Principal Issues: In a given situation, where the exploration of a mining site starts up XXXXXXXXXX and costs must be incurred to make the site safe for the employees before further exploration can proceed, whether the costs related to making the site safe qualify as CEE?
Reasons: Question of fact.
JURISPRUDENCE: Global Communications Ltd v. The Queen, 99 DTC 5377, Oro Del Norte SA v. The Queen, 93 DTC 5217, Petro Canada v. The Queen, 2004 DTC6329, McLarty v. The Queen, 2005 DTC 55.
2005-014965 XXXXXXXXXX Marc LeBlond (613) 946-3261 June 20, 2006
Dear Sir,
Subject: Qualification of certain work as Canadian Exploration Expenses
This is in response to your letter of September 1, 2005, requesting our comments on the application of the Income Tax Act in the situation described below. We apologize for the delay in responding to your request.
Unless otherwise indicated, all statutory references herein are to provisions of the Income Tax Act (the "Act").
The Situation
- Your corporation has recently undertaken preliminary exploration for a "mineral resource", as defined in subsection 248(1), on a mining property located in Canada (the "Property") XXXXXXXXXX.
- The initial results of the recent preliminary exploration work warrant further exploration. Accordingly, it is contemplated that a team of geologists will visit the Property to conduct a more detailed study.
- However, recent work has also shown that the Property is not safe due to XXXXXXXXXX.
- Work must therefore be done to make the Property safe for the geologists before they can begin the additional exploration work planned.
Your Questions, Your Position and Your Analysis
You asked us, in the situation you have presented to us, whether the expenses to render the Property secure (other than expenses that represent the cost or part of the cost of "depreciable property", as defined in subsections 248(1) and 13(21), of a prescribed class) (the "Expenses in question") constitute "Canadian exploration expenses", as defined in paragraph (f) of that expression in subsection 66.1(6) ("CEE"). To the extent that the Expenses in question are not CEE, you asked whether we consider them to be operating expenses or some other type of tax expense.
You are of the view that the Expenses in question are CEE. The alternative would be that the Expenses in question are expenses of a current nature that would be deductible by your corporation in computing its income from its mining business for the year in which the Expenses in question were incurred.
In your view, the Expenses in question would be CEE since it is the objective pursued at the time an Expense is incurred that determines whether it qualifies as "CEE" (assuming, of course, that it is not an outlay that represents the capital cost of a depreciable asset). In your view, the objective must be to determine the existence, location, extent or quality of a mineral resource in Canada.
Furthermore, the Expense in question in the alternative would be a current expense, as the objective of the work in question was to make exploration possible by making the terrain safe. You therefore consider this work to be similar to that relating to the construction of a temporary access road that would make it possible to bring drilling equipment to the site or to cut down trees where the drilling equipment would be installed.
Our Comments
As stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, it is the practice of our Directorate not to issue written opinions on proposed transactions otherwise than by way of advance rulings. Furthermore, when it comes to determining whether a completed transaction has received appropriate tax treatment, that determination is made first by our Tax Services Offices as a result of their review of all facts and documents, which is usually performed as part of an audit engagement. However, we can offer the following general comments which may not be fully applicable to the situation you submitted.
Paragraph (f) of the definition of CEE in subsection 66.1(6) provides that expenses incurred by a taxpayer for the purpose of determining the existence, location, extent or quality of a mineral resource in Canada (the "Purpose Test") are CEE.
In addition, paragraph (f) of the definition of CEE lists certain expenses that could be CEE, namely, prospecting; carrying out geological, geophysical or geochemical surveys; drilling by rotary, diamond, percussion or other methods; or trenching, digging test pits and preliminary sampling. This list of expenses is not, however, an exhaustive list of expenses that could constitute CEE under paragraph (f) of the definition.
As you stated, the purpose of an expense is an essential element in determining whether the expense constitutes CEE within the meaning of paragraph (f) of the definition. However, even though an expense may meet the Purpose Test in paragraph (f) of the definition of CEE, it may not be CEE. The definition of CEE specifically excludes "Canadian development expense" as defined in subsections 248(1) and 66.2(5) and any expense that may reasonably be considered to be related to either a mine that has commenced production of reasonable commercial quantities or to a potential or actual extension of that mine.
In addition, paragraphs (j) to (o) of the definition of CEE list various amounts and expenses that are not covered by the definition. For example, as you stated, an expense that is the cost, or any part of the cost, to the taxpayer of any depreciable property of a prescribed class that was acquired after 1987 is excluded from CEE under paragraph (k.1) of the definition, and any amount that is included in the capital cost to the taxpayer of depreciable property of a prescribed class is excluded from CEE under paragraph (l) of the definition.
The question of whether expenses incurred by a taxpayer constitute CEE within the meaning of paragraph (f) of the definition of CEE in subsection 66.1(6) is essentially a question of fact. In the particular situation you presented to us, it may be that the Expenses in question constitute CEE within the meaning of paragraph (f) of that expression in subsection 66.1(6), but we cannot confirm this. The mere fact that an expense meets the Purpose Test in paragraph (f) of the definition of CEE is not in itself sufficient for it to be considered CEE given the exclusions and exceptions noted above. However, the Canada Revenue Agency's position is to generally accept as CEE costs incurred for the purpose of ensuring the safety and protection of personnel and equipment used in activities that are directly related to exploration and activities carried out for the purpose of bringing a new mine into production in reasonable commercial quantities (other than the design and installation of production equipment) to the extent that the exceptions or exclusions noted above do not apply.
With respect to the alternative you suggested, as we do not have much detail as to the type of work that would be done to make the Property safe, we also cannot confirm that the Expenses in question would be current operating expenses. However, to the extent that, for example, in the course of a taxpayer's business, the Expenses in question were incurred to gain a better understanding of a mineral resource but related to a mine already in operation, or to the extension of that mine, it is possible that these costs could be deductible as current operating expenses, particularly if such costs would otherwise qualify as CEE.
We hope that these comments are of assistance.
Best regards,
Maurice Bisson, CGA
Manager
Corporate Reorganizations and Resource Industries Section
Corporate Reorganizations and Resource Industries Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch