10 April 1989 Income Tax Severed Letter 5-7736 - [890410]

Revenue Canada Taxation Head Office

April 10, 1989

TO: Memo to file

FROM: Resource Industries Section
                  G.R. White
                  957-8953

SUBJECT: XXXXXXXX

We stated that we were not in agreement with the above tax treatment based on jurisprudence relevant in determining whether CEE has been "incurred" by a taxpayer. Such jurisprudence has lead to two conclusions in interpreting the word "incurred".

First, a taxpayer (farmee) will not be entitled to claim CEE as having been incurred by him if he is entitled to reimbursement for the expenses (Okalta Oil Ltd. v. MNR, 55 DTC 1029, Exch.). Second, a taxpayer (the farmee) must make expenditures for CEE and not to acquire a resource property. (Farmers Mutual Petroleum Ltd. v. MNR., 67 CTC 396, SCC).

In Farmers Mutual, the Supreme Court said that the taxpayer in that case "did not itself incur exploration or drilling costs in respect of lands in which it had an interest. What it did do was to pay for a contractual right to acquire an interest in lands on which exploration and drilling had taken place by paying expenses already incurred by Scurry in connection therewith ". The words "drilling and exploration expenses ... incurred by it on or in respect of exploring or drilling for petroleum or natural gas in Canada" were interpreted by the Supreme Court to mean an obligation by the taxpayer to meet a liability for the cost of exploration or drilling.

The meaning of the word "incurred" was also considered by the Exchequer Court of Canada in Pickle Crow Gold Mines Ltd. v. MNR., 54 CTC 390, where it was held that prospecting and exploration expenses "incurred by the taxpayer" under section 1205 of the Income Tax Regulations are those expenses which are either paid for by the taxpayer or which he has become liable to pay.

It is our view that in the circumstances at hand, the farmee, being under no legal obligation to pay CEE incurred by the Company, is acquiring instead a resource property when it pays the Company an amount for the CEE incurred by the Company. Therefore, any such amount paid should be properly classified by the farmee as a resource property acquisition cost.

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Chief Resource Industries Section Rulings Directorate