2016-0680761R3 CEE under paragraph (f) of the definition

Principal Issues: Are exploration expenses to be incurred reasonably related to an existing mine or a potential extension of a mine?

Position: No, based on the favourable opinion of the NRCan.

Reasons: The fault lines running through the property make the existence of a mineral resource uncertain and likely of a different nature.

Author: XXXXXXXXXX
Section: s. 66.1(6) definition of CEE

XXXXXXXXXX                                                                                                     2016-068076

XXXXXXXXXX, 2017

Dear XXXXXXXXXX:

Re:   Advance Income Tax Ruling Request
        XXXXXXXXXX – Business Number: XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX and your subsequent correspondence in which you requested an advance income tax ruling on behalf of the above-noted taxpayer (the “Corporation”).

To the best of the knowledge of the Corporation and that of the taxpayers involved, none of the issues contained in this ruling request are:

(a)   in an earlier return of the Corporation or a related person;
(b)   being considered by a tax services office or tax centre in connection with a previously filed tax return of the Corporation or a related person;
(c)   under objection by the Corporation or a related person;
(d)   the subject of a current or completed court proceedings involving the taxpayer or a related person; or
(e)   the subject of a ruling previously considered by the Income Tax Rulings Directorate.

Unless otherwise noted, all statutory references herein are to the Income Tax Act, R.S.C. 1985, c.1 (5th Supp.), as amended, and all references to monetary amounts are in Canadian dollars.

I.    DEFINITIONS

In this letter, the following terms or expressions have the meanings specified:

“Act” refers to the Income Tax Act, R.S.C. 1985, c.1 (5th Supp.), as amended, together with the regulations thereto;

“A Zone” means the XXXXXXXXXX;

“A Zone Open-pit Mine” means the open-pit mine located at the XXXXXXXXXX;

“A Zone Underground Mine” means the underground mine located at the XXXXXXXXXX;

“B Zone” means the XXXXXXXXXX. The Corporation carried out exploration activities in the B Zone which were subject to advance income tax ruling letter No.: 2005-014322, dated XXXXXXXXXX;

“B Zone Mine” means the underground mine located at the XXXXXXXXXX whose development was subject to advance income tax ruling letter No.: 2010-035572, dated XXXXXXXXXX;

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

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

“C Zone” means the XXXXXXXXXX;

“depreciable property” has the meaning assigned to that term by subsection 13(21) of the Act;

“E Zone” means the XXXXXXXXXX;

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

“G Zone” means the XXXXXXXXXX;

“Mines” means the existing mines known as the XXXXXXXXXX and including: (i) the A Zone Open-pit Mine, (ii) the A Zone Underground Mine and (iii) the B Zone Mine;

“mineral resource” has the meaning assigned to that term by subsection 248(1) of the Act;

“New Zones” means the C Zone and the E Zone;

“Parent” means XXXXXXXXXX, incorporated under the XXXXXXXXXX and more fully described in paragraphs 2 to 5 herein;

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

“Property” means the mining property comprising approximately XXXXXXXXXX of mineral claims and leases, which is located approximately XXXXXXXXXX;

“Proposed Transactions” means the transactions described in paragraph 18 herein;

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

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

II.   FACTS

A.    Corporation Information

1.    The Corporation was incorporated under the XXXXXXXXXX on XXXXXXXXXX under the name XXXXXXXXXX. The Corporation XXXXXXXXXX.

2.    The Corporation is a taxable Canadian corporation and a principal-business corporation.  The Corporation’s fiscal period ends on XXXXXXXXXX. As of XXXXXXXXXX, the Corporation had XXXXXXXXXX common shares outstanding, all of which are held XXXXXXXXXX (the “Parent”). The registered and head office of the Corporation is located at XXXXXXXXXX. Its business number is XXXXXXXXXX and it is served by the XXXXXXXXXX Tax Services Office and the XXXXXXXXXX Tax Centre.

3.    The Parent was incorporated under the XXXXXXXXXX by letters of patent in XXXXXXXXXX under the name XXXXXXXXXX. XXXXXXXXXX.

4.    The Parent has XXXXXXXXXX wholly-owned subsidiaries: the Corporation XXXXXXXXXX.

5.    The Parent is a taxable Canadian corporation, a public corporation and a principal-business corporation. The Parent’s fiscal period ends on XXXXXXXXXX. As of XXXXXXXXXX, the Parent had XXXXXXXXXX common shares outstanding. The common shares of the Parent are listed for trading on the XXXXXXXXXX Stock Exchange. The registered and head office of the Parent is located at XXXXXXXXXX. Its business number is XXXXXXXXXX and it is served by the XXXXXXXXXX Tax Services Office and the XXXXXXXXXX Tax Centre.

6.    The Mines are the Corporation’s only material assets.

B.    Exploration and Mining History of the Property

7.    The Corporation holds title to all of the mining claims and leases comprising the Property.

8.    The Corporation owns and operates the Mines. The Mines’ mill complex has a design capacity of XXXXXXXXXX. The Mines produce XXXXXXXXXX.

9.    During the years, exploration activities were carried out mainly at the XXXXXXXXXX of the Property, concentrating to the XXXXXXXXXX of and immediately XXXXXXXXXX of the XXXXXXXXXX. Some of these exploration activities were subject to advance income tax ruling letter No.: 2004-010307, dated XXXXXXXXXX.

10.   Commercial production at the Mines started in XXXXXXXXXX to exploit the A Zone beginning with open pit mining which became the A Zone Open-pit Mine.

11.   Between XXXXXXXXXX and XXXXXXXXXX, an extensive drilling campaign identified mineralization below the ultimate pit point in the A Zone Open-pit Mine. The exploration identified XXXXXXXXXX separate deposits with potential for underground mining. The development of the A Zone Underground Mine commenced in XXXXXXXXXX and the commercial production began on XXXXXXXXXX.

12.   The A Zone Open-pit Mine and the A Zone Underground Mine were placed on care and maintenance on XXXXXXXXXX due to XXXXXXXXXX.

13.   Intermittent operations at the A Zone Open-pit Mine restarted in XXXXXXXXXX and production therefrom was used as a secondary source of mill feed. The production ceased in XXXXXXXXXX, but it is expected to resume in XXXXXXXXXX.

14.   Operations at the A Zone Underground Mine were restarted in XXXXXXXXXX and ceased in XXXXXXXXXX. It is expected that production will resume in XXXXXXXXXX.

15.   In late XXXXXXXXXX, the Corporation announced operations to gain access to the B Zone. The operations included the sinking of a shaft to a depth of approximately XXXXXXXXXX below surface and the construction of XXXXXXXXXX which was commissioned at the end of XXXXXXXXXX. The operations resulted in the opening of the B Zone Mine.

16.   During XXXXXXXXXX, operations at the Mines were focused on the B Zone Mine.

17.   The Corporation has previously conducted certain flow-through share offerings, most recently in XXXXXXXXXX to finance exploration expenses in respect of the G Zone. The Corporation renounced exploration expenses in favour of the Parent pursuant to subsection 66(12.6) of the Act. The Parent had issued flow-through shares in respect of which it renounced such exploration expenses.

III.  PROPOSED TRANSACTIONS

18.   The Corporation will begin an exploration program utilizing exploration diamond drilling from both surface and underground drill platforms. In addition, some of the targets will be surveyed using either surface or borehole geophysical methods (induced polarization surveys) in order to attempt to map out in three dimensions the signature of any target XXXXXXXXXX that is discovered. The program will explore XXXXXXXXXX targets on the Property:

a.    the C Zone: an approximately XXXXXXXXXX long and XXXXXXXXXX wide XXXXXXXXXX exploration target located XXXXXXXXXX to the XXXXXXXXXX of the surface of the vertical shaft of the B Zone Mine and approximately XXXXXXXXXX of the XXXXXXXXXX of the currently active B Zone production areas. The C Zone is located immediately XXXXXXXXXX of the XXXXXXXXXX.

Several deep underground exploration holes will be drilled to the XXXXXXXXXX from the XXXXXXXXXX limit of the B Zone. The purpose of the drilling is to determine whether any XXXXXXXXXX occur in the C Zone. If any significant mineralization is discovered in the C Zone, it would require a new vertical shaft from the surface of the property to exploit any such discovered mineral resources in the C Zone. 

b.    the E Zone: a XXXXXXXXXX vertical exploration target located along the XXXXXXXXXX of the XXXXXXXXXX, XXXXXXXXXX of the shaft headframe of the A Zone Underground Mine and XXXXXXXXXX of the XXXXXXXXXX of the A Zone Open-pit Mine. The E Zone is located XXXXXXXXXX of the XXXXXXXXXX and XXXXXXXXXX of the XXXXXXXXXX.

Several exploration holes will be drilled to determine the extent of XXXXXXXXXX in the near-surface portion of the E Zone. If enough XXXXXXXXXX is found, the exploitation of such discovery in the E Zone would require construction of a new surface mine (decline or shaft) or an underground portal due to its location being too great of a distance from the Mines to be accessed by the current Mines infrastructure of the Mines.

IV.   ADDITIONAL INFORMATION

19.   None of the ore from either of the C Zone or the E Zone could be economically mined from the Mines.

20.   Production from either the C Zone or the E Zone would be processed at the existing facilities on the Property.

21.   The Corporation wishes to raise the financing necessary (estimated to be $XXXXXXXXXX) to fund the Proposed Transactions described in paragraph 18 above, through one or more issuances of shares each of which is intended to qualify as a flow-through share for purposes of the Act. The Corporation will renounce exploration expenses that qualify as CEE in favour of the Parent pursuant to subsection 66(12.6) of the Act. The Parent intends to issue flow-through shares to the public in a private placement. The Parent will renounce the CEE renounced to it by the Corporation to the subscribers of such flow-through shares.

V.    PURPOSE OF THE PROPOSED TRANSACTIONS

22.   The Proposed Transactions described in paragraph 18 above are planned to commence as soon as possible for the purpose of determining the existence, location, extent and quality of mineral resources located in the New Zones. Exploration activities will comprise diamond drilling using both underground (C Zone) and surface (C Zone and E Zone) drilling stations.

VI.   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 carried out as described above, our ruling is as follows:

Subject to our Comments below, an expense incurred by the Corporation, after the date of this letter in respect of the exploration program referred to in paragraph 18 above, 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 in the New Zones, including any expense incurred:

(a)   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:

(b)   any Canadian development expense,

(c)   any expense that constitutes the cost of, or any part of the cost, to the Corporation of any depreciable property or the cost of any Canadian resource property as this term is defined in subsection 66(15) of the Act; or

(d)   any expense described in (a)(i), (iii) or (iv) above in respect of the mineral resource that is found in the New Zones pursuant to the exploration program described in paragraph 18 above, 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 Corporation pursuant to paragraph (f) of the definition thereof in subsection 66.1(6) of the Act, provided that, if the exploration operations described in paragraph 18 above culminate in the development of a mining operation, such operation is conducted utilizing a new mine rather than an extension of any of the Mines.

VII.  COMMENTS

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 in subsection 66.1(6) of the Act.

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

(a)   the reasonableness of any expenditure;

(b)   whether any particular expense incurred by the Corporation in respect of the exploration program described in paragraph 18 above will qualify as a CEE, or whether any particular expense not considered to be a CEE qualifies as a CDE;

(c)   whether any particular expense incurred by the Corporation that qualifies as a CEE or a CDE will be a Canadian exploration and development overhead expense as this term is described in paragraph 66(12.6)(b) of the Act and section 1206 of the Income Tax Regulations;

(d)   whether the Corporation or the Parent is a principal-business corporation;

(e)   whether any share in the capital stock of the Corporation or of the Parent which may be issued as envisioned in paragraph 21 above will be a flow-through share;

(f)   the determination of the fair market value or adjusted cost base of any property referred to herein; and

(g)   any tax consequences relating to the Facts, Additional Information and Proposed Transactions described herein, other than those specifically described in the ruling given above.

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 CRA provided that the Proposed Transactions are implemented by 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.

Yours truly,

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

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