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Issue 29, January 2014
East Coast Offshore
Are you currently an employee and thinking about incorporating? In this article, the second in a two-part series on employees and independent contractors, we look at the driving forces behind why or why not to incorporate and the factors to consider before incorporating your own company. Norman J. Byrne, Manager, Tax Services, St. John’s, Newfoundland and Labrador East Coast Offshore highlights emerging legislative, regulatory and competitive issues affecting the Atlantic Canada oil and gas industry. All monetary figures expressed in C$ unless otherwise noted.
Some employees, especially professionals (e.g., engineers, doctors and lawyers to name a few), think about severing their employment relationship with their current employer and then incorporating their own company. The person, often referred to as an “incorporated employee,” would use the new company to provide the same or a similar service they provided as an employee. There may be temptation to do this for several reasons, one of which may include tax planning. However, before incurring costs associated with incorporating, maintaining adequate books and records and the additional tax compliance, consideration should be given to the provisions of the Canadian Income Tax Act (the Act) and the Canada Revenue Agency’s (CRA’s) administrative positions regarding personal services businesses. The Act provides a definition of a personal services business. In applying the definition of personal services business, one of the factors the CRA looks for is whether the individual, or a related person, conducting the services would reasonably be considered to be an employee or an officer of the person the services are being provided to, if not for the existence of the company. Another key factor provided in the definition is whether the company providing the services has more than five full-time employees. Careful consideration should be given to all of the factors provided in this definition.
Whose employee are you? The CRA may apply the personal services business rules in situations where it sees the new company as an attempt to circumvent what it considers to be an employee-employer relationship between the person performing the services and the person or partnership to which the services are being provided.
The CRA provides some factors1 that it considers in determining whether the person performing the services is an employee of the person or partnership to whom the services are being provided. Some of the factors include: • W hether the entity to which the services are provided has the right to control the amount, the nature and the direction of the work to be done and the manner of doing it • W hether the payment for work is by the hour, week or month • W hether the entity pays the worker’s travel and other expenses incidental to the payer’s business • W hether there’s a requirement that a worker must work specified hours • W hether the worker provides services for only one payer • W hether the entity to which the services are being provided furnishes the tools, materials and facilities to the worker
Why you may decide to incorporate Payroll deductions and tax deductions A person’s employment income may be subject to payroll deductions for income tax, Canada Pension Plan premiums and/or Employment insurance premiums. An employee may also be subject to payroll deductions for being part of various “plans,” such as pensions, but he or she may wish not to be part of them. In addition to being subject to payroll deductions, employees are restricted on what types of expenses they can deduct for tax purposes on employment income. The Act provides a list of deductions allowed from a taxpayer’s income from an office or employment. However, the list is limited and employees may wish to
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claim deductions for other expenses not provided for in the Act. Depending on the facts, the CRA may deny an employee’s claim for deducting any or all of these expenses. The denial is based on the general limitation on the deduction of expenses from employment income, which states, “no deductions shall be made in computing a taxpayer’s income for a taxation year from an office or employment.”2 The Canadian tax rules provide companies with opportunities to claim deductions for many of the expenses mentioned above and perhaps more. These opportunities, combined with reducing or eliminating some payroll deductions, make it appealing for people to consider using a company to provide services they used to provide as an employee. Tax rates, small business deduction and tax planning opportunities Depending on the amount of income, a company may be subject to less tax than an individual receiving the same amount as employment income. For a company that is taxable in Newfoundland and Labrador and qualifies for the small-business deduction, the combined federal and provincial tax rate is 15%. An individual who is a resident of Newfoundland and Labrador would be subject to personal income tax rates ranging from 22.7% to 42.3%. Though not addressed in this article, there may be opportunities for further tax planning if a company is used, by analyzing the tax difference between paying income to the incorporated employee as salary, dividend or a combination of the two. As well, the shareholder(s) of the company will have control over when the income is subjected to personal income tax by deferring when the individual receives earnings from the company. 1
“Income Tax Interpretation Bulletin – IT-73R6”, Canada Revenue Agency, 26 March 2002.
2
reg Boehmer, Fraser Gall, Jay Hutchison, Ernst & Young’s Federal Income Tax Act 2013 G 11th Edition, ITA S8(2), © CPA Canada, Ernst & Young Electronic Publishing Services Inc., Her Majesty the Queen in Right of Canada.
Why you may decide not to incorporate Because incorporation essentially creates a new taxpayer, there are costs associated with establishing and maintaining a company (e.g., corporate tax returns, HST returns, financial statements and other records). These costs should be weighed against the benefits of incorporating. Also, if the CRA considers the activity to be conducted as part of a personal services business, the corporate tax rate on such income would increase from the 15% tax rate mentioned to the general income tax rate of 29%, pursuant to the definition of full rate taxable income3 of a company. This may narrow the gap between the tax rate the income would be subject to if earned by a company versus employment income earned as an employee of the company to which the services are provided.
In addition to being subjected to the higher tax rate of 29%, there are limitations on the expenses that can be deducted by a personal services business that may further decrease the benefit of providing services through a corporation. The decision to end an employee-employer relationship in exchange for providing the same or a similar service using your own company requires careful consideration. There are specific rules for tax purposes that focus on control and other characteristics of the relationships.
3
Ibid., ITA S123.4(1).
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Other East Coast issues and developments Growth expected, but with challenges There is an optimistic outlook on growth in the oil and gas patch. Our 9th annual Oil and Gas Capital Confidence Barometer found an overwhelming majority — more than 80% — of oil and gas respondents see business growth as an imperative, both at the global and local/domestic level. Ninety-four percent of oil and gas survey respondents plan to grow staffing levels, or keep current rates. These findings certainly back the idea of building a skilled workforce and developing talent in the East Coast offshore region, a topic we covered in the last issue of East Coast Offshore. It may also drive some consolidation in the industry and growth in exploration.
Natural gas production projects in Nova Scotia offshore are not without frustration. Deep Panuke project start-up delays and SOEP’s decommissioning plans have created some worries. The renewed focus on Nova Scotia offshore exploration will provide some relief. Additionally, interest in liquefied natural gas (LNG) market potential remains. LNG projects could stimulate a renewed focus on natural gas — and exploration in deep-water offshore. Early contenders for local LNG projects remain: • Goldboro LNG — Pieridae Energy Canada’s $8.3-billion- 10-million ton-per-year project that could ship product to India and Europe. An environmental impact study was filed with regulators in November 2013.7
Nova Scotia deep-water potential = long‑term growth potential
• Melford LNG — H-Energy’s 4.5 million-ton-per-year Melford LNG (under feasibility study) that could supply two regasification facilities H-Energy8 is developing in India.
Prospect excitement can be contagious. Nova Scotia’s Department of Energy’s Fairways Analysis concluded that the province’s deep water could hold as much as 8 billion barrels of oil and 120 trillion cubic feet of natural gas. Recent seismic test results are building excitement.
One can see why there is an increase in confidence for Nova Scotia offshore, and an optimistic outlook on growth overall.
Both Shell and BP have large exploration blocks in the region. Shell intends to explore for oil, expanding offshore focus of natural gas at Sable Offshore Energy Project (SOEP) and Deep Panuke projects. BP is uncertain whether it will focus on oil or gas. Industry analysts expect it to be oil. Shell Canada plans to use a 12,200 square-kilometre 3-D wideazimuth (WAZ) seismic survey over four parcels off the Nova Scotia southwest shore, to help determine potential locations to drill, as early as 2015.4 Timing for the $970-million deep‑water project exploratory drilling phase remains unclear, but it will likely commence within two years. Speaking at the Maritime Association’s annual energy conference, Randy Hiscock, Shell Canada’s manager of business development and new ventures, said, “We look forward to getting some wells out, having some exploration success and being here for at least another 70, 80 or 90 years.”5 In November, BP hired WesternGeco to perform a 7,750 square‑mile 3-D WAZ seismic survey in 2014, with a 4,100 square-mile narrow‑azimuth seismic survey to follow in 2015. BP trumped Shell’s exploration bid by winning four deep-water blocks in offshore Nova Scotia for $1.05 billion and is now the biggest exploration bidder of in the region.6
“Shell collects 3D wide azimuth seismic data for Shelburne program,” MarketLine (a Datamonitor Company), Company News, 25 October 2013, via Factiva, © 2013 MarketLine an Informa plc business. 5 Melanie Patten, “Shell says drilling off N.S. coast is two years off,” The Globe and Mail, 3 October 2013, via Factiva, © 2013 The Globe and Mail Inc. 6 “Majors hope to revive East Canada as offshore oil basin,” Energy Intelligence Finance, 23 October 2013, via Factiva, © 2013 Energy Intelligence Group. 4
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Security breach is a reminder of risks Offshore production and exploration projects need to stay on time and on track to help companies and governments taking revenue shares stay on course to meet budgets. As East Coast offshore and oil and gas markets grow, so do the risks. A risk getting more attention these days is the threat to security — both internal and external. The oil and gas sector has attracted public attention and generated high-profile headlines around the world for being the victim of targeted attacks. These external threats have prompted IT security departments to invest in multi-million dollar technologies and transformation efforts. However, as project complexity grows and technology infrastructure changes internally allowing companies to link IT and operational technology infrastructure worldwide, security threats could grow. Recent spying allegations against a Canadian naval engineer working on a major shipbuilding contract is a case in point. Irving Shipbuilding Inc. is working on the design phase of Canada’s Arctic offshore patrol vessels and Royal Canadian Navy vessels. The alleged spy worked for Lloyd’s Registry Canada, a subcontractor of Irving Shipbuilding.The incident has prompted public attention on Lloyd’s Registry Canada and Irving Shipbuilding, and on
Pieridae files Goldboro LNG export project environmental assessment report,” SNL Gas FERC, 6 November 2013, via Factiva, © SNL Financial LC. 8 H-Energy is part of India-based Hiranandani Group. 7
access and security clearance to classified information. Security forces managed to contain the situation quickly, and Canada’s strategic plans for shipbuilding were not released to China as allegedly intended. “Security of information … is tightly controlled at Irving Shipbuilding,” said Kevin McCoy, the shipyard’s president. “We adhere to all security protocols required by our customers.”9 Irving Shipbuilding, a private subsidiary of J.D. Irving, is important to the Atlantic Canada economy, including the offshore oil and gas industry, as it provides drill rig construction, offshore fabrication and supply chain management. Security breaches increase the risk to reputation. Are your internal controls working to combat potential and real security threats? Insider threats pose one of the largest security threats to organizations, and they may be growing. Companies and contractors in East Coast Offshore companies linking their IT and operational technology infrastructure should keep this in mind when thinking of ways to protect information. Our study Authorized access: uncovering insider threats within oil and gas companies surfaces key issues East Coast offshore players should consider when reviewing organizational practices. The offshore industry has additional complications being in a remote, harsh and hostile environment for climate and work conditions. Industry is pretty good at identifying and adapting to new ways of doing business. It might be time to ask: is it time to perform a security-focused review of internal controls based on operational changes?
Noteworthy A Royal Bank economic outlook for Newfoundland and Labrador forecasts a 6% growth rate for 2013 but a drop to 1.3% in 2014. Planned capital investment of over $11 billion in construction, including Hebron offshore and the Muskrat Falls hydro development, will drive long-term growth. The outlook forecasts a 1.2% growth rate for Nova Scotia’s economy in 2013, and an increase to 2.3% in 2014. Nova Scotia industry growth is expected to create jobs in areas such as construction, technology and shipbuilding. Transport Canada has proposed new regulations for offshore flights for oil, gas or mineral exploration that include mandatory emergency flotation systems and training of crew and passengers on emergency underwater breathing apparatuses. Murray Brewster, “Outside contractors with inside knowledge need security scrutiny,” Canadian Press, 1 December 2013; Jessica Murphy, Canada’s Arctic secrets a spy target, experts say,” Peterborough Examiner, 2 December 2013, via Factiva, © 2013 Sun Media Corporation. 10 “Platform planned for Husky field offshore Newfoundland,” The Oil Daily, 13 October 2013, via Factiva, © 2013 Energy Intelligence Group; “Husky boosts production, cash flow in third quarter,” Daily Oil Bulletin, 24 October 2013, via Factiva, © 2013 Junewarren-Nickle’s Energy Group; “Q3 2013 Husky Energy earnings conference call – Final, DQ FD Disclosure, 24 October 2013, via Factiva, © 2013 by CQ Transcriptions, LLC. 9
Husky Energy plans to build a new offshore fixed wellhead oil platform to serve the West White Rose extension 350 kilometers offshore east of St. John’s. Detailed engineering is underway, with first oil planned for around 2017. Stakeholders are Husky Energy (69%), Suncor Energy (26%) and Nalcor (5%).10 The Canada-Newfoundland and Labrador Offshore Petroleum Board (CNLOPB) has approved an extension to Husky Energy’s North Amethyst development in the Jeanne d’Arc Basin. Husky reports a fourth water injection well has been brought on to support four production wells and it is drilling a fifth production well, its first multilateral well. Suncor Energy increased its 2014 capital spending plan to $7.8 billion, up $500 million from its 2013 announced plan of $7.3 billion. The Hebron project is part of the 2014 growth project plan.11 Pieridae Energy Canada’s Goldboro LNG construction phase requisite workforce is expected to reach a maximum of 3,500 on‑site workers, with construction to start in 2015.12
“ Suncor Energy announces 2014 capital spending plan and production outlook,” Suncor Energy press release, 20 November 2013; Suncor Energy announces 2013 capital spending plan and production outlook, Suncor Energy press release, 3 December 2012. 12 “Pieridae files Goldboro LNG export project environmental assessment report,” SNL Gas FERC, 6 November 2013, via Factiva, © 2013 SNL Financial LC.. 11
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Contact us Our Atlantic Canada Oil & Gas team consists of 189 people in St. John’s, Halifax, Moncton and Saint John. We bring you deep technical knowledge, global experience and a local perspective. We’re part of EY’s global network of 175,000 professionals, working together to share our knowledge, resources and integrated technology. This global reach means we can coordinate a team to address your oil and gas needs anywhere in the world. For more information about our team or East Coast Offshore, please visit ey.com/ca/oilandgas or contact one of the following professionals: Darrell Bontes Halifax, Nova Scotia +1 902 421 6263
[email protected] Mark Cook St. John’s, Newfoundland and Labrador +1 709 570 8289
[email protected] Richard Harrison St. John’s, Newfoundland and Labrador +1 709 570 8298
[email protected] Dan LeBlanc Moncton, New Brunswick +1 506 388 7728
[email protected] Keith Mercer St. John’s, Newfoundland and Labrador +1 709 570 8276
[email protected] Dean Mullin Saint John, New Brunswick +1 506 634 2134
[email protected] David Steele St. John’s, Newfoundland and Labrador +1 709 570 8264
[email protected] Mike Wilson St. John’s, Newfoundland and Labrador +1 709 570 5405
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