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.
Principal Issues: Determination of income that can reasonably be regarded as attributable to qualifying processing "with the particular property" for purposes of clause 1202(2)(b)(i)(D) after an amalgamation to which subsection 1214(1) applied.
Position: Calculated on same basis as applicable to the relevant predecessor corporation.
Reasons: Interpretation of clause 1202(2)(b)(i)(D) in light of the facts of this situation and the provisions of paragraph 1214(1)(b) which deem the new corporation formed upon the amalgamation to be the same corporation as, and a continuation of, the relevant predecessor for purposes of determining any deduction to the new corporation under subsection 1202(2).
March 6, 2007
Carme Lau HEADQUARTERS
Large File Case Manager 453-3-1 Income Tax Rulings Directorate
Toronto Centre Tax Services Office A.A. Cameron
(613) 347-1361
2007-021973
XXXXXXXXXX ("A Co")
Successor Corporation - Deduction for Earned Depletion Allowance
We are writing in response to your memorandum of January 5, 2007 (the "Memorandum") wherein you requested our opinion regarding the determination of the deduction arising to A Co for its XXXXXXXXXX taxation year under subsection 1202(2) of the Income Tax Regulations (the "Regulations") as a "successor" with regard to the "earned depletion base" of an "original owner" of certain property. In particular, you have requested our views regarding the interpretation of the provisions of clause 1202(2)(b)(i)(D) of the Regulations. We also acknowledge our telephone conversations regarding this matter.
Our detailed comments are provided below; however, based upon the facts of this situation and the provisions of subsection 1202(2) of the Regulations, we are of the view that "the particular property" for these purposes would be the XXXXXXXXXX% interest in the properties relevant to the former joint venture (referred to as "JV 2" below). As such, for the Company's XXXXXXXXXX taxation year "the part of [A Co's] income for the year that can reasonably be regarded as attributable to...[qualifying] processing...with the particular property" for purposes of clause 1202(2)(b)(i)(D) of the Regulations would be XXXXXXXXXX% of A Co's income for that year from the qualifying processing performed with XXXXXXXXXX% of property formerly associated with JV 2.
Our understanding of the facts relevant to this situation is as follows:
1. A Co is a "taxable Canadian corporation" and a "public corporation" within the meaning of subsection 89(1) of the Income Tax Act (the "Act"). It was formed by way of an amalgamation on XXXXXXXXXX (the "Amalgamation") of a predecessor corporation having the same name as A Co ("old A Co") and XXXXXXXXXX ("B Co"), a corporation all of the issued shares of which were owned by old A Co.
2. The relevant background prior to the Amalgamation is as follows:
a) XXXXXXXXXX
b) XXXXXXXXXX
As a result of this acquisition of control of B Co by old A Co, paragraph 1202(7)(c) of the Regulations deemed B Co after that time to be a "successor" that had acquired all of the properties owned by it immediately before that time from an "original owner". In particular, pursuant to paragraph 1202(7)(e) of the Regulations the earned depletion base (the "EDB") of B Co immediately before the acquisition of control was deemed to be the EDB of the original owner immediately after that time.
For income tax purposes, B Co applied the successor corporation rules in section 66.7 of the Act and subsection 1202(2) of the Regulations to determine the deductions for unused resource expenses "transferred" to itself upon the acquisition of control by old A Co. In the case of earned depletion allowance, such deductions were limited to the lesser of the undeducted earned depletion base of the original owner (formerly of B Co) and 25% of B Co's income that could reasonably be attributable to its XXXXXXXXXX% interest in the production income from JV 1 and its XXXXXXXXXX% interest in the processing income from JV 2.
c) XXXXXXXXXX.
3. The Amalgamation occurred on XXXXXXXXXX in accordance with subsection 87(1) of the Act with A Co being the "new corporation" formed thereon and each of old A Co and B Co having a deemed taxation year end immediately before the Amalgamation. The provisions of subsection 87(1.2) of the Act applied to the Amalgamation.
As a result of the Amalgamation, A Co became the owner of XXXXXXXXXX% of the assets associated with JV 1 and JV 2. However, on XXXXXXXXXX A Co transferred the assets associated with JV 1, including both Canadian resource properties and depreciable properties, to a new corporation, XXXXXXXXXX.
4. The only remaining unused resource expense pool of B Co transferred to A Co on the Amalgamation was an unused balance of EDB that was subject to the successor corporation rules.
Prior to the Amalgamation, old A Co had a XXXXXXXXXX% interest in JV 2 that included a XXXXXXXXXX% interest it had acquired from XXXXXXXXXX ("D Co") many years ago. A Co has been applying the successor corporation rules in computing the deduction in respect of the unused resource expenses transferred from D Co. As of XXXXXXXXXX, the balance of the EDB transferred from D Co was nil and the balance of "cumulative Canadian development expense" (as defined in subsection 66.2(5) of the Act) transferred from D Co was only $XXXXXXXXXX before earned depletion allowance (with such balance being subject to the successor corporation rules contained in subsection 66.7(4) of the Act).
5. The first taxation year of A Co after the Amalgamation covers the period from XXXXXXXXXX to XXXXXXXXXX. On original filing of its XXXXXXXXXX T2 income tax return, A Co reported a negative amount of "resource profits" (as determined under subsection 1204(1.1) of the Regulations). As such, it did not claim any earned depletion allowance under section 1201 of the Regulations. In addition, A Co did not claim any earned depletion allowance under subsection 1202(2) of the Regulations as a successor corporation.
Your Position
As a result of an audit of the XXXXXXXXXX taxation year of A Co, you have determined that it is entitled to deduct earned depletion allowance under subsection 1202(2) of the Regulations, in respect of B Co's former EDB, in computing its income for that year.
As noted above, by virtue of the acquisition of control by A Co on XXXXXXXXXX, B Co was deemed to be a successor that had acquired all of the properties it owned immediately before that time from an original owner. In your view, the "particular property" acquired by B Co, which became property of A Co on the Amalgamation, for purposes of clause 1202(2)(b)(i)(D) of the Regulations, would be B Co's XXXXXXXXXX% undivided interest in the processing assets formerly associated with JV 2.
Therefore, in your opinion, A Co as a continuation of B Co may claim earned depletion allowance under subsection 1202(2) of the Regulations equal to the lesser of:
(a) The balance of EDB flowing from B Co to A Co on the Amalgamation (being $XXXXXXXXXX); and
(b) 25% of the amount, if any, by which that part of A Co's income for the year that can reasonably be regarded as attributable to processing described in subparagraphs 1204(1)(b)(iii) and (v) of the Regulations ("Qualifying Processing") with B Co's XXXXXXXXXX% undivided ownership interest in the processing assets associated with JV 2, computed before any deduction under section 65 of the Act (the amount of which income you have determined to be $XXXXXXXXXX).
The lesser of the above amounts would be 25% of $XXXXXXXXXX or $XXXXXXXXXX and would, in your view, be the amount of earned depletion allowance that A Co may deduct under subsection 1202(2) of the Regulations for its XXXXXXXXXX taxation year.
Taxpayer's Position
A Co disagrees with your computation of income from Qualifying Processing in respect of which it may claim a deduction under subsection 1202(2) of the Regulations. They note that while clause 1202(2)(b)(i)(C) of the Regulations refers to income that can reasonably be regard as attributable to "production from the particular property", clause 1202(2)(b)(i)(D) thereof refers to income that can reasonably be regarded as attributable to Qualifying Processing "with the particular property". In their view, XXXXXXXXXX% of the income from the activities of former JV 2 is attributable to XXXXXXXXXX with all of the assets formerly associated with JV 2, i.e., B Co's former XXXXXXXXXX% ownership of such assets cannot be segregated from the whole of such assets which generated the entire income of former JV 2.
Based upon A Co's interpretation of clause 1202(2)(b)(i)(D) of the Regulations, it would be entitled to deduct earned depletion allowance of $XXXXXXXXXX in its XXXXXXXXXX taxation year. This would increase the XXXXXXXXXX non-capital loss that could be carried back to reduce taxable income in XXXXXXXXXX. In addition, the earned deletion allowance would be increased in a similar manner in XXXXXXXXXX and XXXXXXXXXX resulting in increased non-capital losses that could also be carried back to XXXXXXXXXX.
It is our understanding that the taxpayer does not take issue with the application of the successor provisions of subsection 1202(7) of the Regulations, but merely disagrees with your determination of the amount of A Co's income for the purposes of clause 1202(2)(b)(i)(D) of the Regulations. Furthermore, we understand that there is no issue with respect to JV 1 and it will be ignored for the purposes of the following analysis.
The relevant portion of subsection 1202(2) of the Regulations reads as follows:
...where...a corporation (in this subsection referred to as the "successor") acquired a particular property (whether by way of purchase, amalgamation, merger, winding-up or otherwise) there may be deducted by the successor in computing its income for a taxation year an amount not exceeding the aggregate of all amounts each of which is an amount determined in respect of an original owner of the particular property that is the lesser of
(a) the earned depletion base of the original owner immediately after the original owner disposed of the particular property...[essentially to the extent such amount has not previously been deducted by the original owner, a predecessor owner or the successor], and
(b) 25 percent of the amount, if any, by which
(i) the part of the successor's income for the year that can reasonably be regarded as attributable to
...
(D) processing described in subparagraph 1204(1)(b)(iii), (iv) or (v) with the particular property
computed...[on a specified basis and to the extent such income exceeds certain other specified deductions].
In our view, it is clear from the facts of this situation that the "particular property" for these purposes is the XXXXXXXXXX% undivided ownership interest in the assets associated with JV 2. It is also our view that, prior to the Amalgamation "the part of the successor's [B Co's] income for the year that can reasonably be regarded as attributable to" Qualifying Processing with the particular property would have been the income arising to B Co from the XXXXXXXXXX% undivided ownership interest in the assets associated with JV 2 (computed in the manner specified at the end of paragraph 1202(2)(b) of the Regulations).
Subsection 1214(1) of the Regulations provides, in part, that:
Where a particular corporation amalgamates with another corporation to form a new corporation...and subsection 87(1.2)...of the Act is applicable to the new corporation..., the new corporation...shall be deemed to be the same corporation as, and a continuation of, the particular corporation...for the purposes of
(a) computing...the earned depletion base...of the new corporation...; and
(b) determining the amounts, if any, that may be deducted under subsection 1202(2) in computing the income of the new corporation...for a particular taxation year.
As noted above, subsection 87(1.2) of the Act applied with respect to the Amalgamation with the result that, pursuant to subsection 1214(1) of the Regulations, A Co is "deemed to be the same corporation as, and a continuation of" B Co "for the purposes of...determining the amounts, if any, that may be deducted under subsection 1202(2) in computing the income of [A Co]...for a particular taxation year." Furthermore, paragraph 1202(5)(a) of the Regulations provides that subsection 1202(2) thereof does not apply in respect of a property acquired by way of an amalgamation to which section 1214 of the Regulations applies.
As subsection 1214(1) of the Regulations applied to the Amalgamation, A Co is deemed to be "the same corporation as, and a continuation of" B Co for purposes of determining the amount which A Co may deduct under subsection 1202(2) thereof. In other words, A Co "stepped into the shoes" of B Co for purposes of accessing the EDB that was deemed to be that of an original owner on old A Co's acquisition of control of B Co. As such, notwithstanding that paragraph 1202(5)(a) of the Regulations would preclude the application of subsection 1202(2) upon the Amalgamation per se, for purposes of accessing such EDB the part of A Co's income for the year "that can reasonably be regarded as attributable to" Qualifying Processing "with the particular property" for purposes of clause 1202(2)(b)(i)(D) of the Regulations must still be determined and, in our view, would be determined on the same basis as applicable to B Co. In other words, such portion would equal the income arising to A Co from the XXXXXXXXXX% undivided ownership interest in the assets formerly associated with JV 2 (computed in the manner specified at the end of paragraph 1202(2)(b) of the Regulations).
With regard to the origin of the wording of clause 1202(2)(b)(i)(D) of the Regulations, we would note that it arose as part of certain amendments to the Regulations published on December 24, 1990 in the Canada Gazette Part II (Vol. 125, No. 2, SOR/91-79). The "Regulatory Impact Analysis Statement" appended thereto indicates that the amendments to section 1202 of the Regulations were being made to implement changes announced in the federal budget of February 17, 1987. In particular, it is indicated that:
The budget of February 17, 1987 announced a change to the "successor corporation" rules to provide rules for the carry forward of unused resource expenditures incurred by a person for deduction by an unlimited number of corporations acquiring the property originally owned by the person. This change and other changes to the successor corporation rules were enacted in section 66.7 of the Income Tax Act. Amendments to sections...1202, ...1214...of the Regulations are introduced so as to provide for parallel changes with respect to successored depletion deductions in Part XII of the regulations.
Emphasis added.
At page 54 of the Budget Papers released with the budget of February 18, 1987, it is indicated under the heading "Successor Corporations" that under the then existing law:
...the successor corporation is permitted to deduct any unused resource expenses of the predecessor only to the extent of its income from the resource properties acquired from the predecessor. ....If the same properties are transferred once again, the second successor corporation is also permitted within the same limit to deduct the unused resource expenses of the original predecessor. ...
...the budget proposes to extend the successor rules to allow third and subsequent successor corporations to deduct the unused resource expenses of a predecessor within the same limitations that apply to the first and second successor corporations. ...
Emphasis added.
In our view, the comments from these documents provide further support for the interpretation of clause 1202(2)(b)(i)(D) of the Regulations in the manner outlined above.
This memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
We trust that our comments will be of assistance. If we can be of further assistance with regard to this matter, please contact the writer.
for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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