Section 162

In finding that an agreement between two forestry companies (Company A and B), under which A Co will manage and harvest timber within B Co's licences, was not for the right to exploit a forestry resource to which s. 162(2) applied, CRA noted that "a person, who cuts trees where the timber remains the property of the person who was originally granted the right to exploit the resource, is not utilizing the resource or turning it to account," and then stated:

In substance, the purpose of the agreement is for A Co to supply to B Co a service of cutting trees. This position is supported by the fact that…the agreement states that title to the felled timber passes to B Co when the timber is felled in accordance with the applicable B Co licence. … Since B Co already owns the logs, the amounts paid by B Co are not consideration for a supply of logs by A Co but would appear to be [taxable] compensation paid to A Co for cutting the timber.

On the other hand, under a second agreement, B Co grants to A Co (in this regard, a "Harvesting Party") the right to harvest timber under the B Co licences for its own consumption at its mills on the terms and conditions contained in the agreement, and A Co grants to B Co (in this regard, also a Harvesting Party) the right to harvest timber under the A Co forest licence for its own consumption at its mills. In finding that s. 162(2) applied to both supplies, CRA stated:

The… harvested timber becomes the property of the Harvesting Party at the moment it is felled. Thus, the agreement is not for a supply of cut timber… . Nor is the agreement for a supply of a service of cutting trees, since title to the cut timber passes from the licence holder to the Harvesting Party. Furthermore, if the agreement was for a supply of a service of cutting trees, the Harvesting Party performing the cutting would be receiving payment, not making payment.

However, the provision of the licence holder's planning, engineering and assessment work was a taxable supply.

The Optionor "options" mineral resource Tenures to an Optionee who is granted the right to explore the Tenures, and is required to make specified annual payments, to expend certain amount annually on exploration or development, to issue common shares of the Optionee and to assume all the costs for maintaining the Tenures. If these conditions are met, at the end of the specified period of XX years, the Optionor transfers title to the Tenures to the Optionee. In finding that the "optioning" under the agreement by the Optionor was a provision of natural resource rights in respect of an unproven property which s. 162(2)(a) deemed not to be a supply, CRA stated:

Strictly speaking, an option to acquire something is not necessarily the same as acquiring the thing itself and an option to acquire something is generally considered to be a supply. However…we do not consider the Optionor to be making a separate supply of the option. As long as the Optionee meets its obligations, it will automatically acquire the Tenure. It will be deemed to have exercised the Option, and no further consideration is paid. The nature of the Agreement is similar to a conditional sales contract for the sale of a good, whereby title to the good passes automatically upon full payment of the consideration.

Overview of section 162

1. Section 162 deems the following supplies of natural resource property rights not to be supplies for GST/HST purposes:

• a right to explore for or exploit a mineral deposit, a peat bog or deposit of peat or a forestry, water or fishery resource,
• a right of entry or user relating to such rights,
• any right to a royalty or profit interest in relation to the resource, or
• a right to enter or use land to generate or evaluate the feasibility of generating electricity from sun or wind.

Meaning of mineral ss 123(1)

3. "Mineral" includes... substances that are considered to be minerals within the ordinary meaning of that word. Although not specifically mentioned, rock and riprap are also included.

Meaning of explore and exploit

7. The Act does not define "explore" or "exploit" with respect to natural resources. The common meaning of explore is to search and discover, or to make or conduct a systematic search. The common meaning of exploit is to make productive use of or to utilize. Exploration and exploitation generally include activities up to, and at, the "central point", provided the central point for gas processing is located in, or adjacent to, the field. The "central point" is understood in the oil industry to mean the first storage battery after oil treatment for crude oil, and in the gas industry, to mean the facility at which natural gas is collected, cleaned and processed into saleable product for delivery to market.

Meaning of "to explore for natural resources"

8. "To explore for natural resources" refers to the search for a mineral deposit by geological surveys, geophysical prospecting, drilling boreholes and making trial pits, or surface or underground digging or tunneling.

Meaning of "to exploit a natural resource"

9. "To exploit a natural resource" means:

• for petroleum products, the extraction of the products from the earth and processing up to, and including, processing done at the battery for transformation into transportable crude oil, and including transportation to the battery;
• for natural gas, the extraction of the product from the earth and all processing up to, and including, the removal of natural gas liquids at a gas plant, and including transportation to the plant where the natural gas liquids are removed;
• for mining products, the excavation of the minerals from the earth and any processing not beyond, but including, the prime metal stage or its equivalent;
• for sand and gravel, the excavation of the product from the earth and all processing done to crush and filter the sand and gravel;
• for peat bogs or deposits, the extraction of the peat from the bog or the deposit;
• for forestry resources, the harvesting of trees;
• for water resources, the right to use or remove water; and
• for fishery resources, the removal of the resources at the site.

10. Exploitation does not include any additional processing of crude oil (e.g., refining) and any processing of gas downstream from a gas plant. It also does not include transportation to market or downstream to a central point. However, it does generally include transportation up to the central point.

11. Exploitation generally does not include storage rights (e.g., the storage of natural gas in anticipation of improved market conditions or the storage of natural gas in underground storage facilities). Certain storage rights may be considered a right of entry or user within the meaning of paragraph 162(2)(b) (e.g., storage facilities located in, or immediately adjacent to, an oil or gas field that are for the purposes of storing production from the field before the transfer to transportation or transmission facilities).

Freehold v. royalty

19. Subject to the exceptions set out in subsection 162(3), a supply of a right to explore for or exploit a mineral deposit, if supplied by itself, is deemed not to be a supply pursuant to subsection 162(2). Where the right to explore for or exploit a mineral deposit is only one component of a supply of a bundle of rights, subsection 162(2) does not apply because subsection 162(2) applies only to supplies of those rights that are specifically listed therein. Therefore, subsection 162(2) does not apply to a sale of a freehold mineral title or a sale of land that includes the underlying minerals.

Single or multiple supplies

... 24. Whether a single supply of a surface lease is within the scope of subsection 162(2) depends on the purposes and uses for which the land was leased. For example, if a lessee is using the land to complete a geophysical survey, to drill a well, or to extract oil or gas, then this single supply is a supply described in subsection 162(2) ... .

Royalty interest

25. In order to spread the risk when exploring for or exploiting a mineral deposit, a number of persons may have an interest in the property. The interest usually takes one of two forms – a royalty interest or a working interest. A royalty interest entitles the holder of the interest to a fee based on the units or value of production. A royalty interest can take a variety of forms including a gross overriding royalty. A gross overriding royalty is an interest in the revenue from the sale of a product (e.g., oil, gas, iron, or gold) produced at a specific property. It is usually expressed as a percentage of the gross revenue from the property before any expenses and claims by the working interest owner(s) are deducted ("working interest" is defined in paragraph 26 below). Subsection 162(2) deems the supply of such a right not to be a supply ... .

General synopsis of ss.162(1) and (2).

After noting that "special rules are in place in subsection 162(4) to eliminate the requirement to establish a value for certain property or services exchanged between a farmor and a farmee in a farm-out agreement that is entered into for the purpose of the exploration and potential development of real property for mineral deposits," CRA stated:

[B]y virtue of paragraph 162(4)(b), the farmee's contribution need not be valued for purposes of determining any tax on the property or services given by the farmor. This is achieved by deeming the value of the farmee's contribution as consideration for any property or service given by the farmor to the farmee under the agreement to be nil.

However, if part of the consideration given by the farmor for the farmee's contribution is a service or property (each of which is referred to as the farmor's additional contribution) that is not a natural resource right in respect of unproven property:

• the farmee is deemed to have supplied a separate taxable service to the farmor and this separate service is deemed to be consideration for the farmor's additional contribution; and
• the value of the farmee's service is deemed to be equal to the fair market value of the farmor's additional contribution.

CRA provided an example:

[A] GST/HST registered farmor supplies natural resource rights in an unproven property and transfers equipment with a fair market value of $8,000 to a farmee in return for the exploration and development of the unproven property, and a processing service to be provided by the farmee. The usual charge for the processing service performed by the farmee is $10,000. The farmor must charge the farmee tax calculated on the value of the equipment that the farmor is supplying to farmee (i.e., $8,000). In turn, the farmee is deemed to have supplied a service to the farmor for the same value of consideration that was paid for the equipment and must charge tax to the farmor, which is calculated on $8,000. The farmee must also charge the farmor tax on the processing service actually supplied.

However, the tax on the processing service is only calculated on $2,000 (the amount by which the value of the service exceeds the value of the equipment). Therefore, the farmee must charge tax on the total amount of $10,000 (the fair market value of the processing service).

Consequently, with respect to the ancillary supplies of property and services between the farmor and the farmee, each party is required to charge tax on the fair market value of the supply that they made and to pay tax on the fair market value of the supply that they received in return.