BCO will be issuing flow-through shares to fund exploration work. A second company (ACO), which is wholly owned by the controlling shareholder of BCO, provides geophysical services to its customers, including BCO.
Would any portion of the payments made by BCO to ACO for ACO's services be considered exploration and development overhead expense (CEDOE) so that such portion would be excluded from Canadian exploration expense (CEE) pursuant to ITA s. 66(12.6)(b) and Reg. 1206(4.2) and, thus, could not be renounced by BCO to its flow-through share investors?
CRA noted that under para. (d) of the CEDOE definition in Reg. 1206(1), amounts paid by BCO to a person with whom it was connected (i.e., ACO, who was so connected by virtue of Reg. 1206(5)(a)) for the performance of a service, which otherwise would be CEE, will be CEDOE to the extent that the amount charged exceeds the costs incurred by such connected person in providing the service.
Thus, the amount of CEE that BCO would be entitled to renounce in respect of the amounts paid by it to ACO for ACO's services would be limited to the actual cost incurred by ACO in providing such services.
In response to an inquiry as to whether certain non-insurable risks and liabilities (e.g., losses if the survey aircraft crashed) could be considered to be “costs incurred” for these purpose, CRA noted that the “Courts have held that a taxpayer will not be considered to have incurred an expense unless and until the taxpayer has an absolute and unconditional legal obligation to pay an amount.” It seemed unlikely that ACO would have a clear legal obligation to pay an amount in respect of contingent and future non-insurable risks or liabilities, in which case no amount in respect of such non-insurable risks or liabilities could be included in determining the "costs incurred” of ACO in providing its services to BCO.