1 November 1991 Income Tax Severed Letter 91M11273 F - Prospectors and Grubstakers

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.

QUESTION

8.        What recent legislative changes, if any, have been made to the Income Tax Act in relation to prospectors and grubstakers?

ANSWER

8.        Since January 1982, there have been relatively few legislative changes in relation to the treatment of prospectors and grubstakers under the Act.

Consequential changes have been made to section 35 of the Act as a result of the introduction of the capital gains exemption. Section 35 deals with the treatment of shares of a mining corporation received by a prospector or grubstaker in exchange for transferring mining property to the corporation.

A summary of the rules pertaining to the treatment of such shares received by a prospector or grubstaker, who is assumed to be an individual, follows:

-     The individual would not have any income inclusion upon receipt of the shares. However, at the time of disposition or exchange of the shares, the individual would have two distinct income inclusions.

-     Firstly, he would be deemed to have an income inclusion of the lesser of the fair market value (FMV) of the shares at the time they were acquired by him and the FMV of the shares at the time of their disposition. He would also be entitled to a deduction equal to one- quarter of this amount pursuant to paragraph llO(l)(d.2). The ACB of the shares will be nil.

-     Secondly, where the FMV of the shares at the time of disposition exceed the FMV at the time of receipt of the shares, the excess will be included in the individual's income or capital gains, depending on the circumstances.  Where the gain is a capital gain, the cost of the shares, pursuant to subsection 52(1), will be equal to the amount determined above to be the first income inclusion.  A capital gains deduction may be available with respect to this capital gain.  Where the gain is on income account, the amount included in income on disposition of the shares will be the sale proceeds less the first income inclusion.

-     If the FMV of the shares are lower at the time of disposition than at the time of receipt, there is no loss recognized, capital or otherwise, nor need there be, because the first income inclusion is the lesser of the FMV of the shares at the time of receipt and at the time of disposition, so any decline in value of the shares will have been accounted for therein.

The following illustrates the rules currently in place.  Assume an individual prospector exchanged a mining property in 1987 with a corporation for shares of the corporation then worth $25,000.  He sold the shares in 1990 for $60,000.  To simplify the mathematics, there were no costs of selling the shares.

The first income inclusion is, then, $25,000, the lesser of the two amounts. A deduction of one-quarter of $25,000, or $6,250, may be claimed by the individual.

As the value of the shares at the time of their sale exceeded that at the time they were acquired, a second computation is required. Assuming the gain is a capital gain, the gain is the proceeds on sale of the shares, $60,000, less the cost of the shares, $25,000 (the first income inclusion) or $35,000. The capital gain included in his income will be three-quarters of $35,000, or $26,250.  Subject to the rules regarding the limit on the lifetime capital gains deduction, a capital gains deduction may be available with respect to the $26,250.

The overall result, before taking into account any capital gains deduction is a net income inclusion of $45,000 ($25,000-$6,250+$26,250) which is the result as though the $60.000 proceeds had been treated as a capital gain, three-quarters of which would be included in the individual's income.

Chapter 14(35) of our Taxation Operations Manual entitled "Audit Techniques Guidelines Relating to Prospectors and Grubstakers" contains general background information regarding prospectors and grubstakers.  There are two matters in the first subsection, 14(35)2.1(1), dealing with Income Tax Legislation which require comment.  Firstly, the reserve once available for unpaid amounts on the sale of mining property has been repealed.  Secondly, the statement that proceeds on the sale of shares received for mining property will be a capital gain may not always be correct. Such proceeds could be on account of income depending on the circumstances.