18 October 1989 Income Tax Severed Letter RCT 5-8751

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.

Dear XXX

In reply to your letter of September 26, 1989, and further to our telephone discussion of October 17, 1989, we have one major concern regarding the paper which you propose to present at the Oil and Gas Tax Conference of the Canadian Tax Foundation on October 25, 1989 - the portrayal therein of comments we made in correspondence earlier this year with your firm regarding certain farmouts as being a departure from Revenue's position on such matters.

The farmouts in question are those in which the farmee, in addition to performing exploration and development work on the previously undeveloped property in exchange for an interest in production from the property also incurs all of the costs of equipping wells drilled on the property. You suggest that Revenue has consciously treated such arrangements as not resulting in proceeds of disposition of an interest in a resource property for the farmer. We do not agree.

Revenue's practice of treating certain farmout arrangements as not giving rise to proceeds of disposition is applicable only to farmouts where the farmee incurs exploration and development costs only, in exchange solely for an interest in future production from that previously undeveloped property. In such instances, it appears that the better technical view is that the consideration granted by both the farmee and farmor is sufficiently difficult to value that, notwithstanding the obvious disposition, no sufficiently precise amount may De considered receivable to support the argument that there are proceeds of disposition. In such cases, the technical answer is of benefit to both Revenue and the parties to the transaction, none of which are likely to want to attempt to calculate proceeds of disposition in such circumstances.

This practice is not applicable where the farmee, or farmor, for that matter, includes in the bargain, property which may be readily valued. In the situation which concerns you, the farmee will, as its part of the bargain, provide depreciable property which may readily be valued. The farmor consequently has proceeds of disposition of an interest in a resource property equal to the dollar amount of the interest it acquires in the depreciable property.

These comments are no more than a somewhat lengthy explanation of the position set out in paragraph 11 of Interpretation Bulletin IT-125R3, which itself, and in its earlier versions, has consistently expressed the same view since 1973.

You have suggested that the District Offices concerned have adopted a practice of not assessing to include a portion of the equipping costs in income of the farmor. Our discussions with District Office officials indicate that they share our views on the matter, from which we conclude that there is no conscious assessing practice such as you suggest.

We suggest that if there are instances in which an audit has not uncovered such arrangements, they may hardly be taken as a conscious practice of the Department, and suggest further that your paper be revised accordingly.

We look forward to examining your proposal whereby the farmor may effectively incur its own share of equipping costs, thereby avoiding this issue in the future.

We are obliged to close with the disclaimer that while we read your paper in its entirety, our not having commented on other than the matter of your perception of inconsistency on our part cannot be taken as our agreement with all points set out therein. Time, unfortunately, did not permit a particularly detailed examination of your paper.