19 November 1990 Internal T.I. 9030467 F - Hedging Gains Resource Allowance

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.

SUBJECT:  Hedging gains Resource Allowance

This is in reply to your memorandum of October 29, 1990 in which you requested our confirmation that Brian Dawe's July 8, 1983 memorandum setting out an "administrative position" that hedging gains and losses would be taken into account in computing resource profits for the purposes of the resource allowance deduction where the hedge is satisfied by a delivery of the hedger's production was, and remains, in accordance with our views of the law.

While we are unable to do so, it may well be that there is little practical effect of our disagreement. The September 5, 1990 letter from 24(1) which prompted your examination of the matter mentions only "forward sale" agreements. At least in their "plain vanilla" form, forward sale contracts seem to be no more than a means for fixing the price for the production the mining company intends to deliver to the purchaser. Where the producer enters into such a contract and ultimately delivers its own production as required thereunder, we are not inclined to suggest that there is a hedging gain or loss, but accept that the parties have merely fixed the price for the production. We understand that there are complex forward sales contracts which permit delivery deferral at a penalty, but have not seen them and are not certain of their treatment.

That said, we would not so conclude where the mining company enters into a futures position on a commodity market - even if the position were closed out by delivery of the mining company's own production which is a highly unlikely event. Such contracts are what we would consider "hedges", and are entered into, in our view, either as a form of insurance, somewhat like business interruption insurance, or as a speculation. In either event, the intention of the producer seems different than with a forward sale, and in either event, the gain or loss on the hedge is not part of the mining company's production income, despite the hedge gain or loss being on income account. In such cases, the hedging profit or loss has to be determined and removed from resource profits.

As to the remaining issue of the treatment of the holder of a royalty interest that qualifies for a resource allowance, we see no reason to treat the holder differently than the producer. If the holder is entitled to a resource allowance in "normal" circumstances, it ought to be entitled to the allowance where it enters into a standard forward sale arrangement, and actually delivers production as therein required, but not so entitled with respect to a futures contact. In either situation, the issue, broadly, is whether the arrangement is for a sale of product or a hedge against a price decline.

Acting/DirectorBilingual Services and ResourceIndustries DivisionRulings Directorate

Appendix to 7-903046

Enclosures

-     "Going for the Gold" - CA Magazine January, 1990

-     Rulings letter to 24(1) January 11, 1990

-     IRS Letter Ruling 78-42097

-     Cominco Ltd. v. HMQ 84 DTC 6535

-     Gunnar Mining Limited v. MNR 68 DTC 5035

-     Guthrie v. U.S. (323 F. 2D 143, 6th Circuit, 1963)

-     Notes of Mining Industry Information Session, Toronto, September 26 - 29, 1983

-     Ruling memos  September 21, 1988 to Vancouver                       January 8, 1985 to Toronto                        March 31, 1983 to Audit                       February 23, 1982 to Vancouver