Assuming Business Liabilities in an Asset Purchase
The sale of a business by way of an asset sale typically includes an agreement by the purchaser to assume legal responsibility for the business's future obligations. Relief from these obligations can be valuable to the vendor, and such value should presumably be added to the purchase price of the business in computing the vendor's proceeds of disposition. However, the amount to be included in the vendor's proceeds is sometimes unclear and may become subject to dispute with the CRA, particularly if the amount of the assumed obligations is uncertain. The recent FCA decision in Daishowa (2011 FCA 267) offers a partial road map for resolving this uncertainty.
The taxpayer in Daishowa sold two divisions of its pulp mill business to separate arm's-length buyers. The assets of each division included timber-cutting rights in Alberta. Each purchase agreement required the purchaser to assume the reforestation liabilities connected with the timber rights purchased.
The purchase agreement for one of these divisions provided for a cash purchase price at closing of $169 million, which was based in part on a good-faith estimate of the reforestation costs being assumed. The cash price would be increased or decreased, dollar for dollar, following delivery of a revised estimate of those costs by the taxpayer's accountants post-closing.
The court concluded that the amount determined by the accountants represented the value that the parties had attributed to the assumption of the liability and should therefore be included in the taxpayer's proceeds of disposition on the sale. Particularly persuasive to the court was the fact that the agreement described the amount as an estimate of "the aggregate value" of the liability. The fact that the estimate did not take into account factors that would normally be considered in valuing a long-term liability, such as discounting for present value, was held not to be relevant.
The basic lesson from this decision is that reference amounts related to the assumption of liabilities used for the purpose of calculating purchase price should not be described as "values" unless the parties' intent is that such amounts are to be included in the vendor's proceeds of disposition. Even more fundamentally, asset purchase agreements should explicitly state the value actually attributed to the assumption of vendor liabilities by the purchaser. If no value is to be assigned to the assumption of a liability (perhaps because the likelihood of a payment-triggering event is remote or the liability has been taken into account in valuing the associated asset), that should also be explicitly stated. This approach could introduce some much-needed predictability to determining proceeds of disposition.
The Daishowa decision was based in part on the premise that values determined through negotiation by arm's-length parties reflect fair market value. In situations where this premise does not hold, an explicit agreement on value may not avoid disputes with the CRA over the vendor's proceeds of disposition. For example, where the cash purchase price for an asset sale is negotiated up front on the basis of a valuation of the business as a whole, the attribution of value to specific liabilities will not affect the total cash purchase price being paid. Purchasers may also have little tax incentive to attribute value to contingent liabilities because of the CRA's position that a purchaser's costs of purchased assets only includes the amount of assumed contingent liabilities over time as the purchaser incurs costs to satisfy those liabilities (see, for example, CRA document no. 2002-0164607, October 23, 2002). In these situations, there may be a concern that an agreed attribution of value is not truly the result of arm's-length negotiation.
The decision in Daishowa has been strongly criticized (see, for example, "Daishowa: No Tax Patrimony?" Canadian Tax Highlights, November 2011). The taxpayer has sought leave to appeal to the SCC.
Andrew Spiro and Josh Jones
Blake Cassels & Graydon LLP, Toronto