SUBSECTION 111(5) “SAME OR SIMILAR
BUSINESS” CONSIDERATIONS IN AN OIL
AND GAS CONTEXT
Prepared for:
2014 CPTS FALL LECTURE SERIES
October 16, 2014
Matthew Kraemer
Felesky Flynn LLP
SUBSECTION 111(5)
 Why This Is Topical
 Review of Subsection 111(5) Basic Test
 Two Examples Applying Subsection 111(5)
That Demonstrate Interpretive Challenges
 Considerations re Combination of Entities
Post Acquisition of Control
 Takeaways
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INTRODUCTION: LOSS RESTRICTION
EVENT
 Concept of loss restriction event introduced in 2013 budget.
 Used to be the case that loss streaming rules applied where there
was an acquisition of control.
 Now loss streaming rules apply to an expanded set of
circumstances beyond where there is a de jure acquisition of
control.
 Introduced rules for trusts and corporations controlled by trusts.
LRE when a person becomes a majority interest beneficiary of a
trust.
 Burghardt and Chiu, ““Loss” As a Four Letter Word”, 2013 CTF
Annual Conference – Good place to start to understand rules
 More planning may rely on interpretations of 111(5).
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POLICY BACKGROUND TO 111(5)
 Discussion of policy background to 111(5):
– Policy is important to understand – ambiguity in text
demands a purposive interpretation
– Government shares in income - it should share equally in
losses
– But loss trading is restricted
– Nothing inherently wrong with utilizing losses before or
after an acquisition of control provided legislative
requirements met
– The examples in this presentation involve generically
similar businesses (oil and gas exploration and production
businesses).
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SUBSECTION 111(5) BASIC TEST
 No non-capital loss carry forward after an LRE unless:
– Loss business was carried on by the taxpayer throughout
the particular year for profit or with a reasonable
expectation of profit
– Only to the extent of income from
– “that business” or
– If properties were sold, leased, rented or
developed or services rendered in the course of
carrying on that business before that time, any
other business substantially all the income of
which was derived from the sale, lease, rent or
development of similar properties or the
rendering of similar services
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SUBSECTION 111(5) BASIC TEST
 A similar test is included in 88(1.1)(e) after a winding up
and 111(5) applies after amalgamations by virtue of
87(2.1).
 Threshold test: Was the loss business carried on for profit
or REOP throughout the particular year in which the loss is
being applied?
 Quantum Test: to the extent of income from the same
business or a similar business.
 Colloquially referred to as – “same or similar business
test”.
 Language of the provision is not actually a similar business
test - significant interpretive challenges lurk.
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QUANTUM TEST
 Once the threshold test has been met:
– To the extent of income from “that business”; or
– if properties were sold, leased, rented or
developed by the loss business, then to the
extent of income from a business substantially all
the income of which is derived from the sale,
lease, rental or development of similar
properties.
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QUANTUM TEST
 Key words for interpretation highlighted:
if properties were sold, leased, rented or
developed in the loss business, then to the
extent of income from a business substantially all
the income of which is derived from the sale,
lease, rental or development of similar
properties.
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FACT SPECIFIC DETERMINATIONS
 Laden with fact driven determinations - no two situations alike.
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–
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Is the loss business carried on in the year? - Fact driven
determination
Is the loss business carried on with a reasonable expectation of
profit in the year? - Fact driven determination
Is the income against which the losses will be used from the same
business? - Fact driven determination
Are two types of properties similar? - Fact driven determination
Does the profit business earn substantially all its income from the
sale/lease/rental/development of a similar property? - Fact driven
determination
Does the profit entity carry on one or more than one business? - Fact
driven determination
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EXAMPLE #1 – OFFSHORE EXPLORECO
ACQUIRED BY ALBERTA OIL AND GAS CO.
 OffShore ExploreCo:
–
–
–
–
–
–
–
–
a private company
has operated exclusively in offshore Canadian east coast
describes itself as an oil and gas exploration and development
company but as of yet has not produced its assets
has never earned any revenue
has acquired primarily natural gas assets
assets are promising, however the horizon for production is
still in the future
has 20 employees and a head office in St. John’s
Newfoundland
has accumulated $25 million of non-capital losses
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EXAMPLE #1 – OFFSHORE EXPLORECO
ACQUIRED BY ALBERTA OIL AND GAS CO.
 Alberta Oil and Gas Co.:
– is a public oil and gas company with its head offices in
Calgary
– an oil and gas exploration and production company
– producing conventional natural gas and oil assets in
Alberta, B.C. and Saskatchewan
– approximately 50% of its revenue is from the
development and sale of crude oil and 50% from the
development and sale of natural gas
 Alberta Oil and Gas Co. purchases all of the shares of
Offshore ExploreCo
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EXAMPLE #1 – OFFSHORE EXPLORECO
ACQUIRED BY ALBERTA OIL AND GAS CO.
 After acquisition of control Alberta Oil and Gas Co.:
–
–
–
–
shuts the Newfoundland head office of Offshore ExploreCo
offers 5 employees positions in Calgary (full time positions
entirely related to the Offshore ExploreCo assets)
lets the other 15 employees go
retains all the assets of Offshore ExploreCo and continues the
operations of Offshore ExploreCo, albeit at a reduced activity
level.
 Alberta Oil and Gas Co. amalgamates with Offshore
ExploreCo. The amalgamated corporation is called Alberta
Oil and Gas Co.
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EXAMPLE #1 – OFFSHORE EXPLORECO
ACQUIRED BY ALBERTA OIL AND GAS CO.
 Can Alberta Oil and Gas Co. apply the pre-LRE
non-capital losses of Offshore ExploreCo
against its income from production of
conventional natural gas from its Alberta
properties? Oil?
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EXAMPLE #1 – OFFSHORE EXPLORECO
ACQUIRED BY ALBERTA OIL AND GAS CO.
Threshold Test
 Is the loss business being carried on in the
particular year for profit or with a reasonable
expectation of profit?
– CRA Rulings - substantial reduction is a change in the
nature of the business such that there is a new
business
– Canadian Dredge and Dock
– NRT Technologies
– Moldowan
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EXAMPLE #1 – OFFSHORE EXPLORECO
ACQUIRED BY ALBERTA OIL AND GAS CO.
 To the extent of income from the same
business – Is Alberta Oil and Gas Co.’s
business the same business as Offshore
ExploreCo’s business?
–
–
–
–
CRA Technical Interpretation 9234795
STB Holdings
Gaz Metropolitan
Dupont
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EXAMPLE #1 – OFFSHORE EXPLORECO
ACQUIRED BY ALBERTA OIL AND GAS CO.
 To the extent of income from a business substantially
all the income of which was derived from the sale,
lease, rental or development of properties similar to
those properties sold, leased, rented or developed by
Offshore ExploreCo.
– Accept that substantially all is 90%
– How do we characterize “property”? Is it the
hydrocarbon or is it the Canadian resource property?
– A hydrocarbon is a hydrocarbon - CRA Rulings’ verbal
comfort
– Rulings and interpretations re minerals
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EXAMPLE – OFFSHORE EXPLORECO
ACQUIRED BY ALBERTA OIL AND GAS CO.
Two possibilities:
– Alberta Oil and Gas Co. is an oil and gas company that is
carrying on an oil and gas business that is the same as the
oil and gas business carried on by Offshore ExploreCo so
that all income is from the same business; or
– Property means the hydrocarbons or CRP and the natural
gas developed by Offshore ExploreCo is similar to the
natural gas and oil developed by Aberta Oil and Gas Co.
so that substantially all the income of Alberta Oil and Gas
Co is derived from the development of properties similar
to those developed by Offshore ExploreCo.
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EXAMPLE #2 – SHALE GAS CO. ACQUIRED
BY DIVERSIFIED OIL AND GAS COMPANY
 Shale Gas Co.:
– is a private company
– involved in natural gas exploration and
development
– focussed its exploration activity on shale gas in
Alberta and B.C.
– incurred significant losses but has some revenue
from the production and sale of gas.
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EXAMPLE #2 – SHALE GAS CO. ACQUIRED
BY DIVERSIFIED OIL AND GAS COMPANY
 Diversified Oil and Gas Company is a public oil and gas
company with operations across Canada and, through
subsidiaries, internationally. It has revenue from:
–
–
–
–
–
–
the production and sale of oil and natural gas (40% of revenue)
production and sale of natural gas liquids and other
petrochemicals (19% of revenue)
hedging (3% of revenue)
production and sale of industrial lubricants (11% of revenue);
investment revenue (15% of revenue)
franchising of retail outlets (12%)
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EXAMPLE #2 – SHALE GAS CO. ACQUIRED
BY DIVERSIFIED OIL AND GAS COMPANY
 Diversified Oil and Gas Co. buys all the shares of
Shale Gas Co. and amalgamates with Shale Gas
Co.
 Amalco makes few or no changes to the business
operations of Shale Gas Co.
 After amalgamation, the Shale Gas Co. assets do
not produce any income, but Amalco’s income is
similar to prior years of Diversified Oil and Gas
Co.
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EXAMPLE #2 – SHALE GAS CO. ACQUIRED
BY DIVERSIFIED OIL AND GAS COMPANY
 Can Amalco apply pre-LRE losses from Shale Gas Co.
business against income?
 Is the same business carried on?
 To the extent of income from the same business?
–
–
–
–
Technical Interpretation 9234795
Canadian Dredge and Dock Co.
STB Holdings
Gaz Metropolitan
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EXAMPLE #2 – SHALE GAS CO. ACQUIRED
BY DIVERSIFIED OIL AND GAS COMPANY
 To the extent of income from a business substantially all the
income of which was derived from the sale, lease, rental or
development of properties similar to those properties sold,
leased, rented or developed by Shale Gas Co.
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EXAMPLE #2 – SHALE GAS CO. ACQUIRED
BY DIVERSIFIED OIL AND GAS COMPANY
Revenue Sources
Production of sale of oil and
natural gas
Processing of natural gas liquids
and other petrochemicals
12%
Hedging
40%
14%
Production and sale of industrial
lubricants
11%
3%
Investment revenue
20%
Franchising of retail outlets
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EXAMPLE #2 – SHALE GAS CO. ACQUIRED
BY DIVERSIFIED OIL AND GAS COMPANY
 One business or many businesses?
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Degree of interconnectedness/interdependence.
Dupont Canada Inc. - one income producing unit
If separate businesses?
If one business?
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EXAMPLE #2 – SHALE GAS CO. ACQUIRED
BY DIVERSIFIED OIL AND GAS COMPANY
 Not a revenue test
 Gross Income/Net Income/Taxable Income?
–
–
–
–
–
Division B, Subdivision b - Income from a business, start with profit,
apply subdivision b. – But see Ludco uncertainty
Practically difficult test to apply to a corporation that does not track
its net income from each different type of activity
Overhead and general administrative expenses might need to be
allocated to the revenue generated from each type of property
Against which source does Diversified deduct interest expense?
What should Diversified do with its resource pool claims in
determining its income? Disregard them? Should the pool claims be
applied to only reduce income from the production and sale of
natural gas and oil? Or should the pool claims be applied to reduce
income from all activities?
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EXAMPLE #2 – SHALE GAS CO. ACQUIRED
BY DIVERSIFIED OIL AND GAS COMPANY
Production of sale of oil and
natural gas
Income
Processing of natural gas liquids
and other petrochemicals
12%
Hedging
40%
14%
Production and sale of industrial
lubricants
11%
3%
Investment income
20%
Franchising of retail outlets
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EXAMPLE #2 – SHALE GAS CO. ACQUIRED
BY DIVERSIFIED OIL AND GAS COMPANY
 Reasonable answer might be:
–
Oil and gas business is oil and gas business that derives income
from the development, production and sale of hydrocarbons
or Canadian resource properties - i.e., income is from the same
business as the loss business;
 However, if not the same business:
–
–
–
Properties could be characterized as hydrocarbons or CRP;
Hydrocarbons or CRP were developed by loss business in the
course of carrying on the loss business;
Industrial lubricants are similar properties to the gas resources
developed by Shale Gas Co. or the industrial lubricants
operation is a separate business;
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EXAMPLE #2 – SHALE GAS CO. ACQUIRED
BY DIVERSIFIED OIL AND GAS COMPANY
–
–
–
Investment income is income from property and need not be considered in
determining whether substantially all of Diversified’s business income is
derived from the sale/lease/rental/development of similar properties;
Franchising of retail outlets may be separate business (not interdependent
and interlaced);
Substantially all of Diversified’s income is derived from the development of
Canadian resource properties (similar CRP to those developed by loss
business):
•
•
•
•
the production and sale of oil and natural gas is derived from the development of
hydrocarbons or CRP;
the production and sale of natural gas liquids and other petrochemicals is derived
from the development of hydrocarbons or CRP;
the production and sale of industrial lubricants is derived from the development of
hydrocarbons or CRP;
hedging made up such a small part of the income that it does not upset the
substantially all test.
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OTHER ALTERNATIVES TO
AMALGAMATING
 There are alternatives to amalgamating/winding-up.
 The acquired corporation could be left to exist separately and
steps could be taken to make it profitable.
–
–
–
It could acquire an interest in other producing properties.
It could acquire a partnership interest. Carrying on business directly
or through a partnership may not compromise the “carrying on the
business test”.
This may simplify some of the analysis necessary in applying the
Quantum Test.
 This isn’t to say amalgamating isn’t the best option, but
consideration could be given to which alternative provides the
strongest arguments regarding the utilization of losses under
111(5).
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TAKEAWAYS
 Because of the introduction of the concept of “loss
restriction event” the circumstances in which 111(5)
will apply are broader. More planning will rely on
interpretations of 111(5).
 Same or similar business test is a misnomer.
 Actual test has significant interpretative challenges.
 Careful consideration should be given to whether and
how corporations are combined post-LRE. The ability
to utilize the losses post-LRE may depend on it.
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QUESTIONS?
 Matthew Kraemer
 [email protected]
 403-260-3304
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