26 January 1993 Internal T.I. 9232387 F - Certified Property - Natural Gas Processing Plant

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.

January 26, 1993

CALGARY DISTRICT OFFICE	HEAD OFFICE
J.B. Rooke	Resource Industries Section
Acting Chief of Audit	Peter Lee  (613) 957-8977

Attention:  Dave Mattie

Basic File Section

Certified Property Investment Tax Credit Natural Gas Processing Plant

XXXXXXXXXX

This is in reply to your memorandum of October 22, 1992, wherein you requested our opinion on whether a natural gas processing plant is "certified property" pursuant to the definition of this expression in subsection 127(9) of the Income Tax Act (the "Act").

Facts

The relevant facts which you provided are as follows:

1.     XXXXXXXXXX claims that the Plant is a "certified property" pursuant to the definition of this expression in subsection 127(9) of the Act. Investment tax credits were claimed by XXXXXXXXXX accordingly.

2.     XXXXXXXXXX described the activities undertaken at the Plant (the "Plant Operation") as follows:

(a)     inlet separation and metering of raw natural gas ("sour gas");

(b)     compression and dehydration of sour gas, and condensate (C5+ liquid) is separated and removed;

(c)     refrigeration of the remaining sour gas whereby propane and butane liquid mix is removed from the gas through a gravity process (N.B., these gases are heavier than natural gas);

(d)     removal of hydrogen sulphide (H2S) which is heated and mixed with air to form acid gas, sulphur dioxide (SO2);

(e)     removal of sulphur from the acid gas through a sulphur plant (the "Sulphur Plant") which is part of the Plant; and

(f)     the resultant natural gas ("sweet gas") which meets the pipeline-quality specification is then piped to a third party sales pipeline.

3.     The cost of the Sulphur Plant is equal to $XXXXXXXXXX (32% of the aggregate cost of the Plant).

4.     In the process of converting sour gas into sweet gas as described in 2 above, the shrinkage is approximately 11.66%. The final products resulting from the process consist of sweet gas, propane and butane liquid mix, condensate and sulphur. David Mattie has informed us that sulphur is generally considered as a by-product of the process and its market value is substantially lower than that of the other final products, and that sulphur generally requires further processing or manufacturing (e.g., it is further processed into fertilizer) for final use.

Issue

5.     The issue is whether the Plant would qualify as a "certified property" for investment tax credit purposes. Specifically, whether the Plant would fall within the ambit of a "facility" as defined for the purposes of the Regional Development Incentives Act (the "RDIA") under paragraph (b) of the definition of the expression "certified property" in subsection 127(9) of the Act. David Mattie has informed us that all of the other requirements of the definition of the expression "certified property" have been satisfied.

Law

6.     The expression "certified property" is defined in subsection 127(9) of the Act as follows:

     "certified property" of a taxpayer means any property (other than an approved project property) described in paragraph (a) or (b) of the definition "qualified property"

(a)     that was acquired by the taxpayer

(i)     after October 28, 1980 and

(A)     before 1987, or

(B)     before 1988 where the property is

     (I)     a building under construction before 1987, or

     (II)     machinery and equipment ordered in writing by the taxpayer before 1987,

(ii)     after 1986 and before 1989, other than a property included in subparagraph (i), or

(iii)     after 1988,

     and that has not been used, or acquired for use or lease, for any purpose whatever before it was acquired by him, and

(b)     that is part of a facility as defined for the purposes of the Regional Development Incentives Act and was acquired primarily for use by the taxpayer in a prescribed area.

The terms "facility" and "operation" are defined in section 2 of the RDIA, as amended, as follows:

"facility" means the structures, machinery and equipment that constitute the necessary components of a manufacturing or processing operation, other than an initial processing operation in a resource-based industry;

"operation" means, (a) in relation to a facility, the manufacturing or processing operation of which the facility constitutes the necessary components....

Subsection 2(2) of the Regional Development Incentives Regulations (the "RDI Regs"), as amended, provides definitions for the purposes of the RDIA and the RDI Regs. The relevant parts of these definitions are as follows:

"manufacturing or processing operation" means an operation whereby any goods, products, commodities or wares are created, fabricated, refined or made more marketable, but does not include...

(c)     the extracting of minerals by any method,

(d)     the production of energy except as an integral part of and solely for use in an operation whereby any goods, products, commodities or wares are created, fabricated, refined or made more marketable...

(l)     the manufacture of primary petrochemicals from any source of hydrocarbon including the manufacture of methanol, ethanol, ethylene, propylene, butadiene, butylenes, benzene, toluene, xylenes and ammonia...

"initial processing operation" means an operation the product of which is a fossil fuel or a material mainly used for further processing or manufacturing, and includes the refining of petroleum, the production of newsprint and the processing of ores to form mineral concentrates, but does not include

(a)     the processing by roasting, leaching or smelting of mineral concentrates to produce metals...

(d)     the processing, other than petroleum refining, of a product resulting in a significant chemical change in the principal material used...

"resource-based industry" means an industry that uses as a principal material a material

(a)     the original location of which is not the consequence of human design, and

(b)     that is in or close to its natural state.

(Underlines are mine.)

XXXXXXXXXX

Position

7.     It is XXXXXXXXXX view that the Plant Operation does not constitute an "initial processing operation" for the following reasons:

(a)     one of the primary functions of the Plant is to extract sulphur and the conversion of H2S into sulphur is considered as a "significant chemical change in the principal material used"; and

(b)     the above-noted definition of the expression "initial processing operation" implies ineligibility only if some additional processing activity is to take place, but in the case at hand, the primary products generated by the Plant are generally not subject to any further processing.

Our Views

8.     In our opinion, the Plant is not a "certified property" for the purposes of subsection 127(9) of the Act by virtue of the fact that the Plant is not a "facility" as defined for the purposes of the RDIA. Our rationale is given in the following paragraphs.

9.     In order to qualify as a "facility", the Plant must comprise the structures, machinery and equipment that constitute the necessary components of a manufacturing or processing operation, other than an initial processing operation in a resource-based industry. In our opinion, the Plant constitutes the necessary components of a manufacturing or processing operation. However, we have to determine whether the Plant Operation is an initial processing operation in a resource-based industry.

10.      Pursuant to the above-noted definition of the expression "resource-based industry", the natural gas processing industry is a resource-based industry.

11.     The Manual of Oil and Gas Terms defines the expression "fossil fuels" as follows:

     Fuels occurring naturally in the earth, such as coal, oil, or natural gas.

     The Concise Oxford Dictionary defines the term "fuel" as follows:

     material for burning as fire or source of heat or power.

Pursuant to these definitions, the natural gas products, consisting of the final products other than sulphur as described in 4 above are fossil fuels. There is an argument that the expression "mainly used for further processing or manufacturing" in the above-noted definition of the expression "initial processing operation" modifies both the term "material" and the expression "fossil fuel". In the case of Stubart Investments Limited, 84 DTC 6305 (SCC), at page 6323, Estey, J. quoted with approval from the Construction of Statutes (2nd ed.) with respect to the modern rule of statute interpretation as follows:

Today there is only one principle or approach, namely, the words of an Act are to be read in their entire context and in their grammatical and ordinary sense harmoniously with the scheme of the Act, the object of the Act, and the intention of Parliament.

In our opinion, there is a respectable argument that the expression "mainly used for further processing or manufacturing" in the above-noted definition of "initial processing operation" modifies only the term "material" and not the expression "fossil fuel" in the normal grammatical construction. XXXXXXXXXX

Furthermore, we have been informed by David Mattie that sulphur generally requires further processing or manufacturing (e.g., it is further processed into fertilizer) for final use. Accordingly, in our opinion, the Plant Operation is an initial processing operation unless it results in a significant chemical change in the principal material used.

12.     We agree with the taxpayer's argument that the process of converting H2S into sulphur is a significant chemical change. However, H2S is not the principal material used in the Plant Operation. In our opinion, sour gas (approximately 88.34% of which is separated as sweet gas, and the rest is separated into condensate and propane and butane liquid mix or is converted into sulphur) is the principal material used in the Plant Operation and the main final products at the end of such operation are sweet gas, condensate and propane and butane liquid mix, which have the same molecular structure before and after the Plant Operation. Accordingly, in our opinion, the separation of sweet gas, natural gas liquid mix and condensate from sour gas is not a significant chemical change. In other words, the Plant Operation does not result in a significant chemical change to natural gas, which is considered as the principal material used in the Plant Operation. A representative of the Department of Energy, Mines and Resources agrees with this view. Accordingly, it is our opinion that the Plant Operation is an initial processing operation in a resource- based industry, that the Plant is not a facility for the purposes of the Act and the RDIA, and that the Plant is not a certified property for the purpose of the Act. XXXXXXXXXX

If we can be of any further assistance or if you wish to discuss any of the above, please contact the writer.

Acting Section Chief Resource Industries Section Manufacturing Industries, Partnerships and Trusts DivisionRulings Directorate