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Ottawa, September 17,  2004
2004-053

Minister of Finance Proposes Amendments to Royalty Reimbursement Rule

Related document:

• Backgrounder.

Minister of Finance Ralph Goodale today announced his intention to propose amendments to the Income Tax Act that would prevent corporations and other taxpayers from obtaining inappropriate tax deductions in respect of reimbursed resource-related Crown charges such as royalties.

The 2003 budget announced improvements to the tax structure applying to Canada’s resource sector. These improvements, which were enacted in November 2003, included a deduction for Crown charges that is to be phased in during the period 2003 to 2007. Previously, Crown charges such as royalties could not be deducted in computing income for tax purposes.

A special reimbursement rule applies in circumstances where one taxpayer reimburses another taxpayer for a Crown charge incurred by that other taxpayer. This reimbursement rule, which was designed to limit the deductibility of Crown charge reimbursements, may not operate as intended during the phase-in period.

Accordingly, amendments to the Income Tax Act are proposed to ensure that the reimbursement rule imposes the appropriate limits on the deductibility of reimbursement payments and provides for the appropriate tax treatment to the recipients of reimbursements. The attached backgrounder provides a detailed description of the proposed amendments.

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For further information:

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In November 2003, a new regime for taxing resource income received Royal Assent. This regime was outlined in the Department of Finance technical paper in March 2003 and was subject to extensive consultations with the resource sector. As described in that paper, this new regime includes the following three key features, which are being phased in over a five-year period (beginning in taxation years that end after 2002):

• a reduction of the federal corporate tax rate on income earned from resource activities from 28 per cent to 21 per cent;
• elimination of the resource allowance; and
• a deduction for Crown charges, such as royalties and mining taxes.

Consequential to the enactment of the new regime, a long-standing rule in section 80.2 of the Income Tax Act (the "Act") dealing with reimbursements, contributions or allowances (collectively referred to herein as "reimbursements") in respect of Crown charges was repealed, effective for taxation years beginning after 2006. Prior to the introduction of the new regime, a taxpayer who reimbursed a Crown charge incurred by another person (the "recipient") was considered to have made a payment described in paragraph 18(1)(m) of the Act, which payment was not deductible in computing the taxpayer’s income. Thus, neither the taxpayer nor the recipient was entitled to deduct an amount in respect of the Crown charge. The purpose of this reimbursement rule was to put the taxpayer making the reimbursement in the same position as the recipient in respect of the reimbursed Crown charge.

As a result of the phase-in of the deductibility of Crown charges, the reimbursement rule no longer operates as intended and may result in deductions during the phase-in period in excess of those that were intended.

Accordingly, it is proposed that section 80.2 be amended, applicable to reimbursements made after 2001, to provide as follows:

(a) that the full amount of a reimbursement be deemed to be a payment described in paragraph 18(1)(m) of the Act;

(b) that the income of the recipient be adjusted to offset any reduction in income that relates to the reimbursed Crown charge; and

(c) that the percentage of a reimbursement that is deductible in computing the income of the taxpayer making the reimbursement be determined by reference to the percentage that would have applied if the taxpayer had made the reimbursement at the time the Crown charge became payable or receivable.

These proposed amendments are intended to ensure that only the taxpayer making the reimbursement is entitled to a deduction in respect of the reimbursed Crown charge and that, subject to the exception described below, the deduction available to the taxpayer be limited to the amount that would have been available to the taxpayer at the time the Crown charge became payable or receivable.

It is proposed that the requirement to determine the deductibility of a reimbursement by reference to the time the Crown charge became payable or receivable generally not apply to a reimbursement by a taxpayer of actual Crown charges incurred by a partnership during a particular fiscal period if certain conditions are met. These conditions include a requirement that the taxpayer be a member of the partnership at the end of a particular fiscal period of the partnership and that the reimbursement be made in the taxation year of the taxpayer in which the fiscal period of the partnership ends.

In circumstances where the taxpayer or the recipient is required to amend a previously filed tax return, it is proposed that no penalties or interest apply to any additional tax payable as a result of the application of these rules if the tax is paid within two months of September 17, 2004.

For reimbursements made on or after September 17, 2004, it is proposed that:

• The amount of a reimbursement that exceeds the eligible portion of the reimbursement not be subject to the rules described in (a) to (c) above. The eligible portion of a reimbursement is the amount that can reasonably be considered to be the taxpayer’s share of the Crown charges that apply to a particular property determined by reference to the taxpayer’s share of the production or net income from production from the property. In applying this rule, the eligible portion of a reimbursement of a tax on freehold mineral rights would be deemed to be equal to the amount of the reimbursement. The eligible portion of a reimbursement may be deemed to be equal to the amount of the reimbursement in other appropriate circumstances.

• The amount of a reimbursement that exceeds the eligible portion of the reimbursement be included in computing the income of the recipient and, subject to paragraphs 18(1)(a) and (b) of the Act, generally be deductible in computing the income of the taxpayer.

These proposed amendments are intended to ensure that certain taxpayers or partnerships do not enter into reimbursement arrangements to artificially increase the amount that would otherwise be deductible in respect of a Crown charge.