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Depletion Allowance

19.36. The question arises as to whether some allowance should be made for the depletion of a mine not for the purpose of incentive but to establish a true net income by enabling the segregation of the capital element of a receipt from its income element.

19.37. Where depletion allowances are employed by a tax system for the purpose of attempting to present an accurate computation of the net income of a mining venture, different considerations apply to the nature and extent of such allowances from those arising where the depletion allowance is used purely as an incentive measure. Where a depletion allowance, either cost or percentage, is framed in recognition for income tax purposes of the fact that a mine or well is exhaustible and that each year's production diminishes the value of the asset, the subject of depletion should be the cost to the taxpayer of the wasting asset. In this way depletion for tax purposes may bear some equivalence to normal depreciation of wasting assets, since the mine or well is only one component of the assets comprising a mining venture. Some acknowledgement of these considerations may be found in the United Kingdom provisions, which allow a deduction from assessable income of proportions of the ‘royalty value’ of the output of a mine that vary according to the time lapsing between acquisition of the mine and commencement of production (see United Kingdom Capital Allowances Act 1968, section 60).

19.38. The amount of the deduction available is delimited by the cost of acquisition. A fuller explanation of the working of these provisions may be found in Appendix A to this chapter. The depletion allowance is directed to preserving an equivalence between the mining enterprise which works the mineral area on a royalty basis, thereby obtaining a deduction for payments made, and the mining enterprise which purchases a mine or mineral area and itself works the mine. The United Kingdom Royal Commission on the Taxation of Profits and Income (1955) considered that, in enabling an allowance for depletion (equivalent to the amortisation of the costs of acquisition over the life of the mine), an ‘obvious element of cost’ would be recognised, thereby facilitating computation of the ‘true profit’ of a mining venture.




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19.39. The Committee does not favour the percentage depletion allowances which Canada has (see Appendix A). Since percentage depletion is unrelated to expenditure incurred but is simply tied to income receipts, it does not provide a means of segregating the capital element of the receipts of a mining enterprise from the income element other than on a very arbitrary basis. Further, in computing the net income of a mining venture, capital expenditure incurred on a wasting asset should be the subject of allowance (whether by amortisation or otherwise), since it is that capital outgoing which is subjected to the process of depletion as the minerals are extracted. For these reasons, cost depletion is to be preferred as a method of arriving at a net income. Although cost depletion focuses upon the ratio of the annual output of the mine to its total estimated output as being the determinant of the extent of the deduction, this ratio is applied to the capital cost incurred by the mining enterprise in acquiring the mine, since, as pointed out above, it is this cost which represents the asset that is being wasted.

19.40. Strictly speaking, the net effect of Division 10 is to provide a cost depletion allowance; but since most of the capital expenditures incurred in acquiring and developing the wasting asset are ultimately deductible over the life of the mine or earlier, this does not apply where the miner does not undertake exploration activities but acquires a mine from a prospector pursuant to section 122B. In this latter case, the capital expenditure incurred by the miner in acquiring the mine may be written off, but only to the limited extent of the residual capital expenditure at that time available to and transferred by the vendor.

19.41. In summary, depletion allowance of the cost type is essentially directed towards a proper allowance for all capital of a wasting nature in computing net income from mining; the amortisation and write-off provisions of Division 10 are similarly directed. Where those items of expenditure allowable as deductions within the amortisation provisions comprehensively reflect the assets of a ‘wasting nature’, the same overall result should be achieved. Thus, whichever approach be adopted—amortisation or cost depletion—the task is to ensure that all capital expenditure on assets of a wasting nature may be recouped as a prelude to computing the net income of a mining venture. The Committee considers that there is no need for a depletion allowance if Division 10 makes full allowance for the deduction of all expenditure upon assets of a wasting nature. There remains, however, the question of a full allowance for the cost of acquiring a mining or prospecting right or information.

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