Alberta Royalty Review Part Eight: Royalty Rate and Resource Allowance

In an earlier article, I provided a synopsis of the federal taxation model used by the National Oil Sands Task Force (NOSTF). In that article, I provided a table, which I have repeated below. If you require a refresher, I encourage you to revisit the prior article.

Note, I have inserted a large space below for formatting purposes. You might or might not see the large space.

 

 

 

 

 

Alberta Oil Sands Federal Taxation

Line Number	Description
Source:	Kevin H. Stecyk
Line 1	Gross Revenue
Line 2	Less: Operating Costs
Line 3	Preliminary Net Income One
Line 4	Less:
Line 5	Capital Cost Allowance (CCA) 41A
Line 6	Capital Cost Allowance (CCA) 41B
Line 7	Equals: Resource Profit Before Allowance
Line 8	Less:
Line 9	Additional Class 41A CCA Deduction
Line 10	Resource Allowance
Line 11	Canadian Exploration Expense (CEE)
Line 12	Canadian Development Expense (CDE)
Line 13	Equals Preliminary Net Income Two
Line 14	Less: Loss Carryforwards
Line 15	Equals Preliminary Net Income Three
Line 16	Less: Taxes Paid
Line 17	Equals Federal Net Income

In the prior article, I mentioned that when the NOSTF performed its analysis back in the mid 1990s, resource allowance was 25%. It was a proxy for Alberta Royalty. Regardless of the actual royalty paid, the developer was permitted to deduct 25%. This 25% deduction also capped the amount that the developer could deduct. If Alberta raised the rate beyond 25%, too bad, soo sad. So in effect, the resource allowance capped the Alberta Royalty rate at 25%.

Just to be very clear, the developer could claim 25% resource allowance, even if it only paid 1% gross revenue royalty. Conversely, if Alberta had raised its royalty rate beyond 25%, the developer would be limited to only 25% for a federal deduction. Thus, the resource allowance effectively capped the royalty rate.

In a recent federal budget, actual royalty paid replaced the resource allowance. In theory, Alberta could increase its royalty substantially and the federal government would allow this increased deduction. In reality, I doubt it strongly. Both levels of government want their equitable share of the economic pie. The federal government is unlikely to allow Alberta to gain a significantly larger portion of the pie at its expense. The federal government would likely react by placing a limit, similar to the prior resource allowance, to cap Alberta's royalty rate once again.

Alberta's royalty rate could always exceed an imposed federal limit. Then the developer would pay a heavy penalty because it would pay a cost without being allowed to deduct that cost against taxes. That is an onerous measure.

As far as the developer is concerned, royalties and taxes are one and the same. Royalties and taxes are simply a burden that the developer must bear in order to remain in business. Moreover, the developer does not care how the economic pie is split among the different participants so long as its share of the economic pie is reasonable.

The Alberta Review Panel Final Report (PDF, 2.25mb) made no mention of the need to integrate the taxation regime with the royalty regime to create an overall fiscal framework. Moreover, the Panel neglected to mention that if royalty rates are raised, which it proposed, the federal government would likely respond in some measure to protect its interests. I find the Panel's oversight glaring.

As discussed previously, the federal and provincial tax rates have fallen precipitously. Both levels of governments need to work in a cooperative fashion to maintain an equitable fiscal regime where all participants have a fair portion of the economic pie. One level of government cannot act on its own because it will increase its share at the expense of the others. And that will cause retaliatory changes.

In summary, if Alberta were to adopt the changes are recommended by the Panel to increase the royalty rates on oil sands, then federal government would likely create changes as well to protect its interests. The Panel completely neglected to mention that both levels of government need to work together to maintain an equitable sharing of the economic pie among all three participants: the developer, Alberta and federal government.

Edmonton model Nikki G is featured in the photograph, which is hosted at Flickr. If you click on the picture of Nikki, you will be taken to where you can view a larger version and see even more pictures of her.