The following key principles can be drawn from the case:
- Goodwill can exist in a regulated industry.
- There is no set legal definition of goodwill. It is a flexible concept that arises from the expectation of future earnings, returns or other benefits and must be assessed on a case-by-case basis.
- The residual value method of valuing goodwill is to be preferred. Under this approach, the more easily valued assets are first given a fair market value, and any consideration in excess of this fair market value is assigned to goodwill.
- The Minister or the court cannot substitute its judgment for what is a reasonable amount to pay for goodwill. The test is what a reasonable business person would have paid in the circumstances. Regulatory and industry practices are relevant to determining the reasonableness of a goodwill valuation for income tax purposes.
In 2002, TransAlta "sold its regulated electricity transmission business in Alberta to AltaLink, L.P. at a price negotiated as 1.31 times the net regulated book value of its tangible assets. The parties allocated the bulk of the 31% premium over net regulated book value (an amount of $190,824,476) to goodwill.
The Minister reassessed TransAlta under section 68 of the Act on the basis that this allocation was unreasonable, taking the view that no goodwill exists in a regulated industry, and therefore allocated the premium to tangible assets. This resulted in the recapture of capital cost allowance ("CCA) to TransAlta.
TransAlta’s appeal to the Tax Court of Canada "was allowed, in part. Justice Campbell Miller concluded that goodwill can exist in a regulated industry and that TransAlta did, in fact, sell goodwill. However, he considered that $50 million of the amount allocated to goodwill should be allocated instead to tangible assets. In his view, this amount represented the value of two items: the potential for leverage and a potential tax allowance benefit, both of which were attached to the tangible assets.
TransAlta appealed to the FCA and the Crown cross-appealed.
The FCA looked at whether goodwill could exist in a regulated industry, whether the allocation between TransAlta and AltaLink was unreasonable under section 68 of the Act and, if so, whether the Tax Court judge could substitute his own allocation based on his own valuation.
Concept of goodwill
FCA Justice Robert Mainville rendered the reasons for judgment. He noted that there is no clear legal definition of goodwill. Instead, he said that various characteristics of goodwill should be identified and then used to ascertain goodwill on a case-by-case basis.
He set out three characteristics that should be present for goodwill to exist:
- Goodwill must be an unidentified intangible, as opposed to a tangible, asset or an identified intangible such as a brand name, patent or franchise.
- It must arise from the expectation of future earnings, returns or other benefits in excess of what would be expected in a comparable business.
- It must be inseparable from the business to which it belongs and cannot normally be sold apart from the sale of the business as a going concern. (para 54).
Justice Mainville further noted that an established reputation, customer satisfaction, a unique product or process leading to a monopolistic position, good or astute management, favourable location, manufacturing efficiency, harmonious labour relations, advertising, quality of products and financial standing have all been found to constitute goodwill.
The existence of goodwill in a regulated industry
The Crown’s expert argued that what is acquired in the purchase of a regulated business is the revenue stream generated by the tangible regulated assets of that business. Therefore, even though the purchase price in this case reflected a multiple of the net regulated book value of the assets, the entire purchase price should have been allocated to those assets.
The taxpayer’s expert argued the opposite, basically that regulatory restrictions limit the fair market value of rate-regulated assets to their net regulated value, so that any premium above that amount should be attributed to goodwill or other intangibles.
After reviewing the expert opinions, the legal framework of the regulatory system and industry practices, Justice Mainville concluded that returns on equity in excess of those approved by a regulator are possible and could result from exceptional business management, new business opportunities or other strategic factors. In this case, he specifically noted efficient management by TransAlta and the potential for new business opportunities flowing from TransAlta’s transmission business.
These factors resulted in the expectation of future earnings, returns or other benefits in excess of what would be expected in a comparable business. They were inseparable from the business to which they belonged, and they could not normally be sold apart from the sale of the business as a going concern. As such, they were intangible assets that had the requisite characteristics of goodwill.
As mentioned the Tax Court judge had also found that goodwill was sold and purchased in the transaction, but had concluded that the potential for leverage and a potential tax allowance benefit were not part of the goodwill, and that their value, which he estimated to be $50 million, should be allocated to TransAlta’s tangible assets.
FCA Justice Mainville disagreed with respect to the potential for leverage, which he held was an intangible asset that had all the characteristics of goodwill.
The potential tax allowance benefit resulted from the Alberta Energy and Utilities Board’s consideration of taxe