15 August 1985 Income Tax Severed Letter 0-230A

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.

We have a long-standing policy, adopted since the decision in the Sparrow case, [18 Tax A.B.C. 11] 1957 DTC 453 (T.A.B.), that in domestic situations delay rentals, which have characteristics common both to bonuses and rents, constitute proceeds of disposition of a resource property to the owner and a cost of a resource property to the lessee-payor.

A delay rental entails a lease with a development or production obligation that can be deferred by payment of an account. In the United States, a delay rental is income to the recipient.

Non-Residents
Pre-1985:

For many years, we have maintained that a delay rental received by a non-resident is a payment similar to a rent or royalty because it is dependent on the use of the property; and thus subject to Part XIII tax by paragraph 212ff(1)(d) of the Act.

In the case of a recipient who is a resident of the United States, if a position consistent with that applied to resident recipients of delay rentals had been taken so as to require a Part I return under subsection 2(3) and related subparagraph 115(1)(a)(iii.1) of the Act, the U.S. recipient would have been tax-exempt on such delay rentals (treated as proceeds of disposition of a resource property) by virtue of Article VIII of the Canada-United States Income Tax Convention, 1942 (the "1942 Convention").

1985:

The transitional provisions of Article XXX(5) of the Canada-United States Income Tax Convention, 1980 (the "1980 Convention") provide a U.S. resident with the tax treatment which is most beneficial under the 1942 Convention or the 1980 Convention.

Post-1984:

Delay rentals received by a U.S. resident are, except for 1985, subject to Canadian taxation as permitted by Article VI of the 1980 Convention whether taxed as proceeds of disposition of a Canadian resource property under Part I of the Act or taxed as rents or similar payments under Part XIII.

The Question

Should we maintain our present position that Part XIII applies to delay rental payments made to non-residents who do not have a permanent establishment in Canada in view of the above effects of the new treaty with the United States after 1985? That position has only been possible because we have argued that both Part I and Part XIII apply to such payments.

Recommendations

• 1. Since Part XIII treatment provides the easier administrative approach to collecting tax on delay rentals as opposed to the filing of a series of section 116 exemption certificates and subsequently, a Part I return, we recommend that the Part XIII treatment be continued but only for very narrowly defined "delay rental" payments.
• 2. However, if there is any purchase option or other transaction to which the delay rental payments relate, the amount of which could be affected by the rental payments, then the whole arrangement should be treated as a disposition of a resource property, whether made by a non-resident or a resident.
• 3. There does not appear to be a pressing need for clarification of the Part XIII provisions in respect of delay rentals for the moment. Our treatment of non-residents has always been open to an objection based on the Sparrow case (i.e. proceeds of disposition rather than rentals) but there appears to have been no complaints to date. Perhaps, in the United States sector at least, that is because our Part XIII treatment is consistent with the income treatment accorded their own domestic delay rentals under The Internal Revenue Code. In any event, a District Office survey conducted on our behalf by the Industry Studies Section of Audit Directorate revealed a relatively low volume and dollar value of delay rental transactions with non-residents.