7 January 2013 External T.I. 2012-0460791E5 - Qualified Farm Property & Oil Reserves

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: Whether the taxpayer's farm would continue to meet the definition as a "qualified farm property", if oil reserves are discovered on the property.

Position: Maybe

Reasons: The definition of qualified farm property is based on use of the property. However, the property may be considered Canadian resource property as per subsection 66(15), if the land value is principally attributed to the oil reserves. Also must consider if the surface and mineral rights can be separated, in order to preserve the requirements of a qualified farm property.

XXXXXXXXXX
2012-046079
Judith Nichols

January 7, 2013

Dear XXXXXXXXXX:

RE: Qualified farm property and oil reserves

This is in response to your email of August 29, 2012, wherein you requested our views as to whether a taxpayer whose farm property meets the definition as a "qualified farm property" ("QFP") within the meaning of subsection 110.6(1) of the Income Tax Act (the "Act") will be eligible to claim the capital gains deduction under subsection 110.6(2) on a subsequent disposition of the farm property in circumstances where petroleum or natural gas reserves are discovered on the property.

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 a particular fact situation otherwise than in the form of an advance income tax ruling, the following general comments may be of assistance.

Generally, under the definition in subsection 110.6(1), QFP includes real property owned by an individual where the property is used principally in a farming business. Subsection 110.6(2) of the Act provides that an individual taxpayer may claim a capital gains deduction of up to $375,000, where that individual has disposed of QFP as long as certain conditions are satisfied as outlined in subsection 110.6(1.3) of the Act.

It is our understanding that, under the relevant provincial legislation, a taxpayer can own two separate rights, a surface right (the real property) and a subsurface right (the right to petroleum or natural gas). In such a situation, the discovery of oil and gas reserves on the property will not affect the determination of the real property as a QFP. Consequently, where the individual taxpayer disposes of QFP, the taxpayer may be entitled to the capital gains exemption under subsection 110.6(2) of the Act where all the relevant conditions are met.

We note that a right, license or privilege to explore for, drill for or take petroleum or natural gas will constitute a "Canadian resource property" under subsection 66(15). Consequently, the subsurface right owned by the taxpayer may qualify as a Canadian resource property. Where the taxpayer disposes of Canadian resource property, the proceeds of disposition will reduce the taxpayer's cumulative Canadian oil and gas property expense ("CCOGPE") within the meaning of subsection 66.4(5) of the Act by virtue of element F thereof. Where the balance in the taxpayer's CCOGPE is negative, by virtue of subsection 66.4(1), in conjunction with element L of the definition of cumulative Canadian development expense ("CCDE") under subparagraph 66.2(5), any negative balance in a taxpayer's CCOGPE at the end of a taxation year will reduce the taxpayer's CCDE balance. This reduction in CCDE will result in an income inclusion for the taxpayer, by virtue of subsection 66.2(1) and paragraph 59(3.2)(c), if a negative CCDE balance arises.

We note that for purposes of the Act, any real property the principal value of which depends on its petroleum, natural gas or related hydrocarbon content will constitute a "Canadian resource property" as defined in subsection 66(15) of the Act by virtue of paragraph (c) of that definition. For these purposes "principal" means more than 50%. Where the taxpayer owns one right that includes both the surface right and the subsurface right, and more than 50% of the value of the real property depends on the petroleum or natural gas reserves, the right would constitute a Canadian resource property and the disposition of the right would result in the tax consequences described in the previous paragraph. Consequently, in this situation, the proceeds received from the disposition of the right will not give rise to a capital gain such that the capital gains deduction under subsection 110.6(2) will not be available, as the amount determined under paragraph 110.6(2)(d) of the Act in respect of that disposition would be nil.

Where, however, a taxpayer owns one right and more than 50% of the value of the real property cannot be attributable to such reserves, the property will be a QFP and the taxpayer may be entitled to the capital gains deduction if the relevant conditions are met.

The determination as to whether the taxpayer owns one right or two separate rights is a question of law and fact.

We trust that our comments, provided in accordance with paragraph 22 of Information Circular 70-6R5, will be of assistance.

Yours truly,

Fiona Harrison, C.A.
Manager
Resources Section
Income Tax Rulings Directorate
Legislative Policy & Regulatory Affairs Branch