29 October 1993 External T.I. 9300065 F - Income Derived From Royalties (4093-U5-100-12)

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.

Attention XXXXXXXXXX

Dear Sir:

RE:  Non-Resident Owned Investment Corporation ("NRO") Subparagraph 133(8)(d)(ii) of the Income Tax Act (the Act")

This is further to your request for a technical interpretation of whether income resulting from the sale of a petroleum or natural gas royalty would constitute "income...derived from...royalties" for the purposes of subparagraph 133(8)(d)(ii) of the Act.

You submit that such income would constitute income derived from royalties, and you indicate that the jurisprudence indicates that the phrase "derived from" should be given a broad interpretation. In your view the word "derived" can be taken to mean "arising or accruing".

Our Comments:

We agree that the word "derived" is broader than the word "received". And we accept the reasoning of the jurisprudence cited in your letter to the effect that derived from can be taken to mean "arising or accruing". We note that the Canada Tax Words and Phrases dictionary, states that

in a taxing Act words must be given their plain and ordinary meaning, and, accordingly to such meaning the word "derived" covers a wider field than the word "received", and when applied to the word "income" is connotes the source or origin of such income rather than the immediate receipt".

and in Murray's New English Dictionary, Volume 3. p. 230 as:

to flow, spring, issue, emanate, come, arise, originate, having its derivation from

and in the Shorter Oxford English Dictionary, Volume 1, as:

to draw, fetch, obtain;to come from something as its source

In addition to the jurisprudence cited by you, we have referred to the recent Federal Court of Appeal Decision in Westar Mining Ltd. v. HMQ 1992 DTC 6358 concerning the meaning of the term "derived". In that case the court did not determine the meaning of the word "derived" in isolation, but rather it considered the scheme and intention behind the provisions in the Income Tax Act which contained incentives to economic activity.

Each incentive to economic activity incorporated by Parliament into the Income Tax Actseems to me very much a code unto itself; I do not think the intention expressed in one is very helpful to an understanding of the intention of another. That is particularly so when one is trying to understand what Parliament meant by a certain kind of "income" in the context of a provision and the definition of the term in that provision bears little or no resemblance to the pertinent definition in the provision from which assistance is sought.

In our opinion to determine the meaning of "derived" in the context of S. 133(8)(d) we must first look to the intention behind the provision to determine what the meaning is of any particular term. The function of the NRO is to act as a conduit between its non-resident shareholders and its Canadian investment income. The intent of the NRO system of taxation is to allow a corporation which is owned by non-residents to elect a taxation system that would collect the same amount of tax as the non-resident individuals would pay if they made the same investments directly rather than through a corporation. This tax treatment is however subject to the "principal business test" in subsection 133(8)(d)(iv) which tends to restrict business activities and encourages investment as the main source of income for NRO's. .

Income derived from the sale of the royalty itself {which is a source of income} is derived from the disposition of the right. The above would, in our view, support the conclusion that any gains made on the disposition of the royalty itself (i.e. the right to obtain royalty payments) would not in fact be income derived from the royalties for the purposes of S. 133(8)(d)(ii) of the Act. In this regard we refer you to the reasoning in the Supreme Court decision in Frankel Corporation Ltd. v. M.N.R. 59 DTC 1161 which makes a distinction between income from a sale in a business and income made of a business. In our opinion this reasoning would be applicable in the fact situation posed by you.

In light of the interpretative guidance in the Westar decision, it appears clear that "income" in the context of the NRO provisions would not in fact include the disposition of Royalty itself.

Yours truly,

for DirectorReorganizations and Foreign DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch