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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues:

Whether dyke construction costs (i.e., a dyke may be built to retain water, tailings or landfills) should always be on account of current expenses or Canadian exploration expenses?

Position:

No

Reasons:

It is always a question of facts as whether certain dyke construction costs should be considered as current expenses, depreciable property costs or pre-production Canadian exploration expenses.

National Mining Workshop
Kelowna, BC
May 5-8, 2003

Re: Dyke Construction Costs
Prepared by Peter Lee
Income Tax Rulings Directorate
May 5, 2003 (#2003-000323)

Introduction

Dykes may be built to retain water, tailings or landfills, in the course of exploration, development, operation or reclamation of a mine. A dyke is generally considered a structure and the costs of which are included in Class 1(q), 10(g) or 41(b)(i) of Schedule II in the Regulations. However, by analogy to the recent Federal Court of Appeal decision in the case of Suncor Energy Inc., 2002 DTC 7395 (FCA), one may argue that dyke construction costs should always be characterized as current expenses or Canadian exploration expenses. In this case, the Court concluded that the expenditures on the construction of the dykes enclosing tailings ponds in an oil sand mining operation would be considered current expenses. The rationale of this conclusion was based on the facts that these expenditures were incurred on a recurring basis for the removal of the waste produced by mining in the year and such waste removal and dyke construction were integral to the operation of the mine. Therefore, it is always a question of facts as to whether certain dyke construction costs could be considered current expenses, depreciable property costs or Canadian exploration expenses. This paper is going to examine various factors to be considered in making such a determination.

Our Comments

1. With respect to the issue of income v. capital, the Supreme Court of Canada and other Canadian Courts have referred quite often to the following jurisprudence in 2 to 6 below with approval.

2. In the decision of the Privy Council in the case of B.P. Australia Ltd., [1966] A.C. 224 at p. 264, Lord Pearce said:

"It is commonsense appreciation of all the guiding features which must provide the ultimate answer...

Finally, were these sums expended on the structure within which the profits were to be earned or were the part of the money-earning process?"

3. Viscount Cave L.C. commented on the principle of income v. capital in the case of British Insulated and Beisby Cables v. Atherton, [1926] A.C. 205, as follows:

"When an expenditure is made not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think that is a very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital."

4. In the case of Hallstroms Pty. Ltd. v. F.C.T. ((1946) 72 C.L.R. 634 at 648) Dixon J. of the High Court of Australia stated that the answer to whether an expenditure is on income or capital account,

"... depends on what the expenditure is calculated to effect from a practical and business point of view rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process."

5. Dixon J. commented in the case of Sun Newspapers Ltd. et al. v. The Federal Commissioner of Taxation, (1938) 61 C.L.R. 337 at page 359 as follows:

"The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity, structure, or organization set up or established for the earning of profit and the process by which such an organization operates to obtain regular returns by means of regular outlay, the difference between the outlay and returns representing profit or loss.

In other words, as I understand it, generally speaking, (a) on the one hand, an expenditure for the acquisition or creation of a business entity, structure or organization, for the earning of profit, or for an addition to such an entity, structure or organization, is an expenditure on account of capital, and (b) on the other hand, an expenditure in the process of operation of a profit-making entity, structure or organization is an expenditure on revenue account.

Applying this test to the acquisition or creation of ordinary property constituting the business structure as originally created or an addition thereto, there is no difficulty. Plant and machinery are capital assets and moneys paid for them are moneys paid on account of capital whether they are (a) money paid in the course of putting together a new business structure, (b) money paid for an addition to a business structure already in existence, or (c) money paid to acquire an existing business structure."

6. In concluding that the costs of land used in the continual expansion of the mining operation's open-pit would be current expenses, Estey, J. quoted the jurisprudence referred to in 2 to 5 above with approval and commented in the case of Johns-Manville Canada Inc., 85 DTC 5373 (SCC), as follows:

"If we were to apply the three-step test adopted by the Australian court in Sun Newspapers, supra, these expenditures would qualify as expenses rather than being capital in nature. The character of the advantage sought is that of an advantage in the current operations of the taxpayer. The practice was recurring and the manner in which the object of the expenditures was applied was directly incorporated into the mining operations of the taxpayer. Finally, the means adopted by the taxpayer to gain this advantage was the periodic outlay of its funds which would formerly have been classified, in the vocabulary of that day, as circulating capital. In the words of Dixon J., as he then was, in Sun Newspapers, supra, at p. 362, we are here concerned with an expenditure of a revenue nature because:

'its purpose brings it within the very wide class of things which in the aggregate form the constant demand which must be answered out of the returns of a trade or its circulating capital and that actual recurrence of the specific thing need not take place or be expected as likely.'

The same judge in Hallstroms Pty. Ltd., supra, at p. 648, reminds us that the classification of such expenditures '... depends on what the expenditure is calculated to effect from a practical and business point of view rather than upon the juristic classification of legal rights...', supra. The old rule of 'once and for all' as well as the 'common sense' test, supra, lead us to a result favourable to the taxpayer's contention.

In summary, therefore, it can be said without fear of contradiction from this record that these expenditures by the taxpayer were incurred bona fide in the course of it regular day-to-day business operations. Common sense dictated that these expenditures be made, otherwise the taxpayer's operations would, of necessity, be closed down. These expenditures were not part of a plan for the assembly of assets. Nor did they have any semblance of a once and for all acquisition. These expenditures were in no way connected with the assembly of an ore body or a mining property which could itself be developed independently of any ore body, hence the inability to find entitlement for depletion or capital cost allowance for this expenditure under the statute."

(See also the cases of Denison Mines Limited, 74 DTC 6525 (SCC), and Suncor Energy Inc., 2002 DTC 7395 (FCA).)

7. Absent application of paragraphs (k.1) and (l) of the definition of Canadian exploration expense in subsection 66.1(6) of the Act, it appears that dyke construction costs incurred "for the purpose of bringing a new mine in a mineral resource in Canada into production in reasonable commercial quantities and incurred before the coming into production of the new mine" would fall within paragraph (g) of this definition. However, based upon the above-noted jurisprudence, the pre-production dyke construction expenditures would generally be considered on account of capital. By analogy to the cases of British Columbia Forest Products Limited, 71 DTC 5178 (SCC), and Superior Pre-Kast Septic Tanks Ltd. et al., 78 DTC 6263 (SCC), it is our view that dykes would fall within the broad scope of the word "structure" for capital cost allowance purposes. Therefore, the pre-production dyke construction costs would be included in Class 10(g) or 41(b)(i) of Schedule II in the Regulations, as the case may be, and would be precluded from characterizing as Canadian exploration expenses by virtue of paragraph (k.1) or (l) of the definition thereof in subsection 66.1(6) of the Act.