7 April 1991 Income Tax Severed Letter - Widespread Farm-out

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.

Dear Sir:

Re: Widespread Farm-out

We are writing in reply to your letter dated February 22, 1991 wherein you requested a technical interpretation pertaining to a hypothetical arrangement described herein.

HYPOTHETICAL ARRANGEMENT

• 1. Company A owns oil and gas rights in various non-producing properties which are geographically dispersed throughout Alberta. Each property is a Canadian resource property under paragraph 66(15)(c) of the Income Tax Act (the "Act").
• 2. Company B enters into a farm-in agreement with Company A.
• 3. The farm-in agreement provides that Company A would transfer an interest in one of its non-producing properties to Company B in exchange for Company B incurring all costs of drilling a well and completing or capping and abandoning the well, as the case may be. Company B would also incur the costs of acquiring all necessary depreciable properties.
• 4. The well would be located on one of Company A's non-producing properties that is not contiguous to the property in which Company B would receive an interest.

YOUR QUESTION

You ask whether the implementation of the above arrangement will result in

• (i) Company A recognizing proceeds of disposition of a Canadian resource property, or
• (ii) the transactions falling within the administrative policy enunciated in paragraph 11 of Interpretation Bulletin IT-125R3 so that Company B would be considered to have incurred all of the costs of depreciable properties, exploration and development, as the case may be, with the attendant income tax results and Company A would not have to recognize proceeds of disposition of a Canadian resource property.

OUR COMMENTS

It is our view that the hypothetical arrangement described above would result in Company A having to recognize proceeds of disposition of a Canadian resource property and the administrative police enunciated at paragraph 11 of IT-125R3 would not be applicable.

Our current position with respect to farm-out arrangements is that the administrative policy at paragraph 11 of IT-125R3 applies to the simplest farm-out arrangement whereby Company A, for example, would transfer an interest in a specific unproven property to Company B in exchange for Company B carrying out the exploration and development work on that particular property or a contiguous unproven property.

In the simplest farm-out arrangement, it is our view that there is, indeed, a disposition of a resource property, but that there are no proceeds of that disposition. At that time that IT-125R3 was originally issued in 1973, the Department's best view of the tax was that, while there was a disposition, there was no readily ascertainable proceeds of disposition. This conclusion may be reached by following the principles in cases as MNR v. Benaby Realties Limited [[1967] C.T.C. 418] [1967] CTC 418, Vaughan Construction Company Limited v. MNR [[1970] C.T.C. 324] [1970] CTC 324, and Maple Leaf Mills Limited v. MNR [[1976] C.T.C. 324] [1976] CTC 324, which indicate that, without a determinable quantum of proceeds, there is no amount receivable with respect to the property parted with.

The administrative policy at paragraph 11 of IT-125R3 does not apply to depreciable property. Where Company A, for example, receives an interest in any property from Company B which may be readily valued, including as or oil well equipment, it is our view that Company A has received an amount which represents proceeds of disposition of a resource property. This does not mean that Company B's exploration and development expenses represent a quantifiable amount receivable by Company A which amount would also proceeds of disposition to Company B.

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 22 of Information Circular 70-6R2.