28 April 2006 GST/HST Interpretation 49409 - PROPOSED LAW/REGULATION 2006 Budget Proposal of Rate Reduction for GST

Please note that the following document, although correct at the time of issue, may not represent the current position of the Agency. / Veuillez prendre note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'Agence.

Dear XXXXX:

Thank you for your letter XXXXX and supplemental letter XXXXX concerning whether a drop shipment certificate can be issued in respect to a natural gas supply as described below. Please note that all statutory references refer to the Excise Tax Act (ETA).

Scenario

You have provided the following information:

•   A Canadian GST-registered aggregator of natural gas (the "Supplier") supplies natural gas by way of sale to a non-resident, non-registrant (the "Non-Resident").

•   Natural gas is transported by means of a pipeline owned by a third party who acts as a carrier to the transactions (the "Carrier").

•   The Non-Resident's sales contract with the Supplier specifies that the contractual amount of natural gas will be delivered to the non-resident at a specified delivery point in Canada.

•   The Supplier has a transportation agreement with the Carrier providing for the shipment of natural gas from a particular receipt point to a specified delivery point.

•   The Non-Resident takes ownership of natural gas at the delivery point on the Canadian side of the pipeline.

•   After ownership is transferred to the Non-Resident from the Supplier at the delivery point, the Non-Resident transfers ownership of natural gas to a Canadian GST-registered purchaser (the "Purchaser").

•   Physical possession of the natural gas is not transferred to the Non-Resident but remains with the Carrier. The Carrier transfers physical possession to the Purchaser or another third party depending on the terms of the transportation agreement the Shipper has with the Purchaser.

Interpretation Requested

Can the Purchaser issue a drop-shipment certificate to the Supplier under subsection 179(2) of the ETA based on the application of subsection 179(5)?

Interpretation Given

Subsections 179(2) and (5) do not apply in the scenario described above. As a result, the Purchaser may not issue a drop-shipment certificate to the Supplier.

The application of the drop-shipment rules under section 179 of the ETA is based in part on physical possession of the same tangible personal property transferring between parties, as opposed to merely acquiring physical possession of an equivalent quantity of like property. Parties involved in the supply of natural gas that is completely commingled in the pipeline are not considered to have acquired physical possession of the same tangible personal property for the purposes of the drop-shipment rules.

The fungible nature of natural gas, once it enters the pipeline system of the carrier, means that it is completely commingled. Although contractually, the natural gas removed from the pipeline system at the delivery point may be equivalent (in terms of heat content) to the natural gas that entered the pipeline system at the receipt point, it is not the identical property. The extensive nature of the pipeline system (multiple receipt and delivery points) exacerbates tracking the eventual destination of particular property (natural gas).

Generally, subsection 179(2) of the ETA provides that where a registrant makes a taxable supply in Canada of tangible personal property by way of sale to an unregistered non-resident person and causes physical possession of the property to be transferred in Canada to a registered consignee, the supply is deemed made outside Canada if the consignee provides the registrant with a drop-shipment certificate in accordance with the provision.

You have provided an analysis citing parts of subsection 179(5) of the ETA to support your view that paragraph 179(5)(d) of the ETA would apply to deem the Supplier to have transferred physical possession of the natural gas directly to the Purchaser resulting in the Purchaser being able to issue a drop-shipment certificate to the Supplier under subsection 179(2).

Generally, where subsection 179(5) of the ETA applies, we agree that it does deem the registrant referred to in the provision to have transferred physical possession of the property directly to the consignee. However, as is the case with the rest of section 179 of the ETA, a fundamental requirement of subsection 179(5) that must first be met in order for the deeming rule to possibly apply is that physical possession of the same property is transferred to the consignee, as opposed to merely an equivalent quantity of like property. Clearly, this requirement cannot be met in the case of a supply of natural gas that is completely commingled in the pipeline. A person to whom physical possession of natural gas that is commingled in the pipeline is transferred cannot subsequently be considered to be transferring physical possession of the same property (gas) to another person for purposes of subsection 179(5) of the ETA. In this case, it is merely physical possession of an equivalent quantity of gas that is considered to be transferred to another person. We note that this is typical of pipeline industry agreements relating to continuous transmission commodities such as natural gas.

As the tax policy concerns that you have expressed with respect to our interpretation regarding this issue fall within the area of responsibility of the Department of Finance, you may wish to discuss the matter with officials of that Department.

The foregoing comments represent our general views with respect to the subject matter of your letter. These comments are not rulings and, in accordance with the guidelines set out in section 1.4 of Chapter 1 of the GST/HST Memoranda Series, do not bind the Canada Revenue Agency with respect to a particular situation.

Should you have any further questions or require clarification on the above matter, please do not hesitate to contact me at (613) 957-8220.

Yours truly,

Kevin W. Smith
Border Issues Unit
General Operations and Border Issues Division
Excise and GST/HST Rulings Directorate

2006/04/07 — RITS 58897 — Reconsideration of GST/HST Application "Arranging for" Financial Services