Principal Issues: 1. At what time the resource property was transferred by the Vendor to the Purchaser?
2. In which taxation year the proceeds of disposition or part of it should be included in the amount described in F of the definition of cumulative Canadian development expense?
3. Will the CRA apply the administrative position described in paragraph 14 of the Interpretation Bulletin IT-125R4 with respect to the exploration expenses the Purchaser has to incur in consideration for the acquisition of the resource property that is unproven?
Position: 1. In the present situation, the date of the transfer is the effective date provided for in the contract.
2. It will depend on when the proceeds of disposition will become receivable by the Vendor and more specifically, on when the proceeds or part of it will be ascertainable.
3. Yes
Reasons: 1. XXXXXXXXXX .
2. Wording of the Act.
3. Even if the situation in this file is different from the examples described in paragraph 14 of IT-125R4, the CRA will accept to apply the administrative position with respect to farm-out transactions. Consequently, an amount corresponding to the exploration expenses to be incurred by the Purchaser would not give rise to proceeds of disposition for the Vendor for purposes of F of the definition of cumulative Canadian development expense.
March 23, 2011
| XXXXXXXXXX Audit Division XXXXXXXXXX Tax Services Office |
Income Tax Rulings Directorate Sylvie Labarre, CA 2010-038908 |
Subject: Disposition of Mining Assets - Amount and timing of a reduction in cumulative Canadian development expense
This is in response to your e-mail of December 2, 2010 in which you requested our opinion on the tax consequences arising from an agreement for the disposition of a Canadian resource property by XXXXXXXXXX (the "Vendor") to XXXXXXXXXX (the "Purchaser").
Unless otherwise indicated, any reference herein to a statutory provision is to a provision of the Income Tax Act.
Facts
Overview
- The Vendor is a public corporation.
- The end of its fiscal period is XXXXXXXXXX.
- The registered office of the Vendor is XXXXXXXXXX.
- In the relevant period, the Vendor held mineral properties mainly XXXXXXXXXX.
- The Purchaser is also a public corporation with its head office XXXXXXXXXX.
Sale of certain mining properties
A) Original Agreement:
- The Vendor sold XXXXXXXXXX% of its interest in the mining properties BS1, SB2 and SB3 XXXXXXXXXX to the Purchaser. The properties were located XXXXXXXXXX and comprised XXXXXXXXXX claims (the "Mining Properties"). We have assumed that Mining Properties were unproven resource properties.
- The Vendor retained a production royalty equal to XXXXXXXXXX (the "Royalty"). XXXXXXXXXX.
- The agreement between the Vendor and the Purchaser was signed on XXXXXXXXXX. On that date, the average price of the shares of the capital stock of the Purchaser was XXXXXXXXXX per share.
- Under the agreement, the effective date of the transaction was the date on which XXXXXXXXXX approved the transaction as long as, on or before XXXXXXXXXX, the Purchaser had indicated to the Vendor that it was satisfied with its review (its "Due Diligence Review").
- The agreement is subject to certain conditions called "Conditions Precedent" which are:
- XXXXXXXXXX
- Furthermore, paragraph XXXXXXXXXX of the agreement provides that the transfer of the legal title to the Mining Properties will be made when the entire sale price is paid.
- The approval by XXXXXXXXXX occurred on XXXXXXXXXX and the value of the shares of the capital stock of the Purchaser on that date was $XXXXXXXXXX per share.
- Under the XXXXXXXXXX Agreement, the Purchaser must issue to the Vendor XXXXXXXXXX common shares of its capital stock over a period of XXXXXXXXXX years, and no later than each anniversary date of the effective date of the agreement.
- The Purchaser must also pay $XXXXXXXXXX over a period of XXXXXXXXXX years, and no later than each anniversary date of the effective date of the agreement.
- Finally, pursuant to that agreement, the Purchaser must expend $XXXXXXXXXX of exploration expenses on the Mining Properties before the XXXXXXXXXX anniversary of the effective date of the agreement.
- The clause of the agreement that provides for the sale and the consideration given by the Purchaser for the Mining Properties reads as follows:
- XXXXXXXXXX
- * Upon signing, we understand that the Purchaser paid $XXXXXXXXXX in cash and issued XXXXXXXXXX common shares of its capital stock to Vendor XXXXXXXXXX, for a total value in its books of $XXXXXXXXXX. Vendor reported that amount as a deduction from its cumulative Canadian development expense ("CCDE") in Section 4 of Schedule 12 of its income tax return dated XXXXXXXXXX.
- * Pursuant to clause XXXXXXXXXX of the agreement of XXXXXXXXXX, the parties agreed that such agreement would be governed by and interpreted in accordance with the laws of XXXXXXXXXX.
B) Addendum to the original agreement:
XXXXXXXXXX
Other Information
XXXXXXXXXX.
Questions
You wish our opinion on the following points:
- the date of disposition of the Mining Properties;
- the taxation years during which the Vendor must include an amount as a reduction in its CCDEs as a result of the disposition of the Mining Properties; and
- the value of the consideration that must be included as a reduction in its CCDE in those taxation years.
In addition, you inquired as to whether the CRA should take into account the concept of farm-out agreement described in paragraph 14 of Interpretation Bulletin IT-125R4.
Our Comments
Element F of the definition of CCDE in subsection 66.2(5) provides for a reduction in the CCDE for the total of all amounts each of which is an amount in respect of property described in paragraph (b), (e) or (f) of the definition "Canadian resource property” in subsection 66(15) or any right to such property, other than any such right that the taxpayer has by reason of being a beneficiary under a trust or a member of a partnership, disposed of by the taxpayer before that time equal to the amount, if any, by which paragraph (a) exceeds paragraph (b) of that element.
For the purposes of our response, we have assumed that the Mineral Properties that were sold constituted property referred to in paragraph (b), (e) or (f) of the definition of Canadian resource property in subsection 66(15). In particular, it appears to us that they could be property referred to in paragraph (f) of the definition of Canadian resource property in subsection 66(15), i.e., an immovable (other than depreciable property) situated in Canada the principal value of which depends on its mineral resource content. As stated in the Facts, we have also assumed that the Mining Properties were unproven resource properties.
For the purposes hereof, we have also assumed that the proceeds of disposition of the Mining Properties were not reduced by any expenses incurred or made before the time of disposition for the purpose of making the disposition and that were not otherwise deductible by virtue of Part I. We have also assumed that paragraph (b) of F in the definition of CCDE does not apply in this case.
For an amount to be included in Element F of the definition of CCDE at the end of a particular taxation year, the taxpayer must have disposed of the Mining Properties before the end of that taxation year. In addition, proceeds of disposition from the Mining Properties must be received by the end of the particular taxation year.
Paragraph 1 of Interpretation Bulletin IT-125R4 states that the terms "disposition" and "proceeds of disposition" have the same meaning for dispositions of resource properties as they do for capital gains purposes.
In the present situation, the date of the disposition of the Mining Properties, which are immovable rights located XXXXXXXXXX, depends on the law applicable to the transfer of ownership between the parties.
XXXXXXXXXX
XXXXXXXXXX
Consequently, in this case, the date of the disposition is XXXXXXXXXX which is, under the contract, the effective date and the date on which the conditions provided in clause XXXXXXXXXX of the contract were satisfied.
As previously stated, F in the definition of CCDE takes into account the proceeds of disposition that have become receivable before the particular time. That amount must therefore be determined in order to answer your questions as to the amount that will reduce the CCDE in the taxation year or in the taxation years ending after the effective date of the contract.
In this case, no sales price has been specified. However, a description of the disposed property is included in the agreement as well as of the consideration that had been given in exchange therefor by the Vendor (see section XXXXXXXXXX of the agreement). We have assumed that the Mining Properties sold were unproven resource properties. In that context, it may be difficult to establish the value of such assets. In such a case, we are of the view that we could determine the proceeds of disposition taking into account the value of the consideration given in exchange for the property sold.
As stated in XXXXXXXXXX E2010-0370781I7, the definition of "sale price" according to the Dictionary of Canadian Law is as follows:
Sale price. 1. Actual value of thing exchanged. 2. Amount paid for a thing purchased. 3. The phrase "sale price" is not apt to describe an offered price. In this context, sale price means a price agreed upon between the seller and a buyer who was obtained with the assistance of the co-operating agent.
Consequently, as we do not know the value of the property exchanged and as the XXXXXXXXXX agreement does not expressly specify a sale price for the Mining Properties, our position is supported by the second definition of "sale price", i.e. “Amount paid for a thing purchased".
Furthermore, the expression "became receivable" for the purposes of element F of the definition of CCDE in subsection 66.2(5) must also be interpreted. Paragraph 4 of Interpretation Bulletin IT-125R4 tells us that an amount becomes receivable when a collectible right to the amount is acquired. Consequently, the obligee may have a clearly legal, though not necessarily immediate, right to receive that amount.
What is more, we are of the view that the expression "became receivable" should have the same meaning as for the purposes of paragraph 12(1)(b).
Thus, for the purposes of paragraph 12(1)(b), we are of the view that to be able to say that the proceeds of disposition have become receivable, the vendor must have an absolute right, though not necessarily immediate, to the consideration and, secondly, that the proceeds of disposition are determined or determinable. (See inter alia The Queen v. Huang and Danczkay Ltd., 2000 DTC 6549 (FCA); The Queen v. Capital, General Insurance Company, 98 DTC 6215, (FCA); West Kootenay Power and Light Company Limited v. The Queen, 92 DTC 6023 (FCA); Maple Leaf Mills v. MNR, 76 DTC 6182 (SCC); MNR v. Benaby Realties Ltd., 67 DTC 5275 (SCC); and MNR v. John Colford Contracting Company Limited, 60 DTC 1131 (Exch. Ct.).)
Consideration: Sums of Money
We are of the view that it is the totality of a monetary consideration in respect of which a taxpayer has an absolute but not necessarily immediate right that must be included in the proceeds of disposition referred to in element F of the definition of CCDE, from the time of the disposition of the property. We would not deduct any discount for the passage of time. If reliance is placed on certain court decisions such as Avril Holdings Ltd. v. MNR, 69 DTC 5263 (Exch. Ct. and confirmed by 70 DTC 6366 (SCC)) and Attis v. MNR, 85 DTC 37 (TCC), the fair market value of notes received in consideration but not immediately payable is to be measured, for the purpose of determining the proceeds of disposition, at their stated value and not at a value that is discounted for the fact that that they are not payable immediately. It seems to us that this is even more the case when it comes to monetary consideration. Thus, for the purposes of element F in the definition of CCDE in subsection 66.2(5), the amount of $XXXXXXXXXX should be part of the proceeds of disposition that became receivable by the Vendor in respect of the Mining Properties on the effective date of the agreement.
Consideration: Issuance of Shares
With respect to the issuance by the Purchaser of the shares of its capital stock on the year of disposition and subsequent years, that right to the shares appears to be absolute and unconditional. However, in order to be able to consider the value of those shares as being proceeds of disposition that became receivable before the particular time for the purposes of element F in the definition of CCDE in subsection 66.2(5), it is also necessary that the value of such property have become determinable before the particular time.
It may be difficult to establish the value, at the effective date, of that portion of the consideration received. Indeed, the Purchaser is a public corporation and it seems that the share price on the markets is not stable and that it can fluctuate greatly. Therefore, it may be that using the market value at the effective date to determine the value of the shares to be issued by the Purchaser over the course of the subsequent taxation years does not produce a result representative of the value actually received by the Vendor. In that regard, you may wish to consult with Assessment Services, Technical Applications and Evaluations Division, Professional Services Audit Directorate, Compliance Programs Branch.
If it is not possible to establish a representative value, on the effective date of disposition of the Mining Properties, of shares to be issued in the future in the circumstances of this case, that portion of the proceeds of disposition would not be determinable before the issue of the shares. Our position could then be to include (as to the shares of the capital stock of the Purchaser to be issued) in the proceeds of disposition that became receivable by the Vendor at a particular time only the value of the shares issued by the Purchaser to the date of their issuance. Under that approach, the inclusion of the portion of the proceeds of disposition respecting the shares would occur over four years because we had determined that that portion of the proceeds of disposition was not determinable until their issuance.
If you conclude that such portion of the proceeds of disposition for the Mining Properties by the Vendor is not determinable prior to the date of issuance of the shares by the Purchaser and that such portion of the proceeds of disposition would be recognized for tax purposes at the times of their issuance, the addendum to the original agreement will have to be taken into account as and when the shares are issued.
Exploration Costs to be Incurred
As for the totality of the expenses that were required to be incurred by the Purchaser in the subsequent taxation years, either $XXXXXXXXXX under the original agreement or $XXXXXXXXXX as per the addendum to the original agreement, we have assumed that those expenses would otherwise qualify as Canadian exploration expenses ("CEE") as defined in subsection 66.1(6).
The question is therefore whether the administrative position we adopted in paragraph 14 of Interpretation Bulletin IT-125R4, with respect to farm-out transactions, could apply to the present situation and how. The current file covers a situation different from those which are given as examples in that Bulletin. More specifically, the question is whether the CRA is prepared to consider in this case that the exploration expenses to be incurred by the Purchaser are not part of the proceeds of disposition to the Vendor, do not represent a cost of acquiring a Canadian resource property for the Purchaser and represent CEE for the Purchaser.
Although the current situation is different from the examples given in paragraph 14 of Interpretation Bulletin IT-125R4, we are still ready to adopt, in the current file, the administrative position relating to the farm-out transactions described in that Bulletin to obtain the results described in such paragraph, XXXXXXXXXX. Thus, under that position, an amount equal to the exploration expenses would not result in proceeds of disposition to the Vendor for purposes of F in the definition of CCDE provided in subsection 66.2(5).
For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should the taxpayer request a copy of this memorandum, they may request a severed copy using the Privacy Act criteria, which does not remove taxpayer identity. Requests for this latter version should be made by you to Ms. Celine Charbonneau at (613) 957-2137. In such cases, a copy will be sent to you for delivery to the taxpayer.
We hope that these comments are of assistance.
Best regards,
Stéphane Prud'Homme, Notary, M. Fisc.
Manager
Mergers and Acquisitions Section
Corporate Reorganizations and Resource Industries Division
Income Tax Rulings Directorate
Legislative Policy
and Regulatory Affairs Branch