Treatment of Expenditures in Canada

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Executive Summary

  • The cost of expenditures on “depreciable property”, which includes most buildings, structures, machinery & equipment used in mining operations, is added to one of three pools, depending on the use of the property and the status of the mine when it is acquired. Each year the taxpayer is entitled to claim a “capital cost allowance” deduction from income of either 100% or 25% (depending on the pool) of cumulative expenditures included in each such pool (net of previously-claimed CCA deductions from that pool and proceeds from dispositions of property included in that pool).
  • A taxpayer’s “Canadian exploration expenses” consist of expenses to find and assess the quality of mineral resources in Canada and expenses of bringing a mine into production. Such cumulative expenses are put into a pool, and each year the taxpayer may claim as a deduction from income 100% of the year-end pool balance (net of previous CEE deductions claimed).
  • A taxpayer’s “Canadian development expenses” include the cost of acquiring an interest in a mining property in Canada (including a mining royalty), and costs of expanding a mine that has come into commercial production. Such cumulative expenses are put into a pool, and each year the taxpayer may claim as a deduction from income 25% of the year-end pool balance (less previous CDE deductions claimed and proceeds from the disposition of interests in Canadian mining properties).
In computing taxable income from a business for Canadian income tax purposes, a taxpayer is permitted to deduct various amounts in respect of expenditures made in the course of the business.  In some cases the full amount of the expenditure can be deducted in the taxation year in which it is incurred, similar to the accounting concept of a current expense.  Examples of such expenditures are most employee payroll expenses and other amounts where the benefit of the expenditure is largely realized in the immediate year rather than over more than one year.  In other cases the expenditure is deductible over a period of years, analogous to the accounting concept of a capital expenditure.
The treatment of expenditures is particularly important in the mining industry, which is highly capital-intensive and involves projects that often take many years to complete.  Many of the largest expenditures made in the course of a mining business are the subject of special treatment for income tax purposes, some of which are described below.

The text that follows has not been updated to reflect changes from the 2013 federal budget relating to (1) the re-characterization of pre-production development expenditures as Canadian development expense (“CDE”), rather than Canadian exploration expense (“CEE”), and (2) the elimination of accelerated capital cost allowance (“ACCA”), both of which are being phased in over time as described here.

Depreciable Property

Expenditures on certain kinds of property (“depreciable property“) are the subject of “capital cost allowance” (“CCA“), the tax version of the accounting concept of depreciation.  For Canadian tax purposes, depreciable properties are grouped into different classes, with each class having its own separate rate of CCA.  When a taxpayer acquires a depreciable property of a particular class, the cost of that property is added to the pool of expenditures made by the taxpayer for depreciable property of that class.  Each year, the taxpayer is entitled to take as a deduction in computing income a percentage (different classes have different rates) of the remaining expenditure balance in that class (the “undepreciated capital cost“, or “UCC” of that class).  The UCC of each class is then reduced by the amount of that year’s CCA deduction taken by the taxpayer in respect of property in that class.  Dispositions of depreciable property also reduce the taxpayer’s UCC of the relevant class of property (up to the amount of the taxpayer’s original cost of the property).
An example of the operation of the CCA system is set out in Table 1, below, using a class of property with an assumed CCA rate of 25%.
TABLE 1: CCA EXAMPLE
Year 1 Year 2
Start-of-year UCC balance $500,000 $600,000
+ Property acquired in year $300,000 $100,000
–  Property disposed of in year _
_______
$300,000
_______
= UCC balance $800,000 $400,000
CCA claim (25%) $200,000 $100,000
End-of-year UCC balance $600,000 $300,000
As noted, depreciable properties are put into different classes, with each class having its own depreciation rate and all of the taxpayer’s property of the same class put together into a pool.  Classification of most mining depreciable properties depends on whether it was acquired before 1988, as the classification rules changed in that year.
For property acquired after 1987 for use in a mining operation, Class 41 is the CCA class most commonly encountered.  Property in Class 41 includes property acquired after 1987 principally for the purpose of producing income from a mine in Canada operated by the taxpayer and that is:
  • most buildings or other structures, machinery and equipment, (excluding an office not at the mine site and property used for processing another taxpayer’s ore);
  • power generating and distributing equipment and plant used in operating a mine, ore mill, smelter or refinery;
  • railway track and ancillary equipment and machinery (but not rolling stock) used to earn income from a mine; and
  • so-called “social assets”, being property used to provide services to the mine or to a community where a substantial portion of the mine’s workforce reside (e.g., hospitals, houses, roads, recreational facilities, etc.).
The applicable CCA rate for Class 41 property is generally 25%.  However, in certain circumstances the taxpayer is entitled to claim a deduction of up to 100% of the UCC of certain Class 41 properties.  In very general terms, this 100% rate applies where the property was acquired before the mine came into production or as part of a significant expansion of a mine.  This accelerated CCA is meant to offset some of the risk of investing in new mines, by effectively deferring taxation of mine income until the cost of its capital assets has been recovered out of project earnings.
The categorization of mining property for CCA purposes is the subject of a number of complex rules.  Table 2 sets out how different property is categorized within Class 41.  The distinction is important, since only properties in Class 41(a) and Class 41(a.1) are eligible for the accelerated CCA.
TABLE 2   CLASS 41 PROPERTY
Class 41(a) Class 41(a.1) Class 41(b)
Buildings, structures, machinery equipment to produce income from a mine If acquired before mine comes into production or before major expansion completed If not included in Class 41(a), portion of cost that exceeds 5% of gross mine revenue for year If not included in Class 41(a) or (a.1)
Specified social assets to provide services to a mine or community with a substantial portion of mine workers reside If acquired before mine comes into production or before major expansion completed If not included in Class 41(a), portion of cost that exceeds 5% of gross mine revenue for year If not included in Class 41(a) or (a.1)
Power generation and distribution equipment to supply a mine, mill, smelter or refinery If acquired before mine comes into production or before major expansion completed If not included in Class 41(a), portion of cost that exceeds 5% of gross mine revenue for year If not included in Class 41(a) or (a.1)
Railway track structures, machinery and equipment (excluding rolling stock) principally to produce income from a mine If acquired before mine came into production If not included in Class 41(a)
Property designed principally to explore for minerals Included

CCEE and CCDE

Where an expenditure (current or capital) does not constitute the cost of a depreciable property, it may fall within a category of expenses unique to the Canadian tax regime for the natural resource industry.  Certain expenditures relating to resource properties (including mines) constitute “Canadian exploration expense” (“CEE“), and are included in the taxpayer’s “cumulative Canadian exploration expense” (“CCEE“) pool balance.  Other expenditures constitute “Canadian development expense” or (“CDE“), and are included in the taxpayer’s “cumulative Canadian development expense” or (“CCDE“) pool balance.  In each case, qualifying expenditures made by the taxpayer are added to the CCEE or CCDE pool, and the amount claimed by the taxpayer as a deduction from income for tax purposes reduces the CCEE or CCDE pool.  In this manner, CCEE /CCDE pools are somewhat similar to a UCC balance.
CEE encompasses most exploration and pre-production development expenses (other than for depreciable property).  Expenditures included in CEE include the following:
  • Exploration:  expenses (other than those included in CDE) incurred to determine the existence, location, extent or quality of a mineral resource in Canada, including in the course of prospecting, geological/geophysical/geochemical surveying, drilling, trenching, digging test pits or sampling.  Any such expenses related to a mine already producing in commercial quantities (or any extension of such a mine) are excluded; and
  • Pre-Production:  expenses incurred for the purpose of bringing a new mine into production in reasonable commercial quantities (including expense for clearing, removing overburden, stripping, sinking a mine share or constructing an adit or other underground entry), if incurred before the mine comes into production in reasonable commercial quantities.
Excluded from CEE are the costs of depreciable property and expenses resulting in revenue being earned before the mine comes into production in reasonable commercial quantities.In September 2007 in response to representations from the Prospectors and Developers Association of Canada, the CRA issued a letter outlining its views on which environmental study expenses, community consultation expenses and feasibility study expenses come within the definition of CEE (for a copy of the CRA’s response see here)
Each year, the taxpayer is entitled to claim a deduction in computing income up to the full amount of the taxpayer’s year-end CCEE balance, not exceeding the taxpayer’s income for the year (a lesser amount may be claimed if desired), with any remaining CCEE balance carried forward to the next taxation year.  The amount claimed as a deduction reduces the taxpayer’s CCEE balance (as do certain other amounts, such as government assistance).  If for any reason the CCEE balance is a negative amount at year-end (i.e., cumulative reductions exceed additions), that negative amount is added to the taxpayer’s income for the year and the CCEE balance is reset to zero.
CDE is also a very important tax concept in mining, in particular because this pool includes many mining acquisition costs.  More specifically, included in CDE is:
  • the cost to the taxpayer of (and of preserving the taxpayer’s rights to) a “Canadian resource property“, in a mining context being: -any right, licence or privilege to prospect, explore, drill or mine for minerals in a Canadian mineral resource;- any royalty or rental computed by reference to the production from a Canadian mineral resource that the payer has an interest in; or- any interest in Canadian land the value of which is primarily dependent on the value of minerals contained therein; and
  • any expense incurred in sinking or excavating a mine shaft, main haulage way or similar underground work for continuing use in a Canadian mineral resource (except to the extent included in the cost of depreciable property), if built after the mine has come into production, or any expense of extending any such shaft, haulage way or work.
The cost of depreciable property is excluded from CDE.
Qualifying expenditures described above are added to the taxpayer’s CCDE, while certain amounts are deducted from the taxpayer’s CCDE balance, such as the sale proceeds for a Canadian resource property and amounts previously deducted from income by the taxpayer as a CCDE deduction.  The taxpayer is entitled to claim a deduction in computing income of up to 30% of the year-end CCDE balance (a lesser amount may be claimed if desired).  The remaining CCDE balance is carried forward to the next taxation year.  If for any reason the CCDE balance is a negative amount at year-end (i.e., cumulative reductions exceed additions), that negative amount is added to the taxpayer’s income for the year and the CCDE balance is reset to zero.  This might occur if a mining property is sold during the year for proceeds of disposition exceeding the taxpayer’s CCDE balance.
The principal attributes of depreciable property, CEE and CDE are summarized below in Table 3:
TABLE 3: SUMMARY OF CANADIAN MINING EXPENSES
Class 41 Depreciable Property UCC CEE CDE
What is included?
  • Most buildings, machinery and equipment used to earn income from a mine
  • Power generation and distribution equipment to supply a mine
  • Social services assets to support a mine or mining community
  • Railway track and ancillary equipment and machinery used to earn income from a mine
  • Property designed to explore for minerals
  • Expenses to determine existence, quality, etc. of mineral resource in Canada (prospecting, surveying, etc.), unless mine already in commercial production
  • Expenses incurred pre-commercial production to bring mine into commercial production
  • Excluded: depreciable property, expenses generating pre-commercial production revenue
  • Acquisition or preservation costs of CRP (right to prospect mine minerals in Canada, royalty in Canadian mineral resource, interest in land in Canada dependent on mineral content)
  • Expense of sinking or excavating a mine shaft or underground work in Canadian mineral resource, if incurredafter mine in production
  • Excluded: depreciable property
Balance reduced by
  • CCA deductions claimed
  • Sale proceeds of Class 41 property (up to original cost)
  • CEE deductions claimed
  • CDE deductions claimed
  • Sale proceeds of Canadian resource properties
Deduction rate (on year-end balance) 25% (100% in some cases) 100% (up to income) 30%
Costs eligible for flow-though share renunciation? No Yes Limited
If incurred by partnership Deduction claimed by partnership Deduction claimed by partners Deduction claimed by partners