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: Various issues regarding successor pool claims.
Position: Generally, rely on and maintain previous positions.
Reasons: As per previous positions.
October 10, 2006
Jane Stalker HEADQUARTERS
Coordinator, Natural Resources Income Tax Rulings
Industry Specialist Services Directorate
Technical Applications & Valuation Division Marc Edelson, LL.B.
112 Kent St., Room 1330 (613) 957-2123
Ottawa, Ontario K1A 0L5
Successor Pool Issues
We are writing in reply to your memorandum of January 30, 2006, as subsequently amended on October 2, 2006, wherein you requested our views regarding various successor pool issues. In our response, we have used a number of acronyms with which we believe you are familiar.
In this letter, unless otherwise stated all statutory references are to the Income Tax Act (Canada).
Transfer of Successored Property to a Partnership
You have described the CRA's position that a partner's share of income from a partnership resource property retains that character for the purposes of the successor corporation rules. This allows a corporate partner that disposed of a successored resource property to a partnership to continue to deduct its successored pools against income allocated to it by the partnership that can reasonably be regarded as attributable to the property disposed of. There is no specific requirement that the corporate partner continue to own the property at the time its successor pools are deducted.
You have inquired whether this is appropriate as you believe that since the successor rules require the successor to have acquired the successored property that it is implicit that it continue to own the property.
The entitlement of a partner to apply production income from a successored property owned by the partnership against the successored pools of the partner to which the successored property relates was, as you pointed out, confirmed in Question 2 at the 1991 Revenue Canada Round Table, (1991 Canadian Tax Foundation Report) on the basis that paragraphs 96(1)(f) and (g) preserve the source of income of a partnership in the hands of each partner so that income from a particular property of the partnership will be considered income of the partner that is reasonably attributable to production from the particular property. As you also point out, for a partner to claim a deduction from its successored pool where it has the type of income described above, it is sufficient that the partner had, at some time, acquired the particular property. It is not necessary that the partner own the particular property in the taxation year in which it seeks to deduct an amount on account of its successor pool; however, the partnership must have either production income or proceeds of disposition from the successored property that is allocated to the partner in the year.
The treatment of a partner that transfers a resource property to a partnership of which it is a member is somewhat unique since, in most cases, subsection 66.7(16) will operate to deny a successor corporation the use of its successor pools following a disposition of the particular property that gave rise to those pools.
Any change to the treatment described above will, in our view, require a legislative amendment.
Allocation of Successored Income
You have described a situation where a partnership agreement purports to allocate income from successored properties to the particular partner that contributed the property to the partnership so as to entitle that partner to maximize the deduction of its successored pools. The allocation of resource income is apparently different from the income /loss allocation by the partnership. For example, Corporation A contributes to the partnership a property valued at $1.0 m. that gives rise to $100,000 of income per year and Corporation B also contributes to the partnership a property valued at $1.0 m. that gives rise to $100,000 of income per year and the terms of the partnership agreement allocate to Corporation A all of the income from Property A and to Corporation B all of the income from Property B.
In this situation you have asked whether we consider that subsection 103(1) or (2) will apply to an allocation of the resource income stream.
The Agency has, in certain situations, accepted the allocation of a tax amount in respect of a partnership on a basis that is different than the sharing of the profit or loss of the partnership. For example paragraph 5 of archived IT-338R2 Partnership Interests - Effects on Adjusted Cost Base Resulting from the Admission or Retirement of a Partner, dated July 10, 1995, stated:
A partnership agreement may provide that partnership income be allocated in a certain manner if the partners have contributed property to a partnership using subsection 97(2). For example, the partnership agreement may state that when a property is transferred under this provision and is subsequently disposed of by the partnership, any resulting profit or gain will, to the extent it is considered to have accrued prior to the date on which the property was transferred to the partnership, be allocated entirely to the partner who contributed that property. Similarly, the sharing of profits and losses may take such transfers into account. Any such agreed allocation of partnership income is generally acceptable, subject, of course, to the anti-avoidance provisions in section 103. Income properly allocated to a partner is added to the ACB of that partner's partnership interest under subparagraph 53(1)(e)(i).
In addition to dealing with the allocation of income or loss of a partnership from any source or sources, subsection 103(1) also applies to any other amount in respect of any activity of the partnership that is relevant to the computation of income or taxable income. Accordingly, it could apply to the sharing of proceeds of disposition of a CRP. However, subsection 103(1) will only apply if the principal purpose for the sharing of the income or proceeds of disposition in the manner proposed can reasonably be considered the reduction or postponement of the tax that might otherwise have become payable.
Arguably, if a taxpayer contributes a property to a partnership and the taxpayer is entitled to share in the profit of the partnership to the extent of 50% thereof, it would not be consistent with that sharing arrangement for the partner's share of the production income from the property that it contributed to that partnership to be 100% thereof. The purpose of doing so would be to entitle the taxpayer to assert that all of its share of the partnership's production income is reasonably attributable to the property it contributed to the partnership and, in turn, eligible for a deduction from the taxpayer's successored pools. The only logical explanation for such an allocation is to provide a tax benefit to the party contributing the successored property to the partnership. On that basis, arguably, the "principal" purpose of the arrangement to allocate the streamed income of the property to the contributing partner is the reduction or postponement of tax so that subsection 103(1) could apply.
The situation is unlike that described in archived IT-338R where a gain that accrued on property outside of the partnership is agreed to be borne by the contributing partner, rather than rateably by all of the partners, where realization of the gain is deferred until the property is disposed of by the partnership.
Allocation of Income to Separate Resource Properties
The entitlement to claim a successor pool deduction is based on having income that is reasonably attributable to production from a particular resource property. More particularly, as an example subsection 66.7(5) reads:
66.7(5) "... where ... a corporation (..."successor") acquired a particular Canadian resource property ... there may be deducted by the successor in computing its income ... an amount not exceeding ...
(i) the part of the successor's income ... that can reasonably be regarded as attributable to ...
(B) production from the particular property".
Since the property referred to is a particular Canadian resource property, where a taxpayer's oil and gas lease ("PNG Lease") is successored, the question arises whether the income derived from the subsequent drilling of a producing well on the PNG Lease that is, itself, a Canadian resource property, will give rise to income from production that is reasonably attributable to the particular PNG Lease.
If it is concluded that the income from production may reasonably be attributable to the particular PNG Lease, as well as to the particular well, the issue arises whether there should be an allocation of the income between the two forms of Canadian resource property and, if so, on what basis. For example, should all costs of drilling and completing the non-successored well be recovered before any income will be eligible for offset by the successored pools that relate to the PNG Lease?
The relevant wording in the successor provisions concerns income attributable to "production from the particular property", rather than income attributable to the "particular property".
In our view, this allows a taxpayer to deduct its successored resource pools against income from a particular successored property (the PNG Lease) that has only become available as a result of development of the property after the successoring of the resource pools, even though the further development could itself be regarded as giving rise to a new form of Canadian resource property (the oil or gas well). For example, pursuant to paragraph (a) of the definition of "Canadian resource property" in subsection 66(15), an oil and gas lease will be a Canadian resource property and, pursuant to paragraph (c) of the definition, so will the oil or gas well drilled on that lease.
This is consistent with the conclusions in document 9531725, dated December 19, 1995, which expressed the view that production would be from a particular Canadian resource property where the production was from infill wells drilled after the acquisition of the particular Canadian resource property. As well, more recently in document 1999-0011835, dated February 3, 2000, we concluded that the royalty income from a gross overriding royalty retained by a taxpayer on a sale of a successored working interest in an oil and gas lease could be income against which successor deductions could be applied because it would be income for a taxation year that may reasonably be regarded as attributable to production from the particular Canadian resource property.
On the other hand, where a taxpayer acquires an increased percentage interest in the particular resource property following a successoring event, deduction of the taxpayer's successored pools will be limited to income that is reasonably attributable to production from the pre-succession percentage interest.
Whether or not successored pools would continue to be deductible in other instances of changes to the character of the property owned by the taxpayer must be considered on a case-by-case basis.
In those situations where we consider that, following a successor event, the successor corporation continues to earn income that is attributable to production from the particular resource property, we do not see any basis in the legislation to allocate such production income between the successor corporation's successored PNG Lease and any non-successored wells. We believe that all production income realized following the drilling of a successful well on that PNG Lease can be said to be allocable both to the PNG Lease, as well as to the successful well.
We trust that our comments will be of assistance.
Reorganizations and Resources Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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