2020-0850001E5 Depletion of an industrial mineral mine (gravel)

Principal Issues: General comments on the deduction for depletion of a gravel pit including a simple numerical example.

Author: Verlinden, Nicole
Section: 20(1)(a), 13(21), Regulations 1100(1)(g), 1104(4), 1100(2), Schedule V of the Regulations

XXXXXXXXXX                                                                   2020-085000
                                                                                           Nicki Verlinden
                                                                                           (416) 954-0862
June 4, 2020

Dear XXXXXXXXXX,

Subject: Depletion of a gravel pit located on farm land

This letter is in response to your letter dated May 7, 2020 concerning the deduction for depletion of a gravel pit, which is located on farm land in XXXXXXXXXX, Canada (the “Property”). Unless otherwise stated, all statutory references herein are to the Income Tax Act (Canada) (“Act”) and the Regulations thereto. (footnote 1)

I.    FACTS

You described the following fact situation in your letter, and during a phone conversation and in an email on June 1, 2020 (XXXXXXXXXX/Verlinden):

1. A taxpayer that is an individual (the “Taxpayer”) inherited the Property in XXXXXXXXXX.

2.    The Taxpayer is in the business of farming XXXXXXXXXX on the Property, and operates this business as a sole proprietor.

3.    The Taxpayer completes a form T2042 - Statement of Farming Activities to compute his/her net farming income, which is reported in his/her Income Tax Return (T1).

4.    In XXXXXXXXXX, the Taxpayer sold some gravel from a gravel pit located on the Property for proceeds of approximately $XXXXXXXXXX. This sale was incidental to the Taxpayer’s farming business on the Property.

5.    This was the first time that the Taxpayer sold gravel from the pit located on the Property and he/she may continue to sell gravel from this pit in the future because it is not fully depleted.

6.    The Taxpayer has not previously taken a deduction for depletion.

II.   OUR COMMENTS

This technical interpretation provides general comments about the provisions of the Act. It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R9, Advance Income Tax Rulings and Technical Interpretations.

General comments on the deduction for the depletion of a gravel pit

Capital cost allowance (“CCA”) is available to a taxpayer pursuant to paragraph 20(1)(a), Regulation 1100(1)(g) and Schedule V to the Regulations, in respect of the capital cost of

(a) an industrial mineral mine, or

(b) a right to remove industrial minerals from an industrial mineral mine

except where, in either case, the industrial mineral mine is a “mineral resource” defined in subsection 248(1) of the Act. (footnote 2)

Paragraph 3 of IT-492 Capital Cost Allowance - Industrial Mineral Mines (Archived) states:

the term “industrial mineral” means a non-metallic mineral capable of being used in industry, and the word mineral has its ordinary meaning of any chemical or compound occurring naturally as a product of inorganic processes.

This paragraph lists gravel as an example of an industrial mineral.

For clarity, the cost of an industrial mineral mine property is considered a capital cost, and not a Canadian development expense.

The CRA has previously stated that a gravel pit is an industrial mineral mine for purposes of determining CCA in accordance with Schedule V of the Regulations and the definition of undepreciated capital cost (“UCC”) in subsection 13(21). (footnote 3)

Deduction for depletion- Calculation

The following is a summary of the relevant portions of Schedule V of the Regulations, which provides the calculation of the CCA of an industrial mineral mine for a taxpayer for a taxation year.

Section 1 states that the amount that may be deducted in computing the income of a taxpayer for a taxation year in respect of an industrial mineral mine is the lesser of:

(a) an amount computed on the basis of a rate (computed under section 2 or 3 of Schedule V, as the case may be) per unit of mineral mined in the taxation year; and

(b) the UCC to the taxpayer as of the end of the taxation year (before making any deduction under section 1100) of the mine.

Section 2 of Schedule V computes the rate when the taxpayer has not previously taken a CCA deduction in respect of a particular industrial mineral mine.

In this case, based on the description of the facts set out above, (footnote 4) the rate would be computed based on the following formula:

            (A – B) / C

Where element A equals the capital cost of the mine; element B is the residual value of the mine; and element C is the number of units of commercially mineable material estimated as being in the mine when the mine was acquired by the Taxpayer.

Therefore, under Section 2 of Schedule V, in order to compute the rate, the Taxpayer needs to determine the following three amounts:

1.    the capital cost of the mine (i.e., the portion of the Property with the gravel pit),

2.    the residual value of the mine (i.e., the portion of the Property with the gravel pit), and

3.    the estimated number of units of commercially mineable material in the mine.

“Residual value” is defined in  Section 5 of Schedule V of the Regulations as the estimated value of the property if all commercially mineable material were removed.

Numerical example (footnote 5)

For purposes of this example, we have assumed that the gravel pit, which was acquired by the Taxpayer in XXXXXXXXXX, does not meet the definition of “mineral resource” in subsection 248(1) of the Act. Furthermore, this example reflects the fact that CCA has never been claimed vis-à-vis this gravel pit.

Capital cost of the gravel pit = $1 million

Residual value of the gravel pit = $100,000

Estimated number of units of commercially mineable materials from the gravel pit (i.e., gravel) = 100,000 units.

Therefore, the numerator (i.e., A – B) is $900,000 and the denominator (i.e., C) is 100,000 units, resulting in a rate of $9.00 per unit of gravel mined in a year, computed in accordance with Section 2 of Schedule V of the Regulations.

Assuming 4,000 units of gravel was mined from the pit in XXXXXXXXXX, the amount determined under Paragraph 1(a) of Schedule V, in respect of that mine, would be $36,000.

Since Section 1 is a “lesser of” formula, this amount of $36,000 is then compared to the UCC of the mine at the end of the taxation year before taking the amount determined under Paragraph 1(a) into account. Since the Taxpayer had not previously taken CCA in respect of this gravel pit, the UCC is equal to the capital cost of the mine (i.e., $1 million).

Thus, the deduction available under Section 1 of Schedule V under this hypothetical example would be $36,000 in XXXXXXXXXX, pursuant to paragraph (a) of Section 1 of Schedule V of the Regulations.

Other comments

Section 3 of Schedule V is relevant when a taxpayer has taken CCA in respect of a particular industrial mineral mine in a previous year.  In general, the applicable rate to use in this case is the same as the rate used to determine the last deduction granted, unless (i) it can be established that the number of units of material remaining to be mined in the previous taxation year was in fact different from the quantity that was employed in determining the rate for the previous year, or (ii) where it has been established that the capital cost of the mine is substantially different from the amount that was employed in determining the rate for that previous year. In either of these circumstances, the rate would be computed in accordance with paragraph 3(b) of Schedule V.

The “half-year rule” (footnote 6), which applies to certain other types of properties for purposes of computing CCA, does not apply to industrial mineral mines.

Reporting and record keeping

The Taxpayer should maintain his or her own calculations for the annual depletion deduction computed in accordance with the provisions described above, as well as the support for the inputs for the rate calculation. If the Taxpayer reports the proceeds from the sale of gravel as income that is incidental to his farming business income on form T2042, then the annual depletion deduction should also be included as a deduction from farming income on that form.

We hope that these comments will be of assistance.

Yours truly,

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

FOOTNOTES

Note to reader:  Because of our system requirements, the footnotes contained in the original document are shown below instead:

1  R.S.C. 1985, c. 1 (5th suppl.) as amended.

2  Per Regulation 1104(3).

3  This conclusion was based on the Supreme Court of Canada decision Avril Holdings Ltd. v. MNR (SCC) 70 DTC 6366 (“Avril”). We confirmed this in 9728713, where we stated: it is our opinion that the decision in Avril serves as precedent for treating a sand and gravel pit as an “industrial mineral mine” and thus depreciable property under subsection 13(21) of the Act, even though the sand and gravel pit is not a mine.

4  You informed us that the Taxpayer acquired the Property in XXXXXXXXXX, therefore the gravel pit will not meet the definition of an “accelerated investment incentive property” in Regulation 1104(4). The following summary of the rate calculation in Section 2 of Schedule V reflects this fact. The formula is modified for property that is an “accelerated investment incentive property”.

5  This is a hypothetical example only that has been included for illustrative purposes. The calculation of the actual CCA that may be claimed by the Taxpayer for XXXXXXXXXX would need to be completed using the actual facts applicable to the Taxpayer.

6  Per Regulation 1100(2).

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