2008 Ruling 2007-0222741R3 - Oil 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 all the Phase I and Phase II well pairs of the Project for the extraction of material from the deposit of bituminous sands in Phases I and II of the Project constitute one project and will be deemed to be one mine pursuant to paragraph 1104(7)(c).

Position: Yes

Reasons: Based on a technical opinion from Natural Resources Canada dated XXXXXXXXXX .

XXXXXXXXXX 								2007-022274

XXXXXXXXXX , 2008

Dear XXXXXXXXXX :

Re: XXXXXXXXXX ("ACO") (B/N XXXXXXXXXX )
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 the various electronic messages in respect of this ruling.

To the best of your knowledge and that of the taxpayer, none of the issues contained herein:

(i) is in an earlier return of the taxpayer or a related person 1 ;

(ii) is being considered by a tax services office or taxation centre in connection with a previously filed tax return of the taxpayer or a related person;

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

(iv) is before the courts ; or

(v) is the subject of an advance income tax ruling previously issued by the Income Tax Rulings Directorate.

DEFINITIONS

1. 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;
• "bituminous sands" has the meaning assigned in subsection 248(1) of the Act;
• "EUB" means the XXXXXXXXXX Energy and Utilities Board;
• "Central Plant" has the meaning assigned by paragraph 13 below;
• "Initial Well Pairs" has the meaning assigned by paragraph 11 below;
• "Pilot Well Pairs" has the meaning assigned by paragraph 11 below;
• "private corporation" has the meaning assigned in subsection 89(1) of the Act;
• "Project" means the in-situ bitumen recovery project of ACO as described in this ruling;
• "Regulations" means the Income Tax Regulations, as amended as at the date hereof; and
• "taxable Canadian corporation" has the meaning assigned in subsection 89(1) of the Act.

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

Facts

ACO

2. ACO is a taxable Canadian corporation and a private corporation. Its head office is located in XXXXXXXXXX . ACO's taxation year for the purposes of the Act ends on XXXXXXXXXX . ACO's activity is the XXXXXXXXXX . It files income tax returns under account number XXXXXXXXXX .

3. ACO's income tax returns are filed with the XXXXXXXXXX Tax Centre and are serviced by the XXXXXXXXXX Tax Services Office.

The Project Lands

4. The Project is located in XXXXXXXXXX .

The Project Lands constitute XXXXXXXXXX oil sands leases that cover XXXXXXXXXX sections of land located in XXXXXXXXXX . ACO is a XXXXXXXXXX % owner of all these leases.

5. ACO acquired the Project Lands oil sands leases from the Province of XXXXXXXXXX . In general, oil sands leases grant rights to produce and take leased substances. The leased substances described in each of the leases are oil sands below the top of the XXXXXXXXXX

(i) sands and other rock materials containing crude bitumen,

(ii) the crude bitumen contained in those sands and other rock materials, and

(iii) any other mineral substances, other than natural gas, in association with that crude bitumen or the sands and other rock materials referred to in subclauses (i) and (ii).

In general, the leases grant a right to produce and take crude bitumen.

Area History

6. XXXXXXXXXX

7. XXXXXXXXXX

Proposed Transactions

Project

8. There has been no development of the oil sands resource on the Project Lands other than those described in this letter. XXXXXXXXXX The Project will recover bitumen from the XXXXXXXXXX at a depth of XXXXXXXXXX meters using horizontal well pairs and XXXXXXXXXX technology.

XXXXXXXXXX involves drilling pairs of horizontal wells. The upper wells are the steam injection wells and the lower wells, approximately XXXXXXXXXX meters below the injection wells, near the base of the oil pay zone, are equipped as bitumen production wells. Steam will be continuously injected through the upper well bores to heat the formation. The heated bitumen, due to gravity, then drains to the lower horizontal wells and is produced to the surface.

9. The Project will be developed in phases to produce approximately XXXXXXXXXX barrels per day ("bpd") of bitumen by XXXXXXXXXX . The project life span will be approximately XXXXXXXXXX years. Phase 1 has been completed and steaming commenced on XXXXXXXXXX . Phase II was XXXXXXXXXX % complete as of XXXXXXXXXX and is expected to start-up in early XXXXXXXXXX . The expected production levels in each phase are as follows:

• Phase I - XXXXXXXXXX bpd,
• Phase II - XXXXXXXXXX bpd by XXXXXXXXXX ,
• Phase III - XXXXXXXXXX bpd by XXXXXXXXXX ,
• Phase IV - XXXXXXXXXX bpd by XXXXXXXXXX ,
• Phase V - XXXXXXXXXX bpd by XXXXXXXXXX , and then
• Phase VI - XXXXXXXXXX bpd by XXXXXXXXXX .

Phases I and II

10. As of XXXXXXXXXX core holes, XXXXXXXXXX observation wells and XXXXXXXXXX source/disposal water wells have been drilled and extensive XXXXXXXXXX seismic programs covering a portion of the XXXXXXXXXX sections have been completed. In XXXXXXXXXX the core holes and seismic programs further delineated the current development areas, pinpointing horizontal well pair locations, and further delineated additional areas of the total project resource. Core hole drilling will continue on an annual basis to further delineate the XXXXXXXXXX sections and identify horizontal well locations to expand the project to a minimum of XXXXXXXXXX bpd by XXXXXXXXXX .

11. Initially, six pairs of XXXXXXXXXX horizontal wells ("Pilot Well Pairs"), located in XXXXXXXXXX , were drilled from one surface pad location. ACO filed an application and received initial approval (No. XXXXXXXXXX ) from EUB and XXXXXXXXXX to produce XXXXXXXXXX bpd of bitumen. This application was amended and approved in XXXXXXXXXX (N0. XXXXXXXXXX ). A second approval to produce XXXXXXXXXX bpd was submitted in XXXXXXXXXX and the approval is expected in XXXXXXXXXX . When the second approval is obtained, approximately XXXXXXXXXX well pairs will be drilled from XXXXXXXXXX surface pads ("Initial Well Pairs"). The Pilot Well Pairs and the Initial Well Pairs are referred to herein as the "Phases I and II Well Pairs".

All of the bitumen to be recovered from Phases I and II of 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 in the Act, determined and tested in the manner referred to in subsection 1107(1) of the Regulations. Specifically, the bitumen has a density of less than XXXXXXXXXX degrees API and a viscosity of greater than XXXXXXXXXX centipose measured at atmospheric pressure, at a temperature of XXXXXXXXXX degrees Celsius and free of solution gas.

12. To optimize the use of steam and underground steam flow, Phases I and II will develop the resource as one integrated unit.

13. The required steam will be generated by a central plant (the "Central Plant"). Processing equipment, including produced water recycling facilities, slop treating facilities and a vapour recovery unit, are being constructed as part of the Central Plant site .

14. The Phases I and II Well Pairs will have a common steam line from the Central Plant supplying the steam and will have a common line bring the produced fluids from the wells to the Central Plant for processing. Most of the facilities at the Central Plant will be shared by Phases I and II, including water treatment, storage tanks, steaming, oil treating, slop handling.

15. In addition to the horizontal wells, surface facilities will be required to generate and distribute steam, generate power, gather well production, process oil and emulsions, and treat water. Currently, Phase I facilities ("Pilot Facilities") are under construction to produce bitumen from the Pilot Well Pairs. ACO will not claim any expenditures in respect of the Pilot Facilities as "scientific research and experimental development" expenditures under section 37 of the Act. These facilities will form an integral part of the facilities that will produce XXXXXXXXXX bpd in Phase II.

Phases I and II Facilities

16. The Phases I and II Well Pairs wellhead and other equipment located at the pads will be connected to a Central Plant where the steam generation and production processing facilities will be located.

17. The Central Plant facilities have been designed and are being constructed with a view to tie-in and integrate production levels beyond XXXXXXXXXX bpd. At the Central Plant, steam for the Project will be generated using recycled produced water supplemented with non-saline makeup water. Water for the process will be supplied from approved water source wells.

18. To achieve a production level of XXXXXXXXXX bpd a XXXXXXXXXX MW (XXXXXXXXXX mmBTU/hr) Once Through Steam Generator ("OTSG") and a XXXXXXXXXX MW (XXXXXXXXXX mm BTU/hr) Heat Recovery Steam Generator will be added to the XXXXXXXXXX MW OTSG to produce high pressure steam for the Project. A steam separator will then be used to produce dry quality steam for distribution to the production pads.

19. Produced fluids will include bitumen, condensed steam from the injection process, formation water, solution gas, and lift gas. Inlet and bitumen treating, water de-oiling, steam generation, and lift gas compression are some of the activities that will be undertaken at the Central Plant. Tankage for diluent, diluted bitumen, and produced water will be located on site.

20. The following basic streams will be processed at the Central Plant:

• bitumen emulsion will undergo a separation process with diluent addition to meet the pipeline specifications of XXXXXXXXXX % Basic Sediments and Water ("BS&W")
• produced water will be de-oiled and then recycled to the water treatment plant; and
• gas will be removed from the produced fluids and used as fuel for the steam generators.

Field facilities

21. The processing facilities and systems at the Central Plant will include:

• boiler feedwater treatment;
• steam generation;
• plant inlet facilities;
• emulsion treating system;
• produced water de-oiling, recycling and disposal facilities;
• slop treatment facilities;
• heat integration;
• fuel and produced gas gathering, processing, and distribution;
• flare system;
• electrical generation;
• tankage;
• support buildings;
• glycol cooling and heating; and
• utilities.

22. The production pads and the Central Plant will be interconnected with service corridors which will include:

• production pad access roads;
• production flow lines ancillary to the machinery and equipment;
• steam distribution flow lines ancillary to the machinery and equipment;
• lift gas flow lines; and
• electrical power distribution lines.

Service corridor infrastructure has been designed to accommodate future operations beyond XXXXXXXXXX bpd of production. Also, once full production levels are reached, the geographic area of the Project will expand as required to replace production volumes.

23. The Central Plant utilities will include:

• electric power;
• emergency power;
• service and sanitary water;
• sewage system;
• drain system;
• storm and process water pond;
• instrument air; and
• fire, gas, and smoke detecting system.

24. For Phase I, all electrical power for the Project will be provided by the provincial power grid. This will require construction of a substation, ancillary equipment, on-site distribution and several connections to offsite sources.

25. For Phases II to VI, electrical power will be generated by an on-site co-generation unit. It is anticipated that less than XXXXXXXXXX percent of the electricity generated by the on-site co-generation unit will be used by the Project in the first XXXXXXXXXX taxation years in which the power is produced. The excess will be sold to the provincial power grid.

26. The Central Plant buildings will include:

• process building;
• produced water de-oiling building;
• steam generation building;
• diluent pump building;
• glycol/utility building;
• fuel gas and lift gas compressor building;
• water treatment building;
• vapour recovery unit building;
• administration/control/maintenance buildings; and
• employee and contractor camp buildings.

Offsite Services

27. The main access route to the Project site is XXXXXXXXXX

28. The following water source/disposal wells are outside the boundaries of the Project Lands.

XXXXXXXXXX

These wells and future source/disposal wells are required to meet the Project's requirements:

• XXXXXXXXXX
• XXXXXXXXXX

The following source/disposal wells were drilled within the Project's boundaries. They and future source/disposal wells are required to meet the Project's requirements:

XXXXXXXXXX

The above wells will have wellhead and other equipment including flow lines to or from the Central Plant.

29. ACO will be drilling additional gas wells located outside the boundary of the XXXXXXXXXX sections of oil sands leases in order to supply a portion of the gas required at the Project for plant operations, steam and power generation, and lift gas injections. These wells will also have wellhead and other equipment that will be tied into the Projects infrastructure.

30. A XXXXXXXXXX km pipeline is being constructed. There are two legs to the pipeline, XXXXXXXXXX

Additional Information

Upgrader

31. ACO is currently considering the feasibility of constructing an upgrader. However, ACO has not made the final decision with respect to the construction of the upgrader.

Phases III to VI

32. The location of the well pads and the associated equipment for Phases III to VI has not been determined as yet. However, geological work is continuing on the Project leases to determine the locations. ACO intends to develop the Project Lands as one integrated extractive unit.

33. Depending on the location of the future well pads in these phases, satellite steam plants will be constructed for each phase. These satellite steam plants will be strategically located to optimize the use of the steam and its flow underground so that the Project Lands are developed as one integrated extractive unit. For example, the treated hot water for the satellite steam plants will be provided from the Central Plant facilities via flow lines. Other services such as production control, power etc., will also be provided from the Central Plant location. Produced fluids from all these phases will be processed at the Central Plant facilities. Produced water treatment and reuse or disposal will also occur at the Central Plant facility. Produced bitumen from these phases will be sent to XXXXXXXXXX via pipeline located at the Central Plant facilities. The infrastructure constructed will be common for all the phases.

Purpose of the Proposed Transactions

The purpose of the proposed transactions is to enable ACO to develop an oil production and processing facility 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 transactions and purpose of the proposed transactions, we confirm the following:

A. For the purposes of paragraph 1100(1)(y), paragraph 1101(4c), subsections 1102(8) and (9), and section 1107 of the Regulations and for Class 41 of Schedule II, all the Phase I and Phase II well pairs of the Project for the extraction of material from the deposit of bituminous sands in Phases I and II of the Project to produce up to XXXXXXXXXX bpd of bitumen, 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 through 29 hereof, excepting the co-generation facility described in paragraph 25, that is part of the Phase I and II Facilities, and that,

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

(2) would be included in Class 41 because of subsection 1102(9) of the Regulations provided no election is filed to include the particular property in Class 43.1 or 43.2;

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

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

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

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

C. Paragraph 1100(1)(y) of the Regulations will apply to ACO in respect of property to which Ruling B above applies, subject to Comment (C) below.

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.

A. Except as expressly stated, our rulings do not imply acceptance, approval or confirmation of any income tax implications relating to the facts or proposed transactions. 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 Phases I and II Facilities beyond XXXXXXXXXX barrels per day or the additional Phases III to VI of the Project will be part of the mine determined in Ruling A above.

B. For the purposes of Ruling B, the mine will be considered to have come into "production in reasonable commercial quantities" for the purposes of subsection 1104(8.1) of the Regulations on the first day of the 90 day period during which the Central Plant operates continuously to produce XXXXXXXXXX bpd (i.e. XXXXXXXXXX % of XXXXXXXXXX bpd production target for Phases I and II).

C. According to Federal Budget Supplementary Information dated March 19, 2007, accelerated capital cost allowance under paragraph 1100(1)(y) of the Regulations will be phased-out for certain oil sand projects. We are not providing any comment as to whether Phases I and II of the Project will be subject to the phase-out schedule contained in the Federal Budget Supplementary Information.

Yours truly,

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

1 ACO has acquired certain property that it has included in Class 41 of Schedule II of the Regulations. However, ACO has not claimed any capital cost allowance with respect to this property.