16 March 1990 Internal T.I. 58197A F - CEE and CDE Incurred by Partnership

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.

March 16, 1990

Dear Sirs:

We are writing in reply to your letter of June 8, 1989, wherein you requested our confirmation that the comments provided to you in our March 22, 1988 letter will continue to apply following the coming into force of the general anti avoidance rule ("GAAR") contained in section 245 of the Income Tax Act (the "Act").

In that March 22 letter we advised you we were unable to confirm the tax effects of a hypothetical situation however we offered the following general comments:

     The Department considers that CEE and CDE incurred by a partner pursuant to clauses 66.1(6) (a) (iv) and 66.2(5) (a) (iv) is incurred by that partner at the end of the fiscal period of the partnership despite the fact that the expenses were actually incurred throughout the fiscal period of the partnership. Therefore, such expenses may be renounced pursuant to subsection 66(12.6) and 66(12.68) provided the agreement to issue the flow-through shares is entered into prior to the year end of the partnership.

You have also asked us to confirm that where the principal purpose for using a partnership is to facilitate the desired timing of the incurring of Canadian exploration expense ("CEE") and Canadian development expense ("CDE") for tax purposes by the members of the partnership, section 245 of the Act would not apply.

In responding to your query we agreed to modify the hypothetical situation described in our letter to you dated March 22, 1988, to read as follows:

(i)     Oilco is a principal-business corporation ("PBC");

(ii)     Oilco was considering entering into flow-through share agreements in a particular year and accordingly it formed a partnership (the "Partnership") with an affiliated corporation. The sole purpose of this partnership arrangement was to facilitate Oilco's warehousing of resource expenditures until it decided if flow-through share agreements would be entered into;

(iii)     The partnership incurred CEE; and CDE by "farming in" to oil and gas property owned by Oilco;

(iv)     After the CEE and CDE was incurred, but prior to the Partnership's fiscal year-end, Oilco entered into a flow-through share agreement with arm's length investors;

(v)     The first fiscal period of the Partnership ended and the appropriate portion of the CEE and CDE incurred by the Partnership was allocated to Oilco pursuant to subparagraphs 66.1(6)(a)(iv) and 66.2(5)(a)(iv), respectively;

(vi)     It is your view in this instance that subsection 245(2) of the Act should not apply and any resource expenditures allocated by the Partnership to Oilco should be viewed as having been incurred by Oilco on the last day of the Partnership's fiscal period with the result that if Oilco otherwise qualifies under the flow-through share provisions, it will then have resource expenses available to renounce to its flow-through share investors.

RULINGS' COMMENTS

Subparagraphs 66.1(6)(a)(iv) and 66.2(5)(a)(iv) of the Act include in the definitions of CEE and CDE a taxpayer's share of those expenses incurred by a partnership, if at the end of the fiscal period of the partnership the taxpayer was a member thereof.

It is our position that CEE and CDE incurred by a partnership are considered to be incurred by a partner, to the extent of his share thereof at the end of the partnership's fiscal period.This administrative position permits the inclusion of such expenses in the partner's respective cumulative resource expenditure pools, which only include expenses "incurred" by a taxpayer.  In the absence of this position, no person would be able to include CEE and CDE incurred by a partnership in its pools and claim deductions in respect thereof, an obviously unintended result. The flow-through share rules are meant to apply in respect of resource expenditures incurred a flow-through share agreement is entered into.  This is, of course reflected in the definition of "flow-through share" in paragraph 66(15)(d.1) of the Act.  The use of a partnership for purposes of warehousing resource expenditures in the above situation would be offensive in policy terms. Accordingly, we are unable to confirm that the comments provided to you in, our March 22, 1988 letter apply. The comments were those of the officials who gave them and are not to be considered binding on the Department.  Confirmation of the tax consequences of Proposed transactions will only be provided in response to a request for an advance income tax ruling applied for in accordance with Information Circular 70-6R.

As there is no technical basis for your position (i.e. it rests on stretching our administrative position, noted above), we advise our position that expenses incurred by a partnership are considered to be incurred by a partner, to the extent of his share thereof at the end of the partnership's fiscal period, is limited to the inclusion of such expenses in the partners cumulative resource expenditure pools only.

Section 245 of the Act would not apply in the above situation as the transactions in question do not comply with the provisions of the Act.

Yours truly

Section ChiefResource Industries SectionBilingual Services and Resource Industries DivisionRulings Directorate