Calgary Young Practitioners Group

Transcription

1 November 20, 2013 Introduction Partnerships have been a very popular choice for carrying on business in Canada, particularly in the oil and gas industry Over the last few years, there has been a legislative focus and an increased CRA audit focus on partnership structures 2

2 Agenda Basics Oil and Gas Taxation Partnerships 3 Agenda Internal Partnerships 1) Existence of partnership Update CRA is revisiting this issue 2) Capital treatment on disposition Update Legislative changes (tax exempts and nonresidents) 4

3 Agenda Multi-Tier Structures 3) Income Deferral and Anti-avoidance Update Legislative changes ( ASPA Regime) 5 Agenda Transactions and Reorganizations 4) Bump transactions Update legislative changes look through a partnership 5) Successor rules and ownership Update CRA is challenging the application of these rules 6) Unbalanced allocations between partners Update Using partnerships to facilitate access to capital 6

4 The Basics - Oil & Gas Taxation Tax Pools Canadian Oil and Gas Property Expense ( COGPE ) acquisition cost of Canadian resource property ( CRP ) in the oil and gas sector depreciable at 10%, declining balance basis. Canadian Development Expense ( CDE ) generally includes drilling and completion expenses depreciable at 30%, declining balance basis. Canadian Exploration Expense ( CEE ) generally includes exploratory expenses 100% deductible (certain restrictions against losses) 7 The Basics - Oil & Gas Taxation Acquisitions and divestitures: The acquisition cost of CRP (in the oil and gas sector) is added to the purchaser s cumulative COGPE balance Proceeds of disposition of CRP are applied, in order: To reduce the vendor s cumulative COGPE balance To reduce the vendor s cumulative CDE balance Income 8

5 The Basics - Oil & Gas Taxation Successor rules: The rules may apply to asset acquisitions An acquisition of all or substantially all of the properties of the vendor; The parties elect for the rules to apply The purchaser (the successor ) can deduct an amount in respect of resource tax pools incurred by an original owner of the particular CRP The rules must apply if control of a corporation is acquired The corporation is deemed not to have incurred the resource expenses and to have acquired all of its assets from a fictitious original owner and to have elected with that original owner for these rules to apply. 9 The Basics - Oil & Gas Taxation Successor rules: Implications: The deductions are generally limited to sheltering income that is income reasonably regarded as attributable to production from the particular property or proceeds of disposition attributable to the particular property (and an election may be filed to change the order of allocation of proceeds to include successor deductions) Proceeds are applied against successor balances, in order, as follows: Successored COGPE Unsuccessored COGPE Successored CDE (however, a designation can be filed to move this in front of Unsuccessored COGPE) Unsuccessored CDE 10

6 The Basics - Partnerships Separate existence: Not a separate legal entity, but an arrangement between two or more persons who carry on business in common with a view to profit Various deeming rules in section 96 For tax purposes, income of the partners is considered to be their share of partnership income, computed as if the partnership were a separate person For purposes of computing the income of the partners, the partnership s activities (including the ownership of property) are considered to be carried on by a separate person 11 The Basics - Partnerships Income and expenses for tax purposes: All of the income or loss of the partnership is allocated among the partners in accordance with the partnership agreement and is considered to be earned by the partners during their taxation year in which the partnership year end falls Income from a partnership retains its character for tax purposes 12

7 The Basics - Partnerships Allocations must be reasonable Section 103 If partners deal at arm s length, an allocation may be reassessed by the CRA under section 103 if the allocation is principally for the purposes of reducing or postponing tax, and if the allocation is not reasonable in the circumstances If partners are not at arm s length, an allocation must be reasonable in the circumstances The Minister may make any allocation it determines reasonable under section The Basics Partnerships in O&G Partnerships in the resource sector: Resource pools are not deducted at the partnership level Paragraph 96(1)(d) determines partnership income without reference to deductions under the resource provisions Expenses generating resource pools are deemed to have been incurred by the partners Allocations of resource expenses also reduce partnership ACB and at-risk amounts 14

8 The Basics Partnerships in O&G Transfers to and from Partnerships: Due to paragraphs (a) and (c) of subsection 96(1), a partnership is a separate person for purposes of asset ownership The partnership owns the CRP The partners own an interest in the partnership (not CRP) 15 The Basics Partnerships in O&G Transfers to and from Partnerships: Accordingly, a partner and the partnership can participate in asset transfers for tax purposes A transfer from a taxpayer to a partnership is a disposition by the taxpayer and an acquisition by the partnership CRP does not have a cost amount, so under subsection 97(2), resource properties can be transferred at a nominal amount Similar to resource expenses, proceeds of disposition are deemed to be recognized by the partners and are applied against the applicable resource pool balances of each partner 16

9 Internal Partnerships & Existence An Internal partnership refers to a partnership structure where all of the equity interests in the partnership are held by taxpayers in the same corporate group. OilCo Parent (Limited Partner) 99% OilCo Subsidiary (General Partner) Limited Partnership 1% 17 Internal Partnerships & Existence Internal partnerships became a very common method of holding CRP Consolidation of tax results without combining legal entities Deferral of income recognition Capital treatment on disposition rather than a reduction of resource pools and potential income 18

10 Internal Partnerships & Existence 1) Existence of the Partnership Question of fact is there a relationship that is one of carrying on business with a view to profit Pertinent facts: Length of time the partnership has been in existence Intention of the parties Caselaw: Continental Bank of Canada v. R., [1998] 2 S.C.R Internal Partnerships & Existence 1) Existence of the Partnership - UPDATE CRA is revisiting this issue lemon drop transactions Despite the decision in Continental Bank, the CRA has publicly announced that it will continue to review partnerships of limited duration on the basis of existence. 20

11 Internal Partnerships & Existence 2) Capital Treatment on Disposition Partnership interest is a separate asset The definition of CRP specifically excludes a partnership interest, so it remains a non-depreciable capital property Question of fact regarding capital vs. income If the partnership is considered to be in existence, capital treatment is favored (Continental Bank) 21 Internal Partnerships & Existence 2) Capital Treatment on Disposition UPDATE Legislative amendments to section 100 Applicable to dispositions of partnership interests to persons exempt from tax and non-residents Removes the inclusion rate on capital gains to the extent the value of the partnership is derived from property other than non-depreciable capital property (100% of the gain is included in income) The rule prevents an asset sale to a tax exempt or nonresident from being restructured by rolling the assets into a partnership and then selling the partnership for a capital gain 22

12 Internal Partnerships & Existence 2) Capital Treatment on Disposition UPDATE Legislative amendments to section 100 Seems to provide clarity to capital treatment to taxable Canadian purchasers Results in some harsher results: Gains on depreciable property converted to 100% taxable Gains on eligible capital property converted to 100% taxable 23 Multi-Tier Structures Parent (Limited Partner) 99% Limited Partnership #1 Subsidiary (General Partner) 1% 99% Limited Partnership #2 Subsidiary (General Partner) 1% 24

13 Multi-Tier Structures 3) Income Deferral and Anti-Avoidance Corporate taxpayers could defer income by using different corporate year ends than the partnership. If a series of partnerships were used, income could be deferred several years. OilCo Parent (Limited Partner) Year 1 Year 2 Deferred income Limited Partnership 25 Multi-Tier Structures 3) Income Deferral and Anti-Avoidance The use of a mismatched year end to create this deferral became common planning in the industry Multi-tier structures with several year misalignment could result in several years of deferral With internal partnerships, developed property could be held in the partnership and exploration activity could be conducted outside of the partnership CRA was aware of this planning, but the law was clear and other than in cases of abuse there was no clear method to reassess these structures 26

14 Multi-Tier Structures 3) Income Deferral and Anti-Avoidance - UPDATE Introduction of the Adjusted Stub Period Accrual ( ASPA ) The partnership rules remain unchanged Additional income to the corporation equal to ASPA Transitional rules to ease the first year correction into income over 5 years (qualified transitional income, or QTI ) 27 Multi-Tier Structures 3) Income Deferral and Anti-Avoidance - UPDATE Introduction of the Adjusted Stub Period Accrual ( ASPA ) Net = ASPA yr 1 ASPA yr 2 + net of actual partnership income less ASPA yr 1 ASPA ASPA (less prior year s ASPA) OilCo Parent (Limited Partner) Year 1 Year 2 Deferred income Limited Partnership 28

15 Multi-Tier Structures 3) Income Deferral and Anti-Avoidance - UPDATE Introduction of the Adjusted Stub Period Accrual ( ASPA ) ASPA concept is new and taxpayers are getting used to the regime Some anomalies arise (usually respecting stub year ends) The QTI is still being brought into income over time and corporations impacted by these rules are still claiming reserves for the QTI balance of their first transition year 29 Transactions and Reorganizations 4) Bump transactions Package and bump Partnership interests are non-depreciable capital property and are therefore eligible for the ACB bump under section 88 Non-eligible property could be transferred to a partnership on a tax deferred basis under subsection 97(2) prior to an acquisition The acquirer could then bump the partnership ACB to FMV 30

16 Transactions and Reorganizations 4) Bump transactions - UPDATE Legislative amendments to section 88 Subparagraph 88(1)(d)(ii.1) Limits the bump to a maximum amount that would not include unrealized gains and recapture in respect of property that would not otherwise be eligible for the bump had it not been transferred to the partnership 31 Transactions and Reorganizations 5) Successor rules and Ownership If a corporation is acquired, the resource pools are successored to income from production of the properties owned at the time of acquisition Paragraph 96(1)(c) deems a partnership to be a separate person for purposes of ownership, so the corporation doesn t technically own the CRP Introduction of 66.7(10)(j) Partners are deemed to own their proportionate share of CRP held by the partnership Income from the partnership up to the partner s interest is deemed to be income from production from the CRP 32

17 Transactions and Reorganizations 5) Successor rules and Ownership - UPDATE CRA is challenging certain structures If a corporation holds assets in partnership at the time of acquisition, the CRA is applying 66.7(10)(j) restrictively: Multi-tier partnership structures Partnership reorganizations Devon Canada Corporation v. The Queen 2013 TCC 4 33 Transactions and Reorganizations 6) Unbalanced Allocations Section 103 Reasonability of unbalanced allocations Penn West Petroleum Ltd. v. R., 2007 TCC 190 XCO Investments Ltd. v. R., 2005 TCC 655, 2007 FCA 53 Key factors in these decisions include: The length of time the partners are in the arrangement The amount of commercial risk undertaken The amendment of the agreement to accommodate the special allocation 34

18 Transactions and Reorganizations 6) Unbalanced Allocations - UPDATE In an industry that has a dire need for capital, unbalanced allocations are still being used to facilitate the creation of new partnerships The section 103 cases have generally included transient partners who would not otherwise have entered into the partnership had it not been for the tax motivation related to the particular transaction in question Taxpayers still rely on unbalanced allocations in circumstances of true commercial substance 35 Transactions and Reorganizations 6) Unbalanced Allocations - UPDATE Synthetic Farm-In Structures Canadian OilCo Foreign OilCo Step 1 Limited Partnership CRP (tax deferred transfer) Development capital Step 2 36

19 Transactions and Reorganizations 6) Unbalanced Allocations - UPDATE Synthetic Farm-In Structures Partner providing assets contributes no resource tax pools, but receives greater assurance of the tax implications on the transfer Partner providing the cash contributes development capital on an accelerated basis Costs incurred by the partnership are considered earned in a weighted proportion in favor of the capital partner, until such time as they have received the tax benefit equal to their cash contribution 37 Conclusions The commercial flexibility and fiscal transparency of partnership structures make them attractive business vehicles for commercial and tax purposes The same elements that make them flexible and transparent (i.e., reliance on the commercial agreement itself to govern the arrangement) also make them complex when applying the applicable tax legislation to these structures It is difficult to apply generic rules of interpretation to partnership structures because the facts and circumstances (and legal arrangement itself) can vary widely The volume of recent legislative changes, and variance in interpretation of existing rules that can differ widely depending on subtle differences in facts, characterize this area as one of great uncertainty 38