2016-0637221E5 Rollover of Mineral Rights

Principal Issues: What are the tax consequences if mineral subsurface rights are transferred to a taxable Canadian corporation on a tax deferred basis?

Position: Where the Taxpayer transfers the Property to a corporation pursuant to subsection 85(1), the agreed amount can be any amount up to the fair market value of the Property. The deemed proceeds of disposition will reduce the Taxpayer’s CCOGPE balance if any. If the Taxpayer’s CCOGPE balance becomes negative, the amount is deducted from the CCDE. If the Taxpayer's CCDE balance becomes negative, the negative amount will be included in the Taxpayer’s income for that taxation year.

Reasons: Application of the law.

Author: Christov, Boriana
Section: s. 39(1)(a)(ii), 59(3.2)(c), 66(15), 66.2(5), 66.4(5); 85(1), 85(1.1)(c)

XXXXXXXXXX
                                                                                                            2016-063722
                                                                                                            Boriana Christov
                                                                                                            (438) 992-7393
February 7, 2018

Dear XXXXXXXXXX,

Re: Rollover of Mineral Rights

This is in response to your inquiry of March 15, 2016 concerning the tax consequences of a disposition of subsurface mineral rights (the “Property”) to a taxable Canadian corporation on a tax deferred basis. We apologize for the delay in responding.

I.    FACTS

You described the following fact situation:

1.    The owner of the Property (the “Taxpayer“) may or may not be the owner of the land.

2.    The Taxpayer is not in the business of exploration and development of mineral properties.

3.    The Taxpayer is not aware of the exact mineral resource content of the Property or whether petroleum, natural gas or related hydrocarbons could exist therein.

4.    The Taxpayer wants to transfer the Property to a taxable Canadian corporation on a tax deferred basis. In exchange for the transfer, the Taxpayer will receive shares of the capital stock of the acquiror corporation.

II.   OUR COMMENTS

Written confirmation of the income tax implications inherent in particular transactions is given by this directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request as described in Information Circular 70-6R7 dated April 22, 2016 issued by the Canada Revenue Agency (“CRA”). A fee is charged for this service. Although we are unable to provide any comments with respect to a particular fact situation otherwise than in the form of an advance income tax ruling, the following general comments may be of assistance.

Unless otherwise indicated, all references herein are to the Income Tax Act (footnote 1)  (the “Act”).

It is our understanding that the Property may consist of subsurface rights to explore for, drill for or take petroleum, natural gas or related hydrocarbons in Canada. Alternatively, the Property may consist of subsurface rights to prospect, explore, drill or mine for minerals in a mineral resource in Canada, other than a bituminous sands deposit or an oil shale deposit.

The particular tax treatment of the disposition of the Property will depend on whether the Property qualifies as a Canadian resource property (“CRP”). The term CRP is defined in subsection 66(15) as including among others: under paragraph (a) any right, licence or privilege to explore for, drill for or take petroleum, natural gas or related hydrocarbons in Canada; and under paragraph (b) any right, licence or privilege to prospect, explore, drill or mine for minerals in a mineral resource in Canada other than a bituminous sands deposit or an oil shale deposit. Consequently, it is our view that the Property will meet the definition of CRP.

If the Taxpayer is not in the business of exploring or developing resource properties and has not acquired the Property for value, we are of the view that the Taxpayer would not have incurred any Canadian development expense (“CDE”) as defined in subsection 66.2(5) and would not have a balance in his cumulative CDE (“CCDE”) as defined in subsection 66.2(5).

However, where the Taxpayer acquired the Property for value and the Property is a CRP under paragraph (a) of the definition, the cost of the CRP would represent a Canadian oil and gas property expense (“COGPE”) of the Taxpayer that would have been added to the Taxpayer’s cumulative COGPE (“CCOGPE”) balance pursuant to element “A” of the definition of that term in subsection 66.4(5). Where the Property is a CRP pursuant to paragraph (b) of the definition, the cost of acquiring the CRP would represent a CDE that would have been added to the Taxpayer’s CCDE pursuant to element “A” of the definition of that term in subsection 66.2(5).

The CRA’s position with respect to transfers of property to a corporation under subsection 85(1) is outlined in Interpretation Bulletin IT-291R3 (Archived), Transfer of Property to a Corporation Under Subsection 85(1) and Information Circular IC 76-19R3, Transfers of Property to a Corporation under Section 85, copies of which are enclosed herein.

A property that is a CRP is an “eligible property” pursuant to paragraph 85(1.1)(c). Consequently, the Taxpayer may transfer it to a taxable Canadian corporation pursuant to subsection 85(1) in exchange for consideration that includes at least one share of the corporation. Generally, where the Taxpayer and the corporation agree upon an amount that does not exceed the fair market value of the property and that is not less than the fair market value of any non-share consideration that is received, the amount agreed upon becomes (subject to certain specific limitations) the Taxpayer’s proceeds of disposition and the corporation’s cost of the property.

In the case of a CRP, the rules in subsection 85(1) do not establish a minimum limit for the agreed amount. Hence, where the Taxpayer transfers the Property to a corporation pursuant to subsection 85(1), the agreed amount can be any amount up to the fair market value of the Property. Pursuant to paragraph 85(1)(a), the agreed and elected amount is deemed to be the Taxpayer’s proceeds of disposition of the Property and the corporation’s cost of the Property.

In order for the provisions of subsection 85(1) to apply, a joint election must be made in prescribed form by both the Taxpayer and the corporation. The administrative procedures are discussed in IC 76-19R3.

As explained in Interpretation Bulletin IT-125R4 (Archived) – Dispositions of Resource Properties (enclosed herein), the disposition of CRP is specifically excluded from capital gains treatment by subparagraph 39(1)(a)(ii). Instead, where the Taxpayer disposes of oil and gas property, the Taxpayer’s CCOGPE balance will be reduced by the amount of the proceeds of disposition received by the Taxpayer as a result of the disposition, less outlays or expenses made or incurred for the purpose of the disposition and that are not otherwise deductible for the purposes of Part I of the Act. If the Taxpayer’s CCOGPE balance becomes negative as a result of this reduction, the negative amount is deducted from the Taxpayer’s CCDE by virtue of 66.4(1) and element “L” of CCDE definition in subsection 66.2(5). If the Taxpayer’s CCDE becomes negative as a result of this reduction, the negative amount will be included in the Taxpayer’s income for that taxation year pursuant to subsection 66.2(1) and paragraph 59(3.2)(c).

Where the Taxpayer disposes of a mining right that meets the definition of CRP in paragraph (b) there will be a reduction to the Taxpayer’s CCDE, under element “F” of the definition of CCDE in subsection 66.2(5).

The amount of the reduction to the Taxpayer’s CCDE is equal to the proceeds of disposition received by the Taxpayer as a result of the disposition, less outlays or expenses made or incurred for the purpose of the disposition and that are not otherwise deductible for the purposes of Part I of the Act. If the Taxpayer’s CCDE becomes negative as a result of this reduction, the negative amount must be included in income for that taxation year pursuant to subsection 66.2(1) and paragraph 59(3.2)(c).

We hope that these comments will be of assistance.

Yours truly,

Kimberley Wharram
Acting Manager, Resources Section
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy & Regulatory Affairs Branch

FOOTNOTES

Note to reader:  Because of our system requirements, the footnotes contained in the original document are shown below instead:

1  R.S.C. 1985, c. 1 (5th suppl.) as amended; hereinafter (the “Act”).

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