(The following article by Scott Simpson was posted on the Vancouver Sun website on November 18.)
VANCOUVER, B.C. — The British Columbia government’s plan to sell BC Rail operations to CN Rail will probably yield only marginal benefits to taxpayers in this province and could involve a risky plan to declare the Crown-owned railway bankrupt, an analysis of the situation suggests.
It could also see the province abandon hope of recovering any more than a fraction of the roughly $1.9 billion in debts that have been racked up by the Crown corporation.
It could also commit B.C. taxpayers to compensate CN Rail if the complex scheme to privatize operations of Canada’s third-largest railway runs afoul of the Canada Customs and Revenue Authority’s rules on tax avoidance.
The province has yet to formally announce CN as the successful bidder, nor has it disclosed its expectations for a sale price on BC Rail.
The Vancouver Sun is attempting to determine how much — or how little — the taxpayers of British Columbia would benefit from a deal giving control of the Crown-owned railway to a private operator.
As reported last week in The Sun, CN has out-bid Canadian Pacific and an Omnitrax-Burlington Northern Santa Fe partnership for the right to negotiate a deal to take over BC Rail operations from the province.
All three bidders reportedly offered British Columbia roughly the same money, about $700 million.
The Sun looked at BC Rail’s annual reports and other documents, and spoke with Customs and Revenue (formerly Revenue Canada) and other tax experts about subjects including bankruptcy and transfer of financial liability and debt when one company is purchased by another.
What emerged was a complex situation that doesn’t hold much promise of financial reward either to taxpayers in British Columbia or to Canadian taxpayers in general.
In the most recent fiscal year the Crown corporation reported a 14.8-per-cent rate of return and the highest income in five years, $56 million, before special charges.
It’s expected that a sale to a third party will result in at least 600 job losses among 1,618 management and union workers.
The province’s financial advisor on BC Rail, CIBC World Markets, has suggested that a 12-per-cent reduction in operating costs — obtained through layoffs — would boost income by about $35 million a year.
That $35 million amount is roughly equivalent to the payroll for 600 BC Rail employees.
BC Rail is worth about $700 million, with much of that value represented by its 120 locomotives and 9,000 railcars.
Selling BC Rail for $700 million would allow the province to recover about 37 per cent of the $1.9 billion in debts, losses and equipment writedowns that the parent company and its subsidiaries have racked up since the 1990s.
BC Rail began accumulating those debts in the 1990s as a “tax pool” that the government hoped would one day make it an attractive target for a private-sector buyer such as CN.
As a Crown corporation, BC Rail doesn’t pay taxes, so the tax pool was never applied against profits.
However, the province believes that if the tax pool can be transferred to a private company involved in the railway industry in B.C., that buyer could conceivably use the tax pool as a writeoff against income.
In other words, BC Rail’s losses could become CN’s gains.
The tax pools could mean additional revenue from the sale of BC Rail, but there’s extra risk as well as a diminished ability to collect corporate income tax from CN.
CN would use BC Rail’s previous losses to write down its own profits.
The situation is complicated by the fact that, in order to transfer the tax pool, BC Rail must be declared bankrupt.
A bankruptcy would apparently preserve BC Rail’s debts and make them available for transfer to a buyer.
By comparison, a straight-out sale of BC Rail would require British Columbia to forgive all of the railway’s debts.
That would cause the tax pool to disappear because federal tax laws require such forgiveness to be recorded as net income on BC Rail’s books.
B.C. won’t realize the full benefit of the tax pools, even if they’re protected.
In a best-case scenario involving a clean, transparent sale of assets from a debt-burdened seller, a buyer is likely to offer about 20 cents on the dollar.
In this case, British Columbia will be fortunate to get 10 cents back for each dollar of accumulated debt it transfers to a new owner.
That’s because there’s risk for the new owner, who may find that Customs and Revenue doesn’t agree with the interpretations of the tax law upon which the deal is based.
CN is expect to seek assurances from British Columbia that, if Customs and Revenue rejects the deal, that the cost of additional tax assessments will rebound back to the province — not the railway.
In addition, the deal may be so complex that a full analysis of British Columbia’s return from it may not be possible for at least seven years.
That means it could be a decade before taxpayers find out if the government got them a good deal.
There are other ramifications, as well.
For example, tax laws may force CN to abandon BC Rail as a “brand” in order to convince federal tax lawyers that the transfer of tax pools from BC Rail to CN is legitimate.
That would strip British Columbia shippers, primarily in the forest industry, of a regionally managed railway.
In addition, the federal government has in the past strongly discouraged provincial governments across Canada from shifting Crown assets to the private sector, accompanied by tax pools.
For provincial governments, it’s a way of maximizing the value of those assets, but in the federal government’s view, it’s a way to avoid taxes, period.
A transaction involving privatization of a major Canadian railway and almost $2 billion in tax writeoffs is unlikely to escape Ottawa’s notice.
BC Rail previously drew the federal government’s ire in the 1980s when it restructured the Crown corporation into a labyrinth of 22 distinct companies in order to allow the debt to accumulate as an attribute for a future buyer.
The new deal would see many of those companies, such as the one holding title to railbeds and other real estate, remain under the province’s control.
But other companies would shift to the private sector, which would assume responsibility for employees, tax pools, and the corporation’s pension surplus.
Ottawa may also object because the transfer of the tax pool would entitle CN to pay less income tax, by using BC Rail’s debts against profits from its Canadian operations.