1999 Ruling 9827733 - EXEMPT ENTITIES EARN ROYALTIES THROUGH NRO

Unedited CRA Tags

133 245 Article XXI 66(15)

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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.

Facts

Proposed Transactions

Purpose of the Proposed Transactions

Rulings

Opinion

Comments

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

1. Qualification as an NRO

2. Application of paragraph 3 of Article XXI of the Canada-U.S. Convention.

3.Qualification of royalty as Canadian resource property.

Position:

1. Qualifies as NRO.

2. Paragraph 3 does not apply.

Qualifies subject to 10% test.

Reasons:

1. Law.

2. In these circumstances, business not being carried on in Canada, and income not from related parties.

3. Royalty was revised to meet Technical News #10.

XXXXXXXXXX
XXXXXXXXXX		982773
XXXXXXXXXX

Attention: XXXXXXXXXX

XXXXXXXXXX, 1999

Dear Sirs/Mesdames:

Re: XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX in which you requested an advance income tax ruling on behalf of the above-noted taxpayer, the non-resident-owned investment corporations referred to herein, and the partners of the partnerships referred to herein. We also acknowledge the additional information provided in your letters of XXXXXXXXXX, and our numerous telephone conversations (XXXXXXXXXX).

Unless otherwise indicated, all references to the "Act" are references to the Income Tax Act (Canada), R.S.C. 1985 (5th Supp.), c.1, as amended (the "Act"). References to the "Treaty" are references to the Canada-United States Income Tax Convention, 1980, as amended.

Facts

1. XXXXXXXXXX is a corporation incorporated under the laws of the United States of America and is a resident of the United States for purposes of United States federal income taxation and also for purposes of the Treaty. XXXXXXXXXX is not a resident of Canada for purposes of the Act.

2. XXXXXXXXXX is engaged, directly and indirectly, in the acquisition of petroleum and natural gas leases situated within the United States and the development, production and marketing of petroleum, natural gas and related substances produced from the leases. XXXXXXXXXX also manages, directly and through XXXXXXXXXX, investments in oil and gas properties on behalf of investors resident in the United States, as described below.

XXXXXXXXXX

3. XXXXXXXXXX is a limited partnership organized under the laws of the United States of which XXXXXXXXXX is the general partner XXXXXXXXXX is not a limited liability corporation ("LLC"). XXXXXXXXXX. None of the direct or indirect ownership of limited partnership units of XXXXXXXXXX is through a corporation. A number of employees of XXXXXXXXXX have been assigned limited partnership interests in XXXXXXXXXX but the assignments have not been registered and therefore the assignees have an economic interest in XXXXXXXXXX but are not legally recognized as limited partners.

XXXXXXXXXX

4. XXXXXXXXXX limited partnerships have been organized under the laws of the United States since XXXXXXXXXX for the purpose of investing in oil and gas production within the United States. XXXXXXXXXX is the general partner of each limited partnership and the limited partners are individuals, corporations, XXXXXXXXXX none of which are resident in Canada for purposes of the Act. Each of the limited partners deals at arm's length with XXXXXXXXXX.

XXXXXXXXXX

6. Most of the limited partners of XXXXXXXXXX are universities, university endowment funds and other charitable organizations all of which are religious, scientific, literary, educational or charitable organizations. All but one of this type of limited partners are corporations incorporated under the laws of the United States or trusts the sole beneficiary of which is a corporation incorporated under the laws of the United States. XXXXXXXXXX.

7. Some of the remaining limited partners of XXXXXXXXXX, are corporations or trusts or other organizations that operate exclusively to administer or provide pensions, retirement or employee benefits, or operate exclusively to earn income for the benefit of such corporations or trusts, and whose income is generally exempt from taxation in the United States.

8. The remaining limited partners of XXXXXXXXXX are taxable individuals all of whom are resident in the United States or private trusts which are resident in the United States and whose beneficiaries are resident in the United States and either the trusts or their beneficiaries are liable to tax in the United States on the income of the trusts, or partnerships for the benefit of such individuals.

XXXXXXXXXX

10. The limited partners of XXXXXXXXXX (the "Limited Partners") and their status for tax purposes in the United States are as follows:

Limited Partnership
Date Formed
Limited Partner(s)
Taxable or Non-Taxable Status
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX

XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX

XXXXXXXXXX
XXXXXXXXXX

XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX

XXXXXXXXXX
XXXXXXXXXX

XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX

XXXXXXXXXX
XXXXXXXXXX

11. XXXXXXXXXX new corporations (referred to individually as the "NRO" and collectively as the "NROs") were incorporated on XXXXXXXXXX. The names of the corporations and the participating Investing Partnership are:

XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX

In respect of each corporation, the incorporator was an agent of XXXXXXXXXX. At no time were shares issued to the incorporator.

12. Each NRO elected on XXXXXXXXXX and in prescribed manner to be taxed under section 133 of the Act as a "non-resident-owned investment corporation". Each NRO has a taxation year that ends on XXXXXXXXXX of each calendar year.

13. The authorized share capital of each NRO consists of XXXXXXXXXX classes of common shares identified as "Class A Shares" and "Class B Shares". The attributes of each class of shares of each NRO will be as follows.

a) Holders of Class A Shares (to be owned by XXXXXXXXXX as described below in the Proposed Transactions):

i) except for meetings at which only holders of Class A Shares are entitled by law to vote separately as a class, will not be entitled to receive notice of or to attend any meeting of the shareholders of the corporation or to vote at any such meeting, and in particular will not be entitled to vote at elections of directors of the NRO and will not otherwise have any ability to elect or appoint directors;

ii) will be entitled to receive, together with the holders of Class B Shares, dividends if, as and when declared by the Board of Directors of the NRO and in such amount as the Board may determine, provided that the amount declared at any time as a dividend to holders of the Class A Shares shall be equal to the total amount of all dividends declared at that time to be payable to the holders of the Class A Shares and to the holders of the Class B Shares multiplied by the proportion that the stated capital account of the Class A Shares is to the total of the stated capital account of the Class A Shares plus the stated capital account of the Class B Shares, and provided further that no dividend will be declared as a dividend to holders of Class A Shares unless a dividend is also declared at the same time to holders of Class B Shares;

iii) will be entitled, on the dissolution, liquidation or winding-up of the NRO, to all of the property and assets of the NRO that are available for distribution to its shareholders after adequately providing for the payment or discharge of all its obligations and after provision for the prior rights of the holders of Class B Shares; and

iv) will not be able to exchange or convert their Class A Shares into any other share, debt or other security of the NRO.

b) Holders of Class B Shares (owned by XXXXXXXXXX as described in the next paragraph):

i) except for meetings at which only holders of Class A Shares are entitled by law to vote separately as a class, are entitled to receive notice of and to attend all meetings of the shareholders of the NRO and at such meetings will have one vote for each Class B Share held, and will accordingly be entitled to elect the board of directors of the NRO;

ii) are entitled to receive, together with the holders of Class A Shares, dividends if, as and when declared by the Board of Directors of the NRO and in such amount as the Board may determine, provided that the amount declared at any time as a dividend to holders of the Class B Shares shall be equal to the total amount of all dividends declared at that time to be payable to the holders of the Class A Shares and to the holders of the Class B Shares multiplied by the proportion that the stated capital account of the Class B Shares is to the total of the stated capital account of the Class A Shares plus the stated capital account of the Class B Shares, and provided further that no dividend will be declared as a dividend to holders of Class B Shares unless a dividend is also declared at the same time to holders of Class A Shares;

iii) are entitled, on the dissolution, liquidation or winding-up of the NRO and after adequately providing for the payment or discharge of all its obligations, in priority to the holders of the Class A Shares, to receive an amount equal to and limited to the stated capital account of the Class B Shares; and

iv) will not be able to exchange or convert their Class B Shares into any other share, debt or other security of the NRO.

14. Following the incorporation of the XXXXXXXXXX NROs, XXXXXXXXXX subscribed for and has become the owner of XXXXXXXXXX Class B Shares of each NRO in consideration of a cash payment of $XXXXXXXXXX per share for a total investment of $XXXXXXXXXX per NRO. The stated capital account for the Class B Shares of each NRO for purposes of corporate law is therefore $XXXXXXXXXX.

15. In addition, XXXXXXXXXX and a resident of the United States, subscribed for and became the owner of XXXXXXXXXX Class A Shares of each NRO in consideration of a cash payment of $XXXXXXXXXX per share for a total investment of $XXXXXXXXXX per NRO. The stated capital account for the Class A Shares of each NRO for purposes of corporate law is therefore $XXXXXXXXXX paid for these Class A Shares from his own resources and holds the shares for and on behalf of no one other than himself.

Proposed Transactions

16. Where an investor in XXXXXXXXXX is a trust described in paragraph 2 of Article XXI of the Treaty, the investor will transfer its limited partnership interest in XXXXXXXXXX to a United States corporation wholly-owned by the investor. Such a corporation will be one currently owned by the investor or will be incorporated for the purpose of acquiring the limited partnership interest. As with any corporation, beneficial ownership of the assets of these corporations will be with the corporation and not with the shareholders. These corporations will generally be exempt from taxation for United States federal income tax purposes, and will be operated exclusively to earn income for the benefit of the particular investor which owns all of the shares of the corporation.

17. A new limited partnership (referred to herein as XXXXXXXXXX") will be formed under the laws of the United States in which XXXXXXXXXX will be the general partner and XXXXXXXXXX will be the limited partner. XXXXXXXXXX will not be an LLC. The purpose of the formation of XXXXXXXXXX will be to own working interests in the resource properties to be acquired in Canada.

18. The investment by XXXXXXXXXX and by XXXXXXXXXX in producing oil and gas properties will be undertaken by way of a series of transactions described below.

19. XXXXXXXXXX will enter into agreements from time to time with arm's length vendors to acquire working interests in petroleum and natural gas leases which will qualify as "Canadian resource properties" within the meaning of subsection 66(15) of the Act and depreciable properties related thereto. It is expected that most of these acquisitions will relate to properties located within the XXXXXXXXXX. The working interests will be rights to explore for, drill for, produce, save and market petroleum substances, including fee simple interests in petroleum substances and interests granted pursuant to instruments commonly known as Crown or freehold petroleum and/or natural gas leases. XXXXXXXXXX will not acquire royalties or net profit interests which would not provide XXXXXXXXXX with an ownership interest in the resource properties and the production of oil and gas. Also, no oil sands properties will be acquired and there will not be any oil refining or natural gas straddle plant processing undertaken by XXXXXXXXXX or by another party on its behalf. Each NRO will be given the opportunity to participate in each acquisition.

20. On or about the same time as XXXXXXXXXX closes a particular acquisition, each NRO that is participating in the acquisition will issue Class A Shares to its respective XXXXXXXXXX in consideration of a cash payment from XXXXXXXXXX such that the NRO will after the issuance of the shares have funds sufficient to allow the NRO to make the payment to XXXXXXXXXX described in paragraph 23(a) below. In addition, at the time of the first such acquisition, XXXXXXXXXX will sell his XXXXXXXXXX Class A Shares of each NRO to XXXXXXXXXX that has been issued Class A Shares of that NRO for a cash payment of $XXXXXXXXXX per share. Otherwise, it is not proposed that there be any shareholders of each NRO other than XXXXXXXXXX and XXXXXXXXXX.

21. Each participating NRO will acquire a royalty interest in respect of an undivided working interest acquired by XXXXXXXXXX as part of a particular acquisition. The royalty interest acquired by each NRO (referred to herein as the "Royalty Percentage") will be no less than 94% and no greater than 98%, depending on the terms of the arrangement between XXXXXXXXXX and the particular XXXXXXXXXX which will own the Class A Shares of the NRO.

Where there is more than one participating NRO, the royalty interest acquired by each NRO will be a royalty interest in respect of a fraction of the undivided working interest acquired by XXXXXXXXXX. The amount of the fraction will depend on the terms of the arrangement between XXXXXXXXXX and the particular XXXXXXXXXX which will own the Class A Shares of that NRO. For example, if there are two participating NROs and the Royalty Percentage for each is XXXXXXXXXX%, and XXXXXXXXXX has acquired an undivided XXXXXXXXXX% working interest in a particular Canadian resource property and related depreciable property, the arrangement between the relevant Investing Partnerships may be that one NRO will acquire a XXXXXXXXXX% royalty interest in respect of XXXXXXXXXX% of the undivided XXXXXXXXXX% working interest, and the other will acquire a XXXXXXXXXX% royalty interest in respect of XXXXXXXXXX% of the undivided XXXXXXXXXX% working interest. Hence, the one NRO would have a royalty interest equal to its Royalty Percentage (XXXXXXXXXX%) in respect of a net XXXXXXXXXX% undivided working interest in the particular acquisition, and the other NRO would have a royalty interest equal to its Royalty Percentage (XXXXXXXXXX%) in respect of a net XXXXXXXXXX% undivided working interest in the particular acquisition.

References herein to the undivided working interest in respect of which an NRO has a royalty therefore refer to any applicable fraction of such a working interest.

22. In addition, that particular XXXXXXXXXX will lend to XXXXXXXXXX an amount based upon the NRO's Royalty Percentage in an undivided working interest, which funds will be used by XXXXXXXXXX to fund the acquisition of the depreciable property related to that undivided working interest.

23. Accordingly, on or about the same time as the NRO issues Class A Shares to its respective XXXXXXXXXX, as described in paragraph 20 above,

a) XXXXXXXXXX will grant to each NRO that is participating in the particular acquisition, in consideration of a cash payment made to XXXXXXXXXX by the NRO, a royalty (the "Royalty") in respect of an undivided working interest in the particular properties being acquired for a price equal to that NRO's Royalty Percentage multiplied by the portion of the purchase price applicable to that undivided working interest that is allocable, under the agreement between XXXXXXXXXX and the vendor, to Canadian resource property plus an amount equal to XXXXXXXXXX% of the whole purchase price applicable to that undivided working interest including depreciable property; and

b) XXXXXXXXXX acquires Class A Shares in a participating NRO will lend to XXXXXXXXXX an amount equal to that NRO's Royalty Percentage multiplied by the portion of the purchase price applicable to that undivided working interest under the agreement between XXXXXXXXXX and the vendor that is allocable to depreciable property.

Where the NRO has a royalty interest in respect of a fraction of an undivided working interest, as described in paragraph 21 above, the purchase price applicable to that undivided working interest referred to in this paragraph 23 will refer to the purchase price applicable to the fraction of that undivided working interest.

The requirements of section 116 will be complied with by XXXXXXXXXX and each NRO that acquires a royalty interest in a particular undivided working interest in a particular property for each property.

The XXXXXXXXXX% is an acquisition fee which is applied to all past acquisitions made by XXXXXXXXXX of properties located in the United States and has been agreed to between XXXXXXXXXX and the limited partner investors of XXXXXXXXXX or their shareholder. Accordingly, it is contemplated that it will be continued for the Canadian transactions described in this ruling.

XXXXXXXXXX will fund the balance of the acquisition cost of a particular acquisition from its own resources.

24. The loan referred to in paragraph 23(b) above will be evidenced in writing in the form of a note, will bear interest at a market rate, will be repayable by XXXXXXXXXX on terms to be agreed upon between XXXXXXXXXX that will approximate the capital cost allowance deductions available to XXXXXXXXXX in respect of the depreciable property acquired with the borrowed funds, and may be repaid by XXXXXXXXXX at any time in whole or in part without penalty. It is expected that the principal payments will approximately equal the capital cost allowance on the related depreciable assets with a balloon principal payment in year seven of the loan. Interest will be paid annually and the interest rate will be equal to the "reference rate of interest" announced from time to time by XXXXXXXXXX.

25. The terms of the Royalty will be set out in the Royalty Agreement between each NRO and XXXXXXXXXX. The terms of the Royalty acquired by a particular NRO will entitle the NRO as the owner of the Royalty to receive, in respect of each 12 month period ending on September 30 (referred to in the Royalty Agreement and herein as a "Fiscal Year"), a payment from XXXXXXXXXX as the owner of the working interest equal to the particular NRO's Royalty Percentage multiplied by the amount, if any, by which

a) the "Gross Royalty Revenues" received or deemed to be received during that Fiscal Year

exceeds

b) the total of

(i) the "Production Costs" paid or deemed to be paid during that Fiscal Year, plus

(ii) the "Excess Production Costs" as of the end of the previous Fiscal Year.

26. For the purpose of determining the amounts payable under the Royalty as described in paragraph 25 above, each Royalty Agreement will define the following terms substantially in the manner described below:

A) "Gross Royalty Revenues" for a Fiscal Year will mean XXXXXXXXXX share of the gross sale proceeds received in the Fiscal Year, after the deduction of Crown and other third party royalties, from the sale of petroleum and natural gas and related hydrocarbons produced from the properties that are the subject of the Royalty, but excluding any Alberta Royalty Tax Credits received in the year.

B) "Production Costs" for a Fiscal Year with respect to a "Property", where "Property" is defined to mean the aggregate properties that XXXXXXXXXX designates as a single property for determining the Royalty, without duplication and using the cash method of accounting, and whether capital or non-capital in nature, will mean the sum of the costs listed in subsection (a) below but reduced by the amounts set forth in subsection (b) below, determined separately for each Property:

(a) the following amounts shall be included in the calculation of Production Costs to the extent the same relate to the Property, and periods of time after the effective date of the Royalty for the Property:

i) to the extent a Property is subject to operating agreements with a third party(ies), all operating and all other costs and expenses attributable and allocable to the Property incurred by XXXXXXXXXX and properly chargeable under the applicable operating agreement;

ii) to the extent a Property is not subject to an operating agreement, all operating and all other costs and expenses attributable and allocable to the Property incurred by XXXXXXXXXX and chargeable in accordance with the appropriate accounting procedure;

iii) where there are Excess Production Costs outstanding at the beginning of a Fiscal Year, an amount computed by applying a rate of interest that is equal to a commercial rate of interest on the amounts of such Excess Production Costs;

iv) to the extent not excluded or deducted in the determination of Gross Royalty Revenues (and to the extent not separately assessed against a Royalty or XXXXXXXXXX Share of Production burdened by such Royalty), all general property (ad valorem), production, severance, sales, use, excise, rental, value added, gathering and windfall profit taxes and other similar taxes (whether state, local, provincial, federal or otherwise) assessed, imposed or levied on or in connection with or allocable to the Property or the production therefrom or equipment (except to the extent sold) thereon (to the extent of the interest therein attributable to Property) or against XXXXXXXXXX as owner of the Property; (XXXXXXXXXX Share of Production with respect to a Property is defined as XXXXXXXXXX share of all petroleum substances which may be produced from, and which shall accrue and be attributable to, such Property, determined as if the Royalty had not been granted);

v) all amounts attributable to the Property borne by or charged to XXXXXXXXXX on arms-length terms (whether by an affiliate or a non-affiliate) as any of the following: (A) payments made to others in connection with the drilling or deferring of drilling of any well on the Property or lands in the vicinity of any Property (including, without limitation, dry hole and bottom hole payments and payments made to others for refraining from drilling an offset well) or in connection with any cost adjustment with respect to any well and/or leasehold equipment upon unitization of any of the Property; (B) bonuses and rentals; (C) rent and other consideration paid for use of or damage to the surface; and (D) payments to others with respect to overproduction of gas, whether accrued before or after the effective date of the Royalty conveyance, unless such overproduction was escrowed and excluded from Gross Royalty Revenues;

vi) all other costs and expenses borne by or charged to XXXXXXXXXX on arms-length terms (whether by an affiliate or a non-affiliate) which are attributable and allocable to the Property for compressing, treating, separating, dehydrating, processing, storing, transporting, delivering, selling or marketing XXXXXXXXXX Share of Production, including, without limitation: (A) costs of making XXXXXXXXXX Share of Production ready or available for market, and (B) the cost of construction of gathering lines, tanks, meters and other production and delivery facilities on the Property;

vii) general and administrative expenses (other than those treated as acquisition costs) allocated annually among all Properties in the proportion that the net book value of a given Property as of the end of the year for which an allocation is being made bears to the net book value of all Properties at the end of such year;

viii) a quarterly management fee payable to XXXXXXXXXX based on the net book value of the Royalty burdening a Property as of the last day of the quarter;

ix) all costs (including outside legal, accounting, and engineering services) for prosecuting, defending, investigating or settling litigation, administrative proceedings, and other claims and payments made in respect of judgements, penalties and other liabilities not paid for or reimbursed by way of insurance;

x) all insurance premiums related to the insuring of the Property or any facility, item of equipment or other depreciable property relating to the Property;

xi) any refunds required to be made by XXXXXXXXXX of all or any part of the sales price for any of XXXXXXXXXX Share of Production;

xii) amounts of principal and interest and other costs of financing paid by XXXXXXXXXX for the year relating to borrowed funds, including funds borrowed to fund Production Costs, to fund the acquisition of tangible depreciable property or to fund development activities, and including payments of principal and interest thereon to XXXXXXXXXX;

xiii) an amount equal to the product obtained when the combined rate of income tax applicable in the year under Parts I and XIV of the Act is multiplied by the amount, if any, by which

1) the amount that is included in the income of XXXXXXXXXX or denied as a deduction in computing the income of XXXXXXXXXX by reason of paragraph 12(1)(o) or 18(1)(m) of the Act, as the case may be, and that is in respect of production from the Property that is the subject of the Royalty

exceeds

2) the amount allowed to the working interest owner by reason of paragraph 20(1)(v.1) of the Act with respect to the Property; and

(xiv) amounts payable in respect of Crown royalties, freehold royalties and any other royalties to which the property is subject (other than the Royalty) to the extent not excluded from Gross Royalty Revenues;

but not including

(1) costs and expenses incurred in connection with drilling, testing, completing and equipping any development, injection or salt water disposal well, including all expenses that are capitalized for U.S. federal income tax purposes, and all costs of equipment and other depreciable property which must be capitalized for U.S. federal income tax purposes, except that amounts referred to in this clause (1) do not include costs associated with production and ordinary operating activities;

(2) any amount which has also been used to reduce the amount of XXXXXXXXXX Share of Production and/or Gross Royalty Revenues;

(3) any interest, premiums, fees or similar charges arising out of borrowings not used on or otherwise related to the Property;

(4) all costs and expenses incurred in connection with an exploratory well; and

(5) the costs incurred by XXXXXXXXXX in acquiring the Properties that are the subject of the Royalty.

(b) Production Costs with respect to a Property (to the extent thereof for any Fiscal Year or, if not fully utilized in such year, any Fiscal Year subsequent to the year in which amounts described in this paragraph are received) shall be reduced by the amount received in the year by XXXXXXXXXX as a result of the following to the extent such amounts are allocable to (A) the Property, XXXXXXXXXX Share of Production, or any items taken into account in determining Production Costs and (B) the periods of time after the effective date of the conveyance of the Royalty:

(i) delay rentals;

(ii) the gross proceeds of all judgments and claims received by XXXXXXXXXX for damages to the Property or a portion thereof or for any other reason related to the Property;

(iii) shut-in royalties or payments;

(iv) gross proceeds received by XXXXXXXXXX from the sale of any tangible property and miscellaneous assets;

(v) rentals from reservoir use;

(vi) dry hole and bottom hole contributions;

(vii) any payments made to XXXXXXXXXX in connection with the drilling or deferring of drilling of any well on any of the Property or lands in the vicinity;

(viii) lease bonuses or other consideration for the granting of a lease or farmout (except amounts received as a bonus, sale proceeds or other consideration for any transfer or assignment of its interest in any Property that is the subject of the Royalty and except amounts otherwise included in Gross Royalty Revenues;

(ix) insurance proceeds to the extent such proceeds are not expended by XXXXXXXXXX, or reserved for expenditure and ultimately spent, in respect of the repair, replacement, or maintenance of a Property or personal property used in connection therewith;

(x) amounts as payments from a purchaser of any of XXXXXXXXXX Share of Production pursuant to contractual provisions providing for "take-or-pay" or "ratable take" payments (including pre-initial delivery payments);

(xi) amounts attributable to a Property and received as settlement from joint interest owners for any underproduction amount (regardless of whether such underproduction amount accrued before or after the Royalty was created;

(xii) interest on any amounts escrowed;

(xiii) any other amount received (other than amounts received as a bonus, sale proceeds or other consideration for any transfer or assignment of any of XXXXXXXXXX interest in any Property burdened by a Royalty and other than any proceeds of production from an exploratory well whether from production or otherwise) not otherwise included in Gross Royalty Revenues and not otherwise described in (b)(i) through (xii) above which is allocable to, and payable with respect to, the Property or XXXXXXXXXX Share of Production attributable thereto (including, without limitation, any added value received for XXXXXXXXXX Share of Production attributable to Processing occurring prior to the sale of XXXXXXXXXX Share of Production, where Processing means to manufacture, refine, process (including extraction of natural gas liquids), market, compress or transport XXXXXXXXXX Share of Production in a manner which does not constitute well operations); and

(xiv) credits or rebates in respect of Crown Royalties which are paid or credited by the Crown, including those paid or credited under the Alberta Corporate Tax Act which are commonly known as "Alberta Royalty Tax Credits".

The foregoing amounts described in subparagraphs (i) through (xiii) above shall reduce Production Costs in a Fiscal Year only to the extent that in the aggregate they do not exceed ten percent (10%) of the total amounts paid or payable under the Royalty for the year. If the foregoing amounts described in subparagraphs (i) through (xiii) above received in a Fiscal Year exceed such ten percent (10%) limit, or if the foregoing amounts described in subparagraphs (i) through (xiv) above exceed Production Costs for such year, such excess ("Excess Credits") shall be applied to reduce the amount of any "Excess Production Costs" then in existence. "Excess Production Costs" means at any date of determination an amount equal to the excess of Production Costs over Gross Royalty Revenues, for the period ending with such date and beginning with the conveyance of the Royalty burdening the Property in question. The remainder (if any) shall be carried forward and applied to reduce Production Costs for the following Fiscal Year and, if required, subsequent Fiscal Years, subject to such ten percent (10%) limit as if such Excess Credits were amounts described above that were received in such following or subsequent Fiscal Years. All of the foregoing items shall be excluded from Gross Royalty Revenues.

27. XXXXXXXXXX will generally attempt to become the operator in respect of the Property that is the subject of the Royalty. Whether or not it can become the operator in respect of any particular property will depend upon the percentage working interests acquired in the property and the terms of the relevant operating agreements governing operations amongst the various working interest owners.

28. XXXXXXXXXX will make quarterly payments on account of the Royalty for a particular year.

29. XXXXXXXXXX may aggregate properties as it wishes. For example, XXXXXXXXXX may treat one group of properties as one Property and another group as a separate Property. In such a case, the first Property will have one Royalty and the second Property will have a separate Royalty. Both Royalties would be kept separately and not added or netted. Both Royalties would be subject to the one Royalty Agreement.

Nevertheless, subsequent acquisitions which are participated in by that same NRO, whether or not they are in the same geographical area, may also be designated, at the option of XXXXXXXXXX, to be subject to the original Royalty. Cash paid by the NRO for subsequent royalties will be treated as additional cost of the existing Royalty.

However, Royalties in respect of Properties acquired in different acquisitions may be combined and treated as one aggregate Royalty in respect of all the Properties so acquired, so that the aggregate Royalty in respect of a particular NRO will apply (at the option of XXXXXXXXXX) to the total income and expenses of all of the leases so designated combined. The purpose of combining leases in this manner is to simplify the administrative work required to calculate the amount of the royalties payable to each NRO. For example, if XXXXXXXXXX acquires an undivided working interest in a property that consists of several Crown leases and one or more NROs participate in that acquisition, XXXXXXXXXX may designate the several working interests to be a single Property subject to one Royalty in respect of each NRO, or two or more Properties subject to the same number of Royalties, and then, for administrative purposes, combine them again into an overall aggregate Royalty that will be paid to a particular NRO.

For the purposes of meeting the requirements of subsection 116(5.2) of the Act, each disposition of property to an NRO by XXXXXXXXXX remains the disposition of a separate property, requiring its own certificate under that provision, whether or not more than one property is subject to one Royalty.

In a situation wherein XXXXXXXXXX disposes of part of a Property, pursuant to the Royalty Agreement, the NRO will have to surrender its right to receive the Royalty in respect of that part of the Property. In return, XXXXXXXXXX or the purchaser of that part of the Property will pay to the NRO the relevant portion of the sale proceeds or purchase price respectively from that part of the Property as consideration for the surrender, which will be considered a disposition of an interest in the Royalty. As a result, this amount of payment will be credited to the NRO's cumulative Canadian oil and gas property expense pursuant to G of the definition thereof in subsection 66.4(5) of the Act.

30. No NRO will make a payment to XXXXXXXXXX described in section 80.2 of the Act.

31. Each NRO will calculate its income and taxable income for each taxation year in accordance with the provisions of subsections 133(1) and (2) of the Act. Each NRO will include in its income all amounts received from XXXXXXXXXX under and pursuant to the terms of the Royalty.

32. Each NRO will pay the 25% Part I tax on its taxable income in accordance with and pursuant to subsection 133(3) of the Act.

33. A dividend will be declared and paid by the NRO on the Class A and B Shares from its income, if any, in each taxation year of the NRO, other than its first taxation year. The amount of the dividend will be determined by the Board of Directors of the NRO but, except in respect of the first taxation year, will generally be at least equal to the amount required to trigger a complete refund of the Part I tax paid by the NRO in respect of the previous taxation year pursuant to the allowable refund provisions of section 133. Dividends declared by an NRO may be paid by the issuance to XXXXXXXXXX of promissory notes of the NRO which notes would be payable on demand and may or may not bear interest, and with a face amount and principal amount equal to the dividend amount. Notes used to pay dividends will be repaid within 6 months of issuance. Each XXXXXXXXXX will accept such a note as full and absolute payment of the dividend amount in respect of each Class A Share, with the risk of the note being dishonoured. A portion of the dividends may be paid as stock dividends by issuing Class A Shares of the NRO. The amount of the stock dividend will equal the amount by which the paid-up capital of the NRO is increased by reason of the payment of the dividend. The amount of the stock dividend will be calculated taking into account the appropriate Part XIII withholding that will be paid in cash.

34. Dividends received on the Class A Shares by XXXXXXXXXX and interest received by XXXXXXXXXX on loans owed to XXXXXXXXXX by XXXXXXXXXX will be allocated to the general and Limited Partners thereof in accordance with the provisions of the relevant partnership agreement.

35. XXXXXXXXXX will withhold and remit to the Receiver General the appropriate amount of Part XIII tax on interest paid to XXXXXXXXXX, pursuant to subsections 212(13.2) and 212(15). Each NRO will withhold and remit to the Receiver General the appropriate amount of Part XIII tax on dividends paid to XXXXXXXXXX.

36. An NRO will not be subject to taxation by the United States on amounts paid to it under and pursuant to the Royalty.

37. The limited partners of XXXXXXXXXX deal at arm's length with XXXXXXXXXX and with XXXXXXXXXX.

38. Each NRO may invest its Royalty income in short-term securities, including banker's acceptances or similar property. However, each NRO will not acquire the acceptances from the drawer. At least 90 per cent of the face amount of banker's acceptances acquired by an NRO will be held by it to their due date and an NRO will only acquire banker's acceptances if, at the time of acquisition, it intends to hold them to their due date.

39. An NRO will not engage in any activities, take any actions or make any investments, including the reinvestment of the Royalty received from XXXXXXXXXX, in such manner that these activities, when taken by themselves or in conjunction with the proposed transactions described above, will result in the NRO not complying with the conditions described in paragraph (d) of the definition of non-resident-owned investment corporation in subsection 133(8) of the Act.

40. The actions and activities undertaken by XXXXXXXXXX in respect of the Proposed Transactions will be undertaken in, and will occur in, the United States and not in Canada. The actions undertaken by the Limited Partners (investing funds in XXXXXXXXXX to fund the acquisition of the shares of the NRO or funding any loan to be made by XXXXXXXXXX to XXXXXXXXXX) will be undertaken in, and will occur, in the United States. The investment in Class A Shares of a particular NRO will be made by XXXXXXXXXX as the General Partner of XXXXXXXXXX. As XXXXXXXXXX is the general partner of XXXXXXXXXX, the investment will be made through XXXXXXXXXX. Similarly, the loans made by XXXXXXXXXX to XXXXXXXXXX will be made by XXXXXXXXXX as the General Partner of XXXXXXXXXX through XXXXXXXXXX as the general partner of XXXXXXXXXX. None of the Limited Partners have or will have an office in Canada relating to the investment in the particular NRO. Management of each Limited Partner's investments is done by individuals who reside in the United State. None of the directors and officers of XXXXXXXXXX will reside in Canada. Central management and control of XXXXXXXXXX and of each of the Limited Partners is and will continue to be exercised within the United States.

41. No current or future investor in XXXXXXXXXX became a resident of the United States or will become a resident of the United States for the purpose of obtaining the benefits of the Treaty.

42. To the best of the knowledge of XXXXXXXXXX and the Limited Partners of XXXXXXXXXX and your knowledge, none of the issues involved in this ruling request:

i. is in an earlier return of XXXXXXXXXX or a limited partner of an XXXXXXXXXX or a related person;

ii. is being considered by a tax services office or taxation centre in connection with a previously filed tax return of XXXXXXXXXX or a Limited Partner of an XXXXXXXXXX or a related person;

iii. is under objection by XXXXXXXXXX or a Limited Partner of an XXXXXXXXXX or a related person; or

iv. is before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired.

Purpose of the Proposed Transactions

The purpose of the Proposed Transactions is to allow investors in XXXXXXXXXX to invest in Canadian oil and gas production in a manner that is similar to the investment strategies employed in the United States.

Rulings

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions and the purposes of the proposed transactions, and provided that the proposed transactions are completed in the manner described above, our rulings are as follows:

A. Provided that it is an entity described in paragraph 1 of Article XXI of the Treaty, each Limited Partner of XXXXXXXXXX referred to in paragraph 6 above, will be considered to be a resident of the United States for the purposes of the Treaty.

B. Provided that it is an entity described in paragraph (2)(a) or (b) of Article XXI of the Treaty, each Limited Partner that is a corporation created as described in paragraph 16 above will be considered a resident of the United States for purposes of the Treaty. XXXXXXXXXX will be considered to be a resident of the United States for the purposes of the Treaty and a non-resident of Canada for the purposes of the Act.

C. Provided that each NRO is beneficially owned by non-residents and that no partner of XXXXXXXXXX becomes a resident of Canada, and provided that each NRO is not beneficially owned by a foreign affiliate of a taxpayer resident in Canada, each NRO will qualify as a "non-resident-owned investment corporation" for the purposes of the Act, and the proposed transactions in and by themselves will not result in an NRO ceasing to qualify as a non-resident-owned investment corporation.

D. Each Royalty will be considered a "Canadian resource property" by virtue of paragraph (d) of the definition of that term in subsection 66(15) of the Act. The cost of acquisition of a Royalty to a particular NRO will be considered a "Canadian oil and gas property expense" of that NRO and will be included in determining the NRO's "cumulative Canadian oil and gas property expense", as those terms are defined in subsection 66.4(5) of the Act.

E. XXXXXXXXXX will be entitled to deduct, in computing its income for a taxation year pursuant to section 9 of the Act, amounts paid by it to an NRO under and pursuant to a Royalty acquired by the NRO, provided that the amounts are incurred by XXXXXXXXXX for the purpose of earning or producing income from its business or property.

F. In computing XXXXXXXXXX "adjusted resource profits", as described in subsection 1210(2) of the Regulations, the amounts payable to the NROs under and pursuant to any Royalty will fall within the ambit of subparagraph (c)(i) of A of the definition of "adjusted resource profits" in subsection 1210(2) of the Regulations and will not be considered a "production royalty" within the meaning of this term in subsection 1206(1) of the Regulations. For greater certainty, any item referred to in subparagraph (i) to (xiv) of paragraph (b) of the definition of "Production Costs" in paragraph 26 above will be excluded from adjusted resource profits.

G. Provided that the working interests acquired by XXXXXXXXXX continue to be used by XXXXXXXXXX for the purpose of gaining or producing income therefrom or from a business in respect of which the working interests are employed (other than income exempt from taxation under the Act), interest paid by XXXXXXXXXX in a taxation year, or payable in respect of the year (depending upon the method regularly followed by XXXXXXXXXX in computing its income for purposes of the Act), to XXXXXXXXXX in respect of loans made by XXXXXXXXXX to XXXXXXXXXX as described in paragraph 23(b) above pursuant to a legal obligation to pay interest thereon will be deductible in computing XXXXXXXXXX income for that taxation year pursuant to paragraph 20(1)(c) of the Act to the extent that the interest is reasonable in amount.

H. The provisions of paragraph 12(1)(g) of the Act will require each NRO to include in computing its income for each taxation year all amounts received in that taxation year under and pursuant to each Royalty owned by the NRO, to the extent that such amounts received or receivable have not already been included in computing its income pursuant to another provision of the Act.

I. Provided that a Limited Partner of XXXXXXXXXX as named in paragraph 10 above is an entity described in paragraph 1 or subparagraph 2(a) or (b) of Article XXI of the Treaty, paragraph 3 of Article XXI will not apply to deny the benefits of paragraphs 1 or 2 of Article XXI for that entity as a result of the proposed transactions described above, in and by themselves.

J. Because XXXXXXXXXX will be a partner of XXXXXXXXXX, it will be subject to tax under Part I.3 of the Act.

(a) For the purposes of determining XXXXXXXXXX "taxable capital employed in Canada" in section 181.4 of the Act, the carrying value referred to in paragraph 181.4(a), at the end of a taxation year of XXXXXXXXXX, of its partnership interest in XXXXXXXXXX will be equal to that proportion of

(i) the carrying value of all property owned by XXXXXXXXXX at the end of its last fiscal period ending at or before the end of the particular taxation year that is used by it in the fiscal period in, or held by it in the course of, carrying on any business carried on by it during the year through a permanent establishment in Canada

that

(ii) XXXXXXXXXX share of the income or loss of XXXXXXXXXX for that fiscal period
is of

(iii) the income of loss of XXXXXXXXXX for that fiscal period.

(b) In determining for this purpose the carrying value of the working interests owned by XXXXXXXXXX, the value will be the amount determined under Generally Accepted Accounting Principles (GAAP).

K. In applying the tax under Part XIV of the Act to XXXXXXXXXX in respect of its shares of income as general partner of XXXXXXXXXX and as general partner of XXXXXXXXXX, the rate of tax will be 5% pursuant to paragraph 6 of Article X of the Treaty.

L. Subsection 17(2) of the Act will not apply to the loans referred to in subparagraph 23(b) of the proposed transactions.

M. As a result of the proposed transactions, in and by themselves, subsection 245(2) of the Act will not be applied to redetermine the tax consequences confirmed in the rulings given.

The above rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R3 dated December 30, 1996, and are binding on Revenue Canada provided that the proposed transactions 16 and 17 are completed by XXXXXXXXXX, and that the investment referred to in paragraph 18 of the proposed transactions is commenced by XXXXXXXXXX.

These rulings are based on the Act in its present form and do not take into account any proposed amendments to the Act which, if enacted into law, could have an effect on the rulings provided herein.

Opinion

Upon the payment by an NRO of a stock dividend to XXXXXXXXXX, the amount of the stock dividend, as defined in subsection 248(1) of the Act, will be considered a taxable dividend for the purposes of the definition of "allowable refund" in subsection 133(8) of the Act to the extent that the NRO does not elect to have that amount treated as a capital gains dividend within the meaning of subsection 133(7.1).

The foregoing opinion is not a ruling and, in accordance with the practice referred to in Information Circular 70-6R3, is not binding on Revenue Canada.

Comments

Nothing in this ruling should be construed as implying that Revenue Canada, Customs, Excise and Taxation has agreed to or reviewed any tax consequences relating to the facts and proposed transactions described herein other than those specifically described in the rulings given above. In particular, we are not commenting on:

a) any future loans, except those described in paragraph 23(b), by XXXXXXXXXX to XXXXXXXXXX, or to another party, or the effect of those loans on the application of paragraph 3 of Article XXI of the Treaty to the Limited Partners;

b) XXXXXXXXXX which were incorporated at the same time and in the same way as the NROs as described in paragraph 11 and which have also elected to be NROs. We understand these NROs were set up for future investing partnerships which are not yet formed.

c) the income of XXXXXXXXXX for Part I tax purposes, except as specifically stated in Rulings D, E, F and G above.

d) Part XIII Withholding Tax.

The above Rulings apply in determining the ultimate tax liability of the Limited Partners of XXXXXXXXXX; however, they do not apply to the withholding tax requirements. The procedures to be followed in connection with reduced withholding taxes are as follows:

- In order to ensure whether a particular trust or organization qualifies for exempt status under paragraph 2 of Article XXI of the Treaty or under paragraph 1 of Article XXI of the Treaty, as the case may be, and to determine the withholding obligation, the procedures in paragraph 78(d) (in respect of U.S. Pension Funds and Master Funds) and paragraph 78(c) (in respect of Charitable Organizations) of Information Circular 77-16R4 must be followed. Please note that the address in paragraph 78(e) is no longer current. Instead applications under Article XXI of the Treaty should be forwarded to:

Special Projects Section
International Tax Directorate
344 Slater Street
5th Floor
Ottawa, ON
K1A 0L5

Attention: Mrs. Susan Hughes

- Where an NRO or XXXXXXXXXX makes payments to XXXXXXXXXX that has both exempt and non-exempt U.S. partners which are beneficial owners of income from the fund, the Special Projects Section of the International Tax Directorate should be contacted at the address above in order to determine what the withholding tax obligations will be in respect of payments to such partnerships. As indicated in paragraph 1 of Information Circular 76-12R4, it is the taxpayer's responsibility to withhold and remit Part XIII tax at the appropriate rate and the payer is liable to the Crown for any deficiency.

Yours truly,

for Director
Reorganization and International Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch

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1999 Ruling 9827733 - EXEMPT ENTITIES EARN ROYALTIES THROUGH NRO

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Facts

Proposed Transactions

Purpose of the Proposed Transactions

Rulings

Opinion

Comments