Canada: Tax implications for non-resident owners of Canadian Mineral Rights
09 April 2014
Posted by: Author: Regan Exner
Author: Regan Exner (MNP)
If you reside outside of Canada but have mineral rights within this country, it's important to be aware of your tax obligations to ensure compliance. Below are some key tax considerations, whether you have mineral rights already or are on the cusp of obtaining them.
Royalties and Lease Payments
Non-residents of Canada that own Canadian mineral rights are subject to Canadian taxation via a non-resident withholding tax of 25% on the periodic royalties and lease payments they receive. In addition, a 50% withholding tax will also apply on certain lump sum bonus payments received in connection with entering into a Petroleum and Natural Gas (PNG) lease.This withholding tax mechanism on the periodic royalties and lease payments satisfies the non-resident's Canadian income tax obligations, given that no Canadian income tax return is required or even permitted to be filed in respect of these types of payments.
However, the same does not hold true in respect of the lump sum bonus lease payments which were subject to a 50% withholding tax. These payments are considered to be received in respect of a partial disposition of Canadian oil and gas property. Therefore, a Canadian income tax return is required to report the income and corresponding withholding tax. The withholding tax rate of 50% is higher than the actual tax rate the income will be subject to, such that a small tax refund should be triggered upon actually filing the tax return.
Normally, a non-resident will report these same royalty and lease payments on an income tax return of the country in which they are deemed to reside for tax purposes. They should claim the Canadian withholding / actual taxes paid as a foreign tax credit on that return to mitigate any potential for double taxation.
Deemed Disposition on Death
Aside from taxation of the various payments mentioned above, the one significant tax implication that is often unbeknownst to non-residents (and their non-Canadian professional advisors) is the deemed disposition of mineral rights at fair market value upon death per subsection 70(5.2) of the Income Tax Act (ITA). This deemed disposition triggers the requirement to file a Canadian income tax return for the deceased no later than April 30th of the year following death, or six months after death, whichever is later. Typically, this deemed disposition will result in a Canadian tax liability on the appreciated value of the mineral rights, ranging from fairly nominal amounts to rather substantial tax liabilities where the minerals are producing a steady stream of significant royalties.
Ideally, the estate administrators will recognize early on that a Canadian tax reporting obligation for the deceased has been triggered and are able to factor in the associated Canadian income tax obligation when making decisions in respect of the distribution of the Estate assets. In some cases where the resulting tax obligation may be so significant and the estate fairly illiquid, an actual sale of the mineral rights may be contemplated to provide the liquidity needed to satisfy the Canadian tax obligation and thereby distribute the after-tax cash to the beneficiaries in lieu.
Regardless of whether the mineral rights are sold by the Estate or distributed amongst the beneficiaries, the Canadian tax reporting obligations are quite onerous, fairly time-sensitive and come with significant penalties to ensure compliance. A form T2062(A) Request by a Non-Resident of Canada for a Certificate of Compliance Related to the Disposition of Taxable Canadian Property must be filed within 10 days of the mineral titles transfer either to a third party in the case of a sale or to the beneficiaries as partial settlement of the Estate. Form T2062(A) is not required to be filed in respect of the deemed disposition on death.
For Canadian resident taxpayers, the deemed disposition at fair market value of capital and resource property at death can be deferred if the assets are left to their spouse or to a trust for the benefit of their spouse. This same benefit does not extend to non-residents as per the ITA, but may be available according to a tax treaty between Canada and the deceased's country of residence, such as Article XXIX B(5) of the Canada-U.S. Tax Treaty. This article deems the U.S. taxpayer to be a resident of Canada for tax purposes at death for the sole purpose of allowing this spousal rollover and deferring the resulting tax liability until the death of the surviving spouse. The benefits of a tax-deferred rollover such as this are generally quite significant.
It should also be pointed out that in cases where the Estate administrators did not realize the above Canadian income tax reporting obligations and have completely distributed the Estate assets to the beneficiaries, including the Canadian mineral rights, they may be held personally liable for the Canadian income taxes not paid. Further, since the proper tax forms and returns were never filed with CRA, this tax obligation will continue to accrue interest (and potentially penalties) and never become statute-barred. This means the Estate administrators and the beneficiaries, will be jointly liable for the unpaid taxes indefinitely.
Valuing Mineral Rights
One of the most difficult aspects in connection with the deemed disposition of the mineral rights on death is determining their actual fair market value. Open market mineral rights transactions are fairly rare and their values are completely unique, making the determination of fair market value uncertain in many cases. Unless the mineral rights have been substantially developed and have a long track record of consistent royalties, applying a general rule of valuing the mineral rights at say, five or six times the average annual royalties is often not appropriate. A formal valuation of the mineral rights by a qualified professional will be required to satisfy CRA and determine the true tax liability.
Given how complicated and often financially significant area of taxation this can be, it is strongly recommended you speak with a taxation professional to address your own unique situation.
This article first appeared on mondaq.com.