19 June 1991 Income Tax Severed Letter

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.

5911532
                                        John Shaw
                                        (613) 957-8963
          19(1)

June 19, 1991

          19(1)

This is in reply to your letter of June 3, 1991, in which you requested information regarding legislative changes under the Income Tax Act regarding prospectors since the January 1982 pamphlet entitled "You were asking about prospectors and grubstakers", is no longer in print.

Since January 1982, there have been relatively few legislative changes relating to matters discussed in the pamphlet. In fact, other than the last two paragraphs of the pamphlet, dealing with the treatment of shares received by the prospector or grubstaker as a result of transfers of property for shares in a mining corporation, which are inapplicable where the shares were acquired after May 22, 1985, and which we update below, the pamphlet continues to be a good reference source, although it should be kept in mind that the pamphlet is merely a discussion, in fairly general terms, of complex legislation, and is not a substitute for the Income Tax Law itself.

Our comments will assume, as did the pamphlet, that the prospector or grubstaker is an individual, rather than a corporation. Where a prospector or grubstaker has, after May 22, 1985, received shares of a corporation in exchange for his disposing of a right to prospect, explore, or mine for minerals, or of a property the principal value of which depends upon its mineral content to the corporation, the prospector or grubstaker continues to not be required to include an amount in income with respect to the acquisition of the shares. Otherwise, the rules pertaining to such situations have changed considerably.

                                                       .../cont'd

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When the prospector or grubstaker disposes of the shares, in most cases there will be two distinct income inclusions. These will not result in the same amount being reported twice - it is just that there are two sets of rules which come into play. Firstly, he is deemed to have an income inclusion of the lesser of the value of the shares at the time they were acquired by him and the value of the shares at the time of their disposition. He is entitled to a deduction equal to one-quarter of this amount. The net effect of the income inclusion and the deduction is the same as if the lesser of the fair value of the shares on their acquisition and the fair value of the shares on their disposition had been treated as a capital gain with the exception that the prospector or grubstaker will not be entitled to a capital gains deduction with respect to the amount. (In a relatively few cases, since the deduction permitted is made from "net income" in calculating "taxable income", rather than in computing "net income", there may be an effect on certain other deductions or tax credits which are calculated with reference to net income. In most cases in which there is such effect, it will be negligible in amount.)

In many cases, the fair value of the shares on their being disposed of by the prospector or grubstaker will exceed their value on being acquired by him. A gain represented by an increase in the value of the shares during this period may be fully includable in income, or may be a capital gain, depending on the circumstances. (Incidentally, the pamphlet, in suggesting that any gain under the rules then in existence would be a capital gain appears to be in error. There is jurisprudence, the McAdam case, from 1973, and the Kay case, from 1971, which suggest that whether the gain would be on income or on capital account depends on the facts of the situation. We note that one of the leading Canadian federal income tax services cites these cases in also suggesting that whether this part of the gain will be on capital or income account will depend on the facts.) Where the gain is a capital gain, the taxpayer will have a cost of the shares disposed of equal to the amount determined above which is the first income inclusion. A capital gains deduction may be available with respect to this gain. Where the gain is on income account, the amount included in income on the sale of the shares will be the sale proceeds less the first income inclusion. Where the value of the shares was lower at the time of their disposition than when they were acquired, there is no loss, capital or otherwise, recognized, nor need there be. Since the income inclusion is the lesser of the value of the

                                                       .../cont'd

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shares on their acquisition and on their disposition, the decline in value of the shares from their acquisition date will have been taken into account.

The following illustrates the rules currently in place. Assume a prospector exchanged a mining property in 1987 with a corporation for shares of the corporation then worth $25,000. He sold the shares in 1990 for $60,000. To simplify the mathematics, there were no costs of selling the shares.

The first income inclusion is, then, $25,000, the lesser of the two amounts. A deduction of one-quarter of $25,000, or $6,250, may be claimed by the individual.

As the value of the shares at the time of their sale exceeded that at the time they were acquired, a second computation is required. Assuming the gain is a capital gain, the gain is the proceeds on the sale of the shares, $60,000, less the cost of the shares, $25,000 (the first income inclusion), or $35,000. The capital gain included in his income will be three-quarters of $35,000, or $26,250. Subject to the rules regarding the limit on the lifetime capital gains deduction, a capital gains deduction may be available with respect to the $26,250.

The overall result, before taking into account any capital gains deduction is a net income inclusion of $45,000 $25,000-6,250+26,250) which is the result as though the $60,000 proceeds had been treated as a capital gain, three-quarters of which would be included in the individual's income.

As well, you wanted information regarding the applicability of the Goods and Services Tax to prospectors. We have forwarded a copy of your letter, together with the enclosures to:

Mr. Adrian Venne Director-Tax Policy, Special Sections Goods and Services Tax Group Excise Branch Revenue Canada 9th Floor Tower C 25 McArthur Rd. Ottawa KlA OL5 as we understand Mr. Venne's section would deal with such matters. Mr. Venne's phone number is 954-3552.

                                                       .../cont'd

                                                           000205

We enclose a copy of chapter 14(35) of our Taxation Operations Manual entitled "Audit Techniques Guidelines Relating to Prospectors and Grubstakers", which contains some general background information regarding prospectors and grubstakers which may be of some interest particularly given the dearth of published material in this area. There are two matters in the first subsection, 14(35)2.1(1), dealing with Income Tax Legislation which require comment. Firstly, the reserve once available for unpaid amounts on the sale of mining property has been repealed. Secondly, the statement that proceeds on the sale of shares received for mining property will be a capital gain may not always be correct, as discussed above in our remarks on the pamphlet.

Should you wish our comments regarding the income taxation of taxpayers engaged in a resource industry, please feel free to get in touch with us.

Yours truly,

for Director Bilingual Services & Resource Industries Division Rulings Directorate Legislative and Intergovernmental Affairs Branch

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