2007 Ruling 2006-0188921R3 - Bituminous Sand 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 sand project constitutes one project and one mine. Whether depreciable property to be used in the project is property described in Class 41.

Position: Yes.

Reasons: We received an opinion from Natural Resources Canada that concluded that the particular project will be one project. Based on this opinion, we are ruling that the project will be deemed to be one mine.

XXXXXXXXXX 									2006-018892

XXXXXXXXXX, 2007

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
Advance Income Tax Ruling

This is in reply to your letter of XXXXXXXXXX, wherein you requested an advance income tax ruling on behalf of the above-noted taxpayer. We acknowledge your subsequent electronic transmissions in respect of this ruling.

Preliminary Matters

To the best of your knowledge and that of the officers of the Corporation, none of the issues involved in this ruling request is:

(a) in an earlier return of the Corporation or any related person;

(b) being considered by a tax services office or taxation centre in connection with a previously filed tax return of the Corporation or any related person;

(c) under objection by the Corporation or any related person;

(d) before the courts; or

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

DEFINITIONS

Unless otherwise indicated, in this ruling request:

• "Act" means the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp), as amended as at the date hereof;
• "Additional Well Pads" has the meaning assigned by paragraph 15(a) below;
• "Additional Well Pairings" has the meaning assigned by paragraph 15(a) below;
• "bituminous sands" has the meaning assigned in subsection 248(1) of the Act;
• "Buildings" has the meaning assigned by paragraph 16 below;
• "Contractor" has the meaning assigned by paragraph 11 below;
• "EPC Agreement" has the meaning assigned by paragraph 11 below;
• "EUB" means the XXXXXXXXXX Energy and Utilities Board;
• "Central Processing Facility" has the meaning assigned by paragraph 14 below;
• "Corporation" means XXXXXXXXXX, and its successors and assigns;
• "Formation" has the meaning assigned by paragraph 7 below;
• "Initial Well Pads" has the meaning assigned by paragraph 15(a) below;
• "Initial Well Pairings" has the meaning assigned by paragraph 15(a) below;
• "Leases" means XXXXXXXXXX;
• "ParentCo" means XXXXXXXXXX, a corporation validly existing under the XXXXXXXXXX;
• "Project" means the in-situ bitumen recovery project of the Corporation as described in this ruling;
• "Regulations" means the Income Tax Regulations (Consolidated Regulations of Canada, c. 945), as amended as at the date hereof;
• "XXXXXXXXXX Facilities" means the key XXXXXXXXXX components that will be required in the bitumen recovery process as described in paragraph 15 below;
• "Sisterco" means XXXXXXXXXX, a corporation validly existing under the XXXXXXXXXX;
• "taxable Canadian corporation" has the meaning assigned in subsection 89(1) of the Act;
• "Well Pads" has the meaning assigned by paragraph 15(a) below; and
• "Well Pairings" has the meaning assigned by paragraph 15(a) below.

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

BACKGROUND FACTS

1. The Corporation:

a) was continued under the XXXXXXXXXX on XXXXXXXXXX;

b) is a resident of Canada and is a taxable Canadian corporation;

c) has a taxation year end of XXXXXXXXXX and its Business Identification Number is XXXXXXXXXX;

d) files its tax returns at the XXXXXXXXXX Taxation Centre and deals with the XXXXXXXXXX Tax Services Office; and

e) is an indirect wholly-owned subsidiary of XXXXXXXXXX, a corporation formed under the laws of the XXXXXXXXXX.

2. ParentCo holds approximately XXXXXXXXXX% of the issued and outstanding shares of the Corporation, with Sisterco holding the remaining issued and outstanding shares of the Corporation.

3. ParentCo files its tax returns at the XXXXXXXXXX Taxation Centre and deals with the XXXXXXXXXX Tax Services Office. The business number of ParentCo is XXXXXXXXXX.

4. Sisterco files its tax returns at the XXXXXXXXXX Taxation Centre and deals with the XXXXXXXXXX Tax Services Office. The business number of Sisterco is XXXXXXXXXX.

5. ParentCo and Sisterco are each wholly-owned by XXXXXXXXXX, a corporation incorporated under the laws of the XXXXXXXXXX, which is an indirect wholly-owned subsidiary of XXXXXXXXXX.

6. ParentCo, Sisterco and the Corporation are "principal business corporations" as defined in subsection 66(15) of the Act in that their principal business consists of XXXXXXXXXX. The head office and principal place of business of ParentCo, Sisterco and the Corporation are located at XXXXXXXXXX.

THE PROJECT

Overview - Leases and Deposits

7. The project (the "Project") is a project for the in-situ recovery of bitumen from the formations (the "Formation") that are the subject of the Leases. The Project is located approximately XXXXXXXXXX. The Corporation has a XXXXXXXXXX% working interest in the lands and Leases associated with the Project

8. The Project involves in-situ bitumen recovery using XXXXXXXXXX recovery technology to extract approximately XXXXXXXXXX barrels per day ("bpd") of bitumen over the life of the Project. Total recoverable resources from the Formation are estimated at over XXXXXXXXXX barrels. The bituminous sands are buried more than XXXXXXXXXX meters below the surface and are not amenable to surface mining techniques.

9. All of the bitumen to be recovered from the Project will be from the same deposit of bituminous sands. The hydrocarbons recovered will meet the viscosity and density requirements outlined in the definition of bituminous sands, determined and tested in the manner referred to in subsection 1107(1) of the Regulations. Specifically, the bitumen has a density of less than 12 degrees API and a viscosity of greater than 10,000 centipoise measured at atmospheric pressure, at a temperature of 15.6 degrees Celsius and free of solution gas.

10. The Corporation, through ParentCo, filed a joint Application for Approval to construct and operate the Project with XXXXXXXXXX. Regulatory approvals to construct and operate the Project were received in XXXXXXXXXX.

11. On XXXXXXXXXX the Corporation entered into an Engineering and Procurement Contract (the "EPC Agreement") with XXXXXXXXXX (the "Contractor"), pursuant to which the Contractor was engaged to design and engineer the XXXXXXXXXX Facilities and to procure materials for the Project in accordance with the terms of the EPC Agreement.

Bitumen Recovery Process

12. The Project consists of a highly integrated process for the extraction of bitumen from the Formation, to facilitate crude bitumen recovery on the Project site and its export off the Project site by pipeline. The Project is a development pursuant to which bitumen will be extracted by well from a deposit of bituminous sands in the Formation by way of in-situ technology, being the XXXXXXXXXX process.

13. The XXXXXXXXXX process involves the movement of bitumen to the production wells by utilizing gravity and steam. Under the XXXXXXXXXX process, pairs of horizontal wells are drilled into the oil sands. In the upper well (the "injection well"), steam is introduced near the bottom of the reservoir. The steam rises in the Formation until it reaches the bitumen where it cools and condenses, in turn transferring heat and increasing the temperature of the bitumen, thereby reducing the viscosity of the bitumen. The warm bitumen and condensate fall to the bottom of the reservoir and is drained by gravity by the lower well (the "production well"). The bitumen is then extracted to the surface.

14. The recovery process from the reservoir using XXXXXXXXXX is a highly integrated process and, due to subsurface and surface interaction in the recovery process and between the processing and production facilities and the wells, the XXXXXXXXXX components of the Project operate as a single integrated entity. On the surface, all the wells are connected by pipelines to the central processing facility (the "Central Processing Facility") where, as described in greater detail in paragraph 15(b) below, steam is generated for injection into the injection wells, the produced bitumen emulsion is separated into its component parts consisting of water, gas and bitumen and those component parts are then further treated or processed within the Central Processing Facility. The steam generation and water treatment components of the Central Processing Facility are integral to the overall operation of the Project. As described in greater detail below, there is a high degree of integration of the extractive and treatment processes.

Bitumen Recovery Facilities

15. The key XXXXXXXXXX components that will be required in the bitumen recovery process (collectively, the "XXXXXXXXXX Facilities") are as follows:

(a) It is anticipated that there will initially be XXXXXXXXXX surface well pads (the "Initial Well Pads") each with approximately XXXXXXXXXX well pairs (the "Initial Well Pairings"). Each well pair will consist of one injection well and one production well. Throughout the balance of the production cycle of the Project approximately XXXXXXXXXX additional Well Pairings (the "Additional Well Pairings" and, together with the Initial Well Pairings, the "Well Pairings") will be drilled from approximately XXXXXXXXXX additional surface well pads (the "Additional Well Pads" and together with the Initial Well Pads, the "Well Pads"). The Additional Well Pads and the Additional Well Pairings will be drilled as required in order to maintain average daily production at XXXXXXXXXX bpd of bitumen.

(i) In addition to the Well Pairings, each Well Pad will consist of:

(1) production and injection wellheads;
(2) wellhead collection piping;
(3) a group and test separator and related building;
(4) production and injection manifold headers and a manifold building;
(5) a blowdown pop tank;
(6) group pipelines;
(7) produced fluids separation, metering and pumping facilities;
(8) an electrical transformer;
(9) a motor control center and instrumentation building;
(10) surface water drainage collection area; and
(11) a topsoil conservation stockpile area.

(ii) Natural gas will be injected into the production well to manage the pressure in the well (such natural gas is referred to as "lift gas"). Injecting the lift gas will assist in causing the emulsion to flow up the production well to the surface and will also assist in maintaining the pressure in the well.

(iii) The group and test separators located on the Well Pad will collect the produced emulsion from all of the Well Pairings on the Well Pad and separate a portion of the gas from the emulsion. The separated gas will be transported by pipeline from the Well Pad to the produced gas separator (see below). The emulsion will be transported by pipeline to the Central Processing Facility for further processing.

(iv) The Well Pads will be connected to the Central Processing Facility via a series of corridors containing pipelines, power lines and access roads.

(v) There will be observation and monitoring wells associated with the Well Pads.

(b) The Central Processing Facility will be comprised of the following primary facilities:

(i) A steam generation facility which will use natural gas to heat water to generate steam for injection into the Formation via the injection wells. It is expected that there will be up to XXXXXXXXXX steam generators operating in parallel. Natural gas for the steam generators will be provided by sweet gas purchased from third parties on the XXXXXXXXXX as well as the produced solution gas recovered from the production treatment (described below). XXXXXXXXXX

(ii) Water supply wells which will supply water for use in the steam generation facility.

(iii) The produced emulsion entering the Central Processing Facility will consist of bitumen, steam, water in the form of condensed steam, formation water and solution gas. The produced emulsion will enter the separation system through an inlet separator at approximately XXXXXXXXXX kPag. The separation system will separate the produced emulsion into its component parts. After degassing, the emulsion will be cooled through a heat exchanger to approximately XXXXXXXXXX° C. The inlet separator will have three-phase gravity separators, with vapour leaving from the top, the bitumen leaving from the middle and the produced water leaving from the bottom.

(iv) The water content in the bitumen typically will be less than XXXXXXXXXX% as the bitumen leaves the production separation system and is split into two streams that feed the XXXXXXXXXX treaters. To assist in separation of the remaining water, diluent will be added to the streams before they pass through the in-line static mixers and into the two XXXXXXXXXX treaters. After treatment, the blended emulsion will be piped to storage tanks for shipping. Water removed from the emulsion will be routed to the water treatment systems.

(v) Produced gas removed from the emulsion at the Well Pads and in the production separation system will contain liquids in the form of condensed steam and some hydrocarbons (including the lift gas and solution gas). This produced gas will be cooled and separated in the produced gas separator. Natural gas liquids recovered from the produced gas separator will be routed to the XXXXXXXXXX treaters that are part of the emulsion treatment system. Dry natural gas will be fed into the mixed fuel gas separator (see below) for use in the various Central Processing Facility functions. Water removed from the gas will be routed to the water treatment systems.

(vi) Natural gas collected from the production treatment will be combined with purchased sweet fuel gas in the mixed fuel gas separator, and the combined gas will be used to fuel the steam generators.

(vii) The produced water from the production separation system will be cooled by a glycol heat exchanger before it is combined with the water phases from the produced gas separator and the emulsion treatment system. This produced water will be directed to the XXXXXXXXXX tank prior to further treatment and recycling. Oil will be removed from the water in the XXXXXXXXXX tank and routed to the emulsion treatment system.

(viii) The water de-oiling system, the main components of which are XXXXXXXXXX , will remove any remaining oil in the produced water so that the water can be treated for recycle to the steam generators. Any recovered oils will be returned to the production separation system. Once the water has passed through the water de-oiling system, it will be stored in the de-oiled produced water tank before being transferred to the produced water treatment facility.

(ix) The produced water treatment facility will remove the hardness, silica, oxygen and alkalinity from the de-oiled produced water. Produced de-oiled water, a portion of steam generator blowdown water and chemicals will be fed into XXXXXXXXXX softener unit where the bulk of the water treatment will occur. Treated water that is suitable to supply to the steam generators will be transported to the boiler feed water tank. A disposal water tank, pump and pipeline will transport disposal waters to disposal wells.

(x) The vapour recovery system will improve the overall plant efficiency by recovering vapours for use as fuel gas. The vapour recovery system gathers vapours from storage tanks and process vessels. A sweet fuel gas blanket will be supplied at a slightly positive pressure on all tanks with potential hydrocarbon vapours. The vapour recovery system will include separation vessels and a compressor to feed the recovered vapours into the mixed fuel gas separator (see above).

(xi) The various process streams will require heating and cooling. Heat integration will enable the use of hot streams that need cooling to be exchanged with cold streams that require heating. The main heating and cooling medium will be glycol.

(c) A portion of the natural gas required for the Project will be purchased from third parties and transported to the Project site via a pipeline that will be constructed by the Corporation and tied into the XXXXXXXXXX. A series of other natural gas pipelines will be tied into this main pipeline at the Project site for the purposes of supplying natural gas to the production wells, the mixed fuel gas separator and the Central Processing Facility.

(d) All pipelines and pressure control systems needed to transport fluids to and from the Well Pairings and the other XXXXXXXXXX Facilities, including all production gathering pipelines, water pipelines, steam distribution pipelines, natural gas distribution pipelines and vapour return pipelines.

(e) Utility systems, such as emergency back-up power generators, instrument air, power distribution lines, solids disposal and a drain system, will be required and will be integrated into the Central Processing Facility and the Well Pads.

(f) The water disposal wells will be used for water that cannot be re-used for steam generation. Water disposal wells will be drilled, completed and tested within EUB standards and each well will be equipped with a surface installed turbine meter, flow choke and a pressure recorder.

(g) The Project will include a number of above ground storage tanks, some of which are part of the process while others will be used for feed chemicals or product storage. The storage tanks that will be used in the Project include:

(i) Finished product tank - for the storage of blended oil that meets pipeline specifications;

(ii) Diluent storage tank - for storage of diluent for blending with production emulsion;

(iii) XXXXXXXXXX - part of the water de-oiling system;

(iv) Oil recovery tank - part of the water de-oiling system;

(v) De-oiled produced water tank - for the storage of produced de-oiled water prior to the final water treatment stage;

(vi) Boiler feed water tank - for the storage of demineralized water suitable to supply to the steam generators;

(vii) Neutralization tank - receives regeneration wastes from the XXXXXXXXXX and polisher prior to deep well disposal (part of the produced water treatment system);

(viii) XXXXXXXXXX tank - part of the produced water treatment system;

(ix) XXXXXXXXXX tank - part of the produced water treatment system;

(x) Source water tank - for the storage of make-up water;

(xi) Acid storage tank - part of the produced water treatment system;

(xii) Caustic storage tank - part of the produced water treatment system;

(xiii) Disposal water tank - collects steam condensate blowdown for recycle and deep well injection; and

(xiv) Glycol surge tank - surge storage of glycol.

(h) The Corporation has purchased a temporary camp facility for use during the construction phase of the Project. The Corporation is also constructing a XXXXXXXXXX man permanent camp, on site, to house employees during operations.

(i) Other infrastructure related to the Central Processing Facility will include:

(i) perimeter fencing;

(ii) flare stacks;

(iii) aboveground pipe racks;

(iv) glycol aerial coolers;

(v) XXXXXXXXXX pond systems;

(vi) sewage pond;

(vii) storm water runoff pond;

(viii)pumps;

(ix) control systems;

(x) electrical transformers;

(xi) power distribution lines;

(xii) potable water system; and

(xiii)sewer system.

16. Most of the major equipment used in the Central Processing Facility will be housed in steel framed buildings (the "Buildings"). Most of the equipment will be modularized for ease of construction. In addition to the permanent camp, it is currently expected that the Buildings will include:

(a) an emulsion treatment building;

(b) a produced water de-oiling building;

(c) a produced water treatment building;

(d) a steam generator building;

(e) a vapour recovery building;

(f) an emergency diesel generator building;

(g) a pond pumping station building; and

(h) an administrative, control and maintenance building.

17. In addition to the access roads connecting the Well Pads to the Central Processing Facility (referred to in paragraph 15(a)(iv) above), the Corporation is also planning to construct the following roads (the "Roads"):

XXXXXXXXXX.

18. During the start-up period of the production phase of the Project, the reservoir will be heated by circulating steam in both the injection wells and the production wells for a period of approximately XXXXXXXXXX months. The extensive heat reduces the viscosity of the surrounding bitumen and allows for communication between the wells. This helps establish the bitumen flow towards the production wells.

19. The bitumen produced from the Project will not be processed at the Project site. Rather, diluent will be added to the raw bitumen at the Central Processing Facility in order to maintain the density and viscosity within a range that can be transported by pipeline. The bitumen will be sold to a third party with upgrading facilities and transported to the third party using a pipeline and related facilities XXXXXXXXXX.

20. As bitumen recovery begins to decline in some of the Initial Well Pairings, the Additional Well Pairings will be drilled to replace the bitumen production lost from those existing wells. The estimated production life of the Project is XXXXXXXXXX years. The development plan is designed so that production will take place sequentially involving approximately XXXXXXXXXX Well Pads.

PROPOSED TRANSACTION

21. The Corporation proposes to complete the implementation of the Project, including the development and construction of the XXXXXXXXXX Facilities, the Buildings and the Roads in the manner referred to in paragraphs 15, 16 and 17 above.

22. The construction of the XXXXXXXXXX Facilities began in XXXXXXXXXX and is expected to be completed in XXXXXXXXXX, with commercial production expected to begin at XXXXXXXXXX or in XXXXXXXXXX.

PURPOSE OF THE PROPOSED TRANSACTION

23. The purpose of the proposed transaction is to enable the Corporation to develop an alternative oil production project for the purpose of pursuing its goal of accessing a key source of long-term energy supply in XXXXXXXXXX.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, proposed transaction and purposes of the proposed transaction, we confirm the following:

A. For the purposes of paragraph 1100(1)(y), subsections 1101(4c) and 1102(8) and (9), section 1107 of the Regulations and Class 41 of Schedule II, all of the Well Pairings for the Project as described in paragraphs 15 and 20 constitute one project and will be deemed to be one mine pursuant to paragraph 1104(7)(c) of the Regulations.

B. Depreciable property that is described in any of paragraphs 15, 16 and 17 hereof, that is part of the XXXXXXXXXX Facilities, the Buildings and the Roads and that,

(a) but for Class 41, would be included in Class 10 because of paragraphs (g), (k), (l) or (r) of Class 10; or 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;

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

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

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

(e) the property has not, before it was acquired by the Corporation, been used for any purpose whatever by any person who was not dealing at arm's length with the Corporation.

C. Property described in Ruling B above will, for the purposes of subsection 1101(4c) of the Regulations, be considered to be acquired by the Corporation for the purposes of gaining or producing income from the mine referred to in Ruling A above.

These rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 issued by the CRA on May 17, 2002, and are binding on the CRA provided that the proposed transaction is completed by XXXXXXXXXX.

The above rulings are based on the Act in its present form and do not take into account any proposed amendments to the Act, which if enacted, could have an effect on the rulings provided herein.

COMMENTS

Although we received, for review, certain documents relating to the proposed transaction, our rulings are based solely on the representations described herein.

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

(a) that any specific property, such as any particular pipeline or flowline, may be included in paragraph (a) of Class 41 for the purposes of Ruling B above;

(b) the reasonableness of any expenditures referred to in this letter;

(c) the deductibility of any expenditures referred to in this letter, other than as described in the rulings given;

(d) the determination of the fair market value or capital cost of any property referred to in this letter; or

(e) that any proposed expansion of the Project to increase the capacity of the XXXXXXXXXX Facilities beyond XXXXXXXXXX barrels per day or any additional phase of the Project will be part of the mine determined in Ruling A above.

Yours truly,

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