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.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
5-932536
XXXXXXXXXX Peter Lee
Attention: XXXXXXXXXX
February 4, 1994
Dear Sirs:
Re: Property Income v. Active Business Income
This is in reply to your letter of September 1, 1993, wherein you requested our opinion on whether a corporation's royalty income would be considered "income from a source that is property" or "income from an active business" for the purposes of subsection 129(4.1) and paragraph 125(7)(a) of the Income Tax Act (the "Act"). We apologize for the delay in replying to you.
Since the situation described in your letter appears to be related to a situation involving an actual taxpayer and actual transactions, we are unable to provide specific comments with respect to the income tax consequences arising as a result thereof. Opinions with respect to past transactions should be requested from the relevant District Office. However, we are providing the following general comments with regard to the issues raised in your letter which we hope will be useful to you.
In a hypothetical situation, a corporation whose principal business is farming owns certain rights to take petroleum, natural gas or related hydrocarbons from a well which is located on the farm-land of the corporation. The corporation leases such rights to an arm's length third party pursuant to an agreement in exchange for consideration consisting solely of royalty income to be received by the corporation and computed by reference to the amount of production of oil by the third party from the well. Such rights are considered "property" within the meaning assigned by the definition of the term under subsection 248(1) of the Act.
It is frequently stated in both the English and Canadian case law that there is in the case of a corporate taxpayer a presumption that income received from or generated by an activity done in pursuit of an object set out in the corporation's constituting documents is income from a business (by analogy, see the cases of Anderson Logging Co., (1925) S.C.R. 45, and M.R.T Investments Ltd., 75 DTC 5224 (FCTD), affirmed 76 DTC 6158 (FCA)). In England, this presumption appears to have been extended to corporations with a profit-making purpose and not just corporations whose precise objects are set out in their constituting documents (see the case of American Leaf Blending Co. v. Director-General of Inland Revenue, (1979) A.C. 676 (P.C.)). Nevertheless this presumption is a rebuttable one (by analogy, see the cases of Sutton Lumber and Trading Co., 53 DTC 1158 (SCC), and Burri, 85 DTC 5287 (FCTD)). Accordingly, it is our view that in this hypothetical situation and in many other situations, whether royalty income received by a corporation would be considered "income from a source that is property" or "income from an active business" within the meaning of the expressions under subsection 129(4.1) and paragraph 125(7)(a) of the Act, respectively, is always a question of fact to be determined from an examination of the corporation's whole course of conduct viewed in light of surrounding circumstances (by analogy, see the cases of Canadian Marconi Company, 86 DTC 6526 (SCC), and Cragg, 52 DTC 1004 (Ex. Ct.)). In making this determination, courts have examined the number of transactions, their volume, the frequency, the turnover of the investments and the nature of the investments themselves.
In the hypothetical situation at hand, if it is determined that royalty income received by the corporation constitutes income from a business, separate from the farming business of the corporation, such business may be considered a specified investment business within the meaning of the expression under paragraph 125(7)(e) of the Act, unless the requirements under subparagraph (i) or (ii) thereof are met. If that is the case, the royalty income from such business is considered income from a source that is a property by virtue subsection 129(4.1) and paragraph 125(7)(a) of the Act.
Furthermore, pursuant to paragraphs 129(4.1)(b) and (c) of the Act, income from a source that is a property does not include income from property (i.e., rights to take petroleum, natural gas or related hydrocarbons) that is incidental to or pertains to the farming business or that is used or held principally for the purpose of gaining or producing income from the farming business of the corporation.
The Concise Oxford Dictionary (7th ed.) defines the terms "incident" and "pertain" as follows:
"Incident" means apt or liable to happen, naturally attaching.
"pertain" means belong as part, appendage, or accessory; be appropriate; have reference or relate.
The Black's Law Dictionary (6th ed.) defines the terms "incident" and "pertain" as follows:
"Incident" means something dependent upon, appertaining or subordinate to, or accompanying something else of greater or principal importance, something arising or resulting from something else of greater or principal importance; it is used both substantively and adjectively of a thing which, either usually or naturally and inseparably, depends upon, appertains to, or follows another that is more worthy.
"Pertain" means to belong or relate to, whether by nature, appointment, or custom.
Based upon the above-noted definitions of the terms "incident" and "pertain", it is our view that in the case at hand, royalty income received by the corporation is not incidental to and does not pertain to the corporation's farming business. It is also our view that the rights to take petroleum, natural gas or related hydrocarbons are not held or used principally for the purpose of gaining or producing income from the farming business of the corporation.
The foregoing comments represent our general views with respect to the subject matter of your letter. As indicated in paragraph 21 of Information Circular 70-6R2, the above comments do not constitute an advance income tax ruling and accordingly are not binding on the Department.
Yours truly,
for Acting Director
Manufacturing Industries, Partnerships
and Trusts Division
Rulings Directorate
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