2007 Ruling 2004-0106281R3 - Bituminous Sands Project

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Whether a bituminous sands project is a single mine and whether related depreciable property is described in Class 41?

Position: Yes, with some qualification.

Reasons: NRCan concluded that the proposed initial wells, utilizing SAGD technology, constituted a single project. Based on their opinion and our analysis, we concluded the project was a mine and, generally speaking, depreciable property acquired in connection with the project, would be included in Class 41. XXXXXXXXXX Although the XXXXXXXXXX will be property included in Class 41, it is not property that we consider is part of the extractive unit that comprises the project (it is the project that is deemed to be a single mine).

XXXXXXXXXX 							2004-010628

XXXXXXXXXX, 2007

Dear Sirs:

Re: XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
Advance Income Tax Ruling

This is in reply to your letter of XXXXXXXXXX in which you requested advance income tax rulings on behalf of the above-noted parties. We also acknowledge all additional information in connection with your requests, both in correspondence and in our various telephone conversations.

We understand that to the best of your knowledge, and that of the Applicants (as herein defined), as of the date of the initial request for the income tax rulings given herein, being XXXXXXXXXX, none of the issues contained herein:

(a) was dealt with in an earlier return of ParentCo1 or ParentCo2, or any person related thereto; or

(b) was being considered by a tax services office or taxation centre in connection with a tax return of ParentCo1 or ParentCo2, or any person related thereto; and

as of the date hereof, none of the issues contained herein:

(c) is under objection by Amalco1 or ParentCo2, or any related person;

(d) is before the courts or, if a judgement has been issued, the time limit for appeal to a higher court has not expired; or

(e) is the subject of a ruling previously considered by the Directorate.

DEFINITIONS

Except as otherwise noted, all statutory references in this letter are references to the Income Tax Act, R.S.C. 1985 (5th Supp.), c.1, as amended (sometimes herein referred to as the "Act").

1. Unless otherwise stated, the terms and expressions used herein are defined as follows:

(a) "A Lease" means XXXXXXXXXX;

(b) "Amalco1" means XXXXXXXXXX, a corporation formed by the amalgamation of ParentCo1 and SubCo1, as more particularly described in paragraph 4 below;

(c) "AMI" means an area of mutual interest, being an area approximately within a XXXXXXXXXX radius of the A Lease;

(d) "Applicants" means ParentCo1, SubCo1, JVP1, Amalco1, ParentCo2, SubCo2 and JVP2;

(e) "Application" means the Application for Commercial Approval and the Environmental Impact Assessment to XXXXXXXXXX;

(f) "B Lease" means Amalco1's XXXXXXXXXX bitumen lease(s);

(g) "BODs" means barrels of oil per day;

(h) "Central Processing Facilities" has the meaning set forth in paragraph 27(b) below;

(i) "Class 41 Property" means depreciable property of Class 41 of Schedule II of the Regulations;

(j) "XXXXXXXXXX Agreement" means the agreement described in paragraph 15 below;

(k) "Crown" means Her Majesty in right of the Province of XXXXXXXXXX;

(l) XXXXXXXXXX;

(m) XXXXXXXXXX;

(n) "Initial Well Pairings" has the meaning set forth in paragraph 27(a) below;

(o) "Injection Well" means the upper well of a SAGD well pair;

(p) "Joint Venture" means the joint venture of Amalco1 (as a successor/owner, by amalgamation and assignment) and ParentCo2 (as a successor/owner by assignment), pursuant to the MOU and the XXXXXXXXXX Agreement, as the case may be, for the development of certain bitumen leases XXXXXXXXXX;

(q) "JVP1" means XXXXXXXXXX partnership of ParentCo1 and SubCo1;

(r) "JVP2" means XXXXXXXXXX, a partnership of ParentCo2 and SubCo2;

(s) "Location" means an area encompassing, XXXXXXXXXX;

(t) "MOU" means a memorandum of understanding dated XXXXXXXXXX between JVP1 and ParentCo2;

(u) "ParentCo1" means XXXXXXXXXX, a predecessor of Amalco1, as more particularly described in paragraphs 2 and 4 below;

(v) "ParentCo2" means XXXXXXXXXX;

(w) "Pilot Facilities" has the meaning set forth in paragraph 24;

(x) "Pilot Wells" has the meaning set forth in paragraph 24;

(y) "Production Well" means the lower well of a SAGD well pair;

(z) XXXXXXXXXX;

(aa) "public corporation" has the meaning assigned by subsection 89(1);

(ab) "Replacement Well Pairings" has the meaning set forth in paragraph 27(a) below;

(ac) "Regulations" means the Income Tax Regulations promulgated under the Act;

(ad) "SAGD" means steam assisted gravity drainage recovery technology;

(ae) "SAGD Facilities" has the meaning set forth in paragraphs 27 through 28 below;

(af) "SubCo1" means XXXXXXXXXX;

(ag) "SubCo1A" means XXXXXXXXX;

(ah) "SubCo2" means XXXXXXXXXX;

(ai) "taxable Canadian corporation" has the meaning assigned by subsection 89(1);

(aj) "Technology" means XXXXXXXXXX;

(ak) "Undertaking" means the XXXXXXXXXX Project described, in part, in paragraphs 10 and 11 below;

(al) XXXXXXXXXX, and

(am) "Zco" means XXXXXXXXXX.

FACTS

The Parties

2. At all relevant times prior to XXXXXXXXXX, ParentCo1 was a taxable Canadian corporation and a public corporation that subsisted under the laws of XXXXXXXXXX and filed its annual income tax returns at the XXXXXXXXXX Tax Centre. SubCo1 was a wholly-owned subsidiary of ParentCo1 that was governed by the laws of XXXXXXXXXX and, on XXXXXXXXXX, was continued as a XXXXXXXXXX corporation. At all relevant times, SubCo1 was a taxable Canadian corporation that filed its income tax returns at the XXXXXXXXXX Tax Centre.

3. Prior to XXXXXXXXXX 2004, ParentCo1 and SubCo1 carried on business through a partnership, JVP1, which subsisted under the laws of XXXXXXXXXX. ParentCo1 and SubCo1 held XXXXXXXXXX% and XXXXXXXXXX% partnership interests, respectively, in JVP1. On XXXXXXXXXX, SubCo1A, a corporation governed by the laws of XXXXXXXXXX, acquired a XXXXXXXXXX% interest in JVP1 from ParentCo1, reducing ParentCo1's interest in JVP1 to XXXXXXXXXX%. Immediately following that acquisition, and still on XXXXXXXXXX, JVP1 transferred its interest in the Undertaking to SubCo1.

4. Amalco1 was formed on XXXXXXXXXX by the amalgamation of ParentCo1 and SubCo1. As a result of the amalgamation, Amalco1 became the beneficial owner of the interest in the Undertaking of SubCo1. Amalco1 subsists under the laws of XXXXXXXXXX and is a taxable Canadian corporation and a public corporation that files it annual income tax return at the XXXXXXXXXX Tax Centre.

5. ParentCo2 is a taxable Canadian corporation and a public corporation which subsists under the laws of XXXXXXXXXX. ParentCo2 files its annual income tax return at the XXXXXXXXXX Tax Centre.

6. SubCo2 is a taxable Canadian corporation that is a wholly-owned subsidiary of ParentCo2 that subsists under the laws of XXXXXXXXXX. SubCo2 files its annual income tax return at the XXXXXXXXXX Taxation Centre.

7. ParentCo2 and SubCo2 carry on business through a limited partnership that subsists under the laws of XXXXXXXXXX, being JVP2. ParentCo2 and SubCo2 hold XXXXXXXXXX% and XXXXXXXXXX% partnership interests, respectively, in JVP2. SubCo2 is the general partner of JVP2.

8. On XXXXXXXXXX ParentCo2 transferred its interest in the Undertaking to JVP2. At the same time, JVP2 assumed the role of XXXXXXXXXX operator from ParentCo2 (see paragraph 18 below).

9. Each of Amalco1 (as successor to SubCo1, an assignee of JVP1) and JVP2 (by assignment from ParentCo2) is actively pursuing a strategy of increasing bitumen production XXXXXXXXXX.

The Joint Venture

10. The Undertaking is located approximately XXXXXXXXXX on the A Lease.

11. The Undertaking involves in-situ bitumen recovery using SAGD recovery technology XXXXXXXXXX.

12. JVP1 and ParentCo2 entered into a MOU whereby, among other matters, they agreed to the Joint Venture. XXXXXXXXXX

XXXXXXXXXX.

13. XXXXXXXXXX.

14. XXXXXXXXXX. In addition, there is to be a sharing of technical expertise through XXXXXXXXXX technical teams and one management team jointly staffed by both parties.

15. On XXXXXXXXXX, ParentCo2 and JVP1 entered into a XXXXXXXXXX agreement (the "XXXXXXXXXX Agreement") that was based on the MOU and relevant industry standard agreements.

16. The XXXXXXXXXX Agreement provides for the development, construction, ownership and operation of the Undertaking and was entered into for the purposes of documenting:

(a) the terms upon which JVP1 and ParentCo2 will proceed with the Undertaking and their respective Undertaking interests;

(b) the terms upon which the Undertaking will be constructed and operated;

(c) the terms upon which each of JVP1 and ParentCo2 will be responsible for and pay for its respective share of the joint Undertaking costs; and

(d) the terms upon which the share of SAGD production volumes, XXXXXXXXXX products and surplus electricity will be allocated and distributed to each of JVP1 and ParentCo2.

17. Under the XXXXXXXXXX Agreement, JVP1 and ParentCo2 are to each own an undivided interest in the Undertaking and each party will be entitled to process its entire share of the SAGD production from the Undertaking at the XXXXXXXXXX jointly owned by them. Currently, each of Amalco1 (as successor to SubCo1, an assignee of JVP1) and JVP2 (as an assignee of ParentCo2) owns a 50% interest in the Undertaking.

18. XXXXXXXXXX.

The Undertaking

The A Lease and Deposit

19. The A Lease has recoverable reserves and resources of up to approximately XXXXXXXXXX barrels of bitumen.

20. XXXXXXXXXX.

21. All of the bitumen recovered will be from the same deposit, being the XXXXXXXXXX. In addition, all of the hydrocarbons/bitumen recovered by Amalco1 and JVP2 will be from a deposit of "bituminous sands", as that term is defined in subsection 248(1), including that the hydrocarbons recovered will satisfy the viscosity and density requirements determined in accordance with section 1107 of the Regulations.

Bitumen Recovery Facilities

22. The Undertaking consists of XXXXXXXXXX the extraction and processing of bitumen. XXXXXXXXXX

23. Bitumen will be extracted by well from a deposit of bituminous sands by way of in-situ technology, being the SAGD process.

24. A SAGD pilot was developed in order to confirm, demonstrate and optimize the application of SAGD technology at the Undertaking. The SAGD pilot consists of a XXXXXXXXXX BODs facility XXXXXXXXXX and SAGD Facilities site, and includes steam generation, water treatment and handling facilities and oil treatment (the Pilot Facilities"). The SAGD pilot also includes XXXXXXXXXX well pairs (the "Pilot Wells"). In XXXXXXXXXX the construction of the Pilot Facilities was completed and steam injection commenced on all of the Pilot Wells. Operation of the SAGD pilot ceased in XXXXXXXXXX to allow for integration into the Central Processing Facilities. The Pilot Wells will be tied into the Central Processing Facilities and the steam generation and the water treatment components of the Pilot Facilities will be integrated with the Central Processing Facilities. The steam generation component will provide injection steam for the Pilot Wells and other Initial Well Pairings. The water treatment component will retrieve and treat water used in the steam generation component. All product generated from the utilization of the steam generation component and the water treatment component, including product from the Pilot Wells, will be directed to the Central Processing Facilities. The oil treatment component of the Pilot Facilities will be disconnected but may be utilized in the future, as needed, to treat waste and slop oil if significant amounts begin to be produced from the Central Processing Facilities. Otherwise, reasonable amounts of such waste and slop oil are to be transported by trucks for treatment by third parties.

25. The SAGD process involves the movement of bitumen to the Production Wells by utilizing gravity and steam. Under the SAGD process, pairs of horizontal wells, or well pairs are drilled into the oil sands. In the Injection Wells, steam is introduced near the bottom of the reservoir. As the steam begins to rise in the formation, the heated bitumen falls to the bottom of the reservoir and is drained by gravity to the Production Wells. The bitumen is then extracted to the surface and the space caused by the removal of the bitumen is filled with steam, thereby providing constant gravity drainage.

26. During the start-up, the reservoir is heated by circulating steam in both the Injection Wells and the Production Wells for a period of XXXXXXXXXX months. This extensive heat allows the bitumen to flow towards the Production Wells.

27. The Application outlines the key SAGD components ( the "SAGD Facilities") that, together with related machinery and equipment, will be required in the bitumen recovery process.

(a) It is anticipated that there will be XXXXXXXXXX producing well pads with XXXXXXXXXX well pairings per well pad. It is currently estimated that there will initially be XXXXXXXXXX injection and production well pairings (the "Initial Well Pairings") in addition to the Pilot Wells. Both the Initial Well Pairings and the Pilot Wells will be located near the Central Processing Facilities XXXXXXXXXX site and it is anticipated that those wells will be utilized to recover approximately XXXXXXXXXX BODs of bitumen at full production. Additional well pads and well pairings (the "Replacement Well Pairings") will be drilled XXXXXXXXXX, as more particularly described in paragraph 38 below, to maintain bitumen recovery as such recovery begins to decline in the Pilot Wells, the Initial Well Pairings and/or from Replacement Well Pairings themselves.

Production Well fluids, consisting of bitumen, produced water, produced gas, lift gas and steam, are gathered from the wells at each well pad. The produced fluids are separated into liquid and vapour phases by separators located at each well pad and sent to the Central Processing Facilities for further separation.

(b) The Central Processing Facilities are made up of several units, consisting of a production separation and treating unit, a water de-oiling unit, a water treatment unit, a produced gas handling unit, and a steam generation unit. It also includes supporting utility systems, tankage and support buildings. The Central Processing Facilities will produce a diluted bitumen stream that is sent to the XXXXXXXXXX.

(c) Underground wells and connecting pipelines will supply makeup water for use in the SAGD process XXXXXXXXXX. In addition, underground wells will be used for the disposal of water.

28. In addition to the components forming part of the Central Processing Facilities, the Undertaking will include cogeneration facilities, together with related machinery and equipment, owned by the Joint Venture participants that will produce all of the power required for the SAGD Facilities and for XXXXXXXXXX. The cogeneration facilities will also produce approximately XXXXXXXXXX of the steam required for the SAGD well pads. Any excess power after consumption in the bitumen production and XXXXXXXXXX processes will be sold into the XXXXXXXXXX power grid.

29. XXXXXXXXXX. As well, there will be a requirement to build a XXXXXXXXXX kilometre access road and a XXXXXXXXXX kilometre gas supply flow line. The access road will be built by the Joint Venture and the gas supply flow line will be built and owned by third parties. Certain facilities, including a finished product pipeline, a railway spur line and electrical power supply to the Undertaking, will be constructed and owned by third parties.

Description of the XXXXXXXXXX

30. The Application also outlines the XXXXXXXXXX components that will be required to process bitumen produced in the Undertaking.

31. The XXXXXXXXXX will be comprised of various units that, together with related machinery and equipment, will be utilized in bitumen XXXXXXXXXX and processing, which consists of separating, purifying, and converting bitumen feedstock into an equivalent crude oil stage, in this case being a XXXXXXXXXX crude oil. Set forth below is a list of XXXXXXXXXX, along with a brief description of the function that each unit will be performing in the bitumen XXXXXXXXXX process.

XXXXXXXXXX.

32. XXXXXXXXXX.

Planned Implementation

33. The Undertaking involves drilling wells and utilizing the SAGD technology to extract bitumen feedstock. As indicated above, in the initial development area the Initial Well Pairings and the Pilot Wells will be drilled and the relevant facilities will be constructed to produce approximately XXXXXXXXXX BODs of bitumen production.

34. The Joint Venture commenced construction of the SAGD Facilities in XXXXXXXXXX. Steaming of the SAGD wells will commence in XXXXXXXXXX and SAGD production will commence shortly thereafter. It is expected that full SAGD production of approximately XXXXXXXXXX BODs of bitumen feedstock will be achieved by XXXXXXXXXX when the XXXXXXXXXX will be processing/XXXXXXXXXX the bitumen feedstock into approximately XXXXXXXXXX BODs of XXXXXXXXXX crude oil. The Undertaking's commercial life is XXXXXXXXXX years.

35. The design for the XXXXXXXXXX requires that it be running at no less than XXXXXXXXXX% capacity. It is expected that, during XXXXXXXXXX, the XXXXXXXXXX will undergo a program of rigorous testing and, by XXXXXXXXXX, it is expected that the XXXXXXXXXX will have commenced operations. At that time there should be enough bitumen production from the SAGD operations to enable an efficient start-up.

36. Amalco1 and JVP2 anticipate selling some portion of the bitumen production from the A Lease into the open market until such time as the XXXXXXXXXX can handle the full feedstock capacity. In addition, it is possible that from time to time actual bitumen production from the A Lease could exceed the capacity of the XXXXXXXXXX or bitumen may continue to be produced during a period of time when the XXXXXXXXXX is shut down for maintenance. In these cases, the excess production will be sold into the open market.

37. It is possible that for short periods of time, bitumen production from the Undertaking could fall short of the XXXXXXXXXX processing capacity and, for that period, small amounts of additional bitumen could be purchased from third parties for use as feedstock for the XXXXXXXXXX. Otherwise, during the life of the Undertaking it is not anticipated that there will be processing of bitumen that is either owned by or purchased from third parties.

38. The Undertaking also involves the drilling of the Replacement Well Pairings in an expansion area to replace feedstock depleted from other wells in order to maintain bitumen production of XXXXXXXXXX BODs.

PROPOSED TRANSACTIONS

39. The Applicants propose to complete the development of the Undertaking, including the construction of the SAGD Facilities and XXXXXXXXXX, in the manner referred to in paragraphs 22 to 38.

PURPOSE OF THE PROPOSED TRANSACTIONS

40. The purpose of the proposed transactions is to enable the Applicants to develop an XXXXXXXXXX oil production and processing facility for the purpose of pursuing their respective goals XXXXXXXXXX.

RULINGS

Provided the foregoing statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions, additional information and purposes of the proposed transactions, and provided that the proposed transactions are completed in the manner described above, we confirm the following:

A. All of the Initial Well Pairings and, following their integration with the Central Processing Facilities as described in paragraph 24 above, the Pilot Wells, jointly acquired and owned by the Applicants for the extraction of material from the deposit of bituminous sands included in the A Lease will constitute one project and, pursuant to paragraph 1104(7)(c) of the Regulations and for the purposes, inter alia, of Class 41, are deemed to be one mine of the Applicants.

B. Depreciable property of a particular Applicant acquired after XXXXXXXXXX that is described in any of paragraphs 27, 28 and 31 hereof, that is part of the SAGD Facilities, the cogeneration facilities and/or the XXXXXXXXXX and that,

(i) but for Class 41, would be included in Class 10 because of paragraph (g), (k) or (l) of Class 10, or

(ii) would be included in Class 41 because of subsection 1102(9) of the Regulations and no election has been made to include the particular property in Class 43.1 or 43.2,

will be property described in paragraph (a) of Class 41, provided that

(iii) the mine referred to in Ruling A above comes into production in reasonable commercial quantities;

(iv) the property is acquired by the particular Applicant before the mine comes into production, within the meaning of subsection 1104(8.1) of the Regulations; and

(v) the property has not, before it is acquired by the particular Applicant, been used for any purpose whatever by any person with whom the Applicant was not dealing at arm's length.

C. Paragraph 1100(1)(y) of the Regulations will apply to a particular Applicant in respect of property to which Ruling B above applies and for which a separate class is prescribed by subsection 1101(4c) of the Regulations. Provided that substantially all of the material processed by the particular Applicant is from a deposit of bituminous sands or oil shales owned by the Applicant, all of the income of that Applicant that is reasonably attributable to processing by the Applicant of material from any deposit of bituminous sands or oil shales will be included in the Applicant's income from the mine for the purposes of paragraph 1100(1)(y) of the Regulations. Otherwise, only the income of the Applicant that is reasonably attributable to processing by the Applicant of material from a deposit of bituminous sands or oil shales owned by the Applicant will be included in the Applicant's income from the mine for the purposes of paragraph 1100(1)(y) of the Regulations.

The above rulings are given subject to the general limitations and qualifications set forth in Information Circular 70-6R5 issued by the Canada Revenue Agency on May 17, 2002 and are binding on the Canada Revenue Agency, provided that the program for rigorous testing of the XXXXXXXXXX referred to in paragraph 35 has commenced on or before XXXXXXXXXX.

The rulings are based on the Act in its present form and do not take into account the effect of any proposed amendments thereto.

COMMENTS

Although we received, for review, certain documents relating to the proposed transaction, our rulings are based solely on the representations contained in paragraphs 2 to 39 above.

Except as expressly stated, our rulings do not imply acceptance, approval or confirmation of any income tax implication of the facts or proposed transaction. In particular, nothing in this letter should be interpreted as confirming, either expressly or implicitly:

A. the reasonableness of any expenditures referred to in this letter;

B. the deductibility of any expenditures referred to in this letter, other than as described in the rulings given;

C. the determination of the fair market value or the capital cost of any property referred to in this letter;

D. that the Replacement Well Pairings referred to in paragraph 27(a), any additional phase of the Undertaking, or any proposed expansion of the Undertaking to increase the capacity of the SAGD Facilities beyond XXXXXXXXXX BODs will be part of the mine determined in Ruling A hereof;

E. the prescribed class in Schedule II to which any property belongs that was property in existence and in use before the request was made for the income tax rulings herein, including any property that is part of the Pilot Wells or the Pilot Facilities; or

F. that any other specific property that is a depreciable property, such as any particular pipeline or flowline, will be a property described in paragraph (a) of Class 41.

Yours truly,

for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch