Canada: Key Components Of The BC Government’s LNG Tax And Emissions Framework

From British Columbia's spring budget, to the provincially-sponsored LNG conference in May, and throughout the summer, the message from LNG producers to the BC government has been consistent: in order to allow LNG projects proposed for the BC coast to proceed, the province needs to implement a consistent, affordable system of carbon pricing and income tax which allows BC to be competitive with world LNG producers.

The provincial government deliberated the issue over the summer and consulted with multiple stakeholders. In a rare fall sitting of the legislature, the government delivered a draft climate change bill and a draft tax bill that it hopes will encourage the development of LNG facilities, and, at the same time, meet the province's emissions targets and provide the province with much-needed revenue.

The climate change bill and tax bill are expected to be in force by the end of November 2014. In this bulletin, we highlight the important components of both bills and the response from industry.

Greenhouse Gas Industrial Reporting and Control Act (Bill 2)

On October 20, 2014, the BC government introduced Bill 2, the Greenhouse Gas Industrial Reporting and Control Act, in the BC legislature.

Bill 2 limits emissions from LNG facilities to the equivalent of 0.16 Tonnes of CO2 per Tonne of LNG ("T/T") produced. According to the government, this emissions intensity level is lower than any other LNG facility in the world. The government has noted that the leading global LNG facilities produce between 0.18 and 0.27 T/T.

Owners may meet emissions targets by trading emissions credits (through a British Columbia registry) or by contributing to a clean-technology innovation fund to be established by the province at a rate of $25 per Tonne of CO2.

Most of the details, including the cost of any required contributions to the fund, are still to be determined by regulation.

The government has also stated that it will provide incentives to help facilities achieve the benchmark. For facilities producing between 0.16 and 0.23 T/T, an "escalating incentive" based on the facility's compliance costs will be provided. Sources have placed the incentive at 100% of the compliance cost at 0.16 T/T, declining to 50% at 0.23 T/T.

Liquefied Natural Gas Income Tax Act (Bill 6)

On October 21, 2014, the BC government introduced Bill 6, the Liquefied Natural Gas Income Tax Act.

Bill 6 sets out the features of the new LNG tax regime. The LNG taxation proposals have been the subject of great public scrutiny, ongoing negotiations and political pressure since they were announced in the 2014 BC Budget. This tax is levied on any taxpayer involved in "liquefaction activities" at an LNG facility in BC. This tax is in addition to existing federal and provincial taxes.

In introducing this Bill, B.C. Finance Minister Mike De Jong used an example of a hypothetical producer that would have paid approximately $1.5 billion in taxes over 10 years under the earlier proposals, and stated that the same producer would pay only $800 million under the revised taxing regime in the proposed legislation.

The significant components of the tax scheme include a tax of 1.5% on "net operating income", which many are referring to as the Tier 1 Tax, and a 3.5% tax (increasing in 2037 to 5%) on "net income" or Tier 2 Tax. The calculations of net operating income and net income, while starting with net income for regular income tax purposes, are subject to certain statutory adjustments.

In the calculation of "net operating income", no deductions are allowed for capital cost allowance (i.e. depreciation) or financing costs (including interest expense). However, a special "investment allowance," at a rate to be prescribed by regulation will be deductible.

In the calculation of "net income" losses from prior years, a deduction for capital investment may be claimed.

Finally, with respect to the calculation of income, it is important to note that income from LNG operations is broadly defined, and includes income from the purchase and sale of natural gas, income from operating LNG facilities (e.g. tolling arrangements), income from the sale of electrical power from an LNG facility, other ancillary sources of income, the purchase and sale of personal property related to LNG facilities, and the acquisition and disposition of LNG facilities themselves.

As previously announced, there is a mechanism to allow any Tier 1 Tax paid to be recovered against any Tier 2 tax payable in the current or a subsequent taxation year.

As is the case with many sophisticated tax regimes, there will be specific transfer pricing provisions setting out rules for the valuation of transactions between all non-arm's length parties - including self-dealing. This is significantly different from income tax that only applies transfer pricing rules to transactions with non-residents. It is not clear how these transfer pricing rules may be affected by income tax treaties that Canada enters into with other countries.

Proposed Legislation Allows for Tax Credits

There are two other important components of the proposed legislation. First, the legislation provides for a tax credit for "eligible expenditures" incurred on the closure of an LNG facility. The amount of the credit is subject to a limitation calculation based on the amount of Tier 2 Tax paid. The maximum claim is 5% of the eligible expenditures.

Second, a tax credit that applies against ordinary provincial income tax will be provided to corporations with a permanent establishment in BC. The tax credit is based on 0.5% of the inlet cost of natural gas at an LNG facility and may only be claimed in years when the corporate taxpayer is paying LNG income tax. Further, the credit cannot reduce the provincial corporate tax paid below 8%. The number of restrictions around this credit may have a significant impact on proponent structuring decisions.

Industry Response to LNG Framework

Reaction from industry has been positive so far. Representatives of producers have complimented the government for recognizing the reality of global competitive pressures and world conditions. Proponents have also expressed relief that the government has now provided some certainty around the tax and emissions trading regimes.

There has been some criticism of the GHG plan. Some critics have noted that the plan does not address GHG emissions from upstream facilities or at the wellhead. The LNG tax plan has been criticised for the sharply decreased revenue expected to be generated for the provincial government, compared to early estimates.

There remains much work to be done on the LNG file. The proposed projects face a myriad of challenges including softening commodity prices, increasing construction costs, shortages of skilled labour, and complicated regulatory hurdles. Nonetheless, these bills represent a significant step towards creating the economic certainty necessary for the other challenges to be met and for LNG projects to proceed.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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