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: whether certain payments to a connected person will be CEDOE
Position: Yes
Reasons: application of the Regulations
2004-010204
XXXXXXXXXX T. Harris
(613) 957-2114
November 24, 2004
Dear XXXXXXXXXX:
Re: Canadian Exploration and Development Overhead Expense - Connected Persons
We are writing in response to your email message of November 8, 2004 wherein you asked whether any portion of the Canadian exploration expenses ("CEE"), within the meaning of that expression as defined in subsection 66.1(6) of the Income Tax Act (the "Act"), to be incurred in the situation you described would be considered to be a Canadian exploration and development overhead expense ("CEDOE") within the meaning of that expression as defined in subsection 1206(1) of the Income Tax Regulations (the "Regulations").
You have described the following situation:
Company A is in the business of providing airborne geophysical services to the mining industry. Company A generates significant income from carrying on this business. Company A would like to invest in flow-through shares of a junior mining company ("Company J"), but if it does so it will own more than 10% of the issued and outstanding shares of Company J. Company A and Company J will, therefore, be connected to each other pursuant to subparagraph 1206(5)(a)(ii) of the Regulations.
In the course of carrying on its business of exploring for minerals, Company J will engage Company A to provide airborne geophysical services for it at Company A's regular billing rate, which will include a profit element.
Your question relates to whether any portion of the fee charged by Company A to Company J for these services will be considered to be CEDOE to Company J given that Company A is only charging its regular customer rate to Company J.
The particular situation outlined in your letter appears to relate to a factual one, involving a specific taxpayer. As explained in Information Circular 70-6R5 - Advance Income Tax Rulings dated May 17, 2002, it is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an advance income tax ruling. However, we are prepared to offer the following general comments that may be of assistance.
For the purpose of our response we have assumed that the payments for services would otherwise qualify as CEE. The determination of whether such expenses constitute CEE will depend on the facts of a particular situation. Our comments, therefore, should not be construed as confirmation that we have concluded that such expenses will constitute CEE to the payer.
Paragraph (d) of the definition of CEDOE includes as CEDOE any amount in respect of a CEE or Canadian development expense of a taxpayer charged to him by a person with whom the taxpayer is connected for goods, services or rights to use property to the extent that the amount charged exceeds the cost to the connected person of providing the goods, services or rights to use the property. The purpose of the "connected person" rules is to ensure, amongst other things, that any profit element charged to a taxpayer by a connected person will be treated as CEDOE. The fact that the rates charged by the connected person to the taxpayer are the same as the rates charged to other arm's length clients of the service provider does not preclude the profit element of such fees from being CEDOE. In addition, for the purpose of computing the profit element relating to such payments that will be treated as CEDOE, paragraph 1206(5)(b) of the Regulations provides that the following amounts will not be included as costs incurred by the service provider:
(i) any outlay or expense described in any of paragraphs (a) to (c) of the CEDOE definition made or incurred by the person if the reference in those paragraphs to "taxpayer" were read as references to "person",
(ii) any outlay or expense made or incurred by the person to the extent that it is not reasonably attributable to the use of a property by, the performance of a service for, or any materials, parts, or supplies acquired by, the taxpayer referred to in that definition, and
(iii) any amount in respect of the capital cost to the person of a property, other than, where the property is a depreciable property of the person, that proportion of the capital allowance (within the meaning of subsection 1206(6) of the Regulations) of the person for his taxation year in respect of the property that may reasonably be considered attributable to the use of the property by, or in the performance of a service for, the taxpayer referred to in that definition.
The amount of CEE that may be renounced by a principal business corporation is reduced under paragraph 66(12.6)(b) of the Act by any of those expenses that are "prescribed CEDOE" (as defined in subsection 1206(4.2) of the Regulations) which includes any expenses that fall within CEDOE, as well as the profit element of any payments made by the taxpayer for goods, services or rights to use property made to a person, or a person who is connected to a person, to whom the expense is renounced pursuant to the flow-through share provisions.
Consequently, in the circumstances where Company J makes payments to Company A in respect of services that Company A undertakes on its behalf for the purpose of exploring for minerals, the profit element of any such expenses which are renounced to Company A under a flow-through share arrangement will be prescribed CEDOE to Company J regardless of whether Company A and Company J are connected persons.
Our comments are provided in accordance with the practice described in paragraph 22 of Information Circular 70-6R5.
for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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