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 certain types of expenses would constitute CEE or CDE and qualify for renunciation for flow-through share purposes.
Position: General comments provided.
Reasons: Consideration of the nature of the types of expenses in question in light of the relevant legislative provisions.
2003-004378
XXXXXXXXXX A. A. Cameron
(613) 347-1361
December 11, 2003
Dear XXXXXXXXXX:
Re: Classification of Certain Expenses
This is in reply to your letter of October 15, 2003 in which you ask for our views with regard to whether certain types of expenses which may be incurred in respect of a wollastonite deposit, located XXXXXXXXXX, would constitute either "Canadian exploration expense" ("CEE") or "Canadian development expense" ("CDE") [such terms having the meanings assigned by subsections 66.1(6) and 66.2(5), respectively, of the Income Tax Act (the "Act")]. You have also indicated that the above deposit is a "mineral resource" described in subparagraph (d)(i) to the definition of that term in subsection 248(1) of the Act and that the above expenses may be financed through the issuance of shares each of which would be intended to be a "flow-through share" [such term having the meaning assigned in subsection 66(15) of the Act].
Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advanced Income Tax Rulings, dated May 17, 2002. As such, the following comments are of a general nature only. All publications referred to herein can be accessed on the Canada Customs and Revenue Agency (the "Agency") website at the following address: http://www.ccra-adrc.gc.ca/tax/technical/incometax/menu-e.htm l.
The provisions of section 66 of the Act provide that, in specified circumstances, a "principal-business corporation" ["PBC"; having the meaning assigned in subsection 66(15) of the Act which includes a corporation the principal business of which is mining or exploring for minerals] may renounce, in respect of a flow-through share acquired by an investor in its capital stock, amounts determined with reference to certain CEE and CDE it incurs. Whether an expense incurred by a PBC would constitute CEE or CDE as well as whether, and to what extent, the PBC may be entitled to renounce amounts in respect of such expense are questions to be determined based upon the application of the relevant provisions of the Act to the facts of a particular situation. In particular, amounts may only be renounced to a particular investor in respect of qualifying expenses incurred by the PBC on or after the date the agreement in writing relating to the acquisition of the flow-through share was made.
Where a PBC agrees to issue a flow-through share, it is required under subsection 66(12.68) of the Act to file a prescribed form as well as a copy of the relevant agreement with the Agency within a specified time limit. Subsequent to the receipt of the prescribed form, the Agency will assign an identification number. Further information regarding the administration of the flow-through share program is available on the internet at www.ccra-adrc.gc.ca/fts, e.g., form T100 provides various instructions including information concerning the filing of the required forms.
The determination of how a particular expense incurred by a PBC should be classified for purposes of the Act will be a question of fact. In making this determination it will be necessary to consider the reason for incurring such expense in the situation under consideration. In addition, it should be noted that expenses that form all or part of the cost of acquisition of a depreciable property, e.g., equipment, structures or roads, are expressly excluded from treatment as CEE or CDE.
It should also be noted that a right, licence or privilege to prospect, explore, drill or mine for minerals in a mineral resource in Canada would constitute a "Canadian resource property" under subparagraph (b)(ii) to the definition of that term in subsection 66(15) of the Act. The cost of such a Canadian resource property is included in CDE. For example, costs in respect of the acquisition of a right to extract minerals from a mineral resource would constitute CDE.
Expenses incurred by a PBC in a mineral resource context may qualify as CEE under paragraph (f) or (g) to the definition of CEE in subsection 66.1(6) of the Act, with the PBC potentially being able to renounce amounts in respect thereof to investors in flow-through shares.
Paragraph (f) to the definition of CEE essentially relates to certain exploration expenses. One of the requirements is that such expenses be incurred by the relevant taxpayer "for the purpose of determining the existence, location, extent, or quality of a mineral resource in Canada". Whether or not a particular expense incurred by a PBC satisfies this purpose test would have to be determined with reference to the facts of the relevant situation. However, expenses expressly contemplated by that paragraph are those incurred in the course of: prospecting; carrying out geological, geophysical or geochemical surveys; drilling; or trenching, digging test pits and preliminary sampling. On the other hand, expenses expressly excluded by that paragraph are any CDE or "any expense that may reasonably be considered to be related to a mine that has come into production in reasonable commercial quantities or to be related to a potential or actual extension thereof".
A requirement for an expense to qualify for inclusion under paragraph (g) to the definition of CEE is that it be incurred by the PBC "for the purpose of bringing a new mine in a mineral resource in Canada into production in reasonable commercial quantities and incurred before the new mine comes into production in such quantities". Whether or not a particular expense incurred by a PBC satisfies this purpose test would have to be determined with reference to the facts of the relevant situation. However, "an expense for clearing, removing overburden, stripping, sinking a mine shaft or constructing an adit or other underground entry" is expressly contemplated by that paragraph.
In our view, the nature and type of expenses contemplated by paragraph (g) of the definition of CEE are mine development expenses incurred after the decision has been made to proceed with mine development. In other words, expenses incurred to determine whether to proceed with the development of a mine would not be encompassed by that paragraph.
Where a PBC incurs an expense partly for the purpose described in paragraph (f) to the definition of CEE and partly for the purpose described in paragraph (g) to that definition, the Agency will accept a reasonable allocation of such expense between those paragraphs as determined from the circumstances of the particular situation.
The amount that may be renounced by a PBC in respect of CEE or CDE it incurs is subject to reduction for certain items specified under subsections 66(12.6) and 66(12.62), respectively, of the Act. For example, there is a reduction for any assistance which the PBC has received, is entitled to receive or can reasonably be expected to receive, and that can reasonably be related to the expenses in question. In addition, there is a reduction for such expenses that are "prescribed Canadian exploration and development overhead expenses" of the PBC (as defined in subsection 1206(4.2) of the Income Tax Regulations) which include CEE or CDE incurred by the PBC that are in respect of the administration, management or financing of the PBC.
Pursuant to subsection 66(12.66) of the Act (the so-called "look-back" rule) qualifying CEE or CDE incurred by a PBC in a particular calendar year may be deemed, in certain circumstances, to have been incurred by the PBC on the last day of the immediately preceding calendar year. The only CDE which may qualify for such treatment would be expenses described in paragraphs (a) or (b) to the definition of CDE contained in subsection 66.2(5) of the Act, i.e., essentially, certain expenses incurred in an oil or natural gas context. The CEE that may qualify for such treatment in a mineral resource context would be the expenses described in paragraph (f) to the definition of CEE contained in subsection 66.1(6) of the Act.
It should be noted that, where a PBC relies on subsection 66(12.66) of the Act (the look-back rule referred to above) to renounce, to an investor in a flow-through share it issues, under 66(12.6) thereof amounts relating to CEE to be incurred by it, the PBC will be subject to tax under Part X11.6 of the Act, as determined under subsection 211.91(1) thereof, in respect of the total of all such amounts renounced.
Where a PBC renounces an amount under the Act to an individual investor in respect of a flow-through share, essentially, the CEE or CDE to which the amount renounced relates is deemed to be CEE or CDE, as the case may be, incurred in that amount by the investor on the effective date of the renunciation and such CDE or CEE is deemed from that point not to be an expense of the PBC. CEE or CDE so incurred would be added to the cumulative CEE or cumulative CDE "pool" of the individual who may then be entitled to a deduction, in determining income for a particular taxation year under the Act, in respect of the balance of such pools at the end of the relevant taxation year. In the case of cumulative CEE, an individual would essentially be entitled to a deduction of an amount up to the balance of that pool at the end of the relevant taxation year. In the case of cumulative CDE, an individual would essentially be entitled to a deduction of an amount up to 30% of the balance of that pool at the end of the relevant taxation year (subject to increase due to certain adjustments).
Amounts renounced by a PBC, in respect of certain expenses it incurs that are described in paragraph (f) to the definition of CEE, and which are deemed by subsection 66(12.61) of the Act to be expenses incurred by an individual (other than a trust) may constitute a "flow-through mining expenditure", within the meaning assigned that phrase in subsection 127(9) of the Act, to the individual for "investment tax credit" (also as defined in that subsection of the Act) purposes. Among the requirements contained in the above flow-through mining expenditure definition is that the CEE be incurred by the PBC within a specified period and "in conducting mining exploration activity from or above the surface of the earth for the purpose of determining the existence, location, extent or quality of a mineral resource described in paragraph (a) or (d) of the 'mineral resource' definition in subsection 248(1)" of the Act. Expressly excluded is an expense in respect of trenching, digging test pits or preliminary sampling (other than, essentially, to the extent those expenses constitute "specified sampling" as defined in subsection 127(9) of the Act.) Specified sampling is basically the collecting and testing of samples in respect of a mineral resource provided that at the time the sample is collected it does not weigh more than 15 tonnes and the total weight of all samples collected in respect of the mineral resource in a calendar year (other than samples each of which weighs less than one tonne) does not exceed 1,000 tonnes.
The amount of an individual's "flow-through mining expenditure" under the Act will also be used in the determination of that individual's "eligible Ontario exploration expenditures" for purposes of the "Ontario focused flow-through share tax credit" provided for in the Income Tax Act of Ontario (the "Provincial Act"). Among the requirements of this latter tax credit is that: the individual be resident in Ontario on the last day of the relevant taxation year and be subject to tax under the Provincial Act throughout that year; and that the underlying CEE be in respect of a qualifying mineral resource in Ontario and be incurred by a PBC having a permanent establishment in Ontario.
The above comments are given in accordance with the practice referred to in paragraph 22 of Information Circular 70-6R5 which is issued by the Agency. As stated in that paragraph, written opinions are not advance income tax rulings and, accordingly are not binding on the Agency.
Please contact the writer if you have any questions regarding the above comments.
Yours truly,
for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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