2005 Ruling 2005-0133051R3 - exploration/new mine- 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.

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

Position: Expenses to be incurred in respect of the underground exploration program 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 dated July 15, 2005. A representative of that Department visited the site and reached conclusions that support the above position.

XXXXXXXXXX 2005-013305

XXXXXXXXXX, 2005

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
Advance Income Tax Ruling

This is in reply to your letter of XXXXXXXXXX wherein you requested an advance income tax ruling on behalf of the above named corporation. We also acknowledge receipt of additional information provided in your correspondence of XXXXXXXXXX.

We understand that to the best of your knowledge and that of the taxpayer involved, none of the issues contained herein:

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

(iii) is under objection by the taxpayer 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 not expired; or

(v) is the subject of an advance income tax ruling previously issued by the Income Tax Rulings Directorate.

Our understanding of the facts, proposed transactions and purpose of the proposed transactions is described below.

Definitions

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

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

b) "ABC Co." means XXXXXXXXXX,

c) "adjusted cost base" has the meaning assigned to that expression by section 54 of the Act,

d) "A Zone" means the XXXXXXXXXX,

e) "B Zone" means the XXXXXXXXXX,

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

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

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

i) "Corporation" means XXXXXXXXXX,

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

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

l) "Former Mine" means the XXXXXXXXXX mine that was previously owned and mined by XYZ Co. but is now closed,

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

n) "Optionors" means XXXXXXXXXX,

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

p) "Property" means the XXXXXXXXXX,

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

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

s) "XYZ Co." means XXXXXXXXXX.

Unless otherwise specified, all section references contained herein are to sections of the Act.

Facts

1. The Corporation was incorporated under the XXXXXXXXXX on XXXXXXXXXX and its fiscal period ends on XXXXXXXXXX. The Corporation is a taxable Canadian corporation, a public corporation and a principal-business corporation. The registered and head office of the Corporation is located at XXXXXXXXXX. Its business number is XXXXXXXXXX and it is serviced by the XXXXXXXXXX Tax Services Office and files its annual income tax return at the XXXXXXXXXX Taxation Centre. Its principal business is the exploration for and potential development of natural resources in Canada.

2. The original discovery hole of the Former Mine was drilled in XXXXXXXXXX. Production commenced in XXXXXXXXXX and continued until XXXXXXXXXX at which time it ceased. During that time, XXXXXXXXXX tonnes of ore were mined to an ultimate pit depth of XXXXXXXXXX meters. The final pit dimensions were XXXXXXXXXX m deep, XXXXXXXXXX meters long by about XXXXXXXXXX meters wide. After operations ceased, the pit was allowed to fill to its natural level approximately XXXXXXXXXX with water.

3. Ore extracted from the Former Mine was processed at a mill adjacent to the pit, with a capacity of XXXXXXXXXX tons per day. Mining from the open pit ceased when mineralization could no longer be extracted economically via open pit methods. Subsequent to the cessation of operations at the Former Mine, the mill remained in operation until XXXXXXXXXX , processing ores from various adjacent pits and stock piles in the vicinity.

4. Subsequent to the cessation of mill operations in XXXXXXXXXX, XYZ Co. dismantled and removed the mill components. The employees were let go. The electrical sub-station by the mill building is still operational but it is not used by the Corporation in its underground exploration program. Under a reclamation permit, the waste dumps were contoured and reclaimed and the tailings disposal system was closed and the reclamation of the site started. The site was rehabilitated, the tailings dams were covered with soil and seeded, the waste dumps were re-sloped and covered with soil. The trucks, shovels, blast hole drills, loaders, graders and all of the other types of equipment that had been used during the mining operation were either sold, dismantled or removed from the property. No infrastructure remains at the site which (in its current condition) could support any mining operation.

5. ABC Co. (successor to XYZ Co.) does not retain ownership of any of the mineral rights or mining leases at the Former Mine, having abandoned these rights (by allowing the mining claims to lapse) in XXXXXXXXXX. However, it is currently the owner of some of the surface rights to the Former Mine and retains ownership of the mill and other mine buildings and the tailings impoundment area. Some other sections of the lands on the Property are under crown surface ownership.

6. In XXXXXXXXXX, the Optionors staked the claims covering the area of the mining leases previously held by ABC Co. By Option to Purchase dated XXXXXXXXXX, the Corporation acquired from the Optionors the exclusive right for XXXXXXXXXX days to purchase a XXXXXXXXXX% undivided working interest in the XXXXXXXXXX claims. The Option provided for consideration to be a XXXXXXXXXX% net profit royalty to the Optionors and to be exercised by carrying out exploration work of $XXXXXXXXXX and the issuance of XXXXXXXXXX common shares of the Corporation between XXXXXXXXXX.

7. On XXXXXXXXXX, the Corporation acquired an option exercisable on or before XXXXXXXXXX to purchase the Optionors XXXXXXXXXX% net profit royalty for cash consideration of $XXXXXXXXXX. The Company has to-date issued XXXXXXXXXX common shares and expended in excess of $XXXXXXXXXX on qualifying work on the mineral interests. The remaining commitment to issue an additional XXXXXXXXXX common shares must occur on or before XXXXXXXXXX . While the title to the mineral claims has been transferred into the name of the Corporation, it is subject to reversion to the Optionors in the event that the Corporation does not issue an additional XXXXXXXXXX common shares on or before XXXXXXXXXX. In addition to these claims, the Corporation also staked additional claims on its own account to consolidate its land position at the Property.

8. From XXXXXXXXXX, the Corporation commenced surface exploration to determine if additional XXXXXXXXXX mineralization existed to the XXXXXXXXXX of the Former Mine and elsewhere on the Property. The Corporation drilled XXXXXXXXXX core holes for a total of XXXXXXXXXX meters from surface to the XXXXXXXXXX of the Former Mine and discovered the A Zone and the B Zone. Only a portion of the mineral resources on site were known to XYZ Co. before the Corporation started its exploration project. The Corporation has also undertaken metallurgical studies.

9. Using the results from the surface XXXXXXXXXX drill program, the Corporation commissioned a scoping study, which was completed in XXXXXXXXXX and updated in XXXXXXXXXX. A copy of the scoping study was attached as Appendix II to your letter. The study, made to assess the economic potential of the mineralization, calculated a measured and indicated mineral resource containing approximately XXXXXXXXXX. It indicated that underground drilling would be required to increase the confidence level in the grade, geometry and continuity of the resource, and to upgrade those resources to the reserve category. It also examined possible scenarios where this resource could potentially support an economic underground mine with an economic mine life of XXXXXXXXXX years. It proposed to drive a decline from the open pit to test the rock stability and grade of the mineralization. The study concluded that the resource had the potential to support a new underground mine with access via a main access ramp collared at surface to the XXXXXXXXXX of the Former Mine. Additional subsidiary ramps would be driven from this.

10. Pre-production development costs of $XXXXXXXXXX that were forecast in the scoping study are categorized below:

Item
XXXXXXXXXX
Underground Development
XXXXXXXXXX
Crushing and Conveying
XXXXXXXXXX
Underground Mobile Equipment
XXXXXXXXXX
Underground Fixed Equipment
XXXXXXXXXX
Mill
XXXXXXXXXX
Tailings
XXXXXXXXXX
Administration and Miscellaneous
XXXXXXXXXX
Total
XXXXXXXXXX

11. The mining method envisaged in the scoping study was block caving at a rate of approximately XXXXXXXXXX metric tonnes per day. Ore would be crushed underground and transported to surface using a conveyor belt system. The Former Mine infrastructure would not be used in any way to facilitate or support the underground mining operation. Entirely new infrastructure would have to be put in place to excavate mineralization from the underground mine. The existing mill building could be used, but would have to be completely refurbished with new mill equipment.

12. In XXXXXXXXXX, the Corporation issued XXXXXXXXXX flow-through shares for total proceeds of $XXXXXXXXXX. It was originally contemplated that CEE to be incurred for the XXXXXXXXXX property that is located near the Property would be renounced to the holders of these flow-through shares. To date, minimal funds have been expended on this property and these funds may be diverted to the Property in the event that a positive ruling is received and the funds have not otherwise been expended.

Proposed Transactions

13. In order to adequately explore the newly discovered ore zones and to extend the zone that has been partly mined by the previous mining operation, the Corporation decided to conduct additional underground XXXXXXXXXX core drilling from an underground exploration decline. In XXXXXXXXXX, the Corporation commenced excavation of this decline from the XXXXXXXXXX wall of the Former Mine at an elevation of XXXXXXXXXX meters (i.e., above the high-water line). This decline is scheduled to reach a total length of XXXXXXXXXX meters, which total amount will include crosscuts into the mineralized zone. A total of XXXXXXXXXX meters of underground XXXXXXXXXX core drilling is scheduled to be completed from this decline. Drilling commenced in XXXXXXXXXX. In XXXXXXXXXX, the decline had reached a total length of XXXXXXXXXX meters and the crosscut to the mineralization had been started. The exploration decline would also permit the extraction of bulk samples for metallurgical testing from the crosscut.

14. The equipment being used to drive the decline is designed for the working conditions and restricted space of underground openings. The contractor driving the decline has brought its own equipment and employees. The Corporation has built up a staff of professional geologists and engineers that are not Former Mine employees. The miners, working underground at the decline, have skills that are different from the miners that worked in the Former Mine.

15. The total cost of the underground exploration work is forecast to be approximately $XXXXXXXXXX, divided as indicated below:

Item
XXXXXXXXXX
Exploration Drift
XXXXXXXXXX
Miscellaneous Contract Costs
XXXXXXXXXX
Underground XXXXXXXXXX Core Drilling
XXXXXXXXXX
Total
XXXXXXXXXX

Approximately $XXXXXXXXXX has already been expended.

16. The scoping study was a preliminary economic assessment of the potential for the Corporation's Property to be developed into an economic mine. It was neither an exhaustive study, nor one which could be used either to upgrade the resources into reserve category, or to finance a new mine development. In recognition of this, the Corporation intends to complete a bankable feasibility study on the project after completion of all underground exploration drilling. The feasibility study will examine all potential bulk mining underground methods, the potential for access via shaft and/or ramp system from surface, and provide mineralogical aspects required for the development of the mill design. It will also include technical reports on geo-technical, environmental, tailings management and hydrology matters. It will determine the potential economics and capital requirements of developing a new underground mine. It will determine the potential economics and capital requirements of developing a new underground mine. The metallurgical testing referred to in paragraph 13 above is part of this study. The estimated cost of the study is $XXXXXXXXXX and it is anticipated that it will commence XXXXXXXXXX. Upon completion of this study, assuming a positive conclusion, resources will be upgraded to reserves and the Corporation will have a document with which to examine potential options to finance development of the mine.

17. Following the underground exploration program, the completion of the feasibility study and assuming a positive decision, the Corporation will incur capital costs to develop a mine. If development of the underground mine proceeds it would require mining equipment adapted to the underground environment. The different mining techniques that could be used in the possible underground mine are not related to the technique used in the Former Mine and would require different skills and technical expertise. The limited volume of ore that would be mined by the underground operation is not at all comparable to the large volume of ore excavated by the open pit, using blast hole drills, trucks and shovels.

18. The Corporation is considering two scenarios to transport the ore to surface, either a new decline to accommodate a conveyor way or sinking a shaft. While a shaft is the most likely access method, the feasibility study will make the final determination. In any event, even if it were to be a decline/ramp access, it would not be placed in the Former Mine due to issues related to poor stability of the pit walls. In either of these scenarios, the transportation of the ore would be independent of the open pit workings.

19. To avoid possible environmental liability with the area that was disturbed by the mining operations at the Former Mine and the tailings pond, the Corporation is considering developing its own tailings pond on crown lands.

20. In the scoping study, it was contemplated that the mill of the Former Mine, which is still owned by ABC Co. and located on the XXXXXXXXXX side of the pit, would be used. However, at this time, the mill itself is no longer functional as only the mill building has been left on the site. The mill circuit has been deprived of its essential components, such as the flotation cells, the semi autogenous mill and the gravity circuit. The main internal components of the mill circuit were moved from the property. It is not clear that the Corporation could negotiate an agreement with ABC Co. to use the mill building, so the Corporation is contemplating different milling scenarios. The leading scenario being considered is building a mill that would be sized to the capacity of the underground mine. The new mill would be better located on the XXXXXXXXXX side of the Former Mine nearer to the possible location of the shaft.

Purpose of Proposed Transactions

21. The proposed expenditures to be incurred to complete the proposed underground exploration work will allow the Corporation to gain greater confidence and certainty with respect to the location, nature, extent and quality of the mineralization in Zone A and Zone B. If the exploration program is successful, and assuming a positive production decision can be made and a mine development financed, then the Corporation intends to take the project to production.

Other Information

22. The Corporation wishes to issue flow-through shares to assist in financing its exploration activities. It is considering doing this in XXXXXXXXXX. The specific amount and timing will be in part based upon the market conditions for flow-through share financings at that time. The ability to finance its exploration program with flow-through shares depends upon whether the proposed exploration expenditures qualify as CEE for the purposes of paragraph (f) of the definition of CEE. If it does, the Corporation will renounce the CEE to the flow-through shareholders in accordance with the provisions of subsections 66(12.6) and 66(12.66) of the Act.

Ruling Requested and Given

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions and purpose of the proposed transactions, and provided further that the proposed transactions are carried out as described above, our ruling is as follows:

We confirm that, subject to Comment (B) below, an expense incurred by the Corporation, after the date of this letter and in respect of the underground exploration program (referred to in paragraphs 13 to 15 above), which is incurred for the purpose of determining the existence, location, extent or quality of a mineral resource in the A Zone or the B Zone, 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 CEE of the Corporation pursuant to paragraph (f) of the definition thereof provided:

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

b) the expense is incurred before a mine comes into production in reasonable commercial quantities in respect of any mineralization that may be found in the A Zone or the B Zone pursuant to the underground exploration program (described in paragraphs 13 to 15 above); and

c) if the underground exploration program culminates in the development of a mining operation, such operation is developed as described in paragraphs 17 to 20 above and not as an extension of the Former Mine.

Comments

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

(A) the determination of the fair market value or adjusted cost base of any property referred to herein;

(B) whether any particular expense incurred by the Corporation in respect of the underground exploration program (referred to in paragraphs 13 to 15 above) will qualify as CEE of the Corporation. It is our view that expenses that do not meet the purpose test in paragraph (f) of the definition of Canadian exploration expense will only be eligible to be included in paragraph (g) of that definition if they are incurred for the purpose of bringing the mine into production in reasonable commercial quantities. In other words, the expenses must be incurred after the decision has been made to proceed with bringing a new mine into production in reasonable commercial quantities. As a result, expenses that are incurred in order to determine the economic feasibility of whether or not to proceed with developing a new mine, or that are related to the processing or sale of the mined mineral do not, in our view, satisfy the purpose test in either of paragraphs (f) or (g) of the definition of CEE.

Although we have not been provided with details of the various expenses relating to the feasibility study referred to in paragraph 16 above, it is our view as noted above that most of those expenses, including those related to the metallurgical tests on the bulk samples to confirm the mill flow sheet and the recovery rate, as well as the expenses related the development of the mining methods, means of extracting the ore and the mill design, will not be eligible for inclusion in either of paragraph (f) or (g) of the definition of CEE; and

(C) whether the Corporation is a "principal business corporation" and whether any share in the capital stock of the Corporation which was issued (as described in paragraph 12) or will be issued as envisioned in paragraph 22 above will be a "flow-through share".

The above ruling is given subject to the limitations and qualifications set forth in Information Circular 70-6R5 issued by the Canada Revenue Agency (the "Agency") on May 17, 2002 and is binding on the Agency provided that the proposed underground exploration program described in paragraphs 13 to 15 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.

Yours truly,

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