1 March 1991 Internal T.I. 46317 F - Feasibility Study Costs Qualifying as Canadian Exploration Expenses

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.

Subject:  24(1)

Your memorandum of January 4, 1990 requests a technical interpretation with respect to whether certain feasibility study costs would qualify for treatment as Canadian exploration expenses ("CEE") under subparagraph 66.1(6)(a)(iii.1) of the Income Tax Act (the "Act").

We apologize for the delay in rendering our comments.

Background

24(1)

Paragraph 66.1(6)(a) of the Act provides that CEE of a taxpayer means any expense incurred after May 6, 1974 that is

(iii)      any expense incurred by him (other than an expense incurred in drilling or completing an oil or gas well or in building a temporary access road to, or preparing a site in respect of, any such well) for the purpose of determining the existence, location, extent or quality of a mineral resource in Canada including any expense incurred in the course of

(A)       prospecting,

(B)       carrying out geological, geophysical or geochemical surveys,

(C)       drilling by rotary, diamond, percussion or other methods, or

(D)       trenching, digging test pits and preliminary sampling, but not including

(E)       any Canadian development expense, or

(F)       any expense that may reasonably be considered to be related to a mine that has come into production in reasonable commercial quantities or to be related to a potential or actual extension thereof,

(iii.1)   any expense incurred by him after November 16, 1978 for the purpose of bringing a new mine in a mineral resource in Canada into production in reasonable commercial quantities and incurred before the coming into production of the new mine, including (A)  clearing, removing overburden and stripping, and (B)  sinking a mine shaft, constructing an adit or other underground entry.

During the course of its audit, the Calgary District Office has determined

24(1)

Problem

Your concern is whether subparagraphs 66.1(6)(a)(iii) and (iii.1) of the definition of CEE can be interpreted 24(1)

Our Comments

The details whit respect to the particular feasibility study costs which 24(1) incurred in 24(1) were not provided to us and accordingly, we are unable to render any opinion as to whether or not 24(1) feasibility study costs would qualify for treatment as CEE under subparagraphs 66.1(6)(a)(iii) or (iii.1).

Mr. A.H. Baglau of the Calgary District Office, who is in charge of the 24(1) audit, has requested:

A.   our views with respect to the income tax treatment of feasibility studies, and

24(1)

A.        Our Position on Feasibility Studies

     The Rulings Directorate has adopted the position that whether a particular expense constitutes CEE under subparagraph 66.1(6)(a)(iii) or (iii.1) is a question of fact which can only be determined after considering all of the relevant facts pertaining to the particular situation.

     Generally, our position on feasibility studies is that they are too remote from activities undertaken to actually determine the existence, location, extent or quality of a mineral resource in Canada to qualify as CEE under subparagraph 66.1(6)(a)(iii) if they are undertaken to determine whether to proceed with the development of a mine.  Such studies would not qualify under subparagraph 66.1(6)(a)(iii.1) because they are for the purpose of making a determination whether or not to proceed to bring a mine into production, not for the purpose of actually bringing the mine into production.

     Where all of the relevant facts pertaining to a particular situation establish that the feasibility study cannot qualify for treatment as CEE, the costs thereof would be accorded the appropriate treatment described at paragraphs 4 and 5 of Interpretation Bulletin IT-475 and question 28 of the 1986 Revenue Canada Round Table:

     Normally, a feasibility study undertaken to determine whether or not a particular course of action is desirable in connection with an existing business is considered to be a current expenditure.  Once a decision has been made to proceed with a project or to acquire a capital asset, however, all subsequent costs will be included in the capital cost of that project or asset.  If that asset is not acquired, such costs will be eligible capital expenditures if they relate to a business.

B.        Responses to 24(1) Representations

     In its letter to the Calgary District Office dated October 31, 1989,

     24(1)

     The arguments advanced by 24(1) in support of this contention and our general comments are as follows.

I.        24(1) submits that subparagraph 66.1(6)(a)(iii.1) refers to "any" expense and that it can be adduced from the definition of "expense" in Black's Law Dictionary that "any expense" could include expenses of both a capital and current nature.  Further, if the legislators had intended to restrict the expenses in this subparagraph to those of a capital nature, they would have used restrictive language such as capital, or non-current, rather than "any" expense.  current, rather than "any" expense.

Our Response to I

     It is our view that feasibility study costs which are current expenses would be deductible in computing income under section 9 of the Act provided that they are not precluded from deduction under section 18.

     If a detailed examination of the particular 24(1) feasibility study costs reveals that the costs were not current operating expenses (see Denisson Mines Limited v. MNR, 74 DTC 6528, S.C.C.) and were incurred unquestionably for the purpose of bringing a new mine in a mineral resource in Canada into production in reasonable commercial quantities under the provisions of subparagraph 66.1(6)(a)(iii.1) and the costs did not include the cost of capital property, we would not quarrel with the inclusion of such costs in  24(1) CEE.

     We reiterate our comments at page 2 of our memorandum dated October 21, 1986 to the Calgary District Office pertaining to  24(1)

     In January of this year we informed 24(1) in writing that, while the words "any expense" as used in subparagraph 66.1(6)(a)(iii.1) of the Act could be construed very broadly, it is our view that such a broad interpretation is inconsistent with the overall scheme of the Act.  Consequently, we do not interpret CEE in such a broad manner as to allow costs pertaining to capital property to be included in CEE.

II.       The gist of 24(1) second argument which is somewhat lengthy is stated at pages 2 and 3 of the aforesaid October 31, 1989 letter:

     While we do not disagree that these are points or steps that occur or can occur in the total process prior to the development of a mine, these are just some of the many steps or activities that take place in the total process of bringing a mine into production.  We must emphasize however, that you cannot look at these activities in isolation as you appear to be doing.  They are simply some of the steps taken in to the total process of bringing a mine into production.  While it is true that at this stage of the process a decision will be made to (i) proceed with the project, (ii) do more exploratory work, or (iii) terminate the project, this is only one of the many vital steps in a process the objective and purpose of which is to bring a mine into production, which is the stated objective and purpose of the project from day one, when the first dollar is spent on the project, otherwise you would not spend any money on the project.

      There are many phases or steps that take place in bringing a mine into production and as stated above, this is only one of the steps, without which you could not or would not proceed to develop and construct a mine.

     24(1) in order to further its position "that the feasibility activity is one of the vital steps that takes place in the total process of bringing a mine into production without which you could not or would not proceed to develop or bring the mine into production."

      For reasons given in our response below, we do not consider it to be necessary to repeat 24(1)

Our Response to II

     24(1) argument appeals to a broad interpretation of the nature and the types of expenses contemplated at subparagraph 66.1(6)(a)(iii.1).

     We do not subscribe to 24(1) suggested broad interpretation of the nature and types of expenses contemplated at subparagraph 66.1(6)(a)(iii.1).

     We reiterate our position that it is a question of fact whether a particular expense has been incurred for the purpose specified in subparagraph 66.1(6)(a)(iii.1).

     It is our view that the nature and types of expenses contemplated at subparagraph 66.1(6)(a)(iii.1) are those pre-production mine development expenses after the feasibility stage, i.e., after the decision has been made to proceed with mine development, but may include part of the feasibility study itself if the feasibility report contains sufficient details which are pertinent to actual mine development, eg. mine plans, building designs, etc..

     Support for our position that subparagraph 66.1(6)(a)(iii.1) contemplates only expenses incurred in the actual development of a mine is as follows:

1.        Subparagraph 66.1(6)(a)(iii.1) is applicable to expenses incurred after November 16, 1978.  Prior to November 17, 1978, these expenses were classified as Canadian development expenses ("CDE") under subparagraph 66.2(5)(a)(ii).  This change was made in order to implement the Budget Speech of November 16, 1978 wherein the Honourable Jean Chrétien, Minister of Finance announced (at page 15 of the Budget Speech)

"I propose that the current write-off for development expenditures in mining incurred after tonight be raised from 30 to 100 per cent."

2.        It is interesting that the editorial comment with respect to this budget announcement in CCH, Canadian Tax Reports, Number 352 Extra, at page 21 pre-supposes that a decision has been made to develop a mine.  It states:.

     The expenses incurred after November 16, 1978 relating to the development of a mine will qualify as Canadian exploration expenses.  It appears that the former 30% per annum deduction for development expenses is now reclassified in respect of the development of mines ....

3.        The editorial comment is consistent with the Budget Papers of November 16, 1978 at page 3:

That expenses incurred after November 16, 1978 relating to the development of a mine qualify as Canadian exploration expense.

4.        Subparagraph 66.2(5)(a)(ii) was introduced in Bill C49 to implement the Budget Speech by the Honourable John N. Turner, Minister of Finance on November 18, 1974.  In the Budget Supplementary Information thereto at page 5, it is stated that "the rate for development expenditures is reduced to 30 per cent".

5.        Subparagraph 66.2(5)(a)(ii) was preceded by subparagraph 66(15)(b) which defines Canadian exploration and development expense ("CEDE") to mean any expense incurred before May 7, 1974 that is, inter alia:

(ii)      any prospecting, exploration or development expense incurred by him after 1971 in searching for minerals in Canada.

6.        Subparagraph 66(15)(b)(ii) was preceded by subsection 83A(3) of the pre-1972 Act which states, in part:

(3)       A corporation whose principal business is...

(b)  mining, or exploring for minerals,

may deduct, in computing its income under this Part for a taxation year, the lesser of

(c)  the aggregate of such of...

(ii)      the prospecting, exploration and development expenses incurred by it in searching for minerals in Canada....

7.        It seems clear that the history of the legislation supports the view that only actual development expenses pertaining to a mine are contemplated at subparagraph 66.1(6)(a)(iii.1) - within the same meaning and context as the term was used in subsection 83A(3) of the former Act.

8.        In Johnson's Asbestos Corporation v. MNR, 65 DTC 5089 (Exch Ct.) and International Nickel Co. of Canada v. MNR, 69 DTC 5092 (Exch. Ct.), the court considered the meaning of "development expense" and considered four phases of mining, viz, prospecting, exploration, development and production.

9.        In the Johnson's Asbestos case, Jackett, P. wrote at page 5092:

     "Development" of a mine, in general terms, means to uncover the body or area which is to be the subject matter of the extraction process.  Development is the preparation of the deposit or mining site for actual mining.

10.       In the International Nickel case, the taxpayer contended and the Minister disputed, inter alia, that "development expenses" within the meaning and for the purpose of subsection 83A(3) of the former Act do not have to have a direct and specific searching aspect to them to qualify as deductible expenses, but instead "a broader meaning should be given to the category of expenses which qualify as such "development expenses" in searching for minerals in Canada..." (page 5096).

11.       The Minister's position, in part, was stated at page 5098 of the International Nickel case as follows:

...     Development as that term is used in the mining industry connotes the operation following exploration and preceding production, of physically reaching and opening up the ore body in preparation for extraction.  It includes the sinking of development shafts, cross-cutting, drifting and raising.  It does not include construction of a townsite for the accommodation of persons who will be engaged in extraction, milling, smelting and refining operations.

12.       Gibson, J. rejected the broad meaning of "development expense" and wrote at page 5105:

     I am of opinion that the meaning given to those words [i.e , development expenses] by the witness Wright [the taxpayer's witness] is not what parliament intended.  His meaning is much too wide and is one which may be acceptable and relevant in reference to the concept of an overall development of many projects being done to-day which may involve the establishment of a new town but it is not the concept of development which is applicable to the subject matter of this case.  In my view, what Parliament intended in this subsection of the Act, was to confine "development expenses" to those expenses which are incurred at the development stage of mining as understood by people in the mining business which is, in my view, evidenced by the opinion of Mr. Cox [the Minister's witness] and the dictionary definitions and the definitions from mining publications put in evidence. 

     As a result, I am of the opinion the "development expenses" within the meaning of section 83A(3)(c)(ii) of the Income Tax Act mean those expenses which are incurred in the opening up of an ore body by shafts, drives and subsidiary openings for the various purposes of subsequent mining, such as, the valuation of deposits, the estimates of its tonnage and in due course, its extraction.  This, in essence, is the meaning given to development by E.J. Pryor in his Dictionary of Mineral Technology above referred to.

13.       Having regard to the aforementioned history of the legislation, the budget documents and the comments by the courts, we are unable to accept 24(1) contention that subparagraph 66.1(6)(a)(iii.1) should be interpreted broadly so as to include those costs of 24(1)

14.       We have arrived at our conclusion by reference to the law, budget speeches and case law.  We have given full consideration to the excerpts from 24(1) but we do not find it to be of any assistance in providing a technical interpretation of subparagraph 66.1(6)(a)(iii.1).

15.        24(1)

III.      24(1) third defence is by reference to the following court cases:

1.        Sherritt Gordon Mines Limited v. MNR, 68 DTC 5180 (Exch. Ct.);

2.        Re Glover and Glover, 80 DTC 6262 (Ontario C.A.);

3.        Ross v. MNR, 50 DTC 775 (Exch. Ct.); and

4.        Emma MacLaren v. MNR, 1 DTC 246.

Our Response to III

     In the Sherritt case, the taxpayer made payments of bond interest and payments of commitment fees in the relevant taxation years and subsequently attributed and allocated the amounts of such payments to (a) exploration and development expenses, (b) the cost of depreciable assets acquired and (c) operating expenses.

     The issue was whether the interest and commitment fees could, as a matter of law, be capitalized or treated in the same manner as the proceeds of the bond issue, i.e., to acquire depreciable property and to incur exploration and development expenses; or whether the payments were required to be deducted under the relevant provisions of the Act in the taxation year in which they were incurred.

Kerr, J. stated at page 5195:

     There is no decision binding on this court on that question, so far as I am aware.  In my view the question is fairly arguable, but I am disposed to think that interest during construction can be a part of the capital cost of property within section 11(1)(a) and that in Sherritt's case a portion of the payments of bond interest and commitment fee during construction was part of the capital cost to Sherritt of the depreciable property upon which the bond money was expended, within the meaning of that subsection.

At page 5198, he then wrote:

     I think that the reasoning that in my view supports the inclusion of interest during construction as part of the capital cost of the depreciable property acquired or constructed through the expenditure of the borrowed bond money also supports the inclusion, as exploration and development expenses, of interest during the construction period on the borrowed bond money spent in exploration and development work in that period.  Similarly in respect of commitment fee payments.

     Since the Sherritt case merely augments the assertion that bond interest and related commitment fee may be treated in the same manner as that of the proceeds of the bond issue, we are strained to agree that the Sherritt case is relevant to the 24(1) feasibility study issue which, as previously stated, is an issue of whether the costs of the study, or portions thereof, have in fact been incurred for the purpose stipulated in subparagraph 66.1(6)(a)(iii.1).

     24(1) cited the Glover, Ross and MacLaren cases in order to introduce certain principles of tax law into their submission that exclusion of feasibility study costs from subparagraph 66.1(6)(a)(iii.1) would violate these principles.

     The principles are described by 24(1) as follows:

1.        Every clause of a statute should be construed with reference to the context and the other clauses of the Act, so as, so far as possible to make a consistent enactment of the whole statute or series of statutes relating to the subject matter.

2.        Whenever there is a particular enactment and a general enactment in the same statute, and the latter taken in its most comprehensive sense, would overrule the former, the particular enactment must be operative, and the general enactment must be taken to affect only the other parts of the statute to which it may properly apply.

     3.        In a taxing act, the tax must be expressed in unambiguous terms and that, in case of reasonable doubt, the Act must be interpreted in favour of the taxpayer.

It is our view that our interpretation of subparagraph 66.1(6)(a)(iii.1) has not offended any of the above fundamental principles of tax law.

If you have any questions or comments regarding the above, please contact the writer.

DirectorBilingual Services and Resource Industries DivisionRulings Directorate4500000 - 4599999