CRA confirms that the mark-up in the charges for geophysical services by a connected corporation to an exploration company over its incurred costs would be excluded from CEE

BCO will be issuing flow-through shares to fund exploration work. A second company (ACO), which is wholly owned by the controlling shareholder of BCO, provides geophysical services to its customers, including BCO.

Would any portion of the payments made by BCO to ACO for ACO's services be considered exploration and development overhead expense (CEDOE) so that such portion would be excluded from Canadian exploration expense (CEE) pursuant to ITA s. 66(12.6)(b) and Reg. 1206(4.2) and, thus, could not be renounced by BCO to its flow-through share investors?

CRA noted that under para. (d) of the CEDOE definition in Reg. 1206(1), amounts paid by BCO to a person with whom it was connected under Reg. 1206(5)(a) (i.e., ACO) for the performance of a service, which otherwise would be CEE, will be CEDOE to the extent that the amount charged exceeds the costs incurred by such connected person in providing the service.

Thus, the amount of CEE that BCO would be entitled to renounce in respect of the amounts paid by it to ACO for ACO's services would be limited to the actual cost incurred by ACO in providing such services. Regarding whether certain non-insurable risks and liabilities (e.g., losses if the survey aircraft crashed) could be considered to be “costs incurred” for these purpose, CRA noted that the “Courts have held that a taxpayer will not be considered to have incurred an expense unless and until the taxpayer has an absolute and unconditional legal obligation to pay an amount” and indicated that It seemed unlikely that such amounts could so qualify.

Neal Armstrong. Summary of 9 August 2023 External T.I. 2023-0979431E5 under Reg. 1206(1) – CEDOE – para. (d).