Despite the precipitous decline in oil prices, or maybe because of it, farmers are increasingly being approached by oil companies for access to their properties for exploration of oil and natural gas resources.
Although Alberta and Saskatchewan farmers have had longtime experience with this issue, Manitoba farmers are seeing a significant increase in approaches from resource companies.
Much confusion has resulted about how payments and revenue from seismic activity and surface rentals of farm property should be treated for tax purposes.
Some farmers claim that the oil companies told them that such proceeds are not taxable.
In fact, they are taxable, and the Canada Revenue Agency has asked oil companies to specify the tax treatment related to payments in their agreements with farmers so that there is no confusion.
The process of renting access to farmland usually involves negotiating an agreement with the oil company, which includes payments for various components.
Such payments can result in several tax consequences.
The lease payment frequently will cover surface rights to the land-owner for several years of use.
The first year’s payment may include a lump sum for such items as damage to land, land improvements, inconvenience, severance and the first year’s rent without an amount being attached to each element.
Second and subsequent payments may be for rental, severance or inconvenience.
This is how such payments are normally treated:
- A portion of the lump sum paid in the first year, which is equal to periodic payments in subsequent years, should be considered as income.
- Any remaining portion of the lump sum payment for property affected, damaged or destroyed is generally considered to be proceeds of disposition or taxed as capital and may result in a capital gain or loss to the farmer.
- The adjusted cost base for the portion of the property “disposed” under the lease is part of the entire property’s adjusted cost base.
- The adjusted cost base of the entire property is then decreased by the adjusted cost base of the property under lease.
CRA generally accepts any reasonable portion of the adjusted cost that the taxpayer wishes to attribute to the proceeds if the property that is disposed is relatively small in relation to the entire property.
If a portion of the first year’s payment is specifically related to damage to growing crops, then that amount is taxed as income rather than capital.
This is how different components of a land lease are taxed:
- access to property, entry fees, right of way – CAPITAL
- damages to land (no crop) – CAPITAL
- loss of use of land – CAPITAL
- land value – CAPITAL
- Fees: consideration of, signing, or permit – INCOME
- Rental: land, building, equipment and annual lease fees – INCOME
- Damages: fence, crop and equipment – INCOME
- Annoyance: general disturbance, inconvenience and nuisance – INCOME
- Contract items: snow clearing and maintenance of roads – INCOME
Farmers should consult with their financial or tax adviser on how best to structure it for tax purposes before signing such a lease.