John Tobin, "Infrastructure and P3 Projects", 2017 Conference Report (Canadian Tax Foundation), 10:1-31

Summaries

Meaning of substantially complete in the construction industry (p. 10:6)

[T]he term “substantially complete" is therefore an undefined term that should take its meaning from its normal commercial use in the construction industry. The IO [Infrastructure Ontario] template documents essentially define substantial completion as the point when the facility has been completed in accordance with the project agreement and all requirements other than minor deficiencies have been satisfied. As used in the construction industry, it does not mean the time when a building is 90 percent complete, but rather the time when it is fully complete and capable of lawful occupancy, subject to minor deficiencies.

Handling of HST on future due dates if HST has already been paid under s. 168(3)(c) (p. 10:7)

[I]f the substantial completion rule has applied and tax has been remitted by Projectco without having been paid by the proponent, the ETA does not address how to deal with future tax that is collected from the proponent when actual payments are due and paid. This is effectively a prepayment of the HST so that, when a final invoice is rendered, a notation should be made on the invoice indicating that HST has previously been paid under paragraph 168(3)(c)…

Words and Phrases
substantially complete

Distinction between cost-reduction of interim progress payments received and income-account treatment of phase-completion payments (p. 10:9-10)

One challenge is determining how to treat progress payments during the construction phase. Proponents will often make progress payments to reduce the cost of construction, intending to decrease the amount of long-term financing needed for the project. The CRA has ruled that the interim payments reduce construction costs (and the value of the concession) pursuant to subsection 13(7.1). [fn 21: … 2003-0051741R3 [and] …2004-0105611R3…] This policy was adopted when the customary amount of the “interim payments” was not substantial in the context of total project cost. However, in more recent transactions, proponents have prepaid substantially all of the construction-period expenses on substantial completion, leaving financing in place only for operating expenditures such as payroll and overhead. Projectcos continue to rely on the above-referenced rulings and treat the prepayments as reducing the capital cost of class 14 assets. … If a substantial portion of the revenue from the project is being received at the end of each construction phase, such amounts may be treated as construction revenue rather than as a government subsidy toward a capital asset. The CRA also stated that payments during the operation phase do not relate to an earlier period and therefore are not within subsection 13(7.1). Instead, such amounts are income as received …[fn 23 … IT-464R …quoted in … 2012-045508117].

Whether P3 progress payments are cost reductions or revenue (p. 10:9-10)

One challenge is determining how to treat progress payments during the construction phase. Proponents will often make progress payments to reduce the cost of construction, intending to decrease the amount of long-term financing needed for the project. The CRA has ruled that the interim payments reduce construction costs (and the value of the concession) pursuant to subsection 13(7.1). [fn 21: … 2003-0051741R3, 2004, as supplemented by…2004-0105611R3…] This policy was adopted when the customary amount of the “interim payments” was not substantial in the context of total project cost. However, in more recent transactions, proponents have prepaid substantially all of the construction-period expenses on substantial completion, leaving financing in place only for operating expenditures such as payroll and overhead. Projectcos continue to rely on the above-referenced rulings and treat the prepayments as reducing the capital cost of class 14 assets. In general, determining the nature of the rights between the parties is a question of interpretation of the project agreement. If a substantial portion of the revenue from the project is being received at the end of each construction phase, such amounts may be treated as construction revenue rather than as a government subsidy toward a capital asset. The CRA also stated that payments during the operation phase do not relate to an earlier period and therefore are not within subsection 13(7.1). Instead, such amounts are income as received …[fn 23 … IT-464R …quoted in … 2012-045508117].

Whether 2-year rolling-start rule in s. 13(27(b)) should be applied to Class 14 property acquired in a P3 construction project on an expenditure-by-expenditure basis (p. 10:10)

Class 14 assets are subject to the available-for-use rules….

[U]nder the two-year rolling-start rule, any property acquired in a taxpayer’s first taxation year is depreciable in its third taxation year. It is not clear, in a concession agreement where the construction costs are incurred over a period of time, whether the available-for-use rules should be applied to each expenditure on that contract or to the contract as a whole. It appears that the CRA is willing to apply the rules on an as-expended basis. If so, expenses that are incurred in year 1 under the concession agreement would meet the available-for-use test in year 3, even if the entire contract is not complete in year 3. However, the more conservative approach may be to treat the project agreement as not being available for use until the construction phase is complete. This interpretation could give a more favourable result to the tax-shelter analysis but could significantly delay deductions.

Application of s. 7 to a lease-in lease-out structure re student residence (p. 10:11)

[S]ection 7 of schedule V provides an exception for certain ground leases. Consequently, if a university were to provide a ground lease to Projectco, it would be exempt from HST under section 7 on the basis that Projectco will, in turn, be licensing the use of the property back to the university and the university will grant possession to a student.

Whether non-recourse nature of partnership-level debt is a loss-reducing benefit to a partner (p. 10:12)

[O]ften, debt to Projectco’s partners will be limited in recourse to Projectco’s assets. The issue is whether the limited-recourse features of loans to partners of Projectco are a benefit granted to the partners for the purpose of reducing the impact, in whole or in part, of any loss that such partners may sustain owing to their investment in Projectco….In ATR-51, the CRA acknowledges that indemnities given in the ordinary course that were granted between arm’s-length parties (that is, indemnities for breach of contract) would not be considered as being granted to reduce the partner’s loss, unless they were effectively given to generate a specific revenue or income….

[I]n another technical interpretation, [fn 28: … 9301835] the CRA stated that non-recourse debt obtained by a partnership that arose as a result of legitimate commercial transactions unrelated to a general partner’s acquisition of a partnership interest would not generally be considered to be an amount granted for the purpose of reducing the partner’s loss from being a partner. (In that case, the partner’s equity is still subject to loss, even though the partner’s overall liability might be limited.)…

Regulation 6202.1 appears to be a lower threshold than subsection 96(2.2),…The Court [in JES] stated that an objective test was required because of the phrase “reasonably considered….

Government progress payments (treated as s. 13(7.1) capital cost deductions, being a potential benefit under Reg. 3100(1)(b)) can cause partner to be deemed limited partner under s. 96(2.4)(b) (p. 10:15)

[T]o the extent that Projectco takes the view that the amount of the payments for the construction period reduces the capital cost of a class 14 property (on the basis that subsection 13(7.1) applies), these amounts are considered to be prescribed benefits irrespective of whether they are enjoyed directly or indirectly (that is, through the partnership itself). If, however, they were treated as construction-period revenues, they would not be considered to be prescribed benefits.

However, if the construction-period expenses are capitalized as a class 14 property and the construction payments are treated as a government allowance, the construction payments likely cause Projectco’s general partnership interests to be deemed to be limited partnership interests. In that case, the at-risk amount of the partner applies to reduce the access to deductions. Nonetheless, this result may be beneficial to the partner when the potential application of the tax-shelter rules is taken into account.

see also authorities listed under Reg. 231(6) et seq.

Government progress payments (treated as s. 13(7.1) capital cost deductions) are prescribed benefit under Reg. 3100(1)(b) (p. 10:15)

[T]o the extent that Projectco takes the view that the amount of the payments for the construction period reduces the capital cost of a class 14 property (on the basis that subsection 13(7.1) applies), these amounts are considered to be prescribed benefits irrespective of whether they are enjoyed directly or indirectly (that is, through the partnership itself). If, however, they were treated as construction-period revenues, they would not be considered to be prescribed benefits.

However, if the construction-period expenses are capitalized as a class 14 property and the construction payments are treated as a government allowance, the construction payments likely cause Projectco’s general partnership interests to be deemed to be limited partnership interests. In that case, the at-risk amount of the partner applies to reduce the access to deductions. Nonetheless, this result may be beneficial to the partner when the potential application of the tax-shelter rules is taken into account.

P3 project likely flunks the mathematical test at financial close given that costs not yet incurred (p. 19:16)

In regard to the investment in the project agreement, it is not clear how the cost is calculated for the purposes of applying the mathematical test in the tax-shelter rules. On financial close (as defined in the project agreement), the cost of the project agreement is likely to be low (that is, limited to the costs and expenses associated with putting in the bid and negotiating and finalizing the project agreement) compared with the construction payments or the debt amounts. Although the construction expenses continue to increase over the construction phase and get added to class 14 as they are incurred, they have not yet been incurred when the project agreement is acquired. Generally, future costs are not included in the determination of tax-shelter compliance at inception, notwithstanding that Projectco is required to incur the construction costs (and to capitalize those costs). As described below, the prescribed benefits in respect of the project agreement are expected to include the payments from the proponent and the portion of any debt that is not repaid out of the construction payments. Accordingly, the investment by Projectco in the project agreement would likely fail the tax-shelter mathematical test.

Potential requirement to apply mathematical test as each construction expenditure occurs (p. 10:16)

Another interpretive issue relates to whether there is more than one tax shelter. Projectco makes additional “contributions” under the project agreement as amounts are incurred (and are being capitalized). One possible interpretation is that as additional amounts are expended toward the project in the context of the available-for-use rules and other rules in the Act, each such amount should be treated as a new investment when it is incurred, which could cause Projectco to have to satisfy the tax-shelter test during the period that it is capitalizing costs.

TCP status on loans to P3 Projecto LP potentially avoided if partners of non-resident collective investment vehicle partnership lend directly to Projectco rather than through the CIV LP (p. 10:17)

In a CIV structure, it is typical for the non-Canadian partnership to hold both debt and equity of Projectco, meaning that there are two distinct property interests held by the non-Canadian partnership. The loan to Projectco is clearly not TCP on its own. Thus, if the loan exceeds 50 percent of the non-Canadian partnership’s assets, arguably the partnership does not derive its value substantially from the ownership of shares of Projectco because it derives its value from the debt. However, the CRA recently indicated that the intercompany indebtedness should be ignored and the partnership property may be TCP. [fn 47: … 2015-062451117 … [and] 2012-0444091C6] The result may be different if a partnership’s partners made loans to Projectco directly (or through a parallel structure) rather than through the non-Canadian partnership being tested.

Application of thin cap rules to a non-resident (collective investment vehicle) partnership lending to a P3 Projectco (pp. 10:24-25)

[F]or the purposes of determining whether a limited partner is a “specified shareholder,” the holdings of any person that does not deal at arm’s length with the limited partner are aggregated….

In a 2014 technical interpretation [fn 75: ….2014-056378155]…CRA observed that when a partner is not in a position to control a partnership, and that partner has little or no say in directing the operations of the partnership, it is generally recognized that the partner is dealing at arm’s length with the partnership…. [and] that a partner that is considered to be dealing at arm’s length with a partnership should also be considered to be dealing at arm’s length with the corporation controlled by the partnership. This implies that interest paid to the CIV may not be subject to the thin capitalization rules, and although withholding tax may apply, if individual partners are entitled to treaty relief, the partnership may benefit from such relief.

Inapplicability of transfer-pricing arm’s length standard to s. 20(1)(c) reasonable amount test (pp. 10:26-27)

GlaxoSmithKline…emphasized the difference between the reasonableness standard in paragraph 20(l)(c) and the arm’s-length standard in former subsection 69(2). The court noted that the approach in paragraph 20(1)(c) is internal to the actual transactions that occurred, whereas the arm’s-length standard requires a comparison with external transactions or hypothetical arrangements….

These two standards are different, which means that potentially different allowable interest expenses might be permitted as deductions under paragraph 20(1 )(c) or section 67, as compared with transfer pricing.

Alty and Studniberg [fn 81: (2014) 62:4 Canadian Tax Journal 1159-1202.] Canadian case law strongly resists any attempt by the CRA to recharacterize a taxpayer’s bona fide legal transaction, apart from the potential application of the transfer-pricing rules in paragraphs 247(2)(b) and (d) and GAAR in section 245….

S. 212(13.1)(c) precludes transparent treatment of controlling NR partnership

Subsection 18(7) does not apply for withholding tax purposes. If a partnership controls Projectco, it will be considered by the CRA not to deal at arm’s length with Projectco because the partnership is treated as a person for domestic withholding tax purposes under subsection 212(13.1). For treaty purposes, however, the CRA appears to treat the partnership as a conduit, and the treaty protection available to each partner will be applied subject to appropriate documentation proving eligibility. If one or more partners are not eligible for the same treaty relief, as a practical matter a blended withholding rate is applied. [citing 2004-0072381C6]