Proceeds of Disposition: When to Include in Proceeds Obligations/liabilities Assumed by a Purchaser?

Daishowa-Marubeni International v The Queen, 2013 SCC 29

 

At issue was how to properly calculate “proceeds of disposition”, and when a liability assumed by a purchaser forms part of the proceeds pursuant to subsection 13(21).  Or, as Rothstein J put it beautifully at paragraph 1:

In this appeal, the Court is called upon to answer the age-old question:  If a tree falls in the forest and you are not around to replant it, how does it affect your taxes? 

The SCC, per Rothstein J, allowed the taxpayer’s appeal.  In the appropriate case the  assumption of a vendor’s liabilities are properly included as part of the proceeds of disposition, but the case at bar  as not such a case.  In this case, the reforestation obligations were imposed and embedded in the forest tenures by the Provincial regulatory regime and, as such, did not permit for the sale of the tenure without the assignment of the obligations.  Thus, the reforestation obligations were a future cost that is tied to the tenure and works to reduce the value of the tenure itself, and not a separate property or obligation apart from the tenure that is assumed by the purchaser as part of  the purchase price hereof.  The determinative question is whether the obligation/liability can or cannot be severed from the property itself (does it run with the property?).

FACTS

The taxpayer corporation sold two forest tenures in Alberta. The sale agreements provided that the purchaser assumed the obligations of the original licencee to reforest the harvested areas (which the purchase agreement estimated to be $11 Million for one tenure only).  The obligation was imposed by the Alberta Forest Act, RSA 1980 c F-16 (the provision of which is similar to the current Act in force).  For the year in issue, for accounting purposes, the taxpayer charged to earnings the cost of future reforestation obligations in the year of harvesting. This was added back for tax purposes.  The taxpayer never claimed a tax deduction for future reforestation obligations in the years in held the forest tenures, and upon the sale did not include in the proceeds of disposition (therefore income) any amount to reflect the assumed reforestation obligations by the purchaser.

The taxpayers 1999 and 2000 tax years were reassessed by the MNR to include amounts estimated to be the cost of reforestation obligations. These amounts were included under “proceeds of disposition” under subsection 13(21) of the ITA.

TCC Decision

Miller J, for the TCC, allowed the taxpayers appeal in part only.  The TCC held that the assumption of reforestation obligations is property, and that the assumption formed part of the consideration tendered, thus to be included in the seller’s proceeds of disposition under subsection 13(21).  This was on the basis that the price paid for the tenures would have increased IF the obligations were not assumed by the purchaser.  However, only a percentage of the estimated cost ought to have been included as part of the proceeds.

FCA Decision

Nandon JA, for the FCA majority, held that the taxpayer was required to include the entire estimated cost of the reforestation obligations for each forest tenure in proceeds of disposition.

Mainville JA, in dissent, Stated that the reforestation obligations “form an integral part of the forest tenures, and, though they affect the value of the tenures, they are not a separate consideration of the sale transactions involving the tenures, and should thus not be added to the vendor’s proceeds of disposition resulting from those sales”.

SCC ANALYSIS

The SCC broke the issues down into two parts:

1.  Are the reforestation liabilities to be included in the proceeds of disposition because the vendor is relieved of a liability or are they integral to and run with the forest tenures?

2.  Does it make any difference that the parties agreed to a specific amount of the future reforestation liability?

Each of the tenures sold fall within the classification of “timber resource property” (TRP) within the meaning of subsection 13(21) of the ITA.  TRPs are a hybrid for tax purposes – (i) it is treated as capital property for CCA purposes (Income Tax Regulations, C.R.C. 1978, c. 945, Sch. II, Class 33), and (ii) is excluded from capital gains treatment (Income Tax Act, s. 39(1)(a)(iv)). Thus, on the sale of a TRP, any proceeds in excess of the capital cost in included as regular income (ITA ss 13(1) and (21)).

Subsection 13(21) defined “proceeds of disposition” to include “the sale price of property that has been sold”.

The SCC stated that it is beyond dispute that a purchaser’s assumption of a vendor’s liabilities may form part of the sale price, and therefore part of the proceeds of disposition (see, e.g., Telus Communications (Edmonton) Inc. v. Minister of National Revenue, 2009 FCA 49, 386 N.R. 354, at para. 28; Loyens v. The Queen, 2003 TCC 214, 2003 D.T.C. 355 (General Procedure), at paras. 31 and 33).

The MNR argued that the assumption of reforestation obligations are similar to the assumption of a mortgage by a purchaser, and thus should form part of the vendor’s proceeds of disposition.  The taxpayer disagreed with the MNR’s analogy, and argued that the obligations were more analogous to property in need of repairs (with repairs depressing the property’s value) – assumption of repair costs does not form an addition part of the sale price).

The SCC agreed with the taxpayer that the reforestation obligations are not analogous to an existing debt of the vendor. Rather, the obligations were more analogous to repairs needed, thus a future cost embedded in the property that acts to lower the property’s value.  The obligations, in this case, were embedded by Provincial legislation that requires that transfer of the tenure must occur with Provincial approval, and the Province will not approve a transfer unless the purchaser assumes the reforestation obligations.  The obligations cannot be severed from the tenure itself.  As a future cost associated with the property the obligations served to lower the value of the property sold.

The Court distinguished this case from that of a property encumbered by a mortgage, as the value of the property would not be affected by the mortgage. However, the Court did say, at paragraph 33, that:

Parenthetically, I note that it is true that in some circumstances, the terms of a mortgage might have an impact on the sale price of the property it encumbers.  If, for instance, property is encumbered by a mortgage with a very favourable interest rate, it will be more attractive to purchasers who can assume such a mortgage and such purchasers will be prepared to pay more on that account.  However, in such circumstances, the favourable interest rate has a separate value of its own to the purchaser who can assume the mortgage. The interest rate does not affect the value of the property.  In any case, here, the Minister analogizes future reforestation costs to the vendor’s indebtedness on a mortgage.  As I have explained, the vendor’s indebtedness does not affect the value of the property.

The SCC did not foreclose, and did not decide, the possibility that obligations associated with a property right could be embedded in that property absent  legislation or government policy that prevented the sale of the property without assumption of those obligations.

The SCC stated that the MNR’s interpretation would lead to asymmetrical results for the purchaser and vendor, and clarified that “an interpretation of the Act that promotes symmetry and fairness through a harmonious taxation scheme is to be preferred over an interpretation which promotes neither value” (para 43).

The estimates of the reforestation obligations as between the contracting parties is irrelevant. The proceeds of disposition cannot be made to depend on whether the parties chose to provide such an estimate as part of their agreement.  Income tax accounting and financial accounting serve different purposes (Canderel Ltd. v. Canada, [1998] 1 S.C.R. 147, at para. 36).