5 June 1990 Ruling 90M06451 F - 1990 Round Table Questions

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)

Please find enclosed copies of the 1990 Roundtable questions and answers with attached issue sheets where applicable which are not for general release.

Twenty nine questions and answers in total are enclosed herewith, viz. 1-4, 6, 8-16, 22-28, 34-37 and 39-41.  Questions 5, 20 and 32 for which Rulings was responsible for will not be answered.

Copies of Rulings' questions and answers are available upon written request to the  24(1)

ChiefResource Industries SectionBilingual Services and Resource Industries DivisionRulings Directorate

Enclosures

Question 1

A partnership is not entitled to claim a deduction for earned depletion.  Rather, an earned depletion base arising out of partnership activities and any earned depletion deduction is calculated directly at the partner level.

If a partnership disposes of assets, the acquisition of which gave rise to an increase in the partners' earned depletion bases, is it only those partners who acquired an earned depletion base, as a result of having been members of the partnership at the time the assets were acquired, that are subject to the depletion recapture provision in paragraph 59(3.3)(b)?

Answer

Paragraph 59(3.3)(b) would not apply to the partners but to the partnership.

Notwithstanding Regulation 1206(3) which is relevant to a partner's computation of earned depletion base, the partnership would include the cost of depreciable property as provided in Regulation 1205(1) in its computation thereunder of its earned depletion base.  The partnership would not however be permitted to claim a deduction in respect of its earned depletion base under subsection 65(1) by virtue of paragraph 96(1)(d).

Upon disposition of depreciable property, the capital cost of which was added in computing the earned depletion base of the partnership, paragraph 59(3.3)(b) would apply so that the partnership would be required to include the amount computed thereunder in the income of the partnership.

Question 2

We understand that Revenue Canada will not accord parties to a farm-in agreement the favourable treatment available under paragraph 11 of Interpretation Bulletin IT-125R3 where the farmee earns an interest in a producing resource property not related to the property on which the farmee incurs resource expenses (a "widespread farm-in").  If a farmee did earn an interest in a non-producing property on which it incurs resource expenses but simultaneously acquired the right to subsequently exchange all of the interest so earned for an interest in unrelated producing properties, might farm-in treatment be denied on the original farm-in on the basis that the farmee indirectly achieved a widespread farm-in?

Answer

As noted in the answer to Revenue Canada Roundtable question 11, printed in the Fall 1988 edition of the Canadian Petroleum Tax Journal, Revenue Canada does not extend its farm-in treatment available under paragraph 11 of IT-125R3, to widespread farm-ins where an interest in a producing resource property is received by a farmee in addition to or in lieu of an interest in the specific property being developed or explored.

The Department would consider denying its farm-in treatment available under paragraph 11 of IT-125R3 and applying paragraphs 66(12.1)(a) and (b) of the Act where a farmee earns an interest in a non-producing property on which it incurred resource expenses, and simultaneously acquires the right to subsequently exchange all of the interest so earned for an interest in unrelated producing properties.

Question 3

Where a farmee only has sufficient funds to incur Canadian exploration expense ("CEE") necessary to earn an interest in the farm-out lands so that the farmor incurs all costs of equipping the well and other tangible costs, and the farmee therefore earns a smaller interest than it otherwise would have, we understand that Revenue Canada will allow the farmee to claim all of the CEE and the farmor to claim the original Canadian oil and gas property expense ("COGPE") incurred in acquiring the interest and undepreciated capital cost representing the tangible costs.  Is this correct even though it appears a technical argument may be made that in earning a smaller interest in the farm-out lands, the farmee has exchanged an interest in its resource property for an interest in the tangibles and should recognize the associated tax consequences?

Answer

The Department considers there to be a widespread farm-out when in incurring CEE to earn an interest in a farmor's non-producing resource property the farmee also receives an interest in depreciable property previously acquired by the farmor.  These instances would have the following tax consequences:

1.       The farmor will have nil proceeds of disposition and the farmee will have a nil acquisition cost for the interest earned in the resource property by the farmee,

2.     The farmor will be considered to have disposed of depreciable property and the farmee will have an acquisition cost of those depreciables equal to the fair market value of the interest earned in the depreciables by the farmee, and

3.     The farmee will be considered to have an amount receivable, for the purpose of paragraph 66(12.1)(a) of the Act, equal to the fair market value of its interest in the depreciables received from the farmor.

Question 4

A taxpayer transfers a recently acquired Canadian resource property ("CRP") as its capital contribution to a partnership of which there is one other partner.  The partnership agreement provides that the percentage of income allocated to the  contributing partner is small over the first few years but subsequently is much higher; the converse would apply to the other partner.  It appears arguable that both partnership interests may constitute carved-out properties because if the CRP were held directly by the particular partner, there would be a substantial reduction in that partner's interest in income attributable to the CRP within 10 years of the time that partner acquired the CRP.  Is there any administrative policy which would preclude carve-out tax from being levied on each partner in this situation?

Answer

In order to be carved-out property the property must either be a Canadian resource property where any of the circumstances in subparagraphs 209(1)(a)(i) to (iv) of the definition of carved-out property exist, or it must be an interest in a partnership or trust where the circumstances described in paragraph 209(1)(b) of that definition exist.

In the above scenario, the partnership interests would not be Canadian resource properties and therefore the provisions of paragraph 209(1)(a) of the definition of carved-out property would not apply.

Whether it is reasonable to consider that one of the main reasons for the existence of the partnership interests, described above, is to reduce or postpone Part XII.1 tax, such that paragraph 209(1)(b) of the definition of carved-out property applies, is a question of fact.  Each case would have to be reviewed on its own merits.

Question 6

Oilco is a publicly traded company that has outstanding debt in the amount of $10 million.  Oilco is experiencing financial difficulty.  Oilco enters into an agreement whereby its creditors agree to exchange their debt for common shares of Oilco.  At the time this agreement is entered into the trading price of Oilco common shares is $2.00/share.  Pursuant to the agreement each creditor will receive the number of common shares equal to the principal amount of their debt, divided by $2.00.  Two months later the exchange of debt for equity takes place, (following shareholder approval) however, the trading value of Oilco common shares on that date has declined to $1.00 by virtue of the fact that Oilco has publicly announced that it is experiencing cash flow difficulties and has entered into an agreement with its creditors.

Does Section 80 apply on the exchange of debt for shares?

Answer

Yes.  No "payment" or extinguishment or settlement of the debt takes place before closing.  The parties may avoid the problem by agreeing to issue sufficient shares which will, on closing, have a value equal to the then principal amount the debt.

Question 8

Does Revenue Canada accept the decision of the Federal Court -Trial Division in John F. Ward v. Her Majesty the Queen, 88 DTC 6212 as establishing that the only valid "at-risk" rules are those contained in subsections 96(2.2) to (2.7), inclusive, of the Act?  If so, is an express disclaimer of the intention to create a partnership sufficient to establish that a given business organization is a joint venture or some form of co-ownership other than a partnership.

Answer

While Revenue has discontinued its appeal in the Ward matter, it is continuing with its appeal to the Federal Court of Appeal from the decision in Signum Communications Inc. v. The Queen, 88 DTC 6427.  As in Ward, the Signum matter antedates the rules in subsections 96(2.2) to (2.7) inclusive.  Once the Signum matter has been decided, we will be in a better position to comment.  Obviously, certain arguments in Signum could be applied to members of joint ventures where the joint ventures are not fully at risk.

With respect to the second question a disclaimer of partnership, by itself, hardly seems determinate of the nature of the business organization as indicated in Woodlin Development Ltd. v. Minister of National Revenue, 86 CTC 2188, an arrangement which in and of itself constitutes a partnership cannot be negated simply by making a statement to that effect in a written agreement.

Question 9

If an issuer of flow-through shares fails to spend and renounce the whole of the subscription price for the flow-through shares on qualifying expenditures, it is common to provide under the subscription agreement that the issuer must refund the unspent proceeds and/or pay damages to the subscriber in respect of the failure to provide the expected tax deductions.  Will such provisions cause the shares to be "prescribed shares" having particular regard to paragraph 6202.1(1)(c) of the Income Tax Regulations (the "Regulations")?

Answer

Provided the issuer agrees to pay damages to the subscriber only to the extent of any additional tax payable by the subscriber as a consequence of a reduction, pursuant to subsection 66(12.73) of the Income Tax Act, of the expected tax deductions, it is our view that such an indemnity would not cause any issued shares to be "prescribed shares" within the meaning of section 6202.1 of the Regulations.

It is also our view that where no shares have been issued in respect of any unspent proceeds, the issuer agrees to refund such proceeds to the subscribers, and the price of any shares subsequently issued will not be reduced because of the refund, such an indemnity would not cause the prescribed share rules to apply.

Question 10

Will the Department seek to apply subsection 103(1) of the Act to the allocation of gains and losses of a partnership in the following circumstances?

(a)     The partnership agreement provides for two different classes of units (A and B);

(b)     Under the partnership agreement, all losses and income are to be allocated to partners pro rata in accordance with their capital contributions; and

(c)     The partnership agreement provides that in year one, all losses and income will be allocated firstly to the Class A partners up to their capital contribution with the balance, if any, allocable to Class a units and that in year two, all losses and income will be allocated to Class a partners up to their capital contribution with the balance, if any, allocable to the Class A units.  Thereafter, losses and income will be ratably allocated among all units.

Answer

It is difficult to give a specific reply to this enquiry because the question of whether a particular allocation would result in the application of subsection 103(1) of the Act would depend on the circumstances of each particular situation. Generally, partnership agreements provide for the sharing of profits and losses on the same basis from year to year.  Any deviation from this pattern, as in the above noted example, should be supported by valid reasons.  Where the principal reason for the agreed upon allocation may reasonably be considered to be a reduction or postponement of the tax that might otherwise have been or become payable under the Act, the Department would seek to apply the provisions of subsection 103(1) of the Act.

Question 11

What is the Department's view regarding Canadian exploration expenses ("CEE") that have been renounced to a "shareholder corporation" by a joint exploration corporation ("JEC") and then renounced by the shareholder corporation under the terms of either the flow-through share or JEC provisions of the Act?

Answer

Paragraph 66(10.1)(c) deems a shareholder corporation to have incurred expenses only for purposes of the CEE and cumulative CEE definitions, and for no other purpose.  Accordingly, it is the Department's position that a subsequent renunciation by a shareholder corporation under either the JEC or flow-through share provisions of the Act of CEE renounced to it under paragraph 66(10.1)(c) is not technically available, as the preambles of both subsections 66(10.1) and 66(12.6) require the expenses to have been incurred by the party making the renunciation.  Clearly, the expenses renounced by the JEC have not factually been so incurred by the shareholder corporation, and, equally clearly, the JEC provisions do not deem the expenses to have been incurred by the shareholder corporation for either of subsections 66(10.1) or 66(12.6).

Question 12

If a Canadian corporation enters into an oil and gas production sharing contract in a foreign country and the country has no income taxes but a very high royalty rate on the production (i.e. 85%), will Revenue Canada accept a portion of the royalty as foreign income taxes paid for the purposes of computing the foreign tax credit?

Answer

No.  In our view, a royalty on oil and gas production paid to a foreign government pursuant to an oil and gas production sharing contract would not constitute a tax for purposes of the foreign tax credit computed under section 126.  Paragraph 8 of Interpretation Bulletin IT-270R states that payments of resource royalties do not qualify as payments of a "tax".

Question 13

A principal business corporation ("PBC") enters into an arrangement with a government whereby the government "lends" a million barrels of crude oil to the PBC, repayable by a million barrels of oil to be produced from a particular project, and with recourse limited to that project.  The PBC immediately sells the oil and uses the funds for capital expenditures on the project.

(a)     Does paragraph 12(1)(x) apply to include any or all of the loan proceeds in the income of the PBC?

(b)     For tax purposes, does the loan itself or its limited recourse feature "grind" the capital expenditures on the project?

(c)     What are the tax consequences of the loan and of its repayment to the PBC?

Answer

13. (a) and (b)

The answer to these questions would depend on the circumstances. If there is a specific fact situation which is of concern, the Resource Industries Section of Rulings would be pleased to examine a ruling request on the matter.

13. (c)

The matter seems no different in substance from gold loans, which were the subject of Question 22 at the 1989 Canadian Tax Foundation Revenue Canada Round Table.  Briefly, our views on such arrangements is that, on such an acquisition of a property which the borrower deals in, the borrower has purchased inventory at the then prevailing market price.  As the sale of the property is normally virtually contemporaneous with its acquisition, there should be minimal profit or loss on its disposition.

If the borrower satisfies the debt by delivery of its own production, it will, at that time, have resource income qualifying for inclusion in its resource profits under section 1204 of the Regulations based on the then fair market value of the property delivered.  The borrower will also most likely have a gain, or loss on the repayment of the debt, which gain or loss would be on ordinary income account but which would not enter into the computation of resource profits under section 1204 of the Regulations.  As well, in our opinion, any liability under the loan arrangement outstanding at year end should be determined and any accrued gain or loss of the borrower taken into account in determining its profit or loss for that taxation year.  This situation is analogous to situations involving foreign currency conversions.

Question 14

Interest, currency and commodity swaps are becoming more common in the petroleum industry.  We have a series of questions which can best be posed by way of an example.

In 1988 Oilco secured a loan from a Canadian Bank in the amount of $1,000,000.  The loan has since been used for a variety of purposes including the purchase of resource properties, exploration and development costs and the purchase of tangible capital property.  Interest on the loan is at prime plus 1%.

On January, 1990 anticipating rising interest rates, a rising Canadian dollar and falling oil prices, Oilco entered into the following transactions.

(a)     Oilco swapped its floating rate obligation for a fixed rate obligation with Bank A;

(b)     Oilco swapped its obligation to repay Canadian dollars under the loan for an obligation to pay U.S. dollars with Bank B;

(c)     Oilco committed to deliver 100,000 barrels of oil in December, 1990 in return for a promise from Bank C to pay for that oil in December 1990 at a fixed January, 1990 price.

All three contacts contain a set-off provision to the effect that a single payment is to be made at the end of 1990 by whichever party, on a net basis, owes the other money.  It is now December 31, 1990 and the economic results of the three contracts are as follows:

(a)     Interest rates went up; as a result Bank A made a $20,000 payment to Oilco (being the difference between the fixed and floating interest on the loan for 1990)?

(b)     The Canadian dollar went down; as a result Oilco made a $25,000 payment to Back B (being the difference between, the U.S. dollar value of the loan principal on January 1, 1990 and December 31, 1990); and

(c)     Oil prices went up; as a result Oilco made a $15,000 payment to Bank C (being the difference between the price of 100,000 barrels of oil on January 1, 1990 and the price on December 31, 1990).

How will the receipt in (a) and the payments in (b) and (c) be treated for tax purposes to Oilco?

Answer

At the 1988 Canadian Tax Foundation, we were unable to respond to general questions on hedging transactions as a study of such matters had then just begun.  Although much progress has been made, the study is not yet complete, and, as such, we cannot comment on such matters in the abstract.  If you have a specific situation, which concerns you, you may wish to submit it, together with applicable documentation, and your views as to the tax results, and the reasons there for, to Revenue Canada, Taxation, Financial Institutions Section, Rulings Directorate, Ottawa, Ontario K1A 0L8.

Question 15

A well was drilled by Drillco in February 1989.  It will be abandoned no later than June 30, 1990.  Therefore, the expenditures incurred on the well in 1989 should be considered Canadian exploration expense ("CEE").  Will those costs be eligible for the 60 day "clawback" rule contained in subsection 66(12.66), so that they constitute CEE which could be transferred to and claimed by holders of flow-through shares in 1988?

Answer

In order for the so-called 60 day "clawback" rule to apply in the above situation, the following requirements must be adhered to:

1)     the CEE must be incurred by Drillco within 60 days after the end of the calendar year (March 1, 1989);

2)     the CEE must be an expense described in subparagraph 66.1(6)(a)(i), (ii.1) or (iii);

3)     before the end of the 1988 calendar year, a flow-through share agreement providing for the flow-through of CEE was entered into between Drillco and a person, and the person paid the consideration for the flow-through shares in money before that time;

4)     Drillco and the person must deal with each other at arm's length throughout the 60 days; and

5)     Drillco renounces the CEE to the person in accordance with subsection 66(12.6) of the Act within 90 days after the end of the calendar year, i.e. by March 31, 1989.

It is the status of a well which determines whether the costs incurred in drilling an oil and gas well are classified as CEE or Canadian development expense, and in order to be able to renounce a resource expense, the classification of that expense must be determined no latter than the time of the renunciation.  Therefore, where the well is abandoned within 90 days after the end of the year, the corporation may renounce an amount in respect of CEE to holders of flow-through shares in accordance with subsection 66(12.6) of the Act and the effective date of the renunciation will be the last day of the year.

Question 15

A junior mining company incurs significant financing expenses in issuing flow-through shares.  Are the issue expenses restricted to a five-year write-off under paragraph 20(1)(e) of the Income Tax Act (the "Act") or is the junior mining company able to write off the issue expenses as CEDOE (defined in Regulation 1206(1)) completely in the year?

Answer

Under Regulation 1206(1), CEDOE of a taxpayer means a Canadian exploration expense ("CEE") or a Canadian development expense ("CDE") of the taxpayer made or incurred after 1980 that was, inter alia, in respect of financing of the taxpayer.

CEE and CDE are defined in paragraphs 66.1(6)(a) and 66.2(5)(a) of the Act, respectively.  These definitions do not provide for expenses incurred for the purpose of issuing flow-through shares. Consequently, these expenses would not qualify for treatment as CEE or CDE, thereby being precluded from treatment as CEDOE.

We agree however that the expenses incurred in issuing flow-through shares would be deductible as provided under paragraph 20(1)(e) of the Act.

Question 16

(a)     Bill C-62 contains certain proposed consequential amendments to the Act as a result of the Goods and Services Tax.  Among those amendments is one to subparagraph 2(1)(x)(iv), by which that provision will refer to an "outlay or expense" rather than an "expense" as it now does.  Does this amendment require the inclusion in income of receipts such as the Alberta Royalty Tax Credit ("ARTC") which are related to non-deductible outlays?

(b)     Another consequential amendment proposed by Bill C-62 is the addition of subsection 12(2.2).  This provision will enable a taxpayer to elect to net reimbursements with the outlays and expenses to which they relate, provided that the outlays or expenses were incurred within a given period of the reimbursement, in determining the income inclusion under paragraph 12(1)(x).  Since a reimbursement seemingly cannot, by definition, exceed the outlay or expense to which it relates, will an election pursuant to subsection 12(2.2), assuming it is filed on time and that the reimbursement relates to outlays or expenses, incurred within the time frame set out in subsection 12(2.2), eliminate any such income inclusion?

Answer

(a)     Even prior to the proposed amendment, the application of subparagraph 12(1)(x)(iv) was not, in our view, limited to reimbursements of deductible costs, as the provision referred to "expenses" rather than, say, "expenses deductible in computing the taxpayer's income for tax purposes".  The amendment does broaden the application of the provision somewhat, as, clearly, there are outlays which are not expenses, but does not broaden it as the question suggests.

          In any event, in most, but not all instances, ARTC payments would not be included in income under paragraph 12(1)(x). Alberta Crown royalties are imposed under the Mines and Minerals Act (Alberta) and the Freehold Mineral Rights Tax Act (Alberta).  The former Act reserves a royalty to the Province.  As such, the Crown royalties would be income of the taxpayer under paragraph 12(1)(o) of the Income Tax Act. Crown royalties in respect of freeholds are, in our view, expenses, albeit ones not deductible by virtue of paragraph 18(1)(m) of the Act.  As such, their reimbursement would result in the application of subparagraph 12(1)(x)(iv) of the Act.

b)      Yes.

Question 22

What is Revenue Canada's position with respect to:

(a)     multiple designations under paragraph 55(5)(f); and

(b)     designations under paragraph 55(5)(f) which are expressed as a formula rather than as an amount (for example, safe income/total dividends)?

Department's Position

(a)     The Department's Position with respect to multiple designations under paragraph 55(5)(f) was described by Robert J.L. Read at the 1988 Annual Tax Conference of the Canadian Tax Foundation as follows:

     Paragraph 55(5)(f) entitles a corporation that is a recipient of a dividend to designate a portion of the dividend received to be a separate taxable dividend. This provision was enacted to allow a taxpayer uncertain about the amount of safe income on hand, with respect to the shares on which dividends were received, to reduce the amount of a dividend that might be subject to subsection 55(2).

     A description of (the Department's) practice with respect to such designations was announced in (the paper delivered by John R. Robertson at the 1981 Annual Tax Conference of the Canadian Tax Foundation).  A procedure for taking advantage of this practice was explained in (the paper delivered by Michael A. Hiltz at the 1984 Corporate Management Tax Conference).  The comments in both papers are consistent with our fundamental view that the ability to make a designation under paragraphs 55(5)(f) does not relieve the dividend recipient of the onus imposed by the self-assessment system to report as a gain its best estimate of the amount of the dividend in excess of safe income.

     Favourable advance rulings have been provided by (the Department) in cases in which a corporation has proposed, within reasonable limits, to make more than one paragraph 55(5)(f) designation at the time a return is filed, provided that the description of the proposed transactions in the advance ruling application was accompanied by an explanation of the specific uncertain elements in the calculation of safe income on hand that resulted in the need for more than one designation.

(b)     In our view, the wording of paragraph 55(5)(f) does not allow for the use of a formula, rather than an amount, in the designation of a separate taxable dividend.

Question 23

Assume that a corporation with safe income of $100 has one shareholder whose shares, all being of the same class, have an accrued gain of $200.  If the redemption of one-half of his shares results in a deemed dividend of $100, why can such dividend not be considered to have been paid out of the safe income for the purposes of subsection 55(2)?

Department's position

The question for determination is not whether there is sufficient safe income on hand in the corporation out of which to pay the dividend, but what portion of the safe income can reasonably be said to have contributed to the capital gain that, but for the dividend, would have been realized on a sale of the shares at fair market value (the "inherent gain").  In this example, the shares being redeemed have an inherent gain of $100 which would be attributable in part to the safe income on hand and in part to something else.  In our view, given that all of the shares are identical, it would be unreasonable to conclude that the $100 gain inherent in the shares being redeemed is wholly attributable to the $100 of safe income and that the $100 gain inherent in the remaining shares is attributable to something other than the safe income.

Question 24

Paragraph 55(5)(f) permits a taxpayer to designate a portion of a taxable dividend as a separate dividend in order to minimize the risk of a deemed capital gain in lieu of the dividend where the dividend exceeds "safe income".  Why will Revenue Canada, Taxation not accept a late-filed paragraph 55(5)(f) designation?

Department's Position

Paragraph 55(5)(f) provides that a corporation which has received a dividend may make a designation under that paragraph "... in its return of income under (Part I of the Act) for the taxation year during which the dividend was received..."

The Act does not contain any provision which provides for the late-filing of such designations or for the filing of amended designations.

However, it is our practice to accept a designation under paragraph 55(5)(f) which is filed before the time has expired for filing a notice of objection in respect of the initial assessment for the year in which the dividend is received.

It should be recognized, however, that the ability to make a paragraph 55(5)(f) designation does not relieve the taxpayer of the onus imposed by section 151 of the Act of estimating in his return of income the amount of tax payable, and accordingly, the amount of any dividend which is deemed to be a capital gain as a result of the application of subsection 55(2).

Question 25

Revenue Canada takes the position that the costs of refinancing existing debt with the original creditor is an eligible capital expenditure.

What is the basis for this position?

Why are the costs not deductible under Paragraph 20(1)(e)?

Would Revenue Canada's position be the same if the taxpayer refinanced at a different institution?

Answer

Because of the complexity of the problem and the lack of time to research it, we are not prepared to answer.  We would suggest that a written opinion be requested.

Question 26

Generally, an investment will be a "tax shelter" if the aggregate of deductible losses plus other deductible amounts exceed the cost of the investment within four years of being acquired.

This definition appears to be flawed in that it appears to aggregate deductible expenses even if taxable income is generated by the investment.

For example, if an investment costing $50 generates net income of $40, composed of $100 gross revenue less $60 of deductible expenses, the amounts aggregated under paragraph 237.1(1)(a) would be:

which exceeds the cost of the investment of $50.  The definition would find the investment to be a tax shelter, even though the investor realized $40 of net income.

-      Does Revenue Canada agree with the above interpretation?

-      Is this the intended result?

-      If this was not the intent, are any steps being taken to amend the definition or administer the law differently?

Answer

In determining whether a property is a tax shelter for the purposes of section 237.1 of the Act, the calculation of deductible losses and other deductible amounts is to be made on a prospective basis based upon statements or representations made or proposed to be made in connection with that property.

Therefore, in the above example, the actual $60 of deductible expenses would not be the determinative factor as to whether the property is or is not a tax shelter.

If it may reasonably be considered, having regard to the statements and representations made or proposed to be made in connection with the property, that a purchaser will be entitled to deduct losses or other amounts in the four years following the acquisition in excess of the cost of the interest in the property to the purchaser in any such year after the deduction of prescribed benefits, then the property is a tax shelter.

It is our understanding that the amount of loss represented to be deductible for the purposes of subparagraph 237.1(1)(a)(i) of the Act at the definition of tax shelter includes capital losses, non-capital losses and allowable business investment losses. Subparagraph 237.1(1)(a)(ii) would include such amounts as a joint venture investor's share of capital cost allowance and in the case of a partnership, interest expenses, carrying charges and certain resource deductions not claimable at the partnership level.

Question 27

The recently proposed Large Corporations Tax will be applied on the taxable capital of a company to the extent it exceeds its capital deduction for the year.  The capital deduction for the year is established to be $10 million, presumably to exclude the smaller corporations in the country.  However, pursuant to section 181.5, this capital deduction of $10 million must be allocated among all "related corporations".

The allocation among "related corporations" is very broad and will produce some harsh results for those families who have diverse business interests.

For example, there are many family businesses where a grandfather maintains an investment company for his own use, the father would have his own operating group of companies, and perhaps other brothers and sisters of father would have their own business ventures incorporated which are totally separate and distinct from either grandfather's investment company or brother's/sister's operating companies.

In many situations, not only are these companies clearly not associated, but there is little sharing of financial information among the relatives.

It would appear that the requirement to allocate the $10 million capital deduction among "related corporations" is much too broad and in many cases, would be impractical to apply.

It may be preferable to provide a more restrictive allocation, for example, among "associated corporations" where all the required financial information can be readily available in order to allocate the capital deductions.

Is it the government's intention to force all related companies, regardless of their inter-connection of business interests, to come to an agreement on how to allocate the capital deduction, or is it possible that a more reasonable middle ground could be reached by ensuring all associated corporations must allocate the deduction?

In view of the fact the associated corporation rules have been significantly tightened-up to minimize any abuses of the past, it would seem these rules would be sufficient to meet the fiscal aims of the government in imposing a large corporations tax.

Please comment on these concerns and whether any amendments to this provision may be forthcoming.

Answer

The new Part 1.3 tax (otherwise known as the large corporations tax) as announced in the April 27, 1989 Budget has not yet been enacted and is presently being reviewed by a Senate Committee.

We are not aware of any proposal to change the reference in draft section 181.5 from "related to another corporation" to read "associated with another corporation".  Further questions in this regard should be directed to the Department of Finance, whose responsibility it is for the drafting of the law.

Since Part 1.3 is new draft legislation, it is too early for us to comment on how the provision will be administered in its final form.

Question 28

The obligations under a "Take or Pay" contract are reported as deferred revenue by most companies.  For income tax purposes they are considered to be income subject to a reasonable reserve for goods to be delivered after the end of the year.

The wording in subsection 181.2(3) is very broad.  Sufficiently broad to either include or exclude the Take or Pay amount in the definition of "Capital of the Corporation".

What is Revenue Canada's view of Take or Pay obligations for purposes of the large corporations capital tax?

Answer

The new large corporations tax (Part 1.3 Tax) has not yet become law and is presently being reviewed by a Senate Committee.

It is our understanding that Finance intended "taxable capital", as defined in draft subsection 181.2(2) of the Act, to include funds available for use by a particular corporation.

The receipt of an amount of income under a take-or-pay contract would appear to fit this criteria for inclusion therein. However, as this matter is presently under consideration by our Department, we are unable to comment further at this time.

Question 34

In computing profit, gain or income for Canadian income tax purposes and for the purposes of Article XIII(8) of the 1980 Canada-U.S. Income Tax Convention (the "Convention"), where alienation of property occurs in a situation where further property otherwise qualifying as "replacement property" was acquired, is the vendor required to avail himself of the replacement of property election to reduce his profit, gain or income prior to determining the amount for purposes of section 115.1 tax relief?

Answer

In the above situation, assuming that Article XIII(8) of the Convention applies, the amount of gain or income for purposes of section 115.1 of the Income Tax Act (the "Act") would be the amount that the vendor, the purchaser and the Minister have agreed on in respect of the disposition of the property pursuant to Article XIII(8) of the Convention.  For the purposes of Article XIII(8), the profit, gain or income would be the amount otherwise determined for Canadian income tax purposes.

In otherwise determining the taxpayer's gain or income for Canadian income tax purposes, the taxpayer may choose whether or not to elect to reduce the resulting gain or income from disposition of the property using the replacement property rules in subsections 13(4), 14(6) and 44(1) of the Act.  If he so chooses to elect to reduce his gain or income for Canadian income tax purposes, it is the reduced amount that would be relevant for purposes of Article XIII(8) of the Convention.

Question 35

Subsections 69(11), 69(12) and 69(13) are very broadly worded. Furthermore, the dual tests of "fair market value" and "main purpose to obtain a benefit from an unrelated person" coupled with "a disposition to have occurred within three years of the commencement of the series of transactions", cast a multitudinous array of transactions into the purview of the anti-avoidance provision.  Rather than deem the transaction to have occurred at fair market value retroactively, would it not be more appropriate to adjust the "benefits" found so abusive by Revenue Canada, Taxation similar to the operation of Section 245 of the Act.

Answer

A question dealing with the intention of a provision is more appropriately raised with the Department of Finance which is responsible for such matters.

Question 36

The question relates to the mechanics of the application of GAAR. As noted by a Revenue Canada official at a Canadian Petroleum Tax Society luncheon, GAAR would apply to certain ephemeral in-house transfers of property designed to make a successor election technically available, and might apply to in-house transfers designed for such purposes where the transfer is not temporary. In instances in which such property transfers take place, would GAAR be applied solely to deny the transfer of the resource pools to the purchaser, or would it also be applied to make the in-house property transfers, which originally took place on a tax-deferred basis, taxable events?

Answer

The recharacterization of transactions on applying GAAR to a particular situation would depend on the facts of that situation. That noted, we would think that, in situations in which the only "misuse or abuse" of the legislative provisions related to the successor election, GAAR would most likely be applied solely to deny the transfer of the resource pools.  The resource pools would returned to their transferor.

Question 37

Article XIII of the Canada-U.S. Income Tax Convention (1980) (the "Convention") provides a transitional relief provision regarding certain capital assets described therein.  At the time the 1942 Canada-U.S. Income Tax Convention was put into force, what we now know as Canadian resource properties were viewed as capital property.  In the interim certain definitions and tax treatment regarding what we now know as Canadian resource property have been introduced into the Income Tax Act.  Canadian resource properties are now viewed as something other than capital assets.  In interpreting and applying Article XIII, paragraph 9 of the Convention, will Revenue Canada afford Canadian resource property held by U.S. persons the fresh start transitional relief rules contained in Article XIII, paragraph 9 of the Convention?

Answer

Paragraph 9 of Article XIII of the Convention may be applied by a U.S. resident to the disposition of those resource properties which would have been exempt from capital gains tax under Article VIII of the 1942 Canada-U.S. Income Tax Convention, i.e. as a result of the U.S. resident not having a permanent establishment in Canada, provided that such properties are not excluded by virtue of paragraphs 9(c), (d) and (e) of Article XIII of the Convention.

Question 39

Revenue Canada has stated that it considers that the appropriate measure of "all or substantially all" (i.e. 90%) is the fair market value of the property.  For this purpose, is a value to be ascribed the resource pools in determining if "all or substantially all" has been sold within the context of the successoring provisions of the Act?

Answer

Paragraph 66.7(7)(b) of the Act, dealing with successor elections for Canadian exploration and development expenses, Canadian exploration expenses, Canadian development expenses and Canadian oil and gas property expenses requires the vendor to have acquired all or substantially, all of the Canadian resource properties of the vendor.  Similarly, paragraph 66.7(8)(b), dealing with successor elections for foreign exploration and development expenses requires the acquisition of all or substantially all of the vendor's foreign resource properties.

Since resource pools are neither Canadian resource properties nor foreign resource properties, no value need be assigned to them for these purposes.

Question 40

If a U.S. citizen invested $1 million in U.S. oil and gas drilling expenses and subsequently receives $1 million in production income, for U.S. tax purposes he will shelter his production income with the drilling expenses and any future production income will be unsheltered.  He now moves to Canada becoming resident in Canada receiving further production income. Subsection 48(3) of the Act provides that where a taxpayer becomes resident in Canada he shall be deemed to have acquired at the particular time at fair market value each property owned by him at that time, other than the property which would be construed to be taxable Canadian property if he had disposed of it immediately before the particular time or property that was other property in respect of which the taxpayer had previously made an election to defer payment of tax on it under a previous departure from Canada.  Paragraph 66(15)(e) defines foreign exploration and development expenses to include the ".... cost to him of any foreign resource property acquired by him, ...".  Can Revenue Canada confirm that the interaction of subsection 48(3) and paragraph 66(15)(e) will provide the new Canadian taxpayer with a foreign exploration and development expenses ("FEDE") account equal to the fair value of that foreign production income interest at the date of commencement of residence in Canada?

Answer

As indicated in paragraph 2 of Interpretation Bulletin IT-451R, subsection 48(3) applies only for the purposes of subdivision c of Division B of the Income Tax Act.  Since the determination of a taxpayer's FEDE under paragraph 66(15)(e) is not contained in that subdivision, subsection 48(3) would not apply.

Our position with respect to FEDE incurred by a new Canadian taxpayer for the purposes of paragraph 66(15)(e) and subsection 66(4) is provided in our answer to question 15 of the l988 Revenue Canada Round Table, page 317, Canadian Petroleum Tax Journal, Fall 1988, i.e. that Oceanspan Carriers Ltd. v. MNR (87 DTC 5102) would support our position that there was no FEDE incurred by a taxpayer for the purposes of paragraph 66(15)(e) and subsection 66(4).  Therefore, in the above scenario the new resident of Canada would be precluded from a deduction for those expenses already claimed in the U.S.

Question 41

Where a taxpayer has elected pursuant to section 21 to include interest expense otherwise incurred as Canadian exploration expense ("CEE") and the interest remains unpaid at the end of the second taxation year following the year in which the interest was incurred, and the debt was owed to a non-arm's length party, will the action of section 78 apply?  If so, what effects if any, will the actions of section 78 have on the CEE pool?

Answer

Yes.  Subsection 78(1) of the Act refers to "an amount in respect a deductible outlay or expense".  The words "in respect of" are exceedingly broad, as noted by Mr. Justice Dickson in G.A. Nowegijick v. The Queen 83 DTC 5041, when he described the expression as "probably the widest of any expression intended to convey some connection between two related subject matters".  It seems to us that the amount is clearly "in respect of" a (presumably) deductible expense which became an amount not directly deductible only on the election being made.

Accordingly, if at the end of the second taxation year following the taxation year in which the interest was incurred the amount remains unpaid, paragraph 78(1)(a) of the Act requires the taxpayer to include the unpaid amount of such interest in his income for the third taxation year following the taxation year in which it was incurred.  The CEE pool will not be effected by the application of section 78.