Executive Summary: Key Legal and Evidentiary Issues

• Whether pension and post-retirement obligations assumed by a purchaser should reduce the fair market value of equipment sold in a non-arm's length transaction under paragraph 69(1)(b) of the Income Tax Act.

• Application of the Supreme Court's decision in Daishowa-Marubeni International Ltd. regarding obligations embedded in property rights versus separate business liabilities.

• Determination of proceeds of disposition for depreciable property (Class 29 machinery and equipment) in a business sale between related corporations.

• Fair market value assessment must be calculated separately for each individual asset comprising a business, not for the business as a whole.

• Distinction between obligations that are inseverable from property (like reforestation obligations tied to forest tenures) and general business liabilities (like pension obligations).

• Reassessment by the Minister of National Revenue for taxation year ending September 30, 2012, involving fair market value of $56,490,221 for equipment.

Background of the dispute

0808414 B.C. LTD. appealed a judgment of the Tax Court of Canada (2024 TCC 99) dismissing the appellant's appeal from a reassessment issued by the Minister of National Revenue for the appellant's taxation year ending September 30, 2012. The dispute centered on the determination of proceeds of disposition under the Income Tax Act for machinery and equipment sold in a non-arm's length transaction.

The transaction

The appellant sold its contract manufacturing business to a corporation with which it was not dealing at arm's length. The sale included land, building, machinery and equipment, inventory, pre-paid expenses and accounts receivable. Both the vendor and the purchaser were indirect wholly-owned subsidiaries of Ralcorp Holdings, Inc.

The tax reassessment

The reassessment of the appellant related to the determination of the proceeds of disposition under paragraph 69(1)(b) of the Income Tax Act for the machinery and equipment (the "Equipment"). The Equipment is depreciable property included in Class 29 for the purposes of the Act.

Relevant statutory provision

Paragraph 69(1)(b) of the Income Tax Act provides that where a taxpayer has disposed of anything to a person with whom the taxpayer was not dealing at arm's length for no proceeds or for proceeds less than the fair market value thereof at the time the taxpayer so disposed of it, the taxpayer shall be deemed to have received proceeds of disposition therefor equal to that fair market value.

Agreed fair market value

The parties agreed that the fair market value of the Equipment (if it would have been sold on its own) was $56,490,221. This was the amount that the Minister used as the proceeds of disposition for the Equipment.

The appellant's argument

The appellant's argument was that the fair market value of the Equipment should be reduced by the estimated amount of the pension and post-retirement obligations (the "pension obligations") assumed by the purchaser ($8,166,584) since the business was sold as a going concern.

Reliance on Daishowa-Marubeni

The appellant referred to the decision of the Supreme Court of Canada in Daishowa-Marubeni International Ltd. v. Her Majesty the Queen, [2013] 2 S.C.R. 336. In that case, the Supreme Court found that the vendor of certain forest tenures (that allowed the holder of such tenure to harvest trees on Crown land) did not have to include, in determining the proceeds of disposition of such tenures, the amounts related to the reforestation obligations that were imbedded in the tenures.

The Supreme Court described the reforestation obligation and its impact on the value of the tenures in contrast to a mortgage. The effect of Alberta's scheme was to embed the reforestation obligations into the forest tenure, such that the obligations could not be severed from the property itself. As such, the reforestation obligations were simply a future cost tied to the tenure that depressed the value of the tenure. A prospective purchaser of the tenure would take into account the income-earning potential of the tenure as well as the expected future costs associated with ownership of the tenure. The existence of reforestation obligations, a future cost that could not be severed from the tenure, would decrease the amount such a prospective purchaser would be willing to pay.

The Supreme Court distinguished the reforestation obligations tied to a forest tenure from a mortgage, which does not affect the value of the property it encumbers. For instance, a property worth $31 million that is encumbered by a mortgage of $11 million, despite the mortgage, still has a value of $31 million.

The Federal Court of Appeal's analysis

The Federal Court of Appeal rejected the appellant's argument. The Court found that in the present appeal, the pension obligations were not imbedded in the Equipment; they arose because the vendor had pension obligations to its employees. The vendor also had Equipment that it could sell for $56,490,221. The principle as set out by the Supreme Court for not including an obligation that is imbedded in an asset in determining the proceeds of disposition for that asset (or in determining its fair market value) was not applicable in this appeal.

The appellant also referred to comments of the Supreme Court in paragraph 36 of the Daishowa-Marubeni decision regarding the possibility that obligations associated with a property right could be embedded in that property right without there being a statute, regulation or government policy that expressly restricts a vendor from selling the property right without assigning those obligations to the purchaser. The Court found that this comment did not assist the appellant.

While the appellant argued that the pension obligations were imbedded in the "business" that was sold, in applying section 69 of the Act, the proceeds of disposition are not determined for the business per se, but rather separately for each particular asset comprising the business (the land, building, machinery and equipment, inventory, pre-paid expenses and accounts receivable) that was sold. The pension obligations and any other liabilities or obligations assumed by the purchaser would be part of the consideration paid for the various assets. Such obligations and liabilities would not reduce the fair market value of the Equipment.

Ruling and outcome

The appeal was dismissed with costs. His Majesty the King was the successful party. The specific amount of costs was not determined in the decision.