27 April 2000 Internal T.I. 1999-0011827 - Temporary Access Roads

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.

Principal Issues:

Are costs incurred to build a temporary access road or in respect of the preparation of a site CEE, CDE, a capital expenditure or an operating cost in those situations where no oil or gas well is ever drilled.

Position: Question of Fact

Reasons: A review of all of the facts surrounding a specific situation will determine the tax treatment of these expenses. They may qualify as CDE or as CEE.

			April 27, 2000

	Bharat Patel	Resource Industries Section
	Oil & Gas Specialist	A. Seidel
	Industry Specialist Services	(613) 957-8974
	Calgary TSO
			992975

Temporary Access Roads

This is in reply to your memorandum dated November 10, 1999 in which you requested our views with respect to the appropriate classification of expenses incurred in building temporary access roads and preparing a site for the drilling of a well in circumstances where, for various reasons, no well is ever drilled or the drilling is commenced or completed in a subsequent taxation year.

Legislation

Paragraph 66.1(6)(a) of the Income Tax Act (the "Act") provides that a "Canadian exploration expense" ("CEE") includes any expense incurred after May 6, 1974 that is:

"any expense including a geological, geophysical or geochemical expense incurred by the taxpayer (other than an expense incurred in drilling or completing an oil or gas well or in building a temporary access road to, or preparing a site in respect of, any such well) for the purpose of determining the existence, location, extent or quality of an accumulation of petroleum or natural gas (other than a mineral resource) in Canada,"

and paragraph 66.1(6)(d) provides that it includes

"any expense incurred by the taxpayer after March, 1987 and in a taxation year of the taxpayer in drilling or completing an oil or gas well in Canada or in building a temporary access road to, or preparing a site in respect of, any such well"

if one of the criteria outlined in subparagraphs 66.1(6)(i), (ii), (iii) or (iv) of the Act is satisfied.

Subparagraph 66.2(5)(a)(ii) of the Act provides that a "Canadian development expense" ("CDE") includes any cost or expense incurred after May 6, 1974 that is any expense incurred by the taxpayer in:

"drilling or completing an oil or gas well in Canada, building a temporary access road to the well or preparing a site in respect of the well, to the extent that the expense was not a Canadian exploration expense of the taxpayer in the taxation year in which it was incurred,"

Issue

Are the costs incurred in building temporary access roads or preparing a site in respect of an oil or gas well CEE, CDE, a capital expenditure or deductible as an operating cost in those situations where a taxpayer acquires a well license, incurs expenses but no well is ever actually drilled? How are these expenditures to be classified in the situation where they are incurred in one year and the drilling activity will be commenced and completed in subsequent taxation years? (For example, an earlier than expected spring thaw requires that drilling be postponed until the next winter.)

Industry Specialist Services Views

Paragraph 66.1(6)(a) of the Act deals primarily with pure exploratory work done prior to any work done for the purpose of drilling wells. On the other hand, paragraph 66.1(6)(d) and subparagraph 66.2(5)(a)(ii) of the Act deal with drilling or completion activities and an integral part thereof would be the building of temporary access roads and site preparation.

For temporary access roads and site preparation costs to be classified as CEE or CDE, pursuant to paragraph 66.1(6)(d) or subparagraph 66.2(5)(a)(ii) of the Act, respectively, a well must be drilled. In the absence of such a well, the costs are current operating costs. In addition, the primary purpose of building temporary access roads and site preparation is to drill wells and not to determine existence, location, extent or quality of an accumulation of oil or gas as required by paragraph 66.1(6)(a) of the Act.

The term "in respect of the well" in paragraph 66.2(5)(a) of the Act has been interpreted to mean that if the well was not, in fact, drilled, these expenses would not qualify as CEE or CDE. That is, the well must have been drilled for these costs to be CEE or CDE.

Calgary TSO Appeals Division's Views

Paragraph 66.1(6)(a) of the Act specifically excludes expenses incurred "..in building a temporary access road to, or preparing a site in respect of, any such well..". As no well has been drilled, this exclusion does not apply and the expenses qualify as CEE since they meet the secondary purpose of "..determining the existence, location, extent or quality of an accumulation of petroleum or natural gas..".

Taxpayer's Views

Taxpayers argue that since a well license has been issued, these expenses were incurred "in respect of a well" and should accordingly qualify as CDE. The building of a temporary access road and the subsequent preparation of a site are expenses in respect of the well to be drilled. The fact that the well is never drilled does not change the reason for the activity of building a road or preparing a site. When the expenses were incurred, they were incurred in respect of the planned well, and should qualify as CDE. Taxpayers have also stated that there should be no inference that if the well is not drilled that the specific expenses incurred prior to that time will not qualify as CDE. Any other interpretation would clearly be against the intent of the incentive legislation.

Our Comments

Generally, the classification of expenses relating to building temporary access roads to, or site preparation in respect of, a well may be classified as CEE, CDE, ECE or an operating expense based upon the purpose for which the expenses were incurred.

The following comments pertain to the situation where a taxpayer incurs expenses in respect of temporary access roads or preparation of a site for the drilling of a well and the drilling of the well is commenced and completed in a subsequent year.

In this situation, the expenses incurred in the year in respect of temporary access roads or preparation of a site clearly relate to the drilling of a well such that the preamble to paragraph 66.1(6)(d) of the definition of CEE and subparagraph 66.2(5)(a)(ii) of the definition of CDE is satisfied. The specific requirements of paragraph 66.1(6)(d) and subparagraph 66.2(5)(a)(ii) of the Act then determine whether these expenses are CEE or CDE. Subparagraph 66.2(5)(a)(ii) of the Act provides that an expense cannot be CDE if it is CEE. To qualify as CEE, the expenses must satisfy the requirements of paragraph 66.1(6)(d) of the Act. In the situation where the drilling of the well has not commenced or has not been completed in the year and: the drilling to date has not resulted in a discovery; the taxpayer has not abandoned the well; and the taxpayer has not filed a certificate pursuant to subparagraph 66.1(6)(d)(iv) of the Act; subparagraph 66.1(6)(d)(iii) of the Act will determine whether the expenses are CEE. The test in subparagraph 66.1(6)(d)(iii) of the Act is that 24 months has passed since the completion of the drilling of a well. Since it has already been determined that the drilling is not completed, this provision cannot apply to these expenses. Accordingly, these expenses cannot qualify as CEE.

Once it is determined that these expenses are not CEE and it is determined that all of the other requirements of subparagraph 66.2(5)(a)(ii) of the Act are satisfied, these expenses would qualify as CDE. If in a subsequent taxation year it is determined that the requirements of subparagraphs 66.1(6)(d)(i), (ii) or (iii) are satisfied in respect of a well, subsection 66.1(9) of the Act may apply to re-classify the CDE as CEE.

The following comments pertain to the situation where a taxpayer incurs expenses in respect of temporary access roads or preparation of a site for the drilling of a well and, for whatever reason, no well is ever drilled.

In the situation where a well is never drilled, there is a reasonable argument that the taxpayer would be unable to satisfy the purpose test in either of paragraph 66.1(6)(d) or subparagraph 66.2(5)(a)(ii) of the Act. The costs of building a temporary access road or costs incurred in site preparation would also not satisfy the other requirements of the definition of CDE in subsection 66.2(5) of the Act such that these expenses would not be CDE.

These expenses could qualify as CEE if they meet the requirements of paragraph (a) of the definition of CEE in subsection 66.1(6) of the Act. To the extent that the purpose test in paragraph 66.1(6)(d) of the Act is not satisfied, the exclusion in paragraph 66.1(6)(a) of the Act in respect of expenses relating to the building of temporary access roads to, or preparing a site in respect of, a well would not be applicable. These expenses could then qualify for inclusion in CEE pursuant to paragraph (a) thereof if they could be considered to be "any expense ... incurred by the taxpayer ... for the purpose of determining the existence, location, extent or quality of an accumulation of petroleum or natural gas ... in Canada".

In Edmonton Liquid Gas Limited v. Her Majesty The Queen, 84 DTC 6526, (FCA) MacGuigan, J. in considering what expenses qualify as "a geological, geophysical or geochemical expense incurred ... for the purpose of determining the existence, location, extent or quality of an accumulation of petroleum or natural gas" states the following:

"I therefore hold that the type of expense which fall within the scope of subparagraph (i) are those of a primary exploratory type, including those of drilling exploratory oil or gas wells that were not intended to produce oil or gas if found."

This conclusion would support the view that the cost of a temporary access road to a well site would qualify as CEE in those situations where no well is ever drilled.

If the situation were to arise where a temporary access road is determined to be neither CEE or CDE, the determination of whether or not the expenditure is on account of capital or a deductible expense would be required. Depending on the circumstance, the expenditures could be included in a class of Schedule II of the Income Tax Regulations, an "eligible capital expenditure" within the meaning of subsection 14(5) of the Act or an expenditure that is deductible in computing income provided paragraph 18(1)(a) of the Act does not apply to prohibit its deduction.

Conclusion

XXXXXXXXXX, we are inclined to the view that the expenditures for temporary access roads to well sites where no well is ever drilled could qualify for CEE treatment pursuant to paragraph (a) of the definition thereof in subsection 66.1(6) of the Act.

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

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