20 April 1995 External T.I. 9422185 - CROWN ROYALTIES ON NATIVE CUSHION GAS

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:

How Crown royalties to be levied upon "native cushion gas" associated with underground storage facilities in Alberta is to be treated for purposes of the Act.

Position TAKEN:

Question of fact to be resolved based upon the situation of a particular taxpayer and the provisions of the governing legislation and regulations which remain unavailable.

Reasons FOR POSITION TAKEN:

Nature of the determination and unavailability of governing law.

		942218
XXXXXXXXXX		A.A. Cameron

Attention:XXXXXXXXXX

April 20, 1995

Dear Sirs:

Re: Crown Royalties on Native Cushion Gas

This is in reply to your letter of August 24, 1994 wherein you requested a technical interpretation with respect to the treatment under the Income Tax Act (the "Act") of "pre-paid Crown royalties on native cushion gas associated with underground storage facilities in Alberta" (such Crown royalty being the "Royalty"). We apologize for the delay in replying to your letter.

You have indicated that such underground storage facilities for natural gas (each being a "Facility") would have a cushion of "base pressure" gas made up of virgin gas and/or gas purchased and injected into the Facility. A natural gas inventory for resale or third party storage would be cycled on top of this base pressure gas with the purpose of such "base pressure" gas being to provide a certain minimum pressure in order to sustain deliverability of gas from storage.

You have also indicated that your concern relates to a Facility owned and operated by the

XXXXXXXXXX

Your enquiry relates to the fact that the government of Alberta "is in the process of enacting legislative changes which will require the pre-payment of Crown royalties on a lump sum or amortized basis on all native cushion gas associated with storage facilities in Alberta" (you have indicated that the Crown royalties in respect of cushion gas which was injected into a Facility would already have been paid). As a result of such changes, you state that "the Crown's volume of the product rather than the Crown's interest in the product" will be purchased and that the Crown royalty will be paid "up front on existing gas that has not been physically produced and probably would not be physically produced until the storage facility is shut-down or abandoned."

In particular, you have requested our opinion that the treatment under the Act of the Royalty would be as follows:

i)the provisions of subparagraph 18(1)(m)(v) of the Act will not apply as there has been no production of gas;

ii)the volume of native cushion gas will not be eligible for resource allowance purposes under paragraph 20(1)(v.1) of the Act and section 1210 of the Income Tax Regulations (the "Regulations") since there has been no production; and

iii)if the Royalty is not subject to the provisions of subparagraph 18(1)(m)(v) of the Act, it will be part of the cost of the cushion gas for purposes of the definition "designated underground storage cost" found in subsection 1104(2) of the Regulations ("DUSC") and thereby, ultimately, form part of the cost of property included in subparagraph (b)(i) of Class 41 to Schedule II to the Regulations for capital cost allowance purposes. As a result, the provisions of subparagraph 18(9)(a)(ii) of the Act will not apply.

Our Comments

Since your enquiry relates to an identifiable taxpayer, we are unable to confirm that the consequences arising under the Act with regard to the Royalty would be as described above. Confirmation as to the income tax consequences arising to a particular taxpayer are only provided in the context of an advance income tax ruling with regard to proposed transactions as outlined in Information Circular 70-6R2 dated September 28, 1990. We will, however, provide you with the following general comments which may be of assistance to you.

The provisions of the Act applicable to a taxpayer in a situation involving the Royalty with respect to a particular Facility would have to be determined from all the facts relevant to that particular situation, e.g., with reference to the exact nature of the taxpayer's operation, review of relevant agreements, review of the provincial legislation and regulations governing the Royalty in light of that taxpayer's situation, etc.

With regard to the latter factor, you have submitted a copy of Alberta legislation entitled the Mines and Minerals Amendment Act, 1994 which is indicated to have received Royal Assent on May 25, 1994. This legislation made certain amendments to the Mines and Minerals Act of Alberta, under which you have indicated natural gas would be considered a "mineral". In particular, it is our understanding that such amendments provide the authority for the making of regulations concerning the Royalty with respect to a Facility. In a recent telephone conversation you have indicated that such regulations have yet to be released.

The provisions of paragraph 18(1)(m) of the Act refer, in part, to:

any amount (other than a prescribed amount) paid or payable by virtue of an obligation imposed by statute...to

(i) Her Majesty in right of Canada or a province...

as a royalty, tax...that may reasonably be regarded as being in relation to

(iv) the acquisition, development or ownership of a Canadian resource property, or

(v) the production in Canada of

(A) petroleum, natural gas...

The amounts which are "prescribed" for these purposes are detailed in section 1211 of the Regulations and would not appear to be relevant to the above situation. In particular, it would not appear that the Royalty "may reasonably be regarded as being in respect of a rental for a right, licence or privilege to store underground petroleum, natural gas or other related hydrocarbons in Canada" for the purposes of subparagraph 1211(c)(ii) of the Regulations (underlining added).

The determination of whether the Royalty "may reasonably be regarded as being in relation to...the production...of...natural gas" for the purposes of subparagraph 18(1)(m)(v) of the Act would have to be resolved with regard to the legislation and regulations governing the terms of the Royalty which, as noted above, are not fully available at present.

It should also be noted, however, that subparagraph (b)(i) of the definition "Canadian resource property", found in subsection 66(15) of the Act, includes thereunder a property of a taxpayer that is "any right, licence or privilege to...store underground petroleum, natural gas or related hydrocarbons in Canada". Since the provisions of subparagraph 18(1)(m)(iv) of the Act quoted above would encompass the Royalty if it "may reasonably be regarded as being in relation to...the...ownership of a Canadian resource property", it is also our view that it would be a question of fact whether or not the Royalty may reasonably be so regarded.

In the absence of a transaction giving rise to income to a taxpayer, no inclusion could result in the calculation of that taxpayer's "resource profits" under subsection 1204(1) of the Regulations, i.e., without such a transaction "resource profits" could not include the fair market value of the native cushion gas as is suggested in your letter. However, if the provisions of paragraph 18(1)(m) were found to apply to an amount of Royalty paid or payable by a taxpayer with respect to a Facility, such amount would not reduce the "resource profits" of that taxpayer as otherwise determined.

Pursuant to the above mentioned definition of DUSC, in order for a cost incurred by a taxpayer to be included thereunder it must be "in respect of developing a well, mine or other similar underground property for the storage in Canada of petroleum, natural gas or other related hydrocarbons". Therefore, in our view, Royalty incurred by a taxpayer in respect of a Facility (which otherwise satisfied the requirements of that definition) could only be included in the DUSC of that taxpayer if it was incurred "in respect of developing" that Facility, .i.e., Royalty incurred by a taxpayer in respect of an existing Facility could not satisfy this requirement.

The provisions of subparagraph 18(9)(a)(ii) of the Act apply "in respect of an outlay or expense to the extent it can reasonably be regarded as having been made or incurred...as, on account or in lieu of, or in satisfaction of,...taxes...or royalty in respect of a period after the end of the year". Therefore, if a deduction was not otherwise precluded under paragraph 18(1)(m) of the Act, or paragraph 18(1)(b) thereof as capital in nature, this provision would apply to prohibit a deduction if the Royalty incurred by the taxpayer was found to be "in respect of a period after the end of the year".

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 Revenue Canada.

Yours truly,

for Director
Manufacturing Industries,
Partnerships and Trusts Division
Income Tax Rulings and Interpretations Directorate
Policy and Legislation Branch