Principal Issues: 1. Whether the farm-out position stated in Interpretation Bulletin IT-125R4 would apply in a particular situation which is different from those described in that Bulletin.
2. What would be the income tax consequences for the purchaser who pays annual amounts to acquire rights with respect to claims, and who incurs expenses with respect to such claims?
Position: 1. No. Our Directorate is not ready to expand the administrative position on farm-outs in the context of a technical interpretation in this case. The expenses incurred would be part of the consideration given for any right acquired by the purchaser with respect to the claims.
2. General information provided assuming that the right acquired is Canadian resource property. General information also provided assuming that the right acquired by the purchaser is not Canadian resource property.
Reasons: 1. The purchaser does not acquire a right in the claims.
2. The CRA would have to review the relevant information and legal documentation before reaching a definitive position
XXXXXXXXXX 2011-042045 Sylvie Labarre, CA
November 22, 2011
Dear Madam,
Subject: Mineral Claim Acquisition Option
This is in response to your e-mail of September 7, 2011, in which you asked us for our opinion regarding the tax consequences of granting by agreement an option to a buyer in the following hypothetical situation. The buyer would also incur exploration expenses.
Under the hypothetical situation that you submitted to us, an option agreement between Corporations A and B (which were Canadian corporations) was signed for the acquisition of claims. The claims that could be acquired under the option were resource properties C1 to C3 that belonged to Corporation B and that were unproven resource properties. As part of the option agreement, Corporation A made a commitment to Corporation B to make the following payments:
- payment of the sum of $XXXXXXXXXX, on the date of the signing of the agreement
- to retain its option to acquire claims, payment of the sum of $XXXXXXXXXX, six months after the signing of the agreement;
- to acquire the claims, payment of the sum of money of $XXXXXXXXXX and the issuance of XXXXXXXXXX shares of the capital stock of Corporation A, 18 months after the signing of the agreement.
In addition to the above payments, Corporation A undertook to carry out work on resource properties C1 to C3 for the following amounts:
- in the first six months following the signing of the agreement, the amount of $XXXXXXXXXX;
- during the following six months, the amount of $XXXXXXXXXX;
- during the following six months, the amount of $XXXXXXXXXX;
Corporation A could abandon its option right at any time.
You wish to know the tax consequences to Corporation A resulting from the payments described above and the work done on the C1 to C3 resource properties held by Corporation B.
Our Comments
As stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, it is the practice of the Canada Revenue Agency ("CRA") not to issue a written opinion regarding proposed transactions otherwise than by advance rulings. Furthermore, when it comes to determining whether a completed transaction has received the appropriate tax treatment, that determination is made first by our tax services offices as a result of a review of all facts and documents, which is usually done as part of an audit engagement. However, we can offer the following general comments, which we hope will be helpful. These comments may, however, under certain circumstances, not apply to your particular situation.
A study of the legal documents and the facts surrounding a particular situation is necessary in order to definitively determine the appropriate tax treatment to the one paying the amounts and performing the work, and to the owner of the claims. Even if the term "option" is used, it would be necessary to examine, according to the terms of the legal documents, whether it is, in fact, to the one paying the amounts and performing the work, a right to acquire claims. It should also be considered whether the corporation wished to acquire the claims with the intention of exploring or developing them.
Furthermore, we may, following that examination of the legal documents and the facts surrounding the particular situation, conclude that the situation is not that of an acquisition/disposition transaction for a Canadian resource property. For example, the facts and documents examined in a particular situation could lead us to conclude that a corporation was required to perform the work on the claims belonging to the owner for and on behalf of the owner and that the amounts paid were intended to help the owner of the claims to incur exploration or development expenses on its claims.
We will therefore make comments taking into account two alternatives for Corporation A, namely: where the relevant facts demonstrate that Corporation A acquires a right to a Canadian resource property or where the facts demonstrate that that is not the case. Since your question was as to the tax treatment of Corporation A, our comments are primarily as to the tax treatment of it.
Position on Farm-outs
Under the hypothetical situation that you described to us, the consideration offered by Corporation A includes two elements: cash payments and the commitment to carry out work on the resource properties of Corporation B.
When we take into account the entire transaction, we find that your hypothetical situation is a different situation from the farm-out situations referred to in Interpretation Bulletin IT-125R4 and in Technical Interpretation No. 2010-0389081I7. In your hypothetical situation, carrying out the work on the claims does not give a right in the claims but potentially only an option to acquire them. We are not currently prepared, as part of a request for an external technical interpretation, to extend the position stated in Interpretation Bulletin IT-125R4 to a situation like the one you are describing.
Consequently, it is our opinion that for Corporation A, the amounts paid to carry out the work on the claims of Corporation B would be added to the cash payments provided for in the agreement and would be considered part of the overall consideration given by Corporation A to acquire a property. The sums paid to carry out the work on the claims of Corporation B would therefore not constitute "Canadian exploration expenses" to Corporation A.
Acquisition of a resource property
For the purposes of our comments, we have assumed that claims C1 to C3 are described in paragraph (b), (e) or (f) of the definition of "Canadian resource property" in subsection 66(15) of the Income Tax Act (the "Act"). Consequently, we have assumed that the cost of those claims would come within paragraph (e) of the definition of "Canadian development expense" in subsection 66.2 (5) of the Act.
It would therefore be necessary to determine whether what was acquired by Corporation A (when it paid the sums of money and carried out the work) was a right to [“droit relative”] any property described in paragraph (b), (e) or (f) of the definition of Canadian resource property (under the wording of the proposed amendment of July 16, 2010) or an interest in such property [“droit y afferent”] (under the current wording)..
As previously stated, a review of the legal documents and relevant facts surrounding this transaction will be required to determine whether Corporation A actually acquires an option to acquire the claims for the purpose of exploration or development of the claims.
If that were the case, we are of the view that Corporation A acquired a right in respect of property described in paragraphs (b), (e) or (f) of the definition of Canadian resource property (or interest therein, depending on the wording applied). At that time, the amounts paid by Corporation A to Corporation B or to perform the work would be included in paragraph (e) of the definition "Canadian development expense" in subsection 66.2(5), and element A of the definition "cumulative Canadian development expense" in subsection 66.2(5.
Corporation B should add those amounts to Element F of the definition of "cumulative Canadian development expense" in subsection 66.2(5).
Consequently, taking into account the acquisition of the resource property that occurred at the time of the outlays, Corporation A could continue to deduct the deductible portion of its cumulative Canadian development expense account if it does not exercise the option. On the other hand, taking into account the acquisition of the resource property that took place at the time of the outlays, the exercise of the option would not entail any additional tax consequences to Corporation A or Corporation B.
Acquisition of a property other than a Canadian resource property
If, following the examination of the relevant facts and legal documents, we came to the conclusion that Corporation A does not acquire a Canadian resource property, the comments in the previous section "Acquisition of a resource property” would not apply to that situation.
Subject to further study of the facts and legal documents in a particular situation, Corporation A could be considered to have acquired property that is not a right in respect of a Canadian resource property (or an interest therein, depending on the wording applied).
In such a case, we are of the view that the cash payments and the amount of work performed would be capital payments that would be part of the cost of a property considered to be a capital property.
If the right was not exercised, we are of the view that there would be a disposition of such capital property that would result in a capital loss.
If the right was exercised, we are of the view that a Canadian resource property would be acquired, the cost of which would be equal to the cost of the property previously acquired, provided that the claims represented Canadian resource properties under the definition in subsection 66(15). That capital property would be disposed of for proceeds of disposition equal to the cost of the property, which would result in no capital gain or loss.
Corporation A could then add that cost of such property described in paragraph (b), (e) or (f) of the definition of "Canadian resource property" to its "Canadian development expense".
Possible consequences to Corporation B
If, under the facts and legal documents, the outlays or the work performed by Corporation A do not constitute, at the time of payment, a right to a Canadian resource property (or an interest therein, depending on the wording applied) and that the tax consequences in the "Acquisition of a resource property" section do not apply, it may be that the tax consequences to Corporation B are those described in Technical Interpretation No. 2005-0119731E5 (which still represents our position) in the event that there is no disposition of a Canadian resource property. It would then be necessary to determine whether the amounts received by Corporation B come within subsection 66(12.1) or are included in the definition of "assistance" in subsection 66(15). If that were the case, the amounts received from Corporation A by Corporation B could reduce its cumulative Canadian development expense or its cumulative Canadian exploration expense, as applicable based on the relevant facts.
These comments are not advance income tax rulings and are not binding on the CRA with respect to a particular situation.
Best regards,
Stéphane Prud'Homme, Notary, M. Fisc.
for the Director
Corporate Reorganizations and Resource Industry Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch