2018-0739741E5 Disposition of Freehold Mineral Rights in Canada

Principal Issues: What are the income tax consequences to a taxpayer of (i) an inheritance of freehold mineral rights in Canada, and (ii) a disposition of freehold mineral rights in Canada?

Position: (i) If the property is a Canadian resource property that is acquired by the taxpayer as a consequence of the death of another taxpayer, the taxpayer is deemed to have acquired the property at cost equal to its fair market at the time of the death and such cost would be added to the CCOGPE of the taxpayer if it is an oil and gas property or the CCDE of the taxpayer if it is a mineral property. (ii)Proceeds of disposition receivable by the taxpayer (less any selling expenses) on a disposition of a Canadian resource property will reduce the taxpayer's CCOGPE if the property is an oil and gas property or CCDE if the property is a mineral property. If the taxpayer's CCOGPE is negative at the end of the taxation year, the taxpayer's CCDE will be reduced by the negative amount. If the taxpayer's CCDE is negative at the end of the taxation year, the negative amount will be included in computing the income of the taxpayer.

Reasons: The provisions of the Income Tax Act (Canada).

Author: Verlinden, Nicole
Section: Sections 66.2, 66.4, Subsections 66(5), 70(5.2), 59(3.2) and Subparagraph 39(1)(a)(ii)

XXXXXXXXXX                                                                                                                                                2018-073974
                                                                                                                                                                        Nicki Verlinden
                                                                                                                                                                        (416) 954-0862
March 23, 2018

Dear XXXXXXXXXX,

Subject: Disposition of freehold mineral rights in XXXXXXXXXX, Canada

This letter is in response to your inquiry of January 16, 2018 concerning the tax consequences of a disposition of a fractional interest in freehold mineral rights located in XXXXXXXXXX (the “Property”) to an arm’s length purchaser. 

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

I.    FACTS

You described the following fact situation:

1.    A taxpayer that is an individual (the “Taxpayer”) inherited the Property in XXXXXXXXXX.

2.    The Property was initially acquired several decades ago by the Taxpayer’s ancestors who were XXXXXXXXXX.

3.    The Taxpayer is not, for the purposes of subsection 66(5), in the business of trading or dealing in rights, licences or privileges to explore for, drill for or take minerals, petroleum, natural gas or other related hydrocarbons. The Taxpayer is not in the business of exploring and developing resource properties.

4.    The Taxpayer received an offer to sell the Property, and wants to understand the income tax consequences of receiving sale proceeds in exchange for the Property.

II.    OUR COMMENTS

This technical interpretation provides general comments about the provisions of the Act. It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R7, Advance Income Tax Rulings and Technical Interpretations.

Nature of the Property 

The particular tax treatment of the disposition of the Property will depend on whether the Property meets the definition of a Canadian resource property (“CRP”) in subsection 66(15), which includes:

*    any right, licence or privilege to explore for, drill for or take petroleum, natural gas or related hydrocarbons in Canada (herein referred to as an “oil and gas property”); and

*    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 (herein referred to as a “mineral property”).

Income Tax Considerations Relating to the Inheritance

Pursuant to subsection 70(5.2), when a taxpayer dies owning CRP, he is deemed to have disposed of the CRP immediately before death and to have received proceeds of disposition equal to its fair market value (“FMV”) at that time. Any person who, as a consequence of the taxpayer’s death, acquires that CRP, is deemed to have acquired it at a cost equal to its FMV at that time. (footnote 2)

Where the CRP is an oil and gas property, the cost of the CRP would generally be a Canadian oil and gas property expense (“COGPE”) of the taxpayer which is added to the taxpayer’s cumulative Canadian oil and gas property expense (“CCOGPE”) pursuant to element “A” of the definition of that term in subsection 66.4(5) when it is deemed to have been acquired. Where the CRP is a mineral property, the cost of the CRP would generally be a Canadian development expense (“CDE”) of the taxpayer which is added to the taxpayer’s cumulative Canadian development expense (“CCDE”) pursuant to element “A” of the definition of that term in subsection 66.2(5).

Income Tax Considerations Relating to the Disposition of CRP

The income tax consequences that arise on a disposition of CRP will depend on whether the CRP is an oil and gas property or a mineral property.  In particular:

*    If the CRP is an oil and gas property, proceeds of disposition receivable by a taxpayer in respect of its disposition will reduce the taxpayer’s CCOGPE under element “F” of the definition of that term in subsection 66.4(5). The amount of the reduction to the taxpayer’s CCOGPE is equal to the proceeds of disposition that became receivable less outlays or expenses incurred for the purpose of the disposition and not otherwise deductible.  If this reduction results in a negative CCOGPE balance at the end of the taxpayer’s taxation year, this negative amount is deducted from the taxpayer’s CCDE by virtue of subsection 66.4(1) and element “L” of the definition of that term in subsection 66.2(5). If this reduction results in a negative CCDE balance at the end of the taxpayer’s taxation year, 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).

*    If the CRP is a mineral property, proceeds of disposition receivable by a taxpayer on its disposition will reduce the taxpayer’s CCDE balance under element “F” of the definition of CCDE. The amount of the reduction to the CCDE balance is equal to the proceeds of disposition that became receivable less outlays or expenses incurred for the purpose of the disposition and not otherwise deductible. As above, if this reduction results in a negative CCDE balance at the end of the taxpayer’s taxation year, 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).

For clarity, the disposition of CRP is specifically excluded from capital gains treatment by virtue of subparagraph 39(1)(a)(ii).

Numerical Example

The following is an example to illustrate the potential tax implications to the Taxpayer under the current provisions of the Act, as discussed above, using theoretical monetary amounts and based on the facts set out above and the assumptions set out below.  The actual tax consequences to the Taxpayer of the disposition of the Property will differ, depending on the actual facts that are applicable to the Taxpayer’s situation.

Assumptions:

*    The Property is a CRP that is an oil and gas property;

*    At the time the Taxpayer inherited the Property XXXXXXXXXX (“Mr. X”) in 1992, the FMV of the Property was $1 million;

*    At the time the Taxpayer sells the Property to an arm’s length third party in 2018, it will have a FMV of $1.5 million and the closing costs on the sale will be $15,000; and

*    The Taxpayer does not have any other CRP and has never claimed any deductions in respect of the Property or any other CRP.

Income Tax Considerations:

When Mr. X died he would have been deemed to have disposed of the Property for proceeds of disposition of $1 million, in accordance with paragraph 70(5.2)(a) and the Taxpayer would have been deemed to have acquired the Property at a cost of $1 million pursuant to paragraph 70(5.2)(b).  As noted above, such cost would have been a COGPE to the Taxpayer with the result that the Taxpayer’s CCOGPE balance would have been $1 million immediately after Mr. X’s death. Because the Taxpayer did not claim any deductions in respect of the Property or any other CRP, such CCOGPE balance would have remained at $1 million until the time of the sale of the Property by the Taxpayer.

Upon the sale of the Property by the Taxpayer in 2018, the Taxpayer’s CCOGPE balance will be reduced by $1,485,000 pursuant to element “F” of that definition, which is the difference between the $1.5 million proceeds of disposition and the $15,000 of selling expenses. Assuming there are no other adjustments to the Taxpayer’s CCOGPE balance during 2018, the Taxpayer would have a CCOGPE balance of negative ($485,000) at the end of 2018. This negative amount is deducted from the Taxpayer’s CCDE balance, which, based on the assumptions set out above and assuming there are no other adjustments to the Taxpayer’s CCDE during 2018, will result in the Taxpayer having a negative CCDE balance of ($485,000) at the end of 2018. Therefore, in 2018, the Taxpayer will have an income inclusion of $485,000.

Reporting of Income Tax Consequences

An income inclusion arising on a disposition of CRP is reported on line 130 of the T1 General Income Tax and Benefit Return.  Any adjustments to CCOGPE or CCDE should be reported on form T1229 Statement of Resource Expenses and Depletion Allowance.

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.
2  There are special rules set out in paragraph 70(5.2)(c), and explained in paragraph 17 of Interpretation Bulletin IT-125R4 (Archived) – Dispositions of Resource Properties, that apply in certain circumstances when CRP is transferred or distributed to the deceased’s spouse or to certain trusts for the benefit of the deceased’s spouse.  These special rules are not relevant in the present situation since the Taxpayer acquired the CRP as a consequence of the death of XXXXXXXXXX.

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