Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.
Principal Issues: Can refund interest on an overpayment of income taxes be included in gross resource profits under Regulation 1204(1)(b)(ii) or (iii).
Position: Question of fact. In this case refund interest should not be included in gross resource profits.
Reasons: Whether refund interest be included in gross resource profits is a question of fact. In this case, the connection between the interest earned and income earned from production and processing described in Regulation 1204(1)(b)(ii) is too remote to include the interest in resource profits. Gulf Canada Limited and Gulf Canada Resources Limited cases dealt with former sections 124.1 and 124.2 of the Act however the words of those sections are identical to the relevant words in Regulation 1204(1). The resource profits regulations operate as a separate scheme within the Act. Gulf Canada Limited stated that when the Act refers to production as a source, it must be understood to mean the business of production rather than the narrow activity of physical extraction from the ground.
Gunnar Mining dealt with the meaning of the term 'income derived from the operation of a mine' and concluded that the words 'derived from' gave wider a meaning to the type of income that can be included in income derived from the operation of a mine. However, even with that wider interpretation, interest income on short term deposits was not closely connected enough to be included in income derived from the operation of a mine. In Echo Bay, the court found that activities reasonably interconnected with marketing the product, undertaken to assure its sale at a satisfactory price, are activities that form an integral part of production and resource profits, within the meaning of subsection 1204(1) of the Regulations. Cominco supports the view that the income in question must be directly related to actual production to be included in income under paragraph 1204(1)(b) of the Regulations. Cominco also supports the view that amounts received as economic replacement of lost income from production cannot be characterized as income from production.
Irving Oil and Munich Reinsurance dealt with the distinction between income from active business and income from property and are of limited help regarding whether refund interest that is found to be income from an active business would also be included in gross resource profits. XXXXXXXXXX , unlike Irving Oil, is a diversified company with many sources of income other than mining, and it is not possible to conclude that had XXXXXXXXXX not made an overpayment of taxes, the amount of the overpayment would have been used in the business of production for purposes of subsection 1204(1) of the Regulations.
June 19, 2003
Toronto Centre TSO HEADQUARTERS
Carme Lau Resources Industries Section
Large File Case Manager David Shugar
(613) 957-2134
2002-018084
XXXXXXXXXX Adjusted Resource Profits re Refund
Interest on Overpayment of Taxes
This is in reply to your request of December 18, 2002 for our views on whether refund interest on the overpayment of income tax should be included in computing adjusted resource profits under subsection 1210(2) of the Income Tax Regulations (the "Regulations") for purposes of the resource allowance deduction under paragraph 20(1)(v.1) of the Income Tax Act (the "Act").
Legislation
Adjusted resource profits is computed by reference to the definitions of "resource profits" and "gross resource profits" in subsections 1204(1.1) and 1204(1) of the Regulations, respectively. Subparagraph 1204(1)(b)(ii) of the Regulations states:
"For the purposes of this Part, "gross resource profits" of a taxpayer for a taxation year means the amount, if any, by which the aggregate of
(a)...
(b) the amount, if any, of the aggregate of his incomes for the year from
(ii) the production and processing in Canada of
(A) ore... from mineral resources in Canada operated by him to any stage that is not beyond the prime metal stage or its equivalent,..."
Separate Code
Our view has been that the resource profits provisions in the Regulations operate as a separate code within the Act for the purpose of determining income from production and/or processing.
In Gulf Canada Limited1, the Federal Court of Appeal upheld the Federal Court-Trial Division's (FCTD) finding that former sections 124.1 and 124.2 of the Act set up their own separate scheme of inclusions and exclusions from resource income. The FCTD stated that "sections 124.1 and 124.2 are much more specific in their scope and intentment than the calculation of income provisions under section 3 of the Act, in requiring that the income and deductions be related to production in the sense of extraction from the ground as the source of income." Furthermore, unlike the enactment of subsection 1204(1.1) of the Regulations subsequent to these Court decisions to refer to "all amounts deducted in computing the taxpayer's income for the year" (i.e., a reference to income calculation from a source pursuant to sections 3 and 9 of the Act to the extent of deductions only), there is no similar enactment of a reference to "all amounts included in computing the taxpayer's income for the year" in respect of resource revenue in paragraph 1204(1)(b) of the Regulations. Therefore, even though a mining company could include interest in its business income for the purposes of sections 3 and 9 of the Act, such interest may not necessarily be included in the calculation of a mining company's resource profits for the purpose of section 1204 of the Regulations unless the requirements thereof are met.
Income from Production and/or Processing
Gulf Canada Limited dealt with the meaning of 'taxable production profits' in former sections 124.1 and 124.2 of the Act, and the Court's findings in that case apply equally to subsection 1204(1) of the Regulations because the relevant wording in the provisions is identical.
In Gulf Canada Resources Limited2, Pratte, J. commented at pages 6067 and 6068 as follows:
In the first Gulf case relating to its 1974 income tax, it was held that the word "production" in a provision similar to section 1204 was used in the narrow sense of extraction from the ground and that, as a consequence, the only incomes and deductions referred to in that provision were those that were directly related to the actual production of petroleum.
In Gulf Canada Resources Limited the Court concluded that capital cost allowance and interest expenses could only be deducted in computing resource profits to the extent that the expenses were related to the production (in the narrow sense of extraction from the ground) of petroleum and not to the extraction of bitumen from the sand or the upgrading of bitumen to obtain synthetic crude oil.
The Gulf Canada Limited case itself casts doubt about what can be included in resource profits when the Court said that although Parliament described production as being a source, it must be understood as the business of production, since the physical act of taking minerals or oil and gas from the ground does not and cannot produce income. However, the Court did not elaborate on what would be considered as the "business of production" and what should be included therein.
In Cominco Ltd3 business interruption insurance proceeds were found not to be included in 'production profits' because the proceeds were received as a result of the non-production of the taxpayer, and so did not fit within the literal requirements of the regulations nor did it accord with the purposes for which the allowances were provided. Reed, J. stated:
None of the jurisprudence cited by the plaintiff goes further than to say that insurance proceeds of the kind in question should be treated as general revenues for the purposes of income. Such revenues can properly be brought within the wording of the statute because of the breadth of the wording of section 3 of the Income Tax Act.
The insurance proceeds, however, cannot be brought within the much more specific wording of regulation 1201(2) - profits (pre-May 6, 1974) and regulation 1201 - resource profits, (post-May 6, 1974). The proceeds simply did not arise out of the "production of... metal or industrial minerals" or from "the processing in Canada of ores from a mineral resource."
An appeal of this decision to the Federal Court of Appeal was dismissed, and leave to appeal to the Supreme Court of Canada was refused. The Cominco case has never been explicitly overturned by the Federal Court of Appeal or Supreme Court of Canada and therefore, it is appropriate jurisprudence to rely on. The case supports the view that the income in question must be directly related to actual production to be included in income under paragraph 1204(1)(b) of the Regulations. The case also supports the view that amounts received as economic replacement of lost income from production cannot be characterized as income from production. Applying the concept to XXXXXXXXXX, interest earned on overpayment of taxes would not be considered to be income from production even if the overpayment could have been used to earn income from production.
In Gunnar Mining4, the Supreme Court examined whether interest income on short term investments should be included in 'income derived from the operation of a mine' and therefore exempt under former subsection 83(5) of the Act. The Court stated:
What is exempt under the latter section [83(5)] is "income derived from the operation of a mine." The income from the short term investments was not income derived from the operation of the mine but was income derived from the investment of the profits of the mine. This income from the short term investments cannot be regarded as incidental income in the operation of the mine any more than any other income gained from use of the profits of the mine, could be so considered....
...what is being considered is not income for the year from all sources, but income from a source other than the company's mining business, namely, the income from its short term investments.
In Gunnar Mining, the Supreme Court would not include interest income on short term investments in "income derived from the operation of a mine" despite the income relating to some extent to the mining business of the corporation. In effect, the connection between the interest income and mining activities was found to be too remote.
The words 'derived from' are not used in former section 124.1 and 124.2 of the Act, or in subsection 1204(1) of the Regulations. In our view, the use of the words 'derived from,' in the phrase 'derived from the operation of a mine' give a wider meaning regarding what can be included in that phrase, compared to what can be included in the phrase 'income from production and processing' used in subsection 1204(1) of the Regulations. It is arguable that interest income on short term deposits, as well as interest on overpayment of taxes, would not be included in the narrower term 'income from the production and processing in Canada...of ore... ' used in paragraph 1204(1)(b)(ii) of the Regulations.
In Gunnar Mining, the Court did not use the principle later used in Irving Oil and Munich Reinsurance (discussed below) of examining the origin of the interest earning funds or what alternate use the funds could have been put to, to determine whether the interest income was 'income derived from a mine.' In Gunnar Mining the Court noted that although the short term investments originated from mining activities, once invested, interest earned on these investments would not be considered as "income derived from a mine."
In Echo Bay the Court dealt with paragraph 1204(1)(b) of the Regulations, when it addressed the question of whether hedging gains were speculative or were integral to the main business of the taxpayer. The Court concluded that income from production may be generated by various activities, provided those are found to be included in production activities. The Court stated that activities reasonably interconnected with marketing the product, undertaken to assure its sale at a satisfactory price, are activities that form an integral part of production and resource profits, within the meaning of subsection 1204(1) of the Regulations. The Court found that there was sufficient inter-connection or integration with the business of production of silver that a gain from hedging activities could be considered to be income from that business to the extent that it corresponds to actual production. Regarding XXXXXXXXXX, we do not agree with XXXXXXXXXX comment on page 8 of their letter, that XXXXXXXXXX overpayment of income taxes has a similar degree of interconnection to the business of production as the activity of entering into forwards sales contracts in amounts that correspond to actual production.
In Irving Oil5 the Court found, as a question of fact, that refund interest on overpayment of income taxes was income from an active business for purposes of the manufacturing and processing deduction. The Court stated that, in determining the classification of income on a tax overpayment, one must consider the origin of the funds used by the taxpayer to make the overpayment. However, while Irving Oil stated that the origin of the funds is relevant in determining whether an amount is business or property income, as stated above, in Gunnar Mining, the Supreme Court noted but disregarded the origin of the invested funds in finding that interest income earned from the investment of the profits of the mine was not income derived from the operation of a mine, but was income from a separate source.
In Munich Reinsurance6, in deciding whether refund interest on a tax overpayment was interest from property received in the course of carrying on a business, the Court found that the company's right to a tax refund arose out of its insurance business and was a right acquired in the course of carrying on its business. The Court said,
The appellant's obligation to pay its Part 1 tax flowed from the fact that the appellant derived profit from carrying on an insurance business in Canada. The asset management decisions made by the appellant to comply with its tax obligations in the most advantageous way were decisions as to the use of the assets of its own insurance business, and in that sense were decisions made in the course of its business.
We agree with your comment that Irving Oil and Munich Reinsurance merely establish that, in those cases, refund interest was active business income rather than property income, and the rationale giving rise to those decisions do not apply to the determination of whether refund interest that was found to be income from an active business would also be included in resource profits. In addition, as you point out in your letter, XXXXXXXXXX, unlike Irving Oil, is a diversified company with many sources of income other than mining, and it is not possible to conclude that had XXXXXXXXXX not made an overpayment of taxes, the amount of the overpayment would have been used in the business of production for purposes of subsection 1204(1) of the Regulations. It is also not possible to conclude that the origin of the funds used to make the overpayment of taxes originated only from income that was income from production and processing as it is defined under paragraph 1204(1)(b) of the Regulations.
XXXXXXXXXX makes the comment, on pages 10-11 in their letter, that there is a general principle that "if a taxpayer's obligation to pay tax arises because the taxpayer derived profit from carrying on a particular business, that is but for the tax the taxpayer would have employed the funds (used to pay the tax) to earn profits in its business, then any refund interest in respect of that tax is properly considered part of the income from that business." We doubt whether the intention of the resource profits scheme is to give credit in the resource profits calculation, for income opportunities lost because funds were diverted to an unconnected non-production use.
XXXXXXXXXX
for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Legislation Branch
ENDNOTES
1 92 DTC 6123, FCA; 90 DTC 6622, FCTD.
2 96 DTC 6065, FCA; 95 DTC 5189 FCTD.
3 84 DTC 6535, FCTD
4 68 DTC 5035, SCC
5 2002 DTC 6716, FCA; 2000 DTC 2164, TCC
6 2002 DTC 6701, FCA
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