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: Whether a specific agreement should be bifurcated into two components, namely a sale and a loan.
Position: No.
Reasons: The agreements represent purchase and sale agreements and do not create a lender/borrower relationship with respect to the prepaid amount. Jurisprudence does not appear to lend support to the notion of bifurcating the agreements into two components, namely a forward sale and a loan.
May 31, 2001
Calgary Tax Services Office HEADQUARTERS
Oil & Gas Specialists Karen Power, CA
Industry Specialist Services (613) 957-8953
Attention: Zul Ladak & Bharat Patel
2000-006233
Resource Allowance - Prepaid Forward Sales
We are replying to your letter of December 19, 2000, in which you requested our opinion on whether payments received by XXXXXXXXXX under a Master Forward Sales Agreement ("Master") and Form of Purchase Agreement ("Purchase") should be bifurcated into two components, namely a sale and a loan.
The facts, as we understand them, are as follows:
- XXXXXXXXXX acquired interests in certain Master and Purchase agreements from XXXXXXXXXX
- The Master and Purchase agreements are between XXXXXXXXXX
- The Master agreement provides the general terms under which the Purchase agreements operate, including among other things:
XXXXXXXXXX
- XXXXXXXXXX
We have reviewed the Master and Purchase agreements which you have provided and in our view the agreements are arrangements under which XXXXXXXXXX receives an immediate cash payment ("the prepayment") and oblige XXXXXXXXXX to deliver an agreed quantity of production at some time in the future. The agreements combine a financing component and a forward sale of production into a single integrated contract.
As you have indicated, the Canadian courts have relied on the legal form of contracts to determine the income tax treament. The Supreme Court held in Shell Canada Ltd. v. The Queen, 99 DTC 5682 and other decisions, that the economic realities of a situation cannot be used to recharacterize a taxpayer's bona fide legal relationships. It held that absent a specific provision of the Income Tax Act (the "Act") to the contrary or a finding that there is a sham, the taxpayer's legal relationships must be respected in tax cases. Recharacterization is only permissible if the label attached by the taxpayer to the particular transaction does not properly reflect its actual legal effect. In our view, recharacterization is not appropriate in this situation.
The issue of whether payments were an acquisition of a resource property or in substance a loan was considered in the case of Alberta and Southern Gas Co. Ltd. v. Her Majesty the Queen, 76 DTC 6362. The conclusion of Cattanach J. at page 6365 was that:
"In my view the transactions are not temporary loans by the plaintiff to Amoco for the reason that an essential element of a loan is lacking. The essence of a loan is that the advance shall be repaid. The agreements provide that nothing there shall be construed as creating a personal liability on Amoco to repay the principal sum advanced and interest thereon but that the plaintiff for its reimbursement shall look exclusively to the petroleum substances to the extent of Amoco's share therein which was assigned to the plaintiff. In the event that the petroleum substances should become exhausted, or otherwise unavailable, which is a distinct possibility which remains even though the plaintiff exercised extreme care in selecting fields for inclusion in the schedules to the agreement in which it was aware of the potential and estimated deposits underground, then in that event the plaintiff has no recourse against Amoco. I have not overlooked a provision that Amoco shall be liable for damages for breach of covenant but in view of the provision to the contrary that provision cannot include a covenant to repay. It is for these reasons that I am of the opinion that the transactions cannot be construed as being a loan in substance."
In this particular case, any amounts paid by the Trust to XXXXXXXXXX pursuant to the Purchase agreements are to purchase XXXXXXXXXX. The relationship here is that of a seller and a buyer and the terms of the agreements do not create a lender-borrower relationship between XXXXXXXXXX and the Trust. XXXXXXXXXX does not have any obligation to repay the amount of the Prepayment; its sole obligation is to deliver the XXXXXXXXXX at the specified times.
As stated in Interpretation Bulletin IT-396R, paragraph 12, "interest, while not defined in the Act, has been described in general terms in the courts as 'the return or consideration or compensation for the use or retention by one person of a sum of money, belonging to, in a colloquial sense, or owed to, another'. From this description, it follows that interest does not arise unless there is an amount due to, or belonging to, another person for the period for which the interest is calculated."
In addition, interest may be considered to arise where there is a debtor-creditor relationship. In General Motors Acceptance Corporation of Canada v. The Queen, [1997] T.C.C. 2864, Rip, J. stated:
"General Motors Acceptance Corporation provides the mechanics to permit a retail customer without the necessary funds with the wherewithal to purchase a motor vehicle. GMAC, it is true, becomes the purchaser's creditor on assignment of the conditional sale contract, but no lender-borrower relationship is created between them... The Court of Appeal did not make any finding that GMAC is in a lender-borrower relationship with consumers... The Court of Appeal held that GMAC was operating a comprehensive wholesale and retail financing system... The Court of Appeal found that the legal form and nature of the contracts for financing inventory and consumer sale contracts are identical to a conditional sale or installment sale... For an amount to constitute interest, the amount must be paid by the borrower of the money to a person who loaned money to the borrower... In financing contracts with retail customers of General Motors of Canada Limited, GMAC has lost no interest because it did not lend money to the customer."
In general terms, it is our view that, notwithstanding that a payment may be calculated by reference to a notional amount of interest or in a manner similar to interest, the resultant amount does not assume the character of interest. In our view, in order to be considered interest, the prepayment must represent compensation for a sum of money owing to the Trust, be referable to a principal sum, and must accrue on a daily basis. Since the Trust did not loan money to XXXXXXXXXX thereby establishing a lender-borrower relationship, it cannot be said that the prepayment represented compensation for the use of borrowed money by XXXXXXXXXX and no deduction would be available under paragraph 20(1)(c) of the Act.
Based on our analysis, we agree with your conclusion that the agreements do not provide for bifurcation into two components. The prepaid amount received by XXXXXXXXXX under the Purchase agreement should be included in income under paragraph 12(1)(a) of the Act and the taxpayer should be entitled to a deduction for an appropriate reserve under paragraph 20(1)(m) of the Act. The resulting income inclusion would increase resource profits for purposes of calculating XXXXXXXXXX resource allowance. Furthermore, because there exists no lender-borrower relationship between XXXXXXXXXX and the Trust and XXXXXXXXXX has not paid any amount as interest, XXXXXXXXXX is not entitled to a deduction by virtue of subparagraph 20(1)(c) of the Act.
For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Legislation Access Database (LAD) on the Department's mainframe computer. 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 your client request a copy of this memorandum, they can be provided with the LAD version or they may request a copy severed using the Privacy Act criteria which does not remove client identity. Requests for this latter version should be made by you to Jackie Page at 613 957-0682. The severed copy will be sent to you for delivery to the client.
We trust our comments will be of assistance.
for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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