27 August 1980 Income Tax Severed Letter

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.

EDMONTON DISTRICT OFFICE Mr. R. C. Neville Basic File Section

HEAD OFFICE Corporate Rulings Directorate C.J. Muirhead 593-6201

AUG 27 1980 XXXX

Proposed Audit Adjustments

This is in reply to your memoranda dated March 21, April 21 and 30, 1980, wherein you requested our views on the following proposed audit adjustments.

A. Progress Payments to Suppliers

It is our view, based on the information supplied by you (we understand that the purchase order to XXXX is representative of the purchase orders in question), that the progress payments which have been made by XXXX are in the nature of advances towards future delivery of equipment being manufactured. Accordingly, until such time as the equipment is in fact manufactured and identifiable the Participants shall not have acquired depreciable property of a prescribed class.

Our rationale for the above conclusion is based on the Wardean Drilling Limited case (1969 CTC 265) wherein Cattanach, J. stated at 271:

"... it is my opinion that a purchaser has acquired assets... when title has passed, assuming that the assets exist at that tine, or when the purchaser has all the incidents of title, such as possession, use, risk, although legal title may remain in the vendor as security for the purchase price..." (emphasis added)

In the case at hand, although XXXX advanced approximately XXXX of the purchase price to the equipment manufacturers prior to the completion of fabrication of the equipment in question, an asset did not exist since the equipment had not been constructed nor was it in the process of being constructed. Therefore, we can not accept the argument that the advances made to the manufacturer should be regarded as the cost of depreciable property acquired by a XXXX

The only other argument that could be made by XXXX is that although they may not have acquired title to the equipment being manufactured they had all the incidents of title, that is, possession, use and risk. Since the equipment had not been constructed and was not in the process of being constructed this argument is not of use to the taxpayers.

As XXXX have not acquired prescribed machinery that is depreciable property of a prescribed class, XXXX cannot classify the advance payments as the cost of qualifying property as defined in subsection 127(10) of the Income Tax Act (the Act) for the purposes of the investment tax credit.

The Prime Metal Stage or its Equivalent

You have expressed concern that XXXX in the XXXX project have classified activities, which are in your view beyond the prime metal stage or its equivalents, as ore processing activities. If this classification is correct, the cost of assets used in such activities will qualify for inclusion in XXXX earned depletion base and class 28, and the income generated by such activities will qualify as resource profits within the meaning of Regulation 1204, from which the resource allowance may he deducted.

You are of the view that the prime metal stage or its equivalent in the XXXX and XXXX mining operations is attained during the initial extraction process, where the bitumen is separated from the sand and water. Activities beyond this stage (bitumen upgrading and synthetic crude oil production activities) should not be considered as ore processing activities but as a manufacturing and processing activity. In your view such activities are similar to the refining of oil which is a manufacturing and processing activity.

Although we agree that the bitumen upgrading and synthetic prude oil production activities are similar to other crude oil operations, we are of the view that in the case of XXXX and XXXX such activities are processing activities, provided that such activities are performed on the mine site and before the "plant gate". The term "plant gate" in this context means the final point of measurement of the substances recovered from the tar sands before delivery thereof from the project site or before delivery from the storage or stockpile facilities off the project site. In the case of XXXX the plant gate for the synthetic crude oil produced is at or near the pipeline inlet.

The above view is consistent with the views of the Department of Finance and Energy, Mines and Resources, which Departments were consulted prior to the giving of the advance income tax ruling that was given to XXXX

C. Classification of Assets

You rave requested our views on whether the following expenditures are correctly classified for capital cost allowance (CCA) purposes. Such classification will determine whether the expenditures qualify for Inclusion in XXXX earned depletion base (EDB) by virtue of Regulation 1205 to the Act and as qualified property, within the meaning of subsection 127(10) of the Act, for the purposes of the investment tax credit (ITC).

It has been suggested that all assets that are acquired for the purpose of gaining or producing income from a new mine must be classified and included in either paragraph (g) or (k) of Class 10 and that the description of property in paragraph (1) (formerly (ka)) refers only to "social assets" which are assets that were acquired for the mine community. We are of the view that a mining project consists of the following activities:

Extraction and Processing

Generally speaking, an integrated mining operation consists of two distinct operations: extraction (mining) and ore processing. The extraction operations comprise all activities conducted either underground or in the pit, and generally exclude any operations that take place above ground or beyond the "pit's mouth".

Since extraction (or mining) is viewed as ending at the pit's mouth, it is our view that "extraction from a mineral resource" includes only those activities that are related to the drawing forth of the ores from a mineral resource and that are conducted up to the pit's mouth or point of egress from the deposit.

The courts have confirmed the view that the extraction of ore and the ruling of concentrates are two separate operations: Bethlehem Copper Corporations Ltd. (73 CTC 345) confirmed Supreme Court of Canada (74 CTC 707).

Support Activities

We are of the view that support activities are those activities that are not directly associated with the extraction and ore processing activities. Support activities may include the development, generation, and transmission of power to the mining project, the provision of transportation facilities, and the provision of living accommodation for mine personnel.

In our opinion, the Regulations recognize the division of assets into those which are used in the extraction and ore procession activities and those which are supportive; paragraphs (g) and (k) of Class 10 include all extraction and processing assets while paragraph (1), (m) and (r) of Class 10 include those assets which are supportive of the mining activity.

Paragraph (1) of Class 10 is unambiguous. It refers to "Property acquired...for the purpose of gaining or producing income from a mine and providing services to the mine or to a community where a substantial portion of the persons who ordinarily work at the mine resides"(emphasis added). Property will be included in paragraph (1) of Class 10 if it provides a service either to the mine or to the community, or both. To accept the contention that the property referred to in paragraph (1) of Class 10 refers to only those assets that provide services to the community would render meaningless the phrase "provides services to the mine".

On the basis of the foregoing, the properties in question should be classified as follows:

1. Erection Pad

The "Erection Pad" is a structure and falls within paragraph (g) of Class 10. As the "Erection Pad" is not a building referred to in Regulation 4600(1) it will not qualify for the ITC. It will qualify for inclusion in XXXX EDB.

2. (a) XXXX and Related Expenditures

We agree with your conclusion that the XXXX and related expenditures provide a service to the mine in that the water diversion works keep water out of the mine area and provide a reservoir from which fresh water may be drawn for the processing activities. Accordingly, these assets should be classified as included in paragraph (1) of Class 10. The cost of such assets will not qualify for either the EDB or ITC incentives.

(b) Dykes and Tailings Disposal Assets:

It is our understanding that the word "tailing" when used in a mining context refers to the waste material rejected from the mill subsequent to the treatment or processing of the ore from the mine and the words "tailing pond" refer to an area for the impoundment of sill tailings. We also understand that in some mines the mill tailings have simply been damped into natural depressions and very little diking or damming is needed to contain them. The so-called dam is built up as the water evaporates from the tailings.

It is our view that a tailing dam/dike is a structure within the meaning of Class 3 and by virtue thereof the cost of such assets must be included in paragraph (g) of Class 10. Accordingly such expenditures will qualify for inclusion in. XXXX EDB but will not qualify for the ITC.

3. (a)

XXXXXXXX stated that the costs shown as XXXX constitute payments to the provincial government to cover the province's cost of relocating public bridges. On the assumption that XXXX did not enter into an agreement with the Province, wherein the costs of relocating the XXXX would be regarded as a gift to the Crown, and on the assumption that the costs were incurred prior to 1976, it is our view that XXXX have not

(i) made a gift to the Crown,

(ii) acquired depreciable property of a prescribed class (Regulation 1102(18) which deems payments made by a taxpayer to the above described circumstances to be property described in paragraph (1) of Class 10 is applicable to the 1976 and subsequent years only), or

(iii) incurred expenditures which will qualify for either the EDB or ITC.

It is our view that such costs may be regarded as eligible capital expenditures, within the meaning of paragraph 14(5)(b) of the Act.

(b) Permanent Site Roads Site Preparation and Roads

The costs that have been included in the above classifications cannot be regarded as the cost of depreciable property. Such costs should be classified as Canadian development expenses within the meaning of subparagraph 66.2(5)(ii) of the Act. Accordingly, although such costs would be eligible for inclusion in a XXXX EDB, the expenditures would not be eligible for the ITC.

4. Water Recycling Facility

Although water is a necessary ingredient in the ore processing activity at XXXX we cannot agree that the facilities that supply this water can be classified as machinery or equipment described is paragraph (k) of Class 10. It is our view that the facilities that supply water to the processing plant must be regarded as supplying services to the mine and accordingly the cost of such facilities falls within Class 10(1). Accordingly, the cost of such a facility will not quality for the EDB or ITC.

5. Sewers, Sewage Treatment

Construction Gas Line (Natural Gas) Fire Hall

It is our view that the cost of these facilities is clearly described in paragraph (1) of Class 10. The cost of such assets will not qualify for the EDB or ITC.

6. Power Lines:

We view the power lines that are used to supply power to the draglines, bucket wheel reclaimers and conveyors as an integral part of these machines. Accordingly, the facilities that supply power to the equipment on the mine site are included as Class 10(k) property. The cost of such property will qualify for the EDB and ITC.

Chief Mines Oils and Forest Industries Section Specialty Corporations Rulings Division Corporate Rulings Directorate

c.c. Brian B. Cooke Large file Case Manager Special Audit Section Toronto District Office Rsp/lb