2000 Ruling 2000-0013703 - Resource Royalties

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 Department.

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

Principal Issues: see issue sheet

PositionS:

Reasons:

XXXXXXXXXX
XXXXXXXXXX 								2000- 001370
XXXXXXXXXX 								XXXXXXXXXX
XXXXXXXXXX
Attention:	XXXXXXXXXX
	XXXXXXXXXX 

XXXXXXXXXX, 2000

Dear Sirs:

Re: XXXXXXXXXX
Advance Income Tax Ruling

We are writing in response to your letter of XXXXXXXXXX wherein you requested an advance income tax ruling on behalf of the above taxpayer.

To the best of your knowledge, and that of the taxpayer involved, none of the issues contained herein is:

(i) dealt with in an earlier return of the taxpayer or a related person;

(ii) being considered by a tax services office or taxation centre in connection with a previously filed tax return of the taxpayer or a related person;

(iii) under objection by the taxpayer or a related person;

(iv) subject to a ruling previously issued by the Income Tax Rulings Directorate; or

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

In this letter, the following terms have the meanings specified:

(a) "Act" means the Income Tax Act, R.S.C 1985 (5th Supp.) c.1, as amended to the date hereof, and, unless otherwise stated, every reference herein to a Part, section, subsection, paragraph or subparagraph is a reference to the relevant provision of the Act;

(b) "Canadian resource property" has the meaning assigned by subsection 66(15);

(c) "CCOGPE" means "cumulative Canadian oil and gas property expense" within the meaning assigned by subsection 66.4(5);

(d) "COGPE" means "Canadian oil and gas property expense" within the meaning assigned by subsection 66.4(5);

(e) "GOR agreement " means the agreement described in paragraphs 5, 6 and 7 below between Petroleum Co. and the resource company, and which will be substantially similar to the Royalty Agreement dated XXXXXXXXXX that was provided with your advance income tax ruling request;

(f) "Grantor of the GOR agreement" is the resource company that is party to the GOR agreement with Petroleum Co.; and

(g) "Petroleum Co." means XXXXXXXXXX.

Our understanding of the facts, proposed transactions and purpose of the proposed transactions is as follows:

FACTS

1. Petroleum Co. is a Canadian Controlled Private Corporation as defined in subsection 125(7). Petroleum Co.'s business number is XXXXXXXXXX.

2. XXXXXXXXXX.

3. Petroleum Co. maintains its own office in XXXXXXXXXX. It provides services to numerous arms-length corporations, and could not reasonably be considered to be a "personal services business" as defined in subsection 125(7) of the Act.

4. Petroleum Co. is in the business of exploring for oil and natural gas reserves within Canada. It earns income by charging hourly consulting fees for specific services provided to clients. The consulting fees earned by Petroleum Co. are active business income.

5. The principal purpose of Petroleum Co. is to earn income from consulting, that is, from obtaining and supplying information to oil and gas corporations which pay fees to Petroleum Co. on an hourly basis.

PROPOSED TRANSACTIONS

6. Petroleum Co. also searches for undiscovered reserves for its own business purposes when it is not earning hourly consulting revenue. Petroleum Co. does not have the resources to develop certain properties it has discovered and as such, GOR agreements will be entered into with resource companies who are able to develop the properties ("the Grantors of GOR agreements").

7. The GOR agreement will specify that, in exchange for providing certain proprietary and confidential information relating to crude oil and natural gas prospects on certain lands, Petroleum Co. will receive both rights under a GOR agreement and a consulting fee. The GOR agreement will provide Petroleum Co. with a monthly royalty that is a percentage of the petroleum substances removed from the property. Petroleum Co. will perform essentially the same work that it performs when remunerated on an hourly basis as described in paragraph 5 above.

8. The GOR agreement will differ from a pure royalty as it will contain provisions such that Petroleum Co. will:

• receive a percentage of the petroleum substances produced by the grantor of the GOR agreement (a royalty in kind);
• sell the petroleum substances, using the Grantor of the GOR agreement as Petroleum Co.'s agent. This agency relationship may be revoked by Petroleum Co. and it may take possession of the substances in kind;
• have the right to deny consent to the Grantor of the GOR agreement for unitization of the lands;
• receive all technical data, i.e. geological reports, logs, production tests etc. from the wells;
• have the right to assign all or any portion of its interest in the GOR agreement;
• have the right to take over the oil and gas leases if the Grantor of the GOR agreement chooses to surrender them; and
• receive notice before the spudding of a well.

PURPOSE OF THE PROPOSED TRANSACTIONS

9. The purpose of the proposed transactions is to allow Petroleum Co. to participate in the production and sale of petroleum substances from the development of certain properties it has discovered, but does not have the resources to develop itself.

RULINGS GIVEN

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

A. The consulting fees received or receivable by Petroleum Co. as part payment for the information to be provided by Petroleum Co. to the Grantor of the GOR agreement, and the value of the GOR agreement provided to Petroleum Co. as part consideration for the information to be provided to the grantor of the GOR agreement will be considered as income from an "active business carried on by" Petroleum Co. within the meaning of subsection 125(7).

B. The value of the information provided by Petroleum Co. to the Grantor of the GOR agreement (less the consulting fees referred to in Ruling A above) will be the cost to Petroleum Co. of a "Canadian resource property".

C. The cost to Petroleum Co. of the "Canadian resource property" referred to in Ruling B above will be COGPE of Petroleum Co. and will be included in determining Petroleum Co.'s CCOGPE for a taxation year.

D. Petroleum Co.'s interest in the GOR agreement will be an asset used principally in an active business by Petroleum Co. within the meaning of the definition of "small business corporation" in subsection 248(1) of the Act, provided the active business of Petroleum Co. in which the asset is used is carried on primarily in Canada.

E. Amounts received or receivable by Petroleum Co. pursuant to the GOR agreement from the Grantor of the GOR agreement will be included in computing Petroleum Co.'s income from business pursuant to subsection 9(1), paragraph 12(1)(b) or paragraph 12(1)(x), as the case may be.

The above rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R3 dated December 30, 1996 and are binding on the Canada Customs and Revenue Agency (the "CCRA") provided that Petroleum Co. receives payments for the Grantor of the GOR agreement pursuant to the GOR agreement by XXXXXXXXXX.

The above rulings are based on the law as it presently reads 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. In addition, nothing should be construed as implying that the CCRA 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. Furthermore, nothing in this ruling should be construed as implying that the CCRA has agreed to the cost or fair market value at any particular time of any property referred to herein as such a determination is a valuation matter which is beyond the scope of this ruling.

OPINION

The value of the information provided by Petroleum Co. to the Grantor of the GOR agreement will be equal to the amount that Petroleum Co. would have received had it been remunerated on an hourly basis, as described in paragraph 5 above.

The opinion expressed above is provided in accordance with paragraph 22 of Information Circular 70-6R3. This opinion does not constitute an advance income tax ruling and is not binding on the CCRA.

Yours truly,

for Director
Resources, Partnerships and Trusts Division
Income Tax Rulings Directorate
Policy and Legislation Branch