10 March 1989 Income Tax Severed Letter 5-7541 - [Alternate Farm-out Arrangement]

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.

Revenue Canada Taxation Head Office

XXXX

P. Mason (613) 957-4364

March 10, 1989

Dear Sirs:

Re: Alternate Farm-out Arrangement

We are writing in reply to your letter of February 10, 1989, requesting confirmation that a farm-out arrangement described below as an "Alternate Farm-out Arrangement" will not give rise to income for income tax purposes in accordance with paragraph 11 of Interpretation Bulletin IT- 125R3. You describe an Alternate Farm-out Arrangement as follows:

1. At the time of entering into the farm-out agreement, the farmor will assign to the farmee specified interests in the farm-out lands. In return, the farmee will agree to drill a test well on the farm-out lands, to the point of completion, capping or abandonment, at his cost.

2. When the farmee has drilled the test well to contract depth and completed, capped or abandoned it, he will retain the specified interest in the spacing unit of the test well. This interest can be subject to a convertible gross overriding royalty payable to the farmor. If the farmee elects to abandon the well, the farmor can, prior to abandonment, elect to take over the well. In this event, the farmer is required to assign its interest in the test well, the spacing unit of the well and any surface leases pertaining thereto, to the farmor. The farmee retains his interest in the balance of the farm-out lands.

3. Should the farmee default on any term, covenant or condition of the farm-out agreement, the farmor may terminate the agreement. In that event, the farmee is required, under the agreement, to re-assign its entire working interest obtained under the agreement, to the farmor.

You indicate that the essential characteristic of the Alternate Farm-out Arrangement which distinguishes it from the most common type of farm-out in use in the oil and gas industry today is that the interest in the farm-out lands is assigned to the farmee prior to the spudding of, rather than on completion, capping or abandonment of, the test well.

In particular, you request our confirmation that the fact that an interest in farm-out lands is assigned on entering into a farm-out agreement, rather than at the time a test well is completed, capped or abandoned, will not, in and of itself, result in some part of the farmee's drilling costs being considered proceeds of disposition of an interest in the farm-out lands.

With respect to the foregoing, we confirm your view provided that the Alternate Farm-out Arrangement does not constitute a "widespread farm-out". A widespread farm-out is a farm-out in which the farmee receives an interest in non-resource property (e.g. tangible depreciable assets), producing resource property or non-producing resource property which is neither the property being explored or developed, nor a related property, such as a contiguous lease. It is our view that a disposition that gives rise to income takes place in a widespread farm-out.

The opinions given herein are expressions of opinion only and as such are not binding on the department.

Yours truly,

Chief Resource Industries Section Bilingual Services & Resource Industries Division Rulings Directorate