On February 19, 2015, the federal government released proposed amendments to the Income Tax Regulations which would generally allow for accelerated capital cost allowance (“CCA”) treatment in respect of certain property used in connection with liquefying natural gas. The proposed amendments are of principal significance to those in the liquefied natural gas (“LNG”) industry.
Under the current rules, equipment and structures used for natural gas liquefaction are generally included in Class 47, which carries a CCA rate of 8%. Other commercial buildings located at a facility that liquefies natural gas are generally entitled to a 6% CCA rate (the standard 4% rate applicable to Class 1 assets plus an additional 2% allowance for a building which is substantially used for a “non-residential use”).
The draft regulations (link here) would allow an additional 22% CCA claim for “eligible liquefaction equipment” (“ELE”), thereby bringing the total annual CCA rate to 30%. In general, ELE would include equipment – other than “excluded equipment” – used in connection with the liquefaction of natural gas that:
- is acquired after February 19, 2015 and before 2025;
- was not used or acquired for use for any purpose before it was acquired by the taxpayer; and
- is used as part of a liquefaction facility (i.e., a self-contained system – including buildings, structures, and equipment – that is used for the purpose of liquefying natural gas).
As such, liquefaction equipment acquired prior to the release of these proposed amendments will not be eligible for the accelerated CCA claim.
“Excluded equipment” generally means the following properties:
- pipelines (other than pipelines used to transport LNG or natural gas within a liquefaction facility during the liquefaction process);
- regasification equipment; and
- electrical generation equipment.
A separate proposed amendment will bring the CCA rate for commercial buildings that are part of liquefaction facilities up to 10%.
The new CCA rates will continue be calculated on a declining-balance basis. In addition, the usual rules regarding CCA, such as the “available for use” and “half-year” rules, will continue to apply in respect of property entitled to either of the accelerated CCA rates.
One critical aspect of the proposed amendments is that the additional CCA allowances may only be claimed against income attributable to “eligible liquefaction activities.” That term generally encompasses income that either:
- in the case of natural gas owned by the taxpayer at the time it enters their liquefaction facility, arises from the sale of LNG; or
- in any other case (e.g., where the taxpayer liquefies natural gas owned by a third party), is reasonably attributable to liquefaction services provided.
Special rules may apply if the taxpayer carries on more than one business (e.g., one business of liquefying natural gas and another business of extracting, transporting, or distributing LNG).
The proposed amendments have yet to be tabled in Parliament, but are undoubtedly welcome news to members of the LNG industry.
In 2014-0529981I7, the CRA Rulings Directorate considered a case where partnership interests and a debt obligation (Particular Note) owed by a partnership were sold mid-year. No portion of the partnership’s loss for the year was allocated to the selling partners. On audit, the local Tax Services Office (TSO) proposed to reallocate a pro rata portion of the partnership’s loss to the selling partners under s. 96(1.01) and s. 103. The TSO also proposed to treat the sale of the Particular Note as engaging the debt-parking rules in s. 80.01. The Rulings Directorate disagreed with the TSO on both accounts.
- With respect to the reallocation of the partnership’s loss, s. 96(1.1) does not require any particular allocation method. The allocation is governed by the partnership agreement, as contemplated by s. 96(1). In rejecting the proposed assessment under s. 103, the Rulings Directorate cited a 1985 CRA Roundtable Answer where the CRA said that s. 103 should not apply “…in bona fide situations – that is, where a partner is acquiring an interest with a view to becoming an ongoing member of the partnership”.
- The Rulings Directorate further said the debt-parking rules in s. 80.01 were not engaged because at no time did the various owners of the debt obligation deal at arm’s length with the debtor (i.e., the Partnership). Further, at both times that the Particular Note was acquired by another person the other person was related to the holder of the Particular Note.
In Repsol Canada Ltd. v. The Queen, 2015 TCC 21, the Tax Court of Canada found that a deep water pier and plant (Facility) in New Brunswick qualified as a processing asset included in Class 43 for the 2007 taxation year. The Facility was used for receiving, unloading, and storing liquid natural gas (LNG), and re-gasifying the LNG into methane (having required specifications) for sale into a transmission pipeline system. This activity was sufficient to constitute “processing”. The Facility was not included in Class 1(n), as part of a gas distribution system, because the activities at the Facility were conducted prior to the methane entering into a transmission/distribution pipeline system. The capital cost allowance regulations were subsequently amended to include LNG plants in Class 47, depreciable at 8% per annum. Deep water piers are specifically excluded from Class 47. Presumably such piers remain processing assets included in Class 43 based on the reasoning in Repsol Canada Ltd.
In 2013-0509771E5, the CRA confirmed that oil & gas royalties earned by a U.S. resident are subject to tax in Canada and no relief is available under the Canada-US tax treaty (Treaty). Such royalties constitute income from immovable property as contemplated under Article VI of the Treaty, which preserves Canada’s right to tax the income. Article VII of the Treaty does not apply because the income is described in another article of the treaty (i.e., Article VI). Article XII of the Treaty does not apply because oil & royalties are not captured by the definition of royalties in that Article. In Canada, the oil & gas royalties are subject to 25% withholding tax under Part XIII or are taxable under Part I if the U.S. resident carries on business in Canada through a permanent establishment (see s. 115(1)(a), Reg. 805, and Reg. 8201). The U.S. resident will also be subject to taxation in Canada if the U.S. resident either sells a Canadian resource property (s. 115(1)(a)(iii.1) & (iii.3)) or ceases to carry on a resource business in Canada (s. 115(4)). In all events, the Canadian payer will also have reporting and potential withholding obligations in Canada.
In 2014-0541921E5, the CRA said that no debt forgiveness should arise under s. 80 if a debtor has a contingent right to reduce a commercial debt obligation, where it is reasonable to conclude (having regard to all the circumstances) that the right will become exercisable. Where such a contingent right to reduce exists, s. 143.4 should apply to reduce the expenditures that were funded by the debt obligation. The debt obligation would be considered an “excluded obligation” under subparagraph (a)(ii) or (iii) of the definition of that term in s. 80(1), with the result that debt forgiveness should not arise under s. 80 when the debt obligation is ultimately settled or extinguished in law.
In 2014-0539191E5, a Canadian corporation (A Co) with a December 31 taxation year end had a significant interest in a partnership (Partnership) with a fiscal period also ending December 31. On August 1, 2014 A Co amalgamated with its wholly-owned subsidiary forming Amalco, resulting in a deemed year-end for A Co of July 31, 2014. Amalco established December 31 as its first taxation year end. On these facts, the CRA confirmed that A Co would not recognize any income from the Partnership for A Co’s short taxation year January 1 to July 31, 2014. The partnership income deferral rule in s. 34.2(2) would not apply to A Co because no fiscal period of the Partnership ended in A Co’s short taxation year. Furthermore, the rule in s. 34.2(2) also did not apply to Amalco, because the end of the Partnership’s fiscal period fully aligned with Amalco’s first taxation year end: i.e., December 31, 2014.
In two recent interpretations, the CRA confirmed that it has no power to refund tax where the applicable limitation period had expired.
- In the first case (2014-0538901E5), a non-resident corporation (NR Co) carried on a service business in Canada and did not file tax returns within three years from the end of the taxation years in question. Canadian tax under Part I was withheld and remitted to the CRA by the payer under Regulation 105. The CRA later reassessed NR Co for additional tax under Part I, to which NR Co timely objected. NR Co paid the reassessed tax to stop interest from running. The CRA ultimately agreed with NR Co’s objection because NR Co did not have a permanent establishment in Canada under the applicable tax treaty. However, NR Co could not obtain a refund of any tax paid under Part I because NR Co had not filed original tax returns within the 3-year limitation period required by s. 164.
- In the second case (2014-0542061E5), a hypothetical Canadian corporation (Canco) lent funds to its non-resident parent corporation (Parent) and paid Part XIII withholding tax (WHT) on the loan because the loan was not repaid within 2 years. More than 2 years after the end of the calendar year in which this WHT was paid, Canco late-filed a pertinent loan or indebtedness (PLOI) election under s. 15(2.11)(d) and s. 15(2.12), and requested a refund of the WHT paid on behalf of the Parent. On these facts, the CRA said the refund would not be available under s. 227(6) because the application for the WHT refund was not made within 2 years after the end of the calendar year in which the WHT was paid.
A tax-free inter-corporate dividend in Canada can sometimes be converted into a taxable capital gain under s. 55(2) if the purpose of the dividend (or the effect of the dividend if the share is redeemed) is to reduce the accrued gain on the share and the gain is attributable to anything other than underlying income that has been earned and retained (Safe Income). In 2014-0522991C6, the CRA confirmed its long-standing assessing practice to apply s. 55(2) only to the amount by which the dividend paid on a share is greater than the Safe Income attributable to the share, notwithstanding that technically the entire dividend could be assessed as a capital gain under s. 55(2). Accordingly, even if a corporate taxpayer (for some reason) self-assessed the entire dividend as a capital gain under s. 55(2), the CRA would reassess to reverse this result to account for underlying Safe Income – invoking the general anti-avoidance rule in s. 245 if necessary.
In 2014-0525231I7, a Canadian company (Canco) received a dividend from its foreign affiliate (FA) in Japan then sold the shares of FA at no gain. Canco had no other income from a source in Japan. The pre-sale dividend was subject to withholding tax (WHT) in Japan and the question was whether this WHT qualified for a foreign tax credit (FTC) in Canada under s. 126(1). It did not.
- The dividend was paid from FA’s preacquisition surplus, with the result that an amount equal to the dividend less the WHT reduced Canco’s ACB of its FA shares under s. 92(2).
- This reduction drove Canco’s ACB of its FA shares negative, resulting in a deemed capital gain to Canco under s. 40(3).
- The CRA’s longstanding position is that a gain under s. 40(3) is Canadian-sourced. As a result, the WHT paid in Japan could not give rise to a FTC under s. 126(1).
- Article 21 of Canada-Japan tax treaty was of no assistance to Canco because the deemed gain under s. 40(3) was not taxed in Japan.
In Kennedy & Ors v. Kennedy & Ors,  EWHC 4129 (Ch), a voluntary distribution (appointment) of shares was mistakenly made from a trust to a beneficiary, generating a large tax liability in the UK. The UK’s High Court of Justice Chancery Division said the principles set out in Pitt v Holt,  2 AC 108 were satisfied in this case. The beneficiary mistakenly believed the particular clause in the document, which distributed the entire remainder of the trust fund including the shares, gave effect to his earlier instructions under which the particular shares were not to be distributed to him. The trustees mistakenly believed the clause was in accordance with the beneficiary’s instructions (paragraph 37). These mistakes were causative and very serious (paragraph 38), did not involve artificial tax avoidance (paragraph 39), and were such that it would be unjust to leave them uncorrected (paragraph 36). As to the remedy, the mistake made the non-contractual voluntary disposition voidable in equity not void at law (paragraph 41). The equitable remedy of rectification was not available on the evidence, as this would mean rewriting the clause to exclude from the distribution the particular shares only (paragraph 43). The equitable remedy of rescission applied because the clause was self-contained and severable and could be rescinded in its entirety (paragraph 46).