25 January 2000 External T.I. 1999-0011795 - RESOURCE PROFITS; GAS STORAGE

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: Whether the resource allowance is available to a taxpayer who uses 3 underground gas storage reservoirs and produces natural gas from one reservoir.

Position: Yes. However, deductible Crown charges, if any, would reduce resource profits if they are ancillary to or in support of resource activities.

Reasons: Regulation 1204 and 1210

XXXXXXXXXX 								1999-001179
									Denise Dalphy
Attention:	XXXXXXXXXX 						(613) 957-9231

January 25, 2000

Dear Sirs/Mesdames:

Re: Resource Allowance and Underground Gas Storage

This is in response to your letter dated October 29, 1999 wherein you enquire about the effect of a company entering into a commercial gas storage arrangement with the Province of Alberta on its ability to claim resource allowance. You advised that it is desirable to effect one contract for three reservoirs, at least one of which is contemplated to remain in production, since they are in communication and gas from the storage reservoir flows to the other two reservoirs.

Paragraph 20(1)(v.1) of the Income Tax Act (the "Act") provides for a deduction, commonly referred to as a "resource allowance", in computing income. Paragraph 12(1)(z.5) of the Act provides for an income inclusion, commonly known as a "resource loss". Whether certain sources of income or deductions are included in computing a taxpayer's "resource allowance" or "resource loss" depends upon an interpretation of the rules prescribed in Part XII of the Income Tax Regulations (the "Regulations"), and this generally involves making factual determinations.

Both "resource allowance" and "resource loss" are determined in accordance with the Regulations, and in very general (and simplified) terms, a taxpayer must first compute its "gross resource profits" ("GRP"), which is defined in 1204(1). This amount is then modified, or recomputed, in accordance with 1204(1.1), and the resulting amount is a taxpayer's "resource profits" ("RP"), which is itself adjusted by 1210(2) to become "adjusted resource profits" ("ARP"), which may be a negative or positive amount.

Subsequently, the formula in either 1210(1) [prescribed resource allowance] or 1210.1 [prescribed resource loss] is applied to determine the amount that the taxpayer will be able to deduct, or must include, in computing its income. There are further rules that apply to the computation of each of these concepts.

Again, in general terms, "gross resource profits" includes specifically defined kinds of income from production and processing petroleum, natural gas, etc. and certain deductions are made in determining GRP. With respect to the other terms described above (RP, ARP), these amounts are determined by reducing GRP. In particular, in determining RP, GRP is reduced by all amounts deducted in computing income for the year other than certain listed amounts. Subparagraph (1.1)(a)(v) of the definition of RP provides that GRP is not reduced by deductions that relate to non-resource activities ("resource activity" is defined in section 1206 of the Regulations, to include activities that are ancillary to or in support of production or processing).

Whether royalties paid to Alberta pursuant to a commercial gas storage agreement are deductible under the Act is a question of fact and the considerations are described in our letter dated April 20, 1995 to XXXXXXXXXX (which was attached to your October 29, 1999 request for a technical interpretation). If in fact, these payments are deductible, it would be necessary to determine whether the payments are in respect of activities that are all or in part ancillary to or in support of the production of gas. The fact that three reservoirs are included in one contract would not in and of itself result in the full payment being considered ancillary, and apportioning may be appropriate. If all or part of the payments are ancillary to gas production, they would reduce the amount of resource allowance; if they are not ancillary, the amount of resource allowance would not change.

It is our understanding that Alberta's model agreement for commercial gas storage generally considers commercial storage to be "storage that is not primarily related to optimization of recovery from its receiving reservoir". Notwithstanding this however, it is possible that, depending upon the facts, although the payment of a royalty to the Crown may not be primarily related to production, it may be ancillary to the production of gas. In that case, the taxpayer's resource allowance would be reduced by such payments.

If we can be of any further assistance or if you wish to discuss this matter further, please contact the writer.

Yours truly,

John Chan, Manager
Resource Industries Section
Resources, Partnerships and Trusts Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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