23 March 2007 External T.I. 2007-0227981E5 - Canadian Resource Property

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: tax treatment for consideration received on entering into a petroleum and natural gas lease

Position: consideration represents proceeds to be credited to the CCOGPE pool

Reasons: review of the legislation

									2007-022798
XXXXXXXXXX 								T. Harris
(613) 957-2114
March 23, 2007

Dear XXXXXXXXXX:

Re: Petroleum and Natural Gas Lease

We are writing in response to your recent request for our interpretation of the tax treatment for certain payments received as consideration for entering into a petroleum and natural gas lease (the "PNG Lease").

Situation

You describe a situation where several years ago, XXXXXXXXXX each acquired a XXXXXXXXXX% interest in certain mineral rights in XXXXXXXXXX from their parents by means of a gift or bequest. These mineral rights consist primarily of petroleum and natural gas rights. In 2006, XXXXXXXXXX leased these rights to an arm's length party for a term of XXXXXXXXXX years for consideration consisting of a lump sum rental payment, a bonus payment and a signing payment (the "Payments").

You wish to know whether the Payments are required to be included in the income of the recipients for tax purposes.

Our Comments

Written confirmation of the income tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request as described in Information Circular 70-6R5 dated May 17, 2002 issued by the Canada Revenue Agency. A fee is charged for this service. Although, we are unable to provide any comments with respect to your particular fact situation otherwise than in the form of an advance income tax ruling, the following general comments may be of assistance.

Canadian resource property is defined in subsection 66(15) of the Income Tax Act (the "Act") as including any right, licence or privilege to explore for, drill for or take petroleum, natural gas or related hydrocarbons in Canada. As a typical PNG Lease will generally involve the owner of mineral rights (the "lessor") granting to the lessee the exclusive right to explore for, drill for and take the petroleum, natural gas and related hydrocarbons (the "Substances") that occur on or under a particular parcel of land, we believe that the consideration received by the lessor for entering into a PNG Lease (i.e. the Payments) represent amounts received by the lessor in respect of the disposition of a Canadian resource property. Where the Canadian resource property consists of oil and gas rights, these proceeds should be deducted from the taxpayer's cumulative Canadian oil and gas property expense ("CCOGPE") as defined in subsection 66.4(5) of the Act pursuant to element F of that definition.

In the event that the amount in a taxpayer's CCOGPE pool is negative at the end of a taxation year, such negative amount is deducted from the taxpayer's cumulative Canadian development expense ("CCDE"), as defined in subsection 66.2(5) of the Act, by virtue of element L thereof. If the taxpayer's CCDE account is also negative at the end of the taxation year, this negative amount is included in the taxpayer's income for the taxation year through the operation of subsection 66.2(1) and paragraph 59(3.2)(c) of the Act. This treatment is described in paragraph 2 of Interpretation Bulletin IT-125R4 Dispositions of Resource Properties.

Where a taxpayer does not have any balance in either the CCOGPE or CCDE pools because the taxpayer has not previously incurred any Canadian oil and gas property expense or Canadian development expense as defined in subsections 66.4(5) and 66.2(5), respectively, of the Act, the full amount of the Payments receivable by the taxpayer for entering into the PNG Lease should be included in computing the taxpayer's income for the year under paragraph 59(3.2)(c) of the Act.

Generally, where a taxpayer has acquired a Canadian resource property that consists of the right, licence or privilege to explore for, drill for or take petroleum, natural gas or related hydrocarbons in Canada, the cost of such property will represent a Canadian oil and gas property expense ("COGPE") of the taxpayer and will be included in the taxpayer's CCOGPE pursuant to element A of the definition of that term in subsection 66.4(5) of the Act. Where a property, including a Canadian resource property, has been acquired by way of a gift or bequest, the taxpayer's cost of that property is deemed to be an amount equal to its fair market value at the time of the gift or bequest pursuant to paragraph 69(1)(c) of the Act.

Generally, a taxpayer may deduct any amount not exceeding 10% of the balance in the taxpayer's CCOGPE pool at the end of any taxation year pursuant to subsection 66.4(2) of the Act. The claiming of this deduction is at the taxpayer's discretion in any particular taxation year.

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

Yours truly,

for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch