2 September 1983 Income Tax Severed Letter 7-2647

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department. Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Freehold Delay Rental Costs

This is in reply to your memorandum of June 15, 1983 in which you request a statement of our position on the proper treatment of delay rental costs. We understand that this issue was raised by XXX of XXX with Messr. Robertson and Beith at a May 1983 Taxation Advisory Committee meetings. A copy of XXX subsequent submission on the topic was attached to your memo.

As stated in XXX submission, freehold delay rentals are annual payments made to the owners of land under an agreement which provides the payor with the rights to explore for and exploit the natural resources on or under the land. The agreements cover a number of years and usually provide for an initial payment on the signing date, known as a "bonus payment", and an annual payment on each anniversary of the agreement if the payor has not commenced efforts toward exploitation of the natural resources. The annual payments are ordinarily required of the payor until such time as be commences were on the property or terminates the contract. These annual payments are delay rentals. The decision to terminate can be made at any time during the period of the agreement.

A bonus payment to an owner of a resource property to acquire any right, licence or privilege to explore for, drill or take petroleum, natural gas or related hydrocarbons in Canada in respect of that property is proceeds of disposition to the owner and a cost to the payor of a resource property described in subparagraph 66(15)(c)(i). The amount paid may be brought into part I income of the recipient by virtue of clause 66.4(5)(b)(v)(A), subsection 59(1.2) subsection 66.4(1), subparagraph 66.2(5)(x), subsection 66.2(1) and paragraph 59(3.2)(c). if the recipient is a non-resident, he will be required to include any paragraph 59(3.2)(c) amount in his Part I income by virtue of subparagraphs 115(1)(a)(ii) or (iii.1) of the Act. If the recipient is a U. S. resident with no permanent establishment in Canada, the bonus payment is treated as a gain from the sale of a capital asset for purposes of Article VIII of the Canada-U.S. Tax Convention.

The Department has taken the position, since the decision in Sparrow v. M.N.R. [18 Tax A.B.C. 11] (57 DTC 453), that a delay rental payment constitutes proceeds of disposition of a resource property to the recipient, and a cost of a resource property to the payor/leasee. Although delay rental payments can be viewed as proceeds of disposition they also have certain characteristics of rent. They accrue by virtue of the passage of time like any other rent and they are paid for additional time in which to search for oil.

The opening words of paragraph 212(1)(d) subject to withholding of Part XIII tax an amount paid to a non-resident which is "...rent, royalty or a similar payment ...". In our view these words are broad enough to subject delay rentals to withholding of Part XIII tax, notwithstanding the fact that such payments can also be viewed as payments for resource property. We have maintained for many years that delay rentals were subject to withholding.

XXX stated that the Department's views on withholding would require review if we confirmed that delay rental payments were costs of acquisition of resource property. As explained above, delay rentals have elements both of rent and of the cost of property. In view of the uncertainty as to the proper characterization of delay rentals and the practice which has developed over the years, we do not recommend a change in our position at this time. We will, of course, re-examine this position if it is successfully challenged in the courts.

XXX suggested that if we took the position that payors should treat delay rental payments as acquisitions of property, then the abandonment of a delay rental agreement should result in the transfer of the delay rentals and initial bonus payment to Canadian exploration expense ("CEE"), as is the case for dry hole costs. Subparagraphs 66.1(6)(a)(ii) and (ii.1) specifically provide for the inclusion of the cost of dry holes in CEE. These costs would otherwise be included in Canadian development expense ("CDE") under subparagraph 66.2(5)(a)(i). Since there is no provision in the definition of Canadian exploration expense which would result in the inclusion there of the costs of resource properties otherwise includable in Canadian oil and gas property expense ("COGPE") under subparagraph 66.4(5)(a)(i), we cannot agree with XXX suggestion.