7 December 1990 Income Tax Severed Letter - Canadian Exploration Expenses and Operator Allowance under Incentive Program

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: Subsection 5(3) of the CEIP Regulations Subsection 66(12.6) of theIncome Tax Act(the “Act”)

We are writing in reply to your memorandum wherein you requested a technical interpretation in relation to whether the “operator allowance” under subsection 5(3) of the Canadian Exploration Incentive Program (“CEIP”) Regulations would qualify for treatment as Canadian exploration expense (“CEE”) under paragraph 66.1(6)(a) of the Act and whether the CEIP grant with respect thereto would constitute “assistance” for purposes of paragraphs 66(12.6)(a), 66(15)(a.1), 12(1)(x) and subparagraph 66.1(6)(b)(ix) of the Act.

We acknowledge that your primary concern is with the proper amount of CEE which may be renounced by a principal business corporation (PBC) under the flow-through share provisions of the Act, viz. subsection 66(12.6).

GENERAL

• 1. On May 3, 1988 the Honourable Marcel Masse, Minister of Energy, Mines and Resources and the Honourable Gerald Merrithew, Minister of State (Forestry and Mines) announced the creation of CEIP, a program to assist in the financing of mineral exploration and oil and gas exploration through the use of flow-through shares.
• 2. In a News Release on February 21, 1990, the Honourable Jake Epp, Minister of Energy, Mines and Resources announced the immediate termination of CEIP, subject to certain grandfathering rules which were provided in a News Release on March 9, 1990.
• 3. The CEIP Act provided, in general terms, for grants to PBCs at an incentive rate of 30% of “eligible exploration expenses” incurred in Canada within a specified time.
• 4. “Eligible exploration expense” in relation to a mineral resource and hydrocarbons is defined in subsections 5(1) and (2) of the CEIP Regulations.
• 5. Under subsection 5(3) of the CEIP Regulations an operator [the PBC] may include an “operator allowance” in its eligible exploration expenses. This subsection provides

“An operator that incurs eligible exploration expenses within the meaning of subsections (1) and (2) in a calendar year as the operator of an activity shall be deemed to have incurred in that calendar year as additional exploration expenses an operator allowance in an amount equal to three percent of the eligible exploration expenses incurred by the operator as a participant in the activity.

HYPOTHETICAL SITUATION

You describe an hypothetical situation wherein

• (a) a PBC enters into a flow-through share agreement to incur CEE of $100,000,
• (b) the PBC incurs CEE of $97,000, none of which qualifies as Canadian exploration and development overhead expense (“CEOE”) as this term is defined in subsection 1206(1) of the Regulations,
• (c) the PBC applies for and receives a CEIP grant in the amount of $30,000 computed at 30% of eligible exploration expenses of $100,000. The eligible exploration expenses comprise

Actual CEE incurred $ 97,000
Operator allowance
$97,000 x 3%, say 3,000
$100,000

YOUR QUESTIONS

You have asked:

• 1. How the PBC's renunciation may be made where

(A) the PBC receives the CEIP grant of $30,000 and does not incur any additional CEE, i.e., the actual amount of CEE incurred remains $97,000,

(B) the CEIP grant of $30,000 is renounced under the provisions of the CEIP Act and paid to the investors in the flow-through shares, a consequence of which the PBC is deemed never to have received the CEIP grant.

• 2. Whether paragraph 66(12.6)(b) would be applicable to the operator allowance or to the portion of the CEIP grant which is attributable to the operator allowance, i.e. $900 (30% of the operator allowance of $3,000).
• 3. Whether paragraph 12(1)(x) would apply to the portion of the CEIP grant, $900, which is attributable to the operator allowance if subparagraph 66.1(6)(b)(ix) does not apply to this amount.

OUR COMMENTS

It is our view that CEIP grants are “assistance” within the meaning of paragraph 66(15)(a.1) of the Act, because they are amounts received or receivable by a taxpayer from a government by way of a grant. Thus the entire amount of the CEIP grant of $30,000 in the hypothetical situation would, in our view, fall within the ambit of “assistance” under paragraph 66(15)(a.1) of the Act.

The element of uncertainty, which we believe to be the crux of your concerns, is introduced upon application of subparagraph 66.1(6)(b)(ix) in computing the cumulative CEE of the recipient of the CEIP payment.

Under subparagraph 66.1(6)(b)(ix), a taxpayer is required to reduce his cumulative CEE by the amount of any assistance that he has received or is entitled to receive in respect of any CEE incurred after 1980 or that can reasonably be related to Canadian exploration activities after 1980.

For purposes of determining the amount of CEE which a PBC may renounce under subsection 66(12.6) of the Act the amount of CEE incurred by the PBC must be reduced under paragraph 66(12.6)(a) by the assistance that it has received, is entitled to receive, or may reasonably be expected to receive at any time, and that may reasonably be related to those expenses or to Canadian exploration activities to which those expenses relate. We do not have any qualms about considering the portion of the CEIP grant which is calculated by reference to the operator allowance, as assistance in respect of the CEE incurred by the PBC or as assistance that can reasonably be related to the Canadian exploration activities of the PBC.

The underlying question in the hypothetical situation is whether the portion of the CEIP grant, i.e. $900, which is attributable to the operator allowance, can be said to have been received as assistance in respect of CEE incurred or assistance that can reasonably be related to Canadian exploration activities.

Notwithstanding that in computing the amount of the CEIP grant, the base to which the incentive rate of 30% is applied includes an amount, a very minute amount at that, which is not CEE actually incurred but a mere 3 percent of that CEE, we are strained to consider the aforementioned portion of the grant to be other than assistance in respect of CEE or assistance that can reasonably be related to Canadian exploration activities.

We are strengthened in our view by the announcement of the ministers on May 3, 1988 that CEIP is a program to assist in the financing of mineral exploration and oil and gas exploration. Thus, CEIP grants are generally only given in relation to Canadian exploration activities.

We are buttressed in our conclusion by Dickson. J's comments in Gene A. Nowegijick v. The Queen, [[1983] C.T.C. 20] 83 DTC 5041 (S.C.C.), at page 5045

“The words “in respect of” are, in my opinion words of the widest possible scope. They import such meaning as “in relation to”, “with reference to” or “in connection with”. The phrase “in respect of” is probably the widest of any expression intended to convey some connection between two related subject matters.”

Having regard to the board meaning of “in respect of” CEE incurred, and to the operator allowance which is calculated by reference to CEE incurred, it is not difficult to fathom the portion of the CEIP grant which is attributable to the operator allowance as being within the ambit of subparagraph 66.1(6)(b)(ix) of the Act.

Our views are shared by Mr. Dan MacDonald, Energy Mines and Resources with whom the above was informally discussed.

Mr. MacDonald explained that the policy intent of the operator allowance was to partially compensate for the exclusion of Canadian exploration overhead expenses (“CEOE”) from eligible exploration expenses under the provisions of the CEIP Regulations. He also confirmed that the operator allowance does not qualify for treatment as CEOE, nor would it, in his opinion, qualify for treatment as CEOE.

Our answers to your questions are as follows:

1(A). In situations where the PBC has incurred CEE of $97,000 and receives a CEIP grant of $30,000 in respect of that CEE, the PBC may renounce up to $67,000 under the provisions of subsection 66(12.6) of the Act.

The amount which may be renounced under subsection 66(12.6) would be the CEE incurred by the PBC of $97,000 reduced under paragraph 66(12.6)(a) by the CEIP grant of $30,000.

Under these circumstances the PBC would compute its cumulative CEE for purposes of paragraph 66(12.6)(d) by adding the CEE incurred in the amount of $97,000 to its cumulative CEE pool under subparagraph 66.1(6)(b)(i) and reducing the pool by the $30,0000 CEIP grant under subparagraph 66.1(6)(b)(ix). The cumulative CEE of the PBC would therefore be $67,000 immediately prior to the renunciation.

1(B). In situations where the PBC has incurred CEE of $97,000 and the CEIP grant is paid to the investors in the PBC's flow-through shares, the PBC may renounce up to $97,000 of CEE under subsection 66(12.6) and for purposes of paragraph 66(12.6)(d) the PBC's cumulative CEE would be $97,000.

Under these circumstances the investors which have received the CEIP grant of $30,000 in the aggregate would accordingly reduce their cumulative CEE under subparagraph 66.1(6)(b)(ix).

• 2. It is our view that the operator allowance would not qualify for treatment as CEOE and that no part of the CEIP grant of $30,000 would be attributable to CEOE.

Consequently, paragraph 66(12.6)(b), which causes the amount of CEE which a PBC may renounce to be reduced by the amount of CEOE included therein, would not be applicable because the hypothetical situation assumes that the PBC's CEE of $97,000 does not include any CEOE.

• 3. Since it is our view that subparagraph 66.1(6)(b)(ix) would apply to the entire amount of the CEIP grant of $30,000 in the hypothetical situation, paragraph 12(1)(x) would not apply because of subparagraph (v) thereof, which excludes amounts otherwise included in computing a taxpayer's income from the ambit of paragraph 12(1)(x).

We consider amounts which have reduced a taxpayer's cumulative CEE by virtue of subparagraph 66.1(6)(b)(ix) to be amounts that have otherwise been included in computing the taxpayer's income.