Vol. 149, No. 12 — June 17, 2015

Registration

SOR/2015-117 May 29, 2015

INCOME TAX ACT

Regulations Amending the Income Tax Regulations (Accelerated Capital Cost Allowance for Facilities Used to Liquefy Natural Gas)

P.C. 2015-629 May 28, 2015

His Excellency the Governor General in Council, on the recommendation of the Minister of Finance, pursuant to section 221 (see footnote a) of the Income Tax Act (see footnote b), makes the annexed Regulations Amending the Income Tax Regulations (Accelerated Capital Cost Allowance for Facilities Used to Liquefy Natural Gas).

REGULATIONS AMENDING THE INCOME TAX REGULATIONS (ACCELERATED CAPITAL COST ALLOWANCE FOR FACILITIES USED TO LIQUEFY NATURAL GAS)

AMENDMENTS

1. (1) Subsection 1100(1) of the Income Tax Regulations (see footnote 1) is amended by adding the following after paragraph (a.2):

• (a.3) any additional amount that the taxpayer may claim in respect of property that is used as part of an eligible liquefaction facility for which a separate class is prescribed by subsection 1101(5b.2), not exceeding the lesser of
  • (i) the income for the taxation year from the taxpayer’s eligible liquefaction activities in respect of the eligible liquefaction facility (taking into consideration any deduction under paragraph (yb) and before making any deduction under this paragraph), and
  • (ii) 6% of the undepreciated capital cost to the taxpayer of property of that separate class as of the end of the taxation year (before making any deduction under this subsection for the taxation year);

(2) Subsection 1100(1) of the Regulations is amended by adding the following after paragraph (ya.2):

Additional Allowance — Class 47

• (yb) any additional amount as the taxpayer may claim in respect of property used as part of an eligible liquefaction facility for which a separate class is prescribed by subsection 1101(4i), not exceeding the lesser of
  • (i) the income for the taxation year from the taxpayer’s eligible liquefaction activities in respect of the eligible liquefaction facility (taking into consideration any deduction under paragraph (a.3) and before making any deduction under this paragraph), and
  • (ii) 22% of the undepreciated capital cost to the taxpayer of property of that separate class as of the end of the taxation year (before making any deduction under this subsection for the taxation year);

2. (1) Section 1101 of the Regulations is amended by adding the following after subsection (4h):

Class 47 — Liquefaction Equipment

(4i) If a taxpayer acquires property that is eligible liquefaction equipment to be used as part of an eligible liquefaction facility of the taxpayer, a separate class is prescribed for those properties that were acquired for the purpose of gaining or producing income from that eligible liquefaction facility.

(2) Subsection 1101(5b.1) of the Regulations is replaced by the following:

(5b.1) For the purposes of this Part, a separate class is prescribed for each eligible non-residential building (other than an eligible liquefaction building) of a taxpayer in respect of which the taxpayer has (by letter attached to the return of income of the taxpayer filed with the Minister in accordance with section 150 of the Act for the taxation year in which the building is acquired) elected that this subsection apply.

Liquefaction Buildings

(5b.2) If a taxpayer acquires property that is an eligible liquefaction building to be used as part of an eligible liquefaction facility of the taxpayer, a separate class is prescribed for those properties that were acquired for the purpose of gaining or producing income from that eligible liquefaction facility.

3. (1) Subsection 1104(2) of the Regulations is amended by adding the following in alphabetical order:

“eligible liquefaction building” of a taxpayer, in respect of an eligible liquefaction facility of the taxpayer, means property (other than property that has been used or acquired for use for any purpose before it was acquired by the taxpayer or a residential building ) acquired by the taxpayer after February 19, 2015 and before 2025 that is included in Class 1 in Schedule II because of paragraph (q) of that Class and that is used as part of the eligible liquefaction facility; (bâtiment de liquéfaction admissible)

“eligible liquefaction equipment” in respect of an eligible liquefaction facility of a taxpayer, means property of the taxpayer that is used in connection with the liquefaction of natural gas and that

• (a) is acquired by the taxpayer after February 19, 2015 and before 2025,
• (b) is included in Class 47 in Schedule II because of paragraph (b) of that Class,
• (c) has not been used or acquired for use for any purpose before it was acquired by the taxpayer,
• (d) is not excluded equipment, and
• (e) is used as part of the eligible liquefaction facility; (matériel de liquéfaction admissible)

“eligible liquefaction facility” of a taxpayer means 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; (installation de liquéfaction admissible)

“excluded equipment” means

• (a) pipelines (other than pipelines used to move natural gas, or its components that are extracted, within an eligible liquefaction facility during the liquefaction process or used to move liquefied natural gas),
• (b) equipment used exclusively to regasify liquefied natural gas, and
• (c) electrical generation equipment; (matériel non admissible)

(2) Section 1104 of the Regulations is amended by adding the following after subsection (17):

Classes 1 and 47 — Liquefaction Property

(18) For the purposes of paragraphs 1100(1)(a.3) and (yb), a taxpayer’s income for a taxation year from eligible liquefaction activities in respect of an eligible liquefaction facility of the taxpayer is determined as if

• (a) the taxpayer carried on a separate business
  • (i) the only income of which is any combination of:
    • (A) in the case of natural gas that is owned by the taxpayer at the time it enters the taxpayer’s eligible liquefaction facility, income from the sale by the taxpayer of the natural gas that has been liquefied, whether sold as liquefied natural gas or regasified natural gas, and
    • (B) in any other case, income reasonably attributable to the liquefaction of natural gas at the taxpayer’s eligible liquefaction facility, and
  • (ii) in respect of which the only permitted deductions in computing the separate business’ income are those deductions that are attributable to income described in subparagraph (i) and, in the case of income described in clause (i)(A), that are reasonably attributable to income derived after the natural gas enters the eligible liquefaction facility; and
• (b) in the case of income described in clause (a)(i)(A), the taxpayer acquired the natural gas that has been liquefied at a cost equal to the fair market value of the natural gas at the time it entered the eligible liquefaction facility.
  

COMING INTO FORCE

4. These Regulations are deemed to have come into force on February 19, 2015.

REGULATORY IMPACT ANALYSIS STATEMENT

(This statement is not part of the Regulations.)

Executive summary

Background

The extraction, sale and use of natural gas is an important part of Canada’s economy. Natural gas can be cooled to a liquid state (liquefied natural gas, known as LNG), thereby reducing its volume and facilitating its transportation and storage. The liquefaction of natural gas is a capital-intensive activity that requires large upfront investments.

Unlike current expenditures such as wages, the cost of capital property generally cannot be fully deducted in the year the property is acquired. A portion of the capital cost of a depreciable property is deductible as capital cost allowance (CCA) each year, with the CCA rate for each type of property set out in the Income Tax Regulations. The CCA rates are typically set so that the cost of depreciable property is recognized over the useful life of the property. Accelerated CCA treatment is sometimes provided as an exception to this general practice, allowing taxpayers to more quickly recover the cost of their capital investment.

• For example, an accelerated CCA was provided for investments in the oil sands in the early 1970s to help offset some of the risk associated with early investments to develop this strategic resource. Over time, the oil sands sector expanded to a point where the majority of Canada’s oil production now comes from oil sands and accelerated CCA is no longer required to encourage investment. As a result, the accelerated CCA for oil sand projects was gradually phased out between 2011 and 2014.

Equipment and structures used for natural gas liquefaction are generally included in Class 47 of Schedule II to the Regulations and are eligible for a CCA rate of 8%. Non-residential buildings at a LNG facility are currently eligible for a CCA rate of 6% (4% under Class 1 plus an additional 2% allowance for non-residential buildings).

The accelerated CCA treatment is for certain property acquired for use in facilities in Canada that liquefy natural gas

• — to supply LNG to international markets;
• — to supply LNG to domestic markets (e.g. for use in remote power generation or the high-horsepower engines used in trucking, shipping, rail, drilling rigs, and pressure pumping services); or
• — to store LNG in periods of low demand and then re-gasify it in periods of high demand (so-called “peak shaving”).

Issues

Canada has large reserves of natural gas, but has limited capacity to supply it to emerging international and domestic markets where demand is growing. In domestic markets, natural gas is sometimes liquefied in periods of low demand and then re-gasified in periods of high demand (so-called “peak shaving”). LNG is increasingly being used domestically in remote power generation and the high-horsepower engines used in trucking, shipping, rail, drilling rigs and pressure pumping services. The ability to supply LNG to both domestic and international markets represents an important market opportunity for Canadian natural gas.

In this regard, on February 19, 2015, the Government announced (http://www.fin.gc.ca/n15/15-016-eng.asp) the amendments to the Regulations to provide an accelerated CCA treatment.

Objective

These amendments to the Regulations build on existing advantages and make it more attractive to build facilities that liquefy natural gas in Canada. They

• — provide accelerated CCA treatment for investments in facilities that liquefy natural gas, which provides a financial benefit to a taxpayer by deferring taxation and allowing the taxpayer to more quickly recover the cost of their initial capital investment; and
• — help increase the capacity to supply Canadian natural gas to emerging international and domestic markets.

Description

The amendments provide an additional 22% allowance to bring the CCA rate up to 30% for Class 47 property used in Canada in connection with natural gas liquefaction.

• Property eligible for the additional allowance in respect of Class 47 comprises equipment that is part of a facility that liquefies natural gas, including controls, cooling equipment, compressors, pumps, storage tanks, and ancillary equipment, pipelines used exclusively to transport liquefied natural gas from the facility, and related structures.
• Equipment used exclusively for regasification is not eligible for the additional allowance. The additional allowance also does not apply in respect of property acquired for the production of oxygen or nitrogen, electrical generating equipment, and a breakwater, a dock, jetty, wharf or similar structure.

These amendments also include a second additional 6% allowance that will bring the CCA rate up to 10% for non-residential buildings that are part of a facility that liquefies natural gas.

Consistent with the current CCA rules, the additional allowances are calculated on a declining-balance basis whereby the CCA rate is applied to the undepreciated balance of the CCA class at the end of the previous year.

These additional allowances in respect of a facility that liquefies natural gas in Canada can be claimed only against income of the taxpayer that is attributable to the liquefaction of natural gas at that facility. This includes income of a taxpayer from

• — selling natural gas that was liquefied by the taxpayer if the taxpayer owned the natural gas when it entered the facility;
• — selling by-products from the liquefaction process; and
• — providing liquefaction services in respect of natural gas owned by a third party.

Where a taxpayer is not engaged exclusively in the operation of a liquefaction facility — because, for example, it is engaged in natural gas extraction, transportation or distribution — the taxpayer’s income attributable to the liquefaction of natural gas will be determined as though

• — the liquefaction facility were a separate business of the taxpayer; and
• — the cost to the taxpayer of natural gas that was owned by the taxpayer before it enters into the facility was equal to its fair market value.

The existing CCA rules, such as the “half-year” and “available for use” rules, apply in respect of the additional allowances.

The additional allowances apply to property acquired after February 19, 2015, and before 2025. However, property that was previously used, or acquired for use, before it was acquired by the taxpayer will not be eligible for the additional allowances.

Regulatory and non-regulatory options considered

No non-regulatory options were considered. Under the present legislative framework, for income tax purposes, a deduction is provided for CCA in respect of a property of a taxpayer under Part XI of the Regulations. The only way to provide accelerated CCA in respect of property used in LNG facilities is by amending the relevant provisions of the Regulations.

Benefits and costs

The deferral of tax associated with the provision of accelerated CCA treatment for investments in facilities that liquefy natural gas is expected to reduce federal corporate income tax revenues by $45 million over the 2015–16 to 2019–20 period. While cost estimates are based on projected investment in LNG facilities in Canada, the level of investment over the medium to long term is speculative.

By deferring income taxes and reducing the time required for investors to recover the cost of their capital investment, this measure increases the expected rate of return and reduces financial risk on investment in natural gas liquefaction facilities. It therefore makes investment in LNG facilities in Canada more attractive.

This could increase investment in LNG facilities constructed in Canada, but, given competition for investment, is not expected to increase the global supply of LNG. Investment decisions in this area are based on a wide variety of factors, of which taxation is only one. Other important factors include the availability and cost of capital, labour and feedstock, infrastructure, regulatory issues, transportation costs to markets, and expected sale prices. Given the role of these diverse factors, it is not possible to segregate the impact of a single factor such as a particular tax provision on the level of investment.

The construction and operation of a facility that liquefies natural gas, and the pipelines that supply natural gas to the facility, can be associated with a variety of environmental impacts to soil, water and air and, as a result, could have an impact on the goals of the Federal Sustainable Development Strategy. However, all such activity is subject to applicable federal and provincial environmental regulations, including project-specific environmental assessments where required.

Natural gas is a fossil fuel, the extraction, transportation and use of which contributes to greenhouse gas emissions. In terms of emissions from combustion, LNG has the potential to reduce emissions of greenhouse gases and local air pollutants, for example, in export markets if it replaces coal for power generation and in domestic markets if it replaces diesel (e.g. for use in trucking, rail, drilling rigs, pressure pumping and power generation in remote locations). However, the overall emissions impact of a fossil fuel production and their use depends on a range of factors such as extraction methods, transportation modes, and likely alternatives, which differ from case to case, making it difficult to determine the likely net impact on emissions.

“One-for-One” Rule

These amendments to the Regulations may impose new administrative costs on business. As the Regulations address tax or tax administration, they are carved out from the “One-for-One” Rule.

Small business lens

The small business lens does not apply, as these amendments to the Regulations are not expected to have any direct impact on small businesses.

Consultation

The public was invited to comment on these amendments to the Regulations following the February 19, 2015, announcement. Draft Regulations were posted on the Department of Finance’s Web site at http://www.fin.gc.ca/drleg-apl/2015/Regulations-rir-0215-eng.asp.

Interested parties were invited to provide comments on the draft proposals by March 27, 2015.  Only a few written submissions were received, all of which expressed overall support for this measure.

• In some cases, stakeholders sought to expand the accelerated CCA treatment to cover additional assets or activities in manner that was not consistent with the policy intent.
• In other cases, changes to increase the clarity of the amendments to the Regulations were made to address the concerns expressed by stakeholders.
• No substantive changes to the draft amendments to the Regulations have been made since their initial publication on February 19, 2015.

Rationale

Canada has large reserves of natural gas, but has limited capacity to supply it to emerging international and domestic markets where demand is growing. In order to help develop the capacity to supply Canadian natural gas to new and growing markets, the accelerated CCA will build on existing advantages and make it more attractive to build in Canada new facilities that liquefy natural gas.

Accelerated CCA allows the cost of designated capital assets to be deducted at a faster pace in calculating taxable income than would otherwise be the case. While it does not change the total amount of tax ultimately payable in respect of a project, it results in higher tax deductions — and less tax being paid — in the early years of the project, offset by lower tax deductions — and more tax being paid — in the later years. Given the time value of money, this deferral of tax can provide an important financial benefit to taxpayers. By reducing the time required for investors to recover the cost of their capital investment, accelerated CCA reduces financial risk.

Implementation, enforcement and service standards

While the Minister of Finance is responsible for developing tax policy to achieve various economic outcomes, it is the responsibility of the Minister of National Revenue to implement and enforce the provisions of the Income Tax Act and related regulations. The Income Tax Act provides the necessary implementation and compliance mechanisms. These mechanisms allow the Minister of National Revenue to assess and reassess tax payable, conduct audits and verify relevant records and documents.

In addition, the Auditor General of Canada conducts annual reviews of service standards as they apply to the Canada Revenue Agency and provides appropriate recommendations when service standards fall below expectation.

Performance measurement and evaluation

The Department of Finance conducts periodic reviews of the tax policy aspects of the income tax law, including the use of accelerated CCA. The interpretation of tax legislation by the judiciary, tax professionals and the Canada Revenue Agency is also monitored by the Department of Finance and, if needed, appropriate changes to the relevant legislation are proposed.

Contact

Gurinderpal Grewal
Senior Advisor
Tax Legislation Division
Department of Finance
90 Elgin Street, 11th Floor (11096)
Ottawa, Ontario
K1A 0G5
Telephone: 613-369-3667
Email: Gurinderpal.Grewal@fin.gc.ca

• Footnote a
  S.C. 2007, c. 35, s. 62
• Footnote b
  R.S., c. 1 (5th Supp.)
• Footnote 1
  C.R.C., c. 945