Having reviewed many financial models and successfully advised several consortia in the Canadian P3 market, we thought we would share our experience and highlight the top 7 tax issues arising in these types of projects.  These are:

1. Implications of Limited Partnerships

Canadian projects typically adopt a partnership structure for the Special Purpose Vehicle (SPV) as opposed to a corporate structure.

When a limited partnership is formed, unlike general partners, the limited partners have limited liability so the ‘At-Risk’ and ‘Adjusted Cost Basis’ (ACB) rules are applicable to these partners.

Financial models relating to Canadian P3 projects should include the functionality to track the ACB and At-Risk amount for limited partners and take account of the implications should either of these become negative.

A taxable gain is triggered if the ACB is negative with the gain calculated on 50% of the negative ACB amount.  This gain is calculated at the applicable tax rate for the partner.

Similarly, there are implications if the At-Risk amount becomes negative.  If this happens, any taxable losses of the partnership allocated to the limited partner cannot be used to offset the partner’s other taxable income for the year and instead these losses are suspended until the At-Risk amount is not negative.

2. Capital Cost Allowance: Class 14 tax assets

Concession rights held for a limited period are treated as Class 14 assets for tax.  Typically this is the capital cost allowance that we would expect to see in a model.  This is on the basis that Class 14 assets cover licenses and a concession right is considered to be a license.  Therefore financial models should allocate costs to a Class 14 asset and amortise this over the concession period from the available for use date.

The costs typically added to the Class 14 asset are the design and construction costs, SPV, insurance and other overhead costs, interest and fees incurred during the construction period and upfront costs including bid and professional costs.  If any construction period revenue including milestone payments, progress payments or substantial completion payments are received during the construction period, these reduce the Class 14 carrying balance.

3. Available for use rules

The two year rolling start rule should not be an issue in most Canadian P3 projects because the construction periods involved are usually less than 2 years.  However, the available for use rules do need to be considered if the construction period is likely to continue into a third tax year as most models assume that amortisation is claimed from the start of the operating period whereas in reality the amortisation should be claimed earlier if the construction period continues into a third tax year.

In this case, financial models should assume that amortisation on the expenditure incurred in the first tax year is claimed from the start of the third tax year (the time immediately after the beginning of the first tax year that begins more than 357 days after the end of the tax year in which the costs are incurred).  However, in this scenario, most transactions we review tend to ignore this rule and instead assume that amortisation on all construction period expenditure commences from the start of operations date part way through the third tax year.  This is later than the available for use date for the expenditure incurred in the first tax year.

Financial models should assume amortisation is claimed from the available for use date which could be at the start of the third tax year.  Not claiming the amortisation of a Class 14 asset from the available for use date would mean that the portion not claimed on the due date cannot be claimed until the end of the operating period.

4. Changes in the treatment of legal and accounting costs of establishing a Canadian entity

Any legal and accounting costs incurred in establishing a partnership (or company) were previously treated as Eligible Capital Expenditure (ECE)/Eligible Capital Property (ECP) with 75% of these costs being allowed for tax purposes at 7% per annum on a reducing balance basis and the other 25% being disallowed.

From 1 January 2017, a new Class 14.1 asset has been created.  100% of the new legal and accounting costs of establishing a partnership are added to a Class 14.1 pool and allowed for tax purposes at 5% per annum on a reducing balance basis.  Financial models for new P3 projects will now need to include a Class 14.1 asset pool rather than an ECE pool.

In operating models, any existing ECE/ECP balances should be transferred to a Class 14.1 pool on 1 January 2017 and continue to be depreciated at 7% per annum on a reducing balance basis for another 10 years.  Any balance remaining after 10 years will then be allowed at 5% per annum on a reducing balance basis.

5. Corporate Minimum Tax (CMT) in Ontario

 CMT is payable on the ultimate corporate partner’s share of taxable income if either the project or the corporate partner has a permanent establishment in Ontario.  No other provinces require corporations to pay a minimum tax.

The current CMT rate is 2.7% of the adjusted accounting profit of an entity from activity undertaken in Ontario.  Any CMT incurred can be added to a CMT credit pool and carried forward to offset against Ontario provincial corporate income tax (CIT) for up to 20 years.

In P3 projects based in Ontario, CMT is often paid towards the start of the project but the CMT credit is then used to offset CIT payable within 20 years.  CMT therefore usually affects the timing of tax payments in a P3 project rather than the absolute amount of tax paid.

6. Timing of General Sales Tax (GST)/Harmonised Sales Tax (HST)/Provincial Sales Tax (PST)/Quebec Sales Tax (QST) on construction contracts

Generally, the applicable GST/HST/PST/QST on progress payments becomes collectable on the earlier of the date that the progress payment is received or the date the payment becomes receivable by the SPV according to the payment mechanism.  As a result, this might mean the GST/HST/PST/QST is payable to the tax authorities at a date earlier than when substantial completion of the construction works occurs.  The timing mismatch between the date when the sales tax becomes payable to the tax authorities and the later date when it is actually received could lead to projects needing to include a drawdown of debt or a separate debt facility to fund the sales tax payable on progress payments.
However, it may be possible to discuss this issue with the Public Partner to ensure there is not a timing mismatch.

7. Timing of GST/HST/PST/QST on holdback payments

P3 contracts often contain a holdback clause resulting in the payment of a percentage of construction costs being held back each period.  This leads to a potential GST/HST/PST/QST timing issue in that sales tax will become payable when the invoice for the payment of the construction costs held back is issued.  If the contractor issues one invoice for 100% of construction costs incurred each period then the sales tax would become payable in the period that the costs are incurred.  However, in many instances the holdback costs are the subject of a separate invoice.  Financial models will assume that the timing of HST/GST/PST/QST follows the timing of the invoice for the costs.  As a result, models assume that the timing of sales tax on holdback payments corresponds to when the holdback payment is made.  This is on the basis that in many cases, a separate invoice will be issued for the holdback amount at the end of construction.

If you have any questions regarding the above or would like to speak to someone at Operis about potential tax issues arising in Canadian P3 projects, please don’t hesitate to get in touch.

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