For discussion purposes only - Draft GST/HST Memorandum 3.7, Natural Resources

GST/HST Notices - Notice 269
February 2012

This publication is being disseminated by the Canada Revenue Agency (CRA) in draft form for comments or suggestions, which should be sent by April 30, 2012 to the following:

Director
General Operations and Border Issues Division
Excise and GST/HST Rulings Directorate
Canada Revenue Agency
16th floor, Place de Ville, Tower A
320 Queen Street
Ottawa, ON K1A 0L5

Email: Costa.Dimitrakopoulos@cra-arc.gc.ca
Telephone: 613-954-7959
Fax: 613-990-1233

3.7 Natural Resources

This memorandum explains how the goods and services tax/harmonized sales tax (GST/HST) applies to natural resource rights and certain other transactions involving natural resources. Although there are various categories of natural resources, this memorandum only deals with the natural resource rights set out in section 162 of the Excise Tax Act.

Disclaimer

The information in this memorandum does not replace the law found in the Excise Tax Act (the Act) and its regulations. It is provided for your reference. As it may not completely address your particular operation, you may wish to refer to the Act or appropriate regulation, or contact any Canada Revenue Agency GST/HST rulings office for additional information. A ruling should be requested for certainty in respect of any particular GST/HST matter. Pamphlet RC4405, GST/HST Rulings – Experts in GST/HST Legislation explains how to obtain a ruling and lists the GST/HST rulings offices. If you wish to make a technical enquiry on the GST/HST by telephone, please call 1-800-959-8287.
If you are located in Quebec and wish to make a technical enquiry or request a ruling related to the GST/HST, please contact Revenu Québec at 1-800-567-4692. You may also visit the Revenu Québec Web site to obtain general information.

Note

Reference in this publication is made to supplies that are subject to the GST or the HST. The HST applies in the participating provinces at the following rates: 13% in Ontario, New Brunswick and Newfoundland and Labrador, 15% in Nova Scotia, and 12% in British Columbia. The GST applies in the rest of Canada at the rate of 5%. If you are uncertain as to whether a supply is made in a participating province, you may refer to GST/HST Technical Information Bulletin B-103, Harmonized Sales Tax – Place of Supply Rules for Determining Whether a Supply is Made in a Province.

Table of Contents

• Overview
  • Meanings of significant terms used in this publication
• Supply of natural resource property rights
• Other supplies of natural resource property rights
  • Freehold mineral title
  • Leasehold interests
  • Surface rights
  • Royalty interest
  • Working interest
• Farm-out agreements
  • Definitions of terms used in this section
  • Application of the GST/HST to farm-out agreements
  • Types of farm-out agreements
• GST/HST registration for persons in the natural resource sector
• Input tax credits for persons in the natural resource sector
• Amounts paid for supplies of minerals, peat, or any forestry, water or fishery products
• Tax status of a natural resource lease payment by a third party
• Elections
  • Joint venture election
  • Election for nil consideration
  • Supply of business assets
• Exchange of natural gas liquids for make-up gas
• Barter transactions between registrants
• Exports of natural gas and continuous transmission commodities
• Appendix – Prescribed activities for purposes of the joint venture election

Overview

Overview of section 162

1. Section 162 deems the following supplies of natural resource property rights not to be supplies for GST/HST purposes:

• a right to explore for or exploit a mineral deposit, a peat bog or deposit of peat or a forestry, water or fishery resource,
• a right of entry or user relating to such rights,
• any right to a royalty or profit interest in relation to the resource, or
• a right to enter or use land to generate or evaluate the feasibility of generating electricity from sun or wind.

2. As a result, subject to certain exceptions when the purchaser is a consumer or a non-registrant who acquires the rights in the course of a business of making such supplies to consumers, as explained in paragraph 13, no GST/HST is payable with respect to those supplies. There are also special rules for determining the application of the GST/HST to certain transactions under farm-out agreements.

Meanings of significant terms used in this publication

Meaning of mineral
ss 123(1)

3. "Mineral" includes ammonite gemstone, bituminous sands, calcium chloride, coal, gravel, kaolin, oil shale, silica, sand and petroleum, natural gas and related hydrocarbons. In addition, the meaning of mineral includes substances that are considered to be minerals within the ordinary meaning of that word. Although not specifically mentioned, rock and riprap are also included. However, clay, other than kaolin, is not included in the meaning of mineral.

Meaning of real property
ss 123(1)

4. "Real property" includes:

1. in respect of property in the Province of Quebec, immovable property and every lease thereof;
2. in respect of property in any other place in Canada, messuages, lands and tenements of every nature and description and every estate or interest in real property, whether legal or equitable; and
3. a mobile home, a floating home and any leasehold or proprietary interest therein.

Meaning of consumer
ss 123(1)

5. "Consumer" of property or a service means a particular individual who acquires or imports property or service for the particular individual's personal consumption, use or enjoyment or the personal consumption, use or enjoyment of any other individual at the particular individual's expense. It does not include an individual who acquires or imports the property or service for consumption, use or supply in the course of commercial activities of the individual or other activities in the course of which the individual makes exempt supplies.

Meaning of registrant
ss 123(1)

6. A "registrant" is a person who is registered, or who is required to be registered, for GST/HST purposes.

Meaning of explore and exploit

7. The Act does not define "explore" or "exploit" with respect to natural resources. The common meaning of explore is to search and discover, or to make or conduct a systematic search. The common meaning of exploit is to make productive use of or to utilize. Exploration and exploitation generally include activities up to, and at, the "central point", provided the central point for gas processing is located in, or adjacent to, the field. The "central point" is understood in the oil industry to mean the first storage battery after oil treatment for crude oil, and in the gas industry, to mean the facility at which natural gas is collected, cleaned and processed into saleable product for delivery to market.

Meaning of "to explore for natural resources"

8. "To explore for natural resources" refers to the search for a mineral deposit by geological surveys, geophysical prospecting, drilling boreholes and making trial pits, or surface or underground digging or tunneling.

Meaning of "to exploit a natural resource"

9. "To exploit a natural resource" means:

• for petroleum products, the extraction of the products from the earth and processing up to, and including, processing done at the battery for transformation into transportable crude oil, and including transportation to the battery;
• for natural gas, the extraction of the product from the earth and all processing up to, and including, the removal of natural gas liquids at a gas plant, and including transportation to the plant where the natural gas liquids are removed;
• for mining products, the excavation of the minerals from the earth and any processing not beyond, but including, the prime metal stage or its equivalent;
• for sand and gravel, the excavation of the product from the earth and all processing done to crush and filter the sand and gravel;
• for peat bogs or deposits, the extraction of the peat from the bog or the deposit;
• for forestry resources, the harvesting of trees;
• for water resources, the right to use or remove water; and
• for fishery resources, the removal of the resources at the site.

10. Exploitation does not include any additional processing of crude oil (e.g., refining) and any processing of gas downstream from a gas plant. It also does not include transportation to market or downstream to a central point. However, it does generally include transportation up to the central point.

11. Exploitation generally does not include storage rights (e.g., the storage of natural gas in anticipation of improved market conditions or the storage of natural gas in underground storage facilities). Certain storage rights may be considered a right of entry or user within the meaning of paragraph 162(2)(b) (e.g., storage facilities located in, or immediately adjacent to, an oil or gas field that are for the purposes of storing production from the field before the transfer to transportation or transmission facilities).

Supply of natural resource property rights

Natural resources
ss 162(2)

12. Pursuant to subsection 162(2), the following supplies are deemed not to be supplies and any consideration paid or due, or any fee or royalty charged or reserved, in respect of the right is deemed not to be consideration for the right:

• a right to explore for or exploit a mineral deposit, a peat bog or deposit of peat or a forestry, water or fishery resource,
• a right of entry or user relating to a right referred to above,
• a right to an amount computed by reference to the production (including profit) from, or to the value of production from, any such deposit, bog or resource, or
• a right to enter or use land to generate or evaluate the feasibility of generating electricity from sun or wind. (This applies to supplies made on or after February 26, 2008. It also applies to supplies made before this date, but only in respect of the portion of the consideration for the supply that becomes payable, or is paid without having become payable, after February 25, 2008.)

Exception
ss 162(3)

13. The deeming rule in subsection 162(2) does not apply to a supply of a right to take or remove forestry products, products that grow in water, fishery products, minerals or peat, a right of entry or user relating thereto, or a right to enter or use land to generate, or evaluate the feasibility of generating, electricity from the sun or wind, if the supply is made to

• a consumer (as defined in paragraph 5), or
• a person who is not a registrant and who acquires the right in the course of a business of supplying the products, minerals, peat or electricity to consumers.

Exception to ss 162(3)

14. These exceptions do not apply to a supply of a right to remove or to take water.

Other supplies of natural resource property rights

Freehold mineral title

Surface and sub-surface interests can be separated

15. Ownership of real property can be separated into surface and sub-surface (including mineral) interests. In Canada, sub-surface mineral interests are generally severed from surface interests and, for the most part, ownership of the minerals below the surface is retained by the Crown, either through statutes or through the original grant of the land. Therefore, most mineral resources in Canada are owned by the federal or a provincial government, and are referred to as Crown mineral rights.

16. In some situations, however, a person may have obtained ownership of the minerals below the surface as well as ownership of the surface of the land. In some of these situations, the person may have separated the ownership of the minerals below the surface from the ownership of the surface of the land. This would result in two titles being created: one for the surface and one for the minerals below the surface. The title for the mineral rights below the surface is referred to as a freehold mineral title.

Sale of freehold mineral title

17. Where a person owns the mineral rights below the surface, this person may sell the freehold mineral title to another person. The sale of the freehold mineral title generally includes the complete bundle of rights that the vendor holds in the minerals. This bundle of rights includes:

• the right to use the minerals – the minerals can be recovered from the land or can be wasted;
• the right to alienate all or part of the freehold mineral title – the freehold mineral title can be sold or a portion of the mineral rights can be sold or leased out;
• the right to pledge the freehold mineral title for credit – the freehold mineral title can be mortgaged; and
• the right to protect the minerals from trespass and nuisance.

18. The right to use the minerals may include the right to explore for or exploit the mineral deposit. Therefore, a purchaser of a freehold mineral title or a purchaser of land that includes the underlying minerals may acquire the right to explore for or exploit a mineral deposit as one component in the transaction. This right may, however, be limited by provincial or municipal laws.

19. Subject to the exceptions set out in subsection 162(3), a supply of a right to explore for or exploit a mineral deposit, if supplied by itself, is deemed not to be a supply pursuant to subsection 162(2). Where the right to explore for or exploit a mineral deposit is only one component of a supply of a bundle of rights, subsection 162(2) does not apply because subsection 162(2) applies only to supplies of those rights that are specifically listed therein. Therefore, subsection 162(2) does not apply to a sale of a freehold mineral title or a sale of land that includes the underlying minerals.

Real property

20. A freehold mineral title represents an interest in real property, and therefore, for GST/HST purposes, a sale of a freehold mineral title is treated as a supply of real property. As a result, the sale of a freehold mineral title is subject to the provisions that apply to sales of real property. For more information, refer to GST/HST Memorandum 19.5, Land and Associated Real Property.

Leasehold interests

Assignment of rights

21. A leasehold interest is generally created when the owner of rights assigns the rights to a lessee for a particular period for consideration that may include payment of a royalty interest, a lease payment or a lease bonus payment. In exchange for the payment of consideration, the lessee receives the right to explore for or exploit the mineral resource. The assignment of these rights generally falls within the scope of subsection 162(2), and therefore, the GST/HST does not apply to the consideration.

Surface rights

Right to enter and use land

22. A surface lease agreement gives a lessee the right to enter and use land and may include rights of access to explore for, exploit or produce oil and gas, rights for a road allowance or pipeline right of way, or easements in relation to the right to explore for or exploit. The amounts paid under such an agreement are meant to compensate the owner for such things as inconvenience and nuisance, loss of the use of lands, adverse effects, severance, and incidental damages.

Single or multiple supplies

23. Surface leases must be reviewed on a case-by-case basis to determine whether the surface lease payments fall within the scope of subsection 162(2). It must first be determined if the transaction involves a single supply or multiple supplies. Where there is a single supply, it is necessary to determine if this supply is a supply of entry or user right that is related to the right to explore for or exploit a mineral deposit. Where there are multiple supplies supplied for a single consideration, it may also be necessary to determine if any of the supplies is incidental to any other supply. It is then necessary to determine if all, or any, of these supplies fall within the scope of subsection 162(2). For more information on single and multiple supplies, refer to GST/HST Policy Statement P-077, Single and Multiple Supplies.

24. Whether a single supply of a surface lease is within the scope of subsection 162(2) depends on the purposes and uses for which the land was leased. For example, if a lessee is using the land to complete a geophysical survey, to drill a well, or to extract oil or gas, then this single supply is a supply described in subsection 162(2), and is deemed not to be a supply for GST/HST purposes. As a result, amounts paid for this single supply are deemed not to be consideration for a supply and are not subject to tax. However, if the lessee is using the land for a pipeline to transport gas to market, this supply does not fall within the scope of subsection 162(2), and therefore is subject to GST/HST. Furthermore, rights relating to refining or processing after the product has been transferred to transportation or transmission facilities do not fall within the rights referred to in subsection 162(2).

Royalty interest

Royalty interest

25. In order to spread the risk when exploring for or exploiting a mineral deposit, a number of persons may have an interest in the property. The interest usually takes one of two forms – a royalty interest or a working interest. A royalty interest entitles the holder of the interest to a fee based on the units or value of production. A royalty interest can take a variety of forms including a gross overriding royalty. A gross overriding royalty is an interest in the revenue from the sale of a product (e.g., oil, gas, iron, or gold) produced at a specific property. It is usually expressed as a percentage of the gross revenue from the property before any expenses and claims by the working interest owner(s) are deducted ("working interest" is defined in paragraph 26 below). Subsection 162(2) deems the supply of such a right not to be a supply and any consideration paid or due, or any fee or royalty charged or reserve, in respect of the right not to be consideration for a supply of the right. Accordingly, no GST/HST applies in respect of a royalty payment in respect of production from a natural resource property.

Working interest

Meaning of "working interest"

26. A working interest is the right to explore for, produce and own a mineral (e.g., oil, gas, iron, or gold) and all real and tangible personal property bought or built to explore for or exploit this mineral deposit. A person with a working interest must pay the operating costs and is entitled to revenue based on total sales less royalties (such as overriding royalties) and taxes.

27. When a number of people each hold a working interest in a property, their interests are usually undivided. This means that each person holding a working interest has an interest in all the property, and none can claim an exclusive interest in any part of the property except by acquiring all the other working interests.

Oil and gas wells

28. With respect to an oil or gas well, a person can obtain an undivided working interest in the assets of an oil and gas well by purchasing all or part of the working interest held by another person or by converting a gross overriding royalty interest into a working interest in the well.

Mines

29. With respect to a mine, a person usually obtains an undivided working interest in the assets of mine by purchasing all or part of the working interest held by another person.

30. The consideration for the purchase of all or a part of a working interest from another person may be money or it may be a working interest in another mineral property. Sales or swaps of working interests in producing properties are common in the resource sector.

31. When a gross overriding royalty in a mine or an oil or gas well is converted into a working interest, the holder of the royalty interest supplies the royalty interest in exchange for a supply of an undivided ownership interest in the mine, or oil or gas well.

32. When a person acquires an undivided working interest in the assets of a mine or an oil or gas well through the above-mentioned methods, the transaction usually includes the transfer of an interest in tangible personal property, real property and the right to explore for and exploit a mineral deposit (the mineral rights).

Real property

33. Real property may include:

• buildings, plants, refineries, sheds, pipelines or gathering systems, railway tracks; and
• reinforcing ground controls (such as the casings cemented into the ground, cable bolts or grouted supports).

Tangible personal property

34. In all provinces except Quebec^{Footnote 1}, tangible personal property may include:

• machinery used in an underground mine, such as skids, elevators, conveyor belts, compressors, generators, crushers, and ore carts;
• vehicles used in an underground mine, such as loaders, tractors, fork-lifts, and back-hoes;
• personal property used in an underground mine, such as helmets, lights, shovels, dynamite, hand-held drills, and ladders;
• machinery used on the surface at a mine, such as skids, conveyor belts, drills, mills or grinders (may be real property if permanently affixed to the plant at the mine);
• vehicles used on the surface at a mine, such as earth-movers, graders, ore trucks, loaders, tractors, forklifts, and dump trucks;
• machinery used in an oil or gas well, such as well-heads, blow-out preventers, and pump-jacks; and
• machinery used on the surface at an oil or gas well, such as separators, heater-treaters, storage tanks, flow-lines, and pipelines (both flow-lines and pipelines may be real property if permanently affixed to the land).

Supply of an undivided working interest in the assets of a mine or an oil or gas well

35. When a person acquires an undivided working interest in the assets of a mine or an oil or gas well, the transaction normally includes the transfer of an interest in tangible personal property or real property and the right to explore for and exploit a mineral deposit.

Single supply or multiple supplies

36. In most cases, where a person acquires an undivided working interest in the assets of a mine or an oil or gas well, multiple supplies are being made. However, each situation must be reviewed on a case-by-case basis in order to determine whether a supply of an undivided working interest in the assets of a mine or an oil or gas well is a single supply or multiple supplies of the components (i.e., tangible personal property, real property and mineral rights, each of which may have a different tax status). To make this determination, the criteria in GST/HST Policy Statement P-077, Single and Multiple Supplies, should be applied.

Supply of tangible personal property

37. In general, the supply of tangible personal property, by itself, is subject to GST/HST, and if the vendor is a registrant, the vendor is required to collect and account for the tax.

Supply of real property

38. The supply of the real property, by itself, is also subject to GST/HST, unless an exempting provision in Schedule V to the Act applies. The vendor is not, however, required to collect and account for the tax if the supply is made to a person who is registered for GST/HST purposes (provided the supply is not a supply of a residential complex to an individual). The supplier also does not collect tax if the supplier is a non-resident or a resident of Canada only because it is deemed to be a resident in respect of activities carried on through a permanent establishment of the non-resident in Canada. Instead, the purchaser is required to account for the tax on the supply and to self-assess the tax payable.

Supply of mineral rights

39. The supply of the mineral rights, by itself, is deemed not to be a supply pursuant to subsection 162(2), unless the purchaser is a consumer or a non-registrant who acquired the rights in the course of a business of supplying the minerals to consumers.

Farm-out agreements

40. Special rules apply to supplies of working interests in the assets of a mine or an oil or gas well made under written farm-out agreements. See paragraph 41 below.

Farm-out agreements

Farm-out agreements – Overview

41. There are special rules for determining the GST/HST treatment of certain transactions under farm-out agreements. A farm-out agreement means an agreement under which a person (the "farmor") grants to another person (the "farmee") a natural resource right (or portion thereof) relating to an unproven property. In return for granting this right, the farmor receives the exploration of the property for mineral deposits and potentially the development of the property by the farmee (subject to such conditions as economic viability) as well as any information gathered by the farmee from the exploration. The farmor normally retains an economic interest in the property through a gross overriding royalty interest that may be convertible at a later date into a working interest.

Ancillary transactions

42. The farm-out agreement may also provide for ancillary transactions. For example, it might provide for the transfer from the farmee to the farmor of interests in certain mining or well-site equipment at some future time, usually in the case where the farmor ultimately obtains a working interest in the developed property. Another example is where the agreement may provide for the transfer by the farmee to the farmor of such things as seismic information. In turn, the farmor might transfer a property or service other than the interest in the unproven property that is being explored such as an interest in another property already developed.

Definitions of terms used in this section

Meaning of estimated reserves
ss 162(1)

43. "Estimated reserves" of minerals means the estimated quantities of minerals that geological and engineering data demonstrate, with reasonable certainty, to be recoverable under existing economic and operating conditions.

Meaning of natural resource rights
ss 162(1)

44. A "natural resource right" means:

1. a right to explore for or exploit a mineral deposit;
2. a right of entry or user relating to a right referred to in paragraph (a); or
3. a right to an amount computed by reference to the production (including profit) from, or to the value of production from, a mineral deposit.

Meaning of specified mining or well-site equipment
ss 162(1)

45. "Specified mining or well-site equipment", in relation to the exploration or development of unproven property under a farm-out agreement, means:

1. equipment, installations and structures for use at a mine site in the production of minerals from the mine and not in the milling, smelting, refining or other processing of the minerals after production; and
2. equipment, installations and structures for use at a well site in the production of minerals from the well, including a heater, dehydrator or other well-site facility for the initial treatment of substances produced from the well to prepare such production for transportation but excluding
   
   1. any equipment, installation, structure or facility that serves or is intended to serve a well that has not been drilled in the course of the exploration or development under that agreement, and
   2. any equipment, installation, structure or facility for use in the refining of oil or the processing of natural gas including the separation therefrom of liquid hydrocarbons, sulphur or other joint products or by-products.

Meaning of unproven property
ss 162(1)

46. "Unproven property" means real property for which estimated reserves of minerals have not been attributed.

Application of the GST/HST to farm-out agreements

ss 162(4)

47. Generally, where property or services are given as consideration in exchange for other property or services, the value of consideration for one is the fair market value of the other. Special rules are in place to eliminate the requirement to establish a value for certain property or services exchanged between a farmor and a farmee in a farm-out agreement that is entered into for the purpose of the exploration and potential development of real property for mineral deposits.

Value of farmor's contribution
para 162(4)(a)

48. Where a farmor enters into an agreement in writing with a farmee to transfer particular natural resource rights, or portions of them, relating to unproven property to the farmee in consideration or part consideration for the farmee undertaking the exploration of the property for mineral deposits and providing information (or the right to it) gathered from the exploration, the value of the consideration of any property or service given by the farmor to the farmee under the agreement is deemed to be nil to the extent that the property or service is given as consideration for any of the following:

• the undertaking of that exploration or development;
• the provision of that information (or the right to it); and
• any transfer under the agreement by the farmee to the farmor of any interest in specified mining or well-site equipment that is used by the farmee exclusively in that exploration or development.

Value of farmee's contribution
para 162(4)(b)

49. The value of the farmee's contribution as consideration for any property or service given by the farmor to the farmee under the agreement is deemed to be nil.

50. Under paragraph 162(4)(a), any non-monetary consideration given by the farmor in return for the farmee's contribution is deemed to have a value of zero. If no additional monetary consideration is given by the farmor for the farmee's contribution, no tax applies to the farmee's contribution. If a portion of the consideration given by the farmor is monetary, tax on the farmee's contribution is calculated on that consideration. Similarly, by virtue of paragraph 162(4)(b), the farmee's contribution need not be valued for purposes of determining any tax on the property or services given by the farmor in exchange. This is achieved by deeming the value of the farmee's contribution as consideration for any property or service given by the farmor to be nil.

Farmor's additional contribution
para 162(4)(c)

51. If part of the consideration given by the farmor for the farmee's contribution is a service or property (each of which is referred to as the farmor's additional contribution) that is not a natural resource right in respect of unproven property:

1. the farmee is deemed to have supplied a separate taxable service to the farmor and this separate service is deemed to be consideration for the farmor's additional contribution; and
2. the value of the farmee's service is deemed to be equal to the fair market value of the farmor's additional contribution.

Taxable supply of additional contribution

52. Where the farmor's additional contribution is a taxable supply and the farmor is a registrant, the farmor is required to charge tax calculated on the fair market value of the additional contribution at the time of transfer. The farmee is required to collect tax on that same value.

Time of transfer

53. The consideration for the farmor's additional contribution and the consideration for the service deemed to have been supplied by the farmee are deemed to become due at the time of the transfer. The time of the transfer is:

1. if the farmor's additional contribution is a service, when the performance of the service commences, and
2. in any other case, when ownership of the farmor's additional contribution is transferred to the farmee.

Supplies of other property or services to the farmor
subpara 162(4)(c)(iv)

54. If the farmee also supplies a property or service other than the farmee's contribution in return for the farmor's additional contribution, the tax that the farmee must charge the farmor on that other property or service is calculated on only the amount, if any, by which its value exceeds the fair market value of the farmor's additional contribution. This reflects the fact that the farmee is already required to charge the farmor tax calculated on the fair market value of the farmor's additional contribution.

Types of farm-out agreements

Oil and gas industry

55. Most farm-out agreements in the natural resource sector are classified as either typical farm-out agreements or widespread farm-out agreements. Under a typical oil and gas farm-out agreement, the farmor has an interest in certain lands, either as a lessee or as the owner. The farmee agrees to drill a test well on the lands to the contract depth, complete the well and then equip, cap or abandon the well (exploratory work) in exchange for a working interest in the property. The farmor normally retains a gross overriding royalty interest, which is convertible into an agreed upon percentage working interest in the well at a certain point in time (referred to as payout). At payout, the farmor normally exchanges the royalty interest for an ownership interest in the well, including any depreciable property located on the property.

Mining industry

56. In a typical farm-out agreement in the mining sector, the farmee (referred to as an optionee) may agree to perform a specified dollar amount of exploration and/or development work (exploratory work) on the contracted property. After completing the work, the farmee acquires an agreed-upon percentage working interest in the mine.

Widespread farm-out agreements

57. In a widespread farm-out agreement, the farmee receives an interest in another resource property (i.e., not the property that is being explored or developed), or receives property other than an interest in a resource property.

58. Where the supply of the working interest is made under a farm-out agreement, the value of all or a part of the consideration may be deemed to be nil. Generally, GST/HST does not apply in a typical farm-out transaction unless there is some monetary consideration.

59. Where the farmee receives other property from the farmor, as in a widespread farm-out agreement, the farmee is deemed to have made a taxable supply of services to the farmor as consideration for the other property. The GST/HST applies to both the supply of the other property made to the farmee and the deemed supply of services made to the farmor, based on the fair market value of that other property.

Para 162(4)(b)

60. At payout, when the farmor converts its royalty interest into a working interest, the value of certain tangible personal property used in the exploration or development of mineral resources on the unproven property, and supplied by the farmee to the farmor, is deemed to be nil.

GST/HST registration for persons in the natural resource sector

ss 240(1)

61. Generally, every person who makes a taxable supply in Canada in the course of a commercial activity engaged in by the person in Canada is required to be registered for GST/HST purposes.

Meaning of commercial activity
ss 123(1)

62. A "commercial activity" of a person means a business carried on by the person, or an adventure or concern of the person in the nature of trade (other than a business, adventure or concern carried on or engaged in without a reasonable expectation of profit by an individual, a personal trust or a partnership, all of the members of which are individuals), except to the extent that the business, adventure or concern in the nature of trade involves the making of exempt supplies by the person. The definition also includes the making of a supply (other than an exempt supply) by the person of real property of the person, including anything done by the person in the course of or in connection with the making of the supply. Exempt supplies are listed in Schedule V to the Act.

Small supplier threshold
ss 148(1)

63. One exception to the general requirement to register for GST/HST purposes is where the person is a small supplier. In general, a person is a small supplier if the total value of the consideration for the world-wide taxable supplies, including zero-rated supplies, made by the person does not exceed a threshold of $30,000 ($50,000 in the case of a public service body). Where amounts received for the supply of a right are deemed not to be consideration for a supply, such amounts are not included in the calculation of the small supplier threshold. Therefore, the revenue received from such an activity would not require a person to be registered for GST/HST purposes.

Voluntary registration
ss 240(3)

64. Subsection 240(3) provides, in part, that registration for GST/HST purposes is permitted for persons who are not required to be registered and who are engaged in a commercial activity in Canada. Notwithstanding that certain supplies of natural resource rights are deemed not to be supplies, a person engaged in a business of supplying rights to explore or exploit natural resources as described in section 162 would generally be considered to be engaged in a commercial activity to the extent that the person is engaged in a business that does not involve the making of exempt supplies.

65. For more information on GST/HST registration, see GST/HST Memoranda 2.1, Required Registration, 2.2, Small Suppliers, and 2.3, Voluntary Registration.

Input tax credits for persons in the natural resource sector

General ITC rule
ss 169(1)

66. Where a person acquires or imports property (other than capital property) or a service, or brings it into a participating province and, during a reporting period in which the person is a registrant, the GST/HST in respect of the property or service becomes payable by the person or is paid by the person without having become payable, that person may be eligible to claim an input tax credit (ITC) in respect of the tax to the extent (expressed as a percentage) it was acquired, imported or brought into a participating province for consumption, use or supply in the course of the person's commercial activities. Such a property or service is commonly referred to as an input.

Capital personal property

67. For capital personal property, an ITC entitlement is determined in applying a primary use test:

• if the property is acquired for use more than 50% in commercial activities, the registrant is entitled to claim the total amount of tax payable in respect of that property;
• if the property is acquired for use 50% or less in commercial activities, there is no ITC entitlement.

68. Refer to GST/HST Memorandum 8.1, General Eligibility Rules for further details.

ITC apportionment rules
s 141.01

69. Generally, where property or a service is consumed or used partly in the course of a person's commercial activities and partly in its non-commercial activities (less than 90% but more than 10% in its commercial activities), the person must apportion the GST/HST for the property or service between these two activities. Specifically, the person may be eligible to claim an ITC for the portion of the GST/HST paid or payable for the property or service that relates to its consumption or use in its commercial activities as long as all the other ITC criteria are satisfied. This rule does not apply to the acquisition of capital personal property, as discussed in paragraph 67, and to capital real property, as discussed in GST/HST Memorandum 19.1, Real Property and the GST/HST.

70. Subsection 141.01(7) provides, in part, that where a provision such as subsection 162(2) deems consideration for a supply not to be consideration for the supply or a supply not to have been made by the person, that deeming does not apply for purposes of subsections 141.01(1) to 141.01(4).

For the purpose of making supplies
para 141.01(2)(a)

71. Property and services acquired, imported or brought into a participating province for consumption or use in the course of an endeavour are deemed to be acquired, imported or brought in for consumption or use in a person's commercial activities (and give rise to eligibility to claim an ITC) to the extent that the property and services are acquired, imported or brought in for the purpose of making taxable supplies for consideration. As a result, to the extent that a person acquired or imported property or a service for consumption, use or supply in the course of making taxable supplies of rights for consideration to which subsection 162(2) applies, that person is generally entitled to ITCs to the extent of deemed use in commercial activities where all of the other conditions for an ITC are met, provided no other provision of the Act applies to deny or limit the ITC available. See GST/HST Memorandum 8.1, General Eligibility Rules, for further details.

Amounts paid for supplies of minerals, peat, or any forestry, water or fishery products

Fee or royalty based on units of production
ss 162(2)

72. Where a person pays an amount for a mineral, peat, or any forestry, water or fishery product that is based on the units of production of the natural resource from a certain property, and that same person has acquired the right to explore for and exploit the natural resource on that same property, the amount paid is considered to be "any fee or royalty charged or reserved" in respect of the right. Therefore, pursuant to subsection 162(2), the payment is deemed not to be consideration for the supply of the right.

73. Where a person (other than a consumer or an unregistered person who makes supplies to consumers of minerals, peat, or any forestry, water or fishery products in the ordinary course of the person's business) agrees to pay an amount specified per unit to "purchase" the right to enter onto specified lands to explore for, extract and remove a natural resource on that land, and the owner of the natural resource agrees to "sell" at that specified per unit amount, a minimum quantity of the natural resource from the land, the consideration paid by the person is deemed not to be for a supply, notwithstanding the fact that the person may not have removed the minimum quantity of the natural resource.

Tax status of a natural resource lease payment by a third party

74. Where a third party pays a natural resource lease payment pursuant to an agreement with the lessee, the GST/HST status of the payment by the lessee to the third party to reimburse the lease payment depends upon whether or not the third party is acting as an agent of the lessee in paying the lease. For information about the meaning of "agent" and "agency" for GST/HST purposes, refer to GST/HST Policy Statement P-182, Agency.

Elections

Joint venture election

s 273

75. An operator and a participant in a qualifying joint venture may elect jointly to designate the operator as the person responsible for accounting for the GST/HST on behalf of both parties with respect to their purchases and sales made in the course of the activities of a joint venture. A qualifying joint venture is one where a registrant is a participant in a joint venture under an agreement, evidenced in writing, with another person for the exploration or exploitation of mineral deposits or for a prescribed activity.

Joint venture or partnership
P-171R

76. To determine whether the parties to the agreement are eligible to make a joint venture election, it is necessary to distinguish between a joint venture and a partnership. GST/HST Policy Statement P-171, Distinguishing between a Joint Venture and a Partnership for Purposes of the Section 273 Joint Venture Election, is helpful in making that determination.

Meaning of exploration and exploitation

77. "Exploration" and "exploitation" have the same meaning for purposes of a joint venture election as "explore" and "exploit" have for purposes of section 162. See paragraphs 7 to 11 for more details on these meanings.

Joint Venture (GST/HST) Regulations
ss 3(1)

78. Certain prescribed activities for purposes of a joint venture election are activities that are associated with natural resource exploration and exploitation. See the Appendix to this memorandum for a complete list of prescribed activities.

Policy Statement P-106, Administrative Definition of a Participant in a Joint Venture

79. "Participant" is not defined in the Act. To determine whether a person is a participant in a joint venture for purposes of a joint venture election, the CRA has developed the following administrative definition of "participant". Participant means:

• a person who, under a joint venture agreement evidenced in writing, makes an investment by contributing resources and takes a proportionate share of any revenue or incurs a proportionate share of the losses from the joint venture activities; or
• a person, without a financial interest, who is designated as the operator of the joint venture under an agreement in writing and is responsible for the managerial or operational control of the joint venture.

Prescribed forms

80. An operator and one or more participants of a qualifying joint venture can jointly make the joint venture election using Form GST21, Election or Revocation of an Election to Have the Joint Venture Operator Account for GST/HST. Alternatively, the operator and the participant(s) may jointly make the election by preparing their own documents containing the prescribed information. The prescribed information for purposes of a joint venture election is described in GST/HST Policy Statement P-187, Prescribed Form for Joint Venture Elections.

Participant's liability where an election is not made

81. Since a joint venture is not a "person" for GST/HST purposes, it cannot register in its own right. Therefore, under the general rules, each participant in a joint venture must generally account for the GST/HST collected or collectible on its share of supplies of property or services made in the course of the joint venture and claim ITCs for the tax paid or payable on the acquisition, importation, or the bringing into a participating province of property or services (subsequently referred to collectively as "purchases") in the course of the joint venture, unless a joint venture election has been made under section 273. For more information on a participant's tax liability with respect to joint venture sales and purchases where a joint venture election is not made, see GST/HST Policy Statement P-139, Tax Liability and Input Tax Credit Entitlement of a Non-Electing Joint Venture Participant.

Effect of joint venture election

82. Where a joint venture operator and another participant make a joint venture election, purchases and supplies made by the operator on behalf of the participant in the course of the joint venture are deemed to be made by the operator, not the participant. Any supplies made by the operator to the participant for use in the commercial activities of the joint venture are deemed not to be supplies. For more information on a participant's eligibility to register for GST/HST purposes and to claim ITCs, refer to GST/HST Policy Statement P-138, The Effect of Making a Joint Venture Election on a Participant's Eligibility to Register and Claim Input Tax Credits.

Election for nil consideration

Election between closely related corporations or partnerships
s 156

83. Specified members of a closely related group of corporations and/or partnerships resident in Canada can jointly elect with another specified member of the group to treat certain taxable supplies between them as having been made for no consideration.

Applies to property or service acquired exclusively for commercial activity

84. There are certain exclusions from the election under section 156. For example, the election applies only to supplies of property or services that the recipient is acquiring for consumption, use or supply exclusively in the course of its commercial activities; it does not apply to the sale of real property.

Form GST25

85. Persons can make this election using Form GST25, Closely Related Corporations and Canadian Partnerships – Election or Revocation of the Election to Treat Certain Taxable Supplies as having been made for Nil Consideration.

Supply of business assets

Sale of a business or part of a business
ss 167(1)

86. The buyer and the seller of a business or a part of a business may elect to have no GST/HST apply to an otherwise taxable sale of the assets of a business, provided certain conditions are met, including the two following tests:

• the supplier must sell a business or part of a business that was established or carried on by the supplier, or that was established or carried on by another person and acquired by the supplier; and
• the recipient is acquiring, under the agreement for the supply, ownership, possession or use of all or substantially all of the property that can reasonably be regarded as being necessary for the recipient to be capable of carrying on the business or part as a business.

Transfer of an undivided interest in a joint venture

87. The recipient of a supply of an undivided interest in a joint venture may qualify as having acquired a business or part of a business if certain conditions are met. Consequently, the supplier and the recipient of the supply may be eligible to use the election to have no GST/HST apply to the supply of the interest.

88. For additional information concerning the election under section 167, see GST/HST Memorandum 14.4, Sale of a Business or Part of a Business.

Form GST44

89. The election to have no GST/HST apply to the sale of a business or a part of a business can be made using Form GST44, Election Concerning the Acquisition of a Business or Part of a Business.

Exchange of natural gas liquids for make-up gas

Meaning of straddle plant
ss 123(1)

90. "Straddle plant" means a natural gas processing plant devoted primarily to the recovery of natural gas liquids or ethane from natural gas that is transported by pipeline to the plant by a common carrier of natural gas.

ss 153(6)

91. When natural gas liquids or ethane (each of which is referred to as "natural gas liquids") are recovered from natural gas at a straddle plant, a certain amount of gas (referred to as "make-up gas") is often added to the residue gas to make up for the loss of energy content due to the recovery. This sometimes involves transactions whereby the person holding the rights to the natural gas liquids exchanges the liquids or the rights to them for the make-up gas supplied by the other party to the transaction. The transaction may or may not also involve the payment by either party of monetary consideration.

92. The exchange of natural gas liquids and make-up gas is normally between the owner of the gas and the straddle plant operator, but there may be intermediary transactions as well involving such an exchange. For example, a third party might acquire the rights to the natural gas liquids from the owner of the gas before it is processed and promise to supply, in return, the necessary make-up gas after the processing. In this case, there could be more than one exchange to which subsection 153(6) applies, for example an exchange between the owner of the gas and the third party, and another exchange between the third party and the straddle plant operator who supplies the make-up gas to the third party for re-supply to the owner.

Value of consideration
ss 153(6)

93. The value of the consideration or part for any supply of the natural gas liquids (or the right to recover the liquids) recovered at a straddle plant is deemed to be nil if the consideration or a part of the consideration is make-up gas. The value of consideration or part for the supply of make-up gas is also deemed to be nil if the consideration is the natural gas liquids recovered at a straddle plant or the right to recover the liquids. If there is any monetary consideration for either supply, tax would be calculated on it in the normal manner.

Barter transactions between registrants

Product-for-product exchanges

94. Product-for-product exchanges are common among dealers in certain industries such as the upstream oil and gas industries. An exchange of property between two persons in a barter transaction generally constitutes a supply of property made by each of the persons. The value of consideration for the supply made by one person is the fair market value of the property received by the other person. Where the supply is subject to GST/HST, the supplier is required to collect the tax payable.

Exchanges of property of the same class or kind
ss 153(3)

95. Where the consideration or a part of the consideration for a supply of property of a particular class or kind is property of that class or kind, the value of the consideration or a part of the consideration for that property is deemed to be nil, if both the supplier and the recipient are registrants, each of which is acquiring the property as inventory for use exclusively in commercial activities.

Particular class or kind
Policy Statement P-221

96. The Act does not define the phrase "a particular class or kind" for purposes of subsection 153(3). The CRA considers two properties to be properties of a particular class or kind if they meet all the following criteria:

• they are similar in their constituent materials and general appearance;
• they have the same primary end-use;
• they have been subject to a similar level of processing or refining, where applicable; and
• they are capable of performing the same primary functions.

97. To determine whether properties are of a particular class or kind, it is necessary to compare the inherent qualities or elements which give the properties their identities. Such a determination is a question of fact which must be decided on the basis of the relevant details in each situation. In general, the consideration for the exchange of properties will be deemed nil only where neither party acquires new property that is significantly different in all material respects from the one given up.

98. For more information, refer to GST/HST Policy Statement P-221, Meaning of the phrase "a particular class or kind" as found in subsection 153(3) of the Act.

Exports of natural gas and continuous transmission commodities

Meaning of continuous transmission commodity
ss 123(1)

99. "Continuous transmission commodity" means electricity, crude oil, natural gas, or any tangible personal property, that is transportable by means of a wire, pipeline or other conduit.

Natural gas exports
Sch. VI, Part V, s 15

100. A supply of natural gas made by a person to an unregistered recipient who intends to export the gas by pipeline is zero-rated, provided all the following conditions are met:

1. the recipient must
   
   1. export the gas, or
   2. receive a supply of a zero-rated storage service in respect of the gas and subsequently export the gas, as soon after it is delivered to the recipient by the supplier of the gas, or after it is delivered to the recipient on the expiry of the storage period, as is reasonable having regard to the circumstances surrounding the exportation and, if applicable, to the normal business practice of the recipient;
2. the gas is not acquired by the recipient for consumption or use in Canada, (other than by a carrier as fuel or compressor gas to transport the gas by pipeline) or for supply in Canada (other than to supply natural gas liquids or ethane recovered from natural gas transported by pipeline at a straddle plant) before the exportation of the gas by the recipient;
3. after the supply is made, and before the exportation, the gas is not, except to the extent reasonably necessary or incidental to its transportation, further processed, transformed or altered in Canada other than to recover natural gas liquids or ethane from gas at a straddle plant; and
4. the person maintains evidence satisfactory to the Minister of the exportation of the gas by the recipient. Appendix A of GST/HST Memorandum 4.5.2, Exports – Tangible Personal Property provides more information about documentary evidence of an exportation of property.

Supply to a non-registrant
Sch. VI, Part V, para 15.1(a)

101. A supply of a continuous transmission commodity made by a supplier (referred to as the first seller) to an unregistered person (referred to as the first buyer) is zero-rated if:

1. the first buyer makes a supply of the commodity to a registrant and delivers it in Canada to the registrant;
2. all or part of the consideration for the first buyer's supply of the commodity to the registrant is property of the same class or kind delivered to the first buyer outside Canada;
3. between the time at which the commodity is delivered to the first buyer and the time at which the first buyer delivers it to the registrant under an exchange agreement,
   
   1. the first buyer does not use the commodity except, in the case of natural gas, to the extent that is used by a carrier as fuel or compressor gas to transport the gas by pipeline; and
   2. the commodity is not (except to the extent reasonably necessary or incidental to its transportation) further processed, transformed or altered other than, in the case of natural gas, to recover natural gas liquids or ethane from the gas at a straddle plant;
4. between the time at which the first seller's supply is made and the time at which the registrant receives delivery of the commodity, the commodity is not transported by any means other than a wire, pipeline or other conduit; and
5. the first seller maintains evidence satisfactory to the Minister of the first buyer's supply of the commodity to the registrant.

Sch. VI, Part V, para 15.1(b)

102. Where the first buyer is a non-resident person, any service of arranging for or effecting the exchange of the commodity for the property of the same class or kind that is supplied by the registrant to the first buyer is also zero-rated.

Imported taxable supply
para 217(b.2), s 218, and subpara 218.1(1)(b)(ii)

103. In the case where the registrant who acquires the commodity from the first buyer is not acquiring the commodity for consumption, use or supply exclusively in the course of commercial activities of the registrant, the supply is an imported taxable supply and the recipient is required to self-assess and remit the GST/HST on the consideration for the supply of the commodity.

Supply to a registered recipient
Sch. VI, Part V, s 15.2

104. A supply of a continuous transmission commodity made by a supplier to a registered recipient is zero-rated if the recipient provides the supplier with a written declaration of its intent

• to export the commodity in circumstances described in paragraphs 15(a) to (c) of Part V of Schedule VI for natural gas, or in any other case, paragraphs 1(b) to (d) of Part V of Schedule VI (more information on paragraphs 1(b) to (d) can be found in GST/HST Memoranda 4.5.2); or
• to exchange the commodity as provided in section 15.1 of Part V of Schedule VI.

Supply not exported

105. The zero-rated status of the supply is maintained even if the commodity is subsequently neither so exported nor exchanged, provided the supplier did not know, and could not reasonably be expected to have known, at or before the latest time at which the GST/HST would have become payable in respect of the supply, that the recipient would neither export nor supply the commodity under an exchange agreement.

Imported taxable supply
para 217(b.3), s 218, and subpara 218.1(1)(b)(ii)

106. In the case where the declared intent is not fulfilled, the supply to the registered recipient is defined to be an imported taxable supply. Consequently, the recipient is required to self-assess and remit the GST/HST on the consideration for the supply of the commodity, unless the commodity is acquired for consumption, use or supply exclusively in the course of the recipient's commercial activities.

Adjustment if the property is not exported or supplied
s 236.1

107. A registrant who receives a zero-rated supply of a commodity that is not subsequently exported or supplied (as required for zero-rating under section 15.2 of Part V of Schedule VI) is required to add an amount to its net tax for the reporting period in which tax on the initial supply would have become payable had that supply not been a zero-rated supply. This net tax adjustment reflects the cash-flow benefit obtained by the registrant in having received a supply on a zero-rated basis. The amount to be added to net tax is equal to interest, at the prescribed rate, calculated on the total amount of tax that would have been payable in respect of the supply. The amount is computed for the period

• beginning on the earliest day on which tax would have become payable in respect of the supply, and
• ending on the day on or before which the return for that reporting period is required to be filed.

Service of storing natural gas
Sch. VI, Part V, s 15.3

108. A supply made by a person to an unregistered non-resident recipient of a service of storing natural gas for a period, or of taking up surplus natural gas of the recipient for a period, and returning the gas at the end of the period is zero-rated if:

1. at the end of the period, the gas is to be delivered to the recipient for export;
2. at the end of the period, the recipient holds a valid licence or order for the export of the natural gas issued under the National Energy Board Act; and
3. the person did not know and could not reasonably be expected to have known, at or before the latest time at which tax in respect of the supply of the service would have become payable if the supply were not a zero-rated supply that
   
   1. the recipient would not export the gas as soon after the end of the period as is reasonable having regard to the circumstances surrounding the exportation and, if applicable, to the recipient's normal business practice, or
   2. the gas would not be exported
      • in the same measure as was stored or taken up except for any loss due to its use by a carrier as fuel or compressor gas for transporting the gas by pipeline, and
      • in the same state except to the extent of any processing or alteration reasonably necessary or incidental to its transportation or necessary to recover natural gas liquids or ethane from the gas at a straddle plant.

Enquiries by telephone

All technical publications on GST/HST are available on the CRA Web site at www.cra.gc.ca/gsthsttech.

Appendix – Prescribed activities for purposes of the joint venture election

As noted in paragraph 78 of this document, there are prescribed activities for purposes of making a joint venture election under section 273 and some of these prescribed activities are activities related to natural resource exploration and exploitation. The following lists all the prescribed activities:

1. the construction of real property, including feasibility studies, design work, development activities and the tendering of bids, where undertaken in furtherance of a joint venture for the construction of real property;
2. the exercise of the rights or privileges, or the performance of the duties or obligations, of ownership of an interest in real property, including related construction or development activities, the purpose of which is to derive revenue from the property by way of sale, lease, licence or similar arrangement;
3. the marketing by the operator of a joint venture, under any agreement between the operator and a co-venturer, of all or part of the co-venturer's share of the output of the joint venture provided that the output arises from an activity conducted under the agreement referred to in subsection 273(1);
4. the transportation of natural gas liquids by means of a pipeline that operates as a common carrier of natural gas liquids;
5. the operation of a facility that is used to generate electricity;
6. the operation of a transmission line that is used to transmit electrical power;
7. the processing of output (in this paragraph referred to as the "refinement") that arises from the exploration or exploitation of a timber resource, including any jointly conducted exploration or exploitation activity of which the output is processed under the agreement referred to in subsection 273(1) in respect of the refinement and the marketing of the processed or unprocessed output that arises from that activity;
8. the production of a fertilizer and its marketing;
9. the disposal of waste, including the collection and transportation of waste that is in furtherance of that disposal;
10. the exercise of rights or privileges, or the performance of duties or obligations, of ownership of an interest in an animal for the purposes of deriving revenue from prizewinning, stud service fees or sale;
11. the maintenance of a road, other than maintenance that is an exempt supply;
12. the operation and maintenance of the North Warning System;
13. the operation of a farming business within the meaning of the Income Tax Act;
14. the production of liquid methanol from natural gas;
15. the generation and recording of seismic data; and
16. the operation of a lumber, plywood, shake and shingle, pulp, paper or similar wood processing facility.

Footnotes

Footnote 1

In Quebec, the types of property given as examples in paragraph 34 could be considered as immovables by interpretation of section 903 of the Civil Code of Québec.

Return to footnote 1 referrer

Date modified:

2012-02-15