27 April 1990 Income Tax Severed Letter ACC9255 - Exploration and Development Expenses "Deductible" in Prior Years

24(1)
                                               5-901721
                                               John Chan
                                               (613) 952-9019

Attention 19(1)

August 27, 1990

Dear Sirs:

Re: Request for Technical Interpretation Exploration and Development Expenses "Deductible" in Prior Years

We are writing in reply to your letter dated July 27, 1990 wherein you requested a technical interpretation in relation to the meaning of "may deduct" and "deductible" within the context of subsection 66(l) of the Income Tax Act (the "Act") and subsections 29(1) to (4), inclusive, of the Income Tax Application Rules, 1971 (the "ITARS").

In general terms, subsection 66(l) of the Act contains the provisions whereby a principal-business corporation as defined at paragraph 66(15)(h) of the Act may deduct Canadian exploration and development expenses ("CEDE" - as defined at paragraph 66(15)(b) of the Act) which are incurred after 1971 and before May 7, 1974. Subsections 29(l) to (4) of the ITARS provide the means by which exploration and development expenses incurred, respectively,

          (1)  during 1949 to 1952 by petroleum or natural gas    
          companies,

          (2)  during the 1952 calendar year by a mining
          corporation,

          (3)  after 1952 and before April 11, 1962 by petroleum,
          natural gas or mining companies, and

          (4)  after April 10, 1962 and before 1972 by petroleum,
          natural gas or mining companies, may be deducted.

Subsection 66(l) of the Act provides that "A principal business corporation may deduct, in computing its income for a taxation year, the lesser of

(a)       the aggregate of such of its Canadian exploration and   
          development expenses as were incurred by it before the
          end  of the taxation year, to the extent that they were
          not deductible in computing income for a previous
          taxation year, and 

(b)       of that aggregate, an amount equal to its income for the 
          taxation year...."

Subsections 29(1) to (4) of the ITARS generally provide that a corporation whose principal business is petroleum, natural gas or mining as the case may be, may deduct, in computing its income for a taxation year, the lesser of

(i)       the aggregate of the relevant exploration and development 
          expenses to the extent that they were not deductible in 
          computing income for a previous taxation year, and

(ii)      of that aggregate, an amount equal to its income for the 
          taxation year.

Your Views

Your opinion is that use of the words "may deduct" effectively renders the deductions available under subsections 66(l) of the Act and 29(l) to (4) of the ITARS to be optional or permissive deductions. It is your view therefore that in "determining the amount that a taxpayer may deduct in a particular taxation year under these subsections, the amount "deductible" in a previous taxation year is the amount that the taxpayer chose to claim, i.e., the amount that the taxpayer deducted, which in your view may be anywhere between nil and the undeducted amount of the relevant expenses, subject to the income limitations of paragraphs 29(l)(b), 29(2)(b), 29(3)(d) and 29(4)(h) of the ITARS and 66(l)(b) of the Act.

In support of your views, you refer to a technical interpretation issued by Revenue Canada, Taxation dated October ll, 1984. Therein, it is stated that

          "We agree that the words "such amount as the taxpayer may 
          claim" used in subparagraph 66(4)(b)(i) of the Act
          renders the deduction permitted by this subparagraph to
          be an optional amount of up to 10% of the available FEDE
          pool.

          Consequently, the amount "deductible" for a previous    
          taxation year for purposes of paragraph 66(4) (a) would
          be the amount the taxpayer chose to claim in that year
          under subparagraph 66(4)(b)(i) assuming. of course, his
          foreign resource income as determined under subparagraph 
          66(4)(b)(ii) for that year did not exceed the amount so 
          chosen under subparagraph 66(4)(b)(i)." (Underlining    
          added.)

Our Comments

The technical interpretation dated October 11, 1984 (the "Opinion") examined the words "such amount as the taxpayer may claim". These words are not used in subsections 66(l) of the Act and 29(1) to (4) of the ITARS. Further, the Opinion does not address the issues of

(i)       whether the amount deductible by a taxpayer under those 
          subsections' in respect of a particular taxation year is 
          the amount deducted by the taxpayer in that year, or 

(ii)      whether a taxpayer may choose any amount to deduct in a 
          particular taxation year by virtue of the words "may    
          deduct" which are used in those subsections.

In general terms, subsection 66(4) of the Act provides that a taxpayer may deduct the lesser of

      (a)   foreign exploration and development expenses ("FEDE") 
            to the extent that it was not deductible in a previous 
            year, and

(b) the greater of

            (i)   up to 10% of the FEDE which was not deductible in 
                  a previous year, i.e., 10% of the amount        
                  determined in (a) above, and 

            (ii)  the income for the year computed under          
                  subparagraph 66(4)(b)(ii) of the Act.

Assuming that the FEDE not previously deductible by a taxpayer was $1000 and the taxpayer's relevant income was nil, then whatever amount up to $100 (10% of $1,000) that the taxpayer chooses to claim would be the amount that the taxpayer deducted for the year and would also be the amount deductible for the year. This is so solely by virtue of the relevant income for the year being nil. Had the relevant income of the taxpayer been greater than $100 and less than the FEDE of $1,000, say $300, then the amount deductible for the year would be the greater of $100 and $300, i.e., $300, of which the taxpayer may deduct $300 or nil. Should the taxpayer choose to deduct an amount that is less than $300, the remainder of the $300 would not be available for deduction in any subsequent year.

It is clear that under subsections 66(l) and (4) of the Act and 29(1) to (4) of the lTARS, the amount of relevant exploration and development expenses which would be available for deduction in subsequent years must be reduced to the extent that the taxpayer has earned any relevant income. Stated another way, a principal business corporation ("PBC" - as defined in those subsections) is required to deduct the relevant expenses pursuant to the foregoing subsections to the extent of its relevant income earned in the year, provided of course that the available expenses exceed the income. If the maximum permitted deduction, i.e., the amount deductible, is not deducted by the PBC, then the amount deductible which was not deducted would be lost forever.

We therefore do not share your view that the amount deductible under subsections 66(l) of the Act and 29(l) to (4) of the ITARS in respect of a particular taxation year is the amount that the PBC deducted thereunder in that year.

It is our view that the words "may deduct" in those subsections refer to an amount that is deductible for the year. This deductible amount is computed generally as the lesser of the relevant exploration and development expenses which were not deductible in prior years and the income for the year determined under the provisions of the subsections. Having determined the amount that is deductible for the year, the taxpayer "may deduct" that amount or nil.

The amount deductible under subsections 66(l) of the Act and 29(1) to (4) of the ITARS for a taxation year that is not deducted by the taxpayer will not be eligible for deduction in any subsequent taxation year because the deductible amount in the subsequent year would exclude amount which were deductible, not amounts which were deducted, by the taxpayer in a previous taxation year.

For example, a PBC incurred $1,000 of CEDE, no portion of which was ever deducted nor deductible by the PBC due to the PBC never having earned any income. During 1990 and 1991 the PBC earns $800 and $3,000, respectively.

In computing its income for 1990, the PBC's amounts under paragraphs 66(l) (a) and (b) of the Act would be $1,000 and $800, respectively. Under subsection 66(l) of the Act, the lesser of the two amounts, i.e., $800, is deductible by the PBC in computing its income for 1990. The PBC may deduct $800 or nil in 1990.

Assuming that the PBC did not claim any deduction under subsection 66(l) of the Act in 1990, the amount that was deductible, $800, would not be available for deduction after 1990, it is lost forever.

During 1991, the amounts under paragraphs 66(1) (a) and (b) of the Act would be $200 and $3,000, respectively. The amount deductible for 1991 would therefore be $200 of which the PBC may deduct $200 or nil in computing its 1991 income. After 1991, no amount would be available for deduction by the PBC under subsection 66(l).

The above comments are merely the expressions of opinion of those Revenue Canada officials named herein and as such should not be construed as advance income tax rulings, nor are they binding on the Department. Our practice is to make this specific disclaimer in all instances in which we provide an opinion. We refer you in this respect to paragraphs 21 and 24 of Information Circular 70-6R.

Yours truly,

Section Chief Resource Industries Section Bilingual Services and Resource Industries Division Rulings Directorate