Canada's new regime for the mandatory reporting of payments to government, the Extractive Sector Transparency Measures Act (ESTMA), came into force on June 1, 2015. Companies must begin reporting under ESTMA in their first full financial year after June 1, 2015.
ESTMA contains broad reporting obligations with respect to payments to governments and state-owned entities, including employees and public office holders, made by oil, gas and mining companies. It is intended to supplement anti-corruption measures enshrined in the Corruption of Foreign Public Officials Act (CFPOA) and the Criminal Code. The Canadian government has also noted that the purpose of these new standards is to improve transparency within the industry and to achieve alignment with similar measures set out in the EU Accounting and Transparency Directives (Transparency Directive) and the U.S. Dodd-Frank Wall Street Reform and Consumer Protection Act.
Companies in the extractive sectors should be reviewing this legislation closely in light of the significant penalties for non-compliance by firms and their directors, officers and agents and its broader impact on compliance and enforcement under the CFPOA, the U.S. Foreign Corrupt Practices Act and other anti-corruption regimes.
NRCan Consultations and Implementation Guidance
Natural Resources Canada (NRCan) released a suite of tools to assist companies during implementation. The draft of ESTMA implementation tools includes three separate documents: Guidance, Technical Reporting Specifications, and Reporting Template. These drafts were open for public consultation until September 22, 2015, but the final version of the Guidance and the Technical Reporting Specifications have yet to be issued.
These implementation tools are meant to provide guidance on the interpretation of ESTMA. They are not designed to be freestanding supplemental legislation. They do not have the force of law, and companies should always defer to the actual wording used in ESTMA.
Who Must Report?
The new reporting obligations apply broadly to not only entities listed on a Canadian stock exchange but also certain private companies. Section 8 of ESTMA sets out the organizations that are caught by the new obligations:
(a) an entity that is listed on a stock exchange in Canada;
(b) an entity that has a place of business in Canada, does business in Canada or has assets in Canada and that, based on consolidated financial statements, meets at least two of the following conditions for at least one of its two most recent financial years:
- it has at least $20 million in assets,
- it has generated at least $40 million in revenue,
- it employs an average of at least 250 employees; and
(c) any other prescribed entity.
These requirements are independent of one another, and if an entity falls within any of (a) to (c), it will be considered a "Reporting "Entity."
What is an Entity?
ESTMA provides an explicit and exhaustive definition of what constitutes an entity. Under ESTMA, an entity is defined to mean a corporation or a trust, partnership or other unincorporated organization
(a) that is engaged in the commercial development of oil, gas or minerals in Canada or elsewhere; or
(b) that controls a corporation or a trust, partnership or other unincorporated organization that is engaged in the commercial development of oil, gas or minerals in Canada or elsewhere.
Any company that is either Canadian or maintains operations or assets in Canada will be subject to these requirements, even with respect to its non- Canadian operations. The Guidance also provides two points of clarification. First, the company must be subject to Canadian law. Second, ESTMA does not apply to parent companies not subject to Canadian law which have subsidiaries operating in Canada.
There are four business forms that are considered entities under ESTMA: corporations, trusts, partnerships and other unincorporated organizations. The Guidance clarifies that these categories are intended to be interpreted broadly and apply to similar forms of business organizations, including but not limited to unlimited liability corporations, limited partnerships, royal trusts, crown corporations or state-owned enterprises. However, sole proprietors and individuals are not considered entities under ESTMA.
It is also important to note that, for the purposes of ESTMA (including part (b) of the definition of entity), control can be established directly or indirectly, in any manner. One detail that should be carefully considered is the scope of "indirect control," and the potential for non-traditional extractive entities (such as institutional financial or private equity investors) to be caught within the scope of ESTMA. The definition of "control" is also subject to future regulation, so this should be closely monitored. However, the Guidance has stipulated that, at a minimum, if an entity controls another under the appropriate accounting standards (e.g. IFRS, U.S. GAAP, etc.) it will generally be considered to control that entity for purposes of ESTMA.
The Guidance provides the following approaches for determining the size of an entity under s. 8(b) of ESTMA:
- Financial statements: The $20 million asset and $40 million revenue figures are obtained from the company's financial statements in the two previous years; it need only meet the requirements in one of the years to be considered a Reporting Entity.
- Gross assets: Assets should be calculated on a gross basis, not net.
- Total global assets and revenues: Assets and revenues should be calculated on global revenues and assets from all business areas, not just commercial development of oil, natural gas or minerals.
- Exclude parent entities: Global assets and revenues do not include the assets or revenues of a parent company.
- Currency: All non-Canadian currency financial
statements should be converted to Canadian currency for the purpose
of these tests using:
- the exchange rate as of the entity's financial year-end; or
- the entity's method of translating the currency of assets or revenues in its financial statements.
- Employee Test: The test for 250 employees should be calculated using the average of all employees of the entity over the two most recent financial years; employees include full-time, part-time or temporary employees; independent contractors do not constitute employees.
What is "Commercial Development?"
"Commercial development of oil, gas, or minerals" is also exhaustively defined under ESTMA to mean the exploration and extraction of oil, gas or minerals and the acquisition or holding of a permit, lease or other authorization to carry out any such activities. In addition, the definition explicitly contemplates the prescription of other activities in relation to oil, gas or mineral extraction.
The Guidance contains an explanation of what is meant by "commercial development." According to the Guidance, commercial development includes activities conducted in foreign jurisdictions. The definition of commercial development also applies to temporary periods of inactivity. This is especially important to note for entities with seasonal exploration programs — such programs would be subject to reporting obligations regardless of whether they were in an active or inactive season.
However, it is important to note that commercial development is not meant to extend to ancillary or preparatory activities or to post-extraction activities. Likewise, commercial development is not intended to include businesses that provide goods or services associated with or related to commercial development. Companies must still be vigilant about activities that technically fall outside the scope of "commercial development" as they are frequently intertwined with exploration or extraction activities and, as such, are subject to the reporting requirements.
What Must Be Reported?
Under ESTMA, all payments made to payees must be reported annually so long as the aggregate of all payments in a particular category of payment to a particular payee exceeds a minimum threshold of $100,000 per financial year. ESTMA also mandates that payments made to an employee or public office holder of a payee, including a state-owned entity, are deemed to be made to the payee and therefore such payments must be reported under the regime.
The term payee is expansive and includes any government (either in Canada or in a foreign state), any body of two or more governments, or other similar bodies conducting the functions of a government. State-owned enterprises are considered payees for the purpose of determining reporting obligations.
The Guidance clarifies that all payments made to a single payee should be totaled for the year to determine whether they meet the definition of a payment under s. 2 of ESTMA. Payments made by a Reporting Entity to the same payee that meet the $100,000 threshold in one category of payment must be disclosed. To determine if payment was made to the "same payee," the entity must group together departments, ministries, trusts, boards, commissions, corporations, bodies or other authorities that are established to perform a power, duty or function on behalf of a particular level.
In addition, ESTMA deems all payments made to all employees and public office holders of a payee to be made to that same payee. This is especially significant in the context of paying expenses or other monies to government officials or employees. In some jurisdictions it is legal and expected that private entities pay a per diem or other expenses of government inspectors or agents. While any individual may accrue only small per diem payments, the aggregate amount of all such payments made to the officials of a particular deemed payee may be significant.
This provides an additional concern for companies in regards to anticorruption compliance and controls. Payments that are otherwise legal under the CFPOA, or for which corrupt intent would be difficult to prove, are likely to be reportable. Failure to report payments could become a tool used by the RCMP as a lesser included charge to allow for some sanctions even if a corruption charge could not be fully made out.
Finally, ESTMA does not apply to payments made to Aboriginal governments in Canada for the first two years during which the legislation is in force. Aboriginal governments are intended to be within the scope of payee under ESTMA, and will be included after this two-year period.
Payments that fall outside of the seven categories provided in s. 2 of ESTMA do not need to be reported. The Guidance clarifies that the substance of the payment and not the form should be considered when categorizing a payment.
A Reporting Entity must report all payments made:
- by the Reporting Entity; and,
- by the entity controlled by the Reporting Entity.
The Guidance provides further clarification on the following categories of payments, which we have summarized below:
- Taxes: Taxes are intended to capture income,
profit, and production tax payments in relation to commercial
development of oil, gas or minerals. The term tax means any type of
government charge that is enforceable by law. Withholding taxes
need not be reported. Consumption taxes, even if related to the
commercial development of oil, gas or minerals do not need to be
reported. Examples of taxes that need to be reported include:
- income and profit taxes,
- capital gains taxes,
- capital taxes,
- mining taxes,
- windfall profits taxes,
- resource surcharges, and
- petroleum revenue taxes.
- Royalties: The Guidance suggests that royalties should be defined by their common meaning. Furthermore, it clarifies that in-kind royalties should be treated the same as other in-kind payments.
- Fees: It does not matter whether a payment, in cash or in-kind, is characterized as a fee. If it accomplishes the same purpose in substance as a fee it should be reported. This category is not meant to capture amounts paid in the normal course of commercial transactions in exchange for services provided by the government or their entities.
- Production Entitlements: A payee's share of oil, gas or mineral production extracted as part of a commercial development under a production sharing agreement or similar contractual or legislated arrangement should be categorized as a production entitlement. In-kind entitlements should be reported in their equivalent cash value. Volumes of production entitlements paid do not have to be reported.
- Bonuses: Payments which are in substance, regardless of their label, signing, discovery, production and any other type of bonuses paid to a payee in relation to the commercial development of oil, gas or minerals must be reported.
- Dividends: Dividends paid to a payee who is a normal shareholder of the entity need not be reported so long as the payee acquired the shares on the same terms available to others in the market and the dividend is paid to the payee on the same terms as other shareholders.
- Infrastructure Improvements: Whether they are cash or inkind payments, and whether they are payments made pursuant to a contract or not, they must be reported. The purpose is not to capture infrastructure improvement payments that relate primarily to the operational purposes of the Reporting Entity.
Reports under ESTMA are due within 150 days of the end of the financial year and must be accompanied by an attestation by a director or officer of the entity. If the entity retains an independent auditor, the auditor may certify that the report is true, accurate and complete in place of the attestation.
The form of the report is to be prescribed by the Minister in writing, and can be prescribed on a project-by-project basis. However, the aggregate thresholds will not be segregated by project. These requirements, and the reports themselves, will be public unless the regulations provide otherwise.
Penalties: Exposure for Companies, Directors and Officers
A compliance failure is punishable upon summary conviction with a fine of up to $250,000. This fine applies to any entity that fails to comply with the reporting requirements or orders issued by the Minister. The fine also applies to every person or entity that structures any payments or any other financial obligations or gifts with the intention of avoiding the requirements to report those payments. Notably, under ESTMA, each day that passes prior to a non-compliant report being corrected forms a new offence. Therefore, a payment that goes unreported for a year could result in more than $9 million in total liability.
ESTMA also applies to all officers, directors and agents of the offending entity who directed, authorized, assented to, acquiesced in or participated in the commission of the violation. Companies may consider retaining independent auditors to verify their financial reports as this could help minimize the possibility for any personal liability.
Due Diligence Defence
ESTMA includes a broad due diligence defence against liability. Paragraph 26(b) creates a defence to liability if the person or entity can establish that it "exercised due diligence to prevent" the commission of the offence. This provides a strong incentive for companies to adopt rigorous compliance regimes with the input of external counsel and the oversight of independent auditors.
While ESTMA provides for a due diligence defence, it makes no provision for any exemptions or exceptions where, many thought, one would be absolutely necessary: in regard to actions required by local law or contract. The reporting regimes of both the U.S. and EU also have no such exception. This may create serious conflicts for many companies, particularly multinational entities, where conflict exists between reporting obligations under Canadian law and confidentiality or privacy obligations in a foreign jurisdiction.
Substitution Determinations and the Global Trend Towards Transparency
The Canadian government's recent commitment to mandatory reporting builds on a global trend towards increased disclosure by extractive sector companies in hopes of reducing corruption related to resource development. The EU has established transparency rules for extractive industries (including the forestry sector) through its Transparency Directive.1 Similarly, the Securities and Exchange Commission (SEC) recently re-proposed rules under the Dodd-Frank Wall Street Reform and Consumer Protection Act to require that "resource extraction issuers" file annual reports disclosing the payments that they have made to domestic and foreign governments in relation to the commercial development of oil, natural gas, and minerals. 2
The Canadian government has already made an effort to align its legislative requirements with those of the EU. As of July 31, 2015, reports submitted to EU and European Economic Area member-states that have implemented the EU Transparency Directive at a national level may be submitted to the Minister of Natural Resources as a substitute for a report prepared under ESTMA. In order to use the substitution determination, a Reporting Entity must include an attestation statement in its report and specify the jurisdiction in which the substituted report was originally filed. It must also file within the timeline prescribed by the other jurisdiction. If the filing deadline in the other jurisdiction extends beyond 150 days after the end of a Reporting Entity's financial year, the Reporting Entity must inform NRCan within the deadline under the ESTMA. 3
If the payment disclosure rules that have been endorsed by the SEC are enacted in the U.S., it is anticipated that NRCan will similarly issue a substitution determination in an effort to ease regulatory burdens and harmonize Canadian anti-corruption and transparency legislation with that of its close trading partners.
Conclusions – An Eye to the Future
ESTMA compliance will be critical for both traditional extractives and private equity or institutional investors that maintain significant interests in the extractive sector. However, full implementation of the regime is not complete. The Guidance and other technical implementation tools remain in draft form, and firms should be attentive for completion and release of the finalized versions. The definition of control remains subject to future regulation. Finally, the implementation of ESTMA's provisions vis-à-vis Aboriginal governments remains in abeyance.
3. ESTMA, at s. 10(1) authorizing Extractive Sector Transparency Measures Act – Substitution Determination, July 31, 2015, http://www.nrcan.gc.ca/acts-regulations/17754
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