2018-0782181I7 Successored CCEE and Non-Capital Losses

Principal Issues: Can a subsection 66.7(3) deduction for successored CEE create/increase a non-capital loss?

Position: No.

Reasons: Subsection 66.7(3) provides a deduction under subdivision e of Division B of the Act. A subdivision e deduction cannot result in the creation or increase of a non-capital loss.

Author: Gorman, Judith
Section: 3, 18(1)(a), 66.1(2), 66.1(3), 66.7(3), 111(1), 111(8)

                                                                           August 11, 2020

Cameron Morash                                               Income Tax Rulings Directorate
Oil and Gas Industry Specialist                         Judith Gorman
Large Business Audit Division                           613-670-9292
International and Large Business Directorate

                                                                           2018-078218

Dear Cam:

We are writing in response to your email dated October 15, 2018, requesting our views on whether a taxpayer that is a principal-business corporation (“PBC”) may create or increase a non-capital loss with a deduction for a successored cumulative Canadian exploration expense (“CCEE”) under subsection 66.7(3) of the Income Tax Act (Canada) (the “Act”).

Unless otherwise noted, all statutory references herein are to the provisions of the Act.

Discussion

Overview of Subsection 66.7(3)

Subsection 66.7(3) generally allows a corporation (the “successor”) who has acquired Canadian resource property in circumstances in which the successor rules applied (a “successored property”) to claim a deduction with respect to unused Canadian exploration expenses (“CEE”) incurred by one or more other persons who, among other things, owned the property and disposed of it to a corporation in circumstances in which the successor rules applied. This deduction must not exceed the part of the successor’s income for the year that may reasonably be regarded as attributable to, among other things, production from, and proceeds of disposition of, the successored property (per paragraph 66.7(3)(b)).

The limitation in paragraph 66.7(3)(b) requires a determination of the various components or elements of the taxpayer’s current year income in order to isolate the part of that current year income that is reasonably attributable to, among other things, production from, or proceeds of disposition of, the successored property. Such part (i.e., component or element) of the taxpayer’s income would take into account all direct and indirect expenses that can reasonably be regarded as attributable to production from, or proceeds of disposition of, the successored property. (footnote 1)  However, such part would not take into account any other expenses or current year losses from other sources, as these would represent a different part (i.e., component or element) of the taxpayer’s income for the year.

A deduction can be claimed by a taxpayer under subsection 66.7(3) to reduce its current year income prior to the application of any current year losses against such current year income. This effectively preserves all or part of the taxpayer’s current year losses so that they may become non-capital losses which may be applied in preceding or subsequent taxation years, subject to the limits in subsection 111(1).

Illustration of the Limitation in Subsection 66.7(3)

Assumptions

In a particular taxation year, a taxpayer has a $100 loss from Business A.

In the same taxation year, a taxpayer has a $100 profit from Business B, of which $75 (taking into account all reasonably attributable direct and indirect expenses) can reasonably be regarded as attributable to production from a successored property.

The taxpayer has a successored CCEE pool balance of $200.

Deduction Permitted Under Subsection 66.7(3)

In this situation, the taxpayer would be entitled to a deduction of $75 under subsection 66.7(3) because the applicable limit in subsection 66.7(3) is the part of the taxpayer’s income that can reasonably be regarded as attributable to production from the successored property, which is $75. The computation of the taxpayer’s income under section 3 would be as follows:

Paragraph 3(a) – total of incomes from all sources = $100

Paragraph 3(b) – net taxable capital gains = $0

Paragraph 3(c) – total of 3(a) + 3(b) amounts ($100) less subdivision e deductions ($75) = $25

Paragraph 3(d) – amount determined under 3(c) ($25) less current year losses ($100) = $0

As a result, the amount computed under paragraph 3(c) in this situation would be $25. Under paragraph 3(d), it would only be necessary to apply $25 of the taxpayer’s loss from Business A to reduce the taxpayer’s income to nil, with the remaining $75 of that loss becoming a non-capital loss under paragraph 111(8). (footnote 2)

As the above example illustrates, it is possible for a deduction under subsection 66.7(3) to effectively preserve all or part of a current year loss so that it may become a non-capital loss of a taxpayer. This is in contrast to a subsection 66.1(2) deduction for which paragraph 66.1(2)(b) effectively limits the deduction available to the taxpayer’s current year income that remains after the application of current year losses and other deductions in computing income and the sections 112 and 113 dividend deductions for the year. Consequently, a subsection 66.1(2) deduction cannot result in the preservation (or creation or increase) of a non-capital loss.

Subsection 66.7(3) Allows Preservation but Not Creation or Increase of Non-Capital Losses

It is important to note that, even though deductions under subsection 66.7(3) (as well as under subsections 66.7(4) and (5)) might effectively preserve all or part of a current year loss as discussed above, they cannot, in and of themselves, create or increase a taxpayer’s non-capital loss. This is because a deduction under section 66.7 may only be applied to reduce current year income under paragraph 3(c) as it is a deduction that is permitted only pursuant to a specific provision within subdivision e.

In particular, successored resource expenses cannot be deducted in computing the income or loss of a taxpayer from a business or property by virtue of the restriction in paragraph 18(1)(a) which, among other things, limits deductions in computing income from a business or property to outlays or expenses made or incurred by the taxpayer. Successored resource expenses under section 66.7 are, by their nature, not outlays or expenses made or incurred by the taxpayer that is seeking to deduct them, being the successor. Instead, successored deductions are with respect to outlays or expenses that were made or incurred by an original owner of the successored property. As a result, they cannot be deducted in computing the income or loss of a taxpayer from a business or property and therefore cannot create or increase a non-capital loss of a taxpayer. (footnote 3)

Implementation

We understand that the above position, to the extent that it relates to deductions in respect of successored cumulative Canadian development expense and successored cumulative Canadian oil and gas expense, may differ from the CRA’s historic assessing practice. For taxation years ending after 2020, the CRA’s assessing practice will take into account the above position for all types of successored resource pools.

We note that, if transactions are undertaken to avoid the application of the above position to successored resource pools (including transactions undertaken to convert successored resource pools into regular resource pools that are not subject to the successor rules), in a manner that would frustrate the object, spirit and purpose of section 66.7 or any other provision of the Act, the CRA would consider the application of the GAAR to such transactions.

We trust that our comments will be of assistance to you.

Yours truly,

Kimberley J. Wharram
Manager, Resources Section
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

FOOTNOTES

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

1  See Technical Interpretation 2007-0226251I7.

2  Pursuant to the formula in the definition of “non-capital loss” in subsection 111(8), the taxpayer’s non-capital loss for the taxation year would, in this example, be its total losses from an office, employment, business or property for the year ($100) less the amount determined under paragraph 3(c) in respect of the taxpayer for the year ($25) = $75.

3  See Element E of the definition of “non-capital loss” in subsection 111(8).

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