REVENUE CANADA TAXATION INTERPRETATION BULLETIN NUMBER: IT-400 DATE: November 14, 1977 SUBJECT: INCOME TAX ACT Exploration and Development Expenses - Meaning of Principal-Business Corporation REFERENCE: Paragraph 66(15)(h) 1. This bulletin outlines the criteria for determining whether a corporation qualifies as a "principal-business corporation", as that term is defined in paragraph 66(15)(h) of the Income Tax Act. 2. Qualification as a principal-business corporation may be important for a taxpayer in connection with the following provisions of the Act: (a) Subsections 66(1) and 66.1(2) - Special rules for computing the amount deductible by a principal-business corporation for a taxation year in respect of its Canadian exploration and development expenses and cumulative Canadian exploration expense. (b) Subsections 66.1(4) and (5) - Special rules for computing the amount deductible by a principal-business corporation (which is a successor or second successor corporation) for a taxation year in respect of a predecessor corporation's cumulative Canadian exploration expense. (If subsection 28(1) of Bill C-56 is enacted as presently written for 1977 and subsequent taxation years, subsections 66.1(4) and (5) will no longer distinguish between successor or second successor corporations that are principal-business corporations and those that are not.) (c) Paragraph 66(15)(g) - Requirement for a "joint exploration corporation" to be a principal-business corporation. (Such a corporation may renounce its Canadian exploration and development expenses, Canadian exploration expenses, and Canadian development expenses in favour of its shareholder corporations, pursuant to subsections 66(10), (10.1), and (10.2).) (d) Paragraph 59(1.1)(b) - Requirement to deduct, in computing a principal- business corporation's cumulative Canadian development expense, the proceeds from the disposition of a right, licence, or privilege described in subsection 83A(5a) of the former Act, acquired before 1972. (e) Subsection 66(5) - Entitlement of a principal-business corporation whose business includes trading in resource properties to the application of sections 59, 64, 66.1, and 66.2 and subsections 66(3) and (4). (These provisions are not applicable to a taxpayer, other than a principal-business corporation, whose business includes such trading.) 3. For purposes of the provisions referred to in (a) and (b) of the preceding paragraph, it is the corporation's status as a principal-business corporation for the taxation year in which the deduction for exploration and development expenses is claimed, and not for the taxation year in which such expenses are incurred, that is relevant. Thus, where a corporation qualifies as a principal-business corporation in a particular taxation year, it may claim the deduction to which it is entitled in that year as a principal-business corporation in respect of expenses of previous years, without regard to whether the corporation was a principal-business corporation at the time such expenses were incurred. 4. A corporation qualifies as a "principal-business corporation" as defined in paragraph 66(15)(h), if its principal business operations are of a kind or any combination of the kinds specified in that paragraph. 5. The question of whether the principal business operations of a corporation are of the kinds specified in paragraph 66(15)(h) is one of fact that must be determined by reference to all of the surrounding circumstances, and in particular, after a review of all of the various activities carried on by the corporation. 6. In determining whether a corporation qualifies as a principal-business corporation, its activities for the full taxation year must be considered, not just the activities at a particular point in time (see also 15 below). Also, the business operations of the company as a whole should be considered, not only the company's operations in Canada. Qualifying Business Operations 7. Some of the qualifying business operations included in paragraph 66(15)(h) are discussed in 8 to 11 below. The management and administrative functions which are necessary to the conduct of the business operations referred to in paragraph 66(15)(h) are considered to be an integral part of those operations. Production, refining, or marketing of petroleum, petroleum products, or natural gas (subparagraph 66(15)(h)(i)) 8. In reference to petroleum products, this phrase is considered to include all steps up to the production and sale of a petroleum product as a raw material, but not to include the fabrication of articles from such raw material. (For example, the fabrication of toys from plastic is not a qualifying operation.) Exploring or drilling for petroleum or natural gas (subparagraph 16(15)(h)(i)) 9. This phrase is considered to cover all activities of a taxpayer in the course of discovering and developing potential petroleum- or gas-producing properties, including all drilling operations whether or not such operations result in producing wells. For example, the following activities are viewed as "exploring or drilling for petroleum or natural gas": (a) drilling an oil or gas well, building a temporary access road to the well, or preparing the site in respect of the well, (b) drilling or converting a well for disposal of waste liquids from a petroleum or natural gas well, (c) drilling for water or gas for injection into a petroleum or natural gas formation, and (d) drilling or converting a well for the injection of water or gas to assist in the recovery of petroleum or natural gas from another well. Mining or exploring for minerals (subparagraph 66(15)(h)(ii)) 10. This phrase is considered to include all activities necessary in the search for, and examination of, prospective mineral-bearing properties, the development of mineral-bearing properties for mining and the production of ore or minerals from the earth, such as: (a) prospecting, (b) carrying out geological, geophysical, or geochemical surveys; (c) drilling by rotary, diamond, percussion or other methods; (d) trenching, digging test pits, and preliminary sampling; and (e) clearing, removing overburden, and stripping. Fabricating metals (subparagraph 66(15)(h)(v)) 11. This phrase is considered to include operations such as the manufacture of alloys (for example, brass, solder, and stainless steel) and the intermediate or final stages of manufacturing metals such as stamping, forming, machining, welding, cutting, or casting. It does not include the buying and assembling of parts that have already been fabricated. General 12. Where a corporation is a member of a partnership, joint venture, syndicate or similar association, for purposes of determining whether the corporation qualifies as a principal-business corporation, the business operations carried on by such organizations are regarded as being carried on by the corporation directly, to the extent of the corporation's interest in the partnership, joint venture, syndicate, or association. 13. For a corporation to qualify as a principal-business corporation, it is not necessary that the qualifying activities described in paragraph 66(15)(h) be performed on property owned by that corporation. For example, a corporation whose principal business is the development and management of mineral properties owned by other companies may qualify as a principal-business corporation. 14. It is the Department's view that as a general rule a corporation engaged in both natural resource and other business operations qualifies as a principal business corporation if, when considered together, the corporation's activities of the kind described in paragraph 66(15)(h) represent a larger or more important business operation than all other activities of the corporation combined. The determination of the size or importance of the business operations of a kind specified in paragraph 66(15)(h) in relation to a corporation's other business operations is determined by an examination and comparison of all the facts concerning each of the business operations in which the corporation is engaged. The following are regarded as important criteria for making such a determination: (a) the amount of income derived from each business operation, (b) the amount of gross revenue attributable to each business operation, (c) the operating costs and expenses of each business operation, (d) the capital employed in each business operation, and (e) the time and effort expended by the employees on each business operation. No one of the above factors will necessarily be decisive, and the significance of a particular factor may vary from case to case. 15. Although, in determining a corporation's principal business for a particular taxation year, normally only the business operations in that particular year should be considered, it may be necessary to review the operations of the company over a longer period of time. For example, a mining corporation which for many years has qualified as a principal business operation might in a particular year suffer a temporary decline in its mining activity due to adverse economic conditions, labour problems, or other short- term difficulties. In such circumstances it may be appropriate to continue to regard the company as a principal-business corporation for that year even though, if the year were viewed in isolation, the corporation might not so qualify. However, in considering whether a corporation qualifies as a principal-business corporation for a particular year, regard may be had to a future plan of the corporation only to the extent that it is implemented in the year.