14 May 1990 Ministerial Letter 59728 F - Meaning of "Franchise, Concession or Licence" FOP CCA Class 14

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.

19(1)

May 14, 1990

Dear Sirs:

Re:  Request for Technical Interpretation - Class 14, Schedule II of the Income Tax Regulations (the "Regulations")

We are writing in reply to your letter of March 5, 1990, requesting a technical interpretation as to whether a net revenue interest described herein would be a property that is a "franchise, concession or licence" for purposes of Class 14 of Schedule II of the Regulations (hereafter referred to as "Class 14") which provides for

     "Property that is a patent, franchise, concession or licence for a limited period in respect of property, except

     (a)   a franchise, concession or licence in respect of minerals, petroleum, natural gas, other related hydrocarbons or timber and property relating thereto (except a franchise for distributing gas to consumers or a licence to export gas from Canada or from a province) or in respect of a right to explore for, drill for, take or remove minerals, petroleum, natural gas, other related hydrocarbons or timber;

     (b)  a leasehold interest;

     (c)  a property included in Class 23; or

     (d)  a licence to use computer software."

FACTS

You described the following hypothetical fact situation:

1.     Partnership A is a limited partnership, the partners of which are all unrelated private companies.

2.     Partnership A entered into the following contracts with unrelated third parties:

(a)     a gas purchase contract - purchase of gas;

(b)     a facilities contract - for the use of facilities to process the gas;

(c)     gas gathering and sales lines - for the construction of  lines from the wellhead to the processing facility, and the line from the processing facility to the main pipeline system; and

(d)     gas sales agreements - for the sale of gas.

3.     The above contracts all have a "limited period" within the context of Class 14, although all provide for earlier cancellation if the reserves prove uneconomic.

4.     Partnership A sold a 50% net revenue interest (the "NRI") pertaining to the above contracts and an interest in certain related facilities to Company B, an unrelated corporation listed on the Alberta Stock Exchange, for cash and shares of Company B.  The sale was effected at fair market value for tax purposes.

5.     Company B has not acquired any interest in the contracts themselves but rather an entitlement to 50% of the net revenue arising as a result of the package of contracts.

YOUR OPINION

Your concern is solely with respect to the income tax treatment of Company B's acquisition of the NRI described in paragraph 4 of the facts.

It is your opinion that Company B's purchase of the NRI enabled Company B to "carry on its business" and thus could be viewed as acquisition of any of a franchise, concession or licence contemplated at Class 14 for purposes of claiming capital cost allowance ("CCA") pursuant to paragraph 20(1)(a) of the Income Tax Act (the "Act").

TECHNICAL INTERPRETATION

The facts indicate that Company B has acquired a contractual right to share in Partnership A's net proceeds from purchase, processing and sale of natural gas, fees charged for use of gas processing facilities and construction of gas transportation pipelines.

ON ACCOUNT OF CAPITAL

Company B has clearly acquired a property.  "Property" is defined in subsection 248(1) of the Act and includes "property of any kind whatever whether real or personal or corporeal or incorporeal and without restricting the generality of the foregoing, includes (a) a right of any kind whatever...".  The NRI in the hypothetical situation constitutes a bare right to income and this right is a property within the meaning of subsection 248(1) of the Act.

In Gladys Evans vs M.N.R., 60 DTC 1047 (SCC), the court held that a payment in respect of a right to income is deductible for income tax purposes.  Cartwright J. wrote on behalf of the court at page 1050 that "the payment of the legal fees in question did not bring this right (the taxpayer's right to receive income from an estate) or any asset or advantage into existence".  This court case can thus be distinguished from Company B's situation because Company B's payment would bring its right to income, i.e. the NRI, into existence.

That the acquisition of a right to income is a capital transaction is established in The Queen vs Dr. Beverly A. Burgess, 81 DTC 5192 (F.C.T.D.).  In this case, the taxpayer acquired a right to maintenance income upon the divorce from her husband.  Cattanach, J. considered whether her legal expenses incurred to obtain her right to income, viz. the maintenance, were on account of income or capital.  He distinguished the Burgess case from the Evans case and wrote at page 5197 that "in the Evans case the appellant had an existing right to the income and expended the legal fees to obtain payment of that income which was denied her.  The (Evans) suit was for income".  In deciding the Burgess case, he stated at the same place that "... the legal expenses are in the nature of a capital expenditure, by bringing the right into being rather than in the nature of a revenue expenditure to enforce payment of income from a right in being".

Similarly, in The Queen vs David A. Sadovoy, 88 DTC 6065 (F.C.T.D.), Teitelbaum, J. wrote with respect to expenses incurred to obtain a right to income.  He cited the Burgess case and wrote at page 6071 that "the expense incurred to obtain a new right is not a deductible expense under paragraph 18(1)(b) of the Income Tax Act".

Clearly, notwithstanding that the NRI is a right to income, Company B's acquisition thereof would be on account of capital and therefore Company B's cost of acquisition would not be deductible.

CLASS 14

With respect to whether the right itself, which is a property, could be included in Class 14 as a franchise, concession or licence, it is our view that the NRI would not be so included.

It is generally accepted that the words licence and concession must be given the meaning or sense in which they are employed by businessmen.  A "licence" does not create any estate or interest in the property to which it relates.  For greater certainty, a licence does not alter or transfer property but only makes an action lawful which, without it, would be unlawful.  Accordingly, in our view the NRI acquired by Company B would not constitute a licence for purposes of Class 14.

A "concession" contemplates a right to use or occupy a property for a limited time as, for example, a right of way.  A useful comparison in this regard may be the use of the word "concession" in Class 23 of Schedule II of the Regulations relating to assets used in Expo '67.  The NRI, which is a contractual right to income and not a right to use or occupy property, would not be a concession contemplated at Class 14.

Without quoting the numerous court cases which relate to the meaning of "franchise", the conspicuous feature of a franchise in these court cases, which you alluded to in your references to the cases of Capital Management Ltd. vs M.N.R., 68 DTC 5041 (S.C.C.) and Mandrell Industries, Inc. vs M.N.R., 65 DTC 5142 (Ex. Ct.), is that franchise, concession or licence refer to some right, privilege or monopoly to enable the franchise holder to carry on his business or that facilitates the carrying on of his business.

In M.N.R. vs Canadian Glassine Co. Ltd., 76 DTC 6083 (F.C.A.), the court considered whether a franchise was acquired for purposes of Class 14 in circumstances where the taxpayer paid for the cost of installing two underground pipelines, which were owned by another party, to its manufacturing plant in order to obtain a steady supply of slush pulp and steam.  Pratte, J. stated at page 6083 that "I must now consider the respondent's submission that the expenditure, assuming it to have been an outlay on account of capital, had been made to acquire a franchise with the result that the respondent could, in the computation of its income for the years under consideration, deduct a capital cost allowance under section 11(1)(a) of the Income Tax Act and section 1100(1)(c) of the Regulations.  That contention appears to me to rest on the false assumption that there is a franchise every time a person enjoys a right.

This is not so.  Whatever may be the precise meaning of the expression "franchise" in the Income Tax Regulations that expression refers to a right, granted to a person, to carry on an activity which, otherwise, that person could not have carried on, at least in the same conditions."

Having regard to the above, it is our view that the NRI, which is a bare right to income, does not fall within the meaning of a property that is a franchise, concession of licence for purposes of Class 14.

CANADIAN RESOURCE PROPERTY

Since the aforementioned NRI would entitle Company B to share in non-production sources of income such as the net proceeds on the use of Partnership A's gas processing facilities, fees for Partnership A's construction of certain gas lines and Partnership A's gas processing operations, the NRI would not qualify for treatment as a Canadian resource property pursuant to paragraph 66(15)(c) of the Act.

ELIGIBLE CAPITAL EXPENDITURES

The foregoing discussion indicates that Company B's cost of acquiring the NRI would be considered as a non-deductible, non-depreciable capital outlay.

Whether or not the outlay is made by Company B with respect to income from property or in respect of a business is a question of fact that can only be determined by examination of all of the relevant facts of the particular situation.  The necessary facts for such a determination have not been provided in the hypothetical situation.

Assuming however that the outlay was made in respect of a business carried on by Company B, the outlay to acquire the NRI may qualify for treatment as an eligible capital expenditure pursuant to paragraph 14(5)(b) of the Act.

In this regard, it is worthy to note that in rendering his dissenting judgement in The Queen vs. Goodwin Johnson (1960) Ltd., 86 DTC 6185  (F.C.A.), Pratte J. stated at page 6191 that, in deciding whether a payment received by a taxpayer constituted an eligible capital expenditure, it was necessary to determine (1) what consideration was given by the taxpayer for the payment, and (2) whether, if the taxpayer had made a payment for that consideration, that notional payment would have been an eligible capital expenditure in respect of the taxpayer's business.  In the Goodwin case, the taxpayer received a settlement payment for cancellation of a business contract.  Pratte J. concluded that the consideration that the taxpayer gave for receipt of the settlement payment was its rights under the contract and that if Goodwin had paid an amount to acquire those rights, that payment would have been on capital account and hence an eligible capital expenditure.

Where the outlay is made by Company B with respect to income from property, the outlay to acquire the NRI would be added to the adjusted cost base of the NRI pursuant to paragraph 54(a) of the Act.

The above comments are merely the expressions of opinion of those Revenue Canada officials named herein and as such should not be construed as advance income tax rulings, nor are they binding on the Department.  Our practice is to make this specific disclaimer in all instances in which we provide an opinion.  We refer you in this respect to paragraphs 21 and 24 of Information Circular 70-6R.

Yours truly,

J.T. GauvreauChiefResource Industries SectionBilingual Services & ResourceIndustries DivisionRulings Directorate