10 July 2001 Internal T.I. 2000-0034987 - Class. of Pipelines and Appendage Equip.

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: (a) Which Classes in Schedule II of the Regulations pipelines should be included into? (b) Which Classes in Schedule II of the Regulations pipeline appendage equipment should be included into?

Position: (a) Pipelines could be included in Class 1, 2, 8, 10 or 41 in Schedule II of the Regulations, depending on the facts of the circumstance. (b) Pipeline appendage equipment could be included in Class 1, 2, 8, 10 or 41 in Schedule II of the Regulations, depending on the facts of the circumstance. In case of linefill, it would be excluded from property in any Class of Schedule II of the Regulations.

Reasons:

(a) The reference to pipelines in the Act may refer to the pipelines of general use (e.g., see paragraph (l) in Class 1 of Schedule II under the Regulations) and the reference to gas or oil pipelines may includes flow lines, gathering lines, main or trunk lines, and transmission lines. Therefore, a pipeline could be included as asset of Class 1, 2, 8, 10 or 41, depending on the facts of the circumstance. If a pipeline is considered as "gas or oil well equipment", it would be included in Class 10(j) or Class 41(b), as the case may be. If a pipeline is considered as primarily used in "Canadian field processing" (i.e., assuming it would otherwise be included in Class 8), it would be included in Class 41(c) or (d). A pipeline which is not considered as "gas or oil well equipment" nor primarily used in "Canadian field processing", would be included in Class 1(l) or Class 2(b), as the case may be, provided the main source of supply for the pipeline would not be exhausted within 15 years. Otherwise, such pipeline would be included in Class 8(i).

(b) If the pipeline appendage equipment is considered as an integral part of a pipeline, such appendage equipment would be included in the same Class as that of the pipeline. If the pipeline appendage equipment is linefill, it would be excluded from property of any Class in Schedule II of the Regulations by virtue of paragraph 1102(1)(k) of the Regulations. If the pipeline appendage equipment is considered as "gas or oil well equipment", it would be included in Class 10(j) or Class 41(b), as the case may be. If the pipeline appendage equipment is considered as primarily used in "Canadian field processing", it would be included in Class 41(c) or (d). If the pipeline appendage equipment is considered as primarily used in transmission or distribution of natural gas, it would be included in Class 1(n) or Class 2(d), as the case may be. (This position reverses our position as stated in file #971864, wherein pipeline appendage equipment primarily used for transmission of natural gas was considered as Class 8 asset.) Oil pipeline appendage equipment which is not "gas or oil well equipment" nor primarily used in "Canadian field processing" would be included in Class 8(i).

July 10, 2001

	Audit Directorate	Resource Industries Section
	Large Business Audit Division	Peter Lee
	Industry Specialist Services	957-8977

	Attention:   R.C. Neville
	                Coordinator, Resource Industries  
		2000-003498

Classification of Pipelines and Appendage Equipment

This is in reply to your memorandum of June 29, 2000, wherein you have requested our views on the classification of various types of pipelines. This is also in reply to the request of Ms. Catherine Bowen of Technical Publications and Projects Section for our comments in respect of the suggestions and recommendations provided to her by the Oil and Gas Specialists in their memoranda of November 3, 2000 and June 14, 2001 regarding the proposed revision to Interpretation Bulletin IT-476. In particular, she has asked us whether we would agree with the Specialists' view that the pipeline appendage equipment, such as compressors, metering equipment, etc., are part of the pipeline and therefore would be considered as Class 2 (now Class 1) assets in the Schedule II of the Income Tax Regulations (the "Regulations").

Legislation

1. Pursuant to subsection 1104(2) of the Regulations, the expression "gas or oil well equipment" is defined as follows:

"gas or oil well equipment" includes

(a) equipment, structures and pipelines, other than a well casing, acquired to be used in a gas or oil field in the production therefrom of natural gas or crude oil, and

(b) a pipeline acquired to be used solely for transmitting gas to a natural gas processing plant,

but does not include

(c) equipment or structures acquired for the refining of oil or the processing of natural gas including the separation therefrom of liquid hydrocarbons, sulphur or other joint products or by-products, or

(d) a pipeline for removal or for collection for immediate removal of natural gas or crude oil from a gas or oil field except a pipeline referred to in paragraph (b);

2. Pursuant to Class 1 in Schedule II of the Regulations, property of this class includes property not included in any other class that is

... (l) a pipeline, other than gas or well equipment, unless, in the case of a pipeline for oil or natural gas, the Minister, in consultation with the Minister of Energy, Mines and Resources, is or has been satisfied that the main source of supply for the pipeline is or was likely to be exhausted within 15 years after the date on which operation of the pipeline commenced...

... (n) manufacturing and distributing equipment and plant (including structures) acquired primarily for the production or distribution of gas, except

(i) a property acquired for the purpose of producing or distributing gas that is normally distributed in portable containers,
(ii) a property acquired for the purpose of processing natural gas, before the delivery of such gas to a distribution system, or
(iii) a property acquired for the purpose of producing oxygen or nitrogen;...

3. Pursuant to Class 8 in Schedule II of the Regulations, property of this class includes property not included in Class 1, 2, 7, 9, 11 or 30 that is

... (i) a tangible capital property that is not included in another class in this Schedule except... an oil or gas well... a specified temporary access road of the taxpayer...

4. Pursuant to Class 10 in Schedule II of the Regulations, property of this class includes property (other than property included in Class 41 or property included in Class 43 that is described in paragraph (b) of that Class) that would otherwise be included in another Class in this Schedule, that is

... (j) gas or oil well equipment...

5. Pursuant to Class 41 in Schedule II of the Regulations, property of this class includes property

... (b) that is property... described in paragraph... (j)... of Class 10 that would be included in that Class if this Schedule were read without reference to this paragraph... and that was acquired after 1987...

... (c) acquired by the taxpayer after May 8, 1972, to be used directly or indirectly by the taxpayer in Canada primarily in Canadian field processing, where the property would be included in Class 29...

Your Views

6. It is stated in your November 3 memorandum as follows:

In our view, the jurisprudence supports the position that compressors, metering equipment etc. are a part of the pipeline...

Similarly, it is stated in your June 14 memorandum as follows:

Based on the Court decision in Pacific Northern Gas Ltd. [90DTC6252], the appendages are considered part of the pipeline... Also, we would suggest that IT-482 either be revised or withdrawn.

7. It is stated in your June 29 memorandum as follows:

... the only logical approach available was to consider sweet gas and sour gas separately apply the provisions of paragraphs 1104(2)(d) and (b) to the two streams of gas respectively. The rationale for this approach was that for sweet gas the only processing required for acceptance by the common carrier was field dehydration to remove water and separation to remove sediments. A pipeline from the field facility (whether it transmits gas to other lines before the gas enters the trunk line or a line that connects directly to the trunk line) is considered to be excluded by paragraph (d). Sour gas needs to be processed at a gas plant to remove sulphur before it can be accepted by a common carrier and therefore pipeline to transmit sour gas to a processing plant is included in gas or oil well equipment under paragraph (b).

The law does not specifically provide for a distinction between sweet and sour gas. It is interesting to note the wording in paragraph (d) particularly ".... for removal or for collection for immediate removal...". These words would suggest that the gathering lines are to be excluded from the definition of gas or oil well equipment and only the line which directly connects to the gas processing plant is included in (b)... this scenario does not make sense in terms of the sequence of stages through which the gas goes before it enters the trunk line. Gathering lines (whether before field separation or after) are situated before the pipeline used to transmit gas to a natural gas processing plant. Therefore there does not appear to be any rationale to exclude the gathering lines from the definition of gas or oil well equipment.

It should be noted that whether the gas is sweet or sour, generally field separation is done to remove sediments and free water. It would appear that the legislation does not cater for this stage of the gas cycle.

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Our Comments

Pipeline Appendage Equipment

8. In concluding that certain assets attached to a building would be considered as an integral part of the building in the case of British Columbia Forest Products Limited, 71 DTC 5178 (SCC), Martland, J. commented for the Court as follows:

The supporting piers, the reinforced concrete foundations and the chest walls are seen, on an examination of the plans and photographs filed as exhibits, to have no separate existence as tangible capital assets. It is true that they would not have been created except to provide the means for the appellant's production flow, and the mill building was designed specially to achieve that purpose. Nonetheless, the tangible capital asset is the building itself, including everything which is a part of that building, and, as a building, it falls within Class 3. What has been said about the example cited applies equally to the other disputed assets in that building... mezzanine floor... stairways and accompanying handrails... steel "I" beams and some of the supporting columns...

9. In concluding that certain pipes and valves used in conjunction with the compressor stations along a natural gas pipeline would not constitute "pipelines" for the purpose of paragraph (b) of Class 2, Urie, J. commented for the majority of the Court in the case of Nova, An Alberta Corporation, 88 DTC 6386 (FCA), as follows:

Clause (b) relates to pipelines without reference to what is transmitted through them be it gas, oil, water, steam or solids. I would have thought that in construing it in its "popular sense" would mean that sense "which people conversant with the subject matter with which the statute is dealing [in this case those utilizing the service of the pipeline for the transmission of gas, oil, water, steam or solids] would attribute to it" not the popular sense derived from the perception of the man in the street not conversant with either the user industries or pipelines. Even if it were, I find it difficult to conceive that such a man would view a compressor station or metering facilities as part of a pipeline in its most fundamental sense.

The above-noted comments of Urie, J. were quoted with approval in the case of Gulf Canada Resources, 95 DTC 5189 (FCTD), in deciding that the water intake pipe used by the taxpayer for its oil refinery would constitute a pipeline for the purpose of paragraph (b) of Class 2.

10. The case of Pacific Northern Gas Limited, 91 DTC 5287 (FCA), dealt with the issue of whether the compression equipment used to maintain pressure in the natural gas pipelines would be considered as Class 2 assets ("manufacturing and distributing equipment and plant (including structures) acquired primarily for the production or distribution of gas... ") or Class 8 assets (machinery or equipment not included in Class 2). Joyal, J. concluded for the Court (Trial Division) in this case that the compression equipment should be considered as Class 2 assets, relying on the reasoning of the Federal Court of Appeal in the case of Northern and Central Gas Corporation Limited, 87 DTC 5439 (FCA), which was preferred to the reasoning subsequently given in the case of Nova, an Alberta Corporation, 88 DTC 6386 (FCA). The Federal Court of Appeal agreed with Joyal, J.'s conclusion and upheld this lower Court decision. Joyal, J. also commented for the Court in this case as follows:

On balance, I find I must favour the approach taken in the Northern and Central case.

In my view, Class 2(b) sets the leitmotif for a proper appraisal of the meaning ascribable to the subsequent paragraphs in that class. Class 2(b) speaks of pipelines which include, of course, a natural gas pipeline and provides for it a depreciation rate of six percent. Class 2(d) speaks of equipment primarily acquired for the production or distribution of gas. I should find in that respect

natural gas being ordinarily moved or distributed by pipeline, compression stations are part of its appendage. This would indicate to me a legislative intention to place both the pipeline and its equipment in the same class. It would also indicate to me that by referring in the regulation to the two functions of "production" and "distribution" in paragraph (d), by excluding other property in sub-paragraphs (i), (ii) and (iii) and specifically, by excluding processing equipment before delivery to a distribution system, the legislative intent was to place in Class 2 all pipeline equipment whether used in the production of gas, the transmission of gas or the distribution of gas.

In that sense, the concept of transmission or distribution, for purposes of the enactment, could be said to be interchangeable or co-extensive; the reality of any pipeline system is that the process of transmission involves distribution and the process of distribution involves transmission, the whole notwithstanding the prescriptive norms otherwise applicable in the natural gas industry.

We note that in this case, the Court considered the compression stations and the equipment thereof as a part of the pipeline appendage, and presumably not as an integral part of the pipeline. As a result, the Court never considered whether the compression stations and the equipment thereof would constitute a part of the pipeline for the purpose of paragraph (b) of Class 2. This is consistent with the above-noted comments in the cases of Nova and British Columbia Forest Products.

11. Based upon the above-noted jurisprudence and given that the compression stations and metering facilities and the equipment thereof would arguably be considered to have separate existence as tangible capital assets, it is our view that they should not be considered as a natural gas pipeline or an integral part of the pipeline for the purpose of paragraph (b) of Class 2 (now paragraph (l) of Class 1). However, they should be included in Class 2 by virtue of paragraph (d) thereof (now paragraph (n) of Class 1). On the other hand, it is also our view that this paragraph (d) would not apply to oil pipeline appendage equipment because the paragraph only relates to production, transmission and distribution of gas and not oil.

12. By analogy to the cases of Pacific Northern Gas and Northern and Central Gas, our comments in 11 above would remain the same whether the pipeline appendage equipment are used in the transmission or distribution of gas, or whether such transmission or distribution is done for oneself or for a third party. Reed J. commented for the Court in the case of Northern and Central Gas Corporation Limited, 85 DTC 5144 (FCTD), as follows:

It is clear that Class 2 of Schedule B as a whole does not just relate to the natural gas industry. It relates to the production and distribution of electricity, heat and water as well as to the gas industry generally, not merely that involved with the production and distribution of natural gas. Sub-paragraph (b) is even more general, referring to pipelines without reference to the commodity they carry. Accordingly, it is difficult to conclude that the word "distribution" insub-paragraph (d) was chosen with the specific usage of the natural gas industry in mind. Rather, it seems clear that the sub-paragraphs of Class 2 were intended to encompass the whole process from the production (or manufacture) of the gas (electricity energy, water or heat) to its ultimate distribution to customers (with some specific exceptions). I think it would do violence to the word distribution as used in Class 2, if one interpreted it as encompassing only the end use distribution system, as contended by the Plaintiff. Such interpretation would bring within the scope of sub-paragraph (d) gas production facilities and end use distribution facilities but not the intermediate transmission facilities.

On the other hand, by analogy to the majority decision in the case of Will-Kare Paving & Contracting Limited, 2000 DTC 6467 (SCC), one might argue that the generally accepted legal and industry meaning of "transmission" and "distribution" for the natural gas industry should be used. However, it is our view that the case at hand can be differentiated from the case of Will-Kare Paving & Contracting in that Class 2 (now Class 1) as a whole does not just relate to a specified industry, but it relates to production and distribution of electricity, heat, water and natural gas.

13. Further to 11 above, with respect to an oil pipeline appendage equipment, it is our view that it would be classified as Class 8 asset by virtue of paragraph (i) thereof, provided that it would not be considered as an integral part of an oil pipeline, a gas or oil well equipment, or to be primarily used in Canadian field processing.

14. It is our understanding that Finance may not proceed to enact the following draft definition of "pipeline" under subsection 1104(2) of the Regulations:

"pipeline" includes compression and pumping equipment, control and monitoring devices, valves and other equipment pertaining thereto but does not include linefill;

However, paragraph 1102(1)(k) of the Regulations was enacted to exclude linefill in a pipeline from classes of property described in Schedule II of the Regulations. As a result, the above-noted jurisprudence will continue to apply to the pipeline appendage equipment.

15. We note that our above-noted comments in respect of the pipeline appendage equipment and linefill may not be consistent with Interpretation Bulletin IT-482 of November 30, 1981 and its Special Release. As a result, we agree with the Specialists that this Bulletin should be updated as soon as possible and that this Bulletin should not be referred to in the revision to Interpretation Bulletin IT-476 until such an update is made.

Pipelines

16. Under the Internal Revenue Code (the "IRC"), pipelines used for the oil and gas industry can be classified into (a) flow line (carrying gas or oil well fluids from wellheads to lease separator(s); (b) gathering line (carrying gas or oil from separators to central accumulation points); (c) main or trunk line (carrying gas or oil from accumulation point to gas plant); and (d) transmission line (carrying gas, oil, or products to refineries and chemical plants). Furthermore, pipelines may be included in different classifications due to the different businesses of the taxpayers. Unlike the provisions in respect of pipelines under the IRC, the reference to pipelines in the Act may refer to the pipelines of general use (e.g., see paragraph (l) in Class 1 of Schedule II under the Regulations) and the reference to gas or oil pipelines may includes flow lines, gathering lines, main or trunk lines, and transmission lines. A pipeline could be included as asset of Class 1, 2, 8, 10 or 41, depending on the facts of the circumstance. Furthermore, we also note that unlike the above-noted IRC meaning of "gathering lines", the reference to "gathering lines" by the Specialists in the Canadian context refer to pipelines that carry gas or oil well fluids from wellheads to field separator(s).

17. By virtue of paragraph 1104(2)(a) of the Regulations, pipelines which are acquired to be used in a gas or oil field in the production therefrom of natural gas or crude oil would be considered as gas or oil well equipment and therefore would be Class 10(j) or Class 41(b) assets, as the case may be. By analogy to the case of Texaco Exploration Company, 75 DTC 5288 (FCTD), it is our view that production of natural gas or crude oil from a gas or oil field would be considered to cease at the wellhead, i.e., at the upstream side of any separator, be it a field separator or an inlet separator in a gas plant. In other words, those pipelines used to carry gas or oil well substances from wellheads to separator(s) (i.e., including gathering lines to the battery of separators) would be considered as gas or oil well equipment and therefore would be Class 10(j) or Class 41(b) assets, as the case may be. These pipelines would not be precluded from gas or oil well equipment by virtue of paragraph 1104(2)(d) of the Regulations because they would not be considered as pipelines "for removal or for collection for immediate removal of natural gas or crude oil from a gas or oil field" before the field separation.

18. By virtue of paragraph 1104(2)(b) of the Regulations, pipelines which are acquired to be used solely for transmitting gas to a natural gas processing plant would be considered as gas or oil well equipment and therefore would be Class 10(j) or Class 41(b) assets, as the case may be. However, by virtue of paragraph 1104(2)(d) of the Regulations, pipelines which are used to transmit oil to an oil processing plant (i.e., refinery) from separators, or pipelines which are used to transmit gas beyond the separators but are not solely used for transmitting gas to a natural gas processing plant, would not be considered as gas or oil well equipment. As a result, for natural gas which would not require further processing at a gas processing plant, the pipelines used to transmit such natural gas after the point of the separator would not be considered as gas or oil well equipment. But, on the other hand, the pipelines that transmit natural gas, either sweet gas or sour gas, which would require further processing at a gas processing plant (i.e., not including a straddle plant) in order to extract natural gas liquids, condensate, water vapour, hydrogen sulphide, carbon dioxide, nitrogen, or a combination of these substances, would be considered as gas or oil well equipment. This is the case even though the distance of such transmission is a very long distance.

19. For a pipeline which is not considered as gas or oil well equipment as described in 17 and 18 above and is not used directly or indirectly by the taxpayer primarily in "Canadian field processing" within the meaning of the expression under subsection 248(1) of the Act, it would be included in Class 1 by virtue of paragraph (l) thereof, provided that the main source of supply for the pipeline would not exhaust within 15 years after the date on which operation of the pipeline commenced. In the case where such main source of supply would exhaust within 15 years, such a pipeline would be included in Class 8 by virtue of paragraph (i) thereof.

We hope that our above-noted comments are helpful to you. If you have any questions concerning the above or wish to discuss these matters further, please contact us.

Manager
Resource Industries Section
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Legislation Branch

cc. Catherine Bowen

Technical Publications and Projects Section