2003 Ruling 2003-002183A - Underground Exploration Program - CEE?

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 CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: Whether expenses relating to an underground exploration program will qualify for inclusion under paragraph (f) to the definition of CEE.

Position: Expenses incurred in respect of the proposed exploration programs may potentially qualify under paragraph (f) to the definition of CEE.

Reasons: Based upon the facts of the situation and a written opinion received from Natural Resources Canada. A representative of that Department visited the site and reached conclusions that supported the above position and opinion.

XXXXXXXXXX 2003-002183

XXXXXXXXXX, 2003

Dear Sir:

Re: Advance Income Tax Ruling
XXXXXXXXXX (the "Company") (XXXXXXXXXX)

This is in reply to your letter dated XXXXXXXXXX wherein you requested an advance income tax ruling on behalf of the above corporation. We also acknowledge receipt of your letters of XXXXXXXXXX, as well as our various telephone conversations concerning this matter.

The Company's head office is located at XXXXXXXXXX. It is serviced by the XXXXXXXXXX Tax Services Office and the XXXXXXXXXX Tax Centre.

To the best of your knowledge and that of the Company, none of the issues contained herein:

(i) is in an earlier tax return of the Company or a related person;

(ii) is being considered by a tax services office or taxation centre in connection with a previously filed tax return of the Company or a related person;

(iii) is under objection by the Company or a related person;

(iv) is before the Courts or, if a judgement has been issued, the time limit for appeal to a higher Court has expired; or

(v) is the subject of an advance income tax ruling previously issued by the Income Tax Rulings Directorate to the Company or a related person.

Definitions

Unless otherwise stated, in this letter the following terms and expressions have the meanings specified below:

"Act" means the Income Tax Act R.S.C. 1985 (5th Supp.), c.1 as amended to the date of this letter.

"Canadian development expense" has the meaning assigned to that expression by subsection 66.2(5) of the Act.

"Canadian exploration expense" has the meaning assigned to that expression by subsection 66.1(6) of the Act.

"Canadian resource property" has the meaning assigned to that expression by subsection 66(15) of the Act.

"depreciable property" has the meaning assigned to that term by subsection 13(21) of the Act.

"flow-through mining expenditure" has the meaning assigned to that expression by subsection 127(9) of the Act.

"flow-through share" has the meaning assigned to that expression by subsection 66(15) of the Act.

"investment tax credit" " has the meaning assigned to that expression by subsection 127(9) of the Act.

"mineral resource" has the meaning assigned to that term by subsection 248(1) of the Act.

"principal-business corporation" has the meaning assigned to that term by subsection 66(15) of the Act.

"Property" means the XXXXXXXXXX.

"public corporation" has the meaning assigned to that term by subsection 89(1) of the Act.

"taxable Canadian corporation" has the meaning assigned to that expression by subsection 89(1) of the Act.

Our understanding of the facts, proposed transactions and purpose of the proposed transactions is as follows:

Facts

1. The Company is a corporation that exists under the XXXXXXXXXX Companies Act.

The Company is a public corporation and a taxable Canadian corporation for purposes of the Act. The Company's fiscal period ends on XXXXXXXXXX.

2. The Company's authorized share capital consists of an unlimited number of XXXXXXXXXX shares. At XXXXXXXXXX, the Company's issued share capital consisted of XXXXXXXXXX shares.

The Company's common shares are listed on the XXXXXXXXXX Stock Exchange under the stock symbol: XXXXXXXXXX. These shares are widely held with no shareholder owning sufficient shares with voting rights to exercise control of the Company for purposes of the Act.

3. The Company's main business activities consist of the exploration for, and the mining of, XXXXXXXXXX from deposits and properties located in Canada. Its mining operations are principally located in XXXXXXXXXX

The Company is a principal-business corporation for purposes of the Act.

4. The discovery of XXXXXXXXXX on the Property was made by an independent prospector in XXXXXXXXXX. Over the years, the Property has been the subject of exploration by various corporate owners. The only underground workings at the Property, which were developed to provide for exploration purposes exclusively, consist of a three-compartment shaft that was sunk in XXXXXXXXXX, which reaches a depth of XXXXXXXXXX. No ore production has ever been recorded from these underground workings.

The Company acquired a XXXXXXXXXX% interest in the Property in XXXXXXXXXX. After certain surface diamond drilling was performed, the Company conducted open pit mining at the Property from XXXXXXXXXX (with approximately XXXXXXXXXX tonnes of ore being extracted which yielded approximately XXXXXXXXXX). The area that was mined by open pit is known as "Zone XXXXXXXXXX", which is a wide, near surface zone of mineralization, covered by approximately XXXXXXXXXX of overburden.

Due to a XXXXXXXXXX, mining operations ceased at the Property in XXXXXXXXXX and all equipment was removed from the mine site.

5. The Company hired an arm's length third party to conduct a feasibility study regarding an underground mining project at the Property. In XXXXXXXXXX, the Company received the final feasibility study that concluded that an underground mining project could increase the Company's annual XXXXXXXXXX production by XXXXXXXXXX%.

Before proceeding with the development of an underground mine, the Company will have to determine the extent of the XXXXXXXXXX reserves that exists on the Property, i.e., further XXXXXXXXXX reserves need to be established to support such a decision. Surface drilling is impractical for these purposes due to the thick overburden on the surface of the area to be tested as well as the nature of the rocks which make it very difficult to attain a regular pattern of drilling at the XXXXXXXXXX depth to be tested. As such, the Company will undertake an underground exploration program estimated to cost approximately $XXXXXXXXXX and to take approximately XXXXXXXXXX to complete.

The above program includes the development of an underground ramp access and the required exploration drifts followed by an underground drilling program of approximately XXXXXXXXXX metres of drilling. The drilling objective is to significantly increase reserves and resources between the XXXXXXXXXX metre level and the XXXXXXXXXX metre level. All of the actual existing reserves of XXXXXXXXXX on the Property are located above the XXXXXXXXXX metre level. While previous drilling indicated that the ore zones reach at least a depth of XXXXXXXXXX metres, more drilling is needed to arrive at an ore reserve calculation below the XXXXXXXXXX metre level.

6. On XXXXXXXXXX, the Company closed a $XXXXXXXXXX private placement consisting of approximately $XXXXXXXXXX units and approximately $XXXXXXXXXX shares which are intended to be flow-through shares. Each unit was sold for $XXXXXXXXXX and each unit consists of one common share and warrant to purchase XXXXXXXXXX. The XXXXXXXXXX shares intended to be flow-through shares were issued at $XXXXXXXXXX per share.

The Company's net proceeds from the sale of the units are being used for general working capital purposes and to strengthen its financial position. The Company's net proceeds from the sale of the XXXXXXXXXX shares intended to be flow-through shares will be used for the underground exploration program at the Property referred to in 5 above.

7. In furtherance of the underground exploration program referred to in 5 above, the Company recently commenced (in XXXXXXXXXX) certain de-watering (which is expected to take XXXXXXXXXX months) and on-surface site preparation activities.

Proposed Transactions

8. The Company will complete the dewatering and on-surface site preparation activities referred to in 7 above and will proceed with the underground exploration program referred to in 5 above.

9. After de-watering the open pit used in the former mining operations as well as the old exploration shaft referred to in 4 above, a ramp will be driven down from surface to level XXXXXXXXXX (a depth of XXXXXXXXXX metres) in order to carry out the diamond drilling.

The portal for the underground ramp will be excavated on the XXXXXXXXXX side of the pit wall. The ramp will be connected at the XXXXXXXXXX level to the old exploration shaft referred to above, which shaft will be used to provide an exhaust for the ventilation system and as a second escape way, which is necessary for safety reasons.

10. XXXXXXXXXX main locations will be established for the diamond drilling. XXXXXXXXXX.

The underground exploration program will test the extension at depth of the ore zones referred to as the XXXXXXXXXX Zone and XXXXXXXXXX Zone and, as such, will target two areas. Firstly, the rake of the XXXXXXXXXX Zone will be tested by XXXXXXXXXX diamond drill holes for a total of approximately XXXXXXXXXX metres of drilling. These holes will be drilled from XXXXXXXXXX underground drilling stations at the end of a XXXXXXXXXX-metre crosscut excavated from the ramp at elevation XXXXXXXXXX. The second target is the extension of the XXXXXXXXXX Zone where XXXXXXXXXX diamond drill holes will be drilled for a total of XXXXXXXXXX metres of drilling. Other holes will be drilled from the station at the shaft also from elevation XXXXXXXXXX .

11. As noted above, de-watering is expected to take XXXXXXXXXX months, after which it is expected that the development of the underground ramp will take XXXXXXXXXX months and that the diamond drilling will then be carried out over a XXXXXXXXXX-month period. The total cost to access the underground locations from which the diamond drilling will take place is estimated at approximately $XXXXXXXXXX while the estimated cost of such drilling is $XXXXXXXXXX .

The excavation work will be carried out be a mining contractor and the surface facilities are expected to be minimal, consisting mainly of an office/dry building, a garage/compressor building, gatehouse and electrical substation.

Additional Information

12. The feasibility study, referred to in 5 above, envisions that, assuming a positive development decision following completion of the underground exploration program described above, the Company would need to establish an underground mine at the Property to exploit any economic mineralization delineated by the program. The estimated initial capital investment for such mine and infrastructure on the Property is $XXXXXXXXXX, with production expected to occur XXXXXXXXXX months after commencement of construction.

If an underground mine were to be established, it would be the first underground mining operation to exist on the Property.

Purpose of the Proposed Transactions

13. The underground exploration program described in 8 through 11 above is being undertaken with the objective of increasing the Company's XXXXXXXXXX reserve position with regard to the Property. More accurate information regarding such XXXXXXXXXX reserves will enable a decision to be taken regarding the development of an underground mining operation on the Property as envisioned in the preceding paragraph.

Ruling Given

Provided that the above statements of facts, proposed transactions and purpose of the proposed transactions are accurate and constitute complete disclosure thereof, and provided that the proposed transactions are carried out as set forth herein, the following ruling is given:

A. An expense incurred by the Company, after the date of this letter and in respect of the exploration program referred to in 8 through 11 above, to determine the existence, location, extent or quality of a mineral resource on the Property, including any expense incurred in the course of:

(i) prospecting,

(ii) carrying out geological, geophysical, or geochemical surveys,

(iii) drilling by rotary, diamond, percussion, or other methods, or

(iv) trenching, digging test pits, and preliminary sampling,

but not including any Canadian development expense, will qualify as Canadian exploration expense pursuant to paragraph (f) of the definition thereof contained in subsection 66.1(6) of the Act provided:

a) the expense does not constitute the cost, or any part of the cost, to the Company of any depreciable property;

b) the expense is incurred before a mine comes into production in reasonable commercial quantities to exploit economic mineralization established by the underground exploration program referred to above; and

c) the underground exploration program referred to above does not culminate in an extension of a mine that has come into production in reasonable commercial quantities.

The above ruling is given subject to the general limitations and qualifications set forth in Information Circular 70-6R5 issued by the Canada Customs and Revenue Agency (the "Agency") on May 17, 2002 and is binding on the Agency provided that the proposed exploration program described in paragraphs 8 through 11 above is completed by XXXXXXXXXX.

This ruling is based on the Act in its present form and does not take into account the effect of any proposed amendments thereto.

Comments

a) Except as expressly stated, our ruling does not imply acceptance, approval or confirmation of any income tax implications of the facts or proposed transactions. In particular, nothing in this letter should be interpreted as confirming, either expressly or implicitly:

i) the determination of the fair market value or adjusted cost base (within the meaning assigned by section 54 of the Act) of any property referred to herein;

ii) whether any particular expense incurred by the Company in respect of the underground exploration program referred to in 8 through 11 above will qualify as Canadian exploration expense of the Company; or

iii) whether any share of the capital stock of the Company issued as a consequence of the private placement described in 6 above is a flow-through share.

b) A flow-through mining expenditure, potentially relevant to the determination of the investment tax credit of certain individuals who acquire a flow-through share, may only arise in respect of certain Canadian exploration expense incurred by a corporation in conducting mining exploration from or above the surface of the earth. As such, a cost in respect of mining exploration conducted underground is unable to qualify as a flow-through mining expenditure.

c) In our view, the open pit mine operated by the Company from XXXXXXXXXX on the Property (as described in paragraph 4 above) constitutes a mine that has come into production in reasonable commercial quantities for purposes of paragraph (f) to the definition of Canadian exploration expense in subsection 66.1(6) of the Act.

Yours truly,

for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Legislation Branch