2014-2015 British Columbia budget highlights

Budget highlights

BC Minister of Finance, Michael de Jong, presented the 2014 BC Budget this afternoon, announced as Balanced Budget 2014. While steady growth for the BC economy is expected, the budget focuses on spending discipline with modest spending on priority areas. Additional funding of $415 million is provided to help make British Columbia more affordable for BC families, create jobs and stimulate growth.

The following is a summary of the tax highlights contained in the budget.

• Introduction of a Liquefied Natural Gas (LNG) income tax, a two-tier tax on income from the liquefaction of natural gas at LNG facilities in British Columbia.
• Taxes on cigarettes are further increased by $3.20 a carton, effective April 1, 2014.
• Increased threshold for the first time homeowners’ exemption from Property Transfer Tax.

Fiscal/economic outlook

The focus of the budget released today reinforces the commitment of prior budgets to deliver a “balanced” budget and projects surpluses of $184 million in 2014-2015, $206 million in the following year and $451 million in the third year. The fiscal plan includes contingencies to help manage unexpected costs and priority initiatives, including LNG development. Budget 2014 does not provide any additional funding to ministries for public sector compensation. Any future negotiated settlements will be provided from Contingencies vote allocations.

Measures in Budget 2014 include working to eliminate the deficit and reduce borrowings, which is critical in maintaining BC’s triple-A credit rating.

Annual spending is projected to grow at an average of 2.2%,compared to an expected annual average revenue growth of 2.6%. A number of tax policy measures are included in Budget 2014 and are projected to generate $181 million in net benefits to taxpayers. Economic growth is projected at 2.0% in 2014, 2.3% in 2015, and 2.5% in 2016, which is on track with estimates provided last year of 2.2% for 2014 and 2.5% for 2015.

The projected revenue growth of 2.6% will come from increased taxation revenues associated with increased corporate profits, personal income, job creation, housing starts and consumer spending, as well as tax revenues due to job creation and the temporary 2.1% increase in tax rates for individuals with incomes greater than $150,000 per year. This temporary tax measure is limited to two years (2014 and 2015).

Exports and manufacturing improved last year with steady demand outside of British Columbia for its products. The pace of BC employment is expected to continue to improve. The potential slowdown in domestic activity, weakness of the U.S. economic recovery, slowing demand for goods and services by Asia, fluctuating Canadian dollar and ongoing concerns about European Union member debt instability remain concerns for the BC economy.

Measures concerning business

• BC’s Scientific Research and Experimental Development Tax Credit extended for an additional 3 years to September 1, 2017. The credit is available to eligible taxpayers performing eligible research and development activities in the province.
• Film tax credits are extended to the Capital Region District for the purposes of the Distant Location Tax Credit, effective for productions beginning on or after February 19, 2014. This extension applies to both the Production Services Tax Credit and Film Incentive BC Tax Credit.
• Elimination of provincial corporate income tax preference for credit unions that allowed credit unions to benefit from a lower tax rate on a portion of their income. This will be phased out over 5 years starting in 2016. The federal preferential corporate tax rate is being phased out over 5 years commencing 2013.

Measures concerning individuals

• The June Update 2013 introduced the BC Early Childhood Tax Benefit of $55/month per child under 6, starting April 2015 for eligible families. The maximum benefit will be available to eligible families with family net incomes up to $100,000 and will be fully phased out at family net incomes of $150,000.
• Budget 2013 introduced the BC Training and Education Savings Grant of $1,200 for children born on or after Jan 1, 2007 and Minister de Jong confirmed that by the end of the fiscal year the BC government intends to work with the federal government to begin making payments. No matching or additional contributions are required in order to receive the grant. In order to claim the grant, a family is required to open an RESP account and apply for the grant before the child turns seven years old.
• BC’s Mining Flow-Through Share Tax Credit extended to the end of 2014.

Sales tax measures

• Exemption from provincial sales tax (PST) for new residents bringing or sending tangible personal property, used solely for a non-business purpose, into British Columbia is expanded to include such property that enters British Columbia within one year from the date the individual became a resident of British Columbia. Formerly, such goods had to be brought into British Columbia within six months of the person becoming a resident.  
• To facilitate carbon tax collection, the director is authorized to appoint a vendor as a collector up to four years retroactively. Penalties are clarified for retroactive collector appointments which may be imposed on a vendor who sells fuel before being appointed a collector.
• Purchase price of an accommodation sold with meals and services is the lesser of 15% of the total value of the consideration accepted by the accommodation provider or $100 per day, for accommodation providers that only sell packages for a single price, regardless of the type of services provided or the type of the accommodation provider.
• A number of BC PST clarifications are being made, and we note the Ministry of Finance has already re-issued PST Bulletins that are affected, with a summary of the relevant clarifications at the end of each such bulletin.

LNG tax measures

October 22, 2014

British Columbia releases the Liquefied Natural Gas (LNG) Income Tax Act & Greenhouse Gas Industrial Reporting and Control Act

The Honourable Michael de Jong, Minister of Finance for the Government of British Columbia released draft legislation, the Liquefied Natural Gas Income Tax Act, on October 21, 2014 in furtherance of the Liquefied Natural Gas (LNG) tax measures he had announced in February 2014. A summary of the February proposals is contained in our February 18, 2014 Canadian tax alert on the 2014-2015 BC budget highlights.
 
The LNG income tax has emerged as a key consideration in striking a balance among the stakeholders.

David Keane, President of the BC LNG Developers Alliance, which represents six LNG proponents, has consistently emphasized the need for the investors to have clarity and certainty of the fiscal framework. All proponents must be able to project all significant taxes in their economic analyses of whether or not to include a BC LNG project in their global portfolios.

While understanding the need for the proponents to provide a return to their shareholders, the Premier of British Columbia, Christy Clark, has repeatedly confirmed two main principles: The industry must be safe and clean and the people in British Columbia should receive an appropriate return for the consumption of the province’s supply of non-renewable natural gas.

The high level framework included in the 2014 BC budget set out a double-tier income tax structure which would apply to income from broadly defined ring-fenced activities of a liquefaction facility in British Columbia. The first tier of income tax (Tier 1 tax) would become payable when LNG production revenue exceeds allowable operating costs (positive net proceeds) and would be creditable against the second tier of tax (Tier 2 tax). Tier 2 tax would become payable when the operator’s “capital investment account” has been fully recovered through net proceeds.

The initial framework was silent on a number of critical questions, including the following:

• What costs are included or excluded in the capital investment account?
• Whether the capital investment account will be augmented notionally?
• Whether financing costs are deductible?
• How to price the cost of natural gas, sales of LNG, rental fees and processing fees for transactions and arrangements between non-arm’s length parties, under different possible structures?

The draft legislation provides answers to these questions and more. The government has also provided two helpful supplemental documents to the draft legislation to illustrate and explain the mechanics of the LNG income tax. Here are the links to those documents:

British Columbia’s LNG Income Tax – An Overview

British Columbia’s LNG Income Tax – Valuation Rules

Highlights of the draft legislation

• If enacted as proposed, the legislation will take effect for taxation years beginning on or after January 1, 2017 and will be applicable to taxpayers with income from “an LNG source”. An LNG source is defined to mean “liquefaction activities” carried out at or in respect of a particular LNG facility. As expected, the term “liquefaction activities” is defined broadly to capture activities related to various rights and arrangements involving the liquefaction of natural gas including the buying, owning and selling of LNG and natural gas at an LNG facility, the rights to receive income derived from LNG activities, the ownership and operation of an LNG facility, and the activities that support the construction, administration, operations and maintenance of an LNG plant.
• The tax will remain a two-tiered income tax as described in our February 18, 2014 tax alert. The Tier 1 rate will remain at the initially proposed 1.5% while the Tier 2 rate will be reduced from 7% to 3.5%, albeit with a scheduled increase to 5% in 2037. The government explained that the new Tier 2 rate is a result of changes in market conditions, notably the falling prices for LNG and the increase in construction costs. It is also hoped that this new rate will allow the proponents to start their projects, build strong foundations in the affected communities and establish a thriving industry for the long run.
• Tier 1 tax will become payable when the revenues from an LNG source exceeds allowable deductions and investment allowance (positive net operating income) and will be creditable against Tier 2 tax. Tier 2 tax will generally become payable when the LNG taxpayer fully recovers its capital investment account and cumulated net operating loss account through positive net operating income.
• The government has also introduced an amendment to the BC Income Tax Act to include a new Natural Gas Tax Credit that will take effect for taxation years beginning on or after January 1, 2017. This cumulative credit can reduce a taxpayer’s BC corporate tax rate from the current 11% to as low as 8% for taxpayers with a permanent establishment in the province. The credit is calculated as 0.5% of the eligible cost of the natural gas acquired or notionally acquired in the taxation year.

Answers to the above-noted critical questions:

• The capital investment account includes allowable capital costs (net of any financial incentives and after the add-back of any hedging costs and financial charges previously deducted from the original costs) of the tangible and intangible properties used for liquefaction activities at the LNG facility. Components of an LNG facility that can be included in the capital investment account include the systems to deliver, receive and measure natural gas into the liquefaction process, gas purification and liquefaction systems, storage tanks, marine loading systems and other supporting equipment and facilities such as an electrical power generator. Feedstock pipeline, any properties that are located upstream of a feedstock spur pipeline, and pipeline used to transport LNG from the LNG plant other than to load the LNG for shipment or to transmit LNG for regasification are excluded.
• Instead of any notional augmentation of the capital investment account, taxpayers will be able to deduct an investment allowance in the computation of net operating income. This allowance is calculated as a prescribed percentage (not released at this time) of three-quarters of the average adjusted capital investment account for the year. The adjusted capital investment account will essentially only contain the costs of the net tangible capital assets of the LNG facility.
• Generally, investors fund their investments in Canada partly through equity contributions and partly through intercompany debt financing, subject to strict Canadian income tax rules. The interest related to the debt is generally significant. However, the legislation confirmed that all financing costs, whether for related party or third party debts, as well as hedging costs, are not deductible.
• The draft legislation contains specific provisions that generally deem related party transactions and arrangements to be made on terms and conditions that would have been made between persons dealing at arm’s length. Furthermore, penalties may apply where a transfer pricing adjustment exceeding a specified threshold is made and contemporaneous documentation to support related party prices was not prepared.
• Where the ring-fenced liquefaction activities do not involve the purchase of natural gas and/or sale of LNG from/to a non-arm’s length party, the legislation will deem purchases or sales to have occurred at values determined using the transfer pricing rules adopted from the Canadian Income Tax Act but modified to fit LNG activities.

And more…

• The LNG tax legislation heavily references to the Canadian Income Tax Act. In fact, there is a broad provision stating “in any case of doubt, the provisions of this Act [the LNG Income Tax Act] must be applied and interpreted in a manner consistent with similar provisions of the federal Act”. The legislation also mirrors many of the anti-avoidance provisions in the Canadian Income Tax Act.
• Although net income for the purposes of the LNG tax will generally be calculated in a similar fashion as for corporate income tax purposes, there are numerous significant specific exceptions. As such, a separate determination of income for each purpose will be necessary.
• Unlike for corporate income taxes purposes, a taxpayer is required to calculate its LNG net income, determine its LNG tax liability and file separate LNG tax returns on a facility by facility basis.
• Taxpayers will be required to follow specific rules to value the cost of natural gas acquired from a third party at the inlet to an LNG plant. These rules essentially adjust the actual purchase price of the gas to reflect the cost to transport the natural gas to the LNG facility and a reference price based on the market price of natural gas at Spectra Station 2.
• LNG proponents will be able to elect to capture capital expenditures and operating net income or losses incurred prior to the effective date of the LNG Income Tax Act as if they were incurred after the Act is in force.
• For LNG operations carried on in a partnership, net income will be computed at the level of the partnership as if the partnership were a separate person; however, the LNG tax will be payable individually by the partners, based on their proportionate shares of the income and losses of the partnership, assuming the allocation is reasonable.
• For operations carried on in a trust, net income will be computed at the trust level and the trust will bear the incidence of the tax.
• For certainty, corporate income taxes are not deductible for LNG tax purposes and vice versa.

It will take some time for the proponents and their advisors to fully absorb the new legislation. However, as requested, the government has provided more certainty and clarity for the fiscal framework for LNG investments in British Columbia. 

Greenhouse gas emissions benchmarks for LNG

In an effort to be seen as a leader in climate action, the BC government previously introduced a “revenue neutral” carbon tax on July 1, 2008. The carbon tax applies on the purchase or use of fuels within the province and, since different fuels generate different amounts of greenhouse gas (GhG) when burned, the current rates applicable to each specific type of fuel vary but are designed to target a price on carbon of $30 per tonne of carbon dioxide equivalent (CO2e).

In addition to the carbon tax initiative, the Ministry of Environment tabled new legislation, the Greenhouse Gas Industrial Reporting and Control Act, in order to establish a world-class benchmark for GhG emission limits for LNG facilities in the province. For LNG, the benchmark is established at 0.16 tonnes CO2e per tonne of LNG production.

While many of the details are to be addressed in regulations that have not yet been released, the information in the government release provides that the LNG facilities which achieve an average GhG intensity at or below the 0.16 limit will earn performance credits that can be banked or sold. However, where the LNG facility exceeds the limit, it will be required to purchase offsets or technology fund units, the latter of which will be sold by the Ministry of Environment at a rate of $25/t CO2e and will be used for technology investment to reduce GhG emissions. Where a particular facility is above the 0.16 limit but emits less than 0.23 tonnes CO2e per tonne of LNG production, the facility will be still be required to achieve the stated 0.16 benchmark but will reportedly be entitled to receive incentives to reduce the cost of complying with this requirement. The incentives will be prorated based on the level of emissions within the 0.16 to 0.23 range but will be between 50-100% of compliance costs. These incentives would be funded by new taxes and royalties revenues earned in connection with the introduction of an LNG industry in BC. Failure to meet the required benchmark will be a violation of the “compliance obligation” of the LNG facility, and may be subject to administrative penalties and/or enforcement action up to commission of an offence which carries a fine up to $1.5M and/or imprisonment up to 2 years.

If we considered the carbon costs associated with an LNG facility that produced 5 million tonnes per annum, the expected carbon tax and GhG compliance costs, assuming an achievable target level of 0.20 t CO2e/t LNG production, would be:

• Carbon tax: 5,000,000 t * 0.20 t CO2e * $30/t CO2e = $30,000,000
• GhG compliance obligation: 5,000,000 t (0.20-0.16) * $25/t CO2e = $5,000,000

It remains unclear what portion, if any, of the compliance obligation costs may be offset by the incentive program to be introduced. However, it appears that a percentage ranging from 50-100% of the costs of meeting the compliance obligation would be provided where the LNG facility achieves a target emission level that is above the 0.16 benchmark but is less than or equal to 0.23 t CO2e. In our example, it would seem that a portion of the $5,000,000 compliance obligation cost would be subject to reduction under the incentive program because the actual level of emission achieved is less than 0.23 t CO2e. The reduction of costs to attain the 0.16 t CO2e benchmark, such as the cost to the LNG facility of acquiring offset or technology fund units would be in the range of 50-100% but presumably lie at a rate less than 75% reduction given where the achieved emission level lies within the range.

It appears that the commitment of the province to achieve a 33% reduction in the 2007 emission levels by 2020 will certainly be a challenge, notwithstanding the tax and GhG measures that have been introduced, given the projected emissions that will occur as a result of operating an estimated five LNG facilities in the province. Based on the benchmark standards, if the facilities produced a total of 80,000,000 tonnes per annum, this would equate to a minimum level of 12,800,000 CO2e, or approximately 20% of current levels. This, of course, does not include additional emissions expected in connection with upstream or transportation related activities connected with the LNG industry.

For further details, we refer you to the Ministry of Finance website. 

February 18, 2014

The government plans to table legislation for a new double-tiered LNG income tax this fall. This new tax and the return of the 7% BC PST in 2013 will be key cost considerations for organizations looking to invest billions of dollars in BC-based LNG facilities. The minister released a number of high-level details for the proposed tax regime today while noting that they are still subject to review and are to be determined and confirmed in legislation this fall.  

The following is a summary of the general mechanics of the LNG tax announced today.

• Tax is levied at the level of the LNG plant on downstream production income from liquefaction of natural gas at LNG facilities in British Columbia.
• Production income will include revenues from sale of liquefied natural gas, rents and fees for the use of a LNG facility and tolling fees for processing natural gas at a LNG facility, regardless of whether the LNG is exported or sold domestically.
• The first tier of income tax (Tier 1 tax), at a rate of up to 1.5%, becomes payable when LNG production revenue exceeds allowable operating costs (positive net proceeds).
• Tier 1 tax is creditable against the second tier of tax (Tier 2 tax).
• Tier 2 tax, at a rate of up to 7%, is payable when the operator’s “capital investment account” has been fully recovered through net proceeds.
• Both tier 1 and 2 taxes are to be calculated on a facility by facility basis, according to supplemental information provided to the stakeholders.
• The capital investment account will include the costs of constructing the LNG facility and making it operational.  A facility would include gas purification and liquefaction systems, storage tanks, marine loading systems and other supporting equipment and facilities.

In his speech to the stakeholders this morning, the Minister indicated that there are a myriad of complex factors that are still under consideration, including the following:

• What should be included in the capital costs of a LNG plant and what should be excluded?
• Whether there should be augmentation of these capital costs or not?
• The use of transfer prices to determine the cost of natural gas, sales of LNG, rental and processing fees, for transactions between non-arm’s length parties, under different possible structures.

Most, if not all, of the above major considerations will be determined and confirmed in legislation this fall. The government will continue its analysis of global economic and market conditions to ensure that the province receives its fair share of the value added from the liquefaction of natural gas in British Columbia while remaining competitive. The government is aiming to provide certainty on the major components of the new tax structure to the proponents this fall while the details for the administration and enforcement of the tax system will be tabled in the spring of 2015.

Finally, in the questions and answers period with the stakeholders, the Minister reconfirmed the government’s goal of having three LNG facilities in British Columbia by 2020, while noting the investment decisions for the proponents, the government and other stakeholders are complex and difficult with evolving world markets.

Guiding principles for the LNG tax structure

Per the BC government, the proposed taxation framework is based on four guiding principles: 

1. Appropriate share for British Columbians: The people in BC should receive an appropriate return for the consumption of the province’s supply of non-renewable natural gas.
2. Competitive jurisdiction:  The overall tax regime including all taxes will need to be competitive with similar jurisdictions for this type of LNG investment and with characteristics (e.g., skilled workforce, proximity to markets and gas reserves and cooler temperature) similar to British Columbia.
3. Predictability: Project proponents are to be provided with a clear description of the fiscal regime prior to final investment decision.
4. Level playing fields for the proponents: All proponents will be subject to the same framework.

Corporate income tax impact for potential investors

Companies carrying on business in British Columbia are subject to a combined federal and provincial income tax rate of 26%. LNG producers will be subject to a higher rate of tax, possibly up to another 7% of tax. Furthermore, due to the nature of the Tier 1 tax, producers may be required to pay LNG tax when they are not sufficiently profitable to be subject to corporate income taxes.

Under the current federal and BC regimes, income taxes are not deductible unless specifically allowed. Therefore, the proposed LNG tax would not be deductible unless the federal government takes steps to provide relief. In addition, the federal government can provide further assistance by accelerating tax depreciation for LNG production facilities (presently depreciable at a low rate of 8% on a declining basis).

For potential investors facing large upfront capital outlays and high uncertainties, the announcement of the tax follows on the heels of last year’s return of the 7% provincial sales tax (PST) regime, and at a time when many are predicting a reduction in the premium currently associated with oil-linked LNG contracts.  

Comparison to competing countries

The BC government reviewed the tax and royal regimes of key competitor jurisdictions, such as Australia and the United States, particularly with respect to the proposed BC LNG income tax and concluded the proposed framework appears competitive when compared with the frameworks in those jurisdictions.

Contacts

Ron Loborec
Partner, National E&R Leader
and Co-Leader LNG
604-640-3811

Jamie Sawchuk
Partner, BC Public Sector and
Co-Leader LNG
250-978-4448

Racim Gribaa
Managing Director, Oil & Gas practice, specializing in LNG
403-503-1423

Geoff Hill
National Oil & Gas Leader
403-267-1820

Christopher G. Roberge
Partner, Tax and Legal in China
+852 28525627

Peter Letal
Partner, National Oil & Tax Leader
403-267-1818

Susan Chan
Partner, Inbound Tax and E&R Tax
604-640-3352

Lisa Zajko
Senior Manager – Indirect Taxes
604-640-3057

Other tax measures

• Tax rate on cigarettes increased effective April 1, 2014 from $44.60 to $47.80 per carton and the tax rate on fine-cut tobacco is increased from 22.3 cents per gram to 23.9 cents per gram.  
• First Time Homebuyers’ threshold increased for registrations on or after February 19, 2014 to $475,000 from $425,000.  Properties valued between $475,000 and $500,000 will be eligible for a partial exemption. Eligible first time homebuyers can save up to $7,500 in property transfer tax on the purchase of their home.
• Homeowner grant phase-out threshold decreased from $1,295,000 to $1,100,000 for the 2014 tax year.  The threshold enables 93.8% of homeowners to claim the full grant, while 95% were eligible for the full grant under the previous threshold.
• Medical Services Plan premiums will increase effective January 1, 2015 by about 4%. Premium assistance is enhanced so the increase will not affect those receiving assistance.
• Under property deferment programs where a property becomes subject to an easement, eligible homeowners can defer property taxes until the home is sold, transferred to a new owner or becomes part of an estate if they meet a minimum equity requirement.
• Property of a university that is leased to a college affiliated with the university is exempt from property taxation so long as it is held for college purposes. This exemption will be retroactive to the extent necessary to give it effect for the 2014 taxation year.

For further details, we refer you to the Ministry of Finance website.

Contacts

Canadian managing partner, Tax
Heather Evans
416-601-6472

National tax policy leader
Albert Baker
416-643-8753

Vancouver
BC Managing Partner, Tax
Etienne Bruson
604-640-3175

Partner, Tax
Susan Chan
604-640-3352

Senior Manager, Tax
Tracy MacKinnon
604-640-3072

Calgary
National Oil and Gas Tax Leader
Peter Letal
403-267-1818

This publication is produced by Deloitte LLP as an information service to clients and friends of the firm, and is not intended to substitute for competent professional advice. No action should be initiated without consulting your professional advisors. Your use of this document is at your own risk.