25 August 1994 External T.I. 9406335 - FARM-OUT ARRANGEMENTS

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.

Principal Issues:

Will a royalty qualify as an interest in the farm-out property for the purpose of a farm-out?

Position TAKEN:

We are not willing at this time to expand the application of the adminstrative treatment for simple farm-outs, typical farm-outs and widespread farm-outs to include a royalty interest transferred to the farmee.

Reasons FOR POSITION TAKEN:

There is not clear court precedence in Canada to establish that a royalty is an interest in land.

XXXXXXXXXX		5-940633

Attention: XXXXXXXXXX

August 25, 1994

Dear Sirs:

Re: Farm-Out Arrangements

This is in reply to your letter dated March 10, 1994 wherein you requested our views of whether or not a transaction whereby a farmee incurs exploration costs to earn a royalty interest in an unproven farm-out property will qualify for the administrative treatment of the simple farm-out arrangement described in paragraph 11 of Interpretation Bulletin IT-125R3.

In this regard we provide you with the following general comments which may be of assistance to you. Our comments, however, should not be construed as confirming the income tax consequences for a particular transaction.

The hypothetical situation outlined in your letter describes an arrangement whereby a farmee performs exploration work on an unproven resource property in Canada in exchange for a royalty interest in the same Canadian resource property. The example appears to reflect a "simple farm-out" described in 1992 Canadian Petroleum Tax Society Round Table question 16, and differs in that the farmee receives a royalty interest rather than a working interest in the unproven resource property.

Paragraph 11 of Interpretation Bulletin IT-125R3 states that the disposition of part of a resource property does not give rise to proceeds of disposition to the farmor to the extent that an interest in the property is given to the farmee in respect of exploration or development services the farmee performed on that particular property.

More recently, in response to Round Table question 16 at the 1992 Canadian Petroleum Tax Society, it was stated that the administrative position in paragraph 11 of IT-125R3 will apply to a "simple farm-out" transaction whereby the owner of an unproven resource property transfers an interest in that property to another person who conducts exploration and development on the property. We note that the "simple farm-out" does not call for all of the working interest to be transferred to the farmee as is the case for a "typical farm-out" where the farmee incurs exploration and development and equipping costs.

In our view, the above-noted administrative treatment of the simple farm-out arrangement will apply to the hypothetical transaction only if the interest in the property that is transferred to the farmee is the working interest in the unproven property and is in respect of the exploration or development services performed by the farmee on that particular property. If you have a proposed transaction in which the farmee obtains only a royalty interest, we would be pleased to examine it in the context of an advance income tax ruling request in order to determine whether our above administrative position should apply.

The foregoing comments represent our general views with respect to the subject matter. 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 A/Director
Manufacturing Industries,
Partnerships and Trusts Division
Rulings Directorate
Policy and Legislation Branch