Interest Deductibility Limit and the Utility Industry

Electricity Canada: The Grid 2022

Daniel Gent

Director of Risk, Reliability and Resiliency, Electricity Canada

In budget 2021, there was one item that concerned electricity company tax specialists: Interest Deductibility Limitation, or sometimes referred to as the Earnings Stripping Rule. The draft legislation that was proposed in the budget states that starting in 2023, “the limit of interest that ‘certain’ businesses can deduct be limited to 40% of earnings in the first year of the measure, and 30% thereafter.” This tax measure is a component of the OECD Base Erosion and Profit Shifting (BEPS) Project.

The electricity industry is very complex and electricity companies exist in very different operating environments than other businesses. The draft legislation, which was released in early February of 2022, currently fails to take into account these significant differences. The electricity industry is unique in in the following ways:

• The electricity sector is a highly capital intensive one, with long economic life periods of up to 40 years on capital investment. • Electricity Canada members require substantial ongoing infrastructure spending to ensure safe and reliable generation and delivery of electricity to customers. • Electricity companies must also ensure new infrastructure investments meet increasing customer demands. • The electricity sector will be required to meet Canada's emission reduction targets by investing in new, clean, and efficient technologies. • The electricity industry is a highly regulated one which adheres to provincial economic regulatory frameworks. Utility companies are regulated with publicly approved return on equity (ROE) levels.

Electricity Canada: The Grid 2022

The above-mentioned points make the industry particularly vulnerable to the proposed changes to interest deductibility limits. Long-term debt financing is a necessary part of business, because it is a more cost-effective means to finance large capital investments, compared to the higher upfront costs of equity financing. Electricity companies expect to use interest deductions to lower the net financing cost of large infrastructure projects which avoids the alternative of raising costs for consumers. The ability to do this helps to ensure affordable rates for Canadians.

Additionally, the proposed changes mean it will cost more to build the infrastructure required to meet our Net Zero targets, and it will cost more to strengthen the grid in the face of extreme weather events and cyber attacks. Electricity companies will be forced to examine their debt, rate filings, and interest rates, and incorporate increased taxes into rate filings. Ultimately, the Interest Deductibility Limitation will lead to an increase in electricity rates for Canadian customers.

For these reasons, Electricity Canada believes that regulated utilities need to be exempt from this draft legislation. Such an approach would mirror the one taken by the United States in 2017, where electricity and natural gas utilities were provided with an exemption from interest deductibility legislation. This would also be consistent with other international tax norms and practices.

The federal government needs to understand that electricity and gas utilities are very different from the way other businesses operate.

The electricity sector is the economic backbone of Canada, and it is critical to reaching our Net Zero targets. In order to accelerate our energy future, and to ensure customers continue to have access to clean, safe and affordable electricity, this new draft legislation should include an exemption for electricity companies.

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