2017-0695131C6 2017 CPTS CRA Round Table Questions

Principal Issues: Questions at CRA Round Table at 2017 Canadian Petroleum Tax Society Conference.

Position: See below.

Reasons: See below.

Author: Wharram, Kimberley
Section: ss. 2(3); 111(5); 115(1)(b); "taxable Canadian property" - 248(1); "Canadian resource property" - 66(15); Reg. 1101(1); Class 7, 26 and 49; Article 13 of Canada-UK Tax Treaty; section 5 of Income Tax Conventions Interpretation Act

2017 CPTS Roundtable - June 7, 2017

Question 1

In Question 1 of the 2014 Alberta Round Table organized by CPA Canada, various questions were asked regarding the decision of the Supreme Court of Canada (the “SCC”) in Daishowa-Marubeni International Ltd. v The Queen (2013 SCC 29) (“Daishowa”).  In its response, the Canada Revenue Agency (the “CRA”) extends the principles of Daishowa to the resource industry.  Since all industries are subject to environmental laws which arguably "embed" an environmental liability with a property, why does the CRA limit the application of the Daishowa principles to the resource industries?

Response to Question 1

The SCC in the Daishowa case dealt specifically with reforestation obligations, not environmental liabilities in general. However, reclamation obligations in the mining and oil and gas industries are very similar to reforestation obligations: both require the owners of the exploitation rights or the forest tenures to return the related property to its original condition. The SCC also implied, in obiter dicta, that its decision could apply to reclamation obligations in the mining and oil and gas industries. For these reasons, the CRA accepts the application of the decision in Daishowa to the mining and oil and gas industries where there is an embedded obligation.

The SCC did not give clear criteria as to when it would consider an obligation to be embedded. It is CRA’s position that reforestation obligations in the forest industry and reclamation obligations in the mining and oil and gas industries are generally embedded in the related tenures or rights, as they cannot usually be severed and would therefore depress the value. Furthermore, the CRA’s position does not generally extend to sales transactions outside the resource industries but we are willing to consider fact situations on a case by case basis. It remains our position that the Daishowa case does not apply where there is a distinct, existing liability, as opposed to an embedded obligation.

Response prepared by Jan Tollovsen and Jane Stalker, Industry Specialist Services and Leslie Bafia, Legislative Applications Section, International, Large Business and Investigations Branch, in collaboration with Nicolas Bilodeau and Kim Wharram, Income Tax Rulings Directorate

Question 2

Paragraph (d) of the definition of Canadian resource property ("CRP") in subsection 66(15) of the Income Tax Act (Canada) (the “Act”) states that a rent or royalty will qualify as a CRP where, among other things, the payer of the rent or royalty has an "interest in" the well or accumulation.  Can the CRA advise on whether the word "interest" in this context requires a real property interest?  If not, what type of "interest" is required?  Is it enough to have a contractual interest?

Response to Question 2

An “interest” in the well or accumulation for the purposes of paragraph (d) of the definition of CRP in subsection 66(15) requires that the payer must have a right to take production from the well or accumulation.  For example, a farmee who drilled a well pursuant to a farm-out agreement generally has an interest in the well. Also, a lessee under a Crown lease has a right to take production from the accumulation and is considered to have an interest in the accumulation. Of course, the conditions in paragraph (d) of the definition CRP in subsection 66(15) must be met and the general anti-avoidance rule may apply to abusive transactions.

Response prepared by Zul Ladak, Cam Morash, Jane Stalker, Industry Specialist Services, International, Large Business and Investigations Branch, in collaboration with Nicolas Bilodeau and Stéphane Prud’homme, Income Tax Rulings Directorate 

Question 3

Under paragraph 5 of Article 13 of the Canada-United Kingdom Income Tax Convention (the "Convention"), gains from the alienation of shares, other than shares quoted on an approved stock exchange, deriving their value or the greater part of their value directly or indirectly from immovable property situated in Canada, or from any right referred to in paragraph 4 of Article 13, may be taxed in Canada.

Paragraph 2 of Article 6 of the Convention defines the term “immovable property” for purposes of the Convention.  It states that the term “immovable property” shall be defined in accordance with the law of the Contracting State in which the property in question is situated.  But in any case, it shall include rights to variable or fixed payments as consideration for the working of, or the right to work, mineral deposits, sources and other natural resources.

In addition, section 5 of the Income Tax Conventions Interpretation Act defines “immovable property” for purposes of the Convention to include:

(a)    any right to explore for or exploit mineral deposits and sources in Canada and other natural resources in Canada, and

(b)    any right to an amount computed by reference to the production, including profit, from, or to the value of production from, mineral deposits and sources in Canada, and other natural resources in Canada.

However, paragraph 7 of Article 13 of the Convention states that for the purposes of paragraph 5 of Article 13, the term “immovable property” does not include any property (other than rental property) in which the business of the company was carried on.

Rights referred to in paragraph 4 of Article 13 of the Convention are:

(a)    any right, licence or privilege to explore for, drill for, or take petroleum, natural gas or other related hydrocarbons situated in Canada, or

(b)    any right to assets to be produced in Canada by the activities referred to in sub-paragraph (a) or to interest in or to the benefits of such assets situated in Canada.

If a U.K. resident disposes of shares of its Canadian subsidiary that derive the greater part of their value from rights related to an active oil and gas business, is the gain on the disposition exempt from tax in Canada given that resource rights are declared to be immovable property, and, for the purposes of paragraph 5 of Article 13 of the Convention, immovable property does not include property in which the business of a company was carried on?

Response to Question 3

Under subsection 2(3) and paragraph 115(1)(b) of the Act, a U.K. resident is taxable in Canada on taxable capital gains from the disposition of “taxable Canadian property”, as that term is defined in subsection 248(1) of the Act.  We assume that the shares described in the question are taxable Canadian property to the U.K. resident.  Therefore the U.K. resident is taxable under the Act on the disposition of the shares, unless the gain is exempt under the Convention.

Gains from the alienation of shares described in paragraph 5(a) of Article 13 of the Convention may be taxed in Canada if the shares derive their value or the greater part of their value directly or indirectly from:

*    immovable property situated in Canada, or

*    any right referred to in paragraph 4 of Article 13 of the Convention, which describes certain rights related to petroleum, natural gas, or other related hydrocarbons situated in Canada.

Assuming that the shares of the Canadian subsidiary (which carries on an active oil and gas business) derive the greater part of their value from rights described in paragraph 4 of Article 13 of the Convention, then Canada retains its right to tax the gain on the alienation of those shares. It is not necessary to determine whether the shares derive their value from immovable property as defined in the Convention or the Income Tax Conventions Interpretation Act.

Response prepared by Lori Carruthers and Sherry Thomson, Income Tax Rulings Directorate

Question 4

Generally, where a taxpayer is subject to a "loss restriction event" ("LRE"), subsection 111(5) precludes the taxpayer from deducting non-capital losses from a business carried on prior to the LRE ("Pre-LRE Business") in a taxation year ending after the LRE, unless the taxpayer continues to carry on the Pre-LRE Business after the LRE.  Further, the taxpayer's pre-LRE non-capital losses may be deducted for a taxation year ending after the LRE only to the extent of post-LRE income of the taxpayer from the Pre-LRE Business or a business similar to the Pre-LRE Business.

(a)    Could the CRA provide a summary of positions it has previously taken regarding the circumstances in which specific oil and gas production activities and/or properties would form part of the same business for purposes of subsection 111(5)?

(b)    Could the CRA provide a summary of positions it has previously taken regarding the circumstances in which specific oil and gas production businesses would be similar to one another (if the businesses are not considered part of a single business)?

Response to Question 4 

4(a) In technical interpretation 9234795, the CRA commented on a situation where a taxpayer operated oil or gas wells in one province prior to an acquisition of control and then acquired new oil or gas wells in another province after the acquisition of control.  That document suggests that the new oil or gas wells would be considered to be a different business than the pre-acquisition of control business.  However, the focus in that document is on the “similar properties” test in subsection 111(5) (discussed in the next part of the question). The CRA did state in that document that the place of production will not by itself determine whether the same business is conducted after the acquisition of control.  All the facts and circumstances of a particular situation would need to be considered in order to determine whether a taxpayer engaged in oil and gas production activities was carrying on the same business after an LRE as the business it carried on before the LRE.

4(b) In technical interpretation 9234795 (which we just discussed), the CRA stated that oil or gas from wells located in one province would be considered to be a “similar property” for the purposes of subsection 111(5) as oil or gas from wells located in another province.  To our knowledge, the CRA has not taken a position on whether a particular type of hydrocarbon is similar to a different type of hydrocarbon in the context of subsection 111(5).  However, in technical interpretation 9314945, the CRA opined that where a corporation carries on the business of mining and selling metallurgical coal as well as the business of mining and selling other minerals, income therefrom will be considered to be derived by those businesses from the “sale, leasing, rental or development…of similar properties” for the purposes of subparagraph 111(5)(a)(ii) provided that the other conditions in paragraph (a) are met.  The same document confirms the CRA’s view that “similar” is to be interpreted narrowly, stating, “ In our view, the word “similar” in the context of subsection 111(5) of the Act has a narrower meaning than “having characteristics in common” and should be interpreted as “of the same general nature or character”.  This interpretation is based on the case of Barnwell Consolidated School District No. 15 v. Canadian Western Natural Gas, Light, Heat & Power Co. ((1922) 69 DLR 401 (Alta SC (AD)).

The following quotation, at pages 410-411, from that case is relevant. (Note that in this case the word "similar" was being interpreted in the context of the Corporation Taxation Act, 1907 (Alberta)):

"It is, of course, rather strange that rights or obligations with respect to taxation should be made to depend upon a question of "similarity" for there are undoubtedly varying degrees of similarity. For this reason it is obviously difficult to decide what exactly is intended by the expression. The choice ranges from the one extreme of saying that it means "exactly alike" or "similar" in the sense of being completely the same, to the other extreme of saying that it would apply wherever there is any quality of likeness at all, although all other qualities or elements in the tax may be quite unlike. In my opinion, however, the proper way to interpret the expression is to treat it as meaning "of the same general nature or character." In this way, I think that we avoid both the extremes to which I have referred and we ought, I also think, to avoid them, for clearly neither would be proper to adopt."

Response prepared by Zul Ladak, Cam Morash, Jane Stalker, Industry Specialist Services, International, Large Business and Investigations Branch, in collaboration with Nicolas Bilodeau and Kim Wharram, Income Tax Rulings Directorate

Question 5

Assume that a corporation ("Opco") is in the business of exploring, developing and producing hydrocarbons at various locations in Canada. None of the operations occurring at any particular location are treated as separate businesses for accounting or tax purposes by Opco. From time to time Opco will dispose of certain properties in Canada and/or acquire certain properties in Canada. Certain field personnel perform their duties solely with respect to the operations carried on at a particular location whereas certain other field personnel and most head office personnel perform their duties with respect to all of the activities of Opco.

(a)    Would the CRA agree that Opco is carrying on a single business for purposes of the Act such that the acquisition of a property or disposition of a property is not the acquisition or disposition of a separate business for purposes of the Act?

(b)    If the CRA is of the view that more information is required to answer the preceding question, can the CRA describe the additional information that would be required for the CRA to be able to conclude that Opco is carrying on a single business for purposes of the Act?

(c)    If Opco's operations are expanded to include a type of hydrocarbon exploration, development or production that it previously was not undertaking or not primarily undertaking, would the CRA's response change? For purposes of this question, assume that it expands:

(i)    from primarily conventional oil exploration, development and production, with incidental gas exploration, development or production, to include more substantial gas exploration, development or production activities, or vice versa;

(ii)    from primarily conventional in-situ oil exploration, development and production to include non-conventional in-situ oil exploration, development or production, or vice versa; or

(iii)    from primarily in-situ oil exploration, development and production to include surface mining exploration, development or production, or vice versa.

(d)    In technical interpretation 9234795, the CRA expressed the view that oil and gas properties acquired in Alberta after an acquisition of control were a separate business relative to production activities from properties located in Saskatchewan and owned prior to the acquisition of control. The CRA acknowledged in that document that the place of production was not determinative. Assuming that it is not the CRA's position that oil and gas production activities undertaken in two separate provinces would necessarily constitute two separate businesses, regardless of the nature of the activities or the properties in the two provinces, can the CRA:

(i)    confirm that separate businesses are not being carried on if the only material difference between activities is the place of production,

(ii)    explain what factors lead to the conclusion in this document that separate businesses existed, and 

(iii)     indicate the current position of the CRA?

Response to Question 5

In our answers to parts (a), (b) and (c), we assume that the issue of separate businesses is in the context of subsection 1101(1) of the Income Tax Regulations (the “Regulations”) which prescribes separate capital cost allowance (“CCA”) classes for properties of separate businesses. One of the implications of a prescribed separate class is that there may be a terminal loss or recaptured depreciation on the disposition of properties of a particular separate class.

(a) and (b):

The determination of whether an entity is undertaking one business or separate businesses would depend on the facts of the situation. There are substantial jurisprudence and pronouncements from the CRA (including IT-206R) which would assist in this determination. The case Scales (H.M. Inspector of Taxes) v. George Thompson & Company, Limited (1927), 13 TC 83 (Eng. KB) (“Scales”) sets out the test for the determination of whether certain operations are a separate business. The test in this case has been adopted by the Canadian courts. Also, the Federal Court of Appeal in Du Pont Canada Inc. v. The Queen, 2001 DTC 5269 (FCA) set out a number of additional factors for this determination.

Paragraph 2 of Interpretation Bulletin IT-206R draws from the Scales case and states that sufficient interconnection, interlacing or interdependence between the operations would point to the operations being the same business.

In respect of the particular scenario described, the determination of whether a person is carrying on a single business or multiple separate businesses is fact driven and a general answer would not be appropriate.

We do acknowledge that, in the oil and gas industry, it is common for businesses to acquire properties and dispose of non-core properties on a continual basis. Generally, the acquisitions and dispositions during the normal course of business would not be considered acquisitions or dispositions of separate businesses.

(c)    (i), (ii) and (iii)

The exploration and development of types of hydrocarbons by a person may change for various reasons over time, including the discovery of different formations, technological advances, availability of transportation/transmission of the products, supply and demand, and market conditions.

In respect of the particular scenarios described, the determination of whether new activities undertaken by a person as part of an expansion of its operations form part of one of its existing businesses or result in a separate business is fact driven and a general answer would not be appropriate.

(d)    (i), (ii) and (iii)

We discussed technical interpretation 9234795 in the response to the previous question (Question 4), as it concerns the application of subsection 111(5), and does not deal with subsection 1101(1) of the Regulations.

Response prepared by Zul Ladak, Cam Morash, Jane Stalker, Industry Specialist Services, International, Large Business and Investigations Branch, in collaboration with Nicolas Bilodeau and Kim Wharram, Income Tax Rulings Directorate

Question 6

On April 17, 2009, the Department of Finance invited interested parties to participate in a consultative process regarding the creation of accelerated CCA on equipment used in carbon capture and storage projects.  The idea was to provide tax incentives for such projects similar to accelerated CCA, which is currently used to promote investment in certain clean-energy generation technologies (e.g., class 43.2 provides 50% tax depreciation, based on the declining balance method).

Has the Department of Finance/CRA reached/communicated a conclusion in response to the consultative process?

Response to Question 6

In response to the consultation, Budget 2010 included the following paragraph (page 103):

“As announced in the Economic Action Plan, the Government conducted a consultation on the tax treatment of carbon capture and storage assets. The Government will continue to monitor the development of this important technology and assess the best policy approach. The current focus is on direct funding through initiatives like the Clean Energy Fund.”

Response prepared by Department of Finance

Question 7

The CRA is of the view that the costs incurred on the acquisition of new catalysts qualify as property of Class 26 (depreciable at 5%, declining balance method).  The CRA is also of the view that any costs incurred to regenerate catalysts may be expensed, for tax purposes, provided that the regenerated catalyst has the same life expectancy or is not otherwise an improvement over the previous catalyst.

Most modern refinery catalysts have a useful life of 1 to 3 years and are disposed of at the end of this period.  Regenerating non-precious metal catalysts (the majority of refinery catalysts fall into this category) is not desirable due to the significant lower effectiveness of regenerated catalysts.

Generally tax depreciation is intended to be roughly correlated with the expected useful life of an asset; and, as such the question arises whether the low tax depreciation rate of 5%, on new catalysts is reasonable, given that most oil and gas companies do not use regenerated catalysts.  Can the CRA provide an update on its position?

Response to Question 7

Our position remains that the cost of catalysts is properly classified as Class 26, deductible on a declining basis at 5% per year.  If there is inequity in this treatment, it can only be corrected by a legislative amendment, which is the responsibility of the Department of Finance. We suggest you make a submission to the Department of Finance.

Response prepared by Zul Ladak, Cam Morash, Jane Stalker, Industry Specialist Services, International, Large Business and Investigations Branch

Question 8

The CRA has historically had administrative positions on allocating the cost of a pipeline between the cost of the pipeline itself and the "appendages". The definition of pipeline in Class 49 now includes ancillary equipment and Class 7 contains pumping and compression equipment and certain ancillary equipment. Can CRA provide an update on how to breakdown equipment costs for pipelines in Class 49 which may include compression and pumping equipment in Class 7?

Response to Question 8

The CRA is not aware of any historical administrative position for allocation of costs between a pipeline and its appendages. The CRA’s guidance in various advance income tax rulings and specifically Interpretation Bulletin IT-482 only discusses the classification of pipelines and appendages.  The following excerpt from Interpretation Bulletin IT-482 is an example of the guidance the CRA provided:

“Where an attachment to a pipeline is not an integral and component part of the pipeline, it is considered to be separate equipment from that of the pipeline (a "pipeline appendage"). This position is based on the decisions in the court cases British Columbia Forest Products Limited, 71 DTC 5178, [1971] CTC 270 (S.C.C.); Northern and Central Gas Corporation Limited, 87 DTC 5439, [1987] 2 CTC 241 (F.C.A.); Nova, an Alberta Corporation, 88 DTC 6386, [1988] 2 CTC 167 (F.C.A.); and Pacific Northern Gas Limited, 91 DTC 5287, [1991] 1 CTC 469 (F.C.A.). Pipeline appendages generally include equipment such as compressor stations, regulating stations, liquefying and storage facilities, meters, metering stations, hydrants, pumping equipment (e.g., engines, motors, pumps and costs of installation, such as wiring, transformers and special foundations) and pumping stations.”

These documents do not provide any guidance as to how costs are allocated between pipelines included in class 49 and equipment included in class 7.  However, it is our understanding that there is sufficient information at the disposal of taxpayers, such as detailed engineering documents, progress reports, authorizations for expenditures and invoices, to enable a reasonable allocation of costs, including general contractor costs.

Response prepared by Zul Ladak, Cam Morash, Jane Stalker, Industry Specialist Services International, Large Business and Investigations Branch

Kimberley Wharram
2017-069513
June 7, 2017

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