19 September 1989 Ministerial Letter 89M09068 F - GAAR Application to Transfer of Mining Business to Set Up a "Successored" Sale to a Subsidiary

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.

Subject: 24(1)

Following the decision of the "GAAR" Committee that 24(1) proposal to transfer its mining business to a subsidiary to set up a "successored" sale of its oil and gas business to a subsidiary of 24(1) would be subject to GAAR 24(1) has requested that we examine a revised proposal, whereby the only major resource pool which would be transferred would be its earned depletion base.

Bearing in mind Finance's implicit suggestion in its July 12, 1989 letter (copy attached) that if 24(1) made a reasonable effort to apportion its pools between the mining and oil and gas businesses, Finance would not consider the successor election a misuse or abuse of the law, we are obliged to consider 24(1) proposal.

We asked 24(1) for a breakdown of the various resource pools by source (mining or oil and gas) so that we could attempt to determine whether this proposal represented an effort to make a reasonable allocation of the pools.  We then reconstructed each of the major pools, on the basis that its balance was made up of costs most recently incurred.  The pool balances supplied are as at December 31, 1988. and, as such are somewhat less than the balance referred to in 19(1) ruling request.  We did not request below seemed unaffected by any 1989 events other than prospective proceeds on the sale of the oil and gas properties.

The earned depletion base may be somewhat less valuable than the cumulative Canadian exploration expense pool and the cumulative Canadian development expense pool although both the successor election, which restricts the deductibility of the development pools to income from the properties transferred and the probable tax position of the purchaser complicate this matter.  In our view, the taxpayer should be able to demonstrate that the earned depletion base reasonably represents unexpired oil and gas expenditures virtually on a dollar for dollar basis for its proposal to be wholly acceptable.

We considered the appropriate analysis to be whether pool balances adjusted for the sale of the oil and gas properties contained sufficient oil and gas expenses to offset the fact that the earned depletion base, which would be successored, will consist about of mining costs.  Not adjusting the pool balances to take into account the sale seems inappropriate as it would ignore the largest transaction having an effect on pool balances, and would result in an effective double counting of certain of the oil and gas expenses - the expenses would be used both to shelter proceeds of disposition and,,to justify the transfer of the earned depletion base to 24(1) subsidiary.  As well the comparison would then include pool's or portions of pools,' which could not have been transferred under the successor rules.  Pool balances for the successor rules are determined after such proceeds are credited to the pools - to do otherwise would minimize the ability of a vendor having no tax pots other than the pools to shelter the income arising on the asset sale to make a successor election and duplicate the addition to the pools of the purchaser, which would have one addition to the appropriate pool on acquiring the property, and a second equal to the credit not made to the vendor's pools.

This in mind, we established the following:

24(1)

The amount reasonably allowable to the oil and gas expenses in the pools which might have been transferred is not much more than half of the amount of the earned depletion base.  As such it is exceedingly difficult to accept that the transfer of the earned depletion base alone represents a reasonable allocation of the pools between mining and oil and gas.

It may be noted that the cumulative Canadian development expense may contain some costs related to the acquisition of mining properties, and that while the mining properties have been sold, no credit to the pools has been made since the proceeds on that sale were minimal.  The result of allocating fair market value proceeds would be to reduce the pool balance - it could only reduce the amount of the pool, and that amount reasonably attributable to oil and gas operations.

As well, while 1989 additions to the pools of perhaps 24(1) have been ignored, even assuming all of the costs, other-than the 24(1) in earned depletion base, relate to the oil and gas operations, which is likely not the case (we would expect over half of the costs to relate to the mining activities) the result would be that 24(1) in pool balances related to oil and gas activities, while it is proposed to transfer 24(1) in earned depletion base.  Again, it does not seem that the numbers, even under the most generous assumptions, support that a reasonable allocation of pools is being made.

As such, we recommend that the taxpayer's most recent proposal be rejected.

Section ChiefResource Industries SectionBilingual Services and ResourceIndustries DivisionRulings Directorate