Transalta Corporation v. The Queen

Transalta Corporation v. The Queen
Court (s) Database
Tax Court of Canada Judgments
Date
2010-07-13
Neutral citation
2010 TCC 375
File numbers
2009-871(IT)G
Judges and Taxing Officers
Campbell J. Miller
Subjects
Income Tax Act
Decision Content
Docket: 2009-871(IT)G
BETWEEN:
TRANSALTA CORPORATION,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
____________________________________________________________________
Appeal heard on June 2, 3 and 4 2010, at Calgary, Alberta
By: The Honourable Justice Campbell J. Miller
Appearances:
Counsel for the Appellant:
Robert D. McCue
Counsel for the Respondent:
Marta E. Burns and Chang Du
____________________________________________________________________
AMENDED JUDGMENT
The appeal from the reassessment made under the Income Tax Act for the 2002 taxation year is allowed, with costs, and the reassessment is referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the amount of $140,824,476 is to be allocated to goodwill in the sale to AltaLink Limited Partnership, effective April 29, 2002.
Signed at Ottawa, Canada, this 23rd day of August 2010.
"Campbell J. Miller"
C. Miller J.
Citation: 2010 TCC 375
Date: 20100713
Docket: 2009-871(IT)G
BETWEEN:
TRANSALTA CORPORATION,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Miller J.
[1] This is a case about goodwill, more specifically, the allocation of the purchase price between net tangible assets and goodwill in an $800,000,000 sale of Transalta Energy Corporation’s ("Transalta") assets and business to AltaLink Limited Partnership ("AltaLink") in 2002. In their Purchase and Sale Agreement, Transalta and AltaLink allocated approximately $190,000,000 to goodwill and $602,000,000 to net tangible assets. The Respondent, relying upon section 68 of the Income Tax Act (the "Act"), allocated nothing to goodwill and everything to the net tangible assets, on the basis primarily that no goodwill exists in a regulated industry, thus Transalta’s allocation of $190,000,000 to goodwill was unreasonable. The Appellant’s position is that hard bargaining took place between Transalta and AltaLink establishing the allocation and, therefore, such allocation cannot be regarded as unreasonable. Transalta further submits that the Government has been unable to demonstrate the allocation was clearly unreasonable.
Facts
[2] The Parties provided a Joint Book of Documents and an Agreed Statement of Facts, augmented by the testimony of Mr. Woo, an officer of Transalta and project manager of the transaction in question, as well as by evidence of an expert from each party: Ms. Glass from KPMG for the Appellant and Mr. Lawritsen from Meyers Norris Penny LLP for the Respondent.
AGREED STATEMENT OF FACTS
The parties hereto by their respective solicitors agree on the following facts, provided that this agreement is made for the purpose of this appeal only and may not be used against either party on any other occasion, and that the parties may add further and other evidence relevant to the issues and not inconsistent with this agreement. It is also agreed that the admission of these facts is not a concession of the weight or degree of relevance to be attributed to these facts.
1 OVerview
1.1 Throughout 2001 and 2002, among the Appellant’s wholly owned subsidiaries were TransAlta Utilities Corporation (“TAU”) and TransAlta Energy Corporation (“TEC”).
1.2 The Appellant determined to cause TAU to sell its electricity transmission business (the “Transmission Business”) by way of sealed bid auction process targeted to a limited number of recipients (the "Sealed Bid Auction") conducted by CIBC World Markets Inc. (“CIBC”).
1.3 As a result of the sealed auction, AltaLink, L.P. (“AltaLink”) acquired the Transmission Business.
1.4 Representatives of AltaLink’s partners and the Appellant negotiated the terms of the sale, including an allocation of the purchase price to depreciable property, goodwill and certain other items, as a result of which $190,824,476 was allocated to goodwill.
1.5 $190,824,476 was also approximately the amount by which the purchase price exceeded the net regulated book value ("NRBV") and working capital of the Transmission Business’ assets, and was referred to by TransAlta and other parties relative to the transaction as the "premium".
1.6 The Minister reassessed under section 68 of the Income Tax Act, R.S.C. 1985, c.1 (5th Supp.), Chapter 63, as amended (the “Act”) on the basis that the portion of the purchase price allocated to goodwill was unreasonable and should have been allocated to depreciable property.
1.7 As a result of this reassessment, the Appellant appealed to the Tax Court.
2 The Parties
2.1 The Appellant is a corporation subject to the Canada Business Corporations Act, and at all material times was a "taxable Canadian corporation" as defined in subsection 89(1) of the Act.
2.2 TEC and TAU were, at all material times, wholly owned subsidiaries of the Appellant.
2.3 The Appellant is a publicly traded corporation.
2.4 AltaLink is a limited partnership formed under the laws of Alberta by the members of the Consortium, as defined below, for the purpose of acquiring the Transmission Business.
2.5 At all material times, AltaLink was owned either directly or indirectly (through another limited partnership, known as AltaLink Investments, L.P. ("Investments")) by four limited partners, as follows:
(a) as to 50%, SNC Lavalin Transmission Ltd., a wholly owned subsidiary of SNC Lavalin Inc. ("SNC");
(b) as to 25%, OTPPB TEP Inc., a wholly owned subsidiary of the Ontario Teachers’ Pension Plan Board ("Teachers");
(c) as to 15%, Macquarie Transmission Alberta Ltd., a wholly owned subsidiary of Macquarie North America Ltd. (“Macquarie”); and
(d) as to 10%, 3057246 Nova Scotia Company, a wholly owned subsidiary of Trans Elect Inc. (“Trans Elect”).
2.6 At all material times, AltaLink, the Consortium and each of the Consortium’s partners dealt at arm’s length with the Appellant, TAU and TEC.
2.7 At all material times, Investments’ general partner was AltaLink Investments Management Ltd., which owned a nominal percentage of Investments.
2.8 At all material times, AltaLink’s general partner was AltaLink Management Ltd., which owned a nominal percentage of AltaLink.
2.9 At all material times, AltaLink Management Ltd. and AltaLink Investments Management Ltd. were controlled indirectly by SNC, Teachers, Macquarie and Trans Elect in the same percentages as they indirectly controlled AltaLink.
2.10 At all material times, 75% of AltaLink was indirectly controlled by “taxable Canadian corporations” as defined in the Act as result of the fact that each of the subsidiaries of SNC, Macquarie and Trans Elect that were partners in Investments were "taxable Canadian corporations", whereas the subsidiary of Teachers was not.
2.11 AltaLink’s income and deductions for taxation purposes flowed through to its partners at all material times.
2.12 To the extent that AltaLink’s income and deductions for taxation purposes flowed through to Investments, such income and deductions flowed through to Investments’ partners.
2.13 Investments limited partners are deemed owners of the Transmission Business utility for Public Utilities Board Act (Alberta) purposes.
3 the Transmission business
3.1 The Transmission Business consisted of approximately 11,600 km of transmission lines and 260 substations that supply almost 60% of the Alberta population with electricity.
3.2 The original cost of the Transmission Business assets was approximately $1.4 billion. Depreciation for accounting purposes with respect to those assets throughout TransAlta's ownership was approximately $780 million, which resulted in a book value for accounting purposes of approximately $640 million.
3.3 The Transmission Business’ NRBV at the time of the sale to AltaLink was approximately $590 million with respect to depreciable property, and $617 million in total. This is the amount on which the owner of the Transmission Business is entitled to earn a regulated rate of return, on the basis described below.
3.4 The Transmission Business was a consistently profitable going concern prior to its sale to AltaLink.
3.5 The Transmission Business included certain transferable rights, licenses and permits (the “Permits”).
4 the auction
4.1 The Appellant offered the Transmission Business for sale in early 2001, and retained CIBC, an arms length party, in that regard to contact potentially interested parties and conduct a sealed bid auction with a view to selling the Transmission Business.
4.2 The sealed bid auction process commenced in the Spring, 2001 and concluded in June, 2001.
4.3 During the course of the sealed bid auction, the Appellant received bids for the Transmission Business that ranged from $655 million to the $855 million.
4.4 Various bidders referred in their bids to their intention to pay a premium in excess of NRBV for the Transmission Business.
4.5 NRBV is the amount respecting which the owner of a utility regulated by the Board is entitled to receive a regulated rate of return.
4.6 A consortium known as the AlbertaLink Consortium (the “Consortium”) was formed by representatives of SNC Lavalin Inc. (“SNC”), Ontario Teachers’ Pension Plan Board (“Teachers”), Macquarie North America Ltd. (“Macquarie”) and Trans-Elect Inc. (“Trans-Elect”) to bid for the Transmission Business.
4.7 During the bidding process, the Consortium indicated that if it were the successful bidder, it intended to create a limited partnership for the purpose of carrying out the acquisition of the Transmission Business.
4.8 The Consortium bid $855 million for the Transmission Business, and was the high bidder.
5 THE Sale of the Transmission business
5.1 The Appellant negotiated the terms of definitive sale agreements and related documents (the “Agreements”) with representatives of the Consortium with respect to a sale of the Transmission Business (the “Transaction”).
5.2 During the course of those negotiations:
(a) certain assets were excluded from the Transaction and various other adjustments were made, as a result of which the purchase price was reduced to $818 million, a $37 million decline from the Consortium’s initial bid of $855 million;
(b) the Consortium asked TEC to increase the portion of the purchase price allocated to depreciable assets and at closing $36 million more of the purchase price was allocated to depreciable assets than TransAlta had originally proposed to the Consortium;
5.3 The negotiation of the terms of the Transaction commenced shortly after TransAlta received the Consortium's bid on June 15, 2001, and continued until July 2, 2001, at which time all terms of the Agreements were settled.
5.4 The Consortium caused AltaLink to be formed on July 3, 2001.
5.5 From July 2, 2001 to July 4, 2001, lawyers produced execution copies of the Agreements, and the Agreements were signed on July 4, 2001 (the “Signing Date”).
5.6 The Consortium caused AltaLink to execute the Agreements on the Signing Date.
5.7 The Agreements provided for a purchase price of $818,150,705, and contained a purchase price allocation clause which allocated the purchase price as follows:
(a) $590,582,039 to depreciable assets;
(b) $11,897,581 to land;
(c) $14,583,208 to land rights;
(d) $10,263,401 to working capital; and
(e) $190,824,476 to goodwill.
5.8 The amounts allocated to depreciable assets and land were equal to the Appellant’s NRBV in that regard at the Transaction’s effective date, being in total $602,479,620.
5.9 The Agreements contemplated that the Transmission Business would first be transferred by TAU to TEC under section 85 of the Act, and then transferred by TEC to AltaLink.
6 Regulatory Approval
6.1 On August 22, 2001 TAU applied to the Board for approval to transfer the Transmission Business to TEC, and then for TEC to dispose of same to AltaLink, in accordance with the Agreements.
6.2 After a regulatory review and approval process with respect to the Transaction conducted by the Board, approval for the Transaction was received on March 28, 2002.
6.3 Consequently, the sale of the Transmission Business to AltaLink closed on April 29, 2002 in accordance with the Agreements.
6.4 The Board’s approval of the Transaction required that:
(a) The Appellant’s closing undepreciated capital cost (“UCC”) for regulatory purposes must equal AltaLink’s opening UCC for regulatory purposes; and
(b) The Appellant’s closing NRBV with respect to the Transmission Business must equal AltaLink’s opening NRBV, and that the premium could not be recovered through future rate increases.
6.5 The Board’s approval did not require that the Appellant’s closing UCC for actual taxation purposes equal AltaLink’s opening UCC for actual taxation purposes.
7 applicable Regulatory Regime
7.1 At all material times, the Board set the rates the Transmission Business could charge for its services so as to enable the Transmission Business to earn a reasonable rate of return on the NRBV of the capital it employed as set through the regulatory process.
7.2 In particular, at all material times the Board generally set rates based on forecasts submitted by the Transmission Business so as to permit the Transmission Business to:
(a) recover the NRBV of its assets as they depreciated for regulatory purposes;
(b) recover the estimates of or proxies for expenses the Transmission Business planned to incur, including interest with respect to its debt to the extent approved by the Board, taxes and other amounts; and
(c) earn a reasonable return on the portion of the NRBV the Board deemed to be equity for this purpose.
8 Why the premium was paid
8.1 AltaLink paid the premium at least in part because:
(a) AltaLink expected that it would receive as part of its annual revenues permitted by the Alberta Energy and Utilities Board (the “Board”) an allowance for income taxes (the “Tax Allowance”) that would exceed the income tax actually paid by its partners;
(b) AltaLink believed that the return on equity offered by the Board was attractive relative to other investments available to it given the risks it was required to undertake to earn that return; and
(c) AltaLink expected to be able to arrange its affairs to use more leverage than was assumed by the Board for ratemaking purposes;
8.2 During the regulatory approval process with respect to the Transaction, ratepayers raised concerns with regard to the premium, including that AltaLink would try to recover the premium by way of rate increases.
8.3 As a result, AltaLink represented to the Board that the premium could be justified by AltaLink on that basis that:
(a) a performance based regulation (“PBR”) plan could result in a sharing of benefits with customers that would enhance earnings;
(b) the possibility of sustained growth in the regulated rate base could dilute the size of the premium; and
(c) the existence of competitive merchant transmission projects could provide opportunities to enhance earnings and growth.
AltaLink concluded its submission to the Board by indicating that its customers were protected by AltaLink's commitment to exclude any portion of the premium from the rate base, and that AltaLink's ability to earn returns that will justify the payment of the purchase price, including the premium, is a matter of commercial risk for AltaLink's partners.
8.4 PBR is a form of regulation that if implemented would enable operators of businesses like the Transmission Business to earn additional returns as a result of creating cost saving efficiencies that would benefit their customers.
8.5 The Appellant represented to the Consortium during the auction process as well as the negotiation of the terms of the Agreements, that each of the following opportunities had substantial value:
(a) PBR, in the range of $6 to $8 million per year in incremental revenues;
(b) Potential growth in the regulated aspect of the Transmission Business, with total capital expenditures of between $655 and 955 million projected over a five year period;
(c) Growth in non-regulated aspects of the Transmission Business, including telecommunications (wireless and fibre optic), non-regulated or merchant transmission facilities, engineering, procurement, construction management and operations and maintenance services.
9 altalink’s tax allowance
9.1 The Tax Allowance does not generally equal actual income taxes paid.
9.2 AltaLink expected to receive a Tax Allowance in excess of the income taxes its partners would pay as a result of Teachers’ tax deferred status.
9.3 The Board eventually denied AltaLink the right to collect the portion of the Tax Allowance attributable to Teachers.
10 the reassessment and appeal
10.1 The Minister reassessed the Transaction by way of a Notice of Reassessment (the “Reassessment”) with respect to TEC’s December 31, 2002 taxation year on the basis that section 68 of the Act applied to reallocate TEC’s proceeds of disposition on the sale of its Transmission Business to AltaLink so as to reduce the amount that TEC allocated to goodwill and land rights, and to correspondingly increase the amount allocated to depreciable property and land.
10.2 The Appellant amalgamated with TEC and TAU on January 1, 2009.
10.3 The Appellant filed a Notice of Objection with respect to the Reassessment on December 17, 2008.
[3] The Appellant further appealed the Reassessment by way of Notice of Appeal filed March 18, 2009.
[4] There are several provisions of the July 4, 2001 Purchase and Sale Agreement worth reproducing at this point:[1]
…
2.1 Purchase and Sale
In consideration for the payment to the Vendor by the Purchaser of the Purchase Price and assumption by the Purchaser of the Assumed Liabilities, and upon and subject to the terms and conditions hereof, at the Time of Closing the Vendor shall assign, transfer and set over to the Purchaser, and the Purchaser will acquire from the Vendor as a going concern, the Assets and the Business. [emphasis added]
2.2 Purchase Price
(1) The purchase price to be paid to the Vendor by the Purchaser (the "Purchase Price") shall be the sum of the amounts set forth in Sections 2.2(1)(a) and (b) below:
(a) the Net Regulatory Book Value of the Assets at December 31, 2000 (which the Parties agree is $613,200,000) multiplied by 1.31 for a total of $803,300,000 (the "Base Purchase Price"); and
(b) an amount related to certain changes to the Assets from and after December 31, 2000 which amount shall be the amount determined by the adjustments set forth in Section 2.3 hereof.
…
(2) The Vendor and the Purchaser shall allocate the Purchase Price among the Assets in accordance with Schedule 2.2(2) hereof; and the Purchaser and the Vendor, in filing their respective income tax returns, shall use such allocation of the Purchase Price.
…
Schedule 2.2(2) Allocation of Purchase Price
The Purchase Price determined under Section 2.2 shall be allocated among the Assets as follows:
(a) Those of the Assets which constitute Current Assets shall have allocated thereto such amount as may be determined in the calculation of Working Capital under Section 2.3 as at the Time of Closing;
(b) Those of Assets which constitute "non-depreciable capital property" (within the meaning of the Income Tax Act) shall have allocated thereto the amount of $11.3 million;
(c) Those of the Assets which constitute "depreciable property" within the meaning of the Income Tax Act and which are described in Class 8 in Schedule II to the Income Tax Act Regulations shall have allocated thereto the aggregate of $15 million and the cost to the Vendor of additions to such Class from December 31, 2000 to the Time of Closing;
(d) Those of the Assets which constitute "depreciable property" within the meaning of the Income Tax Act and which are described in Class 10 in Schedule II to the Income Tax Regulations shall have allocated thereto the aggregate of $5 million and the cost to the Vendor of additions to such Class from December 31, 2000 to the Time of Closing;
(e) Those of the Assets which constitute "depreciable property" within the meaning of the Income Tax Act and which are described in Class 1 and Class 2 in Schedule II to the Income Tax Regulations shall have allocated thereto an aggregate amount equal to the "Net Regulatory Book Value" for such Assets as at the Time of Closing, such amount to be further allocated as between the Class 1 Assets and the Class 2 Assets as follows:
(i) As to Class 1 the aggregate of $304 million plus the cost of additions to such Class from December 31, 2000 to the Time of Closing;
(ii) As to Class 2 the remaining balance;
(f) The remaining unallocated balance of the Purchase Price shall be allocated to those Assets which constitute "eligible capital property" within the meaning of the Income Tax Act.
…
APPENDIX A GLOSSARY
…
"Assets" means the undertaking and all of the tangible or intangible property (whether real, personal or mixed, choate or inchoate), rights, benefits, privileges, assets or entitlements owned by the Vendor or TransAlta Utilities Corporation or any of their Affiliates, or to which the Vendor or TransAlta Utilities Corporation or any of their Affiliates is entitled and used exclusively or Primarily in the Business, of every kind and description and wheresoever situate. Without limiting the generality of the foregoing, the Assets include:
(i) the Sites and Buildings;
(ii) the Equipment;
(iii) the Land Rights;
(iv) the Current Assets;
(v) the full benefit of the Contracts and all other contracts or commitments to which the Vendor or TransAlta Utilities Corporation or any of their Affiliates is entitled in connection with the Business including, without limiting the generality of the foregoing, all forward commitments of the Vendor or TransAlta Utilities Corporation or any of their Affiliates for supplies or materials entered into in the usual and ordinary course of Business whether or not there are any written contracts with respect thereto, but excluding, for clarity, contracts or commitments of a general nature that do not Primarily relate to the Business;
(vi) the Warranties, if any;
(vii) the Permits;
(viii) computer software listed in Schedule 1.1(a);
(ix) the goodwill of the Business including, without limiting the generality of the foregoing,
A. the exclusive right of the Purchaser to represent itself as carrying on the Business in continuation of and in succession to the Vendor and TransAlta Utilities Corporation and the non-exclusive right to use any words indicating that the Business is so carried on, and
B. to the extent transferable, all customer lists and supplier lists of the Business;
(x) all plans and specifications in the possession of the Vendor or TransAlta Utilities Corporation or any of their Affiliates Primarily relating to the Sites, the Buildings and the Equipment including, without limiting the generality of the foregoing, all such electrical, mechanical and structural drawings related thereto as are in the possession of the Vendor or TransAlta Utilities Corporation; and
(xi) all Records;
But excluding, in any event, the Excluded Assets.
…
"Business" means the existing electrical transmission business carried on by the Vendor or TransAlta Utilities Corporation or any Affiliate on their behalf, including the Transmission Facilities and associated systems and services in the Province of Alberta and the operations, maintenance and construction of facilities service business, telecommunications initiatives, the engineering procurement and management services and the merchant transmission services; all of which are to be transferred to the Purchaser as a going concern but does not include the Generation Facilities or Excluded Assets;
…
[5] Mr. Woo addressed the 1.31 over the “NRBV” premium identified in section 2.2(1)(a) of the Agreement in the following manner. He identified several factors supporting the premium by pointing out that in AltaLink’s bid for the Transalta business it included a section called "Business Plan", identifying core strategies as follows:[2]
…
Growth
The Consortium plans to continue to support the investment of additional capital into the development of the Alberta transmission network. In its current forecast, the Consortium has forecast significant capital expenditures over the next five years to expand and maintain the business.
EPCM
The Consortium recognizes the internal expertise of TransAlta’s EPCM Transmission Projects Group. As part of this transaction, SNC-Lavalin plans to offer the Transmission Projects Group employees’ positions in its Alberta based engineering operations.
…
Regulation
Continuing the process that TransAlta has started, the Consortium plans to take an active role in the establishment of a regulatory regime that incentivizes the development of the Alberta transmission network. The implementation of a performance based ratemaking regime will provide the requisite incentives to attract additional capital to Alberta.
The Consortium recognizes the significant contribution that the transmission employees have made to the development of the business, which has resulted in it being rated in the top quartile in efficiency in North America. The Corporation does not require restructuring to the transmission business and plans to other similar benefits packages to retain key staff.
…
[6] This view was confirmed at AltaLink’s first rate hearing after the acquisition in January 2002, before the Board, at which it argued:[3]
…
5.0 The Purchase Premium Concern is a Red Herring
Notwithstanding AltaLink’s commitment that no portion of its purchase premium will be included in rate base, the Customer Group continues to ruminate on the reasons why AltaLink would pay 1.31x book value for the transmission assets. AltaLink submits that as long as the purchase premium is not included in rate base and recovered from customers, the entire purchase premium discussion is a red herring and is certainly not sufficient to give rise to any concern respecting "harm".
…
Notwithstanding the irrelevance of how or if AltaLink’s partners will ever feel justified in paying more than book value for the transmission assets, there are at least three bases on which the payment of such a premium could be justified.
· A PBR plan could result in a sharing of benefits with customers that would enhance earnings.
· The possibility of sustained growth in the regulated rate base will "dilute" the size of the premium.
· The existence of competitive merchant transmission projects can provide opportunities to enhance earnings and growth.
AltaLink submits that there is nothing nefarious about paying a premium above book value for utility assets. As is well-known to the Board, utility shareholders have historically paid such premiums when purchasing shares in the securities markets.
…
[7] Mr. Woo also suggested that a move to Performance Based Regulation ("PBR"), given TransAlta’s efficient environment, could result in $6,000,000 to $8,000,000 in opportunity. He also referred to TransAlta’s Information memo (basically their marketing tool) to quantify the business growth opportunities both in the regulated and non-regulated sectors. Transmission growth opportunities were estimated at an additional $600,000,000 to $900,000,000 capital cost. The non-regulated opportunities were identified as telecommunications, merchant transmission, EPCM (engineering, procurement and construction management) and operations and maintenance service.
[8] Mr. Woo explained some of these opportunities in more detail. Merchant transmission is the non-regulated business of transmission lines crossing territories, with capacity sold at market rates, not regulated rates. TransAlta’s estimate of potential capital expenditures ran over $3 billion.
[9] The EPCM component involves the construction and management of lines, preferably in the non-regulated sector. AltaLink’s interest in this element of the deal was such that SNC, one of the partners, offered jobs to 76 members of the EPCM group, and contracted those services back to AltaLink pursuant to a 10-year contract. Many years later when the chartered accounting firm of Grant Thornton supplied an expert report in support of AltaLink’s rate application, it stated:[4]
…
When the 76 employees were transferred to SNC-ATP, AML indicated that the transfer of risk was to the benefit of AltaLink and no compensation was paid. An alternative interpretation is that the transfer of the employees gave a valuable asset to SNC-ATP.
When a business is purchased, a value is typically assigned to the assembled workforce. The method of valuation differs with the skills and experience of the workforce and the difficulty of assembling a similar workforce.
…
[10] It is evident from AltaLink’s press release in July 2001 how favourably it viewed the quality of workforce it was acquiring:[5]
…
"This acquisition is a milestone occasion for SNC-Lavalin since it is an important investment in Alberta, and capitalizes on our engineering and financing expertise," said Pierre Anctil, Executive Vice-President, Office of the President responsible for SNC-Lavalin Investment. "By combining the strengths of the TransAlta team with our considerable financial and technical expertise, we are well placed to deliver top quality transmission services to Albertans, and meet current and future needs."
…
"This is our first acquisition, and with our North American focus, this will put Trans-Elect in the forefront as an independent transmission owner," said Frederick Buckman, Chairman and CEO of Trans-Elect. "In any acquisition, it’s the people who make the difference and the capabilities and dedication of TransAlta’s Transmission personnel are outstanding. We are excited about becoming part of the economy and community in Alberta."
…
AltaLink will integrate employees of TransAlta’s transmission sector. As a key part of the transaction, SNC-Lavalin will integrate TransAlta’s engineering, procurement, construction management (EPCM) transmission projects team into its power engineering group.
"The benefits of this new pooling of expertise are two-fold," said Klaus Triendl, Executive Vice-President, Office of the President responsible for SNC-Lavalin Power. "It’s good for our new employees, because they are linking up with a world class case on which to build their considerable expertise in power transmission systems. This combined force will be a global leader in transmission power expertise, while ensuring that AltaLink continues to provide first class services. From SNC-Lavalin’s perspective, this new power base will provide us with the key to better meet a crucial and increasing demand globally for the kind of services we can provide – engineering, energy control systems, procurement, construction, operations and training. This is clearly a win-win situation."
…
[11] Mr. Woo also briefly explained the concept of a deemed income tax allowance, whereby a utility is allowed to recover projected taxes. The Respondent had assumed AltaLink paid the $190,000,000 premium because it expected an annual income tax allowance of approximately $30,000,000. Mr. Woo indicated the allowance will differ from actual taxes paid due to the differing undepreciated capital cost amounts for regulated rate purposes versus for tax purposes. He did not give any indication of the amount of any potential benefit to AltaLink, though, as will be clearer when discussing the expert’s evidence, the tax allowance may not have been as significant as assumed by the Respondent.
[12] Finally, Mr. Woo pointed out that the financial statements of AltaLink for 2002 and 2003 as prepared by Ernst & Young reflected the goodwill of $200,000,000, as did the 2007 and 2008 financial statements prepared by Deloitte & Touche.
[13] Turning now to the two experts, I will briefly summarize their findings and opinions, starting with Ms. Glass, the expert from KPMG put forward by TransAlta. Ms. Glass is an expert valuator having conducted a considerable amount of work in the utilities industry. She firstly addressed the question of what constitutes goodwill in the TransAlta – AltaLink transaction, and secondly, provided a valuation of TransAlta’s net tangible assets.
[14] Before reviewing Ms. Glass’ findings in her 85 page report, it was interesting to note that both she and Mr. Lawritsen, the expert put forward by the Respondent, agreed that a valuator’s approach to defining goodwill is what I call a residual approach, that is, it is the amount by which a purchase price exceeds the Fair Market Value ("FMV") of tangible assets: in effect, it is a plug. I will have more to say on that later.
[15] With respect to the identification of goodwill, Ms. Glass noted that for goodwill to exist, there must be a least one of the following factors: excess earnings, excess return or strategic factors. If none of these exist, there can be no goodwill.
[16] She then went on to raise seven factors that likely led to goodwill in this case:
I. Excess Earnings
i. PBR; and
ii. tax allowance.
II. Excess Returns
i. leverage.
III. Strategic Factors
i. EPCM;
ii. Merchant Transmission;
iii. new markets/growth; and
iv. skilled employee base.
[17] The following is taken from Ms. Glass’ report:
Performance Based Regulation
…
197 At the relevant time, the Transmission Business operated under a traditional cost-of-service model, although the EUB and the Alberta government were actively exploring the introduction of a PBR model. Under such a model, efficiencies are shared between the utility and the customer, such that the utility is able to recover an amount above that allowed under a cost-of-service model if costs are reduced below a threshold level. Thus PBR will give rise to excess earnings.
198 On October 6, 2000, TransAlta and a number of interveners negotiated an augmentation to the terms of a negotiated settlement for the Utility’s 2001 GTA, pursuant to which the parties agreed to begin discussions aimed at achieving agreement on a PBR model. The terms of the negotiated settlement were approved by the EUB in Decision 2001-4. As at Closing, a PBR model was expected to be introduced in the foreseeable future.
199 The bid received from the Consortium indicated that an element of AltaLink’s business plan would be to take an active role in the establishment of a PBR regime. Further, in its written argument relating to EUB Decision 2002-038 (which approved the Transaction), AltaLink indicated that the potential for PBR benefits was one of the factors that caused it to pay a premium for the Transmission Business.
…
201 The prospect of the adoption of a PBR model created the potential for the Utility to generate future excess earnings. As such, any portion of the premium relating to the potential for a future PBR model would be appropriately allocated to goodwill.
…
Income Tax Allowance
…
133 A cost-of-service model allows a utility to recover a deemed income tax allowance. As a limited partnership ("LP"), AltaLink was not itself subject to tax. Therefore, AltaLink would have received an annual deemed tax allowance, but would not have been required to pay corresponding taxes. In contrast, the corporate entities that were the ultimate limited partners in the AltaLink structure were taxable entities, and were required to report their share of AltaLink’s income on their corporate tax returns. The Partners controlled AltaLink, and therefore had access to the tax allowance, which was intended to offset the Partners’ tax liability.
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141 In 2003, AltaLink filed its first GTA, and one of the issues addressed in the application was whether or not AltaLink should be entitled to a tax allowance, given its LP status. In Decision 2003-061, the Board stated:
"On the evidence before it, the Board accepts that the partners are taxable entities in Canada and will assume that there is a reasonable expectation that income taxes in the range approved by the Board will be incurred and paid by the partners with the exception of OTPPB TEP Inc."
142 The Board then disallowed 25% of the deemed income tax allowance, being the portion relating to OTPPB TEP Inc., the entity representing Teachers. …
a) It leads one to conclude that Teachers was likely not required to pay tax and, therefore, the Consortium might have expected a tax benefit in the case of Teachers, and was frustrated in that regard. …
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149 The evidence indicates that, with the possible exception of Teachers, the Partners were Canadian corporations that paid Canadian income tax in the usual way. Since at least three of the Partners were subject to the payment of tax on income earned by the Utility, the deemed tax allowance cannot explain the full premium.
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175 In summary, with the possible exception of Teachers, it is likely that the Partners were required to pay tax on their share of AltaLink’s earnings. Therefore, the income tax allowance would not explain the full premium.
176 In the case of Teachers, it is possible that the income tax allowance might have explained a portion of the premium. …
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Leverage
211 Leverage refers to the manner by which an investment is financed, and in particular, the percentage of equity financing relative to debt financing.
212 When considering the capital structure allowed by the regulator, a purchaser would prefer a higher degree of equity, since allowed returns on equity are higher than allowed returns on debt. In contrast, when actually financing the acquisition, the purchaser would prefer to use a higher amount of debt, since debt can be obtained at a lower cost, particularly once income taxes are considered.
213 In 2002, the Board allowed 35% equity and 65% debt for rate-making purposes. However, it is probable that the Consortium would have financed the acquisition using more that 65% debt. Based on the manner in which infrastructure investments were financed by major players at the time, it would be reasonable to assume that the overall debt ratio would have been 75% at a minimum, and possibly as high as 90%.
214 Based on our review of AltaLink’s financial statements, AltaLink itself was financed using only 60% debt and 40% equity. As such, the equity capital contributed to AltaLink by the Partners would likely have been further debt financed by the Partners.
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220 In summary, given the manner in which infrastructure investments were financed in 2002, it is highly likely that a portion of the premium paid by AltaLink related to the Consortium’s ability to lever the investment beyond debt levels allowed by the EUB. All such additional leverage would have arisen outside of AltaLink – that is, it would have arisen as a result of the Partners borrowing to make their equity investments in AltaLink. Hence, the additional leverage could not have related to the tangible assets.
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EPCM
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268 … In EUB Decision 2003-061 [TransAlta’s Lost of Documents, no. 67], the Board described this contract as follows:
"AltaLink applied for approval of an executed ten-year exclusive contract with SNC-ATP, a subsidiary of SNC-Lavalin Inc., a 50% partner in AltaLink partnership, to provide engineering, procurement and construction management (EPCM) services for all capital projects undertaken by AltaLink. These would primarily be the direct assign contracts AltaLink receives from the AESO, potentially amounting to hundreds of million of dollars over the next seven years"
269 …SNC would nonetheless have been willing to pay premium value for AltaLink given that the Transaction resulted in:
a) The potential for hundreds of million of dollars in additional revenue over the ensuing seven years, thus reducing future revenue risk and avoiding high costs (proposals, marketing expenditures, etc.) required to source projects elsewhere. In addition, this potential revenue backlog would have been expected to positively influence SNC’s public share price.
b) The transfer of 76 highly-trained professionals that SNC could use to service n