Kinder Morgan -- summary under Ss. 84(4.1)(a) and (b) distributions of proceeds

PUC reduction exceeding PUC distribution of pipeline sales proceeds
Overview

As a result of its indirect 30% interest in the Trans Mountain pipeline system, Kinder Morgan realized $1.2 billion on the sale of the system to the federal government for $4.5 billion. Kinder Morgan will distribute that sum to its shareholders as a stated capital (and paid-up capital) distribution. The exclusion from deemed dividend treatment under s. 84(4.1) for a one-off distribution of recently-received sales proceeds is being relied upon. The stated capital reduction (of $1.45 billion) exceeds the $1.2 billion stated capital distribution amount, so that the stated capital of the shares will be reduced to approximately $0.33 billion. This is being done in order to not be subject to potential solvency test restrictions under ABCA in declaring dividends.

Transaction

On May 29, 2018, the Company entered into a share and unit purchase agreement (the ‘‘Purchase Agreement’’) among Kinder Morgan Canada Cochin ULC (“KMCU”), the federal government (the ‘‘Purchaser’’), the Company and Kinder Morgan, Inc. (“KMI”), under which the Purchaser agreed to buy certain entities indirectly held by the Company, including the owner of the Trans Mountain pipeline system and related expansion project, for cash consideration of CDN$4.5 billion, subject to certain adjustments (the ‘‘Transaction’’). The Transaction was completed on August 31, 2018. The Company holds an approximate 30% indirect interest in KMCU, representing an interest in net proceeds of approximately $1.2 billion from the Transaction, after deductions for capital gains taxes, repayment of indebtedness and customary purchase price adjustments, and KMI indirectly holds the remaining approximately 70% interest in KMCU, representing an interest in net proceeds of approximately $2.8 billion from the Transaction, after such deductions.

Stated capital reduction

The stated capital account of the Restricted Voting Shares of the Company is to be reduced by $1.45 billion pursuant to s. 38(1) of the ABCA, for the purposes of (i) effecting a distribution to holders of Restricted Voting Shares by way of a return of capital of $1.2 billion, or approximately $11.40 per share (the “Return of Capital”), and (ii) providing the Company with additional flexibility to pay dividends in the future by way of a further reduction of $0.25 billion. Following such reduction, the stated capital account of the Restricted Voting Shares will be equal to approximately $0.33 billion.

Equivalent distribution on LP units

An equivalent distribution of an amount expected to be approximately $11.40 per Class B LP Unit, will be paid to KMI (indirectly through KMCC and KM Canada Terminals) in accordance with the equivalency provisions of the constating documents of the Company and its direct and indirect subsidiaries.

Purpose of additional $0.25B reduction

The purpose of the above additional reduction is to reduce the aggregate of the Company’s liabilities and stated capital of all classes of its shares so as to increase the difference between such amount and the realizable value of the Company’s assets, thereby providing the Company with additional flexibility to pay dividends if, as and when declared by the Board.

Share Consolidation

The restricted voting shares will be consolidated on the basis of one post-consolidation share for every three pre-consolidation shares.

Canadian tax consequences
Return of Capital distribution and s. 84(4.1)

The proceeds for the Return of Capital were derived from the Transaction. Management is of the view that the Return of Capital can reasonably be considered to have been derived from proceeds of disposition realized by a person or partnership in which the Company has a direct or indirect interest from a transaction that occurred outside the ordinary course of business of that person or partnership and, as a result, s. 84(4.1) should not apply to deem the amount paid to holders of Restricted Voting Shares of the Return of Capital to be a dividend. This determination is not free from doubt and no legal opinion or advance tax ruling has been sought or obtained.

Treatment of Return of Capital distribution as PUC reduction

The amount that will be paid by the Company to the Shareholders on the Return of Capital on the Restricted Voting Shares will not exceed the PUC of such shares. Based on historical trading prices for the Restricted Voting Shares since the Company’s initial public offering, which ranged from $14.93 to $20.00, Resident Holders are not expected to realize a capital gain as a result of the Return of Capital.

Additional stated capital reduction

The amount by which the Stated Capital Reduction exceeds the Return of Capital will have no immediate Canadian income tax consequences to a Shareholder nor will it affect the Shareholder’s adjusted cost base of the Restricted Voting Shares. Such reduction may have an effect in the future, in certain circumstances, including if the Company makes a distribution to shareholders or is wound-up, or if the Company redeems, cancels or acquires its Restricted Voting Shares.

Share Consolidation

In general, a Resident Holder will not realize a capital gain or a capital loss as a result of the Share Consolidation.

U.S. tax considerations
Return of Capital

The gross amount that will be paid by the Company to the U.S. Holders on the Return of Capital (including the amount of taxes withheld therefrom, if any) generally will be includable in a U.S. Holder’s gross income as dividend income on the date of receipt by the U.S. Holder, but only to the extent that such amount would be paid out of the Company’s current or accumulated earnings and profits as determined under U.S. federal income tax principles.

Share Consolidation

The Share Consolidation is intended to qualify as a ‘‘recapitalization’’ under s. 368(a)(1)(E). On that basis a U.S. Holder should not recognize any gain or loss for U.S. federal income tax purposes as a result of the Share Consolidation.

PFIC status

Based on the current and anticipated composition of the income, assets and operations of the Company and its subsidiaries, the Company believes it should not be a PFIC for the current taxable year or in future years.