Farm-Ins/Farm-Outs

A farm-out arrangement is one in which 
one party (a farmor) has an interest 
in a resource property and agrees 
to grant an interest in that resource 
property to another party (a farmee), 
in exchange for the farmee’s either 
funding or performing exploration and 
development work on the farmor’s 
property. The farmee’s undertaking is 
typically referred to as a farm-in and the 
farmor’s commitment is referred to as a 
farm-out. There is no standard form of 
farm-out agreement. Instead, the terms 
of each farm-out agreement are unique 
to the particular circumstances. 

The taxation of farm-out arrangements 
is, in practice, heavily dependent on 
certain administrative concessions 
by the CRA. In the absence of these 
concessions, a farm-out arrangement 
involving a transfer to the farmee of 
beneficial ownership of all or part of a 
farmor’s working interest in a resource 
property might result in a taxable 
disposition by the farmor. 

Because there is little case law that 
has considered the taxation of farm-out 
arrangements, taxpayers will typically 
try to fall within the CRA’s administrative 
policies concerning these arrangements. 
In particular, it is the CRA’s assessing 
practice that a farm-out results in the 
farmor having a disposition but not 
receiving any proceeds of disposition. 
Instead, the farmee is considered to 
incur resource expenses in order 
to earn an interest in the property. 
After the farmee has completed its 
spending commitment, the farmor 
and the farmee will have an agreed 
ownership interest in the working 
interest. The CRA, however, limits this 
administrative position to unproven 
resource properties, which the CRA 
considers to be resource properties to 
which proven reserves have not been 
attributed. Furthermore, in contrast 
to its position relating to farm-outs 
in the oil and gas industry, the CRA 
has not developed a position in the 
mining industry permitting the farmor 
to give up and the farmee to acquire 

depreciable property on a tax-exempt 
basis. The CRA’s administrative position 
in the mining industry extends only to 
intangible rights. 

In the mining industry, the most 
common form of farm-out arrangement 
is one in which the farmor is a 
prospector or grubstaker with an 
interest in mining claims and the 
farmee is a major mining corporation. 
Usually, the farmee agrees to incur 
a fixed dollar amount of exploration 
work over a specified period of time. 
Provided that the farmee incurs the 
expenses in accordance with the 
agreement, the farmee will typically 
be entitled to receive a transfer of 
the mining claims and the farmor will 
be entitled to a net smelter return 
(NSR) or a net profit interest (NPI) 
in the property.

A second form of arrangement in the 
mining industry is one in which the 
farmee agrees to incur a fixed dollar 
amount of exploration work on the 
farmor’s mining claims over a specified 

period of time in order to earn an 
interest in the property. Thereafter, the 
parties share the requisite expenses 
to explore and develop the property in 
proportion to their interests.

A number of years ago, the CRA gave 
a favourable ruling on an arrangement 
pursuant to which the farmee incurred 
the expenses necessary to bring a 
known ore body into production in 
return for an interest in the resulting 
mine. This is commercially not a typical 
arrangement and may not now fit 
within the administrative requirement 
that farm-ins must relate to unproven 
properties. 

Allocation of Partnership Expenses

• Corporation A contributes a mineral resource property to the arrangement.
• Corporation B contributes the funds necessary for exploration.
• Corporations A, B, and C agree to fund the development of any  

discovered reserves.

From a business perspective, it is appropriate to allocate the development 
expenses arising from the contribution of the property to Corporation A; to 
allocate to Corporation B all the exploration expenses; and to allocate the 
cost of development, including CCA, to each of Corporations A, B, and C in 
their respective portions. This result can be accomplished through the use of 
partnership allocations but not through the use of a corporation. (Flow-through 
shares may be used in some circumstances to accomplish some of the 
objectives.)

EXAMPLE 5

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affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

 

Structuring Mining Investments 

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