On February 19, 2015, the Canadian government released draft regulations introducing accelerated capital cost allowance (CCA) for facilities in Canada that liquefy natural gas. The government's intention is to encourage investment in new facilities to support the liquefied natural gas (LNG) industry in Canada.
The draft regulations provide for an additional 22-per-cent CCA allowance for equipment and structures used for natural gas liquefaction that will bring the total CCA rate to 30 per cent. Property eligible for the additional allowance (eligible liquefaction equipment) will include equipment that is part of an "eligible liquefaction facility," being a facility in Canada that liquefies natural gas, including controls, cooling equipment, compressors, pumps and storage tanks. Equipment acquired to produce oxygen or nitrogen is excluded, as are buildings, breakwaters, dock, jetties or wharves. Pipelines will also be excluded, except for pipelines used to move natural gas within an eligible liquefaction facility during the liquefaction process or LNG. Equipment used exclusively to regasify LNG and electrical generation equipment are also not eligible for the accelerated CCA rate.
The draft regulations also provide for an additional four-per-cent allowance for non-residential buildings at an eligible liquefaction facility (eligible liquefaction buildings) that brings the total CCA rate up to 10 per cent.
All eligible liquefaction equipment in relation to a particular facility is deemed to be a separate class of property, as are all eligible liquefaction buildings in relation to a particular facility.
The accelerated CCA rates only apply to equipment and buildings acquired after February 19, 2015 and before 2025. Further, the equipment or building cannot have been used or acquired for use for any purpose before it was acquired by the taxpayer. This "new equipment" requirement is similar to other accelerated CCA provisions in Canada—such as the clean energy generation and energy conservation equipment rules in Classes 43.1 and 43.2 of the Income Tax Regulations—and to the "new equipment" requirement for claiming investment tax credits for qualified property under subsection 127(9) of the Income Tax Act.
The regular "half-year" and "available for use" rules will apply to the accelerated CCA rates. Only half of the usual deduction will be available in the year the property is acquired or becomes available for use. Further, the property must be available for use before any CCA can be claimed.
The accelerated CCA will also be limited to the income from the taxpayer's "eligible liquefaction activities" in respect of the "eligible liquefaction facility." For this purpose, income will be calculated on a facility-by-facility basis.
An eligible liquefaction facility is defined as a self-contained system located in Canada—including buildings, structures and equipment—that is used or intended to be used by the taxpayer for the purpose of liquefying natural gas. The requirement that the eligible liquefaction facility be used or intended to be used by the taxpayer for the purpose of liquefying natural gas appears to exclude LNG facilities that may be leased to another taxpayer from qualifying for these new rules. However, the lessee taxpayer may qualify if the property is deemed to be acquired by the lessee as a result of the application of the provisions of section 16.1 of the Income Tax Act.
For purposes of determining the amount of additional CCA that may be claimed in respect of each facility, income from eligible liquefaction activities is to be calculated as if the taxpayer carried on a separate business and the only income of that business is from the liquefaction of natural gas at the taxpayer's eligible liquefaction facility. Taxpayers that own the natural gas when it enters the eligible liquefaction facility calculate their income based on the sale of natural gas that has been liquefied, whether sold as LNG or as regasified natural gas. Such taxpayers are deemed to acquire the gas that has been liquefied at a cost equal to its fair market value at the time it enters the eligible liquefaction facility for the purpose of calculating the income from the facility. This is different from the B.C. LNG income tax, which in non-arm's length situations prescribes a detailed calculation of the cost of natural gas when it enters the LNG facility. See our November 2014 Blakes Bulletin: B.C.'s Draft Legislation to Implement LNG Tax – Many Answers, Some Questions for more information.
Further, in computing income to determine how much CCA may be claimed, the only deductions permitted are those that are attributable to the income from the facility. For taxpayers that own the natural gas when it enters the eligible liquefaction facility, deductions are further limited to those deductions that are reasonably attributable to income derived after the natural gas enters the facility. These deductions would include direct costs. However, the proposed regulations do not provide further guidance on other deductions that will be considered to be attributable or reasonably attributable to the income. Based on the jurisprudence and the Canada Revenue Agency's administrative positions regarding similar situations, we would anticipate that these other deductions would include the "regular" CCA on eligible liquefaction equipment and buildings as well as CCA on "ineligible" property that is part of the facility, a reasonable portion of interest charges and an allocation of other indirect expenses (e.g., overhead) to the extent attributable to the income. Taxpayers may wish to consider structuring the financing of such facilities to maximize the amount of income from the facility to ensure that the maximum amount of CCA is available. For example, interest expense incurred on debt of a partner that is a member of a partnership operating an eligible liquefaction facility would not reduce the partnership's claim for additional CCA.
Taxpayers operating a "peak shaving facility," but who do not own the natural gas when it enters the eligible liquefaction facility, calculate their income based only on the natural gas distributed by the taxpayer that has been liquefied by the taxpayer. A peak shaving facility is an eligible liquefaction facility (or part of it) used to liquefy natural gas where the taxpayer distributes natural gas that is liquefied and regasified, which is subsequently commingled with natural gas that has not been liquefied. The apparent intention behind this rule is to put taxpayers that liquefy their own gas on a level playing field with taxpayers operating a peak shaving facility that distribute gas that they do not own. The rule ensures that taxpayers that distribute gas that they do not own from a peak shaving facility compute their income eligible for accelerated CCA only on gas that they actually liquefy, rather than all gas that they distribute.
Except for an eligible liquefaction facility that primarily liquefies natural gas not owned by the taxpayer for a fee, eligible liquefaction equipment will continue to be "specified energy property" as defined in the Income Tax Act. As a result, other than for taxpayers that are "principal business corporations," the specified energy property rules will still apply to limit the total amount of CCA that a taxpayer may claim in respect of specified energy property to, in general, the amount of the taxpayer's total income from those specified energy properties. As a consequence, a taxpayer having income from an eligible liquefaction facility but losses from other specified energy property may find that it is not able to claim the full amount of the accelerated CCA due to the application of the specified energy property rules.
Taxpayers reorganizing their business should carefully consider the impact of these rules. In many cases, the property will be deemed to remain in the same, separate prescribed class and still be eligible for the accelerated CCA rate, but planning will be required. Further, taxpayers may wish to consider the timing of any reorganization to ensure that income is available in the year to claim against the accelerated CCA. Otherwise, the newly reorganized taxpayer—although not subject to the half-year rule and still eligible to claim the accelerated rate—may not have enough income in the year from the LNG facility to claim the full amount of CCA.
The Department of Finance is inviting comments on the draft proposals until March 27, 2015. Interested parties may email or write to the Department at:
Tax Policy Branch
Department of Finance
90 Elgin Street
Ottawa, Ontario K1A 0G5
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.