8 August 1989 Income Tax Severed Letter AC73773 - Mine Development Costs Considered Capital Expenditures

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.

Special Audits Division              Specialty Rulings
                                       Directorate
                                     O. Laurikainen
                                     957-2125

C. Savage

          24(1) 

Subsection 5907(2) of the Regulations to the Income Tax Act (the "Regulations")

This is in response to your memorandum of March 21, 1989. You have requested our comments on whether in our view, certain expenditures are in the nature of capital for the purposes of clause 5907(2)(j)(iv)(B) of the Regulations and whether the method employed by the above taxpayer in calculating exempt earnings is correct.

In our view, the term capital expenditure would have the same meaning for the purposes of clause 5907(2)(j)(iv)(B) of the Regulations as that term would have for the purposes of the Income Tax Act (the "Act") in general. Accordingly, most of the mine development costs described in your referral would be considered capital expenditures for the purposes of the above provision. However, the term capital expenditure refers to a transaction such as the purchase of a capital asset. Therefore, since a provision for depreciation and amortization taken for accounting purposes during a particular year would not be considered a capital expenditure, it could not be argued that such an amount should be added back in arriving at the earnings of a foreign affiliate on the basis of the wording of clause 5907(2)(j)(iv)(B) of the Regualtions.

It is our opinion that the adjustment in paragraph 5907(2)(f) of
the Regulations is intended to apply to revenue, income or profit
that arises in the accounting income of the affiliate that will
not, in the normal course, be included in the income of the
affiliate measured under the tax laws of the foreign
jurisdiction.  In this case it should be the net accounting
income from the                                                   
             24(1) operations that is added back.  No adjustment
would be made under clause 5907(2)(j)(b)(iv) of the Regulations.

Accordingly, the amount of the proposed change to exempt earnings proposed by the Vancouver District Office should be increased by the amount of depreciation taken on the buildings used in the goldmining operations and the amount of the foreign exchange loss, unless it can be argued that some portion of the exchange loss was on the account of capital.

The object of the foreign affiliate rules is to allow the income (profit) earned from active business to be returned to Canada tax free. By taking the position that we have, we allow this objective to be met in this case in the same manner it would have been, had the income been subject to tax in the foreign jurisdiction. This position could only be troublesome if it could be argued that by using net accounting income under paragraph 5907(2)(f), we had effectively made a deduction that would not be required under subparagraphs 5907(2)(j)(iii) of (iv). In the case at hand it does not appear that subparagraph 5907(2)(j)(iii) of the Regulations would apply and in any case it certainly would not apply in the ordinary course of business of a foreign affiliate. The only provision of subparagraph 5907(2)(j)(iv) of the Regulations that could apply in this case would be clause (B) but as pointed out above, it is our view that depreciation and amortization are not capital expenditures incurred in the year.

For the same reasons as set out above for including the accounting profit under paragraph 5907(2)(f) of the Regulations, in the case, had there been an accounting loss it would have been deducted under subparagraph 5907(2)(j)(i) in the computation of the adjusted earnings amount.

for Director Reorganizations and Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch