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.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.