7 April 1991 Income Tax Severed Letter - Crown Land for Agriculture Program

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: Crown Land for Agriculture Program (the "Program") Ministry of Forests and Lands British Columbia (the "Ministry")

We are writing in reply to your request of October 23, 1990 for our opinion as to whether certain "Bonus Bids" paid by taxpayers involved in the above-mentioned program represent the cost to them of acquiring timber limits for purposes of the Income Tax Act (the "Act").

Our understanding of the facts is as follows:

• 1. The Ministry from time to time offers parcels of crown land for lease/purchase in regards to the Program, the primary purpose of which is to open up land for agricultural purposes.
• 2. The offerings are made by public auction. In the example sent to us of a November 1987 auction, some twenty-two (22) such parcels were subject to bidding.
3. The land parcels are well described in Ministry publications for the benefit of prospective bidders with the following information being disclosed.
• • as required by B.C. law, individual parcels may not exceed 520 hectares (approx. 1285 acres);
• • these consist of arable/non-arable plots containing stated quantities of merchantable timber as established by Ministry timber cruises;
• • their location, means of accessing, the type of soil and topography, the services available, if any;
• • the amount spent by the Ministry to date on the parcels' development; and
• • the amount of the purchase price should the option to purchase be exercised.
• 4. Within five (5) days of an auction, the successful bidder is required to pay (i) the first annual lease rental, (ii) a small document or transactions fee, and (iii) the amount of his Bonus Bid.
• 5. The Ministry defines Bonus Bid as

"the amount that a bidder is prepared to pay above the established selling (upset) price of the parcel of land for the right to acquire an interest in the land."

• 5. A XXX
• 6. Upon payment as above, the successful bidder acquires a ten year agricultural lease of the land and a license to cut the timber thereon.
• 7. The lease comes with an option to purchase during its term. The option price is the lesser of a price stated in the lease or the fair market value of raw land at option date - subject to further deduction by stated credits to be earned by the lessee if Ministry land clearing (timber removal) and cultivation requirements are met. Finally, the option price is to be no less than the amount specified in the lease as having been spent by the Ministry in the land parcel's development.
8. In terms of timber administration on the leased crown agricultural lands, the following relevant information is noted:
• • as stated above, a license to cut timber is granted to the lessee;
• • stumpage rates are determined by current timber pricing policies;
• • as regards to "arable" lands (lands fit for ploughing and growing crops), the Ministry seeks timely cultivation and thus issues a license to cut a maximum of 80 arable acres at a time, and will not issue a license to cut the next 80 acres until at least 25% of the first is cultivated. Cultivation for this purpose is defined to mean, inter alia, "the clearing, grubbing, breaking and preparation of the soil to the extent that the land is ready for seeding." and clearing means, "cutting and removing all timber, brush ... as set out in the [Ministry's] clearing plan"; and
• • as regards to "non-arable" lands, the Ministry is prepared to allow timber management on a long-term basis under a "Timber Management Plan" if the lands are determined suitable to such an approach.
9. Upon deciding to exercise the purchase option of the agricultural lease, the lessee is given the choice of:
• a) paying for all remaining standing timber at that time,
• b) deferring payment of the relevant stumpage to such time as the timber is cut, but, agreeing however, to a proviso to his deed of land, reserving the timber to the Crown until such future payment.
• 10. Your review of the option prices in respect of the 22 parcels indicates that there is no major difference in the land values based on any timber on the property.

Issue

11. (a) Your question is whether the "Bonus Bids" paid to the Ministry result in the acquisition of a timber limit (a "limit") or right to cut timber from a limit (a "rtc") - which properties are depreciable in accordance with subparagraph 1100(1)(c) and Schedule VI of the Income Tax Regulations (the "Regulations"). Because of their reciprocal definition, your question is equally whether the payment results in the acquisition of a timber resource property (a "trp") in which case the property is depreciable in accordance with Schedule II of the Regulations as belonging in Class 33.
• (b) You also wish to confirm whether the exercise of the option (paragraph 7 above) would result in a deemed disposition pursuant to subsection 13(5.1) of the Act, as more fully detailed in paragraph 11 of Interpretation Bulletin IT464R [IT-464R], dated October 25, 1985.

Your Conclusions

12. Our understanding of your conclusions may be summarized as follows:
• a) payment of the Bonus Bids are made to obtain a right to acquire land and an automatic cutting permit which, together, in your view amount to a "right to cut timber from a limit", which property is depreciable according to Schedule VI of the Regulations and without a "residual value" as defined therein; and
• b) subsection 13(5.1) of the Act would apply on exercise of the purchase option, resulting in a deemed disposition (and a potential recapture in the event the timber limit is sold).

LAW

13. Subparagraph 13(21)(d.1) defines a trp of a taxpayer to mean
• (i) a right or licence to cut or remove timber from a limit or area in Canada (in this paragraph referred to as an "original right") if

(A) ... acquired ... other than in the manner referred to in subparagraph (ii) after May 6, 1974, and

(B) at the time of the acquisition of the original right

(I) the taxpayer may reasonably be regarded as having acquired ... the right to extend or renew that original right or to acquire another ... in substitution therefor, or

(II) ... may reasonably expect to be able to extend or renew that original right or to acquire another ... in substitution therefor, or

• (ii) any right or licence owned ... reasonably be regarded

(A) as an extension or renewal ... or

(B) ... acquired in substitution ...

• 14. A timber limit is not defined in the Act but paragraph 1100(1)(e) of the Regulations allows a deduction calculated in accordance with Schedule VI in respect of the capital cost ..." of a property, other than a timber resource property, that is a timber limit or a right to cut timber from a limit;"

14A. As stated in paragraph 5 of Interpretation Bulletin IT-481, it is the Department's position that land which is acquired as part of a timber limit is depreciable under Schedule VI of the Regulations and does not exist as a separate property for purposes of the Act. The position has the judicial support of the Supreme Court of Canada in the case of Highway Sawmills Limited v. M.N.R., [[1966] C.T.C. 150] 66 DTC 5116, wherein at 5120 Cartwright J. states:

"In my opinion, the phrase "timber limits" describes a parcel of land with merchantable timber standing upon it. It refers, ... to a corporal herediment. The phrase is used ... in contradistinction to the phrase "a right to cut timber from a limit", which is one apt to describe a profit a prendre."

Our Comments

• 15. It would appear that the above-mentioned (paragraph 13) test of "renewal" or "substitution" for trp characterization is not met in this case. While the licenses to cut (a rtc) issued by the Ministry in regards to arable lands are limited to 80 acres at a time and then, "renewed" for another 80 acres upon fulfilling land cultivation requirements, in our view this is simply a program-control mechanism and does not represent a Ministry intention to grant an open-ended right of extension, renewal or substitution as envisaged under the Act. The preferred view in our opinion is that, in effect, a single rtc is being granted to the lessee for the ten-year duration of the lease only, and only while he remains the lessee - with no provision for any extension, renewal or substitution.
• 16. As to the intent of the legislation, the "Explanatory Notes" to Bill C-49, given Royal Assent on March 13, 1975 commenting on paragraph 13(21)(d.1) state:

"This new provision defines "timber resource property". In essence, such a property is a right or license to cut or remove timber from a limit or area in Canada provided there is a right to extend, renew or substitute the property for more timber in future or there is a reasonable expectation that it may be so extended, renewed etc. ..."

Clearly then, the legislators recognized the distinctiveness of a secure, renewable, long-term cutting right (versus one of a transitory, exhaustible nature) and judged it appropriate to grant it special tax treatment.

The rtc's granted to lessees herein are for the limited purpose of removing specific and relatively small quantities of timber from lands that will thereafter serve primarily for agriculture. As such, they do not have the earmarks of a trp.

Rulings Position
(Re: Characterization of "Bonus Bid")

• 17. In light of the above, we are of the opinion that the so-called "Bonus Bids" represent payment for a right to cut timber from a timber limit, a property depreciable in accordance with subparagraph 1100(1)(e) and Schedule VI of the Regulations and not a payment for a trp. We agree with you that no part of the payment would entail provision for a "residual value" as defined in Schedule VI of the Regulations since the "Bonus Bids" represent the acquisition cost of a leasehold interest rather than a freehold interest in land.

Other: Effects of Exercise of Option to Purchase

Our views and Comments

• 18. Subsection 13(3.1) may apply anytime after March 31, 1977 where a person with a leasehold interest in a property acquires ownership of that property. Prior to its introduction, any balance of undepreciated capital cost ("U.C.C.") of the leasehold could be deducted as a terminal loss. The subsection eliminates the terminal loss by (1) deeming the leasehold interest to have been disposed for proceeds equal to its U.C.C., (2) adding the original cost of the leasehold to the relevant CCA class of the acquired freehold, (3) adding the CCA claimed to date on the leasehold to the total CCA allowed in respect of the freehold class. Thus, what would otherwise be claimed as terminal loss will now be allowed as CCA on the new freehold class, subject to possible recapture on a future disposition.

The provision applies where "... a taxpayer has acquired a particular property in respect of which, immediately before that time, he had a leasehold interest that was included in a prescribed class ..."

• 19. In regards to the lessees herein, we are satisfied that their acquisition of a leasehold interest in the land combined with a license to cut timber thereon constitutes a timber limit, hence, a depreciable property to be included in a separate prescribed class pursuant to subsection 1101(3) of the Regulations.
• 20. We concur therefore with your analysis that subsection 13(5.1) will apply on exercise of the option to purchase, resulting, as outlined in paragraph 18 above, in a deemed disposition of the leasehold interest and adjustments to the relevant CCA class of the acquired freehold such as to allow for a recapture on any future disposition of such freehold.
• 21. May we suggest that subsections 13(5.2), (5.3) should also be considered in the event of an exercise of the option to purchase. In general, these provisions apply any time after December 11, 1979 where a taxpayer has acquired a depreciable property, or real property for less than fair market value from a lessor and has paid rent for the use of that property which has been deducted in computing his taxable income. They provide rules to deal with the situation, as herein, where a taxpayer originally leases property, acquires that property pursuant to an option contained in the lease and later disposes of that property. The rules aim to ensure that a portion of amounts paid as rent will be recaptured where the property is sold for more than its actual cost. Generally this is accomplished by restoring the option price to fair market value to the extent of previously deductible rental payments (as more fully explained in paragraph 10 of Revenue Canada Interpretation Bulletin IT-233R, dated February 11, 1983.)
• 22. As indicated above (paragraph 7), a lessee's option price may be reduced below the property's fair market value at the time of exercise, as a result of the application of so-called "cultivation credits." These may in fact be such as to reduce the option price to "nil". In accordance with above-mentioned paragraph 10 of IT-233R, we believe subsections 13(5.2), (5.3) would apply in these circumstances.