Science Eligibility Guidelines for the Oil and Gas and Mining Industries
The Income Tax Act defines Scientific Research and Experimental Development (SR&ED) to include core work including basic research, applied research and experimental development and support work including as engineering, design, operations research, mathematical analysis, computer programming, data collection, testing or psychological research where the support work is commensurate with the needs and directly in support of the core work. One of the activities specifically excluded from the definition is work with respect to prospecting, exploring or drilling for, or producing, minerals, petroleum or natural gas.
CRA Application Policy 95-02 addresses how they will apply this exclusion to companies in oil & gas and mining industries. In this paper they attempt to define the boundary between SR&ED and work with respect to prospecting, exploring or drilling for, or producing, minerals, petroleum or natural gas.
CRA indicates in that paper that the legislative intent of the exclusion is to not include as SR&ED any work where costs qualify for Canadian exploration expense (CEE), Canadian development expense (CDE), foreign exploration and development expenses (FEDE) and Eligible depletion allowance (EDA) treatment. (CEE, CDE, FEDE and EDA are terms defined in the Income Tax Act.)
Support work that is undertaken for the purpose of prospecting, exploring, drilling for or producing minerals, petroleum or natural gas is not considered SR&ED. Support work that is commensurate with the needs and directly in support of core work is considered to be eligible.
Usually the boundary is fairly easy to determine. Work that meets the SR&ED criteria of technological uncertainty and technological advancement is likely to be carried out for the development and testing of new and improved techniques and processes, not for the purpose of prospecting, exploring, drilling for or producing minerals, petroleum or natural gas. Similarly work that is carried out for the purpose of prospecting, exploring, drilling for or producing minerals, petroleum or natural gas is likely to use techniques and processes that are standard practice in the industry and therefore do not involve technological uncertainty and technological advancement.
The Application Policy also addresses the treatment of field pilots and output from testing done to verify technological advancement in oil & gas and mining industries. These issues are treated essentially the same as pilot plants in other industries.
Field pilots will generally be non-commercial scale facilities in which new and improved processes are systematically investigated under conditions simulating full production. Construction and operation of a field pilot plant is eligible experimental development provided the principal purpose is to obtain engineering and other data on applications, conditions, interactions, relationships, equipment, environmental effects etc. for evaluation and development of the process.
Experimental development of equipment or processes in the Oil & Gas and Mining industries may also require development and testing in commercial field facilities. SR&ED treatment of costs related to production output from tests in commercial or pilot facilities is dependent on whether the output is sold and whether or not such sales constitute ineligible commercial activity. Factors that will determine commercial activity in the oil & gas industry include production levels and the number of wells involved. Commercial activity decisions and SR&ED cost allocations are determined on a case by case basis.
The Application Policy uses seven projects as examples to illustrate the application of SR&ED guidelines. Key questions addressed in the examples are:
- Does the work satisfy the three SR&ED criteria of technological uncertainty, technological advancement and technical content?
- Is the testing carried out in a field pilot or a commercial facility?
- Was the work undertaken purpose of prospecting, exploring, drilling for or producing minerals, petroleum or natural gas?
All of the work in project 1 was SR&ED, some in projects 2 and 3, and none in projects 4-7.
Project 1 was concerned with the development of an in situ cyclic steam stimulation process for oil recovery from the Athabasca oil sands. The test facility was a field pilot because it was not of commercial scale and its primary purpose was to investigate and develop the cyclic steam stimulation process. The limited number of injection, production, temperature monitoring, water source and water disposal wells was considered to be part of the research facility. Factors investigated included inter-well communication and interaction, heat and pressure distribution, heat sinks, vertical fracture formation, steam placement, shale breaks, steam rates, steam and water volumes, foam sealants, and formation heaving. All of the work in project 1 was SR&ED because it satisfied the three SR&ED criteria. The project did not fall under the provisions of paragraph 2900(1)(h) because the primary purpose was process development, not to increase oil production rate or recovery.
Project 2 was an unsuccessful multi-year investigation of the viability of a novel steam drive technique for enhanced oil recovery in the McMurray formation. Oil recovery during the course of the project was minimal. The test facility was a field pilot because it was not of commercial scale, oil recovery was minimal, and its primary purpose was to investigate and develop the steam drive process. Core activities were related to horizontal steam drive, producing vertical, steam injector slant and vertical, temperature observation and water disposal wells and to seismic work on the aforementioned wells. All core activity work was SR&ED because it satisfied the three SR&ED criteria. Core activities did not fall under the exclusions because the primary objective was to investigate the novel steam drive process, not to increase oil production or recovery. Non-core activities were related to property or lease evaluation rather than the experimentation process. Non-core activities were not SR&ED because they were routine (unrelated site and facilities preparation), fell under the exclusion provisions (core hole program, site seismic evaluation, and EM survey), or were not directly in support of the SR&ED work (gravel evaluation for road building).
Project 3 was concerned with development of a process for re-entering existing vertical wells to convert them to horizontal wells. Development of cutting tools, a cutting process, and drilling equipment to effect the re-entry and horizontal well conversion was SR&ED because it satisfied the three SR&ED criteria. Drilling of five horizontal wells in current producing wells was not SR&ED because the purpose was to increase the production rate and it therefore fell under the exclusion provisions.
Projects 4-7 were concerned with:
- Application of horizontal re-entry technology on existing wells to remedy high water production in wells drilled too close to the oil/water contact.
- Under-balanced drilling of horizontal sections to reduce well bore damage during drilling of a conventional well.
- Drilling and completing a horizontal well.
- Application of CO2 flooding to increase production in some producing wells and drilling of horizontal wells in a fractured reservoir.
None of the work was SR&ED because all involved application of techniques and technology that were standard industry practice. Therefore the work did not satisfy the technological advancement and uncertainty criteria. All of the work also fell under the exclusion provisions because the primary purpose was to produce petroleum or increase its production.
The Strategy
Where the boundary between eligible and ineligible work is not obvious, a careful analysis of the rules are required. Where the claimant can make a case for eligible work, the work should be claimed and the case should be made in the technical submission to CRA.
