13 August 1990 External T.I. 58380 F - Renounced Resource Expenditures Incurred After Flow-through Share Agreement

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.

August 13, 1990

Dear Sirs:

We are writing in response to your letter dated July 18, 1989, concerning the proper tax treatment in the following hypothetical situation.  All references herein to statutory provisions relate to those respective provisions of the Income Tax Act.

1.         A corporation ("Oilco") is a "principal-business corporation" as defined in paragraph 66(15)(h).

2.         Oilco will form a "subsidiary wholly-owned corporation" as defined in subsection 248(1) ("Explorationco").  Explorationco will also be a "principal-business corporation" as defined in paragraph 66(15)(h).

3.         Oilco and Explorationco will enter into a flow-through share agreement as described in subsections 66(12.6), (12.62) and (12.64) pursuant to which Oilco will agree to subscribe for "flow-through shares" as defined in paragraph 66(15)(d.1) in Explorationco.

4.         Explorationco will incur Canadian exploration expense ("CEE") Canadian development expense ("CDE") and Canadian oil and gas property expense  ("COGPE") as defined in paragraphs 66.1(6)(a), 66.2(5)(a) and 66.4(5)(a), respectively.

5.         After Explorationco has incurred such CEE, CDE and COGPE, but prior to the renunciation of such CEE, CDE and COGPE by Explorationco, Oilco will enter into one or more flow-through share agreements as described in subsections 66(12.6), (12.62) and (12.64) pursuant to which it will issue "flow-through shares" as defined in paragraph 66(15)(d.1) to one or more persons (the "Investors").

6.         Explorationco will renounce such CEE, CDE and COGPE  to Oilco after the date of the agreement between Oilco and Explorationco, but within 24 months from the end of the month in which the agreement between Oilco and Explorationco is entered into.

7.         Oilco will renounce to the Investors the CEE renounced to it by Explorationco after the date of the agreement between Oilco and the Investors, but within 24 months from the end of the month in which the agreement between Oilco and the Investors is entered into.

You have asked us to confirm that for the purposes of subsections 66(12.6), (12.62) and (12.64) Revenue Canada will consider Oilco to have incurred CEE, CDE and COGPE in an amount equal to the CEE, CDE and COGPE renounced to it by Explorationco.  Further, you have requested confirmation that for the purposes of subsections 66(12.6), (12.62) and (12.64) Revenue Canada will consider the Investors to have incurred CEE, CDE and COGPE in an amount equal to the CEE, CDE and COGPE renounced to them by Oilco.

You have also requested confirmation that the general anti-avoidance rule contained in section 245 will not apply in this situation.  In particular, you asked us to confirm that where the principal purpose for using a related exploration corporation is to facilitate the desired timing of the incurring of CEE, CDE and COGPE for tax purposes by the Investors, section 245 will not apply.

Rulings' Comments

On July 13, 1990, the Department of Finance issued, by way of' press release, draft subsection 66(19) which reads as follows:    

     Notwithstanding subsections (12.6), (12.62) and (12.64), where at any time a corporation

(a)     would, but for this subsection, be entitled to renounce

(i)        all or part of its share of an outlay or expense made or incurred by a partnership of which the corporation is a member or former member at that time, or

(ii)       all or part of an amount renounced to the corporation under subsection (12.6), (12.62) or (12.64),

     under subsection (12.6), (12.62) or (12.64) to another person, and

(b)     would, if

(i)        the expression "end of that fiscal period" in subsection (18) were read as "time the outlay or expense was made or incurred by the partnership", and

(ii)       the expression "on the effective date of the renunciation" in each of paragraphs (12.61)(a), (12.63)(a) and (12.65)(a) were read as "at the earliest time that any part of such expense was incurred by the corporation",

     not be entitled to so renounce the amount described in subparagraph (a)(i) or (ii) to the other person,

     the corporation shall not be entitled to renounce such amount under subsection (12.6), (12.62) or (12.64), as the case may be, at that time to the other person.

The Explanatory Notes for draft subsection 66(19) that were also issued by Finance on July 13, 1990, state, inter alia:

     Subsections 66(12.6), (12.62) and (12.64) provide that only  expenditures incurred after the relevant flow-through share agreement is entered into may be renounced by a corporation.  However, where a corporation is ... a corporation in favour of  which a resource expenditure of another corporation is renounced under subsection 66(12.6), (12.62) or (12.64), the  rules in the Act generally delay the time at which renounced ... expenditures are considered to be incurred by the corporation.  As a consequence, subsections 66(12.6), (12.62)  and (12.64) may allow for the renunciation of expenditures originally incurred before the relevant flow-through share    agreement was entered into.

     Subsection 66(19) is introduced to limit renunciations by corporations under subsection 66(12.6), (12.62) and (12.64) to those that would have been effective had the Act provided for  no delay in the time at which ... a flow-through share subscriber is considered to incur the resource expenditures of the flow-through share corporation.  The rule thus prevents the "warehousing" of resource expenditures originally incurred before a flow-through share agreement is entered into for renunciation after the agreement is entered into.

     The introduction of subsection 66(19) is effective in respect of renunciations of expenditures incurred after Announcement Date, other than such expenditures incurred pursuant to an agreement in writing entered into before that time.

It is our view that draft subsection 66(19) was introduced to stop warehousing arrangements such as those described in your hypothetical situation.  If draft subsection 66(19) passes as proposed, Oilco will not be entitled to renounce to the Investors the resource expenses renounced to Oilco from Explorationco. This would be so because if the expression "on the effective date of the renunciation" in each of paragraphs 66(12.61)(a), (12.63)(a) and (12.65)(a) (collectively referred to as the "Provisions") were read as "at the earliest time that any part of these resource expenses were incurred by the corporation", then when Explorationco renounces its resource expenses to Oilco the Provisions would deem those resource expenses to have been incurred by Oilco at the earliest time that Explorationco incurred any part of those expenses.  This point in time would precede the date that Oilco and the Investors entered into their flow-through share agreement. Therefore, pursuant to the preambles in each of subsection 66(12.6), (12.62) and 12.64), Oilco would be precluded from renouncing those resource expenses to the Investors.

This being the case, draft 66(19) would provide that Oilco would not be entitled to renounce such amounts to the Investors under subsection 66(12.6), (12.62) or (12.64), as the case may be.

In light of the above, no additional comments concerning the possible application of section 245 in this hypothetical scenario are required.

The above comments are expressions of opinion only and as such are not to be construed as advance income tax rulings, nor are they binding on the Department.

Yours truly,

ChiefResource Industries SectionBilingual Services & ResourceIndustries DivisionRulings Directorate