On Oct. 30, as part of its annual Fall Economic Statement, the Ontario government unveiled plans to amend the regulations under the Electricity Act, 1998 (the "EA") in an effort to remove barriers to consolidation among local distribution companies ("LDCs"), otherwise known as municipal electricity utilities ("MEUs").
This move signals a renewed push towards consolidation in Ontario's highly fragmented electricity distribution sector, which currently consists of approximately 61 LDCs varying widely in size, capability and customer base. The rationale for consolidation in the LDC sector is the potential to boost efficiency, lower electricity rates and improve reliability.
It is also hoped that the proposed changes would assist in attracting significant private investment into the sector in anticipation of the vast changes coming as a result of electrification and the energy transition.
Background on existing tax measures
Currently, under the EA, Ontario's LDCs benefit from certain tax incentives which are set to expire after Dec. 31, 2024. These include:
- Elimination of transfer tax on the sale of LDCs with fewer than 30,000 customers.
- Reduced transfer tax rate (22 per cent instead of 33 per cent) for LDCs with over 30,000 customers.
- Elimination of capital gains taxation under the departure tax provisions of the EA.
Ontario's proposed changes
The Ontario government has now announced that it will amend the regulations under the EA to extend and expand upon the existing tax incentives. Key proposed changes include:
- Extending the transfer tax exemption for LDC acquisitions until Dec.31, 2028 and setting the transfer tax rate to zero for all LDC acquisitions, regardless of size.
- Continuing capital gains exemptions from payments in lieu of taxes ("PILs") arising under the departure tax provisions of the EA.
These amendments aim to encourage private sector investment in the LDCs and accelerate consolidation in a sector that remains highly fragmented. The government argues that larger, consolidated utilities will be better positioned to make needed infrastructure investments, improve operational efficiency, and keep electricity rates affordable for consumers.
The federal government's role
While Ontario has taken steps to encourage LDC consolidation, the federal government's role remains crucial in addressing key barriers to the process. The tax rules in the EA are not the primary obstacle to LDC consolidation. In fact, mergers between two or more LDCs can already occur without triggering PILs departure tax or transfer tax.
The real challenge for LDCs lies in attracting new, non-municipal capital investment to help fund the significant investments required to meet the net-zero targets associated with the increased electrification of our economy, without causing non-municipal ownership to fall below 90 per cent.
Current industry projections in Ontario show anticipated capital required to meet these electrification objectives to be in the range of thirty billion dollars or more—and there is, at present, no source of available capital to achieve this. If this 90 per cent ownership threshold is not maintained, the departure tax is automatically triggered (and potentially transfer tax as well).
While Ontario's recent measures temper these tax impacts, they do not eliminate them entirely. For larger LDCs, a departure tax event can still be prohibitively expensive, as much of an LDC's value would be in the form of depreciable property which, when subject to a deemed disposition, would give rise to recaptured depreciation rather than a capital gain, thus triggering departure tax.
The LDC community has been actively lobbying the federal government to address this 90 per cent threshold issue. Lowering this threshold would allow LDCs to maintain income tax-exempt status and avoid triggering departure tax while permitting non-municipal investors to invest more than the current 10 per cent limit. This change could significantly facilitate private investment in the sector thereby providing funding for the required investments, accelerating consolidation and creating the conditions for innovative development and investment across the LDC sector.
Conclusion and outlook
There have been discussions at the federal level about potentially lowering this threshold. However, the current political landscape presents challenges to driving policy action. With a minority parliament and a looming election, there's a not insignificant possibility that parliament may prorogue, potentially further delaying any progress on this issue.
Critics argue that creating exceptions to this tax policy specifically for the energy sector might not be constructive, as it is designed to be universally applied. However, it is arguable that enabling non-municipal investment and promoting LDC consolidation serve to improve efficiency and grid innovation and are productive measures for the overall Canadian economy.
In sum, Ontario's proposed changes to the EA represents a welcome step. However, attracting private investment remains a critical challenge that could be addressed through federal action to address the 90 per cent ownership threshold.
As discussions continue, policymakers must balance investment incentives with local control and consumer protection. The outcome of these efforts will shape Ontario's electricity distribution landscape and its ability to adapt to and benefit from the energy transition for decades to come. With ongoing pressure for grid modernization, collaboration between provincial and federal governments will be essential in ensuring a resilient electricity system.
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