British Columbia (BC) is developing a liquefied natural gas (LNG) industry. A key step in furthering the progress of LNG projects is the introduction of an LNG tax regime.
On October 21, 2014, Bill 6 was introduced in the 2014 session of the BC legislature. The Bill introduces the Liquefied Natural Gas Income Tax Act (the "LNG Tax Act").
The public release of the highly anticipated LNG Tax Act comes at a pivotal time for BC's rapidly developing LNG industry. In particular, the LNG Tax Act is a key component for project proponents to reach a final investment decision on various LNG projects in BC.
The LNG Tax: A brief overview
The LNG Tax Act imposes a two-tiered tax on LNG production income (the "LNG Tax"). The LNG Tax will take effect on January 1, 2017, which is likely the earliest date that LNG facilities will be up and running in BC.
The concept behind the LNG Tax is to have two parallel but different rates of taxation:
- A lower tax rate will generally apply whenever an LNG operator has certain losses and can claim depreciation for costs it incurs in developing its LNG facilities; and
- A higher tax rate will apply when there are no losses or depreciation.
Helpfully, for project proponents and other interested parties, the overall rate of tax is lower than was initially announced. This will provide more certainty¾and after-tax profitability¾for industry at a cost to government revenue.
The LNG Tax applies on a project by project basis. As such, even if a project operator or participant is not a resident of Canada or does not have a permanent establishment in BC, the LNG Tax will apply to their project. This is a significant point, as it appears possible that some project proponents may not be subject to federal or provincial income tax, yet their project could still be subject to the LNG Tax. Thus, any non-resident project operator or participant will need to closely consider their over-all liability for tax in BC.
First Tier Tax
When commercial LNG production begins, it is expected that an operator will pay a 1.5% tax on net operating income (the "First Tier Tax").
Net operating income is, generally, revenue less expenses from the particular liquefaction activities. This calculation starts with accounting income. Then, certain adjustments to income that are made under the federal Income Tax Act are recognized. So, net operating income for LNG purposes will roughly represent "taxable income" for corporate income tax purposes.
A crucial distinction is that no federal depreciation or capital cost allowance is recognized. Instead, when calculating income for LNG Tax purposes, there is a special deduction from a capital investment account (CIA).
Essentially, the CIA includes all costs associated with constructing the LNG plant, and the CIA can be deducted in calculating the First Tier Tax. The precise rate at which the CIA can be claimed has not been determined (it will be determined by regulations that have not yet been released).
So long as the CIA account is positive (i.e., costs have not been fully deducted against income) and/or losses may be claimed, the First Tier Tax applies.
Second Tier Tax
If there is no CIA and no losses to be claimed, a higher rate of tax will apply (the "Second Tier Tax"). The Second Tier Tax is currently 3.5%. This may increase in the future (which remains to be determined by the Legislature). This rate contrasts against the much higher rate of 7% that was initially expected.
The Second Tier Tax is applicable to "net income," which is calculated slightly differently from net operating income for the purpose of First Tier Tax. Net income cannot be negative. In other words, no losses will be generated for this purpose. Additionally, if net income is zero, an LNG operator would have no Second Tier Tax to pay, but could still be subject to First Tier Tax (because net operating income is calculated differently).
Helpfully, any First Tier Tax that has been paid can be deducted as a credit in determining liability for Second Tier Tax.
The LNG Tax: Looking ahead
Overall, the release of the LNG Tax Act is a positive development as it provides welcome certainty to industry players.
In implementing the LNG Tax, the government has taken careful steps to ensure that, despite the additional cost to LNG producers, BC remains competitive with its counterparts.
The Energy Group at Dentons Canada LLP has extensive expertise in advising on resource projects and related tax issues. This, combined with Dentons' global reach, makes us uniquely positioned to assist you with any LNG needs.
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