British Columbia releases the Liquefied Natural Gas (LNG) Income Tax Act Tax Insights

Tax Insights
from Energy Tax Services
Issue 2014-39
British Columbia releases the
Liquefied Natural Gas (LNG) Income
Tax Act
October 21, 2014
In brief
Today, British Columbia introduced the much-awaited Liquefied Natural Gas Income Tax Act (the LNG
Act). The LNG Act follows the framework released in BC’s February 18, 2014 budget (see our Tax
Insights “British Columbia unveils its liquefied natural gas (LNG) tax” at www.pwc.com/ca/taxinsights).
But, it provides important new details, including a reduction in the tax rates, an investment allowance for
computing net operating income subject to tax, complex transfer pricing rules and deeming provisions.
In general, the LNG income tax is a two-tier income tax, as follows:

Tier 1 tax rate of 1.5% on net operating income; this tax can be deducted from the Tier 2 tax

Tier 2 tax rate of 3.5% on net income for taxation years beginning after December 31, 2016, and 5%
for taxation years beginning after December 31, 2036 (the maximum rate in the framework was 7%)
The tax applies to income from liquefaction of natural gas at an LNG facility located in BC.
In detail
The LNG income tax is in
addition to federal and
provincial income taxes.
LNG income tax taxpayer
An LNG income tax taxpayer
(LNG taxpayer) is a person that
engages in or has income
derived from liquefaction
activities at an LNG facility,
regardless of whether the
person is resident of BC or is
actually liable to pay the LNG
income tax.
It can be a corporation, an
individual, or a trust.
Partnerships involved in
liquefaction activities are not
taxable but their partners are.
Two-tier income tax and tax
base
In general, the LNG income tax
will be a two-tier income tax.
Tier 1 tax
The Tier 1 tax rate of 1.5%
applies on net operating
income.
Net operating income is based
on income under the federal
income tax rules, but excludes
capital cost allowance and
recapture, interest, hedging
gains and losses, dividends and
capital gain and losses. A
negative net operating income is
a net operating loss.
A deduction from net operating
income is allowed for an
investment allowance. The
investment allowance is based
on the average balance of the
capital investment account
multiplied by 75% and a
prescribed rate.
The Tier 1 tax paid is
accumulated in a tax pool that
can be used to reduce Tier 2 tax.
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Tax Insights
right to use all or part of an LNG
facility
Tier 2 tax
The Tier 2 tax rate of 3.5% applies on
net income.

Net income for purposes of the Tier 2
tax is the net operating income less:



net operating loss account
(consisting of the accumulated net
operating losses from prior years),
and
up to 100% of the capital
investment account
Tier 2 tax rate is:

3.5% for the taxation years
beginning after December 31,
2016

5% for taxation years beginning
after December 31, 2036
Capital investment account
The capital investment account
consists of all costs associated with
constructing an LNG facility, i.e. a
plant that is built to liquefy natural
gas. It typically includes gas
purification and liquefaction systems,
together with storage tanks and
marine loading systems.
An LNG facility can also include
support functions for the liquefaction
process such as control rooms,
material and equipment warehousing,
maintenance shops and infrastructure
facilities.
Liquefaction activities subject to
the LNG income tax
The following types of income
generated from the liquefaction of
natural gas will be subject to the LNG
income tax:


2
acquiring, owning or disposing of
liquefied natural gas, natural gas
liquids or natural gas that is at an
LNG facility
acquiring, owning or disposing of
all or part of an LNG facility, or a
operating all or part of an LNG
facility
carrying on activities that are in
relation to a person that owns or
operates an LNG facility
Who will pay the LNG income tax
The LNG income tax will apply to all
LNG facilities in BC, regardless of
whether the LNG is exported or used
domestically. It applies on an LNG
facility by LNG facility basis.
Specifically, an LNG taxpayer that has
income at more than one LNG facility
must file a separate return for each
facility.
An LNG taxpayer can consolidate its
income from different income streams
at a single LNG facility but cannot
consolidate the net income from
various LNG facilities. The taxation
year for an LNG taxpayer is the same
as its taxation year for federal income
tax purposes.
Deemed sales and purchases at an
LNG Facility
A sale or purchase of commodities (for
example, liquefied natural gas, natural
gas liquids and natural gas) can be
deemed to occur even if there was no
actual sale or purchase at the LNG
facility. For a commodity:


entering the LNG facility, the
deemed purchase is by the person
owning the commodity
immediately after it enters the
LNG facility from itself at the inlet
to the LNG facility
leaving the LNG facility, the
deemed sale is from the person
owning the commodity
immediately before it leaves the
LNG facility to itself

A deemed sale or purchase from a
person to itself is considered a
non-arm’s length transaction.
Transaction values
The LNG Act adopts the federal rules
for determining whether persons are
related and whether they are dealing
at arm’s length, however there are
some key differences.
In the federal legislation the transfer
pricing rules apply to non-arm’s
length transactions between taxpayers
(and partnerships) and non-resident
taxpayers or partnerships with nonresident members, whereas under the
LNG Act the rules apply to all nonarm’s length transactions other than
transactions that are specifically
excluded.
Further, the LNG Act specifically sets
out how the transfer pricing rules
apply to self-dealings and to deemed
sales of liquefied natural gas, natural
gas liquids and natural gas that leave
an LNG plant.
Failure to comply with the transfer
pricing rules under the LNG Act may
trigger a transfer pricing penalty.
The LNG Act requires a taxpayer to
maintain contemporaneous
documentation in respect of the
transfer prices it reports.
Specific rules for valuation of
natural gas at the LNG inlet
The LNG Act sets rules that apply
when valuing the non-arm’s length
acquisition of natural gas at the inlet
to an LNG facility.
Costs incurred in the first
taxation year
Qualifying expenditures can be
included in the net operating loss
account if an election is made.
Similarly, qualifying property can be
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Tax Insights
included in the capital investment
account under certain circumstances.
Natural Gas corporate income tax
credit
BC has also introduced a Natural Gas
corporate income tax credit under the
British Columbia Income Tax Act.
This credit will be available to an LNG
taxpayer that has a permanent
establishment in BC. It will equal
0.5% of the cost of natural gas
acquired by the corporation at the
inlet to an LNG facility as determined
under the LNG Act.
Closure tax credit
A tax credit of 5% of the amount of
eligible expenditures can be claimed
by an LNG taxpayer in its last taxation
year. Eligible expenditures include
closure costs related to the
restoration, reclamation and
remediation of an LNG facility.
The takeaway
The LNG Act provides complex tax
and transfer pricing rules affecting the
BC LNG industry. Careful reading and
interpretation are necessary to apply
these measures to your business’
decisions and operations.
PwC’s LNG tax team can help your
organization:

apply these new measures in your
financial models with respect to
LNG projects,

optimize the operational structure
of your LNG business, and

comply with the LNG Act
For more information on the LNG
industry, see PwC’s publication,
“Investing in the growth of Canada’s
LNG market” at
www.pwc.com/ca/energy.
Let’s talk
For a deeper discussion of what the LNG Act means for your business, please contact:
Domenico Baruffaldi
National Energy Tax Leader
+1 (403) 509 6676
[email protected]
Yuri Revenko
+1 (403) 509 7491
[email protected]
Eugene Quo
+1 (403) 509 6379
[email protected]
Brad Sakich
+1 (604) 806 7730
[email protected]
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