The 2017 Federal Budget announced March 22 by Finance Minister Bill Morneau included some expected and unexpected amendments relating directly to Canada’s oil and gas industry. While a $30-million injection into Alberta’s Orphan Well fund was welcomed by industry, tax changes around drilling new wells and flow-through share credits for junior producer were not.
Prior to the new budget, producers were able to deduct full exploratory expenditures (Canadian Exploratory Expense or CEE) around new discovery wells – drilling, completion, new infrastructure – in the first year. Junior producers were able offer the tax credits off the first $1-million in expenditures to investors through flow-through shares, attracting funding for more exploration and development.
The new rule will put discovery wells under the same treatment (Canadian Development Expense or CDE), as other wells, limiting cost deductions to 30 per cent each year, on a declining basis, forcing companies to pay more tax upfront. The credit will still apply to geophysical and geochemical surveys, and abandoned drills (or at least not producing within 24 months).
The Budget also eliminated the ability for junior producers to treat their first $1-million in drilling costs as exploratory expenses, slashing their ability to offer the credits as flow-through shares to attract investment.
The changes relating to drilling expenditures could result in oil and gas producers having to pay more taxes upfront, which could, in turn, reduce funding for exploration and production. The ability for junior producers to raise capital through flow-through shares could also be impacted through the cost deduction changes, set to take effect for 2018 drilling.
However, tax credits and changes are not the only factors impacting companies’ strategic plans.
The Federal Government also announced $400 million over three years to be made available through the Business Development Bank, a new Venture Capital Catalyst Initiative to increase last-stage venture capital available to Canadian entrepreneurs.
If the reduced tax incentives result in a reduction in drilling, the impact will be felt by all the service companies and their employees whose livelihoods and jobs are directly tied to drilling. This would be unfortunate considering the most recent increased activity in the industry now being reined in due to budget changes.
Also troubling industry players is uncertainty around what might be announced in the U.S. Should more favourable tax rules be announced for industry south of the border, some are concerned investment dollars could also migrate.
Below is a more detailed summary of the 2017 Federal Budget announcements relating to oil and gas producers. The full summary can be read here.
Canadian Exploration Expense: Oil and Gas Discovery Wells
Expenditures associated with drilling an oil or gas well that results in the discovery of a previously unknown petroleum or natural gas reservoir (i.e. the first well in a new reservoir or discovery well) are currently treated as a Canadian exploration expense (CEE). CEE may be deducted in full in the year incurred. In contrast, expenditures associated with drilling a well, other than a discovery well, are generally treated as a Canadian development expense (CDE) of which costs may be deducted at a rate of 30% per year on a declining basis.
Budget 2017 proposes that expenditures relating to drilling or completing a discovery well (or building a temporary access road to, or in preparing a site in respect of, any such well), generally be classified as CDE instead of CEE. This will ensure that expenditures more clearly linked to success are deducted gradually over time as a development expense.
Drilling expenditures can continue to be classified as CEE in situations where the well has been abandoned (or has not produced within 24 months) or the Minister of Natural Resources has certified that the relevant costs associated with drilling the well are expected to exceed $5M and it will not produce within 24 months.
Early-stage geophysical and geochemical surveying expenses will also still qualify as CEE.
This measure will apply to expenses incurred after 2018. However, the measure will not apply to expenses actually incurred before 2021 where the taxpayer has, before Budget Day, entered into a written commitment to incur these expenses.
Reclassification of Expenses Renounced To Flow-Through Share Investors
An eligible small oil and gas corporation (i.e. with taxable capital employed in Canada of not more than $15 million) can currently treat up to $1M of CDE as CEE when renounced to shareholders under a flow-through share agreement. CEE are fully deductible in the year they are incurred. Budget 2017 proposes to no longer permit small oil and gas corporations to treat the first $1M of CDE as CEE.
This measure will apply in respect of expenses incurred after 2018 (including expenses incurred in 2019 that could have been deemed to have been incurred in 2018 under the look-back rule) with the exception of expenses incurred after 2018 and before April 2019 that are renounced under a flow-through share agreement entered into after 2016 and before Budget Day.
For more information on MNP’s OFS services, contact Jeremy Rondeau, Vice President – Oilfield Services, at 306.773.8375 or [email protected]