Canada: Budget 2017: Changes To Canadian Exploration Expense And Flow-Through Shares

All references are to the Income Tax Act (Canada) (Act), unless otherwise noted.


Canadian exploration expenses (CEE) are certain types of expenses incurred by oil and gas, mining and renewable energy corporations. CEE is 100 percent deductible in the year the expense is incurred. Certain types of CEE also qualify for renunciation to investors under the flow-through share rules contained in the Act. With the exception of expenses related to the acquisition of Canadian resource property (which generally would be a Canadian oil and gas property expense), most other oil and gas related expenses (other than tangible costs) qualify as Canadian development expenses (CDE). CDE is deductible at 30 percent on a declining balance basis. CDE can also be renounced under the flow-through share rules, but because of the reduced rate of deduction, is significantly less desirable for investors.

The federal Liberal's 2015 election platform promised to restrict CEE in the oil and gas sector to be only available in cases of unsuccessful drilling. The 2017 Budget proposes to implement that promise.

Flow-through shares are shares which are issued by certain qualifying oil and gas companies (a "principle business corporation", as defined in the Act or a PBC) under subscription agreements that contain contractual terms requiring the PBC to incur and renounce CEE or CDE to the subscribers allowing those subscribers to deduct the renounced CEE and CDE amounts from their income.

The Proposed Amendments

The Definition of CEE

The Notice of Ways and Means Motion released with the 2017 Budget includes draft legislation to implement the change of policy. Prior to the proposed amendment, subject to certain constraints, CEE included expenses incurred to drill and complete an oil and gas well or to build a temporary access road to or prepare a site in respect of a well where the well resulted in a discovery of a new petroleum or natural gas reservoir. Under the proposed amendments those types of expenses will no longer qualify as CEE if they are incurred after 2018. An additional transitional period is permitted if there was a written obligation to incur the expenses prior to Budget Day (March 22, 2017), in which case the expenses can be incurred prior to 2021 and still qualify as CEE.  Expenses related to wells that have not produced and are abandoned within a prescribed time period, or wells that do not come into production within a prescribed period of time, are unaffected and continue to qualify as CEE.

In more general terms, expenses related to drilling for new reservoirs of oil and gas that result in a producing oil and gas well will no longer qualify for CEE.

Flow-Through Shares: The CDE Re-Designation Rule

Prior to the amendments, certain small junior PBCs were able to re-designate up to $1 million of CDE as CEE, which they could then renounce to investors under the flow-through share rules. Under the proposed amendments, the re-designation rule will no longer be available for CDE incurred after the earlier of December 31, 2018, and the day that is 24 months after the end of the month in which a subscription agreement for flow-through shares has been entered into.

In practical terms, the re-designation rule will no longer be available for CDE incurred by any PBCs after 2018.

Effects of the Proposed Amendments


For all oil and gas companies, the restriction of the CEE definition will, going forward, reduce their CEE pools and increase their less desirable CDE pools. Although there are many other expenses that will continue to qualify as CEE, including expenses to determine the existence, location and extent of petroleum or natural gas accumulations, such as seismic data, the CEE definition has been significantly narrowed.

In addition, the proposed amendments introduce significant forecasting and budgeting uncertainty for oil and gas companies. When an oil and gas company commences drilling for a new reserve, they will not be sure whether they can characterize their expenses as CEE or CDE until after they have determined whether the well can/will go into production. This will make planning more difficult.

Flow-Through Shares

We also expect that the proposed amendments will reduce the use of flow-through shares in the oil and gas sector. First, the pool of available expenses for a PBC that can be renounced as CEE will be reduced. Although CDE can be renounced under the flow-through share rules, given its 30 percent deductibility, it is significantly less marketable. In addition, CDE is not eligible for the "look-back rule", which is frequently used by PBCs when issuing flow-through shares. In general terms the look-back rule permits PBCs to renounce amounts to investors prior to having incurred the expenses.  In a typical flow-through share issuance, the PBC will rely on the look-back rule to renounce CEE on December 31 of year 1, providing the investor with a deduction in that year, but will incur CEE in year 2, using the funds raised on the share issuance.

Second, if a PBC cannot be sure whether its drilling expenses will be classified as CEE or CDE, it will be very difficult for that PBC to enter into the necessary contractual terms required for a flow-through share issuance promising to incur and renounce CEE to the investor.

Finally, we expect that the elimination of the re-designation rule will be particularly felt in the junior oil and gas sector. Flow-through shares have been an essential tool for junior PBCs to raise the equity required to fund their exploration budgets. With the uncertainty surrounding the amount of CEE that will be available for renunciation and the elimination of the CDE re-designation, junior PBCs will likely have difficulty in using one of their primary incentives (flow-through shares) to attract investors and raise explorations funds.


The transitional rules for the changes to the definition of CEE have left until the end of 2018 for oil and gas companies to continue to incur expenses under the existing, more generous CEE definition.  Interested companies, if commercially possible, should consider accelerating their drilling to occur prior to 2019 to take advantage of the current CEE rules.

For any oil and gas company considering raising equity within the next three or so years, there is an incentive to act sooner, if commercially possible. First, the additional funds raised can be used to incur expenses that will be classified as more valuable CEE, instead of CDE. Second, if a flow-through share issuance is being considered, the PBC should have a larger pool of CEE to renounce, and for junior PBCs the re-designation rule remains available to permit a renunciation of more valuable CEE.

Companies should also consider using flow-through share financing to fund new discovery wells within the transitional period and flow-through share financing for seismic and other exploratory activities after the transitional period. In addition, oil and gas companies should carefully review their obligations to incur expenses that existed before Budget Day (March 22, 2017) to determine if they can take advantage of the longer transitional period.

CEE and Flow-Through Shares in the Mining Sector

There were no changes to the definition of CEE or the flow-through share rules for the mining sector (the re-designation rule does not apply to mining expenses).  As was previously announced, the 2017 Budget proposes to extend the mineral exploration tax credit for another year.


If you have any questions about the changes to the definition of CEE or flow-through shares or if you would like to discuss strategies to optimize your CEE expenditures or a flow-through share issuance.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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