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.

Principal Issues: classification of feasibility study and environmental assessment expenses

Position: may be CEE, CDE, ECE

Reasons: question of fact

									March 28, 2000

	XXXXXXXXXX  TSO	Resource Industries Section
	Verification and Enforcement Division	Denise Dalphy
(613) 957-9231
	Attention:	XXXXXXXXXX
	Large File Auditor
	1999-001151

Feasibility Study and Environmental Assessment Costs

This is in reply to your memorandum dated November 24, 1999 concerning the proper classification for income tax purposes of certain expenditures incurred by XXXXXXXXXX In particular, you have asked for our comments on the interpretation of the definition of "Canadian exploration expense" ("CEE") in paragraph 66.1(6)(g) and the definition of "Canadian development expense" ("CDE") in paragraph 66.2(5)(e).

Background

XXXXXXXXXX.

Expenses for feasibility studies

Facts

XXXXXXXXXX incurred feasibility study expenses related to site infrastructure, mining processes and environmental assessment and claims that these expenses (excluding those related to environmental assessment) are CEE. The types of feasibility study costs incurred by XXXXXXXXXX and claimed as CEE were as follows:

1. designing a tailings disposal plan, to adequately contain waste rock produced in the mining/milling process
2. XXXXXXXXXX
3. geotechnical testing of land on which mine buildings will be built, to determine if it is capable of supporting the structures planned to be built there
4. mine planning
5. hydrological testing and to determine the amount of water flowing underground through the mine area, which will have to be pumped away from the site
6. road and airstrip feasibility
7. topographical mapping of the mine and port area
8. preliminary design and cost estimate of the mine
9. preliminary design and cost estimate of the concentrator, warehouse, port site, and storage

Legislation

Paragraph (g) of the definition of CEE in subsection 66.1(6) of the Act classifies as CEE "any expense incurred by the taxpayer after November 16, 1978 for the purpose of bringing a new mine in a mineral resource in Canada into production in reasonable commercial quantities...". Earlier legislation had classified these expenses as CDE, and as "development expenses ... in searching for minerals".

Analysis

Whether a particular taxpayer satisfies this purpose at a particular time is a question of fact to be determined on the basis of all relevant information. In order to determine whether each expense incurred by XXXXXXXXXX was or was not incurred for the purpose of bringing the mine into commercial production, one must look to all documentary evidence (which would include public materials issued by the taxpayer) as well as parole evidence. With respect to the latter, what will the taxpayer say its intention was in incurring each expense? Would the taxpayer's statements be credible and supported by the documentary evidence?

Although feasibility studies may be undertaken for the purpose of determining whether not to develop a mine, this is not always the case. In today's business environment, it is our understanding that feasibility studies are often conducted after a decision to proceed with the mine has been made, in part, because a feasibility study may be necessary in order for the company to secure financing, and in part, to "map out" the process of developing a mine.

Based on the information available to us, it appears that XXXXXXXXXX incurred feasibility study expenses at a time when it had made the decision to bring a mine at XXXXXXXXXX into production in reasonable commercial quantities. XXXXXXXXXX.

The term "feasibility study" in and of itself is not particularly descriptive of either the taxpayer's intention or the nature of a particular expense. In determining whether paragraph (g) of the definition of CEE will apply to a particular expense, in addition to the implicit requirement that the taxpayer must have intended at the time when incurring the expense to bring a mine into commercial production [See International Nickel Co. of Canada Ltd. v. Minister of National Revenue, 69 DTC 5092. Although this case deals with earlier legislation which employed the words "development expenses...in searching for minerals", it provides a helpful discussion of the four stages of mining, dictionary definitions of the concept of "development" in the mining industry, and a description by the Carter Commission on developing a mine. Although the current legislation does not use the term "development", the concept still has some utility in providing an understanding of the intention underlying present paragraph (g) in the definition of CEE.], the expense must relate to bringing a mine into commercial production. With regard to the expenses listed above, although all of these expenses may have been incurred after XXXXXXXXXX made a decision to bring a mine into commercial production, they do not all relate to bringing a mine into commercial production (or "developing" a mine) and therefore some, but not all, of the feasibility study expenses would qualify as CEE. For example, the expense described in item #1 relates to developing the mine, whereas item #3 (and some expenses in item #9) would more properly be added to the ACB of the buildings, if in fact the capital assets were acquired.

Expenses for environmental assessment

Whether environmental assessment expenses are part of cost of Canadian resource property

Environment assessment costs, including costs of an environmental impact statement, were incurred by XXXXXXXXXX. These costs were incurred as a result of legislative requirements that environmental approval be obtained before a mining lease (which is a Canadian resource property) is issued. You have asked us how these expenses should be classified. You presume that these expenses have been claimed (incorrectly) pursuant to paragraph 66.2(5)(e) of the definition of CDE, namely, as the cost of a Canadian resource property.

The CICA Handbook defines "cost" as the following:

"Cost is the amount of consideration given up to acquire, construct, develop or better a capital asset and includes all costs directly attributable to the acquisition, construction, development or betterment of the capital asset including installing it at the location and in condition necessary for its intended use."

The question in this case is one of remoteness: how attributable are the costs of the environmental assessment plan to the mining lease? If the taxpayer had in fact obtained a mining lease in this case (or if it were foreseeable in the reasonably near future), it is our view that, since the provincial legislation requires an environmental assessment as a condition of obtaining a mining lease, the taxpayer would have had a good argument that the costs of preparing an environmental impact statement form part of the costs of the mining lease.

In KVP v. MNR, 57DTC 1208 (Exch), the Province of Ontario granted a pulp and paper company a right to cut timber, and the provincial Forest Management Act required the company to provide the provincial authorities with a forestry management plan. The Court held that, to the extent that the expenditures on the forestry management plan exceeded the normal cost of surveys and cruises, the forestry management plan expenditures were not deductible on income account since it was clear that the expenditures would not have been incurred if the company had not been required to provide the province with the plan in order to preserve its rights in the timber limit. Since the obligation to provide information to the province was part of the consideration the company assumed to obtain the cutting rights, the expenditures were capital expenditures. The Court cited Tata Hydro-Electric Agencies Ltd., Bombay v. Commissioner of Income Tax [1937] A.C. 685:

"In short, the obligation to make these payments was undertaken by the appellants in consideration of their acquisition of the right and opportunity to earn profits, that is, of the right to conduct the business, and not for the purpose of producing profits in the conduct of the business."

XXXXXXXXXX

Whether environmental assessment expenses are CEE

Environmental assessment expenses have, in recent years, become an essential part in the process of bringing a mine into commercial production. In this case, XXXXXXXXXX may be successful in asserting that some or all of the environmental assessment expenditures satisfy the definition of CEE. As discussed in the context of feasibility studies, satisfying the definition of CEE will depend upon the taxpayer's intention at the time when the expenses were incurred and the nature of the particular expense incurred. XXXXXXXXXX . With respect to the nature of a particular expense, each expense would have to be reviewed to determine whether it was incurred in developing the mine. For example, expenses incurred to determine where to locate tailings ponds, or to determine the impact that blasting would have on the environment would relate to developing the mine, whereas certain other expenses, such as expenses incurred to determine XXXXXXXXXX , or how the property will be reclaimed when the minerals have been exhausted, would not relate to bringing a mine into commercial production.

For your information, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Legislation Access Database (LAD) on the Canada Customs and Revenue Agency's mainframe computer. A severed copy will also be distributed to commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, he can be provided with the LAD version or he may request a copy severed using Privacy Act criteria which does not remove the client's identity. Requests for this latter version should be made by you to Jackie Page at (613) 957-0682. The severed copy will be sent to you for delivery to the client.

If we can be of any further assistance or if you wish to discuss this matter further, please contact the writer.

John Chan, CA
Manager
Resource Industries Section
Resources, Partnerships and Trusts Division
Income Tax Rulings Directorate
Policy and Legislation Branch