Daishowa Paper Manufacturing Ltd. v. Canada, 2011 FCA 267

In Daishowa Paper Manufacturing Ltd. v. Canada, the majority of the Federal Court of Appeal ("FCA") affirmed the characterization of reforestation liabilities as proceeds of disposition for the purposes of the Income Tax Act (“ITA”). Mainville J.A., in dissent, held that such liabilities should flow with the property.

The case arose when the appellant sold two of its subsidiary timber businesses. Both sales included the assumption by the purchasers of medium-term silviculture (reforestation) liabilities whose values were fixed by the terms of sale. These liabilities arise when a stand of trees is cut down, but are not satisfied until a sufficiently reforested tree crop surpasses a free-growing growth point, typically after eight to fourteen years. Since subpara. 39(1)(a)(iv) of the ITA excludes timber resource properties from capital gain treatment, the Minister of Revenue (“Minister”) viewed the amounts as proceeds of disposition within the meaning of s. 13(21) of the ITA, and accordingly included them in the appellant’s income for the relevant taxation years.

The Tax Court of Canada agreed that the amounts were proceeds of disposition, but discounted the long-term liability for tax purposes to recognize that the actual cost of the liability cannot be known until some years after the sale. The FCA held that it was not open to the court to discount the liabilities, but Justice Nadon (Layden-Stevenson J.A. concurring) agreed that the reforestation liabilities should be included in the appellant’s proceeds of sale. Justice Nadon noted that both contracts agreed to a specific valuation of the reforestation liabilities, and held that this must be the valuation used for income tax purposes. He emphasized that for the purposes of the ITA, the distinction between absolute and contingent liabilities is irrelevant; the key question is how the parties have chosen to value the iability in their contract of sale. Furthermore, the deduction in price that the appellant assumed based on the assumption of liability by the purchaser cannot lead to a reduction of the value for income tax purposes.

Justice Mainville, dissenting, would have found that, as reforestation liabilities form an integral part of the forestry business, and as the government will not allow the sale without the inclusion of the liabilities, the liabilities flow with the property. Consequently, they cannot be regarded separately from the rest of the sale and should not be added to the proceeds of disposition. Justice Mainville held that the majority's approach would create a system in which vendors who do not specifically value their liabilities would escape taxation.

September 23, 2011
Link to Decision

Zarya Cynader, Marc Gibson & Mary Phan
*