On May 23, the Supreme Court of Canada (SCC) rendered its much anticipated decision in Daishowa-Marubeni International Ltd. v. The Queen, 2013 SCC 29 involving the taxation of assumed reforestation obligations. This decision, which was favourable to the taxpayer, should be of particular interest to forestry, mining, oil and gas and real estate companies that have entered into asset purchase agreements in which the purchaser assumes responsibility for reforestation, rehabilitation or reclamation obligations.
Daishowa-Marubeni International Ltd. (DMI) sold two Alberta pulp mill businesses to third parties in two separate assets sales, for a purchase price of $169 million and $6.1 million, respectively. Included among the assets were forest tenures that allowed the holder thereof to cut and remove timber from an area of land owned by the province of Alberta. These tenures imposed a future obligation on the owner to reforest lands covered by the tenure. At no point during the time in which it held the tenures did DMI claim a tax deduction for the estimated future reforestation obligations, although it did maintain a reserve in respect of those future obligations on its balance sheet as required under accounting principles.
Under provincial rules, the tenures could not be transferred unless the associated reforestation obligations were also assumed by the new owner. Thus, the parties estimated the cost of each reforestation obligation and reduced the purchase price accordingly. A contingent amount of approximately $11 million was specified in the purchase agreement for the larger mill, with the parties agreeing to make adjustments if a final estimate of the reforestation obligations was higher or lower than the preliminary estimate. For the smaller mill, the purchase agreement did not specify an estimated cost of performing the reforestation obligations, although DMI had taken an accounting reserve of approximately $3 million in respect of such future costs.
When reporting the asset sales for tax purposes, DMI did not include the estimated amounts of the reforestation obligations in its proceeds of disposition. The Minister reassessed DMI to include such amounts in respect of both sales. More specifically, the Minister’s position was that the obligations assumed by the purchaser were part of the sale price to DMI but not part of the purchase price to the acquirer.
DMI appealed to the Tax Court of Canada (the “TCC”), where it was largely unsuccessful. The TCC did, however, hold that a discounted value of the estimated reforestation obligation (rather than the full value specified in the purchase agreements and/or the financial statements) should be included as proceeds. The Federal Court of Appeal (the “FCA”), in a two-to-one decision, also ruled against DMI, but held that DMI was required to include the entire estimated cost of the reforestation obligations in its proceeds of disposition.
The SCC, in a unanimous judgment, reversed the decision of the FCA and held that DMI was not required to include any estimated cost of reforestation in its “proceeds of disposition” for tax purposes. The Court held that the reforestation obligation was not a distinct existing liability, but rather was “embedded” in the timber rights by virtue of the Alberta regime. As such, the reforestation obligations were simply future costs that reduced the value of the timber rights (i.e., more akin to anticipated future repairs on a building than a mortgage encumbrance). That the parties agreed to an estimated future cost, and that DMI may have previously estimated such future costs for accounting purposes, were both immaterial considerations. Interestingly, the Court also held that the element of contingency was also immaterial: as a general rule, “embedded” obligations should be excluded from proceeds of disposition regardless of whether such obligations are contingent or absolute.
The SCC noted that its conclusion avoided the fundamental asymmetry in the Minister’s approach, which would tax the vendor as though the reforestation obligations so assumed were part of the sale price, while taxing the purchaser as though they were not.
This decision is a significant victory for the taxpayer involved, and should provide comfort to similarly situated taxpayers in the mining, forestry, oil and gas and real estate industries, where the assumption of reforestation and reclamation liabilities is especially common. Examples might include real estate properties sold where liabilities for future environmental reclamation or building code rectifications are factored in to the purchase price.