Canadian Exploration Expenses
The ITA provides a deduction for Canadian exploration expenses (CEE) incurred during the exlporation state of oil and gas activities. These deductible costs include:
- G3 expenses: This category includes geological, geophysical, or geochemical expenses incurred for the purpose of determining the existence, location, extent, or quality of an accumulation of petroleum or natural gas in Canada. These expenses are sometimes referred to as G3 expenses, and they generally include expenses incurred in extracting and studying core samples, in obtaining and studying data concerning formations beneath the surface of the earth, and in chemical analysis in respect of deposits.
- Exploratory probe expenses: By definition, an oil or gas well does not include an exploratory probe, and all costs incurred in drilling an exploratory probe may be classified immediately as CEE. The term “exploratory probe” is not defined in the ITA, but it is generally used in the oil and gas industry to refer to a probe that is used to extract samples for test purposes.
- Drilling expenses: This category currently includes expenses incurred in drilling or completing an oil or gas well in Canada or in building a temporary access road to – or preparing a site in respect of – such as well, provided that:
- the drilling or completion of the well resulted in the discovery that a natural underground reservoir contained either petroleum or natural gas and the discovery occurred at any time before six months after the end of the year;
- the well is abandoned within six months after the end of the year without ever having produced otherwise that for a specified purpose;
- the expense is incurred during the period of 24 months after completion of the well and the well has not produced during that period otherwise than for specified purposed; or
- the Minister of Natural Resources issues a certificate that he or she is satisfied that
- the total of expenses incurred or to be incurred in drilling or completing the well, in building a temporary access road to the well, and in preparing the site in respect of the well will exceed $5,000,000 and
- the well will not produce, otherwise than for a specific purpose, within the period of 24 months commencing on the day in which the drilling of the well is completed.
The phrase specified purpose means (i) the operation of an oil and gas well for the sole purpose of testing the well or the wellhead and related equipment in accordance with generally accepted engineering practices, and (ii) the burning of natural gas and related hydrocarbons to protect the environment.
Expenses incurred in bringing a mine in a bituminous sands deposit into production constituted CEE until March 22, 2011, when the federal budget for the 2011-2012 fiscal year was presented to the House of Commons. That budget provided that such expenses would in the future be categorized as Canadian Development Expenses (CDE), except for certain specific project expenses (specified oil sands mine development expenses), incurred prior to 2015, that have been grandfathered as CEE. There is a transition period with other project expenses a portion of which (eligible oil sands mine development expenses) have been grandfathered as CEE through phase-in rules.
As described above, the determination of whether an expense is CEE may depend upon events which occur after the end of the year. An oil or gas drilling expense that does not satisfy the definition of CEE at the end of the taxation year in which the taxpayer incurs the expense will initially be categorized as a CDE. Such an expense may subsequently be found to meet the definition of a CEE, and it will be re-characterized accordingly at this time.
CEE exclude the costs of depreciable property, such as tubing and pumps.
A taxpayer includes its CEE in its cumulative Canadian exploration expense (CCEE) account:
- A principal-business corporation may deduct up to 100 percent of its CCEE balance at the end of the year to the extent of its income for that particular taxation year. A principal-business corporation cannot create a loss by claiming a deduction in respect of its CCEE account in excess of its income for that year.
- A taxpayer that is not a principal-business corporation may claim a deduction of up to 100 percent of its CCEE account at the end of the year without restriction. However, a deduction in excess of the taxpayer’s income may have significant adverse consequences under federal, and in some cases provincial, minimum tax legistation.
A taxpayer deducts from its CCEE account any amount claimed as CEE in the year. Any balance remaining in the account can be carried forward indefinitely and deducted in future years, subject to the limitations imposed by the ITA.