May 24, 2013
A collective sigh of relief was heard in the natural resource industry in Calgary and other parts of the country upon the release of the much-anticipated decision of the Supreme Court of Canada in Daishowa-Marubeni International Ltd. v. The Queen on May 23, 2013. In a unanimous decision of all nine Supreme Court Justices, the top Court firmly rejected the proposition that estimated future expenses relating to reforestation obligations assumed by the purchaser of a forest tenure were to be included in the seller’s proceeds of disposition for tax purposes.
|Impact on the oil and gas industry |
The Supreme Court’s decision clearly overturned the reasoning in each of the Tax Court of Canada and Federal Court of Appeal decisions in this case. The CRA was relying on the reasoning from those decisions for its position that oil and gas producers could be reassessed for what would likely have been billions of dollars in additional sale proceeds on prior-year sales of oil and gas properties.
In many such cases, a taxpayer’s asset retirement obligation for accounting purposes was apportioned or otherwise used to estimate additional proceeds for the purpose of CRA tax assessments. Additionally, the CRA had taken the position that the purchaser of such assets is not entitled to a corresponding increase to its Canadian oil and gas property expense pool, making the CRA’s treatment of vendor and purchaser inconsistent, or “asymmetrical”.
The Court described its decision as being a choice between two analogies. On one hand, the reforestation obligations associated with forest tenures could be envisioned like mortgages on real property (as the CRA argued). The assumption of a mortgage by a purchaser of real property is considered to be part of the purchase price of the property. On the other hand (as the taxpayer argued), a forest tenure with accrued reforestation obligations could be seen like a property in need of repair — the accrued liabilities reduce the value of the tenure, as outstanding repairs reduce the value of a property.
The Court solidly preferred the “property-in-need-of-repair” analogy. The Court noted that a mortgage does not reduce the value of a property itself — the property’s value is the same with or without a mortgage. A seller can sell the property for a cash payment equal to the full value of the property and repay the mortgage or transfer the property for a lesser cash payment and have the purchaser assume the mortgage. By contrast, the Court found that the applicable regulatory scheme (which prevents a seller from selling a forest tenure without also assigning the reforestation obligations arising from past harvesting) had the impact of embedding the reforestation obligations in the forest tenure and in its value. Thus, because the reforestation obligations affect the value of the forest tenure (by depressing it), they are distinguished from the mortgage analogy.
Although the decision specifically addresses forest tenures and the regulatory scheme applicable to forest tenures, the Court implied (in, arguably, non-binding comments) that such a regulatory scheme requiring the assumption of obligations by the purchaser may not be necessary to arrive at the same result.
The Court also emphasized that its conclusion resolved the CRA’s proposed inconsistent treatment of sellers and purchasers. The inconsistency, or asymmetry, arose because the CRA's approach taxed the seller at the time of sale as if the reforestation obligations assumed by the purchaser were part of the sale price, but taxed the purchaser as if they were not part of the purchase price since they were not included in the purchaser’s adjusted cost base. This inconsistent tax treatment of sellers and purchasers and the potential for double tax appeared to be a significant concern for the Court.
The application of the decision to the oil and gas industry should be immediate. Oil and gas properties are customarily sold in circumstances where abandonment and reclamation liabilities are assumed by the purchaser and historically are considered by industry participants to affect the value of the property. Although the regulatory regime for oil and gas is not identical to the regulatory regime for forest tenures, the similarities between reforestation obligations and abandonment and reclamation obligations in the oil and gas context cannot be ignored or denied. Abandonment and reclamation obligations should be considered embedded in the value of oil and gas properties just as the reforestation obligations are now considered embedded in the forest tenures.
The Court’s decision should be good news for the mining industry as well. If the CRA had been successful, it could have extended its position that reclamation costs should be included in proceeds of disposition to all industries and the mining industry in particular.
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Your KPMG adviser can help you assess the effect of the Court’s decision on your business, and point out ways to take advantage of any benefits arising from the decision or help mitigate its impact. For more details on this decision and its potential impact, contact your KPMG adviser.
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