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.
Principal Issues: 1. Can subsection 66.1(9) apply in respect of expenses included in a partner's CDE by virtue of paragraph (f) of the definition of CDE in subsection 66.2(5)? 2. Should the reference to "taxpayer" in subsection 66.1(9) and in paragraph (e) in the definition of CEE under subsection 66.1(6) be interpreted as a reference to a partnership or to a partner?
Position: 1. Yes 2. The word " taxpayer" in those provisions should be interpreted as referring to a partner and not a partnership.
Reasons: 1. The position is based on the scheme of the relevant resource provisions and the application of subsection 66(18). 2. The position is based on the scheme of the relevant resource provisions.
January 11, 2005
Headquarters Catherine Bowen
Industry Specialist Services Resources Industry Section
Technical Applications and Valuations Division Income Tax Rulings Directorate
Compliance Programs Branch (613) 957-8284
Audit Directorate
Attention: Christine Savage 2004-010434
Co-ordinator - Resource Industries
Reclassification of a Partner's CDE to CEE under subsection 66.1(9)
We are writing in reply to your memorandum dated November 19, 2004, wherein you requested our opinion on whether subsection 66.1(9) of the Income Tax Act (the "Act") can apply in respect of expenses included in the Canadian development expense ("CDE") of a partner by virtue of paragraph (f) of the definition of CDE in subsection 66.2(5) of the Act. In addition, you asked whether the reference to "taxpayer" in subsection 66.1(9) of the Act and in paragraph (e) of the definition of Canadian exploration expense ("CEE") in subsection 66.1(6) of the Act could be interpreted as referring to a partner of a partnership.
Background Provided
You provided the following background information concerning these issues.
If the requirements in paragraph 66.1(9)(a), (b) or (c) of the Act in respect of an oil or gas well are met at any time in a taxpayer's taxation year, all CDE described in subparagraph (a)(ii) of the definition of CDE incurred by the taxpayer in respect of the well in a taxation year preceding the year will be deemed to be CEE referred to in paragraph (e) of the definition of CEE incurred by the taxpayer at that time.
In a preceding fiscal period of a partnership, when the expenses described in subparagraph (a)(ii) of the definition of CDE were incurred by the partnership, the partnership would be considered to have CDE equal to the amount of those expenses by virtue of that subparagraph and paragraphs 96(1)(a) to (c) of the Act. Furthermore, by virtue of that subparagraph and paragraph (f) of the definition of CDE, a partner of the partnership would be considered to have CDE equal to the amount of its proportionate share of those expenses in its taxation year in which the fiscal period of the partnership ended. As subparagraph 96(1)(d)(ii) of the Act does not permit a partnership to claim any deduction under section 66.2 of the Act, only the partners of the partnership are permitted to claim a deduction under subsection 66.2(2) of the Act in respect of the CDE incurred by the partnership and allocated to them.
You provided the following comments concerning the issues raised in your memo.
a) The word "taxpayer" refers to the partner
By virtue of paragraph (f) in the definition of CDE, you believe that it is arguable that each partner would be considered to have incurred CDE that consists of its share of those expenses described in subparagraph (a)(ii) of the definition (i.e., expenses in drilling or completing an oil or gas well in Canada...). As a result, the partner's CDE described in paragraph 66.1(9)(f) of the Act could be reclassified as CEE of the partner provided that the requirements in paragraph 66.1(9)(a), (b) or (c) of the Act in respect of an oil or gas well are met in the taxation year of the partner. This reclassified CDE would be included in the partner's CEE by virtue of paragraph (e) of the definition of CEE. The partner could then claim a deduction under subsection 66.1(3) of the Act for this CEE.
If the above view is taken, you indicate that there may be an unintended acceleration of the CEE claim to the partner. You provided an example to illustrate the point.
Example
Assumptions:
a) The partnership has a fiscal period ending on January 31 and its Partner A has a taxation year ending on December 31.
b) An oil or gas well was drilled and completed by the partnership on November 30, 2004. The well did not result in a new discovery and it was not abandoned.
c) The 24-month period in which there is no production from that well ends on November 29, 2006.
Results:
i) The CDE incurred by the partnership in respect of the well for its fiscal period ending on January 31, 2005 is allocated to Partner A on the pro-rata basis and included as CDE to the partner in its taxation year ending on December 31, 2005.
ii) The reclassification from CDE to CEE under paragraph 66.1(9)(b) of the Act is effective on November 29, 2006 and that date falls in Partner A's taxation year ending on December 31, 2006.
This example shows that the reclassification from CDE to CEE occurs after only one taxation year of Partner A has taken place since the time the expense was included as CDE of the partner.
b) The word "taxpayer" refers to the partnership
You also believe that there is an argument that subsection 66.1(9) of the Act should not apply to each partner of a partnership, but only to the partnership. Paragraph 66.1(9)(f) of the Act refers to "Canadian development expenses ... described in subparagraph (a)(ii) of the definition 'Canadian development expense' in subsection 66.2(5) incurred by the taxpayer in respect of the well in a taxation year preceding the year". Pursuant to the preamble to paragraph (a) of the definition of CDE, these expenses would have to be incurred by the taxpayer. It is arguable that the partners did not actually incur the CDE and it is only the partnership that incurred such expenses. Furthermore, even if the partners were considered to have incurred the expenses, such expenses would be considered to be those described in paragraph (f) of the definition of CDE and not those described in subparagraph (a)(ii) of that definition as required by paragraph 66.1(9)(f) of the Act. Paragraph (f) of the definition of CDE does not deem the partners to have incurred expenses described in paragraphs (a) to (e) of that definition.
a) Finance's Technical Notes for subsection 66(18)
The Department of Finance's Technical Notes issued in May 1991 for subsection 66(18) of the Act provide helpful comments concerning the incurring of CDE by a partnership and its partners for different provisions of the Act. The notes state that this subsection
"... is introduced to clarify the tax treatment of a person (including a partnership) who is a member of a partnership involved in mining or oil and gas. Where a resource expenditure is attributed by the partnership to the person, the person is treated under this provision as having incurred the attributed expenditure at the end of the fiscal period in which that expenditure is incurred by the partnership to the extent that such attributed expenditure is included in the person's foreign exploration and development expense (FEDE), Canadian exploration expense (CEE), Canadian development expense (CDE) or Canadian oil and gas property expense (COGPE). The new rule applies for the purposes of subsection 21(2) and sections 59.1 and 66 to 66.7, except for the purposes of applying the provisions therein defining FEDE, CEE, CDE or COGPE in respect of the taxpayer. These latter provisions already make specific reference to a taxpayer's share of a partnership's resource expenditures. ... As a consequence of subsection 66(18), it is clear that a taxpayer's share of a partnership's FEDE, CEE, CDE and COGPE is included in the cumulative pools to which those expenditures relate. ..."
b) Does the partnership or its partners incur CDE for purposes of that definition?
Although subparagraph 96(1)(d)(ii) of the Act does not permit a partnership to claim any deduction under section 66.2 of the Act, it does not prohibit it from incurring an expense that meets the definition of CDE. It has been our long-standing view that where a partnership incurs expenses in its fiscal period referred to in paragraphs (a) to (e) of the definition of CDE, such expenses would be CDE incurred by the partnership by virtue of those paragraphs. The partners of the partnership would then be entitled to their respective share thereof pursuant to paragraph (f) of the definition of CDE. It has been our long-standing position that the partner's share of such CDE is not incurred by the partner for the purpose of the definition of CDE. As a result, only one taxpayer has incurred CDE for the purpose of that definition. The introduction of subsection 66(18) of the Act did not change this position since that provision is not applicable for the purpose of applying the definition of CDE. In order to determine whether a partnership has incurred such expenses in its fiscal period, the word "taxpayer" in the preamble of the definition and in paragraphs (a) to (e) of the definition should be read as referring to the partnership. In order to determine the partner's share of CDE incurred by the partnership, the word "taxpayer" in the preamble of the definition of CDE and paragraph (f) of the definition should be read as referring to the partner.
c) Has the partner incurred CDE for purposes of the other resource provisions?
As noted above in Finance's Technical Notes, although subsection 66(18) of the Act is not applicable for the purpose of applying the CDE definition (i.e., in order to initially determine whether an expense meets that definition), it is applicable for the purpose of applying other resource provisions. CDE is deemed to have been incurred by a partner at the end of the fiscal period in which the CDE is included in paragraph (f) of the definition of CDE for the partner for the purpose of those provisions. Therefore, when applying subsection 66.1(9) of the Act and the definition of "cumulative CDE" in subsection 66.2(5) of the Act, CDE allocated to a partner under paragraph (f) of the definition of CDE is deemed by subsection 66(18) of the Act to have been incurred by the partner for the purpose of reading those two provisions. Where subsection 66.1(9) of the Act deems CDE incurred by the partner to be CEE, the deemed CEE meets the definition of CEE by virtue of paragraph (e) of that definition.
d) Character of CDE to the partners
As you noted, paragraph 66.1(9)(f) of the Act refers to CDE described in subparagraph (a)(ii) of the definition of CDE. It is our view, based on positions taken in other situations, that paragraph (f) of the definition of CDE (which allocates the partner's share of CDE incurred by the partnership) does not contain any wording which changes the character of the expenses from their original character, i.e., the original character being expenses referred to in paragraphs (a) to (e) of the definition of CDE. Therefore, an expense that is described in subparagraph (a)(ii) of the definition of CDE that was incurred by a partnership would also be categorized as CDE under the same subparagraph in computing the CDE of the partners. Consequently, the requirement in paragraph 66.1(9)(f) of the Act that the CDE be described in subparagraph (a)(ii) of the definition of CDE will be met where the expenses incurred by a partnership in a preceding year are those that are described in that subparagraph and that have been allocated to the partners under paragraph (f) of the definition of CDE.
e) Timing of reclassification from CDE to CEE
Although the reclassification from CDE to CEE in your example occurs after only one taxation year of Partner A has taken place since the time the expense was included as CDE to the partner, this result does not appear contrary to the intent of subsection 66.1(9) of the Act. From a timing perspective, that provision only requires that CDE be incurred in a taxation year of a taxpayer preceding the year in which one of the events listed in paragraphs (a) to (c) of subsection 66.1(9) of the Act takes place. In particular, once a well has not produced for 24 months commencing on the date the drilling of the well was completed, the expenses related to that well can be reclassified to CEE at that point in time pursuant to paragraph 66.1(9)(b) of the Act. Therefore, the fact that Partner A is able to claim CEE on such a well after only one taxation year does not appear to produce an unintended result. It should be noted that the CDE allocated to Partner A and reported in its taxation year ending on December 31, 2005 represents expenses that were incurred 13 months before that date. If Partner A's taxation year had ended on the same date as the fiscal period of the partnership (i.e., January 31, 2005), it would have been allocated its share of the CDE only two months after the well was drilled.
f) Reference to "taxpayer" in subsection 66.1(9) and paragraph (e) of the CEE definition
As noted in your memo, if the word "taxpayer" in paragraph (e) of the definition of CEE was read as referring to the partnership, none of the CDE of the partnership that became CEE of the partnership under subsection 66.1(9) of the Act could be allocated to the partners as there is no allocation of the expenses described in paragraph (e) of the definition of CEE to the partners provided for in paragraph (h) of the definition of CEE. In addition, we note that there is no allocation available for the partner's share of an amount that became CEE for purposes of the corresponding credit to the partner's cumulative CDE under "I" of the formula in the definition of "cumulative CDE".
It is our opinion, based on the overall scheme of the relevant resource provisions, that the word "taxpayer" in subsection 66.1(9) of the Act and in paragraph (e) of the definition of CEE should be interpreted as referring only to a partner of a partnership and not to the partnership. If the word "taxpayer" as used in those provisions was interpreted as including the partnership, then, for the reasons noted above, any amount of a partnership's CDE that was reclassified as CEE by virtue of subsection 66.1(9) of the Act could not be allocated to the partner. This is clearly not an intended result.
Summary
In summary, it is our opinion that subsection 66.1(9) of the Act can apply in respect of expenses included in a partner's CDE by virtue of paragraph (f) of the definition of CDE. In addition, it is our view that the reference to "taxpayer" in subsection 66.1(9) of the Act and in paragraph (e) of the definition of CEE should be interpreted as referring to the partners of a partnership and not to the partnership.
We trust our comments are of assistance.
for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Planning Branch
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