Farm-out coupled with transfer for consideration (p. 664)
CRA Document 2011-0420451E5(F) (November 22, 2011) is a recent external technical interpretation in which the CRA considered another situation involving a farm-out as part of a larger overall transaction. Specifically, the CRA was asked to comment on a situation where the owner of (presumably unproven) resource properties agreed to grant to a corporate purchaser an option to acquire an interest in the properties. In return, the purchaser agreed to make a cash payment to acquire the option and to perform exploration work on the properties and make further cash payments to preserve the option… .
Option should qualify as resource property (pp. 664-5)
The CRA provided comments [in 2011-0420451E5(F)] based on two alternative assumptions, the first being that the option qualifies as Canadian resource property (as defined in subsection 66(15)) and the second being that the option does not so qualify. this was a curious approach given that it ought to have been a simple exercise to conclude that the option qualified under both the current and proposed definitions of Canadian resource property at the time of the interpretation. The current definition included a "right to or interest in" either a working interest or a fee simple interest in a resource property; the proposed definition (now in force) included a "right to or interest in" a working interest and an "interest in" (but not a "right to") a fee simple interest. An option to acquire real property is both a "right to" that property under a plain reading of that term and an "interest in" that property as per the decision in Frobisher Limited v. Canadian Pipelines & Petroleum Limiter et al. [fn 11: (2959), 21 DLR (2d) 497 (S.C.C.) at 169-70, although we note that in the particular case, the Court found that the option was rendered void and of no effect because of a regulatory prohibition. The CRA seems to generally accept this proposition: see CRA Document 2012-048002117 (April 9, 2013).] If the resource property subject to the option qualifies as a Canadian resource property (and presumably it would), [fn 12: A mineral property would qualify under paragraph (b) (any right, licence or privilege to prospect, explore drill or mine for minerals) in the case of a working interest and under paragraph (g) (any real property the principal value of which depends on mineral resource content) in the case of a fee simple interest. Query whether a fee simple interest would also qualify under paragraph (b), given the rights of a fee simple owner would seem to include the rights described therein.] then the option should also qualify….
Need to rely on IT-125 (p. 661)
The application of the Income Tax Act to farm-outs on a technical basis remains unresolved: there are no specific provisions of the Act that apply and there is no jurisprudence directly on point. As such, taxpayers have come to rely on and structure into the rather favourable administrative treatment applied by the CRA to certain types of farm-outs described in IT-125 (the "Administrative Treatment")….
Summary of CRA comments (p. 662)
The CRA's comments [in a number of technical interpretations] may be summarized as follows:
- In cases where a simple farm-out forms part of a larger transaction, the CRA will apply the Administrative Treatment to the farm-out aspect of the transaction where that aspect of the transaction can be identified and notionally separated from the overall transaction.
- In cases where a simple farm-out is one of a number of interrelated transactions, the CRA may seek to aggregate the farm-out with related transactions to form a single transaction for the purposes of applying the Administrative Treatment.
- In cases where the farmee receives a royalty rather than a percentage interest in an unproven resource property in consideration for performing exploration and development work, the CRA will consider applying the Administrative Treatment in the context of an advance tax ruling and according to the "historical basis" of the Administrative Treatment, but will not offer a blanket extension of the Administrative Treatment in the form of a technical interpretation. The CRA has also indicated the same willingness to consider extending the application of the Administrative Treatment to a farm-out under which the farmee acquires an option to acquire a percentage interest in an unproven resource property.
- The CRA will not extend the Administrative Treatment to transactions outside the resource sector, which are arguably analogous to a simple farm-out in a commercial sense.