1 December 2003 External T.I. 2003-0020445 - BC Forest Amendments 2003

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: Questions concerning statutory taking of timber resource properties and timber limits pursuant to 2003 B.C. forestry amending legislation.

Position: Legislation gives rise to a statutory taking. Other issues also addressed.

Reasons: Law.

XXXXXXXXXX 2003-002044
Marc Edelson
December 1, 2003

Dear XXXXXXXXXX:

Re: 2003 Amending Forestry Statutes

We are writing in reply to your correspondence of May 23, 2003 and our various telephone discussions. In your correspondence you included a number of questions regarding the Canadian federal income tax consequences of changes proposed to British Columbia's forestry legislation. More specifically, you are concerned with the changes contained in the "Forestry Revitalization Act" that received Royal Assent March 31, 2003 (ch. 17) and the "Forest (Revitalization) Amendment Act" that received Royal Assent May 29, 2003 (ch. 30).

Your requests appear to relate to proposed transactions or completed transactions. Confirmation of the income tax consequences of proposed transactions involving specific taxpayers will only be provided in response to a request for an advance income tax ruling. To make such a request the advance income tax ruling must be submitted in accordance with the guidelines set out in Information Circular 70-6R5 ("IC-70-6R5") dated May 17, 2002. However, if the situation relates to a completed transaction a request for the Canada Customs and Revenue Agency's views must be made to your local Tax Services Office. We can, however, provide the following general comments.

We have set forth below a description of the amending legislation and we have then presented your questions, together with our responses, in an order we believe allows us to present the responses in an organized manner.

The views and opinions given herein are, except where otherwise stated, limited to timber resource properties and timber limits, within the meaning of those terms for the purposes of the Income Tax Act (Canada) (herein called the "ITA").

Except where otherwise stated, statutory references herein are to the ITA.

AMENDING LEGISLATION

A. The "Forestry Revitalization Act" (the "FRA")

The statute applies to

(a) forest licences,

(b) tree farm licences,

(c) timber sale licences, and

(d) timber licences.

Currently, about 75% of the allowable annual cut in B.C. is committed in long-term, replaceable tenures, such as tree farm licences and forest licences. In the main, this statute seeks to reallocate 20% of logging rights from major licensees to the open market, thereby eventually raising the province's total harvest that is available in the open market to 45% ("Timber Reallocation Creates Opportunities For Entrepreneurs", Backgrounder March 26, 2003, Ministry of Forests). Subject to an exemption for the first 200,000 cubic metres of allowable annual cut in replaceable tenures held by any firm, this statute reduces the allowable annual cut of various licenses by 20% and it reduces the area of Crown land described in each timber licence by 20%. The reductions are effective March 31, 2003 although, in the case of a group of licenses (as defined in the legislation), provision is made for the actual allocation of the reduction to be made within 3 years of that date by order in writing of the Minister of Forests and, in the case of timber licenses, the identification of the specific areas reduced is, similarly, to be made within the 3 year period. All licences affected by the reductions referred to are deemed to be amended, as necessary.

To compensate licence holders for the reductions, the legislation provides that:

(a) for a reduction to the allowable annual cut of an ungrouped licence (section 2(1)), compensation is to be an amount equal to the value of the harvesting rights for the unexpired term of the licence that are taken by means of the reduction;

(b) for a reduction in the area of Crown land described in a timber licence (sections 2(2) and 3(1)), compensation is to be an amount equal to the value of the harvesting rights taken by means of the reduction; and

(c) for a reduction in the allowable annual cut of a licence in a group of licences (sections 2(3) and 3(2)), compensation is to be an amount equal to the value of the harvesting rights taken by means of the reduction.

As well, compensation is to be made for the value of improvements made to Crown land that have been authorized by the Government.

Entitlement to compensation is stated to be vested in the holder to which it applies on the date the section comes into force (which appears to be March 31, 2003).

Section 7(4) specifically excludes the provisions of the Expropriation Act (British Columbia) from application to a reduction.

Draft regulations respecting aspects of the compensation entitlement have been prepared but have not yet been concluded. The draft regulations indicate that compensation is based on the market value of rights on March 31, 2003. The compensation process envisages a negotiated settlement based on principles contained in the regulations with any unresolved dispute being submitted to commercial arbitration, as provided in the FRA. Interest is to be paid on compensated amounts from March 31, 2003 to the date of payment. As well, there are indications that non-cash compensation may be considered if it is feasible.

B. The "Forest (Revitalization) Amendment Act" (the "FRAA")

This statute amends various other British Columbia statutes, principally the Forest Act (BC), so as to:

(a) no longer require holders of forest licences and tree farm licences to continue to operate, construct or expand timber processing facilities or carry out measures to meet certain objectives of the government;

(b) no longer reduce the allowable annual cut of owners or operators of timber processing facilities that close those facilities or reduce their production;

(c) allow for the consolidation and subdivision of existing forest licences (but maintaining the same aggregate allowable annual cut), tree farm licences (but maintaining the same aggregate allowable annual cut) and pulpwood agreements with the consent of licensee;

(d) remove various governmental discretions in respect of, and certain charges required as a condition for, the transfer of a licence from a licensee to another person, including an effective transfer by means of a change of control of a corporate licensee;

(e) allow for the surrender of timber sale licences where no harvesting has taken place under the licence;

(f) replaces existing annual cut control requirements with new provisions.

QUESTIONS AND RESPONSES

Question 1: Disposition - Basic Issue

Will the reductions to the volume of timber or the area in which timber may be harvested pursuant to the terms of existing licences in British Columbia, as a result of the enactment of the FRA, constitute a disposition of all or a part of those licences?

Response: The legislative changes contained in the FRA apply to replaceable licences that are defined in the Forest Act (British Columbia) as a "forest licence", a "tree farm licence" and a "timber sale licence". As well, the changes apply to "timber licences", as defined in the said Forest Act, that are not in a tree farm licence area. The FRA will, effective March 31, 2003, reduce the volume of timber or the area in which timber may be harvested pursuant to the terms of many existing licences in British Columbia.

Each of the licences referred to above may generally be described as timber tenures, which are recognized as being, significantly, contracts concerned with the right to harvest a specified volume of timber within an identified area, either exclusively or non-exclusively. In our view, the reduction in the volume or area of timber that may be harvested pursuant to a licence as a result of the operation of the FRA will represent a "taking under statutory authority".

It is our view that where the statutory taking entitles the licence holder to compensation, the statutory taking will be regarding as giving rise to a disposition by the licence holder of all or a part of the particular licence for the purposes of paragraph (a) of the definition of "disposition" in subsection 248(1) (also see Question 2).

For the purposes of the ITA, rights to harvest timber are characterized as either a timber resource property or a timber limit. Accordingly, a disposition referred to will, depending upon the terms and conditions of the particular timber tenure, be of a disposition of all or part of a timber resource property or a timber limit. In referring to a disposition of "all" of a timber resource property, we are, for example, referring to a situation which may arise whereby a single licence, that is part of a group of licences, loses its entire allowable annual cut.

Question 2: Disposition - Proceeds

Is the compensation provided for in section 6 of the FRA "compensation for property taken under statutory authority" within the meaning of paragraph (d) of the definition of "proceeds of disposition" in each of subsection 13(21) and section 54?

Response: Sections 6(1), (2) and (3) provide for compensation to the holders of licences that suffer reductions under any of sections 2(1), (2) or (3). The compensation is stated to be equal to the value of the harvesting rights taken by means of the reduction, which value is to be determined by regulation, generally for the unexpired term of the licence. Section 6(4) of the FRA entitles a timber tenure holder to compensation in respect of the value of certain improvements made to Crown land, as determined by regulation.

The compensation provided for in sections 6(1), (2), (3) and (4) of the FRA will be "compensation for property taken under statutory authority" within the meaning of paragraph (d) of the definition of "proceeds of disposition" in each of subsection 13(21) and section 54.

No comment is made herein respecting any amounts that may be paid to timber tenure holders as damages (for example, damages paid in respect of improvements that are retained by a timber tenure holder but which have been injuriously affected by the reductions). As well, see Question 7.

Question 3: Disposition - Retroactive

Has there been a disposition when the FRA is passed into law?

Response: The definition of "disposition" in subsection 248(1) states that it includes "... any transaction or event entitling a taxpayer to proceeds of disposition of the property".

In the context of the FRA, "proceeds of disposition" is defined to include "compensation for property taken under statutory authority ..." (paragraph (d) of the definition of "proceeds of disposition" in each of subsection 13(21) and paragraph 54). Where the proceeds of disposition are of the type described in said paragraph (d), subsection 44(2) applies to deem the time when the disposition is considered to take place. Subsection 44(2) reads as follows:

(2) Time of disposition and of receipt of proceeds - For the purposes of this Act, the time at which a taxpayer has disposed of a property for which there are proceeds of disposition as described in paragraph ... (d) of the definition "proceeds of disposition" in subsection 13(21) or paragraph ... (d) of the definition "proceeds of disposition" in section 54, and the time at which an amount, in respect of those proceeds of disposition has become receivable by the taxpayer shall be deemed to be the earliest of

(a) the day the taxpayer has agreed to an amount as full compensation to the taxpayer for the property ... taken ...,

(b) where a claim, suit, appeal or other proceeding has been taken before one or more tribunals or courts of competent jurisdiction, the day on which the taxpayer's compensation for the property is finally determined by those tribunals or courts,

(c) where a claim, suit, appeal or other proceeding referred to in paragraph (b) has not been taken before a tribunal or court of competent jurisdiction within two years of the ... taking of the property, the day that is two years following the day of the ... taking,

(d) the time at which the taxpayer is deemed by section 70 or paragraph 128.1(4)(b) to have disposed of the property, and

(e) where the taxpayer is a corporation other than a subsidiary corporation referred to in subsection 88(1), the time immediately before the winding-up of the corporation,

and the taxpayer shall be deemed to have owned the property continuously until the time so determined.

As a result of the application of subsection 44(2), although the FRA may deem the reduction in the tenure of a right or license (be it the allowable annual cut or the area within which harvesting rights have been granted), to be effective March 31, 2003, the disposition of property by a timber tenure holder in consequence of the reduction will generally not occur until the earliest of the days described in subsection 44(2) (ie. if no claim, suit, appeal or other proceeding has been taken before a tribunal or court of competent jurisdiction within 2 years from the date of the taking of the property, the earliest day could be the earlier of the day the amount of compensation is agreed to and March 30, 2005).

Question 4: Disposition - Date of the "Taking"

What is the date of the "taking" for the purposes of the 2 year limit contained in paragraph 44(2)(c)?

Response: For the purposes of paragraph 44(2)(c), generally it is our view that the term "day of taking" with respect to a property means the day on which title vests with the person who takes the property under the relevant statutory authority (see paragraphs 3 and 10 of Interpretation Bulletin IT-271R "Expropriations - Time and Proceeds of Disposition").

The effect of section 3(4)(c) of the FRA is to deem any reduction in a timber tenure that is made under the provisions of that statute to have taken place on March 31, 2003. As well, draft regulations to the FRA make it clear that compensation for property taken under the terms of the FRA is to be based on the market value of such property on March 31, 2003 (Section 2 of the draft Regulations).

Based on the foregoing, where property is "taken under statutory authority" as a result of the operation of the FRA it is our view that, for the purposes of paragraph 44(2)(c), the "day of taking" of such property will be March 31, 2003.

Question 5: Disposition - Compensation Appeals

Does use of the arbitration process constitute a "claim, suit, appeal or other proceeding ... before a tribunal or court of competent jurisdiction" for the purposes of paragraph 44(2)(b)?

Response: Section 6(6) of the FRA provides as follows:

"A dispute between the minister and the holder of an ungrouped licence, a timber licence or a licence in a group of licences as to the amount of the compensation to which the holder is entitled under this section must be submitted to arbitration under the Commercial Arbitration Act."

It is our view that the arbitrator referred to in the Commercial Arbitration Act, RSBC 1966, c. 55, will be a "tribunal" for the purposes of paragraphs 44(2)(b) and (c) and a dispute concerning compensation to which a tenure holder is entitled that is submitted to such arbitration process will be a proceeding before such a body.

Question 6: Disposition - Separate Properties

Is the timing of the disposition the same, whether one or more licences is held by a licensee?

Response: The fact of and the time of a disposition of a licence or part thereof will be determined on the basis of the principles discussed above. Accordingly, it is not necessarily the case that all licences held by a tenure holder will be considered to be disposed of or that they will be considered to be disposed of at the same time.

Question 7: Proceeds - Allocation

If the Province of British Columbia agrees to compensate a licencee for the loss of something other than the licencee's tenure or improvements (ie. damages for injury to the licencee's business operations), will such compensation nevertheless be treated as proceeds of disposition of the timber tenure or improvements?

Response: Question of Fact

Question 8: Silviculture Issues

(a) What are the income tax consequences associated with accrued silviculture obligations that a timber tenure holder may be required to continue to satisfy on areas that, as a result of the operation of the FRA, are taken by the Province of British Columbia and in which the timber tenure holder no longer has an interest?

(b) What are the income tax consequences to a timber tenure holder of its accrued silviculture obligations that are assumed by the Province of British Columbia in connection with a reduction in tenure under the provisions of the FRA?

Response:

(a) As reaffirmed in the recent case of Northwood Pulp and Timber Limited, 98 DTC 6640 (FCA), accrued silviculture costs are generally not deductible for income tax purposes until such time as those costs are "incurred". Until that time, they are provisional estimates that are conditional, contingent and uncertain. And, as stated in The Queen v. Burnco Industries Ltd. et. al., 84 DTC 6348 (FCA):

"an expense ... is an obligation to pay a sum of money. An expense cannot be said to be incurred by a taxpayer who is under no obligation to pay money to anyone. Contrary to what was decided by the Trial Division, an obligation to do something which may in the future entail the necessity of paying money is not an expense."

Based on the same principle, a silviculture obligation will not represent a capital cost of property until the time that a cost is incurred in satisfaction of the obligation.

Whether expenditures in respect of silviculture that are incurred in a particular year will be deductible in that year or will represent an expenditure on capital account is a question of fact that can only be determined after a review of all of the circumstances relating to a specific situation. For example, costs incurred in satisfaction of silviculture obligations that were assumed by the timber tenure holder as consideration on the purchase of a timber resource property will generally be treated as a capital cost of the timber resource property (see our Document 2002-0164607, dated October 23, 2002).

Where a timber tenure holder may be required to continue to satisfy silviculture obligations in respect of areas that are taken by the Province of British Columbia from the timber tenure holder and in which the timber tenure holder no longer has an interest, it is arguable that there is no longer a "source" from which expenditures in satisfaction of the silviculture obligations may be deducted or that there is no property to which the costs of satisfying the obligation may be added. Notwithstanding the foregoing, in these circumstances we are generally prepared to accept that, depending on the result of the determination referred to in the preceding paragraph, the expenditures will be deductible by the timber tenure holder or they are to be given treatment, in the form of a capital loss and/or terminal loss, that, absent timing considerations, provides a net result that is consistent with the result that would have occurred had the disposition of the particular property not taken place prior to the expenditures being incurred.

The foregoing does not take account of proposed legislation, contained in Department of Finance News Release 2003-055 (October 31, 2003) entitled "Proposed amendments to the Income Tax Act related to the deductibility of interest and other expenses related to a source". The proposed legislation, if and when passed, could alter the positions described.

(b) Where a timber tenure holder is relieved from the obligation to incur accrued silviculture costs in connection with the reduction in a timber tenure pursuant to the provisions of the FRA, the value of the silviculture obligation from which the timber tenure holder is relieved will be included in its proceeds of disposition of the property or part thereof disposed of. We find support for this conclusion in the answer given to a question presented at a Ministry of Forests meeting on July 30, 2003 pertaining to the FRA and the FRAA, as follows:

"What will happen to the silviculture liabilities on take backs?"

The answer given was that:

"the liability remains vested with the company unless the company agrees to have the cost discounted from their compensation amount."

This same conclusion was announced in our Document 2002-0164607, referred to above, where we considered the income tax consequences arising from sale of a business where part of the consideration included the assumption of contingent liabilities. We concluded that the vendor's proceeds includes the fair market value of a contingent liability assumed by purchaser.

Question 9: Replacement Property

Can a timber limit qualify as a replacement property for a timber resource property where a licencee acquires a timber limit to replace some or all of a timber resource property that is disposed of as a result of the operation of the FRA?

Response: Yes, subject to satisfaction of conditions set forth in Interpretation Bulletin IT-259R4 "Exchange of Property", dated September 30, 2003. Also see Document 2002-0135143 dated January 1, 2002.

We trust our comments will be of assistance. Our comments are provided in accordance with the practice outlined in paragraph 22 of IC-70-6R5.

Yours truly,

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