Jun 11, 2026
Overview: CRA Reassessment of $36 Million in Feasibility Study Deductions — Deductibility, Transfer Pricing, and Part XIII Withholding Tax
In ExxonMobil Canada Resources Company v. The King, 2026 TCC 42 [ExxonMobil Canada], the Tax Court of Canada ruled that ExxonMobil Canada Resources Company (“ExxonMobil Canada”) could deduct more than $36 million in Feasibility Study Costs connected to a proposed Alaska-to-Canada natural gas pipeline project.
The Feasibility Study was undertaken to evaluate and progress a proposed pipeline project that would carry natural gas from Alaska, through Canada, and into the continental U.S. The project had three participants, each owning a 1/3 interest – ExxonMobil Production Company (“ExxonMobil U.S.”), BP Exploration (Alaska) Inc., and Phillips Alaska, Inc.
Much of the proposed pipeline would run through Canada, so ExxonMobil U.S. transferred most of its interest in the project to ExxonMobil Canada through a Partial Assignment and Cost Allocation Agreement (“PACA Agreement”). As a result, ExxonMobil Canada deducted the $36,207,810 costs incurred by the Feasibility Study. The Canada Revenue Agency (CRA) challenged this deduction, arguing that the expenses did not meet the requirements for a deduction under paragraph 18(1)(a) of the Income Tax Act because they were not incurred to earn income. The CRA further argued that Canada’s transfer pricing rules should apply to deny the deduction because the terms of the PACA Agreement between ExxonMobil U.S. and ExxonMobil Canada differed from what arm’s length parties would agree to, and alternatively, that the arrangement was undertaken primarily for a tax benefit and no parties would have entered into the agreement.
The Tax Court of Canada rejected both of the CRA’s arguments, finding that the Feasibility Study related to a source of income and that the transfer pricing rules did not apply because the PACA Agreement was undertaken for legitimate business purposes.
The CRA also assessed withholding tax on the payments as a deemed dividend to ExxonMobil Canada’s U.S. parent company, ExxonMobil U.S. The CRA argued that because ExxonMobil Canada’s payments for the Feasibility Study effectively benefited ExxonMobil U.S., they should be treated as a deemed dividend subject to withholding taxes. This would mean that ExxonMobil Canada should have withheld tax from the payments and remitted it to the CRA.
The Tax Court rejected this argument, holding that ExxonMobil Canada paid the Feasibility Study Costs for its own benefit because ExxonMobil Canada had rights connected to the proposed pipeline project and retained the rights to data collected by the Feasibility Study. Because the payments were undertaken to benefit ExxonMobil Canada, there was no deemed dividend.
The decision is important because it clarifies how Canadian courts may approach:
- the deductibility of large feasibility and development costs;
- the concept of a “source of income”;
- transfer pricing rules under section 247 of the Income Tax Act; and
- Part XIII withholding tax on cross-border payments between related corporations.
Background: ExxonMobil Canada’s 2001 Tax Reassessment and the Alaska Pipeline Project
ExxonMobil Canada appealed a tax reassessment issued by the CRA for its 2001 taxation year. The dispute focused primarily on whether ExxonMobil Canada could deduct approximately $36.2 million in Feasibility Study Costs related to a proposed natural gas pipeline project.
The proposed project involved transporting natural gas from Alaska, through Canada into the continental United States. The feasibility study evaluated a pipeline project from Prudhoe Bay on the North Slope of Alaska through Western Canada to the lower 48 United States, undertaken under an Alaskan Gas Pipeline Project Agreement between ExxonMobil Production Company, BP Exploration (Alaska) Inc., and Phillips Alaska, Inc. Each participant held a one-third interest in the project.
Because much of the proposed pipeline would run through Canada, ExxonMobil U.S. transferred a significant portion of its interest in the project to ExxonMobil Canada through a PACA Agreement. ExxonMobil Canada had experience dealing with Canadian pipeline operations and Canadian regulators. As part of the arrangement, ExxonMobil Canada assumed responsibility for a large portion of the project costs and acquired rights connected to the Canadian portion of the proposed pipeline.
ExxonMobil Canada deducted $36,207,810 in Feasibility Study Costs on its 2001 tax return. The CRA later tax reassessed the company, meaning it reviewed the return and denied the deduction.
The CRA argued that the expenses were not incurred for the purpose of earning income from a business or property, as required by paragraph 18(1)(a) of the Income Tax Act. During the litigation, the CRA also argued that ExxonMobil Canada had no source of income connected to the Feasibility Study.
The CRA further argued that Canada’s transfer pricing rules applied to deny the deduction. Transfer pricing rules govern transactions between related corporations in different countries, such as a Canadian subsidiary and a foreign parent company. The transfer pricing rules are intended to ensure that related companies price and structure their transactions as independent businesses would in comparable commercial circumstances.
The CRA also assessed ExxonMobil Canada for approximately $1.8 million in Part XIII withholding tax. The CRA claimed that the Feasibility Study payments amounted to a “deemed dividend” paid to ExxonMobil’s U.S. parent company.
A dividend is normally a payment made by a corporation to its shareholders. A deemed dividend arises when the Income Tax Act treats a transaction as though a dividend had been paid, even if no formal dividend was declared. In this case, the CRA argued that through the PACA Agreement, ExxonMobil Canada paid more than an arm’s length party would have paid and that the excess amount should be treated as a dividend to ExxonMobil U.S..
Under Part XIII of the Income Tax Act, Canada imposes withholding tax on certain payments made to non-residents, including dividends. The standard withholding tax rate is 25%, although tax treaties often reduce the rate. Under the Canada–U.S. tax treaty, the applicable rate in this case was reduced to 5%.
Key Legal Issues: Deductibility of Cross-Border Feasibility Costs, CRA Transfer Pricing Arguments, and Part XIII Withholding Tax
ExxonMobil Canada appealed the reassessment to the Tax Court of Canada. The main issues before the Court were:
- whether the Feasibility Study Costs were deductible business expenses;
- whether Canada’s transfer pricing rules applied to reduce or deny the deduction; and
- whether the payments gave rise to Part XIII withholding tax as a deemed dividend.
In short, the case required the Court to determine whether a Canadian subsidiary that paid costs under a related-party arrangement with its foreign parent could deduct those costs, or whether the CRA could not only deny that deduction through its transfer pricing arguments, but also impose a separate withholding tax liability on ExxonMobil Canada itself by treating those same payments as a deemed dividend to its U.S. parent.
Deductibility of the Feasibility Study Costs: Did ExxonMobil Canada Have a Source of Business Income?
Under the Income Tax Act, a taxpayer generally cannot deduct an expense unless it relates to a source of income, such as a business activity. The central issue was whether ExxonMobil Canada’s participation in the Feasibility Study was part of a genuine commercial business activity.
The CRA argued that ExxonMobil Canada had no source of income from which to deduct its $36,207,810 share of the Feasibility Study Costs. The Tax Court of Canada disagreed. To reach its decision, the Tax Court applied the leading authority on what counts as a “source of income” under the Income Tax Act – the Supreme Court of Canada’s decision in Stewart v. R., 2002 SCC 46 [Stewart].
The Stewart Test: Is the Activity Commercial, or Is It a Hobby?
In Stewart, the Supreme Court established a two-step test used to determine if an activity is a source of income.
The first question is whether the activity is carried on in pursuit of profit or whether it is merely a personal endeavour or hobby. If the activity is clearly commercial and has no personal element, the analysis generally ends there, and a source of income exists.
If the activity contains a personal element, courts then consider whether it is being carried on in a sufficiently commercial manner. Courts may examine factors such as the taxpayer’s business plan, expertise, profit expectations, and past financial performance.
Stewart remained the leading authority on this question for over two decades. More recently, however, two Federal Court of Appeal decisions raised new questions about when and how the pursuit-of-profit inquiry applies.
Recent Federal Court of Appeal Decisions Created Uncertainty: Brown and Paletta Estate
Since Stewart, two decisions from the Federal Court of Appeal—Canada v Paletta Estate, 2022 FCA 86, and Brown v Canada, 2022 FCA 200—have raised important questions about how the Stewart framework should be applied in practice.
In Paletta Estate, the Federal Court of Appeal emphasized the need to examine the economic substance of the taxpayer’s activity, indicating that even where an arrangement appears commercial on its face, courts must consider whether it reflects a genuine income-earning enterprise. While the decision does not explicitly reinstate the reasonable expectation of profit test, it signals a more probing inquiry into the reality of commercial activity, particularly in structured or tax-driven contexts.
In Brown, the Court went further, placing significant emphasis on whether the taxpayer was engaged in a “pursuit of profit.” The reasoning suggests that this inquiry may be relevant in all cases, rather than being confined to situations involving a personal or hobby element. To that extent, Brown introduces a degree of tension with the structured two-stage framework set out in Stewart, which confines the profit inquiry to cases where a personal element is present.
The Tax Court has acknowledged that these decisions, read together, create interpretive tension in the law. Under Stewart, an activity that is clearly commercial and devoid of personal elements will generally constitute a source of income without further inquiry into profitability. By contrast, Brown and Paletta Estate suggest that courts may apply an additional layer of scrutiny to assess whether an activity reflects a genuine pursuit of profit, even in the absence of a personal element. To the extent that such an inquiry is required, it arguably extends beyond the analytical framework articulated by the Supreme Court in Stewart.
The Tax Court Applied Both Tests and Reached the Same Conclusion
Faced with this unsettled state of the law, the Tax Court applied both the original Stewart test and the extended version articulated in Brown and Paletta Estate, in separate analyses.
In applying the original Stewart test, the Court found that ExxonMobil Canada had a source of income related to the Feasibility Study. The Feasibility Study was a purely commercial activity undertaken in relation to a proposed pipeline project. ExxonMobil Canada was in the business of resource development and held various pipeline interests. Conducting a major feasibility study on a proposed natural gas pipeline, a standard industry practice for large-scale projects, has no personal element. Under Stewart, that is the end of the analysis: a source of business income exists.
Applying the extended framework from Brown and Paletta Estate led the Court to the same conclusion. The Tax Court held that ExxonMobil Canada had an intention to pursue profit when undertaking the Feasibility Study. Evidence demonstrated that ExxonMobil Canada could reasonably expect to make a profit if the project progressed, given its experience in the pipeline business and its existing involvement in the oil and gas industry. The Court also accepted expert testimony that feasibility studies of this kind are a normal part of megaproject development in the energy sector, and that ExxonMobil Canada’s participation was a legitimate commercial step in progressing the pipeline project.
In both analyses, the Court found that ExxonMobil Canada had a source of business income related to the Feasibility Study. The CRA’s argument that no source of income existed, and therefore that no deduction was available, was rejected.
“The CRA’s position gets the law backwards. The question is not whether a project succeeded — it is whether the expenses were incurred as part of a genuine commercial undertaking. Feasibility costs on a major pipeline project are exactly the kind of expenditure the Income Tax Act contemplates as a deductible business expense.”
— David J. Rotfleisch, Canadian Tax Lawyer
Transfer Pricing Rules: Could the CRA Reduce ExxonMobil Canada’s Deduction?
Even after finding that the expenses were deductible, the Court still had to consider whether Canada’s transfer pricing rules applied to reduce or eliminate the deduction.
Canada’s transfer pricing rules apply to transactions between related corporations operating in different countries, such as a Canadian subsidiary and a foreign parent company. The rules are intended to prevent multinational corporations from shifting profits between countries in ways that reduce their overall tax burden. To achieve this, the Income Tax Act generally requires related parties to deal with each other on terms that resemble what independent parties would have agreed to in the open market.
If the CRA concludes that the terms of a transaction differ from what arm’s length parties would have agreed to, the CRA may adjust the tax consequences of the transaction. In some cases, the CRA may even disregard the transaction entirely.
In this case, the CRA advanced two alternative arguments under section 247 of the Income Tax Act. Its primary position, under paragraphs 247(2)(a) and (c), was that the terms of the arrangement between ExxonMobil U.S. and ExxonMobil Canada differed from what arm’s length parties would have agreed to, and that the deduction should therefore be reduced or eliminated. Its secondary position, under paragraphs 247(2)(b) and (d), was that arm’s length parties would never have entered into the arrangement at all and that it existed primarily to obtain a tax benefit, such that the transaction should be disregarded entirely for Canadian tax purposes.
The Tax Court rejected both arguments. The Court found that the arrangement served legitimate business purposes beyond tax planning. In particular, the structure helped limit ExxonMobil U.S.’s exposure to Canadian liability and regulatory risk while allowing ExxonMobil Canada to participate in a major commercial project connected to Canadian infrastructure.
The Court also accepted evidence that cost-sharing arrangements of this kind are common in large pipeline and energy projects. As a result, the Court concluded that the agreement was commercially reasonable and consistent with what arm’s length parties could have agreed to in similar circumstances.
Because the transfer pricing rules did not apply, ExxonMobil Canada’s deduction was upheld in full.
“Section 247 gives the CRA broad transfer pricing powers, but those powers have limits. Where a related-party arrangement has real commercial substance and reflects objectives that arm’s length parties could have agreed to, the CRA cannot simply recharacterize or disregard it because the structure also produced a tax benefit.”
— David J. Rotfleisch, Canadian Tax Lawyer
Withholding Tax: Did ExxonMobil Canada Owe Tax on Payments to Its U.S. Parent?
Part XIII of the Income Tax Act imposes withholding tax on certain payments made by Canadian residents to non-residents, including dividends, interest, royalties, and certain other amounts. “Withholding” means that the Canadian payer must deduct a portion of the payment and send, or “remit,” that amount directly to the CRA on behalf of the non-resident recipient.
The CRA argued that by paying the Feasibility Study Costs, ExxonMobil Canada’s payments effectively benefited its U.S. parent company and should therefore be treated as a deemed dividend subject to Part XIII withholding tax. According to the CRA, ExxonMobil Canada should have withheld tax from the payments and remitted that amount to the CRA.
The Tax Court rejected that argument, finding that ExxonMobil Canada incurred the Feasibility Study Costs for its own commercial benefit, not for the benefit of its U.S. parent company. ExxonMobil Canada obtained rights connected to the proposed pipeline project and retained valuable project information and data.
Because the payments were made for ExxonMobil Canada’s own business purposes, the Court concluded that no deemed dividend arose and that ExxonMobil Canada had no obligation to withhold or remit Part XIII tax.
Core Holding: Why ExxonMobil Canada Won on Deductibility, Transfer Pricing, and Withholding Tax
The Tax Court ultimately concluded that ExxonMobil Canada incurred the Feasibility Study Costs as part of a legitimate commercial undertaking carried on for business purposes. The Court also rejected the CRA’s attempt to apply Canada’s transfer pricing rules to deny the deduction and vacated the related Part XIII withholding tax assessment.
The decision is significant because it demonstrates that large-scale development and feasibility costs may still qualify as deductible business expenses even where a project never proceeds to completion. The case also provides important guidance on the limits of the CRA’s transfer pricing powers under section 247 of the Income Tax Act.
Practical Implications: What ExxonMobil Canada Means for Multinationals, Cost-Sharing Arrangements, and Future CRA Litigation
For Canadian subsidiaries of foreign multinationals, ExxonMobil Canada confirms that substantial cross-border feasibility or development costs may be deductible where the Canadian entity can show it assumed those costs for its own business purposes and prospective income-earning activity. The decision supports Canadian participation in projects tied to Canadian assets, operations, or regulatory approvals, but it is not a blanket approval for shifting foreign-parent costs into Canada. The taxpayer succeeded because it could prove a genuine Canadian business rationale, meaningful rights, and a real expectation of direct benefit.
Going forward, cross-border cost-sharing arrangements should be structured with clear commercial substance, contemporaneous documentation, and a close match between cost burden and expected benefit. Agreements should identify the rights, data, development interests, or operational advantages the Canadian entity receives and explain why it, rather than another affiliate, is the proper participant. If costs are loaded into Canada without a clear link to Canadian commercial benefit, the CRA will continue to challenge the deduction under section 247 and may also raise a withholding-tax argument.
The decision also highlights real litigation risk from the unresolved tension between Stewart, Brown, and Paletta Estate. Although the Tax Court found for the taxpayer under both approaches, that will not protect every case. Where a project is abandoned, no revenue is earned, or the commercial rationale is weakly documented, the CRA may argue both that no source of income existed under a stricter reading of Brown and that the arrangement lacked sufficient economic substance under Paletta Estate. Until appellate courts resolve that tension, source-of-income disputes in cross-border feasibility and cost-sharing cases will remain highly fact-sensitive and litigation-prone.
Pro Tax Tips: Lessons from ExxonMobil Canada for Businesses Facing CRA Scrutiny
The ExxonMobil Canada decision offers practical lessons for any Canadian business that incurs expenses connected to a foreign parent or affiliate, undertakes large commercial projects, or enters cost-sharing arrangements with non-resident related parties.
The most important lesson is documentation. The CRA scrutinized the PACA Agreement between ExxonMobil U.S. and ExxonMobil Canada, arguing the structure existed solely to generate a Canadian tax deduction. ExxonMobil Canada prevailed because evidence established clear, non-tax business reasons for the arrangement — protecting ExxonMobil U.S. from Canadian civil and regulatory jurisdiction, and securing ExxonMobil Canada’s entitlement to a potentially lucrative pipeline asset. Any Canadian business entering into an agreement with a non-resident affiliate should record those business reasons contemporaneously, not after a CRA audit begins.
Second, businesses should not assume that exploratory or feasibility-stage costs are automatically disqualified because the underlying project was never completed. The Alaska pipeline was never built, yet ExxonMobil Canada’s deduction was upheld because the Feasibility Study was a genuine commercial activity, consistent with industry practice, and connected to ExxonMobil Canada’s existing business. Companies that incur significant upfront costs on projects later abandoned should document the commercial rationale at the outset.
Finally, the unresolved tension between the Supreme Court’s decision in Stewart and the more recent Federal Court of Appeal decisions in Brown and Paletta Estate creates real litigation risk for taxpayers whose deductions are connected to commercial activities that never generated revenue. The Tax Court applied both frameworks in ExxonMobil Canada and reached the same result, but that outcome is not guaranteed in every case. Contact our experienced Canadian tax lawyers early — before the CRA’s tax audit escalates — to assess your position and protect your deduction.
Frequently Asked Questions: Deducting Feasibility Study Costs, Transfer Pricing Rules, and CRA Reassessments
What happens if the CRA disallows a deduction for expenses related to a project that ultimately failed?
The CRA may take the position that expenses are not deductible because the underlying project never generated revenue or was abandoned before completion. ExxonMobil Canada confirms that this reasoning is flawed. The relevant question is not whether the project succeeded, but whether the expenses were incurred for the purpose of earning income from a genuine commercial activity.
Where a company undertakes exploratory or feasibility-stage work that is consistent with its existing business, as ExxonMobil Canada did with the Alaska pipeline Feasibility Study, the costs can be deductible even if the project never moves forward.
Thorough documentation of the commercial rationale at the time the expenses are incurred is critical to defending the deduction. Our experienced Canadian tax lawyers can help you assess the strength of your position and represent you if the CRA challenges your claim.
We are a Canadian company that paid expenses under an agreement with our U.S. parent. The CRA is now treating those payments as a hidden dividend and assessing us for withholding tax. What are our options?
The CRA’s position may be challengeable, and ExxonMobil Canada is a good illustration of why. The CRA made exactly this argument, claiming that because ExxonMobil Canada’s payments reduced costs that might otherwise have fallen on its U.S. parent, a taxable benefit had been conferred and withholding tax was owed. The Court disagreed.
Where a Canadian company pays expenses under a legitimate commercial arrangement and receives real value in return, no taxable benefit flows to a related party simply because the arrangement exists within a corporate group. ExxonMobil Canada paid those costs in exchange for ownership rights, data rights, and the potential to earn significant pipeline revenues – benefits that were real and substantial.
If your business has received a similar assessment, contact an experienced Canadian tax lawyer to review the basis of the CRA’s position and assess your options.
We paid millions in engineering and feasibility costs for a project that never proceeded past the study phase. Can the CRA deny our deduction because there was no completed asset or revenue?
Not necessarily. In ExxonMobil Canada, the Court rejected the idea that a failed project automatically disqualifies related expenditures. Even though the Alaska pipeline was never built, the Court found the feasibility work was part of a legitimate commercial endeavour. The focus is on whether the costs were incurred in the course of a business activity intended to generate income, not on whether the project ultimately succeeded.
Our Canadian company was brought into a project primarily because most of the infrastructure would be located in Canada. Does that support deducting feasibility study costs?
Yes. In ExxonMobil Canada, the fact that the pipeline would run largely through Canada was a key contextual factor supporting the Canadian entity’s involvement. The Court accepted that ExxonMobil Canada’s participation had a real operational and regulatory purpose, including Canadian expertise and project involvement, which supported the conclusion that the feasibility costs were incurred for its own income-earning business.
We received data and technical reports from a feasibility study conducted by a foreign affiliate. Can that alone justify deducting our share of the costs?
Not by itself. However, in ExxonMobil Canada, access to project data was one of several factors supporting deductibility. The Court emphasized that ExxonMobil Canada did not just receive information—it also obtained project rights and participated in a commercial development process. The deduction was upheld because the Canadian entity had both a cost obligation and a corresponding business interest.
What documentation is most important to defend cross-border cost-sharing arrangements on audit?
Contemporaneous documentation is critical. This includes written agreements setting out commercial objectives, evidence of business rationale (such as risk allocation or operational efficiency), internal approvals, and records showing how costs and benefits were allocated. In ExxonMobil Canada, the taxpayer’s ability to demonstrate non-tax business purposes for the PACA Agreement and its alignment with industry practice was central to defeating both the transfer pricing and withholding tax arguments.
We structured a cross-border cost-sharing arrangement in a way that reduced overall tax exposure. Will the CRA automatically treat the arrangement as tax-driven and deny the deduction?
Not automatically. In ExxonMobil Canada, the CRA advanced a similar argument, claiming the arrangement should be disregarded because it was primarily designed to obtain a tax benefit. The Tax Court rejected this, emphasizing that tax efficiency alone does not invalidate a transaction where there are genuine business purposes. The Court focused on whether the arrangement had real commercial objectives and economic substance beyond tax planning.
When can Part XIII withholding tax apply to payments made between related corporations?
Part XIII withholding tax generally applies only where a payment is characterized as a dividend or similar deemed distribution to a non-resident. In ExxonMobil Canada, the CRA attempted to treat intercompany payments as a deemed dividend, but the Court rejected this because the payments were made for direct commercial benefit to the Canadian taxpayer. Withholding obligations will not arise where the payment reflects a bona fide commercial exchange and no benefit is conferred on the non-resident in its capacity as shareholder.
DISCLAIMER: This article provides broad information. It is only accurate as of the posting date. It has not been updated and may be out-of-date. It does not give legal advice and should not be relied on as tax advice. Every tax scenario is unique to its circumstances and will differ from the instances described in the article. If you have specific legal questions, you should seek the advice of a Canadian tax lawyer.
