As reported in our prior bulletin, "Four Trends in Indigenous Equity Participation in Canada", we have been monitoring reports of Indigenous equity participation in energy and related infrastructure projects. Indigenous equity investments in these projects help advance economic reconciliation with Indigenous Peoples, on whose treaty and traditional territories such projects may be located. Understanding the tax considerations that may apply to Indigenous equity projects is key to decisions on structuring.
While there are numerous taxation rules specific to Indigenous Peoples in Canada, this bulletin focuses on two key tax considerations under the Income Tax Act (Canada) (the “ITA”). First, a municipal or public body performing a function of government (“MPBPFG”) in Canada is exempt from paying income tax under the ITA. The Canada Revenue Agency has confirmed that Indian Act Bands qualify as MPBPFGs in Canada for this purpose. Other First Nations entities may also qualify. Secondly, corporations owned at least 90% by a municipality are exempt from income tax, provided no more than 10% of the income of the corporation is earned outside the municipality’s geographical boundaries. The 10% threshold for income earned outside the
municipality’s geographical boundaries does not apply if the municipality: (a) has entered into an agreement with government (federal, provincial, or municipal) to perform activities normally carried out by the local government within such government’s boundaries; or (b) is acting as a producer of electricity or natural gas, or as a distributor of electricity, heat, natural gas or water. Note however that some of these activities may be subject to payment in lieu of taxes under applicable provincial legislation (for example, under Alberta’s Electric Utilities Act).
While Bands and other First Nations entities may be exempt from income tax under the ITA, the Indian Act presents financing challenges to such groups. Specifically, lands and personal property of an Indian or Band situated on a reserve (as defined under the Indian Act) are generally exempt from mortgage or seizure. This complicates providing security for a loan, given that land, equipment, and other personal property are typically offered as collateral in lending arrangements. In its Fall Economic Statement released November 21, 2023, the federal government announced an Indigenous Loan Guarantee Program to make projects more economically feasible for Indigenous communities by decreasing the cost of capital. Details are to be announced in Budget 2024. The Fall Economic Statement also confirmed that no-interest and low-interest loans from government in the course of earning income will not be treated as “government assistance”, thereby resulting in an income inclusion and/or reduction of certain tax credits or the capital cost of certain property. This is welcome news, since recent case law in Canada has determined such loans may be government assistance.
In terms of structuring for Indigenous equity investments, a partnership is often considered as part of the planning. A partnership offers flexibility, since it is not taxed at the entity level and instead operates as a “flow-through” for Canadian income tax purposes. This means that the income (or losses) of the partnership are allocated to the partners, who report these amounts separately. As a result, any tax shield available to a non-taxable partner can be preserved, with a neutral impact to any taxable partner. Favourable “rollover” rules also allow various types of property to be transferred to a Canadian partnership on a tax-deferred basis, facilitating reorganization of existing businesses. Limited partnerships offer the liability protection of a corporation, though for limited partners losses are limited to the “at-risk” amount, and it is necessary to track cost base, since distributions in excess of the tax cost will result in a capital gain to a limited partner. The most effective planning to be used will always depend on specific factors relating to the project, including the nature of the business, location, expected revenue and expenditures, and any anticipated exit strategies.
