The Important Laws and Company Structures of the Energy Industry in Alberta
An Old War Horse, the Partnership, is Harnessed Anew
A new federal distribution tax undercut the brisk oil and gas activity associated with income trusts and publicly traded partnerships on Halloween, 2006. An alternative business structure – less used, but likewise efficient – also brings entrepreneurs and tax-planning investors together: the Private Limited Partnership.
On October 31, 2006, the federal government imposed a distribution tax on distributions to investors in income trusts and certain limited partnerships, thereby effectively eliminating the tax efficacy of income trusts and publicly traded partnerships as investment vehicles. Existing income trusts and partnerships were generally grandfathered until 2011. These business structures had been attractive to investors primarily because distributions were not taxed prior to receipt by the investors, which enabled the investors to obtain a greater return on their invested funds.
The attraction was so significant that the market for conventional production with appropriate reserves became very hot, thereby enabling many oil and gas companies to obtain a significant return on their exploration investments by selling them to income trusts. Many start-up exploration companies were formed with the specific objective of taking advantage of that, and many income trusts prospered by taking advantage of the benefits this mechanism provided to their investors.
The frenzy of activity that these income trusts and publicly traded partnerships were engaged in as they acquired producing properties (and in so doing provided jobs, business activity and investment returns) has stopped. But there are still entrepreneurs willing to start new oil and gas exploration companies and investors looking for tax-advantageous opportunities for investment. The question is, what sort of business structures can still bring entrepreneurs and tax planning investors together?
One business structure that can achieve that objective is an “old warhorse” that has survived many centuries of common law. It is the partnership. A partnership is a contractual arrangement among persons, whether individuals, corporations or trusts, who agree to carry on business in common, with the rights and responsibilities among the persons largely determined by the partnership agreement. A partnership is not a separate entity like a corporation, so the income of a partnership (those that aren’t publicly traded) flows through to the partners without taxation at the partnership level.
Liability protection for investors can be achieved by choosing to make the partnership a “limited partnership” under partnership legislation (such as the Partnership Act of Alberta), and the application of the new distribution tax to a limited partnership can be avoided if interests in the limited partnership are not publicly traded (i.e. if the partnership is a private limited partnership). Essentially, the benefits of the business structures killed by the distribution tax are still available through a partnership, as long as there isn’t a public market for the purchase and sale of investments in the partnership.
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I’ve been active in taxes for longer then I care to acknowledge, both on the private side (all my employed life history!!) and from a legal stand since passing the bar and following up on tax law. I’ve furnished a lot of advice and corrected a lot of wrongs, and I must say that what you’ve posted makes impeccable sense. Please continue the good work – the more people know the better they’ll be outfitted to handle with the tax man, and that’s what it’s all about.