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: 1. What factors are involved in the re-characterization of certain CDE to CEE? 2. Is there a limit to the amount of funds you can use to incur exploration and development expenses in a given taxation year under a flow-through share agreement?
Position: 1. General comments provided. 2. No, but the PBC cannot renounce CEE or CDE in excess of the consideration received from the flow-through shareholders for the flow-through shares.
XXXXXXXXXX
2012-047231
T. Posadovsky
January 25, 2013
Dear XXXXXXXXXX:
Re: Flow-Through Shares
This is in response to your email of December 10, 2012, concerning the rules associated with resource expenditures and the use of funds raised from a flow-through share offering. Specifically, you asked about the factors involved in the re-characterization of certain Canadian development expenses ("CDE") to Canadian exploration expenses ("CEE") under the applicable provisions of the Income Tax Act (the "Act"). You also wish to know if there is a limit to the amount of funds you can use to incur exploration and development expenses in a given taxation year under a flow-through share agreement.
Our Comments
Whether a particular expense will be included in the definition of CEE in subsection 66.1(6) or CDE in subsection 66.2(5) of the Act can only be determined by examining all of the relevant facts and circumstances of a particular situation. However, we are prepared to offer the following general comments, which may be of assistance.
Flow-through shares ("FTS") are often used by resource companies as a source of financing exploration and development activities in Canada. A FTS is defined in subsection 66(15) of the Act and generally means a share (other than a prescribed share) of the capital stock of a principal-business corporation ("PBC"), or a right to acquire such a share (other than a prescribed right), issued to a person under a written agreement between the person and the PBC. For the purposes of the FTS rules, a person can be a corporation, partnership, individual, or trust. A PBC is also defined in subsection 66(15) of the Act and includes, among other things, a corporation the principal business of which throughout the year was exploring or drilling for minerals, petroleum or natural gas. Under the FTS agreement, the PBC agrees to incur and renounce certain qualifying exploration and development expenditures to the flow-through shareholders within a specified time period. To be eligible for such treatment, the CEE or CDE must be incurred in the period that begins on the date of the agreement and ends 24 months after the end of the month that includes the agreement date. The amount of renounced expenses cannot be less than the consideration paid for the particular shares or rights to be issued under the agreement. The renounced CEE or CDE, as the case may be, is deemed to be incurred by the flow-through shareholder and not the PBC, and can be used as a deduction in the computation of the flow-through shareholder's taxable income. Although it is beyond the scope of this letter, where certain conditions are satisfied, CEE incurred by a PBC in a particular calendar year may be deemed to have been incurred by the PBC on the last day of the immediately preceding calendar year under the "lookback" rules.
Specific to your question, it is possible that certain expenses in respect of an oil or gas well that qualified as CDE in the taxation year they were incurred may be reclassified as CEE in a subsequent taxation year. If the requirements under subsection 66.1(9) of the Act are met at any time in a taxpayer's taxation year, certain CDE is deemed, for the purposes of the Act, to be CEE of the taxpayer at the time of the reclassification and not at the time the reclassified CDE was actually incurred. Generally, subsection 66.1(9) includes the drilling or completing of a "discovery well", a "non-producing well" or an "abandoned well". However, we note that the proposed amendments to subsection 66(12.6), applicable to renunciations made after December 20, 2002, will exclude reclassified CDE from CEE that may be renounced by a PBC.
Subsection 66(12.601) in conjunction with subsection (12.602) of the Act also allows a PBC to renounce up to $1 million of "specified CDE" per calendar year and have those expenses treated as CEE in the hands of flow-through shareholders. Specified CDE includes certain expenses incurred by the PBC in drilling, converting, completing or recompleting wells as described under paragraphs (a) and (b) of the definition of CDE. The CDE eligible under subsection 66(12.601) must generally be incurred in the 24 month period that begins on the day on which the relevant flow-through share agreement is entered into, and must be incurred on or before the effective date of the renunciation. However, the PBC's taxable capital employed in Canada at the time the consideration for the shares was given must not be more than $15 million.
Although not a reclassification, certain eligible development expenses incurred in drilling or completing an oil or gas well, preparing well sites and building temporary access roads, may qualify as CEE under paragraph (d) of the definition of CEE in subsection 66.1(6) of the Act. The criteria for eligibility are listed in subparagraphs (i) to (iv) of paragraph (d) and include the development expenses incurred in respect of a "discovery well" described in subparagraph (i), an "abandoned well" described in subparagraph (ii), a "non-producing well" described in subparagraph (iii) and a well described in subparagraph (iv) in respect of which a certificate has been obtained from the Minister of Natural Resources that the total expenses will exceed $5 million.
Concerning your second question, there is no limit as to how much a PBC can incur on exploration and development activities in any one taxation year during the 24 month period noted above. However, paragraphs 66(12.6)(d) and (12.62)(d) of the Act limit the amount that a PBC may renounce to a flow-through shareholder to the amount of consideration paid for the shares.
We trust that our comments will be of assistance.
Yours truly,
Fiona Harrison, C.A.
Manager
Resources Section
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5
© Her Majesty the Queen in Right of Canada, 2013
Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistributer de l'information, sous quelque forme ou par quelque moyen que ce soit, de facon électronique, méchanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.
© Sa Majesté la Reine du Chef du Canada, 2013
Email this Content