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: Does the Alberta Westcoast Pipeline Royalty Adjustment (the R-factor) meets the condition in paragraph 12(1)(o) of being a royalty "that can reasonably be regarded as being in relation to ... the production ... of petroleum ... ."

Position: Yes.

Reasons:     The Westcoast Adjustment factor is part of the royalty formula as determined by the Royalty Regulations.  The royalty as a whole is computed by reference to the volume of oil produced and that in itself brings the entire royalty within the scope of the phrase "can reasonably be regarded as being in relation to."
									December 3, 2001

Large Business Audit Division	HEADQUARTERS
	Industry Specialist Services					Reorganizations and
	112 Kent Street		   Resources Division
	Ottawa ON  K1A 0L5		David Shugar
			957-2134
	Attention: Blair Chisholm
		2001-007502

Paragraph 12(1)(o) of the Income Tax Act (the "Act")

This is in reply to your correspondence of March 14, 2001 wherein you requested our comments on the application of paragraph 12(1)(o) of the Act with respect to Alberta crown oil royalty payments. XXXXXXXXXX has provided you with their opinion that the amount of the crude oil royalty representing the Westcoast Initiative adjustment, also referred to as the R-factor, does not meet that condition of paragraph 12(1)(o) of the Act which requires that the royalty can reasonably be regarded as being in relation to the production of petroleum. Their reason given is that even though the Alberta crown royalty was levied on production, the Westcoast Initiative adjustment was not reasonably related to production-it related only to reimbursing Alberta Petroleum Marketing Commission ("APMC") for the industry's share of costs incurred with respect to the Westcoast Initiative.

Background

The Westcoast Initiative was the result of the lack of pipeline capacity on the Interprovincial Pipe Line (IPL) system. The IPL could not meet the needs of the production growth in 1995 and, consequently, pipeline space was apportioned to each producer on the IPL system. APMC agreed to free up space in the IPL system by shipping its oil through another pipeline. The Alberta government settled on a royalty increase as the most practical method to raise the revenue to cover its increased costs of using the other pipeline.

As described in Appendix A of the Alberta Petroleum Royalty Guidelines, the Westcoast Pipeline Royalty Adjustment was the result of an arrangement between the APMC, the crude oil producers and industry associations, under which the Department of Energy (formerly the Department of Resource Development), as of May 1, 1995, included an adjustment in the crown royalty factors for old, new and third-tier oil in recognition of industry's share of the costs incurred by the crown of shipping its crude oil through the TransMountain Pipeline to the west coast. Under the arrangement the APMC freed up capacity in the IPL system by removing some of its oil from that system and shipping it through the TransMountain Pipeline system. The additional freed capacity in the IPL system was allocated to the crude oil producers. This arrangement is referred to as the "Westcoast Initiative."

The Westcoast Initiative was not the first such arrangement of its kind. In addition to the Westcoast Initiative, there had been a Sarnia-Montreal Pipeline Royalty Adjustment. As explained in Government of Alberta Information letter 93-9, the royalty factors for crude oil had been adjusted for the months of January 1993 to March 1993 to represent industry's share of the costs incurred by the APMC for crude oil shipped through the reactivated Sarnia-Montreal extension of the Interprovincial Pipe Line System. That royalty adjustment was to reflect the additional costs for shipping charges and fees of shipments from July 1, 1992 to March 31, 1993.

Components of the Alberta crown crude oil royalties

The Mines and Minerals Act of Alberta is the statutory authority entitling the Province of Alberta to a royalty on petroleum. Subsection 35(1) of the Mines and Minerals Act reserves to the Crown in right of Alberta the royalty prescribed from time to time by the Lieutenant Governor in Council. Paragraph 37(1)(a) of the Mines and Minerals Act authorizes the Lieutenant Governor in Council to make regulations prescribing the royalty. Paragraph 37(1)(d) of the Mines and Minerals Act authorizes the Lieutenant Governor in Council to determine any component or value in the calculation of the royalty on a mineral.

Our Comments

The Westcoast Initiative adjustment, also referred to as the R-factor, is a component of the statutory royalty determined under the Mines and Minerals Act of Alberta. The R-factor is not simply an addition to the royalty amount determined under that Act. XXXXXXXXXX letter does not dispute that the R-factor adjustment is part of a royalty obligation imposed by provincial statute, as described in the preamble of paragraph 12(1)(o) of the Act and subparagraph 12(1)(o)(i) of the Act.

The only issue addressed in the letter is whether the portion of the royalty attributable to the R-factor adjustment meets the remaining condition of paragraph 12(1)(o) of the Act of being a royalty that can reasonably be regarded as being in relation to the production of petroleum. In our view, it is. However, XXXXXXXXXX states that even though the Alberta crown royalty was levied on production, the royalty adjustment related only to reimbursing APMC for the industry's share of costs incurred with respect to the Westcoast Initiative.

In our view, it is not the intention of Parliament, in paragraph 12(1)(o) of the Act, that the test of whether the royalty is in relation to production include an examination of the purpose behind raising the royalty income. For example, it is irrelevant whether the royalty income's purpose was to recover the government's cost of shipping oil, or whether the funds went into the provincial general accounts for an undetermined future use. The R-factor was part of a royalty calculation that applied a mathematical formula to the volume of oil produced, and the royalty varied with production. The mathematical connection between the R-factor and oil production is what brings the royalty within the meaning of the phrase 'can reasonably be regarded as being in relation to' in the preamble of paragraph 12(1)(o) of the Act.

In Nowegijick, 83 DTC 5041, the Supreme Court determined that the phrase "in respect of" is probably the widest of any expression intended to convey some connection between two related subject matters. The Court said the words are words of the widest possible scope and import such meanings as "in relation to," "with reference to," or "in connection with." Paragraph 12(1)(o) of the Act is broadened further by the words "can reasonably be regarded." The Court also stated, with regard to section 87 of the Indian Act:

"We must, I think, in these cases, have regard to substance and the plain and ordinary meaning of the language used, rather than to forensic dialectics. I do not think we should give any refined construction to the section."

In our view, the meaning of the phrase "can reasonably be regarded as being in relation to" in paragraph 12(1)(o) of the Act should be interpreted in the same manner as the phrase "in respect of" was interpreted in Nowegijick, and does not require a breakdown and analysis of the components of the royalty calculation to the extent proposed by XXXXXXXXXX. However, having done so for the sake of this letter, in our view, we can still conclude that the R-factor is in relation to production.

for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Legislation Branch