Time is running out to employ your tax-planning strategies for 2015. This is a public service announcement from me and from the good folks at PrairieSky Royalty Ltd.
You can only dream, however, of the tax savings the Calgary royalty company has achieved via its $1.8-billion deal with Canadian Natural Resources Ltd., which PrairieSky shareholders wisely approved Monday. The headlines have focused on 5.4 million acres across six royalty areas, primarily in Saskatchewan and Alberta. Hugely important to the deal, however, are $1.2-billion in "tax pools" that accompany the assets.
These tax pools will eliminate PrairieSky's 2015 taxes, thanks to the shareholder vote that will allow the deal to close before year-end, and cut sharply into its Revenue Canada bill for the next decade.
The power of the pools helps explain how PrairieSky can present a deal to shareholders that dilutes their stake by 45 per cent – the company is paying for the deal by selling shares and issuing new stock to Canadian Natural – and still say that it's accretive to its cash flow.
And they serve as a reminder that tax assets lurking on companies' balance sheets often provide a powerful boost to shareholder value – no matter who ends up using them.
The pools come from Canadian Natural's "Canadian oil and gas property expense (COGPE)," acquisition costs of obtaining things such as rights, wells and royalty interests. The costs are tax deductible at a rate of 10 per cent of the balance of the pools per year. That suggests the equivalent of $120-million of deductions in the first 12 months, with the annual deduction declining along with the balance of the remaining pools. (Actual numbers may vary based on the effective date of the deal on PrairieSky's 2015 tax return, but the company can gain deductions, smaller each year, for decades to come.)
PrairieSky isn't sharing its long-term profit forecasts, so its quantification is limited to 2015: The deal reduces its taxes for this fiscal year to nil (it had accrued about $16-million in the first three quarters to pay taxes), and it will, PrairieSky says, "reduce future taxes."
But some of the analysts who recognize the tax pools as an important part of the transaction have done some work factoring the effects into their own projections.
Michael Dunn of First Energy Capital calls the tax pools "likely a key component of this deal." PrairieSky had about $500-million in tax pools at the end of 2014, he says, in part because it hasn't been spending money to build up its asset base (and therefore accumulating COGPE pools).
Prior to the announcement of the Canadian Natural deal, he'd figured the company could shelter only $44-million of pretax income in 2016. Now, he's bumped up his estimate to $155-million. Those are deduction amounts, so a rough estimate of the bottom-line benefit would apply a 27-per-cent tax rate to the numbers, making the total savings $42-million, about $30-million extra in saved taxes.
Mr. Dunn estimates the net present value of the $1.2-billion in tax pools at about $200-million to PrairieSky, which is a value of 86 cents a share (based on the new count of 227 million shares, once all the new stock is issued).
Is PrairieSky's gain Canadian Natural's loss? Not so much, actually. Canadian Natural has plenty of tax pools, Mr. Dunn says, and likely could utilize others to shield 2015 and 2016 income. "For Canadian Natural, given its ample tax pools, this transaction seems like a great way to move forward the value of those pools for its shareholders." So in the end, both companies end up with reduced taxes in 2015 – and Canadian Natural shareholders likely got a better price for all the assets, tax and land because the buyer was better able to use the tax savings.
There is, of course, a public policy issue at work here for those who question whether deductions should migrate from one corporation to another. Millions of dollars of corporate tax revenue headed to the treasury from PrairieSky are now retained by the company and largely diverted to the shareholders via PrairieSky's dividend. The Canadian taxpayer is, arguably, a loser.
As the deal closes, however, there are two clear winners: PrairieSky and Canadian Natural.
David Milstead