The Supreme Court of Canada Clarifies the Proceeds of Dispositions

Daishowa-Marubeni International Ltd v. Her Majesty The Queen [2013] SCC 29
An important and eliciting tax decision was recently released by the Supreme Court of Canada (SCC) analyzing the difference between liabilities and embedded obligations as well as the role of tax symmetry in the Income Tax Act (the Act).

Daishowa-Marubeni International Ltd v. Her Majesty The Queen also included interesting dicta from the Supreme Court Justices that embedded obligations are not liabilities that form part of the proceeds of disposition.

This case was heard by the SCC in its full capacity, being nine justices at the bench. Interestingly, Justice Rothstein, writing for the unanimous court, began his reasoning by framing the issue as follows:

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 Facts:  Daishowa-Marubeni International Ltd. (Daishowa/the Taxpayer) owned forest tenures in Alberta, with the right to harvest timber from certain designated provincial Crown lands. Pursuant to statute, Daishowa was obligated to reforest areas from which it had harvested timber. The taxpayer was also required to obtain the consent of the Province of Alberta before assigning any forest tenures to a third party, with such consent contingent upon the purchaser assuming those obligations. With provincial acceptance, two third-party purchasers assumed the reforestation obligations upon purchase of tenures in 1999 and 2000.

In the 1999 sales agreement, $20 million of the consideration was allocated to the forest tenures. The agreement also provided that the purchaser would assume the reforestation obligations relating to lands previously harvested by Daishowa, quantified at approximately $11 million, with a clause adjusting this figure to properly reflect the costs and liabilities post-closing.

The 2000 sales agreement similarly passed the reforestation obligations on the lands previously harvested by Daishowa to the purchaser, but there was no estimate of the cost of the obligations referenced therein.

The taxpayer claimed the estimated amount of the statutory obligations as an expense against revenues for accounting purposes. The Minister of National Revenue (the Minister) reassessed the taxpayer to include into income as proceeds of disposition the reforestation obligations for the subject years.

Litigation: The case first went to the Tax Court of Canada (TCC), with that Court ultimately deciding that the sales, including the assumption of reforestation liabilities, were a single transaction, with the liabilities representing part of the consideration. The value of that consideration to Daishowa was found to be less than the estimated amount of those liabilities though; the Court therefore reduced those amounts.

At the Federal Court of Appeal (FCA), the judges decided that the reforestation obligations should be treated as part of the consideration, but in the dissenting opinion of Justice Mainville, the amounts should not have been reduced, as per the TCC’s decision. Justice Mainville stated at paragraph 137 that:

“It is neither reasonable nor correct to conclude that the compulsory assumptions of the responsibilities for future reforestation works by the purchasers were a “sale” or “disposition” of “liabilities” resulting in “proceeds of disposition” in the hands of Daishowa under the meaning of subsection 13(21) of the Act.”

Justice Rothstein, writing for the SCC, essentially adopted Mainville’s reasoning. He agreed that the liabilities were properly viewed as part of the consideration and properly construed as embedded obligations that had the effect of depressing the value thereof, and could not be severed from the property. The statutory requirements (under the Forest Act and the Timber Management Regulations) were the basis of the Court deciding as it did. At paragraph 36 though, Rothstein stated that there may well be situations where, even absent a statute or regulation, obligations associated with a property right may be embedded within that right.

Rothstein also borrowed words from Mainville’s FCA decision when he endorsed the idea of tax symmetry and fairness. He felt as though the taxpayer’s position in this case promoted an interpretation of the Act that was consistent with those notions, whereas the Minister’s argument would have had the opposite effect. For instance, the 1999 purchaser of the tenures would have had proceeds of $31 million, of which $11 would never be received if it sold the tenures the next day.

Conclusion:  The SCC made a clear statement of what is and what is not a liability for the purposes of determining the proceeds of a disposition under the Act, and for that reason this decision should be heralded. The treatment of this issue by most of the judges was confusing and misguided. It will be interesting to see how future courts will construe Rothstein’s dicta pertaining to non-statutory obligations and liabilities.

Greer Jacks is updating jurisprudence in EverGreen Explanatory Notes, an online research library of assistance to tax and financial professionals in working with their clients.