2016-0635341R3 Canadian Exploration Expenses - New Mine

Principal Issues: Whether expenses relating to a proposed exploration program will not be considered to be related to a mine that has come into production in reasonable commercial quantities or to a potential or actual extension thereof.

Position: Yes

Reasons: Based on the facts presented and written opinions provided by Natural Resources Canada.

Author: XXXXXXXXXX
Section: 66.1(6)

XXXXXXXXXX                                                                                      2016-063534

XXXXXXXXXX, 2017

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
      XXXXXXXXXX

We are writing in response to your letter dated XXXXXXXXXX wherein you requested an advance income tax ruling on behalf of the above-referenced taxpayer.

We understand that, to the best of your knowledge and that of the taxpayer, none of the issues involved in the ruling request is:

(i) in a previously filed return of the taxpayer or of a related person;

(ii) being considered by a tax services office or tax centre in connection with a previously filed tax return of the taxpayer or a related person;

(iii) under objection by the taxpayer or a related person;

(iv) the subject of a current or completed court process involving the taxpayer or a related person; or

(v) the subject of a ruling request previously considered by the Income Tax Rulings Directorate.

In this letter, unless otherwise indicated, all statutory references are references to the provisions of the Act (as defined below) and all terms and conditions used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated.  All references to monetary amounts are in Canadian dollars, unless otherwise indicated.

DEFINITIONS

In this letter, unless otherwise expressly stated, the following terms have the meanings specified below:

“ACo” means XXXXXXXXXX, an unrelated third party who owned and operated the mine prior to the Company;

“Act” means the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), as amended to the date hereof;

“Canadian development expense” has the meaning assigned to that term by subsection 66.2(5) of the Act;

“Canadian exploration and development overhead expense” has the meaning assigned to that term by paragraph 66(12.6)(b) of the Act and section 1206 of the Regulations;

“Canadian exploration expense” has the meaning assigned to that term by subsection 66.1(6) of the Act;

“Closure Plan” has the meaning assigned in paragraph 32 below;

“Company” means XXXXXXXXXX;

XXXXXXXXXX;

“Exploration Program” means the exploration and mineral evaluation program described in paragraphs 33 and 34 below;

“flow-through share” has the meaning assigned to that term by subsection 66(15) of the Act;

XXXXXXXXXX;

XXXXXXXXXX;

XXXXXXXXXX;

“National Instrument 43-101” means National Instrument 43-101 for the Standards of Disclosure for Mineral Projects, published by the Canadian Securities Administrators;

XXXXXXXXXX;

XXXXXXXXXX;

XXXXXXXXXX;

“PEA” has the meaning assigned in paragraph 28 below;

“principal-business corporation” has the meaning assigned to that term by subsection 66(15) of the Act;

“Proposed Transactions” means the transactions described in paragraphs 33 and 34 below;

“public corporation” has the meaning assigned to that term by subsection 89(1) of the Act;

“Regulations” means the Income Tax Regulations, enacted under the Act;

XXXXXXXXXX; and

“taxable Canadian corporation” has the meaning assigned to that term by subsection 89(1) of the Act.

FACTS

Company information

1. The Company was incorporated on XXXXXXXXXX pursuant to the provisions of the XXXXXXXXXX under the name XXXXXXXXXX.

2. The Company is a taxable Canadian corporation, a public corporation and a principal-business corporation. The taxation year of the Company ends on XXXXXXXXXX and its business number is XXXXXXXXXX. The head office of the Company is located at XXXXXXXXXX. The Company is serviced by the XXXXXXXXXX Tax Centre and the XXXXXXXXXX Tax Services Office. The Company is engaged in the business of XXXXXXXXXX.

3. Effective XXXXXXXXXX, the Company acquired XXXXXXXXXX.

4. On XXXXXXXXXX, the Company completed an amalgamation with its wholly owned subsidiary, XXXXXXXXXX. These two entities were amalgamated as one corporation under the name XXXXXXXXXX.

5. On XXXXXXXXXX, the Company filed articles of amendment to change its name to XXXXXXXXXX.

Exploration and mining history of the XXXXXXXXXX

6. XXXXXXXXXX staked part of the XXXXXXXXXX in XXXXXXXXXX and XXXXXXXXXX was incorporated in XXXXXXXXXX. XXXXXXXXXX shaft was sunk to XXXXXXXXXX and shortly after the XXXXXXXXXX was discovered. XXXXXXXXXX shaft (otherwise known as the XXXXXXXXXX) was sunk in XXXXXXXXXX.

7. In XXXXXXXXXX, the mill facility opened and operated continuously, producing XXXXXXXXXX over its XXXXXXXXXX mine life, until the mine was closed in XXXXXXXXXX. The mill was decommissioned and removed from site after it finished operating.

8. The XXXXXXXXXX (including the XXXXXXXXXX) changed hands a few times until it was acquired by XXXXXXXXXX. (formerly known as XXXXXXXXXX) in XXXXXXXXXX, although there was no further production from the XXXXXXXXXX during this period. XXXXXXXXXX intended to restart the mine and had purchased a mill from XXXXXXXXXX (the XXXXXXXXXX), which was relocated from the XXXXXXXXXX site in XXXXXXXXXX in the XXXXXXXXXX.

9. In XXXXXXXXXX, XXXXXXXXXX reported that the XXXXXXXXXX had a mineable reserve of XXXXXXXXXX and forecasted production of XXXXXXXXXX in the first XXXXXXXXXX of commercial production at a cash cost of XXXXXXXXXX and a total cost of XXXXXXXXXX. Production was to increase to XXXXXXXXXX per year over time. On the basis of this report, ACo acquired 100% of the shares of XXXXXXXXXX in XXXXXXXXXX, and thereby acquired the XXXXXXXXXX including the XXXXXXXXXX and the XXXXXXXXXX. It should be noted that reserves stated in XXXXXXXXXX.

10. By the end of XXXXXXXXXX, ACo had XXXXXXXXXX from the surface on the XXXXXXXXXX which allowed mineralization to be assessed underground by ramp down to XXXXXXXXXX of the historic workings. ACo mined small stopes and produced a minor amount of XXXXXXXXXX from the XXXXXXXXXX. At this time, the XXXXXXXXXX was dewatered to XXXXXXXXXX.

11. The XXXXXXXXXX is said to be XXXXXXXXXX. The Company believes that in order to use parts of the XXXXXXXXXX and ramp today, it would need to be slashed to at least XXXXXXXXXX. In addition, the Company suspects that a new series of ramps would need to be driven from XXXXXXXXXX or more. Previous mining was by way of tracks from narrow development drifts. The drifts would have limited use in a ramp scenario today, but if utilized, they would need to be slashed to allow for larger equipment, and the existing tracks would need to be cemented in place to reduce extensive rehabilitation requirements. It is anticipated that new larger electric haul vehicles would be used in a modern mining scenario from the XXXXXXXXXX.

12. From XXXXXXXXXX, ACo also rehabilitated portions of the upper levels of the mine, mined historic pillars, drilled shallow targets and open-cast mined for bulk sampling purposes on several narrow veins. This mining was primarily from the XXXXXXXXXX.

13. In XXXXXXXXXX, ACo extracted XXXXXXXXXX, of which XXXXXXXXXX were milled for a total production of XXXXXXXXXX at an average recovered grade of XXXXXXXXXX. Mill recovery was estimated to be XXXXXXXXXX, suggesting a head grade of around XXXXXXXXXX. The predicted grade from previous historical estimates was XXXXXXXXXX. In the final XXXXXXXXXX of production ending in XXXXXXXXXX, a mill throughput of XXXXXXXXXX was achieved for a total of XXXXXXXXXX. Ultimately, mining by ACo ceased because XXXXXXXXXX did not match the expected grade, and a XXXXXXXXXX made mining uneconomic. As a result, ACo put the XXXXXXXXXX on care and maintenance in XXXXXXXXXX. At the same time, dewatering and rehabilitation of the XXXXXXXXXX hoisting facility and XXXXXXXXXX continued to the XXXXXXXXXX.

14. In XXXXXXXXXX, ACo granted to XXXXXXXXXX an XXXXXXXXXX in consideration for $XXXXXXXXXX in exploration expenditures and the production of a bankable feasibility study by XXXXXXXXXX.

15. XXXXXXXXXX fulfilled the exploration expenditure requirement, but decided not to proceed with a bankable feasibility study and therefore XXXXXXXXXX did not acquire any interest in the XXXXXXXXXX or the XXXXXXXXXX.

16. Exploration work conducted by ACo on the XXXXXXXXXX thereafter focused mainly on drilling, historical data compilation, dewatering and rehabilitation of the XXXXXXXXXX. XXXXXXXXXX core boreholes were completed to define further exploration targets and expand the mineral resources. Between XXXXXXXXXX and XXXXXXXXXX, ACo focused its work on near surface targets outside of the XXXXXXXXXX footprint, targeting areas such as the XXXXXXXXXX. From XXXXXXXXXX, ACo drilled from an underground platform on XXXXXXXXXX of the XXXXXXXXXX, a deeper mineralized zone originally discovered in the XXXXXXXXXX. In addition, ACo conducted surface drilling on additional targets on the property outside of the area of the XXXXXXXXXX.

17. In XXXXXXXXXX, XXXXXXXXXX was commissioned by ACo to prepare a mineral resource statement using XXXXXXXXXX historic surface and underground drill holes and XXXXXXXXXX results. XXXXXXXXXX were modeled for XXXXXXXXXX all of which were accessible from the existing underground infrastructure of the XXXXXXXXXX. The XXXXXXXXXX targeting from historic resources consisted of XXXXXXXXXX in the indicated category and XXXXXXXXXX in the inferred category.

18. From XXXXXXXXXX, ACo continued to drill test for mineralization in the immediate area surrounding the XXXXXXXXXX. Despite the XXXXXXXXXX in XXXXXXXXXX, ACo did not recommence mining operations.

19. On XXXXXXXXXX, the Company acquired a XXXXXXXXXX% interest XXXXXXXXXX in the XXXXXXXXXX from ACo.

Historical ownership of the XXXXXXXXXX

20. Although a number of companies have explored the XXXXXXXXXX since XXXXXXXXXX, no mining operation was ever established. The majority of the drilling activities focused on an area along the strike of the XXXXXXXXXX exploited in the XXXXXXXXXX.

21. On XXXXXXXXXX, the Company acquired a XXXXXXXXXX% interest in the XXXXXXXXXX from XXXXXXXXXX, an unrelated third party.

The XXXXXXXXXX

22. The Company currently holds ownership of both the XXXXXXXXXX and the XXXXXXXXXX. The Company considers the XXXXXXXXXX and the XXXXXXXXXX to be one continuous project, currently referred to as the XXXXXXXXXX.

23. When the Company acquired the XXXXXXXXXX including the XXXXXXXXXX, the underground workings had been allowed to flood and the skip for the XXXXXXXXXX had been locked in place to prevent inadvertent access. All other historic shafts had previously been sealed by former operators either by permanent concrete cap or by back-filling them with rock to prevent inadvertent access. The XXXXXXXXXX entry was also sealed with rock by previous operators.

24. Most buildings that supported the XXXXXXXXXX have either been removed by previous operators or by the Company. The current inventory of historic structures includes the head frame to the XXXXXXXXXX, the XXXXXXXXXX, a small building which the Company has converted into a XXXXXXXXXX.

25. It is unknown whether there are any historic workings that are capable of producing ore from the XXXXXXXXXX. The condition of the XXXXXXXXXX and XXXXXXXXXX are uncertain, and the mine continues to be allowed to flood. The current extent of flooding is unknown. The Company has done no work to verify the condition of the underground workings, head frame, XXXXXXXXXX or XXXXXXXXXX. Significant work or rehabilitation would likely be required. The XXXXXXXXXX used unconsolidated fill and the Company believes that this has failed in numerous locations. This renders the existing tracks unusable without significant work.  The condition of the shaft is unknown below XXXXXXXXXX.  There are bulkheads on all levels, but the condition of these are unknown. The Company has recently initiated engineering studies to determine the amount of capital required to get the XXXXXXXXXX up and running again.

Exploration on the XXXXXXXXXX 

26. The Company’s exploration on the XXXXXXXXXX has focused both on expanding and upgrading existing resources related to the footprint of the XXXXXXXXXX, as well as seeking new resources outside the known resource area. This included compiling, consolidating and interpreting historic data; developing new 3D stratigraphic, structural and mineral alteration models to allow more effective drill targeting; conducting a high resolution airborne magnetic survey over the property; and drilling from the surface a total of about XXXXXXXXXX with approximately XXXXXXXXXX% XXXXXXXXXX.

27. XXXXXXXXXX prepared the current mineral resource statement and could not classify any of the known mineralization as a reserve because the required additional studies, in the context of the development of National Instrument 43-101 standards, have not been completed. XXXXXXXXXX re-confirmed the resource as mentioned in paragraph 17 for the Company in XXXXXXXXXX. There are currently no mineral reserves delineated for the XXXXXXXXXX.

28. In XXXXXXXXXX, the Company completed a Preliminary Economic Assessment (“PEA”) of the XXXXXXXXXX to provide a base case assessment of development opportunities utilizing existing infrastructure, including the XXXXXXXXXX and tailings facility, to develop the existing near-surface mineral resource. The PEA was undertaken to help attract additional financing to further the exploration efforts.

29. In order to produce XXXXXXXXXX from the XXXXXXXXXX in the future, the Company currently anticipates such production would most likely come from the XXXXXXXXXX. The PEA, as envisioned, includes an underground mining operation relying heavily on the existing milling and tailings management infrastructure at the XXXXXXXXXX. Primary access would be via the existing XXXXXXXXXX, which is located approximately XXXXXXXXXX from the existing mill, and provides XXXXXXXXXX of the mine workings. The PEA mine plan includes further development of the XXXXXXXXXX to access the upper XXXXXXXXXX levels of the mine. The XXXXXXXXXX would be used primarily for ventilation and as a second means of egress via the manway located in the shaft. Pre-production capital would be minimized by utilizing existing infrastructure. Pre-production capital costs are estimated at $XXXXXXXXXX with the majority of the costs being associated with mill refurbishment as well as ramp and surface development. Additional capital cost requirements include surface installations and a new ventilation and pumping system that will utilize the XXXXXXXXXX. Life-of-mine sustaining capital costs are estimated at $XXXXXXXXXX with the majority of the costs being associated with ramp development, slashing existing workings, and new access development.

30. The PEA supports that the XXXXXXXXXX has the potential to be economically viable. Since the PEA only considers the extraction of XXXXXXXXXX% of the existing mineral resource XXXXXXXXXX, opportunities exist to expand the base case scenario through project exploration and resource growth. The results of the PEA warrant additional exploration to expand the potentially mineable resource by converting inferred resources to measured and indicated.

31. Substantial additional exploration and evaluation would need to be performed in relation to the mineral resource in order to reach the stage where a decision could be made to proceed with development of the mine.

32. The Company is subject to a mine closure plan (the “Closure Plan”) which has been approved by XXXXXXXXXX. The Company has placed financial assurance of XXXXXXXXXX $XXXXXXXXXX to satisfy the financial requirements under the Closure Plan. The Company will be responsible for completing the requirements under the Closure Plan when activities at the site have been completed. In order to re-open the mine and commence mining activities, the Company would be required to file a new mine plan and amend the Closure Plan to account for additional activities from any resumption of mining. The Closure Plan primarily addresses reclamation of the existing tailings facility and removal of any remaining buildings, removal of the headframe and certification of capping or sealing of all mine entrances.

PROPOSED TRANSACTIONS

33. The Company will undertake an exploration and mineral evaluation program. The XXXXXXXXXX mineralization was not completely commercially mined out from the XXXXXXXXXX or XXXXXXXXXX when ACo ceased production in XXXXXXXXXX due to lower than expected grades. The Company has confirmed that a XXXXXXXXXX resource remains that has the potential to be expanded by drilling known mineralization to depth and along strike, as well as by exploring for XXXXXXXXXX targets that are believed to exist within the XXXXXXXXXX of the historic workings. The Company intends to aggressively pursue these targets with future exploration and evaluation programs, including potentially re-opening the XXXXXXXXXX to access the underground workings to conduct further exploration drilling and sampling. In addition, the Company will explore for XXXXXXXXXX targets on the XXXXXXXXXX identified outside of the XXXXXXXXXX.

34. The Company will conduct an evaluation of the mineral resource within the XXXXXXXXXX in order to determine the location, extent and quality of the mineral resource. This would include extensive drilling of known targets from surface and potentially opening the XXXXXXXXXX to access historic workings for drilling, evaluating metallurgy on historic and new core samples from the XXXXXXXXXX, gathering and reviewing the available historical data about the XXXXXXXXXX and the other XXXXXXXXXX in the XXXXXXXXXX such as in the remnants of the XXXXXXXXXX in order to expand and upgrade the resource estimates. While the necessary studies have not yet been completed and future work would be dependent upon ongoing results, the Company estimates that in excess of $XXXXXXXXXX of exploration and development work may be required before the mining of any known mineralization at the XXXXXXXXXX is proven to be feasible.

ADDITIONAL INFORMATION

35. The Company is proposing raising funds for the Exploration Program by issuing flow-through shares.

PURPOSE OF THE PROPOSED TRANSACTIONS

36. The Proposed Transactions are being undertaken for the purpose of conducting an exploration and mineral resource evaluation program on the XXXXXXXXXX in order to determine the existence, extent and quality of XXXXXXXXXX.

RULING 

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions, additional information, and purpose of the proposed transactions, and provided further that the Proposed Transactions are completed in the manner described above, our ruling is as follows:

Subject to our Comments below, an expense incurred by the Company after the date of this letter and as part of the Exploration Program for the purpose of determining the existence, location, extent, or quality of a mineral resource as that term is defined in subsection 248(1) of the Act on the XXXXXXXXXX, including such an expense incurred:

(a) for environmental studies or community consultations (including, studies or consultations that are undertaken to obtain a right, licence or privilege for the purpose of determining the existence, location, extent or quality of a mineral resource on the XXXXXXXXXX); or

(b) in the course of:

(i) prospecting;

(ii) carrying out geological, geophysical or geochemical surveys;

(iii) drilling by rotary, diamond, percussion or other methods; or

(iv) trenching, digging test pits and preliminary sampling;

but not including

(c) any Canadian development expense; or

(d) any expense described in (b)(i), (iii) or (iv) above in respect of the mineral resource, incurred before a new mine in the mineral resource comes into production in reasonable commercial quantities, that results in revenue or can reasonably be expected to result in revenue earned before the new mine comes into production in reasonable commercial quantities, except to the extent that the total of all such expenses exceeds the total of those revenues,

will qualify as a Canadian exploration expense of the Company pursuant to paragraph (f) of the definition of that term in subsection 66.1(6) of the Act, provided that:

(e) the expense does not constitute the cost, or any part of the cost, to the Company of any depreciable property; and

(f) the expense is incurred before a mine comes into production in reasonable commercial quantities in respect of any mineralization that may be found on the XXXXXXXXXX.

COMMENTS

The above ruling is given subject to the limitations and qualifications set out in Information Circular 70-6R7 dated April 22, 2016, and is binding on the Canada Revenue Agency provided that the Company commences implementing the Proposed Transactions by no later than XXXXXXXXXX. The above ruling is based on the law as it presently reads and does not take into account any proposed amendments to the Act which, if enacted, could have an effect on the ruling provided herein.

Although we received, for review, certain documents relating to the facts, proposed transactions, additional information, and purpose of the proposed transactions, our ruling is based solely on the facts and representations contained herein.

Expenses incurred in order to determine the economic feasibility of whether or not to proceed with developing a new mine, or that are related to the processing or sale of a mineral do not, in our view, satisfy the purpose test in paragraph (f) of the definition of Canadian exploration expense.

Except as expressly stated, the ruling provided does not imply acceptance, approval or confirmation of any income tax implications of the facts or proposed transactions. In particular, nothing in this letter should be interpreted as confirming either expressly or implicitly:

(i) the reasonableness of any expenditure;

(ii) whether any particular expense incurred by the Company qualifies as a Canadian exploration expense, or whether any particular expense not considered to be a Canadian exploration expense qualifies as a Canadian development expense; whether any particular expense incurred by the Company that qualifies as a Canadian exploration expense or a Canadian development expense will be a Canadian exploration and development overhead expense;

(iii) whether the Company is a principal-business corporation; and

(iv) whether any share issued by the Company will be a flow-through share.

Yours truly,

XXXXXXXXXX
Acting Manager, Resources Section
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy & Regulatory Affairs Branch

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