A Pause For Reflection
Authors: Parsons Robert B. 
Published: March 2010

Abstract
Recent years have seen dramatic changes in the tax treatment of Canada's petroleum industry. The National Energy Program of October 1980 and the Memorandum of Agreement Relating to Energy Pricing and Taxation between the governments of Canada and Alberta of September 1981 started the ball rolling. Since then resource taxation has been subject to numerous and substantive amendments. It seems appropriate at this time to sit back and take a look at where we stand currently.

Introduction
The taxation of the Canadian petroleum industry has received special attention for many years due to its unique characteristics. The high risk of exploration and production endeavours, combined with the finite or depletable nature of the "raw material" are perceived as attributes that require recognition through special income tax rules. This, combined with the not-too-subtle influence of more recent policy-inspired provisions, has resulted in the petroleum industry facing increasingly complex tax legislation. (Refer to the March-April 1983 JCPT issue for a dissertation on this favourite topic.)
Most Canadian petroleum operators are subject to four different and separate levels of taxation: federal income taxes, provincial income taxes, federal royalties, and provincial royalties or similar levies. The income tax legislation, generally speaking, identifies two distinct phases of oil and gas operations. The first stage includes the so-called "upstream" activities that involve the actual production of crude oil and natural gas. The income attributable to these activities generally constitutes "resource profits" for purposes of certain special allowances discussed later. The second stage consists of processing gas at a gas plant or crude oil at a refinery. These activities qualify for "manufacturing and processing" treatment. This article will concentrate on the tax consequences of the first stage.

Tax Deductible Expenses
In computing income to which federal income tax applies, the amortization of exploration and development expenses recorded in the company's books is not an allowable deduction. A taxpayer's allowable exploration and development expenses are accounted for by way of the "pool" concept (that is, expenses incurred are added to the appropriate pool or category and the amounts deducted reduce the available balance in the pool). The nature of the expenses, when they are incurred, and the classification of the taxpayer incurring the expenses will generally determine the amounts deductible in a particular taxation year. (The comments in this article are directed toward principal business corporations.) Canadian development expenses ("CDE") are deductible at 30% per annum on a declining basis against any source of the taxpayer's income. These expenses are specifically defined for income tax purposes (Table 1) and generally include expenses incurred in drilling or completing an oil or gas well in Canada or in preparing a site in respect of the well, but exclude expenses which qualify as Canadian exploration expenses.
Canadian exploration expenses ("CEE") are also deductible against any source of income but are accorded more favourable treatment than CDE in that they are fully deductible in the year incurred. Subject to the "change in control" rules noted below, unclaimed CEE may be carried forward indefinitely for deduction in subsequent taxation years. Generally, expenses incurred for the purpose of determining the existence, location, extent or quality of an accumulation of petroleum or natural gas in Canada qualify as CEE. Also, the costs of drilling dr