Principal Issues: Various questions concerning geothermal well drilling and completion costs.
Position: Question of fact.
Reasons: Paragraph 1219(1)(f) of the Regulations includes the cost of drilling and completing wells for temporary, non-production purposes such as exploration and testing. Such costs may include casing and piping costs, but excludes the cost of a well that is or can reasonably be expected to be used for the installation of underground piping that is included in Class 43.1 or 43.2, such as piping used for production purposes.
XXXXXXXXXX 2011-042756 T. Posadovsky, CMA January 26, 2012
Dear XXXXXXXXXX :
Re: Geothermal Energy Project
We are writing in reply to your correspondence of November 10, 2011 wherein you requested our views as to whether certain expenditures incurred in connection with a geothermal energy project would qualify as Canadian renewable and conservation expense ("CRCE"), as defined under subsection 1219(1) of the Income Tax Regulations (the "Regulations").
Specifically, you wish to know whether the cost of drilling and completing a well for the purpose of testing the available resource or providing a conveyance mechanism for a geothermal energy project qualifies as CRCE under paragraph 1219(1)(f) of the Regulations in the following circumstances:
1. The well is not lined with piping or casing and is only used for resource analysis purposes.
2. The well is intended to be temporarily lined with piping or casing and used only for resource analysis purposes.
3. The well is intended to be permanently lined with piping or casing and used only for resource analysis purposes.
4. The well is intended to be permanently lined with piping or casing and used for resource analysis purposes, but it may be used for conveyance purposes at some point in the future.
Our Comments
Taxpayers carrying out a renewable energy and energy conservation project may be able to deduct certain expenses incurred in the pre-production development phase of such projects. In this regard, an expense incurred by a taxpayer in respect of the development of a project for which it is reasonable to expect that at least 50% of the capital cost of the depreciable property to be used in the project would qualify for inclusion in Class 43.1 or 43.2 of Schedule II to the Regulations, may qualify as CRCE if, among other things, the expense is not:
- payable to a person or partnership with whom the taxpayer is not dealing at arm's length, or
- specifically excluded from CRCE under subsection 1219(2) of the Regulations.
Whether a particular expense qualifies for inclusion in CRCE is a question of fact that can only be determined by a review of all of the relevant facts in a given circumstance. As you indicated in your correspondence, paragraph 1219(1)(f) of the Regulations was recently amended to ensure that expenses incurred in respect of drilling or completing a well, that is, or can reasonably be expected to be, used for the installation of underground piping that is included in Class 43.1 or 43.2 of Schedule II to the Regulations, are excluded from CRCE. However, it is our view that paragraph 1219(1)(f) would not necessarily preclude the cost of casing or piping in the scenarios you provided as long as the well is used, or intended to be used, only for temporary or non-production purposes. Where it can be established that the well is, or can reasonably be expected to be, used for production purposes, the drilling and completion costs, including the cost of installing any underground piping, may be included in the capital cost of depreciable property under Class 43.1 or 43.2, provided all the requirements in each Class are otherwise met.
We trust our comments will be of assistance.
Yours truly,
Fiona Harrison, C.A.
Manager
Resources Section
Reorganizations and Resources Division
Income Tax Rulings Directorate