Drilling Down: Are drilling costs eligible for SR&ED? It depends...

Drilling Down: Are drilling costs eligible for SR&ED? It depends…

In this post, we walk through eligibility of certain costs related to drilling for Scientific Research and Experimental Development (SR&ED) claims, based around a recent Tax Court of Canada case, ExxonMobil Canada Ltd. v. The Queen. We will explain how in certain cases, projects associated with oil drilling may be eligible for SR&ED investment tax credits (ITCs) and why this project was deemed ineligible. 

ExxonMobil Canada Ltd. v. The Queen

In 2019, oil company ExxonMobil submitted the cost of drilling an oil well as an SR&ED expenditure to the Tax Court of Canada (you can read our full legal analysis of this court case here).1 ExxonMobil submitted their drilling well as they claimed it involved the testing of predictions through a new RCA methodology.2

The issue, in this case, was ExxonMobil’s claim that the cost of drilling ($2,048,215) was SR&ED.3 However, the CRA argued that the purpose of the drilling well was to chart an oilfield in Hibernia, data that would be necessary in order to fulfill the exploration license EL1093, which points towards commercial use.4

This would disqualify ExxonMobil for claiming SR&ED because according to the CRA’s definition of SR&ED:

SR&ED work is not “the commercial production of a new or improved material, device or product or the commercial use of a new or improved process,” nor is it related to “prospecting, exploring or drilling for, or producing, minerals, petroleum or natural gas.”5

In this case, the judge decided that the purpose of the drilling was to determine whether there was oil, and if so, how much.6 The judge determined that it was “common sense and commercial reality” that drove the drilling, incidentally providing data that agreed or disagreed with the predicted outcome.7 The primary intention was not to develop new methods or technological knowledge.

Why was this case ineligible?

In this particular case, the CRA obtained an internal presentation from Exxonmobil which stated that the primary objective was “to determine economic viability”8 of the platform; validating the new methodology model was not mentioned as an objective.

In this case, Exxonmobil planned to use the results of the oil well drilling to validate its model and new methodology to predict where oil is.  The judges stated:

The new/improved RCA methodology predicted the existence of significant amounts of oil in the Hibernia southern extension. Any well drilled in the southern extension subsequent to this prediction could potentially contribute data relevant to assessing the veracity of the prediction. However, common sense and commercial reality dictate that the primary purpose of any such well (even the first one) is not to validate the RCA methodology but rather to obtain data regarding oil in the southern extension. In this case, I find as a fact that well B16-54 was drilled to obtain data regarding oil in the southern extension and to satisfy the requirements of EL1093. The validation of the RCA methodology was incidental to these objectives. This conclusion is consistent with the fact that there was no evidence to tie well B16-54 to the formulation, testing and modification of the RCA methodology.9

If ExxonMobil had collected and analyzed data from multiple sites in relation to the model, the subsequent analyses of data could potentially be eligible for SR&ED, although, this analysis would only be SR&ED if it was in relation to the model, and not the cost to drill the site.

How can oil drilling be eligible for SR&ED?

While drilling for oil is not eligible for SR&ED investment tax credits, advancements made within the drilling industry may be eligible. For example:

  • advancements made to the technology or processes used to drill
  • advancements to the drilling equipment
  • advancements to software needed to drill
  • advancements to automated systems used in drilling
  • advancements to hydraulic systems used in drilling

Each project must meet the criteria set forth by the CRA to determine eligibility.  These projects must meet the eligibility criteria established in the policies:

The method to establish this involves answering the following five questions:

  1. Was there a scientific or a technological uncertainty?
  2. Did the effort involve formulating hypotheses specifically aimed at reducing or eliminating that uncertainty?
  3. Was the overall approach adopted consistent with a systematic investigation or search, including formulating and testing the hypotheses by means of experiment or analysis?
  4. Was the overall approach undertaken for the purpose of achieving a scientific or a technological advancement?
  5. Was a record of the hypotheses tested and the results kept as the work progressed10

Speaking with a tax advisor or SR&ED consultant can help determine if the project may meet all of the criteria.

Conclusion

ExxonMobil’s failure did not come from performing commercial testing on commercial sites but from fact that the only value to the testing was commercial, with a complete absence of a concrete hypothesis and technological advancements. There is potential SR&ED within the oil industry but all projects must meet the criteria set forth by the CRA to be eligible for SR&ED ITCs.

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Show 10 footnotes

  1. Tax Court of Canada. (May 7, 2019.) Exxonmobil Canada Ltd. v. The Queen. Retrieved August 10, 2020, from: https://decision.tcc-cci.gc.ca/tcc-cci/decisions/en/item/405691/index.do
  2. Tax Court of Canada. (May 7, 2019.) Exxonmobil Canada Ltd. v. The Queen. Retrieved August 10, 2020, from: https://decision.tcc-cci.gc.ca/tcc-cci/decisions/en/item/405691/index.do
  3. Tax Court of Canada. (May 7, 2019.) Exxonmobil Canada Ltd. v. The Queen. Retrieved August 10, 2020, from: https://decision.tcc-cci.gc.ca/tcc-cci/decisions/en/item/405691/index.do
  4. Tax Court of Canada. (May 7, 2019.) Exxonmobil Canada Ltd. v. The Queen. Retrieved August 10, 2020, from: https://decision.tcc-cci.gc.ca/tcc-cci/decisions/en/item/405691/index.do
  5. “Eligibility of Work for SR&ED Investment Tax Credits Policy.” Government of Canada, 24 Apr. 2015, https://www.canada.ca/en/revenue-agency/services/scientific-research-experimental-development-tax-incentive-program/eligibility-work-investment-tax-credits.html
  6. Tax Court of Canada. (May 7, 2019.) Exxonmobil Canada Ltd. v. The Queen. Retrieved August 10, 2020, from: https://decision.tcc-cci.gc.ca/tcc-cci/decisions/en/item/405691/index.do
  7. Tax Court of Canada. (May 7, 2019.) Exxonmobil Canada Ltd. v. The Queen. Retrieved August 10, 2020, from: https://decision.tcc-cci.gc.ca/tcc-cci/decisions/en/item/405691/index.do
  8. Tax Court of Canada. (May 7, 2019.) Exxonmobil Canada Ltd. v. The Queen. Retrieved August 10, 2020, from: https://decision.tcc-cci.gc.ca/tcc-cci/decisions/en/item/405691/index.do
  9. Tax Court of Canada. (May 7, 2019.) Exxonmobil Canada Ltd. v. The Queen. Retrieved August 10, 2020, from: https://decision.tcc-cci.gc.ca/tcc-cci/decisions/en/item/405691/index.do
  10. “Eligibility of Work for SR&ED Investment Tax Credits Policy.” Government of Canada, 24 Apr. 2015, https://www.canada.ca/en/revenue-agency/services/scientific-research-experimental-development-tax-incentive-program/eligibility-work-investment-tax-credits.html

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