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: 1) Should the hedging gain be included in gross resource profits?
SECTIONS: Regulations 1204(1)(b), 1204(1.1), 1206(1)
Position: 1) A portion of the gain will be included in gross resource profits.
Reasons: Regulation 1204(1)(b), Echo Bay Mines decision.
July 17, 2003
XXXXXXXXXX Reorganizations and
Resources Division
XXXXXXXXXX TSO Luisa A. Majerus
(613) 946-3558
2003-000377
XXXXXXXXXX ("the Corporation")
Hedging Gain and Gross Resource Profit
We are writing in response to your memorandum dated February 11, 2003, wherein you requested our views on whether the Corporation's XXXXXXXXXX gain on the financial closeout of derivative financial instruments ("hedging contracts"), relating to the disposition of one of its mines, may be included in "gross resource profits" pursuant to paragraph 1204(1)(b) of the Income Tax Regulations ("Regulations").
Facts
1. XXXXXXXXXX.
2. XXXXXXXXXX.
1. XXXXXXXXXX.
1. XXXXXXXXXX.
Legislation
2. "Gross resource profits" of a taxpayer for a taxation year is defined in Regulation 1204(1) and includes:
(b) the amount, if any, of the aggregate of his incomes for the year from
(i) n/a
(ii) the production and processing in Canada of
a. ore, other than iron ore or tar sands ore, from mineral resources in Canada operated by him to any stage that is not beyond the prime metal stage or its equivalent,
1. Our view has been that the resource profits provisions in the Regulations operate as a separate code within the Act for the purpose of determining income from production and processing.
2. In the Federal Court - Trial Division case of Cominco Ltd. (84 DTC 6535), the issue was whether income of a resource company should be included in "resource profits" for the purpose of calculating the resource allowance. The taxpayer received business interruption insurance and included the proceeds in "production profits" pursuant to the wording in the definition of "resource profits" in the Regulations at that time. Judge Reed indicated in his analysis of the facts that insurance proceeds could not be brought within the specific wording in the Regulation, as they did not arise out of the production of metal or industrial minerals.
3. In Gulf Canada Limited (90 DTC 6123) the Federal Court of Appeal upheld the Federal Court-Trial Division's ("FCTD") finding that former sections 124.1 and 124.2 of the Act set up their own separate scheme of inclusions and exclusions from resource income. The FCTD stated that "Sections 124.1 and 124.2 are much more specific in their scope and intentment than the calculation of income provisions under section 3 of the Act, in requiring that the income and deductions be related to production in the sense of extraction from the ground as the source of income." Furthermore, unlike the enactment of subsection 1204(1.1) of the Regulations subsequent to these Court decisions to refer to "all amounts deducted in computing the taxpayer's income for the year" (i.e., a reference to income calculation from a source pursuant to sections 3 and 9 of the Act to the extent of deductions only), there is no similar enactment of a reference to "all amounts included in computing the taxpayer's income for the year" in respect of resource revenue in paragraph 1204(1)(b) of the Regulations and as reiterated in paragraph 16 of your memorandum. Therefore, even though a mining company could include interest in its business income for the purposes of sections 3 and 9 of the Act, such interest may not necessarily be included in the calculation of a mining company's gross resource profits for the purpose of paragraph 1204(1)(b) of the Regulations unless the requirements thereof are met.
4. In Echo Bay Mines Ltd. (92 DTC 6437) the FCTD Judge opined:
...the price received by the plaintiff for the silver it produced was the sum of receipts from the delivery of actual production and from settlement of forward sales contracts. The business of the plaintiff was silver production...the forward sales transactions were in respect of the same commodity as the plaintiff's production; both were in my view, integral aspects of the plaintiff's business of producing silver and returns from these activities were income from production of metals...
As you noted in paragraph 22 of your memorandum, Mr. Parsons, who gave expert testimony in the Echo Bay Mines case, indicated that for accounting purposes the portion of the gain or loss corresponding to actual production will be allocated as revenue from production, while the portion corresponding to any excess over the actual production would be treated as income of a speculative nature. This treatment was applied for tax purposes in Echo Bay Mines in that a proportion of the gain relating to the production and processing of ore from mineral resources in Canada was included in gross resource profits pursuant to paragraph 1204(1)(b) of the Regulations. In the Corporation's situation, the total number of XXXXXXXXXX produced is multiplied by the gain per XXXXXXXXXX hedged.
Production Analysis
5. In light of the decision in Echo Bay Mines, it is necessary to review the estimates of and the actual production for the period XXXXXXXXXX to XXXXXXXXXX.
XXXXXXXXXX.
As provided in our file #2000-0036547, "the recapture provisions of the Act and Regulations are fundamentally adjustments to income of previous years and do not create, in the year of disposal of the asset, some new form or source of income". We agree with your comments as provided in paragraph 32 of your memorandum.
Conclusion
It is our view that only $XXXXXXXXXX of the total hedging gain earned by the Corporation in XXXXXXXXXX should be included in the calculation of gross resource profits for the purposes of paragraph 1204(1)(b) of the Regulations.
We trust these comments will be of assistance.
For Director
Resources and Reorganizations
Income Tax Rulings Directorate
Policy and Legislation Branch
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