2007 Ruling 2006-0211941R3 - Canadian exploration expense

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 expenses incurred in connection with a Bulk Sample Program related to a potential XXXXXXXXXX operation qualify as Canadian exploration expense (CEE).

Whether pre-production revenue will reduce the CEE.

Position: Yes. Yes.

Reasons: Based on an opinion issued by Natural Resource Canada, the Bulk Sample Program will meet the purpose test.

Pursuant to paragraph (k.2) of the definition of CEE, the pre-production revenue will reduce CEE.

XXXXXXXXXX 								2006-021194

XXXXXXXXXX 2007

Dear XXXXXXXXXX :

Re: XXXXXXXXXX (the "Corporation") (XXXXXXXXXX )

This is in reply to your letter of XXXXXXXXXX , wherein you requested an advance income tax ruling on behalf of the above-noted taxpayer. We acknowledge your various e-mails in respect of this ruling.

You have advised that to the best of your knowledge and that of the responsible officers of the Corporation, none of the issues raised in this ruling is

(i) in an earlier return of the taxpayer or a related person,

(ii) 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) under objection by the taxpayer or a related person,

(iv) before the courts, or

(v) the subject of a ruling previously issued to the taxpayers by the Income Tax Rulings Directorate.

DEFINITIONS

In this ruling, unless otherwise specified:

• "Act" means the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), as amended and all statutory references herein are to provisions of the Act unless otherwise specified;
• "adjusted cost base" has the meaning assigned to that expression by section 54;
• "Canadian development expense" has the meaning assigned to that expression by subsection 66.2(5);
• "Canadian exploration expense" has the meaning assigned by subsection 66.1(6);
• "Canadian resource property" has the meaning assigned to that expression by subsection 66(15);
• "CRA" means the Canada Revenue Agency;
• "depreciable property" has the meaning assigned to that term by subsection 13(21);
• "flow-through share" has the meaning assigned to that expression by subsection 66(15);
• "mineral resource" has the meaning assigned to that term by subsection 248(1);
• "prescribed Canadian exploration and development overhead expense" has the meaning assigned in subsection 1206(4.2) of the Income Tax Regulations;
• "principal-business corporation" has the meaning assigned to that term by subsection 66(15);
• "public corporation" has the meaning assigned to that term by subsection 89(1); and
• "taxable Canadian corporation" has the meaning assigned to that expression by subsection 89(1).

Our understanding of the facts, purposes of the proposed transactions and proposed transactions is as follows:

FACTS

1. The Corporation was incorporated in Canada. The Corporation is resident in Canada and has its registered head office in Canada.

2. The Corporation is a publicly traded XXXXXXXXXX mining company (XXXXXXXXXX) that is focused on exploring and developing its XXXXXXXXXX property (the "Property") located about XXXXXXXXXX, Canada. The Corporation is a public corporation, a taxable Canadian corporation and a principal-business corporation.

3. Since XXXXXXXXXX, the Corporation has been planning a major drill program designed to delineate a substantial resource and determine if the quality and quantity of XXXXXXXXXX deposits within the Property are able to support a XXXXXXXXXX operation. Preliminary exploration estimates a production rate of approximately XXXXXXXXXX tonnes per year for a period of XXXXXXXXXX years.

4. Given the prevailing economic conditions, XXXXXXXXXX , the Corporation intends to embark on a bulk sampling program (the "Bulk Sampling Program"). The purpose of the Bulk Sampling Program is to determine to what extent the XXXXXXXXXX. Diamond drill core samples of the Property's XXXXXXXXXX have been subjected to a variety of laboratory scale tests. However, it is not possible to reliably predict from laboratory scale tests precisely XXXXXXXXXX. The Corporation has developed XXXXXXXXXX.

XXXXXXXXXX

5. The Bulk Sampling Program will provide the Corporation with certainty in respect of the XXXXXXXXXX deposits within the Property. The results of the Bulk Sampling Program are necessary in order for the Corporation to determine if the XXXXXXXXXX deposits are of sufficient quantity and quality such that it will be commercially viable to mine the Property. The Corporation has not yet made the decision to bring a mine at the location of the Bulk Sampling Program into production in reasonable commercial quantities.

PROPOSED TRANSACTIONS

6. The Bulk Sampling Program will involve the mining of approximately XXXXXXXXXX tonnes of ore from XXXXXXXXXX The XXXXXXXXXX tonnes mined represents approximately XXXXXXXXXX % of the total published resource. XXXXXXXXXX.

7. In connection with the Bulk Sampling Program, temporary facilities will be constructed at XXXXXXXXXX , which include XXXXXXXXXX . Temporary fuel storage facilities will also be constructed with the capacity to store approximately XXXXXXXXXX litres of diesel. At XXXXXXXXXX camp will be installed together with a XXXXXXXXXX kW diesel generator and fuel storage for XXXXXXXXXX litres of diesel.

8. In addition, the road from XXXXXXXXXX to the XXXXXXXXXX Deposit (the "XXXXXXXXXX Road") will be upgraded to allow haul-truck travel for the majority of the year. The XXXXXXXXXX Road upgrades will include the widening of existing roads, the placement of engineered fill in areas of low bearing capacity soils, the installation of culverts at water crossings and the construction of turnout or passing areas along the XXXXXXXXXX Road. The XXXXXXXXXX Road upgrades will require the construction of a temporary camp, which will act as a service centre for the construction crew and will respond to any emergencies. Prior to the actual commencement of the upgrades, a preliminary survey will be conducted via a fly-over, an on-ground survey, photographic documentation, GPS mapping, soil sampling and geotechnical testing.

9. It is estimated that the Bulk Sampling Program will require on average XXXXXXXXXX personnel and during peak times, it is estimated that XXXXXXXXXX people will be required. All necessary training will be provided by the Corporation.

10. The total cost of the Bulk Sampling Program can be summarized in the following table:

Description 				Amount 
						XXXXXXXXXX

Mining Contractor 			XXXXXXXXXX

Equipment/Camp Costs (other than
costs associated with depreciable
property)			   		XXXXXXXXXX 

Fuel  				   	XXXXXXXXXX 

Improvements to XXXXXXXXXX Road 	XXXXXXXXXX

Shipping 					XXXXXXXXXX

Aviation 					XXXXXXXXXX

Other Expenses 				XXXXXXXXXX

Total Cost 					XXXXXXXXXX

Recovered Costs from XXXXXXXXXX 	(XXXXXXXXXX)

Total Net Cost 				XXXXXXXXXX

PURPOSES OF PROPOSED TRANSACTIONS

11. The Bulk Sampling Program will allow the Corporation to determine, with greater certainty, the amount of XXXXXXXXXX located in and around the Property. If the results of the Bulk Sampling Program are favourable, the Corporation will develop the facilities necessary to bring into existence a mine that will produce reasonable commercial quantities of XXXXXXXXXX.

12. The Corporation intends on primarily financing the Bulk Sampling Program through the issuance of flow-through shares for the approximate aggregate amount of $XXXXXXXXXX CAD. The issuance of the flow-through shares will occur as soon as possible.

13. The feasibility of financing the Bulk Sampling Program is dependant on the proposed expenditures qualifying as Canadian exploration expenses. If the proposed expenditures are Canadian exploration expenses, they will be renounced to the flow-through shareholders in accordance with the provisions of subsections 66(12.6) and 66(12.66) of the Act.

14. A secondary source of financing will be sale of some of the extracted XXXXXXXXXX to XXXXXXXXXX. It is estimated that XXXXXXXXXX% of the cost of the Bulk Sampling Program will be recovered in this manner.

RULING

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions and purposes of the proposed transactions, we confirm the following:

A. An expense incurred by the Corporation, after the date the ruling is issued and in respect of the Bulk Sampling Program which is described in paragraphs 6 to 9 above, for the purpose of determining the existence, location, extent or quality of a mineral resource 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 a Canadian exploration expense of the Corporation pursuant to paragraph (f) of the definition thereof contained in subsection 66.1(6) provided that:

(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 Canadian exploration expense;

(c) the Bulk Sampling Program is not being conducted in connection with any other mineral claim owned by the Corporation;

(d) the expense is incurred before a mine comes into production in reasonable commercial quantities to exploit economic mineralization established by the Bulk Sampling Program; and

(e) the Bulk Sampling Program does not culminate in an extension of a mine that has come into production in reasonable commercial quantities.

B. Pursuant to paragraph (k.2) of the definition of Canadian exploration expense, the Corporation will be required to reduce its Canadian exploration expense by an amount equal to any revenue generated during the Bulk Sampling Program from the sale of the sample ore such that paragraph 66(12.1)(a) will not be applied to include such pre-commercial production revenue in the amount determined for G in the definition "cumulative Canadian exploration expense" in subsection 66.1(6).

COMMENTS

Except as expressly stated, our rulings do no 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 Bulk Sampling Program referred to in paragraphs 6 to 10 above will qualify as a Canadian exploration expense 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.

Although we have not been provided with details of the various expenses relating to the Bulk Sampling Program, it is our view that some of these expenses, especially those related to the construction of fuel storage facilities or the construction of roads other than a "specified temporary access road" as defined in subsection 1104(2) of the Income Tax Regulations, may not be eligible for inclusion in either of paragraph (f) or (g) of the definition of Canadian exploration expense since these expenses may constitute the cost of depreciable property to the Corporation, by virtue of the provisions of paragraph 13(7.5)(b) and subsection 1102(14.3) of the Income Tax Regulations;

c) whether any particular expense incurred by the Corporation in respect of the Bulk Sampling Program will constitute a prescribed Canadian exploration and development overhead expense for the purposes of paragraph 66(12.6)(b); and

d) whether any share in the capital stock of the Corporation which is issued as contemplated in paragraph 12 above will be a flow-through share.

The above rulings are given subject to the limitations and qualifications set forth in Information Circular 70-6R5 issued by the Canada Revenue Agency on May 17, 2002, and are binding provided that the Bulk Sampling Program described in paragraphs 6 to 9 above is completed before XXXXXXXXXX.

These rulings are based on the Act in its present form and do not take into account the effect of any proposed amendments thereto.

Yours truly,

for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch