- News Release 2004-083 -

Explanatory Note

Reimbursement of Crown Charges

ITA
80.2

Section 80.2 of the Act is a special rule that applies where a taxpayer pays an amount to another person as a reimbursement, contribution or allowance (collectively referred to herein as a “reimbursement”) in respect of a Crown charge described in paragraph 12(1)(o) or 18(1)(m) of the Act. If applicable, section 80.2 deems the taxpayer to have paid an amount described in paragraph 18(1)(m) and deems the other person (the “recipient”) neither to have received nor to have become entitled to receive the reimbursement. In effect, section 80.2 provides for the transfer of non-deductible Crown charges from the recipient to the taxpayer. Normally, the taxpayer is entitled to a share of the production or the income from production from the property that is subject to the Crown charge. Therefore, while the taxpayer is treated as having incurred a non-deductible Crown charge, the taxpayer would normally be entitled to a deduction under paragraph 20(1)(v.1) of the Act (resource allowance) calculated by reference to the taxpayer’s income from the property.

Section 80.2 operates to deem the taxpayer making the reimbursement to have paid an amount described in paragraph 18(1)(m) only to the extent that the reimbursed Crown charge was either included in the recipient’s income or was denied as a deduction in computing the recipient’s income. As a result of the phasing out of the income inclusion in paragraph 12(1)(o) and the prohibition against the deduction of Crown charges in paragraph 18(1)(m), section 80.2 may no longer apply to the entire amount of a reimbursement. In addition, section 80.2 does not explicitly preclude the recipient from taking a deduction (or reducing an income inclusion) in respect of a reimbursed Crown charge. As well, since section 80.2 does not deem the taxpayer to have made the reimbursement at the time the obligation to pay the Crown charge arose, a taxpayer may seek to increase the percentage of the reimbursement that is not subject to paragraph 18(1)(m) by delaying the reimbursement. For these reasons, the total amount deductible in computing the income of the taxpayer and the recipient may, in certain circumstances, exceed the amount that was intended to be deductible.

Accordingly, it is proposed that section 80.2 of the Act be amended:

(a) to eliminate any excess deductions that may be available as a result of a reimbursement of a Crown charge;

(b) to preclude a taxpayer who makes a reimbursement from increasing the amount deductible by delaying the time of the reimbursement; and

(c) to ensure that a taxpayer making a reimbursement is deemed to have paid an amount described in paragraph 18(1)(m) only to the extent that the reimbursed Crown charge can reasonably be considered to relate to the taxpayer’s share of the production or the income from production from the property to which the Crown charge relates.

Amended section 80.2 will apply to reimbursements made on or after 2001, except that, the rule described in paragraph (c) above, will only apply to reimbursements made on or after September 17, 2004.

The ability to claim excess deductions in respect of reimbursed Crown charges will be eliminated by treating the eligible portion of the reimbursement (in most cases, the full amount of the reimbursement) as a payment described in paragraph 18(1)(m) (subsection 80.2(2)) and by reversing the benefit of any deduction in respect of a reimbursed Crown charge claimed by the recipient (subsection 80.2(5)). The eligible portion of the reimbursement is referred to in new section 80.2 as the “eligible portion of the specified amount” (see discussion below under ITA 80.2(10) and (11)). The amount of a reimbursement that exceeds the eligible portion of the specified amount is included in the income of the recipient (subsection 80.2(7)) and, subject to paragraphs 18(1)(a) and (b), is deductible in computing the income of the taxpayer (subsection 80.2(8)).

In addition, new subsection 80.2(3) precludes a taxpayer from increasing the deductible portion of a reimbursement by delaying the time of the reimbursement. It does this by ensuring that the amount deductible is determined by reference to the time that the reimbursed Crown charge became payable or receivable.

Application

ITA
80.2(1)

New subsection 80.2(1) of the Act provides that subsections 80.2(2) to (12) apply if a taxpayer (either resident in Canada or carrying on business in Canada) pays an amount, under the terms of a contract, that may reasonably be considered to have been received by the recipient as a reimbursement in respect of a Crown charge described by paragraph 12(1)(o) or 18(1)(m) of the Act. The Crown charge is described in new section 80.2 as the “original amount.” By referring to an original amount “described” by paragraphs 12(1)(o) or 18(1)(m) (and not the amount either included in income or denied as a deduction under these provisions), subsection 80.2(1) ensures that section 80.2 applies to the full amount of the reimbursement. The full amount of the reimbursement is referred to in new section 80.2 as the “specified amount.”

Reimbursement Described by Paragraph 18(1)(m)

ITA
80.2(2)

New subsection 80.2(2) of the Act provides that the eligible portion of the specified amount is deemed to be an amount described by paragraph 18(1)(m). For payments made before September 17, 2004, the eligible portion of the specified amount is equal to the specified amount. For reimbursements made on or after September 17, 2004, the eligible portion of the specified amount may be less than the specified amount. The rules for determining the eligible portion of the specified amount are described below in the commentary to ITA 80.2(10) and (11).

Applying Paragraph 18(1)(m)

ITA
80.2(3)

To ensure that the taxpayer cannot benefit by delaying the reimbursement of a Crown charge, new subsection 80.2(3) of the Act provides that paragraph 18(1)(m) applies as if the reimbursement were made at the time the Crown charge was imposed (i.e., became payable or receivable). If the taxpayer did not exist at the time the Crown charge was imposed (e.g., a new corporation created on an amalgamation), the percentage of the reimbursement that is subject to paragraph 18(1)(m) is computed as if the taxpayer were in existence at that time and had a calendar year end. In either case, the percentage of the reimbursement that is subject to paragraph 18(1)(m) and, accordingly, the amount that is not deductible in the taxation year in which the reimbursement is paid, is determined by reference to the percentages described in the transitional rules to the repeal of paragraph 18(1)(m), as if the reimbursement were made at the time the reimbursed Crown charge was imposed.

Exception for Certain Partnership Reimbursements

ITA
80.2(4)

New subsection 80.2(4) of the Act provides that subsection 80.2(3) does not apply to certain partnership reimbursements if the conditions, set out in new paragraphs 80.2(4)(a) to (d), are met. Those conditions require the taxpayer to be a member of the partnership at the end of the particular fiscal period in which the Crown charge became payable or receivable and require the reimbursement to be paid in the taxation year of the taxpayer in which the fiscal period of the partnership ends.

Inclusion in Recipient’s Income

ITA
80.2(5)

New subsection 80.2(5) of the Act requires the recipient to include in income, for the taxation year or fiscal period in which the original amount was paid or became payable or receivable, the amount by which the eligible portion of the specified amount exceeds the portion of the original amount that was included in the income of the recipient (if the reimbursement relates to a paragraph 12(1)(o) amount) or not allowed as a deduction (if the reimbursement relates to a paragraph 18(1)(m) amount). The purpose of this provision is to offset any reduction in income available to the recipient in respect of the reimbursed Crown charge.

Interpretation – Portion of the Original Amount

ITA
80.2(6)

New subsection 80.2(6) of the Act provides that, in determining the amount included in the income of the recipient under subsection 80.2(5), the portion of the original amount that was included in computing the income of the recipient or that was not deductible in computing the income of the recipient is determined as if the original amount were equal to the eligible portion of the specified amount. For example, assume that, in its taxation year ending on December 31, 2003, a recipient was entitled to a deduction of $500 in respect of $5,000 of Crown charges described in paragraph 18(1)(m) (10% of $5,000) and that one-half of the Crown charges ($2,500) were reimbursed in that year. In this case, the recipient would be required to include $250 in its income (10% of $2,500 – the amount deductible by the recipient if the original amount were equal to the eligible portion of the specified amount). As a further example, assume that the recipient receives a reimbursement of $3,000 after September 17, 2004 in respect of $5,000 of Crown charges incurred in its taxation year ending December 31, 2004. It is further determined that the eligible portion of the specified amount is $2,000. In this case, the recipient would be required to include $500 in its income under this provision (25% of $2,000 – the amount deductible by the recipient if the original amount were equal to the eligible portion of the specified amount). The portion of the reimbursement that exceeds the eligible portion of the specified amount ($1,000) would be included in the recipient’s 2004 income under new subsection 80.2(7).

Inclusion in Recipient’s Income

ITA
80.2(7)

New subsection 80.2(7) of the Act requires the recipient to include, in computing the recipient’s income for its taxation year or fiscal period in which the original amount was paid or became payable or receivable, the amount, if any, by which the specified amount exceeds the eligible portion of the specified amount. The amount included in the income of the recipient under this subsection is equal to the amount that may be deductible by the taxpayer under subsection 80.2(8).

Deduction by Taxpayer

ITA
80.2(8)

New subsection 80.2(8) of the Act provides that the taxpayer may deduct, subject to paragraphs 18(1)(a) and (b), in computing the taxpayer’s income for the taxpayer’s taxation year in which the specified amount is paid, the amount, if any, by which the specified amount exceeds the eligible portion of the specified amount. This is the amount of a reimbursement that is not treated as a payment described by paragraph 18(1)(m).

Specified Amounts Deemed Not to be Payable or Receivable

ITA
80.2(9)

New paragraphs 80.2(9)(a) and (b) of the Act, provide that, except for the purpose of section 80.2, the taxpayer is deemed not to have paid and not to have been obligated to pay, the specified amount and the recipient is deemed not to have received and not to have been entitled to receive, the specified amount. This subsection ensures that the tax implications of payments described in subsection 80.2(1) are dealt with entirely within section 80.2.

Eligible Portion of the Specified Amount

ITA
80.2(10)

The amount of a reimbursement that is deemed by new subsection 80.2(2) of the Act to be a payment described in paragraph 18(1)(m) is the “eligible portion of the specified amount.” The eligible portion of the specified amount is defined in paragraph 80.2(10)(b), subject to certain exceptions enumerated in paragraph 80.2(10)(a), as the taxpayer’s share of the original amount. The taxpayer’s share of the original amount is described in new subsection 80.2(11).

Paragraph 80.2(10)(a) provides that the eligible portion of the specified amount is equal to the specified amount if the specified amount was paid before September 17, 2004, the original amount is a tax imposed under a law of a province on freehold minerals or the specified amount does not exceed the taxpayer’s share the original amount. The specified amount of a reimbursement, in future, may also be prescribed, by regulation, to be equal to the eligible portion of the specified amount.

Taxpayer’s Share of Original Amount

ITA
80.2(11)

New subsection 80.2(11) of the Act provides that the taxpayer’s share of the original amount is the amount that may reasonably be considered to be the taxpayer’s share of the Crown charges in respect of a particular property. New paragraphs 80.2(11)(a) and (b) further provide that the taxpayer’s share of the Crown charges may not exceed the total of the amounts described in those paragraphs.

New paragraph 80.2(11)(a) provides that the taxpayer’s share of the Crown charges in respect of a property upon which the taxpayer has an overriding royalty (a royalty calculated without reference to the cost of exploration or production) is the proportion of those Crown charges that is equal to the taxpayer’s proportionate share of the production from the property.

New paragraph 80.2(11)(b) provides that the taxpayer’s share of the Crown charges in respect of a property (excluding any Crown charges that were reimbursed under the terms of an overriding royalty) is equal to the taxpayer’s share of the income from the property.

The requirement that the taxpayer be entitled to a share of the production or the income from the property to which the reimbursed Crown charge relates is intended to ensure that a taxpayer will be deemed to have paid an amount described by paragraph 18(1)(m) only to the extent that the taxpayer is entitled to an appropriate share of the income generated by the property. This, in turn, is intended to ensure that section 80.2 is not used to separate the Crown charges (through a reimbursement) from the resource profits generated by a particular property for the purpose of obtaining a deduction for the Crown charges that would exceed the available deduction in the absence of the reimbursement.

Reduction in Original Amount for Part XII of the Regulations

ITA
80.2(12)

New subsection 80.2(12) of the Act clarifies that, in computing the resource allowance available to the recipient, the Crown charges that were paid or became payable by the recipient, or that were receivable in respect of the recipient, are reduced by the eligible portion of the specified amount. For example, if a recipient had an amount described in paragraph 12(1)(o) equal to $1,000 and $700 of this amount was reimbursed (and the $700 did not exceed the eligible portion of the specified amount) in circumstances described in subsection 80.2(1), the recipient would be treated, for the purpose of computing the recipient’s resource allowance, as having a paragraph 12(1)(o) amount equal to $300.

Transitional Matters

In circumstances where a taxpayer or recipient is required to pay any income tax that the taxpayer would not be so liable but for the amendments to section 80.2, subsection (2) of the coming-into-force provision provides that such taxes will be deemed to have been paid on the balance due date for the relevant year if the balance due date was before September 17, 2004 and the tax is paid to the Receiver General for Canada before March 2005. Subsection (3) of the coming-into-force provision allows assessments beyond the normal reassessment period, if necessary, to give effect to new subsection 80.2.

Examples

Assume that each of the recipient and the taxpayer is a resident taxable Canadian corporation and that each has a calendar taxation year. The recipient acquires a lease on Crown lands, which gives it the right to explore for and produce oil and natural gas from a particular property. Under the terms of the lease, the recipient is subject to a provincial Crown royalty based on the production from the property. The recipient enters into a contract with the taxpayer under which it sells a royalty interest on the property to the taxpayer equal to 50% of the production from the property free of all costs of development and operation. During each of 2003, 2004 and 2005, the production from the property is $2.4 million, the royalty payable to the taxpayer is $1.2 million and the Crown royalty on the production from the property is $600,000.

Example 1: Assume that the Crown royalty is described in paragraph 18(1)(m) and that, under the terms of the contract, the taxpayer agreed to reimburse the recipient for the portion of the Crown royalty relating to its share of production ($300,000). During 2003, the taxpayer reimburses the recipient on a monthly basis at the same time that the Crown royalty became payable to the provincial government. Although the recipient receives the reimbursement, it claims a deduction in respect of the reimbursed Crown royalty equal to $30,000. In this case, new section 80.2 would apply as follows: 

The taxpayer is deemed by subsection 80.2(2) to have paid an amount under paragraph 18(1)(m) equal to the specified amount (the amount of the reimbursement), 90% of which is denied as a deduction in computing the taxpayer’s income by paragraph 18(1)(m). In addition, the deduction taken by the recipient in respect of the reimbursed Crown royalty is reversed by subsection 80.2(5).

Example 2: Assume that the Crown royalty is described by paragraph 12(1)(o) and that, under the terms of the contract, the taxpayer reimburses the recipient on January 1, 2004 for its share of the Crown royalties that became receivable in 2003. Although the recipient is entitled to the reimbursement, it includes, under paragraph 12(1)(o), only $270,000 in its income in respect of the reimbursed Crown royalties (90% of $300,000). In this case, new section 80.2 would apply as follows:

As in Example 1, the recipient has a $30,000 income inclusion under new subsection 80.2(5). The result is that the total amount included in the income of the recipient in 2003 under paragraph 12(1)(o) and subsection 80.2(5) is equal to $300,000. In addition, new subsections 80.2(2) and (3) ensure that the entire amount of the reimbursement is an amount described in paragraph 18(1)(m) and that the percentage of the reimbursement that is not deductible by the taxpayer is determined as if the reimbursement were paid at the time the Crown royalty became receivable (i.e., 2003 percentages apply).

Example 3: Assume that, under the terms of the contract, the taxpayer reimburses the recipient $400,000 on January 31, 2005 in respect of Crown royalties described in paragraph 12(1)(o), all of which became receivable by the province during 2004. In this situation, the reimbursement exceeds the eligible portion of the specified amount by $100,000. In computing its income for 2004, the recipient includes $300,000 (75% of $400,000) in respect of the reimbursed Crown royalty. Assuming that a deduction for any portion of the reimbursement would not be denied by either paragraph 18(1)(a) or (b), new section 80.2 would apply as follows:

Repeal of Subsection 80.2

Subsection 80.2 was repealed by S.C. 2003, c.28, s.9 for taxation years beginning after 2006. It is proposed that this provision be amended to repeal section 80.2 for specified amounts paid in respect of original amounts that are paid or become payable or receivable in taxation years or fiscal periods of the recipient that begin after 2006. This amendment is intended to ensure that, regardless of when a reimbursement is paid, the tax treatment of that reimbursement will be governed by section 80.2 if the Crown charge was incurred during the period in which the recipient, in the absence of the reimbursement, would be subject to paragraphs 12(1)(o) and 18(1)(m).

- News Release 2004-083 -