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.
November 4, 1997
Quebec Tax Services Office Resource Industries
Richard Cloutier Section
Forestry and Mining Specialist Peter Lee
957-8977
972582
Depreciable Property/Resource Expenses
Further to our informal response to you by telephone, this is in reply to your request for our opinion in respect of the transitional rules in connection with the recent amendment to the definitions of Canadian exploration expense ("CEE") and Canadian development expense ("CDE") that was intended to clarify that depreciable property is not to be included in resource pools.
Background
1. Effective for taxation years that end after December 5, 1996, paragraph (l) was added to the definition of Canadian exploration expense under subsection 66.1(6) of the Income Tax Act (the "Act") as follows:
Canadian exploration expense of a taxpayer means any expense incurred after May 6, 1974 that is... but, for greater certainty, shall not include...
(l) any amount... included at any time in the capital cost to the taxpayer of any depreciable property of a prescribed class,..
The same wording in (l) was added to paragraph (j) of the definition of Canadian development expense under subsection 66.2(5) of the Act.
2. The December 5, 1996 Notice of Ways and Means Motion proposed to amend paragraph 1102(1)(a) of the Income Tax Regulations (the "Regulations") as follows, applicable to taxation years that end after March 6, 1996:
The classes of property described in this Part and in Schedule II shall be deemed not to include property (a) the cost of which would be deductible in computing the taxpayer's income if the Act were read without reference to sections 66 to 66.4 of the Act...
3. On August 28, 1997, the Tax Court of Canada held in the case of Robert Phenix (#93-175(IT)G) that the expenses incurred in 1987 by Resources Minières Radisson Mining Inc., which were of a current or capital nature (including depreciable properties), qualified as CEE, albeit for flow-through share purposes. This decision has been appealed to the Federal Court of Appeal.
Opinion Requested
4. You requested our views on:
(a) whether paragraph (l) referred to in 1 above could be retroactively applied to disallow any capital cost of any depreciable property which was claimed as CEE in taxation years ended before December 6, 1996 for the purposes of the flow-through share provisions of the Act; and
(b) whether this paragraph (l) would apply to require a flow-through shareholder to adjust his cumulative Canadian exploration expense ("CCEE") which arose by virtue of the renunciation of the capital cost of depreciable property as CEE to him in his taxation years ended before December 6, 1996.
5. Our comments will refer only to CEE, but they are also applicable to CDE as well. These comments only apply to depreciable property, the cost of which has been previously included in CEE (assuming it was the only CEE of a taxpayer) before new paragraph (l) of the definition of CEE came into effect to clarify that depreciable property cannot qualify for treatment as CEE. Furthermore, our comments would be relevant only if the Tax Court decision in the case of Robert Phenix is upheld.
6. It is our view that new paragraph (l) would not be retroactively applied to disallow the depreciable-property related CEE in taxation years ended before December 6, 1996 for the purposes of the flow-through share provisions of the Act. It is also our view that new paragraph (l) would not require a flow-through shareholder to adjust his CCEE which arose by virtue of the renunciation of the capital cost of depreciable property as CEE to him in his taxation years ended before December 6, 1996.
7. Pursuant to subsection 66(12.61) of the Act, where an exploration corporation renounces an amount of CEE to a person, such amount is deemed "to be CEE incurred in that amount by the person on the effective date of the renunciation" and "on and after the effective date of the renunciation never to have been CEE incurred by the corporation".
8. It is arguable that an amount included in an exploration corporation's undepreciated capital cost ("UCC") in the first taxation year that ends after March 6, 1996 pursuant to proposed paragraph 1102(1)(a) referred to in 2 above, would preclude the amount from being included as CEE in the previous years in accordance with new paragraph (l). However, because new paragraph (l) came into effect only for the taxation years that end after December 5, 1996, CEE incurred and claimed prior to such time could include capital cost of depreciable property for the purposes of the above-noted flow-through share provisions based on the Tax Court decision in the case of Robert Phenix, provided this Court decision is upheld. In other words, new paragraph (l) would not apply retroactively, but this matter is before the courts. Similarly, although subsections 66(12.71) and (12.73) of the Act, by themselves, would not enable the Department to reduce a flow-through shareholder's CCEE in a prior year, we are not inclined to the view that these subsections can now be applied to a prior year solely upon new paragraph (l) coming into effect. Again, this is because the transitional rules are clear that new paragraph (l) only applies to taxation years that end after December 5, 1996 and does not impact prior years.
9. Pursuant to subsection 66.1(6) of the Act, CCEE of a taxpayer at any time in a taxation year means the amount determined by a formula (e.g. CEE incurred before that time is added and CEE deducted before that time is subtracted in the calculation). If the CCEE amount becomes negative, there would be an income inclusion to the taxpayer by virtue of subsection 66.1(1) and paragraph 59(3.2)(b) of the Act.
By analogy to the case of Alcan Aluminium Limited, 94 DTC 6369 (FCTD) which was recently affirmed by the Federal Court of Appeal, it is arguable that in the taxpayer's first taxation year that ends after December 5, 1996, new paragraph (l) would apply in the calculation of the CCEE amount to exclude any capital cost of any depreciable property of a prescribed class that was considered as "CEE incurred" in taxation years ended before December 6, 1996.
It is our view that new paragraph (l) and proposed 1102(1)(a) would impact the first taxation year ended after December 5, 1996. In simple terms, assuming that the cost of depreciable property prior to such taxation year was the only "CEE" of a taxpayer and that this CEE was deducted in prior years, the impact of excluding depreciable property from CEE in the taxation year (which was included in CEE in prior years) would lead to a negative CCEE amount for the taxation year and an income inclusion to the taxpayer. There would also be an indirect conversion of CCEE into UCC. It is our understanding that this result is in accordance with the policy intent of the above-noted amendments.
10. Since the flow-through shareholders do not have any capital cost and do not own any depreciable property in respect of which they received renunciations as CEE (again assuming that Robert Phenix is upheld), new paragraph (l) and proposed paragraph 1102(1)(a) would not apply to them. There are no provisions which would require adjustments to the flow-through shareholder's CCEE which arose by virtue of the renunciation of the capital cost of depreciable property as CEE to him in his taxation years ended before December 6, 1996.
If you wish to discuss any of the above, please contact the writer.
Manager
Resource Industries Section
Resources, Partnerships and Trusts Division
Income Tax Rulings and Interpretations Directorate
All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5
© Her Majesty the Queen in Right of Canada, 1997
Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistributer de l'information, sous quelque forme ou par quelque moyen que ce soit, de facon électronique, méchanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.
© Sa Majesté la Reine du Chef du Canada, 1997