9 September 1994 GST/HST Interpretation 1994-09-09[1] - Surface Lease Agreements

This is further to your memorandum of January 11, 1993 to XXXXX and also your memorandum of September 9, 1993 to Gunar Ozols on the above-noted subject.

Surface lease agreements give resource and utility companies the right to use land for oil and gas exploration and pipeline and power line right of ways. Payment for the right of entry onto the land is considered a natural resource royalty, as described in subsection 162(1) and the granting of the right of entry is deemed not to be a supply and the amounts paid are therefore not subject to GST.

As we understand it, the amounts paid under a surface lease agreement by resource and utility companies to landowners are meant to compensate the owner in respect of a number of particulars. You attached a description of these particulars and they consist of such items as the value of the land, inconvenience and nuisance, loss of use of lands, adverse effect, severance and incidental damages. Usually, the agreement does not itemize the various particulars, and the amount paid is often identified simply as a "signing bonus" plus an "annual lease payment".

However, some agreements will break down the total amount paid into the particulars noted above. Moreover, where there is a dispute over any amounts to be paid, and the dispute is submitted to arbitration (as is commonly the case), the arbitrator will itemize the amounts awarded among the various particulars, even where the agreement itself does not do so.

As you have noted, Q & A number 6 A.340 states that where the total amount is itemized separately, only the amount which is consideration for the right to enter onto the land is covered by subsection 162(1). The other amounts are subject to GST. You wish to know the correct GST treatment where the amounts are not itemized separately.

We had requested sample copies of surface lease agreements, which you provided in your memorandum of September 9, 1993. However, some of these agreements were incomplete, and others were not strictly surface lease agreements, but rather petroleum and natural gas leases, easements for pipelines, or other types of land use agreements. However, in response to an enquiry from the XXXXX, we have reviewed a typical surface lease agreement used in XXXXX and we have revised our position as stated in the Q & A. Some of the documents provided to us by you are similar in nature to the XXXXX agreement. As discussed below, the answer may vary from case to case. Anyone wishing a conclusive determination in a particular case should submit the specific agreement for review. Nevertheless, we can provide some general guidelines to be used in reviewing a particular case.

In order to determine if the surface lease payments in question are within the scope of section 162, the surface leases must be reviewed on a case-by-case basis. The first issue that must be resolved during this review is whether the transaction in question involves a single supply or multiple supplies. Where there is a single supply it is then necessary to determine if that supply is a supply of entry or user related to the right to explore for or exploit a mineral deposit. Where, however, there are multiple supplies it necessary to determine if all, or any, of these supplies are within the scope of section 162.

To illustrate, a typical XXXXX Surface Lease Agreement" specified the following:

"Whereas the Lessor has agreed to lease and grant a certain portion of the said lands to the Lessee for the purposes and upon the terms and conditions hereinafter set forth:

"The Lessor, at the compensation hereinafter set forth, hereby leases to the Lessee all and singular those parts and portions of the said lands ... to be held by the Lessee as tenant for the term of twenty (20) years from the date hereof for any and all purposes and uses as may be necessary for the exploration, development and production of oil, gas, related hydrocarbons, or substances produced in association therewith ....

Yielding and paying to the Lessor:

For the first year the sum of ... dollars. First year compensation for the granting of these rights to the Lessee from the Lessor is set out as follows:

(a) market value of the land granted

(b) general disturbance

(c) loss of use

(d) adverse effect and severance

(e) other if applicable

"Annual compensation payable for each subsequent year due in advance of the anniversary date of the lease in the sum of ... dollars calculated as follows:

(a) loss of use

(b) adverse effect and severance

(c) other if applicable".

Based on the above, it appears that the object of the Agreement is "the lease and grant of a certain portion of the said lands" from the Lessor to the Lessee. The Agreement also specifies that the first year compensation is "for the granting of these rights to the Lessee from the Lessor" (i.e. the lease of the lands) and is set out in taking into account at least four (4) different factors. The consideration for the subsequent years is calculated based on the loss of use, adverse effect and severance, and other factors if applicable.

The provisions of the Agreement specify clearly that the intent of both parties is to lease the land and that the amounts indicated in respect of the market value, general disturbance, loss of use and, adverse effect and severance, are part of the consideration of the lease payable in the first year. It also appears that the compensation payable in the subsequent years is in respect of the lease and is merely calculated by using factors such as the loss of use and adverse effect and severance.

In addition, it does not appear that, in this example, the elements used to calculate the consideration are properties or services provided to (i.e. supplies made to) the Lessee.

Therefore, based on this sample Agreement, it may be considered that the Lessor is making a single supply to the Lessee, i.e. the lease of the land.

Whether the single supply in this case is within the scope of section 162 will depend on what "purposes and uses" the Lessee is using the land for. Where, for example, the Lessee is using the land to complete a geophysical survey, to drill a well, or to extract oil, gas or related hydrocarbons, the single supply would be deemed not to be a supply pursuant to paragraph 162(1)(b). Where, however, the Lessee is using the land for a pipeline to transport gas to market, the supply is not within the scope of section 162 and is taxable.

If you have any further questions, please contact Gunar Ozols at (613) 952-9589.

H.L. Jones
Director
General Tax Policy
Policy and Legislation

XXXXX