Section 68 of the Income Tax Act (Canada) (the “ITA”) allows the Canada Revenue Agency (the “CRA”) to determine the reasonable consideration for the disposition of a particular property. In TransAlta Corporation v. The Queen (2012 FCA 20), the Federal Court of Appeal (the “FCA”) helpfully clarified two important allocation principles for the purposes of section 68 of the ITA.
In 2002, TransAlta sold its regulated electricity transmission business to an arm’s length purchaser for the negotiated price of 1.31 times the net regulated book value of TransAlta’s tangible assets. The parties allocated the bulk of the 31% premium to goodwill. This allocation was a standard allocation of purchase price premium for regulated industries and was supported by valuation theory, audited financial statements and long-standing industry practice. The Minister reassessed TransAlta, pursuant to section 68 of the ITA to reallocate the premium to tangible assets on the basis that the practice by regulated industries of allocating purchase price premium to goodwill was unreasonable as it allowed the vendors to avoid recapture of capital cost allowance on its tangible assets.
In determining whether an allocation of purchase price to a particular property is reasonable under section 68 of the ITA, the FCA provided the following guides: (1) an allocation of purchase price agreed to by arm’s length parties is an important (but not determinative) factor to consider and will be given considerable weight where the parties have strong divergent interests concerning that allocation and less weight where one of the parties is indifferent to that allocation or where both parties’ interests are aligned with respect to that allocation; and (2) the reasonableness test under section 68 of the ITA is not what the CRA believes is reasonable but rather “whether a reasonable business person, with business considerations in mind, would have made the allocation”.
In this case, the FCA concluded that the parties’ agreed allocation of the premium to goodwill was reasonable “precisely because of its compliance with industry and regulatory norms and its consistency with standard valuation theory for regulated businesses and standard accounting principles applied in such industries.” The taxpayer’s appeal was allowed.