayer’s proceeds of disposition of the forest tenures the estimated cost of the reforestation obligations assumed by the purchasers. The following quotations give you an idea of some of the mental gymnastics engaged in by the courts to get the right answer:

“[40] However, DMI’s argument that the reforestation obligations should not be included in its proceeds of disposition because they are a “contingent liability” is misplaced and appears to have caused some confusion in the courts below. The argument is problematic because, in focusing on whether the reforestation obligations are contingent or absolute, it implicitly accepts that the cost of reforestation is a liability of the vendor that is not embedded in the forest tenure and would constitute proceeds of disposition but for the contingent nature of the liability; see Frankovic, at p. 4. This implicit assumption is incorrect. As I have explained above, the cost of reforestation is not a distinct existing liability of the vendor. The assumption of the cost of reforestation would thus be excluded from proceeds of disposition independent of whether the cost is absolute or contingent. Using the example of the sale of a building in need of repair, the purchaser’s assumption of the future cost of repairing the building is not part of the sale price of the building regardless of whether the purchaser is certain he will have to spend a specific amount on repairs in the future — such that the cost is absolute — or the requirement for repairs depends on some future event — such that the cost is contingent. The certainty or likelihood of the cost of repairs may, of course, affect the sale price by affecting the amount the purchaser is willing to pay for the building. It does not, however, affect whether the cost of repairs is part of the proceeds of disposition. The same is true of the reforestation obligations embedded in a forest tenure.

Avoidance of Asymmetrical Tax Treatment

[41] The approach advanced by the Minister would lead to asymmetry between the vendor’s proceeds of disposition and the purchaser’s adjusted cost base at the time a forest tenure is acquired. The Minister’s position is that the purchaser’s adjusted cost base upon acquiring a forest tenure does not include the estimated reforestation obligations assumed. Notwithstanding that, the Minister would have the vendor’s proceeds of disposition include the amount paid to the vendor plus an additional amount for the estimated future reforestation obligations assumed by the purchaser. The effect would be to tax the vendor as if the reforestation obligations assumed by the purchaser were part of the sale price, but to tax the purchaser as if the reforestation obligations it assumed were not part of the sale price; see P. W. Hogg, J. E. Magee and J. Li, Principles of Canadian Income Tax Law (7th ed. 2010), at p. 322, which explains that a taxpayer’s adjusted cost base generally includes the purchase price of the property, as well as any expenses or fees required to associated with the acquisition of the property.”


Tags: Article; Tax; William (Bill) H. Cooper