Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA. Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Principal Issues: Can a taxpayer carrying on lithium exploration and development activities benefit from flow-through shares financing?
Position: Likely no, except in some limited circumstances.
Reasons: The law.
Author: Christov, Boriana
Section: see below
s. 66(15) definition of “principal business corporation;” s. 66.1(6) definition of “Canadian exploration expense;” s. 66.2(5) definition of “Canadian development expense;” s. 248(1) definitions of “mineral” and “mineral resource;” reg. 1219; Class 41 and 43.1.
December 15, 2020
Re: Tax Incentives for Lithium Brine Projects
This is in response to your request for our views on whether a corporation engaged in the exploration and development of a lithium resource that exists within brines can finance its projects through the issuance of flow-through shares (“FTSs”). This letter also takes into account our subsequent telephone conversations with you and XXXXXXXXXX and others from the XXXXXXXXXX.
This technical interpretation provides general comments about the provisions of the Income Tax Act and related legislation. It does not confirm the income tax treatment of a particular situation involving a particular taxpayer, but it 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 IC 70-6R10, Advance Income Tax Rulings and Technical Interpretations.
Unless otherwise stated all the statutory references herein are to the provisions of the Income Tax Act (footnote 1) and the Income Tax Regulations (footnote 2) (the “Regulations”).
I. OVERVIEW OF THE LITHIUM INDUSTRY
Lithium substances have many industry uses. Historically, lithium substances were primarily used as a chemical in the form of soluble salts (lithium carbonate, lithium chloride or lithium sulphate) for a variety of industries including glassmaking, ceramics, pharmaceuticals, lubricants and battery applications for products such as electronic devices. Recently, lithium demand is driven by the need for energy storage solutions, of which a fast growing sector is the electric vehicle industry.
Sources of lithium include:
* Traditional Sources:
o hard rock deposits which include hard rock spodumene deposits. These deposits are mined by blasting, crushing and grinding the rock into concentrated ore. This ore is further processed into battery grade materials. In Canada, hard rock lithium mines are located primarily in Eastern Canada and Northeastern Alberta; and
o unconfined aquifer brine deposits (also called evaporative salars) where lithium enriched brines are pumped to the surface and collected in vast solar evaporation ponds. The brine evapo-concentrates in the sun for 18-24 months before being processed into refined lithium products. Production of lithium by evapo-concentration has low overall recoveries.
Emerging (Unconventional) Sources:
o Confined aquifer brine deposits, which have been identified to date in what have been traditionally oilfield, geothermal or brine mining operations (bromine, salt). In these cases, lithium enriched brines are pumped to the surface from confined aquifers and the lithium is extracted using Direct Lithium Extraction (“DLE”). This process, not yet commercialized, works by pumping lithium enriched brine to the surface, removing only the lithium using a chemical and/or filtering process, and reinjecting the brine back into the subsurface. DLE is expected to have higher lithium recoveries when compared to other methods of lithium production.
Processes to extract lithium salts from brines must contend with the highly water soluble characteristic of lithium. In emerging sources, the lithium resource occurs generally in deep, confined water reservoirs (e.g. aquifers) some of which sit below an existing oil and gas reservoir. So, it is common to have a reservoir where oil and gas is located in the top layers with lithium brine underneath in the lower parts of the aquifer which often occur at 2-3 kilometres below surface.
Traditional methods for lithium extraction from evaporative salars are not suitable for Alberta’s climate or land use (predominantly agriculture).
There is a potentially vast lithium resource in Alberta. However, the lithium concentration may not be sufficient to allow for the economic exploitation of the resource. DLE presents a new extraction technology that could produce a concentrated lithium brine that, in turn, could be treatable economically by more conventional brine extraction processes. In broad terms, DLE is a new group of technologies that extract lithium from brine using processes like ion exchange, membranes, adsorption and absorption. Some DLE technologies can process low-grade brine to produce a higher grade lithium concentrate solution with low impurity levels; these technologies are applicable to Alberta’s relatively low grade resource. It is common that geothermal power extracted with the lithium brine is used in the DLE technology.
A. Lithium Production from Brines
In Alberta, unconventional lithium brine resources have been discovered in select reservoirs historically tapped for oil and gas production. During the normal extraction of oil and gas, significant volumes of brine is also brought to the surface which is considered to be a by-product of the oil and gas industry. For this reason, existing oil and gas infrastructure and data is heavily relied upon for sampling and mapping of Alberta’s lithium brine resources. It provides the first and relatively easy access to the reservoir containing the lithium resource.
However, the use of the existing oil and gas infrastructure is limited. In particular, oil and gas wells are not drilled to depths sufficient to adequately penetrate the aquifer because the goal is to extract the oil and gas while pumping as little as possible of the brine sitting underneath. Further, oil and gas wells are drilled specifically to access the oil and gas reservoir. Their emplacement cannot always correspond to the boundaries of the aquifer or the discovery concerns new deposits that are not associated with historical oil and gas activity. As a result, although existing oil and gas wells provide initial valuable information about the lithium resource, this information is preliminary and limited with regard to determining the extent and quality of the lithium resource.
This initial information obtained through the use of oil and gas infrastructure has to be further expanded with information from other sources targeting exclusively the flow and the concentration of lithium in the reservoir. More detailed sampling and composition data will help define contaminants, reservoir properties and valuable elements in brines.
In brief, the exploration phase of a typical lithium project carried out in Alberta from an unconventional source such as lithium brines generally includes:
1. access to existing oil and gas infrastructure to examine the brine quality;
2. re-entry of non-producing oil and gas wells for testing; and
3. drilling exploration wells for direct evaluation of the lithium resource. A brine exploratory well has to be drilled to greater depths in order to access the lower portions of the reservoir. Further, more than one exploratory well needs to be drilled in order to determine the flow parameters and the level of lithium concentration at different segments of the reservoir.
B. Lithium Extraction from Brines Part of the Mining Industry
Lithium brine resources are subject to classification by the Canadian Institute of Mining as traditional mining resources. Generally, a resource is classified in three categories based on confidence in the resource. In order of confidence, this is Inferred, Indicated and Measured. In cases where historic data is not available, the process to upgrade to Indicated and Measured involves drilling new holes to acquire additional data.
II. FLOW-THROUGH SHARE FINANCING
Flow-through shares (“FTSs”) help corporations who carry on exploration and development projects in Canada to finance their eligible projects. Certain corporations in the mining, oil and gas, and clean energy generation and energy conservation industries may issue FTSs which allow eligible tax deductions to be transferred from the corporation that incurred the expenditures to its FTS investors. This possibility is of particular advantage to resource companies that are not currently taxable.
An FTS investor benefits from a current deduction of qualifying resource expenses, such as expenditures that meet the definition of: (i) Canadian exploration expense (“CEE”) which are deducted at a rate of 100%, and (ii) Canadian development expense (“CDE”) which are deducted at a rate of 30%.
A. Flow-through Shares
There are a number of requirements for the issuance of flow-through shares.
1. Principal Business Corporation
One of the requirements is that the issuer of the flow-through shares be a “principal business corporation” (“PBC”) as defined in subsection 66(15). In general, a PBC is a corporation whose principal business includes one or a combination of the qualifying business activities described in paragraphs (a) to (i) in the definition. (footnote 3)
“principal-business corporation” means a corporation the principal business of which is any of, or a combination of, […]
(b) mining or exploring for minerals,
(c) the processing of mineral ores for the purpose of recovering metals or minerals from the ores,
(d) the processing or marketing of metals or minerals that were recovered from mineral ores and that include metals or minerals recovered from mineral ores processed by the corporation,
(e) the fabrication of metals, […]
(f.1) the production or marketing of calcium chloride, gypsum, kaolin, sodium chloride or potash,
(g) the manufacturing of products, where the manufacturing involves the processing of calcium chloride, gypsum, kaolin, sodium chloride or potash,
(h) the generation or distribution of energy, or the production of fuel, using property described in Class 43.1 or 43.2 of Schedule II to the Income Tax Regulations, and
(i) the development of projects for which it is reasonable to expect that at least 50% of the capital cost of the depreciable property to be used in each project would be the capital cost of property described in Class 43.1 or 43.2 of Schedule II to the Regulations.
When examining each potentially applicable paragraph of the PBC definition on its own, the following conclusions could generally be made:
* Paragraph (c) would not apply because the extraction of lithium from brines (which are solutions) would not involve the processing of mineral ores.
* Similarly, paragraph (d) would not apply because lithium extracted from brines would not be recovered from mineral ores.
* Paragraph (e) would not apply because the activities described above that are carried out as part of a lithium brine project do not include the fabrication of metals.
* Lithium is not included as one of the listed minerals in paragraphs (f.1) and (g) and therefore those paragraphs could not apply.
* Paragraph (h) covers situations where the corporation generates or produces energy or fuel using clean energy properties. It is unlikely that a corporation carrying on lithium exploration and development from brines would also be primarily involved in the generation or production of energy or fuel using clean energy equipment.
* Paragraph (i) describes the development of certain clean energy and energy conservation projects. These projects may use lithium substances (for example, electrical storage properties); however, a junior resource company carrying out a lithium brine project is unlikely to be involved in such projects as its primary business operation.
Lithium exploration could fit into paragraph (b) of the definition which refers to “mining or exploring for minerals.” This would include all activities necessary in the search for, and examination of, prospective minerals, the development of minerals for mining and the production of ore or minerals from the earth, such as: prospecting; carrying out geological, geophysical, or geochemical surveys; drilling by rotary, diamond, percussion or other methods; trenching, digging test pits, and preliminary sampling; and clearing, removing overburden, and stripping. (footnote 4)
“Minerals” is defined in subsection 248(1):
“mineral” includes ammonite gemstone, bituminous sands, calcium chloride, coal, kaolin, oil shale and silica, but it does not include petroleum, natural gas or a related hydrocarbon not expressly referred to in this definition.
The definition is not exhaustive and, in our view, could include lithium and some of its forms such as lithium carbonate or lithium hydroxide.
Based on the foregoing, a corporation whose principal business is the exploration for minerals in Canada from lithium brines may qualify as a PBC based on paragraph (b) of the definition.
2. Canadian Exploration Expense
The next requirement is that the PBC incurs eligible expenditures, being CEE or CDE. Paragraph (f) of the definition of CEE in subsection 66.1(6) requires that the expense is incurred “for the purpose of determining the existence, location, extent or quality of a mineral resource in Canada […].”
“Mineral resource” is defined in subsection 248(1). The exhaustive definition lists certain deposits, namely base and precious metal, coal, bituminous sands or oil shale. Paragraph (d) of the definition also lists certain additional deposits for which:
(i) the Minister of Natural Resources has issued a certificate that the principal mineral extracted is an industrial mineral contained in a non-bedded deposit;
(ii) the principal mineral extracted is ammonite gemstone, calcium chloride, diamond, gypsum, halite, kaolin or sylvite; or
(iii) the principal mineral extracted is silica that is extracted from sandstone or quartzite.
Again, lithium is not specifically listed in either of subparagraphs (ii) or (iii). However, it is possible for a lithium deposit to qualify as a mineral resource if there is a certificate issued by the Minister of Natural Resources pursuant to subparagraph (d)(i). To meet the requirements of this subparagraph, lithium substances (for example, lithium carbonate, lithium chloride or lithium sulphate) would have to meet three criteria:
1. there is a principal mineral extracted,
2. that principal mineral is an industrial mineral, and
3. that principal mineral is contained in a non-bedded deposit.
The term “industrial mineral” as it is used in the definition of mineral resource, would apply to all minerals that have an economic value and which do not fall into the category of either a metallic mineral or a mineral fuel. And, in order for a mineral property to receive mineral resource certification, the mineral extracted from that property must incur value-added processing.
Lithium substances may be used in metallic forms. In this case, the substances have to be processed to their metal stage. However, lithium substances could also be derived and used in their non-metallic form, such as lithium hydroxide or lithium carbonate. The non-metallic use of lithium is mainly for industrial applications such as the production of automotive batteries. Thus, depending on the form and the subsequent type of processing and use, lithium substances could be considered to be an industrial mineral.
However, it is unlikely that lithium extracted from brines would be contained in a “non-bedded deposit.” Generally, lithium brines are located in bedded, sedimentary deposits. In comparison, hard rock lithium deposits may be “non-bedded deposits” which could be certified as a “mineral resource” if the other requirements of paragraph (d)(i) are met in the particular circumstances.
As a result, deposits containing lithium brines could generally not be certified by the Minister of Natural Resources to meet subparagraph 248(1)(d)(i) of the definition of a “mineral resource”. Hence, any expenses incurred at the exploration phase for lithium contained in unconventional sources would likely not qualify as CEE, even if such expenses are incurred for the purpose of determining the existence, location, extent or quality of the lithium deposit in a reservoir located in Canada.
3. Canadian Development Expense
Subsection 66.2(5) defines CDE exhaustively and such definition does not appear to include the types of expenses that would generally be incurred in connection with the development of a lithium brine reservoir.
The initial stages of a lithium brine project include accessing the reservoir which could be achieved by using existing oil and gas infrastructure. However, it could also include drilling an exploration well exclusively to access the brine solution which could be located underneath the oil and gas reservoir. Drilling a lithium exploration well would also be necessary where the given lithium reservoir is not connected to an existing oil and gas reservoir.
Paragraphs (a) and (b) of the definition of CDE limit the eligible costs for drilling and completing a well to costs that are in relation to an oil and gas well. Notably, there is a limited possibility for costs incurred for drilling for a water or gas well, which may arguably include a brine well. However, such drilling costs are only recognized as CDE if the well is an injection well (a well drilled for the purposes of injecting water or gas into a petroleum or natural gas formation in order to increase the pressure in the reservoir). As a result, to drill a well to access an aquifer and to pump brine to surface, in itself, would not be eligible as a CDE.
Further, costs incurred for the creation of mining infrastructure are also limited. Pursuant to paragraph (c) of the definition of CDE, such costs must be incurred for the purpose of bringing a “new mine in a mineral resource in Canada” into production in reasonable commercial quantities. As discussed above, lithium brine deposits would not generally qualify as a “mineral resource.” Therefore, the expenditures for workings used in lithium extraction from brines would likely not fall within paragraph (c) the definition of CDE.
None of the other paragraphs in the definition of CDE would appear to apply to expenses that are likely to be incurred in connection with a lithium brine project.
4. Canadian Renewable and Conservation Expense
Canadian renewable and conservation expense (“CRCE”) is a category of expenditures relating to the development of eligible clean energy generation and energy conservation projects that may be deducted in full in the year incurred, carried forward indefinitely for use in future tax years or renounced under a flow-through share agreement. CRCE is defined in subsection 1219(1) of the Regulations and it is included in the taxpayer’s CEE pursuant to paragraph 66.1(6)(g.1) of this definition.
CRCE includes certain expenditures incurred in respect of the development of a project for which it is reasonable to expect that at least 50% of the capital cost of depreciable property to be used in the project would qualify for inclusion in Class 43.1 or 43.2. You confirmed to us that, at the current state of the lithium industry in Canada, taxpayers who carry on lithium exploration and development are generally not involved in the development of projects which may be eligible for CRCE treatment.
Nonetheless, because of the use of geothermal power we reviewed the possible application of paragraph (h) of the CRCE definition which includes the cost of drilling a well where at least 50% of the depreciable property to be used in the project is described in Class 43.1(d)(vii), being equipment used primarily to generate electrical energy, heat energy, or both, solely from geothermal energy. The term “primarily” is usually considered to be a threshold of more than 50%. In establishing whether a particular property is used primarily for the purpose of a given activity, different factors are examined such as the proportion of time that it is used in this activity or the relative proportions of the output that is generated from the property. In addition to this quantitative test, the circumstances may require a qualitative assessment of the taxpayer’s main purpose in using the property.
In view of the fact that the main purpose of the project would be to explore for and extract lithium from brines, it is unlikely that the equipment would be used primarily in the production of electrical and heat energy from geothermal energy. As a result, the cost of drilling a well for the extraction of lithium from brines would generally not qualify as CRCE based on the use of the geothermal power in the lithium extraction project and the relative capital cost of equipment using such geothermal power. A comprehensive review of the particular lithium project would need to be undertaken in order to determine whether the cost of drilling a lithium well could potentially qualify as CRCE.
For more information, refer to the Income Tax Folio S3-F8-C2, Tax Incentives for Clean Energy Equipment which can be found on the CRA webpage. Also see the Technical Guide to Class 43.1 and 43.2 and the Technical Guide to Canadian Renewable and Conservation Expenses (CRCE), published by Natural Resources Canada, which may be of assistance.
Based on the foregoing, even if a taxpayer who carries on lithium exploration and extraction activities from unconventional sources may qualify as a PBC, the costs incurred for the exploration of the resource and the development of the infrastructure to extract the lithium from the brine solution would likely not be eligible for CEE and CDE treatment. Consequently, such a taxpayer would not be able to issue FTSs and benefit from the advantages associated with this type of financing of its operations.
In our view, a legislative amendment would be required to allow corporations engaged in lithium resource exploration and development from solution brines to finance their projects by issuing FTSs. The Department of Finance has been made aware of this issue.
We hope that these comments will be of assistance.
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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 C.R.C. c. 945 as amended.
3 We have omitted paragraphs (a), (a.1) and (f) of the definition since they relate solely to natural gas, petroleum or petroleum products.
4 Income Tax Folio S3-F8-C1, Principal-business Corporations in the Resource Industries.
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