2005 Ruling 2005-0143221R3 - 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 a proposed exploration program will qualify for inclusion under paragraph (f) to the definition of CEE.

Position: Expenses to be incurred in respect of the proposed 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 October 14, 2005. A representative of that Department visited the site and reached conclusions that supported the above position. The proposed expenditures a) are not related to the existing open pit mine or a potential extension of that mine and b) will be incurred before the underground mine currently being developed comes into production in reasonable commercial quantities.

XXXXXXXXXX 2005-014322

XXXXXXXXXX, 2005

Dear XXXXXXXXXX:

Re: XXXXXXXXXX.

Advance Income Tax Ruling

This is in reply to your letter dated XXXXXXXXXX wherein you requested an advance income tax ruling on behalf of the above named corporation. We also acknowledge receipt of the additional information provided in your letters dated XXXXXXXXXX and in several telephone conversations (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 and proposed transactions, purpose of the proposed transactions, and additional information is as follows:

Definitions

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

"ABC Co." means XXXXXXXXXX,

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

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

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

"Canadian exploration expense" ("CEE") 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,

"Concentrate," means XXXXXXXXXX,

"Corporation" means XXXXXXXXXX.,

"C Zone" means the XXXXXXXXXX,

"D Zone" means the XXXXXXXXXX,

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

"E Zone" means the XXXXXXXXXX,

"F Zone" means the XXXXXXXXXX,

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

"Mine" means the existing open pit mine used to mine the E Zone known as the XXXXXXXXXX owned by the Corporation,

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

"Ore" means an economic mixture of ore minerals, including XXXXXXXXXX mined from the Property,

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

"Property" means the mining property located XXXXXXXXXX,

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

"Target" means the potential down dip extension of the D Zone at a depth of more than XXXXXXXXXX metres below surface,

"taxable Canadian corporation" has the meaning assigned to that expression by subsection 89(1) of the Act, and
"XYZ Co." means XXXXXXXXXX.

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

Facts and Proposed Transactions

1. XYZ Co. was incorporated under the Canada Business Corporations Act on XXXXXXXXXX and its fiscal period ends on XXXXXXXXXX. The common shares of XYZ Co. trade on the XXXXXXXXXX Stock Exchange under the stock symbol XXXXXXXXXX and on the XXXXXXXXXX Stock Exchange under the stock symbol XXXXXXXXXX. XYZ Co. is a taxable Canadian corporation, a principal-business corporation and a public corporation. The registered and head office of XYZ Co. is situated at

XXXXXXXXXX. Its corporate tax number is XXXXXXXXXX, it is serviced by the XXXXXXXXXX Tax Services Office and it files its annual income tax return at the XXXXXXXXXX Taxation Centre.

2. XYZ Co. is authorized to issue an unlimited number of common shares (the "XYZ Co. Common Shares") and an unlimited number of special shares, issuable in series, including XXXXXXXXXX Series "A" Preferred Shares. As at XXXXXXXXXX there were XXXXXXXXXX XYZ Co. Common Shares issued and outstanding and no special shares or Series "A" Preferred Shares were outstanding.

3. ABC Co. owns or controls approximately XXXXXXXXXX percent of the issued and outstanding XYZ Co. Common Shares.

4. XYZ Co. owns all of the outstanding common shares of the Corporation and the Corporation is a wholly-owned subsidiary of XYZ Co. It was incorporated under the Canada Business Corporations Act on XXXXXXXXXX and its fiscal period ends on XXXXXXXXXX. The Corporation is a taxable Canadian corporation and a principal-business corporation. The registered head office of the Corporation is located at XXXXXXXXXX. Its corporate tax number is XXXXXXXXXX, it is serviced by the XXXXXXXXXX Tax Services Office and it files its annual income tax return at the XXXXXXXXXX Taxation Centre.

5. The Corporation owns and operates the Mine and a processing plant with a design capacity of XXXXXXXXXX tonnes per day (t/d) on the Property.

6. The mining and processing operation produces by flotation a Concentrate. Commercial production of the Mine started in XXXXXXXXXX at a rate of XXXXXXXXXX t/d. The production capacity at the mine-mill complex was expanded in XXXXXXXXXX and XXXXXXXXXX and in XXXXXXXXXX reached and sustained a capacity of XXXXXXXXXX t/d. The open pit is excavated by benches that are XXXXXXXXXX metres high where large trucks, shovels and loaders are used to mine the Ore. The open pit will ultimately be approximately XXXXXXXXXX metres deep.

7. In XXXXXXXXXX, the Corporation commissioned a feasibility study in response to scoping studies and a pre-feasibility study that indicated a higher grade sub-vertical ore body (the C Zone) located directly beneath the Mine was a viable underground mine. The C Zone extends below the economic limits of the Mine. This near vertical planar zone has a strike length exceeding XXXXXXXXXX metres with thickness averaging XXXXXXXXXX metres and is ideal for exploitation by underground mining. It is continuous to a depth of XXXXXXXXXX metres where it is truncated and offset to the XXXXXXXXXX by a fault. Below this fault, the D Zone has been traced to a depth of XXXXXXXXXX metres, over a strike length of XXXXXXXXXX metres, and remains open.

8. The underground mine feasibility study defines, as its base case, a nominal XXXXXXXXXX t/d mechanized longhole stope mine accessed through a portal in the Mine with an initial mine plan containing XXXXXXXXXX tonnes of mineral reserves. The integrated production plan for the expanded mine calls for the blending of higher grade underground ore with that of the Mine to generate a XXXXXXXXXX year mine life at an average production rate of about XXXXXXXXXX ounces of the Concentrate per annum. All of the underground reserves are contained within the sub-vertical zone located directly below the Mine to a depth of XXXXXXXXXX metres below surface.

9. In XXXXXXXXXX, the board of directors of the Corporation approved the development of an underground mine that will access the Ore of the C Zone via a decline (ramp access). By making a decision to develop an underground mine, the Corporation has effectively limited the possibility of further deepening the Mine. The portal of the decline is located at an elevation of XXXXXXXXXX metres; it is collared in the open-pit wall. The decline provides access underground and will be used as the main haulage way for the proposed mine. The drivage of the decline began in XXXXXXXXXX. According to the feasibility study, the underground mine will reach a depth of XXXXXXXXXX metres below surface. The ore of the C Zone cannot be economically mined from the Mine since it would require an excessive amount of waste stripping.

10. On XXXXXXXXXX XYZ Co. issued XXXXXXXXXX flow-through shares (the "XXXXXXXXXX Offering") for proceeds of $XXXXXXXXXX and subsequently purchased XXXXXXXXXX flow-through shares from the Corporation for proceeds of $XXXXXXXXXX. On XXXXXXXXXX, XYZ Co. issued XXXXXXXXXX flow-through shares (the "XXXXXXXXXX Offering") for proceeds of $XXXXXXXXXX and subsequently purchased XXXXXXXXXX flow-through shares from the Corporation for proceeds of $XXXXXXXXXX. The proceeds from the XXXXXXXXXX Offering and the XXXXXXXXXX Offering will be used, in part, for the exploration program described in paragraphs 12 and 13 below. The Corporation will renounce exploration expenses that qualify as CEE in favour of XYZ Co. pursuant to subsection 66(12.6) of the Act. XYZ Co. will renounce the CEE renounced to it by the Corporation to the subscribers of the public offering.

11. It is hypothesized that the C Zone is cut off at the depth or displaced approximately XXXXXXXXXX metres to the XXXXXXXXXX along a flat lying structure where it forms the D Zone. Alternatively, the D Zone is a separate, sub-parallel mineralization zone. Earlier in XXXXXXXXXX, the Corporation completed XXXXXXXXXX deep surface diamond drill holes (hole numbers XXXXXXXXXX) to test the Target at vertical depths ranging between XXXXXXXXXX metres from surface.

12. Concurrently with the development of the underground mine, the Corporation is exploring the Target. The exploration expenses related to the Target will be incurred before the underground mine currently being developed comes into production in reasonable commercial quantities. The location of the Target is delineated on the maps provided of the XXXXXXXXXX.

13. An additional XXXXXXXXXX deep surface holes (hole numbers XXXXXXXXXX) and XXXXXXXXXX follow-up holes (hole numbers XXXXXXXXXX) will be drilled to further test the Target and to expand the known mineral resource. The anticipated "pierce" points of these holes will be in the order of approximately XXXXXXXXXX metres below surface and a minimum of XXXXXXXXXX metres vertical below and XXXXXXXXXX metres laterally away from any proposed underground development of the Mine and underground operation. Most of the holes will be drilled XXXXXXXXXX of the Mine, on sites that provide a good location to cut the D Zone at the desired angle below the projected limit of the underground mine. The upper section of the holes will not provide additional useful information on the geology that could lead the Corporation to proceed with an extension of the Mine, as there are already a sufficient number of holes at and around the locations of the proposed holes to provide that information. Furthermore, the Corporation does not plan to extend the Mine further than the current limits at this time.

Purpose of the Proposed Transactions

14. The proposed transactions described in paragraphs 12 and 13 above are being undertaken for the purpose of determining the location, extent and quality of a mineral resource located beneath and offset up to XXXXXXXXXX metres XXXXXXXXXX of the Mine and the underground mine that is currently being developed.

Additional Information

15. Some of the collars for the proposed holes are located near the F Zone and in an area beyond the planned limits of the Mine. The F Zone was the subject of a drilling program that was completed in XXXXXXXXXX. Based on the results of the program, the Corporation has determined that there is no economic mineralization in the F Zone and the planned boundary of the Mine will not be extended to include the F Zone.

16. Additional flow-through financings may be entered into from time to time, the proceeds of which may be used for expenditures discussed herein.

17. As noted above, the development of the underground mine began in XXXXXXXXXX. The equipment for the underground operation will be smaller than the equipment used in the open pit. It is specifically designed for underground operations and can hardly be compared to open-pit equipment. The Mine has benches where heavy shovels, loaders and large haulage trucks are used to mine waste rock and ore. The underground mine will use the long-hole stoping method as opposed to the bench mining method. The personnel that are or will be working in the underground mine must have specialized skills that are not related to the skills of the workers of the Mine. There will be few or no employees from the Mine that could be transferred to the underground mine.

18. The underground mine will have its ventilation raise and escape way extended to surface outside the Mine. The compressed air required to operate the underground equipment will be supplied by compressors that were not required for the Mine operation. The underground production will be achieved independently from the Mine production. The underground low-profile haulage trucks will use a portion of the open-pit ramp to transport the ore to the primary crusher on the surface. In summary, the underground mine that is being developed will have its own workings, ventilation raise, escape ways, compressors and stopes capable of producing ore. The Ore from the underground mine will be processed at the existing on-site milling facility at the Property. If there is production from the Target, it will also be processed at this milling facility.

19. Ore production from the underground stopes will commence in XXXXXXXXXX with full production, at a rate of XXXXXXXXXX t/d, starting once enough development is completed and the stopes brought into production.

20. If the Ore in the Target is found in sufficient quantity and quality, it will likely require the sinking of a shaft because the larger portion of the zone is quite deep and will be out of reach for a mine using the decline as the principal means to haul the Ore to surface.

21. On XXXXXXXXXX, 2005, a favourable advance income tax ruling (our file # 2004-010307) was issued concerning expenses qualifying under paragraph (f) of the definition of CEE related to proposed exploration drilling programs to be undertaken on three other zones on the Property. If sufficient mineralization were found in any of the three zones and a mining operation developed, such operation would be conducted utilizing a new open pit mine rather than an extension of the Mine.

Ruling Requested and Given

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts and proposed transactions, purpose of the purposed transactions and additional information, and provided further that the proposed transactions are carried out as described above, we confirm that:

An expense incurred by the Corporation in respect of the exploration program (described in paragraphs 12 and 13 above) for the purpose of determining the existence, location, extent or quality of a mineral resource in the Target, 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 not one described in paragraph (k.2) of the definition of CEE;

c) the expense is incurred before the underground mine described in paragraphs 9 and 17 to 19 above comes into production in reasonable commercial quantities; and

d) if the exploration program described in paragraphs 12 and 13 above culminates in the development of a mining operation, such operation is conducted utilizing either

A) the underground mine described in paragraphs 9 and 17 to 19 above, or

B) a new shaft described in paragraph 20 above rather than as an extension of the Mine which is an existing open pit mine that has come into production in reasonable commercial quantities.

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 exploration program described in paragraphs 12 and 13 above will qualify as CEE of the Corporation; and

c) whether the Corporation or XYZ Co. is a principal business corporation and whether any share in the capital stock of the Corporation or XYZ Co. which was issued (as described in paragraph 10 above) or may be issued as envisioned in paragraph 16 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 exploration program described in paragraphs 12 and 13 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