2006 Ruling 2004-0105021R3 - bituminous sands in-situ - 1 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 all of the wells for the extraction of material from the deposit of bituminous sands included in XXXXXXXXXX constitute one project, and will be deemed to be one mine pursuant to paragraph 1104(7)(c) of the Regulations.

Position: Yes.

Reasons: Based on the facts of the situation and a written opinion received from Natural Resources Canada dated XXXXXXXXXX . A representative of that Department visited the site and reached the conclusion that supported the above position.

XXXXXXXXXX 2004-010502

XXXXXXXXXX , 2006

Dear XXXXXXXXXX:

Re: XXXXXXXXXX (the "Partnership")
Advance Income Tax Ruling

This is in reply to your letters dated XXXXXXXXXX, wherein you requested an advance income tax ruling on behalf of the Partnership. We also acknowledge receipt of the additional correspondence dated XXXXXXXXXX and various electronic messages. We apologize for the delay in responding to your request.

We understand that to the best of your knowledge and that of the taxpayers involved, none of the issues contained herein:

(i) is included in an earlier return of the taxpayers or a related person;

(ii) is being considered by a Tax Services Office or Taxation Centre in connection with a previously filed tax return of the taxpayers or a related person;

(iii) is under objection by the taxpayers or a related person;

(iv) is before the courts; and

(v) is the subject of a previous ruling issued by the Income Tax Rulings Directorate.

Our understanding of the facts, proposed transactions and purpose of the proposed transactions is as follows:

Definitions

Unless otherwise stated, in this letter, the following terms and expressions have the meanings specified below:

"Act" means the Income Tax Act R.S.C. 1985 (5th Supp.), c.1 as amended to the date of this letter;

"bituminous sands" has the meaning assigned by subsection 248(1) of the Act;

"Board" means the XXXXXXXXXX;

"Corporation A" means XXXXXXXXXX;

"Corporation B" means XXXXXXXXXX;

"Corporation C" means XXXXXXXXXX;

"Corporation D" means XXXXXXXXXX;

"Corporation E" means XXXXXXXXXX;

"Corporation F" means XXXXXXXXXX;

"Corporation H" means XXXXXXXXXX;

"Electrical Company" means XXXXXXXXXX;

"ENV" means XXXXXXXXXX Environment;

"Joint Venture" means the XXXXXXXXXX;

"Lease Area" means the Project lease area located approximately XXXXXXXXXX;

"Pipeline Company" means XXXXXXXXXX;

"Project" means the XXXXXXXXXX project, located on the Lease Area;

"Project Owners" means the meaning assigned in paragraph 2;

"Regulations" means the Income Tax Regulations (Consolidated Regulations of Canada, c.945) as amended to the date of this letter; and

"taxable Canadian corporation" has the meaning assigned to that expression by subsection 89(1) of the Act.

Unless otherwise specified, all section references contained herein are to sections of the Act.

Facts

1. Corporation A is a taxable Canadian corporation and a subsidiary of Corporation B of XXXXXXXXXX, a publicly traded corporation the shares of which are listed on the XXXXXXXXXX Stock Exchange. Corporation A is engaged in upstream oil and natural gas activities in Canada, both directly and through subsidiaries and partnerships.

2. Corporation A has broad and substantial experience with XXXXXXXXXX exploration and production having operated and participated in various projects since XXXXXXXXXX. Corporation A currently has a XXXXXXXXXX% ownership interest in the Joint Venture (a large oilsands mining operation), and has a XXXXXXXXXX% working interest in the Project held through the Partnership. The Project is operated as a joint venture. The joint venturers ("Project Owners") and their respective interests are as follows:

• the Partnership (XXXXXXXXXX%), and
• Corporation F (XXXXXXXXXX%) .

3. The Partnership is XXXXXXXXXX general partnership (BN: XXXXXXXXXX), the business of which is carried on by its four partners. The partners and their respective interests in the Partnership are as follows:

Partner						Interest
* Corporation A (BN: XXXXXXX ) 		XXXXXXX %
* Corporation C (BN: XXXXXXX )		XXXXXXX %
* Corporation D (BN: XXXXXXX ), and 		XXXXXXX %
* Corporation E (BN: XXXXXXX )  		XXXXXXX %
100.0%

Corporation A is the managing partner of the Partnership. Corporation C, Corporation D and Corporation E are all taxable Canadian corporations and are all wholly-owned subsidiaries of Corporation A. Corporation A is the operator of the Project. The Partnership and its partners are served by the XXXXXXXXXX Tax Services Office and the XXXXXXXXXX Taxation Centre.

4. In XXXXXXXXXX, Corporation H (a predecessor corporation to Corporation A) began work to determine a suitable site for a new experimental XXXXXXXXXX to test the application of XXXXXXXXXX technology on the Lease Area. Construction of XXXXXXXXXX was completed and commissioned in XXXXXXXXXX and continues to be operated by the Partnership. XXXXXXXXXX was approved by the Board on XXXXXXXXXX. ENV approved XXXXXXXXXX on XXXXXXXXXX.

5. The purpose of the work at XXXXXXXXXX is to improve understanding of all the factors related to successful XXXXXXXXXX performance specifically within the Lease Area, thereby providing the information needed for optimal commercial application of XXXXXXXXXX technology. There are currently XXXXXXXXXX operating at XXXXXXXXXX .

6. In anticipation of developing the Project, Corporation A submitted the Commercial Application for the Project to the Board and ENV for regulatory and public review on XXXXXXXXXX. Corporation A, on behalf of the Project Owners, obtained Board approval XXXXXXXXXX (the "Approval") on XXXXXXXXXX and ENV approval on XXXXXXXXXX. The Approval incorporates Order in Council XXXXXXXXXX. Corporation A obtained Board approval for the Project to produce up to XXXXXXXXXX bitumen barrels per day ("bbl/d") from the Project area described in Application XXXXXXXXXX. The Board application describes XXXXXXXXXX. This has been subsequently revised to XXXXXXXXXX under the current development plan.

7. XXXXXXXXXX.

8. XXXXXXXXXX.

9. XXXXXXXXXX The deposit throughout the entire Lease Area qualifies as "bituminous sands".

Proposed Transactions

XXXXXXXXXX

10. The Partnership is currently proceeding with the development of XXXXXXXXXX of the Project which will include XXXXXXXXXX wellpairs to be developed at a total estimated cost of $XXXXXXXXXX to drill and complete. XXXXXXXXXX of these wellpairs will be drilled and completed by XXXXXXXXXX and the balance will be drilled in XXXXXXXXXX. These wellpairs will be connected to XXXXXXXXXX wellpads, Pads XXXXXXXXXX , which, in turn, will be connected to a central processing facility for XXXXXXXXXX (the "XXXXXXXXXX CPF"). The approximate center coordinates in XXXXXXXXXX are as follows:

XXXXXXXXXX.

Steam will be injected into the XXXXXXXXXX wellpairs commencing in XXXXXXXXXX with production expected to commence in XXXXXXXXXX. Production from these wellpairs will flow to the XXXXXXXXXX surface wellpads described above. XXXXXXXXXX will utilize approximately XXXXXXXXXX% of the Lease Area, and will produce XXXXXXXXXX bbl/d of marketable bitumen. The initial costs for XXXXXXXXXX are projected to be $XXXXXXXXXX.

11. XXXXXXXXXX technology will be used as the bitumen recovery process for the Project and it is currently the state of the art technology for optimizing bitumen recovery from deep deposits in the oilsands region of XXXXXXXXXX. This technology is based on drilling a horizontal wellpair that consists of one horizontal steam injection wellbore drilled parallel approximately 5 metres above a horizontal bitumen production wellbore. Steam is injected into the upper wellbore to deliver energy to the bitumen sands by heat conduction. The condensed steam and bitumen flow downwards by gravity through the heated reservoir and are lifted up through the production wellbore.

12. During the startup phase for XXXXXXXXXX, steam will be circulated in both the injection and production wells for approximately three months. This process heats the oil sands between the wells until the bitumen is mobilized and pressure communication is established between the wells. Once this occurs, the steam will be injected only into the injection well to allow a steam chamber to grow vertically and laterally initiating the process of gravity drainage of heated bitumen to the production well.

13. The steam injection rate will be increased until the desired reservoir operating pressure is achieved. It will then be adjusted to maintain the desired pressure. The operating pressure would typically start at a higher pressure to accelerate bitumen rates and then decline with time to make use of stored heat in the reservoir. As the bitumen is heated, its viscosity is reduced, enabling it to flow, with gravity as the driving force, toward the lower production well. The flow-rate of the production well will be controlled so that the bottomhole temperature of the produced fluids is a few degrees Celsius below the saturated steam temperature at the operating pressure.

14. Typical wellpairs will feature horizontal sections averaging XXXXXXXXXX metres in length at a true vertical depth ranging from XXXXXXXXXX metres. The downhole lateral spacing between wellpairs will be up to XXXXXXXXXX metres. Each wellpad will have a wellpad facility. A typical wellpad facility layout will be XXXXXXXXXX metres by XXXXXXXXXX metres. Wellpad facilities will include equipment for field production and gathering, steam distribution and injection, lift gas injection, casing vent gas, and produced gas handling. Access and utilities will be provided by service corridors including roads and pipelines for transporting steam, produced liquids and gas to and from the XXXXXXXXXX CPF. Water and diluent lines between the XXXXXXXXXX wellpad facilities and the XXXXXXXXXX CPF will be buried, while steam and emulsion lines will be aboveground. The pipelines will run on the same right-of-way as road and power lines. A fibre-optic cable will also be run on the aboveground pipe racks.

15. There will be a manifold building at each wellpad to house the valves and controls required for steam injection and production. Operations staff will inspect each wellpad once per shift to monitor the conditions of the well surface equipment. Wellpad operations will be monitored on-site with a distributed control system ("DCS") located at the XXXXXXXXXX CPF site. The DCS will provide continuous information on pressure and injection rate variations to the XXXXXXXXXX CPF. The production fluid phases from each wellpair will also be tested. The daily oil, water and gas production rates will be allocated to the wells based on their flow rates and test values relative to the total oil, water and gas production rates measured.

16. Additional delineation wells, strategically placed and distributed throughout the Lease Area, may be completed as vertical observation wells. It is anticipated that there will be at least one observation well per wellpad. Observation wells will be equipped with temperature sensors and pressure sensors, and will also aid in monitoring steam chamber growth and ensure efficient resource recovery.

Facilities

17. The XXXXXXXXXX wellpad facilities will be connected to the XXXXXXXXXX CPF where the fluids produced will be processed in order to obtain a marketable bitumen product. The XXXXXXXXXX CPF will separate the gas/water/oil produced by the XXXXXXXXXX wells into its components of marketable oil, produced water suitable for steam generation, and solution and lift gas that will satisfy a portion of the plant fuel demand.

18. The processing carried out in the XXXXXXXXXX CPF in respect of production from the XXXXXXXXXX wells will include:

• primary separation of bitumen, water and gas;
• removal of oil from water;
• water treatment (softening);
• bitumen storage and diluent blending;
• high-pressure steam generation;
• cooling and heating systems; and
• fuel and lift gas processing.

19. There will be an office building that includes offices, an operator locker room and a washroom, a lunchroom, and a communications equipment room. In addition, there will be a separate shop building that includes a mechanical shop and warehouse, individual electrical and instrument shops, and an office for the warehouseman.

Infrastructure & Utilities

20. The infrastructure and utilities include roads, electric power, product handling systems and natural gas. Existing infrastructure will be utilized to the maximum extent possible.

21. The main access road will be XXXXXXXXXX which already exists and goes through the entire Lease Area from north to south. XXXXXXXXXX. In addition, there are extensive linear developments that are related to exploration, gas development and forestry in the Lease Area.

22. Natural gas will be delivered to the XXXXXXXXXX CPF by a XXXXXXXXXX kilometre pipeline from the pipeline system owned by the Pipeline Company. The Pipeline Company proposes to install a meter station on its main line. The natural gas will arrive at the XXXXXXXXXX CPF and the flow will be split. Gas flowing to the XXXXXXXXXX wellpads will be used as gas lift in the production wells. The reproduced lift gas combined with the solution gas will be separated at the XXXXXXXXXX wellpads and flow to the XXXXXXXXXX CPF in the produced gas pipelines where it will be combined with additional volumes of natural gas supplied by the Pipeline Company, as required, and utilized as fuel gas in the XXXXXXXXXX CPF for equipment such as the steamer generators.

23. Electric power will be provided from the Electrical Company's XXXXXXXXXX kilovolt ampere ("kVa") transmission line that runs due east of the site. The Electrical Company will provide the letdown transformer station, and XXXXXXXXXX kVa transmission lines to the XXXXXXXXXX CPF and wellpads.

24. A storage terminal (tank farms) and associated pumping station will be installed to transfer bitumen to the selected product pipeline. The XXXXXXXXXX CPF will be connected to the shared terminal by product pipelines. The pipeline will follow a XXXXXXXXXX metre right-of-way, and where practical, an existing linear right-of-way will be used.

Process Water

25. Water will consist of makeup water for steam generation and potable water for consumption and sanitary uses. The source of this water will be groundwater from the XXXXXXXXXX and storm water runoff contained at the facility sites. Approximately XXXXXXXXXX percent of the XXXXXXXXXX disposal water will be recycled for steam generation, and about XXXXXXXXXX percent will be taken from the XXXXXXXXXX.

26. The water management system is based on the criterion that all water that comes in contact with oilsands will be contained in a closed circuit, and reused to the greatest extent possible. Accordingly, the XXXXXXXXXX CPF site drainage, process water, recycled water and de-oiled water will be contained. Prior to XXXXXXXXXX, XXXXXXXXXX disposal water that cannot be recycled will be injected into the bitumen-free XXXXXXXXXX east of the Lease Area.

27. Supply rates may be larger during startup when the reservoir is being heated and the water recycle plant is being commissioned. The steam generators, requiring about XXXXXXXXXX cubic metres per day ("m3/d") of raw source water, will be operated during the startup period and maintained at this level until the XXXXXXXXXX wellpad production water volume rates are sufficient to bring the water recycle plant to its processing capacity. Once steady state production is attained, the raw source water makeup rate will drop to about XXXXXXXXXX m3/d. In addition to these supply rates, a maximum of approximately XXXXXXXXXX m3/d of reverse osmosis-treated water will be required to provide potable water. The stated supply rates will prevail all year, as major seasonal demand variations are not expected.

28. Once the bitumen reserves are depleted from a group of XXXXXXXXXX steam chambers, reservoir pressure will be maintained by injecting water. The water requirements for reservoir pressure maintenance will increase as the number of depleted XXXXXXXXXX chambers increases. Pressure maintenance water will be initially supplied by XXXXXXXXXX disposal water from the XXXXXXXXXX CPF. Once the pressure maintenance water requirement grows beyond the XXXXXXXXXX disposal water rate, transfer water for pressure maintenance could be supplied from the XXXXXXXXXX disposal wells that are converted to production wells.

29. Surface runoff will be collected in a storm water retention pond at the XXXXXXXXXX CPF and be used as plant makeup water. Grading will be used to control site runoff. The XXXXXXXXXX CPF yard area will have ditches and diversion channels constructed to direct any storm water or meltwater to the storm water retention pond. The pond inventory will be pumped to the water treatment plant for use as boiler feed water. Production pads will be surrounded by berms to retain runoff in a corner area. Accumulated water will be tested periodically and will be discharged if it meets the regulatory water quality criteria. Otherwise, it will be reused at the XXXXXXXXXX CPF.

Other information

30. All existing XXXXXXXXXX facilities will remain in use but will not be incorporated into XXXXXXXXXX. The current treating facilities at the XXXXXXXXXX will be kept in operation for testing purposes. All produced emulsion at the XXXXXXXXXX will be transported via pipeline to the XXXXXXXXXX CPF for treating except in upset conditions. The existing source water well will continue in operation to provide the required cooling at the XXXXXXXXXX facilities. This water will be transported to the XXXXXXXXXX CPF and utilized as process makeup water. The existing steam generation equipment will remain in place and will be utilized dependant on steam requirements. As the existing wells at the XXXXXXXXXX are depleted, additional horizontal wells may be drilled to replace this production.

31. XXXXXXXXXX of the Project is currently in the design stage with construction expected to commence in XXXXXXXXXX. It is currently expected that XXXXXXXXXX additional wellpairs will be developed at an estimated cost of $XXXXXXXXXX. It is not currently contemplated that these additional wellpairs will be connected to wellpads Pads XXXXXXXXXX or the XXXXXXXXXX CPF. Production from XXXXXXXXXX is expected to be in excess of XXXXXXXXXX bbl/d, and is anticipated to begin in XXXXXXXXXX. Total costs for this phase are projected at $XXXXXXXXXX. XXXXXXXXXX are expected to reach a combined production of XXXXXXXXXX bbl/d when operating at full capacity in XXXXXXXXXX.

Purpose of Proposed Transactions

32. XXXXXXXXXX
Ruling Requested and Given

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions and purpose of the proposed transactions, and provided further that the proposed transactions are carried out as described above, we confirm that:

For the purposes of paragraphs 1100(1)(y) to (ya), subsections 1101(4c) and (4d) and 1102(8) and (9), and section 1107 of the Regulations and Classes 28 and 41 in Schedule II to the Regulations, all wells related to XXXXXXXXXX as described in paragraph 10 above for the extraction of material from the deposit of bituminous sands in the Lease Area constitute one project, and will be deemed to be one mine pursuant to paragraph 1104(7)(c) of the Regulations.

The above ruling is given subject to the limitations and qualifications set forth in Information Circular 70-6R5 issued by the Canada Revenue Agency (the "Agency") on May 17, 2002 and is binding on the Agency provided that steam injection into the XXXXXXXXXX wells commences by XXXXXXXXXX.

This ruling is based on the legislation as it presently reads and does not take into account the effect of any proposed amendments thereto.

Our Comments

Except as expressly stated, our ruling does not imply acceptance, approval or confirmation of any income tax consequences relating to the facts or proposed transactions described herein. In particular, nothing in this letter should be interpreted as confirming expressly or implicitly:

(a) the class in Schedule II to the Regulations that any depreciable property described herein should be included; or
(b) that the XXXXXXXXXX of the Project will be part of the same project as XXXXXXXXXX for purposes of paragraph 1104(7)(c) of the Regulations. In order for XXXXXXXXXX to be considered to form part of the same project as XXXXXXXXXX, the wells for the XXXXXXXXXX must operate as a single "extractive unit". This determination will depend on the degree of integration of the bitumen extraction processes for the XXXXXXXXXX. In the situation where the XXXXXXXXXX will have separate and distinct systems of well-pads that supply a separate central processing facility, which will operate independently with very little physical integration between the XXXXXXXXXX, as currently proposed, the required degree of integration of the bitumen extraction processes for the XXXXXXXXXX will not be attained. However, once the development plans have been finalized for XXXXXXXXXX, the Partnership intends to request an advance income tax ruling that XXXXXXXXXX will be considered to form part of the same project as XXXXXXXXXX for purposes of paragraph 1104(7)(c) of the Regulations.

Yours truly,

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