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: The income tax treatment of surface lease bonus payments.
Position: The annual surface lease payments would be deductible. The bonus payments would generally be considered an eligible capital expenditure. Where the payments are incurred prior to any relevant production, the payments may be considered CEE or CDE, depending on the status of the relevant resource property, and to the extent that the payments are not in respect of the cost or part of the cost of depreciable property of a prescribed class .
Reasons: Prior positions.
Bob Naufal
XXXXXXXXXX (613) 957-2097
2009-034512
February 15, 2010
Attention: XXXXXXXXXX
Re: Surface Lease Payments in the Oil & Gas ("O&G") Industry
We are writing in response to your letter dated September 23, 2009, wherein you requested our comments with respect to the income tax treatment of certain payments required under surface lease agreements between the owner of the land ("Landowner") and the owner of the subsurface rights (O&G Operators).
In your letter, you noted that certain Provinces in Western Canada have surface rights legislation governing the relationship between Landowners and the O&G Operators. A key component of the legislation is mandatory compensation, which requires that prior to entry an O&G Operator must obtain a lease for rights to use the surface, which would typically specify the amount of compensation to be paid to the Landowner for such use.
In addition, you stated that, generally, the common factors in respect of surface owner compensation include the following:
- Surface leases must establish a first year payment as well as annual lease payments for other years of the lease,
- The first year payment must include lump sum amounts often referred to in the industry as "Bonus Payments", in addition to the regular annual lease payment, and
- The amount of compensation paid is determined by free and open negotiations. In this regard, where an agreement cannot be reached by the Landowner and the O&G Operator, a provincial surface rights board will establish the amount of compensation.
Compensation is normally determined based on a number of factors, which include inter alia, land value, nuisance, inconvenience & noise, loss of land use and adverse effect. Moreover, you have noted that the Province of Alberta's surface rights legislation includes an "entry fee" compensation element.
You have asked for our comments with respect to the tax consequences of the Bonus Payments and the annual surface lease payments made by the O&G Operators under a surface lease agreement.
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.
Where a surface lease agreement does not identify the specific components that are included in the Bonus Payment, it is our view that the Bonus Payment would be an "eligible capital expenditure" ("ECE") pursuant to the definition of that term in subsection 14(5) of the Income Tax Act (the "Act"). However, the annual lease payments are recurring expenses with respect to loss of use and adverse effect and would generally be deductible in the year incurred.
It is our understanding that the O&G Operators may build roads on land that is owned by the Landowners. Generally, roads are constructed under a surface lease arrangement, rather than by acquiring a right of way. Where surface lease payments represent expenses incurred in building temporary access roads to drilling sites, these payments may qualify as either "Canadian exploration expenses" ("CEE") where they meet the requirements of paragraph (d) of the definition of CEE in subsection 66.1(6), or as "Canadian development expenses" ("CDE") where they meet the requirements of subparagraph (a)(ii) of the definition of CDE in subsection 66.2(5).
We trust that our comments are of assistance.
Yours truly,
for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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